Notes on Armenia’s Notes on Armenia’s growth strategygrowth strategy

Dani RodrikDani RodrikSeptember 11, 2010September 11, 2010

Armenia suffers both from under-Armenia suffers both from under-utilization and mis-allocation of utilization and mis-allocation of

resourcesresourcesEconomic structure and productivity, c. 2007

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population of working age labor force employed agriculture construction/realestate

manufacturing IT0

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20000Number of people (thousands)

Labor productivity (thousand dram/person)

Observe: 1. under-employment; 2. productivity gaps

Pre-crisis growth modelPre-crisis growth model

Expansion of construction and other Expansion of construction and other servicesservices– Investment in housing went from 2% of GDP in Investment in housing went from 2% of GDP in

2001 to 15% in 20082001 to 15% in 2008– Non-housing investment constant around 10%Non-housing investment constant around 10%

Financed largely by external transfersFinanced largely by external transfers Significant real appreciation since mid-Significant real appreciation since mid-

2000s2000s Decline of manufacturingDecline of manufacturing

– from 20% of GDP to 10%from 20% of GDP to 10%

Construction has reached its limits Construction has reached its limits (and probably has to shrink), while (and probably has to shrink), while

agriculture remains too largeagriculture remains too large

1. Domestic stock adjustment

2. Diaspora demand

both are one-time

Need for a new growth modelNeed for a new growth model

Clear shift in policy mindsetClear shift in policy mindset– Away from construction, externally-financed, demand-led Away from construction, externally-financed, demand-led

growthgrowth– To a supply-side model, that relies on entrepreneurship and To a supply-side model, that relies on entrepreneurship and

investment in new industriesinvestment in new industries Based on tradablesBased on tradables

– stuff that can be exported and is not constrained by home stuff that can be exported and is not constrained by home demanddemand

Can IT play a leading role?Can IT play a leading role?– currently too smallcurrently too small– even very rapid expansion will not add much to overall GDPeven very rapid expansion will not add much to overall GDP– and cannot turn farmers into software engineers and cannot turn farmers into software engineers

Even under the best of circumstances, Even under the best of circumstances, IT cannot drive the Armenian economyIT cannot drive the Armenian economy

Consequences of a ten-fold expansion of IT employment (assuming all new hires come from among the ranks of the unemployed)

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economy-w ide labor productivity (thousands drams) IT employment

current

w ith a ten-fold expansion of IT

A cumulative increase of only 9.5%

ImplicationsImplications Moving people from unemployment and agriculture into Moving people from unemployment and agriculture into

higher-productivity activities is keyhigher-productivity activities is key Armenia’s growth strategy and industrial policies cannot rely Armenia’s growth strategy and industrial policies cannot rely

on IT or high-tech sectors aloneon IT or high-tech sectors alone– Other tradable sectors will have to expand tooOther tradable sectors will have to expand too

A wider spectrum of A wider spectrum of mid-rangemid-range economic activities will need to economic activities will need to emerge, and possibly be nurturedemerge, and possibly be nurtured

This requires both an This requires both an explicitexplicit industrial policy framework industrial policy framework– Based on institutionalized, strategic cooperation with private Based on institutionalized, strategic cooperation with private

sectorsector– Efforts to date (construction, IT) seem ad hoc Efforts to date (construction, IT) seem ad hoc

And a wider range of policy supports than seem to be in place And a wider range of policy supports than seem to be in place currentlycurrently– More policy instrumentsMore policy instruments– More sectorsMore sectors

It also requires background conditions that are more It also requires background conditions that are more conducive to investments in tradablesconducive to investments in tradables– A competitive currencyA competitive currency– A pro-business environment that is not captured by “insiders” at A pro-business environment that is not captured by “insiders” at

the expense of potential entrantsthe expense of potential entrants

Manufactures and exports are quite Manufactures and exports are quite sensitive to the exchange ratesensitive to the exchange rate

When the real exchange rate depreciated during 1999-2004…

… manufactures and exports expanded quite rapidly.

The cruel dilemma of policymaking in The cruel dilemma of policymaking in emergent economiesemergent economies

Competitive currencies and industrial policy are Competitive currencies and industrial policy are substitutessubstitutes

The less you rely on one, the more you need to The less you rely on one, the more you need to rely on the otherrely on the other

So if the currency is left to float freely, growth So if the currency is left to float freely, growth requires putting much greater emphasis on direct requires putting much greater emphasis on direct industrial supportsindustrial supports– Which is hard to carry out in view of administrative and Which is hard to carry out in view of administrative and

political realities political realities