Moldova Foundation

Why is Moldova Poor and Economically Volatile?

Why is Moldova Poor and Economically Volatile?

June 25
15:10 2014

By Vlad Spânu, Executive Director of the Moldova Foundation, Washington, DC [originally written in 2004 (1)]

The transition to a market economy in Eastern Europe and the former Soviet Union proved to be more difficult and lengthy than many economists predicted. In Moldova, the ‘side effects’ of the reforms had the worst impact on the quality of life of the population. After more than 10 years of economic experiments, the country is much poorer and more volatile than in 1991, when it gained its independence from the Soviet Union.

Although Moldova has been an obedient follower of the international financial institutions’ (IFI) guidelines since 1992, its government consistently failed to implement sound economic changes. Why this underperformance? Lack of institutional capacity, leading to an inability to analyse critically and understand the advice given by IFIs; and a lack of political will to implement tough policies fully. Ironically, it was the Sangheli government, the most anti-reform of all post-independence Moldovan governments, which launched the major reform programme in 1994, including large-scale privatisation of small and medium enterprises and agricultural land. The promoters of the ‘Washington Consensus’[i] used a stick and carrot approach in persuading Moldova to transform its economy by providing loans in return for promises of reform. Moldovan officials paid less attention to the stick while gobbling up the carrots. Otherwise how can one explain Moldova’s accumulated debt to the IMF and the World Bank of $621 million (over 50 per cent of total debt) and the fact that the country is one step from default? Moreover, IMF monitoring reports affirm that Moldova meets most of its targets. Looking at the state of the country today, a question arises: are the targets set by the IMF in consultation with the Moldovan government real? Do they contribute to the country’s development? Or are they deliberately set low?

Moldova failed to be creative in the search for its own path of transition. Governments, due to their weak capacity, blindly accepted the recipes of the IFIs and donor countries without taking a lead in crafting a policy for Moldova that would incorporate local needs, particularities, and differences.

Today, the communist-controlled government and parliament are doing no better than their predecessors. Populist policies oriented towards short-term electoral goals just camouflage the real problems the country faces without touching the roots of Moldova’s poor economic development. While real GDP has risen in the last few years, since the communists won the parliamentary vote, this economic growth in no way reflects sound policies. Two effects, both unrelated to government policies, contributed to the first signs of economic activity since the 1990s: (i) growth in Moldova mirrored the economic boom in Russia, Moldova’s main partner and investor, and (ii) Moldova’s GDP rose because it had no further to fall. From 1990 to 2001 output declined steadily at 8.4 per cent per year, resulting in a 60 per cent cumulative loss of its 1991 value by 2001.[ii] 

Level of development

Moldova is labelled ‘the poorest country in Europe’. The World Bank classifies Moldova in the group of low-income economies. Indeed, its GDP per capita, as measured in 2001 at purchasing power parity, was $2150, putting Moldova at the bottom of the list of countries in Central and Eastern Europe and the western former Soviet republics. Even Armenia, Azerbaijan and Georgia, three Caucasian countries that face war and ethnic conflict, have left Moldova behind. Moldova’s GDP per capita in constant 1995 prices was $678 in 2001, so that Moldovans were even worse off when travelling abroad.

In order to gain a deep understanding of Moldova’s quality of life and development, knowing its GDP per capita is not enough. Income is unevenly distributed among different social groups, regions, and ethnic groups. The inequality index (Gini) in Moldova is 40.6 points. The country’s Gini has increased more than in other countries in the region. In Hungary, for example, the inequality index has increased by 1.6 points in the last decade compared with 13.6 points in Moldova. This growing inequality makes things worse for the many who live below the poverty line. According to the World Development Report 2003, 38.4 per cent of people in Moldova live on less than $2 a day.

Due to the poor performance of the economy, Moldovans are forced to seek jobs abroad, children drop out of school and farmers continue to work at subsistence level. The economic decline of the last decade is the main cause of the poverty. This weak performance stems from three main factors: institutions, geography and demography.

Institutions and structural reforms. Bad governance and high levels of corruption are the main causes of the weakness of Moldova’s institutions. Low wages in government jobs (monthly average of $53 as of 2003) and party-based rather than merit-based job promotion are the main factors keeping highly-qualified professionals out of the system. The low salaries of public officials and the excessive regulation of public services and economic activities cause corruption to flourish. The government shifts the blame for poor performance onto external shocks: adverse weather conditions for scarce agricultural output, or Russia’s 1998 crisis for weak Moldovan exports and volatile financial conditions. The authorities are not focused on smoothing the effects of inevitable shocks through diversification of export markets and reducing dependence on agricultural production for the country’s main exports. Thus, during the last decade little has been done to reduce the country’s vulnerability. The IFIs, the country’s main foreign advisers, concentrate primarily on structural reform and financial stability policies, which, while important in the short run, do little to address the country’s long-term problem of vulnerability to external shocks.

