umnik
12-21-2000, 07:33 PM
This is the first part of my paper, second part is in the one of messages on message boards, look for my nick. I omitted introduction and conclusion, and I omitted certain parts too, ready to provide references, and welcome any comments and suggestions and critisism as well. thank you
Overview
After the break up of Soviet Union, all of the 15 countries of the FSU faced a difficult task of transforming their economies from the central planned to the market oriented. Uzbekistan chose its own way of reforming the economy. Since independence, government of Uzbekistan pursued a gradual approach and avoided shock therapy tactic that has been used in many post communistic countries, arguing that the gradual approach would help minimize social costs of the transition. A decline in the country's GDP was the smallest among the members of the FSU. Government managed to lower inflation, reduce government deficit, and keep government borrowing at moderate levels, (refer to figure 1).
A more detailed analysis shows that the country's economy lacks basic market mechanisms. The government relies on administrative measures when it comes to solving economic problems, and many market restrictions remain in place. Privatization has been partially completed; however, land remains public property and land leasing procedures are not defined. Collective farms have been transformed into joint stock companies and cooperatives. However their behavior did not change because government de facto controls industry's output through state orders, subsidized input prices, and a provision of credits at preferential interest rates. In addition to these arrangements, the government implicitly taxes export sectors and subsidizes import sectors through an appreciated exchanged rate. For example in agriculture, an export sector, farmers have to surrender a certain percentage of the harvest at the government's predetermined prices, which range from 60 % to 70 % of the world's prices at the official exchange rate. Since an appreciated exchange rate is used, the real prices that farmers get are much lower 4. These mechanisms caused the distortion of the agricultural output and induced a resource misallocation.
Initial Conditions of Uzbekistan
From the beginning of independence, the government chose import substitution as a development strategy. Uzbekistan was the only country in the FSU that increased oil-production after independence, trying to reduce its dependence on imported oil. Land devoted to the cotton production was reduced while grain production was increased to reduce imports of grain.
Import substitution policy is often used by developing countries as an attempt to protect import competing sectors, save foreign exchange and increase domestic employment. An important element of the import substitution strategy is reduction of imports. Government uses a multiple exchange rates (MER) regime combined with various trade and non-trade restrictions in an attempt to control imports. While these may be considered as an effective measure in the short run, in the long run these restrictions will ultimately result in the reduction of exports. Also MER is a variation of the capital control and historically any capital control leads to the capital outflow 5.
As previously mentioned, the real output decline in Uzbekistan was the lowest among other countries of FSU, after 1996 real output began to increase which was very unusual because the Uzbek government was very slow in adopting market reforms and the country had one of the lowest liberalization ratios.
Several theories have been used to explain this unusual growth. Uzbek government was stressing that the main reason for a small decline in the real output was a gradual approach chosen by the government, and positive growth of real output was the direct result of government investment strategy. However a study conducted by Taube and Zettelmeyer (IMF, 1998) suggested that Uzbekistan's relatively good economic performance was due to better initial conditions, such as low industrial base, self-sufficiency in energy, large government involvement with subsidies, and social stability. Effect of the government investment policy on the other hand, was insignificant if not negative 6.
After the collapse of the Soviet Union, Uzbekistan was in a better initial position than other countries of FSU. Under Soviet Union, Uzbekistan specialized in the production and export of raw materials and agricultural commodities and had undeveloped industrial base. Industrial bases in the FSU used to be interrelated with each other although they were often located in different member countries. The break up of Soviet Union destroyed these well-established industrial links of suppliers and producers. More developed members of FSU were forced to decrease or completely stop their industrial production. However Uzbekistan never had that problem because it did not have well-developed industrial base in the first place. So once Soviet Union passed, Uzbekistan just redirected its exports to the Western Europe and United States, enjoying steady flows of foreign exchange from exports, a luxury that many other former members of FSU were not able to have.
Other advantages have been self-sufficiency in energy, government support and relative social and political stability. Unlike other counterparts Uzbekistan was not dependent on outside energy sources. Because the government was slow in implementing privatization inefficient large government enterprises enjoyed large subsidies provided by the government. Large subsidies in turn allow government enterprises to maintain levels of output. Also Uzbekistan was relatively stable politically and managed to escape civil wars that were common on the territory of FSU and detrimental for economic development.
Moreover, the IMF study showed that major positive economic changes came from those few structural reforms that government did undertake. The major growth was seen in agriculture and service sectors, although government was pursuing import substitution strategy and investing heavily in industry, not in agriculture. Agriculture was not only getting smaller public investments (7% versus 38% in industry) but also has heavily taxed 7.
According to the IMF estimates, current economic policies pursued by the government will have negative consequences for the medium-term economic growth, constraining it to the range of -2 to +2 % of real GDP per year. If measures necessary for full liberalization are undertaken, GDP growth will accelerate to 6 - 10 % of GDP per year within 3 years 8.
