Sources of growth for Uzbekistan’s national economy: assessment of current potential and opportunities for diversification

As evidenced by the results of 2009 (global financial crisis) and 2020 (global pandemic crisis), the economy of Uzbekistan is resistant to world crises. If in 2009 high rates of GDP growth remained, then in 2020 the economic growth was preserved even in the conditions of strict quarantine restrictions at a low growth rate of 1.6%.

In the last 5 years (2016-2020), the service sector has developed at the fastest rate. Over this period services have increased by a factor of 1.67. The industry also grew rapidly (1.4 times), while agriculture grew more moderately (1.15 times), reflecting deteriorating agricultural production conditions (more frequent dry years, deteriorating quality of land, outpacing price increases for fertilizers and fuels, and increase in interest rates on bank loans).

Similar conclusions are derived from the analysis of other traditional macroeconomic indicators – exports, investments, government spending, and household consumption.

If we use indicators reflecting the quality of economic growth (its contribution to expanding sustainable employment and limiting income inequality, per capita income in dollars, the capital the intensity of economic growth, etc.), the situation is different. The average annual growth rate of employment lags significantly behind the average annual growth rate of the economically active population, and even more strongly behind the GDP growth rate. Thus, while the average annual growth rate of the GDP from 2015 to 2019 is 5.8% and that of the economically active population 1.9%[1], the rate of employment (job growth) is only 1.0%. Unless the growth rate of new sustainable jobs in this structure < 6: 2: 1> is increased to at least 3% (moving to structure < 6: 2: 3>, it will be difficult to expect to solve the problems of large-scale labor migration, shadow employment, and poverty, which have been one of the main barriers to sustainable development for many years.

Thus, for many years there has also been a high level of outflow of the working-age population[2] in the form of labor migration to Russia, Kazakhstan, and non-CIS countries, which demonstrates the instability and short life cycle of the places created and their low quality.

A large proportion of the working-age population cannot find employment in the legal economy, which is reflected in significant levels of the shadow economy. The World Bank estimates its share in the economy as a whole at more than 50%[3] , and in agriculture as high as 80%.

Direct estimates of the employment elasticity to growth suggest that the value of this indicator for Uzbekistan has not exceeded 0.20 for the last 10-15 years. Whereas in some developing countries of the world the corresponding estimates are markedly higher (Morocco 0.4-0.6; Bolivia 0.55-0.62; Costa Rica 0.51-0.55[4], etc.).

            The highest rate of depreciation of the national currency relative to economic and population growth has had a negative impact on the international development ranking position of the republic. While back in 2015-2016 gross national income per capita exceeded USD 2,000, it fell to USD 1,800 in 2019 and declined even further in 2020 (USD 1,700 according to preliminary estimates). Consequently, Uzbekistan’s gap to the lower end of the upper-middle-income category of the world’s UM (about $4,000, Figure 1) has widened. This situation jeopardizes the achievement of the often-declared goal of the need for Uzbekistan to enter this category of mid-developed countries of the world by 2030. In the context of high rates of population growth and increased risks and barriers to development (climatic, pandemic, unexpected changes in market conditions, etc.), taking into account also that by 2030 this limit may be increased to 5 thousand dollars.

Figure 1. Dynamics of gross national income per capita for Uzbekistan (Uzb) compared to the average estimates of the bottom group of the world’s medium developed countries (LM aver) and the bottom boundary of the top group of the world’s medium developed countries (Grand UM)

Source: World Bank (https://datahelpdesk.worldbank.org/knowledgebase/articles/906519)

Sustained economic growth occurs when the potential of established sources of growth is maintained or they are gradually replaced by new sources as the potential of existing sources is depleted.

In the practice of macroeconomic diagnostics[5], it is customary to assess the potential of the established sources of growth based on different theoretical understandings of the mechanisms and sources of long-term development. The potential of the established sources and factors of growth over the last two decades, classified according to different qualitative criteria (dimensions), are analyzed below.

