ISET

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A blog about economics in the South Caucasus.

What Happens When Institutions are Designed to Provide Bullet-proof Protection against Fraud?

DESIGNING LIBRARIES

 “Shock and awe” is a US military term describing the use of overwhelming power to demoralize the enemy, as applied by the American military in Iraq. “Shock and awe” would also aptly describe my emotional state when I entered, at the age of 23, the magnificent reading room at the Bodleian Library in Oxford. This was the moment when I – a former paratrooper and an officer with one of Israel’s security services – understood how badly I want to acquire an education. Not technical knowledge or skills, but an education.

  

Mar-26_2015_500

Bodleian Library. University of Oxford.

 

“Shock and awe”, albeit of a different kind, would also aptly describe my feelings when inspecting, back in 2007, the space designated for ISET’s library. Previously occupied by a Soviet planning institute, our 7-story building on Zandukeli 16 was being remodeled, as befitting Tbilisi State University’s (and Georgia’s) flagship education program. Yet, what I saw was utterly uninspiring.

Whoever “designed” the library, simply connected a series of small offices on one side of a long corridor. All walls were left intact. All office doors but one – designated as the main entrance - were permanently blocked, creating a cul-de-sac situation, with not even an emergency exit. An unusually narrow door, only 60cm wide (barely enough for a healthy Georgian guy), led to the registration desk, located right by the main entrance. An image of the three-headed Cerberus popped on my mind, -- “to prevent the dead from escaping and the living from entering.”

“We want to make sure that precious books don’t get stolen from the library”, I was told by my  new Georgian colleagues.

I was not convinced that preventing theft should be the main purpose of a library’s design. It took another 3 months of wrangling with TSU’s byzantine bureaucracy (nobody wanted to take responsibility for tearing down walls) and $50,000 to remodel the floor and create an effective institution. An institution where students spend all their free time, to study and socialize. An institution that demonstrates the spirit of ISET – modernity, openness, and dedication to learning.

To date, our library is not equipped with an expensive security system. Its doors are wide open 24/7, under students’ own supervision. And, as could be expected, a few books get lost (or maybe stolen) every year, which I consider to be a modest price for having an effective institution.


DESIGNING FARMER COOPS

The law on agricultural cooperatives, passed by the Georgian parliament in July 2013, provided, for the first time since 1991, the legal framework for farmer cooperation, making it very easy for farmers to come together and register a joint legal entity.

All members are expected to be directly involved in agricultural activities of the group, but the minimum number of members is purposefully set a very low level – 5 farmers in the lowlands and 3 in the sparsely populated mountain areas.

The law does not restrict the kind of activities farmer coops are allowed to engage in – these can range from production and processing to transportation and marketing of agricultural products.

While required to operate subject to a fairly detailed charter, coop members are given considerable freedom in designing internal policies and procedures, including the rules for (democratic) decision-making and distribution of profits and losses.

A special legal entity, Agency for the Development of Agricultural Cooperatives (the “Agency”), was created under the Ministry of Agriculture, to facilitate the creation of agricultural coops, monitor their activities, and implement government support measures.

Anticipating a spate of benefits, including preferential credit and grants, tax privileges and training, more than 600 farmer groups registered with the Agency between July 2013 and February 2015. This could be considered a great success, except that registered farmer groups consist of only 6-7 members on average. Thus, the total number of households involved in the coop movement so far stands at less than 5,000 (or about 1% of Georgia’s rural households).

The small size and weakness of registered farmer coops is a cause of concern for the Ministry of Agriculture. Speaking to a group of stakeholders earlier this week, Minister Otar Danelia indicated that “time has come to shift from quantity to quality”, i.e. to make sure that registered farmer coops are real farmer organizations.


RE-DESIGNING FARMER COOPS

The purpose of the meeting, organized by MoA and the Agency in cooperation with the European Neighbourhood Programme for Agriculture and Rural Development (ENPARD), was to discuss a number of amendments to the law on agricultural cooperatives. These amendments roughly fall into two categories: those seeking to strengthen new and existing farmer groups (“positive”) and those seeking to prevent others (individuals or commercial operators) from creating businesses disguised as farmer coops in order to take advantage of whatever tax breaks and support measures offered by the government and international donors. Naturally, the two sets of measures are at odds with each other.