Government Intervention into Economy
Given favorable economic conditions one would expect fast economic recovery and prosperity in Uzbekistan. However government economic policies and general approach toward market reforms failed to bring promised prosperity. The government of Uzbekistan has been slow in adapting market reforms and liberalizing its economy. Uzbekistan was listed 146th out of 156 countries in the "Index of Economic Freedom" by the Heritage Foundation and the Wall Street Journal. Also due to currency restrictions, investment flows remained small averaging to less than $10 per capita compared to the CIS average of $ 20 in 1996 (IMF estimates, 1997).
However to say that government did not attempt to reform the economy would be a mistake. There has been a trend toward liberalization and government showed its commitment toward reforms. For example it undertook privatization campaign, which has been partially implemented. It achieved price liberalization on majority of products, and transferred ownership housing to households. Implemented measures were far from adequate and even privatized enterprises often behaved like former state enterprises 9.
The government continues to dominate and to control every aspect of the economy. Agriculture and foreign exchange market are two main sectors of continuous government intervention. System of state orders, low prices, overvalued exchange rate and heavy subsidization of inputs were the means of controlling farmers. Compulsory surrender of foreign exchange earnings, rationing of the currency by the government and restricted access to the foreign exchange market are the means of controlling currency flows.
Agriculture in Uzbekistan.
Economy of Uzbekistan is still heavily based on agriculture. Agriculture accounted for 32% of the GDP (refer to figure 2); also a large share of GDP is generated by activities that involve agricultural production such as distribution and processing. Agriculture employs about 40% of the total labor force, and 60% of the country's population lives in the rural areas 10. Since the government adopted an import substitution strategy, given underdevelopment of the industrial sector, there was a clear government preference toward the industrial sector; resources were channeled out of agriculture. Public investment in agriculture was only about 7% of GDP versus 38% of GDP in industry during 1993-97. Cotton and wheat sectors of agriculture have been heavily taxed through various explicit and implicit mechanisms such as appreciated exchange rates, system of state orders, administered low producer prices and administrative controls over farmers. All of that led to the distortions in output and hindered natural development of the sector. There have been declines in the cotton yields, reduction in number of newly organized farms, deterioration of the environment and decline in the income of the rural population 11.
Cotton Industry Overview.
Central Asia farmers first started to grow cotton in the late 17th century. Cotton was mostly grown in Bukhara and Khiva (regions in Uzbekistan) and later, cultivation of cotton spread to other regions. One reason for Russian invasion and colonization of Central Asia was to attain cotton fiber. Cotton is a water intensive plant and given region's usual lack of water, it is still not clear why cotton was traditionally planted in Uzbekistan. The region would be better off by planting less water intensive plants. However cotton remains as a major crop, it is the major source of country's wealth and often called white gold. Uzbekistan is the second largest cotton exporter and the fifth largest cotton producer in the world (refer to figure 3). Cotton exports accounted for 40% (average of 1991-97) of total foreign exchange earnings despite government's attempt to diversify economy. After 1991 Uzbekistan shifted its cotton exports from countries of the FSU to Western Europe and United States.
A major increase in cotton cultivation occurred during the Soviet Era between 1960-1980. The area under cotton cultivation had increased from virtually zero to two million hectares. After independence the government increased production of wheat trying to become self-sufficient in food production. High wheat production led to the decrease of cotton, the area sown under cotton declined from 2 million hectares before 1991 to 1.5 in 1997 12. Besides decline in total production there have been decline in yields, suggesting decrease in productivity. This decline partially resulted from inadequate compensation for cotton pickers, ecological degradation, machinery deterioration, and inefficient use of resources and in part resulting from inadequate prices that farmers receive.
System of State Orders and its Consequences
Although government officially privatized farms, it still controls production of strategic major crops such as wheat and cotton. Cotton production is controlled because cotton export is a major source of foreign exchange: it accounts for one sixth of government revenue 13. Wheat production is controlled because bread is a major staple of local population. The control over production in agriculture has been carried out by the system of state orders. Mechanism of the system is as follows: the government states the percentage of the harvest that farmer has to sell to the government at the government stated price. However the government establishes the targets for crop output using percentage of planned not real output. If a farmer is unable to meet target he has to sell all harvest to the government. Thus by setting high production targets, which many farmers can not meet, authorities have been able to obtain commodities at low prices, taxing farmers implicitly.
At these prices farmers were receiving 50% of world market prices in 1997, if an official exchange rate is used, and only 23% of world market prices if unofficial exchange rate is used.
In 1999 state orders' percentage of output has been reduced from 60% to 25 - 30%, but since farmers were not able to export cotton, they had to sell remaining 70% to the government and to a local population at somewhat higher, but still not adequate prices. Naturally this system leads a decrease in output, farmers being dissatisfied, and illegal exports to the neighboring countries where prices were somewhat higher. To prevent this government sets up tight control over harvest movement in the country during harvest season. One can observe an increase in number of the road police checkpoints near farmer fields and at the rural roads. The road police makes sure that the harvest is actually going to the place where it should be going.
Although the state orders were reduced from 50-60% to 25-30% of production in 1998, farmers still were not independent in production decisions. High government officials criticized chairmen of farmers' association and cooperatives for their inability to meet harvest targets and to stop falling cotton yields. Trying to keep their jobs and avoid criticism, administration of cooperatives and farmers' associations force members to increase area under cotton undermining government efforts to diversify agricultural output and restricting farmers independence in decision-making 14.
