Vahagn Khachatrian, Board member, Armat Center for Democracy and Civil Society Development, economic adviser to the President of Armenia in 1996-1998 (Erevan, Armenia)

The main purpose of the effort to transform the planned economy into a market economy is more effective use of labor and other resources to meet the needs of society. In fact, it differs little if at all from the economic problems faced not only by many developing countries, but also by industrialized nations at the early stages of their development. At the same time, each of these countries has its own specific features, which have to be taken into account in writing a scenario for the transition period.

Armenia, like many other post-Soviet states, got down to the construction of an economy based on liberal ideological principles in the early 1990s. The republic launched its market-oriented reforms in the conditions of a breakup of the U.S.S.R., a disruption of intra-Union economic relations, an advance to independent statehood, and a dismantling of the old machinery of government. The problems of reform were compounded by the aftereffects of a devastating earthquake and by the military action and blockade caused by the Karabakh conflict.

The basic macroeconomic indicators give some idea of the main trends of the transition period and help to identify the characteristic features of the republics economy.

The ten years of reform may be tentatively divided into two periods. The first period (1990-1994) brought a major economic recession, when GDP fell nearly 2.5 times to 33.8% of the 1990 level, while prices multiplied nearly 1,400-fold.

The second periodone of stabilizationbegan in 1995 and continues to date. It may also be divided into two stages: 1995 through early 1998 (a time of continued reform) and the past four years (a time of missed opportunities). Over these past four years, the pace of growth has slowed down, the balance of payments has been reduced to a state of sheer impotence, macroeconomic stability has come under threat, business and investment conditions have worsened, and the governments strategic moves have become unpredictable.

Nevertheless, one can safely say that in 1991-2001 market relations took shape in the country. At the same time, the economy has many negative features. These include: a narrow domestic market due to the low value of the created product (with quarterly fluctuations and pronounced seasonality); a large share of imports, with consumption outrunning the production of new value; and polarization of households by income and spending coupled with regional polarization. The republics economy is also marked by a highly manageable banking system, changes in sales patterns and levels in the absence on the financial market of a uniform payments and accounting system; variable tax factor (as a percentage of GDP), the existence of a shadow economy, problems in developing peoples legal conscience; migration and instability in the sphere of employment and job placement.

In market conditions, a sizeable part of the production structures formed in the days of the highly industrialized socialist economy turned out to be ineffective and unviable. In view of that, the decline in production in the first three or four years after the collapse of socialism had a general, law-governed nature and depended very little on the economic policy pursued. Thus, compared with 1990, the physical volume of industrial output in 1994 was down by 55% (in 1999 it was 51% lower than in 1990, and in 2000, 52% lower) and GDP was down by 56% (in 1999 it was 36% lower than in 1990, and in 2000, 38% lower).1 Indicators reflecting effective demand are also highly indicative. Whereas the money incomes of households in 1994 were 136.7 times higher than in 1990, consumer prices were 2,211.1 times higher (which means that effective demand fell 16.2 times). In 1999, household incomes were 7.3 times higher than in 1994, having grown 1.8 times faster than prices. As a result, the level of effective demand (the real volume of the consumer market) in 1999 was over nine times lower than in 1990.2 These factors largely explain the low level of so-called primitive accumulation of capital.

According to the estimates of the CIS Interstate Statistics Committee, Armenias economy is now on the level of the 1970s.3 In particular, GDP in 1999 was on the level of 1970; industrial output, on the level of 1973; gross agricultural output, on the level of 1976; transportation of goods (without cargo shipments), on the level of 1953; commissioned housing, on the level of 1946; and wholesale trade, on the level of 1973.

Although all statistical data since 1995 testify to economic growth, we are sure that living standards in the country cannot be seen as satisfactory. On the contrary, the situation is getting worse as a result of the continued economic blockade, self-isolation, monopoly in some sectors of the economy, etc. The depreciation of the economy reached an extreme and has not been overcome to date. Thus, consumption surpassed the output of goods and services by 10.6% in 1993, 17.5% in 1994, 11.7% in 1996, 13.2% in 1997, and 4.7% in 1998.4

One should note that on the level of households consumption has an even more significant lead. Whereas in 1998 the purchasing power of the population in terms of real income was over 10 times lower than in 1990, household spending on consumption was only 18.2% lower.5 This shows that households are depreciated to an extreme, that they are dependent on official and private transfers and are turning into a kind of subsistence economy.