1. Sectoral dimension (sources of supply-side growth). Until 2017, the services sector was the main contributor to GDP growth. Its share in GDP growth increased from 36% in 2000-2007 (annual average, see Figure 2), to 42%, reflecting, among other things, the rapid growth of small businesses and private entrepreneurship.

In the last 4 years, the main drivers of economic growth have been construction and industry. While in previous years the contribution of the industry was declining (14% to 12%), in 2017-2020 it increased to 17%, which can be attributed to the implementation of many large investment projects launched in previous years.

The largest increase in contribution to economic development was demonstrated by the construction sector – from 10% to 25%, i.e. the sector’s contribution has increased by 2.5 times, reflecting the process of rapid housing, commercial construction, and creation of infrastructure facilities that has unfolded in the country in recent years.

Figure 2. Contributions of economic sectors to GDP growth (GDP growth on the supply side=100%, using 2010 prices)

Source: calculations based on national statistics

1. Measurement by the aggregate demand criterion. The narrowness of the domestic consumer market dictates the need to expand the export potential to generate economies of scale and sustain high economic growth. However, the dynamics of export growth rates over the last decade were highly volatile (see Figure 3), reflecting the low degree of diversification of the national economy, its raw material orientation, and a high degree of dependence on external market conditions.

Figure 3. Periods of the dominance of domestic and external demand factors (excluding investment demand)

Source: SCS data

In the context of high volatility in export dynamics in the first 16 years of the reporting period, high rates of GDP growth (from 6% to 8%) were largely supported by high growth rates of household consumption (with an annual increase from 10% to 14%). This was facilitated by the increase in migrants’ remittances (from USD 1.5 billion in 2010 to USD 5.8 billion) and their continued high level until 2017 (from USD 2.5 to 4.9 billion) in the context of a large number of precarious and low-income jobs.

In 2018-2019, exports played a major role in sustaining growth, rising from USD 12.6 billion in 2017 to USD 17.5 billion in 2019. However, gold and other base metals continued to dominate the export mix (over 60%)[6], as well as low value-added products, posing significant risks to the sustainability of future development.

1. Measurement by “volume – efficiency of resource use”. Economic growth can be sustained either by an increase in the resources brought into economic circulation (labor, production, and natural capital), or predominantly by an increase in the efficiency of their use. The main indicator of resource efficiency at the macro level is the total factor productivity indicator TFP. It is calculated econometrically[7] based on statistics on the dynamics of GDP, fixed capital (investment), and labor. Its estimates show the contribution of efficiency of all factors of production to GDP growth in percentage points.

Analysis of the dynamics of this indicator for 2000-2020 (Figure 4) shows its volatility, especially during the stages of crisis development. The results allow us to identify two periods in the dynamics of factor productivity: 2000-2006 (period A) and 2011-2016 (period C), when factor productivity increased the GDP growth rate (up to four p.p.), and two periods (B and D, 2007-2010 and 2017-2020) when the TFP contribution to economic growth was negative (from -6 p.p. to -10 p.p.).

Figure 4. Dynamics of total factor productivity for the years 2000-2020

Source: author’s calculations based on SC statistics

The main reason for the negative the TFP dynamics in some intervals of the reporting period is the surge of investment activity without reflecting this activity in the proportional growth of the economy. While in first 7 years of the period (2000- 2006, period A), an average annual growth rate of 5.4% was supported by a moderate increase in investment activity (5.1% year-on-year), in the next three years (2007-2010, period B) the investment increase rate jumped to 22.2% (four times higher), due to government anti-crisis measures. At the same time, the average annual GDP growth rate increased by only 1.5 times to 8.5%, dropping to 7.2% in the next 6 years (2011-2016).

A similar situation occurred in the last 4 years of the reporting period (2017-2020 period D), when the average annual investment growth rate rose again from 8.0% to 19.8%, while economic growth slowed down from 7.2% to 4.3%.

