October 27, 2013 heralded a new era in the Georgian politics. The year of power sharing between the two main rival political forces, the so-called “era of cohabitation”, has officially ended, and we can now start to look back and take the stock of how the political developments in the country affected economic growth. In two articles that we publish today and in the next week, we will aim to provide an overview of some specific trends. We will first look at the general economic trends in the year between the parliamentary and the presidential elections (Quarter 4 of 2012 – Quarter 3 of 2013) and then explore the economic drivers behind the significant growth slowdown. Shortly after the Rose Revolution, Georgia entered a prolonged period of high economic growth. The ‘winning streak’ was interrupted in 2009, when the country experienced a 3.8% decline in real GDP, associated with the 2008 war and the global economic crisis. Georgian economy, however, recovered fast. Starting from 2010, the economy was growing at the average rate of almost 7% . The period of renewed high growth ended in the 4th quarter of 2012, i.e. shortly after the parliamentary elections, which brought the then-opposition party, the Georgian Dream, into power. Since the 2012 elections the economy slowed down significantly (Chart 1) and, according to the last official announcement from Geostat (1.5% real growth rate for 2013 q2), the slowdown still continues. Considering in addition the most recent growth forecasts of the ISET Policy Institute for the 3rd and 4th quarters, the average annual GDP growth rate in 2013 will be around 2.9%, which is in line with the 2.5% forecast that the International Monetary Fund announced for Georgia most recently in their October 2013 report. Throughout 2013, there has been a heated debate in Georgia about the reasons behind the slowdown of economic growth. The new government (Georgian Dream) was blaming the previous government (United National Movement), the previous government was blaming the new government and the number of people who were starting to blame both of them was gradually increasing. While the political finger-pointing comes as no surprise, the growth slowdown of the ‘cohabitation era’ nevertheless raises a number questions: which sectors contributed to the country’s stalling growth, and is the internal political struggle mainly to blame for the country’s poor economic performance, or was the outcome determined mainly by the external economic developments?   GOVERNMENT OVERSPENDING IN 2012? What was the reason behind high growth rates leading up to October 2012 elections? According to the critics, the overspendings was part of the electoral campaign strategy of the old government, which led to the artificially high rates of growth in 2012. This, in turn, could explain the low growth rates post-election (as the old government’s spending on “show-off projects” came to an end). Prima facie, the logic of the argument is sound: If the old government spent too much in 2012, this would have not only “artificially” increased the GDP growth rates, but also would have substantially increased the level of real GDP. Thus, even if the GDP levels in any of the quarters of 2013 were quite high, they would still show low growth rates, particularly because they would not be so much higher than the “oversized” 2012 levels. Judging from the year-on-year levels of the seasonally adjusted GDP, the argument appears to have empirical foundation as well. On Chart 2 we see that the growth started to accelerate substantially in the 3rd and especially in the 4th quarter of 2011 (one year before the elections). Furthermore, from the same chart we can see that the quarter-on-quarter growth rate patterns between the year of 2013 and 2011 appear to be very similar. This suggests that the low y-on-y growth rates have less to do with a structural shift in the country’s pattern of growth, but are rather a matter of the one-time dip immediately after the elections. In other words, using scientific jargon, GDP growth exhibits “lag dependence” – one weak quarter creates a downward pressure on all subsequent quarters in a given year (this issue was discussed in detail in the ISET Policy Institute growth forecast in March of this year that can be found on the ISET PI website). So, was the post-election growth dip entirely due to the drop in government spending?  Looking at Chart 3, it is easy to notice the large growth swings in the construction sector. This is the one sector in the economy where government infrastructure spending plays a substantial role. However, the drastic fall in the construction sector alone cannot explain the growth slowdown of 2013.   Construction constitutes about 7-8% of Georgia’s total GDP. Considering its weight we can calculate that despite double digit growth rate in 2012, the construction sector contributed about 1.8 percentage points on average to the total 7.7% average GDP growth during those four pre-electoral quarters (2011 q4 – 2012 q3). This roughly means that the growth of construction sector was contributing approximately 23.1% of total GDP growth, while the main contribution (33.2% of total GDP growth) was coming from manufacturing sector. Meanwhile, in the manufacturing sector the growth rates did not show any unusual pattern of fluctuations before the elections. By the same logic, we can calculate how much the fall in the growth rates in the construction sector contributed to the overall growth slowdown of 2013. Given a relatively small weight in the overall GDP, the drastic fall in construction growth can explain about 43.5% of the overall growth slowdown. (The average drop in growth rate during the three post-election quarters (2012q4-2013q2) was 5.6%, out of which about 2.4 percentage points came from the drop in construction sector). As we can see, the fall in the construction sector did play a significant role in the overall growth slowdown. However, roughly 60% of the drop in growth rates is due to the slowdown in other sectors of the economy, namely manufacturing and retail trade. IT’S NOT THE ELECTION EFFECT ALONE Possibly, a post-elections drop in the growth rates may still have happened, even if the UNM won the 2012 elections, unless the pre-election levels of the government infrastructure spending were maintained. In addition, simple calculations could show that the y-on-y growth rate of the fourth quarter 2013 would be much higher than the growth rates from the first three quarters regardless of the outcome of the elections. This would be the case simply due to the fact that the level of output in the quarter 4 of 2012 was much lower than in any of the proceeding quarters. So, what were then the specific effects of the “cohabitation policy” on the Georgian economy? Find out in our follow-up article next week.

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