THE SECOND SYSTEMATIC COUNTRY DIAGNOSTIC ARMENIA BEYOND BOUNDARIES: UNLOCKING POTENTIAL FOR A SUSTAINABLE TOMORROW ARMENIA THE SECOND SYSTEMATIC COUNTRY DIAGNOSTIC Beyond Boundaries: Unlocking Potential for a Sustainable Tomorrow © 2024 The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of The World Bank. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Beyond Boundaries: Unlocking Potential for a Sustainable Tomorrow. © World Bank.” Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e mail: pubrights@worldbank.org. Cover photo: © Eva M / Adobe Stock Page 1: Photo: © Vrezh / IStock Page 8: Photo: © MindStorm-inc / IStock Page 17: Photo: © Sigmund / Unsplash Page 26: Photo: © Armine Grigoryan / World Bank Page 45: Photo: © Armine Grigoryan / World Bank Page 94: Photo: © lovelypeace / IStock Page 106: Photo: © Nerses Khachatryan / Unsplash Cover design: Florencia Micheltorena iii Contents Executive Summary 1 A rapidly changing context 2 Key challenges to inclusive and sustainable growth 3 Leveraging opportunities 6 1. Introduction 8 2.  Background: Sociopolitical Events and Key Reforms since 2017 13 3.  Trends in Growth, Poverty, and Shared Prosperity 17 3.1. Growth Trends 18 3.2. Poverty Trends 22 3.3. Equity Trends 23 4.  Drivers of Growth and Poverty Reduction 26 4.1. Drivers of Growth 27 4.2. Drivers of Poverty Reduction 38 5. Key Challenges to Resilient, Sustainable, and Inclusive Growth 45 5.1. Vulnerability to Shocks and Environmental Risks 47 5.1.1. Fragility and the Risks of Conflict 47 5.1.2. Vulnerability to Economic Shocks 49 5.1.3. Climate Change, Environmental Risks, and Natural Hazards 53 5.1.4. Risk Differentiation 55 5.1.5. Vulnerable Populations and Building Resilience 56 5.1.6. Governance and Institutional Bottlenecks – A Related Example in the Water Sector 57 5.1.7. Binding Constraints 58 5.2. Accessing Markets and Trade Integration 58 5.2.1. Trade Integration and Global Value Chains 59 5.2.2. Infrastructure and Border Management 61 5.2.3. Digital Access 66 5.2.4. Diasporas as a Catalyst for Enhancing Connectivity 67 5.2.5. Governance and Institutional Bottlenecks – A Related Example in the Digital Sector 68 5.2.6. Binding Constraints 68 5.3. Quality of Human Capital 70 5.3.1. Access to Learning and Relevant Skills 70 5.3.2. Access to Health Services 73 5.3.3. Access to High-Quality Jobs 74 5.3.4. Governance and Institutional Bottlenecks – A Related Example in the Health Sector 77 5.3.5. Binding Constraints 77 iv 5.4. Private Sector Development 77 5.4.1. Sectoral Productivity 78 5.4.2. Access to Finance and Financial Inclusion 82 5.4.3. Competition and Contestability 86 5.4.4. Governance and Institutional Bottlenecks – A Related Example in Public Procurement 88 5.4.5. Binding Constraints 89 5.5. Cross-Cutting Theme: Governance, Institutions, and Data 89 5.5.1. Quality of Institutions 89 5.5.2. Government Effectiveness 91 5.5.3. Investment in Data 91 5.5.4. Binding Constraints 93 6.  Policy Priorities and High-Level Outcomes 94 6.1. Approach to Prioritization and Results 95 6.2. High-Level Outcomes 98 7. References 101 8. Appendixes 106 Appendix A. Selected Actions and Policy Reforms since 2017 107 Appendix B. Government 2021–26 Program (Armenia 2021–26) 110 Appendix C. Findings of SCD1 112 Appendix D. Characteristics of the Poor 113 Appendix E. Selection of Peer Countries 115 Appendix F. Main Sources of Information and Empirical Data 119 Appendix G. Findings and Results from the Stakeholder Consultations 120 Appendix H. International Benchmarking for Prioritization 124 Appendix I. Call for Papers: Sustainable Economic Growth and Poverty Reduction in Armenia 132 Appendix J. Disaster Risk Management Measures Taken after the 1988 Earthquake 133 Appendix K. Social Protection System to Build Resilience 134 Appendix L. The Gravity Model to Estimate Export Potential 136 Appendix M. Justice Sector and the Private Sector 138 Appendix N. Knowledge Gaps 139 v Figures Figure 1. Key Constraints and Policy Priority Areas 12 Figure 2. GDP Growth, Armenia 18 Figure 3. GDP per Capita, Peer Comparison 18 Figure 4. Unemployment 20 Figure 5. Employment and Value Added, by Sector 20 Figure 6. Participation and Employment Rates, 2019 21 Figure 7. Youth versus Adult Employment Rates 21 Figure 8. GDP Growth and Emissions Growth 21 Figure 9. Trends in Poverty and GDP 22 Figure 10. Poverty by Income Levels, Most Recent Year Available 22 Figure 11. Growth Elasticity of Poverty 23 Figure 12. Growth Incidence Curve, 2010–16 versus 2016–21 24 Figure 13. Shared Prosperity, 2010–16 versus 2016–21 24 Figure 14. Growth Incidence Curve, 2020–21 25 Figure 16. Household Budget Allocation 2021 25 Figure 15. Gini Index 25 Figure 17. Contribution to Growth, Demand Side 28 Figure 19. Growth Decomposition, Armenia, 2000–22 28 Figure 18. GDP Structure, Supply Side 28 Figure 20. New Businesses Registered, Armenia, 2010–20 29 Figure 21. Gross Capital Formation 30 Figure 23. Net FDI Inflows, Armenia 30 Figure 22. Capital Expenditure, 2016–21 Average 30 Figure 24. Demographic and Labor Force Trends, Armenia 30 Figure 25. Growth Decomposition of per Capita Value-Added Growth, Armenia 31 Figure 26. Sectoral Contribution to GDP Growth, Armenia, 2012–21 31 Figure 28. Goods Exports, by Destination 32 Figure 27. Exports of Goods and Services 32 Figure 29. Economic Complexity Index 33 Figure 30. New Product Discoveries 34 Figure 31. Exports, by Product Type, Armenia 34 Figure 32. Goods Imports, by Source, Armenia 35 Figure 33. Commercial Service Exports, Armenia and Peer Countries, 2019 36 Figure 35. Benchmarking FDI Net Inflows 36 Figure 34. Commercial Service Export Performance, Excluding Travel and Transport, Armenia and Peer Countries, 2005 = 100 36 Figure 36. Armenia and Peers: Stock of FDI (% of GDP) 36 Figure 37. FDI Stock in Armenia (by Country) 37 Figure 38. Greenfield Investment Projects, Armenia 37 Figure 39. Top Sectors for Greenfield FDI, Number of Projects 38 Figure 40. Top Three Sectors by FDI Inflows, 2014–21 38 Figure 41. Decomposition of Income Poverty Reduction 39 Figure 42. Returns to Schooling 40 Figure 43. Sector of Employment by Poverty Status, 2021 40 Figure 44. Regional Poverty Rates 41 vi Figure 45. Distribution of the Poor, by location 41 Figure 46. Rural-Urban Divide, Accessibility and Human Capital Outcomes 42 Figure 47. Educational Outcome: Harmonized Test Scores, by Poverty Status 42 Figure 48. Health Outcome: Termination of Usual Activities, by Poverty Status 42 Figure 49. Deprivation in Access to Services (%) 43 Figure 50. Opportunities in Labor Market, by Poverty Status (%) 43 Figure 51. Barriers to Growth and Poverty Reduction 46 Figure 52. Evolution of Key Challenges for Inclusive and Sustainable Growth from SCD1 to SCD2 47 Figure 53. GDP Growth in Armenia and Russia and Oil Price 49 Figure 54. Major Imported Agrifood Commodities and Armenia’s Dependency on Supplies from Russia and Ukraine in 2021 50 Figure 55. Armenia’s Estimated Missing Exports 51 Figure 56. Inflation and CBA Policy Rate 52 Figure 58. Evolution of Rigidity in Armenia, 2016-2021 52 Figure 57. Comparison of Growth and Balance Correlations: Correlation Coefficient between Growth and Actual/Structural Balance 52 Figure 59. Evolution of High Rigidity 52 Figure 60. Global Value Chain Upgrading: Per Capita Exported Domestic Value Added, by Country, 2015 60 Figure 61. Logistics Performance Index, Armenia 61 Figure 62. Logistics Performance Index 2023, Armenia versus Peers 61 Figure 63. Delays in Clearing Trade Goods through Customs 62 Figure 64. Human Capital Index, Armenia and Peers, 2020 71 Figure 66. Prevalence of Stunting, Height for Age 71 Figure 65. Learning-Adjusted Years of Schooling, Armenia and Peers, 2019 71 Figure 67. Employment by Educational Attainment (1,000s) 72 Figure 68. Average Share of Time Allocated to Labor and Domestic Work, Weekday 73 Figure 69. Out-of-Pocket Expenditure (as % of current health expenditure) 74 Figure 70. Unemployment Rate (% of Total Labor Force) 75 Figure 71. Share of the Labor Force Working 20 or More Hours a Week with a Contract 75 Figure 72. Share of Youth Not in Education, Employment, or Training (% of population ages 15–29) 76 Figure 73. Labor Productivity: Output per Worker 79 Figure 74. Tourist Arrivals and Revenues 2010-22 81 Figure 75. ICT Service Exports (BoP) 81 Figure 76. Firms Experiencing Electrical Outages 82 Figure 77. Main Obstacles to Doing Business 83 Figure 79. Credit to the Private Sector 83 Figure 78. Obstacles to Doing Business, by Firm Size 83 Figure 80. Sensitivity of Investment to the Cost of Credit 84 Figure 81. Interest Rates on Lending 85 Figure 82. Organization of the Market and Competition, Armenia, 2016–22 87 Figure 83. Organization of the Market and Competition, Armenia versus Peers, 2022 87 Figure 84. Manufacturing Market Structures 88 Figure 85. Proportion of Oligopolistic Market Structures in Armenia’s Manufacturing Sector 88 Figure 86. Government Effectiveness, Armenia and Peers 92 Figure 87. Rankings of Main Areas of Governance, Armenia, 2016–20 92 Figure 88. SCD Prioritization Approach 95 vii Figure C.1. Challenges and Priorities Identified in SCD1 112 Figure D.1. Growth and Redistribution 114 Figure D.2. Poverty Rates, by Region and Location (%) 114 Figure E.1. Select Indicators, Structural Peer Countries 116 Figure E.2. Selected Indicators, Aspirational Peer Countries 118 Figure G.1. Results from the Polls 121 Tables Table 1. Years of Schooling 40 Table 2. Binding Constraints for Vulnerability to Shocks and Environmental Risks 58 Table 3. Proportion of Freight Carried by Rail 64 Table 4. Binding Constraints for Accessing Markets and Trade Integration 68 Table 5. Human Capital Index, Armenia, 2012, 2017, and 2020 70 Table 6. Binding Constraints to Addressing the Low Quality of Human Capital 77 Table 7. Binding Constraints for Enhancing Private Sector Development 89 Table 8. Binding Constraints for Addressing Institutional Quality and Governance Bottlenecks 93 Table 9. Evolution of Policy Priority Areas 97 Table 10. High-Level Outcomes 99 Table A.1. Pillars and Goals Captured in Armenia 2021–26 110 Table D.1. Profile of the Poor and Rural Households 113 Table F.1. Data Sources 119 Table H.1. Indicator-Level Results of Benchmarking 126 Table I.1. Selected Papers and Authors 132 Table J.1. Examples of Government Efforts in Disaster Risk Management and Adaptation 133 Table N.1. Knowledge Gaps, SCD1 and SCD2 139 Boxes Box O.1. Capturing Megatrends—Challenges and Opportunities 6 Box 1. Terminologies Used in SCD2 11 Box 2. The Velvet Revolution 15 Box 3. Structural Factors of Fragility, Risk, and Resilience 48 Box 4. Governance for Digital Transformation 69 Box 5. Justice Sector Reforms 90 Maps Map 1. International Roughness Index, Armenia 2019 63 Map 2. Accessibility to Yerevan 63 viii Acknowledgments This Systematic Country Diagnostic (SCD) was led by Léa Hakim (Senior Economist, EECM1), Natsuko Kiso Nozaki (Economist, EECPV), and Alan Fuchs Tarlovsky (Lead Economist, EMNPV). The core team also included María Fernanda González Icaza (ET Consultant, EECPV) and Diego Gabriel Lestani (Consultant, EECPV). Below is a full list of focal points and Armenia SCD team members. The report was prepared under the guidance of Rolande Pryce (Country Director, ECCSC), Sebastian-A Molineus (former Country Director, ECCSC), Carolin Geginat (Country Manager, ECCAR), Antonio Nucifora (Practice Manager, EAWM2), Salman Zaidi (former Practice Manager, EECPV), and Ambar Narayan (Practice Manager, EECPV). Support was also provided by Miguel Eduardo Sanchez Martin (Senior Economist, EECDR and EFI Program Leader, South Caucasus Countries), Abdulaziz Faghi (Program Leader, IECDR), Ahmet Levent Yener (Practice Leader, HECDR), Arvind Nair (Senior Economist, EECM1), Armineh Manookian (Senior Economist, EECM1), Olena Bogdan (Economist, DFCII), Artsvi Khachatryan (Consultant, EECM1). The team is also grateful to Carolina Sanchez (Director, Strategy and Operations, ECAVP) and to peer reviewers Christos Kostopoulos (Lead Economist, EECM2), Paulo Guilherme Correa (Program Leader, EAEDR), Samuel Freije-Rodriguez (Lead Economist, EECPV), Tobias Akhtar Haque (Lead Country Economist and Program Leader, ESADR), and Alexandru Cojocaru (Senior Economist, EPVGE) for the advice provided. We are grateful to all focal points and colleagues from the World Bank Global Practices, the Armenia Country Management Unit, and other teams whose inputs, comments, and contributions made this document possible. Contributors included Ranu Sinha and Smita Misra (SCAWA); Arman Vatya, Daniela V. Felcman, Nane Harutyunyan, and Eva Maria Melis (EECG1), Francesca Recanatini and Vanessa Cheng Matsuno (ELCG2); Amali Rajapaksa, Elena Lungu, and Aymen Ahmed Osman Ali (IECT1); Arusyak Alaverdyan and Jan Joost Nijhoff (SCAAG); Joern Huenteler and Gor Khatchatryan (IECE1); Remi Pelon (IEEXI); Arman Barkhudaryan, Olga Vybornaia, and Arsen Nazaryan (IFC); Susan Josefina Vasquez Plasencia, Gianfilippo Carboni, Bexi Francina Jimenez Mota, and Gabisile Ndlovu (MIGA); Ifeyinwa Uchenna Onugha (FCI); Renata Freitas Lemos (HECED); David Jijelava and Sophia V. Georgieva (SCASO); Adanna Deborah Ugochi Chukwuma and Artemis Ter Sargsyan (HECHN); Lucian Bucur Pop and Lucia Solbes Castro (SPJ); Nora Mirzoyan and Tafadzwa I. Dube (SCAUR); Charles Pierre Marie Hurpy and Himmat Singh Sandhu (IDD01); Elena Strukova Golub, Irina Ghaplanyan, Madhavi M. Pillai, and Anita Hafner (SCAEN); Nadia Fernanda Piffaretti (GTFS1); and Cristina Constantinescu and Mike Nyawo (ETIRI). The team is also grateful for the support of Christina Leb (Senior Counsel, LEGEN), Arpine Azaryan (Program Assistant, ECCAR), Gayane Davtyan (Program Assistant, BPSSE), Nune Gevorgyan (Consultant, ECCAR), Irina Tevosyan (Operations Officer, ECCAR), Armanda Carcani (Program Assistant, EECPV), Minna Hahn Tong and Robert Zimmerman for editing, and Marika Verulashvili for assistance. The team is grateful to the Government of Armenia, as well as representatives of the private sector, civil society, development partners, and academia, for their active engagement and the valuable feedback provided during the consultations held in June 2022 and May 2023. See Appendix G for results from consultations with stakeholders for further detail. ix Abbreviations and Acronyms ALMMs Active Labor Market Measures AMD Armenian Dram ADB Asian Development Bank ArmStat Statistical Committee of Armenia BACI Base pour l’Analyse du Commerce International (Database for International Trade Analysis) BaTIS Balanced Trade in Services BOP/IIP Balance of Payments and International Investment Position Statistics BPM6 Balance of Payments and International Investment Position Manual, sixth edition BRI Belt and Road Initiative CBA Central Bank of Armenia CIO Chief Information Officer COVID-19 Coronavirus Disease 2019 CO2 Carbon Dioxide CPC Corruption Prevention Commission CPF Country Partnership Framework CSO Civil Society Organization EAEU Eurasian Economic Union ECA Europe and Central Asia EEA European Environment Agency ESG Environmental, Social, and Governance EU European Union FAO Food and Agriculture Organization of the United Nations FDI Foreign Direct Investment FTA Free Trade Agreement GDP Gross Domestic Product GHG Greenhouse Gas GRID Green, Resilient, and Inclusive Development GSM Global System of Mobiles HCI Human Capital Index HLO High-Level Outcome ICT Information and Communication Technology ILCS Integrated Living Conditions Survey ILO International Labour Organization ILOSTAT International Labour Organization Statistics IMF International Monetary Fund ISMB Information Systems Management Board IT Information Technology LCU Local Current Unit LPI Logistics Performance Index IFC International Finance Corporation IRI International Republican Institute x MHTI Ministry of High-Tech Industry MoLSA Ministry of Labor and Social Affairs MRV Monitoring, Reporting, and Verification MW Megawatt NCD Noncommunicable Disease NDC Nationally Determined Contribution NEET Not in Education, Employment, or Training OECD Organisation for Economic Cooperation and Development PHC Primary Health Care PPP Purchasing Power Parity PV Photovoltaic SCD Systematic Country Diagnostic SMEs Small and Medium Enterprises SOE State Owned Enterprise STEM Science, Technology, Engineering, and Mathematics TFA Trade Facilitation Agreement TFP Total Factor Productivity UMIC Upper-Middle-Income Country UNCTAD United Nations Conference on Trade and Development UNICEF United Nations International Children’s Emergency Fund WEF World Economic Forum WDI World Development Indicators WHO World Health Organization WTO World Trade Organization Executive Summary 2 T he Systematic Country Diagnostic (SCD) provides an assessment of the constraints Armenia should address and opportunities it can embrace to accelerate progress toward the twin goals of ending extreme poverty and the measures and gains in market liberalization led to gradual improvements in the business environment. Fiscal reforms included tax administration and tax policy reforms which led to an increase in revenues to 23.2 percent of GDP in 2022 and supported deficit promoting shared prosperity. The first-generation SCD containment. in Armenia, published in 2017, highlighted the need for a new growth model grounded in greater productivity, Overall, Armenia has made important development and it identified four main related challenges: (1) poor gains since 2017, achieving upper-middle income external sector performance, (2) low private sector status while demonstrating resilience to economic productivity, (3) insufficient labor productivity, and (4) key shocks that have had a relatively limited impact on macroeconomic, environmental, and microeconomic poverty levels. Government mitigation measures helped vulnerabilities. This second-generation SCD looks contain larger shocks, and the increase in poverty due into the future by reflecting on the five years that to the onset of COVID-19 and the military conflict with have transpired since 2017. It finds that the challenges Azerbaijan in 2020—the twin shocks—was confined identified in SCD1 remain valid, while it highlights new to 0.6 percentage points, from 26.4 percent in 2019 challenges related to fragility, conflict, and violence. It to 27.0 percent in 2020. Extreme poverty remained also finds that governance, institutional capacity, and low between 1 percent to 1.5 percent during 2017-21. investment in data are cross-sectoral constraints. Inequality as measured by the Gini index grew slightly from 25 percent in 2020 to 28 percent in 2021 (based A rapidly changing context on the international measurement) but remains lower than most countries in the region. These improvements Since 2017, Armenia has seen significant internal and were driven mainly by jobs followed by social protection external changes including the Velvet Revolution, an transfers. Improvements were also observed in non- event that led to a dramatic transformation of political monetary dimensions such as life expectancy and sentiments in Armenia. Armenian society’s growing survival rates as reflected in the Human Capital Index of discontent with their government had been building for 0.58, higher than comparator countries such as Tunisia, several years due to perceptions of systemic corruption Kosovo, and Bosnia and Herzegovina in 2020.1 Armenia and a lack of social and political reform. Mass citizen also made significant progress in closing the gender engagement led to a peaceful transition of power in gap as demonstrated by the improvement in the Gender April 2018 which boosted the democratic aspirations Gap Index—moving up from 98th place in 2018 to 61st of the Armenian people and markedly changed the place in 2023 (WEF 2023). expectations of the population. The Velvet Revolution also ignited fresh momentum for renewed growth. The The post-revolution euphoria came to a sudden halt new government implemented a range of economic in 2020 with the eruption of the military conflict with and governance reforms with a focus on bold anti- Azerbaijan in the midst of the COVID-19 pandemic, corruption and justice sector reforms. Pro-competition shifting public attention from the economic and 1 World Development Indicators database (World Bank) as of July 2023. 3 governance issues that were the focus of the have spurred an increase in firm establishment and some, revolution to national security. Armenia faced the twin if limited, job creation. Despite these improvements, the shocks in 2020 which resulted in one of the largest number of good-quality jobs remains substantially lower contractions in real gross domestic product (GDP) in than in other countries in the region, as indicated by a the region. On the back of changing sentiment after the high level of informality. While 45 percent of the labor 2020 military conflict, a snap election was held in 2021, force in Europe overall had decent jobs working for which the incumbent government won. In 2022, Russia’s 20 hours or more in a week with a contract, the rate invasion of Ukraine and new clashes with Azerbaijan, was only 22 percent in Armenia in 2015. The challenge including in Armenian territory, added to the uncertainty. is also indicated by the large number of temporary The unresolved border issues, and the proximity of emigrants seeking better employment opportunities and forces close to the border settlements in Armenia, have wages abroad. Furthermore, the share of youth not in weighed on economic activity. education, employment, or training is among the highest in the region at 28 percent in 2021.2 While unemployment The political events of the past five years translated has improved from the 18 percent it hovered around for into highly volatile growth performance, driven mostly much of 2008–20, it remains high at 13 percent in 2022. by consumption growth (or contraction) and reflecting a limited contribution from physical capital. Growth Decent jobs are not only scarce but also distributed averaged 5.2 percent during 2017–22, but this was a unevenly, with 47.5 percent of the poor lacking access period of significant volatility, with growth contracting to such jobs compared to 37 percent of the non-poor in by 7.2 percent in 2020 due to the twin shocks then 2021. Especially among the rural poor in the agricultural rebounding in 2021 and 2022 (12.6 percent), supported sector, lack of human capital in terms of education and by post-COVID-19 recovery and by Russian migrants health has resulted in low labor productivity, hindering and money flows, respectively. On the demand side, their ability to secure decent jobs. This challenge is growth was driven by private consumption followed exacerbated by insufficient connectivity to markets, by investment then government consumption, with a preventing workers in remote areas from accessing smaller contribution from net exports. However, limited resources and opportunities. The limited mobility of the capital expenditures, a declining trend in foreign direct workforce into higher-productivity sectors is slowing investment (FDI) during 2008–20, and decreasing progress in poverty reduction and economic growth. domestic private investment led to limited physical Addressing the structural impediments to job creation, capital accumulation. On the supply side, structural both from the supply and demand sides, will be critical transformation resumed as the economy continued to to achieving faster and inclusive growth. On the supply shift from agriculture into services. Workers moved from side, greater investments in the skills and health of the the lower-productivity agricultural sector into higher- existing and potential workforce need to be prioritized. productivity industry and services. On the demand side, Armenia needs to strengthen the competition environment and investment climate further. Key challenges to inclusive and sustainable growth Exposure to shocks For further poverty reduction in the coming years, job Lack of economic diversification in terms of trade creation remains the biggest development challenge partners and export products has been a persistent for Armenia. While the economy has been growing, it source of growth volatility that will remain a challenge has not been creating enough quality jobs. This issue in the coming years. Despite growth averaging 6.2 is critical, as jobs have been the main driver of poverty percent over 2000–22, this period was punctuated reduction in Armenia in the last few years. Improvements by two large slowdowns in growth in 2009 and in governance and the competitive landscape since 2017 2016, largely due to Armenia’s economic structure, 2 ArmStat Labor Force Survey. 4 its exposure to commodity price fluctuations, and its the disaster risk management system is not well limited number of trading partners. More than two- prepared to safeguard the population from shocks such thirds of Armenia’s exports are to Russia, the European as floods, heat waves, droughts, and earthquakes, to Union, China, and Switzerland. Primary products from which Armenia is especially prone. mining—namely copper, molybdenum, and gold—have grown to about 30 percent of exports, both limiting the Armenia has shown some resilience to shocks amid complexity of Armenia’s exports and exposing Armenia sound and improved macroeconomic management. to commodity price shocks. Armenia’s imports are also Estimates indicate that fiscal policy has contributed heavily concentrated. For example, energy supply from to reduced poverty incidence and lower inequality, gas relies exclusively on imports from Russia, and the although it has not been as effective at stimulating high dependence on basic food items poses a risk to short-run growth (World Bank 2023b). In 2020, for food security. example, government mitigation measures helped contain the 2020 twin shocks, with measures to shield The last five years have underscored an increased both households and firms. Assistance included direct vulnerability to fragility and conflict. Armenia’s GDP cash transfers to households and workers, wage shrank by 7.2 percent, and exports fell by 34.0 percent subsidies, utility subsidies, tax benefits for businesses, in 2020 due to the 2020 twin shocks. While Russia’s state-sponsored loans, and higher investment. Fiscal invasion of Ukraine in 2022 has affected domestic policy has been countercyclical and progressive, and consumption and foreign trade positively, it has also the measures helped mitigate impoverishment and placed upward pressure on fuel, housing and food prices, unemployment. As a result, the poverty rate increased and affected future opportunities for inclusive growth. by less than one percentage point in 2020. Real GDP These factors, coupled with some volatility stemming growth rebounded to 5.7 percent in 2021. from shocks, have led to declining private and public investment rates and FDI which have adversely affected Nevertheless, resilience to shocks from fragility and the level of potential growth and economic efficiency. conflict, economic causes, and climate change needs Moreover, as this SCD2 went to print, Armenia was to be strengthened to end extreme poverty and boost experiencing the influx of more than 100,000 displaced shared prosperity. The whole population is vulnerable ethnic Armenians from Nagorno-Karabakh3 as a result to these shocks, especially people in rural areas, women of a military operation by Azerbaijan. Integrating them and girls, the displaced population, and international into the Armenian society and economy poses a new migrants providing remittances. Increased resilience challenge. could be achieved through several actions. For example, to diversify the economy, Armenia can enhance efforts Climate change and environmental and natural to build on its existing trade relationships and diversify disasters represent additional sources of risk to trade products—for example, based on its comparative Armenia’s prospects for sustainable growth. Such advantage in metal products, textiles and apparels, food events would not only affect overall growth but are and beverages, and other manufacturing—and trade also expected to have distributional impacts that partners as well as raise the competitiveness of export could disproportionately hurt the poor. The average products and value chain development. To increase temperature in Armenia has risen more than the resilience to fragility and conflict, Armenia can strengthen global average in recent years, with an increasing emergency preparedness and service delivery for rate of acceleration. Sectors such as agriculture, border areas and enhance the registry and delivery mining, energy, water, and waste management are not mechanisms for social protection. To mitigate exposure sufficiently prepared to adapt to these risks. Moreover, to climate change and environmental risks, Armenia will despite some progress and efforts by the government, need to adapt to climate change and natural disasters 3 With the reference to Nagorno-Karabakh in this document, the Bank does not intend to make any judgment on the legal or other status of concerned territories or to prejudice the final determination of the parties’ claims. 5 by scaling up risk prevention systems and ramping up share of health expenditure paid out-of-pocket, which climate-smart energy, agriculture, and mining sectors. is among the highest in the world at almost 85 percent. It will also need to reduce pressures on natural capital Enhancing the inclusion of vulnerable groups such by scaling up investments in energy efficiency and as women, youth, and displaced populations would renewable energy and by better managing air pollution improve the equity and productivity of the labor force. and land and forests. The economy is not as competitive or as innovative Structural bottlenecks to growth and as it could be. Some measures of the business climate inclusion have improved. For example, since 2016, the perception of competition policy for Armenia has notably improved. Access to markets within and outside of Armenia is However, among the measures related to the organization constrained, both physically and digitally. Armenia of the market and competition, competition policy is the is a landlocked country (with two borders closed for area where Armenia most lags its peers, followed by political reasons) in a region of difficult topography and liberalization of foreign trade. In addition, investment, geopolitical tensions, which constrains access to regional a crucial input, has been declining, the cost of credit is and international trade and integration. Armenia is only relatively high, and access to finance remains a major exporting a small share of its potential and stands to gain constraint to doing business for small and medium firms. from increased trade from full effective implementation Larger firms report being constrained by informality and of the WTO Trade Facilitation Agreement. Currently, political instability. Firms are also faced with increased Armenia’s integration in global value chains is limited power outages and a deteriorating quality of energy to some participation in light manufacturing. While supply. The low quality of human capital and the skills Armenia has scored large improvements in logistics mismatch are also key constraints for the private sector. service quality, tracking and tracing, and customs, poor infrastructure within the country constrains access to Governance and institutional constraints goods, services, and labor markets. This contributes to spatial disparities and hinders basic public service A cross-cutting challenge in achieving inclusive delivery, inputs for productive activities among firms, and and sustainable growth is governance bottlenecks, the household accumulation of human capital. Although institutional quality, and a need to invest in data which digital connectivity is high overall, digital adoption in underlies Armenia’s development challenges. Since rural areas is constrained by affordability, service quality, 2017, Armenia has made progress in strengthening access to digital devices, and lack of digital skills and the quality of its institutions, especially in the areas of awareness. anticorruption and transparency in the public sector. And despite the difficult security priorities for the country, the The low quality of human capital in terms of education government has continued its commitment to reform. and health is an important development challenge in However, institutions remain fragile and vulnerable achieving sustainable and inclusive growth. A relatively to shocks. Despite ambition toward an overarching high enrollment rate in schooling is not coupled with high development agenda captured in the government’s learning outcomes, as demonstrated by the stagnation 2021-26 program, the institutional framework for of international test scores. Achievements are also planning, monitoring, and evaluation is neither clear uneven, reflected in lower access and scores in rural nor comprehensive, and strategic planning is weak. areas and among the poor. Expected years of schooling Government effectiveness—a bottleneck to inclusive have remained virtually constant since 2010. Moreover, service delivery and growth—is the lowest among peers returns to education have been declining, indicating and has regressed. Greater investment in data collection that the education system has not been responsive and management, a prerequisite for government to the rapidly changing demands in the labor market. functions, is needed to accelerate the pace of reforms Access to adequate healthcare is often inaccessible and based on evidence-based policy making. unaffordable to the poor, in part due to the significant 6 Leveraging opportunities Going forward, Armenia will need to address critical bottlenecks to create more jobs and higher-quality jobs Looking forward, Armenia faces high uncertainty and to ensure that its development path is sustainable in the context of a global megatrend of increasing and better prepared to handle shocks from fragility and geopolitical and economic fragmentation, as well as conflict, economic shocks, and climate change. One key rapid changes in technology. While these megatrends opportunity for Armenia is to go beyond its boundaries present challenges, they also inspire new opportunities and strengthen its links with the world, such as through for growth (Box O.1). enhancing its trade partners and products, building on its acumen in ICT, and leveraging its diaspora as a network In conclusion, Armenia needs to build on reform nation. The policy objectives and reforms identified in this momentum and unlock its potential in the context SCD would support Armenia in unlocking its potential to of fragility and uncertainty. Since 2017, in the face of generate higher-quality jobs, enhanced education and significant internal and external changes, the country health outcomes, improved resilience to shocks, and has demonstrated resilience and strong economic ultimately, a sustainable tomorrow for all. recovery through sound macroeconomic management. Box O.1. Capturing Megatrends—Challenges and Opportunities It is critical for Armenia to consider the possible impacts of megatrends on the economy to seize opportunities and prepare for new threats. An understanding of relevant megatrends for Armenia— their pace, interconnectivity, and potential impacts—is a key element in designing policies to achieve inclusive and sustainable growth. It can facilitate the development of strategic action plans that respond to future scenarios, increase resilience to changes, and help capture the advantages and realize potential opportunities. Below are some of the megatrends that may have significant impacts for Armenia. Geopolitical Shifts Connectivity is a pressing issue in Armenia, complicated by the challenging terrain and geopolitical tensions in the region. At the same time, Armenia is vulnerable to economic shocks given that its economy is concentrated in terms of trade partners and products. Should the political climate be amenable, an opening of borders with neighboring countries would be expected to accelerate international trade and integration. This would provide more opportunities to diversify export products, partners, trade routes beyond existing ones with Georgia and Iran. For example, restoring the border with Türkiye could increase freight flows, and reopening the border with Azerbaijan could foster linking Armenia to the Middle Trade and Transit Corridor, a transport corridor connecting China and Europe. Gravity modeling analysis shows important potential export potential for Türkiye. At the same time, it should be noted that although opening of these borders would allow Armenia to improve its trade with current trading partners and diversify trade toward Europe and China, such openings are sensitive and pose significant geopolitical risks. Technological Advancement and Enhanced Connectivity Armenia could build on its dynamic information and communication technology (ICT) sector and better position itself to leverage global digital trends. Armenia aspires to be an ICT hub and has a recent track record of providing outsourcing services to global firms mostly in software programming. This is an important opportunity, as service exports help mitigate Armenia’s physical constraints. ICT service 7 exports as a share of total service exports more than doubled between 2017 and 2021 to 22 percent, and its service exports on a per capita basis outperform those of China and India. It can do more, however, to reach the level of global leaders. To do so, Armenian firms need to branch out to activities that are catalyzed by emerging technologies. The recent relocation of information technology (IT) firms and talent from Russia presents an additional opportunity for Armenia to seize. Armenia is also a potential network nation, with an important role for its diaspora to boost human capital, investment, and connectivity. The size of the Armenian diaspora is currently estimated at 7 million people in more than 100 countries. Much of the diaspora retains strong links to Armenia. In 2021, around 14 percent of households reported that they received remittances, which can serve as an automatic stabilizer during crises. Diaspora connections and prominent Armenians in various ICT hubs around the world have played a pivotal role in the accelerated development of the ICT sector since the early 2000s by bringing in technological multinational companies to Armenia, setting up local research and development centers, investing in IT educational and infrastructure programs, generating leads for local IT companies, and linking with knowledge and funding sources. They can enhance connectivity by promoting trade and FDI, creating businesses, spurring entrepreneurship, and transferring new knowledge and skills. There is also vast untapped potential in the value the diaspora can bring to the science and research ecosystem in Armenia. The scientific community of the diaspora excels in quality and performance. Ways to engage the diaspora in higher value-added activities include stocktaking of strategic connections in priority sectors and building mechanisms for joint projects. Green Transition Armenia can also better seize opportunities from the green transition. Armenia is among the countries that are most vulnerable to risks from climate change, environmental and natural disasters. These risks are amplified by human pressures and a history of unsustainable resource management leading to heightened air, soil, and water pollution and land degradation today. However, moving toward greener growth could—in addition to reducing pressures on domestic natural capital—unlock competitiveness in the private sector through efficiency gains and reduced exposure to future carbon border taxation. Providing financial incentives to promote the green transition, for example, would support integration of the private sector into global value chains. Second, Armenia’s proven reserves of copper and molybdenum and the significant potential for gold and other transition critical minerals that are in high global demand as the world decarbonizes could provide significant near-term revenues. Exploring these opportunities would, in addition to attracting significant investment, require a step-change in environmental, social, and governance-related regulation of the sector to ensure that best practices in minimizing damages are followed and that market prices reflect residual externalities. 1 Introduction 9 A rmenia has experienced rapid changes in external and internal conditions since 2017. The expectations of Armenians changed with the Velvet Revolution of April 2018, as the country witnessed demonstrations involving peaceful citizen must address and the opportunities it can embrace to accelerate progress toward the twin goals of ending extreme poverty and promoting shared prosperity. SCDs represent the analytical foundation of the World Bank’s country engagement, expressed in the Country engagement and the democratic process. Armenia Partnership Framework (CPF). The first-generation SCD has also felt the impacts of external events such as the in Armenia (SCD1) was published in 2017 (World Bank coronavirus disease 2019 (COVID-19) pandemic; the 2017a). SCD1 highlighted the need for a new growth model 2020 military conflict with Azerbaijan; the September grounded in greater productivity and identified four main 2022 fighting in the border areas of Gegharkunik, related challenges: (1) poor external sector performance, Syunik, and Vayots Dzor marzes (provinces); and (2) low private sector productivity, (3)  insufficient labor Russia’s invasion of Ukraine in 2022, which have productivity, and (4) key macroeconomic, environmental, affected current conditions and future opportunities for and microeconomic vulnerabilities. inclusive growth. Nonetheless, the Armenian economy has shown resilience to shocks over the last few years, Many of the challenges identified in SCD1 remain benefiting from a strong track record of macroeconomic challenges today. Although the Velvet Revolution management, fiscal discipline, and a sound financial boosted the reform agenda, implementation is uneven, sector, helping to keep extreme poverty low. and the benefits of policy changes may become manifest only in the medium to long term. While Armenians With its increasingly vulnerable political position, have high levels of educational attainment, the quality Armenia now seems to be at a crossroads, facing of learning is poor. Moreover, despite the economic both challenges and opportunities. Armenia faces transition to greater productivity in services, large high stakes and social expectations internally as well groups and many locations lack connectivity or access as unstable conditions externally, linked to uncertainty to economic opportunities. A large share of households in international trade and finance and geopolitical depends on low-productivity agriculture and transfers, complexities stemming from conflict surrounding including pensions and remittances. its borders and the political implications of Russia’s invasion of Ukraine. The economic impact of the latter, This second-generation SCD (SCD2) identifies the originally forecast to be negative, has so far resulted main development challenges that Armenia currently in an outlier year of economic growth for Armenia, faces under rapidly changing internal and geopolitical supported by inflows of money transfers and citizens circumstances. This new comprehensive SCD revisits of Russia. However, the outlook remains uncertain with and evaluates the persistent and structural constraints risks mainly to the downside, related to the duration identified in SCD1 and identifies emerging challenges and severity of the conflict and sanctions on Russia, from recent developments—including the COVID-19 inflationary pressures, and geopolitical tensions around pandemic, the 2020 military conflict and continued border Armenia’s borders (World Bank 2022a). tensions, Russia’s invasion of Ukraine, and international volatility. However, the analysis was prepared prior to The Systematic Country Diagnostic (SCD) provides the influx of 100,000 ethnic Armenians in September a systematic assessment of the constraints Armenia 2023 from Nagorno-Karabakh, with a data cutoff of July 10 2023. The analysis considers the green, resilient, and challenge areas identified in SCD1 remain valid and in inclusive development (GRID) approach. The economic alignment with the government’s 2021–26 program, challenges ahead are difficult to forecast and include Armenia 2021–26 (Government of Armenia 2021a; inflationary pressures, high volatility in financial and World Bank 2017b). In light of recent developments in commodity markets, and risks of decreased remittances the country and new evidence, SCD2 identifies four and capital inflows. Moreover, Armenia—like many other development challenges that must be addressed to countries—is facing ever-more evident risks from climate achieve the twin goals: (1) vulnerability to shocks and change and natural disasters. While some economic and environmental risks, (2) challenges in access to markets social effects of climate change in Armenia are already and trade integration, (3) low quality of human capital, visible, the full environmental risks will become more and (4) low investment and the need to enhance private salient in the future. The country’s ability to prepare for, sector productivity. While these four challenges are mitigate, and recover from current and future crises is related to SCD1-identified challenges, their framing constrained by challenges in government effectiveness has been updated. For example, within the challenge and high social expectations for rapid change after the of vulnerability to shocks, SCD2 introduces the aspect Velvet Revolution. of vulnerability to fragility and conflict. The external sector which was identified as a challenge in SCD1 is Although Armenia has made important development reframed as accessing markets to capture connectivity gains since 2017, the economy is not as competitive constraints within Armenia as well as those between or as innovative as it could be. Armenia has been on Armenia and other countries. In addition, one recurrent a structural transformation path since independence theme is introduced and considered cross-sectional and even since SCD1, as the economy has continued given its dynamic and simultaneous impact across many to witness a shift from agriculture toward industry and development and policy areas: institutional quality and services. While job creation—which is critical to reducing governance bottlenecks and the need to invest in data. poverty and inequality—has improved since 2017, the economy has not generated enough quality jobs. To address the key challenges to inclusive and Unemployment has remained high, especially among sustainable growth, SCD2 identifies 11 policy priority youth and women. While some measures of the business areas. The prioritization process identifies ten high-level climate have improved, investment—a crucial input—has priority areas in addition to one cross-cutting priority been declining, and the cost of credit is relatively high. area. These priority areas reflect the importance of The low quality of human capital and the skills mismatch achieving the twin goals and the feasibility and urgency are pervasive constraints for the private sector. Reforms of gaining resilience to reach sustainable and inclusive are needed to align the incentives for competition and growth. The priority areas differ slightly between SCD1 investment and stimulate a better allocation of resources. and SCD2. The new sets of priorities in SCD2 reflect a To overcome the constraints of being a landlocked greater emphasis on reforms that improve resilience to country, Armenia needs to modernize its digital and fragility, conflict, and climate change. The cross-cutting physical infrastructure to improve connectivity within the theme of governance bottlenecks, institutional capacity, country and with the world. and data needs is highlighted as a pressing concern and has been identified as a new priority area. Prudent SCD2 posits that the main challenges discussed macroeconomic policy will need to be continued in the in SCD1 still exist, while new and unprecedented coming period, although it is no longer as pressing a challenges have emerged. The terminologies used in concern as at the time of SCD1 as the government has SCD2 are described in Box 1. Sustainable, resilient, and demonstrated its ability to manage and cushion the 2020 inclusive growth is determined by both macroeconomic crises. Changes to the policy priority areas from SCD1 to and microeconomic drivers. Key intersecting challenges SCD2 are presented in Section 6. The key challenges between growth and poverty are identified as the major and priority areas diagnosed in SCD2 are summarized development challenges in Armenia. Overall, the key in Figure 1. 11 Box 1. Terminologies Used in SCD2 Development (or key) challenges: The development challenges are those that are identified through empirical analyses on trends and drivers of growth and poverty reduction in Sections 3 and 4 of this SCD as being priorities to address to achieve sustainable and inclusive growth (Figure 1). Binding constraints: These constraints are the factors that need to change in order to address the key development challenges. These constraints have been identified through empirical analyses, desk review, and discussions with internal and external experts and are discussed in Section 5. Possible policy priority areas: Building on the analysis presented in Section 5, these are policy areas that need further reform to overcome the binding constraints. Among all possible policy priority areas, 11 policy areas that emerged as high priority through the international benchmarking exercise are proposed in Section 6. Details are presented in Appendix H. Additional filters were applied and formal consultation with stakeholders were conducted to validate the results as described in Appendix G. High-level outcomes (HLOs): The 11 priority areas are mapped into high-level outcomes (HLOs).The HLOs were formulated to capture desired improvements in the population’s wellbeing if all policy priority areas are addressed. These HLOs provide options to be adopted in the CPF, which determines the World Bank’s engagement with the government over the next four to six years. Cross-cutting theme: Governance and institutions and the need to invest in data are important determining factors for successful interventions across multiple sectors in Armenia and are thus treated as a cross- cutting theme throughout the diagnostic. This SCD presents some examples of key governance and institutional bottlenecks affecting the progress of reform at the end of each sub-section in Section 5. The policy areas were prioritized based on international to reverse. This filter assessed the urgency to act given benchmarking and verified by two additional filters. the complex geopolitical situation, new challenges that An international benchmarking exercise was conducted have emerged since SCD1, and vulnerability to different to compare the performance of Armenia against the types of shocks. Details are provided in Appendixes E performance of reference groups such as regional, and H. structural, and aspirational comparator countries.4 The prioritization process relied on this methodology as it is SCD2 focuses on the period since SCD1, with a longer objective and based on empirical evidence. Results from time horizon for certain trends or a shorter time period the international benchmarking were verified by applying due to data availability. As a second-generation SCD, a technical feasibility filter to assess the likelihood SCD2 focuses on trends over the past decade, but that the proposed policy areas can be addressed in especially since 2016-17. The macroeconomic context the next four to six years, considering the technical section covers a longer time horizon starting from 2000 complexity. The urgency filter was also applied to assess to provide context for changes in economic activity if any delay in addressing a priority area would lead to and to account for structural breaks in the data, given adverse consequences that would be costly or difficult economic downturn periods. The poverty and equity 4 This exercise entailed (1) selecting relevant indicators to assess performance, (2) computing the differences between Armenia and the median performance of each reference group, and (3) prioritizing based on the magnitude of the differences computed in step 2. 