Abstract
The Kyrgyz Republic is a country with a transitional economy. Its growth performance is constantly one of the lowest compared to the other members of the Commonwealth of Independent States. This weak performance is mainly caused by political instability and high corruption. Despite being a leading reformer in the region, the country has not done enough to solve its key problems. The current study employs the growth diagnostic approach proposed by Hausmann, Rodrik, and Velasco (2005, Growth diagnostics. Cambridge, MA: The John F. Kennedy School of Government, Harvard University) to identify binding constraints on growth. This article finds that weak institutional performance, high corruption, a large share of the informal economy, and an inefficient energy sector are the most binding constraints on the country’s growth.
Introduction
The literature on economic growth broadly discusses the nature of economic growth and there is an increasing debate by both economists and policy designers regarding the set of policies to ignite economic growth, particularly in a transitional and developing economy. But most of the prescriptions on the right policies promoting growth have remained very general. The one size fits all approach, which is well known as the Washington Consensus, typically recommends a general set of required reforms to achieve growth. However, by the end of the 1990s it became clear that these recommended set of reforms did not bring the desired outcomes and it was supplemented by a second generation of reforms more focused on the role of institutions and government. Thus, the original Washington Consensus was widened to include more reforms. This broader set of reforms is known as the Augmented Washington Consensus. Nevertheless, neither the original, nor the Augmented Washington Consensus have worked that well. The enlarged set of reforms was impossible to accomplish for most developing countries due to their limited financial resources and capacity.1 In this context, Rodrik (2006a) has argued that “the question now is not whether the Washington Consensus is dead or alive, it is what will replace it” (p. 2).
Since the beginning of the 2000s, the need to avoid the one-size-fits-all approach and to develop context-specific and country-specific growth policies has become a new conventional stream. In this regard, Hausmann, Rodrik, and Velasco (2005) have proposed a growth diagnostic framework as an analytical instrument to determine what are the key problems restricting economic growth in a particular country (with the emphasis on developing economies). Focusing on a small number of binding constraints, instead of removing all the possible distortions that were targeted in the two versions of the Washington Consensus, are the most distinct characteristic of the growth diagnostic framework (Felipe & Usui, 2008). In order to identify the constraints, the new approach proposes a methodology based on a decision tree, where a low level of private investment and entrepreneurship is considered as the key factor of low economic performance in developing countries. This perspective is focused on the level of investment considering that many developing countries’ main problem is the scarcity of capital equipment and productive capacity. However, Rodrik (2006a) highlights that the issue is not about the relevance of investment for growth, but why investment and capital formation are low in many developing economies.2
In the Kyrgyz Republic (KR), which is one of the Commonwealth of Independent States (CIS) members formed following the collapse of the USSR in 1991, the government implemented market-oriented reforms under the triple scheme of privatization, liberalization, and stabilization. The government of the KR tried to follow the reforms, modeled by the World Bank, the so-called Washington Consensus, but given its limited political power and economic resources only a few of these reforms were successfully implemented. As the result, the country experienced a sharp decline in GDP, hyperinflation, high unemployment rates, and an extreme increase in poverty during the 1990s. Its growth performance has varied from this pronounced declining phase at the beginning of the 1990s to a relative stabilization and a gradual accelerating phase in the first half of the 2000s, followed by another declining phase after 2005. Though the adopted reforms helped the KR to achieve relative macroeconomic stabilization and some positive growth, it appears that the reforms have not contributed to sustained growth. This leads us to the question of what kind of reforms (or conditions) are required to ignite sustained economic growth in the KR?
Following the assumptions underlying the growth diagnostics approach, there is no unique set of reforms (or rules) for all countries at all times and growth policies should be country specific and well targeted based on the specific circumstances of the economy. This article attempts to identify the existing binding constraints on growth in the country by applying this approach. Following the growth diagnostics approach should identify the main obstacles to growth and this should assist the government to develop a well-focused set of growth policies and, by doing so, contribute to the “biggest bang for the reform buck” (Hausmann et al., 2005). Thus, the key objective of this article is to build a plausible hypothesis for growth based on identifying accurately the most binding constraints on growth in the KR.
