|
Choice of Economic Development Model for the Republic of Moldova in the Conditions of European Economic Integration
Pyshkina T.V.
Pyshkin K.S.
Introduction The future economic development of Moldova is an important issue because of the continued eastward expansion of the European Union. Moldova, like other countries of the former Soviet block, is eventually likely to want to join the EU and it is now facing the choice of economic model that would allow it to limit the pain of the transition to a market economy. The EU, in its turn, would like to secure stability and economic growth on its eastern borders. Economic growth would, amongst other benefits, reduce the gap in living standards of the countries across the EU border and as a result at the very least limit illegal immigration and trafficking through its borders. Economically, doing business in Moldova can be very profitable for western companies. The major reasons behind this are a good investment climate and the availability of cheap and well-educated labour. There is also some scientific and manufacturing expertise remaining from the former Soviet defence industries. This can be converted into the base for development of high-tech industries such as electronics and telecommunications. At the moment, foreign companies in Moldova invest primarily in utilities (gas and water supply absorb 53% of all foreign investments, followed by food, transport and only then telecommunications). EU companies account for 40% of these investments, while only 26% of foreign trade is with EU. Several factors affect future economic development priorities for Moldova: The goal of EU membership is very likely to become a priority for Moldova in the not so distant future. However, currently Moldova is the poorest European state – GDP per capita at purchasing power parity is about 9.5% of the average level for the EU. Thus, this goal currently looks unrealistic and far distant. On the other hand, the countries to the East, i.e. Ukraine and Russia, are the former Soviet Union partners with whom Moldova has historically been closely connected. The current situation is that these countries account for 52-57% of the volume of foreign trade and supply 80% of Moldova’s energy resources. Thus, the immediate economic well-being of Moldova is very dependent on its relationship with CIS. Thus, Moldova should work on integrating itself into the European economy while maintaining its current good relationship with its CIS partners. To satisfy EU entry requirements in the long-term it should sustain real growth of GDP between 6 and 10% p.a. To achieve these high levels of GDP growth, Moldova can attempt to implement a growth-oriented economic development model. For example, we can suggest an adaptation of the South-Eastern Asia model, providing it is aligned with Moldova’s national priorities, involves effective use of existing infrastructure left from the legacy of the Soviet Union, and includes support for existing national producers. The EU can help by limiting its protectionism to assist this process. The choice of model and analysis of economic development of Moldova are the subjects of this paper. Moldova, like some other former Soviet-block countries that are now potential EU entrants, may end up being torn between its close ties with former Soviet allies and increasingly important future partners in the EU. Moldova's poverty. How bad are things really? "Of all the former communist states of Europe, Moldova has fared worst in its first decade of freedom—and is now the poorest, in terms of income per person, behind even Albania." writes the Economist1, saying it cannot sink much lower. However, no matter how bad things are, of course, they can always get worse. The lack of sound macroeconomic policy, in particular, can have a large impact. The Economist quotes average wages for the end of last year of around $70 a month. In fact, this level is even lower - around $56 a month. In 2002 GDP per person was $406, i.e. slightly more than $1 per day! GDP at Purchasing Power Parity (PPP) was 9.5% of the average EU level (see Figure 1 for other former communist-block countries). The gap is huge and it is the main factor preventing Moldova's movement into EU. On a positive note, however, this tiny wage can be potentially exploited by manufacturers, giving them an international comparative cost advantage.
