Ukrainian serviceman operates an unmanned ground vehicle equipped with a remote-controlled machine-gun. (Photo by Serhii Mykhalchuk/Global Images Ukraine via Getty Images)
Global Images Ukraine via Getty Images
Before Russia invaded in 2022, Pyotr Ivanenko produced sports equipment in Ukraine’s second largest city, Kharkiv. When Russian troops surrounded the city, bombarding it relentlessly and prompting three-quarters of the population to flee, Ivanenko, a fit man with a shaved head and ice green eyes, made a decision. “I needed to change what I was doing,” he told me an interview, “to switch to making what the country needs.” (Ivanenko is not his real name—he requested a pseudonym to protect his business and his family.)
By 2023, he was churning out homegrown armored vehicles—his company makes everything but the engines—and angling for a contract with the defense ministry. By 2025, he had developed two types of unmanned ground vehicles that can transport supplies to remote military positions, evacuate wounded soldiers, and carry a mounted gun into hostile territory, allowing a gunner in the rear to fire at the enemy from close range.
Now, like almost all Ukrainian arms manufacturers, Ivanenko has a problem. His defense ministry contract is coming to an end, and although he sells personnel carriers and robotized vehicles to fighting units all along the front line, he says he could make 10 times as many if the government had the money to buy them. But the 2025 Ukrainian budget allocates just $17.5 billion to purchase weapons, exactly half the $35 billon in equipment the domestic arms industry says it can produce. Virtually all manufacturers, large and small, are clamoring for some kind of relief.
Legislation passed in parliament last week will begin to address this problem. The Defense City initiative promises deregulation and tax exemptions for qualified manufacturers, complementing a related government push to launch joint ventures with European companies. Under the Build With Ukraine program, joint production can take place either in Ukraine or in the partner country, and the ministry says dozens of projects are already in the pipeline.
Estimates suggest that together Defense City and Build With Ukraine could boost the country’s defense production by tens of billions of dollars. President Volodymyr Zelensky has set an ambitious target—that by early 2026, domestic manufacturers will be producing half of what the country uses on the battlefield, up from the current 40% share.
The question Ivanenko and other manufacturers are now asking themselves: will this be enough? Will it enable them to realize their potential and reduce Ukraine’s need for security guarantees from Europe and the U.S.?
A Booming Defense Industry Hamstrung By Limited Government Funding
Much like Ivanenko’s armored vehicle production, still housed in a cluster of hastily built sheds, the Ukrainian defense industry is largely new and expanding exponentially. Ukraine was at the heart of the Soviet military industrial base, leaving a bounty of engineering talent and an education system that prioritizes math and science. It’s no accident that before the war some 20% of Fortune 500 companies had remote IT development teams in Ukraine or that many technicians in today’s Kharkiv startups come from families that have done defense work for decades, including in the giant Kharkiv plant that produced the Red Army’s legendary World War II T-34 tank.
The 2022 invasion reinvigorated a domestic defense industry that had atrophied beyond recognition since Soviet times. Thousands of IT technicians and engineers dropped whatever they were doing in peacetime to join the defense sector or enlist in the army and provide technical support on the front line. Today, some 700 defense manufacturers employ more than 300,000 technicians and sustain scores of other companies making weapons components and dual-use products.
In 2022, Ukraine manufactured fewer than 2,000 drones. In 2025, it’s on track to produce 4.5 million, and Zelensky says that with adequate financing, it could be making closer to 8 million. Nor are drones the only growing sector. Ukrainian manufacturers produced 25 times more artillery and mortar rounds in the first half of 2024 than in all of 2022.
As important, the new, wartime industry bears little resemblance to what came before it—a legacy defense industrial base made up primarily of lumbering state-owned enterprises controlled by the government and operating at the pace of the state bureaucracy. In 2021, according to Serhii Goncharov, CEO of the National Association of Defense Industry Enterprises of Ukraine (NAUDI), state-owned enterprises accounted for 80% of the defense market. Today, he doubts they make up even 30%.
“The two market segments are very different,” the bespectacled, thoughtful man with a graying beard explains in an interview. “Startups are nimble and innovative. State companies, often with huge factories for tank or airplane maintenance, produce very little from scratch, and what they produce is rarely as good as what a private company can make.”
The Ukrainian defense budget has also grown since 2022, but not enough to keep up with manufacturing. In 2023, according to the state information service, Ukrinform, Kyiv allocated $970 million for drone production, rising to just $1.14 billion in 2025, even as the industry’s productive capacity multiplied many times.
Ivanenko complains that the limited money available often flows first to purchases of foreign weaponry and then to state companies, leaving only crumbs for private entrepreneurs. NAUDI CEO Goncharov estimates that the defense industry as a whole is operating at 30% capacity.
This makes it difficult for companies like Ivanenko’s to survive, let alone prosper. The Kharkiv entrepreneur financed the first stages of his wartime transition with his own money. He earns some cash from sales to individual units and the charitable foundations that supply much of the unmanned weaponry in use on the front line. But high interest rates put bank loans beyond his reach, and his one experience with a government contract was disappointing. It covered his manufacturing costs but not R&D.
