Giuseppe Iarossi, World Bank

1
BusinessClimate, Productivity, and
Competitiveness in Armenia,2002-2005
Armenia
LakeSevan

• Giuseppe Iarossi, World Bank
• Federica Saliola, World Bank and University of
  Rome III
• Giovanni Tanzillo, World Bank

2
Investment climate

• location-specific factors shaping the
  opportunities and incentives for firms to invest
  productively, create jobs, and expand

World Development Report 2005
3
Business Climate Index (BCI)

1. Combines 93 variables (macro and micro)
2. Geometric Aggregation Method

4
Variables in the BCI

• 4 categories, 2 dimensions

MACRO Cost (6) Quality (17) INPUTS Cost
(10) Quality (14) INFRASTRUCTURE Cost (4)
Quality (5) INSTITUTIONS Cost (10) Quality (27)
5
First step in the BCI construction
FACTORANALYSIS
VARIABLES
AGGREGATION
INDEX
Inflation variability Exchange rate
variability Real interest rate variability Capita
l flows Macro instability Corruption
index Procedures to starta business Cost to
start a business Minimum capital to start a
business Credit information index Private bureau
coverage Procedures to enforce contracts Time to
enforce contracts Cost to enforce contracts
Factor1 Factor2 Factor3 Factor4
W1
W2
W3
W4
(Factor1) ? (Factor2) ? (Factor3) ?
(Factor4) MacroQI
6
Second and third steps in the BCI construction
FACTORANALYSIS
FACTORANALYSIS
VARIABLES
AGGREGATION
INDEX
AGGREGATION
INDEX
W2
W1
MacroCIMacroQI InfraCIInfraQI InputCIInputQI
InstitutionsCIInstitutionsQI
Factor1Factor2 Factor1Factor2 Factor1Factor2
Factor1Factor2
Factor1Factor2Factor3
(Factor1) ? (Factor2)
Macro Index
BCIBusinessClimateIndex
F1W ? F2W ? F3W
W2
W1
InfrastructureIndex
(Factor1) ? (Factor2)
W2
W1
(Factor1) ? (Factor2)
Input Index
W1
W2
InstitutionsIndex
(Factor1) ? (Factor2)
7
Characteristic Geometric aggregation method

• Feature Rewards more countries that improve the
  dimension where they perform the worst

