Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized v1 82320 KAZAKHSTAN’S PATH TO GREATER PROSPERITY THROUGH DIVERSIFYING VOLUME I: OVERVIEW JUNE 2013 © 2013 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street NW Washington, DC 20433 USA All rights reserved The report was designed, edited, and typeset by Communications Development Incorporated, Washington, DC. Contents Acknowledgments   iv Overview   1 Why Diversification Is Important for Development    4 Oil Wealth, Volatility, and Macroeconomic Management    9 Gaps and Opportunities for Human Capital Development    13 The Institutions that Matter for Diversification    19 Options to Increase Competitiveness in the Short Term    24 Notes   29 References   30 iii Acknowledgments This report was written by a team led by Fran- stages of preparation. The team is grateful to the cisco Carneiro, Lead Economist, Europe and Macroeconomics and Growth Research Group Central Asia Region at the World Bank. Daniel (DECMG), the International Trade Research Lederman, Lead Economist and Deputy Chief Department (PRMTR), and the Economic Economist, Latin America and the Caribbean Policy and Debt Department (PRMED) for their Region, provided insightful advice on the con- support during the preparation of this report. cept and structure of the report and contrib- The core team included Dorsati Madani, uted substantive inputs at various stages. Ilyas Sarsenov, Evgenij Najdov, Esther The team is grateful to the government of Naikal, Sarosh Sattar, Igor Kheyfetz, Samuel Kazakhstan for its support to this work since its Maimbo, Aziz Atamanov, William Battaile, early stages. The high-level brainstorming on Ervin Dervisevic, Havard Halland, Rinaldo economic diversification held in Astana on April Pietrantonio, Jose Molinas, and Emanuel 16, 2013, with senior Kazakh authorities pro- Salinas. Prof. Eduardo Engel (Yale University vided useful insights. The team also benefited and National Bureau for Economic Research) immensely from early interactions and guidance and Constantino Hevia (DECMG) prepared received from Yerbol Orynbayev, Deputy Prime background papers on optimal fiscal rules and Minister; Kairat Kalimbetov, Deputy Prime Min- resource administration. Alain D’Hoore and ister; Madina Abylkassymova, Vice-Minister of Enrique Blanco Armas were the peer reviewers Economic Development and Trade; government and provided useful guidance to the team. officials from the Ministry of Finance, Min- Naotaka Sugawara prepared several of the istry of Labor and Social Protection, and the figures used in the text. Sarah Nankya Babirye National Bank of Kazakhstan; and representa- provided superb editorial assistance. Gulmira tives from the Economic Research Institute. The Akshatyrova and Xeniya Novozhilova, from team also met with the private sector and civil the Astana country office, and Oxana Shmidt, society organizations in Almaty and Astana at from the Almaty country office, supported the different stages and thanks them for their time team during the several missions associated and thoughtful views on the scope of this work. with this task. The work was carried out under The report uses the analytical framework of the overall supervision of Ivailo Izvorski, Sector the World Bank’s Flagship Report on growth and Manager, Poverty Reduction and Economic diversification in Eurasia. The team benefited Management Sector Unit: Macro Economics 1 immensely from very insightful discussions with (ECSP1), and Yvonne Tsikata, Sector Director, Indermit Gill, Chief Economist, Europe and Poverty Reduction and Economic Management Central Asia Region at the World Bank, and his Sector Unit (ECSPE). Saroj Kumar Jha, team, in particular Kazi Matin, Ivailo Izvorski, Country Director for Central Asia, and Sebnem and Willem van Eeghen, who were kind enough Akkaya, Country Manager for Kazakhstan, to brainstorm with the core team on different provided guidance and supported the team. iv Overview Kazakhstan aspires to become one of the world’s determinants of these divergent trajectories? 30 most developed economies by 2050. The gov- More often than not, the successful countries ernment’s recently announced 2050 Strat- used their endowments more efficiently and egy outlines how the country would refine its focused their policies on reducing volatility, long-term socioeconomic strategy to achieve enhancing productivity, and creating the con- this goal. The focus is on laying the basis for ditions for employment growth. the accelerated diversification of the economy through industrialization and infrastructure This report adopts an analytical framework, used in development—and by enhancing human the World Bank’s Eurasia Flagship Report,1 to look capital to drive innovation and economic effi- into options that could help the authorities to think ciency. Horizontal policies to improve the about diversification across three dimensions: diver- overall business environment are a core part of sification of endowments, diversification of prod- that strategy. The government is also focused ucts and services, and diversification of economic on several vertical policies, as articulated in partners. Endowments are classified as endow- the Industrial Acceleration Plan 2010–14. Like ments that the country already has, such as many other successful resource-rich countries, natural capital, and endowments that can be Kazakhstan has a real chance of fulfilling its created and further developed, such as physi- ambitious objective, but many perils lie ahead. cal, human, and institutional capital. Diversifi- This report addresses some of the main ques- cation of a larger and more diverse basket of tions likely to confront the authorities in the products and services—for domestic consump- pursuit of the country’s aspiration (see spot- tion and for exporting to a more diverse pool light 1). of trade partners—should be the outcome of the structural transformation that the econ- The world’s wealthiest countries have enjoyed rising omy will need to go through. In line with this living standards, and many of them have increased approach, the objective of policy should be to their wealth and prosperity on the back of abundant reduce economic volatility, promote productiv- natural resources. The United States, Canada, ity growth, and create employment. and Norway are well endowed with natural resources and have used this abundance to Further structural transformation and economic create other forms of capital. But their success development in Kazakhstan will require a sharper is not the norm. Many other countries that focus on the country’s less abundant endowments. In started with sizable natural resource endow- this context, this report looks at the quality and ments have not become more developed or provision of human capital and the gaps and diversified. And still others have fallen prey to opportunities for improving the quality of insti- the middle-income trap. What are the main tutions. While diversifying these endowments, 1 Beyond oil—Kazakhstan’s path to greater progress through diversifying especially institutions, is a long-term proposi- The region is blessed with natural resources, tion, this report argues that there can be some but it could do much to better convert resource quick wins. Consider fixing the education sys- rents into resource revenues. Subsoil assets per tem, or improving the business environment capita in Eurasia are at least three times higher further, or giving people more economic free- than in Latin America and at least two times dom, or enabling innovative finance through higher than in the Middle East and North nonbank financial institutions, or even accept- Africa.2 Despite that abundance, the wealthi- ing the idea that a “business failure” is not an est countries in Eurasia, including Kazakh- 2 economic disaster but a market signal about stan, have a weaker track record in converting allocative efficiency. their natural capital into other forms of capi- tal. Table 1 outlines the reform priorities for If Kazakhstan uses the right policy levers well, it Kazakhstan over the medium and long term. could move forward fast and become a model of eco- Spotlight 1 sums up the main questions and nomic development and diversification in Eurasia. answers—that each chapter discusses. Table What should the reform priorities be? 1 Strengths Shortcomings Resource wealth Resource wealth can be an important source of revenues and financing for development. It can be a source of macroeconomic volatility, create Dutch disease, and offer few links to the rest of the economy. Macroeconomic management Macroeconomic management has been prudent and consistent; there are clear rules for the Excessive reliance on oil revenues can lead to management of oil revenues. macroeconomic imbalances; recent changes in the fiscal rule governing the oil fund create expectations of future relaxation of fiscal discipline; the level of nonperforming loans is one of the world’s highest. Trade Exports have increased significantly since independence; there has been Oil exports have risen faster than nonoil exports leading to growing some diversification and experimentation; there are several emerging export concentration; while there has been experimentation with new champions where Kazakhstan has recently become competitive and also exports, survival rates remain low. promising new opportunities. Labor Economic growth has generated a substantial Kazakhstan spends relatively little on education (3% of GDP); the quality of education is perceived number of jobs; employment and real wage as low; there is a perception that the workforce lacks adequate skills. growth have led to substantial poverty reduction; there has been a reduction in self- employment in favor of wage employment over the last decade. Institutions Kazakhstan ranks 49th Corruption is perceived as high and anticorruption institutions as ineffective; there are limits on property ownership by in the 2013 Doing foreigners and enforcement of contracts; credit availability to the private sector is seen as limited. Business survey; there have been recent efforts to improve governance institutions; taxes are perceived as low. Source: Authors. Spot­ light The main questions and answers addressed in this report 1 Questions Answers Why diversification is important for development How rich and abundant Kazakhstan is on natural resources? Kazakhstan is rich in natural resources, but it has not yet accumulated as much wealth as the richest countries in the world. How well has this wealth been used? On the back of natural resource abundance, poverty has been halved in a decade, and the country has moved fast from low incomes at independence to an upper middle-income country today. In the absence of major shocks, Kazakhstan can achieve high-income status by the end of