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A blog about economics in the South Caucasus.

Riding the Dragon

Cultural and intellectual achievements herald economic success of a people, and the Chinese cultural and intellectual heritage is breathtaking. The Chinese discovered gunpowder, the compass, and the movable type printing press long before the Europeans. Admiral Zheng He’s fleet reached Mogadishu and Mombasa with up to 28,000 sailors at the same time when the Europeans set out to discover Africa with crews of not more than 300 sailors. Temporarily lamed by Mao and his followers, capitalism has unleashed the dragon once again! China is about to become the major global economic power soon, and many pundits already now declare the 21st to be a “Chinese Century”, as opposed to the 20th being an “American Century”.

Recently, Georgia came into the focus of attention of Chinese businessmen. The Chinese Hualing group considers the realization of a huge commercial center near the Tbilisi Sea, called the Hualing International Economic Zone. The project was negotiated and signed with the previous government and aims at nothing less than creating a new city near the Tbilisi Sea with a population of up to 200 000 people. This new district of Tbilisi would have modern public infrastructure, it would include an industrial park with processing plants and logistics centers, a trade area, office blocks, and a 5-star hotel. According to the plans, commercial operations would already start by 2015. Is this a chance for Georgia to profit from the economic verve of the Chinese?

 

ridingthedragon

The Hualing Economic Zone being built


THE PURPOSE OF THE ZONE

In Georgia, the debate about this project revolved around three dimensions – demography, culture, and economics. While recently, the first two drew a lot of public attention, the economic aspects of the project were perhaps not fully appreciated.

The project by Hualing International would be one of the largest investments in Georgia within the past two decades. It is not only large because the amount of invested money is huge, but primarily because its implementation may have significant consequences for the Georgian economy at large.

Since the 1990s, Chinese companies, often supported by the government, implemented similar projects in various developing countries, in particular in Africa and South East Asia. In most cases, the primary goal of such ventures was natural resource extraction and the opening up of new markets for Chinese products. As natural resources are arguably not the primary driving force behind the Chinese engagement in Georgia, one may speculate that its natural strategic location on the crossroads of Europe and Asia is what makes Georgia interesting for the Chinese. Like the caravansaries along the ancient Silkroad, Tbilisi could once again serve as a logistics hub for facilitating Chinese exports to the Caucasus, Turkey, and the European market.

How the project will affect economic and social matters in Georgia depends very much on the specific economic activities Chinese companies will carry out. If extensive logistics and manufacturing will pick up in Tbilisi, this may offer jobs for thousands of Georgians. If it is mainly about importing and re-exporting Chinese products through the zone, with very little value added locally, the impacts may be much more limited. Unfortunately, there is only scarce information available on how exactly the Chinese want to earn money in Georgia, so the following analysis is speculative in character.


SHORT-RUN IMPACTS ON THE GEORGIAN ECONOMY

The contract between Hualing International and Georgia states that during the first 10 years, Hualing International will be exempt from value-added tax (VAT), profit taxes, and dividend taxes. During the first five years, there will be no property tax. In addition, no import tariffs on construction materials, machinery, and inventory for the hotel have to be paid until 2015. Georgian companies serving the same markets as the zone might face difficulties to compete with businesses that work under such favorable conditions.

If the contention is right that the Chinese want to use Tbilisi as a logistics basis for their exports to the Caucasus and its adjacent regions, there may be higher imports of machinery and equipment, footwear and clothing, lamps, toys, and furniture to Georgia. Many of these goods are not produced in Georgia on a sizeable scale and Georgian producers will therefore hardly be affected. Yet the competitive pressure for importers and retailers may increase considerably, and local marketplaces like the “Lilo Mall” may feel the arrival of the Chinese very strongly. Some of the imports, however, may indeed compete with local produce. Talking about furniture, currently the Georgian producers have to cope with European and Turkish imports that often serve the high-end segment of the market. Introducing China as an additional major provider of (cheap) furniture may severely tighten the competitive pressure for local producers.


LONG-RUN CONSEQUENCES

While increased competition yields the risk that some Georgian producers and retailers may be crushed by the additional competitive pressure, there may be advantages in the long run. Those Georgian firms that finally survived the harsh competition will have bettered their productivity, cost structure, and improved the quality of their produce. While being a painful process, in this way tighter competition will foster innovation and creativity in the local economy in the long-run. Moreover, a more sophisticated economy requires more advanced human skills. As a result, the value of human capital in Georgia will increase, leading to more resources flowing into on-the-job and vocational training, while at the same time efforts will be made to improve the public education system.