The situation in the sphere of foreign trade remains virtually unchanged: the negative trade balance has acquired a chronic character and does not tend to decrease. Although in 1999 the economys openness ratio fell by 2.5%, it is still very high at around 69%, which shows a heavy dependence on the outside world. At the same time, this does not mean a high degree of integration of the republics economy into the world economy. On the contrary, a low propensity to export and a high propensity to import may perpetuate the countrys heavy dependence on external markets.

Table 1

Movement of Openness Indicators (%)









Economic openness








Average propensity to export








Average propensity to import








Although the propensity to import has tended to decline, it is still very high: in 1999 and 2000 imports came to around one-half of GDP (44.7% and 47%, respectively).

There are also serious problems in the sphere of export. In 1999-2000, exports remained on the level of 1994-1995: $215m in 1994, $290m in 1995, $220.5m in 1999, and $297.7 in 2000. Since Armenia is in effect an open country, it cannot afford to have low export levels. Nevertheless, exports as a share of GDP came to 33% in 1994, 21% in 1995, 18.2% in 1996, 14.3% in 1997, 11.7% in 1998, 12.8% in 1999, and 15.8% in 2000.6

Experience shows that in countries with an open economy and a high development level (Denmark, Norway, Ireland), the foreign economic turnover ranges from 70% to 135% of GDP. In our republic, this indicator in 1998-2000 stood at 53.8%, 57.2% and 63%, respectively, while the trade deficit was 30.4%, 31.1% and 31.2%. Considering that unofficial transfers and international financial aid play a significant role in Armenias economy, the countrys unfavorable balance of trade is a cause for concern (in 2000, it came to $587m). In order to ensure the countrys economic solvency, it is necessary over the next five years to boost exports to around 25-30% of GDP, so that the trade deficit would not exceed $500-550m.7 With due regard for GDP growth, exports over the next five years need to be tripled, and in ten years time they should reach 90-95% of GDP. This means exports should grow at an annual rate of at least 20-25%.

The past ten years have added new problems, especially in the matter of living standards. In the early 1990s, tensions in this area were not particularly pronounced, but now they have risen sharply and present a priority problem. An extreme polarization of household incomes has led to an impoverishment of a sizeable segment of the republics population.

Thus, according to the World Bank, the difference between the incomes of the most-well-off 20% of the population (top quintile group) and the least-well-off 20% (bottom quintile group) is 32.2 times, and between their expenditures, 6.6 times.8 Such a state of affairs means that the so-called middle class has not yet taken shape in the country, and this is not only an economic, but a political factor as well. The absence of a middle class amounts to an absence of a broad political basis for any political force in civil society. In such a situation, it is impossible to create conditions for systemic governance, and ad hoc decisions are bound to prevail, as Armenian citizens now see for themselves.

Another indication of the peoples impoverishment is that the minimum consumer goods basket in the republic, according to various estimates, is $66-70 a month, whereas the minimum wage is around $9 a month, the average wage, around $38, and the average pension, $7.5. The structure of money spending also points to a low living standard. People spend most of their income on food (67%), services (12.4%) and tobacco (6.4%), and a very small share on entertainment. In the least-well-off groups of the population, the expenditure pattern is even more strained: 77% of household income goes to buy food, while spending on services amounts to an average of 7%.

Over the past ten years, poverty has become the most burning social problem. Its causes are as follows: a high rate of unemployment (according to surveys of households, over 25% of working-age people in 1998-1999 were unemployed) and slow progress in creating new jobs; small wages; low efficiency of social production, and mostly subsistence-type agriculture (the share of employment in agriculture is relatively high: over 40%).