12 Figure 1. Key Constraints and Policy Priority Areas Cutting Theme Cross- Governance, Institutional Capacity, and Data I. Vulnerability to Shocks II. Access to III. Quality of Human IV. Private Sector and Environmental Risks Markets and Capital Development Key Challenges Trade Integration 1. Fragility and Conflict 2. Economic Shocks 3. Climate Change, Environment, and Natural Disasters 1. Increase resilience to fragility and conflict by developing an adaptive social protection system and improving trust in political and social institutions 2. Diversify trade partners and export products and enhance the economic complexity of exports 3. Adapt to climate change by building resilience to climate-related shocks and natural disasters by scaling up risk prevention systems and updating technologies and infrastructure 4. Reduce pressures on natural capital for improved resilience and mitigation by improving energy e ciency and Priority Areas security and promote a green economy 5. Boost public and private investment in physical and digital access to close domestic and international connectivity gaps 6. Improve integration for trade by strengthening institutions and continue e orts to facilitate trade 7. Advance human capital accumulation by improving the quality and relevance of education, increasing the a ordability of health services, and allocating resources e ectively 8. Promote access to and generate good-quality jobs by strengthening coordination between education and the labor market 9. Foster a competitive private sector in services and manufacturing by developing a coherent strategy to attract investments (domestic, FDI, diaspora) 10. Improve productivity and cultivate climate-smart agriculture and further develop value chains 11. Cross-Cutting Theme: Strengthen governance and institutions by improving government e ectiveness, accountability and the inclusiveness of institutions, and investing in data for evidence-based policy making analyses leverage microdata and estimations from the Armenia’s current development challenges requires Statistical Committee of Armenia (ArmStat) and compare reflecting on the sociopolitical and economic events two periods: 2010–16 (the period covered by SCD1) that have faced the country and the region since 2017. and 2016–21 (the period since SCD1).5 2016 was also Section 3 discusses overall trends in economic growth the year of a structural break in the growth trajectory of and poverty and inequality. Section 4 highlights drivers Armenia. Other periods of analysis are also considered of growth and poverty reduction in Armenia. Section based on data availability for regional and international 5 presents empirical evidence and diagnostics on the comparisons. main challenges and binding constraints along Armenia’s path toward the twin goals. Section 6 identifies potential SCD2 is structured as follows. Section 2 summarizes the policy priorities in addressing the binding constraints, most recent sociopolitical developments. Understanding along with high-level outcomes. 5 National poverty, inequality, and living conditions are calculated based on the Integrated Living Conditions Survey (ILCS), collected annually by ArmStat. The survey is representative at the national, regional, and urban/rural levels. Changes to the questionnaire and data collection methodology (including the transition to computer-assisted personal interviews) were introduced in 2019. They sought to reflect the changes in living conditions, consumption patterns, and social expectations over the previous decade. In 2020, ArmStat—with technical assistance from the World Bank—redefined the methodology for calculating the consumption aggregate and adopted new national poverty lines based on ILCS 2019 (see ArmStat 2020). Poverty estimation is thus not strictly comparable before and after 2019, but an effort is made to interpret the trends. 2 Background: Sociopolitical Events and Key Reforms since 2017 14 T he Velvet Revolution in April 2018 led to a peaceful transition of power and boosted Armenians’ democratic aspirations and civic engagement, although citizens perceive that progress in anticorruption reform has stalled. The new (CPC), Anticorruption Committee, Anticorruption Court, and Anticorruption Chamber of the Court of Cassation, staffed with professionals selected based on merit and provided with infrastructure and resources.8 Similarly, the government aimed to tackle structural issues in the government of Nikol Pashinyan enjoyed a high degree economy, including high unemployment and regional of legitimacy, but it soon faced many challenges (Stronski geopolitical pressures. Pro-competition reforms and 2018). Under an anticorruption agenda with strong gains in market liberalization led to gradual improvement social support, several former officials were arrested in the business environment. on criminal charges of corruption (Lanskoy and Suthers 2019). Since then, some anticorruption cases have been Assessment of the impacts of all government reforms delayed, and public perception of the anticorruption since SCD1 is not yet realistic. The new government agenda is mixed.6 has implemented a series of reforms since the Velvet Revolution, but evaluating reform outcomes is The Velvet Revolution ignited fresh momentum for complicated due to (1) the short time frame to accomplish reform amid renewed growth (Box 2). In 2017–19, the intended outcomes; (2) unexpected large shocks that economic expansion was rapid, and macroeconomic are likely to have affected the outcomes of the reforms stability was established, aided by effective fiscal (such as the pandemic, armed conflict with Azerbaijan); policies, an active inflation-targeting regime, and sound and (3) complexity in empirically estimating impact under financial sector oversight.7 Monetary and exchange counterfactuals—that is, to assess what the impact of rate policies supported price stability and external the reform could have been if there were no external adjustment. Annual growth rose to an average of 6.8 shocks. percent, recovering from 0.2 percent in 2016. Based on the national income in 2019, Armenia became an However, examples of successful reforms can be upper-middle-income country. The new government identified. For example, since 2019, the tax authorities focused on a governance and anticorruption agenda. have launched tax reforms directed at enhancing In October 2019, it approved the Anti-Corruption transparency and efficiency, thereby attracting foreign Strategy of the Republic of Armenia and its Action investment, and lifting tax revenue. Supported by tax Plan for 2019-22. It established a new anticorruption policy and administrative reforms, revenue collection architecture: the Corruption Prevention Commission increased from 21.3 percent of gross domestic product 6 This is based on a nationwide poll conducted by the International Republican Institute’s Center for Insights in Survey Research, 2023. Accord- ing to the survey, public perception about the direction of the fight against corruption has declined, from 67 percent of respondents saying that “improved a lot” or “somewhat improved” in October 2019, to 43 percent in March 2023. https://www.iri.org/news/iri-armenia-poll-shows-con- cerns-over-national-security-sharp-divisions-on-russia-improving-relations-with-turkey/ 7 For example, the introduction of a new fiscal rule in December 2017. 8 The CPC has the mandate to prevent corruption through, for instance, the collection and analysis of asset declarations, following on the protection of incompatibility, conflict of interest, and related regulations deriving from the integrity framework of public service. It also has the mandate of observing compliance with restrictions on accepting gifts by public servants and individuals holding public positions. The Anticor- ruption Committee is a specialized body for investigating and combating corruption. The Anticorruption Court hears corruption cases related to criminal and civil (confiscation of illicit assets) matters. The Anticorruption Chamber of the Court of Cassation is a specialized chamber in the higher court to hear appeals in civil and criminal corruption cases. 15 Box 2. The Velvet Revolution After Armenia gained independence in 1991, its political system was characterized as hybrid, i.e. a political system that mixes elements of a democratic regime and elements of an authoritarian regime. Formal democratic institutions were accepted as the legitimate means of obtaining and exercising political authority, but political incumbents often failed to comply with conventional standards of democracy (Levitsky and Way 2010). After initial civil protests following accusations of electoral fraud in 1996, Armenia experienced political turmoil and succession challenges. Prime Minister Robert Kocharian established a new authoritarian system after coming to power in 1998 (Lanskoy and Suthers 2019). As with other hybrid regimes, issues of succession emerged in 2008 and 2018. Social discontent increased in 2016 after authorities and elites were blamed for incompetence and corruption in maintaining the armed forces (Iskandaryan 2018). The Velvet Revolution began in April 2018 after civil unrest was sparked in Yerevan following news of President Serzh Sargsyan’s plans to become prime minister and effectively bypass a two-term limit on power. The first protests involved a march from Gyumri, the second-largest city in Armenia, led by Nikol Pashinyan, a former journalist and political prisoner (Foster 2019). A resulting civil disobedience campaign was extensively promoted through social media and joined by thousands of people, including members of the armed forces. The movement led peacefully to Sargsyan’s resignation after only six days. In addition to their grievances over elections, the protestors expressed discontent with other issues, including sluggish economic growth, accusations of corruption, unmet political expectations, and widening inequality (Foster 2019; Stronski 2018). Following the prime minister’s resignation, Pashinyan was elected prime minister in May 2018. Several factors contributed to the success of the Velvet Revolution. Observers argue that the 2018 protests built on the lessons and social networks that had accumulated over the past decades of social and economic protests in Armenia (Lanskoy and Suthers 2019). Other elements that contributed to the success of the Velvet Revolution were the use of social media to mobilize supporters and the relative freedom of nongovernmental organizations (Stronski 2018). (GDP) in 2018 to 23.2 percent of GDP in 2022. Factors successful reforms include judicial reform, aspects of that point to success—as indicated by higher ratings the policy reform including the establishment of the among business users—include greater efficiency in Ministry of Home Affairs and the establishment of the business processes through the consolidation and Patrol Police, and the application of pension reform to simplification of procedures and increased transparency the private sector. In February 2023, the CPC launched thanks to the introduction of e-services, which also an upgraded asset declaration system that significantly increased trust in the tax authority among taxpayers.9 improves the declaration process, including by pre- Institutionalizing feedback loops and boosting filling some information in the declarations from the tax transparency and efficiency by setting up an e-court administration platform, providing a more user-friendly platform is another example of successful reform. Other interface, and putting the focus on analytics. 9 The 2020 Enterprise Survey conducted by the World Bank shows that Armenia’s tax administration performs well compared with other coun- tries in Eastern Europe and Central Asia. 16 In 2020, the COVID-19 outbreak and military The government embraced a new five-year action conflict with Azerbaijan caused social and economic plan—Armenia 2021–26—to shape policy priorities. disruption, requiring mitigation. Real GDP shrank by 7.2 The action plan establishes strategic goals, measures percent while exports fell 34 percent in 2020, among to achieve them, and the expected results, time frames, the sharpest shocks experienced in Europe and Central and funding sources (see Appendix B). The program Asia (ECA). As in many other countries, the government contains six pillars: security and foreign policy, the of Armenia adopted measures to shield households economy (including a sustainable development and and firms from the economic disruptions. In addition green component), infrastructure development, human to greater health spending, 25 policy packages were capital development, law and justice, and institutional introduced, involving fiscal expenditures totaling 1.6 development. The plan also embodies the government’s percent of GDP (World Bank 2022b). Assistance included commitments under the Armenia-European Union (EU) direct cash transfers to households and workers, wage Comprehensive and Enhanced Partnership Agreement, subsidies, utility subsidies, tax benefits for businesses, programs to be implemented under the EU economic state-sponsored loans, and higher investment. The and investment plan, and the main provisions of the measures helped partially offset impoverishment and Eurasian Economic Union strategic programs. unemployment. Although the fiscal response was among the most conservative among similar economies, In 2022, the repercussions of Russia’s invasion of real GDP growth rebounded to 5.7 percent in 2021 Ukraine, coupled with fighting in the border areas of (Government of Armenia 2022). Gegharkunik, Syunik, and Vayots Dzor marzes, led to a paradigm shift in Armenian politics and society. Unprecedented regional and international events The former has not only exacerbated the geopolitical since 2020 have rendered Armenia highly vulnerable. dynamics but has also moved security issues toward the Armenia experienced rising fiscal pressures and center of domestic political debate. The 2020 military debt ratios due to higher spending in response to conflict with Azerbaijan as well as the events since then COVID-19, including higher public spending on defense, have shifted public attention away from economics and a simultaneous fall in revenue, and a decline in GDP governance to security. The more recent escalation of as in many other countries. Despite overall economic fighting in September 2022 has contributed to fears that recovery, risks and regressive trends persist. For the 2020 ceasefire agreement will not hold (World Bank example, higher inflation on food items—felt since 2021, 2023c). but worsening throughout most of 2022—has likely prevented greater reductions in poverty and inequality. Armenia also experienced a domestic political crisis, as heightened political tensions after the 2020 military conflict led to snap elections. Armenia emerged weakened from the conflict due to the loss of close to 3,800 lives and influx of displaced people. A Russia- brokered ceasefire was agreed upon in November 2020. With mounting criticism of the government’s handling of the conflict, a political crisis followed in Armenia. Snap elections in June 2021 resulted in the ruling party obtaining the majority of votes and subsequently adopting a new five-year program.10 10 The Civil Contract Party has experienced a decreasing approval rating, based on a national poll by the International Republican Institute’s Center for Insights in Survey Research 2023. The approval rate fell from 25 percent in June 2022 to 21 percent in March 2023. 3 Trends in Growth, Poverty, and Shared Prosperity 18 3.1. Growth Trends (FDI), export revenues (predominantly metals and minerals), and remittances. During this time, Armenia Since 2000, the economy has been characterized experienced a Dutch Disease episode, including a 45 mostly by periods of substantial growth, punctuated percent appreciation of the real effective exchange rate by lows that reflect the country’s vulnerability to between 2003–08. The global financial crisis revealed sizable exogenous shocks. The growth rate averaged Armenia’s overreliance on commodity export direct 6.2 percent over 2000–22, although this masks three flows, remittances, and other flows as liquidity declined key slowdowns (Figure 2). The economic development and, coupled with the 2008–09 copper price drop, led gains helped the country advance to upper-middle- to a sharp economic contraction of 14.1 percent in 2009. income status in 2018. However, over the past decade, The second period, 2010–16, was a low-growth period GDP per capita mostly lagged peers (Figure 3). and ended with almost zero growth. This slowdown was brought on by the oil price shock that started in mid- Armenia’s growth trajectory since 2000 is marked by 2014, affecting external inflows, and the implementation three periods. In 2000–08, Armenia achieved 11 percent of sanctions on the Russian economy in 2015–16. The average growth underpinned by high investment rates, third period began after 2016 as the economy started to capturing post-independence reform momentum. recover, driven partly by the government’s broad fiscal Growth was driven by domestic demand and fueled by stimuli, and was characterized by several exogenous external inflows, particularly foreign direct investment shocks, including the 2020 twin shocks. Figure 2. GDP Growth, Armenia Figure 3. GDP per Capita, Peer Comparison 20 25,000 13.7 15 12.6 20,000 10 GDP growth (annual %) Constant 2015 USD 5 5.7 15,000 5.9 0 -5 10,000 COVID-19 and -10 Conflict with -7.2 Azerbaijan in 2020 5,000 Impact of Great -15 Financial Crisis -14.1 4,243 3,313 -20 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Albania Armenia Bosnia and Herzegovina Estonia Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Georgia Kosovo Moldova Tunisia Source: “GDP growth (annual %),” World Bank, https://data.worldbank. Source: “GDP (Constant 2015 US$): Armenia,” World Bank, https://data. org/indicator/NY.GDP.MKTP.KD.ZG. worldbank.org/indicator/NY.GDP.MKTP.KD. 19 Despite volatility in economic and exchange rate for second-generation reforms and reinvigorated performance, external economic shocks have been economic growth in 2018–19. The 2020 shocks—the better managed since 2017. Volatility in macroeconomic pandemic and the military conflict—had large negative conditions can have major impacts on investment, impacts on Armenia. Although the pandemic affected consumer spending, the risk premium, and policy countries and regions across the world in 2020, GDP certainty. Quarterly volatility of economic growth has in Armenia fell by 7.2 percent, among the sharpest not changed significantly since 2000, with an average contractions in ECA (World Bank 2021b). New risks of four negative episodes in each of the three periods became manifest in 2022 with Russia’s invasion of discussed.11 However, fiscal authorities have better Ukraine in February as well as the breakout of fighting managed downturns, including by adopting a revised in the border areas of Gegharkunik, Syunik and Vayots fiscal rule in 2017, adhering to it (outside of the 2021 Dzor marzes in September. These shocks revealed exception due to the twin shocks), and actively reacting continued vulnerability, including for tourism, investor to implement fiscal response measures, for example to confidence, and household sentiment. At the same time, address the twin shocks. As for exchange rates, volatility the relocation of 2,600 companies, 6,000 individual in key bilateral nominal exchange rates have relatively entrepreneurs, and 113,000 nonresidents to Armenia decreased over time.12 However, the dram experienced since March 2022, 13 mostly from Russia, fueled double- two periods of significant volatility in late 2020–mid digit growth of 12.6 percent in 2022, the highest in the 2021 in the post-conflict period and following the region (World Bank 2023d). onset of Russia’s invasion of Ukraine in February 2022. In both cases, the exchange rate stabilized without Economic growth in Armenia has not been accompanied significant interventions unlike the former periods. As by job creation. Despite growth at an annual average such, exchange rate flexibility, with limited interventions of 6.2 percent in 2000–22, employment declined by 0.1 by the CBA, has served Armenia well. The trend of real percent on a net basis.14 The rate of employment creation effective exchange rate appreciation since 2013 could at a given level of growth—the employment elasticity of be the outcome of expanded export potential. However, growth—was −0.1, which indicates that a 1 percent rise real exchange appreciation could also be negatively in GDP was associated with a 0.1 reduction in jobs. Job affecting merchandise and service exports in the short- creation improved in 2017–22 with an elasticity of 0.4 term. In 2022, for example, the real effective exchange as employment grew by 127,600. However, the low and rate appreciated by 34 percent, driven by a 90 percent negative elasticities stand out compared with upper- increase in the number of tourists in 2022 year on middle-income countries (World Bank 2019c). year combined with a three-fold increase in net money transfers from Russia, which bore important costs for Unemployment rates are high and heterogenous across firms that provide IT service exports. sociodemographic groups.15 Armenia has one of the highest unemployment rates in ECA.16 The rate hovered The economy has more recently weathered around 18 percent in 2008–20, although it declined unprecedented events that present both risks and to 13 percent in 2022 partly thanks to strong growth opportunities. The Velvet Revolution in 2018 and performance (ArmStat).17 Unemployment in urban areas subsequent momentum for reform opened the door has been higher than rural unemployment consistently 11 The frequency of quarterly negative growth compared to the corresponding quarter of the previous year was five quarters for 2000–08, three for 2010–16, and four for 2017–22, the latter which were due to the 2020 twin shocks. 12 For example, monthly changes of +/-5 percent in bilateral nominal exchanges for the dram vis-à-vis the US$, euro, and ruble were 18 months from 2000-08, 35 from 2010-16, and 21 from 2017-22. The AMD/RUB exchange was the most volatile of the three and increasingly so in 2022, with three months in which monthly changes of the nominal exchange rate were +/-10 percent. 13 Data based on Statistical Revenue Committee, Central Bank of Armenia, and IMF staff calculations. 14 Based on ArmStat employment data. 15 This section is based on ArmStat national employment statistics using quarterly data of the Labor Force Survey (ArmStat 2022). 16 Comparisons based on June 2022 data of ILOSTAT (dashboard), International Labour Organization, https://ilostat.ilo.org/. 17 ArmStat national employment statistics using quarterly data of the Labor Force Survey. The unemployment rate is the share of the labor force that is without work but available for and seeking employment. 20 Figure 4. Unemployment Figure 5. Employment and Value Added, by Sector 30 100% 60 27.8 27 17.0 16.7 15.9 15.8 16.7 22.8 52.8 17.7 Value added, percentage of GDP 24.9 Percentage of total employment 25 24.8 50 80% Percentage of labor force 22.3 23.2 23.4 45.7 20 20.3 40 19 60% 45.1 46.7 48.5 48.8 50.6 52.0 18.5 19 18.2 15 51.4 51.2 30 16.4 16.2 15.5 13.5 40% 12.1 10 11.3 17.9 20 8.8 37.3 36.3 11.4 20% 34.8 35.3 33.6 31.3 5 6.6 6.1 6 6.7 5.7 10 9.4 25.8 24.0 11.3 0 0% 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Urban Rural Total Agriculture Services Industry Agriculture (value Services (value Industry (value added as % of GDP) added as % of GDP) added as % of GDP) Source: ArmStat Labor Force Survey, https://statbank.armstat. Source: Data as of January 2021 of ILOSTAT (dashboard), International am/pxweb/en/ArmStatBank/?rxid=9ba7b0d1-2ff8-40fa-a309- Labour Organization, https://ilostat.ilo.org/; ArmStatBank. fae01ea885bb. since 2008, but the gap has narrowed because rural Participation and employment rates are low compared unemployment has risen (from 6.6 percent in 2008 to with most peer countries, and youth and women are 8.8 percent in 2021) while urban unemployment has less likely to be employed. The participation rate of 48.9 dropped (from 23.2 percent to 20.3 percent) (Figure percent in 2019 lags most peers (Figure 6).18 Deterrents 4). Low unemployment in rural areas may be linked to to entering the labor force include high reservation greater underemployment. The persistent differential wages, remittances, job quality, and a skills mismatch. suggests little spatial mobility in labor. Women are more At 48.9 percent in 2019, Armenia’s employment rate likely than men to face unemployment, although the gap is below most peers. The aggregate employment rate has closed over the last five years. Unemployment is masks striking differences in employment rates across high among young people, reaching 30 percent among groups. The employment rate among youth averaged individuals under age 24 seeking employment. Women, 22.6 percent in 2017–21 compared with 53.7 percent youth, and single people in urban areas are more likely among adults (Figure 7). The low employment rate to be unemployed. among women has also been a long-standing challenge. Female employment averaged 40.6 percent compared The shift in employment by sector reflects the with 58.2 percent among males in 2017–21. transition of the economy from agriculture to services (Figure 5). The share of employment in services grew Economic growth in Armenia has not yet decoupled from 45.1 percent in 2012 to 51.2 percent in 2019 led by from emissions growth, which could affect wholesale and retail trade and accommodation and food competitiveness.19 After the initial drastic decline service activities. The share of employed in industry rose following the dissolution of the Soviet Union in 1991, from 17.7 percent in 2012 to 24.8 percent by 2019 led by greenhouse gas (GHG) emissions have continued to higher employment in construction and manufacturing. rise. Historically, Armenia’s GHG emissions are primarily In contrast, the share of employed in the agriculture from the energy sector, comprising electricity and sector fell from 37.3 percent of the population in 2012 to heat generation, transport and residential sectors, and 24.0 percent by 2019. fugitive emissions from the natural gas system. In the last 18 Based on Armstat Labor Force Survey employment data. 19 Decoupling of emissions growth from economic growth here refers to absolute decoupling, a state where in which absolute emissions decline while GDP grows. It indicates decarbonization progress. 21 Figure 6. Participation and Employment Rates, 2019 Figure 7. Youth versus Adult Employment Rates 70 54 70 53.2 53 60 Estonia 51.9 52.0 54.1 Employment rate, percent Employment rate, percent Employment rate, percent 52 60 51.4 Georgia 50.9 51.1 50 51 Uzbekistan 50.0 50.1 Albania 50 49.8 49.6 40 50 Armenia (SC) 48.9 48.9 49 30 48.1 47.7 47.8 48 Moldova Tunisia 20 40 47 20.3 BiH 10 46 30 45 0 40 50 60 70 80 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Participation rate Total (LHS) Youth (RHS) Adult (RHS) Source: World Development Indicators database; ArmStat Labor Force Source: World Bank staff calculations based on ArmStat Labor Force Survey data. Survey data. LHS = left hand side; RHS = right hand side two decades, CO2 emissions grew in line with energy Figure 8. GDP Growth and Emissions Growth supply, and the carbon intensity of GDP has stagnated since 2010 (Figure 8).20 This data suggests that there is 350 no trend toward increased low-carbon, energy efficient 300 technology and that significant carbon lock-in21 occurs, 250 pointing toward risks of asset stranding and loss of competitiveness as peers accelerate decarbonization.22 200 Index 150 Looking forward, Russia’s invasion of Ukraine represents a new source of uncertainty and pressure 100 on Armenia’s economy and labor market. This 50 development and the associated sanctions on Russia 0 present risks and a changing domestic economic 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 landscape for Armenia. The regional situation remains 2020 precarious, and substantial risks remain in the potential Total energy supply (TES) GDP (PPP, constant 2017) CO2 emissions Carbon intensity of GDP (CO2 emissions/GDP) of the war to cause disruptions in trade and FDI and Carbon intensity of energy mix (CO2from energy/TES) exert more upward pressure on international fuel and Source: World Development Indicators database; International Energy food prices. Armenia is exposed to shocks in migration Agency World Energy Balances 2022. and remittances. Russia has traditionally been the main destination for Armenian labor migrants (mostly men mobilization might lead to return migration to Armenia ages 25–44 with secondary education). The possibility and fewer opportunities for prospective migrants to of declining economic activity in Russia and calls for go abroad, thus creating pressure on unemployment 20 Carbon intensity of GDP is defined as the total of estimated annual carbon dioxide emissions divided by GDP. 21 Carbon lock-in refers to long-term investments in carbon-intensive infrastructure, thereby ‘locking’ a country into a fossil fuel-dependent devel- opment pathway. Asset stranding refers to assets losing value in a changed market environment, for example due to changes in global value chains or more ambitious climate policies. 22 Armenia’s Updated Nationally Determined Contribution (NDC) is to reduce GHG emissions by 40 percent from 1990 levels by 2030 and total emissions to 2.07 tCO2eq/capita by 2050 (Government of Armenia 2021b). However, Armenia may exceed its GHG target if the right measures are not taken (IMF 2022a). 22 Figure 9. Trends in Poverty and GDP Figure 10. Poverty by Income Levels, Most Recent Year Available Poverty headcount ratio at US$6.85 a day 40 5.000 60% GEO (2021), 55.4% 4,522 ARM (2021), 51.7% (2017 PPP) (% of population) 35.8 50% Percentage of population 36 Constant 2015 US$ 4.000 40% 32 3,690 XKX (2017), 34.2% 29,4 30% 28 Upper middle income (2019), 23.5% 2,890 3.000 20% TUN (2015), ECA (2019), 26.5 MNE (2018), 18.5% 17.9% 15.0% MDA (2019), 14.7% 24 10% ALB (2019), 10.9% BGR (2019), 7.2% BIH (2011), 5.8% RUS (2020), EST (2019), 20 2.000 0% 4.1% 1.4% 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 GDP per capita, PPP GDP per capita National poverty headcount (constant 2017 international $) (right axis) (left axis) Source: World Bank staff calculations using data from ArmStat, Source: World Development Indicators database as of January 2023. Integrated Living Conditions Survey (ILCS), and World Development Note: The trend line in the figure shows the correlation between GDP Indicators database. per capita (in constant 2017 international $) and poverty headcount Note: Poverty and consumption are not strictly comparable before ratio using the international poverty line of US$6.85 a day (in 2017 and after 2019 due to revisions in the ILCS questionnaire and data PPP). The blue line represents the expected level of poverty for each collection methods. The dotted line reflects this gap in the series. level of GDP per capita. and wages in Armenia.23 At the same time, the influx of by the government’s broad fiscal stimulus (Figure 9).25 migrants and capital into Armenia in 2022 brought in Extreme poverty—defined as those with consumption skills and could also generate investment opportunities, per adult equivalent below the food poverty line—also particularly in industry and technology services, and declined constantly over 2010–18, from 3 percent to 1 spillover for the rest of the economy. percent (ArmStat 2022a). 3.2. Poverty Trends However, the onset of COVID-19 and the military conflict in 2020 stalled the progress in poverty Poverty has been decreasing steadily since 2010 (as reduction. Government mitigation measures helped measured by the national poverty line).24 After the contain larger shocks, and the increase in the poverty increase in poverty in 2009 and 2010 following the rate was confined to 0.6 percentage points in 2020, from global financial crisis, poverty measured by the national 26.4 percent in 2019 to 27.0 percent in 2020. Economic average poverty line decreased uninterruptedly between recovery in 2021 was associated with poverty reduction, 2010 and 2016, and the rate of reduction accelerated in but at a slower pace (a reduction of 0.5 percentage 2016–18 when GDP growth was rapid, driven partially points to 26.5 percent). 23 Simulation analysis conducted by the World Bank’s Social Protection and Jobs team suggests that the Armenian labor market would need to create an additional 12,000 to 25,000 jobs to compensate for reduced outward migration. 24 The national poverty rate is the midpoint between the lower and upper poverty rates. Poverty lines are adjusted each year using year-on-year inflation. Poverty lines in terms of the adult equivalent per month in current prices used to estimate poverty rates were AMD 33,517 (2010), AMD 40,867 (2016), and AMD 48,146 (2021). The poverty and inequality measures are not strictly comparable before and after 2019 due to revisions in the ILCS questionnaire and data collection methods. Nonetheless, efforts are made to interpret trends to the extent possible. For example, poverty measured against the upper poverty line is used for years prior to 2019, which are the most comparable rates with national average poverty since 2019. Details are described in ArmStat 2022a. 25 National poverty increased from 27.6 percent of the population in 2008 to 35.8 percent in 2010. 23 The poverty reduction achieved in Armenia is Figure 11. Growth Elasticity of Poverty commendable, but the incidence of poverty is still higher than expected given Armenia’s level of income 40% 1.5 (Figure 10). Armenia’s poverty level in 2021 was 51.7 30% 27.7% 1.0 percent (using the US$6.85-a-day poverty line), which 22.6% 0.79 is approximately 30 percentage points higher than the 20% 0.49 0.5 expected poverty rate given the country’s GDP per 10% capita of US$14,193 (in constant 2017 international US 0.0 Elasticity Change 0% dollars). Given the high level of poverty by international -0.5 standards and household vulnerability to shocks, -10% identifying and tackling key development constraints -11.1% -1.0 -20% are critical for sustainable poverty reduction. -21.8% -30% -1.5 2010-2016 2016-2021 The high international poverty rate is associated with Change in poverty (left axis) labor market outcomes. While poverty can be affected Change in GDP per capita (left axis) through multiple channels, the lack of job opportunities Growth elasticity of poverty (right axis) is one critical factor driving poverty in Armenia. This is Source: World Bank based on data of the ILCS and World Development reflected in the high unemployment rate compared Indicators. to countries such as Moldova with an equivalent level of GDP per capita (12.6 percent in Armenia versus 1 percent change in per capita GDP—decreased from 2.3 percent in Moldova in 2022),26 and the gap is 0.79 in 2010–16 to 0.49 in 2016–21, signaling that growth particularly large among those with intermediate and resulted in less poverty reduction in recent years.29 advanced education.27 Lack of job opportunities is Decomposition analysis confirms that growth was more also demonstrated by the large number of temporary important in reducing poverty during 2010–16, while emigrants whose main incentives are wage differentials redistribution or a reduction in inequality was more and better employment opportunities (Garrote-Sánchez important in 2016–21. The result is also consistent with 2022). The quality of jobs is also relatively low as the improvement in inequality over the years. depicted by relatively high informality—for example, 50.3 percent in Armenia compared to 22.1 percent in 3.3. Equity Trends Bosnia and Herzegovina in 2018 (Elgin et al. 2021). While poverty declined steadily in 2010–16, more While reductions in poverty since 2010 have been rapid growth among well-off households led to higher accompanied by economic growth, the contribution inequality. As poverty fell during the pre-SCD1 period of growth to poverty reduction has declined. The (2010–16), households in the bottom 40 percent of poverty and shared prosperity analysis compares two the welfare distribution (the bottom 40) experienced periods before and after 2016 (2010–16 and 2016–21), consumption growth of over 2 percent a year. However, as 2016 was the year of a structural break in the GDP the well-off made even higher gains, as shown by the growth trajectory as discussed in Section 3.1.28 Figure growth incidence curve which depicts the annualized 11 shows that the growth elasticity of poverty—defined growth rate of per capita consumption for every decile of as the percentage change in poverty with respect to a the consumption distribution between two time periods 26 Based on a percentage of unemployment among the total labor force (modeled ILO estimate) (World Development Indicators database as of June 2023). 27 In 2021 (the latest data available), the unemployment rates among those with intermediate education in Armenia and Moldova were 10 percent and 0.8 percent, respectively, and 10.7 percent and 1.2 percent, respectively, for those with advanced education. The rates were lower for those with basic education (6.1 percent and 0.5 percent, respectively). These rates are based on World Development Indicators as of June 2023. 28 This coincides with the latest data used for the poverty analysis in SCD1, allowing the SCD2 analysis to compare before and after SCD1. 29 The growth elasticity of poverty during 2016–21 was highly volatile, peaking at 1.76 during 2016–18 before dropping to 0.25 in 2019–21. The growth elasticity of poverty in 2020–21 alone was 0.35, accompanied by progress in poverty reduction and strong economic recovery in 2021. 24 Figure 12. Growth Incidence Curve, 2010–16 versus Figure 13. Shared Prosperity, 2010–16 versus 2016–21 2016–21 10% 6% Annualized real consumption growth 8% 4.1% 4% Average growth: 2.9% 6% 3.1% 4.1% 4.0% 4.5% 4.4% 4.4% 4.4% 4.2% 2% 4% 2.9% 2.7% Growth 2.5% 3.8% 2% 0% 0.7% -0.1% 0.0% -0.2% -1.2% 0% -2% -1.8% -2.1% -2.2% -2.2% -2.5% -2.3% -2% -4% -3.2% -4% Average growth: -3.3% -3.2% -6% -6% 1 2 3 4 5 6 7 8 9 10 2010-2016 2016-2021 Decile Growth-bottom 40% Growth-average 2010-2016 2016-2021 SP premium (= bottom 40% growth-average growth) Source: World Bank staff calculations based on ILCS. Source: World Bank staff calculations based on ILCS.. Note: Growth incidence curve depicts the annualized growth rate Note: The shared prosperity premium (red dots in the figure) is of per capita consumption for every decile of the consumption expressed as the difference between the mean consumption growth distribution between two time periods. of the bottom 40 percent of the welfare distribution and overall average growth. (Figure 12). The shared prosperity premium—expressed Rising food inflation might have prevented the as the difference between the mean consumption escape from poverty and intensified inequality in growth of the bottom 40 percent and overall average 2021. Poorer households are typically more heavily growth—remained negative, confirming that well-off affected by high food inflation since they allocate larger households benefited disproportionately, leading to the shares of their budgets to food consumption (Figure rise in inequality (Figure 13). 16). Microsimulations based on ILCS data suggest that food inflation associated with the twin shocks might In 2020, inequality as measured by the Gini index have prevented approximately 120,000 Armenians from dropped below the level of peer countries, as well- escaping poverty in 2021 and resulted in an increase in off households were affected more severely by the inequality. crisis, mainly through lost wages and a reduction in remittances. However, inequality grew again in 2021 as the rich enjoyed a strong recovery. In contrast to 2010– 16, consumption showed signs of pro-poor growth as indicated by the negative slope of the growth incidence curve (Figure 12) and higher consumption growth among the poor, which led to a decline in inequality. However, consumption growth among the poor remained close to zero, indicating that the seemingly pro-poor growth during this period did not fully translate into poverty reduction. Moreover, the strong economic recovery in 2021 appeared to benefit the well-off disproportionately, as illustrated by the upward-sloping growth incidence curve in 2020–21 (Figure 14). Thus, inequality rose again in 2021, despite strong economic growth and the decline in the average poverty rate (Figure 15). 25 Figure 14. Growth Incidence Curve, 2020–21 Figure 15. Gini Index 10% 45 Annualized real consumption growth 8.4% 8% 6.9% 40 6% 4.9% 4.5% 4.2% 3.7% 4% 35 Gini index 2.6% 34 1.8% Average growth: 3.2% 2% 1.2% 30 30 0% 30 28 -2% -1.5% 25 25 -4% -6% 20 1 2 3 4 5 6 7 8 9 10 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Consumption Decile Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Source: World Bank staff calculations based on ILCS 2021. Source: Poverty and Inequality Platform (dashboard), World Bank, https://pip.worldbank.org/home. Figure 16. Household Budget Allocation 2021 100% 90% 33% 38% 80% 39% 40% 42% 43% 43% 46% 50% Share of consumption 70% 64% 60% 50% 40% 67% 62% 30% 61% 60% 58% 57% 57% 54% 50% 20% 36% 10% 0% 1 2 3 4 5 6 7 8 9 10 Decile Food Non-Food Source: World Bank staff calculations based on ILCS 2021. 26 4 Drivers of Growth and Poverty Reduction 27 T his section identifies binding constraints on growth, poverty reduction, and shared prosperity in Armenia. On growth, the analysis centers on results from Solow and Shapley decompositions. The drivers of poverty reduction are domestic services (World Bank 2013). Consumption was the key contributor to growth, along with investment, as external trade had a negative contribution (Figure 17). External trade then became a major contributor to growth in 2010–16, reflecting an ambition to diversify based on the Shapley decomposition. The analysis is the economy and focus on export-led growth. An also augmented by focusing on the factors considered expansion in merchandise exports—partly thanks to a under the asset-based framework. Applying the asset- surge in commodity prices for Armenia’s metals and based framework, the analysis asks what the binding minerals in 2010–14—explains the contribution of net constraints in each of the following channels are that affect exports during this time. At the same time, investment household well-being: (1) asset endowments, especially hindered growth during this period following the bust in human capital accumulation; (2) opportunities to use of the construction sector in 2009 and reversal of the the accumulated assets, especially in the labor market FDI trend. In the most recent period of 2017–22 which and in market access; and (3) risks that are prevalent witnessed several shocks, consumption resumed a among the poor and that affect the accumulation of leading contribution to growth, but growth was more assets and the opportunities to use them. Among the broad-based as investment reversed to a net positive known determinants of household welfare, the factors contribution—although modest compared to the first most lacking among the poor and the types of risks to decade of the century—followed by net exports and which the poor are disproportionately vulnerable are government consumption. identified as the most binding constraints on achieving the twin goals.30 On the supply side, services have become ever more important in the last decade as the structure 4.1. Drivers of Growth of the economy has increasingly shifted away from agriculture. The share of services in GDP rose from 46 Evolving Drivers of Growth percent in 2012 to 55 percent in 2022. As the industry share has remained rather flat since 2012 at an average Economic growth drivers have shifted significantly in of around 26 percent, the increase in importance of recent years. Since 2000, consumption has been the services came at the expense of agriculture, which saw main driver of growth on the demand side, followed a decline in its contribution to GDP from 18 percent in by investment. However, further decompositions show 2012 to 10 percent in 2022 (Figure 18). Nonetheless, that growth drivers changed significantly during this while the share of agriculture declined, agricultural time. In 2000–09, high growth was based on a foreign- output expanded, and it remains an important sector for financed expansion of the construction sector and the economy and employment.31 30 The asset-based framework was used similarly in, for example, Cambodia SCD (2017) and El Salvador SCD (2022). 31 There are concerns about the quality of the data on agriculture. Agriculture sector activity may be underestimated by official agriculture data publications, as there appears to be a significant and unreported expansion of perennial crops that can be observed through remote sensing analysis (World Bank 2023d). 28 Figure 17. Contribution to Growth, Demand Side Figure 18. GDP Structure, Supply Side 8 100 6.7 12 10 9 9 8 7 7 6 7 7 7 6 80 4.4 16 16 16 16 18 19 18 19 20 20 19 Percentage points 4 3.6 60 Percentage 2.1 2 1.1 1.4 0.9 0.6 0.5 0.3 0.3 0.2 40 46 46 47 48 50 51 53 54 53 53 55 0 -1.0 -0.8 -2 20 -3.0 18 18 18 17 16 15 14 12 11 11 10 -4 0 2000-2009 2010-2016 2017-2022 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 (growth=8.7%) (growth=3.5%) (growth=5.2%) Households/NPISHs consumption Government consumption Agriculture Services Investment Net export Statistical discrepancy Industry (excl. construction) Construction Source: World Bank staff calculations based on ArmStat data (in Source: ArmStat National Accounts data. constant 2015 LCU). NPISH = non-profit institutions serving households. Armenia’s growth appears to have been driven that, over 2000–22, TFP rather than factor predominantly by total factor productivity accumulation was driving growth (Figure 19). Over (TFP), although the impact of TFP is likely to be this period, TFP contributed 56 percent to real GDP overestimated.32 Decomposition analysis suggests growth, followed by 47 percent from capital stock and Figure 19. Growth Decomposition, Armenia, 2000–22 25 20 Growth rate (percentage points) 15 10 5 0 -5 -10 -15 -20 -25 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Total factor productivity (gA) Human capital per labor ((1-α)*gH) Labor ((1-α*gL) Capital stock (α*gK) Real GDP (gY) Source: World Bank staff calculations based on ArmStat GDP and Gross Fixed Capital Formation data in constant LCU 2015. Human capital is based on “Average Years of Schooling” from World Bank database on education statistics https://datatopics.worldbank.org/education/ Note: Real GDP growth is in natural log (continuous compounding). Growth rates are weighted according to the income share of capital = 45 percent. Returns to education set at 2 percent based on recent analysis as discussed in section 4.2. 32 Total factor productivity is a commonly used measure of productivity. It is calculated as the residual growth that cannot be attributed to the in- creased use of labor and capital. Part of the overestimation is due to the use of a constant labor share of 55 percent across the decomposition period. However, Armenia’s labor share has declined sharply since 2000 based on Penn World Tables data. Accounting for this would reduce the TFP contribution to growth. 29 2 percent from human capital, while labor detracted 4 Figure 20. New Businesses Registered, Armenia, percent from growth.33 The rise in the number of new 2010–20 registered businesses in 2017–19, for example, suggests 8000 that TFP may also be capturing reforms to the business Number of new businesses registered environment which include enhanced competition and 7000 process and requirements for starting a business (Figure 6000 20).34 However, it is striking that while TFP results appear 5000 to be strong, the economy did not generate more and 4000 better jobs. As a residual term, TFP captures innovation, technological change, and managerial capacity but may 3000 also capture measurement errors, and for this reason, 2000 verification would be needed. For example, critical 1000 2640 5700 2527 3493 4443 6877 3190 3510 3180 data gaps related to capital expenditures (including on 3168 6137 maintenance spending) and the lack of asset registers 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 and centralized data for domestically financed projects may also signal data measurement issues in the estimations of capital stock (World Bank 2023b). Source: World Bank’s Entrepreneurship Database (https://www. Physical capital accumulation has become a less worldbank.org/en/programs/entrepreneurship). important driver of growth since 2009 as a result of limited capital expenditures, a declining trend in FDI, million in 2008 to US$47 million in 2020 (Figure 23). The and decreasing domestic private investment. Gross construction sector stands out as one driver behind this capital formation for Armenia has declined significantly reduction, as the sector had attracted an important share as a share of GDP from 34.4 percent over 2000–10 to of FDI before the financial crisis and accounted for 61.7 19.7 percent over 2017–21 and is below all peers except percent of gross fixed capital formation over 2000–09. Tunisia (Figure 21). Volatility and unpredictability in public Since then, construction’s share of gross fixed capital investment execution, limited capital investment plans, formation declined to 39 percent over 2017–22. Finally, and small allocated budgets have contributed to the low domestic private investment has also been declining capital stock in the most recent period. Public investments over time as a share of GDP, from an average of 18.4 as a share of GDP averaged 4.3 percent in 2000–09 percent in 2000–09 to 16.1 percent in 2010–16 then to and dropped to an average of 3.4 percent in 2016–21, 14.6 percent over 2017–22.35 below most peers (Figure 22). Lower capital spending reflected in part a commitment from the government to A shrinking and aging population has affected reduce the debt ratio, as capital spending is less rigid the labor force and weighed on growth. Armenia’s than other spending categories. This trend has resulted population has been decreasing annually since 1991, in a depletion of public capital stock, which fell from with the exception of 2021-22 which were anomaly 160 percent of GDP at the end of the 1990s to about 60 years of population growth to reach 2.97 million as of percent of GDP in 2017. This is lower than public capital 2022 (Figure 24).36 This trend mirrors the trend in net stock in neighboring Georgia and Azerbaijan, where migration which was also negative until 2021, with net the averages are around 80 percent of GDP (Koshima outward migration declining from an average of 27,757 et al. 2019). Lower FDI also contributed to the lower for 2010–19 to 12,825 in 2021.37 The labor force, or the capital stock as net FDI inflows declined from US$944 population between ages 15-64, shrank from 1.41 million 33 Decomposition analysis data assumptions are the same metadata as those in Figure 19. 34 In 2020, Armenia ranked 10th among 190 economies on the starting a business indicator and 47th overall according to 2020 Doing Business. 35 Domestic private investment is estimated based on data from ArmStat and the Central Bank of Armenia. 36 Based on ArmStat data. 37 United Nations Population Division. World Population Prospects: 2022 Revision. 30 Figure 21. Gross Capital Formation Figure 22. Capital Expenditure, 2016–21 Average 40 8 35.0 34.4 34.3 35 31.7 31.6 28.2 28.4 6.0 27.8 27.4 5.7 26.6 30 6 Percentage of GDP 25.2 25.3 Percentage of GDP 24.9 24.7 24.3 24.2 23.9 23.2 23.1 22.2 25 4.7 19.7 18.4 20 4 3.8 3.6 3.4 2.9 3.1 15 2.7 10 2 5 0 0 Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Armenia Albania Bulgaria Estonia Georgia Turkiye Moldova Tunisia Ukraine Aspirational Structural 2000-2010 2011-2016 2017-2021 Source: World Bank national accounts data; OECD National Accounts Source: Data from ministries of finance; World Bank BOOST database; data files. World Bank Expenditure Dashboard (2023); World Bank 2023b. 1,200 Figure 1,000 23. Net FDI Inflows, Armenia 998 Figure 24. Demographic and Labor Force Trends, 944 Armenia 800 1,200 6.0 25.0 US$, millions US$, millions 600 1,000 998 4.0 944 20.0 400 2.0 800 0.0 15.0 Percent Percent 200 600 -2.0 59 10.0 0 400 -4.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 5.0 200 -6.0 59 0 -8.0 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Population change (LHS) Labor force change (LHS) Unemployment rate (RHS) Source: UNCTAD data; https://unctadstat.unctad.org/datacentre/first Source: ArmStat Statistical Indicators and Labor Force Survey. to third quarters of 2022 based on Tradingeconomics.com (https:// Note: Since 2008 labor force indicators are not comparable with the tradingeconomics.com/armenia/foreign-direct-investment). data of previous years. Since 2008, ArmStat changed its methodology to calculate unemployment to the ILO standard definition used by EU countries. in 2008 to a low of 1.23 million in 2016. It has since growth, which can mostly be explained by the stalling picked up slightly to reach 1.31 million in 2022. of average years of schooling at around 13.1 years. Moreover, once the quality of education is considered, Human capital has made only a limited contribution to effective years of schooling decrease to 8.0 years (World growth as education dividends have plateaued. Since Bank 2023a). These results also reflect low returns to 2010, human capital has had a negligible contribution to education and highlight the need to enhance human 31 Figure 25. Growth Decomposition of per Figure 26. Sectoral Contribution to GDP Growth, Armenia, 2012–21 Capita Value-Added Growth, Armenia 8.0 2.0 Annual change (percentage points) 6.0 1.0 4.0 Percentage point 2.0 0.0 Manufacturing Wholesale, retail, Transport and Education Financial Administrative Public administration Health and social work Other activities Mining and accomodation communications and support Professional and scientific Arts, entertainment, and recreation Utilities 0.0 Real estate Construction -1.0 -2.0 -4.0 -2.0 -6.0 2012-2021 2012-2016 2017-2021 -3.0 Agriculture y=3.39% y=2.89% y=2.78% Within-sector productivity Structural change Employment rate Participation rate Change in employment rate Intersectoral reallocation Demographic change Total period Contribution of within-sector productivity change Total contribution Source: World Bank staff calculations based on ArmStat data. Note: GDP at factor prices, in LCU 2015 constant. Financial Intermediary Services Indirectly Measured are pro rata-ed across subsectors. Due to statistical discrepancies, the sum of value added from each sector sometimes does not add up to the total value added. In Figure 23, y = annual growth per capita value added (percent) capital and the quality of education to boost growth. resumed its structural transformation path. Within-sector productivity weighed on growth in 2017-2021 compared A growth decomposition analysis on the contribution to 2012-16, partly because by 2021, the economy had of changes in demographics, the level of employment, not yet recovered to pre-pandemic GDP. At the sub- and the level of productivity growth sheds light on sectoral level, this reflects an adjustment across most how much structural transformation has contributed sectors that had a reduced contribution of within-sector to Armenia in the past decade. The productivity productivity over 2017-21, particularly construction and component is divided into a component that measures real estate. changes in productivity at the sector level (within-sector productivity) and another that reflects labor reallocation A GDP decomposition analysis at the sector level between sectors, which points to the speed of structural reveals that wholesale, retail, and accommodation, change (or intersectoral allocation). In 2012–21, within- followed by manufacturing and the financial sector, sector productivity accounted for 83 percent of growth, were the largest contributors to GDP growth during followed by structural change at 36 percent, employment 2012–21 (Figure 26). These sectors, along with real at 7 percent, and demographic change at 2 percent estate and construction, exhibited the highest share of (Figure 25).38 The participation rate, measured as a inter-allocative productivity or structural change. Within- share of the labor force in the working-age population, sector productivity advances were led by the agricultural reduced 28 percent of growth. This has worsened since sector as employment moved out of the sector and as 2017, reflecting the need to enhance incentives to join agricultural exports rose. Within-sector productivity the labor force. Structural change, or the reallocation of improvements were followed by manufacturing and by labor from low-productivity to high-productivity sectors, transport and communications, reflecting the burgeoning has been more pronounced since 2017 as the economy information technology (IT) sector in Armenia. Enhanced emerged from the low growth 2012-16 period and productivity of the manufacturing industries could 38 Given a methodological change in the computation of national accounts data in 2012, this discussion focuses on the period since 2012 for compatibility. 