Geopolitical problems and macroeconomic reforms are currently preoccupying Armenia, but to achieve long-term growth and lift itself out of poverty the former Soviet republic must also grapple with microeconomic policy. Armenia should focus on developing the industry sectors that have the best chance of competing globally and on eliminating any barriers to productivity within them. Our study of this landlocked economy in the Caucasus (Exhibit 1) suggests that software and IT services are among its most promising sectors.

With annual growth of more than 20 percent since 1999, software and IT companies now account for 2 percent of Armenia’s GDP—a proportion comparable to that of India, the world’s leading offshore IT destination. Businesses in this sector achieve much higher productivity than the average for Armenia’s economy as a whole (11.5 percent of the US level). Why the relatively strong performance? The software and IT services sector is especially suited to exploit Armenia’s three competitive advantages. First, it has a well-educated workforce with an emphasis on science, a result of the country’s heritage as the Soviet Union’s high-tech center. The second advantage is low wages: a software and IT services specialist earns $2,400 to $6,000 a year,...