Georgia’s Revolutions and Economic Development: from 2004 to Present Time

By Eric Livny

The ISET Economist, a blog about economics in Georgia and the South Caucasus by the International School of Economics at TSU (ISET)

Following the collapse of the Soviet Union, the Georgian nation went through a process of rapid dis-investment and de-industrialization. It was forced to shut down industrial plants, sending scrap metal abroad, and workers into subsistence farming. Hunger has never become an issue thanks to the country’s moderate climate and good soil conditions, yet inequality and associated political pressures rapidly reached catastrophic dimensions, unleashing cycles of violence, undermining the political order and inhibiting prospects of economic growth.

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United by a clear vision and knowledge that the broad popular mandate will not last forever, Georgia’s Rose Revolutionaries gained their place in history by taking unprecedented steps to crush the criminal gangs and restore trust in state institutions.

First, they took vigorous steps to convict mafia bosses, gangsters, petty criminals and drug dealers, pushing crime out of Georgia’s borders and bringing the country’s prison population to world record levels (per capita). To perform this task, the criminal justice system was reengineered to presume guilt – not innocence, – subjecting its victims to lengthy pre-trial detention periods and masterfully using the plea bargaining mechanism and pliant courts to extract confessions and money.

Second, they stripped the Georgian state of any imaginary functions it pretended to be performing, using massive layoffs to reduce and renew state bureaucracy (including, famously, the entire traffic police force), slashing taxes, regulations and whole agencies in charge of their “enforcement”.

Third, they created a corruption-proof public administration system reducing the bureaucrat to a robot undertaking simple automatic routines with very little room for discretion or judgment. With the legal repression system in full swing, applying a signature has become the Georgian bureaucrat’s nightmare.

The strategy of “zero tolerance” in handling crime, corruption, tax evasion and non-payment was a key factor in the Rose Revolution’s success – in just a few years – to overcome the failed state predicament. And what a great success it was! The young Georgian generation no longer knows how to give or take bribes; their older siblings and parents are now used to paying their taxes and bills in full and on time. No Georgian would ever miss a utilities payment. Even the share of bad loans in Georgia’s banking system remains extremely low despite the great difficulties experienced by Georgian households (and businesses) in the wake of Lari devaluation. And then, of course, there are the smiling and professional traffic police and street level bureaucrats that have become symbols of Georgia’s new statehood.

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Surprisingly for many, however, Georgia’s Rose Revolution reforms did little to close social gaps. Between 2007 and 2011, the share of people living under the poverty threshold grew by 43%. Equally alarming were the official unemployment statistics, particularly for the young (in the 20-24 age bracket). As shown in Figure 1, by 2014, Georgia has failed to engage the majority of its working age population in the formal sector of the economy.

Figure 1: Georgian occupation structure in 2014

The Georgian Dream coalition rode to a surprise electoral victory in October 2012 on waves of popular protest against legal abuses by the Saakashvili administration and its lack of willingness to deal with economic disparities. Dizzy from global fame, the makers of Georgia’s Rose Revolution became victim of their own success.They did not realize, at least not in time, that the brutal system they have created had to be gradually dismantled, giving way to a more humane and inclusive set of institutions.The result was a painful political defeat in October 2012 and public disgrace; emigration (and new political careers!) for some, and prison terms for others.

Three key elements on Bidzina Ivanishvili’s government agenda were to reset Georgia’s brutal justice system, reduce yawning social gaps, and restore economic relations with Russia while at the same time pressing ahead with Euro-Atlantic integration.

In line with this agenda, one of the first steps taken by the new government involved a comprehensive reform of the justice system, starting with a large-scale amnesty to reduce prison population to more “normal” levels, limiting the use of pre-trial detention and plea bargaining mechanisms by the prosecution (thus restoring the “presumption of innocence” principle); and, last but not least, granting greater independence to the judiciary.

Second, the new Georgian administration tried to act on its electoral promise to spread the benefits of growth to Georgia’s poor who until 2012 had been left out of Georgia’s modern economy. Key “inclusivity” measures undertaken in the first three years of Georgian Dream coalition rule included free healthcare, free access to publically-provided school readiness programs, increased pensions and social benefits, as well as a spate of subsidies thrown at rural dwellers (mostly, subsistence farmers).

