Vested Interests and Status Quo Bias

Since independence, Uzbekistan’s economic development strategy has increasingly relied on a system of implicit and explicit taxes and subsidies and centralized control over the production, pricing, and export of key commodities (cotton, grain, gold, and energy) that are linked through foreign exchange controls. Agriculture and energy, as well as exporters more broadly, are taxed to subsidize the development of selected domestic industries, such as manufacturing, telecommunications, mineral extraction, chemicals, textiles, and food processing. While this strategy is clearly failing to produce the desired effects, it has, nonetheless, persisted largely for political reasons. The willingness to support an import-substitution strategy through a growing deficit and foreign borrowing has been linked directly to severe economic crises in other developing countries.⁸

Foreign Exchange Regime

Tight control of foreign exchange was reintroduced in September 1996, after a sharp drop in cotton prices and declining foreign currency reserves called into question the government’s brief experiment with currency and trade liberalization in 1995–96. The government has set high exchange rates and strictly regulated both the supply and demand of foreign currency at these rates. There are essentially three exchange rates that operate in Uzbekistan: the auction rate, the commercial rate (both set by the central government), and the black market rate. To maintain supply, the government requires that exporters surrender some portion of their foreign currency earnings—from 50 percent to 100 percent for those exporting state-procured commodities. To control demand, the government limits access. Foreign exchange at the auction rate is available only to a restricted list of importers—primarily those importing capital goods—to support the development of domestic industries. Commercial banks, exchange bureaus, and a select group of licensed traders are given access to foreign exchange at the commercial bank rate, which before the April 2002 devaluation was approximately 12 percent higher than the auction rate.

The most direct beneficiaries of this foreign exchange regime are state-designated importers, who have subsidized access to foreign exchange. The central government also benefits by exploiting the difference between multiple exchange rates to service foreign debt. So do government officials in the central ministries and state customs agencies, who can use their power to issue foreign exchange licenses to benefit friends and family or to line their own pockets. The recent decision to lower the commercial exchange rate closer to the black market exchange rate does nothing to change the government’s control over foreign exchange demand and supply or the centralized system of procurement.

The net losers in the current regime are exporters, who must surrender foreign exchange earnings at the overvalued official rate. Exporters of state-procured commodities (or centralized exporters) are hit hardest because they must surrender a higher portion of their earnings and at a lower rate. In June 2001, a government resolution abolished the foreign currency surrender requirements for small and medium-sized enterprises, which will increase the gap between centralized and noncentralized exporters.

Implicit Taxes and Subsidies

The foreign currency regime is just one part of an intricate system of implicit taxes and subsidies—subsidized credit and inputs, production quotas, price and wage controls—that benefit selected importers and producers at the expense of exporters, small and medium-sized enterprises, and farmers. The principal beneficiaries are the industries that receive subsidized credit and production inputs, such as energy producers, enterprises designated in the government’s public investment program, and large joint ventures with foreign investment. Government officials, particularly regional and local level officials, also benefit from privileged access to and control over the bulk of the country’s economic resources, a key source of their power and status under the Soviet regime. This system also reduces downward accountability. Under implicit fiscal regimes, which lack transparency, the governed cannot hold the government accountable for what does not officially exist and so is difficult to quantify.

Among those hurt by the system are farmers, who pay high taxes in the form of price controls, production quotas, and arbitrary confiscation of excess production, all of which offset any gains from access to cheap inputs. Furthermore, subsidized inputs are officially limited to farmers working on restructured state and collective farms, or shirkats, and private farms.⁹ Small and medium-sized businesses are also hurt by the system of implicit subsidies and taxes because directed credits and subsidized inputs go mainly to large enterprises and foreign joint ventures. One result is that most small enterprise growth is in trade rather than production.

Explicit Taxes and Subsidies

There is a system of explicit taxation and subsidies that benefits selected importers and producers, particularly industries that are part of the public investment program and joint ventures with foreign investment, at the expense of small and medium-sized enterprises and small farmers (dehqans). The government also imposes high excise taxes on goods exported for hard currency, such as cotton and energy, and on imported goods that would compete with domestically produced goods. Small and medium-sized enterprises are also hurt by high income and value-added taxes, which they try to evade by hiding their income and keeping a low profile, and this amounts to not investing in growth.