Nobody is to blame for the delays in privatisation but the government. Since the communists took full control of all branches of the body politic in 2001, privatisation has slowed down. Implementation of the last stage of the privatisation programme for large enterprises (the two remaining energy distribution networks, Moldtelecom, wineries and distilleries) has been postponed. 20 per cent of Moldova’s industrial sector is still owned by the state. These enterprises drag down industrial growth. In 2002, their output declined by 10 per cent, while the sector grew 11 per cent overall thanks to the strong performance of privatised companies and those with foreign capital.

Although the appropriate legal framework was created, it failed to ensure a favourable environment for attracting foreign direct investment (FDI). Since 1991, cumulative FDI has reached just $414 million, or $125 per capita. Moldova is far behind Poland ($920) and Hungary ($1970), and even behind Belarus with its $128 per capita. 

Trade amounts to 125 per cent of Moldova’s GDP, so the country had no choice but to embrace openness in trade policy. But trade liberalisation and accession to the WTO in 2001 had no immediate positive effect on economic growth. Both of the country’s main partners, Russia and Ukraine, are non-WTO members and they impose tariff barriers against Moldova’s exports. 

Thus Moldova, unlike other countries in the region, has been unable to secure a sound process of structural reform over the last decade. Reforms were not backed up by efficient enforcement of the law and regulations.

Geography. Almost every second government official in Chisinau will say proudly that Moldova’s geopolitical location means that it can become a second Swiss haven or bridge between East and West. Even speeches by heads of state or government refer to Moldova’s ‘treasures’: ‘fertile black earth which is the best in the world, along with famous Moldovan wines and brandies, sweets and beautiful women’. In reality, the country is more likely to become a second Kaliningrad, dominated by Russian interests, unless Moldova turns to the West, implements sound reforms, and is lucky enough to engage the interest of the EU and US in its political and security concerns. 

In the case of Moldova, I cannot but agree with Harvard Professor of Economics Dani Rodrik, who believes that geography has a significant impact on a country’s economic performance: it affects both trade and institutions. Geography is not Moldova’s ally. Invaded, occupied and divided over centuries, what we now know as the Republic of Moldova always lacked natural resources and relied on agriculture as the mainstay of its economy.

The structure of the economy has not change much in 21st century Moldova, with agriculture still the dominant sector. Since 1998, weather conditions have affected agricultural output. Draught and frost have hit crops almost every year.

Unlike its neighbours, Moldova has not used its proximity to EU markets to its advantage, in part due to the EU’s restrictive policies towards agricultural products from non-members or non-associate members. Neither has it developed new markets outside the former Soviet Union. Thus, Moldova remains heavily dependent on the CIS market, mainly Russia and Ukraine, for its agriculture-dominated exports (which make up over 50 per cent of all exports) and fuel imports (which account for 20 per cent of all imports). There are recent signs of exports to the EU picking up, mainly thanks to German and Italian investment in the textile industry and the use of their distribution channels throughout Europe. Trade with Romania is significant – its western neighbour is Moldova’s number three trade partner – but investment from that country is very low due to lack of interest from both the Romanian business community and the Bucharest government. Relations between the two countries have deteriorated since the communists won the elections in Moldova. In any case the Romanians are preoccupied with their country’s accession to NATO and the EU, and Moldova is no longer on Romania’s priority list.

Demography. Moldova’s population of 4.3 million is ethnically diverse due to Russia’s 150-year occupation, which stimulated migration by different groups, leading eventually to the creation of the quasi-state of Transdniestria, which is de facto independent of Moldova. Transdniestria used to be the most industrialised part of Moldova in its Soviet period. Special arrangements for the Gagauz and the Bulgarians also had nothing to do with the economic interests of Moldova as a whole or of the ethnic groups concerned.

From 1993-2003, population growth was negative and fluctuated between -0.07 and -0.35 per cent annually. But these are official statistics or estimates that do not reflect emigration. Since 1996 about one million Moldovans are believed to have left the country in search of better jobs. Mainly, these are temporary workers, in most cases illegal migrants. Since the vast majority of emigrants are aged 25-45, Moldova is short of about half its labour force. Also, these people are voters who are not able to participate in the electoral process in Moldova.