Belonging into the first type are proposals to:

    • increase the minimum size of a coop from 5 and 3 members (in low- and highlands, respectively), to 11 and 5 (and impose this size requirement on the already registered groups, many of which, it is claimed, are consist of close relatives)
    • allow a class of “associated members”, including businesses or individuals (both Georgian and foreign!), who would not be directly involved in agricultural production activities, but would help get farmer groups off the ground, assist with their organization, technology, skills, market linkages and access to finance, etc.


The second type of amendments includes provisions to:

    • limit the opportunities for “associated members” to receive dividends (capped at 30% of a coop’s annual profit) and influence the coop’s decisions (by denying them voting rights).
    • limit the opportunities for coops to purchase agricultural products from, or provide services to, non-members beyond 30% of the cooperative’s annual turnover. The fear is that businesses will be set up disguised as coops in order to purchase machinery and process agricultural products taking advantage of subsidies, preferential loans and grants.


There are three problems with these amendments.

First, while the goal of increasing coops’ size is generally consistent with international practice and common sense, by retroactively imposing the new size restrictions on already registered coops’ the new law would result in artificial inflation of membership size or, much worse, disqualification of existing groups. Having smaller coops in the system (at least for the time being) would be a small price to pay to avoid a major crisis in the budding coop movement.

Second, the notion of “associated members” certainly addresses an acute need of new farmer organizations. Yet, coming with so many extra requirements and caveats – meant to prevent “abuse” and “theft” - this proposal is very unlikely to achieve its stated objective: create the conditions for cooperation between nascent farmer groups and external market players. A little bit of “theft” and “abuse” may be a reasonable price to pay for the chance to sustain farmer organizations beyond the scope of ENPARD, which is what “associated members” can help achieve better than anybody else.

Third, the cap on purchases and services to non-members is indeed a common way to encourage growth in coop membership. While somewhat true (non-members may decide to become members in order to gain access to processing machinery, storage, or distribution channels), the cap will have two detrimental effects. It would reduce the coops’ initial investment in processing or storage capacity (given limited own land property and agricultural production potential). A smaller investment, in turn, will reduce the coops’ ability to fruitfully absorb new members in the future. Additionally, the need to comply with the cap would create a huge headache for the coops (and the government agency in charge of monitoring compliance), reducing the attractiveness of farmer organizations for inexperienced smallholders.


LEAVE THEM KIDS ALONE AND LET A HUNDRED FLOWERS BLOSSOM!

The contradictions inherent in the proposed amendments are the result of trying to kill too many birds with one instrument, the law on agricultural cooperatives. At this early stage, it might be beneficial to keep the law as simple and as non-restrictive as possible. Farmer organizations are still a rare and exotic flower in the Georgian realities. Rather than restrictions, they need all the support they can get: from government, donors and, most importantly, private sector companies buying and purchasing agricultural products.

The focus of government policies should be, indeed, on the creation of private-public partnerships involving foreign and domestic businesses and groups of smallholders, letting hundreds of flowers bloom, and further nurturing those flowers that show potential for growth and replication. The fear of “theft” and “abuse” may be justified, but it is the wrong time to think about restrictions and caps. Some of the new coops will surely be set up to avoid taxes or benefit from preferential loans or grants, but even these will contribute to the country’s food security, as well as job creation and development in Georgia’s rural areas.

As suggested by Juan Echanove, EU’s Agricultural Attache in Georgia, the law is an important policy tool, but it is not the only tool available to policymakers. Access to government and donor support programs can be much more effective is achieving the policy goal of “shifting from quantity to quality”, with which we all agree.

Changing laws is a delicate matter, as Georgia is learning the hard way. If need to be, laws should be changed based on facts and analysis, and in consultation with those working in the affected sectors.

Let’s not rush.