Thus there are many incentives that favor remaining as small as possible, thereby avoiding excessive taxation and harassment by local administrators (hokimiat) for contributions to extrabudgetary funds and public works projects. The explicit tax regime for individual entrepreneurs or microenterprises (such as hairdressers, caterers, and video tape sellers) is much more favorable because they can opt to pay a lump sum tax rather than the myriad taxes to which small and medium-sized firms are subjected.¹⁰ It is not surprising, then, that microenterprises are reportedly the fastest-growing segment among small and medium-sized firms, according to interviews with local business associations and researchers (Figure 8.1). Most of these firms (outside of agriculture) are involved in services and trade, which are less likely to generate substantial employment than manufacturing enterprises.

View Full Size

Newly Registered Small and Medium-sized Enterprises in Uzbekistan

Source: World Bank staff estimates.

• Download Figure
• Download figure as PowerPoint slide

The Difficulty of Building Support for Reform

Overcoming vested interests and building coalitions with those who stand to gain from reform is not an easy task in any country. In Uzbekistan, doing so is complicated by a political system that increases the costs of challenging the status quo, both because of uncertainty about who will lose and who will gain from reform and because of the much greater influence of those who benefit from current policies. The political system exacerbates uncertainty and therefore the risks involved in supporting economic reform. The political and economic systems and interests are so closely intertwined that the political costs of economic reform appear to be much higher than the net economic gains. Also, groups that receive some benefits under the current system are unlikely to risk losing these gains even if that might mean maximizing their gains in the future.

The goal of economic policy in Uzbekistan, then, is to maintain control while allowing government officials, entrepreneurs, and farmers to make minor legal and illegal “adjustments” to relieve any political pressure. This makes it difficult for any group or set of interests to classify itself as either pure winners or losers under the status quo or under reform. Producers and exporters of state-procured commodities win from tax exemptions and subsidized inputs but lose from having to surrender hard currency earnings. Decentralized small producers and exporters lose from the foreign exchange regime and lack of access to directed credit and subsidized inputs but win from their ability to export legally—without having to surrender hard currency earnings—and to export illegally. Farmers lose from a centralized agricultural policy that dictates what they must grow and fixes the government purchase price, but win from preferred access to subsidized inputs and the existence of informal supply and information networks, and illegal export markets. Regional and local leaders win from their continued control over scarce resources and their ability to extract unofficial payments, but lose from their limited ability to expand their tax base and sources of legitimate revenue.

Potential winners lack both access to the government decision-making process and an effective coordinating mechanism through which to advocate economic reform. Since 1992, when the government began to put down any organized political opposition, there has been little opportunity for groups to organize independently of state-created political and social organizations, including pro-presidential parties, neighborhood committees, and business chambers and farmers associations.¹¹ The coordination problem also applies, though less starkly, to government officials at the regional and local levels who continue to face many barriers to collective action.

Entrenched Government Attitudes Favoring Intervention

Officials in Uzbekistan believe that the government should intervene directly in the economy to promote objectives that are in the best interests of the population. This belief is reflected in policies to prop up large state-owned industries at the expense of small and medium-sized enterprises and of the private sector generally, and in resistance to market reform in the agricultural sector. It is also reflected in the government’s interference in the economic activities of small and medium-sized enterprises.

Maintaining employment—even at the expense of economic efficiency and growing poverty because of low wages—is considered the best way to maintain social and political stability. From this perspective, relying on the private sector for growth is risky because it reduces government control over the economy and will result in high unemployment, at least in the short run, considering that large state-owned enterprises currently employ almost half the working population. This justifies exploiting small and medium-sized enterprises and small farmers to keep failing state-owned enterprises afloat. With this strategy, small and medium-sized enterprises in Uzbekistan are unlikely to have the positive effects on economic growth that they have had in other transition economies.¹²

These perverse incentives are especially acute at the regional and local levels. In the Soviet centrally planned economy, subnational leaders and their constituents shared the expectation that officials would provide basic social services, including jobs, housing, and free access to health care and education. This expectation persists, motivating some subnational leaders to attempt to maintain subsidies and operate under a soft-budget constraint in order to provide a minimum level of subsistence to their constituents. Providing basic social services is also an important means of maintaining political support based on long-standing patronage networks.¹³

In regions where the local economy depends on a single industry or sector, this may reinforce political incentives to continue the system of implicit taxation and subsidies. And because small and medium-sized enterprises are considered profitable and are often politically powerless, they are tempting targets of predatory behavior. As financing of social services is increasingly being delegated to the local level through unfunded mandates, local officials feel compelled to extract revenue from whatever source they can. Many small and medium-sized enterprises report that they are asked to contribute to the budget for repairing hospitals, building schools, and other social services—though it is difficult to know how pervasive this practice is without comprehensive survey data.