The rest of the article is organized as follows: the next section describes the framework and its methodology. The third section identifies the constraints on the country’s economic growth and the last section provides conclusions.
Methodology and Data
In order to achieve the objectives, indicated in introduction, we apply the methodology provided by Hausmann et al. (2005). They proposed a decision tree, which starts by assuming that a low level of private investment and entrepreneurship is the key problem in developing countries and different branches of the tree represent various constraints (see Figure 1). Therefore, by moving downward in the decision tree, we attempt to evaluate along the way the relevance of each potential constraint on growth for the country.
Hausmann, Klinger, and Wagner (2008) recommend several techniques to perform a proper analysis: (a) observation of the firm behavior; (b) international benchmarking; and (c) growth accounting and country regression techniques. Thereby, based on the authors’ recommendations, our analysis is carried out by using a combination of the mentioned techniques. The assessment mainly relies on international benchmarking to perform a comparative analysis (this method was required due to the lack of time series data). Data were collected from the publications and reports of the National Bank of the Kyrgyz Republic, the World Bank, IMF’s World Economic Outlook, UNdata, World Economic Forum, and so on.
The following CIS countries, Armenia, Azerbaijan, Georgia, Belarus, Kazakhstan, Moldova, Russia, Tajikistan, Turkmenistan, and Uzbekistan were chosen as a comparator group of countries to formulate a plausible hypothesis about the binding constraints. These countries were chosen based on the following criteria: level of economic development, for example, they belong to the group of developing economies; landlocked countries (except Russia and Georgia); and they are all former Soviet Union Republics, which implies that they have a common historical, economical, and political background.
Are Investment and Growth Rates Low in the KR?
As it mentioned, the growth diagnostics approach starts with the assumption that low economic growth in developing countries is caused by a low level of investment and entrepreneurship. In this context, Felipe, Usui, and Abdon (2011) divide developing countries into four groups based on its investment share in GDP and GDP growth rates.3 They argue that this approach should be applied only to the countries in the third group. Therefore, before proceeding to diagnostics, following Felipe et al. (2011) we aim to clarify the applicability of the approach for the KR. Thus, we attempt to build a scatterplot of the average GDP growth rates and investment share in GDP for the KR and the comparator countries (see Figure 2).
According to Figure 2, Tajikistan, Armenia, and the KR are in the third group. They represent the GDP growth rates and the investment share in GDP below the world average, while others belong to the fourth group having lower growth rates than the world average, but the investment rates are above the world average. The results of a correlation analysis indicate a strong positive and significant relationship between GDP growth and investment only for the KR (0.65) and Georgia (0.73).4 However, the results for the comparator countries are less encouraging: the coefficients are positive and significant for Armenia (0.41), Azerbaijan (0.42), while there is no correlation for Uzbekistan (0.09) and Kazakhstan (0.02), and a negative and significant correlation for Russia, Belarus, and Tajikistan.
Thus, the results we discussed earlier confirm that the approach is relevant for the KR, and our analysis is addressed to identifying what are the key factors causing low investment and weak growth performance in the KR. Following the decision tree, we first determine which of the two “general” constraints (high costs of financing or low rates of return) could be a constraint in the KR.
Is the Cost of Financing High in the KR?
High costs of financing can be a potential obstacle for private investments in a country, and the costs can be observed by real interest rates and domestic credit in the private sector. Therefore, in this section we proceed to analyze the data according to these indicators to ascertain whether the costs of funds are high in the KR.
Regarding the costs of financing, the real interest rates are the highest regionally and they remains high in 2015 (see Figure 3). Furthermore, the availability of domestic credit for the private sector is also below the regional average (see Figure 4), and regardless of significant increase from 7.9 percent of GDP in 2005 to 23 percent of GDP in 2015, it remains below the average level of the CIS countries (35 percent to GDP) in 2015.
