Integrative Project in Modern Production Methods (IE285e)

1. Integrative Project in Modern Production Methods (IE285e) Lecture #2 05 September, 2005 Integrative Project in Modern Production Methods, IE285e

2. Topic: • An overview of Armenian Industry and Economy. Integrative Project in Modern Production Methods, IE285e

3. Where are we? • One has to understand the current position to find out the right direction to move… • How to describe our position: • Geographic location • Natural resources • Economic relations Integrative Project in Modern Production Methods, IE285e

4. Geographic location • 29000 square KM total, and Artsakh • Being a landlocked, isolated country, the most reliable transportation is through air • Unfriendly countries from East and West, friends in North and South Integrative Project in Modern Production Methods, IE285e

5. The cost of blockade • While the cost of blockade is considerable it is not a major development constraint for Armenia. • The estimate of the blockade is that it hurts Armenia less directly (transportation costs, lost volumes of exports) • than indirectly (depressed investor’s expectations, inflated internal perceptions of risk, etc.). Integrative Project in Modern Production Methods, IE285e

6. Economic regime • Economic regime between 1924 - 1991was based on PLANNED ECONOMY, where the goal was the PLAN, which was decided not by the enterprise. • During the last decade Armenia moved to MARKET ECONOMY, where the goal is the MONEY (should be replaced by “net utility to the society”) through honest competition for a MARKET SHARE. Integrative Project in Modern Production Methods, IE285e

7. How well are we prepared? • How well are we prepared for the relatively new economic relations? How well do we know the markets? • The main problem is in the upbringing and societal mentality. • Is there business ethics norms well implanted? • Do we respect wealthy businesspeople, and vice versa? Integrative Project in Modern Production Methods, IE285e

8. Natural Resources Mines • metallic; • non-metallic Forests Water Resources Energy related: Fossil Fuel Other, Renewables: Solar, Wind, Geothermal Integrative Project in Modern Production Methods, IE285e

9. Mines, metallic Integrative Project in Modern Production Methods, IE285e

10. Mines, non-metallic: Stones! Integrative Project in Modern Production Methods, IE285e

11. Future value of mineral deposits • Note that the mineral deposits have future value, that can be expressed according to the following formula: [Future Value] = [Present Value]x[exp (kt)], where k is a coefficient, and t is the time. Integrative Project in Modern Production Methods, IE285e

12. Strategy • For certain mineral deposits this formula may yield an increase of the value up to 10 times per decade (in the currency of a particular year). • This means that the wisest economic solutions are NOT related with export of raw materials, but in production of the products that are as close, as possible to the final products. Integrative Project in Modern Production Methods, IE285e

13. High technologies • Manufacturing of final products from the mineral deposits increases the net utility for the society much more than selling raw materials to others. • This is especially true in the case of high tech implementation. • Electronics manufacturing comprises 1/3 of all manufacturing in the world! Integrative Project in Modern Production Methods, IE285e

14. Forests • Armenia has only 12% of its territory in forests in North-east and South. • During the “dark years” there has been a dramatic deforestation, which, to a considerable extent, continues now. Integrative Project in Modern Production Methods, IE285e

15. Oak Beech Hornbeam Ash Maple Many wild fruit trees γÕÝÇ Ð³×³ñ»ÝÇ ´áËÇ Ð³ó»ÝÇ ÂËÏÇ ´³½Ù³ÃÇí í³ÛñÇ Ùñ·³ïáõ ͳé»ñ Forests Integrative Project in Modern Production Methods, IE285e

16. Water Resources • General water resources: scarce, 7.5 times less of average of FSU • Underground Water:scarce, 4 billion tons annually, 38% goes to usable springs. Integrative Project in Modern Production Methods, IE285e

17. ENERGY Fossil Fuel • Extremely scarce: more or less considerable are low quality gray coal mines located in between Gumri and Spitak Integrative Project in Modern Production Methods, IE285e

18. Armenian economic history highlights: Status at 1913 Integrative Project in Modern Production Methods, IE285e

19. Status at 1913. Largest cities: • Alexandrapol: 51.3 thousand, • Erivan: 30 thousand inhabitants. Integrative Project in Modern Production Methods, IE285e

20. Armenian economic history highlights: Production at 1913 Integrative Project in Modern Production Methods, IE285e

21. Armenian economic history highlights: Status in 1988, energy Integrative Project in Modern Production Methods, IE285e

22. Armenian economic history highlights: Status in 1985, PRODUCTION Integrative Project in Modern Production Methods, IE285e

23. Main Industry Branches in 1988 • Chemical industry • Machinery (including electro technical and electronics), • 5th place in the volumes of manufactured machinery items, among the USSR republics Integrative Project in Modern Production Methods, IE285e

24. Electronics Metal processing Metallurgy Woodworking and paper production Construction materials Glass and porcelain Light industry (including shoe industry, the 15% of total national volume of production). Food industry Publishing industry Chemistry and Drug manufacturing Agro industry Main Industry Branches in 1988 Integrative Project in Modern Production Methods, IE285e

25. Armenian economic history highlights, 1988 • There were 1744 conveyer belts, and 403 automated conveyer belts in 1985 • Total 2147 operations with conveyer belt layout! • However there were many typical “soviet – style” problems… Integrative Project in Modern Production Methods, IE285e

26. Armenian economic history highlights, Science and Education, 1988 • The national academy of sciences (NAS) had 34 research institutes and centers, a publishing house, and 32 libraries. There were also around 50 industrial research institutes and centers. Integrative Project in Modern Production Methods, IE285e

