The economy of Armenia, lacking in natural wealth, subjected to a blockade, also suffers from the blur between political power and the power of money, which in turn leads to corruption and emigration. Here is an analysis.
After 20 years of independence, if we had to undertake a midterm evaluation of the state of the economy of Armenia, I would say that the situation is worrisome: economic growth is stalling, emigration has reached alarming proportions, there is a lack of progress on major issues facing the country, and corruption is worse than ever.
Without a determined effort, Armenia risks being confronted by increasingly serious problems. The current conditions cast a cloud over the future of Armenia.
To understand this, one must go back to the economic transformations that the country underwent since gaining its independence in 1991.
First and foremost, a word about the economic situation Armenia inherited from the Soviet era until the proclamation of independence. Under Soviet rule, Armenia had a heavy and diversified industrial basis with specialized industrial and technological activities.
Its economy was one of the most integrated in what was then called the international socialist division of labor, which helps us better understand the vulnerability of Armenia during the collapse of the Soviet Empire, with all the consequences that ensued.
In retrospect, the experiences of the various post-Socialist economies show three distinctive periods since they gained their independence.
- Armenia went through a strong depression after the collapse of the Soviet Union from 1991 to 1994,
- then a sustained stabilization period from 1995 to 1998 and finally,
- a structural consolidation period and the emergence of strong growth since 1999.
The economic transition was chaotic at first because besides the collapse of the USSR, Armenia had to deal with the war of Karabakh, the blockade imposed by Azerbaijan and Turkey, and the important consequences of the earthquake of 1988.
After the enthusiasm sparked by a bloodless accession to democracy, the population was feeling growing discontent, after being subjected to hardships and experiencing a sharp decline in its standard of living. In order to save the country which was facing a shortage of basic foodstuffs, Armenia was the first among the former Soviet republics to start land privatization.
During that period, Armenia embarked on a comprehensive reform program, financed by the World Bank and the International Monetary Fund, as soon as the war ended in 1994, with the consensus of Washington. The economic stabilization period from 1995 to 1997 signaled an era of reconstruction and structural transformation, with a gradual return to growth and stabilization of inflation and the dram exchange rate. As domestic production started to supplant imported products, it was the engine of economic growth from 1994 to 1998.
After 1999, the contributions of the various sectors changed with the continuous decline of the industry
Renewed economic growth allowed a market adjustment from the period preceding the recession. The standard of living of 1990 was leveled and exceeded in 2004. After 1999, the dynamic of growth was sustained by large-scale infrastructure projects, financed by international financial institutions, direct foreign investment, privatizations, and financial flows derived from emigration. The following sectors benefited from those financings: agriculture, agrifood businesses, the mining industry, and services, including transports that are closely linked to external trade, notably the disposal of mining products.
Growth was highest in the construction sector during the years that preceded the crisis of 2008, reaching a peak of 26 per cent of the real GDP in 2008, and accounting for the double-digit growth rates (more than 10 per cent between 2000 and 2007).
Independence and the importance of external trade
Starting in 1995, the growing openness of the Armenian trade system allowed a huge import of items that were no longer produced.
Between 1995 and 1997, imports represented 53.4 of the GDP, and then 44.7 percent from 1998 to 2001. The decrease occurred in the non-critical substitutable part, the other being constituted of energy, precious or semi-precious stones or rough diamonds destined to be cut.
Taking into account the small size of the domestic market in Armenia, the ability to export was crucial for maintaining a high level of growth. Exports developed from 1998 to 2003, with a first group of products such as polished industrial diamonds representing more than 30 per cent of exports.
A second group of products was developed thanks to the agrifood business, which exported 23 percent of its production. Nevertheless, the export base remained fragile because it was contributing to growth to a lesser degree than exports substitution.
From 2000 to 2009, precious and non-precious metals, precious and semi-precious stones and minerals constituted more than 65 percent of exports. The significant decrease in machinery, equipment, and devices, as well as textile products, plastic ware and natural and artificial rubber products, clearly indicated a loss in competitiveness. Only agrifood products became an important source of exports.
The export volume from Armenia increased between 2001 and 2008, before decreasing at the beginning of the crisis, at the end of 2008. Since then, the export volume has experienced a modest recovery, while remaining at the level of 2003. This tendency has prevailed at the level of global exports, which have decreased considerably since 2007 (from 0.095 per cent in 2005 to 0. 06 per cent in 2009).
And yet, the only way the GDP growth could exceed growth in domestic demand was through an increase in the export volume. But that strategy requires investments in order to finance a moving up the value chain in sectors and branches of activities that had the technological capacity.
The various official statements shared this preoccupation, without necessarily reaching conclusive results. Investments made in Armenia were not sufficiently focused on high added-value activities that could generate sustained growth.
Developing Businesses as the Backbone of the Economy
Initially, investment development was closely linked to the program aimed at privatizing enterprises, through opening up corporate capital to direct foreign investment, the amount of which doubled between 2006 and 2008. Several obstacles prevented the creation and development of businesses, the first being lack of financial means.
