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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

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