The efficient education system inherited from Soviet times has been preserved and developed since independence. The illiteracy rate is just one per cent. Private education competes with public institutions. Unfortunately, due to the lack of job opportunities in Moldova, this resource is wasted. In most cases, Moldovan emigrants with first and masters degrees or even doctorates work abroad as unqualified workers in construction, retail or, even worse, as prostitutes on the streets of Western Europe. There are estimated to be 200,000 Moldovans in Italy alone. Thus, Moldova has failed to make proper use of its most valuable resource, its educated people.

Moldova’s economic volatility
The main causes of Moldova’s volatility lie in the structure of the economy, high external debt, dependence on CIS export markets, and dependence on CIS fuel imports.

Agriculture employs the largest share of the labour force and also accounts for the largest share of GDP, 21 per cent. Its importance is slowly decreasing, making room for growth in the service industries. Between 1995 and 2002, the share of services grew from one third to almost a half of GDP. Now, trade accounts for 11.5 per cent, transport and communications 10.2 per cent and construction 2.9 per cent.

Moldova’s main exports are food, alcoholic beverages and vegetables, which together account for over 50 per cent of total sales. All these exports are highly dependent on variable climate conditions. High-technology products do not exceed 3 per cent of exports of manufactures. Sales to Russia and other CIS countries dominate Moldova’s exports; these are vulnerable to the stability of these transition economies and dependent on political relations between Moldova and the other countries, especially Russia. For instance, Russia uses trade barriers as leverage in its policies towards the ‘near abroad’ (former Soviet republics), and Moldova is often a victim of such policies. On the positive site, the flexible exchange rate system efficiently promoted by Moldova’s Central Bank helps to alleviate the negative impact on the currency caused by fluctuations on the foreign exchange market.

Dependence on gas, oil and electricity imports from one main supplier increases the volatility of Moldova’s economy. The natural gas price for Moldova is also used for political leverage. Moldova pays $80 per 1000 cubic meters for imported gas from Russia, while Belarus and Armenia pay about half that. The more obedient a country is towards Russia, the better its chances of getting an advantageous price and facing fewer trade barriers to its exports. Thus, using economic leverage, Russia is able to keep Moldova in its sphere of influence and prevent the country adopting a pro-Western orientation in its foreign policy. While the EU and NATO are moving their borders further east, Moldova will not be included in the enlargement process anytime soon. Under pressure from Moscow, the government in Chisinau almost abandoned GUUAM, a regional grouping that aims to enhance economic cooperation through the development of a Europe-Caucusus-Asia transport corridor[iii]. This organisation caught the attention of the US and West European countries, but it is not welcomed by Russia, which sees it as an attempt to break out of the Russia-dominated CIS.

Annual trade deficits are over 20 per cent of GDP, while annual current-account deficits are in the region of 8-9 per cent of GDP. The difference is made up by remittances from Moldovan workers abroad, estimated at $250-260 million annually (15 per cent of GDP), more than foreign aid and investment combined.
Moldova has done little to diversify its fuel imports. Central Asia, Caucasus and the Gulf would be alternative oil and gas sources, if it were not for the strong political and business interest of Moldova’s decision-makers in running things in the old way.

Moldova’s total external debt exceeds $1.2 billion. The external debt/GNI ratio is extremely high: 84 per cent. Moldova has used most of its loans for consumption rather than for infrastructure development which would increase the country’s capacity for growth. Moldova owes $289 million (as of 2002) just to Gazprom, the Russian supplier of natural gas, $114 million in payments for gas and $175 million in penalties for late payment. Most of the gas debt is due to non-payments by inefficient state-owned industrial enterprises. Once these debts have grown to significant proportions, the government transforms them into government loans and pays them from tax-payers’ pockets. When these pockets are empty, under an agreement between Gazprom and the Moldovan government, the Russian concern can take shares in profitable enterprises in lieu of debt. This debt-for-equity swap has made Russia the largest investor in Moldova.

The only way for Moldova to reduce the burden of gas debt is to stop subsidising failed enterprises and put them in the hands of private owners. Then, with less debt for gas, Moldova would strengthen its negotiating position with Gazprom when the fee is set for gas transit through Moldova to the Balkans. In 2003, Gazprom was pressing Moldova to lower the gas transit tariff from $2.5 per 1000 cubic meters per 100 km to $1.5. 

What is the way out?
Does the Republic of Moldova have any chance of preserving its political and economic independence? How can the country achieve sustainable economic development?

