The transformation of Georgia from 2004 to 2012 : state building, reforms, growth and investments

THE TRANSFORMATIONOF GEORGIA FROM

2004 TO 2012

Dimitri Gvindadze

State building,Reforms, Growth and Investments

The Transformation of Georgia from 2004 to 2012

“As documented in this gripping insider account, Georgia’s ascent from a near failed state to a suc-cessful reformer with increasingly strong institutions has been remarkable by any measure. Dimitri Gvindadze is uniquely well placed to shed light on how this process unfolded, and how successful economic reforms were anchored by a broader strategy of institutional and political reforms. His book will provide precious and valuable insights to policy makers and researches everywhere.”

—Edward Gardner, IMF Senior Resident Representative and Mission Chief for Georgia, 2009–2012

“Dimitri Gvindadze was a key member of the team that led the economic transformation of Georgia in 2004–2012. The transformation that is unique by its spectrum and depth in com-parison to any developing country that attempted to undertake similar effort in the recent years. The transformation that should be learnt from by public sector practitioners in emerg-ing markets and studied by scholars of development economics. Dimitri’s book describes in very interesting details the story of this transformation. The book is a well-balanced synthe-sis of theory, facts, personal stories and innovative views that is the must read for any person interested in public sector reforms and in the economic transformation. During this period, Dimitri Gvindadze served as the Deputy Minister of Finance and as the Minister of Finance of Georgia and his leading role in managing the sovereign balance sheet of Georgia and for-mulating the fiscal policy was among main drivers of the transformation.”

—Nika Gilauri, Prime Minister of Georgia, 2009–2012

“Dimitri Gvindadze has produced an engaging and easily accessible narrative of Georgia’s ground-breaking economic reforms in 2004–2012 paving the way for the modernisation of the country. This contribution stands out as the comprehensive account of Georgia’s success, which offers an attractive reform blueprint for other developing economies to follow. Written by an active participant, rather than an observer, Dimitri Gvindadze’s book fleshes out virtually all key issues in a way that is of practical use to any policy maker in a developing economy.”

—Lado Gurgenidze, Prime Minister of Georgia, 2007–2008

“Dimitri Gvindadze’s account of what is indisputably one of the major reform successes in past decades is a fascinating reading. He analyses it with the combined insight of a consummate insider and the cold gaze of a first-class economist. The result is simultaneously a rallying cry and a cautionary tale to reformers the world over: Be prepared to move simultaneously fast forward on many fronts, chiefly on practical, hands-on measures, or face increasing difficulty and ultimately be consigned to the dust heap of history. Georgia in Dimitri Gvindadze’s times chose to be bold and courageous; it is now reaping the benefits of this courage.” —Francis Malige, Managing Director, European Bank for Reconstruction and Development

“Dimitri Gvindadze was among the economic leaders who contributed to Georgia’s highly successful transformation since 2004. Georgia’s economic blueprint explained in this book created unprecedented growth, jobs, domestic and foreign investment and trade. The reforms delivered predictability and the right ambience for a more vibrant private sector. They delivered a smaller but a much more efficient government. Dimitri and his team never believed in outsourcing the responsibilities of government to third parties, especially to so-called foreign experts. Instead, Georgia believed in fostering home-grown thinkers and devel-opment concepts. This approach never stopped Georgia’s reformists from trying to integrate the economy into the global one, or from raising the right amounts of money for what were considered by most to be truly balanced investment programs, programs focused on cutting the infrastructure gap while improving key basic social indicators. Dimitri’s book is a won-derful account of what was done between 2004 and 2012. This is a book that must be read by those who work in countries which aspire to become middle income ones. The basis for Georgia’s transformation was laid over this period. The book covers not only the thinking behind the reforms, but also the politics and the communication strategies required to turn them into reality. The future is never easy, but in Georgia it may well now be made a little easier by the work done by the enlightened team of reformers over this period.”

—Juan Miranda, Managing Director, Asian Development Bank

“Readiness and willingness for a change are decisive for the future of companies, but also for countries. Georgia succeeded because it had a clear target—Europe!!! It had a clear reforms agenda. And it had a strong political leadership. Georgia today still benefits from the transfor-mation explained in this book. Dimitri Gvindadze’s book is a guide-book on how the impos-sible becomes reality.”

—Wilhelm Molterer, Former Vice-Chancellor and Minister for Finance, Austria

“A remarkable account of a remarkable economic development story. Dimitri Gvindadze con-tributes a well written and practical description of one of the most ambitious reform programs of the 21st century.”

—Dr. Tilman Tacke, McKinsey & Company

“The book provides a fascinating insight on how a skillful government only needed a few years to abruptly change the face of a country and achieve reform results that will last a lifetime and serve as a great inspiration to other nations.”

—Stefan Weiler, Managing Director, J.P. Morgan

Dimitri Gvindadze

The Transformation of Georgia from

2004 to 2012State building, Reforms, Growth

and Investments

Dimitri GvindadzeTbilisi, Georgia

ISBN 978-3-319-59200-8 ISBN 978-3-319-59201-5 (eBook)DOI 10.1007/978-3-319-59201-5

Library of Congress Control Number: 2017943638

© The Editor(s) (if applicable) and The Author(s) 2017This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed.The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use.The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

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To Maia, Natuka, Saliki and Elichka

vii

The original version of the book frontmatter was revised: Missed out endorsements have been inserted in Frontmatter. The erratum to the book

frontmatter is available at 10.1007/978-3-319-59201-5_8

http://dx.doi.org/10.1007/978-3-319-59201-5_8

ix

1 The Escape Velocity of Reforms 1

2 Georgia’s “J-Curve” 9

3 Political Economy of Georgia’s Reforms in 2004–2012: The Ten Commandments 19

4 Pillars of Georgia’s Growth and of Investor Outreach in 2004–2012 27

5 TheOutcome:SoundGrowth,SignificantInboundInvestment,SubstantiallyReducedCorruption 93

6 TheLimitsandtheVirtuesof thePublicAction: TheExampleof Agriculture 99

Contents

x Contents

7 Riding the Bicycle 105

Erratum to: The Transformation of Georgia from 2004 to 2012 E1Dimitri Gvindadze

Bibliography 111

Index 113

xi

Fig. 2.1 Georgia’s real GDP in 1990–2012: level and pattern 14Fig. 2.2 GDP per capita, US$, current prices, 1994 14Fig. 4.1 Total general government expenditure as percent

of GDP in 2003, 2009 and 2012 (ranked by 2012 ratios, largest to smallest). Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, the European Union, the USA, Iceland 29

Fig. 4.2 Size of the government and the real GDP growth (average for 2003–2012, all countries) 30

Fig. 4.3 Government effectiveness estimate in 2012 and change in the government effectiveness estimate in 2004–2012* (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey) 31

Fig. 4.4 Capital spending in percent of GDP (general government operations, 2004–2012) 34

Fig. 4.5 Capital spending in percent of total government expenditure (general government operations, 2004–2012) 34

List of Figures

xii List of Figures

Fig. 4.6 Georgia in 2004–2012: high capital spending and positive operating balances 35

Fig. 4.7 Average monthly nominal salaries in the public and non-public sectors, 2003–2012 38

Fig. 4.8 Compensation of employees*, percent of expense in 2012 (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey) 39

Fig. 4.9 Public health expenditure as percent of GDP and of government expenditure, 2012 (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey) 40

Fig. 4.10 Public health expenditure as percent of total health expenditure and total health expenditure as percent of GDP, 2012 (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey) 41

Fig. 4.11 State old age pensions and the subsistence minimum in Georgia, 2004–2013 42

Fig. 4.12 Libor in time 46Fig. 4.13 Georgia’s public debt stock and flow ratios, 2003–2012 47Fig. 4.14 Cross-country comparison, general government gross

debt as percent of GDP, 2012—Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey 48

Fig. 4.15 Georgia’s public debt stock structure, end-September 2012 49

Fig. 4.16 Georgia’s external public debt by type of interest rate, end-September 2012 50

Fig. 4.17 Georgia’s domestic market yield curve (GEL-denominated treasury instruments) 51

Fig. 4.18 Georgia’s stock of treasury securities (USD million) 51Fig. 4.19 Georgia’s 10-year benchmark sovereign Eurobond

(RegS/144A)—secondary market dynamics since the issuance till the end of September 2012 53

Fig. 4.20 Sovereign Eurobond yields to maturity, percent. Georgia vs. peers 54

List of Figures xiii

Fig. 4.21 Impact of the tax liberalization on the government revenues in Georgia, 2003–2012 63

Fig. 4.22 Total tax rate, percent of commercial profits, 2012* (Georgia, the Commonwealth of Independent States, Central and Eastern and South Eastern Europe, the European Union, China, the USA, Turkey, Israel, Singapore, Hong Kong SAR) 67

Fig. 4.23 Georgia’s tariff liberalization path (2003–2012) 69Fig. 4.24 Increase in Georgia’s trade turnover

from 2003 to 2012 71Fig. 4.25 Georgia: No. 7 global rank (out of 180 countries)

in the Heritage Foundation’s trade freedom measure, with higher degree of trade freedom than for any of its main trade partners in 2004–2012* 72

Fig. 4.26 Georgia’s rise in the World Bank’s Doing Business Ranking (2006–2013)* 77

Fig. 4.27 Georgia—the shortest “distance to the frontier” according to the World Bank’s Doing Business 2013 and the fastest progress in shrinking distance to the frontier between 2005 and 2012* 78

Fig. 4.28 Georgia: second highest Index of Economic Freedom (2013) score in the broader region (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey) 78

Fig. 4.29 Senior management time spent dealing with requirements of government regulation (%)* (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe and Turkey) 79

Fig. 4.30 Regulatory quality estimate in 2013* and change in the regulatory quality estimate in 2004–2013* (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey) 80

Fig. 4.31 Georgia’s global ranking and score on “domestic competition” 80

Fig. 4.32 Georgia’s banking sector trends in 2004–2012 86

xiv List of Figures

Fig. 4.33 Bank capital-to-assets ratio, Georgia, Central and Eastern Europe, the Commonwealth of Independent States, 2012 87

Fig. 4.34 Bank non-performing loans to total gross loans in 2012, percent (Central and Eastern Europe) 88

Fig. 4.35 Domestic credit to private sector, percent of GDP in 2012 (Central and Eastern Europe) 90

Fig. 5.1 CAGR GDP, constant prices, 2004–2012. 94Fig. 5.2 CAGR GDP per capita, constant prices, 2004–2012 95Fig. 5.3 Annual and cumulative FDI to Georgia (2003–2012) 96Fig. 5.4 Georgia—highest improvement in the “control

of corruption”* and in the “rule of law”** estimates in 2004–2012 (global dataset, higher figure means improvement) 98

Fig. 6.1 Georgia—labor productivity at constant 1996 prices, GEL. 100

Fig. 6.2 Georgia—employment, in thousand persons. 100Fig. 6.3 Urban population, percent of total * 102Fig. 7.1 GDP per capita in Georgia, Central Europe

and the Baltics (US$, 2016f ). 106Fig. 7.2 GDP per capita, constant prices, 2012 = 1. 107Fig. 7.3 Four growth scenarios of Georgia’s nominal GDP per

capita in US$ terms, assuming constant GEL-US$ exchange rate (“r” is real GDP growth; “i” is change in GDP deflator). 108

Fig. 7.4 Nominal levels of Georgia’s GDP per capita in US$ terms under three growth scenarios in 2012, 2025 and 2030. 109

xv

Table 1.1 Georgia's economy in 2003 and in 2012: the comparison 3Table 2.1 Georgia’s real GDP growth by sector (1990 = 100%)* 16Table 5.1 Cross-country comparison: Average gross

and net FDI/GDP ratios 97

List of Tables

xvii

Box 4.1 Government’s operating balance in a developing country targeting fast growth 35

Box 4.2 Which near-term future for the pension system in Georgia? 43Box 4.3 Libor in time 46Box 4.4 Ultimate beneficial ownership (UBO), related party lending

and conflict of interest 83

List of Boxes

xix

Driven away by political cycles, routine paperwork, self-interest or economic myopia, public servants who elaborate proverbial long-term national development strategies sometimes either deform their answer to this question beyond recognition or end up forgetting to ask it alto-gether. When this happens, outcomes are painful: debased currencies, social and political distress, bailouts, bailins, abrupt economic adjust-ments and poverty.

In contrast, governments which know the right answer to the ques-tion on who creates wealth and defend it through the right actions ena-ble their countries to succeed beyond electoral cycles.

Wealth is created, first and foremost, in the private sector. It is cre-ated by individuals who employ their knowledge, entrepreneurial talent and gut feel to spot niche opportunities, conceptualize ideas, take risks to launch them, borrow, put at stake own equity, outmaneuver com-petitors, contain threats from new entrants, strike deals with suppliers and buyers, and defend market position in the context of an evolving marketplace of substitute products and services.1 All this to generate return which allows to recover costs, repay creditors and retain profit, thus adding value.

Prologue. Who Creates Wealth?

xx Prologue. Who Creates Wealth?

All along, entrepreneurs expose themselves to competition. Some grow rich; others go bankrupt. Gross domestic product is the annual sum of the value added by such individuals and firms, through an array of atomized skin-in-the-game decisions which drive the process of the “creative destruction.” The higher such firm-level added value, the higher the aggregate growth of domestic economy. When an economy grows without major reversals, such annual growth in the value added enhances the stock of national wealth. Tax revenues increase, and gov-ernments provide better social safety, upgrade infrastructure and deliver national security.

Wealth is thus the by-product of activism by the private citizens seeking to cater for their individual needs and to chase their individual dreams.

Governments understanding this causality launch their countries and societies on the path of long-term beyond-the-election-cycle growth and development. They view public action mainly as the instrument to crowd in private entrepreneurship.

Governments which misread the causality grow oversized and encroach upon private entrepreneurship, individualism and creativ-ity. They attract too many people into the relative safety of public jobs which limit downside risks, circumscribe the upside and thus foster the “cap-and-collar” mentality which—when blown out of proportions—inhibits growth and the wealth creation. They end up as the burden for a shrinking pool of successful domestic entrepreneurs.

Note

1. Porter (2008).

Abstract This chapter explains Georgia’s economic achievements in 2004–2012 and reviews the following chapters which detail Georgia’s starting position in 2003 and how Georgia succeeded in spurring and sustaining high growth, attracting investment and fighting crime and corruption. The key message of the chapter is about the “escape veloc-ity of the reforms”: To change the status quo, reforms must be imple-mented simultaneously as part of the comprehensive state-building effort in which multiple reforms supplement and amplify each other. Radical reforms can only be implemented by local reformers and cannot be outsourced to international experts or development partners.

Keywords Growth · Reforms · Investment · Corruption · State building

How did Georgia—the small resource-poor economy in the complex region—spur and sustain high growth, substantially reduce levels of crime and corruption, anchor itself to investors and leave the trap of the infrastructural and institutional backwardness?