this decade. How Kazakhstan can become a more developed economy? The path to increased wealth, prosperity, and diversification in Kazakhstan will be 3 paved with policy options that strengthen fiscal discipline, harness the skills of its labor force, and reshape the institutions that regulate the activities of public and private agents. Oil, diversification, and volatility Have Kazakhstan’s exports become more concentrated? Kazakhstan has increased the number of products that it exports, but oil exports have grown faster, and many new export products do not survive long enough. There has thus been a growing export concentration and dependence on oil. How does dependence on natural resource exports affect Dependence on natural resource exports can create volatility in trade, which macroeconomic volatility? can transmit volatility to the rest of the economy. Kazakhstan is susceptible to these transmission channels but has avoided them with prudent fiscal policy management. What are the potential welfare gains from various fiscal rules? An optimal fiscal rule could bring savings of close to 25 percent of GDP over the next 25 years but would be difficult to implement. A simpler rule with an exit clause for periods of severe private sector downturns could yield similar benefits. What are the lessons for the future? Beyond prudent macroeconomic management, Kazakhstan could diversify its export basket by solving private sector market failures that have thus far hampered its ability to produce and export new products to new markets. Human capital for diversification Where are the jobs in Kazakhstan? Mining and oil, the drivers of growth, employ very few people. Manufacturing also generates little employment. Most jobs are in the service sector; the public sector is also an important employer. Do Kazakh workers have the skills demanded by the market? Each year, more than 300,000 workers enter the labor force in Kazakhstan, but young workers often lack adequate basic skills despite having formal credentials from the country’s education system. What will need to change to reduce the mismatch in the labor Addressing mismatches between the supply and demand for labor is a priority. market? This will require understanding the exact skills necessary for the country’s economic development and aligning the quantity of graduates to the needs of the economy. The institutions that matter for diversification Does Kazakhstan have a strong governance and regulatory Kazakhstan’s institutions have improved since independence but their performance environment? remains mixed. There are many good laws, but they are not always implemented. Corruption is a recurring problem. Are market institutions well developed in Kazakhstan? The country is well ranked on most indices of the strength of market institutions. However, major constraints such as market contestability, the major role of the government in the economy, and an underdeveloped financial sector hold back private sector growth. What will need to change to strengthen Kazakhstan’s institutions? Greater efforts will be required to respect the rule of law to improve the quality of service delivery; make room for the private sector and encourage competition; make the public sector more efficient or smaller; get the financial sector in order; and commit to efficiency and reward excellence in the public sector. Options to increase competitiveness in the short term Where are Kazakhstan’s comparative advantages? Kazakhstan has comparative advantages in products with low technological content, such as mining, iron and steel, and animal leather. Has Kazakhstan faced excessive trade barriers? Important trade partners like China, the EU, Japan, and the Republic of Korea impose higher tariff protection for food products. Kazakhstan faces more difficulties to reach new markets due to the lack of competitiveness of its nonoil exports. How could better logistics help? With exports projected to increase by 50 percent by 2020, and additional freight capacity service on the main export routes to the Russian Federation, China, and Korea, Europe and Central Asia will require much improved transport corridors. When can industrial policy be useful? Sector-specific policies need to promote productivity and not shield stagnant sectors. But such policies can be highly detrimental if they entrench interests among the beneficiary firms and end up making such arrangements permanent. What can be done to help diversification? In the long run, improvements in education, productivity, and institutions will be necessary for diversification. As an intermediate step, however, increased multilateralism beyond Central Asia will help, but it would be equally important to undertake reforms to reduce nontariff barriers and reduce the costs of trading across borders. Why Diversification Is Important for Development Kazakhstan is rich in natural resources, but it has not stocks well in excess of $100,000 per capita yet accumulated as much wealth as the world’s richest in 2010. countries. Kazakhstan’s total wealth in 2008 was estimated at $1,177 billion. Sizable, but Kazakh- Having benefited from a favorable external environ- stan still has a long way to catch the world’s ment, high oil prices, and fast productivity growth, richest countries. Its total wealth per capita Kazakhstan enjoyed steady economic growth and out- at $75,112 is lower than the average for upper standing poverty reduction in fewer than 10 years. middle-income countries ($105,000 per capita) With improving terms of trade and rising oil and Europe and Central Asia ($110,000 per prices, the Kazakh economy outgrew those of capita). In addition, the country has not been its peers in the region and brought the country very successful in converting its natural capital to the group of upper middle-income countries. into other forms of capital, a warning sign that The share of the population living in poverty growth may falter if the oil runs out. With the (as measured by the PPP-corrected $2.50 per vast majority of Kazakhstan’s wealth embed- capita a day) fell from 41 percent 2001 to 4 per- ded in its nonrenewable natural resources, the cent in 2009. If the external demand for oil country faces the challenge of managing them and other commodities remains strong and oil effectively and recovering their resource rents prices are not disrupted by other unexpected for investments in other forms of capital, such economic or political factors, Kazakhstan’s cur- as education and infrastructure. rent income per capita could double by 2020, placing it among the high-income countries. Natural capital is sizable, and progress in increas- ing physical capital per capita has been impressive, Kazakhstan’s performance on the World Bank’s indi- but the gap with the wealthiest countries remains cator of shared prosperity shows significant progress. wide. Kazakhstan is the third wealthiest coun- The shared prosperity indicator is the growth try in natural capital and oil and natural gas in of consumption per capita of the bottom Eurasia, but it is far from the per capita levels 40 percent of the population. In Kazakhstan, observed in other resource-rich countries like the average consumption growth for all house- Kuwait, Norway, and Saudi Arabia (table 2). For holds was about 7 percent over 2001–09, while physical capital, the story is not very different. that of the bottom 40 percent was about 11 per- Kazakhstan increased its physical capital per cent. Only Moldova did better among Europe capita from $6,800 in 2000 to $13,100 in 2010 and Central Asian countries (figure 1). (table 3). It is now the fourth wealthiest in Eur- asia in per capita physical capital, but it is still Growth has been pro-poor, and poverty responded far from the developed countries. For example, more to nonoil growth. There is a strong cor- Norway, Australia, and the United States had relation between economic growth and the 4 Table Natural capital per capita in Eurasian countries and other selected countries, 2005 2 (thousands of 2005 US$) Natural capital Land and forest Coal and minerals Oil and natural gas Russian Federation 31.3 7.1 1.0 23.2 Kazakhstan 23.9 3.6 3.1 17.2 Azerbaijan 11.7 2.5 0.0 9.2 Uzbekistan 7.7 2.3 0.0 5.4 Ukraine 6.9 4.9 0.6 1.4 Belarus 6.0 5.2 0.0 0.8 5 Moldova 4.1 4.1 0.0 0.0 Georgia 3.3 3.2 0.0 0.1 Armenia 3.1 3.0 0.1 0.0 Kyrgyz Republic 3.0 2.9 0.0 0.1 Tajikistan 1.8 1.7 0.0 0.0 Turkmenistan 1.0 1.0 0.0 0.0 Eurasia 20.2 5.4 0.8 14.0 Comparators Kuwait 213.1 1.1 0.0 121.0 Norway 110.2 10.5 0.0 99.7 Saudi Arabia 97.0 10.4 0.0 88.6 Australia 40.0 19.7 10.7 9.7 Canada 36.9 24.3 1.1 11.5 Chile 18.9 9.3 9.3 0.3 Brazil 15.0 12.7 0.9 1.5 United States 13.8 10.3 0.5 3.0 Malaysia 12.7 2.6 0.0 10.1 Germany 5.7 5.2 0.1 0.4 Korea, Rep. 2.6 2.6 0.0 0.0 Singapore 0.0 0.0 0.0 0.0 Source: World Bank (2011). decline in poverty during 2001–09 (figure 2). diversifies its economic structure, its products, The sensitivity of poverty reduction is strongest and its partners—and that becomes less reliant to changes in nonoil growth rather than total on its most abundant endowment—is also less growth, as seen in their respective elasticities of sensitive to macroeconomic shocks transmit- 4 percent and –0.1 percent.3 This reflects the ted through large fluctuations in commodity fact that nonoil growth is shared by a higher prices. And with resource extraction highly portion of the low-income groups in the short intensive, diversification creates addi- capital-­ term, most likely through labor market chan- tional sources of employment for the labor nels. But rural poverty was almost four times force. Indeed, recent research finds a positive higher than urban poverty in 2011. Persistent association between rising economic diversifi- higher poverty in rural areas can be explained cation and rising per capita income for coun- by larger families with more children, poor tries with per capita income of up to $20,000. infrastructure and access to markets, and a Beyond that level, economies tend to recon- lack of human and financial resources in local centrate, though high-income countries do not governments.4 reach the concentrations usually found in low- income countries. If Kazakhstan has promoted pro-poor growth, why should it be concerned with diversification? In many Kazakhstan has grown more and more dependent on resource-rich countries, an obvious concern oil. Kazakhstan’s exports have grown very fast is what the sources of growth will be when and have helped the economy to grow equally oil runs out. A resource-rich economy that fast. With the commodity boom in the second Beyond oil—Kazakhstan’s path to greater progress through diversifying Capital stock per capita in Eurasian countries and other selected countries, 2000, Table 2005, and 2011 3 (thousands of 2005 US$) 2000 2005 2010 