Besides state order system, the government owns all ginneries that transform raw cotton to the fiber, which can be exported. All exports of cotton are centralized and go through government association "Uzkhlopkopromzbyt" which is also a buyer of cotton in the country; individual farmers do not have access to the world markets. Thus government is a monopsonic buyer of the cotton even if no state order system is present.
Low state-determined prices, government marketing arrangements, and overvalued exchange rate were a hidden tax on agriculture. This tax amounted to 8.2%($800 million) of GDP, 2.5% ($360 million) of which was due to overvaluation of currency and 5.7% was due to low producer prices and market controls 15. The burden of current economic policies and government dependence on cotton exports creates dangerous situation for the government revenues. Should government undertake more serious reforms with a subsequent liberalization, cotton output will drop significantly, reducing government revenues and foreign exchange earnings 16.
Recent Changes in Agriculture
Two main changes can be observed currently in agriculture in Uzbekistan: demechanization of the production process and increased wheat production.
Demechanization. Cotton growing is labor-intensive process. However during the Soviet regime the cotton industry was heavily mechanized. Mechanization of agriculture was not consistent with comparative advantage of Central Asia; region lacks capital and has surplus of labor. Demechanization of the cotton production is one of the few changes that can be observed now in Uzbekistan. A major portion of cotton is harvested manually, often with the use of child labor. While this is a natural outcome given regional endowment factors, it is not necessarily a positive change.
The government administrative structure of regions has also contributed to the increased labor use. There are 12 regions (viloyat) and autonomic republic of Karakalpakistan in Uzbekistan. A region consists of several districts (tuman). The president, not local population, appoints governors of the regions and the governor of the region appoints governors of districts. Regions are allocated different harvest quotas. Since cotton is a vital strategic commodity for Uzbekistan, one criteria for the evaluation of the governor's performance is how successful was a certain governor in meeting harvest quota, despite any (including weather and financing) difficulties. During harvesting season rural towns may remind observers of towns in wartime: government institutions have limited staff, schools are closed, and everybody including pupils starting with seventh grade is on the field. Lack of capital for mechanization and governors' fear of losing their jobs make human labor the only way of collecting harvest.
Wheat production. Wheat is a relatively new crop for Uzbekistan. Prior to independence most wheat was imported either from Russia or neighboring Kazakhstan. After independence production of wheat has increased from 0.61 million tons in 1991 to 3.07 million tons in 1997 (refer to figure 4).
An increase in wheat production was at the expense of cotton production and was part of government import substitution strategy. Wheat is considered to be a strategic crop by the government and its production has been subject to extensive government controls. Families in Uzbekistan historically have been large (4-5 children in rural areas) and sharp decline in standards of living made bread a main staple for Uzbek families. Should the price of bread increase dramatically, social unrest would be unavoidable. Overvalued foreign exchange rate and low producer prices allowed government to subsidize imported and domestically produced wheat and bread prices subsequently. While low food prices benefited consumers, they also discouraged farmers from increasing production and encouraged harvest diversion to the neighboring countries where prices were somewhat higher. In addition, according to the World Bank this shift in crops was against comparative advantage of Uzbekistan, whose climate favors to the growth of vegetables and fruits, and although yields have increased in the recent years they still remain low 17.
Subsidies in Agriculture
While taxing agriculture, the government also was providing large implicit and explicit subsidies. Inputs such as fertilizers, water, and electricity were often provided at greatly subsidized prices or even for free. Agriculture was also financed directly through new loans at preferential rates and indirectly through continuous rescheduling and writing-offs of bad debts. Financing was cyclical in nature mostly reflecting preparation to harvest. New loans were provided at low or even negative interest rates and commercial banks often were required to provide financing to the farms. While all these mechanisms eased the burden of taxation to some extent, they also created enormous distortions in economy, increasing inefficiencies and aggravating existing problems. Not only do Uzbek farmers use 3-4 times as much water for cotton irrigation as do the farmers in other countries with similar climate but they also use more fertilizers and chemicals for the same yields. Inefficient water management and low water fees have increased water diversion from the two major rivers (the Syrdarya and Amudarya) causing further evaporation of the Aral Sea and water pollution 18.
In general, allocation of subsidies has been wasteful. The financial subsidies benefited mostly large farms, while small farmers were not able to obtain funds. Also credits at the preferential rates usually lead to higher default rate and tend to crowd out other investments. Free or subsidized provision of inputs caused wide distortions and contributed to existing ecological problems.
Land Tenure and Privatization in Uzbekistan
After independence Uzbekistan has developed its national privatization program. The program consisted of three steps. The first stage was focused on privatization of small enterprises and households' homes. This step was finished in 1995. The second stage focused on privatization of medium-size and some large enterprises through establishment of mutual funds. First these private mutual funds would buy shares of state enterprises using government credits and then they will try to sell their own shares to the local population. The second process is still in progress mostly due to the low interest from the local population. The last stage was so called 'case by case' privatization where government would privatize large enterprises on the individual basis. Little progress was achieved in the third stage because few investors showed interest in buying these companies. Lack of convertibility of Uzbek currency (sum) and government intervention at almost all levels of economy can explain this lack of interest. As a result of the slow progress, revenues from privatization remained low, averaging to only 0.6% of GDP in 1998 and 0.3% of GDP in 1999.