1The Escape Velocity of Reforms

© The Author(s) 2017 D. Gvindadze, The Transformation of Georgia from 2004 to 2012, DOI 10.1007/978-3-319-59201-5_1

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2 D. Gvindadze

This book focuses on Georgia in 2004–2012, the 9 years between the “Rose Revolution” in November of 2003 and the parliamentary elec-tions in October of 2012. For most of that period, I worked in the gov-ernment of Georgia, as deputy minister and then as minister of finance, so the book represents my personal insider account.

I explain how and why Georgia’s reformist transformation in 2004–2012 reached the “escape velocity.” In physics, the escape velocity is the speed to which an object needs to accelerate to escape a gravi-tational pull of a massive body. Unless the escape velocity is reached, an object would fall back to the massive body. The stronger the gravi-tational pull of the massive body, the higher the escape velocity must be, and vice versa. Same in the economics, the weaker the starting posi-tions (Georgia’s starting positions in 2004 were weak, as explained later in the text), the stronger and the more comprehensive the state-building momentum must be to escape the gravitational pull of the past.

Note the difference between individual reforms and the process of the state building. Whereas the term “state building” has an unequivo-cally positive directional connotation, the word “reform” is directionally more nebulous. Think of all the congresses of the Communist Party of the Soviet Union which had their agendas and speeches replete with the word “reforms.” And recall how vested interest groups in certain devel-oping countries have used the word “reforms” to justify passage of laws which serve their own interest.

Developing country governments all meet on regular occasions to churn out resolutions, decrees and orders. They discuss all sorts of leg-islative and regulatory changes, create entities to fight monopolies and engage business community representatives. In short, they are busy, and they report on implementing reforms. In too many places, how-ever, unless packaged into a comprehensive, resolute and altruistic state-building effort which encapsulates all aspects of the state building (macroeconomic and structural reforms, infrastructural development, foreign and national security policies, anti-crime and anti-corruption work, public communication, institutional modernization, management of social expectations, ethnic relations, demography and various sectoral transformations), individual reforms produce no tangible people-level outcomes and do not trigger the “escape velocity.”


In this sense, reformers who aspire to produce a substantive leap for-ward and to accelerate their economies to the point of the “escape veloc-ity of reforms” must collectively elevate themselves to the rank of state builders.

This book focuses mainly on the economic aspects of Georgia’s state-building effort in 2004–2012. In the small country like Georgia which is at war with Russia and is located in the Caucasus region known for its repetitive eruptions of the geopolitical testosterone, miscalculations in any domain of the state building may easily eliminate the value created by the implementation of proper economic reforms. All this at the time when the gamut of measures which can be employed by large regional players to influence and upend domestic politics of small open econo-mies located at the geopolitical fault lines has grown immensely more complex and treacherous.

Table 1.1 explains what Georgia achieved in 2004–2012. This leads to subsequent chapters which explain how Georgia did it—how in terms

Table 1.1 Georgia's economy in 2003 and in 2012: the comparison. Sources: Geostat, National Bank of Georgia, IMF, World Bank

4 D. Gvindadze

of the political economy of reforms and how in terms of the technicali-ties of such reforms.

In Chap. 2, I examine the depth and the scope of Georgia’s post-Soviet economic contraction and provide an overview of the people-level challenges before and after the Soviet breakup. In 1994, Georgia’s real GDP was at only one-third of its level in 1990. That is, in only 4 years Georgia lost almost two-thirds of the volume of its economic output. This dip still influences Georgia’s economics and politics, despite the passage of almost two decades.

In Chap. 3, I explain main principles and factors which shaped and drove the political economy of Georgia’s reforms in 2004–2012: hands-on, disruptive and transformative leadership, clarity on the overarch-ing geopolitical and developmental vector, sense of urgency, consensus around a single economic paradigm, critical mass of people willing to take individual risks to get things done, consolidation of the political landscape, zero tolerance to crime and corruption, overhaul of the sys-tem of the national security, of the law enforcement, and of the admin-istration of justice, awareness of the importance of irreversibility of an institutional transformation and of quality public services, commitment to remaining beyond reproach, and active outreach to manage popular expectations and to preserve the international good will.

Within this big picture, the edifice of Georgia’s economic growth, investor outreach and the fight against corruption stood on the three interdependent pillars which are discussed in depth in Chap. 4:

1. Health of the sovereign balance sheet.2. Soundness of the business environment.3. Efficiency of the banking sector.

I discuss each pillar, invoking concepts, reforms and policies which (1) were, on balance, under the purview of the government, i.e., the public action directly influenced the end-results, (2) were cross-sectoral in their impact and nature and (3) catalyzed downstream transformations at the sectoral and institutional levels.

In the process, I answer questions: What is the proper size of a gov-ernment and the proper structure of the public spending at a given level

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of the wealth creation? How to achieve the sustainability of public debt? What are the virtues of the sovereign access to the international capi-tal markets? How to best harness the international donor assistance? What are the main elements of the business-friendly environment, with emphasis on taxes, customs, trade and transportation, licensing, tariffs and regulations? How to best foster domestic competition? What are the principles of the efficient banking?

To show how these concepts played out in practice, I provide facts and figures from Georgia in 2004–2012. I explain institutional, sys-temic and transactional improvements and innovations which allowed Georgia to fight corruption through the right incentives and checks and balances, through the encouragement of efficiency and punishment for misappropriation, misuse and rent seeking.

In Chap. 5, I discuss results of Georgia’s economic transformation in 2004–2012: (1) one of the highest per capita growth rates in the broader neighborhood, (2) one of the highest volumes of the foreign direct investment and (3) one of the most significant advances in the fight against corruption, globally.

To provide an example of virtues and limitations of the public action, I explain in Chap. 6 how to enhance value added per worker in Georgia’s agriculture and to create additional more productive jobs in the industry and services. Agriculture-centered as it is, this narrative explains how to think of public policies in other areas and how to spark a real and a lasting structural transformation of an economy.

In Chap. 7, I conclude by looking at various growth scenarios which allow Georgia to catch up with the rest of Europe. Leaving aside exter-nal factors over which Georgia has little to no control, Georgia’s sus-tained high-growth scenario can only materialize if:

• Politicians compete without trespassing red lines, without hollowing out each other’s—and their supporters’—living space in the after-math of elections, and without compromising on the political neu-trality and integrity of key public institutions.

• Economic decisions are technically sound by way of being reasonably ring-fenced from the political cycles.

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6 D. Gvindadze

• Politics is geared toward the promotion of individual economic free-doms and toward the alignment of social entitlements with economic fundamentals.

• The authorities succeed in striking—and maintaining—the right socially and culturally acceptable balance between preservation of such individual freedoms and facilitation of growth through activist infrastructure development and investment promotion policies.

• National security and law-and-order-related measures at all times rep-resent the unconditional overarching state priority underpinned by a resilient multistakeholder consensus.

• Leaders lead and inspire, keeping faith with the people, imbuing hope, fighting ideological agnosticism and apathy, staying beyond reproach and progressively reinforcing Georgia’s reformist and liberal franchise which it took almost a decade to build.

In this book, I do not delve into all circumstances and factors which shaped Georgia’s transformation in 2004–2012 (domestic and regional politics and security, law enforcement and the administration of justice, ethnic, cultural, social and public communication-related aspects of the state building). I do not elaborate on the exclusively sectoral reforms which Georgia implemented in 2004–2012, with, e.g., the public safety, health care and energy sector reforms representing the three good exam-ples of many. Such sectoral reforms can be best discussed by authors with hands-on experience in these sectors; to be useful for state builders elsewhere, each successful sectoral reform requires a detailed case study of its own. I also do not examine the complex set of reasons which led to the political change in Georgia in October of 2012. Such broader narrative would blur my effort (1) to steer away from Georgia’s domes-tic politics and (2) to explain what I attribute to the cross-sectoral eco-nomic mainstay of Georgia’s state building and of the global economic positioning in 2004–2012.

Many of Georgia’s reforms launched in 2004 required a multifront commitment to upending the deeply entrenched status quo. No reform would work or survive on the stand-alone basis. The result could only be achieved through the critical mass of reforms implemented simul-taneously. A stand-alone reform, however well intentioned and well


executed, could not lead to a real breakthrough and was likely to fade away with the passage of time and under pressure from unreformed institutions. Tinkering on the margins could win ephemeral praise from certain corners, but this would be no game changer for the local population.

The key takeaway from Georgia is that radical reforms are idi-osyncratic, noisy and sometimes controversial. They can only be implemented by local state builders and cannot be outsourced to inter-national experts or development partners. In the context of a compre-hensive state building, such international experts are generally less able to connect all dots than visionary domestic leaders. Ready-made blue-prints in the domain of the state building usually do not work—each country must act in line with its unique set of challenges, constraints and opportunities. However, the moral compass of the public leadership must be the same across geographies.

Exposed to the challenging regional geopolitics and without any luxury to enjoy the peace dividend, Georgia’s security-related consid-erations were paramount. They influenced decisions, tipping the scales toward the reasonably limited decentralization, toward the consoli-dation of the political and technocratic spectrum to avert horse trad-ing and to foster faster action, and toward strong vigilance of the law enforcement agencies—particularly after the 2008 war with Russia—to prevent adverse foreign infiltration capable of inflicting the damage from within.

Did such concentration of power result in mistakes and in the loss of the political capital? Did this lead to the flaws in the administra-tion of justice and to the weakening of the checks and balances? It did, although Georgia’s circumstances were uniquely nonlinear and they explain the nonlinearity of the thought and action in Tbilisi in 2004–2012. The nonlinearity which manifested itself through the determination to punch above the weight geopolitically, and to reform, fight crime and corruption on absolute terms.

Two things happen when you run a hurdle race with the speed of a sprinter: (1) looking mainly ahead, you do not have much time to grasp and internalize the full spectrum of information around you and (2) you get exhausted fast. Georgia’s transformation in 2004–2012 was

8 D. Gvindadze

the marathon run at the sprinting speed, with high hurdles. In such context, eventual fatigue is not unusual, while the reformist zeal power-ing the attempted rapid economic, structural and mental transforma-tion might act to weaken the umbilical cord connecting the government with the rest of the society. Hence the importance of the transfer of power where the baton is passed to the next runner, in the hope that such next runner is equally strong, that the team will not be disqualified for dropping the baton or for handing it off improperly.

Through many cross-country comparisons, the book explains how Georgia was looked at—and how Georgia’s government of 2004–2012 wanted the country to be looked at—by a global investor on the quest for a destination. Explaining Georgia-specific facts and figures, this narrative can help state builders and reformers elsewhere, although conceptualization, sequencing and scoping of such reforms cannot be replicated indiscriminately.

The book targets readers in Georgia and abroad. It aims at bridging the gap between, on the one hand, technical economic stabilization- oriented reports drafted, e.g., by the International Monetary Fund and, on the other hand, more general publications on Georgia’s transforma-tion in 2004–2012 which (1) tend to be more qualitative than quantita-tive in nature, (2) do not provide a sufficient cross-country perspective, (3) do not focus on the same set of factors and trends as in this book and (4) do not convey the spirit and the ambition of the state-building process which incorporates—and stretches far beyond—the economic and structural reforms which represent the prime focus of this book.

The views expressed in this book are entirely my own and do not rep-resent the views of my current or past employers.

Abstract This chapter discusses the last years of the Soviet Union and the early years of Georgia’s post-Soviet transition. It explains the depth of Georgia’s economic downfall in the first half of the 1990s when the economy lost almost two-thirds of its volume of production compared to 1990. The author explains two implications for Georgia in 2004–2012 and beyond: (1) to reclaim the lost ground, Georgia needs to grow fast over a long period of time and (2) at the low level of the GDP per capita, a genuine mitigation of poverty can happen through growth pro-pelled by policies promoting the equality of opportunity more than the equality of outcome; state activism can help, provided that it supports infrastructrure, crowds in know-how and entrepreneurship.

Keywords Post-Soviet · Transition · Downfall · Rebound

I was 13 years old when Ronald Reagan and Mikhail Gorbachev met at the Reykjavík summit in October of 1986. Reagan was the first US President I could recall. I sensed that something significant was in the air when my barber in Tbilisi glued to his mirror station a photograph of Reagan and Gorbachev shaking hands after their meeting at Hofdi

2Georgia’s “J-Curve”


9

10 D. Gvindadze

House. The Soviet Union then imploded in 1991, leading to the break-neck post-Soviet transition. Georgia exfiltrated itself from the commu-nism and plunged into the vortex of the 1990s.

My memories of those times cut through three periods: (1) last years of the Soviet Union, (2) the post-Soviet downfall in 1990–1994 and relative stabilization in 1995–2003 and (3) rapid transformation after Georgia’s “Rose Revolution” in November 2003. The post-2003 trans-formation represents the central theme of this book and is detailed in subsequent chapters. Below, I explain the periods (1) and (2). The more distant the period, the sketchier the memories; although some memo-ries persist.

Soviet Union

One of the 15 constituent republics of the Soviet Union, Georgia pre-served its distinct culture and traditions. It had a unique alphabet, people never forgot Georgian and were proud of their history. Good cli-mate, tasty cuisine, hospitality, rich natural and cultural heritage, sum-mer and winter opportunities attracted tourists from the Soviet Union and beyond. Georgians were not devout communists—many viewed the party membership as the means to advance their careers. The adher-ence to the communism was externally imposed; it was more materialis-tic than ideological.

But there were deficits, distortions and the inescapable sameness.The mismatch between the demand and the supply was fundamen-

tal and ubiquitous, forcing people to waste their “heart and nerve and sinew” in queues for the most basic of items. Central planning meant lack of the consumer choice and of diversity: identical building designs, identical chairs, tables, book-shelves, books, lamps, cutlery, carpets, food, clothes. A quarter century after the Soviet collapse, this sameness still persists and can be felt when traveling within the post-Soviet space. Gorbachev’s Perestroika launched in 1985 introduced certain mar-ket reforms and exposed the lack of the consumer choice with venge-ance: Montana jeans, American chewing gum with nice etiquettes, cool imported ballpoint pens were atop of everyone’s wish list.


Passenger cars were produced in Russia, and even when you could pay, you had to sign up and wait for months if not for years. For fear of being noticed, those able to afford Volgas were ending up buy-ing Zhigulis which were smaller and cheaper (black Volgas were used mainly by government officials). My father somehow managed to pro-cure his three Zhigulis in a row of the same beloved model and the same beloved color, which involved networking and the genuine will to suc-ceed.

As a kid, I was collecting small model cars sold in a couple of shops in Georgia’s capital Tbilisi. My collection was missing one car only—sports-style Moskvytch with beautiful stickers on it. I could not locate it anywhere. Walking after the school past a hotel in Tbilisi (“Intourist” chain hotel, that’s where foreigners were staying, and this entailed KGB presence), I stumbled into such model car staring at me defiantly from a shelf inside the hotel lobby. Because I could not enter and kept gazing through the glass, an English-speaking man helped me in and I bought the toy. Next day, my parents were notified of my inappropriate behav-ior. Could that man recruit me as the child-spy?

