"Fact" daily writes:
The structural features of the Armenian economy, the impact of a large share of services in the gross domestic product, the expansion of consumption as a result of the increase in social payments and pensions, as well as its possible consequences for inflation and macroeconomic stability. Here, Dr. Rolan Mnatsakanyan addresses all of this in an analytical article written for "Past" newspaper, which we present below. In recent years, high indicators of economic growth have been at the center of discussions about economic policy.
However, in economics, not only the amount of economic growth is important, but also the structure and stability of this growth. Economic growth can be fast, but at the same time have structural problems that can limit the sustainable development of the economy in the long run. If we look at the structure of Armenia's economy, we can notice an important trend. a significant part of the country's gross domestic product is formed in the service sector, and it continues to grow. At first glance, this may seem natural, since the share of services is also large in developed economies. But here it is important to understand what kind of services we are talking about. In developed economies, a large share of services is due to high productivity sectors: research, technology, education, financial and professional services.
These services create high added value and contribute to the long-term competitiveness of the economy. Meanwhile, in the case of Armenia, the growth of the service sector is mainly due to the expansion of retail and wholesale trade, construction activity, revitalization of the real estate market, as well as the growth of financial and intermediary services. In this structure, the growth of the economy is often due to the increase in turnover, not the actual expansion of production capacity.
Under these conditions, social policy decisions also begin to have important, but dangerous, macroeconomic effects. Recently, one of the important directions of the government's social policy has become the increase of pensions and social payments. From a social point of view, this step is understandable and aims to improve the standard of living of the population. However, from an economic point of view, such decisions should also be evaluated from the point of view of their possible macroeconomic consequences. The increase in pensions increases the disposable income of the population and, naturally, leads to an increase in consumption. However, the main part of this consumption is directed to the sphere of trade and services.
As a result, retail trade turnover increases, service sector expands and domestic demand strengthens. This, in turn, can deepen and widen the already existing structural trend, where the share of consumption and services in the economy increases, while the development of manufacturing sectors does not take place at the same speed. Basically, in recent years there has been a qualitative deterioration of the GDP structure. The most worrying thing is that in the case of decisions to increase pensions, there was not a sufficient assessment of what effect this policy could have on the current year's inflation.
If consumption increases rapidly in an economy where production supply is limited, there is short-term demand pressure on prices, and long-term price adjustment occurs. This is especially evident in the conditions when a significant part of the consumed goods is imported. In that case, the increase in consumption can lead not only to an increase in trade turnover, but also to further strengthening of inflationary pressures. If inflation accelerates, another economic problem arises: a decrease in real consumption. In numbers and in nominal terms, the incomes of the population may increase, but if prices rise faster, the real purchasing power of the population may decrease. In this case, the main goal of the social policy, increasing the welfare of the population, can be neutralized due to inflationary effects.
These processes are also influenced by external economic factors. Money transfers from abroad play an important role in Armenia's economy, which have been an important source of domestic consumption for many years. As remittances increase, so does consumption, and the service sector becomes active. However, such a model makes the economy more vulnerable and dependent on external financial flows. At the same time, the exchange rate factor also plays an important role.
If the dram strengthens due to the influence of external flows, imported goods may temporarily become cheaper, but this also weakens the competitiveness of local producers and hinders the development of exports. Thus, the economy may rely more on imports and consumption than on production and exports. All these processes together can lead to a situation where the growth of the economy is mainly formed at the expense of the expansion of consumption, trade and services.
As experts have mentioned many times, such a model in economics is often called consumption-based growth. In this model, economic activity is maintained as long as incomes, social payments or external financial inflows increase. However, if these factors weaken, economic growth may slow down rapidly, as the productive base of the economy has not expanded sufficiently.
Under these conditions, the balance of economic policy becomes more important. Social policy should be aimed at increasing the welfare of the population, but it should also be accompanied by the promotion of production, industry and exports. Otherwise, the expansion of consumption may temporarily stimulate the economy, but in the long term increase macroeconomic risks and imbalances. If economic growth is continuously formed mainly at the expense of services and consumption, then Armenia's economy may gradually move away from the path of production development and turn into a service-based economy. For the stability of the economy, it is important that the sources of growth are not only consumption and services, but also production, technological development and expansion of exports.
Only in that case, the economic growth can be not only high, but also long-term and stable. In this context, another important question arises: what should be the reaction of the monetary policy to such developments? Usually, when fiscal policy increases domestic demand, for example through increases in social security payments or pensions, this can generate additional inflationary pressures. In such situations, the assessment and professional position of the Central Bank plays an important role. One of the main missions of the Central Bank of the Republic of Armenia is to ensure price stability. Therefore, international experience shows that in such cases, central banks often publicly present their assessments of possible macroeconomic consequences of fiscal policy. If such discussions do not take place in an open and institutional manner, then such an impression can be created that there is no sufficient coordination between monetary and fiscal policies. Meanwhile, from the point of view of economic stability, it is important that these two policies are complementary and complementary.
The independence of central banks is important precisely because they can freely and professionally assess the impact of various economic policy decisions on inflation and macroeconomic stability. If this institutional balance weakens, not only the effectiveness of the monetary policy, but also the long-term reliability of the economic system is threatened. In order to curb inflation in the current situation, the increase of the policy interest rate by the Central Bank of Armenia in the current year may, in turn, create an imbalance in the financial market. From an economic point of view, a contradictory situation arises here. The purpose of increasing social payments and pensions is to expand the consumption possibilities of the population.
However, if such a policy is implemented in conditions where the production supply of the economy is limited and consumption growth is mainly directed to imported goods and services, then the same policy can create additional inflationary pressures. In this case, nominal incomes increase, but in the case of accelerating inflation, the real purchasing power of the population decreases. This contradictory situation exists for an economy like Armenia, where a significant part of domestic consumption depends on imports, foreign remittances and exchange rate fluctuations.
In such economies, rapid growth in demand can translate into price increases very quickly. For this reason, during the formation of economic policy, it is important not only to implement social goals, but also to fully assess their possible macroeconomic consequences.
Only in that case it will be possible to avoid the situation when the policy implemented to promote consumption may have an adverse effect on the real well-being of the population in the long run. The stability of the economy is determined not by the speed of consumption, but by the basis on which this consumption is built. Details in today's issue of "Past" daily.
