REPORT NO.124816-AM FUTURE ARMENIA: CONNECT, COMPETE, PROSPER A Systematic Country Diagnostic NOVEMBER, 2017 i Government Fiscal Year: January 1 – December 31 Currency Equivalents: Exchange Rate Effective as of [date] Currency Unit = Armenian Dram (AMD) US$1 = AMD 480 Weights and Measures: Metric System ABBREVIATIONS AND ACRONYMS ALMP Active Labor-Market Program LTGM Long-Term Growth Model AMD Armenian dram M&E Monitoring and Evaluation ARMEPS Republic of Armenia Armenian MCB Minimum Consumption Basket e-Procurement System NCD Non-Communicable Disease BAU Business As Usual NDC Nationally Determined Contribution BBP Basic Benefit Package NRI Natonal Readiness Index CBA Central Bank of Armenia NSS National Statistical Service CIS Commonwealth of Independent States NSW National Single Window CIT Company Income Tax OECD Organisation of Economic Cooperation CPF Country Partnership Framework and Development CPIA Country Policy and Institutional Assessment OOP Out-of-Pocket DRM Disaster Risk Management PAYG Pay-As-You-Go EAEC Eurasian Economic Community PER Public Expenditure Review EAEU Eurasian Economic Union PFM Public Financial Management EBRD European Bank for Reconstruction PM Particulate Matter and Development PPP Public-Private Partnership ECA Europe and Central Asia PPP Purchasing Power Parity ECE Early Childhood Education R&D Research and Development ECHRO Ethics Commission for High Ranking Officials SCD Systematic Country Diagnostic EEU Eurasian Economic Union SCPEC State Commission for the Protection EIA Environmental Impact Assessment of Economic Competition EITI Extractive Industries Transparency Initiative SDG Sustainable Development Goal EU European Union SEA State Employment Agency FBP Family Benefit Program SME Small and Medium-Sized Enterprises FDI Foreign Direct Investment STEM Science, Technology, Engineering FSAP Financial Sector Assessment Program and Mathematics GCI Global Competitiveness Index STEP Skills Toward Employment and Productivity GDP Gross Domestic Product TFP Total Factor Productivity GFC Global Financial Crisis TIMSS Trends in International Mathematics GPA Government Procurement Agreement UNFCCC and Science Study GVC Global Value Chain United Nations Framework Convention ICT Information and Communications Technology on Climate Change IDA International Development Association VAT Value-Added Tax ILCS Integrated Living Conditions Survey VET Vocational Education and Training IMF International Monetary Fund WDI World Development Indicators IT Information technology WHO World Health Organization LPI Logistics Performance Index WTO World Trade Organization Regional Vice President: Cyril Muller EFI Vice President: Jan Walliser Country Director: Mercy M. Tembon Practice Directors: John Panzer & Carolina Sanchez-Paramo Practice Manager: Maria Gonzalez-Miranda & Luis-Felipe Lopez-Calva Task Team Leaders: Genevieve Boyreau & Nistha Sinha ii Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 TABLE OF CONTENTS ABBREVIATIONS AND ACRONYMS................................................................................................................... ii TEAM MEMBERS AND ACKNOWLEDGMENTS.............................................................................................. viii EXECUTIVE SUMMARY....................................................................................................................................... ix CHAPTER 1: ECONOMIC PERFORMANCE: PAST AND FUTURE....................................................................1 A. Macroeconomic Performance and Its Drivers....................................................................................................1 B. Poverty Reduction and Shared Prosperity Performance...................................................................................8 C. Looking Forward: New Engines of Growth...................................................................................................... 11 CHAPTER 2: FOUR CHALLENGES TO ACHIEVING RESILIENT INCLUSIVE GROWTH WITH PRODUCTIVITY GAINS...................................................................14 A. Challenge 1: External Sector Performance...................................................................................................14 i. External Sector Outcomes.................................................................................................................................14 ii. Constraints to Improving External Sector Outcomes........................................................................................17 B. Challenge 2: Private Sector Productivity and Job Creation...........................................................................21 i. Productivity and Firms’ Performance.................................................................................................................21 ii. Constraints to Improving Firms’ Productivity.....................................................................................................22 a. Investment Climate and Governance Gaps.....................................................................................................24 b. Competition and Market Contestability............................................................................................................28 c. Financial Deepening and Financial Inclusion...................................................................................................30 C. Challenge 3: Labor Productivity.....................................................................................................................32 i. Labor Productivity and Human Capital..............................................................................................................32 ii. Constraints to Raising Labor Productivity.........................................................................................................34 a. Labor Market Relevance of the Education System..........................................................................................35 b. Mismatches between Workers’ Qualifications and Demand for Skills..............................................................35 c. Declining and Aging Labor Resources.............................................................................................................36 D. Challenge 4: Resilience and sustainability.......................................................................................................37 i. Macro, Micro, and Environmental Vulnerabilities...............................................................................................37 ii. Constraints to Enhancing Resilience and Sustainability...................................................................................38 a. Macroeconomic Vulnerabilities.........................................................................................................................38 b. Aging and Rising Economic Dependency Ratios.............................................................................................40 c. Availability of Formal Financial Services and Social Protection Transfers.......................................................42 d. Climate Change...............................................................................................................................................44 e. Depleting Natural Resources...........................................................................................................................44 CHAPTER 3: PATHWAYS, POLICY PRIORITIES, AND ACTIONS....................................................................46 Pathway 1: To rebalance growth, Armenia should seek to open markets, seize exports opportunities, and overcome existing connectivity constraints......................................................47 iii Pathway 2: To develop a vibrant productive private sector and create more jobs, Armenia should remove constraints for firms to enter markets and grow............................................................48 Pathway 3: For renewed inclusive growth, Armenia should remove barriers to work and improve individuals’ productivity.......................................................................................................50 Pathway 4: To achieve sustained and inclusive growth, Armenia should build resilience on several fronts................................................................................................52 REFERENCES.....................................................................................................................................................56 ANNEXES............................................................................................................................................................59 Annex 1: Trade and competitiveness selected issues. ............................................................................................59 Annex 2: Data diagnostics for Armenia..................................................................................................................71 Annex 3: Earnings and the gender wage gap in Armenia.........................................................................................73 Annex 4: Internal mobility and International migration..........................................................................................76 Annex 5: Government Program 2017-2022...........................................................................................................77 Annex 6: The prioritization process and knowledge gaps.......................................................................................78 FIGURES Figure 1.1: Growth decomposition by sector and expenditure..............................................................................3 Figure 1.2: GDP growth rates in Armenia and comparators, 2000-15...................................................................3 Figure 1.3: GDP growth rates, 2000-15.................................................................................................................3 Figure 1.4: Armenia economic transformation, 2000-08 and 2008-15..................................................................4 Figure 1.5: Current account balance (% of GDP)..................................................................................................5 Figure 1.6: EBRD transition indicators..................................................................................................................7 Figure 1.7: Shared prosperity: annualized consumption growth, 2004-15............................................................9 Figure 1.8: Growth incidence curve, Armenia, 2010-15........................................................................................9 Figure 1.9: Datt-Ravallion decomposition for Armenia, 2010-15...........................................................................9 Figure 1.10: Poverty headcount by demographic and earner composition.........................................................10 Figure 1.11: Real GDP per capita growth rate.....................................................................................................12 Figure 1.12: Real GDP per capita level (2011 US$)............................................................................................13 Figure 1.13: Poverty headcount rate at the national poverty line........................................................................13 Figure 2.1: Exports of goods and services (% of GDP).......................................................................................16 Figure 2.2: Export orientation index....................................................................................................................16 Figure 2.3: Trade costs........................................................................................................................................17 Figure 2.4: Armenia’s Logistics Performance Index, 2016..................................................................................17 Figure 2.5: Growth accounting decomposition by factor.....................................................................................22 Figure 2.6: TFP growth rates: Armenia and comparators....................................................................................22 Figure 2.7: Most problematic factors for doing business.....................................................................................23 Figure 2.8: Ease of Doing Business Index 2017.................................................................................................24 Figure 2.9: Global Competitiveness Index..........................................................................................................24 Figure 2.10: Regulatory quality, 2015..................................................................................................................24 Figure 2.11: World Bank Governance Indicators, 2015.......................................................................................26 iv Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Figure 2.12: Business risks related to weak competition policies (by component).............................................28 Figure 2.13: Market structure in the manufacturing sector..................................................................................28 Figure 2.14: Potential savings due to strong competition in selected food products, by consumption decile (share of total household expenditure).......................................................29 Figure 2.15: Deposit to GDP vs GDP per capita.................................................................................................31 Figure 2.16: Credit to GDP vs GDP per capita....................................................................................................31 Figure 2.17: Decomposition of interest rate spread............................................................................................31 Figure 2.18: Interest rate spread as percentage, 2016.......................................................................................31 Figure 2.19: Labor productivity growth in Armenia after the crisis has been sluggish and much lower than comparator countries.....................................................................................33 Figure 2.20: Labor resources are declining due declining population growth.....................................................33 Figure 2.21: Median age of the population is rising.............................................................................................33 Figure 2.22: Majority of the poor have completed upper-secondary education..................................................34 Figure 2.23: Rural residents have lower educational attainment than residents of secondary cities or Yerevan.........................................................................................................34 Figure 2.24: Education mismatch in Armenia and comparator countries............................................................36 Figure 2.25: Economic mobility in 2010-15.........................................................................................................37 Figure 2.26: Fiscal developments, 2011-16.........................................................................................................39 Figure 2.27: Armenia’s debt dynamics, 1999-16.................................................................................................39 Figure 2.28: Simulated total health spending increase due to population changes............................................41 Figure 2.29: Ratio of economically dependents to economically active persons, 2015-40.................................42 Figure 2.30: Account at a financial institution, older adults (% ages 25+), 2014.................................................42 Figure 3.1: Twin goals, pathways, and reform areas...........................................................................................47 BOXES Box 1.1: Armenia’s outbreak of “Dutch Disease” and overheating........................................................................2 Box 1.2: Armenia’s structural transformation.........................................................................................................4 Box 1.3: Fiscal policy quality (revenue mobilization, public expenditure mix).......................................................6 Box 1.4: Domestic reforms before the GFC..........................................................................................................7 Box 1.5: What do we know about the poor in Armenia?......................................................................................10 Box 2.1: Armenia agriculture sector: Performance and challenges.....................................................................15 Box 2.2: Armenia has made good progress on border management..................................................................18 Box 2.3: Positioning Armenia in international transit logistics..............................................................................20 Box 2.4: Armenia’s diaspora................................................................................................................................21 Box 2.5: Firms’ dynamics.....................................................................................................................................23 Box 2.6: Income and assets declaration..............................................................................................................25 Box 2.7: Energy sector’s challenges...................................................................................................................27 Box 2.8: Procurement in Armenia........................................................................................................................30 Box 2.9: Dollarization...........................................................................................................................................40 Box 3.1: How can SCD policy directions address regional differences in wellbeing?.........................................50 v vi Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 vii TEAM MEMBERS AND ACKNOWLEDGMENTS This report has been prepared by a World Bank team led The team was inspired by the views of Armenia students by Genevieve Boyreau (co–Task Team Leader, Equitable on the country’s current reality, as well as their vision for the Growth, Finance and Institutions (EFI) Program Leader) and future shared as part of outreach activities carried for the Nistha Sinha (co–Task Team Leader, Poverty and Equity SCD. Fourth and fifth graders of Yerevan’s Basic School Global Practice) and including Gohar Gyulumyan (Macro Number 19 (named after Nikol Aghbalyan) responded to Fiscal Global Practice) and Lourdes Rodriguez Chamussy the World Bank’s request to draw their vision of “Future (Poverty and Equity Global Practice). The World Bank team Armenia”. Sixty-four students across various universities in working on the report includes all Global Practices and Armenia participated in a survey about “Future Armenia” Cross-Cutting solutions represented by their focal points: where they were requested to respond using only one Arusyak Alaverdyan and Bekzod Shamsiev (Agriculture), adjective. Soren Nellemann (Education), Emil Zalinyan (Energy), The report has been prepared under the overall guidance Gillian A. Cerbu and Ruxandra Floroiu (Environment & of Mercy Tembon (ECCSC Regional Country Director), Natural Resources), Kirsten Lori Hund (Energy Extractive), Sylvie Bossoutrot (Country Manager), Laura Bailey Alexandrina Platonova-Oquab (Climate Change Group), (former Country Manager), Jan Van Bilsen (IFC Senior Brett Coleman (Finance & Markets), Arman Vatyan Manager), Maria Gonzalez-Miranda (Practice Manager, (Governance-Financial Management), Armine Aydinyan Macroeconomics and Fiscal Management Global Practice), and Benedicta Oliveros (Governance-Procurement), Luis-Felipe Lopez-Calva (Practice Manager, Poverty Davit Melikyan and David Bernstein (Governance-Public and Equity Global Practice). The team would like to also Sector), Rouselle F. Lavado and Susanna Hayrapetyan thank Roumeen Islam (Economic Advisor), R. Sudarshan (Health), Junko Narimatsu (Information and Communication Canagarajah (Development Effectiveness Manager), Lire Technologies), Iullia Mironova & Arman Barkhudaryan Ersado (Human Development Program leader), Sarah (IFC), Anna Corsi (Land), Persephone Economou (MIGA). Michael (Sustainable Development Program Leader) and Moritz Meyer (Poverty and Equity), Monica Robayo (Jobs Ozan Sevimli (Senior Operation Officer) as well as the diagnostic, Poverty and Equity), Sophia Georgieva and Systematic Country Diagnostic Central Support Team for Harika Masud (Social Development), Maddalena Honorati their guidance. (Social Protection & Labor), Mitchell Wiener (Pension reform), Arsen Nazaryan and Gonzalo Varela (Trade & The team is grateful for comments received from Wolfgang Competitiveness), Tania Priscilla Begazo Gomez (Trade & Fengler and Rinku Murgai (Peer Reviewers) and the teams Competitiveness Competition), Daniel Saslavsky (Trade & across the World Bank who participated at the concept Competitiveness logistics), Nargis Ryskulova (Transport), note, a two-day workshop held in Yerevan and decision Zara Tokhmakhian and Vica Rosario Bogaerts (Urban/ meeting and from an external sounding board of experts. Disaster Risk Management), Winston Yu (Water), Clive G. The report has been enriched by several rounds of internal Harris (Public Private Partnerships), Vigen Sargasyan (SCD discussions, in-country consultations with government, Communications and Outreach). The report was edited by policy research groups, development partners, and civil Peter Milne and formatted by Sarah Nankiya Barbirye. society organizations. viii Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 EXECUTIVE SUMMARY Since its independence in 1991 and until prior to the carrying out the so-called “first generation reforms”. global financial crisis (GFC) in 2008-09, Armenia was Today, almost a decade after the GFC, Armenia’s considered an important success story among the economy finds itself at a juncture in stark contrast to transition economies. Indeed, over several years, the its previous gains (Figure ES1). The country is grappling country displayed a record of sustained macroeconomic with a low growth-low investment nexus, with stalled achievements, reflected in high growth, economic stability, poverty reduction and growing income disparities. A rapidly low inflation, and modest deficits and external debt, increasing public-debt stock has left Armenia with reduced as well as falling poverty rates and shrinking income fiscal space in which to manoeuver, while the vibrancy, disparities. Sound macroeconomic performance was resilience, and inclusiveness of renewed growth depend gradually anchored in a fiscal rule, an inflation-targeting on needed second-generation domestic structural reforms regime, and financial deepening in the development of that have still to be fully implemented. Indeed, after external the banking sector. This performance was supported by a conditions deteriorated during and after the GFC, and later favorable external environment and early domestic reforms during the Russian crisis, growth, poverty reduction and liberalizing the economy. As such, Armenia was one of shared prosperity have shown relatively low resilience to the former Soviet economies that led the way forward in the worsened external circumstances. Figure ES1: Growth and poverty reduction (Percent) 60 54 50 40 29 30 26 20 10 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 -10 Average growth per capita: 12.3% Average growth per capita: 3.2% -20 Source: World Development Indicators and National Statistical Service (NSS), Armenia. Figure shows national poverty rates. International poverty comparisons show a strong fostering inclusive and sustainable growth in Armenia performance globally, but not regionally. At the to support poverty reduction and shared prosperity. international poverty line, poverty in Armenia is estimated The report draws on existing data and analytical tools, and to be only 1.9 percent, far lower than the average extreme builds on existing knowledge and evidence complemented poverty rate of 16.35 percent for lower middle-income by additional analyses. Based on the analytical evidence, countries (World Development Indicators database). At the SCD diagnoses the constraints to achieving growth the lower middle-income class poverty line, Armenia and and shared prosperity. It formulates recommendations, Georgia have among the highest poverty rates in the region, which are prioritized depending on their impact on poverty exceeded only by the Kyrgyz Republic. In 2015, Armenia reduction and shared prosperity. performed slightly better than Georgia, but not as well as other countries with similar levels of GDP per capita. Both Looking back, the SCD acknowledges that the historical Ukraine and Moldova, with lower GDP per capita, have drivers of growth have run their course. Pre-GFC, regional poverty rates that are substantially lower. growth was driven by external financial flows fueling the non-tradeable sector and domestic demand. The strong Against this background, the Systematic Country growth performance, however, may have masked the need Diagnostic (SCD) formulates forward-looking options for to continue pressing ahead with reforms that would have ix helped in handling the changed (and more challenging) challenges posed by the “new normal” that has become external circumstances better when these did finally arrive. entrenched since the GFC. A reinvigorated reform agenda Indeed, today’s new normal is characterized by a far less could build the foundations for resilient, self-sustained, and supportive external environment, which has led to weaker inclusive economic growth. This includes macroeconomic growth outcomes, while the new drivers of growth associated and structural policies that could help deliver a higher rate with productivity enhancements have yet to fully materialize. of growth and shared prosperity during booms and, at the same time, could enhance the economy’s resilience when The historical drivers of poverty reduction and shared downturns arrive. Lastly, the new growth model will also prosperity have become less effective. Both had been need to tackle an adverse demographic trend (consisting driven by private and public transfers (remittances and of a declining and aging population), which will soon pose pensions) and labor earnings and employment, particularly fundamental constraints on economic growth and shared in the non-tradeable construction sector, where low-skilled prosperity. workers could find jobs. These historical drivers, however, seem to have lost their effectiveness: the deterioration of the On this basis, the SCD identifies four challenges for external environment has been followed by a sharp decline Armenia to reinvigorate inclusive growth and resilience in remittances, the exhaustion of fiscal buffers, and a (Figure ES2). First, with far less supportive external collapse of the construction sector, narrowing the channels circumstances, reigniting economic growth calls for a of transmission from economic growth to households and search for new drivers and the rebalancing of growth toward individual wellbeing. the tradeable sectors. Against this backdrop, the country’s As gains from earlier policy efforts and supportive low export performance and limited global multi-connectivity external conditions dwindle, the opportunity arises for caused by high trade and transport facilitation costs are the renewing and revamping the growth model and reform first challenges to be addressed. Second, insufficient private agenda to face current and future challenges. The pace of sector productivity stands in the way of both higher growth recent structural reforms has shown relatively slow progress, and job creation. Firms, as the productive engines of the and this slow pace is perhaps not commensurate with the economy, appear constrained in their ability to lift productivity x Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Figure ES2: Achieving inclusive growth with success in others. Multi-connectivity constraints to productivity gains: constraints and challenges international trade and growth biased toward non-tradeable and domestic demand are reflected at the firm level by slow entry and growth, low product diversification, and relatively little use of innovation and technology. The slack in the labor market and out-migration reflect the lack of job opportunities caused by the lack of a vibrant private sector. In turn, limited private sector development can be explained by a lack of progress in improving the investment climate and market contestability reforms, reinforced by a lagging public and corporate governance reform agenda. Entrepreneurship should be stimulated throughout the economy towards arriving at a more competitive, productive and transparent business environment. Once investment climate and connectivity constraints are addressed and become less binding, firms may become constrained in their access to the right skills, while higher and more inclusive economic growth through more productive jobs will call for higher labor-market participation from all, and women in particular. Inclusiveness is complemented by systems (access to finance, social protection and pensions) for individuals to cope with shocks, preserve their gains from economic growth and avoid falling back into poverty. Macroeconomic policies and institutions could disrupt the productivity-growth- rebalancing adjustment if not appropriately coordinated or not flexible enough to smooth cyclical movements. against the background of unfinished investment climate Finally, managing natural assets and adapting to climate reforms, limited competition, and the need to deepen further change have implications for the long-term macroeconomic financial development. Third, poverty reduction and shared sustainability of resource dependent sectors and society as prosperity, that is, the transmission of aggregate growth whole. to individual wellbeing and poverty reduction, also seems This SCD formulates a set of complementary pathways constrained by labor market challenges: labor resources are shrinking, labor-force participation is low, and the country has and reform areas to address the identified challenges one of the lowest employment and highest unemployment (Figure ES3).1 To achieve inclusive growth with resilience, rates in the Europe and Central Asia (ECA) region, while a new model of economic growth grounded in productivity workers’ productivity has fallen. Learning outcomes seem improvements needs to be embraced. First, growth needs to lag demand, both in terms of the level and type of skills to rebalance from being demand- to supply-driven, and that are sought by the market. Declining labor resources toward exports/tradeable goods and services, and away are compounded by low women participation in the labor from non-tradeable and domestic demand (Pathway market. Fourth, key vulnerabilities at the macroeconomic, 1). Armenia should seek to open markets, seize export environmental, and microeconomic levels are faced by opportunities, and leverage multi-connectivity links. Armenia in its quest for poverty reduction and shared Second, to increase growth dividends and renew the prosperity. Armenia’s aging population will have a significant inclusivity of growth, job creation needs to be reignited impact on health spending and on the pension system, and through productive firms and individuals’ productive labor- could, if not addressed, have major implications in terms of market participation (Pathway 2 and 3). Third, to develop fiscal sustainability and poverty. a vibrant and productive private sector and create more jobs, Armenia must remove constraints on firms entering The above noted challenges at the macroeconomic, markets and growing. And for growth to be inclusive in the microeconomic, and structural levels are inter-linked context of a shrinking and aging population, Armenia must such that constraints in one area cascade into limiting remove barriers to employment and improve individuals’ 1The objective of a Systematic Country Diagnostic (SCD) is to diagnose the main challenges faced by a World Bank Group’s client on growth, poverty reduction, and resilience. In this process, the SCD prioritizes the possible high-level policy areas to help tackle these constraints. The SCD is followed by the preparation of a Country Partnership Framework (CPF), which builds on the SCD diagnostics and prepares a program in partnership with the Government, proposing a selective program of indicative (yet more concrete) policy interventions over a medium-term CPF cycle. xi Figure ES3: Twin goals, pathways, and reform areas public sectors. This priority will help re-balance growth drivers, transform structurally, create jobs, and support Pathway 1: inclusive spatial development. The next priority is to raise labor productivity while managing the implications of a To rebalance growth, Armenia should seek 1. Leverage exports enablers and to open markets, seize exports opportunities leverage muti -connectivity links declining and aging population by increasing labor market and overcome participation and supporting individuals’ resilience. This will Reducing Poverty and boosting shared prosperity connectivity constraints require ensuring that the education system provides skills that are relevant to the labor market, starting with improving Pathway 2: To develop a vibrant teaching quality. It also calls for facilitating women’s labor 2. Ensure on-the-ground market productive private sector and createmore contestability and competition market participation, particularly, expanding early childhood jobs, Armenia should education that has the dual payoffs of promoting women’s remove constraints for 3. Fill other investment climate gaps firms to enter markets work, as well as developing children’s school readiness and and grow wellbeing. Strengthening micro resilience, including raising 4. Ensure the education and workforce households’ access to finance, continued investments in development system provides skills relevant Pathway 3: to the market pensions, and protecting and better targeting health and For inclusive growth, Armenia should remove social protection spending, will also be important. Two cross- 5. Support matching of workers to jobs cutting “must have” policy areas include: strengthening barriers to work and improve individuals' productivity 6. Facilitate women’s labor market participation macroeconomic and environmental management. The former calls for more flexibility and efficiency in fiscal 7. Strengthen macro management supportive management and enhancing the counter-cyclicality of of stability and growth Pathway 4: To achieve macroeconomic policies. The latter could start with better sustainability, 8. Strengthen environmental management and water management and a focus on the impact of climate Armenia should build adaptation to climatechange national resilience change. on multiple fronts 9. Strengthen microresilience through access to finance, socialprotection, and tackling pension and health implications of population aging Implementing this set of reforms could enable Armenia to break out of the middle-income trap and get on its way productivity and employability (Pathway 3). Fourth, Armenia toward high-income country status. A simulation of the needs to strengthen resilience to shocks at all levels, to impact of the reforms on growth, poverty reduction, and sustain the gains from such inclusive growth (Pathway 4). disparities illustrates that the rebalancing of growth from domestic demand to exports and productivity enhancement, Recognizing the importance of connectivity and together with addressing the challenges of an aging and competition for prosperity in Armenia, the reform declining population, would boost Armenia’s income and areas and policy actions can be sorted into the following eradicate poverty by today’s standards. priorities. The diagnostics demonstrate that for Armenia, multiple challenges can be tackled when private sector Encouragingly, these proposed reforms share a common development is unleashed. Private sector development, diagnostic with the Government Program 2017-2022. The productivity, and competitiveness have been lagging, while Government Program includes a diagnosis of areas that exports are below potential. So, the top priority is to expand need to be tackled to achieve the Government’s vision—a export markets and enhance private sector development vision that is well aligned with that put forward in this to boost growth and job creation. For this to occur it will SCD.2 Moreover, the Government Program recognizes be important to leverage export enablers and bypass the presence of important strengths for Armenia that are land connectivity barriers. Also needed are on-the-ground examined within this SCD, both at the macroeconomic improvements to the investment climate and governance, and structural levels, and which could serve as important starting with market contestability and financial inclusion, stepping-stones for the implementation of a reinvigorated as well as the interaction between the private and reform agenda going forward. 2 The Government Program 2017-2022, approved in June 2017, set the vision, goals, and sector reform priorities to come. The vision is based on the principle of “safe, fair, free and smart Armenia”. The goals are to achieve an average of 5 percent economic growth annually, growth in exports of goods and services reaching 40-45 percent as a share of GDP, poverty reduction by 12 percentage points, and a 25 percent increase in nominal wages with employment growth. The Government Program also proposes a high-level set of reforms in the areas of public administration and legal framework, foreign policy, and the economic and social sectors. Concrete support to support these and other reforms through the diverse lending and technical assistance tools available in the World Bank Group’s toolkit will be discussed in detail within the CPF. The Program is summarized in the annexes. xii Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 CHAPTER 1: ECONOMIC PERFORMANCE: PAST AND FUTURE 1.1. This chapter examines the characteristics of between macro-fiscal policies implemented in the macroeconomic performance, poverty reduction, and country and economic growth. It discusses the respective shared prosperity in Armenia before and after the GFC. roles of external shocks, macro-fiscal policy responses, It discusses the drivers of this performance, the role of the and domestic policies and reforms in explaining Armenia’s external environment, the effectiveness of policy responses, growth performance, and macroeconomic stability and and the progress of structural reforms in contributing to sustainability. building the foundations for future inclusive resilient growth. It concludes by looking forward toward what would be a Macroeconomic and Fiscal Performance new model of economic growth that will allow Armenia 1.3. Armenia’s macroeconomic performance before the to resume inclusiveness and resilience. A forecasting GFC compared strongly relative to its peers. Between exercise simulates Armenia’s long-term income and poverty 2000 and 2008, Armenia’s economy grew at an average outcomes depending on the reform path followed and annual rate of nearly 11 percent, significantly outperforming considering Armenia’s demographic trends. It concludes other countries in the region. Other macroeconomic that a rebalancing of growth from non-tradeable to tradeable indicators have also improved considerably since the goods and services, and productivity enhancement would country’s independence: the fiscal deficit narrowed to allow Armenia to resume sustained growth and strong levels below 2-3 percent of GDP, inflation was kept well progress in socioeconomic indicators, enabling the country under control, and the current account deficit declined to get on track toward achieving high-income status. dramatically from double digits to more sustainable levels. A Macroeconomic Performance and Its Drivers During this period, domestic demand was the main driver of economic growth, fueled by external financial flows and 1.2. How can Armenia’s macroeconomic performance be benefitting non-tradeable sectors, particularly construction. characterized? This section examines the relationship External inflows consisted of export earnings from mining 1 and high commodity prices, remittances and foreign fiscal rule (2008), and adopted an inflation-targeting direct investment (FDI), largely originating from Russia. framework and a more flexible exchange rate regime This resulted in the appreciation of the real exchange (2006) that allowed for an improved shock absorption rate and some loss in competitiveness through a Dutch mechanism prior to the GFC. These efforts, however, were Disease-type of effect. While external flows contributed to not enough to fully prevent risks from overheating building physical investment, they neither contributed toward strong up: some evidence suggests that structural fiscal deficits human capital accumulation, knowledge and technology may have remained pro-cyclical through the period and absorption, nor productivity enhancement or the building of inflation edged up as the commodity super-cycle was in full future growth dividends. swing. In this context, the real exchange rate appreciated, 1.4. Throughout this period, the authorities confirmed harming competitiveness, while the persistently high their long-standing commitment to stable and volatility in export volumes hinted at the lingering presence prudent macroeconomic policies. Following their fiscal of vulnerabilities, together with the country’s need for a consolidation efforts, the Government introduced a strict more diversified output and broader export base.3 Box 1.1: Armenia’s outbreak of “Dutch Disease” and overheating Starting in 2003, an extremely supportive external significant increase from 16 percent in 2004. environment led to double-digit growth rates underpinned by high rates of investment. Favorable terms-of-trade During this period, Armenia experienced a “double movements for its mining exports, rising FDI, and strong Dutch Disease” episode, driven both by direct inflows remittances led to a significant expansion of the Armenian from commodities exports, as well as remittances and economy. High growth was essentially led by residential other foreign inflows pouring into the country (mostly led construction, consumption, and domestic services, which by a commodities boom in Armenia’s key trading and absorbed the bulk of domestic resources and capital investment partners), all fueling rapid consumption growth. inflows. Gross capital formation peaked at 40 percent of Foreign currency inflows led to an appreciation in real GDP in 2008. At 46 percent, consumption made the largest terms of the national currency, causing a deterioration in contribution to the cumulative 73.2 percent growth over the competitiveness through an increase of the price of non- period 2004-08. Benefitting from strong growth in Russia, tradeable goods relative to tradeable goods.4 The real remittances to Armenia increased significantly, reaching effective exchange rate (REER) appreciated by 60 percent more than 17 percent of GDP by 2008, boosting private between 2003 and 2008, while the price of real estate—a consumption. good proxy for non-tradeable goods—soared, making investment in real estate far more attractive than any other High investment in the construction sector supported rapid form of domestic investment, not to mention bank deposit economic growth in the years preceding the GFC. Between rates. In a similar pattern, the pace of the increase in real 2004 and 2008, real GDP grew at more than 11 percent wages was much higher than the pace of productivity per year on average. Without the construction sector gains before 2009. As is typical in a country facing Dutch (peaking at almost two-thirds of growth in 2006), average Disease, these macroeconomic developments added growth would have been 7.3 percent instead of 11.2 to existing structural weaknesses, and constrained the percent. A significant amount of construction spending was development of a productive tradeable and export-oriented for residential housing which, while having an impact on manufacturing base. Instead, it promoted a large non- short-term growth, made a negligible contribution toward tradeable sector (including construction) that, while labor- potential growth or productivity. The construction sector intensive and poverty reducing, is not prone to strong accounted for more than one-quarter of GDP in 2008, a productivity growth. 1.5. As external conditions deteriorated during the GCF inflows to finance consumption growth and construction. The in 2008-09 and were further exacerbated by the Russian vulnerabilities and structural weaknesses of the Armenian crisis in 2014-15, the economic model underlying economy, with a persistent savings-investment imbalance, previously strong growth proved to be exhausted. became evident when the period of double-digit growth The model was overly reliant on windfall external financial ended abruptly. The current account deficit ballooned to 17 3 IMF Working Paper Series WP/10/97 “Estimates of the Output Gap in Armenia with Applications to Monetary and Fiscal Policy”, 2010. 4 The real appreciation of the dram had a significant effect both on export values, and also on the survival prospects of Armenian exports. Indeed, a careful analysis of export flows in Armenia showed that a real appreciation of the domestic currency by 10 percent leads to a decline in dollar-exports by 8.7 percent, other things equal. The same appreciation increases the chances of an export flows being discontinued by about 3 percentage points (See Annex: Trade and Competitiveness Selected Issues). 