A similar picture was observed in agriculture. After independence all state farms were transformed into collectives, which later were reorganized into different forms of joint stock companies, shareholder unions and farmers associations. There were 1 400 cooperatives in 1997, these cooperatives were responsible for all cotton and wheat output. Despite the fact that farms have been officially privatized, government retained some control over farms.
Cooperatives control 70% of arable land; remaining 30% was leased to farmers under different arrangements, such as lifetime inheritable use (can be inherited but cannot be sold) and individual leasing.
Land remains government property. explicitly opposed land privatization because cotton is a strategic commodity for Uzbekistan and cannot be grown on private land. Land can be inherited, rented for long term lease (up to 50 years) and can be pledged as a collateral, although absence of the secondary market for such land makes pledging infeasible 19.
IMF, citing World Bank 20, suggested that the current land tenure system would not improve conditions for farmers and would not encourage private sector participation. The issue of land privatization however may not be that significant, because there are countries where land remain public property and yet significant improvement has been observed, such as China. Also there are countries where land privatization was achieved with little if any positive results, such as Russia. The main significant factor for the sector development is the independence of farmers in production decisions. As long as farmers have autonomy in decisions and have land for reasonably long period of time, they will utilize their land efficiently and produce right crops.
Overall privatization in agriculture was partial and inefficient, and together with unclear property rights hindered sector development and discouraged private participation 21.
Multiple Exchange Rates
Lack of foreign exchange has always been present in Uzbekistan. After sum was introduced in 1994, government has granted 1 400 companies unlimited access to the foreign exchange market. In 1996 bad weather negatively affected cotton harvest, reducing government foreign exchange earnings. Due to falling world commodities market prices government revenues have been already declining and low cotton harvest created even larger shortage, forcing government to make prompt decisions. Under freely fluctuating exchange rates a sharp decline in international reserves would cause depreciation of home currency and the establishment of a new exchange rate. Fearing that rigid Uzbek economy would not be able to adjust and trying to prevent drainage of international reserves, the government without any notice, canceled its previous currency arrangements and introduced multiple exchange rates (MER) regime 22.
Reasons for MER
MER is a complex system of different exchange rates for different transactions, where the government rations the usage of foreign currency. Historically government adopts MER regime to manage its international debt payments, to subsidize import prices, to maintain overvalued currency and to keep international reserves. While this strategy is proven to be effective in attaining these objectives in the short run, in the long run it will distort in the patterns of consumption and production. In addition to that it taxes export sectors through the overvalued exchange rate and subsidized imports. According International Monetary Fund, agriculture was the major loser (almost 6% of GDP) from MER 23.
Structure of Foreign Exchange Market in Uzbekistan
The foreign exchange market in Uzbekistan can be divided in two parts official and unofficial 24. Official market has on the supply side government organization, Republican Monetary Commission (RMC); on the demand side there are certain importers of capital goods, raw materials and companies that are servicing contracts on government guarantees. Also importers of high priority food items that are not produced in Uzbekistan are given the right to exchange currency at government exchange rate. A major source of the currency for the government is receipts from centralized exports of cotton and gold. Another portion of foreign exchange reserves comes from compulsory sale of foreign earnings by companies to the government at the official rate. Companies that export their production had to surrender 30% and later from January 1999, 50% of their foreign currency earnings to the government. Only limited number of buyers has access to this market where Uzbek currency is sold at heavily appreciated exchange rate.
A similar picture can be observed at the commercial bank foreign exchange market, the second part of the official foreign exchange market. Technically, the forces of demand and supply should determine exchange rate set at this market. However in reality the commercial bank exchange rate was calculated based on the following formula: official exchange rate + 12% margin. Even after 12% margin was abolished in 1998, difference did not widen 25. To be eligible for this rate each buyer should be approved by RMC, and given quota. Although appreciation of this rate was a little bit lower due to the 12% margin, rate was low as well. Individuals were allowed to buy limited quantity ($50-$100) of the foreign exchange at this rate and only for certain purposes such as tourism.
The third market is the unofficial exchange rate market. It is often called bazaar rate in Uzbekistan because foreign exchange can be bought and sold on the local markets (bazaars) together with fruits and vegetables. This is the most democratic, and the most liberal foreign exchange market in Uzbekistan, where everybody can buy and sell currency without any government intervention. However selling and buying currency at this market is very risky, because officially it is illegal and nobody can guarantee the authenticity of dollars. Local population is most vulnerable to the forgery because locals often do not know English, and rarely see dollars.
There are people who specialize at this illegal trading, making decent living on spreads between buy and sell prices. Spread between buy and sell prices is currently 6-8 sums for dollar and it has been increasing with appreciation of the dollar. Although trading is illegal, foreign currency can be exchanged easily and dealers are seen at the entrances of major markets in the Tashkent and other big cities of Uzbekistan. Most tradable currencies are US dollar, Russian ruble and Kazakh tenge. Although there is no communication among different markets, exchange rates are equal on all major bazaars, ruling out the possibility of arbitrage.
