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ISET Economist Blog

Georgia Riding the Waves of a Political Business Cycle
Monday, 18 November, 2013

In our last week’s article, we examined Georgia’s economic growth in the 12 months before the 2012 parliamentary elections. In particular, we reviewed the popular argument that much of this economic growth was driven by the “political business cycle” effect of public (over)spending prior to the elections.

Our analysis showed that the construction sector (the prime suspect for politically motivated spending) did in fact exhibit an atypical growth pattern just before the elections and that growth rates in construction collapsed right after October 2012. However, we also pointed out that the construction boom alone could not explain the 7.9 percent GDP growth in the four quarters before the 2012 elections (2011 q4 – 2012 q3) because the construction sector constitutes about 7-8% of the country’s GDP.

In fact, the boom in construction accounted for a little more than a fifth (21%) of the pre-election growth gains. Other, much larger sectors, like manufacturing, transport, and wholesale/retail trade jointly accounted for more than half (53%). Since these sectors’ growth dynamics prior to the parliamentary elections did not exhibit an unusual pattern (see charts 4 and 5) it would be hard to argue that the pre-election growth was entirely due to the political business cycle effect.

FROM PRE-ELECTION OVERSPENDING TO POST-ELECTION UNDER-SPENDING?

Given that the post-election slowdown (5.6 percentage points in the first three post-election quarters) cannot be entirely attributed to politically-motivated overspending by the UNM government, a logical question to ask is whether some of the slowdowns was caused by an overly conservative fiscal stance – “under-spending” – by the Georgian Dream government.

The previous government’s construction projects (e.g. the glass bridge on river Mtkvari, the new parliament building in Kutaisi, and the presidential palace) met with public criticism well before the elections. While the critical scrutiny of the public construction projects may be part and parcel of the democratic political process, it was perhaps unfortunate that the Georgian Dream coalition made the criticism of ‘chronic overspending’ one of the centerpieces of the electoral campaign. Hence, the newly elected government may have effectively committed itself to the policy, which from the economic standpoint was bound to reduce the GDP growth rates rather sharply.

Independent experts have since noted that the new administration may have gone a little too far in its zeal to cut public expenses. For example, IMF’s August 2013 report (“Georgia – 2013 Article IV Consultation”), addressed exactly this issue and advised that “in the short term, the government needs to overcome recent budget under-spending and allow a higher budget deficit later this year, to the extent that revenues are lower due to the slowdown.”

ANATOMY OF GEORGIA'S ECONOMIC SLOWDOWN

As we showed last week, the slump in construction was directly responsible for 2.4 of the 5.6 percentage point decline in GDP growth rate in the post-election period (q4 2012 – q2 2013). Which sectors accounted for the remaining 3.2 percentage points? Nearly one-third (1.8 percentage points) was due to weaker performance in the manufacturing sector (which may have been affected by the slowdown in construction).

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Though less pronounced, the slowdown in manufacturing is a serious issue given that it was, and still is, the main driver of Georgia’s economic growth. Besides, as we can see from Chart 4, the slump in manufacturing is much harder to explain by pre-election politics. This is also the case with the transport sector, the third-largest (0.9 percentage points) contributor to the growth slowdown. No unusual pre-election pattern can be detected in these two sectors.

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POLITICAL TRANSITIONS, EXPECTATIONS, AND UNCERTAINTY

The 2012 parliamentary elections and the peaceful transfer of power were largely a new experience for Georgia. The Georgian Dream’s victory caused a sense of euphoria, fuelling expectations of a rapid improvement in living standards. However, the Georgian society had soon discovered that economic progress would only come through hard work.

The reality of “cohabitation” and divided power may have contributed to a sense of political fragility and an extended pause in private investment. Georgia’s private sector was evidently unprepared for the complications arising from Georgia’s confusing transition from one system of governance (presidential) to another (parliamentary republic). With so much political uncertainty, everyone (investors, producers, and consumers) seemed to be holding back and waiting for the presidential elections in October 2013.

In addition, the Georgian Dream government may have taken longer to get its act together and provide assurances of a stable policy environment that would appease investors’ worries in due time. Certain policy decisions (e.g. the moratorium on foreign land ownership) surely did not serve to encourage foreign direct investment on which Georgia has been relying so heavily in the past.

In addition, consumers’ hopes for a better future failed to boost aggregate demand. This could perhaps be a strange case of ‘exuberant complacency’, when optimism translates into inaction rather than action on the part of the private agents, who may be waiting for the government to create a more favorable economic environment (e.g. reduce prices) in a short period of time. More likely, however, the surge of consumer optimism resonated little in the Georgian credit-constrained economic environment of early 2013.

ISET’s Consumer Confidence Index (Chart 6) provides an excellent account of the uncertain political and economic environment up until October 2013: the euphoric jump in expectations after the Georgian Dream’s political triumph, quick disillusionment, and the roller-coaster of expectations against the backdrop of very slow improvement in people’s assessment of the present situation.

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On October 27, the Georgian Dream candidate won the 2013 presidential elections, effectively ending the 12-month period of political “cohabitation” and triggering another euphoric moment in consumer sentiment. With the responsibility for the Georgian economy now being fully shifted to the new government, the Georgian Dream coalition will get a fair chance to reset Georgia’s economic growth. The preconditions for a successful re-launch certainly exist, although the real, hard work may just be starting.

The views and analysis in this article belong solely to the author(s) and do not necessarily reflect the views of the international School of Economics at TSU (ISET) or ISET Policty Institute.
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