32 indicate less barriers to entry in the sector as discussed Figure 27. Exports of Goods and Services in Section 5, as well as enhanced production and exports of apparel which became dynamic during this time. A 100 100 similar sectoral GDP decomposition for the most recent 90 3 period 2017–21 shows that the construction sector was 80 80 36 Percentage of GDP the leading contributor to growth (47 percent) thanks 70 to structural change and saw the largest reallocation 60 60 9 8 Share (%) of labor to the sector. This shows a comeback of the 50 40 sector spurred in part by a government real estate 40 40 3 35 40 development program. However, the negative within- 30 30 sector productivity signals the need to enhance the 20 20 1 23 1 5 allocation of resources within the sector. A critical 10 2 13 14 knowledge gap limits an understanding of the main 0 0 constraints on labor mobility within and across sectors. 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2002 Albania Armenia Bosnia and Herzegovina Estonia Russ Trade Outcomes Georgia Kosovo Moldova Tunisia Source: World Bank national accounts data; OECD National Accounts Trade is an important share of GDP for Armenia— data files. despite being landlocked with only two of four borders open—but Armenia is not well integrated in the global In recent years, the share has been consistent with the economy as its share of trade to GDP is fairly low. average for countries of similar per capita income but still Armenia is a small open economy which is landlocked lower than the share of some peers. Export performance between four countries, two of which have closed was exceptional in 2022, reaching 46.6 percent of GDP, borders. Openness to trade, proxied by the share of boosted by Armenia’s transit hub role and re-exportation total exports of goods and services in GDP, reached its to Russia. peak in 2019 and declined after the twin shocks. The value of goods and services exports as a share of GDP Armenia’s goods exports have become increasingly rose to 41.4 percent in 2019, dropped to 29.8 percent in concentrated on a few trading partners. Major export 2020, and has been recovering since then (Figure 27). destinations include China, the EU countries, Russia, Figure 28. Goods Exports, by Destination 100 90 24 20 24 24 23 24 23 30 26 26 26 29 29 27 28 34 34 32 80 36 5 38 41 2 2 3 3 4 8 3 1 70 7 9 8 6 6 6 17 6 22 22 14 60 8 10 4 28 Share (%) 9 2 28 50 7 49 54 33 30 7 11 37 13 5 48 44 48 46 28 27 4 40 39 36 47 5 40 14 17 18 12 30 12 2 7 11 5 1 0 5 2 11 4 45 20 1 3 1 0 4 1 3 3 1 1 1 5 7 4 3 3 6 4 2 25 28 28 27 28 10 2 20 20 23 20 21 13 14 17 15 15 17 16 11 12 12 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Russia Switzerland China EU USA Rest of the world Source: World Bank staff calculations based on Armenia Statistical Committee external trade database. 33 and Switzerland (Figure 28). Because of the Eurasian Figure 29. Economic Complexity Index Economic Union, Armenia started exporting more to Russia as well as China (which has signed a preferential 0.8 agreement with the Eurasian Economic Union). Exports 0.6 to Russia increased from an average of 17 percent during Economic Complexity Index 2010-16 to 23 percent during 2017-21, while exports to 0.4 China increased from 5 percent to 8 percent. At the 0.2 0.1 same time, Armenia’s exports of gold to Switzerland 0.0 have increased in recent years such that Switzerland -0.2 was the second largest export market for Armenia -0.2 -0.2 between 2017–21, with an average 16 percent share of -0.4 -0.3 exports. -0.6 -0.8 Armenia’s trade is largely focused on mineral exports 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 and services with declining complexity, reflecting Albania Armenia Bosnia and Herzegovina Estonia the thin manufacturing sector as well as barriers to Georgia Kosovo Moldova Tunisia competitiveness. Armenian goods exports are strongly Source: The Economic Complexity Observatory, https://oec.world/en. tilted toward mining and manufacturing products of Note: Simoes and Hidalgo 2011. limited complexity, and the economic complexity of exports has declined since 2012 from an already low- complexity basket.39 As primary products such as Mining accounts for the largest exports for Armenia copper, ore, and gold grew in importance over the and one-fifth of the industrial sector. The sector’s share past two decades, the country’s economic complexity of GDP has been rising gradually, increasing from 3.4 declined, falling 25 positions in the index ranking since percent in 2020 to 4.6 percent in 2022.41 In 2020, copper 2012 (Figure 29).40 In 2020, Armenia ranked 77th among ores, gold, and ferroalloys were among Armenia’s top 127 countries, with an economic complexity index of five export products, accounting for almost half of total −0.37, significantly below peers. Armenia is slightly less exports (Figure 31). At a sectoral level, mining’s share of complex than expected for its income level. This result Armenia’s goods exports increased from 12.4 percent has been driven by a lack of diversification, as exports in the 2000s to approximately 30 percent on average have become more concentrated in primary products. during 2015–2022. This increase was driven primarily by While apparel exports (in particular, coats and anoraks) the emergence of copper, which represented 7.1 percent experienced increased dynamism and significantly of Armenia’s goods exports in 2002 and increased to contributed to growth of overall goods exports, new 27.8 percent in 2015–20. product discoveries have been trending downward for both overall and apparel exports since the mid-2000s (Figure 30). The significant decline in new product discoveries may signal lower competitiveness. 39 Economic complexity is a measure of productive expertise—that is, the knowledge in a society as expressed by the amount of goods pro- duced. It combines the diversity in the exports a country produces and the ubiquity of these exports, as reflected by the number of countries able to produce such goods. Countries that can sustain a diverse range of productive expertise—including sophisticated, unique expertise— are found to be able to produce a wide diversity of goods, including complex products that few other countries can make. 40 Economic complexity is associated with economic growth across countries. Armenia’s current index may represent the narrowness of the ability of Armenia to leverage opportunities to diversify production using existing expertise. The government recognizes this limitation and has set a goal of increasing economic complexity from −0.39 to 0.1 points in the medium term and achieving a good ranking among countries with high economic complexity. This is reflected in the Armenia 2021–26 Strategy. 41 Based on ArmStat national accounts data. The closure of one of the copper mines resulted in a reduced sector share for 2022. 34 Figure 30. New Product Discoveries 500 449 450 404 400 Number of HS6 products 350 300 286 262 250 201 200 196 172 150 128 129 96 106 100 75 76 82 77 74 63 53 51 62 51 39 41 44 45 50 31 20 26 30 29 12 9 12 10 7 11 7 3 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Total Textiles and clothing Source: World Bank staff calculations based on data from BACI; Gaulier and Zignago 2010. Note: BACI = Base pour l’ Analyse du Commerce International (Database for International Trade Analysis); see Gaulier and Zignago (2010). HS6 = products at the six-digit level in the harmonized international product nomenclature of the World Customs Organization. Figure 31. Exports, by Product Type, Armenia 3.5 3.0 1.3 1.5 2.5 1.3 1.2 US$, billions 1.0 2.0 0.2 1.0 0.3 0.1 0.2 0.1 0.2 1.5 0.2 0.2 0.3 0.2 0.2 0.8 0.9 0.8 0.2 0.2 0.9 1.0 0.1 0.2 0.3 0.1 0.4 1.0 0.9 0.3 0.5 0.3 0.8 0.6 0.1 0.1 0.2 0.3 0.6 0.7 0.1 0.1 0.1 0.1 0.2 0.2 0.2 0.3 0.5 0.6 0.4 0.1 0.2 0.1 0.1 0.7 0.1 0.1 0.2 0.8 0.9 0.9 0.2 0.3 0.2 0.1 0.1 0.1 0.2 0.2 0.7 0.7 0.2 0.3 0.1 0.1 0.1 0.5 0.1 0.1 0.1 0.1 0.1 0.3 0.2 0.4 0.3 0.3 0.1 0.1 0.2 0.1 0.1 0.1 0.2 0.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Copper ores Gold Rolled tobacco Hard liquor Ferroalloys Others Source: World Bank calculations based on data from BACI; Gaulier and Zignago 2010. Note: Shows the evolution of exports by product type. Among goods imports, Armenia is heavily reliant on on petroleum, coal, and seed oil imports from Russia and imported fuels. Industrial supplies and capital goods are Ukraine, with only a few comparators showing higher also essential imports for Armenia. Similar to exports, dependency ratios (Figure 32). In addition, Armenia large shares of imports are sourced from a few trading is 100 percent dependent on imports for natural gas partners, with Russia, China, and Iran leading the ranking (mainly from Russia), which accounts for 63 percent of in recent years. Of special interest given the current the country’s primary energy supply and is widely used geopolitical context in ECA, Armenia is highly dependent for power generation, heating, and transport. 35 Figure 32. Goods Imports, by Source, Armenia a. Petroleum and coal products import dependency b. Seed oil import dependency on on Russian Federation and Ukraine, 2017 Russian Federation and Ukraine, 2017 Turkmenistan 9% 2% Germany 4% Gibraltar 11% Azebaijan 4% Turkey 11% Portugal 5% Lebanon 14% Moldova 1% 5% Kazakhstan 14% United Arab Emirates 7% Ukraine 15% Poland 1% 6% Georgia 15% Israel 9% Denmark 16% North Macedonia 9% Latvia 16% Turkey 4% 5% Falkland Islands 17% Netherlands 10% Caribbean Netherlands 19% Iran 10% Malta 19% 1% Egypt 13% Moldova 24% Lebanon 17% Greece 25% Belgium 7% Estonia 29% Belarus 10% 18% Tajikistan 62% Mongolia 35% Kyrgyz Republic 63% Armenia 39% Armenia 71% North Korea 1% Uzbekistan 71% Georgia 29% 34% Mongolia 89% San Marino 88% 0% 20% 40% 60% 80% 100% 0% 20% 40% 60% 80% 100% Russia Ukraine Russia Ukraine Source: World Bank staff calculations based on GTAP Database. Service exports are a key component of Armenia’s diversification of its service exports is helping mitigate exports and mitigate the challenge of being landlocked. the challenge of being landlocked. Service exports accounted for more than 40 percent of Armenia’s total exports in 2019 and 35 percent in Foreign Direct Investment 2021, with the decline mirroring the disproportionate toll of the COVID-19 crisis on services as opposed Armenia’s FDI inflows declined gradually starting in to goods trade. Service exports are mostly driven by 2008 and reached a low during the pandemic, before transport, travel, and IT services (Figure 33). Over time, recovering strongly in 2021. Armenia’s FDI amounted to Armenia’s service exports have been relatively more 2.8 percent of GDP in 2021, up from 0.4 percent of GDP dynamic compared to peers. This finding holds even in 2020 which was its lowest share in over two decades when excluding traditional services such as travel and and the lowest share of all peers in 2020 (Figure 35). transport, highlighting the importance of IT services FDI stocks also picked up in 2021, but their dynamism for Armenia’s economy (Figure 34).42 Information and relative to GDP did not. FDI stocks as a share of GDP communication technology (ICT) service exports as a remained around 40 percent, significantly lower than for share of total service exports more than doubled from most peers and in line with levels since the mid-2010s 10 percent in 2017 to 22 percent in 2021. Armenia’s (Figure 36). Russia is still the largest holder of FDI stocks share of services trade in GDP (30 percent on in Armenia, but its share has declined since 2014 as the average since 2015) also tops the shares of all other shares of the EU, North America, Middle East, and other landlocked countries, suggesting that Armenia’s skillful regions increased (Figure 37). 42 A Trade and Competitiveness Diagnostic, currently under preparation, further examines servicification of Armenia’s manufacturing. 36 Figure 33. Commercial Service Exports, Armenia and Figure 34. Commercial Service Export Performance, Peer Countries, 2019 Excluding Travel and Transport, Armenia and Peer Countries, 2005 = 100 100% 600 341 319 1.572 660 500 80% 654 197 1.276 460 1.203 663 Index (2005 = 100) 35 400 60% Share 472 32 66 3.027 300 308 40% 24 37 24 233 1.691 524 200 26 502 305 20% 774 287 100 329 633 720 752 40 200 1 4 0% 0 Albania Armenia Bosnia Estonia Georgia Moldova Tunisia 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 and Herzegovina Personal, cultural Telecommunications, Albania Armenia Bosnia and Herzegovina Estonia and recreational services computer and information services Georgia Kosovo Moldova Tunisia Goods related services Other business services Construction Financial services Insurance and Charges for use of pension services intellectual property Source: World Bank staff calculations based on data of BaTIS (Balanced Source: World Bank staff calculations based on data of BaTIS (Balanced International Trade in Services, 2005–19) (dataset), Organisation for International Trade in Services, 2005-19) (dataset), Organisation for Economic Co-operation and Development; World Trade Organization, Economic Co-operation and Development; World Trade Organization, https://stats.oecd.org/Index.aspx?DataSetCode=BATIS_EBOPS2010. https://stats.oecd.org/Index.aspx?DataSetCode=BATIS_EBOPS2010. Figure 35. Benchmarking FDI Net Inflows Figure 36. Armenia and Peers: Stock of FDI (% of GDP) 20 140 120 16 100 Percentage of GDP Percentage of GDP 12 80 8.2 8 60 50 5.1 40 4 41 2.8 20 25 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Albania Armenia Bosnia and Herzegovina Estonia Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Georgia Kosovo Moldova Tunisia Source: UNCTAD data from https://unctadstat.unctad.org/wds/ Source: UNCTAD data from https://unctadstat.unctad.org/wds/ TableViewer/tableView.aspx and; BOP/IIP data from Balance of TableViewer/tableView.aspx and Payments and International Investment Position Statistics (dashboard), International Monetary Fund. Note: The figure shows net inflows (new investment inflows, less disinvestment) from foreign investors. 37 Figure 37. FDI Stock in Armenia (by Country) Figure 38. Greenfield Investment Projects, Armenia 6,000 30 1000 841 875 900 359 397 25 5,000 223 25 24 147 800 266 313 22 330 244 545 700 Number of projects 4,000 219 20 104 366 349 372 19 594 US$, millions US$, millions 235 253 280 717 600 310 238 254 16 198 1,162 227 15 3,000 684 15 500 415 446 844 1,459 400 985 10 10 2,000 1,111 9 8 300 7 7 2,598 6 263 200 1,000 2,101 5 1,615 1,713 205 1,374 3 100 89 0 0 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 European Union (27) Russian Federation Number Investment amount (right axis) North America Europe and Central Asia (excl, EU27) Middle East and North Africa Latin America and the Caribbean East Asia and the Pacific Sub-saharan Africa Not classified South Asia Source: IMF Coordinated Direct Investment Survey. Source: FDI Markets database from the Financial Times Ltd 2023. Armenia’s FDI inflows and greenfield investments bulk of FDI inflows involve resource-seeking FDI in have experienced a strong post-pandemic revival, but extractive industries and energy. Most FDI projects it is too soon to gauge whether this trend reversal will coming to Armenia in 2003–12 were in sectors that be sustained. At US$998 million in 2022, FDI net inflows attract resource- or market-seeking FDI, such as were 2.6 times those in 2021 (Figure 23). In 2022, financial services, communication, or metals. Many FDI greenfield investment had an equally strong showing, projects in 2013–22 were also in tradable services, several multinationals with operations in Russia moved such as software and IT and business services, which their offices to Armenia, while an influx of Russian citizens have emerged globally as the top sectors for FDI to the country brought in new talent. Foreign investors (Figure 39). However, overall FDI inflows recorded announced a record 24 FDI projects in Armenia in 2022, by the Central Bank of Armenia (CBA) shows that the a three-fold increase over 2021 (Figure 38). However, average project capital expenditure (capex) was much it is too early to determine whether these recent higher in sectors such as metals (mining/extraction, developments signify a reversal in trend or whether they with average project capex of US$78 million) than reflect a catching up for COVID-era stalled investment in service-oriented sectors such as software and IT and the exceptional inflows to Armenia related to the (average project capex of US$18 million, median capex Russian influx in 2022. of US$6.7 million). The top-performing sectors in FDI inflows in 2014–21 were electricity and gas, mining, The top sectors for greenfield FDI projects have quarrying and other mining support services, and real been shifting toward tradable services, but the estate activities (Figure 40). 38 Figure 39. Top Sectors for Greenfield FDI, Number of Figure 40. Top Three Sectors by FDI Inflows, 2014–21 Projects Software and IT 16 2014 2015 2016 34 Financial services 14 47 Manufacture Mining and Accom- Electricity, of Electricity, quarrying Mining modation Business services 5 gas, beverages gas, support 10 steam steam services Communications 25 Mining and Crop and animal Real state 9 quarrying production activities Transportation and 3 warehousing 5 2017 2018 2019 Renewable energy 3 5 Mining Mining Electricity, Mining Real state support and gas, support Electricity, activities Industrial equipment 3 4 services quarrying steam services gas, steam Metals 2 14 Air transport Manufacture of basic metals Real state activities Textiles 2 2020 2021 Hotels and Tourism 3 Mining Electricity, support gas, 0 10 20 30 40 50 Real state services Mining and steam activities quarrying Number of projects Electricity, Real state gas, steam activities 2003-2012 2013-2022 Source: FDI Markets database from the Financial Times Ltd 2023. Source: Statistical Office of Armenia: Inflows of foreign and direct investments by type of activity, 2014–21 (balance of payment and international investment position, sixth version – BPM6). 4.2. Drivers of Poverty Reduction decreased in both periods as total income per capita rose by 45 and 13 percent, respectively.43 According Evolving Drivers of Poverty Reduction to the ILCS, employment measured by the share of employed among working-age household members Drivers of poverty reduction are tied to the dynamics (ages 15–75) rose in 2016–21 by 12.2 percentage of the ongoing structural transformation. Growth points (from 32.0 to 44.2 percent), compared with a 4 analysis revealed that Armenia is going through a percentage point increase in 2010–16 (from 28 to 32 structural transformation in which the agricultural percent). The dramatic rise in employment contributed sector, characterized by low productivity, is shrinking significantly to poverty reduction in 2016–21. in terms of employment and value-added share while the service and industrial sectors are becoming more Growth analysis shows that the expansion of the prominent. These shifts help explain the results of industrial and services sectors did not necessarily the income growth decomposition analysis, in which result in an increase in employment. Coupled with the households’ income generation structure is linked to demographic shift, employment remains a critical factor poverty reduction (Figure 41). The analysis compares two for poverty reduction. However, during 2010–16, there periods, 2010-16 and 2016-21, as 2016 was the year of was a net reduction in employment. Yet at the same a structural break in the growth trajectory as discussed time, Armenia’s shrinking population, accompanied by a in Section 3. It coincides with the latest data used for decline in the number of working-age adults, resulted in the poverty analysis in SCD1, allowing the analysis to a rise in the share of employed among adults within the compare before and after SCD1. household. This demographic shift led to an increase in income per capita which resulted in poverty reduction. Having jobs has become an increasingly important The larger impact of employment in the second period driver of poverty reduction in recent years. The results is thanks to the larger increase in the share of employed from the decomposition analysis show that poverty among working-aged adults within the household. 43 The income growth decomposition uses income per capita as the variable of interest instead of per adult equivalent consumption aggregate. As such, the national poverty lines for the respective years are adjusted by the marginal propensity to consume. 39 Figure 41. Decomposition of Income Poverty Reduction 3 2.5 2.2 2 1.7 1.2 1 0.5 0.7 0.1 0.1 0 Percentage points -1 -0.4 -0.7 -2 -3 -2.5 -3.1 -4 -3.7 -5 -4.9 -6 -6.1 -6.2 -7 Dependency Employment Wages Agriculture Social Remittances Other Poverty ratio protection 2010-2016 2016-2021 Source: World Bank staff calculations based on ILCS. Note: Negative values indicate contribution to reductions in poverty, while positive values indicate contribution to increases in poverty. Details of each component are as follows: Dependency Ratio: share of adults in the household; Employment: share of employed adults in the household; Wages: average wage income per employed adult in the household (from manufacturing and services sector); Agriculture: average agricultural income per employed adult in the household; Social Protection: average social protection benefits per adult in the household; Remittances: average remittances per adult in the household; Other: average income from other sources per adult in the household (includes income from stocks or financial actions, sales of real estate, and income from property). The increase in wages from the growing industry and schooling and labor market experience) highlights that services sectors was also an important contributor the rate of returns to schooling fell from 6 percent in to poverty reduction, especially in 2010–16. Wages— 2010 to 4 percent in 2016 and 2 percent in 2021 (Figure measured by the wage income from the industry and 42).44 This is an exceptionally large decline: the literature services sectors per adult in the household—increased, shows that, on average, returns to schooling declined by reflecting the improvement in productivity in these two 3.5 percentage points worldwide since 1980, associated sectors driving the structural transformation. However, with an increase in the supply of schooling by almost 50 due partially to a larger shift of labor into the industrial percent (Patrinos 2016). In the case of Armenia, returns sector during 2016–21, the productivity in this sector did dropped by 4 percentage points in a decade without a not grow as much in the second period compared to the change in the supply of schooling (Table 1). first. This resulted in a smaller contribution of wages to poverty reduction in the second period. The improvement in the contribution of agricultural income to poverty reduction reflects an increase in While labor income continues to play an important role agricultural income for those who remained in the in reducing poverty, the contribution of wages has fallen agricultural sector. The impact of agricultural income in recent years, which may be explained by the drop in in 2016–21 was neutral for poverty reduction—an returns to education. Unlike the pre-2016 period, the improvement from 2010–16, when the impact on poverty contribution of wages to poverty reduction fell in 2016– reduction was negative. The improvement in 2016–21 was 21. One possible explanation for the observed changes thanks to a decline in the size of the workforce remaining in wage income is the significant and persistent decline in in the agricultural sector with the ongoing structural returns to education. Analysis using the Mincer equation transformation, which raised productivity and increased (in which wage earnings are regressed as a function of income for those remaining in the agricultural sector. 44 Specifically, the estimates are the result of regressing the logarithm of wage on years of schooling, experience, and experience squared. 40 Figure 42. Returns to Schooling Yet as shown in the growth analysis, productivity of the agricultural sector is substantially lower and has 7% 6.3% a long way to converge with that of the industrial and 6% services sectors. Given the significant share of the 5% poor employed in the agricultural sector (Figure 43), 4.1% 4% improvement in agriculture productivity is expected to 3% lead to higher incomes for the poor employed in the 2% 2.0% agricultural sector if supported by the right policies. 1% Policies need to address the lack of scale, lack of skills 0% and knowledge that is holding back many farmers from 2010 2016 2021 investing in new agricultural technology, inefficient land Source: ILCS 2010, 2016, 2021. markets, and vulnerability to risks from climate change including weak irrigation systems. Table 1. Years of Schooling Although social protection has contributed to poverty reduction, the impact on poverty reduction was Year relatively small compared to other factors. Pensions Population group are the biggest component of social transfers, benefiting 2010 2016 2021 not only the poor but the whole population so the impact 13.2 12.5 13.3 is not progressive. The Family Benefit Program is the Total largest monetary and targeted social assistance program Men 13.2 12.4 12.7 in Armenia, both in terms of population coverage and Women 13.3 12.7 13.7 fund allocation from the State Budget. The program is well-targeted in allocating 80 percent of the benefits Source: ILCS 2010, 2016, 2021. to the bottom 40 percent.45 However, coverage is low, benefiting only about one-fourth (26.3 percent) of the Figure 43. Sector of Employment by Poverty Status, poor as measured by the national poverty line in 2021 2021 (ArmStat 2022a), so it has had a relatively small impact on poverty reduction among the factors considered in 100% the analysis.46 21% 27% 80% The declining rate of growth in remittances among Percentage of workers 21% poor households has counteracted the progress in 60% poverty reduction. On average, per capita remittances 32% 14% per month increased by 10 percent during 2010–16 40% and accelerated to a 16 percent increase during 2016– 14% 21. However, the share of remittances in household 20% 44% total income is consistently larger among better-off 26% households: 9 percent among the non-poor versus 0% 6 percent among the poor in 2010, 9 percent (non- Poor Non-poor poor) versus 5 percent (poor) in 2016, and 6 percent Agriculture Industry Services Others (non-poor) versus 4 percent (poor) in 2021. The rate of Source: World Bank staff calculations based on ILCS 2021. increase in absolute terms between the two periods, 45 In 2021, around two-thirds of the bottom 40 percent was identified as poor. 46 There was also a reduction in the number of beneficiaries among the bottom 40 percent and a smaller increase in the benefits received during the 2016–21 period, which led to a drop in its contribution to poverty reduction. 41 2010-16 and 2016-21, was also larger among the non- secondary cities during 2011–18.48 In 2021, 52 percent poor (9.4 percent) compared to the poor (6.7 percent).47 of the poor lived in rural areas, while the share was 16.7 percent in Yerevan and 31 percent in other urban Spatial Dimensions of Poverty and areas. Disparities in living standards were substantial in Vulnerability 2021, with the average monthly consumption per adult equivalent in Yerevan being almost 30 percent higher Disparities in welfare persist across geographic than in rural areas in real terms.49 areas, and spatial variation is pronounced at the community level. The poverty rate fluctuates widely The spatial gap in welfare is correlated with a gap in across regions each year, with the highest rates observed connectivity and access to basic services. Economic in Gegharkunik followed by Shirak in 2021 (Figure 44). activities are concentrated in Yerevan and surrounding However, the regional average masks the variation of wealth cities and communities in the central-west areas.50 Less at the community level. Yerevan and the surrounding well-off communities tend to be located far from the main communities in the central and northwestern areas are road network and poorly connected to markets. The associated with relatively higher levels of wealth. rural-urban divide is also notable in terms of access to basic services such as roads, schools, water, and health The poor are concentrated in rural areas, followed by facilities, which also affects outcomes in human capital secondary cities (Figure 45). The concentration of the accumulation (Figure 46).51 Although progress has been poor in rural areas has intensified since 2020, while the made in poverty reduction in recent years, secondary share of the poor was equally large or even higher in cities still face a lack of opportunities in the labor market. Figure 44. Regional Poverty Rates Figure 45. Distribution of the Poor, by location 60 100% 50 Gegharkunik; 49.1 48.1 80% 35.7 34.5 35.4 36.2 36.4 38.5 37.6 40.3 34.2 38.2 51.1 52.2 Percentage of population Shirak; 46.9 42.9 Share of poor population 40 Tavush; 38.2 37.5 Armavir; 37.9 60% 32.9 32.8 30 32.2 Ararat; 28 Vayotz Dzor; 26.6 21.9 Kotayk; 23.6 40% 30.1 43.6 37.9 37.5 36.3 34.1 34.2 32 38.1 29.7 27.9 31.1 20 19.9 Lori; 21.8 19 17.4 Yerevan; 15.9 Aragatsotn; 13.5 20% 10 6.1 34.2 27.5 26.7 26.3 27.3 27.4 28.2 27.7 27.7 32.1 21 16.7 Syunik; 2.8 0 0% 2020 2021 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Yerevan Aragatsotn Ararat Armavir Kotayk Shirak Syunik Vayotz Dzor Yerevan Other urban Rural Gegharkunik Tavush Lori Source: World Bank staff calculations based on ILCS 2020 and 2021. Source: ArmStat Social Snapshot, 2011–22. 47 The trend in remittances varies by the definition of households’ welfare status—whether they are based on income or consumption, and wheth- er to use the value excluding or including remittances. It would also depend on how the averages are calculated—whether the estimates are averaged across all households or only among beneficiary households. 48 Historically, the poverty rate has been higher in other urban areas than in rural areas, but the trend reversed in 2019. This may be due at least partially to the changes in the design of the questionnaire of the ILCS and the computation of the consumption aggregates. 49 The average monthly consumption aggregate per adult equivalent in 2021 was 77,957 AMD in Yerevan, 65,746 AMD in other urban areas, and 61,266 AMD in rural areas (ILCS 2021). 50 Economic activities are measured by night-time lights as the proxy for GDP in the area. 51 According to the source, close to 600 rural settlements lack access to regular water supply, many of them located near the border with Azer- baijan. 42 Figure 46. Rural-Urban Divide, Accessibility and Human Capital Outcomes 60% 44.5% Percentage of population 40.5% 40% 38.2% 38.8% 35.7% 32% 30.7% 30% 20% 4.1% 0% 0% 0% 0% 0% 0% 0% School Health services Transportation Not having access to Underemployment decent jobs Low accessibility to services Gap in outcomes Yerevan Other Urban Rural Source: World Bank staff calculations based on ILCS 2021. Characteristics of the Poor: Lack of Human is larger than the typical gap of 55 points across the Capital and Limited Access to Services and 50 countries for which data are available (World Bank Opportunities 2020f). The poor are also deprived in terms of health, with a larger share of the population having to terminate The poor lack human capital in terms of education and usual activities due to illness, injury, or bad health (Figure health, which undermines the growth of household 48). According to the Human Capital Index (HCI), an income over their lifecycle. Educational attainment Armenian child born today will be only 58 percent as is lower among the poor, as shown by the gap in productive during their lives as they could have been harmonized test scores between the poor and non-poor if they had received the full set of health and education (Figure 47). The gap of 66 points—on a scale that ranges services available, and this rate has remained stagnant from 300 (minimal attainment) to 625 (high attainment)— in recent years (2012–20). Figure 47. Educational Outcome: Harmonized Test Figure 48. Health Outcome: Termination of Usual Scores, by Poverty Status Activities, by Poverty Status 600 50% Percentage of population 41.5% 500 483 40% 36.1% 417 400 Score 30% 300 20% 200 10% 100 0 0% Poverty status Poverty status Poor Non-poor Poor Non-poor Source: World Bank 2020f. Source: World Bank staff calculations based on ILCS 2021. 43 Figure 49. Deprivation in Access to Services (%) 50 43.2 45.4 41.0 40 33.0 30 25.3 25.6 25.3 Percentage of population 20 16.8 50 19.7 18.7 43.2 14.7 9.5 11.2 40 11.8 10 4.8 4.1 33.0 1.8 3.4 3.9 0.8 30 25.3 0 Percentage of population 19.7 20 16.8 Not attending compulsory education No access to education Di culty a ording health services Di culties accessing health services No access to centralized sanitation or garbage disposal system No access to centralized water system Using unhealthy heating sources Poor access to transportation No access to hot running water No access to internet 9.5 11.2 10 4.8 4.1 1.8 3.4 0.8 0 Not attending compulsory education No access to education Di culty a ording health services Di culties accessing health services No access to centralized sanitation or garbage disposal system No access to centralized water system Education Health Others Poor Non-poor Source: World Bank staff calculations based on ILCS 2021. Note: For education, figures show percentage of those between ages 15–75. Education Health Poor Non-poor The 50disparity in human capital outcomes 47.5 is associated Figure 50. Opportunities in Labor Market, by Poverty with inequalities in access to services. Compared42.1 to Status (%) 40 37.2 Percentage of population (15+ years) the non-poor, the poor face difficulties accessing32.5basic 30 services such as education, health, sanitation services, 50 47.5 22.6 42.1 20digital connectivity and 19.8 (Figure 49). 40 37.2 Percentage of population (15+ years) 32.5 10 8.2 30 The poor also lack access to opportunities as measured 2.9 22.6 19.8 by access 0 to good-quality jobs. While 65 percent of the 20 Deprived of labor market participation Long-term unemployment Not having access to decent jobs Under employment working-age population (ages 15–75) are employed, the 10 8.2 rate among the poor was 59 percent in 2021. Among 2.9 0 the employed, a disproportionately larger share of the Deprived of labor market participation Long-term unemployment Not having access to decent jobs Under employment poor is employed in the low-productivity agricultural sector and a smaller Poor share Non-poor in the higher-productivity service sector. This is reflected in difficulties accessing good-quality jobs. Good-quality jobs are not widely Poor Non-poor available, and they are unequally distributed across Source: World Bank staff calculations based on ILCS 2021. socioeconomic groups with almost half of the poor (47.5 percent) not having access to decent jobs, compared to 37 percent of the non-poor (Figure 50). by improving labor productivity in the agricultural sector (World Bank 2020b). Labor mobility across sectors was low and did not contribute to poverty reduction, indicating that Vulnerability to Environmental Risks improving labor productivity in agriculture is key to reducing poverty. Analysis by the World Bank shows Armenia’s climate risk is high relative to other that almost none of the poverty reduction came from a countries, with above-average projected temperature transition of workers from one sector to another, revealing rises and climate volatility (IMF 2022a), and exposure low worker mobility and weak labor market dynamism to risks varies significantly across geographic areas. (World Bank 2020b). Therefore, continued efforts are Temperature rise causes shifts in evaporation from needed to decrease poverty among agricultural workers the land, changes in the magnitude and frequency 44 of heavy precipitation, and flooding. Notably, the climate-related risks are not equally distributed across geographic areas of Armenia. For example, regions in the north are exposed to higher risk of floods, while temperature variation is higher in the central-western and south-eastern areas of Armenia. These gaps in exposure to risks will have unequally distributed impacts on livelihoods across space, which can exacerbate disparities in welfare across regions and communities. Climate-related risks and natural disasters are also expected to have distributional impacts across socioeconomic groups. The poor may be more vulnerable to climate change due to both higher exposure and low adaptive capacity. Climate change is expected to heavily affect agricultural activities in Armenia through degradation of land and increased flooding risk, which negatively affect productivity.52 As agriculture is the dominant source of livelihoods for the poor in Armenia, this is likely to hurt the poor. To mitigate the potential damage from climate change, their adaptation capacity should be increased, for example by changing inputs and technology in agriculture and enhancing employability in the non-farm sector through accumulation of human capital. 52 For example, an analysis in India showed that a moderate level of warming over the next three decades could result in a 17 percent reduction in agricultural productivity and a 3-4 percentage point increase in the national poverty rate (Jacoby et al. 2011). 5 Key Challenges to Resilient, Sustainable, and Inclusive Growth 46 T his section examines empirical evidence to identify the main challenges to attaining the twin goals in Armenia in a sustainable way. The section identifies the most salient challenges since SCD1 by exploring both macroeconomic and SCD2 identifies five major challenges to achieving sustainable, inclusive, and resilient growth in Armenia. While most were identified in SCD1, there is a shift in focus given the changing economic and geopolitical circumstances as discussed earlier. Although many of microeconomic constraints informed by the growth and the same constraints are still hindering faster progress poverty analyses in Sections 3 and 4, those identified in achieving the twin goals, Armenia has experienced in SCD1, and those that seem most relevant going rapid changes in external and internal conditions since forward. Figure 51 maps the most important barriers to SCD1, and building resilience to fragility and conflict has more sustainable growth, stronger poverty reduction, become a new challenge in light of the vulnerability and shared prosperity as identified by the analysis of revealed by heightened geopolitical tensions in the Sections 3 and 4. The intersection of the results from the region. At the same time, some of the challenges two analyses informs the key challenges for Armenia to identified in SCD1—for example, macroeconomic address. While “governance, institutions, and data” does management—have become less pressing thanks to not explicitly emerge from the analysis in Sections 3 and successful implementation of certain policy reforms 4, it is identified as a constraint that cuts across sectors since SCD1. Nonetheless, continued efforts are in Armenia and underpins all of the challenges identified. recommended to cope with the highly unpredictable Appendix C includes a summary of the key findings of economic challenges facing Armenia. Since effective SCD1, and Appendix E describes the methodological governance and institutions are essential for creating steps for identifying comparison countries to benchmark an enabling environment for sustainable and inclusive progress and challenges in Armenia. growth, governance and institutions have been Figure 51. Barriers to Growth and Poverty Reduction Barriers to Growth Intersecting Challenges Barriers to Poverty Reduction Vulnerability to fragility and conflict • Vulnerability to fragility and Low quality of human capital and economic shocks conflict Gaps in access to services and markets Low investment from both domestic • Vulnerability to economic in rural areas and for the poor and foreign sources shocks Lack of opportunities to access Low quality of human capital • Unequal access to markets good-quality jobs Misallocation of resources across • Low human capital Vulnerability to fragility and conflict, sectors economic shocks and climate change • Lack of investments in and environmental risks Limited connectivity with external strategically important sectors markets, with high transport and Ine ciencies in the social protection logistic costs system Insu cient incentives to participate Low productivity in the agricultural in the labor forces sector Source: World Bank staff analysis. 47 Figure 52. Evolution of Key Challenges for Inclusive and Sustainable Growth from SCD1 to SCD2 CHALLENGES IN SCD1 CHALLENGES IN SCD2 C4: Resilience and Sustainnability 1.1. Vulnerability to risks of fragility, conflict, and violence (NEW in SCD2) • Macroeconomic management • Demographic changesand impact on health and pension needs • Large share of vulnerable households, instruments 1.2. Vulnerability to economic shocks available to cope with shocks • Climate change, environmental 1.3. Vulnerability to risks from climate change, environment, and natural disasters C1: External Sector Performance • High trade costs • Global connectivity infrastructure (hard and soft) 2. Accessibility to markets and better integration for trade C2: Labor Productivity • Labor market relevance of the education system 3. Quality of human capital • Skill match • Care responsabilities 4. Private sector development C3: Private Sector Productivity • Investment climate • Market contestability Cross-cutting challenge: Governance and Institutions • Financial deepending and access to finance (NEW in SCD2) Source: World Bank 2017a and staff analysis. added as a cross-cutting area given the reduction environment, increasingly frequent destructive events in government effectiveness and the salient need to associated with climate change and natural hazards enhance institutional capacity. Figure 52 summarizes require adequate preparedness for environmental the evolution of the major challenges. and climate shocks. This section discusses three key vulnerabilities for Armenia then highlights vulnerable 5.1. Vulnerability to Shocks and groups who are particularly at risk and some resilience Environmental Risks factors. To achieve sustainable and inclusive economic 5.1.1. Fragility and the Risks of Conflict growth, Armenia will need to strengthen its capacity to manage shocks and environmental risks. At the A deep and widespread sense of insecurity resulted macroeconomic level, fragility and vulnerability to from the outcome of the 2020 military conflict in conflict as well as rising inflation underscore the need to Nagorno-Karabakh, amid broader geopolitical shifts. improve resiliency, particularly given Armenia’s historical The results of the aforementioned event have brought a external dependence on Russia. The huge disruptions paradigm shift in Armenian polity and society, as public in economic growth during the 2007–09 global financial opinion priorities have shifted away from economic and crisis, the end of the commodities super cycle in 2015–16, governance issues to security issues. The 2020 military and the twin shocks in 2020 are evidence of the country’s conflict and the 2021 and 2022 fighting in the border fragility to economic shocks. At the microeconomic area, including in Armenia’s territory, have created level, households remain vulnerable, while the social considerable social scars and grievances and many protection system could be strengthened. In terms of the Armenians (particularly those in border areas) continue 48 to experience disruptions to their livelihoods. Armenia’s negative impacts on investor sentiment, FDI, and sense of insecurity is the product of the interplay of economic outcomes. For example, the September 2022 various factors of fragility moderated by dimensions of fighting disrupted the key tourist town of Jermuk, close resilience (Box 3). to where recent violence occurred, and has affected a nearby gold mining project’s efforts to raise investment. The ongoing conflict and unresolved peace process This has also presented several problems related with have ramifications for Armenia’s development path. non-irrigated and unused lands and water resources Persistent political uncertainty could inevitably have and resulting environmental impact. Box 3. Structural Factors of Fragility, Risk, and Resilience Factors of fragility and risk • Armenia’s fragile state of relations with two immediate neighbors is rooted in deep historical grievances that are difficult to resolve, continue the possibility of renewed conflict, and significantly constrain the prospects for development. • Armenia’s relatively small size and landlocked position, the overall geopolitically complex setting, and the country’s dependence on energy imports create significant dependency on Russia and vulnerability to regional and global power politics. • Domestically, Armenia is ethnically homogeneous but has considerable demographic and regional disparities in outcomes and a high level of social vulnerability that, in a context of exclusion grievances, create space for the erosion of trust in institutions. • Armenia’s economy is vulnerable to externally induced shocks that, considering the share of the vulnerable population, have the potential to disrupt social stability and amplify other drivers of conflict. Factors of resilience • Armenia is a fragile but relatively developed democracy with a homogenous society, strong sense of identity, and high degree of state legitimacy. • Armenia continues to have other sources of remittances outside of Russia, and its diaspora still has considerable untapped human capital potential. • Armenia can rely on a range of external multilateral memberships and bilateral partnerships, as well as on the role of its diaspora to muster political support. • Armenia’s youth and its women, particularly in urban centers, have an increasing sense of agency in the public sphere and are among the most affected by conflict and violence. As such, they can be key drivers in addressing some of the social and political elements of fragility. Potential risks going forward • The potential broadening of geopolitical uncertainty in the region may increase volatility in Armenia’s relations with its neighbors. • The Armenian economy’s dependence on developments in Russia leaves it exposed to short-term economic volatility and shocks, as well as to medium-term structural economic changes as markets adjust to the new conflict situation. • Environmental risks and shocks that increase social vulnerability are also possible, either as a side effect of war or due to continuous degradation by economic activity and climate change. • The government’s ability to build resilience to the drivers of fragility or risks faces the obstacle of limited fiscal space. The materialization of risks would require difficult expenditure trade-offs that may raise issues of debt sustainability or fuel political instability. Source: World Bank 2023c. 49 The increased erosion of trust in institutions stems Figure 53. GDP Growth in Armenia and Russia and from growing political and social polarization and Oil Price economic and environmental stressors that deepen 20 120 0 exclusion. The security concerns sparked by the 2020 112 14.0 military conflict have derailed the broader consensus 15 100 -10 12.6 98 100 on governance reform inspired by the 2018 revolution Trade balance, US$ million 10 -20 7.3 by handing the former political establishment a political 80 Annual variation, % 5 71 -30 Price ($/BBL) cause. While Armenia has put in place a robust anticorruption legislative and regulatory framework, 0 60 -40 62 public servants express limited confidence regarding -2.1 -5 -50 -2.7 42 40 the effectiveness of different actors in the fight against -7.2 -10 25 -60 -7.8 corruption.53 Two-thirds of Armenians continue to 20 -15 -70 believe that the country is run in the narrow interests of - -14.1 elites and not the majority (IRI 2022a). -20 0 -80 W 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 and 5.1.2. Vulnerability to Economic Shocks GDP growth, Armenia GDP growth, Russia Price crude oil, Brent (RHS) The lack of diversification makes Armenia vulnerable Source: GDP World Bank WDI https://data.worldbank.org/indicator/ to economic shocks. As discussed earlier, exports NY.GDP.MKTP.KD.ZG, for 2022 World Bank Macro Poverty Outlook; World Bank Commodity Markets. are concentrated among a few trading partners and products. The country’s economic growth history is somewhat akin to that of an oil exporter. First, about dependency ratio of 0.43 (FAO and World Bank 2023).54 one-third of Armenia’s exports are minerals and are thus Certain key commodities for Armenia have high import exposed to commodity price shocks. Second, the strong dependency. For example, Russia accounted for 98 links to Russia have exposed Armenia’s economy to percent of Armenia’s imports of wheat, wheat flour, volatility including from oil price shocks and the 2015- sunflower seed oil, and other cereals; almost 35 percent 16 sanctions on Russia (Figure 53) (Garrote-Sánchez of all agrifood imports; and 39 percent of poultry in et al. 2022). Russia is Armenia’s leading trade partner 2021 (Figure 54). Russia also accounts for more than 50 (accounting for one-third of all bilateral trade over 2018– percent of imports of bread, pasta, bulgur, and pastries 21) and its primary source of FDI (41 percent of net FDI (in value terms). In addition, Russia is Armenia’s primary stock in 2021) and remittances (5 percent of GDP in 2021). source of fertilizers (38 percent in 2021), an input for Russia’s invasion of Ukraine has exposed Armenia to domestic food production. Thus, ad hoc policy changes trade disruptions, and closures among terrestrial and air and supply disruptions from Russia can pose significant transportation centers in the region are disrupting trade threats to Armenia’s food security. routes into and out of the country. In 2022, Armenia became a transit hub for re-exportation to Russia, Armenia’s high share of commodity exports exposes particularly for electronics, transportation equipment, it to several risks. Armenia’s economy is vulnerable and machinery. It is unclear how potential sanctions on to exogenous commodity price shocks. Furthermore, Russia might affect trading partners in the future. any growth in mineral exports, while important for hard currency generation, could present macro-fiscal and Armenia’s high dependence on certain food items long-term structural risks. To some extent, diversifying could pose a risk to food security. Armenia’s reliance the mineral basket (through discovery and development on import dietary energy is substantial, with an import of high-value minerals other than copper and gold) and 53 Armenia Public Sector Accountability Survey. World Bank (May 2023). 