2 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 and 14 percent of GDP in 2009 and 2010, respectively, and in 2009, bringing about a sharp increase in poverty and remained at 11 percent in the two following years. From 2009 income disparities. Just as the Armenian economy started onward, global liquidity dried up and Armenia was hit by a to get back on its feet, it was hit again—this time triggered sharp slowdown in financial inflows through remittances, by rapidly falling oil prices and the imposition of international FDI, and trade channels. Output plunged by 14.2 percent sanctions on Russia.5 Figure 1.1: Growth decomposition by sector and expenditure 14 Services 14 Private consumption 12 12 Construction 10 10 Public consumption 8 8 Industry 6 Gross Investment 6 Agriculture 4 4 2 Net Exports of G&S 2 Net indirect taxes 0 0 -2 GDP (at market prices) GDP (at market prices) 2000-2008 2010-2016 -2 2000-2008 2010-2016 -4 Source: Calculations based on data from NSS. Figure 1.2: GDP growth rates in Armenia Figure 1.3: GDP growth rates, 2000-16 and comparators, 2000-16 % % 20 13 15 11 10 9 5 7 0 5 2011 2001 2002 2012 2000 2004 2010 2014 2003 2006 2007 2013 2016 2008 2009 2005 2015 -5 3 -10 -15 1 -20 -1 ARM ALB BIH HUN MKD MDA SRB SVN GEO ARM HUN MDA SVN GEO 2000-2004 2005-2008 2012-2016 Source: Calculations based on data from WDI. Source: Calculations based on data from WDI. 1.6. However, while Armenia’s recovery has been strong compares well vis-à-vis other countries in the region, growth relative to its peers, growth has remained insufficient, has become more volatile, exhibiting a significant exposure making some vulnerabilities more evident. All financial to external conditions—particularly given the country’s large inflows fell sharply after the GFC and declined even further dependence on remittances from, and exports to, Russia. following the 2014 Russia crisis. After collapsing with the The current account deficit post-GFC remained stubbornly onset of the GFC, Armenia’s growth rate recovered to an high, at least until 2015, even as imports remained average of about 4 percent between 2010 and 2015, but subdued. This revealed the weaknesses in the country’s has since decreased once again. While this outcome non-commodity tradeable base and the need for structural 5 With Armenia’s close economic links to Russia, this external shock affected Armenia through three channels of exposure: (i) its trade balance, through a depreciation of the ruble and a slowdown of Russia’s growth and demand for imports; (ii) remittances, which dropped significantly; and (iii) a decline of FDI. 3 reforms that would help to strengthen its expansion going driven by the restored trade ties with Russia and penetration forward. into China and Middle East, failed to offset a double-digit contraction in construction and a substantial decline in 1.7. Armenia’s most recent macroeconomic and fiscal agricultural output. The continued reduction in remittances, outcomes suggest that existing vulnerabilities would dwindling FDI inflows, and muted domestic investment be best addressed sooner rather than later. Growth weakened domestic demand substantially, triggering a slowed down significantly to just 0.2 percent in 2016 from deflationary episode. At the same time, an expansionary 3.0 percent in 2015, driven lower by the prolonged slump in fiscal policy (with the fiscal deficit expanding from about 2 global metal prices (Armenia’s main commodities exports), percent GDP in 2014 to about 5.5 percent of GDP by end- together with falling remittances and FDI (most of which 2016) proved ineffective in reviving growth, while causing originate from Russia). While encouraging in nature, a 20 the country’s public debt to rise rapidly and triggering a percent expansion in the non-resource tradeable sectors, violation of the country’s fiscal rule.6 Box 1.2: Armenia’s structural transformation Over the past 15 years, Armenia’s economy has been development of an increasingly vigorous exporting ICT transitioning more toward services and away from sector, and a rapid expansion of agribusiness products, agriculture. Half of GDP and employment was in the namely beverages and tobacco. Better understanding the services sector in 2016, up from about 37 percent in experiences within these sectors—including the features 2000. Over the past 16 years, employment in agriculture of their micro-business climate—will be key to enhancing has contracted by 9 percentage points, while agricultural Armenia’s structural transformation and further broadening GDP has also declined, but more slowly, by 5 percentage the presence of these positive dynamics. points. This illustrates the persistence of a low productivity self-employed (and often informal) sectoral segment Importantly, the boom-and-bust cycle of the construction in agriculture. Meanwhile, the share of industry shrank sector that took place for over 15 years is key to explaining by 9 percentage points in terms of its GDP share, and the dynamics of shared prosperity indicators. Between 2000 3 percentage points in terms of its employment share, and 2008, construction boomed, fueled by large capital over the same period. This suggests the presence of inflows and remittances. This boom in real estate absorbed a de-industrialization process in Armenia, a loss of low-skilled workers who also benefitted from pre-GFC high competitiveness in manufacturing, and the decline in economic growth: employment and production shares of mineral prices negatively affecting exports and the mining the sector rose to as high as 27 and 9 percent, respectively, sector. before returning in 2016 to levels similar to those seen 15 years before. The bursting of the bubble in 2008-09 was Meanwhile, and throughout this transformation, “pockets followed by a sharp contraction of fixed investment (by 50 of productivity” have emerged, holding the promise percent) in the construction sector, which collapsed. This of enhanced trade and productivity outcomes in the profoundly affected the channels of transmission from future. They include a dynamic tourism industry, the growth into poverty reduction in Armenia’s economy. Figure 1.4: Armenia economic transformation, 2000-08 and 2008-16 60% 2000 2008 2006 40% 27% 20% 11% 9% 9% 4% 4% 0% Agriculture Agriculture Industry Industry Servies Servies GDP Employment GDP Employment Construction Construction GDP Employment GDP Employment 6 The fiscal rule states that if public debt exceeds 50 percent of GDP, the fiscal deficit for the next year would be reduced to 3 percent of the average nominal GDP of the previous three years. Thus, the Government needs to reduce its deficit from 5.9 percent of GDP in 2016 to 2.8 percent of GDP in 2017. 4 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Figure 1.5: Current account balance (% of GDP) 45 35 25 15 5 -5 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 -15 Investment Savings current Account Balance Source: NSS. 1.8. Overall, Armenia’s macroeconomic stance remains protracted shock. stable and manageable, providing a useful platform for reform going forward. The current account deficit 1.10. These challenges to fiscal policy suggest the need has shown sustained improvements, following a protracted to adjust Armenia’s strict fiscal rule to make it better period of significant dissaving. The IMF assesses Armenia’s suited to the changed global environment, and more external position to be broadly in line with fundamentals resilient and credible. The existing rule, adopted in 2008, and desirable policy-settings.7 The current account deficit lacks features now embedded in a new generation of rules narrowed to 2.6 percent of GDP in 2015 and 2016, supported that have emerged post-GFC. Specifically, Armenia’s fiscal by a 20 percent increase in exports, coupled with a decline rule has no mechanism to mitigate the pro-cyclical bias, in import demand and supported by a flexible exchange nor to help the authorities’ smooth fiscal adjustment in the rate, which functions as a shock absorber (Figure 1.5). face of severe economic shocks, or cope with the volatility of foreign-financed projects. These weaknesses could lead Macroeconomic Policy Response to abrupt short-term adjustments, destabilizing aggregate demand and limiting the space for capital spending. The 1.9. Fiscal policy has sought to play a more counter- Government is committed to revising the fiscal rule and, cyclical role since the GFC, but greater volatility and more generally, to following rule-based fiscal management.9 the emergence of protracted shocks have posed challenges. In 2009, Armenia implemented a strong 1.11. A flexible exchange rate policy has been expansionary, counter-cyclical response to the global instrumental in cushioning externals shocks. Since shock and the fiscal deficit widened from 1.7 percent of 2008, the Armenian dram has depreciated by close to 60 GDP the previous year to 7.7 percent.8 In the aftermath, percent, after roughly a similar appreciation between 2003 and as growth picked up, Armenia undertook an ambitious and 2008. The central bank, the Central Bank of Armenia consolidation program, seeking to put its fiscal stance back (CBA), has pursued an inflation-targeting policy through on track. This effort, which was largely based on a gradual forex interventions. Prices of non-tradeable goods adjusted reduction of government expenditure, came to a halt as back to levels compatible with this new external environment. another round of stimulus was introduced to mitigate the The real exchange rate depreciated significantly between consequences of the 2014 shock from Russia. The return 2009 and 2013, while real wages adjusted their pace of to an expansionary policy led to a significant build-up of increase back to (low) productivity growth, as did real estate public debt, with gross general government debt-to-GDP prices. The massive depreciation of the Russian ruble did more than tripling, reaching 55 percent of GDP by the end cause some real appreciation between 2014 and 2015, of 2016 (from 14.6 percent in 2008). This activated the strict since the dram did not depreciate to the same extent. fiscal rule enacted by parliament, forcing Armenia back into Overall, monetary and exchange rate policies helped to a significant fiscal retrenchment in 2017, and constraining maintain price stability and supported external adjustment, the scope for implementing policies that would have as evidenced by the gradually declining external current helped to smooth out the impact of what turned out to be a account deficit.10 7 IMF 2017 Article IV. That was the result of the Government strongly ramping up spending, by about 7 percent of GDP, to provide a counter-cyclical stimulus. The increase in the fiscal deficit was attributed 8 mainly to greater budgetary allocations toward social protection and economic sectors, an increase of 1.8 percentage points each between 2008 and 2009 World Bank PER (2014). 9 IMF 2017 Article IV. 10 IMF Article IV reviews (2014 and 2017). The elasticity of exports with respect to the RER was estimated to 0.87 (Annex: Trade and Competitiveness Selected Issues). 5 Box 1.3: Fiscal policy quality (revenue mobilization, public expenditure mix) In addition to supporting macroeconomic stability and because of the small scale of programs.12 The share of public sustainability, fiscal policy does impact economic growth investment in total investment declined from 22 percent in through the level and composition of revenues and 2009 (or 7 percent of GDP) to 12 percent in 2016 (3 percent expenditures. The following examines the quality of fiscal of GDP). Such a low level of capital spending originates from policy in Armenia. limited available resources and the prioritization of current over capital spending, due to social spending obligations Armenia’s budget is low relative to the size of the economy (in particular, social protection and health). Indeed, current due to its limited ability to raise public revenues. At around spending increased slightly from 23 percent in 2009 to 24.6 25 percent of GDP in recent years, Armenia’s general percent of GDP in 2016. government spending is smaller than those of other lower middle-income countries, CIS countries, and EU countries, Investment into productive infrastructure by the public and/ mainly due to the limited ability to raise government or the private sector could revive some of the channels revenues.11 Indeed, despite progress, revenue mobilization of transmission from growth into poverty reduction, while is below regional and international averages. Tax revenue setting a platform for broader based output. The shift increased gradually from 15 percent in 2002 to 20 percent away from public investment raises concerns about future of GDP in 2016. The new Tax Code enacted in 2016 is productivity and growth implications of under-investing in expected to raise tax revenues by about 2 percent of human and physical capital. There is a need to improve public GDP in the medium term. Rigorous implementation of the investment management, to prioritize investment projects Code—and more generally, an effective domestic revenue based on explicit criteria maximizing their economic impact, mobilization strategy—will be key for Armenia to be able to and to improve medium-term planning.13 More broadly, meet its development needs through higher spending on productive infrastructure funded by the public sector, the both physical and human capital. private sector, or a partnership between the two, would build the foundations for resilient and inclusive growth. Failure to The impact on growth, poverty, and disparities of public direct any new flow of resources into productive investments spending is positive but limited, due to the reduced (as opposed to real estate construction) could risk returning government footprint. Overall, while fiscal activities reduce to a new boom-and-bust cycle, should external conditions inequality and poverty, they only have a small impact improve again. Role of Structural Reforms contribution system. The system has been implemented for civil servants and for new private sector workers under 1.12. Structural reforms have shown progress in the age of 40, but its introduction has been delayed for supporting Armenia’s long-term growth agenda, existing private sector workers under the age of 40 until July albeit with some delays. A new Tax Code approved in 1, 2018. Some progress has been made in improving the 2016 constituted a crucial step toward improving the tax telecommunications and civil aviation regimes, as well as environment and boosting medium-term revenues. Tax with the enforcement of property rights. and customs administration, public financial management (PFM), including e-procurement and reforms to improve 1.13. Reforms are underway, particularly those focused business conditions have all advanced, albeit at a relatively on improving the business climate and attracting slow pace. The CBA adopted a review-based monetary FDI. There are very encouraging signs of growing reform policy conditionality to help support the inflation-targeting momentum under the current government, appointed in April framework and has strengthened its contingency planning 2017. The Center for Strategic Initiatives was established in to safeguard financial stability. Measures were adopted January 2017 to foster public-private partnerships (PPP), to improve the financial position of the energy sector attract FDI, and align developmental goals between investors and limit fiscal risks. Pension reforms were launched in and line ministries. The Government is also stepping up January 2014, aiming at introducing a fully funded defined efforts to tackle corruption, including by improving tax and Armenia’s tax system consists primarily of a value-added tax (VAT), a company income tax (CIT), excise and customs duties, and personal income tax (PIT). While the rates at which economic activities and 11 physical persons are taxed are not low, revenue mobilization from these taxes is low. There have been significant leakages stemming from both weaknesses in tax administration and tax policy, including tax relief. Tax productivity, which is the ratio of actual to potential or theoretical tax revenue, is lower than in most ECA countries, although Armenia’s corporate income tax is relatively efficient (World Bank, PER 2015). The endorsement of a new Tax Code represents a major step forward to shift the balance from direct to indirect taxation, and to improve equity. In addition, the Code aims to reduce the costs of tax compliance. World Bank Public Expenditure Review (2014). This analysis is the result of comparing Gini coefficients and poverty rates for market income and final income, before and after taxes, transfers, and expenditure 12 benefits, and examining the targeting efficiency of programs. 13 Indeed, public investment has been at times under-executed or over-executed compared with plans. 6 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 customs administration. The law on centralized procurement law are expected to be approved by the end of 2017. The has been strengthened to ensure a more competitive and authorities are leveraging the EEU membership to promote transparent procurement process. Negotiations with the EU export diversification, improve standards, enhance domestic toward the adoption of a Single Support Framework are competition, and invest in infrastructure, while at the same advancing and amendments to the economic competition time pursuing greater trade integration beyond the EEU. Box 1.4: Domestic reforms before the GFC Domestic reforms have supported to some extent the enhancing reallocation of resources, better infrastructure improvement in economic and social performance, but have necessary for business growth and basic social needs, and fallen short of building the foundations needed for resilience improved institutions. In fact, in 2008, together with Georgia, and a well-diversified output and export base. Armenia Armenia was the top IDA country performer in the World implemented early on a range of market-oriented reforms, Bank Country Policy and Institutional Assessment (CPIA). including free price formation in a highly open market with a liberal regime for trade and investment, a liberal financial However, reforms were relatively fragmented. Several system, total private ownership of land, and privatization important reforms suffered delays despite their urgency. of both small and medium-sized enterprises (SMEs) and For example, the liberalization of the aviation sector, the large enterprises. Accession to the WTO in December 2002 development of the competition policy framework, and the locked Armenia into an open international trade regime. reform of the fiscal regime of the mining sector only took The pre-2009 period also witnessed sound macroeconomic place after the GFC.5 While the economy was benefitting performance—gradually anchored on a fiscal rule and from external tailwinds, incentives to build the foundations an inflation-targeting regime—and financial deepening of a resilient economy were not very strong, leaving the through the development of the banking sector. In addition, country vulnerable to the external environment, as revealed comprehensive reforms supported a financial and technical by the GFC.14 The EBRD transition indicators clearly restructuring of the energy and other utility sectors. The illustrate the rapid progress made in the liberalization Government undertook several reform measures in the of prices, large- and small-scale privatization, and the banking sector to improve the lending environment. The liberalization of foreign exchange and trade. However, the Family Benefit Program (FBP) introduced in 1999 integrated indicators also show that Armenia has made little progress the measurement and administration of existing programs in improving the corporate governance and competition under a single umbrella and introduced targeting. These environment since 2004 in absolute terms and compared policy reforms supported to some extent a productivity with, for example, Estonia. Figure 1.6: EBRD transition indicators Armenia Estonia 4.5 4.5 4.0 4.0 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 1991 2001 2011 1991 2001 2011 1993 1997 2003 2007 1993 1997 2007 1989 1999 2009 2013 1989 1999 2003 2009 2013 1995 2005 1995 2005 Large scale privatisation Small scale privatisation Governance and enterprise restructuring Price liberalisation Trade & Forex system Competition Policy Source: EBRD Transition Indicators. 14 The government budget benefitted relatively little from the boom in metal prices before the GFC because of a fiscal regime that was not designed to capture some of the windfall. 7 1.14. However, the reform agenda would still benefit decisive breakthrough on structural reform has still to be from being revamped on several fronts in which it achieved, with the resulting consequences for private has suffered from slow progress and fragmentation. sector development. Competition, the business climate, and regulatory reforms have advanced at a slower-than-expected pace. For B Poverty Reduction and example, tax reform and the new Tax Code, approved at the Shared Prosperity Performance end of 2016 had been under discussion for a decade. In the 1.15. The poorest 40 percent of the population in area of competition, Armenia has established competition- Armenia shared in economic growth that occurred policy legislation and institutions entailing some reduction before 2009, benefitting from low-skilled jobs in of entry restrictions and enforcement action on dominant the construction sector and buoyant remittances. firms, but the framework is far from complete (cf. Chapter Annualized consumption growth among the poorest 40 2, Section 2). Similarly, Armenia has weak enforcement percent (“bottom 40 percent”) of the distribution is one of bankruptcy legislation and little action has been taken measure of the extent to which the group has shared in to either strengthen corporate governance, or address growth. Between 2004 and 2009, when the construction distortions associated with corruption. The development sector was booming and remittances grew sharply, of financial markets is also lagging. All these unfinished Armenia’s bottom 40 percent enjoyed high growth rates reform agenda items impose a risk premium on investment. of consumption exceeding the consumption growth of the Armenia has also been lagging in absorbing new knowledge better off (“top 60 percent”) (Figure 1.7, left-hand panel). and technology, and in product diversification and locking in The 2009 contraction of the economy hit the bottom 40 integration with international services and factor markets. percent hard: their consumption was reduced by 7.46 More broadly, while progress has been registered, a percent a year. Figure 1.7: Shared prosperity: annualized consumption growth, 2004-15 (%) 10% 5.61% 8% 6% 3.34% 4% 2.94% 2.53% 2.63% 2% 2.33% 2.42% 1.61% 1.49% 0% LVA 2007-12 EST 2007-12 LTU 2007-12 POL 2007-12 CZE 2007-12 BLR 2009-14 SVK 2007-12 KAZ 2008-13 ALB 2008-12 SVN 2007-12 RUS 2007-12 UKR 2009-14 HRV 2009-12 TUR 2008-13 HUN 2007-12 KGZ 2009-14 BGR 2007-12 SRB 2008-13 MDA 2009-14 ARM 2009-14 MNE 2009-14 GEO 2009-14 MKD 2009-13 ROM 2007-12 -2% -4% 2004-2015 2004-2009 2009-2015 -6% High income Lower Upper middle income -8% middle Bottom 40 All Bottom 40 percent Top 60 percent All income Source: ECA region harmonized consumption database (ECAPOV) (Left-hand panel). Global Shared Prosperity Database (Right- hand panel). Note: Shared prosperity measured by annualized consumption growth for the bottom 40 percent. This growth rate is compared with that of the total population. 1.16. After the GFC, with fewer jobs available for low- Armenia performed better than high-income ECA countries, skilled workers and a fall in remittances, growth has which were significantly affected by the GFC (Figure1.7, favored the better off. Since 2009, the bottom 40 percent right-hand panel). Moreover, consumption growth among have averaged less than 1 percent of growth per year, the top 60 percent15 exceeded that among the bottom placing Armenia as one of the worst performers among 40 percent. The growth incidence curve, depicting the the middle-income countries in ECA for which estimates annualized growth rate of per capita consumption for every are available. Apart from Poland and the Slovak Republic, percentile of the consumption distribution between two 8 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 points in time, further illustrates the higher gains enjoyed Figure 1.9: Datt-Ravallion decomposition by the better off (Figure 1.8). for Armenia, 2010-15 10 1.17. This pattern in the sharing of growth has meant that consumption inequality has worsened since the GFC. Prior to the GFC, when the bottom 40 percent enjoyed 5 high rates of growth consumption, inequality measured by the Gini coefficient narrowed from 28 to 24. With growth 0 slowing down overall and favoring the better off, the Gini -2.11 coefficient rose again from 27 in 2010 back to 28 in 2015.16 -5 -5.91 -5.53 1.18. Poverty declined sharply between 2004 and 2008, when the bottom 40 percent shared in growth but the -10 GFC and the accompanying collapse of the construction -11.03 sector pushed up poverty sharply. The poverty rate fell from 53.5 percent to 27.6 percent in 2008, only to go back -15 national Yerevan other urban rural up to 29.8 percent in 2015 (see Figure ES1 for poverty trends and Box 1.5 for poverty profile). The depth of poverty Growth Redistribution Percentage point change also narrowed. As Armenia entered a low-growth period, the drivers of growth also shifted such that the top 60 percent Source: Armenia Poverty Note 2017. benefitted more in terms of consumption growth than did the bottom 40 percent. Further analysis confirms that had growth but also equipping the bottom 40 percent with the inequality not increased, more of the growth would have assets to share in growth (see Chapter 2). been transmitted to the bottom 40 percent and resulted in a much higher poverty reduction of 10 percentage points 1.19. Throughout the period from 2004 to now, the (Figure 1.9). Therefore, looking ahead, reducing poverty drivers of poverty reduction have remained the same. and raising inclusivity of growth requires not just higher Poverty reduction has been driven by labor income, employment, and pensions among household members. Figure 1.8: Growth incidence curve, Armenia, 2010-15 Remittances were also a driver of poverty reduction, especially for rural households where short-term migration 5 to Russia picked up as agriculture shed workers. What has mattered for poverty reduction and shared prosperity is 4 both the lower level of growth and its composition offering Change in consumption fewer opportunities for the bottom 40 percent to participate 3 in productive activities. 2 1.20. Summing up, new sources of growth, led by productivity gains, need to be created and sustained. 1 While growth may have been inclusive and poverty- reducing in the past, it was unsustainable because it was 0 0 20 40 60 80 100 over-reliant on large external funding. Drivers of poverty reduction and shared prosperity need to be reignited 95% CI Consumption ad.eq. through sources of growth that come from within, through Growth rate at mean Growth rate at median domestic comparative advantage and competitiveness, and driven by productivity improvements. Source: Armenia Poverty Note 2017. 15 Similar to most household surveys, Armenia’s Integrated Living Conditions Survey does not adequately cover households with high incomes. Therefore, the better off 60 percent in the survey cannot be considered rich. Almost 50 percent of the population covered by the survey consumes between US$2.50 and US$5.00 per day (at 2005 PPP) and another 25 percent consume more than US$5.00 per day. 16 The Gini coefficient, the most commonly reported measure of inequality, ranges from 0 (complete equality) to 100 (complete inequality), although for consumption spending it is typically in the range of 30 to 50. 9 Box 1.5: What do we know about the poor in Armenia? Yerevan, as the center of economic activity, has the lowest although the concentration is not as stark, there are higher poverty rate in the country (25 percent in 2015). While rates of poverty among the rural population. In contrast, Yerevan’s poverty rate is high considering that the city Albania and Ukraine present a similar context as Armenia, accounts for 50 percent of Armenia’s GDP, poverty outside with higher poverty among the urban population.6 (See also the city is even higher. People living in the 48 secondary Box 3.1.) cities that comprise the other urban areas of the country have consistently had the highest poverty rate (34 percent The poor tend to have lower levels of educational attainment, in 2015). Rural poverty is high as well, but lower than the and show weaker attachment to labor markets. A higher poverty rate of secondary cities (30.4 percent in 2015). percentage of adults being employed in the labor market Counted together, the poor living in secondary cities and decreases the probability of being poor and, in a similar rural areas account for just over 70 percent of all the poor way, better education lays the foundations for individuals in the country. The high share of poor living in secondary and households to escape poverty. Households where the cities is unlike the more typical pattern of the poor being main earner is a woman are therefore more likely to be poor heavily concentrated in rural areas. For instance, in Belarus, because women earn less than men. Armenian women Bolivia, Bosnia and Herzegovina, Croatia, Hungary, Latvia, earn less than men not because they are less educated but Poland, Romania, Russia, and the Slovak Republic, poverty because of the occupations and sectors they work in (see is mainly a rural phenomenon; in Georgia and Serbia, Annex). Figure 1.10: Poverty headcount by demographic and earner composition 45 37.8 38.9 40 35 30.9 31.1 30 25.2 25 19.9 20 17.3 15 9.3 10 5 0 Households Households Households Households Households Households Households Households with no earners with single with single with single with single with single with main with main earner male earner male earner female earner female earner couple both couple both and without and without earners, with earners without dependents dependents dependents dependents dependents dependents Source: World Bank staff calculations using ILCS 2015. Note: Dependent is defined as an individual younger than 18 or older than 69. An earner is defined as having labor income different from zero in the past year. Multidimensional poverty analysis shows that poor of health problems” (compounded with type of activities households have low educational attainment and inferior and age structure of households), financial affordability of health outcomes. Among the poorest 20 percent, there is a health services seems to be much lower for households at higher share of households where members have at most the bottom of the welfare distribution (22.7 percent versus secondary education and where children are more likely to 8.4 percent). These disparities in education and health be absent from school. Although the gap seems very small outcomes not only shape an individual’s wellbeing, but looking to the share of households, “where at least one also determine his/her ability to participate in an inclusive household member needed to interrupt daily routine because economic growth process, and engage in society. Source: World Bank staff analysis of ILCS 2015 and 2017 World Bank Poverty Assessment for Armenia. 17 Poverty and Shared Prosperity Snapshots, World Bank, accessed May 2017. http://globalpractices.worldbank.org/poverty/Pages/SitePages/AAG-PovertyandSharedProsperity.aspx 10 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 C Looking Forward: New Engines of Growth would add another 0.3 of a percentage point of growth annually. This illustrates the scope for supplementing the 1.21. New sources of growth need to be found. Growing reform package with additional measures. with low levels of trade and large financial inflows financing domestic demand has reached its limits in the global Assuming a comprehensive reform package scenario, “new normal” of low growth-low investment. In the “new Armenia would be well on its way to achieving high- normal” global and regional environment, growth sources income status by 2050 and to significantly reducing will not come—as they did before 2009—from financial poverty. Implementing reforms aimed at boosting total inflows fueling the domestic economic and supporting non- factor productivity (TFP), labor and capital efficiency, labor tradeable goods production. First, capital inflows are likely and capital accumulation, and reducing disparities would to be moderate and the volume of remittances will remain directly affect key drivers of growth. Simulations show that muted, making reliance on non-tradeable growth unlikely. this would be sufficient for Armenia to achieve high-income Second, the fiscal stimulus lever has run its course, with the status by 2050. The poverty headcount ratio as measured by fiscal buffer now depleted, which implies that expansionary the current national poverty line would decline dramatically fiscal policies cannot be pursued in the near term. Finally, to 8.6 percent in 2030 and to virtually zero by 2050. the vulnerability of the Armenian economy to external shocks has been revealed and needs to be addressed. In contrast, assuming the continuation of recent This section looks at a new growth model that could build trends, Armenia’s modest per-capita growth will not be resilient inclusive growth in Armenia going forward. sufficient to reduce poverty significantly and to achieve high-income status by 2050. With a lack of strong economic 1.22. Given far less supportive current external growth, per-capita GDP growth is expected to remain conditions, what outcomes for living standards and at below 2.5 percent until 2030. Looking further ahead, poverty reduction could be realistically expected by a Armenia’s per-capita GDP will reach only US$7,490 by comprehensive reform package? By when can Armenia 2050 (in 2016 US dollars), which is far below the aspirational aspire to reach high-income status? By how much would goal of reaching high-income status (US$12,476 or more). poverty and income disparities be reduced? This section Per-capita GDP will increase to US$4,960 (in 2016 US discusses long-term growth projections using a simple dollars), sufficient for Armenia to surpass the upper middle- growth model. It examines two scenarios: the first scenario income country threshold of US$4,035 in around 2021. The assumes a policy shift and reform acceleration to enhance low average growth rate also creates a worrying outlook productivity and factor accumulation. The second scenario regarding debt sustainability. While poverty will slowly assumes that recent historical policy parameters remain decrease, the rate of decrease will be far less that the stated unchanged. goal under the SDG.18 1.23. Simulations suggest that Armenia is facing 1.24. In conclusion, Armenia has the opportunity to important challenges that must be tackled, but that change course, enhance growth and poverty reduction, the country also has very significant opportunities if and get on track toward high-income status if it focuses it seizes them. Both scenarios in the simulation consider on productivity-enhancing reforms. The country’s the predicted demographic trends, which pose fundamental reform momentum needs to become commensurate with challenges for the labor market and growth dynamism, its structural challenges and these have become more social services, and fiscal sustainability. With a fertility obvious since the deterioration of the external environment rate below 1.6 children per woman and net out-migration, post-2009. Already in the aftermath of the GFC, many Armenia’s population is set to shrink by about 10 percent analysts pointed out that the continuation of the pre-2008 down to 2.7 million by 2050. With an aging population and development path required deepening reforms to sharpen a persistent gender gap in labor-force participation, the ratio the competitive framework of the economy, achieve closer of economic dependents (children under 14 years of age integration with international trade and capital markets, and adults aged 65 and older) to the economically active build financial markets, and create the conditions for the population overall (those active among the 15-64 age absorption of knowledge that leads to higher technological group) is projected to rise to close to 80 percent by 2030, sophistication. from about 60 percent in 2015. The decline and aging of the population will have a major impact on GDP growth. Halting 1.25. To do so, given its relatively small domestic the decline of the population would lead to a gain of 0.3 of market, Armenia needs to rebalance its growth toward a percentage point of GDP growth every year. Keeping the exports and open new markets abroad to benefit ratio of those of working age to total population constant more from external demand. This should be supported 18 The Sustainable Development Goal (SDG) 1.2 involves halving the poverty rate at national poverty lines by 2030. In Armenia this means reducing the headcount poverty rate from 29.8 percent in 2015 to 14.9 percent by 2030. 11 by investment in multi-connectivity, leveraging trade and and services, should be an important part of the reform transport facilitation, ICT and softer enablers, such as the package. Productivity improvements will be especially Armenian diaspora, and trade and investment policies important to counter the implications of a declining working- (Section 1 of Chapter 2), investment climate reforms, and age population. To achieve shared prosperity, the country market contestability (Section 2 of Chapter 2). Such reforms needs to make greater and better use of labor resources need to be linked with investments in education and skills, through more and better jobs, as well as through addressing as well as with providing equal access to productive formal the skills mismatch. Together, such a reform package would employment (Section 3 of Chapter 2). There is a nascent lead to higher TFP and human capital growth. It would structural shift toward better jobs, but the presence of low also necessitate and lead to an increase in high-quality, productivity in Armenia’s large informal sector (particularly productive investment. Finally, because it would revive in agriculture) poses challenges. Accelerating the structural channels of transmission between growth and job creation, transformation from subsistence agriculture to agribusiness, it would halt a further worsening of inequality and make and from agriculture to export-oriented manufacturing growth more effective in reducing poverty. Box 1.6: Armenia’s long-term growth projections based on different scenarios Using the DEC-MFM Long-Term Growth Model (LTGM), rate of 66.9 percent. Figures on demographic dynamics we compare business-as-usual (BAU) growth with a come from the World Bank’s Population Estimates and growth trajectory that benefits from a reform package Projects database. aimed at enhancing total TFP, labor and capital productivity, labor participation, and greater investment. The baseline shows BAU assuming the continuation of The LTGM is based on the Solow-Swan growth model, but recent trends and considering historic averages. The extended to include human capital, demographics and other following assumptions deserve further explanation, as they growth drivers, which are important in developing countries. will be changed in the reform scenario. First, TFP growth is The model also keeps track of income distribution: absent set at 1.0 percent, which is slightly above the cross-country changes in inequality, economic growth increases all median and close to Armenia’s historical average of 1.3 incomes, which reduces poverty as growth lifts people percent from 2005 to 2014 (PWT9). TFP growth has been across the poverty line; in contrast, with increasing inequality extremely volatile in the past. For example, TFP growth was growth becomes less effective in reducing poverty. The above 10 percent in some years prior to 2005, while it has basic assumptions for both baseline and scenario are as been negative in recent years. The latter is the reason for follows: initial year for estimation is 2016, initial capital-to- departing from the 10-year average and lower expectations GDP ratio of 2.7, initial GDP per capita of US$3,640 (in 2016 to 1.0 percent. Second, human capital growth is set at 0.1 US dollars), depreciation rate of 2.7 percent, constant labor percent, which reflects the historical average between 2005 shares of 62.5 percent, and initial labor-market participation and 2014, but with less fluctuation in contrast to TFP growth. Third, the investment-to-GDP ratio is assumed to remain Figure 1.11: Real GDP per capita growth rate at the level it has been in recent years, namely around 20 percent. Finally, the Gini coefficient is assumed to continue 5.0% its upward trend to increase to 36.7 by 2030 and remain 4.5% constant thereafter. The Gini coefficient increased from 29.9 4.0% in 2009 to 31.5 in 2014, i.e., by 0.33 per year, as incomes of 3.5% the bottom of the welfare distribution grew at a slower pace 3.0% than incomes in the rest of the population. If we assume that 2.5% this trend continues until 2030, the Gini coefficient would be 2.0% 36.7 by that year. This is not an unrealistic level for Armenia, 1.5% which had a Gini coefficient of 37.5 in 2004. 1.0% Reform Scenario: By 2025, TFP growth would increase 0.5% to 2.0 percent, human capital growth to 0.3 percent, and 0.0% the investment-to-GDP ratio to 26 percent.19 The reform 2022 2032 2042 2020 2030 2034 2040 2050 2024 2044 2026 2036 2046 2016 2018 2028 2038 2048 package also contains policies to tackle inequality that should at least stop the rise of the Gini coefficient. Figure Baseline (BAU) Scenario (Reform) 1.11 shows the impact of such a reform package on growth Source: World Bank staff calculations. and poverty reduction. Figure 1.11 shows a significant 12 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Box 1.6: Armenia’s long-term growth projections based on different scenarios Figure 1.12: Real GDP per capita level (2011 US$) Sensitivity analysis 14,000 Population decline has a significant impact on GDP 12,000 growth. While population growth is predicted to stay positive 10,000 until about 2020, it is on a decreasing trend and will turn 8,000 soon negative. This has a significant impact on the real GDP growth rate. As we have seen above, in BAU annual real 6,000 GDP growth is predicated to average 1.8 percent until 2050. 4,000 However, if the Government manages to halt population 2,000 decline, growth would increase by 0.3 of a percentage point 0 (Figure 1.12). At the same time, per capita GDP growth would change only marginally, but in the opposite direction, 2022 2032 2042 2040 2020 2024 2030 2034 2044 2050 2016 2026 2036 2046 2018 2028 2038 2048 from an average of 2.1 to 2.0 percent. Baseline (BAU) Scenario (Reform) The aging population has an even higher impact on Source: World Bank staff calculations. GDP growth. Currently, Armenia has an aging population Figure 1.13: Poverty headcount rate and this trend is predicted to continue until the early 2030s. at the national poverty line Then, a period of recovery is expected to set in, albeit unsustainable, before the working-age-to-total-population 30% ratio starts to decrease once again. If we assume that the 25% Government manages to halt this trend in 2017 and can 20% keep the working-age-to-total-population ratio constant 15% until 2050, this would have a significant and positive impact 10% on both GDP and per-capita GDP growth. In the counter- 5% 0% factual case with no aging population, real GDP growth would increase from an average of 1.8 percent to 2.1 2022 2032 2042 2020 2024 2030 2034 2040 2044 2050 2016 2026 2036 2046 2018 2028 2038 2048 percent—a similar increase as that produced by halting population decline. However, in the no-aging scenario, GDP Baseline (BAU) Scenario (Reform) growth would also increase on a per-capita basis by 0.3 of a Scenario (Reform) with shifting poverty line* percentage point to 2.4 percent. The demographic sensitivity analysis on the baseline Source: World Bank staff calculations. shows significant scope for supplementing the reform package with additional measures. Halting, or at least increase in per capita GDP growth. Between 2017 and reducing, the trend of population decline and aging would 2050, the average GDP growth rate would be 3.4 percent bring significant improvements for real GDP growth. When and 3.7 percent in per capita terms. This would be sufficient it comes to per-capita GDP growth, only measures to halt or for Armenia to achieve high-income status by 2050 (Figure limit the aging process will bring positive results. What holds 1.12). Figure 1.13 shows the impact on poverty reduction in for the BAU analysis is also true for the reform package two different ways. For one, the poverty headcount ratio as scenario: keeping the population constant would lift average measured by the current national poverty line would decline real GDP growth to 3.6 percent (and decrease per-capita dramatically to just 8.6 percent by 2030 and to virtually GDP growth to 3.6 percent); keeping the working-age-to- zero by 2050. However, as countries become richer they total-population ratio constant would increase average real usually adjust their poverty line upwards. This is shown in GDP growth to 3.7 percent and to 4.0 percent in per-capita the scenario with a shifting poverty line. In this scenario, we assume that the poverty line would gradually shift upward to reach a level twice as high (in real terms) by 2050, which is commensurate with national poverty lines of other countries at this income level.20 Also under this scenario, poverty These figures are within the range of Armenia’s history and cross-country experience. In reality, the variables will 19 would fall significantly to reach 16.8 percent by 2050 under not remain stable, nor will they shift very gradually, but they can be expected to continue to fluctuate. Indeed, keeping the poverty line of a low-income country in an environment where per-capita GDP reaches a the new poverty line, which is twice as high as the initial one. 20 level of high-income countries would not be credible. 