by Haykaz Baghian and Narine Khachatrian Special from ArmeniaNow.com
After seven decades of reliance on the Soviet Union, economic development in Armenia has had only one decade in which to overcome the legacy of that system and the effects of its collapse. War, natural disaster, and blockade politics have made the legacy even harder to survive.
Difficulties are plain to any visiting observer:
• Legislation governing business in Armenia is made by Parliament Deputies who are also the very businessmen whose interests are at stake in the execution of such laws.
• Conducting business in Armenia is hampered by the long-standing tradition of bribes, kickbacks and clannish connection that impede efforts to establish legitimate, transparent, enterprise.
Like its post-Soviet neighbors, Armenia remains the New Frontier, for ill or good. And while charlatans and opportunists have exploited the transition, so too, are well-meaning business people looking at Armenia as a ground for fertile investment.
According to the state statistical service, 2,322 companies are wholly or partly owned by foreign investors in Armenia, and there are a further 292 registered branches of foreign companies. Russia and Iran are the key outside players in the republic's economy, accounting for more than 40 percent of foreign companies and 60 percent of investment capital. The United States ranks third by number, with 305 business investments, but only around seven percent of capital, because many of the partnerships are small in scale. The value of investments from Italy, the United Kingdom, and France match or exceed those of American businesses.
Official data indicates a one-third rise in the value of investments in Armenia in 2002, to $162.5 million. Two thirds of that was foreign direct investment. Diamond cutting and mineral mining, traditional strongholds of the economy, now share the market with a few renovated Soviet-era factories and, significantly, a burgeoning Information Technology industry.
Agriculture and the production of food and beverages account for just over half of manufacturing activity, with tobacco products adding a further 4.7 percent. Diamond processing, despite its high profile, accounts for less than 10 percent of manufacturing by value. The value, though, of the exported goods figures prominently in Armenia's trade balance.
Armenia's economic profile has been changing with its prospects. Two years ago the Heritage Foundation and the Wall Street Journal rated Armenia the most open economy of all the republics in the Commonwealth of Independent States in their Index of Economic Freedom.
Though tainted by accusations of fraud and disapproving reports of foreign observers, President Robert Kocharian's re-election last March may have reflected the sentiment of many Armenians. Simply: although much is far from good, some aspects of life are getting better, particularly in the business world.
Inflation was two percent last year, compared to its hyperinflationary peak of 5,273 percent in 1994. There was 12.9 percent growth in gross domestic product and a more than 50 percent increase in exports from about $307 million to about $507 million. In the first five months of this year, compared to the same period of 2002, GDP rose 13.8 percent, industrial production was up by 22.9 percent and exports by 25 percent—all the highest indices of economic growth in the CIS.
A decade ago, agriculture represented nearly half of the GDP. It now makes up only 23 percent. Also in the past decade, service industries (hotels, restaurants, etc.) have increased from 44.7 percent to 54.6 percent. Both developments are seen as indicators of a modernizing economy. It is expected that at some point this year Armenia's economy will cease to become a net consumer and the volume of GDP will exceed domestic consumption for the first time since independence.
(World Bank experts estimate that the lifting of economic blockades would add $720 million to Armenia's domestic production—equal to twice the annual amount of foreign transfers, mainly from Armenians living abroad.)
Experts caution against exaggerated optimism over signs of economic recovery. Why? Because they predict that the main factors influencing this rapid economic growth (the replacement of imports by domestic production) will decline in importance over the next two to three years. Despite substantial growth in exports and investments, their level, structure and trends cannot be considered satisfactory.
For example, the export of precious stones is equal to $200 million and accounts for 30 percent of Armenia's total export. Such figures, though, are misleading, considering that 85 percent of the value of exported polished diamonds is the value of the imported raw diamonds. In other words, only 15 percent of that $200 million ($30 million) impacts Armenia's economy. As a result, 10,000 Armenian jewelers make half as much value added product as 3,000 computer programmers producing software.
Some analysts say other approaches to reform are required to create a stable economy. Karen Karapetyan, director of the Information Department of Armenian Development Agency (ADA), says: "The time has come when a new economic strategy is necessary—the development strategy, based on innovations and creation of knowledge, as well as its powerful application into practice."