The word “import” had an almost majestic connotation: to secure a coat, shoes or a furniture with a foreign sticker, those who could afford it were ready to grossly overpay to spivs who, in turn, were smuggling these items in or buying them secretly from outlets serving the gov-ernment nomenklatura. The law enforcement knew and was probably involved. Spivs were selling imported medicines, at significant profit margins. Some items were brought to organizations in limited numbers, and people were casting lots. Personal connection to a shop or a ware-house administrator was key to securing nice imported clothes.

Two small state-run retail shops in Tbilisi sold the most revered imported items like stereo cassette recorders and other electronic and kitchen equipment. These shops were targeting Soviet citizens who gained their income in hard currency, mostly abroad. This hard cur-rency was then converted into special “checks” which were used as the sole medium of exchange in these two shops. Possession of the hard cur-rency by Soviet citizens was forbidden (those visiting capitalist countries on official exchanges were allowed to have only a few pounds or dollars in their ascetic pockets). Some owners of the “checks” were trying—not

12 D. Gvindadze

without a risk—to exchange their “checks” back into the hard currency on the black market (“secondary market transactions,” Soviet style).

Those holding managerial positions in industrial plants and factories boasted ceaselessly about their prowess in securing supplies of raw mate-rials and equipment from other Soviet republics. Plants and factories in Georgia—and in other Soviet republics—had their annual production quotas, and these were set through the centralized planning to ensure seamless supply of inputs across the Soviet Union. Expectedly, this did not work. Because the Soviet supply network was supposed to be seam-less, plants and factories were discouraged from atomized contractual relations. In practice, each plant had its own “problem-solver” with strong interpersonal skills and networking talents. He—it was always he—would be sent on regular occasions to plants in other Soviet repub-lics to ensure—through persisting, wining, dining, bribing, etc.—that the materials and equipment were procured on time to meet the pro-duction quotas.

Early Post-Soviet Transition

Georgia’s post-Soviet transition was unlike in other countries. Economic downfall and structural transformation in the beginning of the 1990s was compounded by the conflicts in Georgia’s regions of Abkhazia and Samachablo (South Ossetia) which produced up to 300,000 internally displaced persons, and by the civil confrontation in Tbilisi in 1991–1992. Challenging regional geopolitics and its knock-on impact on the domestic politics and on the public administration meant permanent state of the crisis management.

Regional instability of the 1990s reverberated through the business confidence. Disruption of traditional trade links and then trade embar-goes forced abrupt shifts in trade. The post-Soviet Caucasus was not high on investors’ priority lists. Domestic social norms, political and adminis-trative culture were unprepared for the new realities. Many were selling family possessions to survive. Engineers and scholars ended up as taxi drivers while would-be entrepreneurs were learning the basics of the capi-talism. Professional skills were missing. The end of the Soviet industrial


integration disrupted supply chains and made enterprises redundant. Public finances were in disarray and public salaries were minuscule. Poverty gaps and social dislocation became substantial. Wars and poverty produced stress disorders, traumatized and incapacitated many young people. Crime levels increased and law enforcement almost broke down. Energy sector was plagued by mismanagement and corruption, unable to supply electricity beyond irregular intervals. One regional strongman was de facto not bound by the laws of Georgia and was building his own fief. Security apparatus was porous, unprepared for a meaningful counterin-telligence effort. Local mafia bosses had lots of influence, in Georgia and beyond. In absence of public transport, people were hanging on back lad-ders of overcrowded trolley buses to move around the city, at risk of being electrocuted. To buy a loaf of bread in the beginning of the 1990s, you would need to stand in a 5-h queue. Trade with Turkey—where Georgians traveled to Turkey to sell their household items and various electric appli-ances and in return were getting espadrilles and jeans which they then sold in Georgia—gained vast dimensions. In absence of proper banking, Ponzi schemes emerged where high yields in the first couple of months were usually followed by bankruptcies. Students were distracted by the mess outside, which spilled over into classrooms. After graduations, classes split in all possible directions, with only a few pursuing original careers.

Detailed measurement of the depth and scale of Georgia’s economic downfall in the early 1990s is not helped by (1) the dearth of a reliable statistics dating back to the period immediately preceding and following the Soviet breakup in 1991 and (2) the hyperinflation which followed Georgia’s transition from Soviet rubles to a temporary unit of account (Georgian coupon) before introduction of the Georgian Lari (GEL) as the permanent currency in 1995.

Nonetheless, the downfall was quite epic. Real GDP in 1994 was at around one-third of its 1990 level (Fig. 2.1). That is, in 4 years Georgia lost almost two-thirds of its output. In 1994, Georgia was economically outflanked by many post-Soviet countries (Fig. 2.2). In 1995, when the economy was close to the bottom, average consumer price inflation stood at 163%, current account deficit was approximately 18% of the GDP, and general government revenues and expenditures were very low at, respectively, 11 and 16% of GDP.

14 D. Gvindadze

148

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Georgia

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Moldova

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Belarus

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Russia

IMF, World Economic Outlook, 2016

Fig. 2.2 GDP per capita, US$, current prices, 1994. Source: IMF World Economic Outlook, 2016

(20.6)

(44.9)

(29.3)

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1990

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2001

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2007

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2012

40.0

60.0

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100.0

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Real GDP Growth, % Real GDP (1990 = 100)

Fig. 2.1 Georgia’s real GDP in 1990–2012: level and pattern. Source: Geostat


Growth restarted from 1995. In 1995–2003, GDP increased from US$ 1.9 to US$ 4 billion, GDP per capita increased from US$ 400 to US$ 920, average consumer price inflation decreased to a single digit level, general government revenues increased from 11 to 16% of GDP.1 Strategic pipelines from Azerbaijan via Georgia to the Black Sea and to Turkey were agreed and their construction started, bringing in invest-ment and reinforcing Georgia’s pro-Western geopolitical and geoeco-nomic orientation. Trade patterns and economic structure adjusted to the new reality. Institutions malfunctioned but they were learning by doing. People adjusted to the market economy—some embraced it and others were forced into it. Corruption and the lack of meritocracy remained the overarching challenges. Despite the enormity of problems it was facing, Georgia of 2003 was better than Georgia of 1990–1995.

Then, in November of 2003, came the Rose Revolution which paved the way to Georgia’s transformation described in this book. The revo-lution was sparked by several factors: (1) the parliamentary elections which fell short of international standards, (2) government inefficinecy and corruption, (3) acute institutional and systemic challenges (fiasco in the energy sector, dilapidated infrastructure, poverty, unreformed law enforcement and public services), and (4) severe unresolved eco-nomic problems (Georgia had to restructure its public debt twice in the Paris Club - in 2001 and in 2004; according to the IMF notice of 7 November 2003, “...pervasive corruption and tax evasion remain the most serious obstacles to fiscal sustainability and private sector develop-ment”).

Notwithstanding the economic stabilization and growth from the second half of the 1990s, and the reforms-driven economic break-through from 2004 which I explain in this book, Georgia’s real GDP in 2012 stood at approximately 80% of the 1990 level (Fig. 2.1). Highlighted boxes in the Table 2.1 point to a cross-sectoral nature of the contraction in 1991–1994.

This has had two important implications for Georgia in 2004–2012 and beyond:

16 D. Gvindadze

Tab

le 2

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Geo

rgia

’s r

eal G

DP

gro

wth

by

sect

or

(199

0 =

100

%)*

. So

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1. To reclaim the lost ground, Georgia needed to grow fast over a long period of time. At approximately US$ 1200 in 2004 and US$ 4000 in 2012, Georgia’s GDP per capita was lower than in Central Europe and much lower than in the Euro Area. The catch-up could only be achieved through (1) sustainably high real rate of growth (i.e., growth in volumes of annual production), (2) stable national currency (which can only be achieved in absence of undue external and internal economic imbalances) and (3) reasonable infla-tion expectations.

2. At the low level of GDP per capita, a genuine mitigation of pov-erty could only happen through lasting growth propelled by poli-cies promoting the equality of the opportunity more than the equality of the outcome (i.e., no premature welfare state). State activism could help, provided that public action strengthened the sys-tem of the national security, resulted in better infrastructure, brought in the international capital and know-how and crowded in private entrepreneurship.

Note

1. IMF World Economic Outlook database.

Abstract This chapter explains the 10 principles underpinning the political economy of the state-building process in Georgia in 2004–2012: hands-on, disruptive and transformative leadership, clar-ity on the overarching geopolitical and developmental vector, sense of urgency, consensus around a single economic paradigm, critical mass of people willing to take individual risks to get things done, consolida-tion of the political landscape, zero tolerance to crime and corruption, strengthening of the system of the national security and the overhaul of the system of the law enforcement and of the administration of justice, awareness of the importance of irreversibility of an institutional trans-formation and of quality public services, commitment to remaining beyond reproach, active outreach to manage popular expectations and to preserve the international good will.

Keywords Political economy · Reforms · Leadership · Urgency Consolidation

Imagine reform-minded, intelligent and well-intentioned technocrats in ministries of finance and economy or in central banks who do not

3Political Economy of Georgia’s Reforms in 2004–2012: The Ten Commandments


19

20 D. Gvindadze

enjoy an unequivocal top-down backing from their political establish-ment. Can they uphold the notion of the limited government and restrain pork barrel spending? Can they abolish public entities which add no value, do more harm than good, yet employ many potential voters? Can they ring-fence banking sectors from vested interests, international raiders and money launderers? Can they, on their own, prevent subsidies, directed lending or guarantees to well-connected businessmen which trigger liabilities for future generations without creating much public value? Can they hold the line against calls to increase salaries and pensions beyond what a poor economy can sus-tain? Can they decide fast, without engaging in artificial cycles of con-sultations aimed at diversifying and diluting individual risks? Can they, in absence of a strong national security apparatus, confront the organ-ized crime or the infiltration by foreign special services? In some very improbable cases, the answer might be yes, although almost always it is the clear and loud no. To move beyond window dressing and to imple-ment real reforms, reformists need to operate within a conducive politi-cal economy context.

The political economy context of Georgia’s reforms in 2004–2012 was based on the ten principles:

1. Hands-on, disruptive and transformative leadership from the top which reverberated, on a daily basis, across all layers of the civil service, encouraging—and enforcing—the sense of purpose and of the direction in the realm of the domestic and foreign policies. Such top-down leadership aimed at ensuring that Georgia embraces fast modernization and parts ways with the defeatism and with the apathies of the post-Soviet past. This mode of leadership—forceful, omnipresent and at times overbearing—was not immune to mis-takes. In the grand scheme of things, however, it was prescient and ambitious in promoting Georgia’s national interest and its interna-tional appeal.

2. Clarity on the overarching geopolitical and developmental vec-tors. The European and the Euro-Atlantic integration and the transformation of Georgia into the regional platform for inves-tors represented two mutually amplifying anchors of the foreign

3 Political Economy of Georgia’s Reforms … 21

and domestic policy. Clear understanding of Georgia’s competitive edge in the regional and global economic context and the ability to reinforce such edge through a coordinated state-building process represented the key to Georgia’s proper geopolitical and economic positioning.

3. Sense of urgency, based on the realization that time had been lost and that the economic catch-up game and the management of social and political expectations called for the revolutionary rather than the evolutionary measures. Multidimensional reforms were to allow Georgia to acquire the velocity to escape the post-Soviet gravi-tational pull and to build a better muscle and immunity against external geopolitical pressures.

4. Critical mass of people within the political “inner circle” will-ing to take individual risks when clamping down on crime, cor-ruption and vested interests and able to prod others into similar actions. Such inner circle was, on balance, represented by people closely involved in the Rose Revolution of 2003, although doors were open for the willing and non-corrupt public servants able to spearhead downstream institutional and systemic transformations.

5. Consolidation of the political landscape after the Rose Revolution in 2003, with high approval rating of the president and of the government which helped to conceptualize, ratify and implement reforms without excessive horse trading. In the presi-dential elections of January 15, 2004, the first elections after the Rose Revolution of November 2003, Mikheil Saakashvili received 96.27% of votes, whereas in parliamentary elections of March 28, 2004, the National Movement of which the president was the leader obtained 66.24% of votes. The National Movement obtained similar landslide victory in the local elections of 2006. By the end of the first presidential term, the ratings decreased, although remained at the reasonably high level. In the presidential elections of 2008, president Saakashvili obtained 53.41% of votes which was almost twice higher than the votes which went to his main contender (importantly, though, the contender won the race in Georgia’s cap-ital Tbilisi by garnering 40.43% of votes, almost 8% higher than president Saakashvili). In the parliamentary elections of 2008,

22 D. Gvindadze

the National Movement garnered 53.45% of votes, almost twice higher than for the second-best contender. In the local elections of 2010, the National Movement again won by a significant margin, in Tbilisi and in the regions. Hence, until the parliamentary elec-tions in October of 2012 when the National Movement lost to the Georgian Dream coalition, the National Movement was firmly in control of the central government, of the parliament and of munici-palities. This, together with the strong presidency, allowed to con-solidate power and to advance the state-building process without slippages.

6. Zero tolerance to crime and corruption which drove criminals large and small out of Georgia and allowed to establish credibility early on. Mafia bosses fled the country and their influence on the street dynamics and on political processes quickly vanished. As a result of Georgia’s public safety measures, global media increasingly ranked Georgia among the safest destinations for the tourism and leisure. Faraway locations—mountains, natural reserves—which I would not recommend visiting in the 1990s became safe destina-tions for in-country and international tourists. According to a sur-vey conducted in the middle of 2012, Georgian residents declared reduced crime as the most important achievement of the Georgian government. Public safety was no longer among issues which either Georgia or households were facing.1 Anti-corruption campaign entailed punishments within own ranks and readiness to move beyond the general anti-corruption rhetoric (of which we see a lot in many developing countries which instead of taking concrete steps promulgate lengthy anti-corruption laws and roadmaps and draft multiyear action plans) to expose concrete schemes and indi-viduals.2 In my view, the zero tolerance to the prosecution of the economic crime—the sine qua non in the early years of the heavy-handed reforms which started in 2004—partially went into the overdrive in the later years of the reforms when such harshness (1) started to interfere with the incremental relaxation of the control which many businesses would welcome and (2) left some wonder-ing whether the harshness was general or selective and politically motivated.


