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Armenia: The Challenges of Growth
Armenia: The Challenges of Growth

BUSINESS CAUCASUS STYLE: LESSONS LEARNED, AND WAITING TO BE LEARNED


by Richard Giragosian

At home and especially abroad, Armenians have long been renowned as "good businessmen." Putting aside the veracity of that reputation, it is worth investigating Armenians' place within the larger business environment. More specifically, beyond the years of double-digit economic growth, does Armenian business really have what it takes to overcome its neighbors and to engage in the global marketplace?

Given the reality of the region, which is marked by a shared challenge of overcoming decades of Soviet economics, the main obstacle to business in the South Caucasus is a fundamental one—adapting to the demands of the free market. But faced with the legacy of Soviet central planning, the shift to capitalism has been no easy task. It is also a long and painful transition, necessarily beset with insecurity. Gone are the order and assurance of virtually guaranteed employment and pensions, replaced instead with the chaos of entrepreneurship but nevertheless endowed with rewards as well as risks.

What this means for the countries of the region is that trade must be free and open, with an added emphasis on competitiveness. And for the businessmen of Armenia, Georgia and Azerbaijan, this also means that the countries of the region must allow and indeed encourage a proper business environment. For the South Caucasus, this too is no easy task in light of the combination of various pressures from unresolved conflicts and a reconfiguration of traditional trade routes.

For Armenian business, these structural challenges pose greater problems than for her neighbors. One of the obvious and most immediate of these challenges has been the blockade of Armenia imposed by Azerbaijan and Turkey. Armenia's recent economic growth has confounded the blockade, which goes well beyond a simple closure of borders to encompass a near-full disruption of trade, transport and energy links. Its effects are further magnified by conditions that cannot be changed by geopolitics—Armenia's natural state of being landlocked.

THE FAILED BLOCKADE OF ARMENIA

The initial consequence of the blockade when it was imposed in the 1990s was, of course, an immediate and devastating shortage of foodstuffs and basic commodities, an abrupt and severe energy crisis, and a period of isolation. Armenia was forced to quickly adapt to the sanctions and concentrated on its sole remaining external trade link, northward through Georgia. Although this led to a degree of dual dependence—on Georgia for trade access and on Russia as a major trading partner—the fact that Armenia was forced to adapt emerged as a key competitive advantage. This adaptability was more than a mere weathering of adversity, it was sheer survival. And it is here that Armenian business excels and, in a relative comparison, far outpaces its neighbors.

From a more concrete perspective, however, has this overall sense of Armenia's ability to adapt and overcome been matched by a success in business?

According to one of the few Western assessments of business and the business environment in the region, Armenia has achieved consistently positive ratings. The most recent "Index of Economic Freedom," a joint annual study of the Washington-based Heritage Foundation and the Wall Street Journal newspaper, has rated Armenia as the "world's 32nd freest economy" and as the "19th freest among the 41 countries in the European region."

The 2007 assessment further noted that Armenia "rates highly in many areas, such as fiscal freedom, freedom from government, monetary freedom, financial freedom, business freedom, and labor freedom." It also cited low tax rates and low inflation, as well as a "wholly private and well regulated" banking sector as especially worthy achievements.

A REGIONAL RATING OF BUSINESS

According to the same assessment, in contrast with Azerbaijan, which ranked as the world's 107th freest economy, and Georgia, which attained an improved rating as the 35th freest economy in the world, Armenia's business environment has been hailed as the most open and least restrictive in the region. Despite its energy wealth, Azerbaijani business also faces substantial challenges, such as problems of investment freedom, inadequate property rights, and corruption. On the other hand, Georgia is rated highly for its "business freedom" and a highly flexible labor market, yet is reported to face difficulties in terms of corruption, trade restrictions, incomplete and weak property rights, and "an inefficient bureaucracy" that "burdens many commercial sectors."

The study also focuses on several specific areas that, when applied to the South Caucasus, only demonstrate Armenia's stronger position. For example, in terms of business freedom, starting a business in Armenia takes an average of 24 days, compared to a world average of 48 days. In Azerbaijan, starting a business takes an average of 53 days, and there are serious obstacles to obtaining a business license.

Outperforming both Armenia and Azerbaijan, however, is Georgia, where starting a business is fairly simple and easy, requiring an average of only 16 days, with clear benefits for entrepreneurship and job creation. But an important consideration for business, and especially for the import-export sector, is inflation, which in Georgia is relatively high, with relatively unstable prices exacerbated by state controls over prices and stunted subsidies for agricultural products.

Although Georgia's inflation has been decreasing over the past two years, it remains stubbornly difficult compared to Armenia's success in consistently maintaining single-digit inflation and in keeping a tight lid on inflationary pressures. Azerbaijan is even worse, with its consumer price index (CPI) set to hit a whopping 21.2 percent this year, according to the International Monetary Fund (IMF).

In terms of investment, foreign investors in Armenia hold the same rights of establishing businesses as local Armenians in nearly all sectors of the economy. But in Armenia, the major impediments to foreign investors are, according to the report, seen as "weak implementation of business legislation and corruption in the bureaucracy." And even in Azerbaijan, which has attracted billions in foreign investment in its energy sector, other areas of its economy and business sector remain off-limits to non-Azerbaijani investors.