Russian Federation 13.5 14.3 17.2 Turkmenistan 12.2 11.4 16.8 Belarus 7.6 8.7 14.0 Kazakhstan 6.8 8.4 13.1 Ukraine 5.6 6.0 6.9 6 Armenia 2.5 3.4 5.7 Azerbaijan 2.6 4.3 5.6 Georgia 3.5 4.3 4.9 Moldova 2.5 2.7 3.4 Uzbekistan 1.8 1.8 2.2 Kyrgyz Republic 1.2 1.2 1.5 Tajikistan 0.9 0.9 1.0 Eurasia 9.3 9.8 12.1 Comparators Norway 169.6 176.4 191.3 Australia 117.5 123.6 135.8 United States 114.3 119.9 122.7 Germany 116.8 116.7 120.1 Canada 90.8 96.5 105.1 Singapore 112.9 110.1 105.0 Korea, Rep. 87.2 87.6 90.8 Kuwait 44.6 44.4 58.9 Saudi Arabia 27.6 25.9 30.4 Malaysia 32.5 27.1 24.5 Chile 19.6 20.2 23.5 Brazil 15.0 14.1 14.8 Note: Capital stock is computed by the perpetual inventory method (with depreciation rate of 5 percent) with data for 1995–2010. Source: World Bank (2011). Figure Shared prosperity indicator for selected Europe and Central Asian countries 1 Consumption growth of bottom 40% Consumption growth of total population 12.5 10.0 Rate of growth (%) 7.5 5.0 2.5 0.0 –2.5 Kyrgyz Rep. Moldova Kazakhstan Azerbaijan Ukraine Belarus Tajikistan Romania Latvia Armenia Lithuania Croatia Poland Macedonia, FYR Albania Georgia Serbia Turkey Source: World Bank staff estimates based on the PovcalNet expenditure data as of April 2013. Figure Changes in GDP per capita and poverty 2 Growth rate of GDP per capita, excluding oil Population below poverty line 10.0 0 Change in poverty (percentage points) Change in GDP per capita (%) 7.5 –3 5.0 –6 2.5 –9 7 0.0 –12 –2.5 –15 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Note: GDP per capita in 2005 US$ PPP. GDP per capita without oil is calculated by subtracting oil rents. Source: World Bank staff estimates based on ASRK data. half of the 2000s, higher oil production and ris- invest. Exchange rate volatility can also encour- ing oil prices allowed Kazakhstan to increase its age short-term capital flows, and actions to oil exports and collect more oil revenues. But limit it could result in procyclical monetary this success has been marked by an increasing policy. The Kazakh authorities have been par- dependence on oil, manifest in the rising share ticularly attentive to these challenges and cre- of oil revenues in the government’s budget, an ated credible rules for their oil fund to avoid increasing concentration of exports around oil volatility. products, and a rising share of the oil sector in the economy. The share of oil revenues in Further progress will require a different economic the total budget has remained roughly steady development model. The stylized facts reviewed so since 2009 in the range of 22–25 percent, while far tell a success story of a country that started projections through 2020 based on current and from a very low base and, blessed by its resource future oil production suggest that it is likely to abundance, joined the upper middle-income remain in that same range (figure 3). countries in a decade. As one of the world’s top oil producers, Kazakhstan has been successful Resource-rich economies, especially those excessively in avoiding the perils of resource abundance. reliant on oil, face several challenges. Many of these challenges have been articulated in the Para- The path to increased wealth, prosperity, and diver- dox of Plenty, otherwise known as the curse of sification in Kazakhstan will be paved with policy natural resources. In many oil-dependent econ- options that protect the economy from volatility, omies, one of the main features of this paradox harness the skills of its labor force, and reshape the is the volatility of oil revenues. If not properly institutions that regulate public and private agents. addressed, volatility makes economic manage- Looking forward, Kazakhstan’s development ment difficult, especially as cyclical swings objective of becoming one of the top 30 most are not typically predictable. The difficulties developed countries by 2050 will require a are compounded by the common correlation steady hand at macroeconomic management to between fiscal revenues and expenditures. avoid volatility associated with oil dependence, Volatility in revenues, associated with volatility substantial improvements in governance and in aggregate public and private expenditures, transparency, a business-friendly regulatory creates real exchange rate volatility. That can environment, better skills for its labor force, make profits in the tradable sector very unsta- and social policies that improve the living stan- ble and risky, creating further disincentives to dards of Kazakh citizens (figure 4). Beyond oil—Kazakhstan’s path to greater progress through diversifying Figure Addiction to oil 3 Share of oil revenue in the government budget, 2006–12 Oil revenue spent Oil revenue saved 50 40 Share of total revenue (%) 30 8 20 10 0 2006 2007 2008 2009 2010 2011 2012 Oil and nonoil revenues and expenditures as a share of GDP, projections to 2020 Nonoil revenue Oil revenue spent Oil revenue saved Government spending 50 40 Share of GDP (%) 30 20 10 0 2000 2005 2010 2015 2020 Source: World Bank staff estimates based on Ministry of Finance of Kazakhstan data. Figure Endowments and policy objectives that matter for development and diversification 4 Physical Employment capital Human capital Productivity Reducing volatility Institutional capital Endowments that matter Objectives of policy Source: Authors. Oil Wealth, Volatility, and Macroeconomic Management Kazakhstan’s exports have increased sharply since Despite growing experimentation, survival rates were independence, but the country has exported more of low across the board. The survival rate at the end the same to old partners. The value of Kazakh- of the 2000s was 79 percent for existing prod- stan’s total exports has increased from $6 bil- ucts but only 27 percent for new products.6 The lion in 1996 to $49 billion in 2010 (in constant experimentation rate—or the share of poten- 2005 prices), more than an eightfold increase. tial additional products in a broad product Nonoil exports have increased in value, and category that appeared in the export basket at new products have been added to the export one time or another—was high, particularly basket, but oil exports have grown faster, so in metals, textiles, and manufactured goods. Kazakhstan has increased its export concentra- The highest survival rates were for some foods, tion even more than other resource-dependent chemicals, minerals, and some electrical and countries (figure 5). manufactured products. Survival rates were low in textiles, some apparel, wood-based products, Kazakhstan has exported more of the same to old animal-based products, some manufactured markets. The larger contribution to export products, and (surprisingly) metals. These low growth is from the growth of exports of old rates offset the contribution of experimenta- products in old markets and, to a lesser extent, tion to the net growth of exports and hint at old products in new markets, consistent with difficulties in the business environment, the earlier findings of little export diversification competitiveness of exports, protectionist prac- (figure 6). Kazakhstan has diversified its trade tices against Kazakhstan, or a combination of partners somewhat, but this had a declining all three. impact on export growth, especially in the sec- ond half of the 2000s. There has also been a Fiscal rules for managing volatility growing extinction of products, which prob- ably demonstrates higher “experimentation.”5 Dependence on oil is associated with export con- centration and terms of trade volatility, which can Kazakhstan’s nonoil exports to most of its major trad- bring about domestic macroeconomic volatility. Net ing partners have grown over time. Exports to its exports of natural resources are usually asso- largest trade partner, China, have grown at close ciated with macroeconomic volatility, but this to 20 percent a year, higher than world exports does not happen linearly. The transmission to China, so Kazakhstan gained market share channel is multifaceted and involves volatil- there. Kazakhstan exporters also gained market ity in a country’s terms of trade. That is, net share in the U.S., Japanese, Turkish, and Italian exports of natural resources (particularly oil) markets. The exceptions are markets in the Rus- are associated with export concentration that sian Federation and Islamic Republic of Iran. can then lead to volatility in terms of trade. 9 Beyond oil—Kazakhstan’s path to greater progress through diversifying Figure Kazakhstan’s export concentration has risen from 1996 –98 to 2008 –10 5 Exports 1996–98, $17.8 billion (constant 2005 international $) Exports 2008–10, $151 billion (constant 2005 international $) 10 Primary products Low-tech 2: other High-tech 1: electronics and electrical Resource-based manufactures 1: agro-based Medium-tech 1: automotive High-tech 2: other Resource-based manufactures 2: other Medium-tech 2: processing Special transactions Low-tech 1: textile, garments, and footwear Medium-tech 3: engineering Source: World Bank staff estimates based on Comtrade data. Figure Not much diversification of products and partners, 2000 –10 6 2000–10 2000–05 2006–10 1.5 Percentage point contribution 1.0 to export growth 0.5 0.0 –0.5 Old products Fall of Extinction New products New products Old products in old markets old products of products in new markets in old markets in new markets in old markets Source: World Bank staff estimates based on Comtrade and World Development Indicators data. Volatility in terms of trade can then cause discover or begin to exploit oil reserves, it domestic macroeconomic volatility. Evidence would be optimal for society to consume suggests that this sequence of effects is statis- more and reduce the share of investment in tically meaningful both across countries and GDP. The economy has become richer, so for Kazakhstan. In this context, the use of the incentive to save would be reduced. The fiscal rules for managing the volatility of oil problem for policymakers is that such a world export revenues becomes an important tool for does not exist. Saving too little today to fund policymaking. current consumption can be both risky from a debt management view and from a national If oil export revenues were stable, fiscal rules welfare view. The volatility of consumption would be unnecessary. Indeed, when economies directly reduces household welfare, and macroeconomic volatility hampers private Norway, applying the bird-in-hand rule over investment. the life of the extraction cycle implies higher saving and lower transfers to the budget in the The best fiscal rules explicitly include an element of earlier years because the principle driving this countercyclicality. An optimal fiscal rule could rule is the uncertainty about future revenues. bring savings of close to 25  percent of GDP Such an approach is appropriate