Overview
After the break up of Soviet Union, all of the 15 countries of the FSU faced a difficult task of transforming their economies from the central planned to the market oriented. Uzbekistan chose its own way of reforming the economy. Since independence, government of Uzbekistan pursued a gradual approach and avoided shock therapy tactic that has been used in many post communistic countries, arguing that the gradual approach would help minimize social costs of the transition. A decline in the country's GDP was the smallest among the members of the FSU. Government managed to lower inflation, reduce government deficit, and keep government borrowing at moderate levels, (refer to figure 1).
A more detailed analysis shows that the country's economy lacks basic market mechanisms. The government relies on administrative measures when it comes to solving economic problems, and many market restrictions remain in place. Privatization has been partially completed; however, land remains public property and land leasing procedures are not defined. Collective farms have been transformed into joint stock companies and cooperatives. However their behavior did not change because government de facto controls industry's output through state orders, subsidized input prices, and a provision of credits at preferential interest rates. In addition to these arrangements, the government implicitly taxes export sectors and subsidizes import sectors through an appreciated exchanged rate. For example in agriculture, an export sector, farmers have to surrender a certain percentage of the harvest at the government's predetermined prices, which range from 60 % to 70 % of the world's prices at the official exchange rate. Since an appreciated exchange rate is used, the real prices that farmers get are much lower 4. These mechanisms caused the distortion of the agricultural output and induced a resource misallocation.
Initial Conditions of Uzbekistan
From the beginning of independence, the government chose import substitution as a development strategy. Uzbekistan was the only country in the FSU that increased oil-production after independence, trying to reduce its dependence on imported oil. Land devoted to the cotton production was reduced while grain production was increased to reduce imports of grain.
Import substitution policy is often used by developing countries as an attempt to protect import competing sectors, save foreign exchange and increase domestic employment. An important element of the import substitution strategy is reduction of imports. Government uses a multiple exchange rates (MER) regime combined with various trade and non-trade restrictions in an attempt to control imports. While these may be considered as an effective measure in the short run, in the long run these restrictions will ultimately result in the reduction of exports. Also MER is a variation of the capital control and historically any capital control leads to the capital outflow 5.
As previously mentioned, the real output decline in Uzbekistan was the lowest among other countries of FSU, after 1996 real output began to increase which was very unusual because the Uzbek government was very slow in adopting market reforms and the country had one of the lowest liberalization ratios.
Several theories have been used to explain this unusual growth. Uzbek government was stressing that the main reason for a small decline in the real output was a gradual approach chosen by the government, and positive growth of real output was the direct result of government investment strategy. However a study conducted by Taube and Zettelmeyer (IMF, 1998) suggested that Uzbekistan's relatively good economic performance was due to better initial conditions, such as low industrial base, self-sufficiency in energy, large government involvement with subsidies, and social stability. Effect of the government investment policy on the other hand, was insignificant if not negative 6.
After the collapse of the Soviet Union, Uzbekistan was in a better initial position than other countries of FSU. Under Soviet Union, Uzbekistan specialized in the production and export of raw materials and agricultural commodities and had undeveloped industrial base. Industrial bases in the FSU used to be interrelated with each other although they were often located in different member countries. The break up of Soviet Union destroyed these well-established industrial links of suppliers and producers. More developed members of FSU were forced to decrease or completely stop their industrial production. However Uzbekistan never had that problem because it did not have well-developed industrial base in the first place. So once Soviet Union passed, Uzbekistan just redirected its exports to the Western Europe and United States, enjoying steady flows of foreign exchange from exports, a luxury that many other former members of FSU were not able to have.
Other advantages have been self-sufficiency in energy, government support and relative social and political stability. Unlike other counterparts Uzbekistan was not dependent on outside energy sources. Because the government was slow in implementing privatization inefficient large government enterprises enjoyed large subsidies provided by the government. Large subsidies in turn allow government enterprises to maintain levels of output. Also Uzbekistan was relatively stable politically and managed to escape civil wars that were common on the territory of FSU and detrimental for economic development.
Moreover, the IMF study showed that major positive economic changes came from those few structural reforms that government did undertake. The major growth was seen in agriculture and service sectors, although government was pursuing import substitution strategy and investing heavily in industry, not in agriculture. Agriculture was not only getting smaller public investments (7% versus 38% in industry) but also has heavily taxed 7.
According to the IMF estimates, current economic policies pursued by the government will have negative consequences for the medium-term economic growth, constraining it to the range of -2 to +2 % of real GDP per year. If measures necessary for full liberalization are undertaken, GDP growth will accelerate to 6 - 10 % of GDP per year within 3 years 8.
Government Intervention into Economy
Given favorable economic conditions one would expect fast economic recovery and prosperity in Uzbekistan. However government economic policies and general approach toward market reforms failed to bring promised prosperity. The government of Uzbekistan has been slow in adapting market reforms and liberalizing its economy. Uzbekistan was listed 146th out of 156 countries in the "Index of Economic Freedom" by the Heritage Foundation and the Wall Street Journal. Also due to currency restrictions, investment flows remained small averaging to less than $10 per capita compared to the CIS average of $ 20 in 1996 (IMF estimates, 1997).