7. Strengthening of the system of the national security and the overhaul of the law enforcement and of the administration of justice. The extent to which courts became fully independent and impartial as a result of the post-2004 reforms can and shall be debated, although the entire system of the administration of justice was modernized and purged of corruption. Police—which before 2004 was one of the least trusted and the most despised public institutions—was reconceptualized, reinstitutionalized, restaffed and rebranded into the modern institution. In the middle of 2012, 88% of Georgian residents described their confidence in the police as favorable.3 Patrol police—where almost the whole police force was abruptly fired and new officers were hired and trained—rose to one of the highest approval ratings among public institutions. Modern police buildings all featured glass walls to assert that the police is not afraid of either criminals and or of the transparency. With the law enforcement entities firmly in the service of the state, the authorities were in a position to deploy an efficient counterin-telligence and anti-crime effort and the government reformers felt protected when taking on the vested interests.“No man left behind” principle was at the core of discussions and actions in the realm of the national security. Those at the forefront of combating crime and of countering foreign infiltration were—and in the future must at all times be—certain that their country is firmly and irrevocably behind them, irrespective of which political party holds high public office. The slightest doubt about whether this principle will endure in times of the duress can deal a mortal blow to the whole system of the national security. The slightest mistake on the national security front may start a tornado of conflicts and vulnerabilities which can easily—and very quickly—undo any progress in the realm of the economic reforms.

8. Awareness of the importance of the irreversibility of the insti-tutional transformation and of the quality public services. The public administration was transformed through a series of measures which in 2004 started with heavy-handed restructuring and con-tinued with generally more incremental and lighter-touch efforts to progressively modernize public institutions and to build into their

24 D. Gvindadze

DNA the culture of a high-quality service provision. Institutions and services thus developed in 2004–2012, on balance, survived the political change in 2012 (I write “on balance” because the political change in Georgia in 2012 could not go unaccounted for in cer-tain key public institutions). At least two generations of teenagers brought up in 2004–2012 never confronted corruption and never dealt with criminals in their neighborhoods; they would be hope-fully expecting the same treatment from any future government.

9. Commitment to remaining beyond reproach. When prosecut-ing corruption and embezzlement, or implementing deep reforms which in the near-term result in layoffs, social distress and income inequalities, personal reputation and integrity matters. Many lead-ers around the world who tried and failed to implement reforms were enfeebled by their own families and inner circles which engaged in building business empires behind their backs or at their behest. Radical reforms are about trust. When the trust is breached, the margin of maneuver shrinks instantly. Success of Georgia’s reforms owes to the general readiness to draw the line between the public interest and the personal gain. Many high-ranking civil serv-ants who in 2004–2012 spearheaded reforms exited the government in 2012 effectively starting their lives from scratch, with scarce sav-ings and some with mortgages. Staying beyond reproach, individu-ally and collectively, helps to keep faith with the people, especially in politically charged environments.

10. Active outreach to manage popular expectations and to preserve the international good will. Economic progress observed from the window of the government chancellery or of the presidential palace looks differently from the window of an ordinary citizen. Even the best of the reforms can be easily misunderstood and misinterpreted. Populism and the electoral overpromise are powerful tools, and they can sway both sophisticated and naïve voters who lack deep under-standing of how multiple decisions, choices, factors, exogenous and endogenous constraints interconnect to shape the state-building process. Active public outreach blending simplicity and strength with the requisite sophistication can prolong the political life and generate space for more reforms. Because Georgia was small and


dependent on the international community’s good will and support, significant effort was invested into explaining to foreign experts, diplomats, international civil servants and development practition-ers the prevailing political economy and the national security con-straints and how Georgia’s state-building effort was tailored to the particular situation that Georgia was facing.

Without most of these ten principles observed simultaneously and as part of the resolute state-building effort, even the most reformist of gov-ernment technocrats face high odds of failing and resigning, or in the best of circumstances remaining confined to the domain of the hollow reformist proselytization. They would end up with lengthy strategies and action plans, with series of councils, commissions and conferences attended by international experts who might lack a comprehensive understanding of an intricacy of country-level challenges and of how to connect multitude of dots to resolve such challenges.

Note the highlighted word most above. Even when the political and the bureaucratic fields are largely homogenous (Georgia in 2004–2012), individuals within the government and in the high echelons of the domestic politics constantly position themselves vis-à-vis each other, they have their egos and their allegiances, they flex their muscles, they miscalculate and surprise on the upside and on the downside. Individual mistakes hit reformist teams in their entirety. Despite their inescapable internal complexities, citizens tend to perceive their governments as uni-form creations bearing collective responsibilities.

Lack of reforms and of the state building does not mean that develop-ing countries do not undertake macroeconomic adjustments. They do, to the ovation of the international community, because forces fueling, say, devaluation of a national currency are too tectonic to resist by any particular interest group. Even in places where oligarchs are in control of large swaths of national economies, they acquiesce to external and internal macroeconomic adjustments, even if this hits their net worth in hard currency terms. However, the macroeconomic adjustment is about stabilization and not about growth. To spur the post-adjustment growth, developing countries need to reform their state-owned enter-prise and banking sectors, to prosecute all sorts of state captures, crimes,

26 D. Gvindadze

misuses and mismanagement. This is where—in the absence of the resolute state-building effort—the full armor of political, criminal and financial connections springs egoistically into action to obstruct struc-tural reforms which would bite individually despite helping nationally. In short, unless confronted head-on, real culprits blocking reforms and the modernization continue their business as usual.

Notes

1. Georgian National Study, June–July 2012, International Republican Institute (http://www.iri.org/sites/default/files/2012%20August%2020%20Survey%20Georgian%20Public%20Opinion%2C%20June%2026-July%204%2C%202012.pdf. retrieved on 4 April 2017).

2. Some international reports referred to Georgia’s success in eradicating petty corruption. This qualification is misleading due to its vagueness with respect to the issue of the high-level corruption. There is a distinct link-age between the high-level and petty forms of the corruption as they feed and amplify each other. Absence of the petty corruption (which happens at the point of the public service delivery in institutions where civil serv-ants providing public services—tax, customs, licenses, permissions, vari-ous government verdicts—directly interact with businesses) means that no cash in envelopes is dispatched up along the administrative ladder. At the same time, rarely would you have senior officials enriching themselves below the radars of the public opinion while precluding all others beneath them from doing the same or from taking note of the schemes employed and spreading the word abundantly. The real life produces outcomes which are neither simple nor binary, although in my view the dual causal-ity mainly holds: petty corruption feeds the high-level corruption and vice versa. The right qualification of Georgia’s anti-corruption achievement by 2012 is: Georgia succeeded in substantially reducing the level of corruption in general, which includes both high-level and petty forms of the corruption. Note that the substantial reduction of corruption does not mean its com-plete elimination which can hardly be achieved in the real world.

3. Georgian National Study, June–July 2012, International Republican Institute (http://www.iri.org/sites/default/files/2012%20August%2020%20Survey%20Georgian%20Public%20Opinion%2C%20June%2026-July%204%2C%202012.pdf retrieved on 4 April 2017).

http://www.iri.org/sites/default/files/2012%20August%2020%20Survey%20Georgian%20Public%20Opinion%2C%20June%2026-July%204%2C%202012.pdf.



http://www.iri.org/sites/default/files/2012%20August%2020%20Survey%20Georgian%20Public%20Opinion%252C%20June%2026-July%204%252C%202012.pdf



Abstract Within the context of Georgia’s state building in 2004–2012, this chapter examines three key pillars of Georgia’s growth and investor outreach: health of the sovereign balance sheet, soundness of the busi-ness environment and the efficiency of the banking sector. The author examines political and technical aspects of the reforms, explains both processes and outcomes and brings in the cross-country evidence. The author shares views on the proper size of the government, composition of the public expenditure, management of the public debt, access to the international capital markets and donor coordination. Discussing the enabling business environment, the author examines Georgia’s tax, cus-toms and trade reforms, deregulation, privatization, innovation in the public services and the promotion of the domestic competition. The author reviews the principles which powered the development and the modernization of Georgia’s banking sector.

Keywords Sovereign · Budget · Business climate · Banking · Reforms

4Pillars of Georgia’s Growth and of Investor

Outreach in 2004–2012


27

28 D. Gvindadze

Within the general context of its political economy of reforms in 2004–2012, Georgia’s economic development and global positioning rested on the three interdependent pillars:

1. Health of the sovereign balance sheet,2. Soundness of the business environment and3. Efficiency of the banking sector.

I discuss each pillar below, invoking concepts, reforms and policies which (1) were, on balance, under the purview of the government, i.e., public action directly influenced end-results, (2) were cross-sectoral in their impact and nature and (3) catalyzed downstream transformations at the sectoral and institutional levels. These policies helped economic agents—visceral and cerebral, large and small, savvy and unsophisti-cated, domestic and international—to act in their best interest, adding value in and for Georgia.

Pillar 1—Health of the Sovereign Balance Sheet

Investors, consumers, lenders and depositors all depend on the sound-ness of a sovereign balance sheet. Sovereign risks feed into investee companies’ risk profiles and influence “hurdle rates”—minimum rates of return on investments sought from such companies. High hurdle rates affect investability of otherwise bankable projects, curbing pri-vate investment and consumption. Country ceiling—rating assigned by international credit-rating agencies to a sovereign state—often establishes a binding upper constraint on credit ratings for banks and corporates located in such sovereign and, therefore, impacts on the economy-wide cost of funds and on a flow of credit.

Health of the sovereign balance sheet was thus at the core of Georgia’s transformation in 2004–2012. I decompose the narrative into five parts: (1) proper size of the government, (2) proper composition of public expenditure, (3) proper management of public debt, (4) proper con-ceptualization of the access to the international capital markets and (5) proper donor coordination.

4 Pillars of Georgia’s Growth and of Investor Outreach… 29

Proper Size of the Government

General government expenditure to GDP ratio differs from one coun-try to another. It evolves over time. In 2004–2012 (the period which I examine in this book), this ratio increased in many countries, in part due to the fiscal stimulus measures deployed by governments to mini-mize the impact of the global economic downturn. The ratio was gener-ally higher in advanced economies (Fig. 4.1).

At 16.5% in 2003, Georgia’s ratio of the total general government expenditure to GDP was the lowest out of the countries in the Fig. 4.1. It went up to 35.8% in 2009 on the back of the post 2008–2009 fiscal stimulus and then went down to 29.6% in 2012 (seventh lowest ratio in Fig. 4.1).

One key factor which allowed to increase government expenditure without jeopardizing the sovereign balance sheet was tax reform which Georgia launched after 2004 and which is discussed later in this book.

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Fig. 4.1 Total general government expenditure as percent of GDP in 2003, 2009 and 2012 (ranked by 2012 ratios, largest to smallest). Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, the European Union, the USA, Iceland. Source: IMF World Economic Outlook, IMF country reports

30 D. Gvindadze

Tax and customs revenues as percent of GDP increased from 14% in 2003 to almost 26% in 2007, in the context of materially lower tax rates and of the drastically reduced number of taxes. The resultant scale-up of the public spending allowed to invest heavily in the national secu-rity and in infrastructure, to improve social services and to modernize public institutions.

In 2011, to restrict the size of the government, Georgia’s Parliament adopted an organic law on economic freedom, the so-called Liberty Act which, inter alia, limited the general government expenditure to 30% of GDP and limited the overall budget deficit to 3% of GDP. If a budget law which the Parliament adopts for a coming fiscal year breaches these two limits, the government is required to elaborate and implement a plan of return to full compliance with the limits within 2 years. The Parliament can only allow such deviation if in the current fiscal year the limits are fully observed. Georgia thus asserted—at the constitutional

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Fig. 4.2 Size of the government and the real GDP growth (average for 2003–2012, all countries). Source: IMF World Economic Outlook


level—its vision of the upper bounds of the public action (while at the same time retaining the “safety valve” to deal with ad hoc circumstances).

The thinking behind the Liberty Act was threefold:

1. Politics plays out in the short term. Too often, it neglects longer-term economic consequences. Where upper bounds of the gov-ernment expenditure are not circumscribed—legally or through a time-proof multistakeholder political consensus—its size is more likely to increase, driven by a bureaucratic inertia and electoral cycles. One way to resist this is to circumscribe the limits of the public action at the high legal level and to seek purely private sector solutions or public–private partnerships to avert excessive pressure on the budget.

2. Big government does not mean high growth. Figure 4.2 shows rela-tionship between the economic growth and the size of government (all countries, certain outliers removed). On balance, the generally weak inverse relationship holds even when countries are categorized

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Government effectiveness estimate in 2012 (LHS)

Change of government effectiveness estimate from 2004 to 2012 (RHS)

Higher score compared to neighboring countries and theCommonwealth of Independent States countries; highest increase in the government effectiveness in 2004-2012, globally.

* Government effectiveness reflects perceptions of the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government's commitment to such policies.

Fig. 4.3 Government effectiveness estimate in 2012 and change in the gov-ernment effectiveness estimate in 2004–2012* (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey). Source: The Worldwide Governance Indicators (WGI) Project, World Bank

32 D. Gvindadze

by their GDP per capita to compare countries in similar economic circumstances. At certain medium-to-low-income levels, the rela-tionship at times becomes positive, although the trend is not pro-nounced. Contribution of the government size to the growth is not at all linear. Lean, efficient and service-oriented governments can potentially create more value than inert and oversized bureaucracies.

3. A lean and efficient government acting rapidly and credibly is better positioned to implement real reforms than governments overexposed to vested interests and to the political infighting. In 2004–2012, Georgia’s improvement in the Government Effectiveness Indicator (1.09 point improvement, from −0.49 in 2004 to +0.6 in 2012) was the highest compared to countries in the Central and Eastern Europe and in the Commonwealth of Independent States. This improvement was also the highest globally. At its level of GDP per capita, Georgia’s 2012 government effectiveness indicator (+0.6) was the highest globally (Fig. 4.3).

Proper Composition of the Public Expenditure

Budgets are debated through complex interactions. They mirror domes-tic politics, stage of development, technocratic prowess and attitudes toward the virtues and the limits of the public action. Fractured and polarized political landscape in developing countries leads to larger budgetary trade-offs and compromises. It increases bargaining powers of stakeholders seeking to leverage their deal-making and deal-breaking abilities. The polarization makes holding the line on proper composi-tion of the government expenditure more difficult. It fosters pork barrel spending, may lead to exorbitant and wasteful subsidies, unsustainable social outlays and inflexible indexation mechanisms (e.g., where salaries are indexed to inflation and growth and pensions are indexed to sala-ries). This creates a short-term illusion of the welfare society even if lev-els of the GDP per capita are too low to sustain such welfarism in the medium and long run. Such “premature welfare states” then unravel, sending political and social shockwaves and triggering the geopolitical consequences.


Conversely, reasonable political consolidation in a developing coun-try may reduce the space for horse trading, create healthier margins of maneuver for governments and ensure that red lines between the sound economics and the politics are better respected. This helps, inter alia, ministers of finance who do not need to face, on their own, spending pressures coming from powerful interest groups and from fellow line ministers (mission impossible, unless finance ministers are much more than senior fiscal technocrats and have substantial political support base and following of their own) but rather act in tandem with prime min-isters and other key political players to get things done. All this on the assumption that the political mainstream and its technocratic appoin-tees subscribe to the concept of an efficient and lean government and have the capacity and the political audacity to deliver reforms. If this assumption does not hold, insufficient checks and balances inherent in the overconsolidation of power may lead to a progressively more medio-cre decision making.

