This is an important question for any country at any juncture. However, even more so for a developing country, where the economy is typically lagging and has, theoretically at least, ample room to catch-up.
For Armenia, addressing this question is especially critical, both due to the momentous changes that transpired in 2018, as well as previously accumulated imbalances and current global trade frictions. To put it in more direct terms, it is ultimately this kind of structural growth and outlook that has been the declared and implied target of recent political changes in the country. This is the variable that will determine how smoothly Armenia will be able to address the amassed and forthcoming challenges. Finally, and in more practical terms, structural growth is also one of the main drivers behind current investment decisions.
Structural vs. Cyclical Growth
It is not often that the distinction above is made in mainstream media. Time and again, one hears snippets about economic activity in a given month versus another, or about the current year’s GDP growth versus the previous year. To an economist, such headline numbers by themselves, without a broader context, are of limited consequence. For a small, developing, open (i.e. heavily trade reliant) economy like Armenia, such cyclical growth outcomes offer even less value.
To be more precise, quarterly or even annual numbers reflect short-term economic outcomes referred to as cyclical growth (i.e. the business cycle dynamics). And cyclical outcomes for small economies are, more than anything, determined by global as opposed to domestic economic conditions. In other words, international commodity prices, global financial stability, trade frictions, and access to funding liquidity tend to have far greater impact on short run domestic growth rates, than any decision made by local policymakers. There are exceptions of course, such as the domestic political environment and banking system restrictions, to name a few, but, more precisely, short-term outcomes are by and large an external story.
Structural growth (also referred to as GDP potential or trend growth) is what determines a nation’s long-term wealth generation and prosperity. Cyclical growth and the business cycle oscillate around trend growth, and the higher the trend growth, the faster an economy will be able to catch-up with advanced countries or even outdo them. High cyclical growth rates may be based on unsustainable credit booms or housing overextensions, which by definition will likely result in deeper contractions when the business cycle turns. Structural growth rates are about something else, fortunately something that domestic policymakers can more easily address.
Has the outlook for structural growth improved, and, if so, what are the drivers of such an improvement?
The Velvet Revolution and Factor Endowments
Trying to simplify the theoretical underpinnings of structural growth rates (i.e. Solow/Mankiw model where Y=M/T*[L,H,K,N]), one can state the following: Long term growth potential (Y) is a function of the following factor endowments:
- Quantity of Labor (L)
- Labor force experience and education (H)
- Quantity of Capital in terms of machinery, equipment and capital, (K) and
- Natural resource endowment (N)
- What is perhaps even more important though, is how these above stated talents and resources are Managed and overseen (M/T). The same resources, for instance, can be used in a more or less productive manner. Of essence here is the approach to governance, whether public or corporate, readiness for technological adaptation, as well as the ability and propensity for change and innovation.
Let’s go through these factors one by one and see what might have changed since 2018.
Opining about Quantity of Labor is difficult at this point in time. Demographic and immigration flows take years or even decades to make themselves apparent, and as such, making any conclusions at this point would be, at the very least, premature. Even so, there have been some recent data releases that seem to be more encouraging on this score. What’s more, given the popular support for the Revolution, one could even hypothesize that the country’s birth rate may improve. Humans are, at least partially, driven by sentiment and confidence, and thus improved perceptions of future outcomes with regard to issues such as social justice and equal opportunity could potentially have positive ramifications for birth rates. To summarize, since the 2018 changes, an upside to this variable is easier to discern than otherwise.
With regard to Labor force experience and education, perceptible changes are unfortunately not there yet. Statistics on educational outcomes in Armenia are difficult to come by, also because the country has not participated in international ranking tables to date. What’s more, policies on educational reforms have, since the 2018 government change, either not been formulated or made public yet. In addition, public expenditure on education, which for years has been decreasing as a share of the budget and GDP, continued its downward path also in the 2019 budget.
