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A blog about economics in the South Caucasus.

Georgian Shadow Economy - its Past and its Legacy

The existence of a sizeable shadow (or second, informal) economy in the USSR was and is well-known. The Soviet era was characterized by a very rigid formal system with a high level of bureaucratization and inefficient planning. This resulted in many problems, both in terms of production and consumption. Soviet consumers experienced constant frustration and dissatisfaction caused by endlessly searching for goods and services they demanded, the need to queue for them without any guarantee of getting what they wanted, and the risk of having instead to accept a lower quality version or even to postpone (sometimes indefinitely) the purchase altogether (Kornai 1992). The situation on the production side was not much better, with producers facing regular delays in input supplies while having to comply with plan requirements, producing a limited variety of low quality outputs that failed to meet the market requirements.

Not surprisingly, these conditions constituted fertile ground for the development of a shadow economy. What was not available formally became available informally. There were “commersants” who were producing in parallel with the state sector and privately selling “deficit” goods. “Speculators” were obtaining “deficit” goods through their connections and re-selling them at higher prices. Many specialists were providing private professional and technical services outside their state jobs (sometimes during work hours). Bribery, exchange of goods and favors based on interpersonal relations prospered.

Informal solutions to problems of the planned economy were present in all Soviet republics including Georgia. However, Georgia was something of a special case, with a very high level of informality. According to various estimates, among Soviet republics Georgia had the largest shadow economy, which was very dynamic and deeply entrenched in the formal sector. Georgia’s informal sector was estimated to be over 25% of the Republic’s GNP (Wiles, 1981). Today if you ask an older Georgian about life back in Soviet times, you will hear tales like: “In communist times we (Georgians) were living much better than others (people in other republics)!”

What were the reasons for Georgia’s “leadership” in the informal sector? The system established by the Soviet dictatorship was more or less homogeneous throughout the USSR, perhaps with minor differences among the republics, certainly not big enough to explain the excess level of informality in Georgia. One very important factor behind this “deviant” behavior of Georgians could be cultural.

According to economic literature, there is a strong link between core cultural values of a nation and the status of its informal economy. Being a very traditional country, Georgia is a good case study for understanding how this relationship works. Mars and Altman (1983) study interlinkages between the cultural bases of Soviet Georgia and its second economy from an anthropological perspective and reach very interesting results. The authors collect and analyze information from 5000 Jewish-Georgians who migrated to Israel from Soviet Georgia in the 1980s to understand what could be behind the high level of informality in Georgian society. Jews living in Soviet Georgia shared the same cultural norms and maintained the same socio-economic practices as the native Georgians. The conclusions of this study will appeal to most Georgians. According to the authors, the core values of Georgian society – honor and trust – provide a solid basis for the development of informal economic relations.

Honor in Georgia is a very important concept. It is a family/clan matter; it is not constant - it can be lost and gained - and all members must behave so that the family honor is kept high. Women play a relatively passive role in attaining honor; they mostly have to maintain it by being sexually modest outside the household.

For men, honor is achieved by assertion and dominance. This is why Georgian men have to constantly prove themselves in their circles in order to re-rank personal relations. They always have to be “on the stage”, engaging in conspicuous displays and “shows” demonstrating their place in the hierarchy. A way of achieving this is organizing frequent “supras” (feasts), eating out with friends in restaurants, competing in drinking and in displaying tableware.

A basis of honor is trust. A man who is not trusted has no honor. But why such an emphasis on trust? Trust is extremely important when you know you cannot rely on formal rules to protect your interests and your wellbeing. Trust is also a fundamental requirement for operating in the shadow economy: you should trust a person in order to engage with him in informal transactions. Moreover, trust creates networks – the more you are trusted, the wider your network is. The wider your network, the larger your resource base is.

Georgians, with their widespread sense of honor and high trust within their (large) networks had exactly what it took to take advantage of the opportunities offered by the informal economy during Soviet times. They knew they could always rely on friends and family during bad times, so they found it easier to take more risks because of the relation between bravery, honor, trust and success.

Therefore, it was not a traditional or individualistic Western approach to drive the second economy in Georgia, but a fertile cultural soil, made of shared values, family-based networks and interpersonal relations. It was because of these shared values and this emphasis on networks and interpersonal relations rather than formal rules (historically imposed and enforced by some alien force occupying the country) that the Georgian informal economy prospered under Soviet rule.

This can explain the attitudes of older Georgians towards the “old times”, when indeed a mindset focused on bravery, honor, networks and solidarity (especially against the authorities) allowed individuals to cope with the imperfections of the socioeconomic system better than in most other Soviet republics. But did this mindset also play a positive role during the transition period? And is it helping now?