Political consolidation in Georgia in 2004–2012 allowed to struc-ture public spending in line with Georgia’s stage of development and to minimize the pork barrel spending. This manifested itself through an absence of the social overpromise and through a significant emphasis on the development of infrastructure to improve connectivity and to crowd in private investment.

a. Emphasis on infrastructure and positive operating balance.

Georgia’s capital spending (spending on infrastructure projects which contribute to potential long-term growth) as a percentage of the total general government expenditure increased from 18.5% in 2004 to more than 20% in each of the subsequent years. Georgia’s average annual cap-ital spending in 2004–2012 stood at 22.4% of the total general govern-ment expenditure. This compares to 9% in Ukraine, 15.2% in Moldova and 19.5% in Armenia.1

As percent of the GDP, Georgia’s capital spending increased signifi-cantly from 4.3% in 2004 to up to approximately 8% in 2007–2012. In 2004–2012, Georgia’s average annual capital spending as percent

34 D. Gvindadze

of GDP stood at 7.2%. This compares to 3.9% in Ukraine, 4.4% in Armenia and 6.1% in Moldova (Figs. 4.4 and 4.5).

Such emphasis on the infrastructure and the ability to keep a lid on the recurrent spending allowed Georgia to maintain positive govern-ment operating balance in 2004–2012 (except in 2009 due to a coun-tercyclical fiscal policy to mitigate the impact of the global economic crisis and of the war with Russia in 2008). Post-crisis, Georgia reduced

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Fig. 4.4 Capital spending in percent of GDP (general government operations, 2004–2012). Source: IMF Country Reports

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Fig. 4.5 Capital spending in percent of total government expenditure (general government operations, 2004–2012). Source: IMF Country Reports


its overall budget deficit faster than planned, from 9.2% of GDP in 2009 to 2.9% of GDP in 2012, committing to bringing it further down in 2013. The fiscal consolidation was helped by the rebound in confidence: real GDP grew by 6.2% in 2010, 7.2% in 2011, and 6.4% in 2012. The fiscal stimulus in 2009–2012 was helped, inter alia, by the government’s ability to ensure fast shovel readiness of infrastructure projects and to foster their due implementation (Box 4.1 and Fig. 4.6).

Box 4.1: Government’s operating balance in a developing country targeting fast growth

The government operating balance represents the difference between a government’s recurrent revenues (taxes, other non-tax revenues, grants) and current expenditures (compensation of employees, use of goods and services, subsidies and grants, mandatory social, health and other recur-rent expenses, including interest to residents and non-residents). It thus measures the ability to keep in check the current expenditure, including the general government consumption.

Positive operating balance means that a government’s recurrent rev-enues are sufficient to cover its current expenditure, including man-datory spending whose course cannot be changed fast and without a political cost. Sustained and large positive operating balance in a

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Operating balance as percent of GDP Overall deficit as percent of GDP (actual path)

Overall deficit as percent of GDP (initially planned path) Real GDP growth, percent

Capital spending in percent of total government expenditure

Fig. 4.6 Georgia in 2004–2012: high capital spending and positive operating balances. Source: Ministry of Finance of Georgia (general government opera-tions GFC 1986)

36 D. Gvindadze

country which runs an insignificant overall budget deficit implies that a government is conservative in relation to an aggregate level of its cur-rent expenditure and that the bulk of the contribution to the overall budget deficit formation comes from implementation of public infra-structure projects (capital spending). These—mainly discretionary—pub-lic infrastructure development measures are thus funded through a residual generated by subtracting current expenditures from the recur-rent government revenues and through domestic and external public borrowing. If managed efficiently and cautiously with respect to the resultant public debt dynamics, such setup can represent the sound course of action for a growth-oriented economy which seeks to develop its infrastructure. All along, governments must have in place adequate systems of technical monitoring and of financial controls to avert cost acceleration, to punish embezzlement and to ensure early detection and prevention of the “white elephant projects.”

Countries with pronounced positive operating balances can under-take fiscal consolidation from the position of the relative strength. To consolidate, they do not need to cut deep into the mandatory spending items—the exercise which upends confidence, lifestyles and national politics. Provided that the fiscal consolidation is the reason-able and the agreed course of action, countries with positive operat-ing balances can implement it, e.g., through proper configuration and sequencing of the capital spending. In times of the macroeconomic and fiscal hardship, such countries are, therefore, rewarded for their prior efforts to at least partially decouple their fiscal planning from political cycles. In contrast, when operating balances are close to zero or neg-ative, fiscal consolidation can set a government on a collision course where an abrupt downsizing of socially entrenched and politically sensitive items of the current spending must be implemented without compromising too much on the political stability while at the same time retaining the power to implement structural reforms to readjust to the “new normal.”

• Enhancement of Georgia’s cross-border power transmission network aimed at increasing the international and local private sector inves-tors’ interest toward the construction and operation of hydropower plants in Georgia.

• International highways fostered Georgia’s economic approximation with its neighbors, strengthening its logistical and trade function.


• Local and secondary roads enhanced in-country interconnectiv-ity, helping to develop value-added chains and unlock new tourism opportunities.

• Vertically integrated urban regeneration schemes (where the gov-ernment identified cities and towns with significant vernacular, his-toric and tourism potential and moved to comprehensively upgrade, reengineer and revitalize their municipal and road access infrastruc-ture, beautify facades, return traditional architecture, refurbish pub-lic spaces and urban recreation areas) were implemented to help businessmen and local communities to rediscover and invest into the latent economic opportunities in such cities and towns and, therefore, to multiply the impact of the public action through pri-vate investment and spending. Flagship projects in Old Tbilisi, Sighnaghi, Kutaisi, Batumi, Telavi, Mestia etc., provide the example of how public money can spur the hospitality industry, create local employment and crowd in the private investment.

• In several cases (e.g., the new sea resort and the deep sea port in Anaklia, remote high-altitude ski resorts in the Upper Svaneti and in Goderdzi), the government decided to step in financially to cre-ate new growth pockets in the environment where the private sec-tor was likely ready to follow rather than to lead. All these projects were unusually grandiose by the Georgian standards, were integral parts of the country-wide spatial planning vision and had the ade-quate rationale behind them. In the rush to start the construction, however, such rationale was not always sufficiently well explained to the population.

• The government was not shying away from ambitious projects, designed by expensive and internationally acclaimed architects, which contributed to the uniqueness of Georgia’s tourism and investment proposition. Positive long-term economics of such pro-jects stretches well beyond their immediate costs.

Listed above are what I call “non-contractual public-private partner-ships.” They positioned Georgia’s government as the catalyst of the pri-vate investment. In contrast to traditional public–private partnerships, such non-contractual partnerships did not require formal (contractual)

38 D. Gvindadze

risk-sharing arrangements between the public and private sectors. They, therefore, did not expose the government to the risk of revisions of con-tractual terms or to longer-term contingent liabilities which could not be quantified in the budget upfront.

b. Cautious recurrent spending to avoid emergence of the “prema-ture welfare state.”

Essential to the emphasis on the infrastructure in 2004–2012 was Georgia’s ability to ensure that public and social entitlements were reflective of the level of the economic welfare and of the government’s ability to deliver. Georgia had no automatic indexation of wages and of pensions. Annual wage funding and the bonus pool in the public sector were discussed on the basis of a technical analysis led by the Ministry of Finance and then agreed at the cabinet level. Ministers were in the posi-tion to reward their best performers through monthly bonuses which could be higher than salaries. Volume of budgetary subsidies remained immaterial at all times.

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Fig. 4.7 Average monthly nominal salaries in the public and non-public sectors, 2003–2012. Source: Geostat


After the privatization since 2004, the number of Georgia’s state-owned enterprises (SOEs) was reduced to a minimum. A handful of remaining SOEs were corporatized to become net contributors to the budget. This removed direct and contingent liabilities and closed fiscal loopholes which usually accompany an unreformed SOE sector. Cost recovery principle was gradually phased in for municipal and urban ser-vices (electricity, gas, water, solid waste). Banks were private, conserva-tively managed and required no financial lifelines from the budget.

Because Georgia grew fast, average monthly salaries increased in both public and private sectors (Fig. 4.7).

Total compensation of government employees in Georgia increased from GEL 131.5 million in 2003 to GEL 1.05 billion in 2012, which translated into CAGR of close to 25%.2 In nominal GEL terms, such increase from 2003 to 2012 was close to 700% and in the inflation-adjusted GEL terms—close to 350%.3 The government was watchful to ensure that the compensation of the government employees as percent of the total expense did not diverge from what Georgia could afford.

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* Compensation of employees consists of all payments in cash, as well as in kind (such as food and housing), to employees in return for services rendered, and government contributions to social insurance schemes such as social security and pensions that provide benefits to employees.

Fig. 4.8 Compensation of employees*, percent of expense in 2012 (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey). Source: IMF Government Finance Statistics Yearbook and data files

40 D. Gvindadze

Figure 4.8 shows compensation of employees as percent of government expense in Georgia and in the broader region: (1) the ratio for Georgia is at the lower end of the distribution and (2) the ratio for Georgia remained roughly the same in 2003–2012. The share of the public sec-tor employment in the total employment in Georgia decreased from 20.6% in 2006 to 15.9% in 2012 (from 360,300 public sector employ-ees in 2006 to 273,700 in 2012).4

The reform of the healthcare sector—implemented in several stages through trial and error but successful at the end—sought to modernize and optimize the existing hospital and primary healthcare infrastructure and to improve the quality and the accessibility of the healthcare with-out excessive and unsustainable reliance on the public spending.

The main feature of the healthcare provision reform in Georgia was the efficiency-enhancing strategic public–private partnership between the government, private insurance companies, hospital own-ers and managers. Among main outcomes of the reform were (1) sharp

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Fig. 4.9 Public health expenditure as percent of GDP and of government expenditure, 2012 (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey). Source: World Health Organisation Global Health Expenditure Database


reduction of illegal payments in the sector (by some counts, from approximately 65% before the reform to 5% thereafter), (2) technical efficiency-driven improvements in the health outcome indicators amid Georgia’s lowest public outlays for the healthcare in the region and (3) significant domestic and international private investment into the sector.

Figures 4.9 and 4.10 show the low levels of the public health-care expenditure in Georgia in 2012, amid Georgia’s relatively high total level of the healthcare expenditure as percent of GDP. In 2012, Georgia’s out-of-pocket health expenditure represented 72.7% of the private expenditure on health, which was the third lowest ratio from the set of countries depicted in the Figs. 4.9 and 4.10. From 2003 till 2012, the ratio of the out-of-pocket health expenditure to the private expendi-ture on health in Georgia decreased by 17.8% points, from 90.5% in 2003 to 72.7% in 2012 (third largest decrease in the given cross-coun-try dataset after Croatia and the Slovak Republic).5

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Fig. 4.10 Public health expenditure as percent of total health expenditure and total health expenditure as percent of GDP, 2012 (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey). Source: World Health Organisation Global Health Expenditure Database

42 D. Gvindadze

Georgia’s pension system represents a simple pillar-1 “pay-as-you-go” from the general budget pool, with no special pension funds or ear-marked revenues (see Box 4.2 for views on the future of the pension system in Georgia and on the latest history of currency movements in the region). At the start of Georgia’s reforms in 2004, old age pen-sions in Georgia stood at GEL 14 (US$7.32 at current exchange rate), well below the subsistence minimum (Fig. 4.11). Ten pension increases occurred in 2004–2013, with old age pensions exceeding the subsist-ence minimum for the first time in 2013 when—based on the 2013 budget prepared in 2012—pensions increased to GEL 150 (US$ 90.36 at current exchange rate). Political consolidation in 2004–2012 helped to resist pressures for the front-loading of such increases. The so-called special pensions and early retirement schemes were fiscally insignifi-cant and applied to a limited pool of beneficiaries. Pensions were not indexed to inflation; pension increases were based on analyses of eco-nomic and political trade-offs in the process of the budget formulation. Regular retirement age is 65 years for men and 60 years for women. Gradual increase in retirement age for women was discussed on sev-eral occasions, although it did not materialize as this would hit people with no formal employment for whom such old age pensions represent

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Fig. 4.11 State old age pensions and the subsistence minimum in Georgia, 2004–2013. Source: Geostat


a significant share of cash revenues. Also not materialized—for politi-cal, emotional and social reasons—remained the idea of means-testing of old age pensioners.

Within the budget, Georgia has had no stand-alone pension funds. Social benefits and pensions are paid from the general budgetary pool (the social tax was abolished from 2008, as explained later in the text). This allowed to avoid extra costs involved in maintaining bureaucra-cies which administer such funds and to ensure an explicit reflection of the pension liabilities in the public balance sheet. Where such pension funds exist in other developing countries, they frequently run recurrent annual deficits, with the state forced to come to the rescue, sometimes in midyear. The additional layers of bureaucracy increase risks of cor-ruption.

Box 4.2: Which near-term future for the pension system in Georgia?

In 2012–2013, the government launched discussion on introduction of the pillar-2 of the pension system (mandatory private saving scheme through co-participation of employees and employers).

In theory, pillar-2 can help to (1) increase domestic savings, given Georgia’s dependence on foreign capital, negative current account and negative net international investment position, (2) replace part of con-sumption with investment and (3) spearhead the domestic capital market development.

In practice, before adoption of the pillar-2, a government of a small open developing country must have a clear answer to the following: (1) Is a government (or a government-hired pension fund) a better inves-tor than private citizens contributing to the scheme on a mandatory basis from their earnings? (2) What are the investable opportunities within Georgia which have a very long-term value proposition and allow to absorb the constantly increasing pool of such pension savings? (3) Georgia’s sovereign credit rating is in the sub-investment category and this establishes the sub-investment “sovereign ceiling” for Georgia’s banks and corporates; to what extent is it appropriate to “expose” the contributors by investing their retirement savings into high-risk assets on a compulsory basis? (4) Is domestic private sector able to absorb the increasing pool of mandatory retirement savings? If not, what are the upsides and the down-sides of investments into the government securities? (5) To what extent would investments outside Georgia pressure the exchange rate of the Georgian lari? (6) In the long run, what are the “waterproof” safeguards

44 D. Gvindadze

which would prevent successive governments from using pension savings for funding their budget or other ad hoc needs? (7) If invested domes-tically, how protected shall be the real value of the savings in the small open-economy environment where the inflation is too frequently driven by exogenous factors and the exchange rate equilibrium needs to be maintained in the conditions of the structural current account deficit? (8) How would the pension reform fit with the overall capital market devel-opment context? (9) In view of the still low level of the GDP per capita, to what extent are people who spend the bulk of their incomes on food and on other necessities ready to forego consumption today in exchange for a presumably enhanced social safety in the future? (10) Under which circumstances and how fast would people be able to withdraw their accu-mulated savings (plus accrued capital gains and interest) earlier than the retirement age? (11) Can’t the volume of private savings be increased further, optionally rather than mandatory, through the existing banking system, on the basis of new tailor-made product offerings and awareness raising campaigns (i.e., through continued development of the pillar-3 of the pension system)?