In terms of content, the reason for the weak reaction of the economy to the growth of investment activity may be that for each stage of economic development of any country there is a certain boundary for the growth of investments, determined by the level of development of state institutions, human capital, infrastructure, assets and other opportunities of the financial sector, large enterprises, income of the population. Its excess (in terms of the amount of investments in% of GDP or in terms of their growth rate) leads to the fact that the economy is unable to effectively use additional investment resources, which is expressed in an inadequate growth of resource opportunities, accelerating economic growth (or even slowing down its growth, which happened in the last 4 years), as well as in increasing risks to macroeconomic stability.

Hence, while in 2011-2016 the share of investments was at the level of multi-year averages of 21-24% of GDP. Which is a benchmark for marginal (boundary) estimates of investment growth without losses in efficiency for the current stage of national economic development. And foreign debt was growing only slightly (7.5% – 14.6% of GDP), the investment boom of 2017-2020 has dramatically changed the situation. Investment (in percentage of GDP) significantly exceeded the multi-year average and stood at 35.5% (Figure 5 left). The average annual GDP growth rate fell to 4.3% compared to around 7% in the previous period. Aggregate external debt, under conditions of underdeveloped financial sector and low level of monetization of the national economy, started growing rapidly and according to preliminary estimates by 2020 reached 58.6% of GDP (Figure 5 left part). The total external debt is estimated to reach 58.6% of GDP (Figure 5), primarily because of increased external borrowing for construction and other capital-intensive industries.

The same situation is characteristic of foreign trade. Exceeding the threshold for investment as well as the extensive, ill-advised liberalization of foreign trade has changed the relationship between exports and imports. While in 2011-2016 the foreign trade balance was active (average estimation +1.6% of GDP), in the past 4 years, it has turned into a deficit and increased to minus 10-12% of GDP in 2018-2020. (Figure 5 right-hand side). All this has ultimately had a negative impact on the efficiency of investment resources and hence on the overall factor productivity of TFP.

The following conclusions can be drawn from an analysis of the efficiency of the investment factor, which is crucial for long-term growth. Economic growth in recent years has been characterized by a high level of capital intensity, or low capital productivity.

Figure 5. Dynamics of investment and external economic activity indicators in 2010-2020.

Source: data of SC RUz

The return on capital ratio is defined as the ratio of current year GDP to investment in the current and the two preceding years (with a weighting of 0.7 / 0.2 / 0.1) at constant base period prices, expressed as GDP per investment sum. Table 1 shows the calculation of this indicator for 2005-2020.

Table 1. Capital output indicators for 2005-2020

Source: Calculations based on national statistics.

As can be seen from these calculations, unlike TFP, the return on capital indicator is less volatile and therefore easier to predict. At the same time, the resulting dynamics confirm the earlier conclusion regarding the declining level of resource efficiency in relation to the investment factor. Whereas since the mid-2000s, per SUM of investment (in the current year and in two preceding years with weights of 0.7, 0.2, and 0.1, respectively) exceeded 7 SUM of GDP (in constant 2010 prices), capital efficiency had fallen to 4 SUM by 2010. The rapid growth in investment over the past three years has reduced the return on investment even further, to 3.4 SUM in 2018 and to 2.5 SUM according to expected estimates for 2020, i.e. the return on investment has fallen by a factor of three since the early 2000s.

Calculations show that the continuation of the current negative trend in capital productivity will worsen the prospects of GDP growth in the medium term. The GDP growth rate under the inertial scenario of the current economic model will decrease from the current 5% to 4% by 2025 and 2-3% by 2030, even without taking into account the factor of limited water and energy resources, but only due to the unfavorable trend of GDP capital intensity.

1. Measurement by the “large enterprises – small businesses” criterion. More than 70% of Economic growth in recent years has been driven by small businesses, and less than 30% by growth in output from large enterprises in basic industries and services (primarily transport). However, more than 50% of all investment has been absorbed in recent years by the extractive sector and transport, which are dominated by large enterprises and companies, creating risks of the reducing contribution of small businesses to economic growth and slower the economic development as a whole.

The increasingly difficult financial situation of large enterprises has increased the flow of workers into trade, traditional services and the shadow economy, which has narrowed the tax base and increased the risks of the state to fulfil its social obligations.