Control over the economy, moreover, is integrally related to the political power and status of government officials throughout Central Asia. Under Soviet rule, the rents extracted from the sale of cotton supported an elaborate patronage system that served as the basis for a system of social and political control (Figure 8.2). In the agricultural sector, where reform is most needed, central and local officials resist market-based initiatives, such as the privatization of land, rational use of water, and an end to mandated crops and production quotas, that would end their control over crop production and distribution, which is tied to their economic well-being and political power.

View Full Size

The Role of Agriculture in Forging Reciprocal Relations Under Soviet Rule

Source: Adapted from Weintiud (2002).

• Download Figure
• Download figure as PowerPoint slide

There are signs that these attitudes are changing. Local researchers, for example, claim that it is now possible to discuss currency deregulation openly with the central ministries, something that was impossible in 1996–99. Some regional and local officials are starting to take farmers and farmer associations more seriously, engaging in dialogue with them and taking their concerns and ideas into account. Officials in several regions have even been supporting microcredit programs, even though they are technically illegal. Some officials appear to be more willing to take risks and experiment with the private sector. The reasons behind this variation need to be explored further.

Limited Access to Information

The third major obstacle to economic reform in Uzbekistan is the limited access to information. Obtaining information about the latest laws, resolutions, and decrees requires having personal connections or being able to hire a business consultant. But most small firms and farmers lack this basic information and the means to acquire it. Thus the key problem may not be the legal environment, but accessibility to legal information and knowledge. Independent lawyers and consultants interviewed argued that Uzbekistan has developed a sound legal base for the development of small and medium-sized enterprises. The problem remains as to how to empower entrepreneurs to use this legal base to protect their rights. Many successful businesspeople noted in interviews that they are able to “protect themselves” from government interference and harassment simply by knowing their legal rights and responsibilities. Harassment by regional and local officials seems to be inversely related to the level of legal knowledge.

Timing of information is another problem. Many entrepreneurs and business association leaders complain that they are informed about legal changes that affect them only after the fact, and so have no time to influence or resist these changes. This adds to information and coordination problems, and impedes the ability to make long-term business plans.

Regional and local officials also claim that often they are not informed in a timely manner about legal changes or how to implement them. Some officials claimed that they were not aware of a government resolution passed in August 2001 that streamlines the registration process by significantly reducing the number of bureaucratic steps and the costs to businesses. It is also conceivable that in some cases this lack of knowledge is less a matter of capacity than convenience, because these officials can then continue to extract excess payments or fines from entrepreneurs.

Supporting Coalitions of Potential Winners

Research by the Center for Economic Research and the Institute for Social Research has found that farmers and owners and managers of small and medium-sized enterprises broadly support market-based initiatives, such as private property rights and an end to mandated crops, production quotas, and directed inputs. Some farmers favor change so strongly that they are willing to incur the serious social and financial risks of leaving the cooperative shirkats and pay membership dues for services in order to operate independently. The independent dehqans are a natural constituency for economic reform because they already operate according to market principles—leasing land, legally growing what they want, and securing their own inputs on the private market. They are also extremely productive, and yet have a limited ability to expand their economic activity under the current system because they cannot officially hire employees.

Regional and local officials have a more mixed record of support for market reform. Yet, there are growing signs that they are increasingly frustrated by the current system and willing to embrace some change. Their income and authority have become increasingly threatened by new intergovernmental fiscal relations and the intensification of centralized control over the economy. The central government has increased its claims on cotton revenues that were once more evenly shared with regional governments, while at the same time imposing unfunded mandates on regional governments for providing social services. There is some evidence that regional resistance to handing over cotton and wheat production is growing, forcing the central government on occasion to send the militia to monitor crop production. Regional and local officials have also sought additional revenue by imposing levies on the local population in the form of unpaid wages, road fines, and marketplace duties; illegally appropriating collective farm assets and lands; and leasing land to households on commercial terms.

The limited evidence available also suggests that the willingness of regional and local officials to support market-based initiatives and to promote a positive business climate for small and medium-sized enterprises varies, as does their support of fiscal decentralization. Such variation can be exploited by using the knowledge of what accounts for this willingness in some cases to influence others and by increasing contacts among officials who are more receptive to reform, thus strengthening their ability to develop their mutual interests and coordinate effectively.