13 CHAPTER 2: FOUR CHALLENGES TO ACHIEVING RESILIENT INCLUSIVE GROWTH WITH PRODUCTIVITY GAINS 2.1. The combination of greater export opportunities improvements. The following sections examine external supported by productivity-enhancing investment sector outcomes and underlying supporting drivers: hard and a vibrant private sector would provide sound infrastructure to connect to others (through land, and air), and sustainable sources of growth. It would also offer and soft infrastructure (ICT), trade and investment policies, productive jobs, which individuals with the right skills and and the role of the diaspora. access to the labor market would fill, thereby ensuring growth inclusiveness and reducing incentives for out- i. External Sector Outcomes migration (see Annex 4). The following sections examine 2.3. How has Armenia performed in terms of external the external sector performance (Challenge 1), firms’ and competitiveness? The country features noticeable individuals’ productivity (Challenges 2 and 3, respectively), progress in the recent years, with more diversification of and highlight progress and achievements so far, as well as export products and markets, a marked balance of payment remaining constraints and existing opportunities for further improvement, and increased sophistication of FDI. However, improvement. The last section reviews existing risks and the country’s balance of payments also features a significant vulnerabilities, and how to manage them (Challenge 4). dependence, both on international commodity prices and on A Challenge 1: External Sector Performance Russia’s economic circumstances through exports, foreign investment, and remittances. Armenia’s exports exhibit 2.2. As explained in Chapter 1, going forward Armenia a narrow base, low sophistication, low survival rates, and will need to rely increasingly on the performance of low participation in GVCs relative to its peers. The section its external sector, and on productivity gains to drive concludes that if Armenia is to develop exports as a driver growth and job creation. This calls for a rebalancing of of growth, diversification of products and markets will need growth from domestic demand to exports, from non-tradeable to be deepened, irrespective of improvements of Russia’s to tradeable sectors, and from factor accumulation to TFP economy or global commodity markets. 14 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 2.4. Armenia’s balance of payments has improved Following a protracted period of significant dissaving, the markedly in recent years, but remains vulnerable to current account deficit has shown sustained improvements, global commodity markets, either directly via exports both through depressed imports and increased exports along or indirectly through close economic links with Russia. with greater diversification. The country is a net commodity Box 2.1: Armenia agriculture sector: Performance and challenges Agriculture sector growth has been strong, driven by 1990s. But Armenia’s capacity to produce and export increased productivity of semi-subsistence farms and high-value crop and livestock products has yet to be fully migration out of agriculture. The sector contributed 20 exploited. The suggested building blocks for a new model percent of GDP, 35 percent of employment, and 28 percent of for agriculture sector growth are as follows: exports in 2015. It is predominantly informal, with 76 percent of all informal workers found in agriculture. The sector grew by A focus on medium-scale farms, farmers willing to in the period 2004-15 and contributed to one-quarter of GDP invest in modern farming technology, and the knowledge growth (World Bank Development Indicators). Productivity needed to use this technology effectively. A stronger, increases were the main drivers of agriculture sector growth, broad-based presence of these medium-scale farms and coming from both land productivity and labor productivity agribusiness enterprises would create a more level playing improvements, the latter being pushed by a sharp reduction field and strengthen competition, thereby increasing the in the number of people employed in the sector. The yield vibrancy of private sector activity. The productivity increases increases are the result of increased fertilizer use and the needed for these medium-scale farms and agribusiness wider use of improved seed—simple, low-cost technologies enterprises to be sustainable will come from ongoing that most farmers use and understand. Access to fertilizer support for value-chain development. and seed has improved in response to government subsidy A broad-based medium-term program to facilitate farm programs. Public investment has focused on improving enlargement through the land market through: (i) land access to irrigation, support for development of the extension consolidation programs; (ii) strengthening public institutions system, measures to strengthen water-user associations to responsible for land surveying, land registration, and land improve grass-roots management of irrigation, and farmer conveyancing; (iii) strengthening the private institutions cooperatives and producer associations as a means to responsible for rural land valuation and the sale of rural provide the economies of scale needed to engage more real estate; (iv) reviewing the role of land taxes as a way profitably in agricultural markets. Similarly, access to capital to improve the efficiency of agricultural land use; and (v) has improved significantly during the period of analysis incentives to encourage older farmers to lease or sell their through commercial bank lending for agriculture, FDI, and land to younger farmers (e.g., land tax exemptions, public development-partner funding. Meanwhile, export growth transfers, etc.). has been strong, driven primarily by beverage and tobacco products, with little reliance on the country’s resource base. Investment in knowledge transfer for farmers and agribusiness, and improved education and training for There are two main constraints preventing Armenia’s rural people. There are two compelling reasons to prioritize agriculture sector from transforming itself into a investment in knowledge transfer, and training, and education modern dynamic sector and away from subsistence in rural areas. First, the transformation of agriculture from toward exports: First, and in the context of Armenia’s semi-subsistence to modern farming systems will succeed limited areas of arable land, land ownership is fragmented, only if farmers and agribusiness enterprises are able to and dominated by small-scale, semi-subsistence farms. use this technology effectively. By improving understanding Second, the lack of widespread adoption of advanced of these technologies, an effective agricultural extension technologies and management experience has prevented system also increases the incentives to make these the sector from truly becoming more export-oriented and investments and reduces the risks that the investments will diversifying products and markets. fail. Second, rural people leaving agriculture need a strong, Building a modern agriculture sector calls for a new set broad-based education and access to a range of vocational of institutional infrastructure and knowledge transfer. training programs if they are to find employment elsewhere. Substantial growth has been achieved by improving the Non-farm employment opportunities in rural areas exist productivity of small-scale farms that continue to use the across the whole spectrum of economic activity, including semi-subsistence production systems initiated in the late employment in public services. 15 exporter, with mining and metal-related exports contributing (v) foreign aid. Meanwhile, although exports of services to 60 percent of goods exports.21Significant vulnerability to have shown remarkable dynamism, they do not yet generate international price fluctuations prevails, as illustrated by the a trade surplus.22 close correlation between export earnings and the price of copper and other minerals traded. Thus, the country’s 2.5. Armenia’s external trade exposure is lower than its balance of payments features a significant dependence on peers. Exports of goods and services as a percentage of international commodity prices, which is compounded by GDP remained below 30 percent in 2015 (Figure 2.1). Only a large vulnerability to Russia’s economic circumstances Albania and Bosnia exhibit lower levels of export openness through exports, foreign investment, and remittances from than Armenia. This limited exposure to international trade Armenian migrant workers. Armenia’s imports from the rest also emerges when looking at the position of Armenia and of the world have been roughly financed by: (i) copper and comparators in an export-orientation ranking that measures gold exports; trade-to-GDP ratios.23 Armenia is clearly less integrated with global markets than its comparators (Figure 2.2). Firm-level (ii) a strong performance of sales of agricultural products to data confirm Armenia’s limited participation in international Russia; (iii) remittances from low-skilled Armenian migrant markets.24 In short, Armenia’s untapped export potential workers in Russia; (iv) foreign investment from Russia; and represents a significant opportunity for future growth. Figure 2.1: Exports of goods and services (% of GDP) Figure 2.2: Export orientation index 100 Exports 2012-2015 60 90 80 70 40 SVK Export Orientation Index 60 LTU EST CZE 50 20 40 MDA AZE 30 0 20 LVA GEO 10 MKD -20 0 TUR 2011 2001 2002 2012 2000 2004 2010 2014 2003 2006 2007 2008 2009 2013 2016 2005 2015 ARM -40 -40 -20 0 20 40 60 ARM ALB HUN MDA Ranking SRB SVN GEO Residuals Residuals Source: World Bank staff calculations based on data from WDI. Source: World Bank staff calculations based on data from WDI. 2.6. Other measurements of trade performance point to exports have been gaining global market shares over the opportunities for improvement. On the one hand, there past 10 years but more slowly than its peers. The survival of has been low diversification of exports in terms of both Armenian firms in export markets is a challenge, preventing products and geography, placing Armenia behind most of its firms from fully benefitting from being integrated in the global peers. Main exports are unsophisticated and their destination marketplace. Finally, an international comparison shows that concentrated on Russia (16 percent of Armenia’s total exports Armenia’s participation in global value chains (GVCs) has and mostly agricultural products) and the EU countries (28 been limited, both as a seller and as a buyer.25 However, signs percent of total exports and mostly mining-related exports). of trade diversification both in product and destination are Armenia has a limited number of export products, which has positive and encouraging. In addition, comparisons with peer not expanded since 2010, and low diversification is also countries suggest scope for further improvements. Several found at a more disaggregated level. Similarly, Armenia’s countries with comparable characteristics have been able 21 Armenia’s imports are dominated by final consumption goods (52 percent). Commodity imports (mostly petrol and gas) account for about 18 percent of imports (2015). Out-migration and remittances have substituted for non-commodity exports. Labor has been exported through migration, sending back remittances, instead of goods or services exports bringing export earnings to the country. 22 However, while non-commodity exports of goods and services support productivity and job creation, migration does not contribute as much to creating domestic value added and directly enhancing productivity. In addition, remittances are certainly supportive of economic growth in the short term through increased private consumption, but contribute little to improving growth quality through productive investment. Incentives for household to use remittances more for micro-investment rather than consumption could be further explored. 23 This index is purged of the effects of the size of the economy and other physical characteristics, such as being landlocked or being an island. 24 Only 15 percent of Armenian firms export, either directly or indirectly (BEEPS, 2013). This is well below the average of comparator countries (24 percent) and despite the large share of Armenian firms that have internationally recognized quality certification (45 percent). Evidence suggests that the adoption of internationally recognized quality standards helps firms to export, and this seems especially relevant to exports from developing countries (Swann, 2010). However, while the diffusion of internationally-recognized quality standards in Armenia is above that of Serbia and Slovenia, export participation remains far lower. 25 Annex: Trade and Competitiveness Selected Issues. 16 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 to make progress on trade performance, suggesting that of the external sector, its achievements, and the remaining Armenia could follow a similar path. constraints to be tackled. 2.7. Finally, FDI has proven relatively resilient and has ii. Constraints to Improving External Sector Outcomes become more knowledge and technology intensive. The composition of FDI has followed a gradual productive 2.9. How easily does Armenia connect with the rest of transformation toward more sophisticated, higher value- the world? What progress has been made so far, what added sectors, and has been relatively resilient after the are the remaining challenges to overcome and what are successive external downturns. In 2004-06, financial the opportunities to seize? This section reviews progress services, communications, and metals were the main made and the remaining constraints and opportunities to targets of FDI. However, in 2014-16, the share of FDI in improve Armenia’s external sector performance through communications, software, and ICT services, and renewable/ improving the country’s international connectivity (hard and alternative energies increased significantly. FDI inflows soft infrastructure). have remained strong over time compared with peers, albeit 2.10. Armenia suffers from comparatively high trade still standing below pre-crisis levels, which is a common costs, explained to a large extent by its geographical feature in the region.26 In the post-crisis period, Armenia has situation and closed borders. The overwhelming majority outperformed Slovenia, Moldova, Macedonia, and Bosnia, of Armenia’s trade travels over land and faces higher trade but lags Georgia, Hungary, and Albania. Moreover, Armenia is slightly above the expected levels of FDI inflows given its costs than neighboring countries (Figure 2.3).27 In addition income per capita. to being landlocked, its borders with Azerbaijan and Turkey are closed because of longstanding geopolitical issues, 2.8. In conclusion, to improve the performance of the leaving Georgia and Iran as the only possible trade routes. external sector, Armenia can build on several strengths. Thus, trade is dependent on third countries, especially transit These include a recent improvement in export performance routes through Georgia, which incur bottlenecks through and the current account balance, which includes trade costs, delays, and unpredictability. Similarly, trade through diversification, both in terms of products and destinations; Iran presents its own set of challenges, with large variations a dynamic service sector, which increasingly exports; and in the time to initiate transit and comply with formalities, an improvement in the content and sector of interest of truck availability, and restricted traceability. Rail and ferry foreign investment. However, Armenia’s exports still exhibit services to and across the Black Sea do not yet constitute a narrower base, lower sophistication, lower survival rates, a meaningful alternative to Armenia’s improved accessibility and lower participation in GVCs relatively to its peers. This to foreign markets, except for bulk cargos and the carriage suggests ample opportunities for improvement. The next of high-density goods.28 Armenia is only connected to the section examines what may explain the recent performance Georgian railway network, which is not connected to Russia. Figure 2.3: Trade costs Figure 2.4: Armenia’s Logistics Performance Index, 2016 600 LPI 5 500 4 Timeliness Customs % ad valorem 400 3 300 2 200 1 Tracking & tracing Infrastructure 100 0 Switzerland Russian Fed. Poland Spain Georgia Ukraine Latvia Austria Moldova Slovenia Croatia Singapore Belarus Logistics competence International shipments Armenia 2016 Income: Lower middle income 2016 Armenia Georgia Region: Europe & Central Asia 2016 Source: World Bank’s Trade Cost Database. Source: World Bank’s Logistics Performance Index, 2016. 26 FDI inflows peaked at 9 percent in 2009 and fell sharply thereafter down to 1.8 percent of GDP in 2015. Trade costs capture geographical distance between partners, logistics performance and facilitation bottlenecks at origin and destination, international connectivity of the countries, facilitation 27 at the border, tariffs, non-tariff barriers, and restrictions to trade (World Bank Trade Cost Database). 28 Road transport has expanded its participation to exports, from 37 to 63 percent, at the expense of railways. Between 2010 and 2016. Air cargo remains marginal. 17 2.11. International logistic professionals report chain management techniques by manufacturers and important constraints. Armenia is ranked 141 among importers, and better regulating the traditional transport 160 economies worldwide in the World Bank’s 2016 services and freight forwarding industry. Similarly, there is Logistic Performance Index (LPI).29 Armenia fares worse room for improvement to implement border management than the average of its region, with the developing countries reforms, where significant gap between central reforms in ECA at 2.5 in 2016, relative to Armenia’s 2.2 (Figure 2.4). and the realities on the ground persist (Box 2.2). The same holds for Armenia versus the average of lower- middle-income countries (score of 2.5). Overall, the LPI not 2.12. Finally, while progress has been made to improve only captures information about Armenian institutions, but the north-south corridor, Armenia’s road network also general accessibility issues. Logistics has shown some needs improvement with less than half in good or fair improvement, such as in air connectivity, which is by and condition. The relatively poor quality of the road network large liberalized, and border management where transit adversely affects domestic connectivity. Inadequate procedures are usually conducted without serious delays. transport connections in some communities significantly However, more could be done to develop modern trade restrict the trading potential of the agricultural sector. and transport facilitation services. For example, logistics There is scope for improving the use of existing resources services are highly segmented. There is room to develop and institutional capacity to maintain the domestic road the domestic logistics industry by adopting modern supply network. Box 2.2: Armenia has made good progress on border management BIn 2017, the country ranked a comparatively high 48 out gap between central reforms (five-year action plan, a of 189 countries on the Doing Business “Trading Across new National Single Window (NSW), positive results from Borders” indicator. Its distance to frontier score of 86.45 the valuation and post-clearance units) and realities on (out of a possible 100) puts it far ahead of the average of the ground. For example, the reduction in the number of ECA developing countries, as well as ahead of both the required documents reported by Doing Business does not lower-middle-income and upper-middle-income country seem to have translated into any significant reduction in average. Between 2009 and 2011, Armenia moved up 54 delays and bureaucracy. The risk management approach places in the ranking. Reforms included introducing self- has significant weaknesses and lacks efficiency. Importers declaration under a direct trader input system, investing have to go in person to the Customs office to validate their in new infrastructure and equipment to improve border declarations and pay in cash, while the electronic payment operations, customs computerization, and developing a risk system is still not effective 10 years after its introduction. management system. One reason for Armenia’s high score Overlaps and inconsistencies persist, despite significant in 2016 was that by joining the Eurasian Economic Union efforts to reduce agency overlaps under the NSW initiative, (EEU) it reduced the time and cost for documentary and for example in the clearance of goods, or container border compliance for trade with the Russian Federation clearances. Border management needs improvement to and other EAEC countries. reduce the time needed for border crossing, which involves Room for improvement remains in the clearance of goods considerable congestion at present. Support activities and border management for better international connectivity. are good but these need capacity reinforcement (Post- Across the board, there is a significant implementation Clearance Audit, valuation unit, IT). 2.13. ICT connectivity suggests opportunities for relatively low among comparators. Better access remains improvement by building on the current positive trend. concentrated in urban areas, while broadband penetration Penetration has improved with the gap with OECD in rural areas is lagging. countries gradually narrowing. At the end of 2015, 58 percent of Armenia’s population had access to internet 2.14. Average speeds offered by operators remain lower (total fixed and mobile), higher than the rate in Georgia (48 than comparator countries, partly because of Armenia’s percent), but lower than that of Azerbaijan (77 percent), as landlocked nature. Internet pricing has declined in recent well as Russia (70 percent), the EU (80 percent), and the years. But overall, broadband speed relative to cost, i.e., OECD average (77 percent).30 The broadband market in value for money, is lower in Armenia than in comparator Armenia has been transitioning dramatically with greater countries. For both mobile and fixed broadband, Armenia’s competition and lower prices. In 2015, Armenia had 10 speeds are lower than comparators. This is because, percent fixed broadband internet subscriptions per 100 given its landlocked nature, Armenia must either route its people, a marked increase from 3 percent in 2010, but internet traffic through Georgia or Iran for transmission 18 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 over international fiber-optic cable systems, or use slower payment systems. Given Armenia’s promising developments satellite technologies. These limited options constrain the in the sector and initial comparative advantages, a thorough availability of internet bandwidth and add to the cost of assessment through a better understanding of how to international services, making high-speed internet more accelerate the adoption of the digital economy to boost costly for average citizens. Affordability remains an issue. growth would be critical. The Government Program 2017- Findings suggest that access to fixed broadband is still costly 2022 identifies the digital economy as a cross-cutting priority. for poorer households and small businesses, particularly those concentrated in rural areas.31 2.17. Turning to trade policies, Armenia’s membership of the Eurasian Economic Union (EEU) since 2015 brings 2.15. The small size of the market with limited number opportunities, but also challenges. Trade policy was of players in both the fixed and mobile broadband very open after Armenia’s accession to the WTO in 2003. markets also stifles higher access to more affordable While Armenia’s membership of the Eurasian Economic and reliable internet services. According to the World Union (EEU) in 2015 has brought immediate benefits, it Economic Forum’s Network Readiness Index (NRI), Armenia has also added bureaucratic burdens for trade outside the has a lower average ranking compared with its peers when Union, especially for goods in need of additional permits and considering the ICT environment. Although Armenia has the certification.33 Medium- to long-term impacts are mixed with necessary legal and regulatory framework in place in the ICT reduced benefits from structural and institutional reforms, sector, its enforcement is limited. The country is ranked much and knowledge transfer. Membership in the EEU constrains higher in its business and innovation environment than its ICT the ability of Armenia to negotiate deep preferential trade policy and regulatory environment. One player has over a 60 agreements with third countries. On the positive side, percent share of the mobile market, while another controls considerable interest could be raised from market-seeking almost half the client base in the fixed broadband market. FDI. Investors could see Armenia as a base from which to access the wider EEU market. These investors could bring 2.16. Looking at the broader elements of the digital technology and know-how to Armenia. For example, Armenia economy in Armenia suggests there is room for could become an attractive location for investors interested improvement. Digital economy levers have the potential to in providing services to the EEU. Armenia has a relatively open markets beyond domestic borders. Internet is changing more open trade regime in services than other EEU member trade, firm productivity, demand for skills, and labor-market countries, which gives it a comparative advantage. Investors arrangements. On the one hand, internet technology adoption could be interested in establishing a commercial presence in by firms and households in Armenia is lower than in peer Armenia to avoid existing limitations and conditions that apply countries. On the other hand, since 2006, the ICT and high- in non-EEU member countries. Armenia’s advantageous technology sectors have become two of the fastest growing position with respect to services would strongly depend on sectors in the country. The driving factor behind Armenia’s the degree of integration in services that will be achieved in competitiveness in these two sectors is the availability of the EEU. educated human resources, together with support from the diaspora. However, those firms at the technological frontier 2.18. Beyond the EEU, Armenia could seek to the already report growing difficulties in finding the skills they extent possible to negotiate mutually beneficial trade need, suggesting that supply might not be able to keep up agreements.34 Such agreements would help to put exporters, with demand for skills in these sectors.32 In addition, despite a particularly those in GVC-prone sectors, on an equal footing relatively supportive legal framework, the use of e-commerce to compete with peer countries and neighbors. For example, transactions is low, but growing. Armenia ranked 87 out of an analysis of trade complementarity shows that Armenia’s 137 economies in the B2C E-Commerce Index 2016, which exports are more complementary with both India and China is lower than neighboring countries, including Iran (77) and than with Germany and Russia, but currently Germany and Georgia (84). Indeed, e-commerce soft and hard infrastructure Russia receive far larger shares as markets for Armenia.35 has room for improvement to boost user confidence, including In addition, there seems to be potential for Iran to serve as a consumer protection, privacy and data protection, and transit country for Armenian goods, or perhaps for Armenia cybercrime. The main constraint is the limited use of financial to serve as a transit country for exports to Iran from Russia services in-country, including credit cards and international or Georgia. 29 The World Bank’s Logistics Performance Index (LPI) primarily measures the performance of a country’s gateways to international trade, i.e., ports, airports and international land borders. The LPI ranges from 1 (low) to 5 (high). World Development Indicators. Data collected as part of the E-Society and Innovation for Competitiveness Project (P115647) indicate that Access to Internet (as a percentage of population) in Armenia reached 73.4 percent by June 2016. 30 In 2015, the monthly internet sub-basket cost in Armenia was estimated at US$8, more than 5 percent of total household monthly income for close to 80 percent of Armenian households. 31 32 Following the WDR 2016, Kelly et al. (2017) recommend that Armenia—as an emerging adopter of internet technology—should focus on strengthening educational quality and the foundational skills of students ( Kelly, Tim, Aleksandra Liaplina, Shawn W. Tan, and Hernan Winkler. 2017. Reaping Digital Dividends: Leveraging the Internet for Development in Europe and Central Asia. World Bank). 33 Armenia gained access to the EEU’s common pool of customs revenue, which translates into a sizeable increase in customs revenues for the Armenian government. By joining the Eurasian Customs Union (EACU), Armenia has avoided the negative effects of an increase in the price of gas that it imports from Russia (creating savings worth about 1 percent of GDP). World Bank (2013): “Accumulation, Competition and Connectivity”. 34 The Government Program 2017-2022 explicitly seeks to develop and deepen bilateral relations with a number of countries (China, India, the Middle-East, USA, Russia, Georgia, Iran and normalize relations with Turkey). 35 19 Box 2.3: Positioning Armenia in international transit logistics While soft improvements might make transit solutions not require international transit between Russia and Iran. through Armenia more attractive, the country will also have to compete with alternative corridors to attract meaningful Armenia’s extended market (with limited opportunity to transit cargo volumes. Structural conditions (e.g., border serve Turkey and Azerbaijan) is less attractive for regional closures) will continue to affect the country’s connectivity distribution and value-added services to be located in and ability to participate in GVCs. the country. Instead, these services are likely to choose Georgia due to its strategic access to all neighboring Emphasis has been placed in the north-south corridor, countries, extended road network, and maritime access. connecting Iran with Russia and beyond, since Armenia Lack of more flexible transit and groupage regulations, might not be best placed to capture east-west traffic and a limited warehousing regime may also weigh on the movements. Major road investments along the north-south previous considerations. Moreover, some changes can be corridor will soon materialize, connecting the Bavra border achieved by altering national legislation, but others might crossing (with Georgia) with Meghri, on the border with Iran. be impeded by Customs Union-level regulations, or even Coordination with Georgia to improve its north-south road dictated by the latter in the near future (as is the case for corridor infrastructure will be instrumental to complement motor transport). domestic investments. Alternative routes through Turkey and Azerbaijan compete with Armenia for transit The normalization of Armenian-Turkish relations, without opportunities, offering existing rail connections (some soon pre-conditions, as laid out in the Government Program 2017- to be completed) and the ability to “skip” additional transit 2022, would have a significant impact on strengthening the countries. Furthermore, Transcaspian rail-ferry services do positioning of Armenia in international transit logistics. 20 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 2.19. Finally, another enabler of external performance have the potential to facilitate cross-border information may well be the Armenian diaspora, which holds flows and spur increased investment in their country of potential to support increased international trade, origin. Existing albeit limited evidence suggests ample room investment flows, knowledge transfer, and innovation. to better leverage the Armenian diaspora, which may have Globally, the size of a country’s diaspora is correlated with been under-utilized for a number of often complex reasons.36 both trade and investment. Large diaspora communities Box 2.4: Armenia’s diaspora Between 9 and 11 million individuals of Armenian descent rudimentary bond and equity markets. live worldwide. Three million Armenians live within Armenia, leaving a 6 to 8 million strong diaspora spread worldwide Since before Armenia’s independence, the diaspora and split into two categories: the “old diaspora” descends has been an active contributor of FDI, humanitarian aid, from pre-1970 migrants and is well organized but less and other philanthropic transfers. Analyzing investment connected to the homeland; and the “new diaspora” flows from 1994 to 2004, researchers found that around includes post-1970 migrants and their descendants, and is 69 percent of foreign investors that invested in Armenia less well-integrated in their host countries, but more closely were diaspora-connected, and 68 percent of FDI-recipient connected to the ancestral homeland. Overall, the Armenian companies had relevant diaspora ties. Furthermore, 60 diaspora is not only numerous, organized, well established percent of diaspora-connected investors came from just in host countries, and widespread geographically. It also three countries: Russia (29 percent), the US (17 percent), keeps close cultural, material, and emotional ties with the and Iran (14 percent). Between 2000 and 2010, four sectors homeland. These qualities make the Armenian diaspora, accounted for 72.5 percent of cumulative FDI in Armenia: arguably, the quintessential modern diaspora. transport and telecommunications; electricity, gas and water; financial intermediation; and mining. The role of Financial transfers, particularly personal remittances, diaspora in the ICT sector has been particularly relevant have gone from US$65 million (less than 5 percent of over the past five years. Tourism, in particular “responsible GDP) in 1995, to US$168 million (around 6 percent of tourism”, has become a priority sector for the Government GDP) in 2003, to US$2.1 billion (over 19 percent of GDP) to develop the regions. in 2014. However, the high dependence on remittances originating in the Russian Federation raises concerns for The diaspora also brings important intangible contributions an estimated contraction of at least 20 percent in 2015, (e.g., institutional, knowledge transfer). A good track record and subsequent years. The size of its diaspora and the of engagement can be found in the private sector, where country’s high dependency on remittances makes Armenia the diaspora contributes to education, to the transfer of a good candidate to implement new financial instruments for knowledge and skills, and to projects with local spillovers. leveraging remittances for development. These instruments Future policy efforts should aim to re-earn the trust of include diaspora bonds and the future-flow securitization the diaspora by fostering these private projects through of remittances. However, for those instruments to be better legal frameworks and business environments. As implemented, important institutional challenges in the these improve, the diaspora may continue to increase its domestic financial system must be addressed, such as the engagement. B Challenge 2: Private Sector Productivity by a vibrant dynamic private sector ready to grow, absorb and Job Creation knowledge and technology, and open new markets. This section examines the dynamics of firms’ performance and 2.20. With a far less supportive external environment, a associated underlying constraints.37 vibrant business sector is essential for further economic growth and poverty reduction through improvements i. Productivity and Firms’ Performance in productivity and job creation. Indeed, while improving external performance and international connectivity will 2.21. The drivers of growth have shifted in the post- be key in supporting Armenia’s rebalancing and finding crisis period, as the potential for further efficiency new growth drivers, it will only be successful if supported improvements associated with the transition period has 36 Armenian migrant destinations receive fewer imports from their home country than other migrant groups, while in terms of exports from their destination country to their country of origin Armenian migrants are similar to other groups. Armenia attracts little FDI from the EU countries where its diaspora resides. There is a limited correlation between migrant destinations, FDI, and the presence of foreign subsidiaries in Armenia (World Bank, 2013). A noticeable exception is the ICT sector in Armenia, which has benefitted from support and investment of the US-based Silicon-valley diaspora. See Annex: Trade and Competitiveness Selected Issues. 37 21 diminished. Total factor productivity (TFP) was the main gains decelerated even more. Labor’s role in GDP growth, contributor to growth as the Armenian economy transitioned on the other hand, has remained consistently low and from a centrally planned to a market economy, and capital has declined in the aftermath of the crises, as Armenians and labor were re-allocated to more productive sectors. sought employment opportunities abroad. Notice, however, Between 2005 and 2008, as efficiency gains decelerated, that while Armenian efficiency growth in 2012-15 was half capital accumulation played a larger role (Figure 2.5). But its level in 2005-08, from a cross-country perspective it the contribution of capital fell in 2012-15, and efficiency remained significantly high, particularly within the region. Figure 2.5: Growth accounting decomposition Figure 2.6: TFP growth rates: Armenia by factor and comparators 14 13 12 11 10 9 8 6 7 4 5 2 0 3 -2 1 -4 2000-2003 2005-2008 2012-2015 -1 ARM ALB GEO HUN MKD MDA SLV BIH Labor Capital Total Factor Productivity Growth of GDP, log change -3 2000-2003 2005-2008 2012-2015 Source: Calculations based on data from Conference Board. 2.22. The observed patterns of deceleration of GDP and existence of barriers to competition that prevent the exit of productivity growth at the macro level result from the inefficient plants. aggregation of growth and productivity dynamics at the firm level. Specifically, for overall productivity to grow at 2.24. However, Armenia’s most productive firms the macro level, two forces need to be at play. First, firms exhibit features that are consistent with international need to become more productive over time. Second, the experience, suggesting opportunities for improvements. most productive firms need to grow and absorb resources The country benefits from high rates of entrepreneurship. that the least productive firms release through a ‘Darwinian’ Moreover, successful firms show patterns that are consistent creative destruction process of competition, which should with international experience: most productive firms tend to result in a reduction in the dispersion of productivity levels be younger, use more technology, and are more innovative, between firms. while exporters are more likely to be innovators and foreign- owned. SMEs are important employers and job creators.38 2.23. Limited productivity growth has been witnessed 2.25. These patterns suggest considerable scope for at the firm level post-GFC and firms appear constrained improving efficiency and productivity. This can be done in their ability to enter markets, grow, and consolidate. by shifting labor and capital to more productive firms through Productivity at the firm level remained unchanged between addressing the causes of resource misallocation. The next 2009 and 2013, in contrast with, for example, Georgia, section examines the progress made so far in addressing where firms’ productivity improved (Figure 2.6). Slow growth these causes and the remaining constraints to be tackled. in entry rates of new companies and difficulties being encountered by small firms trying to grow larger suggest ii. Constraints to Improving Firms’ Productivity significant barriers to entry and in terms of employing more workers or accessing capital. Firms also show high 2.26. Policies and the business environment affect dispersion of productivity, suggesting limited competition. A incentives for firms to become more productive. higher number of low productivity firms is consistent with the Analysis shows that over one-third of productivity at 38 About 40 percent of manufacturing jobs and more than half of all formal services jobs are found in SMEs. Small firms and firms in the services sector are leading in job creation. In the period 2013-15, small firms contributed positively to net job creation, while both medium and large firms experienced a net decline in employment. The increase in employment seen in the services sector—the largest sector of the economy—more than compensated for the contraction in employment experienced by both the agriculture and manufacturing sectors. 22 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Box 2.5: Firms’ dynamics An analysis of firms’ patterns reveals important grow over their lifecycles has decelerated in recent years. constraints for firms: Employment growth over the lifecycle of firms has notably decelerated in recent years, hinting to increasing barriers First, firms’ entry and consolidation seems difficult. and costs that firms face to grow in terms of employing Despite relatively high rates of entrepreneurship, firms more workers or accessing capital. This is consistent with display a relatively low success rate among their peers. the finding that entrepreneurship seems to be hindered by a Armenia ranks among the top countries in terms of the share lack of access to productive assets (i.e., access to finance, of the adult population that has tried to set up a business, cf. next section). with the share also rising by 7 percentage points since 2010. However, the success rate among Armenian entrepreneurs Third, the high dispersion of productivity and slow is among the lowest in the region, with almost 40 percent of growth hints at a lack of competition and a lack of start-ups failing to survive, suggesting difficulties to start a exit, leading to resource misallocation and suggesting business. Similarly, in the formal sector, the number of newly scope for improving efficiency by shifting labor and registered firms in Armenia has increased only slightly since capital to more productive firms. Firms in the lowest 2010, and at a far slower pace than Georgia, after a decline decile of the labor productivity distribution are three times during the GFC in 2008-09. less productive than those at the highest decile. When compared with neighboring Georgia, the distribution of Second, firms’ growth is also constrained. The TFP shows a greater dispersion. Armenia’s higher number probability that a micro establishment (those small of low productivity firms suggests the existence of barriers firms with fewer than five employees) grows to become to competition that prevent the exit of inefficient firms and a larger firm within the following two years is low. In therefore the reallocation of resources to more productive fact, between 2013 and 2015, only 7 out of 100 micro firms uses. Firm size increases only slowly over its lifecycle, successfully grew into the next size bracket (i.e., employing which is a symptom of resource misallocation. In Armenia, 5 to 9 employees), and only 1 in 100 grew into the SME old firms (20 years old or more) are, on average, three times category (10 to 49 employees). This means that about larger than young firms (5 years old or younger). In the US, 92 percent of micro firms with fewer than five employees for example, older firms are more than seven times larger were still in the same employment category two years later. than the younger ones. This is well above what is observed Instead, it is more likely that firms shrink. In 2015, about in Armenia and suggests considerable scope for reducing 26 percent of firms with 5 to 9 employees shrank to have barriers to grow and facilitating the accumulation of firm- fewer than five employees. Moreover, the ability of firms to specific organizational capital for Armenian firms. Figure 2.7: Most problematic factors for doing business Access to financing 15.3 Corruption 11.3 Inefficient government bureaucracy 10.6 Tax rates 10.5 Tax regulations 10.1 Inadequately educated workforce 8.9 Foreign currency regulations 7.9 Inflation 6.8 Inadequate supply of infrastructure 6.1 Insufficient capacity to innovate 3.7 Policy instability 33 Poor work ethic in national labor force 2.8 Restrictive labor regulations 1.3 Poor public health 0.9 Crime and theft 0.3 Government instability 0.1 0 4 8 12 16 Source: Global Competitiveness Index, Executive Survey, 2017-18. 23 the firm level in Armenia can be explained by the policy and pledges, and mechanisms to support modern financial environment, broadly speaking.39 When asked, surveyed transactions and property transfers. A modern registry senior executives respond that access to finance, combines cadaster and registration systems under the corruption, bureaucracy, and tax are the most problematic State Committee of the Real Estate Cadaster. A regulatory factors for doing business in Armenia (Figure 2.7). and institutional framework allows for using land and property as collateral, and this practice is increasing, 2.27. This section reviews the key areas of although bank acceptance of land as collateral in rural improvement in the investment climate in Armenia. It areas remains limited. Positive steps have been taken identifies progress made so far and remaining issues to be to improve public sector efficiency in the area of human addressed. Existing challenges pertain to: (i) investment resource management systems, e-health and e-police to climate and governance gaps despite some progress; (ii) a improve service delivery to citizens. A system of income lack of competition and market contestability despite some and asset declarations for high-level public officials has progress; and (iii) the need for further financial deepening also been put in place. As a result, the business climate and access to finance. in Armenia has improved over the past decade. Armenia has improved its performance in most business climate a. Investment Climate and Governance Gaps indicators, increasing its Distance to Frontier ranking in the Doing Business Index (DBI) from 61 in 2010 to 74 in 2017. 