27. Output of industrial consumer goods per capita, 1990 Integrative Project in Modern Production Methods, IE285e

28. Problems at 1988 • Being Isolated from WORLD COMPETITION • Thus, behind in quality, due to: • Most technologies were outdated, by about 15 years! • Management methods were not effective, almost no incentives. • Obvious strategic mistakes in Macro and Microeconomics levels. • Mistakes in setting directions for economy. Integrative Project in Modern Production Methods, IE285e

29. Costing out the Big Bang: Impact of external Shocks on the Armenian Economy at the Outset of Transition Reference: Lev Freinkman, Vahram Avanesyan Armenian Journal of Public Policy, Volume 1, Number 1. Integrative Project in Modern Production Methods, IE285e

30. The Reasons for Economic Decline • Unavoidable costs: • Terms of Trade (TOT) shock – deterioration of real incomes due to economic liberalization and shifts in domestic prices towards prices in of the world market. • External Demand Shock – Market Loss – opening of markets to global competition. Integrative Project in Modern Production Methods, IE285e

31. The Reasons for Economic Decline • Fiscal Shock – removal of traditional explicit budget and quasi-budget transfers. • Secondary effects of all above shocks – decline of the overall domestic demand due to a), b), c). Integrative Project in Modern Production Methods, IE285e

32. The Reasons for Economic Decline • Avoidable costs:Mistakes in management of reforms:Delays;Too rapid;Inconsistencies. Integrative Project in Modern Production Methods, IE285e

33. Analytical Framework • The paper follows the framework suggested by Rodrick (1992), • It is also modified to include the fiscal shock associated with elimination of fiscal and quasi-fiscal transfers to Armenia from the consolidated budget of FSU, • however, these transfers were insignificant before the 1988 earthquake. Integrative Project in Modern Production Methods, IE285e

34. Modified TOT approach, Income Loss • Armenia – 11.1% • Moldova – 31.9% • Georgia – 17.3% • Estonia – 12.7% • Comparing when with when? Not well described Integrative Project in Modern Production Methods, IE285e

35. Initial conditions • 400 000 people in the Industrial sector • 25 300 people involved in R&D • 17 000 researchers • Light industry – 37.7% • Machinery – 25.2% • Food – 14.3% • Chemical – 10.0% • External trade – 103% of GDP Integrative Project in Modern Production Methods, IE285e

36. Reasons for Industrial Decline • Sharp decline in defense and other demand. • Low competitiveness of the Armenian goods esp. in consumer sector after energy and other subsidies withdrawn: markets lost to Turkey and China. • Political factors that pushed Russian producers (e.g. in defense) to switch to local producers. Integrative Project in Modern Production Methods, IE285e

37. Reasons for Industrial Decline • New cost factors, such as increased transportation costs. • Excessive size of many enterprises that cannot be profitable at low rate of production. Integrative Project in Modern Production Methods, IE285e

38. Reasons for Industrial Decline In short: “too many of wrong enterprises operated in wrong sectors” – too many subsidized sectors: low energy and raw material prices and no international competition. Integrative Project in Modern Production Methods, IE285e

39. GDP dynamics Integrative Project in Modern Production Methods, IE285e

40. In 1993 • 55% of GDP decline from ~$5B to $2.5B (the great depression of the USA = - 26%) • ¾ of the total industrial production affected by negative price shock • 77% of total exports affected by negative price shock • In 1987 exports were responsible for the 47% of the GDP. Integrative Project in Modern Production Methods, IE285e

41. Vulnerability index • of Armenian Economy:in 1988: 1.71in 1990: 2.00 • <1.8 – good • >1.8 – bad • Lav chi dzevakerpats Integrative Project in Modern Production Methods, IE285e

42. Balance of Payment (BOP) in 1987 • Balance in trade of goods and services –- 10% of GDP • Inter-budgetary transfers - ~ - 2% of GDP • Difference between Pension Fund transfers - 3.3% of GDP, investment financing, and taxes of Armenian Enterprises – ~ - 4% of GDP • Total account deficit was ~ – 16.6% of GDP (-12.7% was already sitting in the budget). • HOWEVER THE INFLUENCE OF THIS DEFICIT WAS VERY MODEST. REAL TRANSFERS = 6%! Integrative Project in Modern Production Methods, IE285e

43. Trade Balance, viewed from outside,1987 • If one assumes that in 1987 Armenian economy would become overnight integrated to world economy, • Deterioration from - 1.7% of GDP to- 18.5% of GDP would take place, • Totalling a loss of 17% of GDP. • In 1996 the trade balance is - 32.3% of GDP Integrative Project in Modern Production Methods, IE285e

44. Declined Markets • Overall decline of demand by 3 – 10 times, power and machinery are the most affected! • About $2B lost in exports – 80% of the export rate in 1987 • Equivalent of 25% of total industrial output, • Equivalent of loss of $715M of GDP (8%). Integrative Project in Modern Production Methods, IE285e

45. Scenario A Output: $1.7B GDP: $746M (14.2%) Export: $527M Import: $540M Tr. Bal.: -$13M-1.7% of GDP Scenario C Output: $3.5B GDP: $1555M (29.8%) Export: $527M Import: $1030M Tr. Ba.: -$502M-32.3% of GDP Overall Shock Results, GDP in 1987 has been $5.2B (100%) Scenario B • Output: $1.9B • GDP: $793M (15.2%) • Export: $527M • Import: $541M • Tr. Bal.: -$14M-1.7% of GDP Integrative Project in Modern Production Methods, IE285e

46. In 1996 GDP = $1599M! Integrative Project in Modern Production Methods, IE285e