World Bank warns of 3 key challenges for Uzbekistan’s services sector

Prospects for the Growth of the Services Sector in Uzbekistan: Challenges, Opportunities, and Development Paths

The services sector plays a central role in Uzbekistan’s economic structural transformations. Over the last three decades, the share of services has exceeded 50% in total employment, compensating for the decline in agriculture’s share. In early December, during a press conference attended by Ilkhom Norkulov (First Deputy Minister of Economy and Finance) and Timur Ishmetov (First Deputy Advisor to the President of the Republic of Uzbekistan), the World Bank presented its first detailed report on the services sector in Uzbekistan, which, according to Shukhrat Vafaev, Director of the Fund for Reconstruction and Development of Uzbekistan, was based on a direct request from the President of Uzbekistan.

The report highlights that despite significant achievements, the services sector in Uzbekistan faces several challenges, including low competitiveness, insufficient external market integration, and limited competencies.

Key Trends in Uzbekistan’s Services Sector

According to the World Bank, the services sector has become the main compensator for the structural changes in Uzbekistan’s economy. From 1991 to 2022, the share of employment in agriculture has nearly halved, while services have driven growth in employment and added value. However, although labor productivity growth in the services sector has outpaced similar indicators in industry, productivity remains significantly below the global average.

• Employment share: Services have become the leader in employment share, surpassing agriculture and industry.
• Added value: The services sector is providing sustained growth in its share of GDP.

World Bank lead economist Gaurav Nayyar, during the presentation of the report Prospects for Growth through the Services Sector in Uzbekistan in Tashkent on December 6, 2024, explained in detail how different service categories impact the country’s economy. He emphasized that the services sector is not homogeneous, and its contribution to the economy depends on the skill level, integration with other sectors, and opportunities for international trade.

Categories of Services in Uzbekistan’s Economy

Nayyar outlined four main categories of services, each with its own characteristics:

1.Global Innovative Services

This includes sectors such as Information and Communication Technology (ICT), professional, and financial services. They are highly skilled, closely linked to other sectors of the economy, and have high potential for international trade.

“Global innovative services make up only about 5% of jobs but contribute about 40% of the added value growth in recent years,” Nayyar noted.

2.Low-skilled Support Services

Low-skilled support services account for 60% of all employment but contribute only one-third of the added value growth. Services like transport and telecommunications are less dependent on highly skilled labor, but they are still connected to other sectors.

“These services perform connective functions, such as transporting goods involved in international trade,” added Nayyar.

3.Low-skilled Consumer Services

Retail trade and hospitality are examples of services that do not require significant skills and have a weak connection to other sectors. They focus directly on serving consumers, including tourists.

4.Social Services

This category includes government sectors like education and healthcare.

“Social services created about three out of four jobs over the last five years, but their link to the rest of the economy is limited,” emphasized Nayyar.

Productivity and Competitiveness Gaps in Uzbekistan

Despite positive trends, Uzbekistan lags behind OECD countries and its neighbors in labor productivity. The annual labor productivity growth rate in Uzbekistan remains below the regional average.

• Labor productivity: The services sector in Uzbekistan shows higher growth rates than agriculture and industry, but its productivity level is still significantly lower than OECD countries.
• Gaps: The productivity gap with leading countries is estimated at 3-5 years.

Main Challenges for Uzbekistan’s Services Sector

Gaurav Nayyar outlined three key challenges Uzbekistan faces in developing its economy through the services sector. These challenges relate to insufficient integration of services into the economy, a low share of innovative services, and low productivity in low-skilled sectors.

1.Insufficient Integration of Services with the Rest of the Economy

Nayyar noted that the share of services used in the manufacturing sector in Uzbekistan is only 9%. In comparison, in developed countries, particularly in the EU, this figure reaches 30-40%.

“Uzbekistan needs to strengthen the connections between the services sector and other industries,” emphasized the expert.

2.Low Share of Global Innovative Services in Exports

Despite growth potential, global innovative services account for only 10% of Uzbekistan’s total services exports.

“The structure of the services sector needs to be reconsidered to increase the share of high-productivity segments,” stated Nayyar.

3.Low Productivity in Low-skilled Services

These sectors, despite being among the largest employers in the country, suffer from insufficient adoption of digital technologies. Only about 20% of companies use basic digital solutions.