The ADA was founded in 1999 to provide services for potential investors. It received $1.3 million in start-up finance from the World Bank in 2002 under a program for promoting investments and exports. Its annual budget is 120 million AMD (approx $210,000). Despite some skepticism concerning the effectiveness of ADA's activities, about 300 Armenian enterprises have participated in international trade shows with its assistance in the past two years. The recent appointment as co-director of Padraic Murray, from the highly-regarded Irish Development Agency, has strengthened the ADA's capabilities.
"The discourse has been on how to get out of a hole so far, but not how to burst forward," says Arsen Ghazarian, chairman of the Union of Manufacturers and Businessmen of Armenia (UMBA). The UMBA, whose aims include the development of ideas for reform, is one of the most influential and active business organizations in Armenia: its members' personal wealth is equal to 70 percent of the State budget. It has promoted drafts of laws that have been passed by the National Assembly to reduce the number of official inspections of businesses, simplify regulations and make the tax code more efficient.
Armenia's low labor costs and its pool of well-educated specialists are powerful motors of development. Fifteen percent of the population has higher education, and 99 percent is literate, while analysts estimate that labor costs in Armenia are only 10 percent of those in the European Union. The high level of ability has been a key factor, for instance, in the development of an Information Technology industry in Armenia.
But to meet Western standards, education, science and research require much larger investments than the State is capable of making. Many people also consider that the lack of investment in education is a factor in social tension in Armenia.
"People can explain their own failures by the transition to a market-based economy, but they will be humiliated if their children's opportunities are limited and potential is lost," says Gayane Panosyan, principal of Charentsavan's School Number 1.
Tom Samuelian, president of the American Chamber of Commerce in Armenia, says education and science should be the main focus of charitable activity in the country. The Chamber is a non-profit organization of U.S.-related businesses that aims to promote good business practices and advocate improvements in the legal and business environment based on experience around the world.
Armenia has risen in the Wall Street Journal's and Heritage Foundation's index from 115th out of 161 countries in 1996 to 44th in 2002, making it by far the most liberal business environment in the region. Georgia is 113th, Azerbaijan 104th, Turkey 119th, and Iran 146th. The rating is based on analysis of trade conditions, level of taxation, government intervention, monetary policy, foreign investments, banking deals and finances, wages and prices, property rights, regulation and black market. Among countries in transition, only the Baltic nations and the Czech Republic showed more significant improvement during this time.
Armenia's best score was in liberalization of foreign trade, where it is ranked alongside places such as Hong Kong and Singapore. Improvements were also noted in the areas of taxation, government influence, and monetary policy. But the Heritage Foundation criticized poor implementation of legislation and continuing high levels of corruption.
According to Yervand Zhakarian, Head of the State Tax Service of Armenia, the shadow economy of untaxed and unregulated activity, makes up 35-40 percent of the economy. There is, though, progress. During 2002, tax officials identified numerous shadow businesses and taxed them 8 billion drams (about $15 million). He claims this has reduced the non-legal business activity to just two or three percent, though experts say that calculating the size of the shadow economy is a notoriously inaccurate effort.
A report prepared by the International Monetary Fund, World Bank, European Bank of Reconstruction and Development and the Asian Bank of Development showed Armenia had made most progress among seven CIS countries in the struggle against corruption. The average value of bribes in companies' profits in Armenia had fallen to 0.9 percent last year from 4.2 percent in 1999.
Successful completion of Armenia's program of civil service reforms should reduce further the possibilities of corruption. The number of civil servants will be reduced from 12,000 to 7,000, with a simultaneous rise in salaries for those kept on. Since January 1, the wages of tax inspectors were increased from $120 to $200 per month in an effort to curtail bribery. The sum appears small, but is four times the average wage of teachers and 15 times the average pension.
Against all the positive business and economic trends is the reality that Armenia's GDP per head is still very low. At $750 per capita, it is five times lower (taking account of purchasing power parity) than Portugal and Greece, the poorest members of the present European Union. After massive economic contraction—Armenia's GDP shrank a catastrophic 41.8 percent in 1992 alone—it will take at least five more years of 10 percent annual growth just to restore Armenia to the levels it enjoyed in 1989.
Estimates of unemployment vary. The Social Affairs Ministry places the total at 133,700, or 9.4 percent of the working population of 1,415,600. A survey of 1,116 households carried out using World Labor Organization methodology, however, put the total at 31.4 percent. In both measures, unemployment has fallen slightly this year, by 1 percent and 1.1 percent respectively compared to 2001. But for thousands of highly educated Armenian specialists, working in their chosen field remains little more than a mirage.