Thus, the current trend of high real interest rates and the low share of domestic credit in the private sector are indicative of the high costs of funds in the country. According to Hausmann et al. (2008), the lack of availability of domestic credit accompanied with high real interest rate indicates that the high cost of financing is caused by the scarcity of resources rather than a low demand for credit. Having identified that the costs of funds are high, we analyze if this is caused by limited access to international or domestic financing.
International Financing
Many developing countries face difficulties attributed to an access to international credit markets due to either adverse international credit market conditions or country-specific problems. The latter does not necessarily mean that limited access to international financing is a binding constraint; indeed, this signals a country has macroeconomic and/or political risk problems. In the case of the KR, access to international financing is not a binding constraint to growth at the present moment. The country’s attractiveness for foreign direct investment (FDI) is increasing year by year and it represents the second highest position among the countries, shown in Table 1. The average rate of FDI is 7.5 (share of GDP) during 2005–2015, and a significant increase in FDI inflows took place in 2011–2015. Its average share of FDI is two times higher than the average of the CIS countries as a whole (4.8). Furthermore, the country receives a significant amount of Official Development Assistance (ODA)—8.9 percent of GDP—and remittances are 24.4 percent of GDP. A considerable share of remittance inflows is used for a residential investment and for the purchase of imported consumer goods. If an access to international financing were a constraint, we would expect that the increase in remittance inflows would have gone into productive investment, but this is not the case of the KR. Furthermore, the average external debt accounts for 94.3 percentage of gross national income, and 42.7 percent of all external debt is concessional and long term (95.5 percent). Interest rates and maturities for the KR are more favorable than for the other comparator countries. The interest rate on external debt commitments is at 1.3 percent, which is one of the lowest regionally (see Table 1).
International Financing
Based on the earlier discussion, we consider that access to international financing is not a binding constraint, as the country is able to borrow from the international financial market, and relatively low interest rates are indicative of low country risk compared to the comparator countries.
Is Domestic Financing a Problem in the KR?
According to the assumption in the decision tree, inadequate access to domestic financing can be attributed to low savings or/and poor financial intermediation. Therefore, moving down the right branch of the tree, we look to see if financing costs are the result of either low savings or poor intermediation.
As in many developing countries, the KR’s savings have been low and even negative during almost the entire period under analysis (see Figure 5). Gross domestic savings between 2005 and 2015 were negative in the KR (–7.02), as well as in Tajikistan (–24.3) and Moldova (–13), while positive in Turkmenistan (65.9), Azerbaijan (50.4), Kazakhstan (40.9), and Belarus (31.5).
If a low level of domestic savings is a binding obstacle, then we expect that it can be caused by inability of profitable investment projects to find financing. In such case, we would observe relatively high deposit interest rates, caused by bank competition to fund profitable investment projects. During the period in question the average deposit interest rate was at 2.4 percent, representing one of the lowest rates among the countries considered and it has increased only by 1 percent over the last decade. With regard to the average lending interest rates, in the KR the rate is the second highest among the comparator countries, and it has decreased only by 2.4 percent over the last decade (consequently, the interest spread is the highest in the region, see Table 2).
Financial Intermediation Indicators in the KR and CIS Countries
The data indicate that the KR’s savings have been the lowest regionally, yet this does not imply that it is a binding constraint due to the following reasons: first, the data on savings may underestimate the true amount of savings because many people prefer to save their money abroad, since they consider that this is safer than doing so in the KR; second, in theory (by Hausmann et al., 2008), if inadequate access is a constraint, then changes in interest rates should result in a substantial increase in investment. However, in the case of the KR, there is no statistically meaningful relationship between the real interest rates and investment shares in GDP over the last decade (the coefficient is small and statistically not significant). Third, we do not find high deposit rates driven by bank competition for deposits to fund profitable investment projects.
