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A blog about economics in the South Caucasus.

Tiger in the Caucasus?

On the 14th of February, the Ministry of Economy and Sustainable Development of Georgia published the draft version of the Socio-economic Development Strategy 2020 (SDS). This comprehensive document identifies the main socio-economic challenges Georgia will be facing in the next years and presents a strategy how to cope with them. The overall goal is to achieve sustainable and inclusive growth until the end of this decade.

The spirit of the document very much reflects the principles of the new government. There is no belief in the self-regulatory power of market forces anymore, which was a dominant guideline for the economic policy of the United National Movement. Rather, the SDS emphasizes the role of a proactive public sector in reducing unemployment and in promoting investments and exports.

One cornerstone of the SDS strategy is the diversification of the Georgian economy, in particular through the development of sectors that have export potential. Specifically, the government plans to unlock new markets for Georgian exports by strengthening the partnership with potential export destinations, for example through trade agreements. Moreover, the government plans to defend more actively the interests of Georgian exporters in international markets. The document also mentions direct assistance to companies that would like to export but are too small to do the necessary market analyses (i.e. evaluating how much demand there will be in a foreign market). The SDS document also speaks about the government helping in the promotion of Georgian products abroad and about upgrading strategic infrastructure, in particular in transportation and logistics.


WE SAW THAT BEFORE

SDS closely emulates the so-called export-oriented industrialization strategy (EOI), an economic policy that aims at accelerating the industrialization process of a country through export expansion. The approach performed impressively when it was adopted by the so-called “Asian Tigers”: South Korea, Taiwan, Hong Kong, Singapore, and Thailand. Important elements of EOI were also successfully implemented in Indonesia, the Philippines, and, most prominently, China.

It is an empirical fact that EOI has the potential to develop a country – in the end of the 1950s, South Korea was one of the poorest countries of the world. Today it is considered to be a fully developed country, playing in the same league as Japan and Western Europe. South Korea is not a recipient of development aid anymore, but has become a donor that helps other countries.

Interestingly, in the 1950s of the last century, the conditions in the above-mentioned countries were similar to Georgia. There was large-scale poverty, sharp inequality, high unemployment, and a low-skilled but cheap labor force. While it would be wrong to describe the Georgian labor force as “low-skilled”, the qualification mismatch on the Georgian labor market essentially has the same effect. From the point of view of a company, it does not matter whether there are no engineers and technicians because of a general lack of human capital or because people have learned the wrong subjects.


THE DEVIL IS IN THE DETAIL

So, does SDS lay out the road map for turning Georgia into a “Caucasian Tiger”?

Georgia is not the first country trying to copy the success stories of the Asian Tigers. Unfortunately, EOI policies do not always work as well as in Korea and Singapore. Though EOI appears to be a straightforward and rather simple economic recipe, the concept largely failed to develop countries like India, Pakistan, and Bangladesh.

The problem is that there is a lot of fine-tuning necessary for making EOI work, and, even worse, there are relevant factors that are not under the control of a country like Georgia.

An important factor contributing to the success of EOI are high savings rates for a long period of time, something that seems go well with Confucian values of humility and modesty, but conflicts with the post-soviet desire for conspicuous consumption. Likewise, the Asians were eager to become technicians and engineers, i.e. to build up exactly the kind of human capital that is needed for EOI, while most young Georgians dream of becoming lawyers and managers, and they notoriously avoid technical and mathematical subjects at the universities. Bluntly speaking, if the Georgians want to adopt EOI, they may have to work on their mentalities first, something that is often unpleasant and painful.

Even worse, the general circumstances for successfully implementing EOI may have been more favorable between 1960 and 2000 than they are today. For example, at first sight it might look as if world trade has become more liberal due to GATT, WTO and the like. Yet a country that wants to export, say, agricultural produce to the European Union, will get a nasty surprise. Export to the EU is discouraged by excessive sanitary requirements, the demand for exact certificates of origin, and the need to comply with a whole bunch of other EU regulations. The EU even prescribes a range for the bend of bananas to be sold in EU markets. Arguably, it is more difficult today to export to developed countries than it was 30 years ago.