1. Measured in terms of a nation’s assets. According to the World Bank’s approach, the degree of sustainability of development depends on the capacity, depletion rate and replenishment of a nation’s assets[8]. The assets are productive (physical), natural, and intangible (social, human, institutional) capital. A quantitative measure of sustainable development potential here is the indicator of net (adjusted) savings, a concept developed by World Bank experts[9]. If by the time the natural asset is exhausted, there is no mechanism to transform it into other assets – productive and intangible (mainly human and institutional) – the moment will come when the rate of economic growth falls sharply.

Among the developing world, according to the World Bank, average scores for this indicator in recent years have been positive for countries such as China, Malaysia, Indonesia, Korea and several others, and negative for Armenia, Kyrgyzstan, Tajikistan and Uzbekistan.

The main differences are related to the structure of the nation’s assets, where natural capital dominates (over 50% – a generalized estimate for world states such as Nigeria, Congo, Venezuela, etc.), reflecting the raw material orientation of the structure of these economies.

For Uzbekistan, there has been an unfavorable trend over the last 15-20 years in increasing levels of natural resource depletion, amounting to 30-35% of GNI and above (compared to 5-10% in the world’s sustainably developing countries). Commodity markets are highly volatile, which creates significant risks when global price levels fall and results in less sustainable economic growth and vulnerability to external shocks.

Summary results of the analysis based on new sources of economic growth concludes about a high degree of their exhaustion, the need to search and activate new development factors. Traditional growth factors such as large-scale modernization of the real sector of the economy (with a focus on extractive industries and primary processing of raw materials), large -scale investment in expanding mineral production accelerated development of small business and the service sector, and the transfer of labor migrants that are close to exhaustion. Thus, the share of the employed in small business has reached ¾ of all the employed and is close to its limit (taking into account those employed in large enterprises, state-financed and other sectors of the economy).

Since 2017, there has been a downward trend in the remittances of migrant workers from Russia, due to the deteriorating overall economic situation in the country, sanctions pressure, Russian ruble devaluation, coronavirus restrictions and the effects of the global pandemic crisis of 2020.

There is a rise in the cost of mining, a deterioration in the financial position of the country’s major enterprises, which poses a significant barrier to increase gold export and other non-ferrous metals. The quality of land is declining, the existing irrigation system is deteriorating, energy, water shortages are increasing, export revenues are falling, and capital-intensive development is increasing.

The negative impact on the dynamics of exports in the coming decades will be exerted by such factors as unpredictable and unfavorable global trends in the commodity and energy markets, the increasing volatility of world prices for raw goods and energy resources from developing countries of the world, including Uzbekistan.

The search for and activation of new sources of development are only possible as part of the transition to a new economic model, which needs to be worked out with the joint efforts of all stakeholders. It should focus primarily on domestic sources of development, resource efficiency, increasing the contribution of economic growth to solve social problems, including the fight against poverty and the shadow economy, reducing the burden on natural capital, and revising the criteria for the success of economic reform. The key elements are:

• New industrialization, economic diversification and expansion of sustainable employment in industrial sectors of the economy, increased industrialization of small businesses and a shift to new resource-efficient, low-carbon technologies;
• Reforming the economic management system with a focus on limiting excessive state interference in current economic processes, implementing the principles of indicative strategic planning, public-private partnership, eliminating parallel management decision-making circuits, developing public institutions, increasing the efficiency of public investment and public procurement, limiting corruption and personal responsibility of public administration for achieving specific targets;
• Changing economic policy priorities towards resource efficiency, enhancing the contribution of economic growth to social issues, accelerating the development of green economy sectors, and expanding sustainable employment;

• The development of existing regulatory instruments and the creation of new ones aimed at the implementation of these priorities. These include the development of exchange trade and other market infrastructure for the formation of modern commodity markets, strengthening competition as the main incentive for significantly reducing energy, material and carbon intensity of output, water and capital intensity of economic development, and limiting the level of inflation. Instruments (mechanisms) should be developed to transform incomes from raw material exports into human capital and strengthen institutions, and incomes of labor migrants into new jobs.