In a survey carried out by the World Bank (2013), 40 percent of the firms answered that they did not need loans and only 3.9 percent of firms were denied credit. However, 26.1 percent of firms identified access to finance as a major obstacle to growth, which is significantly higher than the average of the CIS countries (see Table 3).
Access to Finance as a Constraint on Firm Growth in 2013 (Percentage of Firms)
Perhaps, the most serious constraint on access to bank loans is the collateral requirements in the KR. As shown in Table 3, 89.5 percent of the firms that obtained loans from banks had to provide collateral. As a result, banks provided only 8.7 percent of fund borrowed by the firms. Consequently, most of the country’s funds are provided by the internal sources of firms and entrepreneurs, which account for 80 percent.
Therefore, our analysis shows that savings are not considered as a binding constraint in the KR. The high costs of finance are driven by the lack of domestic funds and the fact that the majority of loans require collateral, which makes it difficult for firms to get financing from banks. Furthermore, interest rate spread is a reliable indicator of financial intermediation, and a high spread indicates an inefficient financial system. The KR’s interest rate spread was the highest during the period under examination. It is possible, therefore, that financial intermediation in line with the strict rules on loans have been binding constraints on firms in the KR.
Is Social Return on Economic Activity Low in the KR?
Moving further down the decision tree, we proceed to analyze the social returns on economic activity, which can occur due to a poor geography (including natural resources), a lack of human capital, and/or deficient infrastructure. With regard to geography and natural resources, they are not binding constraints on growth in the KR. The country’s central location makes it a major transportation corridor between Russia, China, and other Central Asian countries and its proximity to a neighboring market means that geography is not a major constraint on growth. In terms of the KR’s natural resources, the country has significant sources of gold, coal, mercury, bismuth, as well as small deposits of oil and gas. Therefore, a lack of natural resources cannot be considered as a binding constraint on the growth of the country.
With reference to the KR’s transport infrastructure, we observe that the country has excess transport capacity at the present and the country’s tendency to improve the quality of its roads is reflected in its international rankings by the World Economic Forum (2016) and the results of Business Environment and Enterprise Performance Survey (BEEPS) surveys5 undertaken by the World Bank, transport infrastructure does not appear to be a binding constraint on economic growth in the KR.
In regard to the KR’s energy sector, it has the second richest hydro resources in Central Asia (followed Tajikistan), and a high hydropower potential. Yet, the KR’s energy sector faces difficulties related to its low productivity and efficiency. Its low productivity is driven by the lack of investment in this sector and ineffective management rather than the deficit of resources. In this context, the Asian Development Bank (ADB) (2014) has reported that the country’s hydropower potential is estimated to be 150,000 million kWh, yet only 10 percent of its potential is used. The KR has one of the lowest electricity output (15 billion kWh) compared to the average of the CIS countries (21 billion kWh).
Inefficient use of its hydro potential is determined by two factors: first the level of water in Toktogul Reservoir (the main electricity production plant) varies significantly from season to season depending on weather conditions. Second, the key constraint on productivity and the efficiency of the sector is the existing outdated generation assets that have not been updated since the Soviet period. The average age of generation equipment was estimated at 35 years in 2015, and only 11 percent of the equipment has been in use for less than 20 years. More than half of the transmission equipment is 20 years old, and more than 5 percent is 45 years old (ADB, 2014). The outdated assets and long years of exploitation have resulted in high technical losses, which comprise more than a fourth of its production (see Figure 6).
As it can be seen in Table 4, the percentage of firms surveyed identified electricity as a major constraint and this is the highest (34.9) regionally. The duration of electricity outages and the number of electrical outages are significantly higher than most of the comparator countries (except Tajikistan and Uzbekistan). Moreover, the quality of electricity supply is the second lowest (see Table 4).