However to say that government did not attempt to reform the economy would be a mistake. There has been a trend toward liberalization and government showed its commitment toward reforms. For example it undertook privatization campaign, which has been partially implemented. It achieved price liberalization on majority of products, and transferred ownership housing to households. Implemented measures were far from adequate and even privatized enterprises often behaved like former state enterprises 9.
The government continues to dominate and to control every aspect of the economy. Agriculture and foreign exchange market are two main sectors of continuous government intervention. System of state orders, low prices, overvalued exchange rate and heavy subsidization of inputs were the means of controlling farmers. Compulsory surrender of foreign exchange earnings, rationing of the currency by the government and restricted access to the foreign exchange market are the means of controlling currency flows.
Agriculture in Uzbekistan.
Economy of Uzbekistan is still heavily based on agriculture. Agriculture accounted for 32% of the GDP (refer to figure 2); also a large share of GDP is generated by activities that involve agricultural production such as distribution and processing. Agriculture employs about 40% of the total labor force, and 60% of the country's population lives in the rural areas 10. Since the government adopted an import substitution strategy, given underdevelopment of the industrial sector, there was a clear government preference toward the industrial sector; resources were channeled out of agriculture. Public investment in agriculture was only about 7% of GDP versus 38% of GDP in industry during 1993-97. Cotton and wheat sectors of agriculture have been heavily taxed through various explicit and implicit mechanisms such as appreciated exchange rates, system of state orders, administered low producer prices and administrative controls over farmers. All of that led to the distortions in output and hindered natural development of the sector. There have been declines in the cotton yields, reduction in number of newly organized farms, deterioration of the environment and decline in the income of the rural population 11.
Cotton Industry Overview.
Central Asia farmers first started to grow cotton in the late 17th century. Cotton was mostly grown in Bukhara and Khiva (regions in Uzbekistan) and later, cultivation of cotton spread to other regions. One reason for Russian invasion and colonization of Central Asia was to attain cotton fiber. Cotton is a water intensive plant and given region's usual lack of water, it is still not clear why cotton was traditionally planted in Uzbekistan. The region would be better off by planting less water intensive plants. However cotton remains as a major crop, it is the major source of country's wealth and often called white gold. Uzbekistan is the second largest cotton exporter and the fifth largest cotton producer in the world (refer to figure 3). Cotton exports accounted for 40% (average of 1991-97) of total foreign exchange earnings despite government's attempt to diversify economy. After 1991 Uzbekistan shifted its cotton exports from countries of the FSU to Western Europe and United States.
A major increase in cotton cultivation occurred during the Soviet Era between 1960-1980. The area under cotton cultivation had increased from virtually zero to two million hectares. After independence the government increased production of wheat trying to become self-sufficient in food production. High wheat production led to the decrease of cotton, the area sown under cotton declined from 2 million hectares before 1991 to 1.5 in 1997 12. Besides decline in total production there have been decline in yields, suggesting decrease in productivity. This decline partially resulted from inadequate compensation for cotton pickers, ecological degradation, machinery deterioration, and inefficient use of resources and in part resulting from inadequate prices that farmers receive.
System of State Orders and its Consequences
Although government officially privatized farms, it still controls production of strategic major crops such as wheat and cotton. Cotton production is controlled because cotton export is a major source of foreign exchange: it accounts for one sixth of government revenue 13. Wheat production is controlled because bread is a major staple of local population. The control over production in agriculture has been carried out by the system of state orders. Mechanism of the system is as follows: the government states the percentage of the harvest that farmer has to sell to the government at the government stated price. However the government establishes the targets for crop output using percentage of planned not real output. If a farmer is unable to meet target he has to sell all harvest to the government. Thus by setting high production targets, which many farmers can not meet, authorities have been able to obtain commodities at low prices, taxing farmers implicitly.
At these prices farmers were receiving 50% of world market prices in 1997, if an official exchange rate is used, and only 23% of world market prices if unofficial exchange rate is used.
In 1999 state orders' percentage of output has been reduced from 60% to 25 - 30%, but since farmers were not able to export cotton, they had to sell remaining 70% to the government and to a local population at somewhat higher, but still not adequate prices. Naturally this system leads a decrease in output, farmers being dissatisfied, and illegal exports to the neighboring countries where prices were somewhat higher. To prevent this government sets up tight control over harvest movement in the country during harvest season. One can observe an increase in number of the road police checkpoints near farmer fields and at the rural roads. The road police makes sure that the harvest is actually going to the place where it should be going.
Although the state orders were reduced from 50-60% to 25-30% of production in 1998, farmers still were not independent in production decisions. High government officials criticized chairmen of farmers' association and cooperatives for their inability to meet harvest targets and to stop falling cotton yields. Trying to keep their jobs and avoid criticism, administration of cooperatives and farmers' associations force members to increase area under cotton undermining government efforts to diversify agricultural output and restricting farmers independence in decision-making 14.