2.28. Over the past decade, Armenia has begun Armenia has also seen some improvement in its ranking in implementing a number of reforms aimed at removing the Global Competitiveness Index (GCI) from 97 in 2009- regulatory obstacles for the private sector and 10 to 73 in 2017-18. citizens, reducing corruption, and improving the efficiency of the public sector. These reforms include a Figure 2.9: Global Competitiveness Index comprehensive review of the regulatory stock (regulatory guillotine), business inspection reforms, streamlining, Subindex A: Basic requirements 7 Innovation Institutions and one-stop centers for regulatory procedures, as well 6 as assessments of the impact of new regulations. Other Business sophistication 5 Infrastructure 4 important reforms have included the adoption of a new Tax Subindex C: 3 Innovation and Macroeconomic Code aimed at simplifying tax policy and administration, sophistication factors 2 environment 1 and making it more transparent. It has unified and simplified 0 tax legislation, both policy and administration, and limited Market size Health and primary education the number of exemptions. As explained above, border Subindex B: management policies and procedures have improved Technological Efficiency enhancers readiness markedly. In addition, the legal framework for protecting Higher education and property and legal rights are in place, with the legislation Financial market development training Labor market efficiency Goods market efficiency providing a basic framework for secured lending, collateral Armenia -4.1 Georgia -4.3 Estonia -4.8 Figure 2.8: Ease of Doing Business Index 2017 Source: World Business Forum 2016. SVN Figure 2.10: Regulatory quality, 2015 ARM Regulatory Quality (100=Best) HUN 100 90 MDA 80 79 70 70 61 SER 60 50 49 40 33 ALB 30 20 BIH 10 0 0 20 40 60 80 Armenia Georgia Europe and Lower Middle Upper Middle Central Asia Income Income Ease of doing business index (1=easiest to 185=most difficult) Countries Countries Source: WBG DBI 2017. Source: Worldwide Governance Indicators. 39 World Bank (2015): “Republic of Armenia: Drivers of Dynamisms”. 24 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Box 2.6: Income and assets declaration The system of income and asset declarations for high- followed the establishment of ECHRO. A draft package of level public officials was initially implemented by the tax legislative changes is sought to enhance the jurisdiction and authorities in early 2004, following which the declarations capacity of ECHRO to convert it into an effective corruption were published, albeit not regularly and not in the volumes prevention agency. The legislative changes are expected to openly available to the public. In 2011, the new “Law on introduce additional disclosure of interests, and criminalize Public Service” included mandatory submission of income failure to file a declaration or the submission of false and assets declarations by over 500 high-level officials (and information, enabling the publishing of more comprehensive their affiliated persons) to the Ethics Commission for High information online that will reflect potential conflicts interest Ranking Officials (ECHRO), constituted by a Presidential of public officials. Further enhancements of the system may Decree dated January 9, 2012. Increasing public focus on also require new approaches for accounting for beneficial state capture by narrow vested interests emphasizes the ownership,9 which is impossible to capture through cross- importance of online publication of the disclosed information checks with formal registries (databases). Recently, Armenia to catalyze bottom-up pressure for reform. made specific international commitments to publicize beneficial ownership in the financial and mining industries. The Ethics Commission launched an advanced system In 2016, the CBA approved a regulation to fill some gaps in and portal for electronic disclosures in the second half of its legal and regulatory regime for the disclosure of ultimate 2013, and in 2014-15 achieved almost 100 percent formal beneficial ownership of financial institutions and groups in compliance in terms of the collection and publication of line with international benchmarks (Basel core principles declarations. The Ethics Commission has been proactive for effective banking supervision [2012]).  The CBA should, in signing MOUs with ministries to ensure interoperability nonetheless, deepen its assessment of the transparency of databases necessary for third-party cross-checking of of the ownership structure and the sources of initial capital disclosed information. The December 2014 amendment to ensure that it has identified all beneficial owners that to the Law on Electronic Document and Electronic Digital exert a controlling influence on financial institutions and Signature (and relevant sub-laws) further enhanced inter- groups. Joining the Extractive Industries Transparency operability of databases, making the cross-checks more Initiative (EITI) on March 9, 2017, Armenia committed to effective. The Ethics Commission also put significant effort disclose beneficial ownership in the mining sector by 2020. into risk-based analyses. Meanwhile, 2018 is the deadline for the adoption of a formal However, given the administrative and jurisdictional roadmap for preparation and adoption of the necessary constraints, no real (or at least publicly visible) investigations regulatory framework. 2.29. While the Worldwide Governance Indicators rule statements and transparency, relatively inefficient public of law has shown progress, regulatory quality and the internal control framework and weak audit institutions.41 control of corruption are areas where there is space In the same vein, progress should be made to improve for improvement. PFM reforms have shown improvement accountability and oversight in the public sector, greater since the last (2014) PEFA. For example, financial and use of evidence-based analysis in policy formulation compliance audit manuals have been developed in line with with strengthened public scrutiny, and strengthening the the international standards and applied by the Chamber of independence of the judiciary.42 Conflicts of interest in the Control on a case by case basis. The number of public executive, legislative, and judiciary weaken government sector internal auditors including certified internal auditors effectiveness further. This is compounded by a lack of has increased. However, there is still progress to be made meritocracy in the civil service, with a pay scale that does to address the lack of government consolidated financial not reward performance and skills, and allows the use of The last Public Expenditure and Financial Accountability Assessment (PEFA, 2014) identifies as key issues (which remain valid today) internal controls, internal and 40 external audits, financial statements quality and legislative scrutiny. The oversight of the numerous State Non-Commercial Organization (SNCO) could also be strengthened. The last Public Expenditure and Financial Accountability Assessment (PEFA, 2014) identifies as key issues (which remain valid today) internal controls, internal and 41 external audits, financial statements quality and legislative scrutiny. The oversight of the numerous State Non-Commercial Organization (SNCO) could also be strengthened. The lack of an independent and competent judiciary is an impediment to doing business. It also weakens property rights in the absence of easy settlements of property 42 disputes and alternative mechanisms for judicial recourse. These weaknesses are reflected in the Doing Business survey indicator for the time to enforce contracts, which has remained at 570 days since 2012. Armenian judicial independence ranked 106 out of 140 countries by the Global Competitiveness Report 2015-16. According to Transparency International’s 2013 Global Corruption Barometer, the judiciary in Armenia was perceived as one of the most corrupt institutions in the country. 25 cronyism to allocate positions and promotions. Findings of participation by taking measures to close the feedback the 2018 Regulatory Governance Indicators for Armenia loop and improve bottom-up participation. show there is scope to strengthen avenues for public Figure 2.11: Worldwide Governance Indicators, 2018 Percentile Rank Indicator Country Year ? (0 to 100) Regulatory Quality Albania 2015 Armenia 2015 Bosnia and Herzegovina 2015 Georgia 2015 Hungary 2015 Macedonia, FYR 2015 Moldova 2015 Rule of Law Albania 2015 Armenia 2015 Bosnia and Herzegovina 2015 Georgia 2015 Hungary 2015 Macedonia, FYR 2015 Moldova 2015 Control of Corruption Albania 2015 Armenia 2015 Bosnia and Herzegovina 2015 Georgia 2015 Hungary 2015 Macedonia, FYR 2015 Moldova 2015 0 20 40 60 80 100 Source: WBGI 2017. 2.30. A number of reforms are lagging, with a gap 2.31. Corporate governance challenges make it between what has been approved on paper (de jure) difficult to attract FDI or obtain financing from the and what is implemented on the ground (de facto). domestic market. Limited transparency, inefficient Examples can be found in the areas of border management, Boards of Directors, and limited protection of the rights property rights, tax administration, and the competition of shareholders challenge the ability of Armenian firms to environment (cf. next section). While starting a business, attract investors, obtain financing from banks, or establish registering property, enforcing contracts, and accessing relationships with reputable international partners, thus credit are made easier by regulations, getting things significantly limiting their growth prospects. Shadow done to carry out business operations, such as obtaining accounting and underreporting of profits are widespread construction permits, and getting electricity can still be and partly caused by deficiencies in tax and customs cumbersome (Ease of Doing Business 2018). In addition, administration. Disclosure of non-financial information as seen in the earlier section discussing connectivity, the (e.g., on ownership structure, strategy, etc.) is generally price of inputs such as digital services is relatively higher poor. Boards lack independence, a strategic role, and than in peer countries relative to performance, weighing on oversight over the management of the company. While competitiveness. Similarly, access to quality infrastructure basic shareholder rights appear to be granted by law, it is relatively lower than in peer countries. For example, is not clear how shareholder agreements and rights are the poor condition of critical power transmission and enforced.43 The Government’s ongoing efforts to develop distribution assets compromises supply reliability. the domestic capital market and scale up FDI inflows in 43 Armenia ranks relatively low, at 36th percentile, on GCI’s protecting minority shareholders’ interest indicator. 26 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Box 2.7: Energy sector’s challenges Power supply adequacy. New generation capacity will be the Government will identify feasible mechanisms to attract needed to meet the forecast peak load and ensure sufficient long-term private capital into the energy sector to ensure supply capability in the power system starting from 2021 reliability and adequate electricity supply for vibrant growth when Hrazdan TPP is planned for decommissioning. of the productive private sector. Energy efficiency is the least-cost option for meeting the electricity demand. The cost of saving 1kWh of electricity Reliability. The poor condition of power transmission assets is estimated at 25 to 30 percent of the long-run marginal jeopardizes supply reliability. The average interruption cost of new supply. A focus on energy efficiency would frequency per line for 110 and 220 kV overhead transmission also address affordability concerns as well as contribute to lines (OTLs) is 2.5 times higher than for comparator well- increased energy security, together with the development performing utilities. The average age of substations is of renewable energy (2013 National Energy Security around 35 years and most of the substations have not Concept). undergone any major rehabilitation or upgrade. The quality of electricity service, as evidenced by the service quality Governance and investment climate. Starting from 2016, indicators computed and published by the Public Services the financial standing of the power sector started to improve Regulatory Commission (PSRC), has deteriorated since due to successful implementation of the Government’s 2013 due to increased number of outages at distribution Financial Recovery Program. Building on this improvement, level.45 New investments in the transmission and distribution the Public Services Regulatory Commission (PSRC) plans networks will help improve reliability. to move on with the next phase of regulatory reforms and eliminate cross-subsidies in the end-user tariffs set for Affordability. Traditional indicators show that energy various voltage groups. Overall, the legal and regulatory affordability is a salient issue in Armenia, affecting relatively framework in the country is conducive for attracting private more the poor and vulnerable groups. Energy represents investments. Building on the successful reform momentum a substantial share of household consumption in Armenia: started in 1997, the sector attracted more than US$1.2 energy expenditures account for 12.4 percent of overall billion in private investment. With the approval in July 2017 household expenditures and electricity accounts for 6 of the Action Plan for Liberalization of the Power Market, the percent. About 11.2 and 52.5 percent of the households in sector will transition from a regulated to a liberalized model, Armenia are estimated to be “electricity and energy poor”, with the objective of introducing contemporary trading rules, respectively.11 Electricity tariffs are expected to increase further improving the tariff structure, and promoting cross- further, given the sizeable expected investments in the border trade. Against the backdrop of public debt constraints, power sector. export-oriented sectors will succeed only if the protection for firms that engage in organizational innovations, such of shareholder rights is strengthened.44 as business practices, workplace organization, or external relations or invest in R&D.48 However, low overall integration 2.32. Finally, greater use of innovation, technology, may be reducing the scope for gains through innovation. and knowledge absorption would be effective to Participation in R&D and innovative activities has declined boost productivity. Innovation does pay off in terms of over time and Armenian firms lag their peers from productivity, suggesting opportunities for improvement comparator countries in terms of their innovation activity (in should Armenia become more globally integrated. terms, for example, of R&D spending and encouragement Armenian firms that conduct innovative activities enjoy a for employees to use innovations by employers). Firms may large productivity premium: those firms that have introduced struggle to secure financing for some of these innovations a new product or method of production are twice as productive and others may be too small to gain from them. as non-innovative firms. A positive premium is also observed 44 Armenia ranks relatively low, at 36th percentile, on GCI’s protecting minority shareholders’ interest indicator. 45 Source: Corporate Governance in Transition Economies: Armenia Country Report, EBRD 2016. 46 The country-wide System Average Interruption Duration Index (SAIFI) increased from 5.18 in 2012 to 6.98 in 2016. The country-wide System Average Interruption Duration Index (SAIDI) was in the range of 8.69 in 2013 to 12.66 in 2016. The deterioration of supply reliability may be a result of under-investment in distribution due to distressed financial condition of ENA in 2012-2014. 47 A household is considered electricity/energy poor if it spends more than 10 percent of its overall budget on electricity/energy. 48 Source: World Bank SCD Trade and Competitiveness Background Note. 27 b. Competition and Market Contestability market dominance, and 77 on the effectiveness of anti- monopoly policy.49Recent years have seen an improvement 2.33. The competition environment has shown progress in the regulatory framework of certain sectors allowing in recent years. Competition perception indicators of the more competitive environments to develop.50 Discussions World Economic Forum’s Global Competitiveness Report on how to improve the functioning of various important (2016-17) show that Armenia ranks 91 out of 138 countries markets, such as pharmaceuticals, fertilizers, and health on the intensity of local competition, 51 on the extent of services, are ongoing.51 Figure 2.12: Business risks related to weak competition policies (by component) 14 12 10 8 6 4 2 0 Poland Herzegovina Lithuania Moldova Georgia Latvia Ukraine Albania Armenia Romania Serbia Bulgaria Estonia Macedonia, FYR Hungary Bosnia and Vested interests/cronyism Discrimination against foreign companies Unfair competitive practices Price controls Source: Economist Intelligence Unit, 2017. 2.34. Nevertheless, important concerns remain for (Economist Intelligence Unit’s [EIU] 2017-18 report). Indeed, investors. While the state-owned sector is limited in according to the EIU’s Risk Tracker, business risks related Armenia, weak competitive conditions and competition to weak competition policies are the second-highest in the policies are perceived as contributing to a high degree of region, just after Ukraine (Figure 2.11). These perceived operational business risk for private sector firms. Investors in risks are mainly related to vested interests and cronyism, Armenia face one of the highest risks in conducting business and unfair competitive practices that hinder the creation of a among other European and Central Asian (ECA) countries level playing field for firms in the market.52 Figure 2.13: Market structure in the manufacturing sector 100% 22% 80% 34% 36% 32% 41% 47% 39% 52% 43% 46% 45% 57% 59% 53% 54% 54% 60% 66% 47% 40% 53% 53% 47% 43% 42% 44% 32% 41% 44% 39% 40% 37% 40% 20% 36% 0% Poland Georgia Estonia Latvia Romania ECA Average Albania Armenia Bosnia Moldova Serbia Ukraine Bulgaria Lithuania Macedonia, FYR Hungary Monopoly Oligopoly (3 to 6) Duopoly More than 6 Source: World Bank, Enterprise Surveys. Share of markets characterized by monopoly, duopoly, oligopoly and more players on the vertical axis. This represents a significant improvement relative to 2010, when Armenia ranked 138 out of 140 countries on effectiveness of anti- 49 monopoly policy, 136 on intensity of local competition, and 133 on the extent of market dominance. 50 Sectors such as air transportation, retail, and fuel that used to be highly restrictive have been opened in recent years, but the largest firms continue to dominate these markets. 51 Supported by the State Commission for the Protection of Economic Competition (SCPEC). 52 World Bank, Enterprise Surveys, latest available data. 28 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 2.35. Entry has been observed in some subsectors for households.56 If we assume that prices of selected food but many Armenian markets have few participants or products present overcharges due to weak competition, are highly concentrated, increasing the risk of non- savings from boosting competition for the bottom decile will competitive market outcomes. Armenia has the highest double or triple the relative savings for the top consumption share of manufacturing markets that are monopolies, decile (Figure 2.13). duopolies, or oligopolies among peers in the ECA region (Figure 2.13).52 Evidence suggests that over time subsectors 2.37. The lack of market contestability and appropriate in manufacturing and services are becoming more pro-competition regulation in some sectors that concentrated.53 Entry has been observed in some markets provide production inputs (railways, utilities, internet but many important markets remain highly concentrated54. connectivity) adds to the costs of firms operating in Armenia and reduces their competitiveness. While it is 2.36. Weak competition and lack of market contestability true that the small scale of the market for these services is have negative effects on productivity growth and not as conducive to the operation of various providers, lack consumer welfare.55 The contribution of the private sector of effective regulatory frameworks to simulate competitive to GDP growth and shared prosperity depends on the degree pressure in terms of price and quality of services can of competition in markets. Analysis shows that subsectors leave consumers unprotected and distort related markets. with lower concentration are associated with higher real Monopolies such as in railway infrastructure, water supply, labor productivity growth at the subsector level. More electricity supply, and telecommunications infrastructure concentrated markets are more prone to non-competitive can use their market dominance through the discriminatory outcomes, such as reduced incentives to innovate and to or discretional treatment of business consumers and affect become more productive. In addition, previous analysis their competitive position in their markets. If allowed by conducted for Armenia has shown that weak competition weak regulatory frameworks, this adds to the costs of firms can have negative impacts on consumer prices that are key operating in Armenia and reduces their competitiveness. Figure 2.14: Potential savings due to strong competition in selected food products, by consumption decile (share of total household expenditure) 0.030 Average share of total expenditure 0.025 0.020 0.015 0.010 Bread & cereals 0.005 Milk, cheese & eggs 0.000 Oils & fats 1 2 3 4 5 6 7 8 9 10 Consumption deciles Source: Estimations based on ECA Poverty & Equity team calculations on ILCS 2014. 2.38. There are various areas in the competition policy fines, and the definition of economic entities to account for framework that require revision. The introduction of individual companies that operate under common control. a competition perspective to resolve market problems through government interventions has been on an ad- 2.39. Measures to ensure government competitive hoc basis, depending on the State Commission for the neutrality have yet to be put in place. In the area of Protection of Economic Competition’s (SCPEC) focus procurement, various reforms have taken place but anti- rather than on a system that incorporates competition competitive practices seem prevalent (Box 2.7). Existing principles in regulatory impact assessment. There are instruments of state aid to foster investment in the country still important gaps that reduce the effectiveness of the (such as tax exemptions and concessional loans) lack a enforcement of the Competition Law and the possibility of full framework to minimize distortions on competition. The deterring abuse by dominant firms and collusion among Competition Law includes some provisions on state aid, competitors. These include investigative powers, level of which are not enforced. Based on firm-level State Revenue Commission data for the years 2011-2015.The distribution of concentration indices that account for number of firms and shares in subsector revenues has moved to the right for 53 subsectors within manufacturing and services. 54 That would be true for example for granulated sugar, petrol, banana and poultry. Concentration analysis based on 2011-15 data from Armenia State Commission for the Protection of Economic Competition (SCPEC). 55 Findings are drawn from the World Bank SCD Trade and Competitiveness Background Note. Prices of certain essential food products, such as milk, eggs, bread and butter, were found to be higher than in other CIS countries (at least by 23 percent) even after controlling for proxies of market size and transportation 56 costs. See World Bank (2013). 29 Box 2.8: Procurement in Armenia The procurement of works, goods and services is a big- level of bidders and largest average contracts, while certain ticket item in public spending for private sector growth forms of procurement, such as framework agreements, all over the world. Armenia is no exception, where public feature a low level of participation (for example, in 2014, 161 procurement expenditure was around 7 percent of GDP framework agreements were signed for the same number of in the period 2014-16, accounting for an important share registered firms). of public spending. Therefore, encouraging competition in these markets could reduce the pressure on fiscal accounts, Competition analyses carried out by SCPEC informed while crowding in the private sector. the new public procurement law, but also revealed gaps in public procurement practices and the prevalence Public authorities have proactively engaged in reforms. of anti-competitive agreements among competitors As soon as 2005, an online platform was created, Republic for public contracts. Investigations of anti-competitive of Armenia Armenian e-Procurement System (ARMEPS), agreements in public procurement have involved medicines, listing legislation, procurement plans and appeals, and the food products, office furniture and supplies, computer necessary information to apply to public contracts advertised equipment, construction materials, construction services, or to appeal the Government’s decisions. Moreover, in and cleaning and sanitary products. These agreements 2010, Armenia joined the WTO’s Government Procurement can raise costs for the Government by 49 percent on Agreement (GPA), to improve the access to public contracts average (Connor, 2014). Recommendations to boost by international competitors. The Government then competition include: clarification of the concept of “related approved a revised version of the Government Procurement party” to prevent entities controlled by the same economic Agreement (GPA) in 2015, and passed new rules stipulating entity from participating in the same tendering process; that invitation to participate to public contracts should be improving the appeals process and the independence of sent to at least three companies, and be reported on the the appeal commission; and increasing transparency of public procurement agency’s website. ARMEPS, the country information on ARMEPS. The full implementation of these e-procurement system, is up and running. However, its recommendations is pending. coverage is limited and an important number of procurement selections are not open to competition. Overall, the country has a tremendous opportunity to use procurement spending more effectively as a tool to Armenia’s experience illustrates the challenge of promote private sector development. First, information outsourcing in a small economy where there is little to potential bidders about contract opportunities can be competition among suppliers. An analysis of procurement increased by building on the new rules requiring the use data reveals that competition in public procurement is of e-procurement in procurement. Second, steps can be relatively limited. While there is a large volume of contracts, taken to encourage registration of SMEs and to encourage there are relatively few open tenders or open competition. bidding. Third, improving competition on larger tenders would Within the latter, the level of participation of firms is very low, provide greater effectiveness and competitiveness. Lastly, with on average between 1.7 and 1.9 bidders. The number improving the detection of bid rigging and discouraging of competitors also varies substantially across different such practices would help to boost value for money in public methods of procurement. Open tenders feature the highest investment to support productivity growth. c. Financial Deepening and Financial Inclusion limited, as evidenced by several converging indicators.57 The size of the financial sector is broadly in line with Armenia’s 2.40. Financial depth and financial inclusion have level of income when using a credit indicator (Figure improved over the past decade, but they remain 2:15), but lags peers when using deposits, suggesting important constraints to growth and private sector limited domestic savings (Figure 2.14). This limited level of development. Substantial progress has been made in domestic savings is becoming even more binding against implementing the 2012 Financial Sector Assessment the backdrop of scarcer foreign saving, with diminished Program (FSAP) recommendations. However, the financial foreign investment and fierce global competition for financial sector remains bank-dominated and financial inclusion is resources. 57 Domestic credit to the private sector as a percentage of GDP was at about 46 percent in 2015, in the range of other countries with a similar income per capita. Access to finance is cited as the top constraint in the Global Competitiveness Index and in the most recent BEEPS survey. Only 3 percent of Armenian firms indicated that access to finance was not a problem in 2013, compared with an average of 49 percent across ECA countries. In addition, access is skewed toward large firms (75 percent of them reporting having bank loan, against 31 percent of small firms and concentrated in Yerevan). Only 46 percent of companies have loan or credit lines with banks and less than 10 percent of corporate investment is financed by banks. Collateral is commonly required (89 percent of loans) and appears excessive (264 percent of the loan value on average). Banking services have expanded with the increase in number of ATMs, branches, and loan and deposit accounts. However, only 17 percent of the adult population have financial accounts. In addition, the informal borrowing channels are still popular. Only 20 percent of adults obtained loans from financial institutions in 2014, while 27 percent of adults received credit from their family or friends (IMF Article IV, 2017). 30 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Figure 2.15: Deposit to GDP vs GDP per capita Figure 2.16: Credit to GDP vs GDP per capita Avg. log Domestic private credit to the real sector Avg. log Domestic Bank Deposits/GDP (%) 6 6 by deposit money banks to GDP 5 5 ARM 4 4 3 3 ARM 2 2 6 8 10 12 6 8 10 12 Avg. log GDP per capita (current US$) Avg. log GDP per capita (current US$) Source: World Development Indicators, Finstats database, World Bank. Note: 2014-2015, 143 countries, log transformation. 2.41. Structural challenges hinder financial deepening. average interest rate spread of 5.2 percent has declined Interest rates are high in Armenia, both due to the high as competition has lowered profit margins, but remains a cost of raising deposits and to the high interest rate full point above the regional average of 4.2 percent of its spread to borrowers. Against a backdrop of poor corporate comparators (Figure 2:18). Small borrowers often lack the governance practices, in particular the lack of transparency necessary skills to be considered creditworthy. Lenders and absence of reliable financial statements, banks apply often lack the skills to work with small firms to understand high risk premiums to lending rates and require substantial their businesses, construct reliable financial statements, and collateral.58 In recent years, the risk premium has grown assess their credit applications. Efforts to reduce informality while other factors contributing to the spread have declined and to increase financial education would be important or remained largely unchanged (Figure 2:17). Armenia’s complements toward financial deepening. Figure 2.17: Decomposition of interest rate spread Figure 2.18: Interest rate spread as percentage, 2016 20% 10 9 8 15% 7 6 5.2 10% 5 Average is 4.2 4 3 5% 2 1 0% 0 2011 2012 2010 2014 2006 2007 2008 2009 2013 2016 2017 2005 2015 Poland Spain Estonia Latvia Slovakia Russia Armenia Ukraine Bolivia Georgia Regulatory cost Credit Risk Operational costs Source: Central Bank of Armenia. Source: Central Bank of Armenia. 58 A new legal framework and pledge registry for using moveable assets as collateral is beginning to expand credit to smaller businesses, but is still under-used by banks in Armenia relative to banks in other countries following similar reforms. 31 2.42. Developing capital markets to complement affected by the size of labor resources, as well as the bank intermediation will be important in the future to decision of working-age people to seek work. Since 2008, deepen and diversify access to finance. Capital markets there has been a slight increase in the percentage of the in Armenia are particularly small. Armenia’s stock market labor resources that have become economically active. But capitalization to GDP was 8.5 percent of GDP in 2015. most of the rise in economically active people has resulted The Armenian market still suffers from a high and volatile in rising unemployment rather than employment—a interest rate environment, as demonstrated by government reflection of the labor demand conditions and job creation. bond yields in recent years. Therefore, it is challenging While between 2004 and 2008 employment grew by 9.4 for companies to suggest even higher rates to attract percentage points (mostly driven by construction), since investments into corporate bonds. It will be crucial for the 2008 employment has been on the decline; employment Government to deepen the primary and secondary markets contracted by 10-percentage-points between 2008 and for government bonds to boost demand for these bonds 2015. Growth in the number of unemployed, which and, consequently, lower their interest rates. A strong peaked in 2010, has once again picked up since 2013. catalyst for capital market development in Armenia is the The analysis in Section B suggests that a vibrant private Government’s ongoing pension reform program. Armenia’s sector can address this lackluster performance of the labor pension fund assets are one of the lowest compared with its market by stimulating demand for labor. Recognizing the peers. In 2015, Armenia’s pension fund assets amounted demographic and skills challenges facing the economy, to just 0.6 percent of GDP, compared with an average of this section focuses on the supply side of the labor market. 14.1 percent for comparators. The pension industry in Armenia has been slowly taking shape with a strong initial 2.45. From the supply side of the labor market, accumulation of funds coming from the implementation of a productive labor is essential not only for rejuvenating mandatory defined contribution plan from January 1, 2014, the private sector but also for lifting workers’ earning covering civil servants and new labor market entrants. potential, especially as technology advances and skills Current government plans call for mandatory participation needs change. Over the long run, productivity growth is the by all workers under the age of 40, beginning on July 1, economic factor that has the potential to lift living standards 2018 (see Section 2.4). As the pension funds accumulate, for all, especially the poor. The nature of jobs and the skills they can be expected to cause much needed pressure to they demand are changing as agricultural employment lower interest rates as they increase demand for bonds declines and the prospects of IT-led sectors grow. While and other securities. short-term labor migration to work on farms or construction sites in Russia will remain an option for low-skilled 2.43. The CBA is committed to addressing constraints Armenian workers (see Annex 4), addressing demand side on financial deepening and access to finance by: challenges discussed in Section B complemented with (i) assessing the weaknesses and vulnerabilities of the boosting workers’ employability and earnings potential (the financial sector; and (ii) jointly setting new goals and tasks focus of the current section) will be important. with the Government to improve financial intermediation, including by addressing the low level of financial literacy i. Labor Productivity and Human Capital and inclusion; and (iii) supporting the development of 2.46. Labor productivity growth61 slowed significantly capital markets.59 However, improving governance in the in Armenia in the aftermath of the crises, and the corporate sector will be key to improving access to finance productivity gap with comparator countries is not to enhance firms’ productivity. closing (except with Georgia). After the GFC, output C Challenge 3: Labor Productivity growth recovered but employment began to decline and labor productivity experienced a period of meager growth. 2.44. Employment growth since the GFC has been on In fact, productivity only grew at an annual rate of 2.34 the decline reflecting the difficult labor market supply percent during this period (2010-15), which is well below and demand conditions. The number of economically the 12.4 percent growth rate during the previous pre-GFC active people—employed, as well as unemployed—is crisis period (Figure 2.16, left-hand panel). Due to meager 59 The CBA has requested an FSAP in 2018, which is expected to cover key issues such as capital market development, modernization of the payment system, and pension reform. 60 Existing evidence does not indicate that labor market regulations cause the observed employment trends. Firms do not indicate such regulations to be a constraint. For example, a common concern is that minimum wage could be “binding” and discourages job creation among low- skilled workers leading to high unemployment among this group. However, in Armenia, unemployment is concentrated among those with secondary or higher education: n Yerevan, where unemployment rate is high, 38 percent of the unemployed have tertiary education. This suggests that other factors are at play. 61 There are various ways to construct productivity measures. In the evidence presented above, we use as a proxy for labor productivity GDP (in constant 2011 US dollars) per person employed. The GDP series before 2013 has not been adjusted due to the methodological changes. Adjusting the series may affect the GDP growth rates in the period 2009-14. Please note that “persons employed” does not distinguish between full-time and part-time employment. We do not use GDP per hours worked due to unavailability of data. Therefore, our measure of productivity is the product of two components: GDP per hour X hours per person employed (a measure of worker’s effort). 32 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 labor productivity growth since 2010, the productivity hand panel). Labor productivity in countries of Southeast gap with comparator countries has persisted and is not Europe is between 1.3 and 2.4 times labor productivity in closing over time. In 2000, Armenian labor productivity Armenia. Labor productivity in EU-11 countries is between was the second-lowest among comparator countries, and 2 to 3.3 times the level in Armenia. it continues to be extremely low in 2014 (Figure 2.16, right- Figure 2.19: Labor productivity growth in Armenia after the crisis has been sluggish and much lower than comparator countries Labor Productivity growth Labor productivity, 2014 (percent change) GDP per person employed, 2011 PPP $ 15.00 Slovenia 12.7 12.3 12.8 Hungary 10.00 9.2 Lithuania 5.8 5.3 Croatia 5.00 4.1 Latvia 0.7 0.6 1.1 0.00 Bulgaria -1.3 2011 2012 2004 2010 2014 2006 2007 2008 2009 2013 2005 2015 Macedonia, FYR -5.00 Bosnia and… -10.00 Albania -12.8 Georgia -15.00 0 20000 40000 60000 80000 Source: World Development Indicators, Real GDP in 2011 PPP US dollars. Labor productivity measured as GDP per person employed in 2011 in PPP US dollars. 2.47. Low productivity growth is worrying for several productivity and ensuring that the economy employs all reasons. First, with falling productivity, firms cannot afford productive workers are crucial for averting a fall in aggregate wage increases and hiring is likely to be dampened. output. Since 2008-09, employment growth in Armenia has Second, for a country whose labor resources (working- been in decline, partly due to falling labor resources and age population) are declining and aging, boosting workers’ partly due to labor market conditions (Figure 2.18). Figure 2.20: Labor resources are declining due Figure 2.21: Median age of the population is rising declining population growth 50 110 45 105 40 100 35 95 30 90 25 85 20 80 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2008 2009 2010 2011 2012 2013 2014 2015 Armenia Georgia Labor resources 2008=100 Emp 2008=100 Source: UN Population Prospect 2015. Source: World Bank staff calculations based on NSSRA publications. 33 2.48. Recent years have been marked by growth in the Measured in terms of enrollment rates and average years demand for highly educated and skilled and technical of education, Armenia stands out in the region with average workers. Armenia’s structural transformation has shifted years of schooling62 among workers of 12.5 years, high jobs away from agriculture and construction toward services. tertiary education enrollment of 52.9 percent, and even Services experienced a 6.9 percent average annual growth higher 91.6 percent enrollment in general education in 2015. rate in GDP. Agriculture and industry also experienced some productivity growth. Services now account for almost half of 2.50. Education is the most common way to accumulate all employment in Armenia. In addition, since 2006, the IT human capital; the poor have lower levels of educational and high-technology sectors have become two of the fastest achievement than the non-poor. It is therefore important growing sectors in the country. The driving factor behind to ensure that what students learn in school pays off Armenia’s competitiveness in these sectors has been in the labor market. Among the poor, 44 percent of the the availability of educated human resources. Due to the working age population63 have completed upper-secondary growing number of IT companies in Armenia, demand for IT education (or high school) and an additional 15 percent specialists will continue to increase. Based on conservative have completed middle-vocational education, which offers estimates, if the market and productivity continue to grow at a vocational qualification with a secondary diploma (Figure an average rate of 18 percent and 1 percent, respectively, 2.19). Among the non-poor too, the majority have upper- the absorption potential of additional IT specialists will grow secondary education (38 percent) or middle-vocational at a rate of 17 percent annually and reach 15,000 workers education (19 percent). However, the non-poor have a by 2017 (World Bank, 2014a). higher share than the poor of the working age population with tertiary education. Spatially, rural residents have the lowest 2.49. Human capital assets are therefore an important educational attainment with nearly 50 percent having upper- source of continued growth in labor productivity. secondary education (Figure 2.20). Yerevan and secondary Workers’ years of schooling, school quality, training, and cities have higher shares of working age population with attitude toward work all comprise their human capital. middle-vocational education and tertiary education. Figure 2.22: Majority of the poor have completed Figure 2.23: Rural residents have lower educational upper-secondary education attainment than residents of secondary cities or Yerevan 100% 100% Non-poor; Rural; 9% Yerevan; 22% 31% Poor; 10% 80% 15% 80% 14% Secondary 60% 19% cities; 25% 60% 20% 20% 40% 44% 40% 50% 38% 33% 20% 20% 28% Non-poor; Poor; 8% 7% 0% 0% Poor Non-poor Rural Secondary cities Yerevan tertiary tertiary middle vocational (technical college, college) middle vocational (technical college, college) preliminary vocational (handicraft, industrial) preliminary vocational (handicraft, industrial) upper secondary upper secondary primary primary Source: World Bank staff tabulations for 15- to 75-year-olds, Source: World Bank staff tabulations for 15- to 75-year-olds, based on ILCS 2015. based on ILCS 2015. ii. Constraints to Raising Labor Productivity equip both the poor and the non-poor with the qualifications and skills to integrate into the higher productive sectors 2.51. Looking at the supply side of the labor market, emerging as the economy transforms to lower agricultural Armenia faces at least three constraints to raising employment and higher services sector employment. The labor productivity. The first constraint is the labor market second challenge relates to the matching of workers to relevance of the education system, especially as it must jobs that meet their qualifications; persistent mismatches 62 We construct the years of schooling variable (continuous variable) based on educational attainment (categorical variable) using ILCS 2010-15. In Armenia, general/lower secondary refers to individuals who have completed general/basic education (9 years of schooling). Upper-secondary education level means high school, which normally takes extra 2 to 3 years after general education. Tertiary indicates bachelor degree or higher, which needs at least 16 years to complete. 63 We follow NSSRA’s definition of working age as 15 to 75 years. 