Even more important, for being successful as an exporter, a country has to utilize on its “comparative advantages”. By the very concept, every country has a comparative advantage in producing something, but it is not the case that all possible comparative advantages one might have are equally beneficial. The comparative advantage in the production of advanced machinery and cars is arguably with countries like the US, Germany, and Japan. Supplying the world with advanced machinery is, however, very profitable. A comparative advantage for producing cheap textiles, plastic toys, or coffee beans, yields less potential for developing an economy. It is very questionably whether, at least at the moment, Georgia has a comparative advantage in the production of goods that foster affluence and prosperity – otherwise, our country would not be so poor.

So, while it is nice to outline an EOI strategy, the true challenges come with its implementation. The Asian Tigers could ride on the waves of various technological revolutions, in particular related to electronics, computers, and software, that took place in the last 50 years. Moreover, they were the beneficiaries of the exodus of many traditional industries, like textile production, out of high-income countries. An EOI strategy is something to be considered seriously, and it is good that the government creates documents like the SDS, yet the crucial question remains: What could a Caucasian Tiger provide to the world better than other countries?

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Guest - vato on Monday, 03 March 2014 18:02

While the so called vision 2020 emphasizes the need for export orientation it does not tackle the issue on how shall Georgian businesses obtain the respective technologies to be competitive worldwide, which is the essential issue I believe.

As for comparative advantage, I really doubt that Japan or S.Korea had any comparative advantage when they started industrialization, but they somehow achieved that. We need to understand what policies they employed otherwise there will never be any comparative advantage in Georgia

While the so called vision 2020 emphasizes the need for export orientation it does not tackle the issue on how shall Georgian businesses obtain the respective technologies to be competitive worldwide, which is the essential issue I believe. As for comparative advantage, I really doubt that Japan or S.Korea had any comparative advantage when they started industrialization, but they somehow achieved that. We need to understand what policies they employed otherwise there will never be any comparative advantage in Georgia
Guest - Eric on Tuesday, 04 March 2014 04:48

Tigers are long extinct in the South Caucasus... Only their paper version (wrapped in tiger skin) may be found in bookstores...

Tigers are long extinct in the South Caucasus... Only their paper version (wrapped in tiger skin) may be found in bookstores...
Guest - Ia on Wednesday, 05 March 2014 05:00

More optimistic view: If South Caucasus tiger does not exist (any more) we need to think up ways how to built appropriate "zoo" for Asian Tigers.

More optimistic view: If South Caucasus tiger does not exist (any more) we need to think up ways how to built appropriate "zoo" for Asian Tigers.
Guest - Giorgi on Tuesday, 04 March 2014 21:26

Very interesting Ia... definitely this document alone is not enough, it should be followed by the complex set of comprehensive policies, each of them prescribed in detail with full account of not only the impacts on the target sectors but also their externalities...
when properly planned and done, everything is possible.... when :)

Very interesting Ia... definitely this document alone is not enough, it should be followed by the complex set of comprehensive policies, each of them prescribed in detail with full account of not only the impacts on the target sectors but also their externalities... when properly planned and done, everything is possible.... when :)
Guest - Simon Appleby on Friday, 14 March 2014 03:15

The "failures" of India, Pakistan and Bangladesh to harness the benefits of export-oriented production are debatable. Pakistan is a significant exporter of stainless steel instruments and food products to the Middle East. Bangladesh is now a significant textile and garment producer.

All three South Asian countries made the same critical error after independence, to engage in various versions of protectionism and bureaucratic socialism (laced with a little crony capitalism). This was colloquially known as "government-approval-Raj" and it held all three countries back for decades. It is difficult to develop a fast-moving manufacturing sector when you need five hundred permits to open a factory and a massive wad of chits stamped to bring in a container of raw materials.

