Gohar Minasyan
Economic transition: challenges and prospects for Armenia   

The long-term goal of transition is the same as that of economic reforms elsewhere: to build a thriving market economy capable of delivering long term growth in living standards (cite-WB). What distinguishes transition from reforms in other countries is the systemic change involved. Reforms must penetrate to the fundamental rules of the game, to the institutions that shape behavior and guide organizations, which means economic transition cannot be separated from social transition in general. 

Planned vs. Market Oriented Economy 

In terms of comparing the different economic systems, it is interesting to consider a summary of the positive achievements of the centrally planned system by the WB in one of its world development reports. They are: increased output, industrialization, education-health care-housing-jobs, the avoidance of the great depression of the 30-s and equal income distribution.
Despite the rich variety of the arguments against the planned system, the version of the WB will be brought here, according to which there are two main sets of problems: 
•	Inadequate information flows between the decision makers and economic agents: planners could not get enough information to substitute for the information that would be supplied by the price mechanism in a market economy. 
•	Suppression of individual initiatives, that was becoming more and more dangerous for the functioning of the system with the weakening of authoritarian regime as well as with the information becoming available about the rest of the world. 
In order to get an intuitive picture of the worsening dynamics of the economic developments of the socialist states and the Soviet Union in particular some statistical data would be interesting. The long run dynamics of average annual GDP growth rate in USSR, according to official estimates: in the 50-s it was 10%, 60-s 7%, 70-s 5%, 80-s barely 2%. This downward trend occurred despite significant and in fact increasing shares of investment in GDP – returns to capital formation began a steady and rapid descent in the mid 50-s, due to inefficient resource distribution.   
 Insert graph from WB World development report p. 3 
(the graph illustrates the idea )
However the above mentioned involves only the economics of the process. The sociological reasons, for the collapse of the system were very deep and had a crucial role, and in particular issues of national or ethnic differences were significant factors.