 

The article was produced with the assistance of the European Union through its European Neighbourhood Programme for Agriculture and Rural Development, Austrian Development Cooperation, CARE Austria or CARE International in the Caucasus. The contents are the sole responsibility of the authors and can in no way be taken to reflect the views of the European Union, Austrian Development Cooperation, CARE Austria or CARE International in the Caucasus.

 

 

 

 

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Guest - Simon Appleby on Thursday, 26 March 2015 19:29

Co-op size of 3-5 members makes perfect sense for the current Georgian reality. People related by blood or marriage, who have long-established traditional dispute resolution methods, can solidify their informal co-operation and start to become more commercial. Forcing such co-ops to take on members from outside the immediate family, by lifting minimum size, may be pushing the concept too far, too fast and increasing the risks of destructive internal disputes. Too many public failures of co-ops at this stage will kill the concept off so low-risk, simple approaches are needed.

The Byzantine proposed regulations regarding associate members (having already excluded foreign citizens from being members) dramatically overestimate the appetite for involvement in co-ops by commercial players. Most people in industry take the approach that, if regulation at the outset is this convoluted and restrictive, it will only get worse with time and they might as well avoid the headache.

Co-op size of 3-5 members makes perfect sense for the current Georgian reality. People related by blood or marriage, who have long-established traditional dispute resolution methods, can solidify their informal co-operation and start to become more commercial. Forcing such co-ops to take on members from outside the immediate family, by lifting minimum size, may be pushing the concept too far, too fast and increasing the risks of destructive internal disputes. Too many public failures of co-ops at this stage will kill the concept off so low-risk, simple approaches are needed. The Byzantine proposed regulations regarding associate members (having already excluded foreign citizens from being members) dramatically overestimate the appetite for involvement in co-ops by commercial players. Most people in industry take the approach that, if regulation at the outset is this convoluted and restrictive, it will only get worse with time and they might as well avoid the headache.
Guest - Nikita on Friday, 27 March 2015 21:29

Coop growth diagnostics

Can you answer the following questions?

1. Why do Georgian farmers form coops? Do they want to grow their businesses, do they want to reduce the risk of crop failure/income shocks, do they want to receive subsidies/privileges from the government? Are there other reasons why farmers form / refrain from forming coops in Georgia?

2. Those farmers who seek to grow their enterprises through coops, what prevents them from growing? Which of the following constraints are binding?
a. Credit / technological constraints: lack of funding for vital investments in new machinery, fertilizer, seeds, animal stock, etc.
b. Organizational constraints: lack of managerial capital, wrong incentives for coordination/cooperation/collective problem solving, wrong organizational structure
c. Social constraints: monitoring/trust building is easier among close relatives, but friends may be also more forgiving towards each others’ mistakes, have similar (i.e. redundant) information and skills, be more susceptible to group think than unrelated professional business partners, coop norms may be influenced by social structure/norms that the friends/relatives live by outside the coop,
d. Personal constraints: lack of entrepreneurial drive, lack of skills for modern agricultural production,
e. Other constraints.

3. What are the most cost-effective ways to remove the binding constraints?

Coop growth diagnostics Can you answer the following questions? 1. Why do Georgian farmers form coops? Do they want to grow their businesses, do they want to reduce the risk of crop failure/income shocks, do they want to receive subsidies/privileges from the government? Are there other reasons why farmers form / refrain from forming coops in Georgia? 2. Those farmers who seek to grow their enterprises through coops, what prevents them from growing? Which of the following constraints are binding? a. Credit / technological constraints: lack of funding for vital investments in new machinery, fertilizer, seeds, animal stock, etc. b. Organizational constraints: lack of managerial capital, wrong incentives for coordination/cooperation/collective problem solving, wrong organizational structure c. Social constraints: monitoring/trust building is easier among close relatives, but friends may be also more forgiving towards each others’ mistakes, have similar (i.e. redundant) information and skills, be more susceptible to group think than unrelated professional business partners, coop norms may be influenced by social structure/norms that the friends/relatives live by outside the coop, d. Personal constraints: lack of entrepreneurial drive, lack of skills for modern agricultural production, e. Other constraints. 3. What are the most cost-effective ways to remove the binding constraints?
Guest - Nikita on Friday, 27 March 2015 23:32

More questions:

How would a diagnostics tool look like that is fast, frugal, and cheap in identifying binding constraints for the growth of each individual coop? If each coop faces a set of binding constraints and these binding constraint sets differ between coops, could public policy tackle the constraints of each individual coop instead of implementing laws that treat all coops in the same way? How could such individualized interventions be implemented without creating a bureaucratic mess?