The weakness of the banking sector in terms of capitalization and credit allocation left the business fabric vulnerable and under-developed. Due to a lack of means, support measures focused on making the territory attractive to foreign investments, by creating favorable legal and tax incentives.
During the years of strong growth, the financing of the economy markedly improved, from 9.6 percent of the GDP in 2000 to 23.7 percent in 2009, but it was lower than average growth in the countries of Central Asia and the Caucasus, which was around 35 percent of the GDP.
In spite of the dynamism and business acumen in Armenia, the shortage of funding was a factor limiting business development, particularly in technological activities, where comparative advantage was progressively diminishing.
The comparison between countries in Asia and the CIS showed an important gap in the financing of growth and investments. Bank credits were predominantly distributed on the short term. Thus, limited resources were primarily devoted to more lucrative investments, which did not necessarily produce most of the wealth.
Then, there was the problem of corruption and oligarchy. According to the World Economic Forum, Armenia ranked well below most of the CIS and European countries in terms of competitiveness indicators. It ranked 98th among 139 countries in 2010 and was only ahead of Tajikistan and the Kirghiz Republic.
In 2010, the main obstacles in the business environment were the lack of local competition, an overwhelming market domination and inefficient anti-monopoly policies. Concerning those indicators, Armenia was relegated near the bottom, ranking respectively 136th, 133rd and 138th among 139 countries.
Although the GDP annual rate of increase was around 12 per cent between 2005 and 2008, the international competitiveness of Armenia decreased. A survey showed that creating a business in Armenia was relatively easy, but managing it turned out to be problematic.
Most businesses indicated that corruption, lack of access to financing, criminality, theft, and the absence of orderly business were major preoccupations. This difficult environment did nevertheless not prevent Armenia from having an average growth rate of 12.3 per cent between 2000 and 2008, which was among the strongest in the Central Asia and Caucasus region.
Two main factors accounted for this result: the boom in the construction sector, which contributed more than 17 per cent to the GDP, and the very sharp increase in income transfers by the Armenian emigrants, which was considerable, amounting to 21 per cent of the GDP.
Vulnerability to the crisis of 2008
This period of strong growth was characterized by a high rate of dollarization (49 per cent) which was relatively higher than in most other republics. It thus created a predisposition to the crisis in the fall of 2008. Armenia, like the majority of the countries of the region, was affected by its economic consequences, through the combined decrease in unilateral income transfers received from Russia, and in exports.
- Income transfers received from families who emigrated to Russia dropped by more than 30 per cent, which entailed a considerable decrease in revenues and thus of consumption among the most modest families, which were facing increasing poverty. This situation forced the government to intervene through direct support measures aimed at helping the most affected peoples and sectors.
- The second transmission channel was through exports, which decreased, owing to the slowing global demand. Armenia was the most affected country in the region, its GDP dropped by 6.8 per cent in 2008 and 14 per cent in 2009, before it experienced a slight economic recovery of 2.6 per cent in 2010.
What are the conditions for sustainable growth?
The Armenian economy needs a strategy for sustainable growth, something that is not foreseeable, given the current circumstances. It would be a good thing to be aware of this threat, along with the presence of a financial oligarchy that is concentrating the wealth of the country within a few hands.
This reality, a distinctive feature of the Soviet legacy, mainly appeared during the privatization period. In that small country, owing to the huge connivance between political power and the oligarchs, the population seriously loses confidence in them and this, in turn, dramatically decreases its hopes for change. The strong emigration that follows is its most visible and worrying symptom.
The weight of regional tensions
Regional tensions exert strong constraints on the economy of Armenia, which is the most landlocked among the three countries of the South Caucasus, all the more with the economic blockade imposed by Azerbaijan and Turkey, which costs a considerable amount, estimated by the World Bank to be 10 percent of the annual GDP.
It is impossible to establish conditions for sustainable growth in Armenia without bringing up the need for a general stabilization of the region.
The size of the three countries of the Caucasus, Armenia, Azerbaijan and Georgia, and their geographical interdependence constitute all the more reason to consider regional stability as a key factor for long-term growth.
Regional integration has been made more complex due to the shocks and frictions experienced by the countries of the region. It has a primary strategic interest for Russia and the United States, who compete there against each other, while being implicated in the negotiation process that is underway.
Conflicts of interests and objectives have created division lines in the region, with on the one side Georgia and Azerbaijan (and the other GUAM countries) which are close to the United States, and on the other, Armenia and Iran, which are close to Russia and its Collective Security Treaty Organization (CSTO). Russia's economic weight is incidentally considerable in Armenia, whose network infrastructures it mostly controls.
An economic cycle is concluding in Armenia and the environment seems to be much more strenuous than during the period before 2008. External demand will probably remain weak—which is also the case of growth in Russia and Europe—and threatens to reduce to 10 per cent of the GDP the amount of income transfers, exports and direct investments. It is urgent to define a new model for economic growth and remove political and economic obstacles that are darkening the future of the country.