Third, the new government took energetic steps to advance the European integration agenda by accelerating the implementation of harmonization measures across a broad spectrum of policy areas from migration and visa regulation, to labor markets, to TV advertising and excise taxes on alcohol and tobacco. Negotiations on the Association Agreement (AA) with the EU have been completed in record time, allowing for the AA to be signed on 27 June 2014; by October 2015, it has been ratified by the European Parliament and by 25 out of the 28 EU Member States.

The Deep and Comprehensive Free Trade Area (DCFTA) agreement, committing Georgia to non-trivial economic and institutional reforms in exchange for greater access to the EU, went into force on 1 September 2014. On March 9, 2016, quoting “the successful implementation by the Republic of Georgia of all the benchmarks set in its Visa Liberalisation Action Plan”, the European Commission proposed “to allow visa-free travel to the Schengen area for Georgian citizens holding a biometric passport.”

In parallel, Ivanishvili’s coalition was successful in its bid to mend fences with Russia. By June 2013, the informal Karasin-Abashidze dialog resulted in the re-opening of the Russian market for Georgian wine, mineral water and “low phytosanitary risk products” (such as tea, laurel, dried fruit, nuts, citrus, grapes, apples, pears etc.). As if competing with the EU, in May 2014, Russia lifted restrictions on “high risk” agricultural products, triggering a round of foreign and domestic investment in Georgia’s production and processing capacities. With most travel restriction removed, 925,000 Russian tourists visited Georgia in 2015 (14% up from 2014); more than 1mln are expected to arrive in 2016.

TAKING STOCK

From “revolutionary justice” to rule of law. There is little arguing in Georgian society and politics in about the need to follow conventional rule-of-law principles. What is still not fully appreciated today is that some of the zero-tolerance policies, which survived the Rose Revolution days, could and should be relaxed today thanks to the tremendous and irreversible cultural changes Georgia has gone through since 2003!

For example, giving customers a few weeks to settle their bills (while charging penalties and interest!) will not run the risk of spawning a culture of non-payment as long as the new rules are clearly communicated and enforced. Likewise, the zero-tolerance and zero-discretion practice of subjecting businesses to maximum allowable penalties and freezing their bank accounts in every case of (suspected) tax evasion is clearly counterproductive in today’s realities.

It may be that giving tax auditors some discretion in dealing with delinquent tax payers (and subjecting their decisions to court review) would marginally increase corruption risks and reduce tax collection (in the short run). However, the benefits of doing so (in terms of improved business climate, investment, business activity, and, ultimately, tax revenues) clearly outweigh any such risks.

Growth and equity. Ultimately, it is up to each society to decide – politically – what is a fair distribution of resources and how much it is willing to lose in economic efficiency in order to achieve it. In the process of doing so it is important to consider that providing the poor with a minimum level of income and access to social services, such as healthcare and education, reduces the amount of resources available to the private sector. Hence, an obvious tradeoff.

So far, the efforts by the Georgian Dream government to achieve inclusivity have often been rushed, resulting in considerable waste of public resources, and most importantly, in little improvement in the lot of Georgia’s poor. A related concern is whether or not the generous social outlays could be sustained from the fiscal point of view, given the competing needs to accelerate investment in public infrastructure and reduce the tax burden on businesses.

Between Europe and Eurasia. Implementing the DCFTA with Europe while maintaining economic exchanges with the Russia-led Eurasian Union will be a daunting balancing act, politically, economically and diplomatically. The EU will undoubtedly provide technical assistance and funding to offset some of the harmonization costs. At the same time, Georgia may have to deploy every diplomatic tool at its disposal to reduce the risk of Russia’s retaliation for joining a competing trading block. There are many reasons for Georgia to be closer to Europe, as laid out in Zurab Zhvania’s passionate speech at the European Parliament. However, dipping into the deep (and comprehensive) FTA with the EU without a careful consideration of national economic interests may backfire. If the costs of AA/DCFTA agreements exceed their benefits, Eurasia may come back with a vengeance. Economically, as well as politically.