It appears that only in 2002 Moldova's GDP returned to growth in real terms. Thus, in 2002 GDP grew by 7.2% to $1624.5 million at a yearly inflation rate of 4.4%2, or 2.8% in real terms; in comparison, in 2001 the growth was 6.1% with comparable inflation level. However, according to the World Bank3 analysis, Moldova had 7 years of output decline between 1990 and 2000. Cumulative output declined by 63% and real GDP in 2000 was 35% of its 1990 level. This is one of the worst performances among all former communist block countries, outmatched only by Georgia (real GDP fall). For comparison, this recession was significantly larger than any Western economics ever experienced in peaceful time, including the Great Depression of 1930/34 with 2-4 years of output decline and 6-27% cumulative output decline in France, Germany, UK and the US. The situation was so bad mainly because of the lack of coherent and decisive macro-economic policy. Additionally, Moldova suffered from corruption, similarly to its neighbors to the east - Russia and Ukraine, and apparently even EU candidates to the west - Romania and Bulgaria4. Unlike Russia and Ukraine, however, Moldova does not have vast natural resources to drive economic growth and in the early 1990s it also endured a damaging internal conflict with its industrially strong and power producing Trans-Dniestrian region. Changes in GDP in Moldova are explained by the underlying level of productive potential In the long-run, changes in GDP are explained by the underlying level of productive potential. This is affected by changes in the capital stock, labor and improvement in technology (TFP - Total Factor Productivity), which are all intimately connected in practice. During the prolonged recession in the 1990s in Moldova the economy has undergone such massive upheaval that it is very difficult to separate out exactly which factors have been most important in reducing the growth rate. There has been deterioration in all the inputs, reflecting the general deterioration in background economic conditions, which of course implies that any moves to achieve greater macroeconomic and political stability would almost certainly yield an additional growth dividend, encouraging all the inputs. Labor In the past decade a substantial number of people have migrated from Moldova. The unofficial number of people working abroad is estimated to be between 120,000 and 1,000,000 (or between 3-23% of the whole country)5. The official migration rates have been very high exceeding 5-6 thousands people a year for the last ten years. Unfortunately, there are no reliable figures to show the exact state of affairs or to estimate the current population of the country. Moreover, the economically active proportion of the Moldavian population has reduced from 54% in 1989 to 45% in 2002 and in the following 5-7 years this trend is likely to continue6. People are not motivated to work because the average wage is less than the minimal consumption budget. This is a fundamental problem and successful economic development of the country depends on the elimination of this disproportion. The country needs a clear policy to reduce migration and protect its labor resources. Current efforts by the State are clearly insufficient. However, as we have noted earlier this disproportionately low wage can be successfully exploited by the manufacturers to give them an international comparative cost advantage. The effort to reduce migration should be simultaneously focused in two different directions: macroeconomic, which includes implementation of structural economic reforms, stimulation of entrepreneurship and other economic measures; and social, which includes specialized rehabilitation, counseling and information programs. Capital In 1991 Moldova had 15 large high-tech enterprises. At that time the level of manufacturing volume, technology employed and skills of workforce was comparable with that of the developed countries. These enterprises produced heavy machinery, microelectronics, and special technologies for space programs, defense and for export... Just one enterprise "Meson" had a turnover of $550 million and exported its products to 30 countries. It means that in 2002 the GDP was 3 times less than the volume of production manufactured by one enterprise in 1991. It is all now a history. Badly conducted privatization followed by depreciation has eliminated most of the capital stock accumulated in economy till 1991. During the first stages of privatization large state enterprises were split into small cooperatives to encourage the development of small businesses. However, instead of producing goods, valuable materials (for example precious metals) and equipment were often stolen and sold off abroad. Depreciation has also contributed to the capital stock reduction. The level of investment was not sufficient even to maintain the former level of capital. It is happened, as we mention below, because of the limited abilities and absence of economic sense of the local producers while reinvesting their profits to the local economy, in particular, in long-term capital-intensive projects. The market was also too small to attract any meaningful level of foreign investments. Overall, net capital investments over the last decade were substantially negative and instead of catching up with the developed nations the gap grew bigger. Total Factor Productivity Moldova used to have a highly skilled work force and world-class researchers as a result of being one of the microelectronics centres of the former Soviet Union and a part of its well developed defence industry. However, after the disintegration of the Soviet industries those highly skilled and well educated individuals that would have no problems finding employment abroad were the first ones to leave the country. This has reduced TFP. Little or no investment into new technology accompanied by the rapid ageing of the existing high-tech equipment has also resulted in the reduction of TFP. Those who remained were usually badly rewarded for their labour and thus had little incentive or desire to learn new skills, worsening the productivity of the labour force. The "brain drain" had a major impact on TFP. After the collapse of the Soviet Union an ever-increasing number of people, including the most talented ones that remained in the country have been involved in "rent seeking" activity as opposed to "entrepreneurship". This was illustrated, for example, by dramatic reduction of the student enrolment in the engineering courses, in comparison to the end of 1980s* and indicated that society allocated little talent to value-added activities. "Rent seeking" here refers to activities of taking fees from those firms that innovate or boost output. In Moldova, for example, there are enormous number of the 3rd party resellers in various industries and firms whose main activity is reselling, say fuel, to other resellers at a premium. This number of resellers significantly exceeds the number that is necessary for normal functioning of the economy. Consumers also suffer because they always have to pay a large premium. One important reason for the ever-increasing number of people involved in "rent seeking" is poorly defined property rights. According to the EBRD7 Moldova in 1999 had the most insecure property rights among a large group of East-European countries (see Fig 2). Property rights are crucial for establishing entrepreneurial businesses that are the major driver for innovation and creation of output.