Besides state order system, the government owns all ginneries that transform raw cotton to the fiber, which can be exported. All exports of cotton are centralized and go through government association "Uzkhlopkopromzbyt" which is also a buyer of cotton in the country; individual farmers do not have access to the world markets. Thus government is a monopsonic buyer of the cotton even if no state order system is present.
Low state-determined prices, government marketing arrangements, and overvalued exchange rate were a hidden tax on agriculture. This tax amounted to 8.2%($800 million) of GDP, 2.5% ($360 million) of which was due to overvaluation of currency and 5.7% was due to low producer prices and market controls 15. The burden of current economic policies and government dependence on cotton exports creates dangerous situation for the government revenues. Should government undertake more serious reforms with a subsequent liberalization, cotton output will drop significantly, reducing government revenues and foreign exchange earnings 16.
Recent Changes in Agriculture
Two main changes can be observed currently in agriculture in Uzbekistan: demechanization of the production process and increased wheat production.
Demechanization. Cotton growing is labor-intensive process. However during the Soviet regime the cotton industry was heavily mechanized. Mechanization of agriculture was not consistent with comparative advantage of Central Asia; region lacks capital and has surplus of labor. Demechanization of the cotton production is one of the few changes that can be observed now in Uzbekistan. A major portion of cotton is harvested manually, often with the use of child labor. While this is a natural outcome given regional endowment factors, it is not necessarily a positive change.
The government administrative structure of regions has also contributed to the increased labor use. There are 12 regions (viloyat) and autonomic republic of Karakalpakistan in Uzbekistan. A region consists of several districts (tuman). The president, not local population, appoints governors of the regions and the governor of the region appoints governors of districts. Regions are allocated different harvest quotas. Since cotton is a vital strategic commodity for Uzbekistan, one criteria for the evaluation of the governor's performance is how successful was a certain governor in meeting harvest quota, despite any (including weather and financing) difficulties. During harvesting season rural towns may remind observers of towns in wartime: government institutions have limited staff, schools are closed, and everybody including pupils starting with seventh grade is on the field. Lack of capital for mechanization and governors' fear of losing their jobs make human labor the only way of collecting harvest.
Wheat production. Wheat is a relatively new crop for Uzbekistan. Prior to independence most wheat was imported either from Russia or neighboring Kazakhstan. After independence production of wheat has increased from 0.61 million tons in 1991 to 3.07 million tons in 1997 (refer to figure 4).
An increase in wheat production was at the expense of cotton production and was part of government import substitution strategy. Wheat is considered to be a strategic crop by the government and its production has been subject to extensive government controls. Families in Uzbekistan historically have been large (4-5 children in rural areas) and sharp decline in standards of living made bread a main staple for Uzbek families. Should the price of bread increase dramatically, social unrest would be unavoidable. Overvalued foreign exchange rate and low producer prices allowed government to subsidize imported and domestically produced wheat and bread prices subsequently. While low food prices benefited consumers, they also discouraged farmers from increasing production and encouraged harvest diversion to the neighboring countries where prices were somewhat higher. In addition, according to the World Bank this shift in crops was against comparative advantage of Uzbekistan, whose climate favors to the growth of vegetables and fruits, and although yields have increased in the recent years they still remain low 17.
Subsidies in Agriculture
While taxing agriculture, the government also was providing large implicit and explicit subsidies. Inputs such as fertilizers, water, and electricity were often provided at greatly subsidized prices or even for free. Agriculture was also financed directly through new loans at preferential rates and indirectly through continuous rescheduling and writing-offs of bad debts. Financing was cyclical in nature mostly reflecting preparation to harvest. New loans were provided at low or even negative interest rates and commercial banks often were required to provide financing to the farms. While all these mechanisms eased the burden of taxation to some extent, they also created enormous distortions in economy, increasing inefficiencies and aggravating existing problems. Not only do Uzbek farmers use 3-4 times as much water for cotton irrigation as do the farmers in other countries with similar climate but they also use more fertilizers and chemicals for the same yields. Inefficient water management and low water fees have increased water diversion from the two major rivers (the Syrdarya and Amudarya) causing further evaporation of the Aral Sea and water pollution 18.
In general, allocation of subsidies has been wasteful. The financial subsidies benefited mostly large farms, while small farmers were not able to obtain funds. Also credits at the preferential rates usually lead to higher default rate and tend to crowd out other investments. Free or subsidized provision of inputs caused wide distortions and contributed to existing ecological problems.
Land Tenure and Privatization in Uzbekistan
After independence Uzbekistan has developed its national privatization program. The program consisted of three steps. The first stage was focused on privatization of small enterprises and households' homes. This step was finished in 1995. The second stage focused on privatization of medium-size and some large enterprises through establishment of mutual funds. First these private mutual funds would buy shares of state enterprises using government credits and then they will try to sell their own shares to the local population. The second process is still in progress mostly due to the low interest from the local population. The last stage was so called 'case by case' privatization where government would privatize large enterprises on the individual basis. Little progress was achieved in the third stage because few investors showed interest in buying these companies. Lack of convertibility of Uzbek currency (sum) and government intervention at almost all levels of economy can explain this lack of interest. As a result of the slow progress, revenues from privatization remained low, averaging to only 0.6% of GDP in 1998 and 0.3% of GDP in 1999.