8
Sample composition of micro data
Country
2002
2005
1
Albania
170
204
2
Armenia
171
351
3
Azerbaijan
170
350
4
Belarus
250
325
5
Bosnia-Herz.
182
200
6
Bulgaria
250
300
7
Croatia
187
236
8
Czech Rep.
268
343
9
Estonia
170
219
10
Macedonia
170
200
11
Georgia
174
200
12
Hungary
250
610
13
Kazakhstan
250
585
14
Kyrgyzstan
173
202
15
Latvia
176
205
16
Lithuania
200
205
17
Moldova
174
350
18
Poland
500
975
19
Romania
255
600
20
Russia
506
601
21
Slovakia
170
220
22
Slovenia
188
223
23
Turkey
514
557
24
Ukraine
463
594
9
Business Climate Index and GDP growth in ECA,
2002-05
GDP growth (average 2002-04)
10
Armenia
Albania
Kazakhstan
8
BiH
Latvia
Belarus
Lithuania
6
Georgia
Ukraine
Russia
Estonia
Bulgaria
Kyrgyzstan
Hungary
4
Slovenia
Slovakia
Croatia
Poland
Turkey
Moldova
Romania
Czech Rep.
2
0
2
3
4
5
BCI index 2002
10
Business Climate Index and total factor
productivity in Armenia, 2002-05
2
1
TFP - 2005
0
15
16
17
18
-1
-2
BCI - 2002
11
Change in business climate 2002-05
I
Improving Good Bad
Deteriorating
12
BCI Index and ranking of ECA countries, 2002-05
Country
Rank 2002
FYROM
1
Azerbaijan
2
Albania
3
Georgia
4
Poland
5
Kyrgyzstan
6
Russia
7
Kazakhstan
8
Armenia
9
Lithuania
10
Turkey
11
Slovenia
12
Latvia
13
Romania
14
Estonia
15
Belarus
16
BiH
17
Bulgaria
18
Croatia
19
Slovakia
20
Hungary
21
Ukraine
22
Moldova
23
Czech Rep.
24
13
Change in ranking 2002-05
15
Turkey
10
5
Azerbaijan
0
-5
Georgia
-10
-15
Armenia
-20
14
Components of BCI, 2002-05
1
2002
2005
0.5
0
Macro index
Infrastructure index
Inputs index
Institutions index
15
Inputs Market Index, 2002-05
Azerbaijan
Turkey
Inputs index 2005
Estonia
Latvia
Croatia
Lithuania
Slovakia
Slovenia
BiH
Albania
Romania
Bulgaria
Georgia
Moldova
Armenia
FYROM
Kazakhstan
Poland
Hungary
Kyrgyzstan
Belarus
Czech Rep.
Ukraine
Russia
Inputs index 2002
16
InstitutionsIndex,2002-05
Turkey
Albania
Institutions Index 2005
Kyrgyzstan
Slovenia
Ukraine
Bulgaria
Belarus
Croatia
Russia
Poland
Hungary
Lithuania
Latvia
Estonia
Czech
FYROM
Georgia
BiH
Slovakia
Kazakhstan
Romania
Moldova
Azerbaijan
Armenia
Institutions Index 2002
17
Dimensions of institutions and inputs indices in
Armenia, 2002-05
1
2005
2002
0.5
0
Quality
Costs
Quality
Costs
INSTITUTIONS INDICES
INPUTS INDICES
18
First step in the BCI construction
FACTORANALYSIS
VARIABLES
AGGREGATION
INDEX
Excess labor Cost of finance Proximity to
rawmaterials Access to foreign inputs Access to
foreign customers Technology Education of
workforce Access to finance Trade
credit Availability of skilledworkers Availabilit
y of managers Informality of suppliernetwork Loan
duration
Factor1 Factor2 Factor3 Factor4
W1
W2
W3
W4
(Factor1) ? (Factor2) ? (Factor3) ?
(Factor4) InputsQI
19
Principle component factors in the Inputs Quality
Index
0.5
Factor 1
0.4
0.3
Weight
Factor 2
Factor 3
0.2
Factor 4
0.1
-0.6
-0.4
-0.2
0
0.2
Change 2002-05
20
Main variables underlying Factors 1 and 3 of the
Inputs Quality Index
1
Cost of finance
0.8
Access to finance
0.6
pavapro
Suppliers network
0.4
0.2
Load
0
-0.6
-0.4
-0.2
0.2
-0.2
-0.4
-0.6
Availability of managers
-0.8
Availabilityof skilledworkers
ptimloa
-1
Percentage change in variable, 2002-05
21
Principle component factors in the Institutions
Quality Index
0.4
Factor 1
0.3
Factor 2
0.2
Weight
Factor 5
0.1
Factor 4
-0.1
0
0.1
0.2
0.3
0.4
0.5
Change 2002-05
22
Main variables underlying Factors 1 and 2 of the
Institutions Quality Index
1.0
0.8
Politicalinfluence
0.6
Load
0.4
0.2
-1
0
1
2
3
4
5
Percentage change in variable, 2002-05
23
Main variables underlying Factors 1 and 2 of the
Institutions Cost Index
1.0
Corruption
0.8
Functioning of the judiciary
Mafia
Crime
0.6
Red tape
Load
Regulationuncertainty
0.4
0.2
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
Percentage change in variable, 2002-05
24
Principle component factors in the Institutions
Cost Index
0.5
Factor 1
0.4
Factor 2
0.3
Weight
0.2
Factor 3
0.1
Factor 4
-0.2
-0.1
0
0.1
0.2
0.3
Change 2002-05
25
Main variables underlying Factors 1 and 2 of the
Institutions Cost Index
1
Bribes ongovernmentcontracts
Bribes
Protectionpayments
Load
0
-4
-3
-2
-1
0
1
2
3
4
Excesslabor
-1
Percentage change in variable, 2002-05
26
Conclusions

• Institutions both perceptions and costs have
  contributed to the deterioration of the business
  climate in Armenia in the last three years
• More specifically, political influence,
  corruption, security, red tape, judicial
  inefficiency
• To a lesser extent, also access and cost of credit