One may also hope for technological spillovers from Chinese firms if these would engage in technologically advanced activities. Utilizing on technological spillovers that emerged from Western companies producing in China allowed the Chinese to quickly close the technological gap to the Western countries, and Georgia could take China as a role model in this respect.

Finally, the government would benefit from any economic activity induced by the zone, even if there were no VAT and profit taxes. Georgian personnel will have to pay income taxes, and people working in the zone will also make purchases outside the zone on which VAT does apply. Finally, the Georgian government will not grant tax advantages to the Chinese firms forever. Once these advantages are removed, additional income will accrue to the government.

Europeans and Americans may be culturally closer to the Georgian mentality, but when their economies are lame ducks that do not move, one should try out to ride on the Chinese dragon.

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Guest - Eric Livny on Monday, 03 June 2013 14:25

A very interesting undertaking, thanks for posting.

There is a development theory attributed to Alexander Gershenkron (http://en.wikipedia.org/wiki/Alexander_Gerschenkron) which suggests that backward nations can skip stages in development by adopting the latest technology or cutting edge institutional designs. In other words, the backward nations can free ride on the knowledge pool created by other nations. And they can learn from their mistakes, too.

During the past 60+ years, ever since China was liberated and united by Mao, China has been picking and choosing from the vast array of options available to it from the West and its own history. It started with Marxism (a purely Western idea), moved to capitalism, and is now onto building a global economic empire, very much like the British, French and Americans before them (but without killing or slaving the natives).

Maybe it is time for all of us, Georgians and not only, to learn from the Chinese experience (and the Chinese language?)

A very interesting undertaking, thanks for posting. There is a development theory attributed to Alexander Gershenkron (http://en.wikipedia.org/wiki/Alexander_Gerschenkron) which suggests that backward nations can skip stages in development by adopting the latest technology or cutting edge institutional designs. In other words, the backward nations can free ride on the knowledge pool created by other nations. And they can learn from their mistakes, too. During the past 60+ years, ever since China was liberated and united by Mao, China has been picking and choosing from the vast array of options available to it from the West and its own history. It started with Marxism (a purely Western idea), moved to capitalism, and is now onto building a global economic empire, very much like the British, French and Americans before them (but without killing or slaving the natives). Maybe it is time for all of us, Georgians and not only, to learn from the Chinese experience (and the Chinese language?)
Guest - Simon Appleby on Monday, 03 June 2013 14:54

Good to see this analysis, well done.

Xinjiang Hualing is a private company, albeit with close connections to the Chinese government. It will likely develop factories and logistics companies of its own within the zone, but also other Chinese companies are likely to locate themselves within the zone. As far as anyone can tell, these independent Chinese firms will not be entitled to the same tax concessions as the developer is. When one considers the massive opportunity cost on capital invested (let us say 12% p.a.), and the long period between breaking ground and establishing cashflow (perhaps 2-3 years), the concessions are perhaps less likely to distort the market as much as might be feared.

Over the past decade, the Chinese government policy has shifted from being hostile to Chinese firms investing their capital abroad, to cautiously permitting Chinese investment abroad where it appears to be in the national interest. To a large extent, these investments are made by listed Hong Kong holding companies of Chinese firms, which allows greater forex flexibility, tax-effectiveness, and access to foreign currency through share placements and bond issues in the Hong Kong market.

Both logistics and manufacturing are very desirable industries to encourage in Georgia, as they have the potential to employ many tens of thousands of semi-skilled labourers who have not had regular employment in the past two decades. The Deep and Comprehensive Free Trade Agreement with the EU, likely to be fully ratified in 2015, may prove very attractive to Chinese TCF (textile-clothing-footwear) manufacturers to locate here instead of Bulgaria or Romania, where labour and power is more expensive.