The international donor community can also strengthen NGOs and government-sponsored business and farmers associations by soliciting their input and including them in the projects and activities sponsored by the donors. This will encourage the government to take these organizations more seriously, many of which are already becoming increasingly independent. The Women’s Business Association, for example, helped establish credit associations throughout Uzbekistan long before they received official government approval, and the Chamber of Entrepreneurs raises funds by providing legal services to entrepreneurs for a small fee. Both organizations also draft proposals to the government based on the concerns of their members and clients.

Other associations have served as a springboard for more independently minded business leaders and farmers to form their own smaller organizations. Farmers in Andijon and business leaders in Ferghana, for example, have developed informal networks that supply information on how to operate successfully within the current environment and gain access to a growing market for production inputs. Their effectiveness is limited, however, because there has been no effort to formalize these networks as legitimate small businesses or to use them to influence the legal environment. Yet, if allowed to grow, they could eventually serve as an effective coordination mechanism among owners and managers of small and medium-sized enterprises and farmers, first at a regional and local level and then at the national level as, for example, in Poland.¹⁴ This would have positive economic as well as political effects.

As support grows for reform and mechanisms to coordinate the various interests of those who support such reform and as reforms are put in place, the government’s ability to renege on those reforms is seriously compromised. The development of small and medium-sized enterprises, particularly in the agricultural sector, will also help to soften the blow of reforms, such as privatization of inputs—and, hence, resistance to such reforms—by creating a parallel system to replace the government monopoly on supply and fixed prices.

Providing Public Administration Training to Government Officials

To address the second major obstacle to economic reform in Uzbekistan, i.e, government attitudes about the proper economic role of the state, the international donor community can provide comprehensive training in public administration to officials at all levels. To promote effective coordination and positive interaction among governments and the private sector, moreover, business and farmers associations and other NGOs should be included in training sessions. NGOs, many with more access to business and market-related training than government officials, could take an active role by demonstrating the results of their efforts and activities, particularly in generating employment. This is known to have had a positive impact on government attitudes in Tajikistan and the Kyrgyz Republic, for example. One of the first areas of training should be fiscal decentralization, including its benefits. Government officials have little knowledge about how fiscal decentralization works and are more familiar with its disadvantages than its advantages.

This training should be coupled with efforts to improve the quality of data collection at regional and local levels. This will improve the government’s understanding of the economic situation at regional and local levels and of the likely effects of fiscal decentralization and other economic reforms.

Increasing Access to Information

The third and final major obstacle to economic reform, limited access to information, can be addressed by financing the publication and distribution of information to the population at large and to regional and local government officials. This will help ensure that new laws, resolutions, and decrees are enforced more effectively. If existing organizations and networks, such as the Women’s Business Association and the Chamber of Entrepreneurs, are used to publish and distribute these materials, this will also contribute to strengthening their financial independence and their role in promoting economic reform. These organizations currently have the desire to play such a role but lack sufficient funding, technical equipment, and staff to realize this goal. At the same time, the donor community should support the development of an independent local media as an alternative source of information and analysis.

Fragmented State

The main political obstacle to economic reform in Tajikistan is the absence of a fully functioning state. Although there has been some progress in strengthening government control, regional fragmentation and official corruption threaten state consolidation and continued peace. The five-year civil war that left 60,000–100,000 people dead and cost the country an estimated $7 billion officially came to an end with the peace treaty of 1997, which granted amnesty to members of the United Tajik Opposition (UTO), provided for their assimilation into a unified army, and established a coalition government that reserved 30 percent of administrative positions for the UTO.²³ While the peace treaty, along with subsequent presidential (1999) and parliamentary (2000) elections, reduced hostilities and restored some stability, it has not served to fully consolidate the state.

For one thing, most former UTO members are not satisfied with the current arrangement. Many refused to join the government and now accuse those who did of having been co-opted. Many also complain that elites from the southern district of Kulob (Kulyab)—the president’s original power base—have dominated key political and economic positions, with elites from the northern region (Sughd, formerly Leninabad), believing themselves to be underrepresented.²⁴ This is particularly worrisome because the origins of the civil war were rooted in precisely this kind of dominance by one region, which bred resentment in excluded regions.²⁵ It is also a concern because this type of personalized government hiring breeds patronage, corruption, and vested interests opposed to reform.

Another impediment to consolidation of the state is that the strongest opposition to the current government continues to be regionally based. Gharm and the Karetegin Valley, for example, remain strongholds of the Islamic Renaissance Party (IRP), and the party’s popularity is growing in the north, long considered the most secular region.²⁶ This is potentially very destabilizing. The territory that the Soviet Union amalgamated to form the Republic of Tajikistan was made up of regions with little or no connection to each other either culturally, economically, or even geographically and did not include the main centers of Tajik culture in Central Asia, Samarqand and Bukhara.²⁷ The civil war and its aftermath have exacerbated the cultural, economic, and geographical divisions among regions, creating regional fiefdoms funded by drugs and bolstered by weapons.

