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ISET Economist Blog

A blog about economics in the South Caucasus.

"Inclusive Growth" Policies: Roads Paved with Good Intentions

The recently published government strategy “GEORGIA 2020” aims “to ensure that the majority of Georgia’s population benefits from economic growth”. The natural million-dollar question, however, is how this “inclusive growth” objective could be achieved in reality. In other words, how to make sure that the economy grows while creating jobs and business opportunities for the poor.

Before delving into this “how” question, let’s state the obvious trade-off: efforts to achieve inclusivity by means of aggressive income redistribution (e.g. increased social benefits, public provision of preschool education &healthcare, etc.) could just as well backfire. This would be the case if increased social transfers come at the expense of public and private investment in infrastructure and productive capital. Slower growth implies that there will be fewer jobs and less resources to draw on for both investment and redistribution purposes. Hence, a vicious circle.

This does not mean that “inclusive growth” is not an attainable target. Rather, what follows is that the government should be advised to look beyond redistribution in its crude tax-and-transfer form to smarter interventions that can make the markets – and economic growth - work for everybody, including the poor.

One “smart” alternative to straightforward redistribution is to employ public funding (whether Georgian or international) in order to incentivize private sector investment in new activities that directly engage or otherwise benefit the poor. Examples of complex interventions falling into this category are regional development initiatives implemented by the previous Georgian administration in Svaneti or Tskhaldubo (a giant Soviet-era spa resort in the vicinity of Kutaisi). Thus, paving the new road to Mestia and the well-orchestrated PR campaign portraying Svaneti as the “Switzerland in the Caucasus” may be said to have triggered a round of private investment in the hospitality industry, creating ample jobs and business opportunities in this once difficult-to-reach region.

Critics may point out, however, that while (perhaps) improving the wellbeing of an average Svani, this approach mainly helped those who could help themselves, leaving out the most vulnerable strata of the population. It is also hard to judge whether or not a massive private and public investment in Svaneti or Tskhaldubo will, indeed, pay off. Both are highly risky ventures, yet many of the Georgian businesses investing in these government-backed development projects may have done so to please their UNM masters, without paying a lot of attention to proper business planning and/or cost-benefit analysis.

An alternative approach to promoting inclusive growth is to directly target the poor in order to connect them to existing market opportunities. Since many of the poor are unemployed or under-employed, the Georgian Ministry of Labor, Health and Social Protection has recently embarked on an ambitious program to re-train the unemployed in order for them to qualify for existing jobs. The Ministry of Agriculture, on the other hand, is implementing an even more ambitious plan, supported by the EU ENPARD program, to facilitate the creation of farmer organizations connecting Georgian subsistence farmers to the existing demand for agricultural products.

This approach is also not without its challenges, the chief one being the risk of missing out on real private sector involvement (i.e. employers, service providers, and buyers of primary agricultural products). For example, training the wrong people for the wrong jobs will not increase employment. Similarly, supporting cooperatives that are not going to be able to sell their products will not improve rural livelihoods. The general point is this: interventions that put the cart (the poor) before the horse (the private sector) are very unlikely to lead to sustainable outcomes.


MARKET FAILURES AND GOVERNMENT FAILURES

Government interventions in the functioning of markets – whether in order to develop a region/industry or help the poor – is a subject of heated ideological and academic debate. As argued by Dani Rodrik of Harvard University and many other economists, in principle, an intervention could be justified when it helps the markets function better. This, however, is not a sufficient condition. The government should also have the intellectual and administrative capacity to improve on the free market outcome. While markets may fail left and right, inaction may still be preferable to clumsy government interventions wasting public resources, distorting the markets, or, still worse, fueling corruption.

There are many theoretical and practical situations in which markets may fail to produce an optimal outcome. Svaneti is an excellent example of a government action trying to address the failure of free markets to coordinate among private decision-makers. Coordination failures are a real thing. Imagine private investors considering the option of building new hotels in Svaneti. To make an investment decision, they have to be given reasonable assurances that by the time construction works are completed, all other pieces of the puzzle are put in place: access road, water, sewage and electricity infrastructure, ski lifts and hiking trails, cafes and restaurants. In the absence of such assurances, private investors will look for other projects (and countries).