Knowledge of the trade-offs involved in enacting of the pillar-2 of the pension system in Georgia would allow to proceed understanding all opportunity costs and risks. In 2004–2012, at the low levels of the GDP per capita, Georgia pursued its simple and fiscally responsible pension scheme and developed stable and modern banking sector offering saving products with reasonable long-term returns and safety buffers.

Developments in Europe in 2014–2016 illustrate complexities inher-ent in sustaining the long-term real value of the national currency of a small open economy. Georgian Lari depreciated against the US$ by 34% in 2014–2016.6 Reasons behind the depreciation—beyond the heated domestic politics and certain policy pronouncements by the government—were mostly external over which Georgian policymakers had no control: (1) Ukraine’s Revolution of Dignity culminating in the beginning of 2014 and the enhanced regional risk aversion due to the subsequent annexa-tion of Crimea and the war in Ukraine’s East; (2) the resultant almost 70% depreciation of Ukraine’s Hryvnia against US$ in 2014–2016 and the deep recession in Ukraine where the real GDP contracted by approxi-mately 6.6% in 2014 and by 10% in 2015 (Ukraine is Georgia’s important trade partner); (3) the economic and geopolitical impact of sanctions and countersanctions between Russia and the West in 2014–2016; (4) the con-current fall in the price of oil from more than US$ 100 per barrel in the beginning of 2014 to approximately US$ 30 per barrel in the beginning of 2016 which, in turn, triggered the almost 50% depreciation of the Russian ruble against US$ in 2014–2016 and forced Russia into recession, with its real GDP contracting by 3.7% in 2015 and by 0.76% in 2016; (5) significant knock-on impact of the currency depreciation and the reces-sion in Russia on Belarus which depends on Russia for trade and subsidies


(Belarus ruble depreciated against US$ by close to 50% in 2014–2016 and Belarus’s real GDP contracted for 3 years in a row in 2015–2017) and on all other neighboring countries which maintain with Russia trade, investment and other financial linkages; (6) pressures created by the low oil prices on Azerbaijan’s economy, due to its reliance on the export of hydrocarbons (Azerbaijan’s economy contracted in 2016 and Azerbaijani manat was step-devalued against US dollar by 56% in 2014–2016 to rebalance the economy externally and internally and to restore its competitiveness).

This complex web of the regional currency interdependencies and of the crisis and recession passthrough channels which encompasses Georgia and its important trade and investment partners is further complicated by the volatility of the Turkish lira (in 2016, Turkey accounted for 8% of Georgia’s exports and 15% of its imports).

To what extent is the government of Georgia—or the government-hired private pension fund manager—prepared to preserve and to mul-tiply the real value of the mandatory pillar-2 contributions by individuals, when these contributions are invested long term in such a convoluted con-text?

Proper Management of the Public Debt

In 2004–2012, one frequent question from the people and from the media was: when will Georgia bring its stock of public debt to zero? The answer was never, although in the charged political context it required lots of explanation.

No uniform set of debt sustainability ratios can be applied to coun-tries at various stages of development. The 60% public debt to GDP ceiling set out in the Treaty of Maastricht for countries wishing to adopt the Euro is the poor yardstick for developing economies with lower thresholds of the debt intolerance.7 Negative net international invest-ment position in an open, small and dollarized low-middle income economy can abruptly increase debt service costs, make it vulnerable to currency devaluations and to adverse balance sheet effects. Even low stocks of the public debt may disguise risks. International capital mar-kets may seize and inhibit refinancing of short-term external liabilities. Local capital markets may be too shallow to replace external funding or to remain liquid in times of stress. Because many developing economies

46 D. Gvindadze

have narrow economic base, crises can cause disproportionate economic contractions with associated spikes in debt ratios driven by the “denom-inator effects.” Global interest rate benchmarks may go up, increasing debt service costs even if contractual spreads over such benchmarks are fixed (see Box 4.3 and Fig. 4.12 for the Libor trends).

Box 4.3: Libor in time

London Interbank Offered Rate (Libor) is the international benchmark rate which was somewhat discredited in 2012 due to the fixing scandal yet continues to be used globally to price debt worth trillions of US$. Libor rate went from more than 7% in May of 2000 to approximately 1% in spring of 2004 to more than 5% in 2006–2007 to almost 0.5% at the end of 2012.

The public debt sustainability was thus of the essence for Georgia’s growth and FDI push strategy in 2004–2012. It materialized through: (1) Conservative measurement of what constitutes a low-risk stock of public debt, in absolute terms and as a percentage of the GDP and of the budget revenues; (2) Attention to the flatness of the public debt redemption path to mitigate refinancing risks; (3) Limited exposure of the sovereign to commercial debt and to floating rates; (4) Absence of direct or contingent sovereign guarantees (public debt only incurred

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Fig. 4.12 Libor in time. Source: Bloomberg


directly by the Ministry of Finance representing Georgia); (5) Limited indebtedness of state-owned enterprises; (6) Absence of state-owned banks and hence of directed or subsidized lending which usually engen-ders quasi-fiscal risks and liabilities ending up on sovereign balance sheets as the domestic public debt; (7) Avoidance of direct borrowing by sub-sovereign entities (with a small number of exceptions, public debt is incurred solely by the Ministry of Finance which can on-lend to sub-sovereign entities adding a risk margin); (8) Strict ban on the monetiza-tion of budget deficits by the central bank; (9) Integrated approach to borrowing from donors, international financial institutions, domestic and international markets, pursuant to the government’s medium-term expenditure framework; (10) Public debt management-related legislation and procedures which de facto abolish personal discretion and ensure adequate cross-checks within the government and in the parliament.

As anything else explained in this book, the ability of public debt managers to remain on track with respect to the factors, principles and safeguards 1–10 listed above was helped by the team play within the government. Where external debt-based infrastructure development ideas were deemed by the prime minister and by the ministry of finance excessive in view of Georgia’s debt absorption and repayment capacity,

Fig. 4.13 Georgia’s public debt stock and flow ratios, 2003–2012. Source: Ministry of Finance of Georgia

48 D. Gvindadze

their voice was heard and—to a large extent—acted upon. To a large extent because in the real life outcomes are never binary.

Georgia’s public debt dynamics in 2004–2012 can be split into three periods: 2004–2007, 2008–2010 and 2010–2012 (Fig. 4.13). In 2004–2007, public debt as percent of GDP decreased from 50.5 to 25.5%, driven by the economic growth and conservative borrowing. Low level of the public debt in the first half of 2008 and the flat debt redemp-tion path allowed to implement, in 2008–2009, a fiscal stimulus which returned Georgia to growth from 2010. Public debt ratio which in 2010 peaked at 42.4% decreased to 34.8% in 2012. Simultaneously, exter-nal public debt to GDP ratio decreased to 27.6% in 2012.8 In 2012, Georgia’s general government debt was on the lower end compared to other countries in the broader region (Fig. 4.14).

The period from 2004 to 2012 also saw evolution of the structure of Georgia’s public debt. Debt owed to international financial institu-tions and development agencies increased at the expense of the less concessional and shorter-term debt to bilateral creditors (Fig. 4.15).

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Fig. 4.14 Cross-country comparison, general government gross debt as per-cent of GDP, 2012—Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey. Source: IMF World Economic Outlook Database


Grant element (standard measure of the concessionality of loans) of the portfolio of the public debt went up as a result, and so did the average number of years to maturity (more than 10 years for the public exter-nal debt stock in 2012). In 2012, average weighted interest rate on the public external debt stock stabilized at below 2%. Refinancing and mar-ket risks were reduced to a minimum. By 2012, more than two-thirds of the outstanding stock of the public external debt had fixed interest rate, limiting the exposure to the floating base rates (Libor, Euribor, etc.) (Fig. 4.16). In 2004–2012, Georgia was the top performer in the Country Policy and Institutional Assessments (CPIA) conducted by international financial institutions (the World Bank, Asian Development Bank). This boosted performance-based eligibility for cheap funding from the IDA (World Bank) and the ADF (Asian Development Bank) windows.

As Georgia was developing its domestic public debt market in 2010–2012, economic growth and resilience helped to flatten down the yield curve across all maturities and to extend treasury bonds’ maturity to 10 years (Figs. 4.17 and 4.18).

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Fig. 4.15 Georgia’s public debt stock structure, end-September 2012. Source: Ministry of Finance of Georgia, own estimates

50 D. Gvindadze

Increase in the stock of Georgia’s treasury securities in 2010–2012 was taking place in small steps as explained below. By end-Septem-ber of 2012, it represented only approximately 2% of Georgia’s 2012 GDP—the low ratio compared to more advanced economies which borrow more in the capital markets and where the frontier between the domestic and the external public debt is less pronounced. Because the weighted average interest rate on Georgia’s external public debt was approximately 2%, fast switch from the low-cost long-term pub-lic external debt to a higher-cost and shorter-term public domestic debt was difficult to justify politically and financially. Georgian lari’s gener-ally stable exchange rate vis-à-vis hard currencies in 2004–2012 worked to mitigate the perception of the exchange rate risk.

Reliance on the domestic debt will increase progressively as and when growth will increase the size of the economy and will phase Georgia out from more concessional forms of the international assistance. All this assuming continued development of the domestic yield curve in

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Fig. 4.16 Georgia’s external public debt by type of interest rate, end-September 2012. Source: Ministry of Finance of Georgia, own estimates


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Fig. 4.18 Georgia’s stock of treasury securities (US$ million). Note: Converted into US from GEL; US/GEL exchange rate on the given dates. Source: Ministry of Finance of Georgia

52 D. Gvindadze

the context of the macroeconomic and the financial sector stability. Importance of such gradual transformation—unless it happens prema-turely creating risks of sudden reversals—will transcend the realm of the public debt management. This will (1) help to price domestic risks more transparently, (2) support dedollarization, (3) enhance banks’ liquid-ity management tool kit (treasuries can be pledged as collateral with the central bank for liquidity management purposes), (4) help to price corporate risks and to develop domestic commercial tradable debt, (5) mitigate economy-wide exchange rate risks, (6) help to implement the second pillar (mandatory private savings) of the pension system if and when it becomes rational in lights of arguments and risks presented earlier and (7) promote the concept of the “integrated public finance” where fiscal-monetary interaction contributes more to the management of monetary aggregates and helps to target the inflation.

Proper Conceptualization of the Access to the International Capital Markets

By the end of 2012, proceeds of the Eurobond represented approxi-mately one-tenth of Georgia’s outstanding public external debt stock. Why did Georgia issue its first Eurobond in 2008 and then refinance it in 2011, given its access to cheaper development assistance? Why would a sovereign issue a Eurobond in the absence of an immediate financing need? Can a sovereign Eurobond foster investor outreach and inbound international investments?

In April of 2008, to cement its international reputation, Georgia was the first country in the South Caucasus to make a US$ 500 million 5-year debut Eurobond issue. It was more than three times oversub-scribed and priced at 7.5%—the tight end of the market. Two years later, in April of 2011, Georgia successfully issued a 10-year Eurobond and used proceeds to redeem the previous bond almost entirely through an “any and all” cash tender. Priced at the lower yield of 7.125%, the 2011 Eurobond broadened the investor base (RegS/144A in 2011 versus RegS in 2008) and allowed Georgia to establish a longer sovereign benchmark.


The landmark status of these two transactions anchored Georgia to investors’ radars and established an independent yardstick for the meas-urement of its sovereign risk. It created a momentum for non-sovereign issuances from Georgia. Subsequent Eurobond deals by the Georgian Railways, Georgian Oil and Gas Corporation and commercial banks were helped by the good secondary market performance of Georgia’s sovereign Eurobond (Fig. 4.19).

Overall, more than 300 international investors invested in the Georgian debt and equity securities—the rather unprecedented breadth of the investor coverage for the small economy. Whereas, prior to the sovereign debut Eurobond of April 2008, the aggregate volume of non-sovereign Eurobond issuances was approximately US$ 200 million, subsequent to the sovereign debut in 2008 till the end of 2016 the aggregate volume exceeded US$ 2 billion.

Georgia remained trusted by the capital markets: the Eurobond traded consistently above par in the secondary market, despite turbu-lence of 2008–2009 and the resultant enhanced regional and global risk aversion (Fig. 4.19). Yield to maturity on Georgia’s 10-year Eurobond

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Fig. 4.19 Georgia’s 10-year benchmark sovereign Eurobond (RegS/144A)—secondary market dynamics since the issuance till the end of September 2012. Source: Bloomberg

54 D. Gvindadze

compared favorably to yields for other sovereigns in the same credit-rat-ing category (Fig. 4.20).9

Both in 2008 and in 2011, the government in Tbilisi was hard pressed to justify its decision to tap international capital markets in the absence of an immediate need to borrow. The matter was approached—and decided—by asking: how to best measure Georgia’s sovereign credit worthiness and to ensure that the government’s performance is under con-stant scrutiny?

The real-time yield-price dynamics of an international bond traded in the secondary market reflects a consensus investor view on an issuing sovereign and on its policies. Large institutional investors study an inves-tee sovereign continuously as they have their skin—and their money—in the game. The secondary market dynamics thus reflects the real-time market perception of an investee sovereign’s risks. It informs potential foreign direct and portfolio investors into the real and financial sectors. Intensity of such international scrutiny rewards reformers, punishes lag-gards and, therefore, unlocks positive performance incentives.

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Fig. 4.20 Sovereign Eurobond yields to maturity, percent. Georgia vs. peers. Source: Bloomberg


The two questions then are: (1) is an issuing sovereign able and will-ing to work with a universe of its sovereign Eurobond investors to prompt them into exploring non-sovereign opportunities within the country? (2) can domestic banks and firms capitalize on existence of the sovereign benchmark to tap international markets?

In 2009–2012, the government increasingly sought to engineer Georgia’s transformation into a multisectoral regional platform for the services and manufacturing, spearheaded by the regional and interna-tional investment. By 2012, this vision moved to the core of Georgia’s global economic positioning. In this context, relationship with investors into the sovereign Eurobonds mattered beyond the immediate cash gen-eration.

Such relationship must be nurtured through good economic per-formance, through stable politics, and through the willingness and the ability of domestic private agents to capitalize on such relationship for their own gain. Unless this holds, (1) beyond-immediate-cash virtue of a sovereign Eurobond in absence of an immediate need to borrow loses its waterproof qualities and (2) the questions to the government become more difficult to answer.

Proper Donor Coordination

Akin to other developing countries, Georgia depended on and ben-efited from the foreign aid. This came in different forms: budget sup-port, infrastructure finance, capacity building and technical assistance. Importantly, though, Georgia never bragged about the volumes of the assistance it was receiving. It was working to reduce its dependency—mental and financial—on the foreign aid.

From the beginning of Georgia’s transformation in 2004, there was the general understanding that the foreign aid could help, although in the grand scheme of things it could in no way replace mainstream trans-formations which could only be conceptualized and implemented by the national authorities.