54 The import dependency ratio reflects the extent to which a country’s supply of a commodity comes from imports. The higher the ratio, the more dependent a country is on importation. World Bank. Forthcoming. Reconfiguring Trade to Overcome Geographical Limitations: A Trade and Competitiveness Diagnostic for Armenia. Washington, DC: World Bank. 50 Figure 54. Major Imported Agrifood Commodities and can better capitalize on market access to members of Armenia’s Dependency on Supplies from Russia and the Eurasian Economic Union of which it is part and Ukraine in 2021 related free trade agreements (FTAs). Armenia could 120 0 -9 -11 also explore boosting trade with countries where -15 100 -10 there is significant export potential, such as the United 12.6 100 -5 -2 -17 -36 States, France, and the United Kingdom (Figure 55). Trade balance, US$ million -20 -12 80 -30 -27 Price ($/BBL) -67 -18 -29 Estimates based on past crises project that Russia’s 60 -40 -1 invasion of Ukraine could reduce the stock of migrants -37 and increase the labor supply in Armenia (Garrote- -2.1 -50 -43 -2.7 -44 40 -60 Sánchez et al. 2022). Economic developments in Russia 20 could have a strong impact on migration flows in Armenia. -70 -67 In 2020, the stock of migrants dropped from 5.1 percent 0 -80 to 2.9 percent of the working-age population in Armenia Wheat Poultry Sugar Sunflower- Margarine 2021 2022 and meslin seed oil (43 percent of the stock in 2019). Remittances dropped sia Russia Ukraine Rest of the world significantly during the first months of the pandemic but then rebounded, with a final annual drop of 12 percent, Source: FAO and World Bank (forthcoming). lower than previously projected. Shocks to the Russian economy due to international sanctions and the war could lead to contractions in the stock of Armenian moving downstream to domestic processing of minerals emigrants: simulation exercises based on household can reduce the degree of risk. Heavy reliance on primary microdata suggest that the shocks could affect 20,000 commodity exports to generate hard currency can lead to 50,000 returning migrants, or 1-2 percent of the to an over-valued currency, placing other export sectors working-age population (Garrote-Sánchez et al. 2022). at a competitive disadvantage. The lessons learned The net impacts of the return of migrants to Armenia among resource-rich countries over past decades call remain uncertain—the benefits include the supply of for macro-fiscal measures to dampen shocks and avert skilled workers, while the risks include pressures on an over-valued currency. labor markets and other disruptions. To reduce its vulnerability from concentrated trade Economic and other shocks could trigger the realization products and partners, Armenia could seek to expand of important liabilities. Armenia’s debt to GDP ratio fell its export offerings based on comparative advantage, from 63.5 percent in 2020 to 47 percent as of end- diversify its partners, and identify potential alternate 2022 thanks to the dram’s appreciation and strong markets for goods that are vulnerable. Armenia GDP performance. While the public debt is sustainable, would benefit from an export strategy to identify a debt sustainability analysis reveals high sensitivity of these avenues. Armenia’s manufacturing sector Armenia’s public and external debt to a variety of shocks, has a comparative advantage in metal products, with shocks to growth and the exchange rate having the textiles and apparels, food and beverages, and most pronounced impact (IMF 2022b). Climate change other manufacturing.55 In particular, estimates from a risks and contingent liabilities arising from state-owned gravity model using 2021 data suggest that Armenia’s enterprises (SOEs) such as the Armenian National strongest comparative advantage in the manufacturing Interest Fund as well as public-private partnerships are sector relative to agriculture is in metal products other important sources of fiscal risk that need to be (Appendix L). Armenia could also enhance trade with carefully monitored and managed. Such risks could be a wider group of trade partners. For example, Armenia triggered by economic and financial shocks. 55 Countries are said to enjoy a comparative advantage in a certain good when they can produce it more efficiently (at a lesser cost) than other countries. Textiles and wearing apparel, food and beverages, and other manufacturing have a comparative advantage of greater than 0.8 relative to agriculture. 51 Figure 55. Armenia’s Estimated Missing Exports 450 400 Average missing exports in US$, 350 millions (2013-2019) 300 250 200 150 100 50 0 United States China France United Kingdom Türkiye Japan Germany Italy India Korea, Rep. Kazakhstan Ukraine Poland Austria Sweden Australia Saudi Arabia Israel Brazil Spain Czech Republic Belarus Finland Singapore Indonesia Greece South Africa Kuwait Norway Thailand Ireland Denmark Mexico Lithuania Egypt, Arab Rep. United Arab Emirates Iran, Islamic Rep. Portugal Hungary Uzbekistan Pakistan Lebanon Qatar Slovak Republic Malaysia Argentina New Zealand Nigeria Colombia Source: World Bank staff calculations based on gravity model using BACI. Note: This analysis was done using data before the onset of the COVID-19 pandemic. Trade patterns between Armenia and Russia changed significantly after the imposition of sanctions on Russia in 2022. Given increasing global uncertainty and monetary prices, while the exchange rate pass-through associated policy normalization, Armenia also faces risks from with currency depreciation is large and highly significant inflation, especially in the case of dram depreciation. (Khachatryan and Grigoryan, forthcoming). In an uncertain global environment with monetary policy normalization coupled with the risk of commodity Armenia has a reasonable track record of and food price shocks and given Armenia’s energy countercyclical fiscal policy which has dampened dependence, inflation poses a risk to households and output volatility but can be improved. In the face of firms. Headline and core inflation stood at 8.3 percent multiple crises including natural disasters and conflict, and 8.8 percent, respectively, in December 2022 year on Armenia’s reasonably good countercyclical fiscal policy year, and the CBA raised the policy rate to a historically over the last couple of decades—supported by a fiscal high 10.75 percent by end-2022 in response (Figure rule56—has led to less volatile growth compared to many 56). Domestic prices respond differently to currency of its peers (World Bank 2023b). However, the correlation appreciations and depreciations in the short and long in Armenia between real GDP growth and the fiscal run. Exchange rate pass-through analysis on Armenia balance—a signal of countercyclicality—is less strong indicates that, in the long run, currency appreciation has than in Estonia, for example (Figure 57).57 The degree of no statistically significant effect on domestic consumer countercyclicality in Armenia can be improved. 56 Armenia was able to maintain fiscal discipline over the last decade, showing a strong commitment to fiscal rules. However, in response to various shocks, government debt rose significantly from 15 percent of GDP in 2008 to close to 54 percent of GDP in 2017. Fiscal rules were up- graded in 2017 through the establishment of a statutory threshold of 60 percent of GDP. The government demonstrated a strong commitment to these rules by reducing public debt to 50 percent of GDP by the end of 2019. In 2020, as in many other countries, there was a sharp jump in debt to GDP due to high COVID-19-related spending, a sharp fall in revenues, and decline in GDP. Debt rose above the statutory threshold, and the government triggered the escape clause in the fiscal rules to allow for the temporary increase in response to the emergency. 57 This is measured by both the actual balance, which refers to the difference between actual revenue collection and executed spending, and by the structural balance, which is the difference between government revenues and expenditures, corrected by the effect that could be attribut- ed to the economic cycle and one-off events. This indicator aims to capture structural trends to assess whether fiscal policy is expansionary, neutral, or contractionary for a given period. 52 Figure 56. Inflation and CBA Policy Rate Figure 57. Comparison of Growth and Balance Correlations: Correlation Coefficient between Growth and Actual/Structural Balance 12.0 0.7 0.6 0.6 0.6 10.0 0.6 0.5 0.5 0.5 0.5 0.5 0.5 0.5 8.0 0.4 0.4 0.4 0.4 0.4 0.4 6.0 Percent 0.3 4.0 Inflation target 0.2 2.0 0.1 0.0 0.0 Georgia Bulgaria Armenia Poland Romania Turkey Estonia Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct -2.0 2020 2021 2022 2023 CPI inflation, 12-month Policy rate Actual balance Structural balance Source: CBA database. Source: World Bank 2023b. Note: The correlation chart shows the correlation coefficient between real GDP growth and the change in actual and structural balances of the selected countries. Armenia can build more buffers to support fiscal high budget rigidity (Figure 58). On average, 77 countercyclical policy. Budget rigidity refers to the percent of the budget was on spending areas that are constraints on changing the size and composition assessed as “high” rigidity, higher than all peers during of public spending. An increasingly high degree of 2016–21 (Figure 59). High-rigidity expenditure areas budget rigidity may constrain Armenia’s ability to typically include the wage bill, public debt servicing adjust to crises and enhance countercyclical fiscal costs, pensions, subnational transfers, and spending policy. In recent years, Armenia has had persistently on defense and courts. Figure 58. Evolution of Rigidity in Armenia, 2016-2021 Figure 59. Evolution of High Rigidity 100% 90% 90% 80% 81% 79% 77% 76% 70% 74% 73% 80% Percentage share of budget 71% 70% 67% 60% 63% 61% 61% 59% Percentage of budget 70% 58% 50% 60% 75% 75% 79% 75% 40% 81% 80% 50% 30% 20% 40% 19% 10% 15% 30% 0% Armenia Albania Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia 20% 9% 9% 11% 9% 8% 8% 10% 15% 16% 10% 12% 14% 14% 0% 2016 2017 2018 2019 2020 2021 Peers Low Medium High 2015-2019 2020 Source: Ministries of Finance, World Bank BOOST Database; World Source: Ministries of Finance, World Bank BOOST Database; World Bank Force and Momentum Model, World Bank 2023b. Bank Force and Momentum Model, World Bank 2023b. 53 Given the spending pressures related to policy through damages to the agriculture, water, and energy commitments, Armenia will require a combination sector.60 According to the estimates, 0.7 percent of GDP of budget cuts, domestic revenue mobilization, and is at risk from natural disasters such as landslides, floods, improvements in spending efficiency to fulfill policy and severe droughts, which are projected to increase.61 commitments in the event of an economic shock The potential impacts on the well-being of the population (World Bank 2023b). Reforms have led to impressive are also high in Armenia—which ranks 35th globally in results, including increased revenue collection terms of vulnerability to natural disasters—compared and well-managed spending levels, contributing to other countries (Hallegatte et al. 2017; World Bank to macroeconomic stability and debt sustainability. 2022f).62 Relying on additional debt financing may not be viable as it would result in non-compliance with the Adapting to Climate Change and Natural established fiscal rule and further increase borrowing Disasters costs. Revenue mobilization can be boosted further by building on Armenia’s existing strengths in tax policy Adaptation policies focused on resilient infrastructure and administration to enhance the quality of revenue and climate-smart agriculture will help reduce collection and revise the tax policy roadmap. Expenditure Armenia’s vulnerability to chronic and acute climate cuts in other areas would be necessary, although high risks. Armenia has a large adaptation deficit to manage, budget rigidity limits the scope of adjustments. Thus, including insufficient irrigation and high vulnerability to improving spending efficiency is crucial for addressing natural hazards such as droughts, floods, frosts, severe difficult spending choices and thus providing additional storms, and acute disasters such as earthquakes. cushion in preparing for economic shocks. Tailored policies to increase resilience with a focus on the most vulnerable populations can immediately 5.1.3. Climate Change, Environmental Risks, reduce climate risk to assets from 0.73 percent to 0.70 and Natural Hazards percent of GDP and risk to well-being (calculated from consumption loss) from 1.03 percent to 0.86 percent Environmental risks, including climate change and of GDP, equivalent to US$34 million in potential annual natural hazards, pose high economic and social risks gains (Hallegatte et al. 2017). Investing in climate-smart for Armenia. Armenia is a climate-vulnerable country58 agriculture, supported by innovations by larger farms and highly dependent on natural resources for exports, and agribusiness, is expected to increase productivity government revenue, and as a source of livelihood. and enhance resilience while also reducing GHG With the average temperature rising faster than the emissions.63 Awareness about climate change risks and global average (2.5°C versus 1.3°C in 2020, respectively) adaptation needs also carries opportunities beyond (Berkeley Earth, n.d.), Armenia is exposed to multiple agriculture to unlock new growth engines for greener environmental challenges, including heat waves, floods, growth with the right policies in place. drought, and air pollution. Armenia is also exposed to a high risk of earthquakes, as the country lies in a Despite some progress and efforts by the government region of high seismicity.59 These events may have huge of Armenia, policies for resilience and emergency distributional economic and health impacts, for example preparedness still need improvement and should 58 In recent decades, climate change has significantly increased the frequency and intensity of hazardous hydrometeorological phenomena in Armenia (World Bank and ADB 2021). 59 Analysis indicates that an earthquake with a magnitude of 7.0 or greater would destroy most of the buildings in Yerevan, potentially killing 300,000 people (ADB 2019b). 60 Vulnerability assessment by the University of Notre Dame https://gain.nd.edu/our-work/country-index/ 61 Hallegatte et al. 2017. 62 According to the analysis, the risk to well-being is estimated to cost 1.03 percent of GDP (Hallegatte et al. 2017). 63 World Bank Climate-Smart Agriculture https://www.worldbank.org/en/topic/climate-smart-agriculture. Areas for innovation include: circular models and the use of renewable energy (such as biogas production and aquaponics), financing of equipment, and technical advisory services to enhance aggregation capacity and processing capacity as well as product quality, with an emphasis on climate-friendly innovations along the value chain. 54 be a priority for achieving sustainable and inclusive sustainable development policy priorities in its new five- growth. Following the 6.5 magnitude earthquake year (2021–26) program.67 that hit the city of Spitak in 1988, the government increased its commitments in disaster risk reduction and Reducing Pressures on Natural Capital for emergency preparedness to safeguard its country from Improved Resilience any renewed shocks (Appendix J). However, given the relatively high risk of natural disasters, the government Human pressures on the natural capital stock further could improve the disaster risk management system by increase vulnerability to environmental risks. For preparing risk-alert mechanisms, real-time assessment example, the mining sector is causing serious direct and of asset condition post-disaster by enhancing digital indirect impacts on water quality, forests, and biodiversity. technologies both at the central and local levels,64 The emission intensity of mining of mineral products is strengthening the social protection system to enhance significantly higher than in all neighboring countries and the efficiency and timeliness of emergency support, ten times higher than in the EU.68 At mining sites, land and developing a disaster risk financing and insurance preparation and expansion and waste management strategy to make the financial management of disasters are destructive processes, changing abiotic and biotic more effective (UNICEF 2021; World Bank 2017d). conditions and in some cases transforming natural forests and threatening species and ecosystems. About 8,000 Armenia produced its first National Adaptation hectares of land have been degraded by mining activities, Plan in 2021, but this plan remains limited in scope, with an additional 1,500 hectares used to store tailings providing only an overview of institutional actions to dumps. Pollutants are commonly leached out, affecting build resilience to climate change across the country. waterways and local biodiversity (World Bank 2016). The National Adaptation Plan lists 26 measures to (1) Due to mining activities, 16 rivers in Armenia have been introduce and enhance the National Adaptation Plan identified as exhibiting the highest degree of pollution.69 process in Armenia and (2) enhance institutional and Other problems in the mining sector are related to the technical capacity for the National Adaptation Plan lack of rehabilitation efforts and management of mining process, with an assessed cost of AMD 560 million. sites that negatively affect valuable water resources and However, the plan does not contain any specific actions threaten the health of people and ecosystems. While to build resilience and adapt to climate change. Instead, many of these problems stem from abandoned mine the plan focuses on the early processes of establishing sites and past waste disposal, some mining operations the technical capacity to assess risks and needs. The have generated controversy due to pollution and other few policy actions related to fiscal risk management impacts on the local ecology.70 specified in the National Adaptation Plan are delayed65 and are not expected to be completed until 2023 (IMF Armenia’s air quality ranks among the worst in Europe, 2022a).66 Acknowledging the urgent need to mitigate and untreated waste and wastewater continue to and adapt to climate change and be prepared for a pollute the environment. Welfare costs associated with strong recovery from natural disasters, in 2021, the air pollution by fine particles (PM2.5) represent about government also renewed its commitment to green 11 percent of GDP equivalent, compared to 4 percent recovery and growth by introducing green economy and on average in the ECA region (World Bank 2022e). An 64 Government officials are committed to enhancing the potential of digital technologies to enhance climate resilience. See https://www.unescap. org/events/2022/armenia-national-workshop-digital-technologies-disaster-risk-management . 65 These include (1) Action 2.1 on the development of a guideline on the integration of climate-related risk management into sectoral and regional development strategies and (2) Action 2.4 on the mapping and development of a database on risks related to climate change. 66 Republic of Armenia National Adaptation Plan, 2021. https://unfccc.int/sites/default/files/resource/NAP_Armenia.pdf 67 The government has also launched the “Growth and Recovery for the Strengthening, Upgrading and Prosperity of Armenia” platform with the goal of combining and optimizing policies and investment initiatives to support Armenia’s transition to a green economy. 68 Global Trade Analysis Project 10 via EITE tool. 69 2018 data of the Hydrometeorology and Monitoring Center and the Ministry of Energy Infrastructures and Natural Resources. 70 The construction of the new Amulsar open pit gold mine was suspended in 2018 after protests linked to the environmental impact related to subsoil use rights. NGOs tracking the mining sector regularly highlight issues raised at a local level over a range of environmental threats posed by mines. After extensive due diligence and dialogue, construction is set to restart in 2024. 55 estimated 74 percent of the rural population depends on Armenia is not water-scarce, water resources are fuel wood for cooking and heating, which contributes to declining in quantity and quality, and the availability of mean population exposure to PM2.5 that is three times water resources and river flows has become uncertain. the WHO guidelines (World Bank 2022h). In addition The vulnerability will vary by basin and watershed, but to fuel wood use, air pollution in Armenia is caused by according to an estimate, the average river flow could fossil fuel combustion in energy, industry, agriculture, decrease by 39 percent by the end of the century, transport, and buildings as well as by fires, windblown affecting multiple sectors including agriculture and dust, and other dust which account for approximately 50 hydropower infrastructure (World Bank and ADB percent of PM2.5 pollution, signaling the importance of 2021). Improving water storage capacity in Armenia by landscape restoration and improved land management constructing reservoirs will also be critical to ensuring practices (McDuffie 2021). Also, in Armenia, only more resilient water services to the agricultural sector, 9 percent of the wastewater is treated, and waste as highlighted in the Armenia 2021–26 program.75 management capacity is very low.71 Outdated water infrastructure (over 78 percent) and rising water demand 5.1.4. Risk Differentiation increase the risk of water shortages.72 In 2020, Armenia used 44 percent of its internal freshwater resources, up The vulnerabilities Armenia is exposed to in terms of from 25 percent in 2002 and significantly more than the shocks vary in cause and solution. Fragility and conflict- global average of 9 percent.73 related risks include those from inter-state conflict and those from risks of internal tensions, arising from eroding Agriculture is not only one of the sectors most trust in institutions and government effectiveness. vulnerable to climate change but also the second- While the two are closely linked, as trust in institutions largest producer of GHG emissions in Armenia and a is highly responsive to the government’s handling of source of other land pollution. Extreme weather events the border issue, additional mitigating factors can be such as storms, droughts, hot dry winds, hail, and spring planned . While risks from inter-state conflict are outside frost have been more frequent and have lasted longer, the scope of development interventions, government already inflicting great damage on agriculture. At the can mitigate their impacts through social protection same time, crop and livestock production is still carried systems, for example. Risks from international tensions out using traditional means, which are inefficient and could also be partly addressed through development harmful to natural resources. Land degradation due interventions, for instance by strengthening government to chemical pollution from mineral substances used in effectiveness, service delivery, and fostering a more agriculture and chemicals in urban areas, salinization inclusive society and accountable government. partly due to poor irrigation and drainage practices, as However, other risks such as vulnerability to economic well as deforestation due to overcutting, overgrazing, and climate shocks require a different approach. mining, and forest fires are all affecting agricultural Development interventions and government policy productivity and reduce valuable ecosystem services can shift the economy towards a more diversified one erosion control.74 in terms of dynamic sectors, export partners, products, and sources of FDI. Although Armenia is mostly affected One of the biggest challenges for agricultural reform by the impacts of climate change, the government can is the management of water. Nearly 70 percent of take measures to support the country’s adaptation to water withdrawals in Armenia are for agriculture. While climate change effects. 71 Yale Environmental Performance Index. https://epi.yale.edu/ 72 European Environment Agency (EEA) and ENI SEIS II East Project https://aarhusclearinghouse.unece.org/resources/eea-seis-ii-east-proj- ect-outputs-access-environmental-information 73 FAO Global Information System on Water and Agriculture. https://www.fao.org/aquastat/en/ 74 The annual economic costs of deforestation and forest degradation in Armenia are estimated to be US$99.5 million (World Bank 2022h). 75 Improvements in the water sector have huge externalities. For example, increasing water storage will not only affect the sustainability of agricul- ture but also the reliability of hydropower generation. According to an estimate, climate change could cause a reduction of hydropower-based electricity generation by 15 percent by 2100, compared to the 2020 level (IMF 2022a). 56 5.1.5. Vulnerable Populations and Building tasks and the narrow use of childcare services. Most Resilience households rely on women as primary care providers in child rearing and development, while fathers contribute This section highlights populations who are particularly to a lesser extent.79 This is reinforced by the low access vulnerable to the three shocks discussed above due to high-quality childcare, early education, and flexible to lack of access to services and opportunities or low care for elders. Data from the Time Use and Gender accumulation of capital—namely, women and girls, the Survey 2022 indicates that one-third of households with displaced population, and international migrants. children under age five do not have access to regular childcare services. Women and Girls Social stereotypes and gaps in legal protection Despite considerable progress, gender gaps persist contribute to gender disparities. Gender stereotypes and hinder Armenia in reaching its development persist, leading to gender disparities in labor potential. Improving gender equality is a government participation, employment type and sector, and fields of priority anchored in the national gender strategy for 2019– study. For example, women students are not traditionally 23, Armenia 2021–26, and Strategy 2050. Evidence encouraged to pursue technical specialties. In addition, points to significant progress: for example, the sex ratio Armenia has no criminal penalties or civil remedies at birth—a common indicator of gender disparities and for sexual harassment experienced in the workplace, social preference for sons over daughters—improved although the evidence suggests that sexual harassment from 1.17 boys per girl in 2001 to 1.11 in 2016–18 (ArmStat of women in the workplace and the political arena is 2019).76 Women’s representation in public and political widespread (US State Department 2022). life has also improved. For example, female members of parliament now constitute 35 percent of all lawmakers of Displaced Population the National Assembly, up from 18 percent in 2017,77 and the share of women judges increased from 27 percent The displaced population faces barriers to economic in 2019–20 to 33 percent in 2023.78 Nonetheless, many and social opportunities. There are tens of thousands Armenian women continue to be outside the labor of displaced persons in Armenia since 2020 from market or are employed in poor-quality jobs, despite Nagorno-Karabakh as a result of the military conflict with their high level of human capital. Reducing gender gaps Azerbaijan, including those who have been displaced is not only important from the standpoint of equity and from Gegharkunik, Syunik, and Vayotz Dzor marzes fairness but should also be a major priority in any effort due to the September 2022 fighting in the border to boost inclusive growth and realize a country’s full districts, according to authorities. Many face high rents potential. Enhancing women’s participation in the labor in Yerevan and challenges accessing land in rural market is critical, especially in the context of an aging areas. The displaced population lacks opportunities to population and declining productivity growth. accumulate and use their human capital or gain access to basic services—such as health care and psychosocial The sources of gender disparities are multidimensional assistance—and good-quality housing. Armenia faces and often difficult to quantify. Economic, social, and the challenge of ensuring sustainable housing and institutional factors contribute to this pattern of exclusion livelihoods for the displaced population that is still largely of girls and women from economic opportunities. Women dependent on social transfers. To do so, it is important experience time poverty linked to unpaid domestic to have an accurate snapshot of the living conditions of 76 The ratio increases from 1.04 for the firstborn child to 1.40 for the third child (ArmStat 2019). Interpreting the skewed sex ratio at birth as missing girls points to a loss of girl births due to a preference for sons and thus recourse to sex-selective abortion (Sinha and Kumar, 2019). Gegharkunik marz at the border has the lowest female sex ratio at birth, reflecting a cultural preference for males that is rooted also in military traditions. 77 National Assembly of the Republic of Armenia. http://parliament.am/?lang=eng . 78 Judicial Power of the Republic of Armenia. https://court.am/. “Gender equality in the judiciary of Armenia: challenges and opportunities,” Part- nership for good governance 2019-2021, Council of Europe; and World Bank calculations as of March 2023. 79 Based on the Armenia Time Use and Gender Survey collected by the World Bank in May–June 2022 via telephone interviews. 57 displaced persons and to identify the barriers they face Social Protection to Build Resilience in access to education, health care, and other services (World Bank 2023c). Social protection can be critical for building resilience to different types of shocks, and the social protection International Migrants system in Armenia has been important in preventing Armenians from falling into poverty. While the social Remittances from international migration provide an protection system requires additional adjustments to essential income source for Armenian households. The ensure it is fiscally sustainable and socially adequate, size of the Armenian diaspora is currently estimated at 7 it has undergone significant reform in the last decade, million people, living in more than 100 countries.80 In 2021, including the introduction of a mandatory funded around 14 percent of households reported receiving pension pillar. Armenia has a relatively well-developed remittances (2021 ILCS). Households with migrants social protection system underpinned by legislation abroad that are receiving remittances tend to be better and comprising three pillars that are common around off and less likely to live in poverty (Garrote-Sánchez et al. the world: social insurance, social assistance, and labor 2022). Moreover, during times of crisis, remittances can market policies and programs. The analysis shows that serve as an automatic stabilizer for households whose in the absence of any social protection benefits, and members can continue to work abroad.81 if households were unable to compensate with other sources of income, half of Armenians would live in However, international migrants remain highly poverty, and inequality would increase by 40 percent. vulnerable to external shocks due to their geographic However, the social protection system does require and occupational concentrations. Migration from adjustments to address gaps, ensure it is fiscally Armenia—as for other countries in the Caucasus and sustainable and socially adequate, and be better Central Asia—is highly concentrated on one single prepared to expand outreach in response to shocks. country. Among households with members who had Refer to Appendix K for more information on the social migrated during 2019–21 and had not returned as protection system and areas for improvement. of 2021, the majority went to Russia (65.5 percent), followed by internal migration to other communities 5.1.6. Governance and Institutional in Armenia (24.8 percent). Thus, a large proportion of Bottlenecks – A Related Example in the migrants and their families are exposed to risks of Water Sector economic fluctuation in the Russian economy. Migrants also lack diversification in their sectors of occupation: Challenges in managing shocks and environmental in 2019, 77 percent of Armenian migrants were working risks include poor governance arrangements and weak in the construction sector, which is considered to be a institutional capacity to govern, maintain, finance, cyclical industry prone to being negatively affected by operate, and regulate resources in the water sector. economic downturns. Only 6 percent were working in The water sector is critical to building resilience to manufacturing, services, or transportation (Garrote- shocks, especially for poor and vulnerable households Sánchez et al. 2022). Estimates also show that relying on agriculture for their livelihoods.82 However, households with returned migrants in 2020 suffered the sector faces multiple challenges associated with large income losses, leading to an increased poverty weak governance and institutions. First, the sector is rate among this group (Ibid). fragmented as multiple agencies are involved in the 80 High Commissioner for Diaspora Affairs. http://diaspora.gov.am/en/diasporas. It has also been estimated that close to 960,000 emigrants with Armenian citizenship live abroad (UNDESA 2020). However, this estimate does not necessarily account for ethnic Armenians who may hold other citizenships but maintain strong linkages and affinities to the country (IOM 2022). There is heterogeneity among the diaspora communi- ties. Often, they are distinguished into “old” and “new” based on the timing of the emigration—whether before or after the independence. Evi- dence shows that the first group has fewer ties with Armenia, while the latter is more willing to take risks and has higher stakes in contributing to the country (IOM 2020). 81 For example, these households observed a rise in the value of remittances and a reduction in poverty in 2020 (Garrote-Sánchez et al. 2022). 82 There is also a health risk from the low quality of water, as Armenia lacks irrigation water quality control. 58 management and regulation of water resources, with farmers to participate in irrigation scheme management, no coordination at higher levels of government among the mechanism is not functioning effectively due to the various agencies that supply, regulate, and monitor dilapidated infrastructure, poor administrative planning, water management in Armenia. Second, Armenia does weak accountability, and financial management issues not have an overarching water strategy that provides an among farmer organizations.84 overall vision and sets targets for water management. In addition, there are no standalone strategies for the 5.1.7. Binding Constraints irrigation sector or the drinking water and sanitation sector, resulting in weak planning and implementation The table below summarizes the binding constraints of infrastructure investment. Third, accountability discussed in this section. measures are weak. Checks and balances need to be strengthened to improve the cost efficiency of the 5.2. Accessing Markets and Trade sector.83 Fourth, the sector lacks a modern information Integration system, which affects data transparency, quality, and timeliness in responding to shocks to water availability in Connectivity obstacles within and outside Armenia are the context of growing demand for water. Fifth, although one of the most salient development challenges and are irrigation operation and management at the secondary a defining characteristic of everyday life for Armenian and tertiary levels is decentralized, thus allowing local people and businesses. As, discussed earlier, Armenia Table 2. Binding Constraints for Vulnerability to Shocks and Environmental Risks Key Challenges Binding Constraints Weak emergency preparedness and service delivery for border areas 1.1: Risks of fragility, conflict, and Lack of adaptive social protection systems violence Weakened trust in political and social institutions Concentrated trade products and trade partners High dependency on raw materials for export Heavy dependence on natural gas imports from Russia 1.2: Vulnerability to economic shocks Low coverage, quality, and efficiency of public services Lack of equal access to services and opportunities Lack of adaptive and efficient social protection system Insufficient investments to address energy efficiency and energy security Lack of financial incentives to promote the green transition 1.3: Exposure to climate change Limited investments in climate-smart infrastructure to reduce GHG emission and environmental risks Lack of adaptive and efficient social protection system Limited protection and management of natural resources (including air pollution) 83 For example, the Water Supply Agency that is responsible for the main irrigation systems through large canals faces a huge funding gap of around 55 percent (i.e. the difference between the costs incurred for the provision of services and tariff charged for the services), but the tariff structure has remained unchanged since 2010. In addition, the accounts of the water user associations, which are responsible for management, operation, and maintenance, are not independently audited. 84 Some service areas are too large to ensure local farmers’ participation in governance. 59 is a landlocked country located in a region of difficult global value chains. In contrast, Estonia, an aspirational topography and geopolitical tensions. Of its four borders, peer, is in the group of advanced manufacturing and two borders (Azerbaijan and Türkiye) have been closed service economies. for years, limiting access to regional and international trade and integration. Similarly, poor infrastructure within A gravity model estimates that Armenia’s exports the country constrains access to goods, services, and are only at 35.7 percent of their potential.85 While labor markets. It hinders the delivery of basic public full potential may not be able to be realized due services—inputs for the productive activities of firms and to certain barriers, closing the gap between actual for the household accumulation of human capital—and and potential exports in Armenia requires improving contributes to spatial disparities. This section analyzes access to markets by expanding the scope of export the evidence on physical connectivity, trade logistics, destinations, diversifying the export basket, raising the and digital connectivity as development constraints and competitiveness of exported products, and developing the role of the diaspora in enhancing connectivity. value chains. Progress along these lines is contingent on identifying and addressing connectivity and logistics 5.2.1. Trade Integration and Global Value bottlenecks, removing excessive trade barriers, Chains identifying opportunities for the diversification of exports (including through opportunities in regional markets), According to a global value chain taxonomy, Armenia’s and encouraging Armenia’s upgrading in global value global value chain links were mostly related to limited chains. Raising competitiveness will also entail improving manufacturing in 2015 (World Bank 2020a). Armenia resource efficiency to match peers and, going forward, specializes in upstream global value chain tasks, selling lowering the emissions intensity of industrial production primary goods of limited complexity that other countries that is expected to become subject to border carbon use to produce exports. Its position is reflected in the adjustments, for example under the EU’s proposed small manufacturing share in the export basket (an mechanism from 2026.86 average 20 percent in 2014–19); the low intensity of global backward links, proxied by the share of value Armenia stands to gain from the effective added in gross exports (25.5 percent in 2021); and the implementation of the WTO Trade Facilitation larger share of forward participation, proxied by the share Agreement (TFA) and needs to mitigate the in gross exports of the exported domestic value added implications of the loss of preferences under the EU’s used by Armenia’s direct trading partners to produce Generalized Scheme of Preferences.87 Implementation their own exports (25.6 percent in 2015). Armenia has lags are primarily in three areas: involvement of the not upgraded to the upper tiers of the taxonomy, such trade community, internal border agency cooperation, as advanced manufacturing and services or innovative and external border agency cooperation.88 A general activities, which are typically associated with higher value equilibrium model of world trade has been used to added in global value chain engagement. Structural analyze counterfactual simulations of two scenarios peers also tend to have low and limited engagement in using a 2021 baseline. The first is Armenia’s full 85 For 2013–2019 based on observable characteristics such as economic size and geography and current policies. The methodology is available in Annex L. World Bank, Reconfiguring Trade to Overcome Geographical Limitations: A Trade and Competitiveness Diagnostic for Armenia (forthcoming). Armenia’s peers have the following exports-to-potential ratio: 26 percent Albania, 40 percent Bosnia and Herzegovina, 42 per- cent Georgia, 52 percent Moldova, and 64 percent Estonia. 86 Around 2.5 percent of Armenia’s exports are aluminum and iron and steel exports to the EU and would therefore be covered by the carbon adjustment mechanism as put forward by the European Commission’s latest proposal from December 2022. 87 An important aspect to consider is that the provisions of the TFA can be implemented at different maturity levels, leading to varying differences in trade facilitation, speed of trade flows, and related costs. For example, a country may implement risk management in Customs, being aligned with WTO TFA-related provisions, but still physically inspect more than 20 percent of the cargo, while more mature administrations inspect only less than 5 percent of all cargo as their risk management systems are more effective and usually supported by post-clearance audits. Similarly, many countries already assess that they have implemented single window solutions while some processes and procedures are still paper based. It is therefore important to consider the TFA Gap Assessment methodology, which analyzes the situation of the country considering full and effective implementation of provisions, not necessarily the minimum requirement to comply with the agreement. 88 OECD Trade Facilitation Indicators, 2022 http://compareyourcountry.org/trade-facilitation/en/1/ARM/ARM/default 60 implementation of the WTO TFA, which would generate the skills to find reliable international partners, negotiate large increases in both imports and exports (by over 10 terms and conditions, and market products internationally percent for the former and close to 15 percent for the (ERDSC, forthcoming). As of 2019, the Business Armenia latter, relative to the baseline scenario), which translate Foundation is no longer responsible for implementing into a substantial decrease in the price level as well as a trade promotion activities. Enterprise Armenia focuses higher real GDP (of about 2.5 percent). The second is the on investment promotion, and the Export Insurance loss of preferences under the EU’s Generalized Scheme Agency of Armenia only focuses on export insurance. of Preferences+ scheme, which would produce small Armenia could benefit from a foreign trade strategy and losses in exports, imports, and GDP in an aggregate an export promotion agency to offer services related to sense but large losses (by over 20 percent) in exports image building, export support services, marketing and to the EU in sectors such as metal products, textiles and market research, and publications (ERDSC, forthcoming). apparel, agriculture, and food and beverage.89 Armenia can potentially reap more value-added While Armenia has been part of the Eurasian Economic benefits from global value chain engagement (Figure Union (EAEU) since 2015 and has several FTAs in 60). With its current specialization in commodities and force, it could benefit from expanding and deepening limited manufacturing tasks, Armenia lags many peers in integration. Prior to 2015, Armenia had signed eight per capita exported domestic value added. Participating FTAs with former members of the former Soviet Union.90 in global value chains as a seller of primary products is Since 2015, Armenia has been in a customs union with beneficial in years when commodity prices increase, Belarus, Kazakhstan, the Kyrgyz Republic, and Russia but it can quickly become a source of vulnerability under the umbrella of the EAEU. As a member of the during times of slowing global prices. At the same time, EAEU, Armenia implements the common external tariff specializing in light manufacturing typically helps boost applicable to all other members but is allowed to apply employment but brings modest value-added benefits. also the tariffs negotiated as part of the FTAs signed Scaling up value added benefits to boost GDP is more before 2015. Furthermore, as a member of the EAEU, closely associated with participation in global value Armenia has had an FTA with Vietnam since 2016, with China since 2019, and a recently concluded one with Figure 60. Global Value Chain Upgrading: Per Capita Iran. In addition, Armenia signed the Comprehensive Exported Domestic Value Added, by Country, 2015 and Enhanced Partnership Agreement with the EU in 7 2017. Armenia’s exports to the countries in the trade 6.2 agreements have picked up following implementation 6 US$ per capitta, thousands of the agreements, but as suggested by the gravity 5 model estimates, there is scope for further integration— 4 for example, by having the EAEU sign agreements with 3.1 3.1 3 more trading partners. 2 1.7 A key aspect of facilitating trade in Armenia relates to 0.9 0.9 0.8 0.8 1 0.7 0.5 0.4 0.4 0.4 0.3 0.3 0.3 0.2 export promotion. Armenia does not have an up-to-date Albania 0.2 0 export policy, and there is no public body responsible Armenia Bosnia and Herzegovina Georgia Azerbaijan Tunisia Philippines Chile Estonia for supporting the export business. Challenges faced by the trade community include limited information on trade reforms, regulations, and requirements; new market 2005 2015 access opportunities; implications of international Source: World Bank staff calculations using data from the EORA Global agreements; and market developments. Many SMEs lack Supply Chain Database and World Development Indicators database. 89 Gain and loss estimates are preliminary and subject to revision. 90 Georgia, Tajikistan, Belarus, Kazakhstan, Kyrgyz Republic, Moldova, Turkmenistan, and Ukraine. 61 Figure 61. Logistics Performance Index, Armenia Figure 62. Logistics Performance Index 2023, Armenia versus Peers 3.0 LPI 2.84 5.0 2.8 2.70 4.0 2.60 2.60 Tracking 3.0 2.55 2.6 Customs 2.50 and tracing 2.50 2.51 2.45 2.0 2.39 2.38 2.39 2.4 1.0 2.30 Score 0.0 2.20 2.2 Logistics 2.0 competence Infrastructure and quality LPI overall Customs Infrastructure International shipments Tracking and tracing Timeliness Logistics service quality International shipments Albania Armenia Bosnia and Herzegovina 2012-2018 2023 Estonia Georgia Moldova Source: World Bank Logistics Performance Index. Source: World Bank Logistics Performance Index. Note: 2012–18 refers to aggregated ranking. chains as advanced manufacturing and services and countries, Armenia has done well in terms of the time innovative activities. Strategies that could help with this containers stay in one place.93 Armenia’s performance goal include encouraging vertical FDI, which is known to worsened over time in terms of timeliness of a shipment go hand in hand with global value chain participation;91 arriving within the scheduled or expected delivery finding opportunities to specialize in more complex time and competitively priced international shipments. manufacturing tasks; and thinking of ways to use Armenia also lags behind peers especially in the quality services to boost the sophistication of manufacturing of trade- and transport-related infrastructure (such as products (servicification), including by building on the roads, IT), competence and quality of logistics services comparative advantage that Armenia has developed in (such as transport operators and custom brokers), ability IT services. to track and trace consignments, and ease of arranging competitively priced shipments (Figure 62). 5.2.2. Infrastructure and Border Management Weak connectivity infrastructure (along with high trade costs) was one of the factors responsible for While Armenia has improved key aspects of trade Armenia’s poor external outcomes. The time to pass facilitation measures since 2018, its connectivity through Armenia’s open borders is long compared to the infrastructure lags its peers. According to the Logistics ECA average and average of all countries where data Performance Index (LPI), 92 the largest improvements have are available (Figure 63), due to capacity constraints, been observed in infrastructure, logistics service quality, customs procedures, and cross-border administrative and customs (Figure 61). Compared to other landlocked integration. As a result of poor maintenance and 91 Vertical FDI is a type of investment in which a foreign company invests in different stages of the production process in different countries. By fostering countries’ specialization in tasks, vertical FDI promotes global value chain links and trade related to global value chains. For example, the investment of Samsung in Vietnam is a type of vertical investment that has brought benefits to the recipient country. 92 LPI measures a country’s performance on trade logistics based on a worldwide survey of 160 countries. The aggregated LPI provides an aver- age of the 2012–18 LPI scores with higher weights for more recent years and smooths out oscillation occurring from one edition to the other, especially as the LPI is a perception-based indicator. 93 Specifically, dwell time measures: port dwell time, reference dwell time for transit countries, and inland and destination dwell time. Based on the World Bank Logistics Performance Index. 62 Figure 63. Delays in Clearing Trade Goods through Customs a. Days to clear direct exports b. Days to clear imports 14 30 28.5 12 25 12.0 10 20 22.1 Share of firms (%) Share of firms (%) 8 15 7.3 6 10 11.8 4 4.3 3.3 5 2 6.1 0 0 2009 2020 ECA (2020) All countries 2009 2020 ECA (2020) All countries Armenia (2020) Armenia (2020) Source: World Bank 2020h; Enterprise Surveys (dashboard), World Bank, https://www.enterprisesurveys.org/en/enterprisesurveys. underinvestment, the country must also deal with old and economic growth.95 At the same time, Armenia could obsolete transport infrastructure (World Bank 2021e). explore other opportunities to improve its connectivity This is especially important for the border crossing point to international markets, including negotiations for at Upper Lars on the Russian-Georgian border, as this is reopening international borders and investments to the main transport corridor and the only surface transport grasp indirect benefits from the Belt and Road Initiative route connecting Russia to Armenia.94 However, the (BRI).96 Government plans to have the railway modernized through the concessionaire South Caucasus Railways, a The lack of direct connectivity to Armenia’s main subsidiary of Russian Railways. trading partner, Russia, increases transport costs and hinders export competitiveness. The road network is High transport costs hinder Armenia’s export strategically important, as it is the only surface transport performance. During the COVID-19 pandemic, mode that connects directly with Russia, and the Border preexisting difficulties hindered cross-border trade and Crossing Point at Upper Lars, Georgia is the only viable inflated transport costs. Transport by road, weather connection for Armenia to access Russia by road. Lars permitting, became prohibitively expensive and is congested due to limited throughput capacity, difficult involved significant delays which exceeded one month topography, and seasonal conditions such as avalanches for inbound cargo from distant markets such as China. and mudslides. This situation increases the waiting time Switching to air transport was not feasible, with air cargo of trucks and transportation costs. rates increasing by 30-35 percent from the pre-pandemic period. These shocks have highlighted and worsened Despite an extensive road network, poor road quality connectivity issues in Armenia, and its isolation from is an obstacle to connectivity. Road condition data international transport routes inflates trade costs and collected through a road survey suggest that Armenia disrupts supply chain operations. Logistics and transport has a relatively well-developed road network, serving services must be modernized. Improved efficiency in all parts of the country. The share of paved roads, at logistics could boost competitiveness and stimulate 84 percent, is high compared with other developing 94 90 percent of all freight flows move via Georgia and 10 percent via Iran (World Bank 2021e). 95 There is a correlation between logistics performance and higher incomes (IFC 2021). The cost of logistics can be up to 25 percent of GDP in some developing economies, compared with 6–8 percent in Organisation for Economic Co-operation and Development (OECD) countries. 96 Although no corridor of the BRI passes through Armenia, indirect benefits from the BRI could be enhanced by implementing complementary policies and infrastructure improvements. 