Good to see this analysis, well done. Xinjiang Hualing is a private company, albeit with close connections to the Chinese government. It will likely develop factories and logistics companies of its own within the zone, but also other Chinese companies are likely to locate themselves within the zone. As far as anyone can tell, these independent Chinese firms will not be entitled to the same tax concessions as the developer is. When one considers the massive opportunity cost on capital invested (let us say 12% p.a.), and the long period between breaking ground and establishing cashflow (perhaps 2-3 years), the concessions are perhaps less likely to distort the market as much as might be feared. Over the past decade, the Chinese government policy has shifted from being hostile to Chinese firms investing their capital abroad, to cautiously permitting Chinese investment abroad where it appears to be in the national interest. To a large extent, these investments are made by listed Hong Kong holding companies of Chinese firms, which allows greater forex flexibility, tax-effectiveness, and access to foreign currency through share placements and bond issues in the Hong Kong market. Both logistics and manufacturing are very desirable industries to encourage in Georgia, as they have the potential to employ many tens of thousands of semi-skilled labourers who have not had regular employment in the past two decades. The Deep and Comprehensive Free Trade Agreement with the EU, likely to be fully ratified in 2015, may prove very attractive to Chinese TCF (textile-clothing-footwear) manufacturers to locate here instead of Bulgaria or Romania, where labour and power is more expensive.
Guest - M on Monday, 03 June 2013 16:41

There is a history of Chinese immigration into Georgia jumpstarting domestic industries: "[...] a tea-specialist named Liu Junzhou came from China’s Guangdong province to Chakvi in Adjara region of Georgia in 1890. He, along with the handful of colleagues he brought from China can be attributed with creating the first tea culture in Georgia. The red tea he cultivated won the top award at the Paris World Fair in 1900, and Georgian tea continued to maintain a high reputation decades later."

There is a history of Chinese immigration into Georgia jumpstarting domestic industries: "[...] a tea-specialist named Liu Junzhou came from China’s Guangdong province to Chakvi in Adjara region of Georgia in 1890. He, along with the handful of colleagues he brought from China can be attributed with creating the first tea culture in Georgia. The red tea he cultivated won the top award at the Paris World Fair in 1900, and Georgian tea continued to maintain a high reputation decades later."
Guest - Admin on Monday, 03 June 2013 17:43

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Guest - Karina on Monday, 03 June 2013 17:45

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Guest - blintu on Monday, 03 June 2013 20:21

After giving so many advantages is there really much benefit left for Georgia? And is it worth the dangers, which Georgian businesses will face?

I hope it will be very beneficial for Georgian development, but it may not

After giving so many advantages is there really much benefit left for Georgia? And is it worth the dangers, which Georgian businesses will face? I hope it will be very beneficial for Georgian development, but it may not
Guest - Simon Appleby on Sunday, 09 June 2013 15:57

China's economic history in the 20th century is an interesting one.

From the fall of the Qing Dynasty in 1911 to the end of the Warlord Era in the late 20's, China's economy was moribund. The Nationalists' Northern Expedition of 1926-1928, the assassination or assimilation of the regional Warlords, and the extermination of the Communists in China's larger cities allowed for a modest economic boom in the 1930's in much of China, as well as a relatively free press and universal suffrage being exercised in many regions. The Japanese invasion of northern and eastern China in 1937 scuttled this progress, and the Civil War laid waste to China's economy until the early 1950's, when the restoration of basic peace and order resulted in chronic food shortages abating and some modest economic growth, notwithstanding nationalisation of many private businesses.

Mao's "Great Leap Forward" from 1958-1961 was modelled on Stalin's suppression of the kulaks and collectivisation of agriculture. It resulted in China's economic collapse and the starvation of over 30 million people; cannibalism was rife at this time. Mao was eventually sidelined by moderates and some progress in addressing severe food shortages was made; some modest economic growth as the country began industrialising again was noted.

Mao's "Great Proletarian Cultural Revolution" of 1966-1976 was revenge against the elements who had sidelined him in 1961, and resulted in schools and universities closing, educated people being deported to the countryside to 'Learn from the Peasants", the economy collapsing, and over 20 million fatalities due to starvation and violence.

When Deng Xiaoping took control of the country in 1978, he inherited a country with a massive population experiencing huge food shortages, a moribund and backward manufacturing sector, a weak military incapable of defending the country against Soviet and American encroachment, and a whole generation of young people who had been denied education. Tapping into the expertise and networks of diaspora Chinese rejuvenated China's industrial and trading base, as did encouraging foreign investors to relocate manufacturing in China with special tax concessions. Reforms to agricultural production, allowing peasant farmers the right to sell produce independent of the state once they had achieved basic state quotas, resulted in the fastest rate of economic growth in the Chinese countryside in history; economic growth in rural areas between 1978 and 1989 has never been matched since.