International development partners can advise on technicali-ties of reforms, invoking best international practice. However, key

56 D. Gvindadze

reforms—especially the proverbial “first-generation reforms” aimed at breaking with the past and at enforcing new norms—are painful and politically contentious. International development partners are una-ble to connect all dots—political, social and economic—to lead such reforms. They also face reputational risks if such reforms go astray and trigger social backlash. The national ownership and leadership were, therefore, the only game in town.

Georgia’s aid dependency had been decreasing steadily in 2004–2008 all the way until the war with Russia in August of 2008 which dented confidence and resulted in immediate and the longer-term post-war reha-bilitation needs. At which point, with the European and the American support and sponsorship, Georgia held a Donors’ Conference at the min-isterial level (October 22, 2008, Brussels). The purpose of the conference was “to mobilize external assistance to support the country in the recon-struction of damaged infrastructure, reintegration of internally displaced people and in accelerating Georgia’s recovery from the impact of the August 2008 conflict on its economy as well as improving the security of Georgia’s energy infrastructure.” The donor pledge of approximately US$ 4.5 billion allowed to close gaps in the budget in 2008–2009, to address immediate needs of thousands of internally displaced persons and to increase infrastructure spending to counter the double whammy of the war and of the global financial crisis which started in 2008 (this was probably the first international financial crisis with tangible impact on Georgia). The government moved fast. Within the next 3–4 years, the whole pledge was transformed into firm contractual commitments. The pace of project implementation—and, therefore, of absorption of the allocated funds—was exceptionally fast. High-ranking representatives of international financial institutions confided that this implementation pace was much higher than anything they had seen before.

In the course of my career, I have seen some foreign leaders present-ing their development plans (proverbial strategies-2020, this is the spici-est title of all) which virtually start by boasting that countries they lead are significant receivers of the foreign assistance and that they aim at complying with the IMF requirements. Each time I hear this bravado, I mentally skip details of the rest of the presentations. How can foreign aid be the axis of the state building in the modern Eastern Europe?


Georgia never bragged about foreign aid. Our investor pitch empha-sized, in the first place, the state building, institutional transformation, regulatory liberalization, fight against crime and corruption and mac-roeconomic stability. Whenever we negotiated loans and grants with international financial institutions and with foreign governments, we were going an extra mile to undertake no commitments which would undercut our own vision and our own freedom to act. Because interna-tional partners saw first-hand that we had the courage, the instinct and the knowledge to drive our own agenda, the cacophony of international advice was less noisy than where recipient authorities are not in con-trol and rely on donors to conceptualize and fund their development in accordance with the “best international practice.”

The donor coordination in Georgia was helped by three main factors:

• The strong mandate of the Ministry of Finance (MOF) which is the only entity able to ensure the genuine interface between (1) managing foreign aid, (2) managing public debt and (3) managing budget process which presumes MOF’s sway over budget lines whose funding can be outsourced to donors. Other ministries were generally discouraged from challenging MOF’s mandate. Only MOF could negotiate big ticket assistance items with donors: loans and grants which are reflected in fis-cal accounts or have material policy implications. Because MOF was in charge, and because MOF was expected to deliver fiscal stability and growth, it was politically and institutionally responsible for the timely disbursement of there form-based budget support (general, sectoral and macrofinancial) where breach of disbursement conditionalities by line ministries would result in disbursement delays with consequences for the budget deficit financing and beyond. As a result, disbursement rates under reform-based budget support schemes in Georgia was close to 100%, the highest in the broader region. Line ministries and munici-palities did engage in direct discussions with international development partners, although their mandate was limited to agreeing sector-specific forms of capacity building or of technical assistance, not large schemes with financial or policy-related components which would have to be pre-agreed with MOF and endorsed by the cabinet. In countries where ministries of finance are too technical and too low-profile to exercise

58 D. Gvindadze

this stop-gap function, international development partners negotiate with too many powerful government counterparts: ministries of econ-omy which draft the national development strategies, advisors to prime ministers, heads of government chancelleries and powerful line ministers who pursue their own personal, political and institutional agendas and are unable or unwilling to measure debt affordability and sustainability constraints. The ensuing maze of decision making usually ends in mess.

• Realistic vision of the donor coordination. In 2005, when I started as deputy minister of finance in charge of the public debt and of the international finance, I was hearing international development part-ners’ regular complaints about the lack of the coordination. Lack of the donor coordination is the cross-border buzz word which owes its existence to the dearth of pragmatic discussions on what is the realis-tic donor coordination setup. Main development partners coordinate among each other and with the government more intensely because funds they provide are significant and are reflected in the budget. Such big ticket assistance items need to be negotiated and processed in line with the laws of a recipient country. This does not exclude competition among key donors for projects, be this leadership roles in reforming various sectors, or allocation of financing toward infra-structure schemes (“urge to lend”). Then, there are smaller bilateral development partners who work mainly with non-state recipients, provide training, advice and capacity building. Part of such aid is managed by embassies which, in the absence of dedicated donor cooperation sections, may be stretching the assistance across many sectors to achieve higher political visibility in a recipient coun-try. Some of such smaller-volume assistance funds non-state actors, international consultants and the provision of the tied aid. In many cases, funds do not enter a recipient country. Adding another layer of complexity, bilateral development partners have their own mul-tiyear planning cycles and priorities which reflect general approach to the international development cooperation sealed in their respec-tive capitals. This narrows down margins of maneuver when trying to adapt such priorities to idiosyncrasies of the aid recipient coun-tries. Georgia’s message to the donor community thus was: (1) donor coordination is the responsibility of the recipient government as much as it is of the international development partners; (2) ministry


of finance is immediately responsible for coordinating and processing all assistance which has material financial and policy implications and is reflected in fiscal accounts; (3) line ministries shall engage in direct discussions with international development partners, provided that any important agreements have to be endorsed by the cabinet and have to be fully aligned with the national development vision. Such “concentric circles” vision bestowed upon the ministry of finance the key role in coordinating big ticket assistance items (in terms of funding and policy implications) and devolved to line ministries and other spending units the responsibility for sectoral donor coordina-tion, provided that such coordination was in synch with Georgia’s general state-building vision. This allowed the donor coordination unit of 10 persons within the ministry of finance to avoid “herd-ing cats” by micromanaging all donor assistance. It took some time before this vision sank in and key stakeholders subscribed to it.

• Strong implementation units in all key areas of the donor assis-tance. Roads Department’s capacity was beefed up significantly to ensure fast implementation of expensive roads projects without com-promising on quality and control. Anecdotal evidence suggests that price per 1 km of highway construction in Georgia was, on balance, cheaper that in some other countries, even when the same interna-tional procurement rules applied. In the municipal sector, Georgia created the Municipal Development Fund—a public entity which allowed to significantly increase project management capacity and to build safeguards against corruption. The same principle applied to the water sector and to other sectors where volumes of assistance were material, risks of ending up with “white elephant” projects were non-negligible and dangers of the misuse and of the misappropriation could not be discarded. Cooperation of these implementation units with the law enforcement agencies was regular, and this worked to preclude and punish corruption. Professional infrastructure project cycle management helped to mitigate—although not eliminate—risks of the price escalation. Because volumes of infrastructure loans negoti-ated with international financial institutions were based on findings of feasibility studies, the price escalation represented the risk once loan agreements were signed and detailed designs were prepared (detailed designs are usually funded from proceeds of loans). Such “catch-22”

60 D. Gvindadze

situations are not uncommon and require a very strong discipline on the side of a recipient government. If a project cost spirals out of con-trol and the project economics is jeopardized, the cabinet of ministers must be in a position to stop such project early on, even if certain pre-paratory costs are already incurred. This requires strong political talent and lots of individual and collective courage.

Pillar 2—Soundness of the Business Environment

Fiscal and monetary policies may boost domestic demand in the short run, although long-term growth, resilience and the mitigation of pov-erty depend on the extent to which business environment enables firms to employ, invest and add value. Even in the short run, where business environment is unreformed, state ownership of enterprises is prevalent and fiscal footprint is excessive, efforts to use the fiscal or the mone-tary stimulus to boost growth can fail due to the productive constraints in the economy and its lack of competitiveness. In such cases, boost to the domestic demand through the fiscal and the monetary expansion is likely to be offset by the accompanying deterioration in net exports.

By and large, the soundness of the business environment boils down to the clarity on the rules of the game and to the existence of the genu-ine level-playing field. The government activism can help: the muscular, forward-looking and innovative public action in Georgia in 2004–2012 did help to acquire the “escape velocity of the reforms,” with the crea-tion of the level-playing field at the core of the whole effort.

Nonetheless, such government activism creates inevitable risks and its success is not unconditional. It is not always cognizant of its ultimate impact on the private sector decisions and not always able to discern, dissect and act upon the market failures.

Where structural reforms to create the environment conducive to the private enterprise are missing or deficient, the government activism becomes the problem, not the solution. Unable or unwilling to imple-ment real mainstream reforms to unlock, demonopolize, liberalize and purge of corruption key sectors of their economies, some developing country governments come up with sectoral subsidy schemes and with


programs to support small and medium enterprises (SMEs) or infant industries which customize the realm of these programs’ beneficiaries at the expense of the rest of the economy. Benign as these intentions might in some cases be, if implemented in the unreformed and corrupt con-text they misallocate scarce public resources without producing positive long-run aggregate outcomes.

Then, there are subsidies for start-ups and innovation in the develop-ing country context. Again, the intention might be benign, and under certain conditions such subsidies might add value. Although positive outcomes are in no way guaranteed. Not because the innovation is bad, but because civil servants handling the process are not good at picking innovative winners and losers. Home runs are rare even in the Silicon Valley, where many successful investors cut their teeth—and made their first millions—doing nothing else but innovating, surrounded by the exceptionally supportive human and physical infrastructure. Hence, unless the state innovation support policies are run independently, impartially, conservatively and professionally, they end up channeling taxes paid by viable—and innovative—firms toward start-ups whose viability and success are unclear. The resultant outcomes are inefficient.

The same logic applies to public entities whose objective is to pro-mote exports and investments. While I believe that strong investment and export promotion agencies can add distinct value in the develop-ing country context, I see no rationale behind creation of many of such agencies with overlapping mandates.

The following narrative on the transformation of Georgia’s business environment in 2004–2012 is split into three parts:

1. Tax reform.2. Customs, trade and transportation.3. Deregulation and domestic competition.

Tax Reform: Much More Than the Reduction in Tax Rates

From 2004, Georgia’s tax policy and administration underwent signifi-cant transformation.10

62 D. Gvindadze

• The number of taxes—21 in 2004—was reduced to 7 from 2005 and to 6 from 2008. Taxation became flat. Same tax rate was charged irre-spective of income brackets. Any prospect of the progressive taxation was brushed aside amid general understanding that the progressive taxation would unleash the race to the bottom where skilled lawyers representing individuals and firms in the top income brackets would work to decrease tax burden on their clients. Such race to the bottom represents a significant challenge in the developing countries which decide to pursue social justice at the expense of simplicity and effi-ciency and end up with neither.

• Loopholes and tax avoidance schemes were closed through car-rots (streamlined policies and modernized administration, explained below) and sticks (prosecution of the economic crime and corruption). Tax code was simplified to avoid dual interpretation which could be exploited by both firms using legal loopholes to unduly minimize their tax liabilities and by tax inspectors. This work had a continuous nature and benefitted from the weekly delibrations at the two-tier tax dispute resolution board at the Ministry of Finance which together with tax specialists of the ministry included independent experts and represent-atives of international audit firms operating in Georgia.

• Consolidated political landscape and general aversion to the notions of protectionism and of defense of “national champions” meant that no sectoral or special interest lobby groups could curve out preferen-tial tax treatment for their sectors and companies.

• All tax rates were reduced. VAT decreased from 20% in 2004 to 18% from 2006. Personal income tax (12–20% in 2004) became 12% flat in 2005. After abolishment of the social tax—at 33% in 2004 and at 20% in 2005–2007—personal income tax became 25% in 2008 and 20% from 2009 (all social payments were paid from the general budget revenue pool). Corporate income tax was reduced from 20% in 2004 to 15% from 2008. Dividend and interest income tax was reduced from 10% in 2004 to 5% from 2009. Figure 4.21 depicts the tax reduction timeline. The authorities committed themselves to a further incremental decrease across all tax rates.

• Fiscally insignificant and “special” taxes (gambling, pollution, road, advertisement, etc.) were scrapped to avoid red tape and to minimize tax evasion. Georgia emerged with no payroll or social insurance


tax, no capital gains tax, no wealth tax, no inheritance tax or stamp duty, no property transfer tax. Foreign source income of individu-als is tax exempt. Dividend on free floating debt and equity securi-ties and interest paid by licensed financial institutions became tax exempt. Companies re-exporting foreign goods through Georgia paid no profit tax, VAT and import tax. Financial institutions whose Georgia-sourced income did not exceed 10% of their global income became eligible for the status of an international financial company which exempted from profit tax, dividend and interest tax and VAT. Hotels with special status in free tourist zones became exempt from

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Adoption of the Liberty Act

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Fig. 4.21 Impact of the tax liberalization on the government revenues in Georgia, 2003–2012. Source: Ministry of Finance of Georgia, World Bank's Entrepreneurship Survey and Database

64 D. Gvindadze

the corporate income tax and property tax. Simplified accounting and taxation applied to micro- and small businesses.

• All national taxes accrued to the central budget. Only property tax of up to 1% represents local tax. Centralized revenue collection meant moderate fiscal decentralization, reflective of the administrative capacity of regional and municipal governments and of the desire to preserve centralized leverage over the budget allocation decisions.

• Georgia emerged from the tax policy reform with no sectoral taxes and, therefore, with no sectoral tax revenue earmarks. Tax reve-nues were allocated to ministries and spending units from the gen-eral budget pool, annually, and line ministries were justifying their budget requests at meetings with the ministry of finance and with the prime minister before broader cabinet-level, parliamentary and other political discussions. This made the budget formulation process more flexible and allowed to avoid special funds which accumulate and spend sectoral tax revenues. For example, rather than having the road usage taxes accruing to a road maintenance fund, Georgia’s Roads Department (part of the Ministry of the Regional Development and Infrastructure) and municipalities were receiving their annual budget allocations for the construction of new roads and the maintenance of existing roads directly from the state budget. Two important pre-requisites for the success of this model were: (1) predictability of the resource allocation (from the tax revenues and donor funds) and (2) reasonable team play between the central and municipal govern-ments.

Having simplified its tax policy, Georgia undertook to preclude policy reversals in the future. In July of 2011, the Parliament adopted the organic law on economic freedom (“Liberty Act”) which obliged the government to submit to a referendum any introduction of new national taxes (except excise) or any increase of the existing tax rates (except when new tax replaces an existing national tax without increas-ing the tax burden). The referendum could not be sought to introduce progressive taxation.

Given the aversion toward high taxes and its predictable impact on an outcome of any such referendum, this provision meant that any


permanent tax increase could only materialize in truly extraordinary cir-cumstances (this is not to say that a future government with a differ-ent economic thinking and with sufficient political support cannot seek to unravel the Liberty Act; politics is replete with surprises and “rever-sions to the mean” are all too often, hence the need for vigilance and wisdom).

