The EBRD’s annual forum takes place in Samarkand on May 16−18. EBRD Chief Economist Beata Javorcik and Eric Livny, the bank’s lead regional economist, told Gazeta.uz about the new global threats to the economy, the needed reforms, the strategies for attracting investment, the priorities in the privatisation process, and the significance of public support for reforms.
— The theme of this year’s EBRD Annual Meeting is “Investing in Resilience”. Can you please share your thoughts on the emerging risks for national economies, especially Uzbekistan, that could challenge their resilience?
Beata Javorcik: I would name three global risks. The first one is the cost of international borrowing. Ever since the beginning of the war [between Russia and Ukraine], countries in which we operate have seen an increase in the cost of borrowing in international markets. And Uzbekistan is no exception. This costs has almost doubled. The discussions in the U.S. on raising the debt ceilings and the tenuous negotiations there created the possibility of the U.S. debt being downgraded, as it happened in 2011 when Standard & Poor’s changed the rating of the US. If this were to happen this time, it could further raise the cost of borrowing for emerging markets. What we saw since the war started is that the costs of borrowing went up both in absolute terms and relative to the costs of borrowing faced by countries such as Germany and the US. Because in turbulent times, investors pay more attention to macroeconomic risk. So should there be no agreement in the US that can send jitters through international markets and increase the compensation investors require for macroeconomic risk.
The second risk is inflation. Inflation is a problem everywhere. But of course, it is somewhat higher in emerging markets than on average in advanced economies. As we document in our regional economic prospects, in countries where we are active, inflation has peaked. But that was mostly due to the costs of energy and food going down while core inflation remained stable. And when we consider projections, for instance, from the IMF for this inflation, they seem very optimistic by international standards. Here, it’s worth contrasting advanced economies with emerging markets. In the US last time people saw double-digit inflation was in the late 1970s. So it was 50 years ago. So there is no memory of that in this part of the world. Many people, especially those over 50, remember the period of hyperinflation. And that’s why people may be more sensitive to inflation. And inflationary expectations can become more entrenched, which makes fighting inflation more costly.
And the third risk is what people call “friendshoring,” decoupling or fragmentation. So, in other words, the geopolitical tensions that could lead to the world splitting into two blocks and forcing countries to choose which block they are. In our latest transition report, we did a simulation exercise to see what such a situation would mean for our countries of operations. The message was that everybody would lose from this, essentially.
— Taking this into consideration, what kind of policies or institutional changes should the government introduce to step up the reform process?
Beata Javorcik: Perhaps the question is not which reforms the government should do, because that’s something the government decides itself, but rather what principles should be followed when introducing the reforms.
What does international experience tell us? The first one is predictability. You want the environment to be predictable because that makes the life of foreign investors in the private sector easier. Without predictability, there is uncertainty, which is detrimental to investment.
International experience tells us that openness to the outside world is a way of getting knowledge and technology from the outside, whether it’s through trade, foreign direct investment, or the movement of people.
And the third one is privatization. There is a large body of literature documenting the challenges associated with the state sector. If you look at countries where the EBRD operates, the state sector is larger in our countries than in countries with similar levels of income. In the countries where the EBRD operates, on average, public employment is 7 percentage points higher as a share of total employment than in other economies.
And often, there are very good reasons why you want to have state involvement in the economy. But there are challenges that state ownership brings with it. One of them is, for instance, that state owned companies are tasked with providing services. They have a mandate to provide various types of services, often at below-cost rates. But there is no explicit budgeting for that. So they are providing the services below the cost, and they run into a deficit. They have to get the transfer from the government, and the cycle continues. So even in the state sector, there are many reforms that one can undertake to improve the functioning of the state.
Eric Livny: People in Uzbekistan are extremely entrepreneurial. You go to Ferghana Valley and you see them working so hard that every piece of land is cultivated. It seems like people never stop. The best strategy a government can have in this situation is to leave people alone. But of course, there are quite a few things that have to be done, and there are certain things that should not be done.
What is driving Uzbek story since 2017 is an opening up. This is the big driver. It’s just unbelievable how many companies among our clients have their foundation date in 2018 because things opened up. All of a sudden, you can trade, you can get access to foreign currency, and you can predictably and properly operate.
Privatization is a big driver. It’s not happening very fast. We’ve seen a big breakthrough in the banking sector with the Hungarian OTP buying Ipotekabank. It’s not just that they buy a bank; but it’s changing their whole attitude toward how they go about banking. Similar story of Georgian bank TBC, the first fully digital bank to enter. And now with their help, the whole system was redesigned. So more competition from the outside helps the great beneficiaries: the consumers.