63 Map 1. International Roughness Index, Armenia 2019 Map 2. Accessibility to Yerevan Source: World Bank 2021e. Source: World Bank 2021e. countries and in line with most European countries (World Rehabilitation efforts to address Armenia’s connectivity Bank 2017b). However, road quality is a concern: close to challenges are underway. Over the past few years, the 41 percent of roads are in good or very good condition; government has been engaged in various initiatives 19 percent are in fair condition; and 40 percent are in aimed at developing the road network and developing poor or very poor condition. Disparities are even more asset management processes and practices. Major acute between the primary road network and feeder projects include the 556-kilometer North-South corridor roads (World Bank 2017b). Map 1 shows the international project and the 190-kilometer Yerevan-Northeast section roughness index for roads in Armenia. Most show values to Georgia. greater than 2.5, indicating poor to bad road conditions. Rail infrastructure is another bottleneck in the Rural connectivity is a challenge for Armenia’s road Armenian logistics sector. The Armenian rail system network. A road survey showed that the network in comprises a network of 780 kilometers of railways. Armenia still has significant deficiencies, 97 including: The Railway system in Armenia is currently owned, (1) intervillage connectivity is cumbersome in some managed and operated by South Caucasus Railway, a marzes and (2) last-mile connectivity challenges still joint stock company created by “Russian Railways” under exist for a small share of the population (5 percent by a 30-year Concession Agreement valid until 2038. This World Bank estimates) who live more than an hour agreement requires the South Caucasus Railway to carry from a high-density population center. The survey out necessary improvements and repairs to the railway also showed that significant investment is needed in assets including the maintenance of speeds at 30 km/h. transport road infrastructure to bring Armenia closer to The South Caucasus Railway is capable of transporting the rural accessibility level of higher-income countries in up to 8.0 million tons of cargo annually. Taking into Europe.98 Map 2 illustrates the poor accessibility by road account investments from the concession date, the local from Yerevan: it takes four hours to reach the Georgian speed is currently about 40 km/h. This speed is due to the border 200 kilometers away and eight hours to reach complex profile and single-track sections. Armenia lacks the Iranian border 370 kilometers away. a direct railway connection to Russia.99 The transport of bulk freight to and from Russia (i.e. wheat) is currently 97 This was the first countrywide survey of national, republican, and lifeline roads done in Armenia and was used in World Bank 2017b. 98 Over 30 percent of Armenia’s rural population did not have access to an all-weather road in 2017 (World Bank 2017b). 99 The rail connection via Abkhazia is closed, and the rail ferry service from Poti to Port Kavkaz (in Russia) has been discontinued. 64 Table 3. Proportion of Freight Carried by Rail million passengers in 2022, coinciding with an upsurge in tourism during the same period. The adoption of an Country % by rail or inland waterway “Open Skies” policy played a big role in this growth, as it allowed foreign airlines to increase capacity. The opening Armenia 5% of the air cargo route between Türkiye and Armenia is Belarus 65% also expected to have a huge impact, as demonstrated by the recent increase in air cargo between Russia Georgia 24% and Armenia. The recently signed Common Aviation Moldova 19% Area agreement between Armenia and the EU, the upgraded cargo terminal at the main international Ukraine 52% airport, and the needs assessment of the logistics Source: Integrated Transport Planning Ltd. 2021. sector by the government should all help accelerate trade by air. However, improving the conditions of local being carried out by truck, which is inefficient and roads that connect airports with markets will be a critical expensive. Transportation of products using rail transport prerequisite for boosting cargo transportation by air. is only possible using sea transport through the ports of Georgia, which in turn increases the delivery time and An opening up of the borders with Armenia’s two cost of transportation. The rail infrastructure consists of neighbors could bring about diversions in current mostly single tracks with old equipment and rolling stock transport flows as well as induce demand. A road that requires modernization and the use of technology. connection between Yerevan and Nakhichevan As a result, the volume of freight carried by rail in Armenia opens a north-south road transit route that connects is significantly lower than the volume in other countries in Russia through Georgia to Iran (through Yerevan and the South Caucasus and the region (Table 3). Nakhichevan) and the Middle East, placing Armenia in the center of the transport route, a very advantageous To improve connectivity, Armenia needs to improve its position for trade and transport as opposed to its rail system and its operational efficiency and develop current position of poor accessibility and connectivity.100 a system for information sharing. In addition to lack A potential opening up of a route connecting Yerevan of investment, Armenian Railways lacks intermodal to the west of Azerbaijan—as has been discussed in services, which impedes the efficiency of container recent years in the context of the peace negotiations— shipments to and from Georgian ports. Armenia needs could present opportunities for the development of rail to establish regular block train services to the Georgian connecting to the East-West Trans Caucasus transit rail Black Sea ports to attract more containers on the rail and corridor, encouraging a modal shift from road to rail. optimize container supply chain operations. In addition, In addition, opening the border between Armenia and the lack of information sharing between operators and Türkiye through Gyumri could increase the freight flows customs authorities remains a barrier and affects transit and accessibility of Armenia significantly more than time. The performance of the Trans Caucasus Transit opening the border with Azerbaijan alone. The opening corridor can be improved by strengthening information of these borders would allow Armenia to improve its flows among operators and making transport data trade with current trading partners and diversify trade available to all users through a Corridor Management toward Europe and China, although such openings are Information System. sensitive and subject to geopolitical risks. As a landlocked country, another priority for Armenia Connectivity challenges are also present for the is to improve air connectivity. Air transport flow has power sector, as Armenia faces major supply security been growing rapidly since 2013, reaching a record 3.7 challenges in the decades ahead, which makes closer 100 The Nakhichevan-Yerevan connection creates a north-south route that then connects to the east-west/middle corridor that runs across Georgia and Azerbaijan (Armenia is not physically on the east-west route and needs to connect through the north-south to get to the east-west route). This provides Armenia the opportunity to become a transit country for both the north-south and east-west routes for freight flows. 65 regional integration of its power network an urgent are falling behind. Natural gas provides about two-thirds priority. About two-fifths of Armenia’s power supply of the overall energy consumption of Armenia, which comes from the aging Armenia Nuclear Power Plant, has mainly been imported from Russia (85 percent) as currently scheduled to close in 2036, and about half of discussed earlier. The price of gas imports is fixed but is the remaining share comes from natural gas imported subject to frequent (unilateral) price adjustments, making from Russia, which is not compatible with the country’s Armenia vulnerable to sudden price shocks. long-term climate and energy security ambitions.101 Domestic renewable energy—in particular, wind and Domestically, Armenia will have to continue investing solar power—represents a substantial alternative source. in the electricity transmission and distribution However, these resources are intermittent and vary networks. Over the past years, High Voltage Electric seasonally. Closer integration with regional power grids Networks has rehabilitated or started rehabilitating would help improve energy security by reducing the most of its 15 substations. In recent years, it has also need for back-up capacity in times of lower renewable rehabilitated two critical transmission lines that are energy availability and by providing export markets in essential to improving the country-wide reliability of periods of abundance. Currently, Armenia’s electricity electricity supply. However, rehabilitation works on network only has two high-voltage linkages (220 kV +) four substations remain to be designed and financed. with neighboring Georgia and Iran. Electricity trading Implementation of this program will have to continue with Georgia is currently limited, as Georgia and Armenia throughout this decade to complete the rehabilitation have asynchronous systems and the market in Armenia of major network assets. At the distribution level, is mostly closed, and interconnections with Azerbaijan since 2017, a revised tariff framework has allowed and Türkiye exist but are not active. The development the privately owned distribution company Electrical of high-voltage interconnections with Georgia (5400 Networks of Armenia to increase annual investment kV) and Iran (400 kV) are underway but are substantially in the distribution grid from US$12 million in 2015 to delayed compared to the original schedules. In the long US$70 million in 2020. Investments will have to increase term, Armenia has the opportunity to interconnect with further over the coming years to meet the distribution the EU market through the Black Sea undersea cable grid rehabilitation requirements, estimated at US$750 currently being prepared between Georgia and Romania million between 2021–28 (World Bank 2021d). (European Commission 2022). The policy framework to improve energy efficiency The recent energy sector reform includes liberalization and scale up renewable energy needs further of the electricity market, but reform of the gas improvement. Apart from several large hydroelectric sector is falling behind. In 2022, Armenia launched plants, the contribution of renewables to the overall the first phase of a five-year process for liberalization energy mix is still modest (International Energy of the electricity market to unlock new sources of Agency 2022a), despite an impressive recent ramp- commercial finance and to modernize the power sector, up of distributed solar photovoltaics (PV). The National supported by legal amendments to the Energy Code, Program on Energy for 2022-30 aims to increase the the Transmission and Distribution Network Codes, and share of electricity generation from solar to at least the Rule and Regulations by Market Regulator. The first 15 percent (from less than 3 percent in 2020) and to phase kicked off in February 2022 by (1) enabling some reduce total final energy consumption by 20 percent by power plants to avoid selling electricity at prices set by 2030. With the amendments made to the Energy Sector the Public Services Regulatory Commission and to sell Development Strategy till 2040 and its implementation at prices determined according to market supply and plan, it is foreseen to increase the capacity of solar demand and (2) shifting from monthly to hourly trading power plants to 1,500 MW and wind power stations to of electricity. In comparison, reforms in the gas sector 500 MW by 2040. This is expected to raise the share of 101 A new nuclear power plant is proposed, but a final investment decision has not yet been taken, and design and construction will take a long time. 66 electricity produced from renewable energy sources in Barriers in affordability, service quality, and access to gross final electricity, including large hydropower plants, digital devices affect digital adoption in rural areas. to about 60 percent in 2040. Elements of the policy While entry-level broadband packages are affordable and regulatory frameworks exist, including through a and cost less than the affordability threshold of 2 percent suitable power sector market framework, the experience of per capita gross national income,102 fixed broadband with numerous pilot programs and projects such as the tends to cost over 4 percent of per capita gross national competitive auction for solar PV for the Masrik-1 plant, and income, and the cost of high-speed packages (above 50 a dedicated financing entity for renewable energy and Mbps) is even greater (International Telecommunications energy efficiency promotion (the Renewable Resources Union 2022). Even entry-level broadband services and Energy Efficiency Fund). However, Armenia will can be unaffordable for the bottom 40 percent. The need to put in place the incentives and conditions to quality of services delivered tends to be lower in rural integrate growing shares of renewable energy into the areas than in urban centers, as urban centers have power grid and to rapidly scale up energy efficiency concentrated on the development of broadband throughout the economy to achieve its targets in an markets and the deployment of modern technologies. economically efficient way. World Bank analysis of 18 months (January 2021–June 2022) of voluntary speed tests data from Ookla reveals 5.2.3. Digital Access that over 55 percent of speed tests conducted during that period were below 30 Mbps and concentrated Access to digital connectivity in Armenia is high but outside the main urban centers.103 Rural areas face high uneven across subnational areas. Nearly 100 percent of costs in deploying wired networks, lag in investment in the population is covered by mobile internet services (3G modern technologies by internet service providers due or 4G). However, this has not translated into a high uptake to lower expectations of financial returns, and tend to be of connectivity, particularly in rural areas. Approximately connected by technologically inferior solutions. The cost 60 percent of households subscribe to fixed broadband of digital access devices (laptops, tablets, smartphones, services (compared to nearly 80 percent in Georgia) and so on) is another barrier to digital adoption among (Telegeography GlobalComms Database 2022), and rural and economically vulnerable populations. approximately 65 percent of the population subscribes to mobile internet services (compared to around 50 The lack of digital skills and awareness of digital percent in Georgia) (GSM Association 2022). However, services poses another barrier to digital adoption in nearly 80 percent of the population reports that they rural Armenia. The perceived lack of demand among use the internet, indicating that a share of internet users rural populations acts as a barrier to investment by is likely only accessing the internet via mobile services telecommunication and internet providers, who see (International Telecommunications Union 2021), which in limited returns for their investments in these areas. turn may limit the scale and nature of digital services that This creates a negative cycle in which the perception can be adopted by that population. The unconnected of low demand hinders investment in higher-quality tend to be more concentrated in rural areas, where connectivity, which then disincentivizes the adoption fixed broadband household penetration is 15 percent of these services by individuals due to the price-quality lower than in urban areas (World Bank 2019b). While mismatch.104 the COVID-19 pandemic accelerated digital adoption globally, including in Armenia, it has also highlighted Unlocking constraints in access to digital connectivity is key underlying challenges in developing broadband fundamental for boosting inclusive growth in Armenia. markets, with rural areas at increasing risk of exclusion According to the International Telecommunications due to lower access to, and use of, digital connectivity. Union, a 10 percent increase in broadband penetration 102 The United National Broadband Commission for Sustainable Development has established 2 percent of GNI per capita as the affordability threshold for entry-level broadband plans. 103 Ookla data was accessed through the Data Development Partnership. 104 Results from consultations, analysis, and survey conducted by the Digital Global Practice at the World Bank during 2019–22. 67 raises GDP growth by 1.4 to 1.8 percent in ECA countries and consumers in Armenia and vice versa; countries. A more coordinated approach could be enhancing investment by boosting investor confidence adopted in Armenia to accelerate the penetration. This in the Armenian market; and transferring valuable skills, requires key legal and regulatory reforms aimed at experiences, and contacts from abroad back to Armenia promoting competition in services, reducing the cost that can promote entrepreneurship and create new of infrastructure deployment including through cross- businesses. sectoral infrastructure sharing, as well as strategic investments from the public and private sectors to close The ICT services sector has a proven track record access and skill gaps in areas that are at higher risk of of building and enhancing business opportunities exclusion. The domestic IT industry in Armenia has strong through diaspora links. In the early 2000s, diaspora foundations and existing interlinkages with global digital connections and prominent Armenians in various ICT markets that can be leveraged to drive digitization and hubs around the world (largely in Silicon Valley) played the establishment of an export-oriented digital services a pivotal role in the accelerated development of the ICT industry. In addition, digitization of the government sector. Since then, they have been critical in bringing would support enhanced public service delivery and technological multinational companies to Armenia, inclusion. Nearly all citizen-facing public services are setting up local research and development centers, available digitally in advanced economies—for example, investing in IT educational and infrastructure programs, 99 percent of all public services in Estonia are digitally generating leads for local IT companies, and linking with available. The expertise and global experience of the knowledge and funding sources. There is also a vast domestic IT industry can also be better leveraged to untapped potential in the value the diaspora can bring implement public sector digitalization activities, both as to the science and research ecosystem in Armenia. The suppliers of IT services as well as through public-private- realization of this potential is possible by engaging high- partnerships on key infrastructure and services such as performing diaspora scientists at renowned international cloud infrastructure, authentication and trust frameworks institutions in research collaborations and joint work among others. with local scientific teams. The scientific community of the diaspora is nearly the same size as the local 5.2.4. Diasporas as a Catalyst for science community but excels significantly in quality and Enhancing Connectivity performance. Ways of engaging diaspora Armenians in higher value-added activities include stocktaking of Diasporas can enhance connectivity by promoting strategic connections in prioritized sectors and building trade and FDI, creating businesses and spurring mechanisms for joint projects. entrepreneurship and innovation, and transferring new knowledge and skills (Newland and Plaza 2013).105 While Armenia has an engaged and connected The largest Armenian population exists in Russia (around diaspora, and the government recognizes its important 3 million) followed by the United States (around 1.6 role including as investors, diaspora investments still million), France (around 650,000), Georgia (200,000– seem to be limited. Established in June 2019 by the 400,000), Iran (60,000–80,000), and Germany (around Prime Minister, the Office of the High Commissioner for 60,000).106 There is increasing recognition that beyond Diaspora Affairs and Enterprise Armenia assist diaspora providing economic support through remittances, Armenian investors by addressing their concerns diasporas can be important sources of knowledge, for investing and providing comprehensive support skills, investment, and business connections. For for the implementation of investments. According to example, they can have a positive impact on trade by a survey conducted by the Ministry of Economy, 74 creating connections between producers in destination percent of the 2,000 Diaspora-Armenians included 105 The potential role of the diaspora in accelerating Armenia’s development process has been emphasized in the SCD2 consultation and dis- cussed, for example, in IOM 2023. 106 Office of the High Commissioner for Diaspora Affairs; http://diaspora.gov.am/en 68 in the survey were willing to make investments in connectivity for a digitally enabled society. Public Armenia.107 However, little information is available to service digitization, especially in rural areas, can be an assess the magnitude, effectiveness, and full potential important driver of digital demand, which can create of this diaspora.108 Drawing from the success of other incentives for the expansion of privately financed countries, the first step for the government is to devise digital networks. While the government is committed to a roadmap or strategy that identifies the sectors and the digitization of government services, progress has areas that require diaspora input.109 As acknowledged been hampered because public service digitization has by the Office of the High Commissioner, it is also critical been siloed in Armenia, with individual ministries and to gain a better understanding of who and where the agencies adopting digital technologies at varying rates. diaspora populations are. This involves comprehensive There is also a lack of unified standards, protocols, and data collection, including mapping of the location, skills, shared infrastructure which are essential prerequisites and experiences of the diaspora.110 Given the diversity of for interoperability and integration of databases, diaspora agendas, interests, and strategies, building a registries, and services. The government recently system of communication to find areas of mutual interest established the Information Systems Management for practical collaboration is also critical. Board to address these challenges, which is a critical step toward a more digitally enabled and integrated 5.2.5. Governance and Institutional public sector (Box 4). Bottlenecks – A Related Example in the Digital Sector 5.2.6. Binding Constraints A more holistic and coordinated approach to The table below summarizes the binding constraints digital development is needed to enhance digital discussed in this section. Table 4. Binding Constraints for Accessing Markets and Trade Integration Key Challenges Binding Constraints Inadequate transport infrastructure Insufficient public investment and need for continuous prudent macroeconomic management Inadequate investment to build capital stock Need to enhance digital connectivity 2: Accessibility to markets and better Insufficient legal and regulatory framework to enhance trade integration to trade Weak logistic services Closed borders with neighboring countries Weak institutions to promote export and diversification Need to ensure a reliable energy supply 107 https://www.1lurer.am/en/2022/05/26/Investment-environment-really-promising-Vahan-Kerobyan/729653 . 108 The need for a more systematic approach to diaspora relations was confirmed in the SCD consultations (Appendix I). 109 For example, the past success of governments such as the Republic of Korea and Taiwan, China in bringing diaspora talent and treasure to the table was in large part possible because both governments had sound development strategies in place to invest in education, promote science and technology, build infrastructure, and foster entrepreneurship (IOM 2012). 110 In India, the government tasked a High-Level Committee to analyze the location, situation, and potential development role of the estimated 20 million non-resident Indians and persons of Indian origin. The information resulting from this two-year exercise led to a new direction in diaspora policy, including the creation of a Ministry of Overseas Indian Affairs in 2004 (IOM 2012). 69 Box 4. Governance for Digital Transformation The IT industry in Armenia has historically been the most established among the South Caucasus countries, with strong links to international markets. The dynamism of the private sector extends from the digital infrastructure and connectivity markets to digital service delivery and cross-cutting issues such as cybersecurity and digital authentication. The industry has also evolved from IT to advanced digital services (including artificial intelligence products), with two companies, PicsArt and ServiceTitan, attracting international investment at valuations above US$1 billion and achieving unicorn status.a There are also several private sector coding academies that complement the formal education system, in turn bridging gaps between industry and the formal education sector curricula as well as attracting individuals to invest in digital skills. The TUMO Center for Creative Technologies is a successful example, educating over 20,000 teenagers on technology and design free of charge. It has also become a successful Armenian export, with seven TUMO franchises opened in six other countries. However, the level of digitization of the private sector, including core industries like banking, is not reflected at the same level in the public sector. The gap in digitization between the public and private sectors (including in data infrastructure and cybersecurity) reflects the need for a more coordinated approach to digital transformation, while it also provides an opportunity to leverage the domestic private sector to a greater extent to help achieve Armenia’s digital ambitions. The government has expressed a strong commitment to digital development and seeks to transform the country through digitalization. The Digitization Strategy envisages the digital transformation of the government, economy, and society through the introduction and development of innovative technologies, cybersecurity, data policy and e-services and e-government systems, coordination of digitalization processes, creation of common standards and digital environment, as well as initiatives promoting the use of digital technologies in the private sector and the development and implementation of programs promoting the use of electronic tools by the public.b The government has established several institutions to support the digitization agenda. The government has reformed and created institutions including the Information Systems Management Board (ISMB), Chief Information Officer (CIO), Ministry of High-Tech Industry (previously Communications and Transport Ministry), and public-private engagement forums on digitization, which are fundamental for building the overall digital ecosystem. In particular, the ISMB, led by the Central Bank of Armenia, comprises key line ministries including the Ministry of High-Tech Industry (MHTI) which reports to the Deputy Prime Minister (who is also the country’s CIO). To implement the digital transformation vision set by the ISMB, the Information System Agency of Armenia was recently established under the auspices of the Central Bank. The Agency is also expected to house the Civilian Cybersecurity Operating Center and Cybersecurity Emergency Response Team. The agency is meant to become a full-fledged regulatory and supervisory body of digital infrastructure (which may affect the roles and responsibilities of the current telecommunication regulator, the Public Services Regulatory Commission). A strong and coordinated institutional and legislative set-up will be required to effectively implement the national Digitization Strategy, given its cross-sectoral nature. The substantial evolution in institutional arrangements follows a few years of absence of clear ownership and of the agenda within the government, including lack of clarity on the role of the CIO and MHTI. The Agency is only starting to recruit staff and will likely suffer from limited capacity and resources for some time, given its considerable scope of interventions. In parallel, the MHTI underwent multiple management changes and has continued to lack adequate technical staff. The Public Services Regulatory Commission relies also on a very limited number of staff to carry out its duties and has followed a laissez-faire approach on many issues, with relatively successful outcomes in terms of market development thanks largely to a competitive market led by dynamic private operators. However, even if basic legislation for digital development exists, most of the laws appear to be outdated, and important areas such as infrastructure sharing, advanced market analysis for competition, cybersecurity, data governance, and technology standards also lack adequate regulations and development policies. a Tosunyan 2021. b World Bank 2022h. 70 5.3. Quality of Human Capital 5.3.1. Access to Learning and Relevant Skills The low productivity of the labor force continues The stock of human capital is as expected at Armenia’s to be a major development challenge for Armenia. stage of development, but the country is behind some Under SCD1, an aging population with a large share comparator countries. As mentioned earlier, the HCI of of young people unprepared for the labor market Armenia measured in 2020 indicates that children born and lacking required skills were identified as major in Armenia today will be only 58 percent as productive reasons for low productivity. This constraint still during their lives as they could have been if they had poses a challenge today, with labor productivity received the full set of health and education services stagnating since 2019, associated with stagnation in available, and this indicator has not improved since 2012 the improvement in human capital in terms of both (Table 5). Armenia’s overall HCI level is comparable to education and health. While the years of schooling are several peers, but Armenia could further improve its HCI relatively high by international standards, the level of to the level of aspirational peers such as Estonia (Figure learning outcomes can be improved. High prevalence 64). In terms of learning, in 2020, Armenian children were of noncommunicable diseases (NCDs), limitations expected to complete 11.3 years of schooling on average, in the financial coverage of health services, and the which is only slightly lower than the average for upper- high share of out-of-pocket expenditures hinder middle-income countries (UMICs) (12.2 years) and ECA improvement in health outcomes. Investment in human (13 years). However, the years of schooling declines to capital through expenditures on education and health 8.0 years if the quality of education is considered, which enhances the productivity of labor as people become is lower than many peers (Figure 65).111 Human capital physically fit and skilled at their jobs. This section improvements in Armenia also seem to be stagnating— further analyzes human capital in terms of education for example, after improvements in stunting outcomes and health, and active labor market measures to boost between 2012–20, progress is now slowing, and the returns to human capital. prevalence of stunting remains high compared to peer countries (Figure 66). Table 5. Human Capital Index, Armenia, 2012, 2017, and 2020 2012 2017 2020 Indicator Men Women Overall Men Women Overall Men Women Overall Overall Human Capital 0.56 0.61 0.58 0.55 0.59 0.57 0.56 0.6 0.58 Index Survival to age five 0.98 0.99 0.98 0.99 0.99 0.99 0.99 0.99 0.99 Expected years of 11.5 12.2 11.8 10.9 11.3 11.1 11.1 11.5 11.3 schooling Harmonized test scores n/a n/a n/a 439 448 443 439 448 443 Learning-adjusted years of n/a n/a n/a n/a n/a n/a 7.8 8.3 8.0 schooling Adult survival rate 0.82 0.92 0.87 0.83 0.93 0.88 0.83 0.94 0.89 Not stunted rate 0.78 0.8 0.79 0.89 0.92 0.9 0.89 0.92 0.91 Source: World Bank 2020e. 111 There was an improvement in 2019 TIMSS scores for Armenia which may increase the overall HCI score, which will be announced later in 2023. 71 Figure 64. Human Capital Index, Armenia and Peers, Figure 65. Learning-Adjusted Years of Schooling, 2020 Armenia and Peers, 2019 0.9 12 11.7 0.8 0.78 11 0.7 Human Capital Index 0.63 ECA: 10 0.58 0.58 0.57 0.58 10 0.6 0.57 Years 0.52 0.5 9 9.0 0.4 8.3 8.3 8.0 UMIC: 7.8 0.3 8 7.9 7.8 0.2 7 0.1 6.5 0.0 6 Albania Armenia Bosnia and Herzegovina Estonia Georgia Moldova Tunisia Kosovo Estonia Albania Moldova Georgia Armenia Kosovo Bosnia and Herzegovina Tunisia Source: World Bank Human Capital Project 2020. Source: World Bank staff calculations; methodology of Filmer et al. 2018; Note: Scale 0 to 1. TIMSS (Trends in International Mathematics and Science Study) (data repository), International Association for the Evaluation of Educational Achievement, https://www.iea.nl/data-tools/repository/timss Figure 66. Prevalence of Stunting, Height for Age since the 1990s, they have remained virtually constant since 2010. Overall enrollment rates have declined 35 across most levels of schooling, with geographic and Percentage of children under age 5 30 socioeconomic disparities. At earlier stages of life, access and enrollment in preprimary education are 25 lower in rural areas. Moreover, despite some progress 19 20 18 in learning outcomes, students in upper secondary school are absorbing only two-thirds of the knowledge 15 9.1 imparted, as demonstrated by their low test scores. The 10 scores also show regional disparities (urban versus rural) 5 and socioeconomic disparities (World Bank 2023a). The fact that higher enrollment was not coupled with higher 0 test scores signals the low quality of education. Later in 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 life, only 50–60 percent of graduates from institutions Albania Armenia Bosnia and Herzegovina of higher education and from vocational education and Estonia Georgia Kosovo training find work after completing their studies (World Moldova Tunisia Upper-middle-income Bank 2023a). Source: UNICEF, WHO, World Bank: Joint child malnutrition estimates (JME). Low returns confirm the perceived low quality of education. The labor market relevance of the education Progress in education has been stagnating, and system was an issue raised in SCD1. The low rate of learning outcomes indicate disparities and quality returns to one extra year of education confirms that issues. During the last decade, it appears that Armenian education is suffering from a severe problem achievements in education have been reversing. in quality. Employers in Armenia have continuously While expected years of schooling have increased noted the lack of practical skills of new graduates and 72 the fact that they are not work-ready. Education is overly Figure 67. Employment by Educational Attainment broad and general, with a lack of focus on specialization (1,000s) and a lack of well-functioning internship/practicum 600 programs to equip students with skills. Thus, students Employed people (in thousands) have traditionally remained in student mode until the 500 very end of their courses (Anush Shahverdyan 2008). 400 Strengthening higher education—especially in 300 specialized secondary and tertiary education—to build the professional expertise necessary for innovation 200 and technology adoption is instrumental for resilient and sustainable economic growth. Economic research 100 unequivocally shows high rates of private and social return on investments in tertiary education (Murthi et 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 al. 2021) and the significance of specialized skills for innovation and technology adoption (World Bank 2022g). Tertiary, post-graduate Primary and lower Vocational In Armenia, employment among the tertiary-educated Secondary, specialized Secondary, general Basic population and those with specialized secondary Source: ArmStat https://statbank.armstat.am/pxweb/en/ArmStatBank/ ArmStatBank__2%20Population%20and%20social%20 education has been rising since 2018 (Figure 67), and processes__23%20Employment%20and%20unemployment/PS- the economic returns for tertiary education graduates eu-13-2021.px/?rxid=9ba7b0d1-2ff8-40fa-a309-fae01ea885bb. are the highest.112 However, efforts are needed to enhance accessibility and effectiveness. In Armenia, One gap for vulnerable children is in access to and tertiary education remains out of reach for many of the utilization of early childhood development services, poor: among the working-age population, the share of despite the availability of high-quality facilities. The those with tertiary education was 30 percent among the quality of kindergarten services is comparable with poor, while the rate was 48 percent among the non-poor regional peers—the curriculum is a strong point, although in 2021. human resourcing needs improvement. A World Bank facility survey of early childhood development service Even at a young age, children in Armenia face providers in four marzes also found well-established inequalities in accumulating high-quality human public early childhood development services across capital, excluding them from future economic health and education (World Bank 2017c). Nonetheless, opportunities and mobility. One-fifth of Armenian there is a gap in the promotion of cognitive and social children are growing up in multidimensional poverty and development for children under age three, which is may also lack the means to overcome intergenerational especially problematic given that global evidence poverty in the future. A large share of children lacks basic suggests that the returns to investment are likely to be inputs to accumulate high-quality human capital, driving highest among the youngest children (Ayliffe, Honorati, high inequality of opportunity and low economic and and Zumaeta 2019; Richter et al. 2016). social mobility (Tiwari et al. 2018). Children living in poor households are 6 percentage points more likely to be Access to preschool and childcare services also has stunted than children in more well-off households, and important implications for women in Armenia. In they perform worse in terms of harmonized test scores. Armenia, the time allocation to childcare as a share of At the macro level, the exclusion of these children from total activity is three times higher for women than men economic opportunities weighs down labor markets and and consistent across all locations (Figure 68). Increased inclusive growth (World Bank 2020e). access to and usage of childcare services is thus 112 Analysis undertaken for this SCD2 based on the 2021 ILCS show that the returns to tertiary education (in terms of the logarithm of wages) were 1.3 percent for tertiary, compared to 0.4 percent for general secondary and 0.2 percent for specialized secondary. 73 Figure 68. Average Share of Time Allocated to Labor and Domestic Work, Weekday Female Male Work and commuting Work and to work; 14.4 commuting to work; 26.8 Domestic tasks; 12.6 Other; 61.3 Other; 65.2 Domestic Elderly tasks; 3.2 care; 1.9 Elderly care; 1.3 Childcare; 9.8 Childcare; 3.5 Source: WIcaza and Tarlovsky 2023. Note: Includes adult respondents. Shares are calculated based on the total hours of activity reported by each respondent of the survey and averaged across gender and location, applying population weights. Activities not shown are studying, leisure, sleeping, self-care, transport, and others. expected to have huge impacts in improving female appropriate financing, capacity development support, labor force participation. Similarly, given that women are and monitoring (World Bank 2023a). predominantly responsible for unpaid domestic care work (Icaza and Tarlovsky 2023), increased access to 5.3.2. Access to Health Services and utilization of preschools would increase women’s opportunities to join the labor market and retain their Challenges in accessing high-quality health services jobs. result in poor health outcomes. Evidence points to gaps in access to high-quality health care services— In terms of education spending, higher levels of for example, Armenia is rated 70.7 out of 100 in the spending and reforms to improve the efficiency of healthcare access and quality index developed by spending will be critical to increasing Armenia’s the Institute for Health Metrics and Evaluation (GBD human capital. Aggregate country data suggest there 2017 DALYs and HALE Collaborators 2018). Healthy life is a close correlation in the ECA region between expectancy—an indicator that excludes from longevity education spending as a share of GDP and performance any years of less than full health due to disease or on standardized assessments as captured by the Trends injury—was 67.1 years in 2019, below the peer countries, in International Mathematics and Science Study.113 such as Georgia (73.3 years) and Estonia (78.9) Kruk et Armenia’s spending on education as a share of GDP al. (2018) estimated that the percentage of amenable is among the lowest in ECA, fluctuating between 2–3 deaths—premature deaths (deaths under age 75) that percent of GDP over 2011–17 compared to the ECA could potentially be avoided, given effective and timely average of 4 percent. Moreover, the education sector’s healthcare—due to poor quality service exceeded 50 fragmented governance and lack of autonomy at the percent in Armenia. Although this rate is lower than the local level reduce the effectiveness of the sector and average rate of 79 percent among the central European negatively affect resource efficiency. Recent reform in countries considered for the analysis, there is scope the education sector aims to establish effective, open, for improvement. The main contributing factors to the performance- and outcome-based governance and gaps in access include challenges in health financing, financing systems, but it needs to be accompanied by delivery, and governance (Chukwuma et al. 2020). 113 Trends in International Mathematics and Science Study (TIMSS) (data repository), International Association for the Evaluation of Educational Achievement, Amsterdam, https://www.iea.nl/data-tools/repository/timss. 74 Figure 69. Out-of-Pocket Expenditure (as % of current Low government funding and spending inefficiencies health expenditure) contribute to a large share of out-of-pocket expenditures and result in inequities in access to 100 health care services. Government spending on health Percentage of current health expenditure in Armenia is one of the lowest in the ECA region, 80 78 contributing to financial gaps in access and limiting 62 the capacity to improve health care quality. Moreover, 60 there are large inefficiencies in public spending: total health expenditure in Armenia was 11.3 percent of GDP 40 in 2019—higher than the 2019 averages in UMICs (5.9 percent) and the world (9.8 percent)—but the share of 20 public financing in total health spending is among the lowest in the world and is below the average in UMICs 0 (57 percent). The share of out-of-pocket spending is also 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 high at 78 percent, one of the highest shares in the world Albania Armenia Bosnia and Herzegovina (Figure 69).117 Next to quality issues, financial barriers are Estonia Georgia Tunisia Moldova the second-most important cause of the underutilization Source: World Health Organization, The Global Health Observatory of primary health care services. A key driver of out-of- database as of January 2021. pocket spending is the lack of coverage among up to 70 percent of the population for outpatient medicines, The health system has traditionally focused on diagnostics, and hospital care. Given the limited financial curative rather than preventive services,114 leading resources, a greater focus is needed on the effective to major shortcomings in addressing the growing allocation and governance of resources for health burden of NCDs (WHO 2022). In addition to the costs spending to provide households—especially poorer of preventable premature deaths and years of disability, households—with financial protection and to minimize the estimated economic burden of NCDs is significant. the probability of catastrophic health expenditures The WHO estimates that the most common NCDs (Chukwuma et al. 2020). account for 63 percent of total public health spending. The burden of NCDs partly reflects the underutilization of 5.3.3. Access to High-Quality Jobs high-quality care and exposure to behavioral risk factors, including the high prevalence of smoking and obesity.115 The persistence of substantial unemployment over The coverage of care for NCDs is low in Armenia, and the past decade suggests that there are structural, the utilization of primary health care services is also low long-term barriers and potential mismatches to with only 32 percent of the general population visiting finding employment. Unemployment in Armenia has the facilities according to the last assessment in 2020– been high compared to some of its peers (Figure 70). 21 (National Institute of Health 2022). The health care The main reported obstacle to finding jobs among model in Armenia is centered on curative care which jobseekers is a lack of jobs—55 percent of jobseekers accounted for 59 percent of health care expenditures in reported it to be a main constraint. This response was 2018, above the average for Europe.116 more prevalent among men (61 percent), individuals with relatively low educational attainment (lower-secondary education or less, 78 percent), and residents of rural 114 Existing programs implemented by the Ministry of Health with the aim of prevention, early detection, effective and timely treatment of non-com- municable diseases include screening and free medical treatment for acute medical condition (Ministry of Health). 115 Over 50 percent of Armenian men ages 15 and above are smokers, and 55 percent of the population ages 15 and above are obese (National Institute of Health 2022). 116 Armenians have a 20 percent probability of death before age 70 associated with the main NCDs, which is above the average for countries in the Europe region (16 percent) and the global average (18 percent) (World Health Organization Global Health Observatory Data Repository). 117 Private health expenditures in Armenia are mainly out of pocket. 75 Figure 70. Unemployment Rate (% of Total Labor Figure 71. Share of the Labor Force Working 20 or Force) More Hours a Week with a Contract 40 80 35 70 Percentage of total labor force 30 60 25 50 20 19 40 15 30 10 13 20 5 10 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Belarus Czech Rep Latvia Estonia Germany Lithuania Bulgaria Slovak Rep Russia Poland Hungary Romania Slovenia Croatia Ukraine Italy Serbia Kazakhstan Montenegro Bosnia Herzegovina FYR Macedonia Moldova Cyprus Uzbekistan Albania Mongolia Greece Georgia Armenia Kyrgyz Rep Kosovo Tajikistan Türkiye Azerbaijan Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Source: ArmStat Labor Force Survey data for Armenia and ILOSTAT Source: Tiwari et al. 2019. Work Statistics –19th ICLS (WORK database) as of July 2023 for other countries. areas and secondary cities (over 60 percent). Around are often underutilized. Unemployment is high among 10 percent of jobseekers attribute unemployment to the young women ages 15–24 at 33.6 percent, compared to lack of jobs corresponding to their profession or skills; 28.3 percent of men in the same age group.118 Women this share is 20 percent among jobseekers with tertiary are also more likely (22 percent) than men (11 percent) to education (ADB 2019a). Among individuals registered work part-time.119 Analyses of the equality of opportunity as unemployed with the public employment services, based on a human opportunity index highlight the around 75 percent suffer long-term unemployment, and incidence of gender as an unfair determinant of access to over 90 percent are considered uncompetitive in the high-quality jobs.120 Women’s access to high-paying jobs labor market (Honorati et al. 2019). Some subsectors are is affected by occupational segregation—for example, growing in terms of employment—such as information women are underrepresented in science, technology, and communication, financial and insurance activities, engineering, and mathematics, accounting for only 38 and professional activities, which tend to require percent of graduates in these fields.121 relatively high skills—but these sectors are still small in absolute size of employment. Moreover, good-quality Women also earn less than men, with a large jobs are not available to many in Armenia (Figure 71). unexplained gender wage gap. Women employees earn only 74 percent of the net wages of men.122 Women face high unemployment, potential Men earn higher average wages relative to women, underemployment, and barriers to accessing high- regardless of age and educational attainment—even quality jobs. Armenian women achieve high levels of women employees with tertiary educational attainment human capital and skills, although their work and talents earn only 71 percent of the wage earnings of men 118 Statistics are for 2021 from ILOSTAT Work Statistics –19th ICLS (WORK database) as of July 2023 for other countries. 119 Statistics are for 2021 from ArmStat Labor Force Survey Data. 120 Statistical Data (dashboard), Statistical Committee of Armenia, https://armstat.am/en/. 121 2018 data of Gender Data Portal (dashboard), World Bank, https://genderdata.worldbank.org/. 122 World Bank staff calculation based on 2021 ECPOV harmonized database. 76 at the corresponding level of education.123 Women’s Figure 72. Share of Youth Not in Education, underrepresentation in occupations associated with Employment, or Training (% of population ages 15–29) higher wages may partially explain the lower earnings of 40 38 women. Rodríguez-Chamussy, Sinha, and Atencio (2018) estimate that women face an average earnings gap of 33 Percentage of youth population percent (unadjusted), and while econometric adjustments 30 28 for differences in education, age, experience, and other observable characteristics reduce the wage gap, the 20 adjusted wage gap is still high at 20 percent. This gap points to unexplainable factors that may reflect gender discrimination. 10 Another challenge for Armenia is the large share of youth not in education, employment, or training 0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 (NEET). The rate of youth NEETs in Armenia is among the highest in the region despite some progress Albania Armenia Bosnia and Herzegovina (Honorati et al. 2019) (Figure 72). According to estimates, Estonia Georgia Europe and Central Asia Moldova Kosovo World: high income 37.3 percent of women and 19.2 percent of men ages 15–29 were NEETs in 2021.124 Regardless of the exact Source: ArmStat Labor Force Survey for Armenia. Other countries are from ILOSTAT Work Statistics –19th ICLS (WORK database) as of July age cohort, young women are always more likely than 2023. https://ilostat.ilo.org/data/ young men to become NEETs. The share of women Note: For countries other than Armenia, age range is 15-24. NEETs increases sharply for the 25–29 age group, most likely related to motherhood and family responsibilities. reach only a small number of beneficiaries. Public Among men, circular and seasonal migration is the Employment Services has established 15 active most common reason for inactivity. People with low labor market measures (ALMMs), but many of these educational attainment report that seasonal migration programs remain small. Overall, the largest share of and discouragement—that is, failure in finding job—are funding for ALMMs goes to rural self-employment common reasons for their inactivity. Based on regression support. However, the targeting of such measures analysis, the individual characteristics (aside from sex) is not fully aligned with the profile of the registered that correlate strongly and positively with the probability unemployed. Whereas the majority (54 percent) of of NEET status include age, membership in a vulnerable the beneficiaries are rural residents, this group only minority (such as displaced population or persons with makes up 41 percent of the registered unemployed disabilities), and an immigration background. Household (World Bank 2022). Due to a lack of resources and composition (especially the presence of young children) limitations in engaging people with weak labor market and marital status stand out as important correlates of attachment, public employment services only reach NEET status among women but not men. Socioeconomic and serve a small share of all the unemployed. Among status is also an important correlate, with most NEETs the unemployed, only 26 percent are registered with living in lower-income households (Buitrago-Hernandez, public employment services. The limited outreach is a Fuchs, and Cancho 2019). result of the narrowness of the financing and limited human resource capacity at the recently established Although Armenian Public Employment Services local centers of the unified system of integrated social offer a broad portfolio of services, the support might services, which provide counseling to jobseekers and not be targeted effectively, and most programs employers (World Bank 2022). 123 World Bank staff calculation based on 2021 ECPOV harmonized database. 124 ArmStat staff calculation based on Labor Force Survey. 