The absence of a fully functioning state severely constrains Tajikistan’s economic reform process. As many who study the transition in the postcommunist world have increasingly come to realize, in the absence of effective central administration and rule of law the state cannot achieve the autonomy and capacity or build the public confidence necessary to design and implement a broad strategy of reform.²⁸ In Tajikistan the weakness of the central administration has further obstructed efforts at adopting and implementing economic reform as a result of an ongoing struggle between central and regional officials for control of key economic resources and a weak legal and regulatory environment due to resistance by vested interests and rampant official corruption.

Central Regional Struggle for Control of Resources

According to one Western non-governmental organization (WNGO) representative and a close observer, the central tenet of the government’s economic policy is to maintain control over the primary sources of income. Even worse, divisions between the central and regional governments have manifested themselves in a struggle to control key economic resources. Of the three dominant sectors of the economy, the central government has captured more control over nonferrous metals (particularly aluminum) and electric power engineering, while regional governments have more control over cotton production.

During 1992–99 aluminum accounted for some 45 percent of industrial output and exports, for both geographical and structural reasons.²⁹ The largest aluminum smeltering plant in the country, Tursunzade Aluminum Smelter or TADAZ, is located near the capital, Dushanbe, where the central government generally has greater supervision. Aluminum production also depends heavily on imported raw alumina, which is secured at the central government level.

Electricity generation, concentrated at the Nurek power station just south of Dushanbe, and distribution are highly centralized and so are structurally more conducive to central rather than regional control. Hydroelectric power is a primary export for Tajikistan and is bartered for imports such as gas, electricity, and water from Uzbekistan, rather than yielding cash income. Thus, it holds less value for regional officials (and economic elites) than cash crops, such as cotton. The state company that supplies electric power, Bark-i-Tajik, is heavily in debt because of the high rates of nonpayment among industrial and household consumers,³⁰ although the collection rate improved substantially during 2002. Electricity is an important source of political currency for the government by enabling it to provide a nearly free good to the population, though there has been some effort to raise tariff rates and increase charges to households.³¹ This is why central and regional officials contest over the power sector.

The central government has also tried to hold onto the control of heavy industry overall, which, in addition to nonferrous metals and energy, includes coal, chemicals, and machinery. Most medium-sized and large industrial enterprises remain state owned, earning Tajikistan one of the highest levels of state participation in industrial production among the transition economies.³² While there has been some effort at restructuring, the continuation of directed credits and subsidies, the growth of huge arrears, the predominance of barter, and the failure to enforce bankruptcy laws have significantly curtailed the ability of this sector to contribute to growth. The result has been a severe decline, with high unemployment and a significant shift in labor from industry to agriculture.³³ Many displaced workers have migrated to Russia, Kazakhstan, and the Kyrgyz Republic, seeking seasonal employment. This represents a net loss for Tajikistan’s economy because the government has no effective way to claim remittances, and this is leading to increased political tensions.

The reluctance of the central government to fully cede control over heavy industry stems in large part from its desire to insulate itself from regional challenges by guaranteeing itself a source of income, barter, and social protection. There is a real fear that liberalization of industry will result in the same degree of regional control that came with the liberalization of agriculture.

There has been considerable liberalization in the cotton sector. The system of centralized procurement and export, along with the official government purchasing and export agency, Glavkhlopkoprom, was officially abolished in the mid-1990s. Farmers are free to sell cotton either through the Republican Cotton Exchange or directly to foreign buyers; cotton ginneries were completely privatized in 2001.

But the end of the state monopsony has not had the intended effects of liberalizing prices and increasing competition because regional monopolies have emerged in its place. In the two dominant cotton growing regions, Leninabad (about 30 percent of production) and Khatlon (60 percent), local officials enforce de facto production quotas and artificially low prices by withholding inputs from farmers who refuse to grow cotton, blocking farmers’ access to external markets, and allocating the best land to cotton. Farm restructuring has proceeded at a much slower pace in these two regions because local officials have also blocked the redistribution and privatization of land to farmers.³⁴

Farmers in cotton growing regions are thus the net losers, often forced to grow cotton and sell it to local ginneries (often at a loss) in lieu of growing more profitable cash crops or food for their families because the farmers need access to the production inputs that local officials control. Farmers are also subject to heavy taxation. The central government continues to derive some revenue from cotton production through hefty excise taxes.