34 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 can result in a misallocation of talent and therefore lower Government has responded by decreasing the teaching productivity. The third challenge to labor productivity is load to part-time. However, this could have implications on posed by demographic forces of population shrinkage teaching quality due to lower average take-home salaries and aging that are already affecting the size and age and possibly less motivation to participate in professional composition of the active working age population. The effect development. of demographics on the shrinking and aging of active labor resources is further exacerbated by the fact that a significant 2.54. The education system appears to be lagging in share of women does not participate in the labor market, meeting the demand for skills related to IT. The IT and despite having high educational attainment. high-tech sectors are two of the fastest growing sectors in Armenia. Nonetheless, the size of these programs within a. Labor Market Relevance of the Education System vocational education and training (VET) is small. Low student enrollment in science, technology engineering and 2.52. There are several indicators of how well the mathematics (STEM) at the tertiary level as well means that education system is preparing students for the labor the education system is not prepared to meet the predicted market. One such indicator is the youth unemployment rise in demand for workers with technology skills. Armenia rate. NSSRA estimates that in 2015 the youth (15-24) lags more developed economies in innovation.65 Education, unemployment rate was 32.5 percent, the highest for all age particularly in the science, technology, engineering and groups. In fact, youth unemployment has been persistently mathematics fields, is critical for the advancement of high over the past decade. While job creation by firms and innovation. A skills shortage was identified as a major friction in workers’ job search affects the age composition of obstacle by firms participating in the 2013 Enterprise Survey, unemployment, the labor market relevance of what students including those at the technological frontier who introduced learn in school also affects their ability to find employment. new products, invested in R&D, and upgraded their existing The quality of what students learn in school (foundational products during the boom years in Armenia. skills) affects their ability to find a job with ease. The quality of education as measured by test scores shows that, by b. Mismatches between Workers’ Qualifications and international standards, Armenian students’ achievement in Demand for Skills mathematics and science is lagging. Armenia most recently participated in the Trends in International Mathematics 2.55. Skills mismatches can also constrain labor and Science Study (TIMSS) in 2003, 2007, and 2011. The productivity. For example, a cross-country study of achievement level for Armenia in TIMSS 2011 lags those skills mismatches in OECD countries shows a negative of the comparator countries, outperforming only Georgia in relationship between the extent of the skills mismatch and this group, and is slightly below the international average labor productivity (McGowan and Andrews, 2015). Such of 500. skills mismatches are also typical of transition economies such as Armenia, as they undergo economic restructuring 2.53. Learning quality can be improved through spending and structural transformation. If matching does not work efficiency gains, given that the student population is in smoothly, then mismatches between workers’ skills and decline due to demographic trends. In Armenian general qualifications and available job requirements can lead education, total student enrollment of nearly 360,000 in to allocative inefficiencies. The transition has induced a 2010/11 was 100,000 lower than five years earlier, reflecting growing demand for new skills (not only measured by population trends (World Bank, 2012c). In 2015/16, the total educational attainment, but also by other proxies that student enrollment was 364,39864. While enrollment declined capture cognitive and non-cognitive skills), but the supply by more than 22 percent between 2005/06 and 2010/11, the of skills has not kept up, despite the fast expansion in size of the teacher workforce and the number of schools coverage of tertiary education. Therefore, over-education is remained largely flat. In 2010/11, Armenia’s 1,365 general likely to be more common in transition countries than in non- education state schools employed 39,021 teaching staff, transition countries. compared with 1,367 schools employing 40,069 teachers in 2005/06 (World Bank, 2012c). In 2015/16, there were 2.56. Evidence of mismatch comes from employed 38,690 teachers employed in general education schools workers’ participating in the 2013 STEP66 survey who of the country. Therefore, the average student-to-teacher reported whether their qualifications matched what ratio in Armenia—which was already low at 11.5—further was needed for their job. A recent World Bank study67 declined to 9.2 by 2010/11 and in 2015/16 it was 9.5. The using data from the STEP household surveys conducted 64 National Statistical Service: http://www.armstat.am/file/article/soc_15_2.pdf 65 Source: World Economic Forum’s Global Competitiveness Report, 2016-2017. 66 Skills toward Employment and Productivity. 67 Handel, Valerio and Sanchez Puerta (2016). 35 Figure 2.24: Education mismatch in Armenia and children per woman in 2015. This current low fertility rate comparator countries is well under the rate needed for population replacement or growth. Official estimates put the population at 2,998,600 Individual (actual) match rates between woker education and job required education in 2016, down from 3,018,900 counted in the 2011 census. 2.58. The combination of falling fertility and rising life Ukraine 3.8 72.1 24 expectancy have impacted labor resources in Armenia. Household survey data show that half of Armenia’s working FYR Macedonia 5.1 72.6 22.3 age population was older than 42 years in 2015—an age range where most would have obtained their education Georgia 4 66.4 29.4 before transition and therefore made their education choices based on a very different set of labor market conditions. Armenia 4.8 66.2 28 2.59. Aging workers and a shrinking population can 0 50 100 150 result in lower labor productivity. Older workers may be less productive than younger ones if they have been trained Under-education Matched Over-education through a different educational system, or if their work experience and technical skills are no longer relevant for the new technology and changing skills demanded at the Source: Handel, Valerio and Sanchez Puerta (2016). Estimates workplace. Firms may also be biased against hiring older based on STEPS (Skills Toward Employment and Productivity) workers because of their higher cost or perceived lower household surveys of working-age adults (ages 15-64) residing productivity. The research on the policy implications of in urban areas. these demographic changes shows that the most effective way to address the potential reduction in labor productivity in 12 countries, found that education mismatch is high in is to raise labor force participation and provide lifelong ECA’s transition economies. In Armenia, only 66.2 percent learning opportunities to workers to update skills and raise of workers’ jobs require education that match their own, productivity. while 5.8 percent of workers are in jobs that require less education. However, 28 percent report being over-educated 2.60. Only 60 percent of women participate in the labor (Figure 2.21). This rate of over-education is similar to force and this further exacerbates the demographic Georgia, but higher than in other comparator countries. impact on labor markets. There are 1.5 women for every Unpacking this report of qualification mismatch by STEP man enrolled in tertiary education. Yet, almost half the survey respondents by age, Kupets (2015)68 shows that women with intermediate education, and more than one-third over-education is highest for older workers aged 50-64 in of the women with advanced education, do not participate Armenia (34 percent), Georgia (38 percent), and Ukraine in the labor market. Women’s child-caring responsibilities (30 percent). Over-education is also reported by 25 percent constrain their labor force participation. A simple Probit of young workers in the Armenian survey. For older workers, model estimation of the determinants of participating in the over-education can arise due to degrees obtained during the labor force shows that in Armenia marriage and motherhood Soviet era now becoming obsolete. For younger workers, are strongly associated with lower labor force participation; over-education can be the result of joining entry-level jobs. married women or women living with a partner and mothers Over-education is also highest among those with secondary of young children show a lower probability of engaging in specialized education (vocational) gained during the Soviet the labor market. Similarly, there is a negative correlation era (Kupets, 2015). The proportion of over-educated between the proportion of children aged 6-14 and the workers in this group was 56 percent in Armenia, 66 percent participation of women in the labor market. These factors do in Georgia, and 40 percent in Ukraine. not appear to affect men’s probability of being in the labor market. c. Declining and Aging Labor Resources 2.61. One policy option to address the shrinking and 2.57. Like other countries of Central Europe, the aging of the population is to raise fertility rates to Russian Federation, and the Western Balkans, Armenia sustainable levels. However, research shows that the is experiencing aging and shrinking of its population key to moving toward a sustainable or replacement fertility (Bussolo, Koettl and Sinnot, 2015).69 The fertility rate level is to facilitate a reconciliation between work and family declined from 2.55 children per woman in 1985 to 1.65 life. Many aging countries in Europe and Central Asia and 68 Kupets, O. Education in Transition and Job Mismatch: Evidence from the Skills Survey in Non-EU Transition Economies. Kyoto Institute of Economic Research Discussion Paper No. 915, 2015. 69 Bussolo, Maurizio, Johannes Koettl, and Emily Sinnott. 2015. Golden Aging: Prospects for Healthy, Active, and Prosperous Aging in Europe and Central Asia. Washington, DC: World Bank. 36 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 throughout the world have been experimenting with policies the share of the population that is vulnerable to falling into aimed at increasing fertility rates. These policies fall largely poverty has grown (Chapter 1). Economic mobility analysis into three areas: financial transfers, child care services, and shows considerable churning linked to a household head’s maternity leave policies. Depending on the exact design, education, employment status, and sector of employment most policies have some impact but often affect the timing of (Figure 2.25). Armenia has a sizeable share of households births rather than the completed family size. If the goal is to that send migrant workers and these households are increase the number of births then policies that help women therefore directly impacted by international economic combine motherhood with labor market participation—in downturns, especially in Russia. Moreover, as the economy particular, child care services—seem to be critical. undergoes structural transformation, at least half of the population is experiencing considerable movements into D Challenge 4: Resilience and sustainability and out of poverty (churning). Another source of vulnerability for households is the risk of natural disasters, especially i. Macro, Micro, and Environmental Vulnerabilities earthquakes. Yerevan and secondary cities are exposed to the risk of earthquakes, as the country lies in a region of a 2.62. People, firms, and the economy in Armenia high seismicity.70 Earthquakes have affected large numbers face some inherent vulnerabilities driven by of people and caused significant economic losses over the macroeconomic, social and natural/climatic conditions. past 20 years. At the macroeconomic level, Armenia is exposed to some significant vulnerabilities. Growth has been heavily 2.64. Functioning credit markets and social protection dependent on financial inflows, be they remittances, programs can allow households to cope with the windfalls from high commodity prices, or other inflows. shock and smooth consumption without resorting to Since the sudden slump of these inflows in 2008-09, strategies such as cutting back on health or children’s Armenia has had to put in place measures to recover. education spending. A public policy concern is that, when The fall in commodity prices and the adverse regional faced with shocks, households—especially those that are external environment prolonged sluggish economic activity poor and vulnerable—may choose coping strategies that in 2015-16, and growth prospects are not encouraging. In are harmful for future welfare. Dasgupta and Ajwad’s (2011) addition, the pro-cyclical nature of international remittances analysis of households’ coping behavior between 2009 and exacerbates macroeconomic imbalances of the business 2010 in Armenia, Bulgaria, Montenegro, and Turkey found cycle during good and bad times. interesting results. Households affected by income shocks cut health spending—they reduced visits to the doctor, and 2.63. Households’ wellbeing is directly impacted by spending on medicine and medical care. Households also shocks such as job loss or illness, and indirectly cut back education spending but did not withdraw children affected by macroeconomic vulnerabilities. Over time, from schools. A significant body of evidence shows that Figure 2.25: Economic mobility in 2010-15 (% of population) A: Household head’s education B: Household head’s sector of employment 70% 80% 60% 70% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% basic and high school college and university agriculture manufacturing construction services general vocational poor-poor poor-nonpoor poor-poor poor-nonpoor nonpoor - poor nonpoor - nonpoor nonpoor - poor nonpoor - nonpoor Source: Tiwari, Cancho and Meyer (2017). Author’s calculations based on ILCS 2010 and 2015 using synthetic panel methodology. Notes: Figures show by characteristic of household heads, the percentage of population poor in 2010 and 2015, poor in 2010 and non-poor in 2015, non-poor in 2010 and poor in 2015, and non-poor in both years. 70 UNISDR, Central Asia and Caucasus Disaster Risk Management, http://www.unisdr.org/files/11641_CentralAsiaCaucasusDRManagementInit.pdf 37 social safety nets help improve resilience at the household ii. Constraints to Enhancing Resilience and Sustainability level by increasing their savings as buffer to bad times, reducing distress sales of assets and reducing the need to 2.67. The country faces four constraints in making turn to child labor, for example. Impact evaluations in Brazil, growth more resilient and environmentally sustainable. the Philippines and several countries in Africa, have found The first challenge relates to macroeconomic vulnerabilities. significant impacts on the probability that cash transfer The second challenge is rooted in the country’s beneficiaries would save and be more resilient to shocks.71 demographic decline and its implication for the future (Handa et al. 2013; Bowen 2015; Berhane et al. 2015; De sustainability of pensions and health spending. The third Brauw et al. 2012; Orbeta et al. 2014.) challenge relates to the measures available to households to smooth consumption in the face of shocks. The fourth 2.65. The sustainable management of the environment challenge arises from climate change and depletion of and natural resources is vital for Armenia’s future natural resources, which together affect environmental economic growth. Environmental and natural resources sustainability. provide the foundation for sustained inclusive growth via better performance of sectors such as agriculture, mining, 2.68. There are also important strengths to build on, as tourism, and forestry, as well as providing a buffer against Armenia embarks on strengthening its resilience and extreme weather events and climate change. In Armenia in sustainability on all fronts. The country benefits from a 2005, forest and land were estimated to be worth US$3,000 well-regulated banking sector and has a track-record of per capita, with coal and minerals estimate at US$100 per sound macroeconomic management, including a flexible capita.72 The forestry sector contributed US$17.0 million to exchange rate policy accompanied by a sustainable the economy in 2011, or about 0.2 percent of its GDP.73 fiscal policy. The credibility of macroeconomic policies However, Armenia has had limited success in managing its is strengthened by existing institutional arrangements, environmental and natural resources sustainably. such as fiscal rules to limit the country’s public debt and an inflation-targeting mechanism. To tackle vulnerabilities 2.66. In secondary cities and rural areas, the lack of at the household (microeconomic) level, the country has a access to basic infrastructure heightens household targeted cash transfer program, the Family Benefit Program, vulnerabilities. Recent investments in infrastructure have which, albeit small, is relatively well functioning and could helped to reduce the gap between urban and rural areas, but be scaled up to better reach the poor. Armenia has already gaps still remain. For instance, 46 percent of rural households introduced measures to improve the sustainability of and 40 percent of secondary city households have water pensions as the share of the elderly in the population rises supply for less than the full 24 hours desired. Most rural due to demographic changes. The natural resources and households and about one-fifth of households in secondary environmental management sector benefits from a well- cities heat with wood. This makes them vulnerable as it developed legal and regulatory framework which, if fully exposes them to indoor air pollution, together with depleting implemented, would go a long way toward protecting and an important natural asset.74 Households, poor and non- poor, and especially those living in Yerevan and secondary managing sustainably natural assets. cities, spend on average close to 10 percent of their a. Macroeconomic Vulnerabilities budget on energy sources (consisting mainly of electricity and gas)—a budget share that is widely considered to 2.69. At the macroeconomic level, Armenia is exposed be “unaffordable”. Connectivity and accessibility, which to some significant vulnerabilities. As discussed in are poor in rural areas, are both critical requirements for Chapter 1, Section 3, economic growth has been heavily poverty reduction and shared prosperity. Improving lifeline dependent on external financial inflows, be they remittances, roads in rural areas would go a long way toward increasing windfalls from high commodity prices, or other inflows. rural access to basic services. A national multidimensional Since the sudden slump of these inflows in 2008-09, and in poverty index (MPI), which measures poverty from the 2014 with the Russian crisis, Armenia has been struggling perspective of deprivations as captured in access to basic to recover. The fall in commodity prices and the adverse services, housing conditions and employment opportunities, regional external environment prolonged sluggish economic shows a higher rate of deprivation in rural than urban areas. activity in 2015-16. 71 Handa, S., M. Park, R. Osei Darko, I. Osei-Akoto, B. Davis and S. Daidone. 2013. “Livelihood empowerment against poverty program impact evaluation”. Carolina Population Center. University of North Carolina. Berhane, G., K. Hirvonen, J. Hodinott. 2015. “The Implementation of the Productive Safety Nets Programme, 2014: Highlands Outcomes Report”. International Food Policy Research Institute, Washington, D.C. Bowen, T. 2015 “Social Protection and Disaster Risk Management in the Philippines: The case of Typhoon Yolanda”. World Bank Policy Research Working Paper Series 7482. De Brauw, A., D. Gilligan, J. Hoddinott, V. Moreira, and S. Roy. 2012. The Impact of Bolsa Familia on Child, Maternal, and Household Welfare. Washington, DC: International Food Policy Research Institute. Orbeta Jr., A., A. Abdon,  M. del Mundo, M. Tutor, M. T.  Valera, and D. Yarcia. 2014. Keeping Children Healthy and In School: Evaluating the Pantawid Pamilya Using Regression Discontinuity Design Second Wave Impact Evaluation Results. Washington, DC: World Bank. 72 World Bank. 2011. The Changing Wealth of Nations: Measuring Sustainable Development in the New Millennium. Washington, DC: World Bank. 73 www.fao.org/3/a-i3710e.pdf. 74 Experience from other countries suggests that wood use can be managed such that it becomes an efficient and safe heating source. 38 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 2.70. Armenia’s external position has been very sensitive more vulnerable to shocks, both external and domestic. to volatile private flows and terms-of-trade shocks. The rise has been caused by expansionary fiscal policies Traditionally, Armenia has experienced large current and a depreciation of the exchange rate, which has led account imbalances. Remittances have helped to cover to an increase in the external debt burden expressed in a portion of this gap, while the rest of the current account domestic currency. It has also triggered Armenia’s fiscal deficit was financed through FDI and borrowing. The recent rule which, with no escape clause, mechanically required trend to lower current account deficits reflects a significant that the 2017 budget deficit should be no more than contraction of imports, combined with a significant reduction 3 percent of the average GDP for the past three years. in remittances (by 40 percent between 2015 and 2016), but This triggering therefore led to an abrupt public spending also an improvement in export performance and greater retrenchment in 2017. Consequently, the authorities are diversification (cf. Chapter 1). However, as the economy considering revisiting the fiscal rule to adapt it to modern recovers it will inevitably see a resurgence in imports. At the standards. same time, prospects for a return to remittances at pre-crisis levels (i.e., at about 18 percent of GDP) seem remote, given 2.72. Armenia’s debt sustainability is vulnerable to the ongoing weakness in the Russian economy (a source exchange rate movements and growth prospects. for 90 percent of remittances to Armenia). Therefore, to With 84 percent of public debt denominated in foreign avoid a further deterioration in Armenia’s external balance, currency, the exchange rate risk is significant. Debt rebalancing growth toward exports, as described earlier in sustainability analysis suggests that real GDP growth has this report, will be essential to adjust the country’s significant the largest impact on Armenia’s debt indicators. Without a dissaving and mitigate balance of payments vulnerabilities major effort to address underlying structural weaknesses, to external shocks. the Armenian economy will be highly vulnerable to shocks, particularly in terms of its growth rate or the exchange rate. 2.71. The sharp rise in Armenia’s public debt burden Were such a shock to occur, debt sustainability would be has eroded fiscal space, making Armenia considerably threatened.75 Figure 2.26: Fiscal developments, 2011-16 Figure 2.27: Armenia’s debt dynamics, 1999-16 (% GDP) (% GDP) 60 0 60% 50% -2 40 40% -4 30% 20% 20 -6 10% 0% 0 -8 2001 2011 2002 2012 2000 2004 2010 2014 2003 2006 2007 1999 2008 2009 2013 2016 2005 2015 2011 2012 2013 2014 2015 2016 External debt External public sector debt (lhs % GDP) Domestic debt Domestic public sector debt (lhs %GDP) CBA's external debt Fiscal balance (rhs - %GDP) Source: NSSRA, MoF and World Bank estimates. Source: NSSRA, MoF and World Bank estimates. 2.73. In the financial sector, vulnerabilities stem mostly has adopted numerous policies and procedures to manage from the potential currency mismatches of borrowers, in or mitigate risks in the banking sector. However, the high the context of high dollarization. The Armenian financial degree of dollarization in the banking sector exposes both sector appears to be healthy and, therefore, well positioned borrowing customers to a currency mismatch risk, where an to expand in ways to support the country’s economic adverse shock would lead to difficulties in repaying foreign development. The sector has remained stable through currency loans, and non-borrowing customers indirectly, recent international financial crises. In addition, the CBA given the subsequent rise in non-performing loans. 75 IMF Article IV, 2017. 39 Box 2.9: Dollarization Dollarization has been a defining feature of the pension fund asset managers. The development of the Armenian economy since independence, although money market through the joint initiative undertaken by dollarization deepened following the recent crises. Nasdaq OMX (the country’s stock exchange) could generate Preference for US dollars is, in part, due to the high level of sufficient liquidity to support a currency forward market. remittances emanating from the large diaspora population This initiative should be aligned with further streamlining the (7 million diaspora vs. 3 million in-country) residing in yield curve, through a government debt strategy focused on Europe, the US and Russia. The 2008-09 and again in fewer but stronger benchmark points. This would allow for 2014-15, devaluations increased the holdings of US dollars more liquidity in the secondary market and intermediaries as a safe haven. The annual average loan dollarization has could use such instruments to develop a spread curve for experienced a steady increase over several years: in 2008, Armenian dram risk. The existence of a stronger yield curve it was only 38.4 percent, but this increased to 65 percent could also facilitate the entry of foreign investors taking more in 2016; and 63 percent of deposits are currently in foreign strategic positions in the dram, and avoid the unnecessary currency. financial risk to companies of issuing foreign currency debt in dram-earning sectors. Banks face four risks from high dollarization. First, direct exchange-rate risks arise if there are currency mismatches The Central Bank of Armenia (CBA) has employed between banks’ assets and liabilities. In this case, banks macro-prudential policy tools to address risks from are exposed to risks of valuation losses in the case of dollarization. The CBA has applied higher risk weights sharp changes in the exchange rate of the Armenian dram. and higher provisioning for foreign currency lending than for Second, indirect credit risk continues to rise due to a larger dram lending, to mitigate credit risks associated with foreign share of loans issued in foreign currency; firms or individuals currency lending. To reduce the direct currency mismatch that borrow in foreign currency but earn their income in dram risks, the CBA restricts banks’ net open position to 7 percent will have difficulty repaying if the dram depreciates. Third, of capital. The CBA has also applied a higher minimum foreign currency liquidity risks arise when a bank does not reserve requirement ratio for foreign currency liabilities to have sufficient foreign currency liquid assets, so the bank stave off deposit dollarization. However, the CBA does not may suffer a foreign currency liquidity shortage in the case have in place tools to mitigate foreign currency liquidity of unexpected needs to repay foreign currency obligations. risks: while the CBA requires banks to meet two liquidity Fourth, risks also stem from possible distress in parent ratios (the highly liquid asset to total asset ratio, and the banks with a significant presence of foreign-owned banks. highly liquid asset to demand deposit ratio), these ratios Foreign-owned banks rely less on customer deposits and fill are required only on the total assets and liabilities, not by the gap by funding from parent banks and IFIs. Although the currency. Hence, further improvements can be made in likelihood is low, a possible run on deposits combined with the following areas: (i) monitoring the currency mismatch a liquidity shortage in the parent bank (e.g., as occurred in of borrowers; (ii) introducing liquidity coverage ratios by many countries with many foreign banks during the GFC in currency; (iii) further clarification of the terms of reference 2008-09), is a systemic risk. of the Financial Stability Committee; and (iv) greater public The high level of dollarization also poses barriers to communication on systemic risk monitoring and macro- the development of the securities markets needed by prudential policy formulation. b. Aging and Rising Economic Dependency Ratios to 49 are tobacco consumers. This is one of the potential factors behind the much higher mortality rate among men 2.74. With population aging, the financial burden on than women at relatively young ages: in the 15 to 44 age- government resources and households’ out-of-pocket group, the mortality ratio between men and women is spending on health stands to increase significantly almost 3:1.76 Similar to many low- and lower-middle-income over time if the current cost of treatment of non- countries, the country faces a record increase in non- communicable diseases remains unchanged. Armenia’s communicable diseases (NCDs).77 With population aging, health-care system is already facing an epidemiological shift the burden of NCDs will increase. If the cost of treatment in morbidity and mortality patterns. Moreover, smoking has remains as in 2015, then health expenditure will increase as elevated health risks for men. The World Health Organization follows. Using 2030 population numbers, health expenditure (WHO) estimates that 63 percent of Armenian men aged 15 will decrease by 6 percent due to population shrinking but 40 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 increase by 40 percent due to a higher share of the elderly. 2.76. Another concern with an aging population is the Hence, the total expected increase in health expenditure rise in the cost of preventing old-age poverty. Armenia’s is 34 percent. In 2050, given that most of the population pensions system has been effective in tackling old-age would be in their 60s, health expenditure will increase by poverty and is an important component of its poverty 186 percent, composed of a 14 percent drop due to the prevention program for the elderly.79 Pension systems population decline counteracted by a 200 percent increase generally have two goals: (i) to prevent poverty among due to the health-care needs of an aging population (Figure the elderly; and (ii) to replace earnings following departure 2.25). from the labor force (consumption smoothing). In Armenia, pensions cover 60 percent of poorest 20 percent of the 2.75. The fiscal space for meeting rising health-care population. Moreover, as shown in Chapter 1, pensions costs through public spending could be a constraint in have made a significant contribution to reducing poverty the future. At 1.9 percent of GDP, Armenia’s public financing overall. Simulations show that poverty would be higher in for health is among the lowest in the world.78 Already most of the absence of pension transfers. the health spending in the country comes from out-of-pocket (OOP) spending by households rather than public spending. 2.77. The rise in the economic dependency ratio could Households’ OOP spending accounts for 54 percent of total threaten the funding of the pension system. With an aging health expenditures, which is well above the recommended population and current patterns of labor force participation, WHO level of 20 percent. Thus, with population aging, OOP the share of economic dependents will rise significantly. The spending for households could rise unless revenues can share of economic dependents (children under the age of expand sufficiently to support an increase in public spending 14 and adults aged 65 and older) in the economically active on health. Considering the tight future fiscal space situation, population overall (those active among the 15 to 64 age implementing a mandatory health insurance scheme to group) was about 60 percent in 2015, but this is projected to reduce OOP costs would be a major challenge for the rise to close to 80 percent by 2030, dipping only slightly to Government, as much of the needed revenues would need 77 percent by 2040 (Figure 29, Scenario A). to come from rationalization of the Basic Benefit Package and eligibility categories. Other efficiency gains could come 2.78. However, since 2010, the public pension system through modern and strategic purchasing/provider payment has begun major reforms and institutional rationalization systems, revisions in targeting, integration of care, and to address the issue of funding and the adequacy of pharmaceutical reforms, among others. pensions. Armenia’s pay-as-you-go (PAYG) pension system has been successfully keeping the elderly out of extreme Figure 2.28: Simulated total health spending increase poverty, while paying low and flat pensions. With pensions due to population changes that are unrelated to income earned and contribution tied 250% to income, the PAYG system lacks incentives to participate and report income, with poor prospects for future pension 186% 200% benefit adequacy due to population aging. The 2010 pension reform sought to improve future adequacy and 150% incentives by introducing a mandatory funded pillar financed with supplementary contributions of 5 percent matched by 100% 200% the state from 2014. To date, this system has only been implemented for civil servants and new workers under 50% age 40 entering private sector employment. The system is 40% scheduled to be extended to all private sector workers under 0% 34% -6% -14% age 40 on July 1, 2018. It is important for the government -50% 2030 2050 to proceed with the coverage extension on schedule to help assure future benefit adequacy for all workers. % increase due to aging/population composition % decrease due to population decline 2.79. Armenia’s pension system transformed from a pay-as-you-go system to a funded system. The system consists of two components: (i) a defined benefit Source: World Bank staff estimates. The simulation forecasted component that is financed from the state budget; and (ii) population and age distribution for 2030 and 2050. a defined contribution program that has been in place since 76 NSS 2013. 2013. Women and Men in Armenia, 2013. Statistical Booklet. Yerevan, Armenia. 77 NCDs include cardiovascular disease, cancer, mental health problems, diabetes mellitus, chronic respiratory disease and musculoskeletal conditions. Note that public financing includes health related expenditures of ministries other than the Ministry of Health (MoH). This figure is comprised of the MoH/SHA budget (92.4%), the Ministry of 78 Labor and Social Issues, (4.1%), the National Security Service (0.3%) and the Police (0.1%), and the remaining are from other state administration bodies.  Please see pages 26-27 of NHA 2015. 79 Pension System in Armenia 2015:  Outlook and Further Reform Options. 41 2014, which covers only civil servants and new labor-force generates savings in the long run. Further adjustment of entrants since that date. The defined benefit component of PAYG parameters, especially a higher retirement age Armenia’s pension system is primarily intended to prevent and tighter disability criteria, would yield savings and poverty among the elderly. The new defined contribution contribute to overall reform package sustainability. A more plan is intended to provide the income replacement portion gradual implementation of the ambitious pension targets of benefits. The defined contribution plan is financed by set in the 2014-2025 Armenia Sustainable Development a combination of worker contributions that are treated as Program would also ease the short-run PAYG financing a tax and matching contributions from the Government. requirements. It is important for the government to proceed The combined contribution rate from individuals and the with mandatory participation for all private sector workers Government is equal to 10 percent of earnings up to a on July 1, 2018 without further delays. wage ceiling. The system covers all civil servants and new labor-market entrants since the system began on January 2.81. Together with pension reform, raising female 1, 2014. Current government plans call for mandatory labor-force participation rates could halt the rise in the participation by all workers under the age of 40, beginning economic dependency ratio. In 2015, there was nearly on July 1, 2018. Workers aged between 40 and 50 have a a 20-percentage-point gap in male and female labor-force one-time option to join the defined contribution plan prior to participation among those aged 15 to 64. If this gap were July 1, 2018, while workers older than the age of 50 remain to close by enabling more women to seek and find work, in the defined benefit plan only. the adverse trend in the economic dependency ratio could be significantly reduced (Scenarios B and C, Figure 2.26). 2.80. The pension reform and the 2014-2025 Armenia Sustainable Development Program have also c. Availability of Formal Financial Services and Social programmed the catch-up of PAYG pensions with the Protection Transfers Minimum Consumption Basket (MCB) to further reduce poverty among the vulnerable elderly. If generously Figure 2.30: Account at a financial institution, older indexed, the PAYG system would become fiscally adults (% ages 25+), 2014 costly. A mandatory second pillar offers the prospect of longer-term improvement in pension adequacy for all. It requires additional fiscal costs in the short run, but 100 90 80 Figure 2.29: Ratio of economically dependents to 70 economically active persons, 2015-40 60 50 40 30 19.3 20 number of individuals 0 to 14 or 65+ per 0.90 10 person active in the labor market 0 B&H Switzerland Spain Poland Israel Slovenia Armenia Moldova Albania Georgia Ukraine Romania Chile Costa Rica Russia Slovakia Croatia Singapore Latvia Austria Estonia Belarus Serbia Bolivia Hungary 0.80 0.70 0.60 Source: World Bank staff calculations using Findex data. 0.50 2.82. In the absence of an adequate insurance market, 2015 2020 2025 2030 2035 2040 people can buffer economic shocks by drawing down on savings, or access credit when confronted with a Scenario A: Labor participation does not change shock. Insurance is an important part of the financial sector Scenario B: Female labor force participation growing at average rate of 1.05% annually to equalize male that helps firms and households manage and cope with and female rates of participation in 2040 shocks. Armenia’s insurance sector, however, is small and underdeveloped, and therefore does not serve this purpose. Source: World Bank staff calculations using age specific UN The limited development of Armenia’s savings and credit population projections and modeled ILO estimates of labor- markets suggests that they too are inadequate to enable force participation for 15-64. firms and individuals to respond to shocks. Indeed, as noted 42 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 in Chapter 2, the share of adults in Armenia with a formal to survey data, this program reached around 13 percent account in a financial institution is low and bank deposits of the population in 2015. However, there is further scope are correspondingly low as well. Only 19.3 percent of to improve its targeting—only 61 percent of its resources adults (aged 25+) had an account at a financial institution went to the poor.80 The coverage of the poor is generally in 2014. This is the lowest among peer countries, which low, since only about 27.5 percent of the poor (below the had an average of 74.5 percent (Figure 2.28). With such upper poverty line) received the transfers in 2015. low usage of financial institution accounts, the penetration of deposit services in Armenia remains among the lowest 2.85. The scale and supply of active labor-market in the region. programs (ALMPs) for job-seekers and youth transitioning from school to work is limited. It is also 2.83. When it comes to coping with the financial important to ensure that workers have the skills required implications of treating health shocks, the Basic by modern sector jobs and ALMPs are critical policy Benefit Package of health services offers only limited instruments. With the removal of unemployment benefits, protection. The Basic Benefit Package (BBP) is the active labor-market programs remain the main component program under which the Government provides extensive of labor-market policy. However, these programs are coverage of essential health services. The BBP is financed not a major part of Armenia’s social protection system. from general government revenues. Low public financing The capacity of the State Employment Agency (SEA) for health, and co-payments for services covered under the is constrained both in terms of staffing and resources BBP, as well as a lack of coverage for expensive aspects of allocated for active labor-market policies. The budget for health care (hospital care and outpatient pharmaceuticals), ALMPs has been declining since 2006, due to a shrinking have resulted in high out-of-pocket (OOP) spending by envelope for wage subsidies and public works. households on health. Very few pharmaceuticals are provided through the BBP and pharmaceuticals are a major 2.86. Promoting labor activation among FBP item of household expenditure in Armenia, amounting to 74 beneficiaries remains a primary policy goal. Several percent of total household OOP expenditure in health in factors may discourage social assistance beneficiaries 2014. The high levels of OOP spending increase the risk from taking up formal employment, including the lack of that households could be impoverished when faced with formal jobs, their low level of education, care-giving duties, high levels of health spending, and reduce the potential and high labor taxes (low net income) relative to the loss redistributive capacity of any health financing system. of social assistance benefits, especially for lower paid Small improvements in targeting of the BBP could lead to jobs. Given the limited capacity of SEA to serve vulnerable substantial gains. Given that about 30 percent of Armenia’s groups, work incentives could be embedded in the FBP population of 3 million lives below the poverty line, a benefit design. Critically, these activation measures would 1.0-percentage-point increase in the coverage of the poor have to be complemented by a parallel investment in and an equivalent decrease in the coverage of the non- the capacity of SEA to serve a larger number of clients, poor in Armenia translates into an additional 9,000 poor both in terms of vacancies collected and ALMPs, and by people becoming eligible, and the same number of non- integrating the information systems to allow the monitoring poor becoming ineligible. of compliance with conditionalities. 2.84. Poor and vulnerable Armenian households also 2.87. Looking ahead, the Government has initiated the are eligible to the country’s flagship social assistance implementation of an integrated approach to delivering program, the Family Benefit Program (FBP), although social protection services. The main beneficiaries of only 27.5 percent of the poor are covered by the program. the new model of service provision are marginalized and The FBP is a hybrid means-tested non-contributory cash vulnerable members of society. One of the main objectives transfer program. While the main program’s coverage has of the integrated service delivery model is to improve the varied over time, little progress has been made in improving outcomes of service users, while minimizing the clients’ cost the targeting and the coverage of the poor. The number of accessing services and benefits. This is of importance for of FBP recipient families declined from 121,000 (annual the most vulnerable population groups—people who face average) in 2008 to around 91,000 in 2011, and then multiple and complex problems, and are usually furthest increased steadily again to 107,000 at end-2016. According away from the formal labor market. 80 The indicator is calculated as the sum of all benefits that go to poor (defined as below the official upper poverty line) FBP beneficiaries in one year divided by the sum of all FBP benefits paid in one year. FBP beneficiary households are defined as those households reporting to receive the family benefits in the “diary of household income and revenues” module of the ILCS (item 5 “family benefit”). The consumption aggregate used to define poor households is the total adult equivalent consumption subtracting all social assistance benefits (the FBP benefit, the child benefit and other benefits corresponding to items 5, 6, and 8 in the income module, respectively). This is different from the consumption aggregate used to estimate official poverty which is “post social protection transfers”, including FBP, child benefits and pensions.  However, for purpose of assessing the targeting accuracy of the FBP the consumption aggregate without social assistance transfers in considered as the population that should be targeted by the FBP is the “pre-transfers” poor. 43 d. Climate Change 2.91. The Government recently ratified the Paris Agreement under the United Nations Framework 2.88. Over recent decades, climate change has Convention on Climate Change (UNFCCC), and defined significantly increased the frequency and intensity of its mitigation and adaptation targets in the Nationally hazardous hydro-meteorological phenomena (HHMP) Determined Contribution (NDC). The government in Armenia. These events include extreme frost and the announced that the “(i) NDC will be based on the principle number of days with heavy rainfall and hailstorms. In recent of ‘Green economy’ and be compatible with the social and decades, extreme weather events (drought, hot dry winds, economic development goals of Armenia”. The overall NDC hail, spring frosts) have become more frequent and longer objective is to “achieve ecosystem neutral GHG emission lasting, inflicting great damage on agriculture. In 2010 and in 2050” (this target is fully conditional on the availability of 2013, the financial losses to Armenia’s agriculture from international support). extreme weather events were estimated to be AMD 35.5 million and AMD 23.9 million, respectively. From 2009 to e. Depleting Natural Resources 2013, the overall damage from extreme weather events related to crops amounted to AMD 72.71 billion (about 2.92. Mining is one of the largest contributors to GDP and US$177 million). Future climate trends are expected to exports. There are concerns about the economic, social, exacerbate the high climate variability that already affects and environmental sustainability of mines. The dominance Armenia today and to increase Armenia’s vulnerability to of one single operation over the Armenian minerals sector natural disasters. makes it vulnerable to possible external shocks and this threatens the longer-term sustainability of the sector. 