“It’s very hard to function,” he says, “on a one-year government contract that may or may not be renewed.” The upshot for his company is a classic Catch-22. He lacks financing to grow but has little hope of significant state funding until he can produce combat vehicles on a much larger scale.
‘Build With Ukraine’ Is A Big Step, But Manufacturers Say It Doesn’t Go Far Enough
The laws passed last week aren’t Kyiv’s first effort to support arms manufacturers. It began in 2022 and 2023 with the deregulation of the drone industry. Instead of turning to state-owned enterprises to produce the new weapons, the government used tax incentives, packaged in a project called Diia.City, and deregulation—faster, more transparent approval of new products and streamlined contracting procedures—to unleash a generation of startups. A related program, Brave1, supported emerging defense firms with small grants and organizational support.
A second set of initiatives launched in mid-2024 looks to international partners to provide funding for the domestic defense industry. In the first iteration, known as the “Danish model,” several allies—Denmark, Norway, Sweden, the Netherlands, Canada, and the European Union—provided financing for Ukrainian defense procurement contracts, funneling money directly to handpicked firms through the defense ministry in Kyiv. The companies that receive funding are screened and selected by the ministry, then vetted by the Danish government.
The model works particularly well for countries that lack large domestic defense industries or weapons stockpiles they can spare for Ukraine. On-site production closer to the front is faster and cheaper than it would be in Europe, and the increased procurement helps close the gap, so problematic for Ivanenko and other manufacturers, between government financing and their productive capacity.
But the initiative has not produced anything like the $10 billion a year Ukraine was initially hoping for. In 2024, by all accounts—reliable numbers are hard to come by—Denmark and other partners contributed some $700 million to underwrite Ukrainian procurement contracts. The total so far in 2025 is $2.3 billion—an important boost but not game-changing.
The new initiatives, Defense City and Build With Ukraine, are the next steps down this road—a multipronged industrial strategy that builds on the lessons of Diia.City and the Danish model. The goal is to attract allied countries that seek a long-term investor’s stake in the Ukrainian defense sector by allowing them to partner directly with Ukrainian firms to co-produce weapons, either in Ukraine or abroad.
The tax breaks in Defense City—reduced income, land, real estate, and environmental levies—are meant to make Ukrainian contractors more appealing to foreign investors. Other provisions in the law ease technology transfer across borders. Kyiv envisions that production abroad will focus on assembly—to protect Ukrainian intellectual property.
According to National Security Secretary Rustem Umerov’s chief of staff, Diana Davityan, on some projects, all the weapons assembled in Europe will be sent back to Ukraine for use on the front line. In other cases, investing countries will keep some product for domestic use or to sell to third parties, with a share of sales revenue flowing back to partnering Ukrainian firms. The ministry is already in discussions with several dozen interested countries, and there are preliminary agreements with Denmark, Sweden, Norway, Germany, Lithuania, and the United Kingdom.
But two important questions hang over the new law.
The first is who will benefit. Ukrainian defense contractors are pleased by the general thrust of the legislation. But many complain that, as with the Danish model, benefits will flow to only a few, well-connected Ukrainian firms. The law limits the pool of Ukrainian companies that can participate in joint ventures to those that count on state contracts for at least 75% of their revenue.
“It shouldn’t be a closed club,” NAUDI CEO Goncharov told me. “We want the same options to be available to all viable Ukrainian defense manufacturers.” Just days before the parliament voted, NAUDI opposed passage of the bill. Manufacturers that are left out will face an even stiffer climb, the organization complained on social media, competing against firms with tax advantages and lower production costs. “Such an approach does not stimulate the defense sector—it harms it.”
An even more significant question is about exports. The law includes provisions simplifying customs procedures and export controls, and the defense industry hopes it will effectively end the ban on defense exports imposed after the 2022 invasion.
“We have more than enough capacity to produce for the front line and for export,” Goncharov maintains. The thinking behind the ban—that domestic defense production is a fixed pie unlikely to grow—is no longer valid, he says. “If anything, a drone startup that’s allowed to export will be able to produce far more drones, lowering its production costs and the price it can charge the ministry. A company that produces for export will also hire more technicians, and they’ll pay income taxes—revenue the government can use to buy additional weapons.”
Zelensky has talked in the past about the possibility of lifting the export ban. A recent survey by second defense industry association, the Ukrainian Council of Defense Industry, found that 94% of Ukrainian defense contractors are eager to sell their product abroad. But according to Umerov chief of staff Davityan, that’s not in the cards for now, despite the language in the new law. “We’re focusing on transferring technology to our partners,” she told me. “We’ll see how that goes.”
Ivanenko knows it’s a long way from here to there, but he dreams that someday, perhaps after the war is over, he will see his combat vehicles for sale on the NATO market. Many who support Defense City share the same vision—that Ukraine will one day be among the world’s top arms exporters, the arsenal of Western Europe. The innovation of the last three years leaves little doubt—Ukraine has the potential to realize this dream. But only if the government is willing to unleash the defense industry, supporting but not overregulating manufacturers and allowing the market to work.
Source: https://www.forbes.com/sites/tamarjacoby/2025/08/27/ukraine-looks-abroad-for-joint-ventures-to-boost-its-defense-industry/