Weak Legal and Regulatory Environment

Another important consequence of Tajikistan’s fragmented state is a weak legal and regulatory environment, including inconsistent implementation. The legislative base for the development of small and medium-sized enterprises is weak. Farmers cannot secure private loans, for example, because they have no legal right to transfer land use certificates; without this collateral, banks will not risk lending. Tajikistan also lacks comprehensive legislation on microfinancing. Excessive bureaucratic interference (mainly through inspections) and licensing requirements also stunt the growth of small enterprises. The increasing tax burden—the payroll tax; social fund, pension fund, and road fund taxes; and the property tax—has led many firms to reduce their activities and register as individual enterprises or to refuse to register at all. This explains both the dramatic increase in individual enterprises and the decline in small and medium-sized enterprises since 1995 (Figure 8.3). Entrepreneurs’ limited access to information on laws and regulations and their inexperience using the legal system compound the effect of the weak legal and regulatory environment.

View Full Size

Decline in Number of Small and Medium-sized Enterprises in Tajikistan¹

Source: NABWT (2001).¹ Based on data that include small and medium-sized enterprises that are not officially registered, and are therefore likely to be more accurate than government data.

• Download Figure
• Download figure as PowerPoint slide

There are some indications that the legal and regulatory environment is improving, which may be linked in part to the landslide victory of President Rakhmonov’s party in the 1999 elections. Since then, Rakhmonov has reportedly made considerable progress in consolidating his power at the central level and appears to be using this power to further reform.³⁵ In September 2001, the government consolidated the former departments of inspection and taxation into the new Ministry of Revenue. According to local NGO representatives, this was in response to a business leader’s complaints that the principal barriers to business development were high taxes and complicated registration. The central government has also shown an interest in drafting legislation to support microfinancing.

Despite these efforts, vested interests at all levels of government resist implementing reforms that would reduce their political influence and economic gains. Local officials and their business partners who enjoy monopoly rights in the cotton sector, for example, are unwilling to forfeit rents by supporting competition. Despite its recent commitment to reducing subsidies, the central government continues to distort market reforms, such as privatization and price liberalization, by subsidizing failing industries through directed credits and arrears, and by not enforcing bankruptcy laws. Also, corruption is rampant at all levels of government because of weak enforcement, patronage in hiring civil servants, and low wages.

Limited Access to Information

Access to information is extremely limited. The Chamber of Commerce, a quasi-governmental agency, publishes laws and regulations only once a quarter. Official information is prohibitively expensive to obtain for farmers and entrepreneurs. As a result, most farmers are unaware of their rights regarding land use and access to inputs and export markets, and most entrepreneurs are unaware of the recent improvements in the regulatory environment and thus are unable to protect themselves against arbitrary inspections.

Moreover, unlike in Uzbekistan, there are few private consultants to advise businesses on such matters. The NGO sector, however, is much more developed than in Uzbekistan. Some local NGOs are already addressing this problem by publishing and disseminating relevant laws and decrees to their own clients, but their scope and financing for such activities are limited. The media, which some have described as active and relatively pluralistic, is also limited because newspapers are a luxury for most people in impoverished Tajikistan and because there is little access to other media in the regions.³⁶

At the same time, both struggling entrepreneurs and government officials, particularly at the local level, lack fundamental knowledge about how markets work. Some organizations, such as the National Association of Small and Medium-sized Businesses, provide training and advise entrepreneurs on how to create business plans and advertise their products. But the services they provide are hardly enough to meet the growing demand, and local officials still lack a source for knowledge about markets.

Obstructions to Trade

Legitimate trade, within Tajikistan and between Tajikistan and its Central Asian neighbors, is obstructed by official corruption, requirements for excessive documentation, high export and import tariffs, transit fees on trucks and freight-carrying vehicles, and border closures. Corrupt border guards and customs officials have become a systemic problem, often purchasing their lucrative positions. As a result, transit costs are prohibitive, the growth of small and medium-sized enterprises beyond local markets is stunted, and enterprises connected by common resource use and suppliers are denied access to inputs. Transport costs are inflated by the demands of local trucking monopolies, extortion along roads, and geographical constraints that are exacerbated by border closures. Several districts within Tajikistan are separated from each other by Uzbekistan, requiring passage through multiple customs checkpoints.