for mature over the next 25 years. But it would be dif- producers with large accumulated financial ficult to implement because of the need to reserves and an extraction cycle close to the rely on numerous economic parameters while end. Current projections for Kazakhstan 11 deciding what to do with current oil revenues. show that the annual transfers from the oil Econometric simulations suggest that a simple fund to the budget are expected to surpass its rule based on a standard permanent-income investment income only by 2025. So, adopting approach—with an exit clause for periods of this type of rule in Kazakhstan could reduce severe private sector downturns—could yield the nominal amount transferred to the budget benefits similar to the optimal (and extremely significantly until at least 2025. complex) rule. An additional advantage is that it could provide discretion to the fiscal author- A simple fixed transfer rule with an escape clause ity to tap the oil fund in severe transitory reces- allows nearly as much gain in welfare as does a theo- sions (a 30 percent drop in private income).7 retically optimal rule. That is, a fixed rule with clear criteria to allow for a deviation from the Kazakhstan’s fiscal rule performs well against other fixed amount to be transferred to the budget types of rules. Several criteria can assess the every year for a limited period (the escape robustness of a given fiscal rule, and this report clause) performs as well as an optimal and considers those of Kopits and Symansky (1998) very complex rule. The countercyclical policy to test how well the current rules in Kazakhstan stance adopted to cushion the effects of the perform. These criteria include several aspects 2008–09 economic crisis was a de facto imple- that would be expected in any fiscal rule, but mentation of such a rule. For the future, this the most important is that fiscal rules should approach could be codified—specifying the be simple and transparent for reasons of threshold for triggering an escape clause and credibility and enforceability. Kazakhstan does the number of years for such an alternative well on both criteria (and in many others). regime to remain in effect before assuming that the shock is chronic rather than transitory. The fiscal rules in Chile and Norway highlight differences with those in Kazakhstan. The There are three main recommendations to deal with differences do not, however, mean that the transitory shocks within the current fiscal rule. Kazakh rule is inferior. Chile’s fiscal policy is • First, consider revisiting the $8 billion base anchored on a structural balance target that amount that has been in effect since the depends on the long-term price of copper inception of the rule in 2010 and that has while Norway’s follows a complex structural not been reevaluated since that time. Apply- deficit rule that depends on the nonoil deficit. ing the growth of nonoil GDP would adjust While these rules have desirable properties in the base to about $11  billion. That should theory, they are very hard to implement and preserve the nondistortionary character- not entirely transparent. And if they are too istics of the original $8  billion base while difficult to implement, they can undermine allowing for the greater absorptive capac- the credibility of the government in financial ity of the now-larger domestic economy. markets. Simple, effective, and transparent, the For the future, periodic adjustment of the Kazakh rule has dealt with transitory shocks in base might be desirable. In principle, the a satisfactory way. goal would be to use trend growth in nonoil GDP, something that could be calculated A bird-in-hand rule would not be a good replacement only over longer periods—four to five years, for the current Kazakh fiscal rule either. As in if not longer. Beyond oil—Kazakhstan’s path to greater progress through diversifying • Second, confirm the current fixed rule but the structure of the tax code (by doing add two limiting factors for implementing such things as making taxes conditional any 15  percent deviation. One factor is to on income or profits) and the structure specify the size of the shock that would trigger of expenditure programs (by doing such such a deviation, and the other is to impose a things as making poverty or other assis- time limitation on how long such additional tance programs conditional on income or transfers could be used (say, two years). employment status) to make countercyclical • Third, implement “automatic stabiliz- revenue and expenditure changes as auto- 12 ers” to the extent possible. That is, use matic as possible. Gaps and Opportunities for Human Capital Development Economic diversification will require a highly skilled education system. In 2009, Kazakhstan par- labor force and productivity and job creation in the ticipated for the first time in the Programme nonoil sector. According to the World Economic for International Student Assessment (PISA) Forum’s classification of different stages of that assesses functionality of students in math- development, Kazakhstan’s GDP per capita ematics, reading, and science. The PISA results of $11,000 places the country in the group of suggested that Kazakhstan students under- economies transitioning from an efficiency- performed on these assessments compared driven stage of development to an innovation- with their peers in other income comparator driven stage of development (figure  7). The countries (figure 8). In particular, students relevant question, however, is whether Kazakh- underperformed compared with other coun- stan has the characteristics typical of an effi- tries at similar levels of development, scoring ciency-driven economy: good higher education an average of 40 exam points lower on the PISA and training, efficient goods markets, efficient reading scale—equivalent to about one year labor markets, to name a few. of schooling—than the level predicted by the country’s GDP per capita (figure 9). Each year more than 300,000 new workers enter the Kazakh labor force. In 2011, 160,000 students There are, however, two bright spots on Kazakh- graduated from public and private universi- stan’s record of cognitive skill provision, as mea- ties. Another 184,000 completed vocational sured through international student assessments. secondary education in colleges and profes- The first is the aspect of gender differences. In sional lyceums.8 Thousands more entered the the PISA 2009 round of assessments, Kazakh- labor force with general secondary education stan’s 15-year-old girls scored significantly bet- or less. Among young workers ages 16–24 not ter than boys on the reading portion of the enrolled in school, about 41 percent enter the assessment and slightly better than—though labor market with general secondary education not statistically differently from—boys on the or below, 36 percent with vocational secondary mathematics and science assessments. In math education, and 23 percent with higher educa- in particular, Kazakhstan’s gender-balanced tion degrees. performance stood in stark contrast to most of the comparator countries and the Organisation In international terms, Kazakhstan fares poorly for Economic Co‑operation and Development when it comes to providing adequately trained work- (OECD), where girls typically underperformed ers to the labor market. The new entrants to the in relation to boys. labor market often lack adequate levels of basic skills when entering the labor force despite The second bright spot is the possible improvement having formal credentials from the country’s of Kazakhstan’s performance over time in these 13 Beyond oil—Kazakhstan’s path to greater progress through diversifying Figure Competitiveness and different stages of development 7 (percent, unless otherwise indicated) Stages of development Stage 1: Transition from Stage 2: Transition from Stage 3: factor-driven stage 1 to stage 2 efficiency-driven stage 2 to stage 3 innovation-driven GDP per capita thresholds <$2,000 $2,000–$2,999 $3,000–$8,999 $9,000–$17,000 >$17,000 Weight for basic requirements subindex 60 40–60 40 20–40 20 Weight for efficiency enhancers subindex 35 35–50 50 50 50 14 Weight for innovation and sophistication factors subindex 5 5–10 10 10–30 30 Basic requirements Stage 1 • Institutions Key for • Infrastructure factor-driven • Macroeconomic environment economies • Health and primary education Ef ciency enhancers • Higher education and training Stage 2 • Goods market ef ceincy Key for • Labor market ef ciency ef ciency-driven • Financial market development economies • Technological readiness • Market size Innovation and sophistication factors Stage 3 Key for • Business sophistication innovation-driven economies Source: World Economic Forum (2012). Figure Students in Kazakhstan underperformed in PISA tests compared with their peers 8 Mathematics Reading Science 75 Share of students performing at level 1 or below (%) 50 25 0 Kazakhstan Malaysia Russian OECD Hungary Poland Singapore Federation Note: Malaysia’s students were assessed in 2010 as part of the PISA 2009 Plus round of assessments. Source: World Bank staff estimates based on data from OECD (2010) and Walker (2011). Figure The average reading score is relatively poor in Kazakhstan 9 550 Poland Estonia 500 Hungary 2009 mean performance Latvia Slovenia Turkey Croatia Czech Rep. Lithuania Slovak Rep. Serbia Russian Federation 450 Bulgaria Romania Montenegro 400 Kazakhstan Albania 15 Azerbaijan 350 Kyrgyz Rep. 300 0 25,000 50,000 75,000 100,000 2008 GDP per capita, PPP (current international $) Note: The best-fit line represents a regression of countries’ predicted PISA scores based solely on GDP per capita. The dotted line represents the OECD mean reading score. Source: Sondergaard and Murthi (2012). international benchmarking exercises. The results of the PISA 2012 round, which will for recently released 2011 results of the Trends in the first time allow Kazakhstan to examine International Mathematics and Science Study its performance over time in a comparable (TIMSS) indicate that Kazakhstan’s students manner. performed closer to—though still slightly behind—their peers in comparator countries There is excess demand for workers with higher than they did in PISA 2009.9 The results were and vocational education and excess supply of particularly encouraging for Kazakhstan’s workers with general secondary education and fourth graders, who scored significantly below. Workers with basic vocational skills are higher than their counterparts in Poland on in higher shortage than workers with higher the TIMSS 2011 mathematics assessment. education (figure 10). In fact, for men a basic However, it is not possible to draw conclusions vocational degree was highly valued in the about trends in performance across different labor market in 2010, while higher education types of assessments. Policymakers should degrees were in demand for both men and therefore keep a close eye on the forthcoming women Over 2002–10, there was a substantial Figure Labor shortages and surpluses by education attainment, 2002 and 2010 10 2002 2010 0.5 Shortage 0.0 Index Surplus –0.5 –1.0 Basic General Basic Secondary Higher secondary secondary vocational vocational Note: The index is calculated as (e/u –1), where e and u are respectively employment and unemployment shares of a given occupational group. Positive values of index indicate shortages of particular occupational group, while negative values indicate a surplus. Source: World Bank staff estimates based on ASRK data. Beyond oil—Kazakhstan’s path to greater progress through diversifying reduction in the shortage of workers with the fastest growing sector, up from 38 percent secondary vocational and higher education, four years earlier, and 31 percent of the overall but a slight increase for workers with basic workforce, up from 26 percent in 2007. These vocational education. gains—as well as the modest gains by voca- tional graduates—have come at the expense Most employers place a high value on skills and of those who receive no specialized vocational training, but they do not always pay for it.10 Firms training at the secondary or postsecondary place high requirements for formal educa- level (figure 11). 