I remember that when Zbigniew Brzezinski, former US National Security Adviser, was asked in 1998 about the future of Moldova, he said he thought that the only way for the country to survive was to become part of the Euro-Atlantic political and security structures. Brzezinski also believed then that the only vehicle by which Moldova might join the EU and NATO was Romania. Five years have passed since that discussion and Brzezinski’s words have been proved right. Romania is already in NATO and will join the EU in the near future. Moldova’s western neighbour is now in a good position to support the country’s integration into Europe. Unfortunately, Chisinau has missed this chance by letting its relations with official Bucharest deteriorate. Fear of unification between the two countries has kept all post-independence governments in Moldova from building friendly relations with Romania. And, of course, pro-Russian communists have even more acute feelings in this respect towards Romania.

From the economic standpoint, joining the EU would indeed be Moldova’s only chance of improving the life of its people. The economic and social development achieved by the Baltic states and the countries of Central and Eastern Europe since 1991, when they made their choice between Moscow and Brussels, are irrefutable arguments showing the Moldovans which path they should take.

Moldova needs to reduce its economic volatility in order to prevent the damage caused by frequent external shocks. It must increase the share in GDP of high-value-added products and services, thereby reducing its dependence on agricultural exports prone to severe weather conditions, fluctuating world prices and demand, and restrictive import policies for food and beverages. High-tech industries are one of Moldova’s still unexplored avenues. Once known as a supplier of electronic components for the Soviet military complex, Moldova has an abandoned electronic sector today. Its whole army of engineers have nowhere to use their skills. While software programming is booming in other countries in the region (especially Russia and Romania), programmers in Moldova have no jobs.

By providing more opportunities for Moldovan businesses to cooperate with companies in the EU through transparent policies and trade and investment promotion campaigns, the government would address another problem that makes the country vulnerable: dependence on one market to the east and a single large investor, Russia. Instead, the only major Western investor, the Spanish Union Fenosa, was harassed in 2002 by the Moldovan Audit Court, which claimed that the electricity distribution infrastructures privatised by this firm were undervalued, and that the deal should therefore be considered null and void. Intervention by the IFIs was required to avoid an embarrassing scandal.
Diversification is what Moldova needs most in both export and import markets. In order to improve the quality of its products and their competitiveness on external markets, the country needs technology transfers from the industrialised countries. Government intervention to lower or eliminate import tariffs for technological equipment and machinery would play a crucial role in this regard.

To reduce its external debt/GNI ratio, Moldova must take bold steps to end its subsidies to industries that are not economically viable and constitute a burden on the state budget. Free from the pressure of gas debt, Moldova could be more selective in choosing investment in its economy. Diversification of foreign interests would also be to Moldova’s advantage.

Finally, the country must create a favourable environment for local and foreign investors. Moldova’s institutions must do their best to reduce the political risk that now keeps investment low. Re-nationalisations carried out by the communist government since 2001, such as those of Eurofarm, a US-Romanian joint venture, and Air Moldova, a firm with significant German capital, do no good to the country’s image. The Transdniestrian conflict, until resolved completely, will be a threat to Moldova’s national security and increase the risk premium demanded by foreign investors. Also, the Russian army stationed in Moldova will continue to deter western investors. In sum, Moldova needs to realise that it is not only high rates of return that attract foreign investment; it is equally important to ensure that investors have confidence in the country’s institutions.

Vlad Spânu is the executive Director of the Moldova Foundation in Washington, DC and on the advisory board of the Viitorul Institute for Development and Social Initiatives, an independent think tank in Moldova. He has been a senior Moldovan diplomat in 1992-2001. Mr. Spânu got his master degree in public administration from a mid-career program at the Harvard’s Kennedy School of Government.

[i] A term invented by John Williamson from the US Institute for International Economics for the liberalising economic policies of the past two decades that were imposed on emerging countries by Washington-based institutions like the World Bank and the IMF.
[ii] In this article, most of the data for the Republic of Moldova does not include data for Transdniestria; although official Chisinau considers the break-away region part of Moldova, governmental institutions do not provide statistical data for Transdniestria, nor are estimates available.
[iii] GUUAM also became a forum for discussing common security concerns and for promoting conflict resolution, in particular in Azerbaijan’s Nagorno-Karabakh, Georgia’s Abkhazia and Moldova’s Transdniestria. 

(1) The article is written as a chapter of the book “The EU and Moldova: on a Fault-line of Europe”, published by the Federal Trust Fund, London, 2004


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