Uzbekistan still has a very large segment of the industry owned by the state. And a lot of these companies are playing key roles in their respective industries. Some of them, by the way, are located in sort of mono-industrial towns and cities, which creates yet another layer of complications. Looking at the experience of how the privatization efforts went over the last couple of years, first of all, I have a lot of appreciation for the fact that things did not progress very quickly because it is something that has to be done very carefully.
One element is to make sure that when you privatize a company that has a dominant position in an industry, you don’t create a private monopoly in the same industry. I’m not sure a private monopoly is exactly what we need in Uzbekistan. And this is true for quite a number of industries, such as construction, industry, cement, and glass. In agriculture, we have very big fertilizer companies that used to be state-owned and/or are still state-owned. And the question is how they’re going to be privatized, to whom and how, how the industry will be regulated, how competition will be maintained or not. So these are all questions that require a lot of thinking and active participation not only by the State Asset Management Agency but also by the Antimonopoly Committee.
— The Russian war on Ukraine has drastically influenced global value chains, causing disruptions. Is the new reality for global value chains already formed or is it still forming, and where should Uzbekistan find itself in the global value chains, what should we do to increase the role or significance of our economy in this.
Beata Javorcik: There are three big trends in international trade right now. The first one is the reshaping of global value that was first prompted by all the disruptions we faced during the pandemic. It’s linked to the realization that the concentration of suppliers in one location poses a risk. When the war broke out, what it did was trigger real action on that front, not because Russia or Ukraine were integrated in global value chains, they were not. But because firms suddenly realized that geopolitical tensions are not going away and therefore the cost of inaction is higher than the cost of making adjustments.
Nobody wanted to adjust global value chains before because they were optimized from a cost perspective. So building in redundancy and resilience means extra costs. Last summer, we surveyed 3,000 manufacturing firms in Germany, and two-thirds of them already reported adding additional suppliers, and half of them had intentions of doing so within the following 12 months. So it’s a process that’s going to last longer.
The second big trend is the reshaping of the trade. In particular, trade with Russia is affected by the war and sanctions. And here what we have seen is a dramatic drop in exports from Western Europe and the U.S. to Russia and an increase in exports from Western Europe to Central Asia and the Caucasus, and in turn greater exports from those countries to Russia. In terms of volume, this intermediated trade accounts for a small percentage of the direct trade that disappeared. This drop in linkages between Western Europe and Russia created an opening for other exporting countries to supply the Russian market, and here we see, in particular, Turkey as well as China stepping up.
And then finally, the third development that we see is related to the US-China trade war and the intention of many countries to decouple from reliance on China for fear of being exposed to China, weaponizing trade. The US-China trade war, which started under the [Donald] Trump administration, continues in this sense that the tariffs that were introduced in 2017 and 2018 are still in force and the US has introduced further restrictions, for instance, in terms of technology exports. But there is a real possibility that this trend of decoupling of economies and the world splitting into trading blocs will continue.
Eric Livny: I have a very strong sense that Central Asian countries are realizing that they need each other much more than before. And here is where Uzbekistan is actually playing a key role. Because Uzbekistan is exactly in the middle of Central Asia. It borders all other Central Asian countries, including Afghanistan. So it’s the central piece without which any sort of regional integration will be impossible.
What I observe is a lot of diplomatic activity. You see President Mirziyoyev traveling to Kyrgyzstan and other neighboring countries and signing important agreements about water and energy cooperation, improving border management and making sure that trade flows go unhindered. This is about trade and investment in neighboring countries. For example, I have just seen the Uzbek automobile sector setting up assembly plants in Kyrgyzstan, and similar assembly activity is going on in Kazakhstan as well.
The importance of Uzbekistan is not only because of its central location, it’s the largest market; but it also has the largest labor force. It’s the only country in the region that has skilled labor and technical capabilities. There is experience working in manufacturing, whether it’s automotive, food, or textile. And these traditions, these skills are extremely important when it comes to developing manufacturing activities. And this is a comparative advantage of Uzbekistan compared to other countries: it can be the manufacturing hub for Central Asia. And probably this is the future of this country.
— Sanctions against Russia imposed due to its invasion of Ukraine are influencing regional economies as well, in some cases even boosting trade between the countries of Central Asia and the Russian Federation. Are there discussions between the EBRD and regional governments on the consequences of these sanctions and best practices on how to follow them?
Beata Javorcik: I am not aware of the EBRD being involved in such discussions. The European Commission is considering another package of sanctions. As I mentioned, even though the volume of trade that is being intermediated via Central Asia and the Caucasus is small compared to the trade that disappears, for many of the economies in the region, it’s large relative to their GDP. So it is a source of revenue. The question is how sustainable it is as a source of revenue, as this change in trade has been noticed in the West. And there may be a desire to try to limit such trade.
Eric Livny: Not all of this trade is intermediate. Some of it is proper exports. The Russian market was left open by quite a number of companies. And there is a vacuum, and some Uzbek companies are able to fill that vacuum. One example is consumer electronics and home appliances (gas or electric stoves or refrigerators). This is not something that we should be overly concerned about. The same goes for agriculture, for fruit and vegetables, and for textiles.