In Georgia there has been a marked commitment to reform aimed at creating a "business-friendly environment." In this way, Georgian reforms have included measures to treat all foreign investment equally, with no restrictions on investments or acquisitions of domestic companies, stocks, bonds, or any other property. Moreover, there is a so-called "one-stop-window" system for Georgian and foreign investors to obtain a business license within 24 hours. "Judicial inefficiency" and corruption are identified as the "only major impediments to foreign investors," according to the report.

One specific area for improvement, as far as bolstering Armenian business is concerned, relates to the need for greater credit and start-up capital from the country's still underdeveloped financial sector and the infant stock exchange. The need for access to credit markets is also essential for the longer term development of Armenian business. And on a broader level, the ability to secure and utilize reasonably priced, long-term credit is also necessary for home ownership, through mortgages, for small business start-ups by providing business loans, and even for post-secondary education, through student loans. Each of these three areas is also important for the strengthening of business through strategic investment, such as education.

Thus, the development of capital markets in Armenia is essential for access to credit. Given the obvious linkage between such access to capital and credit and overall stability, economic growth and even poverty reduction, the modernization and expansion of capital markets in each of the three states must be a priority for their governments.

Azerbaijan's financial system is also seriously underdeveloped and, because it remains largely cash-based, is still limited and burdened by non-performing loans. The banking sector is also dominated by two state-owned banks that account for a combined 60 percent share of banking assets, and provide financing for state-owned enterprises, often at below-market rates. This stands in sharp contrast to Armenia, where the state no longer holds a stake in any bank, as all of the 21 commercial banks in Armenia are now privately owned.

Another significant obstacle to the further development of business in Armenia is corruption, which is recognized as "widespread." For yet another year, Armenia has been judged to be unacceptably corrupt, according to the rankings of Transparency International's Corruption Perceptions Index.

For Armenia there is a need for a new focus on middle class-oriented development, with policies to promote access to capital and credit. Such policies have already proven successful in a number of countries, such as Brazil, Mexico, and several Asian states. One of the most successful of these policies is "micro-lending," an innovative development designed to give ordinary people access to credit to start a small business. This has contributed both to promoting economic growth and reducing poverty, as well as helping to expand an emerging middle class.

Another promising policy that has proved effective in other economies in transition is a "mini-lending" program, a somewhat larger loan program for families and communities, rather than simply individuals. Such mini-lending programs offer targeted assistance for community-based business ventures and family-run small businesses. This too holds significant promise for national and regional economic development in Armenia, as well as throughout the South Caucasus.

CLEANING UP BUSINESS

The danger for business in Armenia is one of complacency. In order for Armenian business to not only maintain its competitive advantage, but to also attain a more secure position, there is need to overcome the constraint of corruption.

A related need for Armenian business, especially given the small size of the national economy, is the need to tackle monopolies and to further open the economy through transparency and competition. Although the emergence of monopolies in the Armenian business sector has not been as profound or as powerful as in other former Soviet states, they have created two especially serious problems for the overall Armenian economy.

First, Armenia's business monopolies, unlike their more traditional counterparts in the case of Russia, for example, have a rather unique form; they are comprised of informal cartels based on a dominant control over the import and export of specific key commodities. Such a stranglehold has serious economic consequences, as it tends to stifle economic growth by restricting the export-import trade sector. The net result is an overall weakening of economic growth.

The second economic impact of these commodity-based cartels or monopolies is their role in obstructing the rise and expansion of new firms and businesses. This too harms overall job creation and maintains the closed and limited nature of the national economy. In Armenia's case, this not only reinforces the landlocked and blockaded limits on the Armenian economy, but creates a reinforcing cycle—where the monopolies become "vested interests" in maintaining closed borders in order to reinforce their control over key sectors of the economy.

As with lessons from similar cases, the only effective way to tackle this problem has been to introduce "anti-trust" legislation strong enough to counter and contain the monopolies and cartels. But here too, as demonstrated in the experience of other countries, it is the implementation and enforcement of the laws and legislation that matters most.

Furthermore, despite the most well-designed anti-trust legislation and bodies empowered to limit or break up monopolies, without the rule of law and political will, very little can be reasonably expected. In larger economies, and elsewhere in the region, such "cronyism" has resulted in a high "transaction costs," whereby corruption becomes entrenched, even to the point of actually weakening the state by depriving it of much needed tax revenue. It also limits economic growth in the short run, and constrains competition in the long run, which in turn leads to higher prices and slower innovation.

Thus, the cumulative effects are devastating on the national economy overall and on society in particular. But as seen in the model of Armenian business in particular, such a failure to tackle the closed, monopolized economy also threatens to only destabilize and further isolate the country.

Richard Girgosian is a Yerevan-based political and economic analyst, specializing in former Soviet countries. He writes for Radio Free Europe and Jane's, and is a consultant for various international organizations, including OSCE.

Originally published in the November 2007 ​issue of AGBU Magazine. Archived content may appear distorted on your screen. end character

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