16 tional qualifications on the workers they expect to hire—when hiring specialists and Despite continuing employment growth, the education managers, more than two-thirds of all employ- system produces more graduates in some sectors ers prefer candidates with higher education than the labor market can absorb. Although there degrees. For most other positions, vocational has been no net job creation in agriculture or specialized secondary education is pre- in recent years, Kazakhstan’s vocational ferred—a general secondary diploma is not education institutions continue to produce enough. When asked to rate skills based on thousands of agriculture specialists. Industry- importance for their specialists, 500 employ- and construction-related specializations ers put the ability to work independently at also receive more technical and vocational the top of the list, followed by time manage- education (TVE) graduates each year than ment. Communication, analytical thinking, the number of jobs created. Only in some problem solving, and customer relations were parts of the service industry does job creation also important for at least three-quarters of keep up with the number of graduates.12 And employers. The main reason firms find it dif- although large quantities of graduates enter ficult to fill vacancies for specialists (the most the labor force each year, they may still lack demanded occupation) is the low quality of the appropriate quality and mix of skills that local training, cited by 63 percent of employ- employers demand. ers. While less than half of Kazakh employers provide opportunities for worker training or A two-pronged approach could better align secondary retraining, the likelihood of receiving training education needs with market needs. This would tends to increase with the level of skill (special- involve improving access to labor market ists receive training in more than 40 percent of information to facilitate the matching of surveyed firms).11 skills and needs—and encouraging closer collaboration between educational and The key question for Kazakhstan: is the country’s research institutions and private firms to education sector producing the right kinds of work- foster sector-specific research and human ers? Between 2007 and 2011, the country’s capacity. Kazakhstan’s vocational and higher labor force added almost 550,000 net jobs that education institutions train more skilled were filled by graduates of higher education specialists in some sectors (such as agriculture) institutions. Another 390,000 net jobs went to than the labor market demands. TVE can be workers with vocational secondary degrees, improved by enhancing the TVE curriculum while those with general secondary education content, upgrading the qualification system or below faced a net loss of 265,000 jobs. Not to better match labor market demand, and surprisingly, the vast majority of jobs gained deferring early tracking from secondary to by those with university degrees (81  percent) postsecondary. were in services. Among vocational education graduates, 69 percent of the net job gains were Managing the flow of students into higher education in services and a further 24 percent in industry is also important. The stated goal of bringing and construction. The losses for those without the share of workers with higher education specialized degrees came mainly in agricul- degrees to 50  percent by 2020 —from ture. Higher education graduates now make 30  percent in 2010—should be considered up 43  percent of the workforce in services, in line with projected economic demand. If Figure Structure of total employment in Kazakhstan by sector and level of education, 2007–11 11 All levels of education Higher education Services Construction Services Construction Industry Agriculture Industry Agriculture 10.0 3 Employment (millions) Employment (millions) 7.5 2 5.0 1 2.5 17 0.0 0 2007 2008 2009 2010 2011 2007 2008 2009 2010 2011 Vocational and secondary education General secondary education or below Services Construction Services Construction Industry Agriculture Industry Agriculture 3 4 Employment (millions) Employment (millions) 3 2 2 1 1 0 0 2007 2008 2009 2010 2011 2007 2008 2009 2010 2011 Source: World Bank staff estimates based on ASRK data. not done carefully, the expansion of higher the Republic of Kazakhstan until 2020,13 the education can impair the quality of graduates State Program on Development of Education and exacerbate the mismatches in the of the Republic of Kazakhstan for 2011–20,14 labor market. The tertiary education gross and the Employment Program 2020,15 among enrollment rate in Kazakhstan in 2010 was others. The Strategic Plan, “Investing in the 24.8  percent, lower than the 40  percent for Future,” sets out goals for the education system Russia and the 31 percent for OECD countries. and labor force by 2020—enhancing the qual- While this would indicate room to expand, ity of skills possessed by graduates at each level access to higher education institutions should of education (box 1). not become an entitlement. Gaps remain between the stated objectives and The government’s main policy objectives focus appro- the policy needs for achieving the country’s long- priately on skills development. These objectives are term development aspirations. First, a thorough stated in the Strategic Plan for Development of understanding is needed of the skills required Box Selected strategic goals for education and labor force development by 2020 1 • General secondary schools will provide academic knowledge and develop the skills for promoting the formation of an educated, ethical, critically thinking, and physically and spiritually developed citizen, seeking self-development and creativity. • Pupils in general secondary schools will achieve high results on international comparative assessments, such as PISA, TIMSS, and the Progress in International Reading Literacy Study. • High-quality knowledge and skills of technical and vocational education graduates will be recognized by employers. • The quality of higher education in Kazakhstan will correspond to the best global practices. • The graduates of domestic higher education institutions will be in demand by employers. • The share of highly skilled workers in the working population will increase to 50 percent. Source: GoRK (2010a). Beyond oil—Kazakhstan’s path to greater progress through diversifying for the country’s economic development. • Provide in-service support to schools and Rapidly expanding the domestic pool of teachers, equipping them with innova- highly trained specialists, while simultane- tive and effective tools for curriculum ously increasing reliance on foreign labor development. (including the lower skill categories)—also • Continue with phasing-in per capita financ- envisioned by the Strategic Plan—has risks. ing as it has the potential to reform educa- To counter these risks, in-depth studies of tion systems through enhanced efficiency, the labor market demand in the medium and equity, transparency, and accountability. 18 long terms should be considered. Informa- • Deepen school autonomy and accountabil- tion needs to be gathered to identify which ity so that schools can redefine their incen- skills are important to employers and where tive structure to create better conditions for the skill gaps exist. Building this knowledge learning and teaching; create accountability base through skill measurement studies that mechanisms through community participa- can inform education and training policies is tion for school autonomy and accountability. critical to aligning government policy with the • Improve monitoring and evaluation systems country’s development needs. to identify gaps and respond on time to stu- dent and school needs. The authorities could consider several policy options • Put in place a well-articulated early child- to improve the quality of education in Kazakhstan: hood development program for children • Improve planning to address more effi- ages 0–3 years, emphasizing the most vul- ciently perceived gaps in the education nerable groups. environment. • Build job-relevant skills by offering train- • Improve teacher effectiveness and focus on ing and tertiary education and promoting teacher policies, including teacher training improvements in technical and vocational (pre- and in-service), teacher pay, and incen- education to improve the relevance of its tives to attract the most qualified. curriculum and match it to labor demand. The Institutions that Matter for Diversification The institutions that matter for diversification man- content requirements, perceived corruption, age volatility, regulate the business environment, and an insufficiently independent court system. and provide public services. The government faces uncertainty of how much revenue will be avail- Corruption remains an important concern and is a able to finance investments and provide public bigger problem in Kazakhstan than in comparator services. Private agents and investors become countries. According to the 2012 World Justice increasingly wary of taking risks and may Project, corruption is much more prevalent decide not to start new businesses or undertake in Kazakhstan than in OECD countries, with new investments. The quality of public service the legislative and judicial branches being the delivery affects the functioning of markets, most affected. A significantly higher percent- the speed