— Nowadays, one of the main topics on the agenda for the Uzbek government is poverty reduction and the attraction of FDI. In your opinion, which sectors of the economy could play a big role in reducing poverty and should be prioritized? And what are the key areas to work on to improve the investment climate?
Beata Javorcik: Globally, there is very fierce competition for inflows of foreign direct investment. And one way of drawing the attention of foreign investors is to make serious progress on reforms, because that sends a very strong signal that the country is open for business, that the country is interested, and that the country welcomes foreign direct investment.
What foreign investors are looking for is predictability and stability. And they don’t like surprises. They like to understand what the rules of the game are. In terms of the role of foreign direct investment, it can certainly help reduce poverty by creating jobs. It can certainly improve the technological sophistication of the manufacturing or service structure, and it can help with the diversification of the economy.
What the international experience tells us is that it’s very hard for a country to start exporting new products. And cases of countries that succeeded in becoming good at exporting something that was new to their portfolio are mostly driven by multinational firms. So, how can one sort of use FDI in order to diversify the export portfolio or the structure of the economy? That can be done through investment promotion efforts and by targeting investment promotion efforts towards firms from particular sectors.
On attracting FDI, I don’t necessarily mean giving handouts, offering huge tax breaks and so on. There is a lot of value in actually informing investors about the reasons why they should come to Uzbekistan rather than somewhere else and tailoring this message to specific sectors.
The investment promotion campaign is much more effective if it talks about Uzbekistan as a great place to do business in a specific area as opposed to saying Uzbekistan is a great place to do business in general. You want the message to be specific to showcase the advantages of Uzbekistan that speak to particular industries or sectors.
Livny: We see lots of examples of fantastic success stories when it comes to foreign direct investment. One of our clients, Indorama, has been in the country for quite a number of years. And this is a success story just by looking at how they expand vertically, both up and down. They started from processing cotton, and now they’re growing cotton, and they bought two fertilizer factories to enable their agriculture operation. This is the kind of success story that can sell your country to everyone else. Just by showing such successes outside, you can attract even more investment.
We’ve been instrumental over the past couple of years in creating something called the Foreign Investor Council in Uzbekistan. The first meeting happened last November, attended by both President Mirziyoyev and the President of the EBRD. There was fantastic engagement, including one-on-one and a lot of troubleshooting. Companies were able to raise issues, they got the all the attention, and there’s follow-up. There are working groups to address problems in taxation and customs, getting licenses and permissions, and getting corruption out of the way if there is a problem. So this sort of institutional setup is extremely good at handling pos- investment issues. So it’s one thing to bring investors in. The other one is to keep them happy.
One issue I believe Uzbekistan is still facing is that a lot of issues are decided at the very top, decided in a good way, but at the very top. And not everybody can access the very top. So you have to have systems that allow for problems, small and large, to be addressed without going all the way to the top.
Beata Javorcik: There are four ingredients to successful investment promotion efforts. The first one is that you want to market your country. Many countries advertise themselves as great tourism or investment destinations. So that’s sort of the first step. Inform the world that you’re open for business.
The second step is to approach potential investors. And that can be international fairs, contacting companies, contacting suppliers, or companies that are already in the region.
The third step is, once you have an investor who is interested or potentially interested, helping them navigate through the bureaucratic maze. And here, the goodwill, and the commitment of the government are important. That various players within the state administration understand that they need to make the process as painless as possible. Because if the process is too difficult, foreign investors will just go somewhere else. It is role of an investment promotion agency to help navigate this process.
And the final part of investment promotion is what my colleague was talking about: having a way of communicating the concerns of investors to the decision-makers. And often, as you know, an investment promotion agency can play this role by serving as an intermediary. The Foreign Investor Council is another way of doing that, informing the top and sort of catalyzing change.
Eric Livny: The IT sector was a huge success and an excellent example of how all four steps have been taken. The IT Park is going out of its way to accommodate investors in Uzbekistan: sending people to meet investors at the airport, getting the visas, licenses, all the paperwork done in no time, offering amazing hospitality, even offering office space in their compound. And the number of companies now being registered in the IT sector is growing by the day. A lot of it has to do with the fact that companies are moving out of Russia, Belarus, and Ukraine. They’ve been coming to this part of the world. But you have to grab this opportunity. You have to have the labor force prepared because these companies are hiring. If they have nobody to work with, if they don’t have the developers to employ and train and upgrade, they won’t be able to to operate. And there’s a lot of competition: Kyrgyzstan and Kazakhstan are is doing the same. So you are in the competition, but it’s a good one, and we see a lot of success in these: every country is exporting more IT, more computer products and services, and they are moving from pure outsourcing to actually product development and exports.