What is Economic Transition?
Talking about economic transition, three main sets of reforms are usually underlined.
•	Liberalization, which primarily refers to freeing prices, trade and entry to markets from state controls, complemented by macroeconomic stabilization. Since markets cannot operate in an environment of high inflation and macroeconomic uncertainty, stabilization is to accompany a sharp lifting off state controls. This refers primarily to achieving appropriate budget constraints and to keeping inflation at moderate levels. 
•	Establishing property rights and privatization refer to the next main set of reforms. The main objective is to remove the state from the ownership of and decision making within enterprises. On one hand privatization is regarded as an important complement to liberalization and stabilization, on the other hand it is aimed at improving post-privatization performance of enterprises, that would arise from the commercial focus instilled by private owners and from effective post-privatization corporate governance. 
•	Institutional change. In the environment of economic transition the extent to which the state is able to ensure certain basic rules of market behavior is crucial to the success of initial reforms. Once the basic reforms of liberalization and privatization have been implemented and the state has consolidated its new role, the focus of institutional reforms shifts towards strengthening of the supporting institutions. It is worth mentioning that the establishment of institutions is a two side process of demand for institutions from the side of the developing private sector, and their corresponding supply from the side of the reforming state as well as the society in general. 
The described sets of reforms should be complemented with the reshaping of social policy (the other side of the coin, since as it was noted, rising living standards are the main goal of transition). This involves creation of social protection system, that would be more appropriate for the market oriented economy, and will ensure more efficient income distribution combined with high level of social protection. These issues will be covered by the next presenter.
The ten-year history of transition
Looking at the 10-year history of transition: EBRD has considered the dynamics of  comprehensive transition indicators across all 26 countries and all the core dimensions of reform (markets and trade, enterprises and financial institutions). Subject to much more variation in the first years, they show a rapid progress 1994-1997 and a marked slowdown afterwards (show graph)
Generalizing over the issues of economic transition is apparently subject to the limitations due to ignoring the huge differences in the region. Economic structure, history, including history of reforms, geography, resource endowments, culture, etc. all varied sharply across the transitional countries.  
 EBRD emphasizes two patterns of progress in transition. First is the clustering of the countries by overall progress in reform within particular geographical sub-regions: Central and Eastern Europe, Baltic States, South-Eastern Europe, Central CIS, Caucasus and Central Asia. The second pattern is the persistent disparity between progress in liberalization and privatization on one hand and in development of institutions that support markets and private enterprises  - governance and enterprise restructuring, competition policy, banking reforms and securities markets and non-bank financial institutions on the other hand.
Future prospects: Transition is better described as an ongoing process that involves achieving the objectives of the structural reforms. There are different estimates as to the time needed for these accomplishments. In terms of distinguishing short-term and long term prospects, privatization, competition, public finance efficiency and “fighting”(can you use another word?) against corruption can be attributed to the short-run issues, while long run issues would refer to social nets and stable macroeconomic environment in particular, in terms of balance of payment adjustment.
Insert table 2.1 from EBRD report – Comment about the Armenia as compared to the others
Overview of the economic developments in Armenia
From the perspective of economic development the past ten years of economic transition in Armenia can be divided into two stages: the stage of comprehensive transformation of the economy and economic stagnation and the subsequent stage of achieving macroeconomic stability and economic growth. To view it in the above described framework, liberalization, macroeconomic stabilization and the establishment of basic property rights can be attributed to the first stage, while the structural developments, including those of institutions can be attributed to the second stage. 
After the declaration of independence in 1991 in addition to the many economic and political difficulties common for all of the former Soviet Union Armenia also faced challenges of reconstruction requirements caused by the 1988 earthquake and the military conflict in Nagorno-Karabach, that also resulted in economic blockade. 
In the period of 1990-1993 GDP fell by 53% in 1992 alone (the peak year of contraction) GDP fell by 41.8%, surpassing the CIS average contracting in GDP by more than six times. The contraction was accompanied with hyperinflation. The industry sector, which used to amount to the largest share of the economy prior the collapse of the Soviet Union, fell by 60 %, housing construction experienced the sharpest fall: 85%. During 1990-94 real consumption of the population fell more than 10 times. Armenia experienced one of the largest declines among the countries of former Soviet Union which resulted in massive unemployment and a subsequent emigration (by some estimations amounting to around 1 million people).
In 1994, which can be considered to be the turn-point from the collapse to towards a recovery, depression came to an end and positive real economic growth was experienced. The average annual growth of real GDP during 1994-1999 was 5.3%, (36 % for the whole period), which brought the level of GDP in 1999 to be equal to the 63 % of 1990 level. 
Talking about the real economic growth of the last years starting 94 two main things should be noted. The years 1994-1996 followed a 4-year unprecedented economic decline where we had negligably low level of recourse utilization, so the economic growth immediately after this decline could be achieved without large investments into the economy. In 1997 economic growth was only 3.1% suggesting that the period of so-called “autonomous” growth came to an end and that macroeconomic stability by itself is not sufficient for achieving sustained rapid economic growth. This confirmed the neseccity of accelerating the speed of structural adjustments. The second issue is the so-called quality of the growth. As it is known, aggregative economic indicators do not capture issues of social developments, poverty, income distribution, quality of public services, meeting populations’ basic needs, etc. Your attention will be brought to the issues of Social protectedness by the next presenter.