The Tiananmen Incident of 1989 was driven in part by skyrocketing food prices in the cities, that had risen close to world prices once price controls were relaxed. In order to keep a lid on dissent in China's cities, price controls were reintroduced on many food items and economic growth in the countryside slowed. Taxation in China's villages escalated so that many poor farmers were paying the equivalent of 60% of their gross income to the state in the 1990's and early 21st century; much of China's gleaming urban infrastructure was built with funds squeezed out of China's long-suffering peasantry.

The current economic model in China is not dramatically different to that of Spain or Italy in the 1930's (or indeed, Russia now); strategic industries controlled by the State, somewhat important industries controlled by Party members and their relatives, and the ordinary citizens free to fight over market share in manufacturing, retail trade and hospitality.

China's policy of offering large concessions to diaspora and foreign investors in the rejuvenation of its industrial and trading base has generally been a great success. It has empowered the domestic industry rather than the country being economically colonised by foreigners as initially feared; many successful Chinese entrepreneurs are veterans of foreign-invested or diaspora-invested firms, as are many of their top managers.

Two good general non-academic texts on some of these historical issues are 'Mao; The Unknown Story' by Jung Chang and John Holliday (2005) and "Will the Boat Sink the Water?; the Life of China's Peasants" by Chen Guidi and Wu Chuntao (2006).

China's economic history in the 20th century is an interesting one. From the fall of the Qing Dynasty in 1911 to the end of the Warlord Era in the late 20's, China's economy was moribund. The Nationalists' Northern Expedition of 1926-1928, the assassination or assimilation of the regional Warlords, and the extermination of the Communists in China's larger cities allowed for a modest economic boom in the 1930's in much of China, as well as a relatively free press and universal suffrage being exercised in many regions. The Japanese invasion of northern and eastern China in 1937 scuttled this progress, and the Civil War laid waste to China's economy until the early 1950's, when the restoration of basic peace and order resulted in chronic food shortages abating and some modest economic growth, notwithstanding nationalisation of many private businesses. Mao's "Great Leap Forward" from 1958-1961 was modelled on Stalin's suppression of the kulaks and collectivisation of agriculture. It resulted in China's economic collapse and the starvation of over 30 million people; cannibalism was rife at this time. Mao was eventually sidelined by moderates and some progress in addressing severe food shortages was made; some modest economic growth as the country began industrialising again was noted. Mao's "Great Proletarian Cultural Revolution" of 1966-1976 was revenge against the elements who had sidelined him in 1961, and resulted in schools and universities closing, educated people being deported to the countryside to 'Learn from the Peasants", the economy collapsing, and over 20 million fatalities due to starvation and violence. When Deng Xiaoping took control of the country in 1978, he inherited a country with a massive population experiencing huge food shortages, a moribund and backward manufacturing sector, a weak military incapable of defending the country against Soviet and American encroachment, and a whole generation of young people who had been denied education. Tapping into the expertise and networks of diaspora Chinese rejuvenated China's industrial and trading base, as did encouraging foreign investors to relocate manufacturing in China with special tax concessions. Reforms to agricultural production, allowing peasant farmers the right to sell produce independent of the state once they had achieved basic state quotas, resulted in the fastest rate of economic growth in the Chinese countryside in history; economic growth in rural areas between 1978 and 1989 has never been matched since. The Tiananmen Incident of 1989 was driven in part by skyrocketing food prices in the cities, that had risen close to world prices once price controls were relaxed. In order to keep a lid on dissent in China's cities, price controls were reintroduced on many food items and economic growth in the countryside slowed. Taxation in China's villages escalated so that many poor farmers were paying the equivalent of 60% of their gross income to the state in the 1990's and early 21st century; much of China's gleaming urban infrastructure was built with funds squeezed out of China's long-suffering peasantry. The current economic model in China is not dramatically different to that of Spain or Italy in the 1930's (or indeed, Russia now); strategic industries controlled by the State, somewhat important industries controlled by Party members and their relatives, and the ordinary citizens free to fight over market share in manufacturing, retail trade and hospitality. China's policy of offering large concessions to diaspora and foreign investors in the rejuvenation of its industrial and trading base has generally been a great success. It has empowered the domestic industry rather than the country being economically colonised by foreigners as initially feared; many successful Chinese entrepreneurs are veterans of foreign-invested or diaspora-invested firms, as are many of their top managers. Two good general non-academic texts on some of these historical issues are 'Mao; The Unknown Story' by Jung Chang and John Holliday (2005) and "Will the Boat Sink the Water?; the Life of China's Peasants" by Chen Guidi and Wu Chuntao (2006).
Guest - Florian on Sunday, 09 June 2013 20:45