Indeed, governments have the capacity to unlock such all-or-nothing situations by ensuring coordination among the various stakeholders, developing a commonly agreed strategy and master plan, and providing essential infrastructure. The case for intervention may be further strengthened if there is scope for handing out private concessions (e.g. to build and operate new roads, tunnels, etc.) and thus shifting some of the financial burden to end users – e.g. commuters and tourists.

There are many theoretical and practical problems with this line of argument, however. First, while coordination failures abound, it is easy to imagine the government targeting the wrong region or industry. Of course, private businesses may also err in their judgment of risks, yet the likelihood of government failure in this regard is higher given the lack of relevant expertise and perverse incentives (to generate short-term political gains). But even with the best project one can expect a multitude of implementation problems.

Svaneti is a case in point. It is not the only underdeveloped region of Georgia and there may have been other, more profitable opportunities for investing public and private funds. By picking Svaneti as the target of its intervention, the government has necessarily neglected other possibilities. Second, the whole project was rushed to produce quick political gains. This led to planning and implementation mistakes, including the offhand treatment of property rights, pristine landscapes and the environment, as documented by TI-Georgia and other NGOs. Third, coordination failures should not be resolved by coercion. Forced to participate, private investors have often paid lip service to “investment”, erecting the required physical infrastructure, but neglecting the management of assets in which they have no business interest.

Coming to power in late 2012, the Georgian Dream coalition adopted a much more conservative fiscal stance, putting a freeze or cutting back on many of Saakashvili’s signature projects, including Svaneti and Tskhaldubo. Some of the public funds thus saved were channeled into “recurrent” social spending – higher pensions, free preschool education, universal healthcare insurance, etc. It remains to be seen how effective will be the new government initiatives directly targeting the poor – through farmer cooperatives, vocational education and training. As discussed above, while paved with good intentions, this road may also be a road to nowhere. Unless very carefully designed and executed.

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Guest - Florian Biermann on Tuesday, 18 March 2014 04:46

Governments are generally bad entrepreneurs. If the government refrains from pushing large-scale economic projects with public money, there are still enough things to do.

Governments are generally bad entrepreneurs. If the government refrains from pushing large-scale economic projects with public money, there are still enough things to do.
Guest - Philippe on Tuesday, 18 March 2014 18:37

The underlying issue raised by this post is actually the capacity to co-ordinate different logics of intervention: the economic and the political one. While the former is a rather straightforward approach ("When do I have my money back?"), the latter encompasses a broader range of factors, in particular the capacity of the government, based on voter's expectations, to maintain a relative equality of opportunities accross the country.

When a business has become unprofitable - be it for the shortsigthedness of the investor or his lack of competences - there is always the possibility to shut the door and invest somewhere else. No doubt, politicians dream of such an option when they look at the least developed part of the country they are in charge of !

To Florian: Having a look at the huge infrastructure networks which have been one fo the core factors of growth in developped countries, I can't share the view that "governments are generally bad entrepreneurs". Same, whith a look forward, with reagrd to the new energy infrastructure (RES) being built accross the world and made possible only through government market and fiscal interventions, when not direct subsidies, and this although everybody shares the view that we are running out of oil in a few decades.

The underlying issue raised by this post is actually the capacity to co-ordinate different logics of intervention: the economic and the political one. While the former is a rather straightforward approach ("When do I have my money back?"), the latter encompasses a broader range of factors, in particular the capacity of the government, based on voter's expectations, to maintain a relative equality of opportunities accross the country. When a business has become unprofitable - be it for the shortsigthedness of the investor or his lack of competences - there is always the possibility to shut the door and invest somewhere else. No doubt, politicians dream of such an option when they look at the least developed part of the country they are in charge of ! To Florian: Having a look at the huge infrastructure networks which have been one fo the core factors of growth in developped countries, I can't share the view that "governments are generally bad entrepreneurs". Same, whith a look forward, with reagrd to the new energy infrastructure (RES) being built accross the world and made possible only through government market and fiscal interventions, when not direct subsidies, and this although everybody shares the view that we are running out of oil in a few decades.
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