A decline in the traditional branches of production has had an extremely negative effect on total employment and average incomes. At the same time, new private enterprises being set up in production and in the service sector are marked by relatively higher productivity and lower labor requirements. Over the years, Soviet enterprises have been cutting jobs in view of a loss of traditional markets and inadequate budget funding, while new small and medium-sized businesses are still unable to create many new jobs because of a lack of funds, an unstable economic policy, including tax policy, and high interest rates. Two groups of highly effective owners - banks and foreign investors - play a very insignificant role in the economy.

Unless the employment problem is resolved, the development of the state and society will be simply impossible. Considering the state of affairs in the sphere of education, migration and health care, the present situation in the country should be seen as close to critical. A unique example here is the impact of poverty on the environment. As prices have risen and incomes have gone down, most of the population has been obliged to overuse natural resources, so that the natural reproduction of water, forest and fish stocks has been put in jeopardy, lands are degrading, and urban pollution has gone out of control.

The choice of measures in combating the decline in living standards depends on the economic, structural and cultural specifics of each country. Until recently, the republic had no integral poverty reduction plan. Today such a plan has been drawn up with the assistance of international organizations. It is based on intensive use of labor resources and investment in enhancing the human potential of the poor. Both these elements are necessary, because the first provides opportunities for using the abundant labor resources available among the poor strata, while the second directly helps to raise their living standards and enables them to make fuller use of the new opportunities.

Without questioning the quality of this plan, let us merely note that its success will depend on how the executive authorities set about its implementation, on whether their action is principled, effective and free from demagogic political demarches. According to the estimates of World Bank specialists,9 in 1996-1999 the rate of poverty in Armenia was around 55% of the population. Today nearly one-third of all people able to work are either unemployed or are on leave without pay for long periods of time. Nearly one-half of all people aged 25-49 years have no gainful employment, and in the younger age brackets unemployment is around 80%. If one adds the problem of migration (according to official data, 20% of the population has left the country, whereas the unofficial figure obtained from state statistical reports and analytical studies of many international organizations is twice as high), one will get a truly depressing picture. Of course, the situation could have been different if the reforms had been carried out with due regard for the need to create new opportunities and make up for potential losses.

A reduction in income inequality is of particular importance in this respect. The choice and implementation of government measures aimed to meet the needs of the poor depends on the interaction between societys political, social and other forces, while access to market mechanisms and government services depends on state and social institutions, which should be receptive to the needs of the poor and be accountable to them.

We have touched upon only some of the economic, social and political problems facing the republic, but even so there is every reason to say that transformations in the economy and its tangible growth are obstructed by factors which the authorities prefer to pass over in silence. These problems can be solved, but only provided the entire state and political system displays due will and singleness of purpose without seeking cheap and precarious here-and-now dividends. Let us outline the main problems in this area.

First, there are the problems of regional integration. All specialists (with the exception of the countrys authorities) are agreed that without integration not only Armenia, but the whole of the Southern Caucasus cannot be an attractive destination for investment. The geographical location of our republic - at a crossroads between Asia and Europe - nevertheless gives it a chance to build a significant international market, but only upon the solution of a number of political and economic problems. However, the countrys leadership merely pays lip-service to integration processes while obstructing them in practice.

Second, far from serving to counterbalance the political system, the republics economic system is a mere appendage of the latter. It is neither law nor legal conscience that serves as a guarantor for business circles, but surety provided by this or that governing structure, with the result that equal conditions for business activity have not been created.

Third, there is the Nagorno-Karabakh conflict. According to World Bank experts, the unresolved problem of Nagorny Karabakh is a serious hindrance to economic development. Because of the conflict, a part of the overland communications are blocked, so that Armenia is obliged to make shipments only via Georgia and Iran, which markedly raises commercial expenses. An opening of borders could serve to reduce transport costs by 30-50%, to double exports, and to increase GDP by 30-38%.10 The country should be prepared to open borders, which makes it necessary, among other things, to improve the infrastructure of road, rail and air communications; to create favorable conditions for the development of branches and lines of production whose output is competitive on the international market, like the agricultural processing industry; to ensure safety of shipments on the roads and at border crossing points; to ensure compliance with regulatory documents, reduce bribery and corruption to a minimum, and promote closer tax and customs integration between the three states of the South Caucasus.

