Georgia’s growth performance since independence has gone through extremes, from an unprecedented -44.9 percent in 1992 to 12.3 percent in 2007. Although growth rates temporarily fell in the aftermath of the Russian-Georgian war and the world financial crisis they have since then recovered to 7 percent in 2011. With on average robust GDP growth since the Rose revolution economic growth seemingly should not be of particular concern to policymakers. On the other side, in this study we find that economic growth in Georgia is mainly driven by total factor productivity growth, and not by capital accumulation or increases in the labor force. This finding reflects the significant improvements in the economic and business environment in Georgia since the Rose Revolution, and can be explained by a catch-up effect through which Georgia converges to the higher levels of total factor productivity in other economies. On balance this is good news, but it also raises two concerns. First, about future growth prospects given that high productivity growth rates are hard to maintain as Georgia catches-up. Second, in contrast to economic growth driven by capital accumulation growth driven by productivity improvements does not in itself generate employment. Given Georgia’s persistently high unemployment rates we thus try not only to answer the question how economic growth can be raised, but also how capital accumulation can be fostered.

To answer these two interrelated questions we use the growth diagnostics framework by Hausmann, Rodrik and Velasco (2008), and attempt to identify the binding constraints to economic growth in Georgia. Binding constraint, by definition are those constraints that if relaxed will promote economic growth. Vice versa, relaxing non-binding constraints will do little or nothing to promote economic growth. We find that in Georgia real lending rates are some of the highest in the world, a finding consistent with low rates of capital accumulation. Potential explanations are low domestic savings or a difficulty in accessing international finance. While access to international finance does not appear to be an issue, domestic saving rates are indeed exceptionally low. But a low domestic saving rate is not a convincing explanation given that the spread between real lending and deposit rates is one of the highest in the world. As the Georgian banking sector is relatively competitive, the spread should be small as banks are competing for deposits in the face of high lending rates. That the spread is not small suggests an underlying uncertainty that makes banks reluctant to lend. Moreover, this underlying uncertainty would also explain relatively low domestic saving rates and low rates of capital accumulation.

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