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ISET Economist Blog

A blog about economics in the South Caucasus.

On Social Planning, Symphonies and Cacophonies

An unprejudiced look at the Georgian economy is rather disenchanting. Starting in 1990 at a per capita income that was close to Poland’s, Georgia went into a free fall as a result of secession wars, loss of markets, an explosion of crime and corruption, and the staggering incompetency of its governments. It took Georgia 17 years, until 2007, to merely return to where it stood at the end of the Soviet Union. In these 17 years, Poland increased its output per capita by almost 700%, achieving a level of more than 25% percent of its neighbor Germany.

While Georgia’s tragedy is largely “home made”, the experience of recent years suggests that Georgians, a decent and hospitable people with many likable peculiarities, are also very good at finding solutions to problems of their own making. Without any doubt, the last 10 years are quite encouraging – starting from a pathetic level in 2003, per capita income has almost quadrupled. The lion share of this growth can be attributed to the Saakashvili regime’s ability to clean up the Augean stables of corruption and incompetence. Yet, the kind of growth that can be fostered through such internal reforms is ultimately limited. Georgia may by now have a modern and efficient state, but its economy is anything but modern. And it can only continue on the upward trend if the country gets better integrated in the global economy and has something of value to offer to other countries. In other words, to sustain high growth rates, Georgia has to find its long-run “business model”.

As it turns out, it is all but easy to make a unique contribution in a competitive world in which all stakes are claimed and all niches are occupied. What are the specific advantages Georgia can build on? And what can the Georgian government do to exploit them?


BENEVOLENT SOCIAL PLANNER AS AN ORCHESTRA DIRECTOR

One may argue that Georgia has low levels of physical and human capital, yet this is not the only problem. If that was all, Georgia would have experienced large inflows of capital goods and high level of training (financed by foreign borrowing), because returns to investment would be high. One reason we do not observe an investment rally in Georgia (as well as in many other developing economies) is the presence of what economists refer to as “coordination failures” (or cacophonies).

To understand this concept one has to understand that related economic activities can have a mutually reinforcing effect on each other. Economists say that these activities have “positive externalities”. The classical example is the Silicon Valley in California. Because there are so many companies working on software and computer technology in what was previously known as the Santa Clara Valley, it is a highly attractive place for new companies that are active in the same fields. You need a programmer specialized in 3D graphics programming? Can be found in the Silicon Valley. You search for a company that provides a highly specialized software solution for an electronic commerce application? No problem in the Silicon Valley. You look for cooperation partners for technology projects and companies with expertise that complements your own? Guess where you will find them...

Ever since the Silicon Valley succeeded so overwhelmingly as an information technology hub, many countries all over the world have tried to perform the same symphony. Some did very well, like Israel, while others are now left with empty industrial parks and lots of wasted subsidies. Nonetheless, it is clear that government policies may play an important role in promoting private investment, as there is an obvious coordination problem when private entrepreneurs are left alone. If my business can only flourish in combination with your business and vice versa, one of us must start his business first in order to make the other one profitable. If the government coordinates these efforts, for example through targeted subsidies, it may cause both businesses to start at the same time, solving the coordination problem.

In all likelihood, Georgia won’t become an information technology hub as Georgia’s contribution to the global computer industry has so far been limited to a failed attempt to establish a government-subsidized computer assembly industry. If Georgia wants to go for a hub strategy, it has to take advantage of its unique strengths, for instance Georgia’s position at the heart of the South Caucasus.


GEORGIA AS A LOGISTICS HUB ALONG THE CAUCASUS TRANSPORT CORRIDOR?

Indeed, Georgia could use its geographic location to establish an integrated Caucasus Transport Corridor (CTC). This would combine airports, road transport, train lines, and a maritime connection point at Poti with world class logistics services. If Georgia succeeds in coordinating private investment in related industries, it would be able to offer low cost, safe, and timely transshipment services to exporters and importers operating between Central Asia, Caucasus and Europe. Such combined logistics services would naturally complement each other. Goods could enter at Poti, then be transported by train to Azerbaijan and from there, over the Caspian sea, to Central Asia. Alternatively, cargo could be reloaded and carried by trucks to Armenia, or via the Georgian Military Road to Russia. Road transport would fertilize train transport and vice versa, and both would fertilize and profit from sea transport via Poti.

With this goal in mind, it seems logical for a social planner with tight budget to not try to pick a specific industry for public investment but instead embark on reducing transport and transaction costs. Reducing trade costs does not only mean eliminating protection and regulatory barriers , but also investing in transport and logistics infrastructure. That is why actual public capital investment is also needed.  In this respect, Georgia pursues many promising projects. Deepening the shallow waters at the entrance channel to Poti will allow goods to enter the country via huge container ships. The almost completed Baku-Tbilisi-Kars Railway will allow the transport of cargo from Turkey through Georgia to Azerbaijan and back – literally connecting Asia with Europe. Road overhauls allow for road cargo. These should include the Georgian Military Road, leading to the only open border crossing with Russia at Kazbegi and connecting Russia with its ally Armenia. Road projects can be refinanced through road charges, while railway cargo yields income for Georgian railways servicers and the rail network owners. Harbor dues would incur at Poti.

Yet public investment in infrastructure is by no means the only instrument available to Georgia for unleashing its logistics potential. Moreover, in light of the tight budget constraint the public investment must be just sufficient to spark a round of private investment while outsourcing financing and the actual operations to the private sector or foreign investors (e.g. through concessions).

Independent of infrastructure, trade has to be made simple and cheap – also in this respect, Georgia is on a promising path. It has favorable trade agreements with most of its important trade partners, simple customs and border regulations, a low bureaucratic burden and no corruption. A really key issue, however, is that Georgia is at best only a part of the Caucasus Trade Corridor (CTC). There are many other bottlenecks along the CTC, including infrastructure problems in Azerbaijan and Kazakhstan, hence the need for international coordination – through diplomacy and alliance building. Last but not least, Georgia should make effective use of the tools available to it as a member of WTO to ward off protectionist policies by some of its neighbors, e.g. Turkey.

Of course, Georgia could and perhaps should go for other symphonies as well, yet, whatever it pleases to do, it should make sure it has an orchestra director with a good understanding of her role.

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Tuesday, 20 August 2019

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