Energy Sector as a Constraint on Firms’ Growth (Percentage of Firms)
The results of international assessment of the energy sector can be explained by the lack of technical support of the generation assets. The latest reports of the World Bank have estimated that an investment of 865 million US dollars is needed to rehabilitate the energy assets and reduce the losses. The energy sector’s financial performance remains poor including its accumulated debts over the last periods. Evidently, there is a high risk of collapse of the existing outdated equipment, and if this happens there could be strong negative consequences for the country. In order to prevent the collapse and to increase the efficiency of the energy sector, a considerable amount of physical and financial capital is urgently needed. Therefore, based on the earlier discussion, which represents the unreliability of the sector as well as its importance for the businesses in the KR, we consider that it is a binding constraint on growth.
Human Capital
The availability of qualified human resources is one of the key components of any growing economy. In the case of the KR, a lack of skilled human capital could be a possible constraint on growth. According to ADB (2014), the country’s labor productivity is one of the lowest of the CIS countries, which is determined by numerous factors. First, a majority of the labor force is concentrated in low-productivity sectors. This is a general pattern in the CIS countries, where agriculture and services have lower labor productivity than manufacturing (Mitra, 2008). Second, it is caused by the lack of a skilled labor force, despite the fact that more than 70 percent of the working-age population has a secondary education, and 19 percent has a tertiary education (International Labor Organization, 2016). Furthermore, this is consistent with the trends in employment and wages in the country. Employment of people with complete secondary education is lower (4.5 percent) than those with tertiary education (5.2 percent). The average wage of the labor force with a tertiary education is 2.4 times higher than that with primary education, and 2.1 times higher than those with secondary education.6 According to the World Economic Forum (2016), enrolment in secondary education is slightly lower than the CIS average. Enrolment in tertiary education is the second highest in the region (see Figure 7). The enrolment rate is not a binding constraint for the country, the problem is the workers’ qualifications.
According to the World Economic Forum (2016), the quality of the educational system in the KR is poor, and the country ranks 123rd out of 144 countries (see Figure 7). The score on the local availability of specialized research and extent-training services is at the average level of the comparator countries (see Figure 8).
The third (possible) explanation for low labor productivity could be preferences in study programs of the youth in the KR. The youth in the country prefer to study economics, law, or business, and there is a significant lack of students who are studying in the technical professions, mechanics, engineering, and so on. This has resulted in a mismatch between the available and the required labor force with particular qualifications.
Summing up, the KR’s labor productivity is the lowest when compared regionally, which is caused by the low productivity in the sectors where a majority of labor force is engaged; the low quality of the educational system; and a large mismatch between the labor supply and demand. However, bearing in mind that the country shows the average enrolment rates, a high level of investment in training, and a relatively good score on the availability of research and training facilities, we conclude that a lack of human capital is not a binding constraint on growth at the moment. If necessary measures to improve the quality of education are not taken, however, it can become a critical constraint in the future.
Is Government Failure a Binding Constraint?
Macro risks matter when the government’s ineffective macro policy increases the probability that the country will face macro instability and a major crisis in the long term. If potential future macro risks are considerable, this can depress private investment, as investors are unwilling to take the risk of investing in the economy. In this regard, Hausmann et al. (2005) argue that macroeconomic instability is caused by a high fiscal deficit and the high volatility of inflation and exchange rates. Following their arguments, we review the fiscal account and monetary stability in the KR and its regional peers.
