ISET Economist Blog

A blog about economics in the South Caucasus.
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Save Gudiashvili Square
One thing few visitors to Tbilisi fail to notice is the rich and layered architectural heritage of the city. There are medieval churches in Old Tbilisi. There are art noveau buildings in Sololaki. There is Stalinist architecture in Vake. And there are modernist experiments such as the Wedding Palace or the former Transportation Ministry Building. But at the same time this rich architectural heritage is threatened – either left to decay or destroyed or overwhelmed by new building developments. One worrying development is the proposed reconstruction of Gudiashvili Square in Sololaki. One of the loveliest squares in Tbilisi, a proposal by an Austrian architectural firm would completely destroy the historic substance and the unique atmosphere of the square. Fortunately this proposal caused a firestorm of protests by concerned citizens, and Tbilisi city hall denied that this project will be implemented and is not more than just a private competition without any bearing on the future of the square. Although the architectural firm Zechner & Zechner claims that “The result of the study will be the basis of an intense discussion and process together with interested participants and the urban government“, so far they do not seem to be interested in any discussion of their project. Neither were they available for comment, nor do they seem to have responded to concerns raised in the Georgian press. This leaves the future of Gudiashvili Square uncertain, and forces everyone to speculate and assume worst-case scenarios. What should city hall do? Is it even their business to meddle in private real estate projects? Shouldn’t entrepreneurs and investors know how to best use land or buildings? The short answer is yes, city hall should intervene and should restrict private investors. Economic theory provides at least two justifications for a heavy involvement of city hall in real estate projects, in other words, active and interventionist city planning. One is that historic buildings and structure are a public good. While the owner enjoys some of the benefits of the building, others will too – passers-by, tourists and citizens. Even better, one person’s enjoyment of the historic building does not diminish the enjoyment others derive from it. While the owner might capture some of the benefits accruing to others by charging entrance fees, or higher rents,  he will not be able to capture most of these benefits. This means that the social value of the building is higher than the value to the owner, who will probably underinvest in the maintenance from a society’s point of view. This gives a role to city hall. The other justification is that real estate projects cause externalities. Suppose an investor destroys a historic building and replaces it with a new and unattractive structure. This would harm the owners of other buildings or businesses relying on tourists. All these costs imposed on others will be ignored by the investor, implying that there will be more than is socially optimal building projects. Again, this gives a role to city hall.
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The Georgian Christmas tree
What would Christmas be without a Christmas tree? In Georgia, in Europe or anywhere else in the world. But little known to most Europeans, most trees sold in Europe can trace their origin to Georgia. It is the seeds of the Nordmann fir which are exported from Georgia to Christmas tree farms in Denmark, Germany and other countries. Why? The Nordmann firs from the mountain regions of Georgia are some of the finest in the world – what Bordeaux is for the wine world, Ambrolauri in Racha is for Christmas tree producers. Already in the 1960s Danish and German Christmas tree farmers travelled to what was then Soviet Georgia to explore the tree population and to develop trade relations. The business is not pretty. The best Nordmann firs grow at altitudes between 900 and 2200 meters, and have a height of up to 60 meters. The cones have to be harvest from the tree, which means that pickers have to climb up – a dangerous and very tough job. Safety equipment is rarely used, and each year pickers die. They are paid little, but living in one of the poorest regions of the country there are few alternatives. For one kilogram of seeds, up to ten kilogram of cones are needed. Pickers are paid around two Euro per kilogram of seeds. Intermediate traders holding licences sell one kilogram of seeds for 25 Euro to Europe, where the seeds are traded at a price of around 100 Euro. One kilogram of seeds produce up to 5000 Christmas trees – after five to ten years of growing. In a season of one to two months a picker can make up to 1000 Euro, enough to attract hundreds of pickers to Racha, too many given how dangerous and tough this job is. How will I celebrate Christmas this year? With a Christmas tree of course, grown in Germany or Denmark with seeds that have travelled all the way from Georgia five or ten years ago. Merry christmas to all of you!
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Who needs a safety net?