77 5.3.4. Governance and Institutional and high out-of-pocket expenditures. About 30 percent Bottlenecks – A Related Example in the of total health spending in Armenia is on medicines and Health Sector medical supplies, which is high for a UMIC.125 This can be attributed to relatively high retail prices and markups Governance and institutional bottlenecks in addressing due to high manufacturer charges, distribution costs, and the low human capital include inefficiencies and limited the value-added tax, which is the highest in the region accountability of the responsible government agents, at 20 percent. The differences between wholesale and lack of transparency in decision-making, capacity already-high retail prices across molecules range from constraints to implementing the reforms, and slow 2 to 125 percent, and at an average of 29 percent, it progress in reaching the underserved populations in exceeds the markups in comparator countries.126 the health sector. In 1998, the State Health Agency in the Ministry of Health was established as the single public 5.3.5. Binding Constraints payer responsible for purchasing services in the Basic Benefit Package on behalf of the government. However, Table 6 summarizes the binding constraints discussed its role has been eroded as multiple private purchasers in this section. are being approved by the Ministry of Health non- selectively, leading to fragmentation and inefficiency in 5.4. Private Sector Development the health system. Furthermore, while Armenia shifted to program-based budgeting in 2019, there are no Insufficient private sector productivity was one of the program managers accountable with a clear objective of four challenges identified in SCD1. The productivity the program areas. In addition, no institution has a clear of firms and workers is affected by numerous factors, mandate to monitor the quality of services in primary including: the availability of high-skilled, healthy workers healthcare facilities, and health information systems are in the labor market; efficient connectivity and logistics to not fully functioning due to limited digital capacity at the reach markets; and resilience and mechanisms to cope local primary healthcare facilities. with shocks. Low and heterogenous productivity can be a consequence of challenges with those factors, as well Decentralized procurement and insufficient regulation as a contributing factor perpetuating other development and monitoring of wholesalers, retailers, and health challenges.127 SCD1 found that “insufficient private sector service providers contribute to high prices of medicines productivity stands in the way of both higher growth Table 6. Binding Constraints to Addressing the Low Quality of Human Capital Key Challenges Binding Constraints Low quality and relevance of the education system Unaffordability of health services 3: Human capital Need to improve efficiency and effectiveness of public spending Lack of coordination between education sector and labor market Weak active labor market programs, including addressing gender gaps in labor market 125 This is the share of drugs and medical products in total health spending (public and private spending combined) in 2021 from National Health Accounts (2022). 126 Market Performance Group 2021. Pharmaceutical Market Assessment for Armenia cited in World Bank 2023b. Data were collected on 50 commonly used molecules from 20 hospitals and 20 PHC centers from Yerevan and selected administrative areas. 127 The problem can also be analyzed as a “coordination failure.” For example, in a country with low productivity and lack of innovation in the IT sector, workers would not have incentives to accumulate human capital in specialized areas of STEM, and universities may not even invest in 78 and job creation. Firms, as the productive engines smallholder farmers with farms of 1.5 hectares on average of the economy, appear constrained in their ability (Agricultural Census 2014). Agricultural productivity is to lift productivity” (World Bank 2017b). This section low, as measured by productivity per hectare, per worker, evaluates progress over the past years on firms’ inputs and per unit of water use (FAO 2020c), and the sector is and the enabling environment for the private sector, highly vulnerable to adverse climate events. Moreover, and it identifies the emerging challenges for boosting some evidence indicates declining agricultural output productivity in Armenia. It first discusses productivity at in recent years: according to data collected by ArmStat, the sector level then summarizes the main obstacles the sector experienced a decline for five consecutive to improving output and productivity beyond those years, by -0.7 percent of GDP in 2021 and by -1.8 percent discussed in Section 5, with which productivity gaps in in 2022. However, there are reasons for concern about Armenia are highly interlinked. the accuracy of official statistics on agriculture (including the classification of land and property for agricultural 5.4.1. Sectoral Productivity production), and there is also evidence of considerable heterogeneity and success cases within the sector.129 By measures of labor productivity—measured here as total output per worker—private sector productivity in Irrigation is important to agricultural productivity Armenia is low, stagnant, and varies across economic in Armenia, with more than 80 percent of the gross sectors. Labor productivity measured by value added crop output produced on irrigated lands. Agriculture per worker has been growing over the last two decades in Armenia is heavily dependent on irrigation, and across the main sectors. This appears in line with the returns are higher on irrigated lands. However, irrigation results from the TFP analysis discussed in Section 4.128 systems in Armenia have suffered from decades of However, the average level of labor productivity by lack of investment and modernization. Water losses are sector is among the lowest relative to Armenia’s peers. high, and energy usage (to pump water) is expensive. Notably, average productivity in services is twice as high Because tariffs remain low, subsidies are often needed as in agriculture, and productivity in industrial activities to maintain a basic level of irrigation service for farmers. is three times higher than the average in agriculture (Figure 73). These productivity gaps across sectors Access to inputs and capital for agricultural production suggest a misallocation of resources. Although average has improved in recent years. Government subsidy productivity can mask heterogeneity within sectors, the programs have supported improvements in access to low estimated productivity in agriculture is related to the fertilizer and seeds, and public investment has focused small average size of plots and the related disincentives on enhancing access to irrigation, farmer cooperatives, for large investments and technological upgrades. and producer associations. These measures could Armenia’s levels of manufacturing productivity are in line improve grassroots irrigation management and promote with peer countries, but productivity in agriculture and economies of scale and profitability in agricultural services is lower than among peers. markets. However, implementation is far from complete; the Ministry of Agriculture was subsumed into the Despite evidence of low productivity and recent Ministry of Economy several years ago, and the farmer declines in output, agriculture continues to be a extension service was abolished. Given the importance strategic sector of the Armenian economy. Today, of knowledge as a basis for technology adoption among agriculture is dominated by semi-subsistence, part-time farmers (including technologies and practices that providing those skills. The lack of high-skilled STEM workers would simultaneously contribute to a low-productivity equilibrium and underde- velopment of the IT sector. Breaking this coordination problem is hence an important policy challenge. 128 This would need to be confirmed through an analysis of firm-level productivity data. Otherwise, it could seem that there is a paradox between Armenia’s seemingly high TFP rates and low labor productivity. Low labor productivity can in principle coexist with high TFP if capital intensity is low, although this would require technical progress that is not at all embedded in new physical capital investment. Furthermore, the labor productivity measured used here (i.e. value-added per worker) may not be as accurate as the marginal labor productivity measure which is unavailable. 129 Anecdotal evidence collected during the identification mission to Yerevan (June 2022) and to be researched further. Export data shows in- creasing volumes and values of agricultural exports. 79 Figure 73. Labor Productivity: Output per Worker a. All Sectors b. Agriculture 25,000 35,000 PPP (constant 2017 international $) PPP (constant 2017 international $) 30,000 20,000 $18,714 $19,308 25,000 $16,366 15,000 $13,922 20,000 $11,839 $10,543 15,000 10,000 10,000 $5,796 $5,523 5,523 $5,000 5,000 5,000 5,000 0 0 2012 2017 2019 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Agriculture Services Industry Albania Armenia Bosnia and Herzegovina Estonia Georgia Moldova Tunisia c. Services d. Manufacturing 40,000 40,000 TitPPP (constant 2017 international $) TitPPP (constant 2017 international $) 30,000 30,000 20,000 20,000 13,922 19,308 16,366 10,000 10,000 10,543 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Albania Armenia Bosnia and Herzegovina Estonia Albania Armenia Bosnia and Herzegovina Estonia Georgia Moldova Tunisia Georgia Moldova Tunisia Source: World Bank staff calculations based on World Development Indicators (dashboard), https://datatopics.worldbank.org/world-development- indicators/. enhance climate resilience), public support is needed in agriculture, raising the possibility for sectoral for knowledge transfer around new technologies and improvements in the medium to long term, provided the farming practices that would enhance climate resilience targeting and delivery mechanisms of support programs among farmers. More support is also needed to improve are improved. the performance of irrigation sector institutions. At the same time, access to capital has advanced significantly Despite this recent progress, some key challenges to through subsidized commercial bank lending programs agricultural productivity seem deeply rooted. Three in agriculture, as well as FDI and funding by international main constraints are preventing the transformation financial institutions. A large share of the fiscal stimulus of agriculture into a modern dynamic sector. First, implemented since 2020 was channeled to investments Armenia has limited areas of arable land, and land 80 ownership is fragmented and dominated by small- However, environmental, social, and governance scale, semi-subsistence farms. Second, low adoption practices in the mining sector remain challenging. rates of advanced technologies and farm management The mining sector in Armenia has a legacy of practices have prevented the sector from becoming irresponsible mining practices in past decades, which more productive, market-oriented, and diversified. has resulted in low acceptance toward mining in host Third, producers are poorly integrated into agriculture communities. Environmental, social, and governance value chains, and agribusinesses lack the capacity to (ESG) standards, which increasingly set a benchmark include more small-scale farmers in their supply chains for responsible mining internationally, need to be (Agricultural Census 2014). A lack of reliable agricultural enhanced. Commensurate with this is a need to improve data makes the design of appropriate support measures the capacity of regulatory institutions to set and enforce for the sector difficult. higher standards. The strategy for the development of the mining sector, adopted in May 2023, aims to rebuild Within manufacturing, the productivity of mining confidence and restore trust by promoting investment in has improved, and the sector has potential for responsible mining founded on sustainability principles expansion but is constrained by investment and a and higher ESG performance. need to green the sector. Given Armenia’s favorable mineral geology, the mining sector has potential for In the services sector, certain sub-sectors such as further expansion considering rising global demand tourism show promise for boosting productivity, and mining investment. The global mining industry particularly if measures are taken to help realize is scouring the globe to find the next generation of their full potential. International tourism arrivals more deposits, especially those of climate critical minerals than doubled in the last decade to reach a peak of 1.9 which are in strong demand as the world moves to million tourists in 2019, and the sector accounted for decarbonize. Armenia has proven reserves of copper 12.5 percent of total employment that year (World Bank and molybdenum and a significant potential for gold 2021a). After a decline in 2020 due to the twin shocks, and a range of other minerals that could be further tourism has shown dynamic growth, reaching 1.7 million valued through geological research and exploration. In in 2022 (Figure 74). This was supported by tourism from the medium run, the demand for minerals needed for Russia, with Russian visitors increasing more than two- the energy transition could also create opportunities fold in 2022 year on year. for mining, if Armenia is able to attract investment oriented toward a green growth model. Armenia would More can be done to help realize the full economic need to attract investment on a far larger scale than at potential of tourism. The country ranked 61st among 117 present, primarily from foreign sources, for its growth countries on the World Economic Forum (WEF) 2021 travel ambitions to be realized. Even maintaining the sector and tourism competitiveness index, with low rankings at its present scale will require an increase in capital in infrastructure (WEF 2022). In addition to addressing investment to avoid depletion due to the exhaustion of infrastructure gaps, medium-term interventions to available reserves. The sector could be expanded both improve competitiveness could target digital nomads, by increasing the volume of minerals mined and adding free independent travelers, and nature and wellness value by processing minerals before export. While this tourists, including measures such as enhanced digital would not contribute to increased economic complexity infrastructure, market-relevant product offerings, of Armenia’s exports, it could be an important source coordinated promotion at the firm level, and awareness of growth and fiscal revenues in the decade ahead. raising (domestically and abroad) on Armenia’s tourism Mining already accounts for two of the country’s top offerings (World Bank 2021a). five taxpaying enterprises and accounted for around 10 percent of direct tax receipts in 2021. 81 Figure 74. Tourist Arrivals and Revenues 2010-22 Figure 75. ICT Service Exports (BoP) 2,000 3,000 2,400 2,513 2,000 1,600 2,400 Number of persons (000) Current million US$ 1,600 US$ million 1,200 1,800 1,553 1,200 875 800 1,200 813 800 694 1,464 400 888 1,305 524 600 328 929 986 1,191 400 715 223 790 559 631 687 315 263 273 303 347 430 352 127 125 127 156 210 138 0 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Russia Other countries Tourism revenues, mln USD (RHS) Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Tunisia Source: ArmStat Socio-Economic Situation of the Republic of Armenia; Source: World Development Indicators database. CBA, Balance of Payments BPM6. Similarly, the ICT sector has been dynamic, but offers an additional opportunity for Armenia to seize: Armenia can do more to better position itself to over 50,000 IT specialists from Russia are estimated leverage global digital trends. Armenia aspires to be to have arrived in Armenia after several companies an ICT hub and has a recent track record of providing relocated in 2022 and registered in Armenia.130 outsourcing services to global firms. ICT services dominate Armenia’s high-tech exports—mostly in The increasingly poor reliability of electricity service software programming—and ICT service exports nearly affects private sector productivity, especially for those tripled from US$127 million in 2010 to US$382 million industries that rely on uninterrupted processes or in 2021 (Figure 75). Among its comparator countries, digital services. After a period of improvement in the Armenia is second only to Estonia in ICT service 2000s, lack of investment in the power network is leading exports, and on a per capita basis (US$137) in 2021, it to increasingly poor reliability of electricity service which outperformed even China (US$36) and India (US$85). harms the general business environment and could However, Armenia could do more, as exports of global result in increased costs, disruption of production, and leaders exceeded US$1,000 per capita in 2017 (World equipment damage. The system-average frequency of Bank 2019a). Armenian firms may struggle to stay interruptions increased from 5.3 yearly interruptions per competitive in high-tech global value chains if they customer in 2013 to 9.1 in 2021, indicating that the average continue to target software and hardware solutions for customer experienced almost twice as many outages in vertical applications. The government can strategically 2021 than in 2013. The average interruption frequency support Armenia’s migration toward activities that are per line for 110 and 220 kV overhead transmission lines catalyzed by emerging technologies, for example in is 2.5 times higher than for comparator well-performing the areas of biotech and digital health, cleantech, utilities. The World Bank enterprise surveys indicate a and earthquake engineering (World Bank 2019a). The similar trend of deteriorating reliability between 2013 recent relocation of IT firms and talent from Russia and 2020 (Figure 76).131 130 Estimate from Minister of Economy, September 2022. Interview with RTVI. 131 The share of firms experiencing electrical outages fell from 41 percent in 2009 to 34 percent in 2013 but then increased to 63 percent in 2020, twice as high as the regional average (31 percent). Similar trends can be seen in the number of outages per month (0.9 in 2009, 0.4 in 2013, and 2.5 in 2020, compared to the ECA average of 0.8) and their typical duration (3.7 hours in 2009, 1.9 hours in 2013, and 2.9 hours in 2020). 82 Figure 76. Firms Experiencing Electrical Outages at above 36 percent. Credit grew by over 6 percent as of May 2023, driven mostly by lending to households. 70 Despite adequate fundamentals, risks mainly relate to 62.7 60 the high level of dollarization, rising real estate prices, 52.1 tighter global financial conditions, a slowdown in 50 major trading partners, and geopolitical risks from the Share of firms (%) 40 persistent tensions with Azerbaijan.  34.4 31.1 30 The banking sector is well regulated and supervised. 20 In the last few years, the CBA has undertaken significant efforts to modernize its regulatory and supervisory 10 framework for the banking sector and financial 0 safety net to ensure that it is in line with international 2013 2020 ECA (2020) All countries standards and best practices. Key reforms include: (1) (2020) Armenia bringing the definition of non-performing loans in line with international standards; (2) amending the capital Source: World Bank 2020h, Enterprise Surveys. requirements regime; (3) enhancing macroprudential tools and tackling imbalances, as shown by restricting 5.4.2. Access to Finance and Financial the provision of mortgage loans in foreign currency; Inclusion (4) upgrading its supervisory toolkit, including implementing bottom-up micro-prudential stress Armenian manufacturing and services firms report testing, recovery planning requirements, and others; obstacles to growth related to finance, the business (5) preparing a draft Bank Resolution Law that will environment, and human capital.132 These obstacles confer the CBA with new, ample powers to manage include access to finance, informal practices of bank failures, (6) establishing a bank resolution unit, competing firms, political instability, an inadequately and (7) working to increase capacity to assess banks’ educated workforce, and tax regulations (Figure 77). The recovery plans and develop resolution plans for intensity of these obstacles varies by size of firm (Figure systemically important banks. 78). For instance, access to finance is an obstacle that is reduced with size, whereas informality and political Overall, domestic credit to the private sector instability are bigger concerns for larger firms. Midsize accelerated in recent years, reaching seemingly firms are the most affected by the inadequately educated appropriate levels. Armenia’s financial depth— workforce and tax rates. measured as the proportion of domestic credit to the private sector in relation to GDP—increased by 20 Armenian banks are adequately capitalized, liquid, percentage points and is now at a level that is expected and operating in a broadly supportive macroeconomic for the country’s income level and one of the highest context. They experienced record profits in 2022, levels among peers (Figure 79a). However, the credit supported by the huge increase in nonresident must be flowing to large firms, as reflected by the deposits, foreign exchange gains, and low provisioning. percentage of small firms that find access to credit to As of May 2023, capitalization stood at over 20 percent, be the biggest obstacle (34 percent), half the share nonperforming loans at 2.6 percent of total loans, return among big firms (17 percent). At the same time, the cost on equity at 17.9 percent, and liquid assets to total assets 132 Firms surveyed through the Enterprise Surveys (dashboard), World Bank, https://www.enterprisesurveys.org/en/enterprisesur- veys. The sample in Armenia included firms in manufacturing (all subsectors), construction, motor vehicles sales and repair, wholesale, retail, hotel and restaurants, storage, transportation, and ICT. Firm size included more than five employees. Status: formal firms with more than 1 percent private ownership. Excluded sectors: agriculture, fishing, mining, public utilities, financial intermediation, public administration, education, health care, and social work. Size of excluded firms: less than five employees, informal firms, and 100 percent state-owned enterprises. 83 Figure 77. Main Obstacles to Doing Business Figure 78. Obstacles to Doing Business, by Firm Size 40 Access to finance 29.7 Practices of the informal sector 12.9 34.1 Political instability 11.8 Inadequately educated workforce 11.3 30 Percentage of firms 25.9 Tax rates 10.2 Trade regulations 4.7 21.5 Tax administration 3.9 20 17.7 16.7 16 Corruption 3.8 14.7 13.5 Access to land 3.3 12.2 12.1 11.4 10.7 9.2 Transportation 2.1 10 8.1 8.9 Labor regulations 2.1 Business licensing and permits 1.3 Courts 1.2 0 Access to Practices of Political Inadequately Tax rates Electricity 0.8 finance the informal instability educated Crime, theft, and disorder 0.8 sector workforce Percentage of firms Small (5-19) Medium (20-99) Large (100+) Source: 2020 data of Enterprise Surveys (dashboard), World Bank, Source: 2020 data of Enterprise Surveys (dashboard), World Bank, https://www.enterprisesurveys.org/en/enterprisesurveys. “Percent of https://www.enterprisesurveys.org/en/enterprisesurveys. “Percent of firms choosing access to finance as their biggest obstacle.” firms choosing access to finance as their biggest obstacle.” Figure 79. Credit to the Private Sector a. Financial depth versus income level, 2019 b. Domestic credit to private sector 200 100 Credit to Private Sector (% of GDP) 80 150 72 Percentage of GDP 60 60 100 40 GEO TUN ARM BIH EST 50 28 XKX 20 ALB MDA 0 0 6 8 10 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Albania Armenia Bosnia and Herzegovina Estonia GDP per Capita (log) Georgia Kosovo Moldova Tunisia Source: World Bank staff calculations based on World Development Indicators (dashboard), https://datatopics.worldbank.org/world-development- indicators/ of credit declined by almost 3 percentage points. The While access to finance is improving, it remains a cost of domestic credit is at a level expected given the significant constraint to growth and private sector financial depth of the country, although it is the highest development. Access to finance was identified as a among peers (Figure 79b). The lower cost among peers major constraint by 31.6 percent of firms, compared to probably comes from constraints among firms, including 14.5 percent in ECA and 23.4 percent for all countries lack of awareness, low financial literacy, and widespread (World Bank 2020h). Armenia’s financial markets are informality. bank- and credit-dominated, with lower participation by 84 Figure 80. Sensitivity of Investment to the Cost of Credit a. 2000s b. 2010s 50 50 42.6 42.6 40 38.8 40 30 30 Percent Percent 25.6 21.2 20 20 18.6 17.0 14.9 16.2 17.0 16.0 10 10 11.8 0 0 1999 2000 2001 2001 2003 2004 2005 2006 2007 2008 2008 2011 2014 2017 2020 Gross fixed investment (% of GDP) Gross fixed investment (% of GDP) Lending interest rate (%) Lending interest rate (%) Source: World Bank staff calculations based on data of the Economist Intelligence Unit and International Monetary Fund. non-banks and capital market institutions. Alternative securities market is moderately developed and instruments such as leasing, factoring, trade finance, provides the basis of the local securities market. early-stage financing, and equity financing are The total market value at the end of 2021 was AMD underdeveloped. In addition, collateral requirements 1,867 billion, of which AMD 1,204 billion (64 percent) are high in Armenia. The prevalence of cash and corresponded to the government bond market, AMD informality makes it more difficult for banks to evaluate 489 billion (26 percent) to the corporate bond market, the repayment capacity of borrowers, which combined and AMD 174 billion (9 percent) to the equity market.133 with difficulties in collateral execution, results in higher The stock market is shallow and has low liquidity, with collateral requirements, especially for SMEs. Loans are a market cap of AMD 277 billion (with 10 issuers and collateralized at over 207 percent of the loan amount, 205 trades) as of June 2023. The development of compared to the ECA average of 164 percent (World the capital market is a priority for authorities, as per Bank 2020h). One symptom of binding finance is the the capital market development strategy approved sensitivity of investment to changes in the cost of credit. in 2020. An action plan with specific milestones and Between 1999 and 2008, reductions in lending interest timelines covering reforms to the money market, rates were associated with increases in the investment foreign exchange market, sovereign market, as well as rate (Figure 80a). This suggests that the cost of credit derivative markets is currently under implementation. was preventing firms from investing. However, after The CBA is facilitating the introduction of an over-the 2008, reductions in the cost of credit did not mirror counter commercial trading platform for the overnight investment growth (Figure 80b). The cost of credit is repo market. It is also undertaking a major review high compared to peers (Figure 81). of the payment system to align the operation and oversight of the financial market infrastructure with Furthermore, domestic capital markets are growing the Objectives and Principles of Securities Regulation from a low base but remain shallow. The government Principles. 133 Armenia Securities Exchange (AMX) Annual Report 2021. 85 Figure 81. Interest Rates on Lending a. Expected rate by level of credit penetration, 2019 b. Rate comparison 50 20 17.6 16 17.8 Lending Interest Rate (%) Lending Interest Rate 12 11.8 25 8 ARM GEO 4 MDA ALB BIH 0 0 0 25 50 75 100 125 150 175 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Albania Armenia Bosnia and Herzegovina Credit to Private Sector (% of GDP) Georgia Kosovo Moldova Source: World Bank staff calculations based on World Development Indicators (dashboard), https://datatopics.worldbank.org/world-development- indicators/ In addition, aspects of Armenia’s corporate law are United States, even if the US headquarters are virtual or poorly suited to early-stage financing and investment. nominally staffed. This firm structure reduces the entity to Armenian law only allows joint-stock companies to subsidiary status, meaning that any investment remains issue preferential stock, and these must be nonvoting in the US account, and dollar transfers are limited to shares. Armenia has no legal structure that permits operational costs, salaries, and overhead. different classes of voting shares, which entail differing entitlements to dividends and various levels of voting Other barriers inhibit FDI in Armenia, particularly power. When seed funding is received as a debt, lack of predictability and a missing government converting that investment into equity during subsequent strategic vision for FDI. Over one-fifth of investors funding rounds is not possible. These constraints surveyed by the International Financial Corporation impede venture capital and angel investors in acquiring in 2023 cite lack of predictability in decision-making preferred stock with liquidation or dividend preference based on laws and regulations of government bodies (as is typical). Similarly, early-stage investors are not able (IFC forthcoming). Decisions are often slow and do not to request voting power—even if subordinate—which always meet deadlines outlined in laws and regulations. makes Armenian start-ups less attractive. This affects the predictability of project timelines and implementation. Regulations also often change: for Due to these limitations and an outdated FDI law, example, in 2022 alone, there were 30 amendments to Armenian firms often incorporate abroad to attract the Tax Code. Among investors, 18 percent cited the lack investment, limiting local spillover. The lack of early- of a strategic vision of the country’s development path as stage financing has driven some Armenian tech firms a barrier to investment, along with insufficient targeting to seek investment abroad. In most cases, investors and outreach to investors. Other challenges highlighted request that investees incorporate under laws with which by investors included few exit routes and exit strategies the investors are familiar—this is especially true of US due to the underdeveloped stock market, as well as investors. Given that many Armenian firms have grown project scalability and bankability given limitations in through US investment (thanks largely to diaspora links), physical infrastructure and the size of the local market. most Armenian tech start-ups are incorporated in the An FDI strategy that identifies measures to improve the 86 business climate, develop supporting infrastructure, including a particular emphasis on an updated national enhance skills and knowledge transfer, and identifies payment system strategy. Significant opportunities viable sectors for investment would support further FDI exist for further advancing digital payments by attraction and diversification of investments in terms of addressing constraints posed by the identification (ID) sectors and destination of flows. infrastructure and regulatory environment to develop non-bank payment services. These efforts will support Private capital mobilization will be crucial to implementation of Armenia’s digital transformation bridge investment gaps in infrastructure, regional strategy. connectivity, and access to finance. As such, further improvements in the investment climate and active Building the architecture for green finance and FDI attraction are needed. While more information is strengthening the innovation ecosystem will needed on private capital mobilization values across unlock green technology uptake, increase the sectors, indicators suggest substantial volumes in competitiveness of the private sector, and help connect infrastructure alone. For example, in the energy sector, the private sector to global value chains. Greening the transmission grid investment needs—excluding the the financial system will increase financing flows into regional interconnections for Georgia-Armenia and activities that contribute to climate and environmental Armenia-Iran—are estimated at US$230 million for 2021- objectives. The estimated need for green investments 35, and distribution grid investment needs are estimated (climate mitigation and adaptation in line with the NDC) at US$445 million for 2021–27.134 is estimated at US$5.7 billion during 2020 and 2030 (Kato and Neuweg 2021) and far exceeds public sector In terms of financial inclusion, despite improvements capacity. Removal of barriers to green finance for the in recent years, Armenia continues to lag the region private sector is key to addressing climate and transition on key metrics and could do more to advance risks and sustainability challenges. There is an urgent digital payments. Account ownership is low relative need to introduce a green taxonomy in Armenia as a to the regional average. According to the 2021 Findex consistent guideline to define green economic activities database, only 55 percent of adults have an account, and appropriate financial instruments to enhance market and the gap is more pronounced for young adults, transparency and facilitate the alignment of capital flows women, those in rural areas, and the poorest 40 percent with environmentally sustainable and green economic of the population. Following the adoption of the Law activities. Green bonds and carbon pricing could have on Noncash Transactions in 2022, which required all an important role to play in mobilizing private sector payments exceeding AMD 300,000 to be non-cash for resources. individuals, entrepreneurs, and firms, Armenia witnessed a notable enhancement in its non-cash payment 5.4.3. Competition and Contestability infrastructure and a significant upsurge in the proportion of non-cash transactions.135 However, cash is still quite While perceptions of Armenia’s competition policy dominant, especially in rural and remote regions (Global and organization of the market have improved, more Findex 2021). Only 16 percent of adults made a digital can be done to boost competition. Since 2018, there merchant payment, compared to 54 percent in ECA has been a notable improvement in perception of (excluding high-income economies). Banks are the main competition policy (Figure 82). The new government providers of payment services on both the issuing and pledged to open industries that had previously been acquiring side, and there is little evidence of existing closely connected to the state to competition. The focus players or new players leveraging new technologies of these efforts has been on anticorruption actions and business models to provide innovative products. rather than economic reforms. Recent reforms to curb The CBA is pursuing digitalization in the financial sector, state aid to limit the anticompetitive effects of state 134 World Bank staff calculations. 135 As of early 2020, there were only 11,613 POS terminals and 1,735 virtual POS terminals within the country. As of the second quarter of 2023, these figures had surged to 75,469 and 4,234, respectively (Central Bank of Armenia). 87 Figure 82. Organization of the Market and Figure 83. Organization of the Market and Competition, Armenia, 2016–22 Competition, Armenia versus Peers, 2022 9 Organization of the 8 8 8 8 market and competition Bertelsmann Transformation Index 8 10 7 7 7 7 7 6.5 6.8 6.3 6.3 6 6 6 6 6 8 6 5 6 5 Market 4 4 Banking 4 organization 4 system 2 3 0 2 1 0 Market organization Competition policy Liberalization of foreign trade Banking system Organization of the market and competition (overall) Liberalization Competition of foreign trade policy Albania Armenia Bosnia and Herzegovina Estonia 2016 2018 2020 2022 Georgia Kosovo Moldova Tunisia Source: Bertelsmann Transformation Index2022. Source: Bertelsmann Transformation Index 2022. subsidies in a manner consistent with good international proportion of firms in Armenia’s manufacturing sector practices are under implementation. However, despite that considered that they were operating in concentrated the improvements in the competition policy indicator, markets or oligopolistic structures was relatively high (39 competition policy is the area in which Armenia most percent) in 2020 compared to those in peer countries lags peers, followed by liberalization of foreign trade such as Tunisia (18 percent) and Kosovo (21 percent) (Figure 83). A holistic competition policy is needed, (Figure 84). This share was, however, better than in other encompassing three pillars: opening markets through peer countries such as Estonia (45 percent) and Georgia pro-competition sectoral regulation, promoting a level (47 percent). The share of respondents operating in playing field, and ensuring effective enforcement of concentrated markets in Armenia’s manufacturing sector the competition law. While perception-based indicators declined from about 84 percent in 2013 to about 39 such as these reflect an improvement in competition percent in 2020—a decrease of 54 percentage points in Armenia, more information is needed to determine (Figure 85). Relative to peer countries, this decline was the extent to which competition and contestability the largest reduction in oligopolistic structures during challenges have continued since the Velvet Revolution. that period. Several factors may have contributed to this decline, including government regulations and Armenia’s manufacturing sector has a relatively interventions that ease entry or level the playing field. moderate level of market concentration compared The level of market concentration at a given point in to some peers, and while the reported level of time in any economy could also be the consequence concentration declined markedly over 2013-20, it of natural barriers, small market size, or firms operating remains high. In industries that are typically characterized more efficiently because of scale economies. by low levels of market concentration such as in the manufacturing sector, the latest 2019–20 firm-level The impact of SOEs on the competitive landscape is survey data from the World Bank’s Enterprise Survey not expected to be significant, as SOEs are much less suggest a significant presence of oligopolistic structures prevalent than in other post-Soviet countries following (that is, monopoly, duopoly, and oligopoly markets) or a major privatization effort in the 1990s and early 2000s. concentrated markets in 2020. The data show that the Armenia has 215 state and community owned companies, 88 Figure 84. Manufacturing Market Structures Figure 85. Proportion of Oligopolistic Market Structures in Armenia’s Manufacturing Sector 100% 100% 16 80% 84% 45 55 54 53 60 56 64 80% 62 59 61 58 62 69 60% 79 82 66 Percent 40% 60% 39 Share 28 32 33 33 27 35 32 39 20% 30 23 33 32 39% 17 12 40% 0% 2013 2019 2013 2020 Bosnia and 2013 2019 2013 2019 Georgia 2013 2019 2013 2019 2013 2019 2013 2020 20% Albania Armenia Herzegovina Estonia Kosovo Moldova Tunisia 0% 2013 2020 Monopoly Duopoly Oligopoly (2-5) More than 5 Monopoly+Duopoly+Oligopoly Source: World Bank staff elaboration based on World Bank Enterprise Survey for the years indicated in the figures. Note: The shares reflect the percent of responding establishments that answered “None,” “One,” “2-5,” or “More than 5” or whose responses were classified as such to the question “For fiscal year [indicated in parenthesis], for the main market in which this establishment sold its main product, how many competitors did this establishment’s main product/product line face?”. For example, “None” or “0” was coded as “Monopoly,” and “One” or “1” as “Duopoly.” Establishments with no or missing answers to the question and establishments whose main market for their main product line was international are excluded. The exclusion of the latter was because these establishments tend to have missing answers to the question. of which 168 have central government ownership and labor markets, and innovation and technology adoption. 47 have Yerevan Municipality ownership.136 SOEs that However, more information is needed to assess the have central government participation account for 11 impacts of all SOEs in these areas. percent of GDP in assets. While the data may not be strictly comparable, the number of SOEs in Armenia, 5.4.4. Governance and Institutional their share of total employment and size of assets Bottlenecks – A Related Example in Public compared to GDP for those SOEs with 90 percent or Procurement more ownership is less pronounced compared to peer countries such as Georgia (Gigineishvili et al. 2023).137 Limited private sector competition in public SOEs in Armenia are mainly in energy, health, water, procurement lowers the efficiency of public spending telecommunications and transport, The key risk from and quality of public services and increases corruption SOEs is as a source of fiscal risk, as 22 percent of SOEs risks. Low competition and non-competitive tendering in Armenia operation at a loss. Energy sector SOEs, practices are prevalent in Armenia, and the use of non- for example, have public or publicly guaranteed debt competitive tendering procedures and the resulting single for electricity sector investment. Further, the energy source procedure rates are higher than in comparable sector comprises 82 percent of liabilities of central European countries.138 According to the 2022 Ministry government SOEs. Similarly, transport SOEs could be a of Finance annual report, the share of direct contracting source of fiscal risk, as airports and the railway network (single sourcing or non-competitive bidding) has been are under concessions. Energy SOEs are not expected 37.8 percent by value and 45.98 percent by number.139 to have a major impact on competition, firm dynamism, Using public procurement open data between 2017 136 Ministry of Finance. Fiscal Risks Statement based on 2021 data. 2024-26 Medium-Term Expenditure Framework. 137 Based on 2019 or latest data available. 138 Single bidding means all those tenders in which only one bid was received, irrespective of procurement method. 139 10 percent of all single source contracts correspond to natural monopoly services. 89 Table 7. Binding Constraints for Enhancing Private Sector Development Key Challenges Binding Constraints Insufficient access to finance and lack of financial deepening Need to promote startups and firm entry and exit by strengthening business regulations and practices 4. Private sector Need to enhance investment climate and business regulations development Need to enhance access to finance especially for SMEs from domestic investment, FDI, and diaspora investment Sparse opportunities and incentives to invest to enhance productivity and accelerate growth and early June 2020, World Bank analysis shows that ability to strategically manage prioritization, design, and 41 percent of expenditures were single-bidder contracts implementation of government policies. (excluding framework agreements and request of quotations). Contracts larger than AMD 10 million (around Armenia has made progress in strengthening the US$25,000) had a slightly higher proportion of single- quality of its institutions since 2016, especially in the bidder contracts at 44 percent. These high-value single- areas of anticorruption and transparency in the public bidder contracts are estimated to cover 39 percent of sector. Strengthening the rule of law, accelerating the total procurement spending. A significant share of non- fight against corruption, and ensuring an accessible, competitive contracts are single source and urgent equitable, accountable, and better-performing justice single source contracts that account for roughly 14 system have been core elements of the government percent of total expenditure (including spending through program (Box 5). An anticorruption strategy (2019–22) framework agreements and request for quotation).140 was approved, and a new anticorruption institutional Average participation in tenders remained low at 1.7 architecture has been established. A comprehensive per activity from 2019 to 2021, increasing to 1.9 in 2022. Strategy for Judicial and Legal Reforms (2019–23) was Non-competitive tendering practices lower efficiency adopted which was followed by the 2022-26 Strategy and increase corruption risk. for Judicial and Legal Reforms. The government remains committed to establishing an accountable and efficient 5.4.5. Binding Constraints governance framework and improving public sector effectiveness and trust in government. Priorities include Table 7 summarizes the possible polity priority areas and advancing a comprehensive public administration binding constraints discussed in this section. reform; strengthening strategic planning and policy implementation, public financial management, and 5.5. Cross-Cutting Theme: public investment management frameworks;141 improving Governance, Institutions, and Data domestic revenue mobilization; and putting forward ambitious modernization and digitalization reforms 5.5.1. Quality of Institutions including in public service delivery. Progress was reflected in higher levels of trust in government—trust Institutional quality and governance bottlenecks in the Prime Minister and Ministers increased from 20 underlie all of Armenia’s development challenges and percent in 2017 to 71 percent in 2019—and a reduced are thus identified as a cross-cutting constraint. As perception of corruption as measured by Gallup World mentioned earlier, this constraint is newly highlighted for Poll’s Corruption Index in Government (decreased from SCD2. It covers institutional quality and the government’s 73 percent in 2017 to 33 percent in 2019).142 140 While Armenia stopped using framework agreements starting 2017, the analysis considers the use of framework agreements where those cases occurred. 141 Progress includes strengthening Public Investment Management regulations and establishing a new Investment Committee. 142 https://caucasusbarometer.org; Gallup World Poll’s Corruption Index measures perceptions in a community about the level of corruption in government. Higher scores on the Corruption Index indicate that more residents perceive corruption to be widespread. 90 Box 5. Justice Sector Reforms Following the Velvet Revolution, Armenia set ambitious goals for reforming the justice sector. A strong political will for change toward a citizen- and business-centric approach in delivering justice sector services, with an emphasis on quality and integrity, is reflected in the comprehensive Strategy for Judicial and Legal Reforms 2019–23 and its successor the Strategy for Judicial and Legal Reforms 2022–26. However, implementing the ambitious reform agenda and delivering tangible results on the ground have proven to be challenging due to lack of relevant data for informed decision-making; a stretched-thin workforce frequently lacking specialized skills (for example, in ICT); and scarce financial resources that leave little to no resources for reform once salaries are paid. These factors—coupled with gaps in robust policies and guidelines—hinder long-term planning, leading to faster-than-usual deterioration of investments in hard infrastructure and ICT. Aware of the challenges and the spotlight they are under, the justice sector leadership is taking steps in the right direction. For example, for the rendering of court decisions, Armenia’s courts currently rely on a piecemeal approach in which several Case Management Systems are running in parallel—at times even in the same court—making it impossible to manage caseloads and workloads and to ensure quality and timely delivery of services. To overcome and apply a whole-of-sector approach, an E-Court platform has been mapped out that foresees leveraging of existing e-government structures for equal standards in public service delivery across Armenia and cost savings for the justice sector in the long run. Improvements can also be seen in improving collaboration and institutionalizing feedback loops. Previously applied top-down approaches in decision-making are slowly being removed, both for internal as well as external users of the systems. For example, judges are informed and consulted with on a regular basis to ensure institutional buy-in and to translate policy changes into front-line service delivery improvements. Progress is also being made in identifying gaps in the legal, regulatory, and procedural frameworks. For example, although an electronic system was introduced for fast tracking uncontested claims, it is not used due to system gaps, such as absence of a bulk payment option. Allowing for feedback loops and addressing concerns raised by users such as businesses and corporate lawyers has been a significant step forward that facilitates meaningful improvements. Source: World Bank, 2023. Supporting Judicial Reforms in Armenia: A Forward Look. Institutions in Armenia remain fragile and vulnerable been made in domestic revenue mobilization, progress to shocks. After improving significantly following the in public financial management reforms has been slower, Velvet Revolution, Armenia’s institutional development including in financial reporting and implementation of an then stalled due to the pandemic and the conflict with Integrated Financial Management Information System, Azerbaijan.143 Even top government priorities such as and there have even been backward steps in internal judicial reform are not advancing according to public control and internal audit reforms. expectations, and anticorruption efforts are perceived to have stalled after the initial momentum that followed the The institutional framework for planning, monitoring, Velvet Revolution.144 While significant achievements have and evaluation is neither clear nor comprehensive. The 143 The State Fragility Index fell dramatically in 2017 (score of 71) but reversed with the pandemic and the war (score of 64.2 in 2020). Other indi- cators such as the Bertelsmann Transformation Index show a similar trend. 144 Citizens’ perception of corruption increased from 33 percent in 2019 to 52 percent in 2022, according to Gallup’s World Poll. 91 existing regulatory and institutional framework in Armenia is problematic in small rural communities. Prior to the for strategic planning has limited connection between administrative consolidation process, Armenia had 915 strategic documents; weak linkages to budget planning; local self-government entities (of which 866 were rural), and insufficient evaluation, monitoring, and performance which impeded the delivery of high-quality services, management. These challenges were identified by a the raising of sufficient revenue, and the maintenance Baseline Measurement Report on the Principles of the of public infrastructure.148 In 2011, the government Public Administration (OECD and SIGMA 2019), which launched a reform process that merged and enlarged rated the “Quality of the strategic framework of public administrative units, aiming to make budgeting and administration reform, effectiveness of implementation local self-government more efficient. The first phase and comprehensiveness of the monitoring system” with of consolidation of the communities kicked off in 2015 its lowest score of 1 out of 5. and was completed in September 2022, resulting in the consolidation of 915 communities into 71 (including 5.5.2. Government Effectiveness Yerevan), of which 64 contain many settlements. The consolidation process offers opportunities for building Institutional changes have not translated into local government capacity and promoting inclusive improved services, reflecting limited government local development, but it requires managing risks and effectiveness. The reform process has generally been providing targeted support to the most vulnerable ambitious in design but piecemeal in implementation. communities and administrative units. This can be attributed to low institutional capacity, lack of long-term planning, and lack of evidence-based Weak government effectiveness is a critical bottleneck decision-making, leading to duplication of efforts, to inclusive service delivery and growth, and more deterioration in investments, and low-quality service information is needed to understand and address provision. According to a recent World Bank survey, the causes. Cross-country indicators such as the there are limited career or compensation incentives Bertelsmann Transformation Index and Worldwide to motivate public servants to perform well. While Governance Indicators suggest that the government recruitment practices are generally perceived as fair institutional setup, the quality of design, and the capacity and transparent by public servants, use of performance and commitment to implementation affect the successful evaluations is more limited than in other countries for realization of policies and reforms. More disaggregated which comparable data is available, and public servants data are needed to unbundle the drivers of government have concerns on how they are conducted and on their effectiveness in Armenia. For instance, it would be impact. Only 27 percent of public servants report being useful to have access to data on service delivery, labor satisfied with their salary, a lower share than for the institutions, regulatory quality, and service delivery at majority of countries with comparable data available.145 the local, sectoral, and national levels to better identify Armenia ranks low in government effectiveness relative constraints in government effectiveness. to several structural peers and all aspirational peers (Figure 86) (Quality of Government 2022).146 147 5.5.3. Investment in Data The administrative consolidation of communities may Investment in data is another critical cross-cutting area also have major implications for local development, that serves as a basis for evidence-based policymaking service delivery, and spatial disparities. Governance and policy implementation. Data are a prerequisite 145 Armenia Public Sector Accountability Survey. World Bank (May 2023). 146 Peer countries selected in the institutional analysis differ from comparator countries used otherwise in the SCD, as the analysis considers fac- tors such as a country’s history, political structure, and other indicators that are not captured in the core comparator countries. 147 Government effectiveness under the WGI captures perceptions of the quality of public services, quality of the civil service and the degree of its independence from political pressures, quality of policy formulation and implementation, and credibility of the government’s commitment to such policies. 