of economic transactions, and even age of companies indicate that informal gifts national competitiveness. A court system that are requested or expected at various stages does not work well reduces the enforceability of of the business cycle in Kazakhstan than in contracts, the application of the rule of the law, OECD countries. The prevalence of corruption and the respect of property rights. An educa- is confirmed by the low ranking of Kazakhstan tion system that does not prepare students for a on the 2012 Transparency International Cor- competitive market limits the capacity to inno- ruption Perception Index (ranked 133 of 176 vate. These conditions limit the prospects for countries) and other global indicators such as developing the nonresource sectors and make the 2012 Worldwide Governance Indicators economic policymaking more complex. Control of Corruption and the 2012–13 World Economic Forum Global Competitiveness Indi- The quality and coverage of regulatory institutions cators (WEF-GCR), where corruption is listed have improved, but gaps remain in implementing as the second most problematic factor for regulations effectively and without discrimination. doing business (figure 13). Kazakhstan has a regulatory enforcement gap with OECD countries—especially for Markets develop and private businesses flourish when due process in administrative proceedings, the behavior of those who govern is not arbitrary. suggesting that respect for the rule of the Clear rules and a level playing field encourage law is not guaranteed (figure 12). Half the competition in well-functioning markets that respondents in a recent survey felt that legal thrive with the appearance and disappearance and regulatory transparency and predictability of opportunities. By contrast, excessive transac- are insufficient (Ernst and Young 2012). tion costs due to burdensome procedures and The main concerns are inconsistency in the regulation, incomplete definition and enforce- interpretation of laws and their selective ment of contracts and property rights, and bar- application, overregulation and onerous local riers to entry for new market participants limit 19 Beyond oil—Kazakhstan’s path to greater progress through diversifying Figure Regulatory enforcement gap with OECD average 12 China Kazakhstan Russian Federation Regulatory enforcement Government regulations effectively enforced Government regulations applied without improper in uence Administrative proceedings conducted 20 without unreasonable delay Due process in administrative proceedings The government does not expropriate without adequate compensation –0.8 –0.6 –0.4 –0.2 0.0 Note: Data are calculated from the formula [(Country score – OECD average score) / OECD average score], based on a score of 0 to 1, with 1 the highest possible score. Source: World Justice Project: Corruption and transparency. Figure Selected indicators of institutional quality for Kazakhstan and comparators, 2012 13 China Kazakhstan Russian Federation Turkey HF–Property rights WJP–Regulatory enforcement HF–Corruption 100 75 50 WJP–Crime 25 WGI–Rule of law WJP–Absence of corruption WGI–Control of corruption WJP–Limited government powers WGI–Political stability, no violence Source: World Bank staff estimates based on Heritage Foundation (HF), Worldwide Governance Indicators (WGI), and World Justice Project (WJP). opportunities and discourage new investments. strengthened and implementation arrange- Kazakhstan has done well in several areas ments effectively enforced. The country ranks important for the functioning of markets, but 92 on the 2012–13 WEF-GCR intellectual prop- it has room for improvement in others. erty rights indicator. Key legislation prescribes well defined and sound The government has taken important steps recently property rights. The constitution guarantees to establish a new model of civil service based on property rights, and this principle is included meritocracy. In March 2013, new amendments in key laws and regulations. Kazakh and for- to the legislation on the civil service came into eign individuals may establish and operate effect. The amendments provide financing businesses in most sectors and acquire, regis- for the Corps A and include annual perfor- ter, use, and sell most assets. Land ownership mance appraisal of administrative civil servants by private entities is allowed, but only 0.9 per- among other measures. The new model aims cent of agriculture land has been privatized, to achieve five objectives: strengthen the prin- and some restrictions continue on the ability ciples of meritocracy in selection and promo- of foreigners to own agriculture land. The tion of human resources; create a managerial legal framework generally protects intellectual Corps (called Corps A); introduce elements of property rights, but some aspects need to be anticorruption into the civil service framework including a code of conduct, standards of eth- corporate governance situation in a country. ics, and other elements of reducing corruption The Company Law of Kazakhstan provides a in the system; improve mechanisms of human broad measure of direct voting rights by inter- resource management; and increase the status national standards. Further, recent improve- of human resource services. Written tests for ments include the introduction of manager’s civil service appointments have been comput- personal liability for related party transac- erized to minimize manipulation. Interview tions (an unintended consequence of this is processes and procedures have been tightened that qualified managers are discouraged from up. And committees are used to ensure that applying), ability of shareholders to file an 21 the selection of candidates is objective. action, and compulsory market valuation for larger transactions. These efforts are contributing to reduce the role of patronage in the civil service. Civil servants with The banking sector is still recovering from the financial assets need to place them in trusts financial crisis. Reported capital adequacy when taking office, and a vetting of civil appears healthy and bank liquidity is ample, servants on observance of anticorruption but the industry still has depressed profits legislation for certain position is being due to the lack of business opportunities for proposed. The number of political civil banks and the modest recovery in the nonoil servants is being reduced, and clear guidelines economy. Nonperforming loans remain high have been set out for hiring the Corps A civil at 37  percent of total loans (figure 14). They servants. This is to encourage transparent, are well provisioned (93 percent of total) but merit-based selection and to reduce political keep a third of bank loan portfolios idle and influence peddling in the civil service. Finally, not working for the economy. The authorities the annual performance appraisal is being have been supporting the banking sector introduced to administrative civil servants. through interventions, restructurings, and extensive liquidity provision, but reforms need While trust in political institutions is high, to bear fruit in the near future for the sector to satisfaction with institutions that citizens are more recover.16 likely to interact with on a daily basis—such as public health services and the courts—is mixed. Adopt a more proactive approach to Kazakhstan ranks in the bottom third of business environment reforms Europe and Central Asian countries in the satisfaction of its citizens with public service Kazakhstan has enjoyed a great improvement in delivery—from a low of 27  percent in the indicators such as Doing Business over the past five courts, to 40  percent in traffic police, to a years, with its overall position improving from 89 to high of 69 percent in primary and secondary 49 in the global ranking of ease of doing business. education. The reported prevalence of These impressive results highlight the commit- unofficial payments to receive public services ment of authorities to business environment correlates negatively with the satisfaction reform and the decisiveness of these efforts. about the public service received. While To a large extent, the definition of the reform these negative correlations are insufficient to priorities has been guided by those areas in establish causality, reducing corruption could which Kazakhstan ranked lower than its peers improve the quality of services and strengthen in global indicators. This first generation of the trust in institutions. business environment reforms provides a solid foundation for a conducive business envi- Kazakhstan has recently emphasized improving its ronment, but it is not enough. Priority areas position on the Doing Business protecting investors that deserve the attention of the authorities indicator. But note that the Doing Business include: guiding future reforms by a close and indicator measures the degree of protection consistent Public-Private Dialogue that cre- for minority shareholders in a joint-stock com- ates well-structured communication channels pany and does not give a full picture of the for enterprises of all sizes and industries—this Beyond oil—Kazakhstan’s path to greater progress through diversifying Figure Problem loans are well provisioned but constrain banks’ lending expansion 14 Nonperforming loans Provisions 40 30 Share of loans (%) 20 22 10 0 January January January January January December 2008 2009 2010 2011 2012 2012 Source: National Bank of Kazakhstan. process should not be bound to areas covered of reforms, including simplifying and stream- in global indicators such as Doing Business; lining court procedures to eliminate delays in reforming laws and regulations to address the case processing and improve access to justice. specific obstacles facing enterprises in differ- Fourth, judicial training needs to be profes- ent sectors; and emphasizing adequate imple- sionalized. It should include an institutional mentation and evaluation of reforms. Even and functional assessment of the Institute of though there is no formal assessment, the gap Justice and the subsequent preparation of a between laws and practice is significant and costed and sequenced Medium Term Training varies widely across the country. and Infrastructure Needs Assessment action plan. It is also necessary to modernize training Respect the rule of the law and improve curriculum for judges and judicial staff with the quality of service delivery attention to specialized training such as new criminal and economic legislation. Four main areas should be considered when design- ing reforms to improve the quality and effectiveness of Make room for the private sector service delivery. First, it is necessary to improve and encourage competition and implement key elements of the legal frame- work. This can help develop and implement key