On the fiscal front, Figure 9 shows the difference between the government revenue/expenditure of the country and the fiscal balances in the comparator countries. The government’s revenue has been between 14 percent and 17 percent (share of GDP) over the period analyzed (except 9% in 2010 when there was political instability). Since 2010, government revenue has increased due to improved tax administration and international trade expansion. At the same time, after the overthrown of the previous government in 2010, the new government made fiscal adjustments through across-the-board expenditure cuts. The government reduced spending on strategic priorities such as irrigation networks, energy, and transport infrastructures, education, and health services (ADB, 2014). This led to small improvements in the fiscal deficit over the last years, yet the deficit has been higher than those in the majority of comparator countries, except Georgia and Armenia (see Figure 9). Nevertheless, the country has a sustainable tendency to decrease its deficit, and much of this is associated with decreased expenditure rather than the increased revenue. Regardless of the country’s higher level of fiscal deficit by regional standards, given the criteria of stability, the KR’s fiscal balance was not volatile over the period under investigation, and its volatility is at the average of its regional peers.7
On the monetary and exchange rate side, Figure 9 shows that the inflation rate in the country during the analyzed period has been at the average level of the comparator countries (9.01% in the KR and 9.19% in the CIS countries). Bursts of inflation in 2008 and 2011 were attributed to the adverse effect of the world’s financial crisis of 2008 and the presence of high political instability (as mentioned before). Furthermore, the domestic price level is highly responsive to external shocks and monetary trends in Russia and Kazakhstan and Figure 10 shows that the KR’s inflation path replicates inflation trends in Russia and Kazakhstan.8 Lastly, our assessment is consistent with the analysis of the ADB (2014), which reports that inflation rates of the KR remain relatively stable and close to the level of its regional peers.
Regarding the exchange rate volatility, it does not appear to be excessive in the KR (see Figure 11), and the same is true for the exchange rate volatility of the CIS countries. The exchange rate increase in 2009 was driven by the consequences of the world’s financial crisis, by the US dollar’s appreciation and an extreme devaluation of the Russian ruble and the Kazakh tenge in 2015. Nevertheless, in terms of stability criteria, inflation and exchange rates are not considered to be a constraint on growth in the KR.
Summing up, following the criteria of stability in fiscal and monetary areas, macroeconomic instability does not appear to be a constraint on growth for the KR. However, in the fiscal arena, more fiscal adjustments are needed to increase the quality and efficiency of the government’s expenditures. In the monetary arena, despite a relative stability of prices and the exchange rate, it is important to highlight the high sensitivity of domestic prices to external shocks which signals the fragility of monetary sector. Thus, the government should focus its policy on enhancing the resilience of the financial sector.
Microeconomic risks can occur due to high taxation rates, ineffective tax management, difficulties in obtaining licenses and permissions, high corruption, and political instability and so on. In case of the KR, the risks attributed to taxes can be excluded from the list of potential constraints; we argue that the tax rates are not likely to be a binding constraint on growth for the KR. The overall tax rates are the fourth lowest of the CIS economies (the KR’s income tax is the lowest in the region (10 percent), the corporate tax rate is the third lowest at 10 percent and the CIS average is 19.5 percent. The profit tax (6.4 percent) is one of the lowest in the region.
Several aspects of the regulatory apparatus, namely tax administration, customs and trade regulations, and business licensing and permits are not identified as major constraints on growth. According to the World Bank’s (2013) survey, only 0.5 percent of firms identified tax administration, 1.6 percent identified customs and trade regulations, and 1 percent identified business licensing as major constraints on growth (see Figure 12).
Referring to the most problematic factors for firm’s growth in the KR, 36.1 percent of firms identified political instability, 20 percent identified practices in the informal sector, and 12 percent identified corruption as a major obstacle to growth. These three constraints reflect the nature of the institutional framework and functioning of the legal system in the country (as noted by a total of 68.1 percent of the firms surveyed).
In regard to a political uncertainty, there are two important aspects. First, there are frequent changes in the law and regulations. The legal system undergoes considerable change every time there is a change in the government. This was the case after the political overthrows of 2005 and 2010, when changes were made in the constitution. Furthermore, the KR frequently amends important economic laws (e.g., the frequent changes in the law on value added taxes, profit taxes), which leads to unpredictability and uncertainty in the legal system. Secondly, the political revolutions of the 2000s (aforementioned), resulted in the destroying and closing of companies operating in the country, and a majority of enterprises were not able to recover and had to close. These results can be confirmed by the assessment of the World Bank, in terms of the political stability and absence of violence indicator rankings of the KR (see Figure 13).