The major problem is poverty In 2002 26.2% of the populating lived below the accepted poverty level - they had an average income of $15.6 per person per month, not enough to buy even a minimal basket of goods. The minimal consumer budget was $83.8 per month or about 1.6 times the average wage and about 9.5 times the average monthly pension. About 1.6 times more people below the poverty level lived in rural areas than in urban areas. At the same time the least wealthy 20% accounted for 5.5% of total income, while the richest 20% accounted for 47.5% of the total income7; and this represents a slight improvement on the situation in 2001, see Figure 3.
There is obviously a huge negative impact of mass migration for Moldova's economy because many highly skilled workers are among the first to leave the country. For the EU in particular, however, illegal migration also poses large problems because of the involvement of organized crime in human trafficking. The huge existing gap in living standards of the countries across the EU border is the main driver for illegal immigration into the EU. Therefore, when the EU assists in the creation of security, stability and economic prosperity on its eastern borders and helps to fix the underlying causes of poverty, it at the very least limits incentives for trafficking through its borders thus reducing its own domestic crime. Impact of Globalization and European Economic Integration As The Economist puts it1: " Trade, not aid, would help Moldova most. Only a fifth of its exports reach the European Union. But for the EU's farm protection, say the Moldovans, they might be able to sell 70% of their stuff there. The EU blocks the import of the only products Moldova could compete in—wine, fruit and vegetables—while undercutting it in the Russian market with subsidized products of its own. So the EU, absurdly, is increasing aid to Moldova while denying it access to the markets that would do most to improve the lives of its rural poor." Thus the EU's current protectionism has a big negative impact on Moldova's economy. However, we argue that European economic integration presents Moldova with both threats and opportunities for the future. On the one hand it further deepens social division in society and unfavorably changes the structure of GDP. On the other hand it presents opportunities for transfer of know-how and leveraging on recent development of information technology for development of a knowledge-based economy. We suggest that Moldova can benefit from its geographic location on the future border of the EU, its well-educated labor and its former status as one of the centers for Soviet microelectronics and integrate itself well into the European economy. Threats Increasing social division in society We have already mentioned the inequality in the distribution of income among the poorest and the richest segments of the population. The Gini coefficient, a standard measure of inequality, according to World Bank3 has changed from around 0.25 in 1987-90 to about 0.45 in 1996-99, ensuring Moldova's place amongst the most unequal countries in the world. European economic integration increases inequality even further because local producers cannot effectively compete in the world economy - thus wages are low and people lose motivation and withdraw themselves from the labor force and value-added activities. The most skilled and talented ones either migrate abroad or engage in "rent-seeking" activities. The least capable rely on diminishing state support. As a result social division in society grows. Changing structure of GDP As we have already mentioned, at the start of the 1990s Moldova had some high-tech and manufacturing industry able to compete in the world market. Nowadays, industrial and construction share of GDP, for example, has fallen from 71% to 17%, and 56.4% of the population leaves in rural areas (this is the largest proportion in Europe) and Moldova could only compete in agricultural products and wine. The EU, however, blocks even these exports. As a result Moldova is forced to focus on the Russian market with low-margin agricultural products, minimizing profits of its local producers (and thus the potential level of future reinvestments). The only viable business strategy for players in the market in these circumstances would be "hit and run", i.e. maximize return in the short term preventing anyone investing in longer-term projects requiring high initial investment and cash burn without profits for several years. Unfortunately, this means that no local investor is willing to commit to restoring manufacturing, electronics and similar capital-intense industries. Foreign investors are not excited about Moldova's small market and feel uneasy about its insecure property rights. Disintegrating infrastructure, including frequent shortages of power and water, worsen the situation further. Opportunities Moldova, like many other former communist-block countries, is lucky to have a well-educated and capable workforce. Many scientists, academics and engineers have not (yet) left the country and are looking to use their knowledge