If the farmers' goal for creating their coop is e.g. to increase the probability of business survival / resilience, should public policy be alligned with farmers' preferences or should it address the governments' success indicators (economic growth, investments, foreign trade volume, ...)?

More questions: How would a diagnostics tool look like that is fast, frugal, and cheap in identifying binding constraints for the growth of each individual coop? If each coop faces a set of binding constraints and these binding constraint sets differ between coops, could public policy tackle the constraints of each individual coop instead of implementing laws that treat all coops in the same way? How could such individualized interventions be implemented without creating a bureaucratic mess? If the farmers' goal for creating their coop is e.g. to increase the probability of business survival / resilience, should public policy be alligned with farmers' preferences or should it address the governments' success indicators (economic growth, investments, foreign trade volume, ...)?
Guest - Eric Livny on Friday, 27 March 2015 23:44

Thanks for asking these questions, Nikita... I like the approach of tacking the so-called binding constraint(s), which would of course differ for each individual coop. However, I don't think that the law on cooperatives is the right policy tool for individual interventions. The law, if it is at all needed, should provide a legal definition of what is a coop, and how it is different from any other business partnership (LLC with a few partners). The law is needed only insofar the government wants to promote farmer coops as a particular organizational form designed to help smallholders become more productive and better integrated into the economy ("value chains" as the jargon goes). It is important to understand that individual farmers are free to form LLCs, borrow at the going commercial rates, engage in contracts with other businesses, invest and reap the fruit of the labor and investment. Coops maybe thought as "LLC-light", with each farmer maintaining their individual production activities while sharing some expenses and collaborating on the marketing or processing of their products.

As I argue in the article, individual constraints are best addressed through support programs that target coops. These support programs, if well designed, could indeed include an evaluation component, to identify the binding constraint of each coop (funding, skills, technology, organization, whatever) and tackle that particular constraint.

Thanks for asking these questions, Nikita... I like the approach of tacking the so-called binding constraint(s), which would of course differ for each individual coop. However, I don't think that the law on cooperatives is the right policy tool for individual interventions. The law, if it is at all needed, should provide a legal definition of what is a coop, and how it is different from any other business partnership (LLC with a few partners). The law is needed only insofar the government wants to promote farmer coops as a particular organizational form designed to help smallholders become more productive and better integrated into the economy ("value chains" as the jargon goes). It is important to understand that individual farmers are free to form LLCs, borrow at the going commercial rates, engage in contracts with other businesses, invest and reap the fruit of the labor and investment. Coops maybe thought as "LLC-light", with each farmer maintaining their individual production activities while sharing some expenses and collaborating on the marketing or processing of their products. As I argue in the article, individual constraints are best addressed through support programs that target coops. These support programs, if well designed, could indeed include an evaluation component, to identify the binding constraint of each coop (funding, skills, technology, organization, whatever) and tackle that particular constraint.
Guest - Nikita on Saturday, 28 March 2015 23:40

Are the Agency for the Development of Agricultural Cooperatives / ISET-PI / ENPARD interested in developing such an evaluation component within the support programs that you propose?

