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Seven Pillars of Prosperity—Diversifying Economic Growth in the Caucasus and Central Asia

(Version in Русский)

Medium-term economic growth prospects in the Caucasus and Central Asia region are strong. But, to secure ongoing prosperity, the eight countries of the region—Armenia, Azerbaijan, Georgia, Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan—will need to look beyond traditional sources of growth.

The challenge for policymakers will be to foster new and more diverse growth drivers, outside mining, oil, and gas.

There are seven policy pillars that can help them do that:

  • reduce the role of the state;
  • greater openness to new domestic and foreign firms;
  • develop a more competitive and effective banking sector;
  • strengthen governance and the quality of institutions;
  • other improvements to the business environment—like reducing the cost of procedures for trade (critical given high transport costs), the time needed for permits, and the frequency and variety of tax payments;
  • improve transport and telecommunications infrastructure; and,
  • improve regional trade and investment links.

Impressive growth

After some countries in the region were hit hard by the global financial crisis, growth across the region recovered nicely last year, averaging just over 6½ percent. Growth even exceeded 7 percent in the three Central Asia oil and gas exporters—Kazakhstan, Turkmenistan, and Uzbekistan.

The strong recovery should continue in 2011 and beyond, although at a somewhat slower pace—5 to 5½ percent over the medium term. The global recovery and high growth in China and Russia will provide a boost, including through remittances and capital flows. The pickup of oil and gas production is expected to moderate in Kazakhstan and to reverse in Azerbaijan, the region’s two largest economies.

This performance—detailed in our latest Regional Economic Outlook: Middle East and Central Asia—is impressive. But it falls short of the stunning rates of growth registered during the 2000s. In the eight years before the global crisis, growth averaged a staggering 10.7 percent in the oil and gas exporting countries (Azerbaijan, Kazakhstan, Turkmenistan, and Uzbekistan) and 8.3 percent in the importing countries (Armenia, Georgia, the Kyrgyz Republic, and Tajikistan).

So why diversify?

However, this pre-crisis growth was driven to a large extent by external factors.

  • Strong growth in Russia and China, and favorable commodity prices—the oil and gas importers are big exporters of other commodities (cotton, copper, and gold, and molybdenum and tungsten!).
  • Remittances from Russia and other foreign inflows (FDI, bank borrowing) were key forces, particularly in driving consumer demand, construction, and real estate.

Governments in the region entered the crisis with the space to respond aggressively by raising spending or cutting taxes, but as this stimulus wanes, growth will require other drivers. Unfortunately, most of the pre-crisis forces proved volatile or unsustainable, and commodity exports seem to have provided relatively few jobs.

Leaving their future growth prospects to the whims of these external factors once again seems a gamble, especially as poverty remains high across the region, especially in Tajikistan, the Kyrgyz Republic, and Uzbekistan. Income inequality, unemployment, and underemployment are a big concern, and a sizable youth population will enter the job market in large numbers in just a few years in some Central Asian countries.

The seventh pillar

So back to those seven pillars for diversifying growth. Let’s focus a bit on the last one: strengthening economic and financial ties within the region.

Total trade among these countries is considerably lower than would be expected based on the size of the economies and their geographical proximity. Only about 5 percent of their total exports or imports are destined for or come from other countries in the region. And this ratio has been declining. Most of the trade consists of agricultural commodities.

There are good reasons for this. In the 20 years since independence, countries in the region have had to move away from the Soviet system—countries were highly specialized in producing a few commodities, and trade and financial flows. Integration was further complicated by frequent and severe shocks—most notably, the Russian financial crisis of 1998—and frictions and tense relations between some countries in the region. These disrupted trade and transportation links and hindered the development of labor, energy, and capital markets.

But, there are some surprises. Despite most regional countries having substantially reduced tariff and nontariff barriers, intraregional trade is low. And, despite broadly shared institutions, language, and history, investment flows within the region are small, with just a few local banks or companies active in other countries in the region.

Remaining impediments are mostly institutional and reflect relatively poor business environments in much of the region, including lengthy and cumbersome export or import procedures.

Moving forward on each of the seven pillars will help reinforce efforts to address these impediments. Improvements in governance and the business environment across the region would help attract investment both from within and outside the region. And this should lead in turn to more trade and more jobs.