At the initial stage of the transition to a new economic model, the tasks of strengthening the capacity of state institutions in terms of limiting corruption and the shadow economy. Strengthening property rights, developing commodity markets and creating conditions for fair competition. Implementation of environmental, resource-saving standards and modern digital technologies, develop an appropriate reform map and identify persons responsible for its implementation.

The quality of economic growth must also be significantly improved by strengthening its contribution to the expansion of productive sustainable employment and other social challenges. To this end, as the capacity of institutions is strengthened, an increasing share of resources should be directed towards improving the quality of management in large public companies and corporations. As a prerequisite for reducing non-payments and increasing energy efficiency, creating conditions for the industrialization and digitalization of small businesses and the transition to a new industrial policy. Implementing deep reform of the education system, building necessary infrastructure, to enhance the contribution of small and private entrepreneurship to the country’s export potential.

A team of experts should be created in the state administration, focused on the implementation of the new development model. Decisions on economic reform should be made on the basis of broad discussion with representatives of business, the expert community, and civil society organizations.

The sphere of state support for the economy should be substantially reduced. Instead of supporting individual privileged companies, the state should fully support investment processes, the creation of new consumer products, and new jobs.

In agriculture, the recent decrees on the complete abolition of state procurement of grain and cotton and the granting of greater freedoms and guarantees to farmers must be implemented. A significant potential for growth in sustainable rural employment is associated with the conversion of additional land to cultivate more labor-intensive crops, such as fruits and vegetables, which would increase land productivity and provide greater opportunities for selling these agricultural products in domestic and foreign markets. In addition, after the harvest of the main crop, the practice of growing secondary crops that yield in the year of sowing such as forage crops for livestock and vegetables in the field should be expanded.

Rural employment growth can also be achieved by introducing new green technologies – drip irrigation, biogas plants for generating electricity and organic fertilizers as part of the creation of modern cattle farms, intensive orchards and vineyards, and modern greenhouse facilities.

Addressing these and the challenges discussed above will provide the first catalyzing step towards new sources of growth, thereby the sustainable development and the quality of life of the population.

[1] According to SC, the growth rates of the economically active population in 2015-2019 were 1.9%, 1.9%,

1.3%, 2.9%, 1.5% and 1.9% respectively, using annual average estimates of the economically active population. Estimates for employment growth (jobs) in the period were 1.9%, 1.8%, 1.0%, -1.4%, 1.8%, 1.0%.

[2] According to the estimates of the World Bank, the Federal Migration Service of Russia and other organizations, the number of labor migrants from Uzbekistan in recent years ranged from 2 to 3 million people. or from 7% to 10% of the population, which is 2-3 times higher than the world average. Among young people between 20 and 24, every third man is a labor migrant (see Uzbekistan: Systematic Country Diagnostics. World Bank, 2015).

[3] Uzbekistan. Systematic diagnostics of the country. World Bank 2015. Page 10.

[4] Estimates based on the World Bank’s WDI information resource.

[5] INTERNATIONAL MONETARY FUND JVI / Institute for Capacity Development European and Middle Eastern Division Course on Macroeconomic Diagnostics. https://www.jvi.org/uploads/tx_abajvicoursemanager/Reading_List_17IM25_-_MDS.pdf

[6] Economic Monitor Uzbekistan. German Economic Team. Issue four | January 2021.

[7] Defined as the difference between the GDP growth rate on the one hand and the sum of the labor and capital

(Investment) rates weighted by the coefficientsαand (one-α) estimated econometrically.

[8] The Changing Wealth of Nations.Measuring Sustainable Development in the New Millennium. WorldBank, 2011.

[9] The net savings measure is derived by subtracting estimates of natural capital depletion, production, labor and pollution from the conventional savings measure (calculated within the traditional system of national accounts). However, expenditure on education increases the level of net savings because it partly compensates for labor consumed and increases intangible capital.