Are the Agency for the Development of Agricultural Cooperatives / ISET-PI / ENPARD interested in developing such an evaluation component within the support programs that you propose?
Guest - Eric Livny on Sunday, 29 March 2015 00:00

In principle, this is what the ISET Policy Institute was hired to do (among other analytical tasks). We are members in one of the NGO coalitions that delivers support to budding coops, but in fact we are providing analytical support to the entire project. This includes conducting baseline and final surveys in years 1 and 4, conducting case studies of specific coops, analyzing changes in behavior and market linkages. What is not possible, unfortunately, as part of the project, is randomization and more rigorous evaluation relating outcomes to specific interventions (organization, finance, capital investment, training, external linkages, etc.)... Sorry I don't have better news...

In principle, this is what the ISET Policy Institute was hired to do (among other analytical tasks). We are members in one of the NGO coalitions that delivers support to budding coops, but in fact we are providing analytical support to the entire project. This includes conducting baseline and final surveys in years 1 and 4, conducting case studies of specific coops, analyzing changes in behavior and market linkages. What is not possible, unfortunately, as part of the project, is randomization and more rigorous evaluation relating outcomes to specific interventions (organization, finance, capital investment, training, external linkages, etc.)... Sorry I don't have better news...
Guest - Nikita on Sunday, 29 March 2015 03:35

Consider a doctor who wants to diagnose a patient’s illness. The doctor neither has the funds nor the time to set up a rigorous evaluation, a randomized study to determine what causes the patient’s aches. Instead, he asks specific questions and makes a few important measurements to determine the patient’s most likely/severe problems.

The fast, frugal, and cheap diagnostics tool that I propose should do the same – ask a set of questions, do a few measurements – to make a proposal for an intervention that will help the coop to resolve its main problems. I think that the case studies could be used for developing the diagnostics tool, while the surveys could be used to implement it.

Consider a doctor who wants to diagnose a patient’s illness. The doctor neither has the funds nor the time to set up a rigorous evaluation, a randomized study to determine what causes the patient’s aches. Instead, he asks specific questions and makes a few important measurements to determine the patient’s most likely/severe problems. The fast, frugal, and cheap diagnostics tool that I propose should do the same – ask a set of questions, do a few measurements – to make a proposal for an intervention that will help the coop to resolve its main problems. I think that the case studies could be used for developing the diagnostics tool, while the surveys could be used to implement it.
Guest - megiddo02 on Wednesday, 15 April 2015 16:30

A great article. Unfortunately, there are so many people around who believe that every issue, whatever it is, can be solved by additional regulations. This problem has aggravated under the new government. Whatever one thinks about the optimal size of government in general, everyone should agree that in developing countries a minimal government is an optimal government. This is just an empirical truth.

Moreover, it also is a fact that regulations in most cases harm the economy and do not achieve the desired goals. This is true in all countries, yet a robust economy can stand more stupid regulations than an economy which is as fragile and weak as Georgia's. The European countries are all keen to regulate wherever they can, and the result is less growth than in the USA in every year since Reagan took over in the 80's. Economically, Europe is a failed model, and now the Europeans are trying to export this failed model to countries like Georgia.

As most regulations either do not work at all or have so many negative side-effects, in any prudent economic policy regulations will be a means of last resort, and they will be imposed extremely parsimoniously. Apparently, Georgia has to learn this lesson the hard way, though a comparison of European and US growth rates would be enough to understand it.

A great article. Unfortunately, there are so many people around who believe that every issue, whatever it is, can be solved by additional regulations. This problem has aggravated under the new government. Whatever one thinks about the optimal size of government in general, everyone should agree that in developing countries a minimal government is an optimal government. This is just an empirical truth. Moreover, it also is a fact that regulations in most cases harm the economy and do not achieve the desired goals. This is true in all countries, yet a robust economy can stand more stupid regulations than an economy which is as fragile and weak as Georgia's. The European countries are all keen to regulate wherever they can, and the result is less growth than in the USA in every year since Reagan took over in the 80's. Economically, Europe is a failed model, and now the Europeans are trying to export this failed model to countries like Georgia. As most regulations either do not work at all or have so many negative side-effects, in any prudent economic policy regulations will be a means of last resort, and they will be imposed extremely parsimoniously. Apparently, Georgia has to learn this lesson the hard way, though a comparison of European and US growth rates would be enough to understand it.
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