and skills should an opportunity arise. Moreover, the remains of the former Soviet defence and electronics industries can be used as a base for building new high-tech industries. Thus, ideally, Moldova could have a comparative advantage in knowledge-intense products, like semiconductors. It could become a European base for cheap production of high-quality high-tech goods. It would then benefit from the transfer of knowledge and technology from the developed countries. Foreign investors in their turn would also benefit enjoying higher returns. However, EU should limit its protectionism in order that manufacturers could re-export to the EU. Choice of economic development model Strategic goals The World Bank recommends3 two main ingredients for success: encouragement and discipline. Encouragement - strategy to encourage growth of new firms, in particular small- and medium-size enterprises (SME). These are crucial for generating economic growth and employment. Discipline - strategy to discipline the old enterprises left from the planned economy, in the form of imposing hard budget constraints, demanding full payment of taxes, social security contributions and debt. This two-fold strategy aims to allocate assets to more productive users, provide economic space for emerging firms and ultimately intensify production and innovation. Knowledge-based economic development To reduce poverty and start closing the GDP gap with the EU Moldova should sustain real growth of GDP between 6 and 10% p.a.9 We have built a 5-sector macroeconomic model for Moldova that allows us to calculate GDP and estimate both production and consumption10. Our main variables include taxes, exogenous variables include level of inflation, exchange rate, monthly wage, interest rate, state borrowings, foreign investments. We estimate that in the optimistic scenario Moldova's GDP is capable of growing at an average real rate of 7.9% a year to 2006. Our pessimistic scenario gives real growth rate of only 4.8%. Our optimistic scenario is based on knowledge-based economic development accompanied by the policy of discipline suggested by the World Bank. Key drivers for economic development in this scenario are industrial and high-tech parks, something that has been very successful in the United States leading to such regional economic drivers as Silicon Valley. While focussing on the European economy we also suggest the maintenance of close ties with former Soviet allies. Encouragement of high-tech industries and entrepreneurship in this field will create jobs and allow effective use of existing labour, technology and capital resources remaining from the former Soviet defence and microelectronics industry. This policy will increase the competitiveness of the Moldova's exports and therefore is aligned with the interests of local producers. Major potential benefit will come in the form of transfer of know-how and foreign direct investments. Government can further assist knowledge-based economic development. In particular creation of high-tech parks can be further encouraged - special concessions should be offered to firms that, for example:
Conclusion Moldova during the last decade has been through a very hard time. From one of the wealthier republics of the Soviet Union it has become the poorest state in Europe. The prolonged recession has reduced all three factors determining long-run economic growth: labour, capital and technology. The poverty of the population is currently its main problem, which also causes illegal immigration and human trafficking into the EU. We suggest that European economic integration gives Moldova an opportunity to develop a knowledge-based economy and a new competitive advantage, for example in low-cost high-skilled manufacturing for high-tech industries such as semiconductors or telecommunications. We calculate this would allow GDP to grow at around 8% p.a. in real terms and satisfy EU economic entry requirements in the long-term. In our model certain high-tech industries are prioritised in the economy, while entrepreneurship and the creation of high-tech business parks are encouraged by the State. This would allow Moldova to use effectively its remaining potential as one of the former Soviet centres for microelectronics and defence, and its skilled and well-educated labour to develop its new competitive advantage in Europe. There is currently a good investment climate with tax concessions offered to foreign investors and small domestic businesses. There already exist several industrial (high-tech) business parks and five zones of "encouraged entrepreneurship". Government, however, has to do much more to encourage entrepreneurship, attract foreign investors and expertise, develop high-tech industries and infrastructure. In particular, improving the security of property rights has to become a priority. But the first steps in the right direction have already been made. Acknowledgements
The authors would like to thank Professor David K Begg and Dr David
Shepherd from the Imperial College London Tanaka Business School for
their comments. References
Copyright ©2002-2004 |