Apart from these factors, a settlement of the Karabakh conflict will help to reallocate budget funds toward a solution of many problems in health care, education and the social sphere, and so to make the country more attractive in the eyes of foreign investors.

When speaking of problems connected with the conflict, one should mention that in view of the Karabakh standoff the so-called power departments (Interior Ministry, Defense Ministry, National Security Ministry and Foreign Ministry) have the casting vote in the adoption of strategic plans. As a result, economic and institutional tasks tend to move into the background. The centralization of power in the hands of a few decision-makers merely worsens the situation, while the weak political parties and nongovernmental organizations have nothing to counter with. The government, for its part, is also unable to cope with many problems, especially social ones. The countrys executive agencies are neither open nor accountable to society, while the said ministries and their senior officials have concentrated too much authority in their hands, which has had an effect on the whole system of governance in the republic. In fact, the country has turned into a single unitary enterprise, with the top echelon of the power departments as its new owners.11

So, the political equilibrium has been upset. The lack of accord and dialogue between the authorities and society makes it more difficult to resolve both domestic and foreign policy problems and to reach the public consensus required to overcome the Karabakh standoff. The republics citizens have virtually no opportunity to take part in decision-making on social, economic or political matters, whereas reforms implemented from above can only have an effect when they are understood and supported by broad strata of the population.

In summing up the processes that have been at work in the economy over the past ten years, one could say the following.

Upon Armenias rise to independence, the collapse of intra-Union and regional economic, trade and payment agreements had an extremely negative effect on its economy, coupled with a slowdown in trade and financial flows as a result of the Nagorno-Karabakh conflict.

The introduction (in November 1993) of a national currency, the ceasefire agreement of May 1994, and credits from international organizations enabled the government from December 1994 onward to stop the country from sliding further into recession. The upturn in the economy was promoted by a tight financial policy and structural reforms.

Later on, the executive authorities were unable (or did not want) to go over from the first stage of transformations to institutional reforms, jeopardizing the achievements of the first few years of independence. Whereas at the first stage the political will of all the branches of power played a crucial role, the subsequent lack of will and the populist attitudes of the government proved to be a barrier in the way of further economic development. At the second stage of reform, it was necessary to create institutions that would help to make the changes irreversible, to develop the economy and ensure its automatic regulation.

The main cause of economic stagnation under socialism and of the mounting crisis of socialism which subsequently led to its collapse was that the socialist economy lacked the institutions for ensuring the generation and use of effective innovations or for an automatic redistribution of resources in favor of economic entities capable of using them in a rational way. In a developed market economy, the key mechanism serving this purpose implies tight budgetary constraints on economic agents. Entities unable to make effective use of resources or failing to apply the most rational methods of production turn out to be noncompetitive, run into liquidity problems and begin to suffer losses, so that their managers lose their job and their owners lose their property.

A tight link between the financial stability of an entity and its ability to retain control of the respective resource flows is the key mechanism bringing success in a market economy. And effective operation of this mechanism, let me repeat once again, calls for resolve and political will. It is precisely the lack of resolve among the countrys leaders, their urge to cater to public opinion, and their stake on re-election that serve to worsen the situation.

1 See: The Specifics and Stages of Economic Reform in Armenia. Statistical Handbook, Erevan, 1998 (in Armenian); The Socioeconomic Situation in the Republic of Armenia. Analytical-Information Report, Erevan, 2000 (in Armenian).

2 See: The Main Characteristic Features of Armenias Economy. Final Analytical Report, Erevan, 2000 (in Armenian).

3 See: Ibidem.

4 See: Ibidem.

5 See: Ibidem.

6 See: The Socioeconomic Situation in the Republic of Armenia, January-December 2000, Erevan, 2001 (in Armenian).

7 See: The Main Characteristic Features of Armenias Economy. Final Analytical Report.

8 See: A.Kh. Markosian, The State and the Market, Book One, Erevan, 2000 (in Armenian).

9 See: World Bank Report, 6 June, 2001.

10 See: Trade, Transport and Telecommunications in the South Caucasus: Current Obstacles to Regional Cooperation, World Bank, 2001.

11 See: The Results of a Study of Institutional Policy and Governance in Armenia, IMF, Erevan, June 2000.

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