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The Thirty Year Recovery, or How to Accelerate Armenia's Economy by King Banaian The elections forthcoming this month provide Armenia with a remarkable opportunity to renew the economic transition that began six years ago. In some ways Armenia has proved itself resilient: its decline in living standards was one of the sharpest in transition (from 1990 levels output fell by almost two-thirds by 1994) and the depreciation of the savings of its citizens one of the largest. While it has displayed high growth rates since then, these come from a very low base. While stabilization has occurred, insofar as inflation has been tamed, Armenia has experienced the pain of stabilization without the joy of growth. Nor is that joy likely to come soon or in great quantity. In "Transition Report 1997", the EBRD reports a set of studies of long-run growth rates for the countries of the former Soviet Union (FSU). Due to its low level of investment, Armenia is expected to have a long-run growth rate of 3.2% per year. Only Macedonia and Moldova are expected to grow at slower rates. This estimate even incorporates the high level of education in Armenian labor. At that rate, Armenia would not return to its 1990 level of GDP until the year 2028! And what can our candidates offer us to spur growth? Whatever faults one might find with the Ter-Petrosian administration, it made substantial progress on privatization and restructuring. Most countries of the FSU went through a phase in which industry and services shrank much more dramatically than the agricultural sector as the shock of transition took hold; the share of output in industry and the service sector then rises again. In Georgia, for example, agriculture accounted for 68% of GDP in 1993 and industry only 6%; the latest figures are for 17% of output from industry and less than 30% in agriculture. This same phenomenon is happening in Armenia, where now over a third of GDP is from industry. Bankruptcies are being recognized, and privatization of large firms (such as the telephone company) is proceeding apace. The latest privatization phase has begun as well to encourage foreign investment; at year-end 1996, Armenia had only attracted $35 million US from abroad in direct investment. Pledges to continue these reforms would be welcomed. Needed, too, are capital markets. Banks are begged to take in government debt on their books, but cannot resell these bonds if liquidity needs arise. Capital requirements have risen now to $600,000 forcing banks to restrict lending even further, in turn costing the government more money in the form of higher debt financing rates from the banks, now running about 55%. A new government must continue financial sector reforms with the goal of providing for growth of securities markets. Both of these reforms would address the serious issue of improving investment in Armenia. Outside of this, what can be done? Recently, Some economists have begun to point to the property rights structure of a country. In short, countries with more secure property rights have grown faster than those without. Property rights can be broken into five areas (as done by Political Risk Services, a US consulting firm): expropriation risk, rule of law, repudiation of contracts by government, corruption, and quality of the bureaucracy. In some areas Armenia is on sound footing: Expropriation of property is not done without compensation, Armenia tends to honor her contractual obligations and Armenia's bureaucracy is fairly good. But corruption remains, and the rule of law is still uncertain. There is a definite lack of transparency in Armenian regulations, which may again hamper investment from abroad. While we lack any precise measures of how much growth is retarded by corruption in Armenia, an analysis of Russia's growth prospects shows that its expected long-run growth rate would be 5.9% with an average level of property rights, but only 5.1% with its current level. Similar reduction of about one-half to one percent per year occur for other countries in transition. Thus the bleak forecast given above for a 30-year recovery may even be optimistic. The policies of increased investment and securing property rights are intertwined. Studies of foreign investment in Asia have shown quite clearly that foreign investment flows to those countries where property rights are secure. When calculating a rate of return on some investment, some allowance must be made for losing a revenue stream due to expropriation. That needs not be outright legal transfer -- governments can simply change regulations and taxes to increase their take of the revenue stream. A candidate interested in speeding economic recovery should resolve first to make regulation transparent, and then to leave taxes unchanged for three years after the necessary reforms to reduce effective tax rates on official sales from their current 70%. These tax rates continue to reduce the after-tax return on investment to unprofitable levels. The target should be to double the investment share of GDP to 18% within four years. This is a very modest goal; Russian investment is almost 25% of GDP. To attempt to do much more, however, risks reducing consumption further, placing the poor of Armenia under even greater strain. But this growth would be enough to move the country onto a significantly higher growth path. The target, if met, would add about 1.5% to the target long-run growth rate, and reduce the recovery time by a third. If it could then replicate the average level of property rights of the countries of the EU, then Armenia would return to its original level by 2016, and the country would in the year 2030 be more than twice as well off as it would be under current conditions. The new government will have some advantages. It will have no reason to be loyal to existing policy, nor to corrupt bureaucrats. It can therefore move quickly on property rights. It can then use its good standing in the international economic community to secure financing over the medium term to maintain private consumption at current levels while attracting funds for investment. Lastly, it must reach out to attract more foreign investment, at least until securities markets are developed enough to attract domestic savings out of dollars. Doing so will allow Armenia to avoid the thirty-year recovery. ------------------------------------------------------------------- King Banaian is associate professor of economics at St. Cloud State University in Minnesota. He is currently working on a book on economic reforms in Ukraine, where he has served as a monetary advisor.