There are several sectors and products in which laws to reduce the role of the state in private Kazakhstan has an inherent comparative advan- sector functioning, promote self-regulation in tage. Yet the private sector has not moved in the private sector (through codes and laws for that direction. Two plausible reasons for that registration and licensing), and reduce clogged are not enough incentive for competition, and court dockets by moving certain disputes to the heavy footprint of the state in the economy. administrative resolution mechanisms. Second, For example, while the country is ranked in the Ministry of Justice needs to improve the the top third in the Doing Business indicators, quality and responsiveness of its services. This competition policy and market orientation are can be done by improving operational effec- seen as weak and incipient. There are several tiveness in such areas as enforcement of judi- restrictions to market entry in a number of cial decision and improvement in information sectors keeping significant parts of the econ- systems and monitoring and evaluation. Third, omy inaccessible to the private sector. But the strengthened judicial professionalism and importance of the public sector in the economy quality is key to the success of the reform pro- remains high, and many private activities com- gram. To achieve this, the Supreme Court and panies in other countries, such as transport the judiciary will need to undertake a number and storage of oil, gas, water, and sewer systems and management of airports, are considered enterprises as well as households that lack strategic in Kazakhstan and remain under the access to banking and other financial services. responsibility of the state. They will enhance competition in the payment services industry and allow the entry of innova- Make the public sector more tive approaches to meet the transaction service efficient, or make it smaller needs of the economy as a whole. If successful, reforms in that area will also strengthen the The most effective response to a market failure is not financial management in the public sector by necessarily government provision. International facilitating electronic delivery and collection of 23 experience shows that it is better to let the pri- government payments. Kazakhstan should also vate sector in while the government sets the consider using factoring, leasing, and micro- standards and regulates. In that context, it may finance to help small and medium-size enter- be advisable for Kazakhstan to reassess the prises finance assets and obtain faster access strategic areas and monopolies that exist with to working capital. Getting these instruments a view to reducing the footprint of the state in right would go far in increasing the depth and the economy. At the same time, there is a need coverage of the financial sector. to improve efficiency, particularly in public procurement where existing legislation seems Commit to efficiency and reward excellence appropriate but does not cover a significant part of the public sector (for example, govern- Kazakhstan needs to make faster progress in insti- ment holdings and state-owned enterprises). tutionalizing a professional and merit-based civil service. The importance of a highly qualified Get the financial sector in order and motivated cadre of civil servants cannot be overemphasized. Many of the institutions that The financial sector in Kazakhstan is still suffer- support markets are provided by the public ing the hangover of the 2008–09 crisis. The level sector. The ability of the state to provide these of nonperforming loans in the country is one institutions is thus an important determinant of the world’s highest. The lack of a concrete of how well individuals behave in markets and resolution can hinder the performance of the how well markets function. In Kazakhstan, economy and the prospects for diversifica- there is a lack of clear criteria for merit-based tion. There should also be more active steps competition, career progression, and remu- to strengthen the country’s payment system by neration for administrative positions, as well as improving the legal and regulatory framework, loopholes allowing noncompetitive selection. raising awareness by consumers and businesses This encourages inefficiency and corruption, about payment services, reducing the cost and hurting public sector credibility. There are tax disincentives for the use of electronic ser- also gaps in terms of insulating public admin- vices, improving the capacity of service pro- istration staff from political pressures and viders to market their payment services, and influence. Such a separation exists in other strengthening payment system infrastructure. countries and is encouraged in order to sepa- Reforms to modernize and reform the retail rate professional civil servants from political payment system will benefit small and micro staff. Options to Increase Competitiveness in the Short Term Product space analysis can frame a dialogue between Using each product’s revealed comparative the government and the private sector. Sectors with advantage over time, Kazakhstan’s exports emerging comparative advantage outside oil can be divided into four categories: “classics,” include mining, iron and steel, and animal “emerging champions,” “disappearances,” and leather. But because the private sector has not “marginals” (box  2). Classics and emerging taken up these products, important bottlenecks champions were competitively exported in the and barriers may need to be removed first. This most recent time period, while disappearances is corroborated by the high experimentation and marginals were not. Emerging champions and low survival rates of new exports. The con- have recently gained competitiveness while dis- centration of Kazakhstan’s existing products appearances have recently lost it. It is easy to is in the periphery of the product space, with see the high number of disappearances across few products in the “core.” This implies that it most product categories, where competitiveness would be difficult and risky to shift into more has been lost in the most recent time period. sophisticated, high-tech, and better connected But apart from oil, the dominant classic export products without investments in endowments with sustained competitiveness, some groups of that would make the Kazakh exports more products have either maintained their competi- competitive. tiveness or appear as emerging champions. This includes mostly oil-based or metals-based prod- Static product space maps for Kazakhstan show a ucts but also some agricultural products such as sharp decline in competitively exported products, wheat and animal skins. especially more sophisticated and capital-intensive ones. Product space maps show a decline in the The growing number of disappearances may indicate number of competitively manufactured prod- unaddressed barriers to private sector development. ucts over time (figure 15). The decline occurs In the absence of a high revealed comparative in many parts of the network, but most sig- advantage, it may be riskier to invest in this type nificantly in the core of the network including of products. The declining competitiveness may machinery and other capital-intensive goods, reflect weakening capabilities and severe obsta- consistent with increasing export concentra- cles to production at an efficient scale—such as tion over time. The pattern is similar in Russia. lack of adequate technology, unavailability of skilled labor, excessive regulatory barriers, and The current export structure shows the prevalence of rising competition in global markets. primary products and resource-based agricultural or other products. The limited number of medium- One strategy is to look at new products that are or high-tech products reveals the lack of sophisti- close to currently competitive exports and that offer cation in Kazakhstan’s export basket (figure 16). income potential, strategic links to more sophisticated 24 Figure Kazakhstan’s competitive exports, 1996 –98 and 2008 –10 15 1996–98 Oil Leather Fruits Fishing Vegetable oils Vegetables Forest products 25 Milk Cereal Garments Mining Iron and steel Vehicles Textiles Electronics Machinery Animal agriculture Chemicals 2008–10 Oil Leather Fruits Fishing Vegetable oils Vegetables Forest products Milk Cereal Garments Mining Iron and steel Vehicles Textiles Electronics Machinery Animal agriculture Chemicals Note: Products exported competitively are marked in red and are identified as those with a revealed comparative advantage of greater than 1. Source: World Bank staff estimates based on Comtrade data. Beyond oil—Kazakhstan’s path to greater progress through diversifying Figure Classics, emerging champions, disappearances, and marginals 16 1996–98 1996–2010 Oil Leather Fruits Fishing Vegetable oils Vegetables 26 Forest products Garments Cereal Iron and steel Mining Textiles Vehicles Classics Emerging Electronics Machinery Disappearances Marginals Animal agriculture Chemicals Source: World Bank staff estimates based on Comtrade data. Box Defining classics, emerging champions, disappearances, and marginals 2 • Classics are products with demonstrated competitiveness over time where it would be less risky to invest. • Emerging champions are products in which Kazakhstan has increased its comparative advantage in global markets. • Disappearances are products that were competitive in the past but have lost that competitiveness recently. • Marginals are products in which Kazakhstan had a low comparative advantage in the past and that remains low. products, and large market opportunities. This strat- Tapping the potential competitiveness of new products egy considers new products or “marginals” that with higher technological content requires upgrading are income-enhancing and that are close to the country’s physical, human, and institutional Kazakhstan’s current location in the product capital. Kazakhstan’s exports have a much space only. Grouping these products into sec- larger gap in their human capital content when tors, they can be sorted for their market poten- matched with the imports from comparator tial, measured by the volume of world trade in countries. The emerging message is that diver- these products. They can also be sorted in terms sification across both products and markets in of strategic value, indicating their potential for the long term will depend on how well Kazakh- further movement in the product space to more stan can harness its endowments. In addition, centrally located products. Large volumes of dynamic and rich-country markets in the EU trade would indicate large international mar- and East Asia import goods that are exported kets, while high strategic value indicates possi- intensively by countries with relatively