In terms of the second major constraint noted by firms—widespread practices in the informal sector, the official statistics of the KR estimate the informal sector, excluding agriculture, accounted for 19.9 percent of the GDP in 2012 (NSCKR, 2016). However, the ADB (2014) has assessed it at 50–80 percent of the GDP. Other estimates indicate that it accounts for more than 50 percent of the country’s GDP.9 Furthermore, according to ADB (2014) informal activities are common in cross-border trade, as is evidenced by a large mismatch between the official statistics of the KR and the “mirror statistics” reported by China.10 The country’s informal businesses have the lowest productivity rates; as these small-size firms prefer to stay “invisible” to avoid the attention of the government bodies and this limits their ability to implement new technologies and new business practices. The labor force engaged in the informal sector is also paid considerably less, and they work in poor working conditions.
The third obstacle is corruption. A large body of international assessments indicates that the KR’s economy is hampered by widespread corruption. According to the World Bank (2013) the KR’s has the highest number of corruption incidents (including giving gifts to public officials “to get things done”, bribes, and other informal payments) compared to its regional neighbors (see Figure 14).
Like previous assessments of corruption, the World Bank (2016b) recently scored the KR at only 11.5 on the index for control of corruption in 2015, which is one of the lowest scores among the CIS countries. Comparing the most recent score to its level in 2005 (10.8), the country has not made any meaningful progress against corruption. Furthermore, Transparency International (2016) reported that the judiciary system and law institutions are highly corrupt and not independent. The perception of corruption in the country and the CIS has not changed much over recent years (see Figure 15). It assesses the judiciary system as the weakest and the most corrupt state institution of the country. Similarly, the ADB (2014) reports that the poor efficiency of the judicial system has worsened the public’s trust in it and more than 30 percent of survey respondents identified the judiciary system as a problem for their business—35 percent indicated that they were ready to bribe the judge if necessary.
Resuming, based on the international assessment of micro risks in the country, we conclude that the KR shows good results only in tax management and tax rates. Consequently, they are not considered as constraints on growth for the KR. However, the most problematic factors are political uncertainty, the widespread influence of the informal sector, and high corruption. Thus, we consider that the micro risks (excluding taxes) are likely to be the most binding constraints on growth in the KR.
Conclusions
The purpose of this article has been to identify the most binding constraints on economic growth in the KR by applying the growth diagnostic framework. Our analysis indicates that the functioning of the country’s legal and regulatory institutions is the most binding constraint on growth in the KR. The absence of well-functioning institutions affects every part of the economy. Without the required protection of a well-functioning institutional system, it is not possible to ignite growth. The majority of firms point out that the widespread practices of the informal sector, the insufficient independence of the court system, the high incidence of corruption, as well as ongoing political uncertainty are the major constraints on growth. Therefore, the institutional failure of the governmental system is considered a key constraint on growth in the KR.
Furthermore, limited access to domestic financing is considered a second binding constraint on growth. The costs of domestic funds are very high due to the lack of domestic financing. The international surveys reveal that more than a quarter of firms identified limited access to finance as a major constraint on their businesses. The results show that obtaining finance is complicated not only by high interest rates and a scarcity of financial resources, but also due to the collateral that is needed to obtain loans and regulations that make it difficult for firms to get financing from the banks.
Lastly, despite the fact that the KR is marked by the presence of rich water resources and hydroelectric potential, the energy sector faces a number of difficulties related to low productivity, outdated equipment from the Soviet Union period, and a shortage of qualified workers. These difficulties have resulted in increased electricity losses with a strong negative impact on business. The international surveys show that an unreliable electricity supply is a strong obstacle on firm’s growth.
Concluding, we argue that the implementation of an improved legal framework by adopting new laws to change the existing system will not be a sufficient measure; the legal framework must be consistent with the actual situation and should be proceeded by independent courts and effective regulatory institutions. Independent and credible legal institutions will increase public trust in the government, and may promote incentives for long-term private investment, as well as create incentives for the country’s informal firms to operate legally.
Declaration of Conflicting Interests
The authors declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.
Funding
The authors received no financial support for the research, authorship, and/or publication of this article.