2.89. Climate change impacts have the strongest Forming linkages with other sectors of the local economy impact on agricultural production and on water is one way of enhancing economic performance and social availability for agriculture and other sectors. A recent sustainability. Although linkages and “local content” exist comprehensive World Bank report82 assesses the risks in Armenia, there is considerable scope for increasing the of climate change for the agricultural sector in Armenia participation of local and Armenian businesses within the as a particularly immediate and important problem, be wider mining sector. None of the existing metal mining cause most of the rural population depend either directly operations appears to be environmentally sustainable. The or indirectly on agriculture for their livelihoods. The key small metal mining companies that are involved in poorly negative impacts of climate change on agriculture are managed “mining/exploration projects”, which were first expected to arise due to the reduction of soil fertility and discovered during the Soviet era, cause significant damage a more intensive degradation of land; the redistribution of to the environment (both to air and water). Plans and funds agro-climatic zones; increasing share of irrigated areas; to enable reclamation and rehabilitation of mine sites and and the need for additional irrigation water. associated waste facilities appear to be inadequate. Given the high seismic risk, and overall high risk of land instability, 2.90. Armenian farmers are not well adapted to the significant risks exist for waste facility collapses and/or current climate and they need to undertake more accidents. There are many mines and waste facilities that adaption actions to prepare for impact of climate are either no longer mined, or no longer used, and as yet no change. The large adaptation deficit of the agricultural efforts have been made at rehabilitation and reclamation. sector in Armenia includes: unsustainable management of soils; insufficient irrigation; and high vulnerability to natural 2.93. Environmental laws and regulations that could hazards such as droughts, floods, frosts, and severe storms. potentially address most of the above problems do Evidence suggests a low adaptive capacity to the present exist. However, these laws are not properly implemented. climate. The rural poor will be disproportionately affected Laws are also ambiguous and not streamlined. Existing because of their greater dependence on agriculture, fines and the consequences for non-compliance with their relatively lower ability to adapt, and the high share environmental laws are too low and may not be a sufficient of income they spend on food. If unaddressed through a deterrent against breaking the law. Furthermore, among comprehensive national adaptation plan, climate impacts many companies, knowledge of the law and understanding could impede the dynamism and resilience of agriculture of compliance with the law might be limited. and adversely impact food security and economic growth in vulnerable rural areas. While the impacts of climate 2.94. Other natural assets are also being depleted. change on farm productivity are relatively well understood Natural rangelands are being degraded, resulting in terms of crops, they are less well understood for the both in deterioration of the environment, livelihoods, livestock. and mountainous areas, together with threatening the 44 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 sustainability and future growth of agriculture and livestock. drinking water, over the past 15 years the implementation Armenia is one of the least forested countries in the Europe of a successful public-private partnership (PPP) program and Central Asia region, with resources that are scarce has enabled a significant improvement in the quality and and disappearing. Forests make up less than 10 percent of reliability of the potable water supply. For instance, the the land area and have declined by more than 10 percent population in the capital Yerevan has benefitted from safe, since 1993.83 This decline in forest resources is partly the continuous (24/7) potable water supply for several years result of overuse by forest-dependent people, which in turn now. However, about 450,000 people do not have access to is primarily a result of perverse policy incentives and a 24/7 drinking water. This population is spread across about lack of an enabling environment for the implementation of 560 municipalities, equivalent to 20 percent of the national sustainable forest management practices and investment population, but as much as two-thirds of the area of the in the sector. country. This corresponds mostly to villages and remote settlements, but also towns that for historical reasons have 2.95. Management of water resources is crucial for retained their own responsibility for their water supply. sustainable growth, especially as the future availability People in these municipalities have been left aside by the of water could be impacted by climate change. About successive PPPs that have been implemented over the 80 percent of the country’s crops are irrigated. Hydropower past 15 years. Although this segment of the population accounts for 40 percent of total electricity production. has access to improved water sources, this is only rarely Groundwater is the source of 96 percent of drinking through piped water and household connections. Even water. The Ministry of Nature Protection (2010) projects then, the water supply is often highly intermittent and the a 4°C increase in temperature and 9 percent reduction in potability is not guaranteed. precipitation by 2100. The Ararat Valley region (an important agricultural and fish-producing area) is projected to Most households connected to the water distribution experience higher warming and thus higher future irrigation network are also connected to a sewerage collection demands. As a result, according to the Ministry of Nature network, however, virtually all collected sewage is released Protection (2009), a 25 percent reduction in river flow is untreated into the environment. This situation generates projected to result in a 15 to 34 percent reduction in the major environmental degradation, not just in rivers but also productivity of irrigated cropland (average 24 percent). The in ecologically sensitive areas, such as Lake Sevan (940 total future losses to the agricultural sector are estimated at km²). around AMD 75 billion to AMD 170 billion (US$180 million to US$405 million). The energy sector will also be affected, Outdoor air pollution occurs mainly in the form of as Armenia uses its rivers for hydropower generation, and particulate matter (PM). The annual mean ambient PM2.5 cooling water for nuclear and thermal power plants. The concentration was reported to be 17.75 micrograms per country’s energy program to further develop hydropower cubic meter in 2013. There is a lack of understanding could be at risk. of the full extent of the impact of outdoor air pollution due to a lack of information/data collection in the form of The delivery of irrigation water and drinking water faces monitoring stations (outdoor air pollution), and household challenges. For irrigation water, the high cost of services (in surveys that collect information on individuals’ exposure to part related to the need in some places to use expensive indoor air pollution. It is very likely that PM2.5 and PM10 pumps) and the current low cost recovery in these systems concentrations are under-reported, as monitoring is very continue to result in a sector that is performing below par. For limited in the South Caucasus.84 Republic of Armenia. Third National Communication on Climate Change under the United Nations Framework Convention on Climate Change. 2015. 81 World Bank. Unbreakable: Building Resilience of the Poor in the Face of Natural Disasters. World Bank Report. 2017. World Bank. Reducing the Vulnerability of Armenia’s Agricultural Systems to Climate Change. World Bank Study. 2014. 83GIZ 2014. http://biodivers- 82 southcaucasus.org/wp-content/uploads/2015/02/GIZ-2014-BioFact-Forest-Cover-of-Armenia.pdf (High resolution multispectral satellite images (Rapideye) have been ordered for the whole territory of RA based on which the total forested area of RA has been assessed.) 84 www.euro.who.int/__data/assets/pdf_file/0006/189051/Health-effects-of-particulate-matter-final-Eng.pdf 45 CHAPTER 3: PATHWAYS, POLICY PRIORITIES, AND ACTIONS 3.1. For inclusive growth with resilience, a new certainly important priorities to rebalance growth toward model of economic growth grounded in productivity tradeable and exports, they will not be sufficient. They will improvements needs to be embraced to address the need to be complemented by an enhancement of firms’ challenges identified in Chapter 2. Four pathways productivity, which will be the fundamental engine of this toward achieving the twin goals are identified (Figure 3.1). rebalancing. To become more productive, firms will need Growth needs to rebalance from being demand- to being to access the right skills, while more economic growth supply-driven, and toward exports/tradeable goods and through more productive jobs will call for higher labor- services, and away from non-tradeable and domestic market participation. Systems need to be put in place demand (Pathway 1). To increase growth dividends and (access to finance, social protection and pensions) for renew inclusivity, job creation needs to be reignited through individuals to cope with shocks to preserve their gains from productive firms and individuals’ productive labor-market economic growth and avoid falling back into poverty. Sound participation (Pathways 2 and 3). Lastly, Armenia needs macroeconomic policies supportive of growth need to be in to strengthen its resilience to shocks at all levels, to be place as a prerequisite for a virtuous productivity-growth- able to keep and sustain over time the gains from such rebalancing cycle to occur. Finally, the country needs to inclusive growth (Pathway 4). Reform areas and priorities manage natural assets and adapt to climate change for are selected according to the most binding constraints to long-term sustainability. achieving the twin goals. This prioritization also draws from feedback from country team experts (Annex 6). 3.3. Recognizing the importance of connectivity and competition for prosperity in Armenia, the policy areas 3.2. The pathways are inter-related and share strong can be sorted into the following priorities. The diagnostics complementarities. To simplify, the pathways and their demonstrate that for Armenia multiple challenges can be reform areas are presented successively. However, they tackled when private sector development is unleashed. share strong complementarities, supporting simultaneous The analysis provided in Chapter 2 points to significant implementation. For example, while removing constraints slack in the labor market—a reflection of the limited job to international trade and enhancing multi-connectivity are creation in Armenia’s economy. Private sector development, 46 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 productivity, and competitiveness have been lagging, while Figure 3.1: Twin goals, pathways, and reform areas exports are below potential. So, the top priority is to expand its export markets and enhance private sector development Pathway 1: to boost growth and job creation. For this to happen, it To rebalance growth, Armenia should seek 1. Leverage exports enablers and will be important to leverage export enablers and bypass to open markets, seize leverage muti -connectivity links exports opportunities land connectivity barriers. Also needed are on-the-ground Reducing Poverty and boosting shared prosperity and overcome connectivity constraints improvements in the investment climate and governance, starting with market contestability and financial inclusion, as Pathway 2: well as the interaction between the private and public sectors. To develop a vibrant 2. Ensure on-the-ground market contestability and competition productive private sector This will re-balance growth drivers, transform structurally, and createmore jobs, Armenia should remove create jobs, and support inclusive spatial development. constraints for firms to 3. Fill other investment climate gaps enter marketsand grow 3.4. The next three priorities help the country raise 4. Ensure the education and workforce labor productivity, while managing the implications development system provides skills relevant Pathway 3: to the market For inclusive growth, of a declining and aging population by increasing Armenia should remove 5. Support matching of workers to jobs labor market participation and supporting individuals’ barriers to work and improve individuals' resilience. This will require ensuring that the education productivity 6. Facilitate women’s labor market participation system provides skills relevant to the labor market, starting with improving teaching quality. It also calls for facilitating 7. Strengthen macro management supportive Pathway 4: of stability and growth women’s labor market participation, particularly, expanding To achieve early childhood education (ECE) that has the dual payoffs of sustainability, Armenia should build 8. Strengthen environmental management and adaptation to climatechange promoting women’s work, as well as developing children’s national resilience 9. Strengthen microresilience through access to on multiple fronts school readiness and wellbeing. Strengthening micro finance, socialprotection, and tackling pension and health implications of population aging resilience, including raising households’ access to finance, continued investments in pensions, and protecting and better targeting health and social protection spending will Policy area 1: Leverage export enablers also be important. 3.7. The top priority is to boost exports and to do so 3.5. Two cross-cutting “must have” policy areas include: by leveraging the multi-connectivity links available to strengthening macroeconomic and environmental Armenia. Addressing this binding constraint will require management. The former calls for more flexibility and a multi-pronged approach combining actions in several efficiency in fiscal management and enhancing the counter- domains. The following are recommendations of actions to cyclicality of macroeconomic policies. The latter could start contribute to addressing this top-priority: with better water management and a focus on the impact of climate change. Connect through better logistics and infrastructure. This includes improving basic transport infrastructure by Pathway 1: To rebalance growth, Armenia should addressing gaps at the local and regional levels, and the seek to open markets, seize exports opportunities, efficiency of road expenditures and sustainable institutional and overcome existing connectivity constraints arrangements to preserve the domestic road network. It also entails enhancing services and transport facilitation through: 3.6. As shown in the Chapter 2 analysis, connectivity (i) modernizing supply-chain management, improving the constraints underpin low export performance, while a legislative framework governing freight-forwarding and number of opportunities exist. Constraints were found logistics, reducing informality, professionalizing logistics, in trade and transport facilitation (logistics and border and ensuring market competition; and (ii) streamlining management), and in ICT infrastructure and access, as transit, improving connectivity and upgrading basic services well as in internal connectivity. Opportunities were identified to improve the connectivity of Armenia to regional and in: trade policy and trade agreements; leveraging better global markets, and actively promoting improved corridor trade in services; leveraging the digital economy through performance using modern logistics tools. its many dimensions to overcome physical landlockedness constraints; leveraging Armenia’s diaspora in a more Connect through digital economy levers, which have systematic manner, providing better export intelligence; the potential to open markets beyond domestic borders. taking advantage of EEU membership by positioning the Internet is changing trade, firm productivity, demand for skills, country as a base for market-seeking investors looking and labor-market arrangements. For example, supporting to access the wider EEU market; and seeking trade and access to competitive internet connectivity, developing investment agreements beyond the EEU. e-commerce, and supporting digital technology adoption by 47 firms and skilled individuals would foster Armenia’s multi- technology and knowledge would be able to flow to the most connectivity agenda. productive firms and sectors. This would in turn support greater productivity, which at the macroeconomic level Connect through services as a platform for the would underpin the rebalancing called for under Pathway sophistication of exports (increased knowledge content 1. To address these gaps, the following measures could be of exports). To do this will require attracting FDI into the considered: sector and seeking agreements that reduce the costs for services firms (e.g., software developers) to penetrate Policy area 2: Ensure on-the-ground market contestability foreign markets. A typical example would be agreements on and competition double taxation. More broadly, this will require a business- friendly, open, and predictable investment climate (see 3.10. The top priority in the investment climate and policy area below). governance is to improve competition and domestic market contestability, including in those sectors that are Connect through people. There is room for greater input providers of exporting firms. Doing so would support leverage of diaspora trade, investment, and knowledge greater foreign investment and at the microeconomic level networks, and promoting export intelligence. Connecting would allow firms to enter markets and grow. Addressing to diaspora business networks, finance, and know-how this binding constraint will require a multi-pronged approach through innovative financial instruments could be useful combining actions in several domains. The following are in attracting investment associated with knowledge and recommendations of actions that would contribute to technology into Armenia. Making use of modern export addressing this top-priority: promotion institutions could help to reduce the fixed costs that firms face when entering new markets by ensuring Strengthen the competition framework. A that available information about potential export markets comprehensive competition framework rests upon fostering circulates among firms. pro-competition regulations and government interventions, guaranteeing the Government’s competitive neutrality in 3.8. Other priorities pertain to: markets; and enforcing economy-wide the Competition Law. The effectiveness of the Competition Law can be Taking advantage of Armenia’s EEU membership strengthened by: (i) including competition principles in by positioning the country as a base for market-seeking regulatory impact assessment, which will reinforce ad- investors wishing to access the wider EEU market. hoc interventions by the SCPEC to remove regulatory Armenia could attract more market-seeking FDI if its policy restrictions on competition; (ii) introducing true investigative environment were more supportive than those of other EEU powers; (iii) adjusting the level of fines; and (iv) articulating members and if investors came to regard Armenia as a base a definition of economic entities to account for individual for expanding into the wider EEU market. If increased FDI companies that operate under common control. Measures brought new technologies to Armenia, positive productivity to ensure competitive neutrality should be put in place, spillovers could compensate for the disadvantages of trade such as implementing state aid control. The e-procurement diversion. framework needs to be fully implemented with competition Seeking beneficial trade and investment agreements and transparency pro-actively supported. More broadly, a outside the EEU. Such agreements with the EU and beyond fact-based assessment of ownership and market dynamics would help place exporters, particularly those in GVC-prone would help to reconcile perceptions and evidence, and sectors, on an equal footing to compete with neighbors such formulate recommendations accordingly. as Georgia. Strengthen public governance. This includes Pathway 2: To develop a vibrant productive private strengthening voice and accountability, improving oversight sector and create more jobs, Armenia should remove of the executive, enforcing the rule-of-law, and fighting constraints for firms to enter markets and grow corruption. In doing so, strengthening limits on conflicts of interest in the public sector would go a long way (see separate 3.9. In order for firms to invest, grow, and innovate they point below). The policy formulation process should become require a stable, predictable, and supportive investment evidence-based and subject to thorough public scrutiny to climate broadly speaking. Despite progress, Armenia’s limit the influence of narrow vested interests. Strengthening investment climate is left with a number of important gaps. core downstream PFM controls (internal controls, internal In addition, Armenia exhibits a significant lack of market and external audits, financial statements and legislative contestability, which hinders firms’ entry and growth. With a scrutiny) will be also key. In addition, enhanced stakeholder supportive investment climate, labor and skills, and capital, consultations and citizen engagement would strengthen 48 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 the effectiveness of policy design and implementation. Civil Ensure reliable and adequate electricity supply, and service reform could usefully focus on the adoption of a sustain the financial health of the sector. Rehabilitation of law integrating the civil service and decentralizing human power transmission, and distribution assets and construction resource management in the public and civil service. It of new generation capacity are needed to ensure adequate is also important to integrate the multiple public service electricity supply to the economy. To attract long-term training facilities. private capital into much needed infrastructure investment, renewable energy regulatory and legal frameworks will Strengthen the conflicts-of-interest framework and need to be improved by industry standards, building on follow through on cases. While the system of income and the success of past reforms. The adequate maintenance asset declarations by high-level officials is effective, little and expansion of energy infrastructure include preventing follow through and few investigations have occurred. The non-core business-related expenditures by power sector Ethics Commission for High Ranking Officials’ jurisdiction companies and adjusting tariffs to the cost of supply, and capacity need to be expanded to an effective corruption including eliminating cross-subsidies of end-user tariffs. prevention agency with investigation powers. Upcoming Improve access to finance. Access to finance is seen as legislative changes are expected to introduce additional an important constraint to firms’ growth. To improve access disclosure of interests, criminalize the failure to file a to finance the following measures could be considered. declaration or the submission of false information, and First, implement the new secured transactions framework. enable the publishing of more comprehensive information This would broaden the possibility for MSMEs to use online that will reflect the potential conflicts of interest of moveable property as collateral and would allow them to public officials. Further enhancements of the system may secure loans. Armenia now has a new legal framework also demand new approaches for accounting for beneficial and registry, but its use remains limited because of a lack (as opposed to de jure) ownership. of capacity or awareness of the banks. Training of staff at banks and universal credit organizations (UCOs, which are Improve corporate governance. Good corporate values microfinance institutions) will be needed. Second, develop help to achieve firms’ longer-terms goals: formulate and the capital markets, so banks that currently compete for implement strategy, increase efficiency, enable good large corporate clients go down market to SMEs as the risk management, attract capital, ensure smooth inter- corporates raise funds in the capital markets. Third, promote generational transitions, and attract and retain talent. To savings. Armenia is about average in delivering credit, but do this, Armenia needs to improve corporate transparency, is half of the average in mobilizing savings. Banks seem to including the disclosure of financial and non-financial have little incentive to attract deposits. Fourth, improve skills information, strengthening Boards of Directors, and in MSMEs and in lenders (banks and UCOs) to address the protecting the rights of shareholders. Improving corporate lack of capacity and mistrust both in MSMEs and lenders. governance could go a long way toward better mobilizing A financial inclusion assessment is underway to identify the foreign savings by attracting global investors. key policy and institutional constraints to access to finance, and its results will be used to design a financial inclusion Policy area 3: Fill other investment climate gaps strategy. 3.11. Other priorities pertain to: Enhance access to innovation and knowledge. A World Bank 2015 report85 proposed measures that remain Improving other aspects of the lagging investment valid in this regard and consist of inter alia: creating climate. Starting a business, registering property, innovation institutions bringing together public and private enforcing contracts, and accessing credit are made easy stakeholders; connecting public research organizations by regulations. However, getting things done to carry out with the national economy; analyzing the prospective business operations can be cumbersome. A number of benefits of new technologies and promoting projects reforms are lagging, with a gap between what has been that generate tangible economic benefits; strengthening approved on paper and what is implemented on the ground, intellectual property rights; supporting the dissemination for example, in border management, property rights, and and commercialization of new technologies; creating a tax administration. Stronger institutionalized mechanisms marketplace for innovation; strengthening access to the for regulatory scrutiny are needed. This includes tools such skills, resources and professional networks of Armenian as introducing a regulatory impact assessment and ex ante scientists abroad; and adopting international standards strategies for execution already at the start of the regulatory for evaluating R&D and private-sector innovation, and the planning process. feasibility of implementing them. 85 World Bank (2015): “Drivers of Dynamism”. 49 Box 3.1: How can SCD policy directions address regional differences in wellbeing? Seventy percent of Armenia’s poor live in secondary cities maintaining, and sustaining traditional transport services are and rural areas—away from country’s economic center higher in isolated areas. These policy investments include in Yerevan. What should the GoA do about this spatial also improving ICT to increase the flow of information and imbalance? Should policies try to generate jobs in these ideas. “lagging regions”? As WDR 2009 explains, growth is inherently unbalanced in terms of geography, with some When the poor are concentrated in lagging areas, as parts of a country doing better than others. With the right in Armenia, spatially blind institutions that promote the policies in place, people should be able to move to leading mobility of labor (internal mobility is low in Armenia) and regions and benefit from economic opportunities. The SCD capital, and ensure the provision of basic services must found that Armenians do move, but they are more likely to be supplemented by policies to improve the access of do so internationally with people from economically lagging entrepreneurs in lagging areas to markets (Pathways 1 regions migrating, especially to Russia. and 2). Better infrastructural links between lagging and leading areas, by improving market access, may allow Economic geography principles discussed in the WDR some activities to flourish in lagging areas, especially those 2009 suggest that countries should aim for inclusive that can either benefit from the agglomeration economies/ and spatially balanced development and not necessarily economic density of secondary cities (e.g., ICT), or do not spatially balanced economic growth. need such agglomeration economies (agriculture, labor- intensive manufacturing). Of course, Yerevan-based firms Continued strategic investments in transport infrastructure could also benefit from better connectivity with lagging should be made with the aim of improving provision regions. and access to basic services (Pathways 3 and 4), and optimizing connectivity between and throughout regions “Spatially-targeted” interventions to stimulate economic (Pathway 1), which would allow for reducing distance and development should be considered very carefully. These costs. In part, the idea here is that strategic investments measures include investment subsidies, tax rebates, will help prevent congestion in more urban areas from location regulations, local infrastructure development, undermining the building of density. In addition to improving and targeted investment climate reforms, such as special network efficiency, transport improvements may be needed regulations for export processing zones. It is important to for accessing basic services such as schools, health consider such policies only after investing in information to facilities, and local markets. While access to these services identify sources of comparative advantage, and to amplify is important for people to improve their welfare, and make the benefits from spatially-blind and spatially-connective the most of local opportunities, the costs of providing, policies. Source: WDR 2009; World Bank (2014). Pathway 3: For renewed inclusive growth, Armenia market participation. should remove barriers to work and improve individuals’ productivity Policy area 4: Ensure the education system provides skills relevant to the labor market 3.12. Raising productive capacity of the working- age population and removing barriers to economic 3.14. To ensure that students of the Armenian education participation will be important to meet the human system graduate with skills that are relevant to the labor resource needs of a growing economy. In addition, market, teacher education and training and students’ supporting women’s participation in the labor market is a STEM performance must be prioritized with efficient “win-win” for Armenia, as higher levels of employment education spending. These investments in teachers will among women would not only compensate for the decline address the skills mismatch of the labor force by equipping in labor resources but also drive economic growth higher. the aging teacher workforce with the most up-to-date and relevant pedagogical practices. Recognizing the growing 3.13. Efforts to address these challenges fall into three importance of jobs in certain STEM fields, it is also important elements: ensuring that the education system provides that the education system promote students’ learning and skills that are relevant to the labor market; supporting the performance in STEM subjects. Armenia’s population is matching of workers to jobs; and facilitating women’s labor shrinking, which will affect the size of the student population. 50 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 To maintain efficient spending in general education without These practices have been successfully introduced in other compromising quality, Armenia should continue to provide countries in the region with similar education sector contexts per-capita financing. as Armenia. Learning from their implementation could prove valuable for Armenia. Redefining teacher education and training to provide educators with the tools to teach higher-order skills 3.15. There are additional priorities for the education in the classroom. The Government should consider system over the longer term. Not only do the vocational updating its teaching program curricula and in-service education and training (VET) institutions need reforming, training. Curricula and training should incorporate more but modernizing the entire workforce development system pedagogical guidance on strengthening the use of cognitive, is also needed over the longer term. socioemotional, and technical skills in the classroom, and at all levels of education, particularly in rural areas. Improving the quality of existing VET institutions. These core skill groups have been proven not only to lead For greater accountability, standardization, and integration to higher educational outcomes, but also to greater long- with the labor market, the Government should consider term economic prosperity. Teaching is becoming an aging reforming and improving the regulation of the National profession in Armenia. The number of teachers working who Center for VET Development and the National Council for are past retirement age matches that of the youngest cohort VET Development. In addition, more integration of cognitive, of teachers just graduating from education programs. There socioemotional, and ICT skills in pedagogies and curricula is a slight skew toward older teachers, with more than half of would help to meet the needs of Armenia’s emerging ICT all employed teachers over 45 years of age. These figures and high-tech sectors. are comparable in both rural and urban areas. Meanwhile, Modernizing the workforce development system. Over the number of graduates entering the teaching profession the longer term, a dual VET model that begins in general has declined by 49 percent since 2012. The low number education and partners with the private sector to provide of teachers exiting the profession at retirement age not students with apprenticeships similar to those found in only perpetuates the already low student-to-teacher ratio European countries, such as in Austria, Switzerland, and but could also means that a smaller share of teachers has Germany, could be explored in the Armenian context. updated pedagogical skills. Policy area 5: Support matching of workers to jobs Creating a clearer pathway to STEM education. To increase student performance in science, technology, 3.16. The role of employment services institutions, engineering and mathematics (STEM), the Government such as the State Employment Agency (SEA), is to should reform STEM curricula, pedagogies, and materials, facilitate the best job-worker matches and help to and train teachers to incorporate more innovative and reduce skills mismatches. Employment services can student-centered learning, which has been found to address mismatches, especially shortages of some types motivate student learning. To tackle low STEM outcomes, of skills, by providing career guidance and necessary active the Government should continue to administer the universal labor market programs (ALMPs). Effective activation calls entrance exam and regularly participate in international for greater investment and requires an integrated approach assessments, such as TIMSS, to use the findings to inform that considers local labor demand, an increased capacity education policymaking. To increase enrollment in STEM in of SEA to provide ALMPs, and counseling services and higher education, higher education institutions (HEIs) should partner with private and social sectors to provide secondary active case management. Low-income workers may face students with competitive and subsidized pre-university specific challenges because of lower education and other academic preparation, and university scholarships for constraints to participating in the labor market, and thus STEM. Special emphasis should be placed on attracting face worse labor outcomes. To be inclusive, ALMPs need to more female students to STEM. be better coordinated with social assistance programs, such as the Family Benefit Program and the Emergency Benefit General education rationalization. Any savings from Program, especially in the absence of unemployment general education can then be applied to other critical and benefit (discontinued since January 2014). underserved areas of education, including early childhood, vocational, and tertiary education. To tackle multiple Improving job-worker matching by strengthening the efficiency challenges in general education, such as the State Employment Agency (SEA) calls for higher levels very low (9.2) student-to-teacher ratio, expected student of investment. Improved monitoring and evaluation population decline, and part-time teaching, Armenia should (M&E) systems, including advanced statistical profiling consider introducing hub-and-satellite schools, multi-grade techniques, would contribute to directing SEA’s teaching, and training teachers to teach multiple disciplines. scarce resources more effectively. Considering capacity 51 constraints, the use of an advanced system for the profiling for success in school and subsequently in the labor market. of work-able beneficiaries could help to identify those who While most of these studies are from developed countries, are more likely to need access to the services offered by recent studies in middle-income countries, mostly in Latin SEA and those who are easier to place. Armenia could America, show evidence of consistently positive effects consider adopting a statistical profiling system that would of access to childcare on women’s probability of being prioritize some households for ALMPs. Examples from employed, and on the probability of mothers working more Ireland, Sweden, and Australia show that administrative hours. data can be used to generate statistical models that are easily implementable in the public education system and Expand provision of quality preschool education, can predict the duration of the unemployment spells of the especially for children aged under 3 and in rural registered unemployed, from the day of registration. This communities. The ongoing Education Improvement allows the early identification of different segments of job- Project, which includes expansion of early childhood seekers who are most vulnerable. Such a system would education (ECE) coverage as one of its objectives, is a help one-stop shops or employment services to manage the good precedent and experience for implementing ECE large inflow of beneficiaries and prioritize clients. systematically across the country. Lessons learned from Low-income groups, including social assistance countries with similar ECE challenges, such as Bulgaria and beneficiaries, need targeted activation policies Mexico, could offer additional opportunities for Armenia to to facilitate their transition to (more productive) provide local municipalities with more financial and capacity- employment and/or have preferential access to existing building support, and generate greater parental demand ALMPS programs. In the context of Armenia, characterized through a conditional fee education program. by low labor demand and decreasing rural employment, programs supporting entrepreneurship through business The education system should address stereotypes grants accompanied by business training have proven to be of women and men, and girls and boys, in general and successful instruments in providing job opportunities to the higher education. To tackle such stereotypes in the public most vulnerable (the lower educated, women and those in education system, which have been shown to negatively rural areas). Making FBP receipt fully or partially conditional correlate with women’s subsequent career paths, the on formal job-offer acceptance in (urban) areas where Government should explicitly and more consistently ensure there is unmatched labor demand could be considered a that there is equality in educational standards, curricula, design feature to incentivize activation of social assistance syllabi, teachers’ guides and training, and textbooks so beneficiaries. Promoting labor activation among FBP that they are more balanced regarding men’s and women’s beneficiaries could be achieved by embedding work social and economic roles. incentives in social assistance benefit design (to make ‘work pay’ for benefit recipients), and not to penalize beneficiaries. Pathway 4: To achieve sustained and inclusive In urban areas, additional design features could include: growth, Armenia should build resilience on (i) promoting mandatory registration with the SEA; and (ii) several fronts defining and specifying a maximum duration of the SEA unemployment certificates’ validity to encourage active job- 3.18. Vulnerabilities need not result in economic hardship seeking behavior. Critically, these activation measures need if policies supporting resilience are put into place. A to be supported by a parallel investment in the capacity of sustainable growth model—one that does not jeopardize the SEA to serve a larger number of clients, both in terms future growth—must also be based on policies that build of vacancies collected and ALMPs, and by integrating the resilience, and help the economy and households adapt information systems to allow monitoring of compliance with and bounce back. To protect current and future aggregate conditionalities. output and people’s consumption and wellbeing, policies supporting resilience and sustainability help to manage Policy area 6: Facilitate women’s labor market vulnerabilities at multiple levels. To address identified participation vulnerabilities in Armenia, the following recommendations are proposed at the macro and microeconomic levels: 3.17. Raising women’s labor participation and tackling gender stereotypes will not only help support women’s Policy area 7: Strengthen macroeconomic entry into the labor market but also address some of the management supportive of stability and growth sources of gender wage gaps. A sizeable literature provides evidence that increased availability of formal childcare 3.19. Mitigating fiscal risks and supporting options results in improved labor-force participation among macroeconomic stability are key for Armenia’s women, while also providing children with solid foundation resilience to macroeconomic shocks. 52 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Re-build fiscal buffers and mitigate fiscal risks. reforms in specific areas include: Important elements here would include improving revenue collection through the sustained implementation of the Tax i) Irrigation water: To maximize overall irrigation water Code, prioritizing efficient, productive (and equity enhancing) productivity, needed interventions include investments public investment spending, improving value for money in rehabilitating irrigation infrastructure (both main and in public procurement, and encouraging public-private secondary), introducing more efficient irrigation systems partnerships (PPP) to deliver selected public services, while at the farm level, reducing the dependence on expensive carefully assessing risks. Reviewing the existing fiscal rule pump energy, and implementing reforms in the irrigation to enhance the credibility of the fiscal framework, while institutional structure (to improve technical and financial protecting growth, will also be critical, as already decided sustainability). by the Government Program. Financial sector policy should ii) Drinking water: Finding a viable institutional solution to continue to focus on supporting the resilience of the sector ensure that the 450,000 people who have been left out of and strengthening the macro-prudential framework. the PPP reform so far can also benefit from the successful Macroeconomic policies should be broadly supportive potable water reform and receive quality water supply is an of macroeconomic stability and growth. Macroeconomic important priority. stability is the cornerstone of any successful effort to iii) Waste water treatment: Protect endangered water increase private sector development and economic growth. resources (such as Lake Sevan) from raw wastewater Ensuring that the macro-fiscal policy mix remains well discharges. The Government will need to identify the most balanced and that countercyclical policies are applied will sensitive discharge areas, assess the various technologies be important to that end. best suited to the local context, and duly prioritize future Policy area 8: Strengthen environmental Waste Water Treatment Plant (WWTP) investments. management and adaptation to climate change Strengthen the response to climate change with a 3.20. Managing natural resources and disaster clear and comprehensive plan for adaptive actions in risks effectively, tackling pollution, and prioritizing the agriculture and water sectors. This would include adaptation to climate change are the key priorities. steps for aligning agricultural policies with climate change, Better implementation of existing environmental laws for developing key agricultural institutional capabilities and regulations would go a long way toward improved (providing agriculture-specific hydromet forecasts), and management of Armenia’s natural resources, as the for making needed infrastructure (i.e., improving irrigation sustainability assessment of mining sector has shown. schemes and water-use efficiency, and increasing national water storage capacity) and on-farm risk mitigation and Strengthen the management of water resources adaptive measures (selecting climate-tolerant seeds; to ensure sustainable and productive use. Overall, improvement of farmer access to agronomic technology three aspects must be addressed. First, to improve water and practices to improve crop yields), as well as agricultural management, a strategic plan for the development of insurance. priority small reservoirs in Armenia is needed to build small water-storage capacity. Second, it is important to Enhance the capacity of Armenia’s Disaster Risk build a strong foundation of monitoring and measurement Management (DRM) system. In the two decades since the of water use. To enhance the current monitoring system, 1988 earthquake, the Government has passed significant a comprehensive view should be developed using updated legislation to improve disaster risk reduction and emergency technology to expand the number of monitoring points and management systems. Strengthening the capacity of this adopt new approaches to data collection, verification, and DRM system will be crucial. It will also be important to management. The sharing of data among different agencies mainstream DRM in urban planning and building disaster and providing better access to data by the public should resilience in key infrastructure sectors such as schools. also be promoted. Third, analysis and knowledge of what Strengthened DRM system will be needed also to raise would be the best allocation for the different water users in the country’s resilience to higher frequency and intensity of each basin is needed to ensure the full economic potential hazardous hydro-meteorological phenomena due to climate of water resources is realized. Currently, the planning change. of irrigation, water supply, and hydropower investment programs—all of which are managed at the central level— Tackle pollution from mines by implementing existing has a limited relationship to river basin management plans environmental laws and regulations; strengthen fines that have been prepared. There is a disconnect between the and the consequences for non-compliance; and raise basin plans and sector programs and budgets. In addition, public awareness. The Law on Environmental Impact 53 Assessment (EIA) and the Law on Waste Management set Policy area 9: Strengthen micro resilience through standards for responsible mining to align the industry with access to finance, social protection, and tackling global environmental best practice. Environmental laws pension and health implications of population aging and regulations that could potentially address most of the pollution arising from mines already exist. However, these 3.22. Micro resilience must be built both through social laws are not properly implemented, and there are also protection (pensions, health, and social assistance) significant problems related to legal ambiguity and of laws and financial services (credit, savings and insurance). not being streamlined. There are also concerns that the fines Armenia’s demographic changes make it imperative to and consequences for not following existing environmental plan pro-actively for alleviating old-age poverty and rising laws are too low and do not constitute an adequate deterrent. health spending needs. Expanding and deepening financial Furthermore, among many mining companies, especially services will help families cope with shocks. For poor and the smaller ones, there may be a lack of knowledge of the vulnerable families, improved design of the social assistance laws, as well as a poor understanding of what is required to program will provide effective support. Recognizing that be compliant with them. vulnerable families often face multiple deprivations that reduce their ability to cope with shocks, an integrated model 3.21. Additional priorities include: of delivering social services will be effective. Translate the Nationally Determined Contributions Consider a more gradual implementation of pension (NDC) into an effective implementation strategy to targets for the defined benefit component (PAYG) and deliver on its adaptation and mitigation targets by pursue as planned the re-establishing of the defined promoting cross-sectoral dialogue. The NDC remains contribution component in 2018. A more gradual a high-level document that should be translated into an implementation of the ambitious pension targets set in the actionable implementation strategy to provide clear policy 2014-25 Armenia Sustainable Development Program would signals to influence behaviors of domestic households ease the short-term PAYG financing requirements. It is in and investors, and attract necessary international support the interest of both individuals and the public to re-establish (including climate finance). The NDC implementation the second pillar in 2018 as planned, accelerate the opt- strategy can also be used as an additional platform to back option for private sector employees, and attract as strengthen the dialogue between sectoral institutions to many individuals between the ages of 40 and 50 as possible to join voluntarily. ensure alignment of policy incentives and increase the efficient use of scarce public resources. In the absence of an adequate insurance market, strengthen both access to credit and savings Improve management of forests. For forestry, instruments. As recommended for firms’ productivity, the strengthen forest management capacities in cooperation deepening and broadening of credit, savings, insurance, with neighboring Georgia. There are also opportunities to and capital markets will be important. The expansion of achieve sustainability of forestry through climate-change capital markets will also strengthen the insurance sector. dialogue on both mitigation and adaptation, as well as Given Armenia’s good laws and regulations, developing explicit forestry climate-change links and support for insurance will be an interrelated and mutually reinforcing Armenia’s NDC. matter of good practice on the part of the insurance sector (serving customers well, honoring their contracts), and of Scale-up development of energy efficiency measures trust on the part of the population (including seeing the and clean renewable energy resources. The Government value of insurance).  