The Georgian shadow economy extended impressively during the 1990s. According to IMF estimates, the shadow economy represented 63% of GDP in 1994-95 (Schneider 2000). Yet, almost every Georgian would agree that in that period things were as bad as they had ever been. Corruption was rampant while the state was powerless and incapable of performing its functions in a proper way. Even though it is understandable that in such a dismal situation individuals would rely on their informal networks for support, it could also be argued that, in the struggle for survival, the action of the informal networks continued to weaken the very fabric of society, in a self-reinforcing vicious cycle. In the 1990s Georgia experienced the largest drop in GDP per capita among the Soviet Republics – more than 80% from its peak – a drop from which it is recovering only now. Georgia’s economic recovery took off mainly after the Rose Revolution, in 2003, which was followed by an impressive crackdown on corruption and organized crime, paralleled by a similarly impressive “season” of reforms. But is a new legislation sufficient to erase attitudes, values, and even psychological traits that have been shaped during centuries?

Substantial anecdotal evidence seems to suggests that many of the “core” values that constituted the humus for the growth of the informal economy in Soviet times are still there and still at work. If so, one should not expect to overcome those forces in a short period of time through superficial institutional reforms. For more effective policy making, one should have a better understanding of the role informality plays now in the Georgian economy and how the recent changes have (if at all) affected Georgian cultural values. In our future articles we will try to explore further this and some other interesting aspects of informality.

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Guest - Eric Livny on Friday, 23 May 2014 14:53

A very interesting aspect of the Georgian legacy!

I am fascinated by the contrast between the extremely positive role of honor-based informal relationship etc., for Georgia's economic development AS LONG AS IT WAS PART OF A LARGER NATION, with the extremely negative role it played AFTER INDEPENDENCE.

Under the Soviet system, the Georgians (and Georgian Jews in particular) were key players in creating a parallel business universe that provided an alternative to the formal Soviet supply network. This, of course, screwed the Soviet "system", but redistributed a lot of wealth from the Soviet Union to Georgia.

Come independence, the system to be screwed was no longer somebody else's. It was own state budget (and schools, and hospitals) that was not receiving any revenues anymore. These were own businesses that were strangled by criminal gangs and "government" held together by the informal code of honor (воровской закон). Wealth was redistributed from own people to the powerful few.

It took somebody as crazy as Saakashvili to root out the criminal code and put in place something more civilized. The rest is history.

A very interesting aspect of the Georgian legacy! I am fascinated by the contrast between the extremely positive role of honor-based informal relationship etc., for Georgia's economic development AS LONG AS IT WAS PART OF A LARGER NATION, with the extremely negative role it played AFTER INDEPENDENCE. Under the Soviet system, the Georgians (and Georgian Jews in particular) were key players in creating a parallel business universe that provided an alternative to the formal Soviet supply network. This, of course, screwed the Soviet "system", but redistributed a lot of wealth from the Soviet Union to Georgia. Come independence, the system to be screwed was no longer somebody else's. It was own state budget (and schools, and hospitals) that was not receiving any revenues anymore. These were own businesses that were strangled by criminal gangs and "government" held together by the informal code of honor (воровской закон). Wealth was redistributed from own people to the powerful few. It took somebody as crazy as Saakashvili to root out the criminal code and put in place something more civilized. The rest is history.
Guest - Adam on Friday, 23 May 2014 15:28

Great piece!

Great piece!
Guest - NP on Saturday, 24 May 2014 04:02

This contrast is indeed remarkable. We just need to see whether Saakashvili's "revolution" has been sufficient to alter permanently the state of things or the "old habits" will prevail in the long run.

This contrast is indeed remarkable. We just need to see whether Saakashvili's "revolution" has been sufficient to alter permanently the state of things or the "old habits" will prevail in the long run.
Guest - Hans Gutbrod on Sunday, 25 May 2014 15:00

great post, great topic. One fascinating question is how new systems can manufacture trust and engagement. There still are great gaps, that probably prevent value from being generated. I yesterday heard from someone who said that some Georgian restaurants take a great interest in Trip Advisor, to communicate that their services are great and reliable. Georgian homeowners are coming onto AirBnB, and creating track records of delivery. Where else could we apply that principle?

great post, great topic. One fascinating question is how new systems can manufacture trust and engagement. There still are great gaps, that probably prevent value from being generated. I yesterday heard from someone who said that some Georgian restaurants take a great interest in Trip Advisor, to communicate that their services are great and reliable. Georgian homeowners are coming onto AirBnB, and creating track records of delivery. Where else could we apply that principle?
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