A similar picture was observed in agriculture. After independence all state farms were transformed into collectives, which later were reorganized into different forms of joint stock companies, shareholder unions and farmers associations. There were 1 400 cooperatives in 1997, these cooperatives were responsible for all cotton and wheat output. Despite the fact that farms have been officially privatized, government retained some control over farms.
Cooperatives control 70% of arable land; remaining 30% was leased to farmers under different arrangements, such as lifetime inheritable use (can be inherited but cannot be sold) and individual leasing.
Land remains government property. explicitly opposed land privatization because cotton is a strategic commodity for Uzbekistan and cannot be grown on private land. Land can be inherited, rented for long term lease (up to 50 years) and can be pledged as a collateral, although absence of the secondary market for such land makes pledging infeasible 19.
IMF, citing World Bank 20, suggested that the current land tenure system would not improve conditions for farmers and would not encourage private sector participation. The issue of land privatization however may not be that significant, because there are countries where land remain public property and yet significant improvement has been observed, such as China. Also there are countries where land privatization was achieved with little if any positive results, such as Russia. The main significant factor for the sector development is the independence of farmers in production decisions. As long as farmers have autonomy in decisions and have land for reasonably long period of time, they will utilize their land efficiently and produce right crops.
Overall privatization in agriculture was partial and inefficient, and together with unclear property rights hindered sector development and discouraged private participation 21.
Multiple Exchange Rates
Lack of foreign exchange has always been present in Uzbekistan. After sum was introduced in 1994, government has granted 1 400 companies unlimited access to the foreign exchange market. In 1996 bad weather negatively affected cotton harvest, reducing government foreign exchange earnings. Due to falling world commodities market prices government revenues have been already declining and low cotton harvest created even larger shortage, forcing government to make prompt decisions. Under freely fluctuating exchange rates a sharp decline in international reserves would cause depreciation of home currency and the establishment of a new exchange rate. Fearing that rigid Uzbek economy would not be able to adjust and trying to prevent drainage of international reserves, the government without any notice, canceled its previous currency arrangements and introduced multiple exchange rates (MER) regime 22.
Reasons for MER
MER is a complex system of different exchange rates for different transactions, where the government rations the usage of foreign currency. Historically government adopts MER regime to manage its international debt payments, to subsidize import prices, to maintain overvalued currency and to keep international reserves. While this strategy is proven to be effective in attaining these objectives in the short run, in the long run it will distort in the patterns of consumption and production. In addition to that it taxes export sectors through the overvalued exchange rate and subsidized imports. According International Monetary Fund, agriculture was the major loser (almost 6% of GDP) from MER 23.
Structure of Foreign Exchange Market in Uzbekistan
The foreign exchange market in Uzbekistan can be divided in two parts official and unofficial 24. Official market has on the supply side government organization, Republican Monetary Commission (RMC); on the demand side there are certain importers of capital goods, raw materials and companies that are servicing contracts on government guarantees. Also importers of high priority food items that are not produced in Uzbekistan are given the right to exchange currency at government exchange rate. A major source of the currency for the government is receipts from centralized exports of cotton and gold. Another portion of foreign exchange reserves comes from compulsory sale of foreign earnings by companies to the government at the official rate. Companies that export their production had to surrender 30% and later from January 1999, 50% of their foreign currency earnings to the government. Only limited number of buyers has access to this market where Uzbek currency is sold at heavily appreciated exchange rate.
A similar picture can be observed at the commercial bank foreign exchange market, the second part of the official foreign exchange market. Technically, the forces of demand and supply should determine exchange rate set at this market. However in reality the commercial bank exchange rate was calculated based on the following formula: official exchange rate + 12% margin. Even after 12% margin was abolished in 1998, difference did not widen 25. To be eligible for this rate each buyer should be approved by RMC, and given quota. Although appreciation of this rate was a little bit lower due to the 12% margin, rate was low as well. Individuals were allowed to buy limited quantity ($50-$100) of the foreign exchange at this rate and only for certain purposes such as tourism.
The third market is the unofficial exchange rate market. It is often called bazaar rate in Uzbekistan because foreign exchange can be bought and sold on the local markets (bazaars) together with fruits and vegetables. This is the most democratic, and the most liberal foreign exchange market in Uzbekistan, where everybody can buy and sell currency without any government intervention. However selling and buying currency at this market is very risky, because officially it is illegal and nobody can guarantee the authenticity of dollars. Local population is most vulnerable to the forgery because locals often do not know English, and rarely see dollars.
There are people who specialize at this illegal trading, making decent living on spreads between buy and sell prices. Spread between buy and sell prices is currently 6-8 sums for dollar and it has been increasing with appreciation of the dollar. Although trading is illegal, foreign currency can be exchanged easily and dealers are seen at the entrances of major markets in the Tashkent and other big cities of Uzbekistan. Most tradable currencies are US dollar, Russian ruble and Kazakh tenge. Although there is no communication among different markets, exchange rates are equal on all major bazaars, ruling out the possibility of arbitrage.