Georgia to date has failed to follow the basic strategic model of encouraging the processing-trade to set up in its jurisdiction. Successful competing jurisdictions offer fully-equipped industrial parks with all utilities connected and factory shells ready to move into overnight ( the Poti Free Zone has no waste water treatment system, severely limiting what industries can operate there, and very few shells available). Until its WTO entry, China offered tax rates to foreign industrial investors half that paid by local firms, which attracted thousands of foreign industrialists and facilitated its rise as an industrial power. Georgia missed that boat when it joined the WTO. Competing jurisdictions offer food processors in remote rural areas complete tax holidays for long periods and partial holidays for extended periods beyond. This has helped develop China and most of southeast Asia from very vulnerable cases to stable food security locations, with an interesting balance of food imports and exports. (For example, China is now the leading supplier of fruit and vegetable to both Japan and Korea; forty years ago China could hardly feed itself).

Competing jurisdictions also allow local accounts to be settled in foreign currency if desired, which reduces exchange rate risk and reduces costs, but cannot be done here. Competing jurisdictions also do not have a blanket ban on farmland being converted into industrial estate. Lastly, competing jurisdictions have good quality technical universities and vocational colleges immediately adjacent to industrial zones that respond quickly to industry's demands, and they poach top talent from abroad to staff these schools. Georgia's logical industrial heartland is the narrow belt of territory from Batumi to Anaklia along the Black Sea Coast, but much of the educational infrastructure is located a tiring 6 hour drive away in Tbilisi. Georgia's government would do well to see how competing jurisdictions have successfully attracted export-oriented manufacturing to their shores, instead of just chanting the mantra "No Corruption-Low Flat Tax" to potential investors.

The "failures" of India, Pakistan and Bangladesh to harness the benefits of export-oriented production are debatable. Pakistan is a significant exporter of stainless steel instruments and food products to the Middle East. Bangladesh is now a significant textile and garment producer. All three South Asian countries made the same critical error after independence, to engage in various versions of protectionism and bureaucratic socialism (laced with a little crony capitalism). This was colloquially known as "government-approval-Raj" and it held all three countries back for decades. It is difficult to develop a fast-moving manufacturing sector when you need five hundred permits to open a factory and a massive wad of chits stamped to bring in a container of raw materials. Georgia to date has failed to follow the basic strategic model of encouraging the processing-trade to set up in its jurisdiction. Successful competing jurisdictions offer fully-equipped industrial parks with all utilities connected and factory shells ready to move into overnight ( the Poti Free Zone has no waste water treatment system, severely limiting what industries can operate there, and very few shells available). Until its WTO entry, China offered tax rates to foreign industrial investors half that paid by local firms, which attracted thousands of foreign industrialists and facilitated its rise as an industrial power. Georgia missed that boat when it joined the WTO. Competing jurisdictions offer food processors in remote rural areas complete tax holidays for long periods and partial holidays for extended periods beyond. This has helped develop China and most of southeast Asia from very vulnerable cases to stable food security locations, with an interesting balance of food imports and exports. (For example, China is now the leading supplier of fruit and vegetable to both Japan and Korea; forty years ago China could hardly feed itself). Competing jurisdictions also allow local accounts to be settled in foreign currency if desired, which reduces exchange rate risk and reduces costs, but cannot be done here. Competing jurisdictions also do not have a blanket ban on farmland being converted into industrial estate. Lastly, competing jurisdictions have good quality technical universities and vocational colleges immediately adjacent to industrial zones that respond quickly to industry's demands, and they poach top talent from abroad to staff these schools. Georgia's logical industrial heartland is the narrow belt of territory from Batumi to Anaklia along the Black Sea Coast, but much of the educational infrastructure is located a tiring 6 hour drive away in Tbilisi. Georgia's government would do well to see how competing jurisdictions have successfully attracted export-oriented manufacturing to their shores, instead of just chanting the mantra "No Corruption-Low Flat Tax" to potential investors.
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