The most severe barriers to trade, however, come from official sources. Uzbekistan, in particular, has erected high barriers to regional trade in response to its fear of cheap imports from its poorer neighbors and to security concerns after incursions by Islamic militants from Tajikistan in 1999 and 2000. Uzbekistan has even placed mines along its border with Tajikistan, destroying a once vibrant local economy based on cross-border trade in the Ferghana Valley.

Improving Relations Between Government and the Private Sector

The international donor community should build on the positive relationships that have been emerging between all levels of the government and the private sector, particularly business-oriented NGOs. Several organizations have established partnerships with government officials and governing bodies. The National Association of Small and Medium-sized Businesses (NASMB), for example, advises the central government on ways to increase employment and has partnerships with the Ministry of Labor, the official trade unions, and the Anti-Monopoly Committee. Most NGO leaders believe that the government has become more supportive and realize that NGOs provide an array of social and financial services and can generate employment and relieve poverty. NGOs consider the government’s recent adoption of a new World Bank and IMF-supported Poverty Reduction Strategy as an opportunity to gain greater government support for their activities.

Independent organizations such as the NASMB could also work with government units at the local level to provide business training for both entrepreneurs and officials, helping to promote productive dialogue on the legal and regulatory frameworks. The NASMB also participates in roundtables with the Anti-Monopoly Committee, helping to draft legislation on taxation and regulation of the private sector.

Another source of potential support for business interests is the national parliament. Although the parliament currently serves as a rubber stamp for the decisions of the president, the deputies represent a wider group of economic and local interests. Empowering the parliament might curtail the ability of a few central leaders in the executive branch to defend their own vested interests. Deputies could also represent the growing interests of the private sector in a pro market business environment, which would include tax and regulatory reform as well as the rule of law. The international community should push for greater democratic reform by advocating a stronger role for the legislative branch.

Building Coalitions Among Potential Winners from Reform

The international donor community should cultivate the interests of those who stand to benefit most from economic liberalization in Tajikistan and help to build coalitions among them. These include farmers, owners and managers of small and medium-sized enterprises, and regional and local governments. Farmers and entrepreneurs increasingly are showing signs of readiness to move toward a market economy. Officials in non-cotton-producing regions are also more receptive to reform. Coordination within and among these interest groups should be facilitated by sponsoring meetings, soliciting the groups’ input in projects and activities, and including them in sponsored projects and activities. At the same time, regional leaders in cotton-producing regions in particular must be encouraged to support greater competition. The international community should push for continued monitoring of this process, while empowering farmers by providing a forum in which they can expose the vested interests that are sabotaging the process.

One way to cultivate regional leaders’ interest in market reform is to smooth the transition toward greater fiscal decentralization. This can be done by supporting the central government’s efforts to restructure public administration in order to increase efficiency and improve the government’s financial monitoring capacity. These efforts to restructure public administration, including the establishment of the State Committee for Financial Control in 2001, clearly signal the government’s desire to address some of these problems.³⁷

Weak Implementation of Reform

Obstacles to the full realization of reform are particularly acute in the industrial sector. Arrears between enterprises, on wages and taxes, and in the budget, as well as direct state subsidies to enterprises interfere with the ability of private and state enterprises to respond to market incentives. Enterprise arrears have been on the rise since 1995, reaching an estimated 6.3 percent of GDP by 1999.⁴⁷ The World Business Environment Survey found the highest percentage of reported overdue payments for suppliers and workers. Arrears are highly problematic for enterprise restructuring because they produce economic distortions and exacerbate other problems. Interenterprise arrears contribute to tax arrears, while wage arrears contribute to widespread poverty.⁴⁸ Direct subsidies to enterprises have also increased steadily since 1994, reaching 2.3 percent of GDP by 1999 and indicating state support for enterprises that have not fully adapted to new market conditions.⁴⁹

The problem of arrears and subsidies is not limited to state-owned enterprises. Nominally private enterprises, particularly if they account for a significant amount of local employment, are often allowed to accumulate tax arrears by local authorities and also to rely on noncash transactions to remain in operation. The primary mode of privatization in the Kyrgyz Republic was to transfer assets to managers and workers, who continue most of the old practices because they lack the knowledge or capital necessary to invest in restructuring.

Efforts to protect domestic industry through subsidies and soft-budget constraints are strongest at the regional and local levels because leaders feel a sense of responsibility to maintain the livelihoods of the population at least at some minimum level. Firms that participated in the World Business Environment Survey, for example, reported that arrears to local governments make up a higher share of their total overdue payments than do arrears to the national government. As in Uzbekistan, these leaders are also motivated by a fear of social unrest and the loss of direct control over scarce economic resources.