Structural Reform Challenges
To give a more specific picture, it would be useful to underline the most important challenges in terms of structural reforms and development that Armenia currently faces and the solutions to which are crucial in respect of future development prospects and economic policy formulation (cite MinFin)
Poor management of state enterprises and the low speed of privatization of some large enterprises.  A number of enterprises are still state owned, since they are not attractive to the private sector because of huge debt arrears, poor financial auditing, need ”modernizing”. This includes mostly the utilities sector.
Hidden Subsidies: Although budget subsidies as such have been eliminated, with privatization and the development of a private sector, there is a number of “hidden” ways the government is able to subsidize the private sector. This includes the accumulation of tax arrears, government guarantees on banking loans provided to state-owned enterprises. Experience has shown that these loans usually end up being serviced by the government, rising concerns on both public finance management and on the economic efficiency of the guarantees. 
Poor development of capital and securities markets: In addition to he unfavorable environment including the unsatisfactory level of institutional development in this particular field, a crucial concern are the high real interest rates. Although Armenia is enjoying relative macroeconomic stability, the level of real interest rates currently average to around 35% (estimated average for 2000). This has a very significant negative impact on business activity, since under a very low level of national savings and modest capital flows, high interest rates reduce competition. There is no effective access to bank loans and most small and medium businesses cannot survive. 
The size of the banking system: It should be noted that the size of the Armenian banking system is very small as compared to other transitional economies. At the end of 1999 the ratio of commercial banks’ core capital to GDP was only 3.5%. Banks face high interest rates on one hand and a low level of private savings on the other hand.
Dollarization: one of the main challenges that the Armenian monetary system faces is the dollarization of the economy. At the end of 1999 the ratio of banks’ foreign currency deposits to broad money was 48%, and this ratio has been increasing over the last years. Although the dollar/dram exchange rate is relatively stable and inflation rates have been moderate, savers prefer to keep their savings in dollars.
Low salaries and wages: Macroeconomic indicators such as per capita GDP show that Armenia is a low income country, and it is expected that the wages are low. However, the ratio wages and salaries to total value added is very low, thus creating problems of income distribution. At the end of 1996 this ratio was 46% and at the end of 99 it was 34%. The most difficult problem facing Armenia today is poverty, which is also associated with unequal income distribution. Some analysis has shown that there is a correlation between reduction of the share of wages in GDP and the level of emigration from Armenia. On the other hand it is forecasted that the decrease of wages/GDP ratio will cause slowdown of economic growth rate. 
Low level of investment: the complicated economic situation excessively risky environment and the negative level of national savings caused the deep decline in the level of investment during the period of basic transformation. There has been no significant increase in the level of investments afterwards either. 
Absence of a land market: Although agricultural land was privatized, the market relations in respect to land are nor developed yet. 
Looking forward to the future development path of the Armenian economy, the future can be roughly divided into a stage of completed the structural reforms, which is supposed to be a stage of high economic growth aimed at achieving full economic recovery and the second phase of development will be the start of the sustained economic growth period. So, the main objective of the long term economic development under the conditions of macroeconomic stability should be achieving rapid growth in the first stage and maintaining stable and long term growth in the second stage. Distinguishing between the two is also intended to highlight the peculiarities and differences of the needed economic policies in the two stages. 
The first stage, is crucial from the viewpoint of economic recovery and development and assumes an active implementation of state economic policies. However, the approach doesn’t imply direct interference of the state into economic relationships: ensuring efficient distribution of resources through market mechanisms, thus fostering an optimal usage of the economic potential of Armenia should be the main point. 
Talking about sustained growth from the economic perspective implies an endogenous factor that is able to generate economic growth and thus becomes strategically important for the economy. Human capital is such a factor and thus becomes a main fundamental for long term development. On the other hand factors, external to the economy, (such as geopolitical factors) yet crucial for its long-run dynamics can be preconditions for maintaining growth.
There are coherent arguments for the idea that Armenia can (should) rely on human capital in terms of long run economic growth. This involves the existence of a well-qualified labor as well as potential for developing mechanisms (such as education in a broad meaning of the word) for enhancement of human capital.
The term social capital as distinguished from human capital, can also be useful. According to EBRD definition social capital refers to voluntary compliance with established laws, trust and basic codes of conduct. By using the language of capital, it is  emphasized both that it can be enhanced through “investing into it” and that as a fundamental to the development of institutions it can complement other factors of production, such as physical and human capital. 
As for geopolitical factors, the resolution of the regional political problems is crucial for the long-term development and growth in Armenia.  If the military and political conflicts in the Caucasus region are resolved, Armenia will have the opportunity to become one of the main crossroads in the region.
Resuming I would like to go back to the beginning of the report to talk about final goal of economic restructuring or reforms being rising living standards. Poverty is currently the most urgent and probably most severe problem, that Armenia faces. Although the way to reach elimination of poverty is economic development in the long run, there is also a double causality between poverty, as well as inequality and economic growth. In particular, poverty is a major cause of emigration from Armenia, on the other hand poverty as well as inequality have a negative impact on aggregate consumption. The restructuring of social protection policy, suitable for the new environment is in fact a complement to economic reform in general and the next presentation will concentrate on the issues of Social Security policy.