“Global experience shows that digitalization can significantly improve productivity, but in Uzbekistan, the level of technology adoption remains extremely low,” added Nayyar.

Shukhrat Vafaev emphasized that the services sector in Uzbekistan faces two major challenges: high financing costs and tax burdens.

“Today, Uzbekistan offers returns of 20-25% annually in US dollars, but due to tax and collection barriers, businesses find it extremely difficult to scale and reduce costs,” he noted.

In this context, developing infrastructure, IT technologies, telecommunications, logistics, and transport services is critical.

Among the successful initiatives highlighted in the report, Vafaev pointed to companies like TBC Bank and OTP Bank, as well as IT park residents. He stressed that removing barriers, such as the lack of a legal framework for data protection, is necessary for the growth of these sectors.

Service Exports and Foreign Investment in Uzbekistan

Service exports and foreign direct investment (FDI) inflows into the services sector are increasing, but growth rates remain insufficient. Contrary to global trends, service export growth in Uzbekistan lags behind goods exports, limiting Uzbekistan’s integration into the global economy.

• Trade dynamics: The total volume of trade in services is significantly lower than in goods sectors.
• FDI inflows: Although investment in the services sector is growing, it lags behind other sectors like utilities.

Social and Low-skilled Services in Uzbekistan: Structural Features

The structure of the services sector in Uzbekistan is skewed toward social and low-skilled services, which provide the majority of jobs but contribute less to added value growth.

• Social services: Healthcare, education, and public administration hold a significant share, providing employment growth. Social services and the public sector accounted for about 75% of new jobs in the last five years, contributing 25% to added value, but only representing 35% of total employment.
• Low-skilled services: Retail and hospitality form a large share of jobs but require productivity improvements. These services account for about 60% of all jobs, make up about 43% of added value in services, but their contribution to value-added growth is only one-third of the total services sector.

Meanwhile, global innovative services, although they create only 5% of jobs, account for about 40% of the added value growth. Global innovative services in Uzbekistan contribute 20% to added value.

Telecommunications, Internet, Connectivity, and Logistics in Uzbekistan: Prospects for Improvement

Uzbekistan lags behind other countries in the region in terms of connection to external markets. The development of 4G and logistics infrastructure requires significant investment.

• Digital connectivity: 4G coverage in the country remains 3-5 years behind neighboring countries like Georgia (100% coverage), Russia (~92%), and Kazakhstan (~85%).
• Logistics: The Logistics Performance Index (LPI) of Uzbekistan, based on customs ratings, international deliveries, monitoring, and infrastructure ratings, shows that Uzbekistan lags behind even lower-income countries. Uzbekistan’s LPI rating is 88, while Kazakhstan and Georgia have scores of 79, and European countries score 66.

Competitiveness: Barriers and the Potential for Trade Liberalization in Uzbekistan

High levels of trade restrictions hinder the development of the services sector. The Services Trade Restrictiveness Index (STRI) shows that services in Uzbekistan are more closed than in most countries.

• Uztelecom monopoly: Control over international access limits competition.
• State-owned enterprises: Most state-owned companies operate in sectors where competitive markets are possible.

Legislative Initiatives and Reforms in Uzbekistan

Uzbekistan is taking active steps to improve the business environment in the services sector. In October 2023, a new presidential resolution was passed aimed at improving the efficiency of Uzbek Railways. Additionally, a law on railway transport was adopted to attract the private sector and adjust tariff policies.

“For freight transportation, tariffs will no longer be controlled by the state, opening up more opportunities for private companies,” said Vafaev.

Special attention is also being given to modernizing aviation infrastructure, including Uzbekistan Airways and Tashkent International Airport, aimed at improving Uzbekistan’s competitiveness in the global economy.

Education Competence: The Need for Investment in Uzbekistan

Uzbekistan’s focus on advanced technical education creates a foundation for future development, but the share of STEM graduates remains low.

• Higher education: The share of the population with higher education in Uzbekistan is significantly lower than in neighboring countries.
• Digital skills: The introduction of structured management methods in businesses requires additional investments.

Necessary Changes for Uzbekistan’s Economic Growth

The key message from Nayar is that Uzbekistan should pay more attention to developing global innovative services. These sectors not only have high productivity but also have the potential for long-term growth in international markets.

Additionally, it is essential to address the low level of service sector integration, particularly in areas like logistics and digital infrastructure. Strengthening this framework is key to achieving economic growth in the services sector.