strong bilities for better diversification in the medium general institutional settings, high financial to long term. development, and high capital to labor ratios. Without addressing these gaps, current efforts very satisfied with a strong commitment from to diversify the economy will yield limited key government agencies like the Customs results. Control Committee. But the organization of supply chains and clearance procedures still Greater multilateralism could help Kazakhstan depends on a multitude of private bonded reach new markets. The lack of competitiveness “warehouses.” Another limiting factor is the of local products, the ineffective use of dependence on international and national the countr y’s most critical endowments transit. Given the country’s size, geographi- (human capital and institutions), and an cal position, and landlocked status, it depends 27 underdeveloped business environment are on transit through third countries, and its all internal reasons that might explain why imports are preferably cleared (about 93 per- Kazakhstan has not diversified its products cent) after transiting through different coun- and services or its trading partners. The lack tries. Optimizing the transit regime is thus of a broader multilateral trade policy is the critical to reducing logistics costs and encour- external part of this story. Evidence shows that aging transit through Kazakhstan. The transit Kazakhstan has placed a greater emphasis on regime under the Customs Union of Belarus, intraregional trade arrangements, for political Kazakhstan, and Russia is much more com- or historical reasons, limiting its exposure to plex and less friendly than the one in place for the rest of the world. As the country aspires decades in the EU. to reach new markets, it will need to adopt a more multilateral trade policy. Improve transport corridors Reduce fragmentation and inefficiencies Kazakhstan’s exports are projected to increase 50  percent by 2020, requiring additional freight Geography and history constrain supply chains in capacity on the main export routes to Russia, Kazakhstan. Transit is operated over long dis- China, Korea, Europe, and Central Asia. Trade tances, generally with many transport provid- among neighboring countries is also expected ers. Borders, especially with China, disrupt to increase by about the same amount, creat- the supply chains. Further, the legacy design ing the possibility of substantial transit traf- of the supply chain from the breakup of the fic through Kazakhstan. The 2050 Strategy Soviet Union implies separate interventions, aims to develop Kazakhstan as the preferred such as customs brokers, and the obligation of Central Asian trade, logistics, and business going through a bonded warehouse. So supply hub. The objective to double the capacity for chains are especially fragmented and vulner- transit traffic by 2020 remains very ambitious. able. Shippers and consignees have limited The main focus is upgrading the infrastruc- control on the supply chain, including trac- ture along the main transit corridors (at an ing goods in transit (reflected in the World estimated cost of $8  billion for the Western Bank’s Logistics Performance Index scores). Europe–Western China road corridor alone). Fragmentation can happen because there are But the government recognizes that invest- many interventions in the supply chain. For ment alone would not achieve the objectives example, independent controls (roads and cus- in the 2050 Strategy, and it is ready to intro- toms in Kazakhstan and third countries) and duce policy measures and investments beyond trade clearance procedures are operational infrastructure. For services, the strategy calls constraints that prevent providers from achiev- for simplifying custom activities and border ing high service quality. management procedures in view of the cre- ation of the Customs Union, Single Economic Remove constraints to trade facilitation Space, and accession to the World Trade and border management Organization. The various agencies involved are also asked to reach international stan- Trade facilitation is changing fast in Kazakhstan, dards for safety, speed, and modernization of with some positive impacts. The private sector is the aircraft fleet, among others. Beyond oil—Kazakhstan’s path to greater progress through diversifying Following the physical upgrade of the transport cor- Industrial policy can help diversification in the ridors, the government should promote operation short term, but it needs to be used wisely. If sector- and maintenance. The government should also specific policies are to be used, they need to foster a client-oriented culture, ensuring that promote productivity and not shield stagnant the expectations of the transport industry are sectors. Badly designed and implemented ver- met for quality of service, deregulation of tar- tical policies can work against the diversifica- iffs, and access to infrastructure. While sup- tion they intended to encourage. As a matter porting the modernization of international of principle, companies need, in the medium 28 transport corridor and associated services, the and long term, to pass the test of international government should not forget to distribute the competitiveness. In that context, specific stud- dividends of increased trade traffic; the gap in ies look at the barriers to the development of quality of intercity public transport and rural sectors with potential for growth. The recent accessibility should also be addressed. OECD report identified obstacles and oppor- tunities to promoting access to finance in the It is not always what a country exports that mat- agribusiness sector, foreign direct investment ters. Countries that develop their export in the agribusiness value chain, and informa- basket toward increased similarity with the tion and communication technology develop- export basket of high-income countries grow ment through public-private partnership. 20 more rapidly.17 In this sense, countries may Such studies can provide valuable insights for “become what they export,” converging to the the focus of useful horizontal policies. incomes of their competitors. Others contend that the type of good matters less than the Smart industrial policies could correct distortions in way that the good is produced.18 If a country the economy and generate positive externalities. A produces a high-quality class of good, or pro- smart industrial policy would attempt to cor- duces at the technology frontier, it will cap- rect an economy wide market failure that pre- ture more technological spillovers and higher vents the private sector from producing a good value added than if it produced a lower qual- for which the country has an inherent compar- ity of the same good, or at a lower level of ative advantage. It would be wise to promote productivity. Identical goods can thus be pro- self-discovery and experimentation based on duced with very different levels of productiv- existing capabilities. This is important because ity, quality, and technical sophistication. For the process of finding out which of the many example, when Korea produces computers, potential products can be profitably produced it uses frontier technology, which generates could generate information about technology high levels of technological knowledge. Mex- and markets available for that product and ico also produces computer components, but benefit many other producers. Finally, the best at a lower technological level where advanced outcome for smart industrial policy is to raise technological learning is less likely. While the country’s returns to schooling and making “picking winners” is risky, there are argu- private agents invest more in education. This ments for subsidizing exports that may raise could be done by placing greater emphasis on the country’s returns to schooling and make how the new product is produced rather than private agents invest more in education.19 on which type of product is to be produced. Notes 1. See World Bank (2013a). 11. Please see annex 1 for a more complete list 2. Eurasia covers the countries that used to of key results from this survey. be part of the Soviet Union excluding the 12. Because many vocational graduates choose Baltics (Estonia, Latvia, and Lithuania): to continue their studies in higher educa- Azerbaijan, Kazakhstan, Russia, Turkmeni- tion institutions, it is not possible to cal- stan, and Uzbekistan (the resource-rich culate the exact labor market absorption countries in the group) plus Armenia, levels for Kazakh graduates with the data Belarus, Georgia, the Kyrgyz Republic, currently available. Moldova, Tajikistan, and Ukraine (the 13. GoRK (2010a). countries in the group that do not export 14. GoRK (2010b). hydrocarbons). 15. GoRK (2011). 3. This elasticity is calculated as the nega- 16. As discussed in World Bank (2013c), to tive ratio between changes in poverty the address the nonperforming loan (NPLs), rate of growth in GDP per capita with and the regulator established a national and without oil rents. The reported coefficients private asset management companies and of elasticity are averages for 2002–11. The provided additional incentives for NPL negative elasticity of poverty to total GDP write-offs. For resolving NPLs and releas- per capita is driven by strong poverty ing their provisions, the National Bank of reduction in 2008 under negative growth Kazakhstan is following its initial strategy of GDP per capita. of setting up a national asset management 4. GoRK (2010b). company (the Problem Loans Fund was 5. A higher experimentation rate for Kazakh- established in April 2012 and started buying stan’s exports has also been found in problem loans [with a discount] from banks World Bank (2012). on a pilot basis) and private bank-specific 6. World Bank (2012). asset management companies (four banks 7. The discussion here draws on World Bank have already set up special purpose vehicles (2013b). [SPVs] for this purpose and are expected to 8. ASRK. start transferring bad loans to their respec- 9. For the past 20 years, TIMSS has measured tive SPVs). As part of the required incen- trends in mathematics and science achieve- tives for NPL write-off, the authorities came ment at grades 4 and 8. Kazakhstan first up with two new initiatives: extended tax participated in the quadrennial assess- exemptions for NPL write-offs until the end ment in 2007. However, its first interna- of 2013 and imposed ceilings for NPLs (over tionally comparable assessment of fourth 90 days overdue) at 20  percent of a loan and eighth graders took place in 2011. portfolio in 2013 and 15  percent in 2014. 10. Ivaschenko (2008) is based on a skills and 17. Hausmann and others (2012). labor demand survey conducted in 2008 18. 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