The Armenian insurance sector will could consider scaling up existing successful models likely take many years to develop, and such development for financing public energy efficiency investments to will happen only with insurance companies consistently include other social, public, and residential buildings. providing good service and honoring contracts promptly, Environmentally sustainable development of small hydro together with improving financial literacy on insurance power plants (HPPs) and the rehabilitation of large HPPs products. The Central Bank of Armenia (CBA) has initiated are critical for sustainable management of water resources. a financial inclusion review, which will review and formulate Moreover, development of new mid-size HPPs set in the recommendations in this regard. recently adopted Hydropower Development Strategy of Armenia, as well as exploration and use of the potential Given the constrained fiscal space, improve targeting of other renewable energy resources, including solar and of the Basic Benefit Package (BBP) to make health wind, will contribute to a greener generation mix and the spending affordable and improve the efficiency of the Government’s strategic objective of increasing energy health system. Given that roughly 30 percent of Armenia’s security. population of about 3 million people live below the poverty 54 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 line, a 1.0-percentage-point increase in the BBP’s coverage Implement the integrated delivery of social services, of the poor and an equivalent decrease in the program’s especially for marginalized and vulnerable families. coverage of the non-poor translates into an additional 9,000 With the introduction of its integrated social services delivery poor people becoming eligible and the same number of non- model, Armenia has initiated substantial reforms in how poor becoming ineligible. Other efficiency gains could come the social protection system functions. A comprehensive through modern and strategic purchasing/provider payment family assessment and joint social case management systems, integration of care, and pharmaceutical reforms, would ensure that the needs of each family member are among others. adequately addressed and services are delivered in a coordinated and coherent way. The development of a Improve the coverage of the poor and the efficiency methodology for social case management as an instrument of spending of the Family Benefit Program (FBP)). To to enhance the integration of social services and improve increase targeting accuracy (hence, how well the current budget reaches those who are really in need or its efficiency) the assessment and verification of social vulnerabilities is and coverage of the poor in the program, continued efforts among the top priorities of the government plan 2017-2022. are needed to improve the design and implementation of the Social case managers, as mandated by law, would help scoring formula to determine eligibility to social assistance these vulnerable populations improve their social inclusion benefits, reach out to the poorest and encourage them to and livelihoods by connecting them to available services apply, and strengthen the management and monitoring of and programs, including active labor-market programs and FBP. job-search services. 55 REFERENCES Macroeconomic and fiscal Republic of Armenia: Fourth Review Under the Extended Arrangement. 2016. International Monetary Fund. 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A higher number of low productivity firms (indicated by a fatter left tail in Figure A 1), in particular in 2013, is Armenian firms show high dispersion of productivity consistent with the existence of barriers to competition suggesting scope for improving efficiency by that prevent the exit of very inefficient firms. Were these reallocating resources to higher productivity firms. The inefficient firms to exit, resources would be reallocated productivity ratio between the 10 percent of most productive away from less-productive and into more-productive firms, firms to the 10 percent least productive is almost three, increasing aggregate productivity. In fact, international about 20 percent greater than for comparators (Table A 1:). evidence shows that resource misallocation results in high When compared with neighboring Georgia, the distribution costs in terms of aggregate productivity (Hsieh and Klenow, of total factor productivity shows a greater dispersion (Figure 2009). Figure A1: Distribution of TFP: Armenia versus Georgia Table A 1: Measures of dispersion of TFP TFP Armenia, 2009 Armenia, 2013 TFP 2009 .4 .4 Measure Armenia Others .3 .3 .2 .2 CV 0.54 0.59 72-25 1.48 1.21 .1 .1 90-10 2.91 2.54 0 0 -2 0 2 4 6 -2 0 2 4 6 TFP 2013 Georgia, 2009 Georgia, 2013 Measure .6 0 .1 .2 .3 .4 .5 Armenia Others .4 CV 0.74 0.54 72-25 1.25 1.10 .2 90-10 2.90 2.53 0 -2 0 2 4 6 -2 0 2 4 6 Note: World Bank staff calculations from the World Bank Enterprise Survey. On the table “others” indicates the simple average of dispersion measures for Albania, Georgia, Hungary, Serbia, Macedonia, Bosnia and Herzegovina and Moldova. Slovenia is excluded from the labor productivity analysis because data on labor productivity are not available. CV = coefficient of variation, 75 − 25 is the difference between the 75th and 25th percentiles, and 90 − 10 the 90th vs. 10th percentiles. Moreover, the levels of productivity have not dramatically firms (5 years old, or younger) (Figure A 2). This result is increased when comparing 2009 and 2013. Indeed, the similar to that observed in Bosnia Herzegovina, Macedonia, two distributions practically overlap, contrasting with what Moldova and Serbia. Data also show stable firm growth is observed in Georgia where, on top of a reduction in the (measured in terms of employment growth) throughout the dispersion mentioned above, productivity increased (the lifecycle (this is not the case in comparator countries, where distribution of productivity shifted to the right over time). growth occurs only at a later stage, or does not occur at all as in Georgia). However, employment growth over the Firm size increases over the lifecycle of a firm, but the lifecycle of firms has notably decelerated in recent years, ability of firms to grow over their lifecycle has decelerated which could be associated with increasing barrier costs that in recent years. Evidence shows that low growth over the firms face to grow (in terms of employing more workers, or lifecycle is a symptom of resource misallocation and this can accessing capital). The growth rate of employment across have important adverse effects on aggregate productivity firms was more sustained in 2009 than in 2013 (Figure A 3). (Hsieh and Klenow, 2014). In Armenia, old firms (20 years Lifecycle employment growth can occur either because more old, or more) are, on average, three times larger than young productive firms survive (selection), or because firms create 59 jobs (firm productivity growth). High-income countries show Klenow, 2014). This is well above what is observed in both that both forces contribute to overall employment growth. years in Armenia and suggests great scope for reducing In the United States, for example, older plants are more barriers to grow and facilitating the accumulation of plant- than seven times larger than the younger ones (Hsieh and specific organizational capital for Armenian firms. Figure A 2: Employment over the lifecycle Figure A 3: Employment over the lifecycle: Armenia 5 5 ALB ARM BIH 2009 2013 GEO HUN MDA Average employment (Age<5 =1) 4 MKD SLO SRB 4 3 3 2 2 1 1 0 0 <5 5-10 11-15 16-20 >20 <5 5-10 11-15 16-20 >20 Age Age Note: World Bank staff elaboration from the Enterprise Survey. The graph plots average employment and the geometric mean of labor productivity and TFP. Productivity and employment in the youngest group (age<5 years) is normalized to 1 in each country. The employment and labor productivity covers both the manufacturing and service sectors. TFP is only available for the manufacturing sector. Figure on the left use data pooled across both available waves of the survey, i.e. 2008-09 and 2013. The figure on the right shows the two waves separately. 2 Innovation among Armenian Firms same period (Figure A 4). Participation in R&D and innovative activities have declined Armenian firms lag their peers from comparator countries over time. Regardless of how strict or lax one is in the in terms of their innovation activity. In 2012-13, less definition of ‘innovation’, data reveal that innovation trends than 5 percent of Armenian firms reported an increase show a negative time trend. The share of firms that declare of expenditures in R&D during the three previous years having introduced new products during the past year (Figure A 5). These low levels of R&D spending are below declined from 63 percent in 2009 to less than 16 percent in those of smaller peers such as Bosnia and Moldova. Only 2012-13. If instead the focus is placed on a stricter definition 17.5 percent of Armenians reported encouraging innovation of innovation—whether firms invest in R&D—the share among employees, compared with 35.3 percent of firms declines from 23 percent to less than 5 percent over the from Bosnia and Moldova, respectively. Figure A 4: Percentage of firms innovating over time Figure A 5: Innovation activity, 2012-13 70 Encouraged innovation among employees 50 60 45 40 50 35 40 30 30 25 20 20 15 10 10 5 0 2009 2013 2009 2013 0 New products Investment in R&D ALB ARM BIH GEO HUN MKD MDA SRB SVN Source: Authors’ calculations based on data from BEEPS. 60 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Limited levels of innovation in terms of product and firms in peer countries, such as Bosnia, Serbia and Slovenia service development, as well as operational and (Figure A 6). While less than 7 percent of Armenian firms management processes, may also contribute to low experimented with new production/supply or management productivity growth. Less than 16 percent of Armenian firms practices, 12 percent reported innovating in terms of marketing surveyed reportedly introduced new products or services methods. Only Albanian and Georgian firms lagged Armenian in the post-crisis period, compared with over 35 percent of businesses in these categories (Figure A 7). Figure A 6: Goods and services innovation Figure A 7: Operational/process innovation Percentage of firms that introduced Percentage of firms that introduced new.... new products or services 45 40 40 35 35 30 30 25 25 20 20 15 15 10 5 10 0 5 Production/supply Management practices Marketing methods methods 0 ALB ARM BIH GEO HUN MKD MDA SRB SVN ALB ARM BIH GEO HUN MKD MDA SRB SVN Source: World Bank staff calculations based on data from Source: World Bank staff calculations based on data from BEEPs. BEEPs. Innovation pays off in terms of productivity. In also observed for firms that invest in R&D (Table A2), in fact, firms that conduct innovative activities enjoy a particular in 2012-13, where innovative firms appears to large productivity premium. Armenian firms that have be 2.5 times more productive than other firms. However, introduced a new product or method of production are firms may struggle to secure financing for some of these twice as productive as non-innovative firms (Table A2).86 In innovations and others may be too small to gain from them. 2009, the premium was larger than that observed in other Interviews with the private sector in the textile and apparel countries, with the exception of Georgia. It remained above sector revealed, for example, that the usage of electronic other countries in 2012-13, although it stood at a much inventory management systems (highly prevalent in firms lower level (68 percent). A positive premium is observed operating in advanced economies) is not widespread. The also for firms that engage in organizational innovations managers argued that first, many firms are small, and they such as business practices, workplace organization, or may not see the need for them as they will not be cost external relations. Organizational innovation encourages effective. Second, even if these innovations do improve the reallocation of inputs and factors of production across efficiency, firms report lacking the financial means to activities within firms. A positive productivity premium is introduce them. Table A 2: Innovating activities impact Product Product and Organizational Marketing Investment in Investment Country innovation process innovation innovation innovation R&D in R&D (2009) (2012-13) (2012-13) (2012-13) (2009) (2012-13) Albania N/A 31.45 -10.97 -2.6 N/A N/A Armenia 108.66*** 68.38* 98.09*** -1.33 15.49 154.50*** Bosnia Herzegovina 62.86** 41.34* 24.96 50.99* 52.54** 26.95 Georgia 315.38*** 32.67 10.18 159.22*** 531.29*** 22.27 Hungary 75.81*** 5.41 -21.75 38.59 55.45 41.13 Moldova 47.50* 204.46*** 1.47 27.31 59.79* 389.36*** Macedonia 60.23** 68.72*** 31.63 -7.38 20.31 104.37*** Serbia 29.58 8.33 52.46** -14.01 6.81 -9.50 Note: the results are obtained by regressing a dummy indicating whether the firm has undertaken one of the types of innovative activity reported on the header on the log of labor productivity and controlling for the employment, age and sector of the firm. *** indicates significance at the 1%, 5% (**) or 10% (*) level. Process and product innovation can increase firm productivity through more efficient use of intermediate inputs and factors of production, and through learning-by-doing (Lopez-Acevedo, 2016). 86 Notice, however, that the causality between innovation and firms’ performance may run the other way. It may be that only better performing firms can afford. 61 Innovation and firms’ integration into the global exposed to increased competition, foreign technologies, marketplace are associated, but low overall integration and know-how that tend to increase pressures for them to may reduce the scope for gains through innovation. innovate. Indeed, Armenian exporters are 90 percent more Participation to export markets has been showed to have likely to have introduced a new product (Figure A 8) and 50 a two-way relationship with innovation. Innovation affects a percent more likely to have invested in R&D (Figure A 9). firm’s decision to export, and in turn is influenced by the On the other hand, Armenian firms are not well integrated in experience of exporting through a ‘learning-by-exporting’ the international market and exposure to international trade effect (Aw et al., 2011). Exporters are more likely to be remains limited as further discussed below. Figure A 8: Export and product innovation, 2012-13 Figure A 9: Export and R&D investment, 2012-13 60 Non-exporters Exporters 30 Non-exporters Exporters 50 25 40 20 30 15 20 10 10 5 0 0 Bosnia Herz. Albania Armenia Moldova Georgia Slovenia Macedonia Serbia Hungary Bosnia Herz. Albania Armenia Georgia Moldova Slovenia Macedonia Serbia Hungary Note: World Bank staff elaboration from the World Bank Enterprise Survey. The graph plots the percentage of firms adopting a new product (left) and investing in R&D (right) across countries. Data are pooled across both available waves of the survey, i.e. 2008-09 and 2013. 3 Trade Competitiveness export openness than Armenia (Figure 2.1: This also emerges when looking at the position of Armenia and How has Armenia performed in terms of export comparators in an export-orientation ranking that measures competitiveness? Examining the evolution of trade, trade-to-GDP ratios purged of the effect of the size of export market shares, diversification, quality upgrading, the economy and other physical characteristics, such as and survival patterns is useful to assess the evolution of being landlocked (Figure A 11). Armenia is less integrated overall competitiveness. This is the focus of the subsection into global markets than comparators. Firm-level data that follows. confirm the limited participation in the international market Armenia’s exposure to international trade remains (Figure A 12). Only 15 percent of Armenian firms export limited, particularly compared with its peers. Exports (directly or indirectly). This is well below the average of of goods and services as a percentage of GDP, which comparator countries (24 percent) and despite the large reached 31 percent in 2004, remained below 30 percent share of firms having internationally recognized quality in 2015. Only Albania and Bosnia exhibit lower levels of certification (45 percent). Evidence shows that the adoption Figure A 10: Exports of goods and services (% of GDP) Figure A 11: Export orientation index 100 Exports 2012-2015 60 90 80 Export Orientation Index 40 70 SVK LTU 60 EST CZE 20 % 50 MDA AZE 40 30 0 LVA 20 GEO MKD -20 10 TUR ARM 0 2011 2001 2002 2000 2012 2004 2010 2014 2003 2006 2007 2008 2009 2013 2005 2015 -40 -40 -20 0 20 40 60 ARM ALB BIH HUN Ranking MDA SRB SVN GEO Residuals Residuals Source: World Bank staff calculations based on data from WDI Source: World bank staff calculations based on data from WDI. 62 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 of internationally recognized quality standards helps firms diffusion of internationally-recognized quality standards to export, and this seems especially relevant to exports in Armenia is above that of Serbia and Slovenia, export from developing countries (Swann, 2010). Still, while the participation is much lower. Figure A 12: Integration in the global marketplace at the firm level, 2009 and 2013 (Percentage of firms that export, percentage of firms with internationally recognized quality certifications) 60 50 40 30 20 10 0 Bosnia Herz. Bosnia Herz. Moldova Slovenia Moldova Slovenia Georgia Albania Armenia Georgia Albania Armenia Serbia Macedonia Serbia Macedonia Hungary Hungary % of firms having Internationallly-recognized % of exporters (directy or indirectly) quality certification Note: World Bank staff elaboration from the World Bank Enterprise Survey. The set of column on the left indicates the percentage of exporters across countries (2009 and 2013) while that on the right indicate the percentage of firms adopting internationally certified quality standards such as ISO (2009 and 2013). Growth and Market Shares Armenia has been slowly gaining market shares. In 2005, out of every US$100,000 of merchandise exported Armenia’s trade balance has improved in the post crisis globally, US$8 were originated in Armenia. This had period but remains negative. Exports grew at an average increased to US$9 by 2015. This means that overall, 17 percent between 2010 and 2016. Despite a slight decrease in 2015, exports expanded by 24 percent in 2016. Armenian merchandise exports grew faster than world However, imports have remained well above exports for the exports. However, Armenia’s market share over the past whole period (Figure A 13). decade has grown less than those of its peers (Table A 3:). Figure A 13: Merchandise trade Table A 3: Market shares 4 500 000 60% 4 000 000 50% 2005 2015 CAGR 3 500 000 40% Georgia 0.009 0.011 1.6% 30% 3 000 000 Latvia 0.035 0.075 8.0% US$ '000 20% 2 500 000 10% 2 000 000 Moldova 0.008 0.009 0.2% 0% 1 500 000 Macedonia 0.022 0.029 3.2% -10% 1 000 000 -20% 500 000 Armenia 0.008 0.009 1.2% -30% 0 -40% Czech Republic 0.826 1.033 2.3% 2011 2002 2012 2004 2010 2014 2003 2006 2007 2008 2009 2013 2016 2005 2015 Slovakia 0.336 0.493 3.9% Imports Exports Lithuania 0.127 0.167 2.7% Export growth Import growth Source: World Bank staff calculations based on data from Source: World Bank staff calculations based on data from Comtrade. Comtrade Armenia’s services exports have exhibited significant 29.6 percent in 2015 (Figure A 15Error! Reference source dynamism. Exports in services more than doubled between not found.). However, the ratio of trade in services-to-GDP 2005 and 2015, growing at an average annual rate of 14.4 for Armenia is lower than for comparator countries, such as percent. Trade in services grew from 20 percent in 2005 to Albania, Hungary, and Georgia (Figure A 15:). 63 Figure A 14: Trade in services, 2005-15 Figure A 15: Trade in services (% of GDP) 2000 45 40 1500 35 30 USD Millions 1000 25 20 % 15 500 10 5 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 0 ARM ALB BIH HUN MKD MDA SRB SVN GEO -500 Exports Imports Trade Balance 2005 2010 2015 Source: World Bank staff calculations based on data from Source: World Bank staff calculations based on data from UNCTAD. UNCTAD. The Armenian economy has experienced some period, going from 4.13 in 2005 to 7.56 in 2015. The productive transformation, although not necessarily comparative advantage in textiles and clothing also grew toward sophistication. The revealed comparative from 0.19 to 0.80 during this period. In contrast, Armenia advantage in animal, foodstuffs, and mineral products saw its revealed comparative advantage (RCA) in stone expanded significantly between 2005 and 2015. Indeed, and glass products dramatically eroded between 2005 the RCA index in foodstuffs almost doubled during this and 2015. Figure A 16: Services exports, 2005 and 2015 100% 80% 60% 40% 20% 0% 2005 2015 Goods-related services Transport Travel Construction Insurance and pension services Financial services ICT Other business services Personal, cultural, and recreational service Source: World Bank staff calculations based on data from UNCTAD. Trade in services has shown less of a productive Armenia exhibits low diversification both in terms of products transformation. In 2005, travel services accounted for and markets, particularly compared with its peers. Armenia more than half of Armenian services exports, followed by increased its market reach from 30 in the early 2000s to 60 transport services, which represented 22 percent of total in 2010 (Figure A 17). While the number of export markets exports. The share of travel services had grown to 62 fell again in 2014, the market concentration of Armenian percent by 2015, while the share of transport services fell to exports has declined, with the share of exports going to 11 percent. The share of ICT services also fell, albeit slightly, the three top destinations falling from 50 percent in 2005 to from 11 percent in 2005 to 9 percent in 2015 (Table A 16). 39 percent in 2015. In terms of products, Armenia has not expanded the number of varieties it exports. The level of In contrast, construction services increased from 2 to 11 product concentration of Armenian exports has also fallen, percent, reflecting the recent recovery of the construction with the HHI dropping from 0.18 in 2005 to 0.09 in 2015. sector. These diversification patterns place Armenia behind most Trade Diversification of its peers. 64 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Figure A 17: Number of export markets reached Figure A 18: Number of exported products 140 3000 120 2500 100 2000 80 1500 60 1000 40 500 20 0 0 ALB ARM BIH GEO HUN MDA MKD SER SVN ALB ARM BIH GEO HUN MDA MKD SER SVN 2000 2005 2010 2014 2000 2005 2010 2014 Source: World Bank staff calculations based on data from Source: World Bank staff calculations based on data from Comtrade. Comtrade. Export Survival Patterns that start in Armenia in a given year, only 36 of them remain active one year later. This puts a halt to the consolidation Survival of firms in export markets is a challenge in of export growth and can create inefficiencies if the fixed Armenia, particularly after 2006, preventing firms from costs of entering export markets are high. Low export fully profiting being integrated in the global marketplace. survival reflects informational failures, which hinder firms’ Table A 4: shows the export survival probabilities for export learning processes, leading them to rely on trial and error.87 flows originating in Armenia and comparators. Armenia, Survival rates also seem to vary with across destinations, together with Georgia and Albania, show the lowest survival with exports to Russia and other ECA countries exhibiting a chances. Our analysis suggests that out of 100 export flows higher rate of survival (Figure A 19). Table A 4: Export survival rates for Armenia and comparators Spell Length BIH ARM ALB GEO HUN MDA MKD SRB SVN 1 year 47.8% 36.8% 38.9% 38.5% 54.6% 45.9% 43.7% 48.9% 59.1% 2 years 29.2% 16.8% 20.7% 19.9% 37.3% 26.9% 26.5% 30.4% 42.0% 5 years 13.4% 5.0% 7.1% 5.5% 19.2% 11.4% 11.9% 13.9% 23.6% 10 years 4.2% 1.3% 2.1% 1.2% 9.4% 3.7% 3.5% 5.0% 13.1% Figure A 19: Export survival by destination Export Relationships by Destination Survival Rate 2004-2015 1.00 Asia ECA EU27 MENA Other RUS 0.75 Probability 0.50 0.25 0.00 0 5 10 15 Years Active Source: World Bank staff calculations based on data from Comtrade 87 Informational failures are important obstacles to good export performance (which implies growth, diversification and survival). As argued by Hausmann and Rodrik (2003), learning what one is good at producing is an important challenge faced by countries in their path to development. Because self-discovery is costly, and the appropriability of the discovery is low once it occurs (because other entrepreneurs could easily imitate the discoveries), there is typically an undersupply of ‘learning of what can be produced and successfully marketed’. Exporters need to learn about the characteristics of foreign demand (tastes, willingness to pay, volume, etc.), about the intricacies of the exporting activity (dealing with customs regulations, freight forwarders, insurance companies, etc.), and about the actual production costs (technologies, minimum efficient scale, sources of inputs, etc.). In the absence of information, firms learn through trial and error, typically leading to low export survival, which can be inefficient in the presence of the generally important sunk costs of entry and exit to export markets. The absence of information also restricts firms’ ability to obtain credit, since the financial sector, like the entrepreneurs themselves, are uncertain about the future profitability of export projects, and thus, reluctant to lend. 65 GVC in Focus in the exports of third countries (also known as ‘forward integration’).88 For small economies, global value chains (GVCs) can be powerful platforms for integration. How integrated is An international comparison shows that Armenia’s Armenia into GVCs? Integration into GVCs can be measured participation in GVCs has been limited, both as a seller in two ways. First, if you are closer to final demand, you may and as a buyer. The import content of Armenia’s exports, be integrated as a “buyer”, sourcing inputs that are produced measured in value-added, has declined over time, from further upstream in the process. Integration as a buyer can 29 percent in 2000 to 21 percent in 2011, suggesting that be measured by the portion of foreign value-added that is Armenian firms have lowered their reliance on foreign embedded in a country’s exports (also known as ‘backward intermediates to produce exports (Figure A 20). Armenia’s integration’). Second, if you are positioned upstream in the integration as a seller is even lower, although it has increased production process, you may be integrated into a chain as slightly in recent years. The share of Armenian value-added a seller. Integration as a seller can be measured by the to foreign exports increased from 26 percent in 2000 to over portion of Armenia’s value-added exports that is embedded 30 percent in 2011. Figure A 20:Share of foreign value-added in home Figure A 21: Share of home value-added in foreign exports exports 0.6 1 0.5 0.8 0.4 0.6 % 0.3 % 0.4 0.2 0.1 0.2 0 0 Armenia Georgia Czech Serbia Slovakia Armenia Georgia Czech Serbia Slovakia Republic Republic 1996 2000 2006 2011 1996 2000 2006 2011 Source: World Bank staff calculations based on EORA. Source: World Bank staff calculations based on data from EORA. An analysis of performance of key GVC-prone sectors apparel products that have experienced the most export in Armenia suggests that it is in final and intermediate growth between 2000 and 2015. The main destination for apparel and footwear where firms have managed to these products is Russia, which accounts for over 90 percent integrate most with international production networks. of these exports, except for trousers made of synthetic Textiles and apparel, electronics, and vehicles tend to be fibers, 70 percent of which are exported to Germany. those sectors in which trade is dominated by GVCs. Of Armenian apparel products exhibit a strong quality these sectors, it is apparel and footwear, where Armenian performance, with these products located close to the firms have gained market shares (Figure A 22). Indeed, top of the quality distribution among competitors in the the textile and apparel sector—one of the oldest industries same segment, as proxied by the unit value they secure in the country—has been experiencing a revival and has for these products (Figure A 23). The exception is trousers become of the main suppliers of garments in the region. made of synthetic fibers, where Armenian firms have In 2015, of every US$10,000 of world exports, US$1.3 substantial scope for quality upgrading. The challenge is originated in Armenian firms, up from less than US$0.6 in twofold: being price-competitive to be able to serve more every US$10,000 in 2000.89 than one destination, and moving up the low margin cut- A small number of products and one destination explain make-trim activities (where most firms currently operate) most of Armenian exports of apparel. Anoraks, trousers, into fashion design, introducing new styles and quality overcoats, jerseys and pullovers, and cotton t-shirts are the labels, targeting high-end customers. Results from focus 88 Backward integration provides access to quality inputs, which contributes to downstream competitiveness; it also has significant potential to deliver productivity spillovers through access to global frontier technologies. As such, backward integration tends to be particularly important for countries as it links to several measures of structural transformation. Similarly, forward integration is an indicator of integration into value chains and also provides opportunities to benefit from technology spillovers. 89 Identified by the government as one of the 11 “strategic” export-oriented sectors, and its revival made a priority “as a means to create jobs, boost value-added trade and expand exports by exploiting a number of comparative and historical advantages both in the region and internationally.” The companies produce cotton and woolen yarns, cotton, woolen and silky clothes, carpets, knitted fabric, stocking socks, sewing products and textile, art goods, leather and fur, specialized garments. 66 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 groups conducted with Armenian firms in the textile and past two years, according to statistics from the Central Bank apparel sector—most of them being exporters—suggested of Armenia).90In addition, these firms struggle to secure that firms struggle to secure competitively priced financing trained professionals that are willing to work for competitive (in fact, bank loans to the sector have been falling over the wages.91 Figure A 22: GVC-prone sectors: apparel/footwear, electronics and autos 0.05 0.045 Armenia 2000 Georgia 2000 Moldova 2000 Armenia 2015 Georgia 2015 Moldova 2015 0.04 0.035 Global Marketshare (%) 0.03 0.025 0.02 0.015 0.01 0.005 0 Final Apparel & Final Electronics Final Textiles Final Vehicles Intermediate Intermediate Intermediate Footwear (Pass+Comm) Apparel & Electronics Vehicles Footwear Source: World Bank staff calculations based on data from Comtrade. Figure A 23: Quality ladders for key export products ARM Men/Boys Overcoats, Synthetic (2015) ARM Men/Boys' Trousers, Synthetic Fibers (2015) ARM 2.5 TUN ITA ARM 2 CAN GBR BRN LTU POL 2 Relative Unit Value Relative Unit Value 1.5 CHE NZL MDA LUX 1.5 HUN ECU ARG URY BRN SVN CAN HRV NOR LVA LTU MKD KAZ SWE KOR ITA CHL KAZ NOR BGR 1 SER CMR ISL CRI BWA ESP DEU AUT VNM IDN FRA SVK MAR JPN DOM BIH PRY QAT OMN MDG JOR CHL BGR NIC GTM THA EST BRA ZMB SLV COL GBR ROM FJI UKR DNK ROM DNK LVA POL 1 FIN SWE NZL SVN MLT CZE HUN KWT MKD FIN HRV PRT COL PRT NLD BWA AUS ISR CZE MLT GEO NCL JAMETH QAT PSE CPV OMN PRY BRB KHM JPN GTM EGY CRI DOM FRANIC DEU BIH SLV VNM ESP IDNMDG SER SVK MAR AUT VCT ISL ARE NLD FJI BEL EST ARM BRA ALB UKR RUS .5 OASBEL KWT TUR MNT MOZ MYS GEO URY PHL IRL .5 USA BLR ARG TUN RUSPHL SGPGRC CHN OAS BHRBLR THA GRC IRL ALB MDA ECU MUS TUR PYF PER BOL KOR USA IND MEX PER ARM MEX IND MYS LKASGP ZAF NPL CHN PAK BOL ZAF LKA ZWE PAK 0 ARE KGZ 0 UGA MNG MAC ETH CYP BHR 0 20 6040 80 100 0 20 60 40 80 100 Rank Rank Rel Unit Values Rel Unit Values ARM Rel Unit Values Rel Unit Values ARM ARM Men/Boys Overcoats, Synthetic (2015) ARM Jersey of Man-Made Fibers (2015) ARM 2.5 TUN ITA ARM CHE 2 ARM CAN HKG NPL BRN 2 URY POL ARM Relative Unit Value Relative Unit Value CYP 1.5 NZL MDA BOL MDA LTU 1.5 HUN ECU ARG CAN URY NOR LVA FIN MNT LTU KAZ BRA ARG ITA SWE KOR THA CHLEST BRA LVA CMR SERAUT DEU FRA ESPIDN BIH JPN MAR VNM DOM PRY SVK JOR QATMDG OMN BGR GTM NIC 1 GBR CRI BWA SLV ZMB COL ISL ROM FJI UKR SWE MKD DNK EST COL 1 GBR NOR CZE ECU GRC KAZ SVN MLT BWA BGR ROMNLD ARE JAM QAT SVN UKR BIH DOM JOR PAN GTM NIC OMN SLVESP IDN SERDEU FRA MDG PSE VNM SVK AUTJPN MAR TZA CRI KHMISL PRY MKD FIN PRT MLT DNK HRV PRT TUN IND HUN CZE NLD POL RUS ALB KOR HRV PER BLR BEL THA OAS MUS TUR IRL BEL KWT TUR OAS MEX USA .5 MYS KWT MYS .5 GEO USA BLR SGP CHN LKA CHN GRC PHL PHL SGP RUS IRL PAK MNG ALB IND MEX PER ZAF BOL ZAF LKA ZWE PAK UGA KGZ 0 ARE CYP BHR ETH MAC MNG 0 0 20 60 40 80 100 0 20 6040 80 100 Rank Rank Rel Unit Values Rel Unit Values ARM Rel Unit Values Rel Unit Values ARM Source: World Bank staff calculations based on data from Comtrade. 90 Indeed, bank loans to the sector fell to AMD 2.17 billion in March 2017 from AMD 4.34 billion in July 2014 (source: Central Bank of Armenia). 91 This obstacle is similar to that observed in Georgia by the booming textile and apparel sector. 67 Another GVC-prone sector is ICT, where Armenian firms In the recent years, price competitiveness as measured have expanded over the past 10 years, increasing links by the real effective exchange rate has declined in to global suppliers and clients. ICT services account for a Armenia. Between 2003 and 2011, the dram appreciated sizable share in services exports, as well as growing portion Figure A 25: Real effective exchange rate in Armenia of FDI inflows. Total revenues in the sector reached US$559 (increases are real appreciations) million in 2015, an increase of 17.7 percent from 2014. The 110 number of ICT companies in Armenia has also grown from Real Effective Exchange Rate (WDI) 55 in 2000 to 450 in 2015. Indeed, Armenia has come to be 100 regarded as a “hub” for software development and industrial computing. 90 The ICT sector is primarily oriented toward exporting software, with North America and Europe as the main destinations. Eighty percent of ICT exports in 2015 went 80 to the US and Canada, while 11 percent was destined to European countries (Figure A 24). Russia and the CIS is 70 the third main destination, accounting for 11 percent of all 2000 2005 2010 2015 ICT exports. A third of companies in the sector are foreign- year owned, with the US and Canada topping the list of foreign Source: World Bank staff elaboration based on WDI. investors, followed by European countries and Russia. in real terms by 49.5 percent (Figure A 25). More recently, Figure A 24: ICT exports, 2015 although the sharp appreciation process decelerated, since Russia & CIS Other 2012, the domestic currency appreciated by an extra 7 1% Europe 8% percent in real terms. Anecdotal evidence obtained through 11% focus groups suggests that firms care about the evolution of the real exchange rate, in particular exporters. Indeed, most textile and apparel producers that were interviewed revealed that the “appreciated” real exchange rate is to some extent an obstacle for their operations. Armenian exports, and their survival prospects, are sensitive to real exchange rate movements. A careful analysis of export flow patterns in Armenia over the period 2000-15 reveals that a real appreciation of the domestic currency by 10 percent leads USA & Canada to a decline in US dollar-exports of 8.7 percent, all other 80% things being equal. In addition, a real appreciation of the same magnitude increases the chances of an export flow of Source: Enterprise Incubator Foundation. a given product to a given destination to be discontinued by 3 percentage points, implying a proportional increase of the probability of exiting of 5 percent (Table A 6:). Price Competitiveness Other factors also play a role in export performance, A key condition for export competitiveness is a among which information provision and demand conducive macroeconomic environment and, in conditions stand out. Information matters both for boosting particular, a competitive real exchange rate. For example, export values and export survival. As more and more export when the Armenian dram depreciates against the US dollar, products reach a given destination, the survival rate of Armenian products become cheaper relative to American export flows to that given destination increases. Indeed, a ones, when expressed in the same currency, leading to 10 percent increase in the number of products that reach expenditure switching at home and abroad away from US a given export market reduces the likelihood of a flow to and into Armenian products.92 In practice, how sensitive that export market becoming extinct by about 4.2 to 4.4 have exports been to changes in the real exchange rate? percentage points, and increases exports by about 1.6 to 3.0 And what role did real exchange rate movements play in percent. This is because, as more exporters sell to a given the low survival rates observed among Armenian exporters. market, more information about the requirements to export International evidence points to a role of real depreciations in boosting export performance. Freund and Pierola (2012), for example, show that export surges are associated with large real 92 depreciations. The effect is larger in developing countries – where market failures preventing reallocation into tradables are more pervasive, and it operates mostly through the extensive margin: more entry into new markets or products. More recently, a decline in the effect of real exchange rates on export performance has been documented, due to a greater import content of exports due to GVC-related trade, however, the channel continues to be at work (see, for example, Cheng et al (2016), Ahmed et al (2015), Amiti et al (2012) or Bernard and Jensen (2001)). 68 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 to that given market become available, becoming less costly peaked at US$944 million in 2008, fell significantly in for firms to obtain. A similar effect is found for the number of the aftermath of the GFC. FDI as a percentage of GDP destinations reached with a given product, an indicator of decreased from 9 percent in 2009 to 1.8 percent in 2015. information availability about the specifics of exporting that Armenia lags behind some of its peers, such as Georgia, given product, although it mainly operates on export values Hungary, and Albania, in terms of investment attraction rather than on the chances of survival. Moreover, exports are (Figure A 26). In the post-GFC period, however, Armenia boosted by positive product or destination specific demand outperformed Slovenia, Moldova, Macedonia, and Bosnia. shocks, as would be expected (Table A 6:). Moreover, Armenia is slightly above the expected levels of FDI inflows given its income per capita (Figure A 27). 