These considerations make it difficult to draw positive conclusions on structural change in this labor force qualification variable, at least at the present. While some initiatives like Armath are both broad and impactful, they have been in place for several years and are driven by NGO and private sector stakeholders. It is not groundbreaking news in any way that Armenia’s main success factor will be its labor force qualification depth and width within the Tech and IT industries. This, and to some extent, previous governments did in fact put emphasis on Tech/IT, creating national and international buzz, resulting in an increased demand for such labor, but an inadequate addition to supply. The result? Higher wages, lower international competitiveness and increasing anecdotal (and quite disconcerting) evidence of Armenian tech firms outsourcing projects abroad!
On the Quantity of capital, the issue is multifaceted. The availability and price of domestic sources of finance in the long run ultimately depend on savings rates (risk perceptions and propensity to provide credit by investors and banks impact shorter run financial ease). Two effects can be mentioned on this matter. On the one hand, the welcome decrease in the shadow economy seems to have increased public revenues and, by extension, savings rates. On the other hand though, expected tax cuts are likely to return as much, if not more, of these new funds back to the private sector. An intermittent conclusion is that savings rates are likely to remain the same or lower until and unless new policies are implemented.
Foreign capital on the other hand (for the purpose of this article, defined as private sector and Western multilateral, and non-state-owned enterprise driven), usually takes into consideration and evaluates factors such as policymakers’ propensity for reform, as well as the opportunity for profit. On the first score, needless to say perceptions have changed for the better, which is likely to transpire into more infrastructure and other public sector initiative funding. With regard to profit generating opportunities, the improvement is less clear. Bottlenecks such as labor force quality, logistics, the absence of supply chains and others persist, raising the cost of doing business and restricting the set of available profit opportunities for foreign investors.
Making conclusions about the longer term changes in the fourth variable, Natural resources endowment, is an easier task. While not a major economic driver per se, accounting only for some 3 percent of GDP in 2016, it did account for 20 percent of goods exports in the same year, bringing a considerable amount of foreign currency, which is of substantial importance to Armenia, given the lack of export competitiveness. What’s more, given new mining pits that were due to start operating, both of the above numbers were bound to increase. This is not to argue about the pros or cons of mining as an economic driver in Armenia (which, to be frank, I’m not a proponent of); instead, the above aims to provide a sober analysis on the outlook for the mining sector in general. To summarize then, the longer term changes in this variable will likely play a relatively minor, but still negative effect on the structural growth outlook.
Structural Growth has a Further Underappreciated and Substantial Upside
Reviewing the above, it seems the picture is rather mixed with regard to changes in Armenia’s structural growth outlook since 2018. The analysis is not complete though, as the main change that has taken place thus far, is with regard to how these talents, resources, endowments are going to be managed and overseen (M/T).The question here is whether these four factor inputs are going to be utilized more or less efficiently and productively. Here, I’m more confident that the Velvet Revolution has indeed catalyzed and facilitated meaningful improvement and thus raised longer run GDP growth projections. The issues of shadow economy reduction, legal fairness, property rights will indeed spur longer term productivity increases. Not least because individual creativity and effort will now be unleashed and rewarded in a more meritocratic manner. Current policies also lead one to believe that technological penetration in the economy is indeed encouraged by policymakers, which, to state the obvious, will improve resource utilization. Finally, this Government seems more committed and determined to adopt best practices, policies and reforms that have led to successful outcomes elsewhere.
To conclude, trend growth has indeed likely turned upwards because of the new policies and approaches undertaken. Is there more potential for an upside? Definitely. Many of the bottlenecks mentioned will be difficult to solve for any Armenian Government in the foreseeable future. Yet on the matter of Tech and IT education, not only is there substantial room for improvement, but also, I would argue, an underappreciated potential for a further meaningful upside – both in the short and in the long-term. This endowment factor, and to some degree the capital accumulation one (i.e. savings), is what future policies should put the greatest emphasis on.
by the same author
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