Hi Simon, Thank you for this well informed contribution. Ignoring the moral dimension, Mao's economic achievements are controversial among many Chinese, similar as Russians still disagree on how to evaluate Stalin's industrialization of Russia. Personally, I agree with you -- there is little positive to be said about Mao's take on economics. Yet decades of propaganda obscure the assessment even of smart people, and that's why many Chinese have a deep-grained admiration for Mao. Propaganda has even more impact when it comes to Taiwan -- I experienced that it is impossible to speak about Taiwan even with otherwise fully reasonable Chinese people.

Hi Simon, Thank you for this well informed contribution. Ignoring the moral dimension, Mao's economic achievements are controversial among many Chinese, similar as Russians still disagree on how to evaluate Stalin's industrialization of Russia. Personally, I agree with you -- there is little positive to be said about Mao's take on economics. Yet decades of propaganda obscure the assessment even of smart people, and that's why many Chinese have a deep-grained admiration for Mao. Propaganda has even more impact when it comes to Taiwan -- I experienced that it is impossible to speak about Taiwan even with otherwise fully reasonable Chinese people.
Guest - Eric Livny on Tuesday, 11 June 2013 09:41

Many thanks for your comment and references, Simon, much appreciated. Unfortunately, I never had the chance to read up on Chinese history, not even the recent one. Many years ago I took a very impressive course on Asian Marxism which had a lot of influence on the way I am thinking of Asia to this date.

Many thanks for your comment and references, Simon, much appreciated. Unfortunately, I never had the chance to read up on Chinese history, not even the recent one. Many years ago I took a very impressive course on Asian Marxism which had a lot of influence on the way I am thinking of Asia to this date.
Guest - Simon Appleby on Sunday, 09 June 2013 23:00

Even Chinese Communist Party members, after enough drinks, will agree that Mao had a disastrous effect on the economy. There is little controversy in this, it is well accepted by all levels of society and nobody goes to jail for saying this anymore (but you might be blackballed by the Communist Youth League for saying so).

Taiwan to an extent represents what China would be economically if the Communists had lost the Civil War; the Mainland's GDP per capita is about 1/3 that of Taiwan.

It is now quite easy for Mainland people to travel to Taiwan for trade and tourism, so the ignorance and antipathy amongst Mainlanders is subsiding. Various museums in the Mainland that commemorate aspects of Generalissimo Chiang Kai-Shek's life have been renovated so that "evil dictator and running dog of the American Imperialists Chiang Kai-Shek" has been rehabilitated to "significant historical identity Mr Chiang Kai-Shek". The major role that the Nationalists played in resisting the Japanese occupation is now being recognised by many Mainland historians. Taiwan and the Mainland are very closely linked economically and separatist parties in Taiwan are now much less popular than they were a decade ago.

Even Chinese Communist Party members, after enough drinks, will agree that Mao had a disastrous effect on the economy. There is little controversy in this, it is well accepted by all levels of society and nobody goes to jail for saying this anymore (but you might be blackballed by the Communist Youth League for saying so). Taiwan to an extent represents what China would be economically if the Communists had lost the Civil War; the Mainland's GDP per capita is about 1/3 that of Taiwan. It is now quite easy for Mainland people to travel to Taiwan for trade and tourism, so the ignorance and antipathy amongst Mainlanders is subsiding. Various museums in the Mainland that commemorate aspects of Generalissimo Chiang Kai-Shek's life have been renovated so that "evil dictator and running dog of the American Imperialists Chiang Kai-Shek" has been rehabilitated to "significant historical identity Mr Chiang Kai-Shek". The major role that the Nationalists played in resisting the Japanese occupation is now being recognised by many Mainland historians. Taiwan and the Mainland are very closely linked economically and separatist parties in Taiwan are now much less popular than they were a decade ago.
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