Beata Javorcik: The importance of this welcoming attitude cannot be underestimated. If you think about global success stories like Ireland or the Czech Republic, both of them had incredibly effective investment promotion agencies and authorities that were committed to bringing in investment.
Eric Livny: Uzbekistan has a comparative advantage in this regard, because this is a country that has for centuries been hosting guests, caravans, and traders. And the country is amazingly good at it. And the food is excellent, this is not a joke. Investors want to have a good quality of life, so it’s about safety. It’s about culture, bars, restaurants, coffee shops, and the quality of schools. I would like to emphasize international schools, because people come with their families. So you have to have all these ingredients, and you actually have them in Tashkent. It’s a bit more challenging to create a similar situation in other regions. So once you get there, investors will also reach the outlying regions because it’s very important.
— What would your forecasts be on the impact of AI on national economies, and what should governments do?
Beata Javorcik: Last year, our transition report was on digitalization, and we looked at where countries are in terms of their digitalization. We took into account government regulations, access to broadband, skills, e-government, and so on and so forth. And even though Uzbekistan made some progress between 2015 and 2020, it is still not ranked very highly among our countries of operations when it comes to digitalization. So there is a lot to be done in this area.
In the context of our countries of operations, it’s useful to think not just about AI, but also about automation. We did such an exercise looking at the structure of employment and asking, “Are our countries of operations exposed to job losses or structural changes because of either automation or AI? And we were quite surprised to see that they were no less exposed than Western Europe. Because many of them rely on manufacturing, which can be automated.
But also, what automation does is hollow out the middle part of the jobs. Because highly sophisticated jobs are safe because you can’t automate them and AI will not take care of them, and the jobs at the bottom of the pyramid, like basic cleaning, cannot be automated either. So it’s the middle jobs that are exposed.
And I think the message from the report is that our regions need to prepare for the structural changes that automation and AI will bring. It’s like a tsunami, you can’t stop it. These changes are coming. And one of the problems in our regions is that, particularly older workers, the less skilled when it comes to technology than their counterparts in other countries. When you look at young people, they are equally sophisticated as people in advanced economies, but it’s older workers who have the problem.
— Some people may have thought process of the reforms can’t be reversed. But as we see in practice, even those who successfully completed transition can fall back. So, what do you think we should do as a society to guarantee that the outcomes of the reforms are there to stay and that it is extremely hard to reverse them?
Beata Javorcik: The short answer is that you want to make the reforms sustainable from a social point of view, meaning you want society to support the reforms. Any changes create winners and losers. It’s important to take care of the losers and make sure that people who may lose employment as a result of the reforms are receiving some form of help. Because you want society to perceive reforms as something that creates a fair outcome. You want society to understand why the reforms are going on and how they can help. We have post socialist countries that have succeeded and there are role models. And 30 years after the transition started, there is some experience to draw on.
Eric Livny: In this specific context of Uzbekistan, I’m mostly concerned about the privatization process. It is extremely important that the outcomes of privatisation are seen as legitimate and trusted. We’ve seen countries in the 1990s that proceeded with privatizations that were not deemed legitimate by the population or by anybody for that matter. And they did result in reverses.
Specifically in Uzbekistan, we are likely to see movement of people out of agriculture to some other occupations. And there is a danger that there will be no other jobs available. We’re talking about people above the age of 40. So, somebody has to take care of it. There has to be either active labor market policies or retraining. There should be a smoothening of this transition because otherwise there will be discontent and people in the streets.
Another area that is very sensitive in Uzbekistan is the cost of utilities. We saw the crisis last winter because it was extremely cold. The country doesn’t have enough gas, the pressure in the pipelines is not sufficiently high, there’s not enough electricity, and the infrastructure is not in very good shape. So a lot of investment has to happen.
There could be private investment in the energy sector, but it’s not happening as fast as we would like it to because tariffs are too low. So something has to be done about it. But then the question is, will people be able to afford it? So you have to have a policy that allows you, on the one hand, to cover the costs of operation, to bring in investment and, on the other hand, to help those who actually need help.
You don’t have to subsidize energy for everyone. There are people who can perfectly afford to pay the real market price: owners of large estates and mansions. But people with very small houses consume little but need every kilowatt. They need to be helped and supported. And then we will have a much more robust energy sector and utilities in general. That is the foundation on which you can build the economy.
Beata Javorcik: This brought us to our initial argument about state owned enterprises. If you have the state sector providing something, but nobody thinks about budgeting, what’s their mandate? If they have to provide services at a subsidized rate but they are not budgeted for, that’s when you suddenly have shortages. Being explicit about what the mission is, what it’s going to cost to provide the service and who you want to provide this service to at a subsidized rate and who can afford to pay the market price.
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Interviewed by Davlat Umarov.