148 https://documents1.worldbank.org/curated/en/205871585015279882/pdf/Armenia-Social-Investment-and-Local-Development-Project-Addi- tional-Financing.pdf 92 Figure 86. Government Effectiveness, Armenia and Figure 87. Rankings of Main Areas of Governance, Peers Armenia, 2016–20 0 20 40 60 80 100 0 10 20 30 40 50 60 70 2016 31.7 corruption 2016 Control of 42.3 Armenia 2018 41.3 2018 48.1 2020 57.7 2021 41.8 2021 59.6 2016 42.3 terrorism e ectiveness Government 2016 Costa Rica 65.9 2018 48.1 2018 66.8 2020 40.4 2021 61.1 2021 41.8 2016 22.4 stability and 2016 absence of 82.7 violence/ Political Estonia 2018 29.2 2018 84.1 2020 20.3 2021 89.4 2021 19.3 2016 63.0 Regulatory 2016 Korea. Rep 80.8 quality 2018 64.9 2018 83.7 2020 60.6 2021 90.9 2021 57.2 Rule of law 2016 49.5 2016 81.3 Lithuania 2018 48.6 2018 81.3 2020 51.0 2021 81.7 2021 50.5 2016 31.0 accountability 2016 71.2 Voice and Uruguay 2018 39.1 2018 69.7 2020 49.3 2021 76.0 2021 48.8 Source: World Governance Indicators 2022, World Bank. Source: World Governance Indicators 2022, World Bank. for the design, execution, monitoring, and evaluation The government of Armenia has prioritized the digital of public programs and policies. Data can also help economy as a key pillar of economic growth and public accelerate the pace of many reforms executed by the sector modernization, but a whole-of-government government and contribute to inclusive and sustainable approach to digitalization is needed to maximize the growth by holding the government accountable and use of government data for improving government prioritizing scarce resources. In Armenia, the lack of data and citizen services and enabling high-impact reforms. and modern information systems was identified as a Satellite imagery and remote sensing data that are bottleneck by many sectors, including the water, health, publicly available can also inform policymaking. This digital, and agricultural sectors.149 Improving data and would be possible, however, only if Armenia prioritized public sector modernization are also critical for better investments not only in the collection of quality data but quality and access to services. A World Bank ICT survey also in the technological and human capital necessary found that only five percent of Armenian citizens and for frontier applications on data. businesses currently use online government services.150 149 For example, to monitor progress toward increased productivity in agriculture, Armenia needs accurate, crop-specific measures of the area under cultivation and the production of yields, not only at the national level but also at a more granular level to allow better targeting of policies and designing of programs that promote agricultural and rural development and resilience against disasters and extreme weather events. 150 World Bank, Press Release, March 2022, Armenia to Improve Public Sector Performance through Digital Solutions, with World Bank Support, www.worldbank.org/en/news/press-release/2022/03/03/armenia-to-improve-public-sector-performance-through-digital-solutions-with-world- bank-support. 93 5.5.4. Binding Constraints Table 8 summarizes the binding constraints discussed in this section. Table 8. Binding Constraints for Addressing Institutional Quality and Governance Bottlenecks Key Challenges Binding Constraints Inadequate government effectiveness and service delivery due to insufficient planning, monitoring Cross-cutting and evaluation, and prioritization challenge: strengthen governance and Need to strengthen the social contract through accountable and inclusive institutions institutions and invest in data Need to prioritize investments in quality data for evidence-based policy making 94 6 Policy Priorities and High-Level Outcomes 95 6.1. Approach to Prioritization and by comparing Armenia’s performance against the Results rest of the world and comparator countries based on numerous development indicators. Among more Grounded in the diagnostic conducted in the preceding than 200 indicators for benchmarking Armenia’s sections, SCD2 identified Armenia’s policy priority performance in the possible priority policy areas, 130 areas to address the key challenges. Corresponding indicators were selected based on their relevance as to the binding constraints discussed in Section 5, SCD2 assessed by World Bank experts. Each indicator was identified 11 possible policy priority areas for government compared against the median value of the countries action. Among all possible priority areas, a prioritization in eight different reference groups: (1) World, (2) EU, was conducted to narrow down the priorities that are (3) New EU, (4) ECA without high-income, (5) ECA all, likely to have the greatest bearing on gaining resilience (6) UMIC, (7) regional peers, and (8) OECD countries and generating sustainable and inclusive growth. (see Appendix E and H for details). For each indicator, The prioritization process involved a quantitative a measure of distance to the median value within the international benchmarking exercise and an assessment reference group was computed for every country in using additional filters based on the deliberation of the reference group. The countries were then ranked World Bank experts and a series of consultations with according to the distance to the median value. The major stakeholders In Armenia (Figure 88). ranking helped indicate areas in which Armenia is far from the median and thus areas that require higher The prioritization process relied on international priority. Details on the methodology and results are benchmarking. International benchmarking was done presented in Appendix H. Figure 88. SCD Prioritization Approach Additional Filters Policy SCD International for Verification Priority Diagnostics Benchmarking • Technical Feasibility Areas • Urgency Internal and External Consultations Source: World Governance Indicators 2022, World Bank. 96 These results were further validated by applying Some priority areas were dropped in SCD2 in light of additional filters of urgency and technical feasibility. progress made since SCD1. Prudent macroeconomic To provide a realistic sense of what could be achieved, management, an area in which the government action a technical feasibility filter was applied to assess the has proven to be effective, is no longer identified likelihood that the proposed policy reforms in each area as a policy priority area in SCD2. Together with the could be implemented in the next few years considering improvement in social protection programs, especially the technical complexity. The urgency of implementing through pensions reform, these government efforts the policies was also considered to assess whether probably helped cushion the impacts of the crises in any delay in easing a particular priority area led to 2020 and 2022. Despite the country’s exposure to the adverse consequences that would be costly or difficult twin shocks in 2020, expanded clashes in 2022 with to reverse. The level of priority was assessed by the Azerbaijan, and Russia’s invasion of Ukraine, Armenia World Bank experts by assigning a criticality rating of maintained macroeconomic stability with improved “high,” “medium,” or “low.” All priority areas identified by macroeconomic management, fiscal discipline, a the international benchmarking are associated with an sound financial sector, and support through the social average score of “high” or “medium” in terms of urgency protection system. Despite remaining challenges, due to and technical feasibility. relatively low inequality and low losses from electrical outages compared to other countries, equitable society In addition, public engagements with diverse and connectivity issues in energy that were identified as stakeholder groups were organized in May 2023 in priorities in SCD1 have been dropped from the priorities Yerevan to seek views on Armenia’s development in SCD2. challenges and priorities. Four meetings were held in total, with close to 100 participants. The meetings Governance, institutions, and data—treated as a included representatives from the central government, cross-cutting theme in SCD2—have become a more Parliament, development partners, civil society pressing concern since SCD1 and have been identified organizations (CSOs), academia, and national and as a new priority area. Despite some progress made in international firms in the private sector. Appendix G policy priority areas identified in SCD1, SCD2 confirms provides a summary of the discussions and opinions that 15 out of 16 policy priority areas are still valid. This expressed by participants in the meetings. indicates a need for stronger governance and institutions that enable the state to commit to and implement the The prioritization process identified 11 priority areas, policies for positive development outcomes. SCD1 including governance, institutions, and data as the focused on governance as a prerequisite for ensuring cross-cutting area that affects all priorities. Table 9 market contestability and competition, but SCD2 treats shows how the priority areas evolved between SCD1 the challenge as a cross-cutting theme that affects and SCD2. multiple dimensions of policy areas to address the major binding constraints. Recommended policy actions The new set of priorities in SCD2 reflect a greater include strengthening institutions by enhancing strategic emphasis on reforms to improve resilience to fragility planning capacity and improving the link between and conflict. With growing uncertainties triggered by planning and budgeting; improving the capacity of increased regional tensions, the country stands at a institutions and enhancing inclusiveness in planning critical juncture for addressing its intrinsic vulnerability to at all legislative levels (national, marz, municipality) for risks from fragility and conflict. In addition to continuing better service delivery; and advancing public financial the peace negotiation efforts, it will be important to management reforms. Deeper analysis is needed based strengthen the system to improve service delivery and on a better understanding of the decision-making promote inclusion and resilience of the communities process and bottlenecks to implementing individual affected by conflict to help them cope with diverse types reforms. of shocks. 97 Table 9. Evolution of Policy Priority Areas SCD1 Priorities SCD2 Priorities Overlapping Priorities 1. Adapt to climate change by building resilience to climate-related shocks and natural disasters by scaling up risk prevention systems i. Strengthen environmental management and and updating technologies and infrastructure adaptation to climate change 2. Reduce pressures on natural capital for improved resilience and mitigation by improving energy efficiency and security and promote the green economy 3. Diversify trade partners and export products and enhance the economic complexity of exports ii. Leverage exports enablers and multi-connectivity 4. Improve integration for trade by strengthening institutions and links continue efforts to facilitate trade 5. Boost public and private investment in physical and digital access to close domestic and international connectivity gaps iii. Ensure on-the-ground market contestability and competition iv. Fill other investment climate gaps 6. Foster a competitive private sector in the services and manufacturing sectors by developing a coherent strategy to attract investments (domestic, FDI, diaspora) v. Strengthen macro management supportive of stability and growth vi. Ensure the education and workforce development system provides skills relevant to the market 7. Advance human capital accumulation by improving the quality vii. Strengthen micro-resilience through access and relevance of education, increasing the affordability of health to finance and address the health implications of services, and allocating resources effectively population aging viii. Support matching of workers to jobs 8. Promote access to and generate good-quality jobs by strengthening coordination between the education sector and ix. Facilitate women’s labor market participation labor market New Priorities in SCD2 9. Increase resilience to fragility and conflict by developing an adaptive social protection system and improving trust in political and social institutions 10. Improve productivity, cultivate climate-smart agriculture, and further develop value chains 11. Cross-Cutting Theme: strengthen governance and institutions by improving government effectiveness, accountability, and inclusiveness of institutions and investing in data for evidence-based policy making Priorities Dropped in SCD2 Strengthen social protection and tackle pensions Enhance prudent macroeconomic management Build an equitable society Address connectivity challenges in the energy sector 98 Given Armenia’s exposure to fragility and conflict, 6.2. High-Level Outcomes several scenarios could affect the policy priorities. The geopolitical uncertainty in the region may complicate the High-level outcome (HLO) is a concept associated conflictual relations between Armenia and Azerbaijan in with a sustained improvement in well-being aimed at a range of scenarios. Possible medium-term scenarios facilitating the achievement of the twin goals. HLOs range from a negotiated peace settlement to volatility are goals to be achieved in the long run that directly and episodic fighting in the border areas to a larger- capture the desired improvements in the population’s scale war (World Bank 2022d). Three scenarios are welfare.151 Achieving HLOs requires contributions from considered: a peace scenario, a protracted volatility the public and private sectors, but development in these scenario, and the extreme case of a large-scale war sectors itself will not be considered as HLOs as they scenario. The 2020–25 World Bank Fragility Conflict and do not directly reflect the well-being of the population. Violence Strategy provides a guiding framework on how These HLOs provide options to be adopted in the CPF policy priority areas could shift (World Bank 2020i). The which determines the World Bank’s engagement with peace settlement scenario would involve an opportunity the government over the next four to six years. to strengthen resilience and institutions by supporting investments in connectivity and infrastructure, access to Four HLOs were identified, guided by the expected livelihoods among displaced populations, inclusion, and long-term outcomes from the priority areas, and they recovery and resilience in districts affected by conflict. are in alignment with Armenia’s own development At a regional level, such a development would better strategy and the long-term goals specified in the position both Armenia and the South Caucuses to work Armenia Transformation Strategy 2050.152 When all on joint regional projects to enhance their standing in priority areas identified in the SCD2 are addressed, the the region, such as in energy, transport, water, tourism, people in Armenia are expected to achieve the following: and environment. The protracted volatility scenario (1) better education outcomes to ensure inclusive, would involve a shift toward preventing grievances and sustainable, and resilient growth; (2) better health tensions by strengthening processes and institutions outcomes by having equal access to quality care; (3) a that foster resilience. Development gains and the dynamic and innovative private sector to create more capacity of the private sector would be protected during and better quality jobs; and (4) increased household crises and the transition toward stability. In the large- resilience to shocks. The 11 priority areas identified scale war scenario, policy would shift to addressing in SCD2 are mapped to the four HLOs, formulated to humanitarian and emergency situations, working toward capture desired improvements in the population’s well- peacebuilding, and considering medium- to long-term being (Table 10). development challenges arising from displacement. 151 HLOs reflect, for example, progress in the accumulation of human capital including education and health, access to opportunity, improvement in security, enhanced mobility, or improvement in the standard of living. 152 For example, see https://www.primeminister.am/en/press-release/item/2020/09/21/Nikol-Pashinyan-meeting-Sept-21/. Development objec- tives in Transformation Strategy 2050 include educated citizens, healthy and safe people, effective and accountable government, and green and resilient growth. 99 Table 10. High-Level Outcomes # Policy Priority Areas HLOs Increased Better health More household Better outcomes and resilience education and lower better- to climate- outcomes incidence of quality related shocks NCDs jobs and natural disasters Increase resilience to fragility and conflict by 1 developing an adaptive social protection system and x improving trust in political and social institutions Diversify trade partners and export products and 2 x enhance the economic complexity of exports Adapt to climate change by building resilience to climate-related shocks and natural disasters by 3 x scaling up risk prevention systems and updating technologies and infrastructure Reduce pressures on natural capital for improved resilience and mitigation by improving energy 4 x efficiency and security and promote the green economy Boost public and private investment in physical and 5 digital access to close domestic and international x connectivity gaps Improve integration for trade by strengthening 6 x institutions and continue efforts to facilitate trade Advance human capital accumulation by improving the quality and relevance of education, increasing 7 x x the affordability of health services, and allocating resources effectively Promote access to and generate good-quality jobs by 8 strengthening coordination between education and x x the labor market Foster a competitive and innovative private sector in 9 the services and manufacturing sectors by promoting x investments (domestic, FDI, diaspora) and innovation Improve productivity, cultivate climate-smart 10 x x agriculture, and further develop value chains Cross-Cutting Challenge: strengthen governance and institutions by improving government effectiveness, 11 x x x x accountability, and inclusiveness of institutions and investing in data for evidence-based policy making HLO1: Better education outcomes sector growth but also enable Armenia to compete in the global economy. Modernizing education would Investing in education to create a knowledge-based, also allow citizens to prepare to work in green jobs, innovative economy that prioritizes market-oriented thereby facilitating sustainable and resilient growth. To education reform is a focus area in Strategy 2050 ensure inclusive growth, it is critical to improve access and a key development challenge in SCD2. Policies to quality education for all, including the poor and that equip citizens with the knowledge and skills vulnerable in remote areas. Progress in HLO1 will also required in the rapidly changing business environment contribute to improving the labor outcomes indicated will not only improve productivity and support private in HLO3. 100 HLO2: Better health outcomes and lower HLO4: Increased household resilience incidence of NCDs to climate-related shocks and natural disasters The development of the health sector is a main priority in Armenia 2021–26 and Strategy 2050. Better health As the livelihoods of the poor rely heavily on natural outcomes are also a critical component of human capital resources and agriculture, improving the management which has been identified as a priority in SCD2. Equitable of natural resources to ensure that they are used in a access to quality health services that are affordable for sustainable manner remains critical. As the agriculture all is vital to ensuring healthy and productive workers sector continues to be an important sector for inclusive and is also linked to HLO3. growth, improving agricultural productivity and resilience is a priority. This requires investing in the irrigation HLO3: More and better-quality jobs system; incentivizing the adoption of climate-smart agricultural practices among farmers; including rural Armenia is committed to tackling poverty reduction economies in agricultural value chains; and developing through job creation and raising real wages for the a disaster risk management system to safeguard and working poor as advocated in Strategy 2050. A insure people against shocks from climate, weather, and dynamic and innovative private sector and improved other natural-related disasters. connective infrastructure, including digital connectivity, are crucial to job creation. A well-functioning labor market, improved education, and better health outcomes through equitable access to services (HLO1 and HLO2) are crucial to enabling access to good jobs. 101 7. References Armenia Transformation Strategy 2050. https://www. 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World Bank. 2022d. “The Global Health Cost of PM2.5 Air Pollution: A Case for Action Beyond 2021.” International Development in Focus Series. Washington, DC: World Bank. World Bank. 2022e. Armenia Rapid Environmental and Climate Change Diagnostic. Washington, DC: World Bank. World Bank. 2022f. Armenia Forest Landscape Restoration Note–- draft. Washington, DC: World Bank. 8 106 Appendixes 107 Appendix A. Selected Actions and Policy Reforms since 2017 This Appendix summarizes key actions and policy • E-government. The government has prioritized the reforms implemented since 2017 as per the government’s digital economy as a key pillar of economic growth assessment (that is, the World Bank does not necessarily and public sector modernization. Among other endorse each of these actions as a reform). The actions, it adopted the Digitalization Strategy for effectiveness of these actions and reforms is not 2021–25 and established the Ministry of High-Tech evaluated, given the limited time since implementation Industry in 2019. It has established the e-petition and the exceptional circumstances in 2020. system and the e-request platform. Through these platforms, citizens can file requests and complaints Governance digitally as well as submit various license applications online. • Anticorruption agenda. Anticorruption was a key • Procurement. To foster spending efficiency, new pillar of the Velvet Revolution, and the government budget allocation rules have been introduced. of Armenia has implemented a strong agenda. These rules are expected to incentivize competitive Along with legislative changes, policy reforms procurement through the new e-procurement system. have included the establishment of the Corruption Prevention Commission in 2019 and the adoption Justice and Rule of Law of Armenia’s Anticorruption Strategy and Action Plan for 2019–22 (Government Decree N1332-N). In • Judicial reform. The government’s ambitious reform March 2021, the Parliament adopted a law creating a agenda aims to ensure a strong and independent new anticorruption body with stronger investigative judiciary, as reflected in the adoption of the 2022– and enforcement functions, merging several existing 26 Judicial and Legal Reform Strategy in 2022 agencies with anticorruption powers. It also adopted (Government Decree N1133-L). Reforms planned legislation establishing a specialist anticorruption under this strategy include the launch of a network court to handle all corruption-related cases. In of anticorruption courts, digitization of judicial 2020, the Law on civil forfeiture of illicit assets was processes, and introduction of an e-court system. adopted, and a relevant department was established Introduction of an e-criminal case platform for in the General Prosecutor’s Office. The CPC’s role preliminary investigation bodies will play a pivotal includes regulating and controlling the process of role in modernizing this system. gift registration and implementing control over the • Human rights. The law on the rights of people with current financial activities of political parties in cases disabilities was amended in May 2021. The change prescribed by the Constitutional Law ‘On Political aims to end discriminatory practices and improve Parties’ and other related regulations outlined in the the assessment of disability. The assessment is ‘Law on Corruption Prevention Commission’ and the transitioning to a method based on the extent of ‘Law on Public Service.’ limited functionality and personal needs, rather than • Over time, the mandate of CPC was strengthened the degree of disability only. New Criminal Codes together with improvement of the the legislative and Criminal Procedure Codes were adopted in framework for asset declarations, gifts, conflict of 2021, with the aim of bringing criminal procedures in interests. A new electronic asset declaration system line with international standards. was developed and launched in February, 2023, • Money laundering. In June 2021, a centralized allowing pre-filling of data due to interoperability registry of bank accounts of individuals was created with other state databases. An integrity checking to align with global standards for combating money system was established for candidates for judges, laundering and terrorism financing. This registry investigators, and prosecutors. The beneficial meets one of the obligations in the EU-Armenia ownership institute was introduced. Partnership Agreement. 108 • Police reform. The Police Reforms Strategy • Technology start-ups. The government has granted and Action Plan for 2020–2022 (Government tax privileges to start-ups in the technology sector Decree N638-L) was adopted in April 2020 and and amended the Law on State Support for the implemented. In line with the strategy, the Ministry of Information Technologies Sector (effective May Internal Affairs was established in December 2022 2019). This amendment includes a 0 percent profit and has been fully operational since January 2023. tax and 10 percent income tax on eligible technology The Ministry is responsible for policy development start-ups with 30 or fewer employees. The vision and implementation in the following areas: police, behind these measures is to draw the Armenian rescue, migration and citizenship service. One of diaspora back to the country. the key reforms was the establishment of the Patrol • Capital markets. In July 2020, a new capital market Police in all marzes of Armenia (from 2020-23) as development program was adopted with the a new, modern external police service. The Water objective of helping to utilize domestic savings more Patrol Police will be launched by end-2023, and the effectively, increase transparency in the corporate establishment of a Police Guard, and redesign of the sector, and enhance monetary transmission. Criminal Policy are planned. Fiscal Policy and Revenue Mobilization Business Environment • Fiscal rule. In January 2018, a new fiscal rule was • Investment. The Investment Support Office at introduced. The rule aims to curb current spending, the Ministry of Economy was created in 2019 to while allowing more flexibility for investment promote domestic and foreign investments. The projects based on public debt thresholds. When the office is a one-stop shop for investors, providing government debt-to-GDP ratio exceeds 40 percent, information on investment opportunities and the the government will be allowed to run a fiscal deficit business environment and supporting investors in exclusively to finance capital expenditures. In those accessing public services and communicating with cases where the ratio rises above 50 percent, the the authorities. government will also be required to cap current • State-owned enterprises. In January 2020, stricter spending and develop a medium-term plan to lower mandatory criteria were introduced for the audit the debt burden. When government debt surpasses and publication of financial reports of state-owned 60 percent of GDP, the government will be obliged to enterprises. link current expenditures to tax revenues and submit • Customs. The government has introduced digital a remedial action plan to Parliament. Escape clauses solutions for exporters, who can submit all relevant were introduced for extreme cases such as natural documents via a single online portal and receive disasters, armed conflicts, and economic shocks. certificates of origin within one working day (one- • Personal income tax regime. The income tax rate stop shop portal). The system has cut the border was previously structured into three progressive crossing customs clearance time from 20–70 brackets at 24.4 percent, 26.0 percent, and 36.0 hours to 2–3 hours on average, and in 2022, over percent. A major reform introduced a flat tax rate of 2,300 preliminary declarations were registered 23 percent beginning in January 2020. The rate is (ARMENPTRESS, February 14, 2023). to be reduced by 1 percentage point annually until it • Insolvency and bankruptcy framework. The Supreme reaches 20 percent in 2023. Judicial Council approved the composition of a new • Tax administration. The Ministry of Finance specialized Insolvency Court and selected 12 acting implemented the automatic value added tax refund bankruptcy judges, effective in August 2018. The Law system. The budget execution of the government on Bankruptcy was amended on December 26, 2019 and tax collection have improved in recent years. and introduced major changes and improvements to Armenia has maintained a trend of increasing tax the regulatory system for insolvency practitioners. revenues, despite declines during periods of crisis. 109 In 2019, the tax-to-GDP ratio stood at 22.5 percent. ten wholesale electricity traders and ten retailed Armenia has also had significant changes in its tax suppliers (four of them are the same companies structure. The contribution of income and trade taxes holding both licenses). to total taxes has increased since 2010. • Renewable energy. The Energy Sector Development • Pensions. All workers are now under a mandatory Strategy till 2040 and its Action Plan were adopted funded pension system. The new system has been in in 2021. The National Program on Energy Saving and place for private sector workers since July 2018, after Renewable Energy for 2022–2030 was adopted in becoming compulsory for public sector employees 2022 and aims to increase the share of electricity in 2014. Retirement savings are administered by an generation from solar to at least 15 percent (from asset management provider and are invested into less than 3 percent in 2020) and to reduce total final local and foreign financial assets (see Appendix G). energy consumption by 20 percent by 2030. Result targets are mainly expected to be reached by end- Labor and Social Protection System 2023 and 2024. Several actions have commenced, including studies for wind energy and battery • Employment and minimum wage. An employment storage potential, agreements for energy efficiency, strategy (“Work, Armenia”) was adopted in December energy-saving improvements in public facilities, and 2019. It proposes a set of active labor market policies heating studies to find sustainable ways to replace to address labor market shortcomings and create fossil fuel energy. With the amendments made to sustainable and inclusive employment. In January the Energy Sector Development Strategy and Action 2020, the government approved a 23 percent Plan to 2040, the construction of solar power plants increase in the minimum wage. with a capacity of 1,500 MW, connected to storage • Social assistance. A unified system of integrated stations upon necessity is envisaged along with wind social services was created to rationalize the delivery power stations with a total capacity of 500 MW for of social assistance and employment services. the period 2030-2040. • Paternity leave. Armenia approved paid paternity leave in 2021. The approved paid leave for working Climate and Environment fathers is five days. • Climate change. Actions include the April 2021 Energy update of the Nationally Determined Contribution, set under the United Nations Framework Convention • Electricity market liberalization. Armenia launched on Climate Change (Governmental Decree No. 610- a five-year process for the liberalization of the L). Armenia’s updated contribution is aligned with a electricity market in 2022, supported by legal 2030 mitigation target of a 40 percent reduction in amendments to the Energy Code, Transmission greenhouse gas emissions (relative to the level in and Distribution Network Codes, and Rules and 1990). Pretax subsidies on fossil fuels as a percentage Regulations by Market Regulator. The first phase of GDP were cut. The National Action Program kicked off in February 2022 by (1) enabling some of Adaptation to Climate Change and the List of power plants to avoid selling electricity at prices set Measures for 2021–2025 were approved in May by the Public Services Regulatory Commission and 2021. Amendments to the Water Code, Forest Code, to sell at prices determined according to market and Law on Atmospheric Air Protection were also supply and demand and (2) shifting from monthly adopted. The Hydrometeorological Agency moved to hourly trading of electricity. The Yerevan Thermal to the Ministry of Environment and merged with the Power Center provides the balancing service settled Environmental Monitoring Agency, increasing the by the Universal Supplier. The electricity market in capacity of the joint agency. Some Aichi biodiversity the transition stage proves that supply is more than targets were achieved (Armenia’s 6th National Report adequate to meet the load. The market already has to the Convention of Biological Diversity). 110 Appendix B. Government 2021–26 Program (Armenia 2021–26) Table A.1. Pillars and Goals Captured in Armenia 2021–26 Main Goals Economy Pillar • GDP: reach a minimum average annual growth rate of 7 percent (and in case of favorable external economic conditions, 9 percent) • Unemployment: reach a level of unemployment lower than 10 percent • Incomes: target fund for salaries in the non-governmental sector of the formal employment equal to 25 percent of GDP • Productivity: achieve at least 5 percent annual growth of gross factorial productivity • Investment: attain investment as a share of GDP higher than 25 percent, with FDI to GDP being higher than 6 percent • SMEs: reach 55 percent in the share of SME participation in GDP over five years • Infrastructure support: provide at least AMD 50 billion over five years • Manufacturing industry: provide support of at least AMD 80 billion over the coming five years and establish three industrial zones, increase participation to at least 15 percent of GDP, increase economic complexity from -0.39 to 0.1 points over the medium term, and create grounds for being classified among countries with high economic complexity over 10 years • High technologies: reach a level of employment of 35,000 people (16,000 new jobs) and a level of turnover of AMD 500 billion (6–7 percent of GDP) • Military: promote the development of a military-industrial complex • Digitalization and telecommunication: provide municipal and rural settlements with at least 80 percent broadband (optic fiber), provide round-the-clock control over radio airtime in the whole territory of the Republic of Armenia, and ensure up to 100 percent clean airtime • Agriculture: implement several measures to intensify agriculture, increase productivity, target use of land resources, ensure the effective and economical use of water resources, and so on • Tourism: increase the number of international visitors to 2.5 million by the year 2026 and have flights to at least 25 new destinations by 2025 • Green economy: minimize the role of natural gas in the structure of electricity production by replacing it with sources of renewable and alternative electric energy, prepare the electric power transmission infrastructure for change in terms of growth of demand and structure, prepare the transition of infrastructure to facilitate alternative transportation and to help the population obtain electric systems for food preparation and heating Infrastructure Development Pillar • Transport: (1) automobiles: introduce a unified railway network, ticket system, interactive map, electronic systems, and so on; (2) air: raise the level of flight and aviation safety and increase the effectiveness of civil aviation management; (3) railways: obtain a new passenger and freight rolling stock and raise the level of traffic; (4) water: adopt a new law on commercial navigation • Road construction: renovate nearly 500 kilometers of roads annually, implement the North-South Road Corridor Investment Program (reconstruction of Tranche 2 and Tranche 3), launch activities for construction of the new 60-kilometer Sisian-Kajaran road, plan and launch monetary implementation of the 175-kilometer Artashat-Sisian section of the North- South Road Corridor, reconstruct 52 kilometers of M-6 • Water economy: renovate capital of certain accident-prone sections of the Arpa-Sevan tunnel; make inventory and assessment of irrigation systems; save 7.3 million kWh electricity every year and increase irrigated lands by 1,373 hectares; carry out ten primary antiflood action plans; and work for urgent restoration of the sections of water supply and water disposal systems in 11 cities and 41 rural settlements in 6 marzes and restoration of distribution networks by 2023 • Energy: gradually liberalize the electricity market; build solar power stations, including automatic solar power stations with a capacity of up to 1,000 MW to make the share of production of solar power reach at least 15 percent by the year 2030; carry out preparatory works to build wind power stations with a capacity of nearly 500 MW; complete modernization to ensure safe operation of the Armenian Nuclear Power Plant by 2036; raise the electricity system to a fully new level through modernization and expansion of the high-voltage transmission network; launch the Armenia-Iran and Armenia- Georgia 400 kW power transmission lines and rehabilitate the old substation; finalize activities related to the four-party (Armenia-Iran-Georgia-Russia) North-South Power Transmission Corridor initiative; gradually implement the EU energy- related directives on energy policy, energy security, diversity of energy sources, diversification of transmission path, competitive electricity markets, use of renewable energy sources, promotion of energy efficiency and energy saving, regional energy cooperation, technological and scientific-technical cooperation, and so on; improve SOE governance and match the ISO basic certificates for all SOEs in the energy sector; promote sustainable heating policy to reduce natural gas and firewood consumption 111 Table A.1. continue Main Goals Law and Justice Pillar • Implement the judicial-legal reforms agenda, ease the workload of courts, and reduce the time limits for examining cases in courts; modernize procedural law; and reform the police by introducing patrol service in the whole territory of the Republic of Armenia by the end of 2023 and by comprehensively reviewing the remuneration of police officers Institutional Development Pillar • Public administration reform: introduce policy on unified data, a unified electronic platform, and a modern model of unified offices system of decent remuneration in the state service system; modernize the system of performance evaluation; review the existing system of education, training, and retraining of state servants; create a unified national spatial data infrastructure and a database of sector-specific cadasters; launch a national geoportal • Fiscal policy: foster stability of public finance; ensure larger financing of the deficit of the State Budget at the expense of loans in the dram to minimize the sensitivity of debt with regard to currency fluctuations; improve the tax-to-GDP ratio by at least 2.6 percentage points, making it reach at least 25 percent in 2026; and reduce the debt-to-GDP ratio, reaching a target of less than 60 percent • Tax and customs administration: gradually lift the value added tax on imported goods, review the tax regulations in the capital market, expand international cooperation in the Tax and Customs sectors, apply regulations for pricing of transfers and the systems of information exchange for taxation, simplify customs administration and introduce the one-stop shop system, and establish a bank for the Public Investment Program Development of Human Capital Pillar • Demography: ensure a sustainable increase in births in the upcoming years, expand beneficiaries receiving benefits for care of a child under age 2, and grant monthly financial assistance of AMD 50,000 to families for the third child and subsequent children under age 6. • Education: build and renovate at least 300 schools by 2026; create modern natural science and engineering laboratories in all 1,400 schools; change and introduce new textbooks and educational materials; introduce a differentiated policy on the professional development of teachers; create effective, open management and financing systems; enhance electronic learning tools; build and renovate at least 500 kindergartens and preschool institutions by the year 2026; increase the percentage of children ages 3-5 enrolled in preschool institutions to at least 85 percent by 2026; introduce and expand dual training based on employment in at least two educational institutions on an annual basis; improve the building conditions of educational institutions and ensure training and production bases (laboratories) in at least two institutions a year; and introduce Master’s degree programs for professions following new demands in the labor market • Science: develop infrastructures that are favorable for competitive scientific activities; enhance qualifications of workers in the field of science and engage young specialists (implement grant programs to support PhD students, postdoctoral research, vocational training, and qualification of employees); increase the efficiency of state financing in the field of science; and reform legislation regulating the field of science • Health care: ensure the availability and affordability of health care services for citizens, reduce the ratio of private expenditures to general health care expenditures by 40 percent, introduce an integrated electronic health care system, and upgrade 50 health care institutions • Labor and social protection: equalize the minimum pension amount and average pension amount to the costs of the food and consumer baskets and set AMD 85,000 as the amount of minimum salary Source: Government of Armenia 2021a. Note: The pillar on security and foreign policy is not included. 112 Appendix C. Findings of SCD1 SCD1 identified four challenges facing Armenia in • Resilience and sustainability: Armenia faced boosting equitable growth and shared prosperity as vulnerabilities at the macro, environmental, and of 2017: micro levels, including an aging population which had implications for fiscal sustainability (through • External sector performance: Armenia imposed high health spending and the pension system) and for trade and transport costs on economic activity, and poverty. Managing natural assets and adapting the country suffered from limited global connectivity to climate change had implications for the long- infrastructure (hard and soft). term macroeconomic sustainability of resource- • Private sector productivity: Insufficient productivity dependent sectors and society as a whole. was linked to three factors: unfinished investment climate reforms, low degree of competition, and The priorities identified for SCD1 included expanding low level of financial development and access to labor markets, enhancing private sector development, finance. and raising labor productivity to create jobs, rebalance • Labor productivity: Challenges included shrinking growth drivers, transform structurally, and support labor resources, low labor market participation inclusive spatial development. The challenges and (particularly among women), low employment, high priorities identified in SCD1 are summarized in Figure unemployment, falling worker productivity, and C.1. learning outcomes that lagged demand (by level and type of skills). Figure C.1. Challenges and Priorities Identified in SCD1 INTERNAL AND EXTERNAL CONSULTATIONS Internal and External Consultations CHALLENGE 1 CHALLENGE 2 CHALLENGE 3 CHALLENGE 4 External Private Labor Resilience and Sector performance Sector productivity productivity sustainability Ensure the Strengthen Leverage exports education Strengthen micro resilience Ensure and environ- through access enablers and Facilitate Strengthen on-the-ground workforce Support mental to finance and multiconnectivity links Fill other wome’s macro market development matching manage- socila investment labor market management contestability system of workers ment and protection, and climate gaps participation supportive of and provides to jobs adaptation tackling pension stability and competition skills to climate and health growth relevant to change implications of the market population aging Source: World Bank 2017a. 113 Appendix D. Characteristics of the Poor Certain individual and household characteristics are In rural areas, poverty reduction achieved through associated with higher probability of poverty. Larger redistribution during 2016-21 was offset by the negative households, female-headed households with children, impact of growth on poverty reduction, leading to an and those without tertiary educational attainment tend increase in poverty (Figure D.1). Poverty reduction in to be poor (Table D.1). In addition, the poor tend to live 2016–21 was driven by redistribution (or improvement in in poor housing conditions with dilapidated walls and inequality), and growth (or increase in mean consumption) floors, broken frames and doors, insufficient living space, did not contribute to poverty reduction (unlike during as well as poor heating, dampness, leaking roofs, poor 2010–16). This applies in all areas: Yerevan, other urban, lighting, and lack of green zones (Armstat 2022b). A large and rural areas. Although all areas contributed to the urban-rural divide can be seen in access to a centralized reduction in the national poverty rate in 2010–16, the sewerage system, 24-hour access to drinkable water, slowdown in poverty reduction in 2016–21 was due to and access to centralized garbage disposal services, the slowdown in poverty reduction in other urban areas such as a garbage collection system and disposal by and the poverty increase in rural areas. Rural poverty truck. For example, more than 10 percent of households rates in border regions such as Shirak, Gegharkunik, in rural areas rely on burning garbage for disposal Tavush, Vayots Dzor, Armavir, and Ararat are higher than compared to 0.1 percent of households relying on the the national poverty rate of 26.5 percent in 2021 (Figure same practice in urban areas (Armstat 2022b). A huge D.2). Urban poverty is also high—even higher than rural gap also exists in heating sources, with a significantly areas in Gegharkunik, followed by Armavir, Tavush, and larger share of rural households relying on wood and Shirak. Analysis is needed to understand the sources of less using electricity and natural gas. anti-poor growth in these border regions. Table D.1. Profile of the Poor and Rural Households Poor Non-poor Average household size* 5.2 4.1 Tertiary education attainment (complete or incomplete)** 38% 54% Female-headed household Male-headed with children under age 6 household Poverty rate 39.1% 27.4% Rural Urban Centralized sewerage system 47.5% 99.2% 24-hour access to drinkable water 70.6% 91.6% Centralized garbage disposal services 89.5% 99.8% Heating sources - wood 61.4% 6.2% - electricity 5.0% 36.8% - natural gas 40.5% 74.0% Sources: ILCS 2021; ArmStat 2022b. Note: * Population weighted and calculated by the World Bank. ** Estimates among individuals 15 years and older. Other estimates are taken from ArmStat 2022a. 114 Figure D.1. Growth and Redistribution Figure D.2. Poverty Rates, by Region and Location (%) 15 80 10 11.5 Variation in percentage points Percentage of population 9.8 5 7.2 60 63.7 6.3 4.7 4.1 -2.4 0 52.2 47.4 -2.1 40 32.7 -5 National 39.8 38.7 -5.6 37.4 37.7 37.2 -6.4 Poverty = 26.5 -9.1 -10 -9.1 -10.5 -12.0 -11.9 26.5 31.7 25.9 -12.1 20 21.7 19.4 18.1 -15 -16.3 16.1 -16.8 5.0 11.8 1.4 7.2 -20 0 2010-16 2016-21 2010-16 2016-21 2010-16 2016-21 Shirak Gegharkunik Tavush VayotsDzor Armavir Ararat Kotayk Lori Aragatsotn Sjunik Yerevan Other urban Rural Changes in Poverty - Redistribution Contribution Changes in Poverty - Growth Contribution Changes in Poverty Rates Other urban Rural Source: World Bank staff calculations based on ILCS 2010, 2016, and Source: World Bank staff calculations based on ILCS 2021. 2021. 115 Appendix E. Selection of Peer Countries Armenia’s performance was benchmarked relative Regional peers: Most of the structural peers happened to peer countries, including structural, regional, to be countries in the region. Georgia is the only country and aspirational peers. The identification of peers in the region with distinct structural features. Therefore, was conducted using the CEM 2.0 Data Generator the neighboring country was added to the list. tool developed by the Macroeconomics, Trade, and Investment Team at the World Bank. The group of Aspirational peers. After selecting the structural structural peers comprises six countries that are indicators, the tool allowed for the selection of considered most similar to Armenia in terms of structural aspirational peers based on one outcome variable of economic indicators, such as GDP per capita, human interest (and not the intersection of more than one as capital, age dependency ratio, inflows of FDI, value was done with the structural peers). Four indicators added of the services sector, and international tourism. benchmarked the aspirations of Armenia to improve its Using the same tool, the aspirational peers were performance: selected from a shortlist using GDP per capita, poverty headcount, and Gini index as aspirational variables. The • GDP per capita, PPP (constant 2011 international US final selection was made during an internal consultation dollars) with the country team and Country Management Unit. • GDP per capita (constant 2010 US dollars) • Poverty headcount ratio at US$1.90 a day PPP Structural peers. The structural peer group consisted of (constant 2011 international US dollars) several countries considered similar to Armenia in terms • Gini index (World Bank estimate) of selected indicators. The similarity was measured by distance—that is, how close the country was to all other The countries that appeared consistently in these countries based on each country’s relative global ranking four rankings were: Indonesia, Thailand, and Tunisia. on a selected indicator. The period considered for the Anecdotal evidence suggests that the Baltic countries values of the indicators was 2017–19. Six indicators were represent an aspiration in the region. Specifically, used to identify regional and global structural peers: Armenia observes Estonia with considerable attention. The final list of peer countries was Albania, Bosnia and • GDP per capita, PPP (constant 2011 international US Herzegovina, Estonia, Georgia, Kosovo, Moldova, and dollars) Tunisia. • Age dependency ratio (percent of the working population) Figure E.1 presents features shared by the selected • Services, value added (percent) set of countries, based on the six indicators from the • FDI, net inflows (percent of GDP) CEM tool (to identify structural peers), in addition to • Human capital index information on governance and remittances. Figure • International tourism, receipts (percent of total E.2 presents the outcome variables of interest (such as exports) GDP, poverty, and inequality) that were used to assess potential aspirational peers. Ex post checks verified two variables absent from the tool: landlocked and remittances inflows (percent of GDP). 116 Figure E.1. Select Indicators, Structural Peer Countries Age dependency ratio Services, value added 60 100 Percentage of working-age population 80 Percentage of GDP 50 63.0 59.1 60.2 49 55.8 60 53.2 55.5 48.4 46.6 42 40 40 20 30 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Source: World Bank sta estimates based on age distributions of United Source: World Bank national accounts data, and OECD National Nations Population Division's World Population Prospects: 2022 Accounts data files. Revision. Foreign direct investment, net flows Human Capital Index 14 0.9 0.78 12 11.5 0.8 0.7 0.63 10 Percentage of GDP 0.58 0.58 0.57 0.58 0.6 0.57 0.52 8 7.1 0.5 Index 6 0.4 5.1 0.3 4 3.5 0.2 2.2 2 1.3 1.4 0.1 0.5 0 0 Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Source: International Monetary Fund, International Financial Statistics Source: World Bank sta calculations based on the methodology and Balance of Payments databases, World Bank, International Debt described in World Bank (2018). openknowledge.worldbank.org/hand- Statistics, and World Bank and OECD GDP estimates. le/10986/30498. Remittances 20 18.7 18 16 15.2 14.1 Percentage of GDP 14 11.6 12 10.5 10 9.4 8 6 4.7 4 1.6 2 0 Albania Armenia Bosnia and Herzegovina Estonia Georgia Kosovo Moldova Tunisia Source: World Bank sta estimates based on IMF balance of payments data, and World Bank and OECD GDP estimates. 117 Figure E.1. continued Rule of law Government e ectiveness 1.5 1.5 Government e ectiveness index 1.0 1.0 Rule of law index 0.5 0.5 0.0 0.0 -0.1 -0.1 -0.5 -0.2 -0.5 -0.5 -1.0 -1.0 -1.5 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Albania Armenia Bosnia and Herzegovina Estonia Albania Armenia Bosnia and Herzegovina Estonia Georgia Moldova Tunisia Georgia Moldova Tunisia Control of corruption Voice and accountability 2.0 1.5 1.5 1.0 Voice and accountability index Control of corruption index 1.0 0.5 0.5 0.0 -0.04 -0.03 0.0 -0.5 -0.85 -0.5 -1.0 -0.70 -1.0 -1.5 -1.5 -2.