One of the definitions of a safety net that one can find on the internet is the following: “a net placed to catch an acrobat or similar performer in case of a fall”. This brings to my mind images of thrilling performances I saw at the circus when I was a child. I have to admit in most cases a safety net was used. It was only removed on some rare occasions, and the increased tension became palpable. We knew that only the best acrobats could dare perform in those conditions because even a slight mistake or distraction could lead to disastrous consequences. Born in this context, the term safety net has soon been extended beyond circuses. The same internet source, right below the standard definition adds: “fig. a safeguard against possible hardship or adversity: a safety net for workers who lose their jobs”. Imagine you are a European worker in a time of crisis. You are the only breadwinner in your family and you become unemployed. Your families situation is going to worsen significantly, but you know that – at least for some time - you and your family will be able to survive thanks to your unemployment benefits and to other forms of social support. In the meantime, hopefully, you will be able to get a new job – maybe thanks to the help of a public employment agency - or will at least be admitted into some publicly sponsored training program increasing your probability to get back to work. Imagine that, instead of being fired, you get sick. Luckily most of the costs for your care will be covered by the public healthcare system. You will continue receiving your salary (with a reduction as the length of the period of sickness goes beyond a certain number of days) for at least a few months, typically until you can go back to work. If your sickness is really serious, at some point you will not receive compensation but you will keep your job unless you stay away from your workplace continuously for a very long period. Should you lose your job, you will still be able to rely, for a while, on unemployment benefits and on additional forms of social support. Your family will be suffering of course, but at least you will be able to “gain some time” to try finding a solution. Now imagine a different scenario. You lose your job. You get one month severance pay but no unemployment benefits. The labor market is hardly creating new jobs, so you have a high probability of not finding a good job and will have to either accept being unemployed for a long period of time or to work in badly paid temporary jobs, maybe in very dangerous working places (because nobody is in charge of checking working conditions). In case you choose not to take the risk, and to try looking for safer jobs, most likely during your unemployment period you will not receive any training and certainly no support from (non-existing) public employment agencies. What if you are sick? All the healthcare costs fall on you. If you have private health insurance, you get some assistance. If not, you have to use your savings in order to get some treatment. You receive one month worth of salary, after which your employer is free to fire you without having to give you any compensation. So you suddenly find yourself sick and not only unable to help your family but being a burden to them, with no public support and no income. To be fair, you might receive some sort of assistance, after you have applied to the government for support as a needy household, if your situation has deteriorated so much that you cannot ensure even your subsistence (maybe by selling assets). But don’t expect the support to be that high. The picture looks much different, doesn’t it? This second case is not that of a fictional country. It is just a representation of the conditions of most workers in Georgia. If you keep this in mind, you will not be surprised when looking at the following pictures taken from the latest EBRD (European Bank for Reconstruction and Development) Transition Report, titled: “Crisis and Transition: the People’s Perspective”. The tables and pictures included in the report are based on a series of household surveys conducted by EBRD in a number of transition countries plus a few selected countries of Western Europe. The aim of this study was to study how crisis had affected household’s welfare in order to draw some conclusion about the potential vulnerability of countries and households to future crises.   In this first graph, Georgia (in red) stands out quite a bit above the regression line. This is defined as an “outlier”. In this case being an outlier means that Georgian households, despite having been themselves hit by a relative small number of negative events, appear to have suffered much more than households in similar situations in other countries. In other words, they were forced to cut their consumption much more than households in other countries. The second graph (below) allows us to see where Georgian households had to cut their consumption. Of course, cutting the consumption of luxury goods is not the same as cutting on food or healthcare. Looking at the second picture, if possible, makes things look even worse. Most households had to cut exactly where one would hope they would not have to: staple food consumption and visits to doctors. Neither of these cuts bode well for future Georgian households, as they are likely to have long lasting (negative) effects on them. Especially as a new world crisis seems to be approaching.   Why this discussion about Georgia and safety nets? Because for some time now Georgia has been presented consistently as a showcase country with an impressive reform track (including an extremely liberal labor market reform that has drastically reduced all forms of workers’ protection) and equally impressive growth rates. Much less has been said about how Georgian people have been affected by these reforms. For sure the picture that emerges from the EBRD study is of a country where households are extremely vulnerable to any slowing down of the economy or worsening of the macroeconomic conditions. Much more than in most other countries. Again, looking at the EBRD study, we can see that this is related to at least two factors: on one hand the extremely weak safety net provided by the state; on the other hand, the limited success (so far) in translating high growth rates into a substantial amount of new, “good quality” jobs. This is what led the EBRD, after presenting these results to suggest the following two key priorities for the Georgian government. “…to create a basis for export led growth… […] but also to establish an effective social safety net”. I would like to conclude with my personal answer to the question: “who needs a safety net?” A lot of people, I would say, especially in times of crisis like these ones. After all, even the best acrobats would not dare performing all the time without it, especially when they are trying their most dangerous performances for the first time and when preconditions are less then perfect. Why? Because the cost of failure would be too high. Like in the case of acrobats – even more, as they are not risking their lives only – policy makers have the responsibility of taking into account in their evaluations what could go wrong and think of ways to minimize negative impacts on the population. Most economists would agree that only a sustainable increase in the welfare of citizens (including the most vulnerable ones) is the true sign of development of a country in the long run. Assuring this, as someone sometimes seems to forget, requires also creating and maintaining – especially when markets are less than perfect, a solid social safety net.