Predatory Business Environment and Official Corruption

Economic reform is also constrained by a predatory business environment and endemic corruption among officials. Despite significant tax reform, tax compliance remains low.⁵⁰ High tax rates and the great number of taxes encourage enterprises to underreport their income. High payroll taxes also limit incentives to increase employment. Many additional taxes and fees for some firms and exemptions for others are created outside the Code.⁵¹ Enterprise tax arrears continue to be high as well, although they have declined in recent years.⁵² Widespread official corruption also lowers revenue collection. The highest proportion of bribes spent on government “services” reported in the World Business Environment Survey (almost 54 percent) was to avoid excessive taxation. The complicated licensing and permit system creates additional opportunities for rent seeking by local officials. The proportion of bribes spent to avoid taxation or obtain licenses is much higher than the average for postcommunist states.⁵³

This environment of heavy taxes, multiple administrative barriers, and bureaucratic control is particularly damaging to small and medium-sized enterprises, driving them into the shadow economy. In interviews, representatives of entrepreneur organizations consistently cited the burdensome licensing, permits, and certification process and frequent inspections by local officials—often resulting in unofficial payments—as the chief impediments to small and medium-sized enterprise development. Many attribute this harsher treatment to the fact that small and medium-sized enterprises do not enjoy the protection of regional and local leaders, both because they are considered to be more profitable than large enterprises and because they do not provide so many (visible) jobs.

More generally, the prevalence of corruption constitutes a significant obstacle to business development. The low and declining number of small and medium-sized enterprises in the Kyrgyz Republic is especially surprising because the country has one of the most active sectors in the region.⁵⁴ It is a cause for serious concern because these enterprises are the most likely source of business expansion and employment opportunity, given the country’s limited domestic market, and because the decline in officially registered small and medium-sized enterprises represents a net loss for economic growth.

Corruption in the Kyrgyz Republic is related to limited civil service reform and local poverty, as well as the lure of the drug trade. As in Tajikistan, officials often accept unofficial payments in exchange for lucrative jobs, such as border guards and customs officials, and people in those positions then view bribe taking as their primary form of repayment. Illicit drug cultivation is often the only option for impoverished farmers, particularly those living in regions along the border with Tajikistan.

Limited Access to Information

As in both Uzbekistan and Tajikistan, one of the biggest obstacles to the development of small and medium-sized enterprises, according to leaders of the Committee for Private Entrepreneurs, is that most entrepreneurs don’t know their legal rights or how to defend them. Several factors constrain their ability to obtain information about changes in legislation or regulations. First, there is generally a low awareness of the value and benefits of business support services. Second, access to these services is limited, particularly outside of Bishkek and Osh. Finally, small and medium-sized enterprise owners and managers prefer to remain anonymous because they fear retaliation by local officials.

Entrepreneurs, farmers, and local government officials also have limited access to information about private sources of production inputs, distribution networks, and domestic and foreign markets for their goods and services. Many farmers, for example, still view expanding beyond subsistence farming as too risky, despite long-term leases for land and private land ownership. Similarly, many local officials believe that it is necessary only for each village to be self-sufficient and to produce goods for internal consumption.

Trade and Transit Barriers and Contraband

Although the Kyrgyz Republic has an open trade regime, it has been unable to reap the full benefits, due largely to political disputes with its neighbors. Strained relations with Uzbekistan have resulted not only in an uncertain supply of electricity but also in significant trade barriers. Although both countries agreed in the early 1990s to maintain a barter system of exchange—trading Uzbekistan gas in the winter for Kyrgyz water in the summer growing season—this agreement has been violated repeatedly. Furthermore, Uzbekistan’s efforts to guard its borders by laying land mines and requiring excessive documentation have destroyed legitimate cross-border trade. The Kyrgyz Republic also has disputes with its two other biggest trading partners, Kazakhstan and the Russian Federation, involving unpaid debts and high import tariffs. Finally, Kyrgyz exporters encounter official and unofficial hurdles with all three countries, and leaders of the Committee for Private Entrepreneurs maintain that it is much easier to import than to export.

These trade barriers have hurt the Kyrgyz economy, especially the development of small and medium-sized enterprises. Exports declined by almost 20 percent in 1999 due to punitive tariffs imposed by Kazakhstan and frequent border closings by Uzbekistan.⁵⁵ Trade with Russia has also suffered as a result. Importers have turned increasingly to contraband to avoid high Kyrgyz import duties. Trade difficulties thus provide another incentive for small and medium-sized enterprises to move to the informal sector.