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Albania Armenia Bosnia and Herzegovina Estonia Albania Armenia Bosnia and Herzegovina Estonia Georgia Moldova Tunisia Georgia Moldova Tunisia Source: World Governance Indicators. Detailed documentation of the WGI, interactive tools for exploring the data, and full access to the underlying source data available at www.govindicators.org. The WGI are produced by Daniel Kaufmann (Natural Resource Governance Institute and Brookings Institution) and Aart Kraay (World Bank Development Research Group). Kaufmann, Daniel, Aart Kraay and Massimo Mastruzzi (2010). “The Worldwide Governance Indicators: Methodology and Analytical Issues”. World Bank Policy Research Working Paper No. 5430. The WGI do not reflect the official views of the Natural Resource Governance Institute, the Brookings Institution, the World Bank, its Executive Directors, or the countries they represent. 118 Figure E.2. Selected Indicators, Aspirational Peer Countries GDP per capita Poverty headcount ratio at US$5.50 (2011 PPP) 40,000 80 PPP (constant 2017 international $) 62 Percentage of population 30,000 60 52 53 49 20,000 40 13,358 10,000 20 9,069 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Albania Armenia Bosnia and Herzegovina Estonia Albania Armenia Estonia Georgia Kosovo Moldova Tunisia Georgia Kosovo Moldova Source: International Comparison Program, World Bank | World Source: World Bank, Poverty and Inequality Platform. Data are based Development Indicators database, World Bank | Eurostat-OECD PPP on primary household survey data obtained from government Programme. statistical agencies and World Bank country departments. Data for high-income economies are mostly from the Luxembourg Income Study database. For more information and methodology, please see Inequality pip.worldbank.org. 45 40 35 Gini index 34 30 30 30 25 25 20 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Albania Armenia Estonia Georgia Kosovo Moldova Source: World Development Indicators. 119 Appendix F. Main Sources of Information and Empirical Data Table F.1. Data Sources Source Indicators / Themes Indicators on macroeconomics; employment and labor World Development Indicatorsa markets Basic macroeconomic and price indicators; national accounts; ArmStatBank (ArmStat)b statistics from household surveys, firm-level microdata, and so on Poverty; household welfare and consumption; dwelling and Integrated Living Conditions Survey (ILCS) living conditions; household income sources Labor Force Survey Labor force and employment indicators Time use; gender roles and preferences; intrahousehold Time Use and Gender Survey dynamics Impacts of COVID-19, inflation, food insecurity, and other Armenia High-Frequency Surveys shocks on employment and household welfare Official poverty and inequality estimates; trends in social Social Snapshot of Armenia protection and social assistance; living conditions; demographic trends Labor Markets in Armenia Labor force and employment indicators; NEETs Statistical Yearbook (ArmStat 2022b) Demographic trends; agglomeration Findex database Financial inclusion indicators Obstacles to doing business; access to productive inputs; Enterprise Surveysc access to adequate human capital; impacts of COVID-19 on firms; and so on Poverty and Inequality Platformd Poverty and inequality estimates World Bank Gender Data Portale Gender statistics Budget and expenditure data; public spending on social Ministry of Finance protection, social assistance, and human development National statistics and administrative data on mining and Ministry of Energy infrastructures and Natural Resources energy sectors Macroeconomic trends and projections; international poverty Macro Poverty Outlook projections Harvard Growth Lab Economic complexity index Fiscal policies; debt sustainability; financial and International Monetary Fund macroeconomic indicators PWT10 Total factor productivity and labor share data a. World Development Indicators (dashboard), World Bank, https://datatopics.worldbank.org/world-development-indicators/. b. See ArmStatBank (statistical tables), Statistical Committee of Armenia, https://statbank.armstat.am/pxweb/en/ArmStatBank/?rxid=9ba7b0d1- 2ff8-40fa-a309-fae01ea885bb. c. Enterprise Surveys (dashboard), World Bank, https://www.enterprisesurveys.org/en/enterprisesurveys. d. Poverty and Inequality Platform (dashboard), World Bank, https://pip.worldbank.org/home. e. Gender Data Portal (dashboard), World Bank, https://genderdata.worldbank.org/. 120 Appendix G. Findings and Results from the Stakeholder Consultations The World Bank SCD team conducted two external partners; and (4) government and government bodies. stakeholder consultations for the preparation of SCD2. All meetings were held in hybrid mode with translation, The first was an identification mission to Yerevan, Armenia and most stakeholders participated in person. Each during June 6–10, 2022. The mission’s main objective meeting was allocated 1.5 hours of presentation from the was to hold in-country stakeholder consultations on SCD team and the discussions that followed. the preliminary hypotheses of the upcoming SCD. The mission met with relevant government counterparts, Polls were taken twice during the meetings to keep representatives of the private sector, experts in private the consultations interactive. Questions asked in each interdisciplinary research groups, academia, civil poll were the following: society, and development partners. The team is grateful for the comments received and support provided from 1. First Poll: “What are the top five most important policy the participants at the consultation meetings. priority areas in Armenia today?” The participants were asked to choose the top 5 priorities among The team requested feedback on two main questions: the 15 possible areas provided by the SCD team. (1) “Are the identified challenges in line with The first poll was held before the SCD presentation. perceived constraints to development in Armenia?” and (2) “Are there additional areas that are not 2. Second Poll: Two questions were asked in the considered?”. Participants stressed the need for a second poll. deeper understanding of (1) drivers of low productivity in agriculture; (2) constraints on private sector growth, • (Q.2.1) “What are the top five most important policy including access to low-cost financing; (3) human capital priority areas in Armenia today, after hearing the constraints, including inadequate skills in the labor presentation today?” force and mismatches between the labor force and industry needs; (4) government effectiveness; (5) social • (Q2.2) “Is there an important policy priority the SCD norms and other drivers of low economic participation is missing? What is it?” by women; (6) the need for greater connectivity and market diversification; (7) demographic challenges and Figure G.1 summarizes the results from polls 1 and outmigration; (8) exposure to climate risks; (9) regional 2, aggregated across all the meetings. A clear list of disparities and lack of opportunities outside Yerevan priorities emerged from the consultations with little and other large cities; and (10) risks and opportunities variation across the different stakeholders. given the situation in Ukraine and the influx of foreigners to Armenia. These results were reflected in the draft to Results from the Polls the extent possible. The results show that the ranking of priority areas was The second external stakeholder consultation took similar across the two polls, but the emphasis shifted place May 10–12, 2023 in Yerevan. Views were substantially toward specific areas. Specifically, greater sought on the narrative of the SCD2, key development preeminence was given to fragility and conflict, human challenges, and policy priority areas that the team had capital accumulation, governance and institutions and identified. Four meetings were held in total with close data needs, diversification, and trade integration in poll to 100 stakeholders from (1) civil society organizations, 2 after the presentation. These are all consistent with think tanks, and academic institutions; (2) private the priority areas identified in SCD2. sector; (3) international organizations and development 121 Figure G.1. Results from the Polls 80 Poll 1 Poll 2* 70 60 Share of respondents 50 40 30 20 10 0 Increase resilience to fragility and conflict Advance human capital accumulation Strengthen governance and institutions and invest in data Diversify the economy Foster a competitive and innovative private sector in services and manufacturing sectors Promote access to and generate good quality jobs Adapt to climate change by building resilience to climate-related shocks and natural disasters Boost public and private investment in physical and digital access to close the domestic and international connectivity gap Build an equitable society Cultivate climate-smart agriculture and value chain development Improve integration for trade Enhace prudent macroeconomic management Address connectivity challenges in energy sector Mitigate GHG emissions and ensure sustainable resource use Reduce the cost of rm establishment and operation Source: Results obtained from the polls during the consultation meetings. Note: A technical glitch prevented the first question from poll 2 in the meeting with CSOs. In the aggregated responses for poll 2 above, this includes the CSO meeting poll 1 results to capture the preferences of this group. The sample size was 94 for poll 1 and 77 for poll 2 (assuming that the responses from the CSOs did not change after the presentation). In all meetings except for the one with the private investing in data (ranked 2nd in poll 2 across all sector, increasing resilience to fragility and conflict meetings). Some participants also stressed the low was the most important policy area both in the first capacity of local government, low public participation, and second polls.153 Interestingly, the private sector was and civic education. This priority area is discussed in the the only group that ranked human capital consistently SCD2 as one of the critical factors for effective service as the most important policy priority in the two polls delivery. (73 percent and 82 percent, respectively), ahead of fragility and conflict (ranked 2nd in both polls).154 This The only gap between the results from the polls and result resonates with the priority identified in the SCD2: the 11 priorities identified in the SCD2 is that more that investing in human capital, especially in skills and emphasis was given to building equitable society knowledge that are relevant for the changing demand in (ranked 9th in poll 2, but dropped from the priority list the labor market, is critical to further develop the private in SCD2) and less emphasis was given to the migration sector and increase the productivity of firms and labor. of GHG emissions (ranked 14th in the poll, but identified as a priority in SCD2). The greater emphasis on building The majority also supported the importance of equality seemed to stem from perceptions that differ from strengthening governance and institutions and the reality in Armenia. In Armenia, the level of inequality 153 The second poll in the meeting with the CSOs which was done orally due to technical issue confirmed that the results did not change between the two polls. 154 In the second poll for the private sector, fragility and conflict and “strengthening governance and institutions and investing in data” were both in second place. 122 is relatively low compared to other peer countries. The looking nature in the analysis. Given that the SCD is issue was not presented in the meetings, but the team an evidence-based report based on the latest data clarified the trend during the discussion that followed available, the team emphasized that the objective of the poll 2. SCD is to identify priority areas based on a diagnostic of the past, and it stressed the need for data to enable The low ranking of mitigation of GHG emissions empirically rigorous analysis. The team also explained provided useful insights to the team in reframing the that there are other corporate products to present the main challenge related to the risks from climate change. forward-looking analysis, such as the upcoming County After the consultation, instead of highlighting the need Economic Memorandum. to reduce GHG emissions, the team emphasized the need to reduce pressures on natural capital to improve The importance of security issues was emphasized resilience to climate-related shocks in the diagnostic. in the open-ended responses. Topics related to social norms as well as the need to strengthen the social Featured Topics in the Discussions contract and foster a dynamic relationship between the community and government were discussed. Related to A few topics were raised several times during the government effectiveness, the community consolidation consultations, including the diaspora. The consultations process and decentralization agenda were highlighted highlighted the importance of the diaspora, not only as as important areas in which government effectiveness a source of income but also as a source of knowledge could be improved at the central and local levels. and innovations. The team agrees that leveraging the Digitalization of government services such as for taxes connection to diasporas provides vast opportunities for was discussed as an example of ongoing reform that Armenia, as discussed in the report. could support government effectiveness. Among the many existing challenges, the high As for private sector challenges, the consultations international poverty rate compared to other revealed that lack of financial literacy is a bottleneck countries with equivalent levels of income per capita for the use of finance for establishing and building was brought up and discussed as a pressing issue in a business. The discussion also highlighted the multiple sessions. The team emphasized that despite challenges to greening businesses and the need to plan low rates of extreme poverty, poverty reduction remains for a green growth model. The need to develop capital an important national goal. The team clarified that the markets was also featured in the open-ended poll objective of the SCD is to address the bottlenecks to answers. The strong appreciation of the dram in 2022 achieve further poverty reduction. was highlighted as hurting competitiveness, especially for the agricultural sector. Related to poverty, some participants highlighted the importance of discussing multidimensional poverty Four sets of written comments were also received as and related food insecurity issues in the report. a follow-up to the discussion during the consultations. Reference to vulnerable groups such as women and Many expressed their support and endorsed the children and discussion on gender gaps were also overall storyline and priority areas presented. Some suggested to ensure inclusive growth. Although these additional information provided included the need to topics were not highlighted during the presentation, consider political settlement and the power structure of the team recognizes their importance, and the topics the country; construction sites and traffic as additional (including non-monetary aspects of poverty, vulnerable causes of environmental risks; and the sectors in which people, and gender gaps) are discussed in SCD2. the diaspora communities have advantages in Armenia’s development process. The information received was Concerns were expressed over the data used for the referred to in SCD2 where relevant and useful in analysis, the need to acknowledge the most recent supporting the storyline. progress made in Armenia, and the lack of forward- 123 The feedback was helpful in strengthening the narrative and validating the prioritization results which have been incorporated into the SCD. This included the suggestion for the team to further elaborate on the changing nature of the persistent challenges and priorities discussed in SCD1 and SCD2. Although many topics discussed in SCD1 are indeed still valid in SCD2, the team recognizes the shifts in focus due to recent events, and this was reflected in SCD2. 124 Appendix H. International Benchmarking for Prioritization The prioritization followed a two-step procedure: STEP 1: The first step was the international benchmarking exercise. The team collected a wide range of indicators to assess Armenia’s performance in each possible policy priority area. Around 180 indicators were used across 17 possible policy priority areas. Each indicator was compared against the median value of the countries in eight different reference groups: (1) World, (2) EU, (3) New EU, (4) ECA (without high income), (5) ECA All, (6) UMIC, (7) regional peers, and (8) OECD countries. Countries included in different groups are listed at the end of this section. The determination of priority level (color coded as green for low, yellow for medium, and red for high) was conducted as follows: 1. For each indicator, the magnitude of the difference between Armenia and the median value of the reference group was normalized using the formula , where is the value of Armenia for indicator i and is the median value of indicator i across countries in the reference group s. This was done for all the countries in the reference groups. 2. Indicators were re-ranked so that the lower the value of the normalized gap, the more the country was underachieving with respect to the median of the reference group. 3. Thresholds were set to define the level of priority by taking the 33rd and 66th percentiles of the distribution of the normalized gap for each reference group. If the indicator for Armenia was below the 33rd percentile, the indicator was given a high priority. Level of Priority Normalized Gap 1 High 2 Medium 3 Low 4. The set of rules to identify priorities from the international benchmarking were: Rule 1: If any indicator was dominated by a “high” level of priority (that is, red cells), then the policy area was identified as a “high” priority in this first step of the prioritization. Rule 2: If there was no indicator with high priority (that is, no red cells), then the result was determined by the dominant level of priority within the possible policy priority area. The results from the international benchmarking exercise are shown in Table H.1. 125 STEP 2: The urgency and feasibility filters were used to validate the results from the international benchmarking. The level of priority of each policy area was assessed by the World Bank experts by assigning a rating of “high,” “medium,” or “low.” All policy priority areas were confirmed to have an average ranking between medium and high. · Urgency filter: This filter assessed the urgency to act given the complex geopolitical situation faced by Armenia and the country’s vulnerabilities to shocks (fragility, conflict, and violence (FCV); economic shocks; and environmental risks). · Feasibility filter: This filter assessed the likelihood that the proposed policy actions could be implemented in the next 4–6 years, taking into account the technical feasibility of the government’s implementation of the reform. Countries included in the reference groups: 1. Regional peers (7 countries): Albania, Bosnia and Herzegovina, Estonia, Georgia, Moldova, Tunisia, Kosovo. 2. EU (27 countries): Austria, Belgium, Bulgaria, Croatia, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden. 3. New EU (countries that joined the EU after 2003): Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovakia, Slovenia. 4. ECA (18 countries): Albania, Armenia, Azerbaijan, Bulgaria, Bosnia and Herzegovina, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, North Macedonia, Montenegro, Serbia, Tajikistan, Turkmenistan, Türkiye, Ukraine, Uzbekistan, Kosovo. 126 Table H.1. Indicator-Level Results of Benchmarking Binding Constraint 1.1: Risks of fragility, conflict, and violence Reference Group Possible Policy Priority Indicators Priority Area Level World EU New EU ECA ECA All UMIC Regional OECD Military expenditure per capita (constant 2019 US$) (If high, then low medium medium low low low low medium low priority) Refugee population (If high, then high high high high high high high high high priority) Political stability and absence of high high high low low low low high violence/terrorism: estimate Government effectiveness: estimate low high high low low low low high Control of corruption: estimate high high high high high high high high 1.1.1 Increasing Regulatory quality: estimate high high high high medium high low high resilience to High fragility and Rule of law: estimate medium high high high low high high high conflict Voice and accountability: estimate high high high high medium high low high WGI government efficacy, index low high high low high low low high (-2.5 to 2.5) Rule of law: estimate medium high high high low high high high Voice and accountability: estimate high high high high medium high low high 2018 Corruption perception index (0-100, 0 = country perceived medium medium medium medium medium medium medium medium as highly corrupt) (Transparency International) Binding Constraint 1.2: Vulnerability to economic shocks Reference Group Possible Policy Priority Indicators Priority Area Level World EU New EU ECA ECA All UMIC Regional OECD Economic complexity high low low high high high high high Global merchandise exports as a 1.2.1. share of GDP (Fouquin and Hugot; high medium high high high high high medium Diversifying the CEPII 2016; National data) High economy Market concentration index (Hirschman-Herfindahl index of high high high high high high high high exports value destination) 127 Binding Constraint 1.2: Vulnerability to economic shocks (continue) Reference Group Possible Policy Priority Indicators Priority Area Level World EU New EU ECA ECA All UMIC Regional OECD Taxes on goods and services incl. sales taxes, VAT, and excise duties medium medium medium medium medium low medium low (% of GDP) Taxes on incomes, profits, and low medium low low low low low medium capital gains (% of GDP) Total tax revenue from social contributions, direct and indirect medium medium medium medium medium medium medium medium taxes (% of GDP) 1.2.2. Enhance Current account balance (% of GDP) low high low medium medium low high high prudent macro- GDP per capita growth (annual %) low low medium high medium low high low Medium economic management GDP per capita, PPP (constant 2017 medium medium high medium high medium medium high international $) Inflation, consumer prices (annual %) high high high high high high high high Total reserves (% of total external high high high high high high high medium debt) Central government debt, total (% medium low medium high medium high high low of GDP) Tax revenue (% of GDP) low low low low low low low low Discriminatory norms toward medium high high medium high high high high women*** Gender pay gap as difference in high high high high high medium high high monthly earnings Labor force participation rate, female (% of female population ages medium medium medium medium medium medium medium medium 15+) (modeled ILO estimate) Labor force participation rate, male (% of male population ages 15+) medium medium medium medium medium medium medium medium (modeled ILO estimate) Labor force, female (% of total labor medium low low medium low medium medium medium force) Male to female ratio at birth medium medium medium medium medium medium medium medium Proportion of seats held by women medium medium medium medium medium medium medium medium 1.2.3. Build in national Parliaments (%) an equitable Women's Parliamentary Medium society medium medium medium medium medium medium medium medium representation Account ownership at a financial institution or with a mobile money high medium medium high high high medium medium service provider, female (% of population ages 15+) Account ownership at a financial institution or with a mobile money medium medium medium medium medium high medium medium service provider (% of population ages 15+) Social contributions (% of revenue) high high high high high high high high (If low, then high priority) Social assistance adequacy low . . low low low medium low Social assistance coverage medium . . medium medium high high low Social insurance adequacy medium . . medium medium medium high medium 128 Binding Constraint 1.3: Vulnerability to environmental risks and natural hazards Reference Group Possible Policy Priority Indicators Priority Area Level World EU New EU ECA ECA All UMIC Regional OECD People using at least basic drinking water services, rural (% of rural medium low low medium low medium low low population) People using at least basic drinking water services, urban (% of urban medium low medium medium medium medium medium low population) People using at least basic sanitation services, rural (% of rural medium medium medium medium medium medium medium medium population) People using safely managed drinking water services (% of medium medium medium low medium medium low medium population) People using safely managed medium medium medium low medium low low medium sanitation services (% of population) Waste collection coverage, rural (% 1.3.1 Adapt to high high high high high high high high of rural population) climate change by building Waste collection coverage, urban (% low medium medium medium medium medium medium medium resilience of urban population) High to climate- Waste treatment open dumping (%) related shocks high . . high high high high high (If high, then high priority) and natural disasters SDG 6.4.1. Water Use Efficiency high high high high high high high high SDG 6.4.2. Water Stress high high high high high high high high Energy Intensity of GDP (TOE per medium low low medium low medium medium low thousand 2015 USD PPP) Total freshwater withdrawal high low high low high medium high low Treated municipal wastewater high high medium high medium high low high Water productivity, total (constant 2015 US$ GDP per cubic meter of high high high high high high high high total freshwater withdrawal) Number of deaths, missing persons and directly affected persons high high high high high high high high attributed to disasters, per 100,000 population Air pollution deaths from fossil fuels high low low low low medium low low Annual C02 emissions from fossil high low low low low low low low fuels and industry Forest area (sq. km) (If low, then high high high high high high high high high priority) CO2 emissions (kg per 2017 PPP $ 1.3.2. Reducing medium medium low low low low low medium of GDP) pressures on natural capital Coal subsidies as % of GDP, High for improved low low low low low low low low real 2021 USD resilience Natural gas subsidies as % of GDP, high high high high high high high high real 2021 USD Oil subsidies as % of GDP, real 2021 medium high high high high high high high USD Renewable energy consumption (% of total final energy consumption) (If high medium medium high high high high medium low, then high priority) 129 Binding Constraint 2: Accessibility to markets and better integration to trade Reference Group Possible Policy Priority Indicators Priority Area Level World EU New EU ECA ECA All UMIC Regional OECD 2.1 Boost public Rail lines (total route-km) high high high high high high high high and private investment in Railways, goods transported (million high high high high high high high high physical and ton-km) digital access Road connectivity index high medium medium medium medium high medium medium High to close the domestic and Account ownership at a financial international institution or with a mobile money connectivity high medium high high high high medium high service provider, poorest 40% (% of gap population ages 15+) Logistics performance index: overall medium medium medium medium medium medium medium medium (1=low to 5=high) International tourism, number of 2.2 Improve high high high high high high high high arrivals (If low, high priority) integration for High trade Time to export: border compliance low high high high low high high (hours) Time to import: border compliance low low low low low high (hours) If there were outages, average losses due to electrical outages (% low high medium low low low medium high 2.3 Address of annual sales) connectivity challenges Number of electrical outages in a High high high high high high high high high in the energy typical month sector Percent of firms experiencing medium high high high high high high high electrical outages Binding Constraint 3: Human Capital Possible Reference Group Priority Policy Indicators Level Priority Area World EU New EU ECA ECA All UMIC Regional OECD Government expenditure per student, high . . high high high high medium tertiary (% of GDP per capita) Government expenditure on education, high medium medium high high high high medium total (% of GDP) Government expenditure per student, high . . high high high high medium tertiary (% of GDP per capita) School enrollment, preprimary (% high medium medium medium high high high medium gross) Cause of death, by non-communicable medium low low medium low medium medium low diseases (% of total) 3.1 Advance Probability (%) of dying between human age 30 and exact age 70 from any High capital of cardiovascular disease, cancer, medium high medium low low medium medium high accumulation diabetes, or chronic respiratory disease, both sexes Probability (%) of dying between age 30 and exact age 70 from any of cardiovascular disease, cancer, low medium medium low low medium medium high diabetes, or chronic respiratory disease, female Probability (%) of dying between age 30 and exact age 70 from any of cardiovascular disease, cancer, high high medium low low high medium high diabetes, or chronic respiratory disease, male 130 Binding Constraint 3: Human Capital (continue) Possible Reference Group Priority Policy Indicators Level Priority Area World EU New EU ECA ECA All UMIC Regional OECD Labor force participation rate for ages medium low low low low medium medium medium 15-24, total (%) (modeled ILO estimate) Labor force participation rate, total (% of total population ages 15+) (modeled ILO medium medium medium medium medium medium medium medium estimate) Unemployment, total (% of total labor high high high high high high high high 3.2 Promote force) (modeled ILO estimate) access to Unemployment, youth total (% of total and generate High labor force ages 15-24) (modeled ILO high high high high high high medium high good-quality estimate) jobs Average wage (2017 PPP $) (If low, high high high high high high high high then high priority) Average wage female (If low, then high high high high high high high high high priority) Average wage male (If low, then high high high high medium high high high high priority) Binding Constraint 4: Investment and Private Sector Inputs Possible Reference Group Priority Policy Indicators Level Priority Area World EU New EU ECA ECA All UMIC Regional OECD Account ownership at a financial institution or with a mobile money medium medium medium medium medium high medium medium service provider (% of population ages 15+) Commercial bank branches (per low low low low low low low low 4.1 Reduce 100,000 adults) the costs of Domestic credit to private sector (% of firm estab- low medium low low low low low medium Medium GDP) lishment and operation Foreign direct investment, net inflows high high high high high high high high (% of GDP) Global competitiveness index 4.0: medium medium low low low medium low medium financing of SMEs ** Gross capital formation (% of GDP) (If medium medium medium high medium medium medium medium low, then high priority) Research and development high high high medium high high medium high expenditure (% of GDP) International tourism, number of high high high high high high high high arrivals (If low, high priority) 4.2 Foster a International tourism, receipts (% of competitive low low low low low low medium low total exports) (If low, high priority) and innova- tive private Market organization: To what level have the fundamentals of market- low medium medium medium medium medium medium medium High sector in services and based competition developed? manufactur- Competition policy: To what extent ing sectors do safeguards exist to protect low medium medium medium medium medium medium medium competition, and to what extent are they enforced? Manufactures exports (% of high high high high high high high high merchandise exports) 131 Binding Constraint 4: Investment and Private Sector Inputs (continue) Possible Reference Group Priority Policy Indicators Level Priority Area World EU New EU ECA ECA All UMIC Regional OECD Medium- and high-tech manufacturing value added (% manufacturing value high high high high high high high high added) If there were outages, average losses due to electrical outages (% of annual low high medium low low low medium high 4.2 Foster a sales) competitive Number of electrical outages in a and innova- high high high high high high high high typical month tive private High sector in Percent of firms experiencing electrical services and medium high high high high high high high outages manufactur- ing sectors 2017 percentage of survey respondents who reported having paid a bribe in the last year to access public services such as education; judiciary; low low low low low low low low medical and health; police; registry and permit services; utilities; tax revenue and customs; and land service Agricultural raw materials exports (% of high high high high high high high high merchandise exports) Agriculture, forestry, and fishing, value medium high high medium medium medium low high added per worker (constant 2015 US$) Arable land share (% of land area) low medium medium medium medium low medium medium Cereal crop yield (If low, then high medium medium high high high medium medium medium priority) Cereal crop yield, attainable (If low, low low low medium medium low low low then high priority) 4.3 Cultivate Maize crop yield gap high high high high high high medium . climate-smart agriculture Potato crop yield gap high high high low low high low high High and value chain devel- opment Wheat crop yield gap low low low low low low low low SDG 6.4.1. Water use efficiency (if low, high high high high high high high high then high priority) SDG 6.4.2. Water stress high high high high high high high high Total freshwater withdrawal high low high low high medium high low Treated municipal wastewater high high medium high medium high low high Water productivity, total (constant 2015 US$ GDP per cubic meter of total high high high high high high high high freshwater withdrawal) 132 Appendix I. Call for Papers: Sustainable Economic Growth and Poverty Reduction in Armenia As part of the consultation process, the team announced analytical rigor and relevance of analysis in relation to the a call for research proposals to understand the current overarching theme of sustainable and inclusive growth challenges facing Armenia from the local perspective. (Table I.1). The research papers were revised based on Responding to the call, a total of 28 proposals were the virtual quality enhancement review meeting that submitted from academia, research institutions, civil took place in January 2023 and served as critical inputs society, and other development and policy practitioners. to support the storyline in the SCD. Among the 28 proposals, 5 were selected based on Table I.1. Selected Papers and Authors Title Author Research Description Gor A. Khachatryan By using the nonlinear autoregressive distributed lag Asymmetry in Exchange (Yerevan State University) framework, the paper shows empirically how the exchange Rate Pass-Through into and Aleksandr Grigoryan rate passes through to consumer prices in Armenia. The study Consumer Prices: Evidence (American University of finds that domestic prices respond differently to currency from Armenia Armenia) appreciations and depreciations. Policy Changes and Labor Vardan Baghdasaryan The study estimates the causal impact of the contributory Market Outcomes: Effects and Gayane Barseghyan pension and minimum wage on informality and unemployment of Contributory (Funded) (American University of in Armenia based on discontinuity models and shows that Pension Scheme and Armenia) there are no significant impacts. Minimum Wage Policies Migration Intentions and The research explores the relationship between the intention Labor Market Conditions: Aleksandr Grigoryan to migrate for labor and the deprivations in the labor market. Evidence from the (American University of The analysis finds that the deprived workers in the labor Armenian Labor Force Armenia) market are more willing to migrate, but willingness is also Survey for the Period 2018 affected by the options available to the workers. - 2020 By collecting the original survey, the study confirms that Improving the Quality of Ruzanna Tadevosyan factors such as low financing, lack of teacher motivation, School Education in the (Armenian State University and inadequate teachings importantly affect the educational Republic of Armenia of Economics) outcomes in Armenia. The paper analyzes the export promotion institutional model Facilitating International Margaret Baburyan in Armenia and compares it with international benchmarking Trade through (Economic Research and countries. Supplemented by the original data collected from Development of Relevant Development Support local stakeholders, the paper suggests a model that best fits Infrastructure Center) Armenia to enhance exports. 133 Appendix J. Disaster Risk Management Measures Taken after the 1988 Earthquake Table J.1. Examples of Government Efforts in Disaster Risk Management and Adaptation Year Policy Actions 1991 Established a new Disaster Risk Reduction system 1994 Adopted the first Armenia Seismic Code 1997 Established the Cabinet Contingency Fund 2008 Established the Ministry of Emergency Situations Established the National Platform for Disaster Risk Reduction to support multi-sectoral 2010 coordination for disaster risk reduction 2011 Introduced the legal framework for damage and loss assessment Signed the 2015-2030 Sendai Framework to improve the country’s resilience to disasters 2015 Adopted the Disaster Risk Management National Strategy Became a member of the UN International Search and Rescue Advisory Group (INSARAG) 2017 Enacted the Disaster Risk Management National Strategy and the Action Plan Carried out the Earthquake Response Exercise (ERE) to improve awareness and best practices of national and local authorities 2018 Adopted the Inter-Agency Needs Assessment (ARIANA) to increase the country’s preparedness Conducted national implementation of the Multi-Cluster Initial Rapid Assessment (MIRA) Adopted a new seismic hazard map adopted and initiated an update of Armenia’s seismic 2019 codes Hydrometeorology and Monitoring Center was established under the Ministry of Environment 2020 to support development of a united environmental monitoring system and to improve data exchange. Enacted the decree on National Adaptation Plan (National Action Program of Adaptation to 2021 Climate Change and the List of Measures for 2021-2025) Approved the Program on Energy Saving and Renewable Energy for 2022–30 2022 Submitted amendment to the Law on Atmospheric Air Protection Submitted amendment to the Law on Environmental Impact Assessment and Expert Appraisal Developed a unified early warning data system and mobile phone application. Weather 2022-23 satellite system acquired to strengthen forecasting and early warning systems. 134 Appendix K. Social Protection System to Build Resilience Social protection can be critical for building resilience poor almost doubled (from 32 percent in 2019 to 56 to different types of shocks, and the social protection percent in 2020), associated with the increase in system in Armenia has been important in protecting government spending (vertical scale-up).157 However, Armenians from falling into poverty. The social the rise in spending was accompanied by an increase protection system in Armenia has undergone significant of only 15 percent in the number of social assistance reform in the last decade, including the introduction beneficiaries (horizontal scale-up), thus leaving of a mandatory funded pension pillar. Armenia has a many of the poor and vulnerable (particularly those relatively well-developed social protection system, in the informal sector) without support during the underpinned by legislation and comprising three pillars pandemic. This raises questions about the ability of that are common around the world: social insurance, the system to be shock-responsive—its capacity to social assistance, and labor market policies and identify and reach out to the most vulnerable families programs. The analysis shows that in the absence of and individuals who are not already enrolled in the any social protection benefits, and if households were system and who need immediate assistance when unable to compensate from other sources of income, affected by large-scale shocks. Focusing on vertical half of Armenians would live in poverty, and inequality scale-up might reinforce the bias toward existing would increase by 40 percent.155 groups that are already served by social protection systems, which may not include all the vulnerable or However, gaps remain, and the social protection those most affected by the shock.158 system requires additional adjustments to ensure that it is fiscally sustainable and socially adequate. To build adaptive social protection to enhance poor Even after the delivery of social protection transfers, and vulnerable households’ resilience to shocks, it one in four Armenians remains poor, and more than is critical to systematically include protection against half (57 percent) of those who remain in poverty are not unemployment and employment injury in the social reached by any social assistance benefit.156 At the same protection system. Unemployment insurance was time, many non-poor households receive the benefits, removed from the social protection system in 2013 and suggesting that there is room for improvement in the was replaced with a cash support system providing targeting of the programs. support to unemployed job seekers on a case-by-case basis. Therefore, little support is available to protect Moreover, Armenia’s social protection system does workers from income loss, although the government not seem well prepared to expand outreach in plans to reintroduce unemployment insurance. Similarly, response to shocks . During the COVID-19 pandemic, it is also important to extend social insurance schemes the government protected the financing of regular to self-employed and informally employed so that programs and increased the social protection budget individuals are protected against shocks at different to make room for additional spending. The share of stages of their lives and in particular at old age or in case social assistance benefits in the consumption of the of a health shock. 155 Unless otherwise specified, the welfare indicator used in all analyses in this Appendix is based on household consumption per adult equiva- lent. See ArmStat 2022 a. 156 Estimates using ILCS 2021, taken from World Bank 2023b. 157 Some social assistance benefits increased more than others. For example, the temporary increase in the Family Benefit was more than three- fold. 158 Survey data suggest that the response to the COVID-19 shock was effective but not particularly efficient. While the poverty rate and poverty gap did not increase, the benefit-cost ratio of social assistance benefits dropped. The benefit-cost ratio is measured as the poverty gap reduc- tion, in local currency units, for each 1 unit spent on the social program. However, it is important to note that the efficiency lens needs to be ap- plied to shock-response measures with caution. In most cases, a “no regrets” approach (anticipatory action) is more suitable to shock-response interventions. 135 The social protection system can be more efficient and effective by addressing the fragmentation of the social assistance and labor market programs and services. In 2021, a total of 35 schemes (almost half of the overall number of social protection programs) were being implemented for disability benefits and services, housing, and labor market measures, with overall financing amounting to less than 3 percent of the social protection budget (or 0.24 percent of GDP). Many of these schemes were affected not only by the low financing but also by limited coverage and uneven spatial distribution. Consolidation of delivery mechanisms and using alternative public-private models, coordination across different programs, and institutional information sharing may increase cost-effectiveness and coverage of the social protection system. 136 Appendix L. The Gravity Model to Estimate Export Potential The analysis of Armenia’s export potential and missing exports is based on a gravity model. 159 This analysis follows earlier work done by Mulabdic and Yasar (2021) by estimating a gravity equation160 using data for 160 countries over the 2013–2019 period.161 Bilateral exports are modeled as a function of exporters’ and importers’ nominal gross domestic products (GDPs), economic development (GDP per capita), and remoteness indexes. Trade costs are proxied by policy variables such as the level of weighted applied tariff duties and presence of trade agreements in addition to distance and controls for sharing a common border, language, or colonial ties. Methodology and Data Bilateral trade data at the HS 6-digit (HS 2002) are from the CEPII’s BACI database. The data cover 160 countries across all geographic regions for the 2013–19 period. The sample is restricted to countries with populations greater than 1 million. Population data are from the World Development Indicators (WDI) database. To empirically assess if Armenia is under-exporting, a Poisson Pseudo Maximum Likelihood (PPML) estimator was used to estimate the following gravity equation: where is the bilateral trade flow from country to country in a specific industry, are bilateral applied tariff duties, comes from Mario Larch’s Regional Trade Agreements Database from Egger and Larch (2008) and is an indicator variable that takes value of 1 if i and j have a trade agreement in year t, is the geographical distance between i and j , is a variable that takes value of 1 for country-pairs that share a border, is a binary variable equal to 1 if i and j share the same language, and captures the presence of any colonial ties. Bilateral tariff duties are from the Market Access Map (MAcMap) database, while all the other variables come from CEPII’s gravity database. Other control variables such as exporters’ and importers’ GDPs as well as per capita GDPs are from the World Bank’s WDI database. Finally, the analysis controls for a dummy of mineral resources, which is equal to 1 if minerals exceed 10 percent of GDP for the 2013–19 period, and capital per worker (Chor 2010; Romalis 2004)by extending the Eaton and Kortum (2002. Variables were constructed for capital stock per worker based on data from the Penn World Tables 9.1 following work by Levchenko and Zhang (2014). To control for the unobservable multilateral resistance 159 Based on Mulabdic and Yasar (2021) and World Bank (2022) 160 These estimates are slightly different from Mulabdic and Yasar (2021), as this sample is restricted to the pre-COVID period. In addition, Mulabdic and Yasar (2021) used simple average tariffs in their estimation, while this model uses weighted average tariffs at the exporter-importer level. 161 See Mulabdic and Yasar (2021). The index is defined as , where are observed exports from country i to j , while are the predicted flows based on a gravity model. 137 terms, “remoteness indexes” (Baier and Bergstrand, 2007; Wei, 1996) the gravity equation has been a workhorse for cross-country empirical analyses of international trade flows and, in particular, the effects of free trade agreements (FTAs were constructed instead of using exporter-year and importer-year fixed effects).162 162 See Mulabdic and Yasar (2021) for details. 138 Appendix M. Justice Sector and the Private Sector Jurisdictions around the globe recognize accessible, Moving forward, and as Armenia seeks to propel its effective, and efficient justice to be indispensable to economic growth through private sector development, the protection of citizens’ rights and freedoms and court performance may become more of an issue as critical for supporting private sector development and firms intend to grow and expand and would rely on economic growth. Accountable and effective justice courts to solve (economic) disputes. Given the lack of institutions and efficient procedures create the enabling disaggregated data available for judicial performance, it environment and level playing field for increased is difficult to assess how efficiently commercial cases are private sector investment, and they allow citizens processed. While small in share (with less than 1 percent and businesses to unlock their economic potential by of the total court caseload in Armenia), the demand for protecting private property rights, enforcing contracts, court-supported insolvency procedures increased by and fostering growth in compliance with legal and 8 percent during 2017–21 (World Bank 2023e). In 2021, regulatory frameworks.163 In contrast, poorly performing just below one in five cases (19 percent) were brought courts delay business activity, undermine predictability, forward by companies. In light of this growing demand, and increase risks, thereby constraining private sector additional judges were added, helping to sustain growth. desirable clearance rates. However, the Bankruptcy Court has seen an increasing backlog, high congestion, While courts are not immediately considered to be and the highest disposition time among all courts a major constraint to doing business in Armenia in Armenia with 1,158 days per case (2021).164 Issues today, broader areas related to the justice sector are. around contract enforcement—or perception thereof— According to the Enterprise Surveys 2020, only 1.2 constitutes a constraint on economic development as it percent of firms in Armenia list courts as a constraint discourages doing business with strangers. The business (see also Figure 77). However, other areas in which community seems to be torn regarding the efficiency courts and the justice sector play an indirect role are of bailiff services: according to a multi-stakeholder listed as areas of concern. Informal practices, which justice sector survey (World Bank 2021c), 33 percent of go contrary to growth in compliance with the legal business representatives believe bailiffs are efficient, and regulatory frameworks that courts and the justice while 19 percent believe the opposite, and the vast sector are supposed to safeguard, are ranked as a majority did not provide an answer. Furthermore, non- main obstacle (12.9 percent), second only to access to awareness regarding the availability of other dispute finance. Corruption (3.8 percent) and access to land settlement mechanisms in Armenia were expressed, (3.3 percent) are also among the top 10 obstacles to with only 1 in 10 and 2 in 10 of businesses being aware of doing business and within the scope of work of courts the availability of arbitration and mediation procedures, and the justice sector to create a level playing field and respectively. protect property rights. Generally, weak justice systems disproportionately hamper micro, small, and medium- sized enterprises because they have less buffers to absorb these challenges, which can become make-or- break for their businesses. 163 https://www.worldbank.org/en/topic/governance/brief/justice-and-rule-of-law 164 As Armenian court statistics do not provide data on actual disposition times, a proxy indicator developed by the Commission for the Efficiency of Justice at the Council of Europe was applied. 139 Appendix N. Knowledge Gaps SCD2 identified a few knowledge gaps that have remained since the publication of SCD1 as well as new knowledge gaps that have emerged. Table N.1. lists the gaps addressed and the newly identified gaps to be addressed in future studies. Table N.1. Knowledge Gaps, SCD1 and SCD2 Knowledge gaps identified in SCD1 that were addressed Trade and transport facilitation assessment Assessment on the challenges and policy actions in the ICT sector Short-term migration flows and educational attainment of emigrants Population trends and urban share of population Trade and competitiveness diagnostic Selected new and remaining knowledge gaps Reasons for high contribution of total factor productivity on growth Quality firm-level data for analysis of productivity at the sectoral level Wage employment trends within sectors, employment by education per sector to understand into which jobs human capital is going, and spatial analysis to analyze mobility issues Main constraints on labor mobility within and across sectors Agricultural sector data, including data on the classification of land and property for agricultural production Profile of the diaspora, including mapping of the location, skills, experiences, and investments made in Armenia Political economy underlying the weak governance and institutions Natural capital accounting exercise and distributional impact of climate change and natural disasters Comprehensive analysis of the factors underlying the high international poverty rates Identification of critical bottlenecks hindering the functioning of Armenia’s markets and the extent to which competition and contestability challenges have continued since the Velvet Revolution Review of the development of insurance mechanisms, considering the country’s fragility and anticipated physical risks from adaptation Estimate of the private capital mobilization values needed for infrastructure across sectors Key constraints to boosting domestic investment Review of the country’s current FDI policies and programs based on solid analytics and evidence to identify key reform areas for FDI attraction Effect of remaining state-owned enterprises on competition, firm dynamism, labor markets, innovation, and fiscal implications