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Small Country, Big Ambitions
From the new issue of Investor, on Georgian film productions:  "It is not easy to cover the expenses of the film with the small number of screens that are in Georgia. The market is limited and the number of screens is also limited," he said. "If you want to make a Georgian film commercially successful, you have to expand this market, you have to go outside...either to Russia or international." There was certainly no shortage of talented Georgians who made it in the Soviet Union, or later in Russia. While we can safely assume that today there are still Georgians in Georgia with the talent of Mikheil Kalatozov, Tengiz Abuladze and Otar Iosseliani, it is doubtful that the world will hear from them. Being confined to a small market, and in an industry with high fixed cost they seem to face an almost impossible task. The only hope – new technology that will lower the fixed cost of producing a film, and a world market open to films from other countries. While the cost of producing a film has indeed gone down and the world film market is indeed more open than ever, there is still an insurmountable obstacle in the way. The film industry is characterized by positive externalities, that is, the more films a country is producing, the easier it is to produce a film. Vice versa, with little film production the cost of producing a film will be very high, implying a vicious cycle in which a film industry will not start without subsidies or other support programs. Why are there positive externalities? There are many reasons. A large film industry is able to support a very specialized labor pool of screenwriters, directors or actors. A large film industry allows investors to hedge their risk, by financing not one but many films. Most importantly, it seems that there are large creative spillovers in film or more generally art production – think of the French new wave of the 1950s, the new German cinema of the 1970s or more recently the Romanian new wave.
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The Store of Value
Far from being the root of all evil, money is one of the most spectacularly useful human inventions.  On par with the technology of a wheel, the technology of money has made civilization as we know it possible.  But what kind of technology does money replace? Narayana Kocherlakota (JET 1998) argues that money is a form of memory. Here is an example: John has apples and wants bananas.  Mary has oranges and wants apples. Paul has bananas but wants oranges. When John and Mary meet, John can accept money from Mary in exchange for apples and use this money to buy bananas from Paul. Alternatively, however, John can give Mary a gift of apples. If the gift is made, Paul will give John bananas in the future (and be able to receive a gift of oranges from Mary). If the gifts are not exchanged, everyone stays with what they had before. Viewed in this way, monetary exchange is nothing but an intricate web of gifts. Money is just a way of “remembering” the past deeds – a way for Mary to let Paul know that John has fulfilled his side of the bargain by giving her a gift in the past. And so, throughout our working lives we accumulate the tokens of memory. Hoping that in the future, when we are no longer able to work, these tokens will remind people of how much they valued the things we did for them in past and will reward us in return. Surely, this hope may not always be fulfilled.  Hyperinflation is one example of such a break of trust, a form of collective amnesia, when the society no longer remembers the past. In one of the worst cases, Hungary in 1946, the memory slates were being wiped in half approximately every 16 hours. The stores of value, other than paper money, exist, of course. Gold, jewelry, houses, and even skills we acquire over lifetime are used for that purpose. But these things too hold only as much value as the people around us are willing to attach to them - at the moment of time we need to make the exchange. The graph below shows the output collapse in the Republic of Georgia in the 1990s.  People lost life savings throughout the Soviet Union. But more than that – all of a sudden like in a fairytale gone wrong, a mathematician turned into a taxi driver and a physicist sold second hand clothes on the street.   On the individual level this would be equivalent to waking up one morning to find that you have lost your place in the community, the friends you trusted, the knowledge and skills you have accumulated throughout your life.  Such cataclysms are rare, but once they happen, they affect people profoundly. It may take more than one lifetime to re-establish the society.  And both individually and collectively it may take us a while to do the same or better than we once had. So what is the best store of value? I’m afraid I don’t have a good answer to that. Perhaps the examples of economic cataclysms can remind us of the importance of good institutions. With the severe malfunction of the institutional frameworks, even the very important skills can become suddenly useless, and even the best of people will lose their memory.