27
Armenias perception of investment climate
constraints
Tax administration
Macroeconomic instability
Tax rates
Cost of finance
Access to finance
Anti-competitive/informal practices
Customs and trade regulations
Corruption
Economic regulatory policy uncertainty
Licensing and operating permits
Access to land
Legal system/conflict resolution
Transport
Telecommunications
Skills of available workers
Labor regulations
Electricity
Crime, theft,disorder
0
20
40
60
80
Percentage of firms rating each constraint a
major obstacle
Source BEEPS 2005
28
Tax rates
Percent of tax on gross profit
50
40
30
Armenia
Azerbaijan
Georgia
Turkey
Source Doing Business
29
Tax administration number of tax payments and
time to comply with tax requirements
Payments
60
1200
Time to comply
50
1000
40
800
Number
30
600
Hours
20
400
10
200
0
0
Armenia
Azerbaijan
Georgia
Turkey
Source Doing Business
30
Tax collection
Tax revenues as a share of GDP
18
16
14
12
10
Armenia
CIS
Lower middle-income countries
Source Davoodi and Grigorian (2005)
31
Linear model between tax evasion and number of
inspections
32
Probability of perceiving corruption as a
constraint
Probability
100
80
60
0
10
20
Number of inspections by tax officials
33
Linear model between tax evasion and number of
inspections
34
Impact of corruption on tax evasion
Rate of tax evasion
0.4
0.2
Inspections
0
Inspections bribes
-0.2
-0.4
-0.6
-0.8
35
Cost of finance Real interest rate in Armenia
30
20
10
0
2000
2001
2002
2003
2004
Source IMF, International Financial Statistics
36
Nominal interest rate on firm loans
25
20
15
10
5
0
Armenia
Azerbaijan
Georgia
Turkey
Source BEEPS 2005
37
Access to financeShare of firms with access to
bank financing
Short term financing
Long term financing
with
access
with
access
without
without
access
access
Source BEEPS 2005
38
Amount of collateral on loans
200
150
100
50
0
Armenia
Azerbaijan
Georgia
Turkey
Source BEEPS 2005
39
Legal Rights Index
8
6
4
2
0
Armenia
Azerbaijan
Georgia
Turkey
Source Doing Business
40
Credit provided by the banking sector
Percent of GDP
80
Low middle income countries
60
40
ECA countries
20
Armenia
0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
41
Conclusions

• Access to finance, red tape, and corruption are
  the 3 most important investment climate
  constraints for firms in Armenia

42
Escribano-augmented Cobb-Douglas production
function
43
Firm productivity
Impact on firm productivity
10
Red tape
0
Finance index
Bank loan
Corruption
-10
-20
44
Priority of reforms
Marginal impact on firm productivity
16
Red tape
12
Finance
8
4
Corruption
0
0
10
20
30
40
50
60
Share of TFP
45
Armenias productivity gap with selected
countries, 2005
200
150
100
Turkey
50
Kazakhstan
Tajikistan
0
Georgia
Estonia
Latvia
Lithuania
Uzbekistan
-50
Moldova
Kyrgyzstan
-100
46
Estimating the productivity gap
47
Impact of Investment Climate variables on
Armenias competitiveness compared to Turkey
TFP

TFP

TFP

(1)

(2)

(3)




Armenia (dummy)

-
0.698

-
0.795

-
0.622

(1.70)

(1.09)

(2.29)

Red tape

-
0.005


(0.06)

ArmeniaRed tape
0.030


(0.40)




L
oan


-
0.760




(1.05)


Armenialoan


0.394






(0.51)
Corruption

-
0.097

(0.94)

ArmeniaCorrupt

0.047

(0.44)

48
Incremental impact on Armenias productivity,
over Turkeys
6
5.3
4.4
4
1.7
2
0.0
0
Banks,short term
Banks,long term
Trade credit,short term
Trade credit,long term
49
Conclusions

• Political influence in economic activity is the
  main factor driving the deterioration of the
  business climate in Armenia in the last 3 years.
• Red tape, access to finance and corruption are
  the major business obstacles to private sector
  development in Armenia.
• Red tape is the top Investment Climate
  constraint affecting firm performance in Armenia.
• Better access to long term finance, both in
  terms of bank lending and trade credit, would
  help bridge the 40 productivity gap with Turkey.