4 Investment Russia remains the largest source of FDI inflows to Another key determinant of productivity and Armenia. From 2001 to 2012, Russia accounted for 40 competitiveness relates to investment, and in particular percent of FDI flows. Western European countries, in the ability to attract high quality FDI and gain from it particular France, Germany, and the Netherlands, have through spillovers. expanded their shares in total FDI inflows to Armenia FDI inflows have remained strong over time but have since 2010. By contrast, Canada, the US and Greece yet to recover to pre-crisis levels. FDI inflows, which have significantly decreased their investments in Armenia. Figure A 26: FDI (% of GDP) Figure A 27: FDI integration 14 20 AZE 12 15 10 FDI (% of GDP) 10 8 GEO 6 ARM MDV LVA CZE 5 BIH SVK 4 LTU SVN 0 2 0 -5 ALB ARM BIH GEO HUN MDA SRB SVN MKD 6 8 10 12 2001-2004 2005-2008 2012-2015 Log of GDP per capita (PPP, av.) Source: World Bank staff calculations based on WDI. Source: World Bank staff calculations based on WDI. A shift in sectoral composition in FDI inflows targets of FDI. However, in 2014-16, the share of FDI in reflects the Armenian economy’s gradual productive communications, software and IT services, and renewable/ transformation. Between 2004 and 2016, financial alternative energies has increased significantly (Figure A services, communications and metals have been the main 28). Figure A 28: FDI inflows by sector a. 2004-16 4% 3% 1% 5% b. 2014-16 2% 1% 2% 23% 26% 3% 31% 11% 49% 24% 6% 7% 2% Beverages Automotive OEM Alternative/Renewable energy Alternative/Renewable energy Communications Communications Coal, Oil and Natural Gas Food & Tobacco Software & IT services Hotels & Tourism Financial Services Semiconductors Metals Transportation Textiles Consumer Products Textiles Financial Services Source: World Bank staff calculations based on data from FDI Markets 69 Table A 5: Growth accounting decomposition: 2000-15 2000-2003 2005-2008 2012-2015 Growth of GDP, log change 10.50 11.25 4.17 Contribution of Labor Quantity -2.61 0.48 -0.44 Contribution of Capital Services provided by ICT Assets 0.41 -0.34 0.13 Contribution of Capital Services provided by Non-ICT Assets 0.08 3.05 0.80 Growth of Total Factor Productivity - Estimated as a Tornqvist Index 12.62 8.06 3.68 Source: World Bank staff calculations based on Conference Board. Table A 6: Determinants of Export Performance (values, and probability of exit) Log Exports Log Exports Log Exports Log Exports P(Exit) P(Exit) P(Exit) P(Exit) (Log) Number of products exported to destination d 0.302*** 0.161*** 0.159*** -0.0421*** -0.0432*** -0.0440*** -0.0476 -0.0461 -0.0468 -0.0114 -0.0119 -0.0123 (Log) Number of countries reached with product i 0.579*** 0.141 0.158* -0.0569*** 0.0370* 0.0368* -0.0888 -0.0879 -0.0934 -0.0149 -0.019 -0.02 (Log) World imports of product i 0.250** 0.248* 0.0659*** 0.0603** -0.126 -0.136 -0.0228 -0.0246 (Log) World Imports from destination d 0.423*** 0.397*** -0.100*** 0.0907*** -0.0853 -0.0922 -0.0167 -0.018 (Log) Number of competitors for product I in destination d 0.146** -0.0228 -0.0613 -0.0181 REER -0.00433*** -0.00720*** -0.00841*** -0.00869*** 0.00473*** 0.00507*** 0.00327*** 0.00298*** -0.00131 -0.00131 -0.00131 -0.0016 -0.00029 -0.00029 -0.00032 -0.00038 Constant 5.232*** 2.748*** -6.837*** -6.876*** -0.00326 0.230*** 0.842*** 0.860*** -0.126 -0.394 -1.323 -1.387 -0.0281 -0.063 -0.251 -0.264 Product-Destination Fixed Effects Yes Yes Yes Yes Yes Yes Yes Yes Observations 7,449 7,449 7,070 6,548 13,597 13,597 12,524 11,527 R-squared 0.004 0.063 0.109 0.113 0.026 0.03 0.023 0.019 Number of cpid 1,925 1,925 1,873 1,776 4,672 4,672 4,435 4,157 Source: World Bank staff calculations based on UN Comtrade and WDI. Annex 1 References Aw, B. Y., Roberts, M. J. and Xu, D. Y. 2011. R&D Investment, Exporting, and Productivity Dynamics, American Economic Review, 101, 1312–44. Hsieh, C., and Klenow, P. J. 2009. “Misallocation and Manufacturing TFP in China and India” Quarterly Journal of Economics, 124(4), 1403–1448. Hsieh, C. T., & Klenow, P. J. 2014. The life cycle of plants in India and Mexico. The Quarterly Journal of Economics, 129(3), 1035-1084 Lopez-Acevedo, G., Medvedev, D., & Palmade, V. 2016. South Asia’s Turn. World Bank Publications. Swann, G. P. 2010. ‘‘nternational Standards and Trade: A Review of the Empirical Literature’’, OECD Trade Policy, Working Papers, No. 97, OECD Publishing 70 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 ANNEX 2: DATA DIAGNOSTICS FOR ARMENIA Armenia scores 92.2 out of 100 with the 2016 Statistical assessed and some existing criteria tightened, Armenia Capacity Indicator (SCI) using the old methodology. The received a total overall score of 64.99 out of 100, which country scores are relatively balanced between the three shows a relatively lower level of statistical capacity (with dimensions: Methodology (100), Source Data (100) and 2014 data used for AKI section). This indicates that with Periodicity (76.7). With the new SCI, the capacity of the weaknesses identified by the new SCI, there is a Armenia is assessed by evaluating four dimensions of the need for capacity improvement of the statistical system system (Methodology, Standards & Classifications (MSC); to properly inform evidence-based decision-making Censuses and Surveys (CS); Dissemination Practices & processes, as well as monitoring and evaluating the Openness (DPO); Availability of Key Indicators (AKI)) that development progress in coming years. expand over the old methodology. With more indicators Country: ARMENIA I Date completed: October 24, 2016 Section 1: General Information about the Statistical System The National Statistical Service of Republic of Armenia (NSS RA) is an independent Legal status of NSO government agency Objectives and tasks of statistics are based on the Law of Armenia “On State Statistics”, Statistical Legislation which entered into force as of 10 May 2000. latest) http://www.armstat.am/en/?nid=183 NSDS/Statistical Three-Year State Statistical Work Program of the Republic of Armenia for 2016-18 masterplan Section 2: Micro data Representativeness Data Accessibility Disaggregation Second Latest (national, (open access/ (Y/N) Type of census/survey Latest (Year) regional, with permission/ (Year) Optional urban/rural) no access) Sex Regional Censuses Open access to main results Population census 2011 2001 National and tabulates Y Y Agriculture census 2014 Business/establishment census No access Surveys Household Survey on Yearly With income/consumption93 ILCS 2015 2001-2014 National Permission Y Y Household survey on education (e.g. MICS) STEP 2013 National Open Access Y Y Household survey on health (e.g. DHS, MICS) http://armstat.am/en/?nid=81&p thid=demo&year=2016&submit DHS 2015 2010 Labor force Survey LFS 2014 (LFS, household survey on (2015 to be available labor only) probably in January 2017) LFS 2014 National With permission Y National/regional (4 regions, city and the surrounding area)/ industry (manufacturing, Enterprise survey 2009 retail and other services)/ Business/establishment survey 2013 (IBRD-WB) (2005, 2003) firm size (L, M, S) Y Other (specify) 93 All HHS since 2000 listed in Country Profiles. 71 Section 3: Macro data Does the country subscribe to the IMF SDDS or SDDS participate in the eGDDS? If eGDDS - Periodicity Timeliness eGDDS Data Category SDDS Country SDDS Country National accounts: Gross Q,A Q,A 2M/4M Domestic Product by Production [Annual: for complete and Expenditure at Current and accounts by institutional Quarterly: 90-92th day Constant Prices. sectors] after the reference quarter. Since 2012: 60-62th day http://dsbb.imf.org/Pages/SDDS/ after the reference quarter. DQAFBase.aspx?ctycode=ARM& [Annual: on April 30 of the catcode=NAG00 second year (after the reference year).] Consumer price index M M 5D http://dsbb.imf.org/Pages/SDDS/ Data are published in DQAFBase.aspx?ctycode=ARM& 5 days after reference catcode=CPI00 month. Central government operations M M M http://dsbb.imf.org/Pages/SDDS/ 1 month after the end of DQAFBase.aspx?ctycode=ARM& the reference period. catcode=CGO00 Balance of payments Q,A Q,A 1Q/2Q http://dsbb.imf.org/Pages/SDDS/ One quarter after the end DQAFBase.aspx?ctycode=ARM& of the reference period, catcode=BOP00 for quarterly data. Two quarters after the end of the reference year for annual data. External debt Q,A M,Q,A 1Q http://dsbb.imf.org/Pages/SDDS/ One quarter after the end DQAFBase.aspx?ctycode=ARM of the reference period. &catcode=EXD00 Annual data are published in the corresponding handbook. Merchandise trade M,A M,A 3W/1M http://dsbb.imf.org/Pages/SDDS/ Preliminary data on DQAFBase.aspx?ctycode= exports and imports are ARM&catcode=MET00 disseminated on the 20th day and revised one month after the end of the reference period. Production index M M 3W/1M http://dsbb.imf.org/Pages/SDDS/ Preliminary data are DQAFBase.aspx?ctycode=ARM published on the 20th day &catcode=IND00 after the reference period, and final data are published one month after the end of the reference period. Employment Q Q 3M http://dsbb.imf.org/Pages/SDDS/ The data are published in DQAFBase.aspx?ctycode=ARM& three months after the catcode=EMP00 end of the reference period. Unemployment Q M,Q 3M http://dsbb.imf.org/Pages/SDDS/ Data are published in DQAFBase.aspx?ctycode=ARM& three months after the catcode=UEM00 end of the reference period. Producer Price Index M M 3W/1M http://dsbb.imf.org/Pages/SDDS/ Preliminary data are DQAFBase.aspx?ctycode=ARM& published on the 20th day catcode=PPI00 following the reference month. Final data are published one month after the end of the reference period. 72 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 ANNEX 3: EARNINGS AND THE GENDER WAGE GAP IN ARMENIA94 In Armenia, the proportion of women among employed The difference in average wages between men and women workers increased from 45 to 48 percent between 2008 is still among the largest compared with countries in the and 2015. This evolution was accompanied by a fall in the Europe and Central Asia region. Just below Georgia and gender earnings gap from 41 to 33 percent. with a similar level to Israel, the gender gap is some 10 percentage points higher than in Estonia, Belarus, Ukraine Analysis based on data from the Labor Force Survey shows and Spain in the most recent year. The dynamics over that earnings adjusted only for changes in the cost of living the past decade in Armenia have been similar to those in (inflation) followed an increasing trend between 2008 and Georgia, although with relatively lower levels (Figure A 30). 2015 for both women and men in Armenia. However, wages for women have grown relatively more so that the difference The wage gap is not homogeneous across the wage with men’s wages has closed over this period. Despite distribution. In fact, looking at the different percentiles it is this progress, women in Armenia still earn on average 33 observed that the disparity in wages in Armenia in 2015 percent less than men (Figure A 29). shows an inverted-U shaped form (Figure A 31). The gap is larger in the middle of the distribution with the bottom and Figure A 29: Trends in real wages and the unadjusted gender wage gap, 2008-15 the top of the distribution showing less differential in wages between men and women. The gap seems to increase Gender wage gap (percentage points) 250000 80 substantially around the percentile 20th and expands even 70 200000 more until percentile 50th, after which it starts to decrease. Real wages, AMD 90 50 Figure A 31: The wage distribution for men and 150000 women and the wage gap by percentile, 2015 40 100000 30 a)Wage distribution 20 1 50000 10 .8 0 0 2011 2012 2010 2014 2008 2009 2015 2012* 2013** Density .6 Gap (%) Men Women .4 Men Source: World Bank staff calculations based on WDI. Women .2 Figure A 30: The gender pay gap in monthly earnings, selected countries 2008-14 0 2 4 6 8 10 12 50 log (hourly rate of pay) 45 b) The wage gap by percentiles of wagedistribution 40 .6 Gender wage gap (%) 35 30 .4 25 Log wage gap 20 15 .2 10 5 0 0 2008 2009 2010 2011 2012 2013 2014 Georgia Israel Belarus Spain Armenia Estonia Ukraine Serbia -2. Source: World Bank staff elaboration based on UNECE 0 20 40 60 80 100 Statistical Division Database (2016) and NSS of RA (2016) Percentile for 2013 and 2014 data for Armenia. Source: World Bank staff elaboration based on LFS 2015. 94 Based on Rodriguez-Chamussy, L., N. Sinha and A. Atencio. 2017. “The gender wage gap in Armenia”. World Bank. Mimeo. 73 Behind the difference in earnings by gender there is a and decreasing along the wage distribution with larger complex interplay between economic and institutional magnitudes for women.95 The impact of being married mechanisms. Social and demographic characteristics reduces earnings at the top of the distribution for women have a clear differential impact on wages across the and has a positive impact for men at the bottom of the distribution, for example, the effect of experience is positive distribution. Figure A 32: Returns to characteristics across quantiles (unconditional wage distribution) by gender, 2015 Potential experience Sq potential experience Primary -.02 -.01 0 .01 .02 .03 .0005 3 2 1 0 0 -.0005 -1 0 20 40 60 80 100 0 20 40 60 80 100 0 20 40 60 80 100 Lower secondary Upper secondary Teriary/post-graduate 2 2 2 1 1 1 0 0 0 -1 -1 -1 -2 -2 -2 0 20 40 60 80 100 0 20 40 60 80 100 0 20 40 60 80 100 Quantile Public firm Informal .1 Urban-Yerevan .1 .2 .2 .1 0 -.3 -.2 -.1 0 0 -.1 -.1 -.2 -.2 0 20 40 60 80 100 0 20 40 60 80 100 0 20 40 60 80 100 Other urban Married -.1 -.05 0 .05 .1 .15 -.2 -.15 -.1 -.05 0 .05 Women Men 0 20 40 60 80 100 0 20 40 60 80 100 Quantile Source: World Bank staff elaboration based on LFS 2015. Three main results characterize the current differences in have lower returns than men, especially in ICT activities and pay: First, the impact of education is important at the bottom in the financial sector, which are among the better paid on of the distribution and has a positive effect for women. average. Second, working in informal sector has a negative impact Factors driving the gap across the wage distribution on earnings in the first half of the distribution both for men and women; for men, the effect is close to zero in the upper The difference between men and women’s wages can part of the distribution but for women it is positive and large. arise from differences in the distribution of observables Third, working in the public sector has a negative impact characteristics, such as education (“composition effect”), on earnings, except for women between the 20th and 40th or differences in how the labor market rewards male and percentile. Finally, women at the top of the wage distribution female workers for their characteristics (“wage structure 95 The results on experience need to be taken with caution because given data limitation the variable experience is constructed subtracting from age the years of schooling therefore being imperfect as measure of work experience. 74 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Figure A 33: Returns by economic sector and occupation across quantiles (unconditional wage distribution) for men and women, 2015 Industry Construction Trade, transport 1 1.5 2 1 1.5 1 1.5 .5 .5 -.5 0 .5 0 -.5 0 -.5 0 20 40 60 80 100 0 20 40 60 80 100 0 20 40 60 80 100 Info & communication Financial Real Estate 1 1.5 1 1.5 1 1.5 .5 .5 .5 0 -.5 0 -.5 0 -.5 0 20 40 60 80 100 0 20 40 60 80 100 0 20 40 60 80 100 Technical activities Support service Other services 1 1.5 1 1.5 1 1.5 .5 .5 .5 0 0 0 -.5 -.5 -.5 0 20 40 60 80 100 0 20 40 60 80 100 0 20 40 60 80 100 Quantile Source: World Bank staff elaboration based on LFS 2015. effect”). Structural effects are considered to reflect labor Overall, the findings for Armenia suggest that occupational market discrimination. In Armenia, the wage gap along the and industry segregation are important contributors to the distribution is driven mostly by the wage structure effect gender pay gap. Skills-enhancing policies are important for (Figure A 34). An exercise of decomposition based on the women in low-wages activities. However, greater gender Recentered Influence Function (RIF) methodology shows equality in pay would mostly come from policies that help that in 2015 the wage structure (that could be linked to to break the glass ceiling, for example policies to remove discrimination) accounts for almost all the wage gap in the barriers for women to fill management and decision-making middle part of the distribution (30th to 55th percentiles); at positions. the top of the contribution of the wage structure is greater, Figure A 34: Decomposition of the gender but better educational endowments of women offset to some wage gap by percentile, 2015 extent the effect of the wage structure. In the bottom part of Gender wage gap Composition Wage structure the distribution, however, the composition effect is larger, (in_hrp) effect effect .25 consistent with lower human capital endowments among women. .2 The results of the decomposition showing a stronger wage .15 structure effect at the top of the distribution suggest a ‘glass .1 ceiling’ phenomenon, which refers to ‘unseen’ barriers .05 (discrimination) that keep women from advancing beyond a certain level in the corporate hierarchy and obtaining higher 0 wage, irrespective of their qualifications or achievements. In -.1 -.05 fact, the negative composition effect in the top 40 percent of the distribution indicates that for a large proportion of wage 0 10 20 30 40 50 60 70 80 90 100 levels women are overqualified compared with men in the Percentile same percentile of earnings. Source: World Bank staff elaboration based on LFS 2015. 75 ANNEX 4: INTERNAL MOBILITY AND INTERNATIONAL MIGRATION96 Given the generally slack labor market and low informality even among ECA countries, where there is evidence that rates outside agriculture, it is not surprising that men and aside from weak labor demand other forces might be at play. women do not move internally for employment. According to Incentives, demographics, and institutional factors may play the recent Life in Transition Survey (2016), only 22 percent a role here. An older and aging population, together with of Armenians reported that they were willing to move within underdeveloped housing and liquidity constraints associated the country for employment reasons. This is a low share with frictional credit markets, may play a role too. Figure A 35: Limited internal mobility in Armenia 70% 60% 50% 40% 30% 20% 10% 0% Slovak Rep. Bosnia and Herz. Kyrgyz Rep. Czech Rep. Azerbaijan Tajikistan Poland Uzbekistan Kazakhstan Lithuania Albania Georgia Ukraine Serbia Greece Moldova Slovenia Romania Russia Latvia Armenia Kosovo Cyprus Montenegro Belarus Mongolia Bulgaria FYR Macedonia Croatia Estonia Germany Turkey Hungary Italy Source: World Bank staff calculations based on Life In Transition Surveys (EBRD, 2016). The y axis measures the share of those who are unemployed and willing to move within the country for employment reasons. Short-term labor migration97 is the predominant form of skilled jobs. The OECD/CRRC (2017) report also shows external migration in Armenia. The exact figures on the that most migrants are involved in low-skilled agricultural or number of migrants are unavailable. The Russian-Armenian construction sector work. study (2015) reports that the share of population participating Push factors are the dominant reason for decisions in short-term migration increased from 24.3 percent in 2007- to migrate for work. Bellak et al. (2014) studied men’s 13 to 33.8 percent in 2012-15. According to the OECD/CRRC migration to Russia for a sample of Armenian households (2017), which draws on data from the United Nations, there during 2006-10. Their study finds that being unemployed were 937,000 Armenian migrants abroad in 2015, about significantly raises the probability that a person will migrate 31 percent of the total population. The dominant migration for work. Unemployment rates in Moscow have no impact on corridor is between Armenia and Russia (facilitated by visa this decision. Moreover, being tertiary educated reduces the free travel and familiarity with Russian language). Nearly 70 probability that a man will engage in short-term migration to percent of short-term migrants interviewed in the Integrated Russia—consistent with the type of work that is taken up in Living Conditions Survey (ILCS) 2015 reported Russia the destination country. The OECD/CRRC (2017) analysis (mainly Moscow) to be their destination. Most of this type of confirms the dominant role of push rather than pull factors migration comes from households outside Yerevan. Similar in migration decision. The report finds that participation in to most migration flows from low-income to high-income vocational training programs (active labor market policy) and settings, there is a strong sectoral focus in the jobs Armenian receipt of subsidies by agricultural households is associated migrants take up in Russia: mainly construction and low with a reduced intention to migrate. 96 This Annex draws on the following sources: Bellak, Christian, Markus Leibrecht, and Mario Liebensteiner, 2014, Short-term Labour Migration from the Republic of Armenia to the Russian Federation, Journal of Development Studies. 50 (3). 349–367, http://dx.doi.org/10.1080/00220388.2013.858125. Russian Armenian (Slavonic) University. 2015.Three Year Monitoring of External Migration of Republic of Armenia.OECD/CRRC-Armenia (2017), Interrelations between Public Policies, Migration and Development in Armenia, OECD Development Pathways, OECD Publishing, Paris.http://dx.doi.org/ 10.1787/9789264273603-en World Bank. 2017. Armenia Poverty Note (background paper for the SCD). 97 Working abroad for at least 3 months and at most 11 months. 76 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Migrants gain economically from the decision to seek work By providing an avenue for low-skilled workers to find jobs, abroad but are susceptible to economic downturns abroad. short-term migration plays an important role until the domestic The Bellak et al. study shows that between 2007 and 2010 labor market picks up. But associated remittance flows on average short-term migrants to Russia increase their have an impact that must be managed. The limited use of monthly earnings by 279 percent relative to what they could remittances to start a business or invest in productive assets have earned at home. However, since 2014, the Russian is at least in part a reflection of the local economic conditions, economy has been on the decline, affecting Armenian where the broader credit and regulatory environment does migrants and the remittances they send back home. Central not encourage micro-entrepreneurial activity. There is also Bank of Armenia data show that remittances fell by 35 a concern that receipt of remittances will discourage work percent in 2015 and a further 10 percent in 2016, mainly by household members—a concern for which there is some due to a decline in remittances from Russia. supportive evidence. However, this work-discouraging impact of remittances should be interpreted within the current Income earned from short-term migration mainly flows labor market context where there is limited job creation. A in the form of remittances. The impact of this income on much more deleterious impact of remittance flows takes households and the domestic economy can be substantial. place at the macro level. Remittances tend to be pro-cyclical There is a modest poverty impact of remittances for rural in nature (recently amplified by Russian recession). For and secondary city households. However, most studies example, remittances have been as high as 20 percent of point to very limited to no impact on productive investments GDP at the peak of the cycle, while in the recent slow-growth by migrant-sending/remittance-receiving households. years they have shown a marked decline. Exchange rate The OECD/CRRC study found that remittance-receiving appreciation due to remittance inflows make exports less households were less likely to own a business. competitive, pushing jobs into non-tradable sectors.98 ANNEX 5: GOVERNMENT PROGRAM 2017-2022 The Government Program 2017-2022, approved in June that an anticorruption and public oversight institutional 2017, set the vision, goals, and sector reform priorities to framework is in place; and (v) supporting social protection come. It shares a broadly similar vision to the one put forward and targeting vulnerable groups. in this SCD. That includes the recognition that Armenia must look outward if it is going to fulfill the key medium- and Free Armenia points to the need to provide free of charge long-term objectives set out by the Government Program. services, including medical care. Support for these and other reforms through the diverse Smart Armenia means: (i) a modern, competitive labor lending and technical assistance tools available in the World force, which is qualified, educated, motivated, and mobile; Bank Group’s toolkit will be discussed in detail in the World (ii) smart and innovative economy promoting efficiency Bank Country Partnership Framework. in resource allocation and competitiveness through an increase in exports as key driver of growth; (iii) a focus on The vision is based on the principle productivity gains and the use of new technologies, with a of “safe, fair, free and smart Armenia”. focus on embracing a wide-ranging digital agenda; (iv) a Safe Armenia refers primarily to regional challenges and competitive and friendly business ecosystem and a level threats to national security. Recognizing these challenges, playing field for domestic and foreign investors; and (v) the program stresses the need to formulate and sustain strong relation ties with diaspora Armenians. legal, political, and military measures for national security. Through the implementation of this program, Fair Armenia refers to building trust and justice in for the period 2017-22 the following goals have been set: the society. To this end, several areas are focused on: (i) strengthening public administration, through higher Ensuring that economic growth is faster than developed efficiency, more transparency, and more accountability; (ii) countries by achieving an average of 5 percent gross GDP strengthening competition and a level playing field for the growth; private sector will be essential to attract private investment Achieving significant growth in exports, with the exports and create quality jobs; (iii) fostering an independent, of goods and services reaching 40-45 percent as a share impartial, and predictable judicial system; (iv) ensuring of GDP; 98 Karapetyan and Harutyunyan (2013) found evidence for such patterns in Armenia. 77 Achieving poverty reduction by lowering it by 12 percentage and anticorruption, security and public order, reducing points; and emergencies and disaster risks, state property management, Achieving a 25 percent increase in nominal minimum cadaster; wages, optimally combining employment growth and 2) Foreign policy, including foreign policy, diaspora, defense; compensation for dignified jobs and taking into account 3) Economic and social sectors, including economic progress structural unemployment and risks of reduction in the (exports, investments, business environment, tourism), country’s competitiveness, the proportion of the mitigating fiscal policy and finances, tax and custom systems, energy minimum wage and median wage. infrastructure and natural resource energy, agriculture, On this basis, the Government Program proposes transport, communication, and information technology, civil a high-level set of reforms in the areas of: aviation, urban development; 1) Public administration and legal framework, including 4) Social sectors, including education and sciences, work modernizing public administration, territorial administration and social policy, health, nature protection, culture, sport and local governance, human rights protection, justice and youth. ANNEX 6: THE PRIORITIZATION PROCESS AND KNOWLEDGE GAPS The SCD moved from the diagnostic findings to reform and implications for women’s economic participation. priorities, with concrete policy actions as follows. Reforms areas have been selected on the basis of how First, the country team confirmed a long list of what was advances in these areas are expected to impact progress constraining progress toward resilient and inclusive growth toward shared prosperity and poverty reduction in a and poverty reduction, based on the analysis of each sustainable way. The timing of reforms, their fiscal impact, pathway. After the core SCD team had drafted this list, it existing complementarities, and their feasibility have also was discussed by the SCD team and refined based on the been considered. The implementation of policy priorities is team’s expertise (Chapter 3). expected within a medium-term timeframe of six years. Second, reform priority areas (and later the policy The team considered the feasibility of implementation actions) were identified for each pathway by applying of reforms identified and their implications, without criteria to narrow down the extensive list of constraints. the intent to influence the prioritization or ranking of The criteria are: (i) the size and sustainability of the impact identified constraints. Taking this approach helped to of recommendations on the twin goals; (ii) the extent of shed light on reform areas with a high chance of being complementarities, i.e., whether the recommendations successfully taken up. This approach also helped inform the generate benefits across different dimensions of inequality, possible sequencing of reforms. growth, or sustainability; and (iii) whether the priority Lastly, the team examined the implications of priorities recommendations have a neutral or positive impact on for women’s and men’s economic advancement within fiscal sustainability as a necessary pre-condition. The team each pathway. This analysis is useful because greater also considered the feedback from internal and external economic participation by women would help Armenia to consultations. The team relied on a sounding board of tackle the potentially growth-reducing effects of a shrinking external experts to seek feedback on the prioritization. population. All pathways identified by the SCD can create Nine priority reform areas emerged. The core team then economic opportunities for women. If the recommendation formulated policy actions for each priority area based on on expanding early childhood education (Pathway 3) is the comprehensive analysis carried out for the SCD. The implemented, then these opportunities can be converted implementation of policy priorities is expected to set the into greater labor-force participation by women. Meanwhile, course for progress within the medium term (set to six the focus on micro-resilience (Pathway 4) shows that years), although the country will not necessarily accomplish health services that have a strong preventative focus would all objectives within this timeframe. help to address the concerns about men’s health and life Table 1 sets out the pathways and priority reform expectancy. Health risks from smoking (prevalent among areas, and examines their impact on the twin goals men but not women) are among the potential factors behind 78 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 the much higher adult mortality rate among men than experts on Armenia was invited during the first day of the women. workshop, while the second day was dedicated to internal The country team participated in an open discussion discussions and feedback, including prioritization of policy to validate and refine the policy priorities and actions measures. During the discussion, the policy actions were proposed. All country team members and management refined in response to the sector-specific expertise of were invited to a two-day workshop at which the core team participants and dialogue on complementarities between presented the proposed priorities and detailed the analytical different policy areas. In addition, the team reached out to basis and rationale for each. An external sounding board of the SCD Central Support team for guidance and support. Box A 1: Knowledge gaps As the team progressed into the systematic diagnostic of bottom-line evidence-based assessment of competition Armenia’s pathway toward reducing poverty and boosting issues in Armenia would help to support this reform agenda. shared prosperity using all available evidence, data, and analyses from both within and outside the World Bank, Data on demographic trends and the assessment of it identified a number of knowledge gaps, of which the their impacts. Population aging, declining population size following emerged as the most important for additional and outmigration affect Armenia’s future growth and poverty analysis: reduction prospects. The population trends and projections reported by the National Statistical Service (NSS) and the A multi-connectivity assessment: How a country United Nations differ especially in the pace and timing of connects with the rest of the world becomes increasingly population decline. Also, indicators such as the urban multi-faceted through not only goods and services, but share of the population differ markedly between NSS and also through people, technology, and knowledge. As UN projections. Investing in harmonizing these population the team progressed in analyzing how Armenia could series would be of considerable help in assessing the rebalance growth and better connect to the rest of the economic impact of Armenia’s population changes and world to expand its markets, it was found that a trade and benchmark these findings to countries undergoing similar transport facilitation assessment was missing in a country changes. The SCD analysis based most of its analysis on that faces critical logistics and landlocked-ness constraints. the NSS population series. However, this affected the ability In addition, while much anecdotal evidence is available on to benchmark to other countries and make international the links and relationship of Armenia with its diaspora, an comparisons. For migration, up-to-date data on short-term evidence-based assessment with policy recommendations migration flows and the extent of labor migration among the on the basis of international experience is lacking. Lastly, tertiary educated (“brain drain”) are not available. Several while some piecemeal information is available on ICT household surveys have been conducted to examine the access, policy and infrastructure, as well as information on determinants and impacts of migration. However, these the growing exports of the ICT sector, the country is missing surveys are limited in their scope and coverage. As migration an assessment on the challenges and policy actions that is important for the Armenian economy, investing in strong would allow Armenia to fully embrace the so-called “digital data collection systems to monitor these flows would close economy”. a crucial knowledge gap. Competition/market contestability assessment. Comprehensive environmental assessment for Competition and a lack of market contestability emerged as Armenia: The SCD’s analysis of the sustainability of a significant constraint to firms’ productivity during the SCD growth was greatly limited by the lack of a comprehensive exercise, both from available data and from consultations. assessment of the country’s natural resources wealth. For a However, little Armenia-specific information is available due country that is well endowed with natural resources and that to a lack of data availability and analysis to better understand relies on these resources for important sources of revenues the issue and its implications. There are now well known (tourism, mineral exports), GDP provides only a partial methodologies to assess the degree of competition in an picture—the value of agricultural land, minerals and forests. economy and/or selected sectors and, most importantly, For the sustainability of Armenia’s growth to be adequately to evaluate the economic gains that a country as a whole, assessed, conducting a Natural Capital Accounting exercise and economic agents in particular (consumers, firms, would be a useful investment. Internationally followed government), could enjoy should competition improve. A methodologies are available to carry out this exercise. 79 3.1.The SCD team also built on an extensive internal messages. The consultation process involves different and external consultation process. The objective from groups of stakeholders consisting of the Government, the the conceptual stage of the SCD onward was to obtain private sector, civil society organizations, academia, and continuous advice from experts in Armenia and the World development partners. During this process, discussions Bank country team on areas of emphasis and, as the helped to identify a number of major knowledge gaps (Box work progressed, on the emerging storyline and main A 1). Table A 7: Pathways, priority reform areas, impact on the twin goals and implications for women’s economic participation Impact on the twin goals, timing, Implications for women's Pathways Priority Reform Areas sustainability, complementarities economic participation Pathway 1: 1. Leverage exports enablers and Activating key export enablers will Currently, around 35 percent of To rebalance growth, Armenia bypass land connectivity barriers impact positively the twin goals, workers in the ICT-based service should seek to open markets, (trade policy, export intelligence, and has strong industry are women (World Bank, seize exports opportunities and diaspora, fill logistic gaps, focus complementarities, by increasing 2013). Development of the ICT overcome or bypass existing on trade in services and ICT) economic growth, making it more sector is expected to create jobs. connectivity constraints resilient to shocks through Pairing efforts to foster domestic diversification of markets and competitiveness, trade and products, enhancing productivity regional integration with gender- through exchange of technology equality enhancing policies in the and knowledge, and increasing labor market would allow a quality job opportunities for stronger competitive advantage workers. There may be short-term for Armenia in terms of the high "quick wins" through enhanced number of graduates-men and multi-connectivity infrastructure, women-of higher education level while a medium-term timeframe and competitive cost base. will support the realization of gains from implementing a multi- Firms with women top managers connectivity reform agenda. are underrepresented in every Feasibility of reform from a sector in Armenia except in the political-economy standpoint is textile and garment industry and relatively good, although it brings in hotel and restaurant services, in additional costs that will have where 35 percent of firms have to be funded in a fiscally neutral women in top management manner. positions (World Bank, 2016). Making use of modern export promotion institutions to reduce the fixed costs that firms face when entering new markets for the garments industry would support widening economic opportunities for women in entrepreneurship and contribute toward fostering inclusive growth. Pathway 2: 2. Fill the investment climate gaps Providing a level-playing field for More participation in To develop a vibrant productive (including regulations, their firms to enter and grow by entrepreneurship and the private sector and create more implementation, access to accessing skills, finance and narrowing of the gender gap jobs, Armenia should remove finance, to innovation, market innovation will go a long way in would contribute to fostering a constraints for firms entering contestability, corporate improving productivity, and productive private sector that markets and growing governance) thereby job creation, in a labor creates more jobs. Women's market that is demand- lagging participation in constrained. It will have a large entrepreneurship represents a positive impact on growth, its misallocation of Armenia's human sustainability, and disparities by resource potential. Calculations strengthening the link between suggest that the gender gaps in growth and livelihoods through participation and in jobs. The timing is short to entrepreneurship result in a loss medium term, with immediate of economic output equivalent to actions (e.g., implementing the 5 percent of GDP (World Bank, existing approved regulatory 2016). framework) possible, and others more medium term, in particular when requiring capacity and institution strengthening. 80 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Impact on the twin goals, timing, Implications for women's Pathways Priority Reform Areas sustainability, complementarities economic participation 3. Ensure on-the-ground market Ensuring market contestability is contestability and competition a key ingredient necessary for firms to be able to enter markets and sustain growth. That would have a positive large impact on growth and shared prosperity, by limiting rents and ensuring healthy competition in well regulated markets. That will also contribute to sustainability by supporting diversification. Feasibility might be more medium-term since it will require ensuring a balance between various stakeholder interests. Pathway 3: 4. Ensure the education and A critical complement to priorities Efforts to ensure that education For inclusive growth, Armenia workforce development systems 1 and 2 (above) is that workers and skills acquisition for both men should remove barriers to work provide skills relevant to the have the needed skills to meet and women lead them to jobs in and improve individuals' market (through teacher training, the needs of new and growing sectors that are projected to grow productivity promotion of STEM and higher firms. Investing in workers' skills and provide better pay. education, expansion of tertiary in therefore creates the channel for rural areas, better VET regulation, translating growth into shared Capitalizing the investments of workforce development and prosperity and poverty alleviation. valuable resources in women's apprenticeships) High-quality education is an education requires the important source of technical implementation of policies that skills and knowledge. Workforce remove barriers on both the development is needed to ensure demand side and the supply side. not only that the education Policy efforts aimed at adequate system provides relevant skills job creation need to be but also for an aging workforce to accompanied by policies to help renew skills and keep up with the balance care and work needs of the labor market. Thus, responsibilities. quality education and workforce development are both crucial Tackling barriers to women's complementary investments for participation in the workforce priorities 1 and 2 above which call would result in efficient allocation for leveraging digital technology of valuable human capital and and greater innovation. economic gains not only for Stepping up investments in women and their families, but for education can be achieved in the the entire society. short term and supported through education expenditure rationalization. Investing in workforce development can be achieved in the medium to long term in partnership with the private sector. The feasibility of developing a strong workforce development program depends on the willingness of the private sector to collaborate and create opportunities. Improving the regulation of existing Vocational and Technical Education (VET) programs can be implemented in the short term. 81 Impact on the twin goals, timing, Implications for women's Pathways Priority Reform Areas sustainability, complementarities economic participation 5. Support matching of workers to As the economy creates more jobs (through strengthening the jobs and invests in better skills of State Employment Agency, its workers, matching workers to activation of social assistance jobs is important for efficient beneficiaries) allocation of labor and hence productivity improvements. More than 70 percent of Armenians participating in the Life in Transition Survey reported that connections were essential or very important for access to good jobs. Thus, a functioning public job-matching service is needed. Still, the capacity of expansion of State Employment Agency seems limited given the small resources currently allocated toward active labor market programs. Public spending and greater private sector participation will be needed to strengthen and enhance the use of the State Employment Agency. 6. Facilitate women's labor- Having more women participate market participation (through in the labor market will counteract ECE; gender mainstreaming in the effect of population decline general and higher education) and high rates of male outmigration on Armenia's labor resources. If gap between male and female labor participation were to close by enabling more women to seek and find work, the adverse trend in the economic dependency ratio could be significantly reduced, and as much as 14 percent of GDP could be gained. An essential reform to facilitate women's work is expansion of quality Early Childhood Education (ECE) programs delivered through public kindergartens for children under the age of 3 and in rural areas. ECE investment is internationally recognized to be a smart policy that helps the economy today (through more female participation) and in the future (through children's greater productivity as adults). Countries such as Sweden have also successfully tackled population decline with an expansion of ECE programs. Supporting women through the implementation of ECE can build on the existing public kindergartens and rolled out in the short to medium term. This expansion can be supported through rationalization of education spending. 82 Future Armenia: Connect, Compete, Prosper I A Systematic Country Diagnostic I NOVEMBER, 2017 Impact on the twin goals, timing, Implications for women's Pathways Priority Reform Areas sustainability, complementarities economic participation Pathway 4: 7. Strengthen macro Macroeconomic resilience and Along with raising female labor for To achieve sustainability, Armenia management supportive of sustainable macroeconomic participation rates, strengthening should build national resilience on stability and growth policies supportive of long-term pensions could halt the rise in multiple fronts economic growth are a economic dependency ratio. In prerequisite for successful 2015, there was nearly a 20- progress toward the twin goals percentage-point gap in male and and effective policy reforms female labor-force participation across the board. The timing is among those aged 15 to 64. If immediate, because a slippage of this gap were to close by enabling macroeconomic sustainability in more women to seek and find the short term can have a long- work, the adverse trend in the lasting impact. An example can economic dependency ratio could be found in the recent fiscal be significantly reduced with the retrenchment of public investment positive effects on fiscal following the automatic fiscal strengthening. consolidation triggered by Enhancing resilience at the Armenia's fiscal rule, which will household level through well- have short- and medium-term targeted social assistance would impact on economic growth. improve the prospects of households with dependents and 8. Strengthen environmental The sustainable management of a single female earner, as well as management and adaption to the environment and natural households with majority of climate change impacts resources is vital for Armenia's women, which are particularly future economic growth. vulnerable to poverty and old-age Environmental and natural poverty. resources provide the foundation Health services with strong for sustained inclusive growth via preventive focus would help better performance of sectors, reducing concerns about men's such as agriculture, mining, health and life expectancy (the tourism, and forestry, as well as mortality rate among adult men is via strengthening resilience to far higher than among women). extreme weather events and adaption to climate change impacts. 9. Strengthen micro-resilience Household wellbeing is directly through access to finance, social impacted by shocks such as job protection, and tackling pension loss or illness, and indirectly and health implications of affected by macroeconomic population aging vulnerabilities. Over time, the share of the population that is vulnerable to falling into poverty has grown. A public policy concern is that when faced with shocks households, especially those that are poor and vulnerable, may choose coping strategies that are harmful for future welfare, especially for the human capital development of children. The limited social assistance coverage of the poor and the lack of “good” jobs, especially in rural areas, are key constraints to address the resilience challenge and the productive inclusion (by graduating SP recipients to jobs and sustainable livelihoods). Old-age poverty is also increasingly a policy concern given demographic trends and rising share of economic dependency ratio. Population aging could further add to households' rising costs for health care, especially given the rising burden of non-communicable diseases. Source: Implications for women and men’s economic participation are taken from World Bank analytical work summarized in World Bank (2016) Armenia Country Gender Assessment 2016, World Bank (2013) “Accumulation, Competition and Connectivity” and World Bank (2017) “Armenia: Leveling the STEM Playing Field for Women”. 83 84