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Land - Who Cares?
Classical production theory knows three so called “production factors”: labor, capital, and land. One needs a certain amount of each of these factors in order to set up a production of whatever good. Then, in the 20th century, it became common to not count land as a separate production factor anymore. Today, we usually speak about labor and capital, with the understanding that some of the capital is the land on which the production facilities are built. On the surface, this looks just like a pure change in terminology. Yet in fact it reflects an underlying economic development which could be called the “marginalization of land”. Let me explain. Thomas Malthus’ famous theory predicted that famines and mass starvation were inevitable in the face of exponentially growing populations and constant food production due to the fixed supply of land . Up to 1798, when his theory was published, this analysis was roughly correct. Investigations into demographic history show that during ancient and medieval times famines occurred in regular intervals. The industrial revolution, which started in England in the middle of the 18th century, put an end to this. Food supply (i.e. land) was no restriction for population growth anymore, and consequently the population soared. Since 250 years, the productivity gains in the agricultural sector are always higher than needed for sustaining the (increased) population, making famines a thing of the past in the developed world. For prosperity and power of a country, the amount of land it possesses has become more or less insignificant. In modern economies, in which agriculture usually accounts for less than 5% of the GDP, land is virtually never a limiting constraint for higher living standards. Energy, human capital, technological knowhow, a stable business environment -all these factors and many others are crucial for modern production, but land isn’t. There is always enough land available to erect a production plant or a service facility. Surprisingly, in geopolitical thinking, the marginalization of land hasn’t occurred. In fact, most countries are fighting for land as if it was still as important today as it was in agricultural times. An example is China’s occupation of the Tibet and the Uyghur regions. What does China earn from dominating these provinces besides internal unrest, terrorism, and being a cruel oppressor in the eyes of history? Note that the moral repugnance of such occupations is not my main point here. I am rather asking the question of rationality. Why does China want to control a poor and underdeveloped region like Tibet? Similarly, there is Turkey. Why are the Turks keeping their grip on the Kurdish East Anatolia? Why are rational politicians, elected by rational populations, concerned about the possession of dusty, unpleasant plains, in which retarded villagers and nomads stick to primitive traditions and rites? Alleged raw material resources, sometimes claimed to be the true reason behind pre-modern strives for land, are in fact no explanation. Firstly, the fixation on land can be similarly observed in cases where raw materials play no substantial role (like in the two examples mentioned above). Secondly, possession of raw materials has usually done no good for the country which harbored these resources. The absence of significant amounts of raw materials is at least no growth restriction (see the examples of Japan and many Western European countries). Geopolitical thinking needs to abandon the “doctrine of land”. In almost all disputes between countries, land is completely useless for the well-being of the involved countries. If land was important, why is the living standard not highest in Russia, which is the largest country on earth? Why is there no immigration pressure from Holland – which has a high population density – to Russia? In fact, the migration pressure goes in the other direction. Why do I raise this topic in a Caucasus blog? Well, when I recently dared to mention to a Georgian friend that Georgia should consider to just let go of certain regions and make no fuss about it, this friend almost killed me. I was taught that these regions belonged to Georgia “since time immemorial” and that letting them go would be a betrayal of the Georgian people. Facing those arguments, there was no point in mentioning that ongoing secession conflicts drive away tourists and that they spoil investor climate. Likewise, it was useless to point at the military expenditures which directly reduce the Georgian living standard. The same could be said about a certain regional conflict between Armenia and Azerbaijan. Some countries have understood that land is just irrelevant. As a result of the Second World War, Germany lost about 30% of its land. Whenever there is an economic crisis in Russia, there are voices which call for selling the Kӧnigsberg (Kaliningrad) to Germany. This will not happen for two reasons. Russian nationalists are (like all nationalists) staunch adherents of the doctrine of land, and they would never allow to give Kӧnigsberg back to Germany. Yet even more important, there is no doubt that Germany does not want to take Kӧnigsberg back, even if it was for free. The Kaliningrad region has severe social and economic problems, and its integration into Germany would make the country just much poorer. For modern people, this counts more than the fact that Kaliningrad was a German city since its foundation in 1255 and remained so until 1945 (“times immemorial”). Western Europeans have simply understood that it is far better to control a small but rich country than a poor but large one. This may have decisively contributed to the absence of war in Western Europe within the last 65 years. For Armenians, Azeris, and Georgians, there is a lesson to learn from Western Europe.