The tax policy liberalization—endorsed by the Ministry of Finance of Georgia as part of the broad political consensus—benefitted from the virtuous circle. As much as it helped to broaden the tax base and to increase revenues, the positive tax revenue response was—very impor-tantly—spearheaded by other indispensable factors and reforms which unfolded from the beginning of 2004, in the run-up to and simultane-ously with the mentioned tax policy liberalization measures:

• Zero tolerance to the crime, corruption and embezzlement and front-loaded overhaul of the system of the law enforcement and of the administration of justice.

• Transformation of the tax and customs administration which ena-bled, early on, to close loopholes and tax avoidance schemes, to cut middlemen and to change personnel; to progressively streamline business processes, consolidate databases, mainstream risk-based audits, enact e-solutions, enhance service orientation, customize out-reach to businesses through provision of on-demand services, mod-ernize infrastructure and eventually rebrand the Revenue Service to emphasize openness and accessibility.

• Increase of Georgia’s potential growth rate through business climate improvement measures: liberalization of trade and transportation, deregulation and modernization of agencies delivering public ser-vices, simplification of the labor legislation, massive privatization of enterprises and of the state property together with the corporatiza-tion of a small number of remaining state-owned enterprises, proac-tive engagement with international investors.

• Macroeconomic stability: exchange rate stability in the context of unrestricted capital mobility, absence of balance of payments gaps, healthy banking sector and conservative fiscal planning.

66 D. Gvindadze

The strategy paid off. The ratio of total annual tax and customs revenues to GDP increased from 14% in 2003 to close to 26% in 2007 and sta-bilized at the level of approximately 25% of GDP thereafter (Fig. 4.21). Tax revenues increased from GEL 1228.6 million in 2003 to GEL 6671 million in 2012, an almost 5.5-fold increase translating into a com-pound annual growth rate (CAGR) of approximately 20% (note that in all years from 2004 till 2012, average annual consumer price inflation was kept at a single digit level). General government expenditure as per-cent of GDP increased from approximately 16.5% in 2003 to close to 30% in 2007 and thereafter, with capital spending representing as much as one quarter of such expenditure. In 2012, Georgia’s total tax rate in percent of commercial profits was among the lowest globally (Fig. 4.22).

It is important to continue simplifying the tax legislation—the tax code and multitude of its sub-legal acts. In the ideal world, businesses large and small should be able to comprehend and act upon all provi-sions of the tax legislation without much expert advice and without fear of dual interpretation. This is still not the case in Georgia. “Simple is beautiful” must, therefore, be the main guiding principle for both the tax policy and the tax administration.

It is important to avoid special tax regimes, sectoral taxes, convo-luted tax incentive schemes, income-based tax brackets, progressivity and any other unnecessary gymnastics which on paper might be liber-alizing the tax policy and administration yet in practice creating com-plexities which would act to disrupt the level-playing field. It is much better to keep reducing rates of the existing taxes, thus moving toward an increasingly low-tax jurisdiction. Such reduction may be incremen-tal and insignificant in any given year, yet it will be sending the right signal. This would contribute to Georgia’s liberal franchise and would force governments in Tbilisi into thinking creatively of what else can be outsourced to the private sector—through outright privatization or through public–private partnerships. Enhanced private sector participa-tion in the delivery of public services can ensure better efficiency, conti-nuity and predictability, ring-fencing public policies from electoral and bureaucratic vicissitudes. In my opinion, the unwise approach to the tax policy formulation would be to come up with a new measure on the expenditure side and then raise taxes to implement such measure.


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Customs, Trade and Transportation

Customs and trade legislation which Georgia inherited in 2004 dated back to the 1990s. It triggered an average tariff in excess of 20% (16 tariffs from zero to 30%). Non-tariff barriers to trade and their enforce-ment by several agencies led to corruption. Collection of customs rev-enues at the ports of entry—as opposed to an incremental shift of the collection inland—affected clearance procedures and trade. Incentives for bribery and misreporting were rampant.

This started to change from 2006, when Georgia implemented broad unilateral liberalization of its trade regime and streamlined pub-lic services in the area (Fig. 4.23). Around 90% of imports to Georgia qualified under zero tariff rate. Rates of 5 and 12% applied to a lim-ited range of goods in politically and economically sensitive domestic market segments. Georgia reported such zero tariffs to the World Trade Organization (WTO) as bound tariff rates to prevent future revisions of the tariff policy. The new norms applied to all countries, irrespective of their WTO membership (Georgia is the WTO member since 2000). Strong bias against protectionism, absence of technical non-tariff barri-ers to trade and of quotas, voluntary product standards (except in public health and safety areas) and zero tariffs on export, re-export and transit fostered trade diversification and increased volumes.11

Transformation of Georgia’s customs administration in 2004–2012 can be notionally split into the same stages as for the tax administra-tion, with the initial heavy-handed approach aimed at uprooting the established criminal practices and at enforcing the early credibility pav-ing the way to the more granular institution-building effort. Customs checkpoint infrastructure was rebuilt from scratch. Roads leading to all checkpoints were progressively repaired. New checkpoints were opened or reopened in areas where cross-border exchanges could ignite additional regional growth. Working conditions were improved on the understanding that customs officers who share open space in modern glass buildings would be more efficient and more transparent than their predecessors in opaque offices behind closed doors. Simple processes and consolidated databases gradually eliminated red tape and helped to cut off middlemen. Many customs officers were fired and replaced by


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70 D. Gvindadze

those with no past record of serving in the customs administration at the time when it was notoriously corrupt. Risk management modules and automation progressively minimized discretion of customs offic-ers, cut paperwork and ensured faster and more impartial treatment.12 Companies with the good track record of compliance with the customs procedures and, therefore, posing no evasion or smuggling-related risks were included in the Golden List which provided for a simplified cus-toms treatment, including the post-clearance payment of customs fees. The number of public entities operating customs checkpoints decreased from nine to two: Patrol Police of the Ministry of Interior and the Revenue Service of the Ministry of Finance. Transformation in the Patrol Police happened earlier than in the customs administration, due to the specificity of the tasks involved and due to the significant politi-cal influence exercised by the leadership of the Ministry of Interior. Such joint action by the Patrol Police and the Revenue Service facili-tated positive spillovers for the Revenue Service. To have their docu-ments checked and processed, drivers no longer needed to exit cars.

In 2010, Georgia pioneered the customs clearance zones (CCZ). Imported cargo was fast-tracked through checkpoints and forwarded to related CCZs providing comprehensive single-window services. Importers filing advance declarations could have their documents processed even at their final destination. Customs-point revenues were reduced as they shifted inland. Crossing borders became faster and easier. Driven by Georgia’s high growth rates and spearheaded by the enhanced customs throughput capacities, trade turnover increased significantly (Fig. 4.24). From 2014, Georgia’s free trade network was boosted by the Deep and Comprehensive Free Trade Agreement with the European Union.

Economic openness, reformed tax and customs administration, quality of public services (including those provided by the Service Agency of the Ministry of Interior) and absence of corruption trans-formed Georgia into the regional hub for trading of motor cars. By 2012, Georgia’s exports of motor cars represented as much as 25% of its overall exports, up from zero in 2003. Companies and individuals were bringing to Georgia new and second-hand cars and selling them to neighboring countries mainly in the Caucasus and Central Asia. The


“car business” created many jobs in the parking, auto repair and other auxiliary services. It offered the example of how Georgia could leverage its transit function in other areas.

To enhance its transshipment orientation (by 2012, transshipment values amounted to approximately three times Georgia’s GDP) and its logistical potential, Georgia abolished transit barriers, fees and quotas, commercialized railway tariffs (as part of the comprehen-sive restructuring, optimization and modernization of the Railway Company) and liberalized its international aviation market. The country became better accessible, with travelers free to choose among alternative transportation options. The Tbilisi International Airport continued to perform its traditional flagship functions while the new airport built near Georgia’s second-largest city of Kutaisi started to provide the rapidly increasing range of low-cost transportation options to multiple destinations.

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Share of Russia in Georgia's total exports decreased from 18.2% in 2003 to 1.9% in 2012; in total imports -from 14% in 2003 to 6% in 2012. Exports decreased abruptly from 2006 as a result of Russia's embargo against Georgian products; share of imports from Russia decreased incrementally and dipped after Russia's invasion into Georgia in 2008.In 2004-2012, diversification into new markets allowed to reduce dependence on the Russian market.

CAGR 2003-2012 = 23%

Fig. 4.24 Increase in Georgia’s trade turnover from 2003 to 2012. Source: Geostat

72 D. Gvindadze

In the Heritage Foundation’s Index of Economic Freedom (2012 data analysis), Georgia ranked seventh out of 180 countries in the “trade freedom” measure, with its degree of trade freedom higher than for any of its main trade partners in 2004–2012 (Fig. 4.25). Rather than dis-cussing with its trade partners quid pro quo mutual market opening measures, Georgia liberalized its trade regime unilaterally, as part of the general liberalization strategy.

Fig. 4.25 Georgia: No. 7 global rank (out of 180 countries) in the Heritage Foundation’s trade freedom measure, with higher degree of trade freedom than for any of its main trade partners in 2004–2012*. Source: Heritage Foundation Index of Economic Freedom, 2013


Deregulation, Privatization, Innovative Public Services and the Domestic Competition

In 2004, Georgia’s GDP per capita was at around US$ 1000. It ranked 137th out of 183 countries in the World Bank’s Doing Business indi-cators and was classified as “mostly unfree” economy in the Index of Economic Freedom of the Heritage Foundation, largely due to cumber-some regulations.

In 2004–2005, Georgia launched an overhaul to modernize agencies which delivered public services. This resulted in the removal of parts of the bureaucracy which were both feeding and fed by the excessive and redun-dant regulation. Transformation took place in all entities which deliver public services and deal with all sorts of permits and licenses (Ministry of Interior, Civil Registry, Public Registry, Procurement Agency, etc.). Public entities unable to pass the test of relevance were downsized or dismantled. Those whose mandate was relevant yet the ability to fulfill it was absent were considered for invalidation and for reengineering from scratch.13

Near-term political costs were obvious. In Georgia’s closely knit soci-ety where everyone is everyone’s neighbor, friend or relative, abrupt moves on this scale worked to erode the political support base. From 2004, however, the sense of urgency was in the air. The government moved fast to take advantage of its post-electoral “honeymoon.” It repealed around 70 and 90% of some 300 licenses and 600 permits.14 This almost halved the number of inspection agencies. New law in 2005 minimized the number of licenses, specified activities requiring licenses and permits and clarified procedures.

Georgia realized that proper regulatory capacity would take time to develop and that over-reliance on domestic standards and codes would add red tape or uncertainty without necessarily producing requisite outcomes. It thus applied the “regulatory outsourcing” whereby technical standards and codes of advanced economies were treated on par with the national standards. Georgia abolished relicensing for pharmaceuticals licensed in advanced economies. Technical standards and codes of the EU, OECD and the Commonwealth of Independent States were allowed to be used along-side national norms. Imported consumer goods, including processed food,

74 D. Gvindadze

certified in the OECD countries required no recertification.15 The regula-tory outsourcing increased domestic competition by facilitating entries by new market participants and by enabling them to challenge incumbents on the pricing and client acquisition strategies.

From 2005, public agencies started providing licenses, certificates and permits through their one-stop-shops (“single windows”). The “silence is consent” principle established binding deadlines for processing of citizens’ requests and inquiries. Upon expiry of such deadlines and in absence of a reply, such licenses, certificates and permits were consid-ered granted. Georgia then consolidated the “single-window” services into 12 “Public Service Halls” built in 2011–2012 in all main cities. Serving more than 16,000 customers daily, the Public Service Halls integrated—under one roof—more than 300 services. They proposed transactional and operational improvements which set the new interna-tional standard of public service innovation. This experience was then discussed and branded for replication in other countries.16

In 2006, the new labor code replaced previous regulations. It devolved to employers and employees the bulk of the responsibility for agreeing their contractual terms, including working days per week, overtime work and remuneration package (no minimum wage requirements). Indefinitely renewable fixed term contracts of any duration were allowed for perma-nent tasks. Notice period for the redundancy dismissal was set at zero and the severance pay was equalized to a one-month salary, irrespective of a worker’s tenure.17 Collective bargaining was allowed by any group rather than by trade unions alone. Same set of rules and principles applied to the nationals and non-citizens. Foreign nationals were allowed to obtain for-mal employment without work permits. Such contractual relationship—once established—became sufficient to receive residency. In the 2013 Index of Economic Freedom of the Heritage Foundation (based on the data for 2009–2012), Georgia’s labor freedom score was third highest glob-ally, behind the USA and Singapore.

Foreign and domestic investors were subject to equal treatment in rela-tion to land, ownership rights, repatriation of assets and funds. Land and other immovable assets could be bought and sold freely. The state set no tariffs for private companies, except in relation to natural monopolies.

In 2004–2012, Georgia privatized almost all its major state-owned companies and many of its state-owned assets. Plain vanilla privatization


deals represented the priority, although the privatization drive also involved customized deals where upfront prices paid by investors reflected their future obligations with respect to the purchased assets.

As everything else described in this book, the privatization process was helped by the positive international narrative on Georgia, by the anti-corruption and anti-crime drive and by the domestic political and tech-nocratic consolidation. In developing countries where all this is missing, there is high risk that either of the two things can happen: (1) no investor interest, hence non-productive and often loss-making assets and compa-nies remain indefinitely on the sovereign balance sheet and/or (2) the pri-vatization process becomes the backdoor for vested interests to transform their de facto control over the state-owned assets into the de jure control.

By 2012, the state owned only a handful of strategic enterprises, includ-ing the Georgian Railways (Georgia’s integrated rail company whose busi-ness stems from Georgia’s location as the shortest transportation route from the Black Sea to the Caspian Sea), Georgian Oil and Gas Corporation (ensures security of gas supply to Georgia and represents the state in inter-national energy transit projects) and Georgian State Electrosystem (provides in-country and cross-border high-voltage electricity transmission and exclu-sive dispatch services). Both Georgian Railways and the Georgian Oil and Gas Corporation issued Eurobonds to fund their development. In 2012, the government agreed to the listing of the Georgian Railways’ 25% stake on the London Stock Exchange, although the deal was postponed due to the challenging market conditions and the Eurozone economic problems. Listing of the 25% stake could impose an international investor scrutiny on the company’s corporate strategy and culture, mitigating many political and other risks and pressures to which all railways are inevitably exposed.

Georgia largely unilaterally liberalized visa and residence permit rules for foreign citizens. In 2012, citizens of more than 90 countries—including from the EU and from the OECD—did not need a visa to enter and stay in Georgia for 1 year. Similar treatment was accorded to the British, Danish, French and Dutch territories and dependencies. Visa-free regime applied to almost all countries of the Commonwealth of Independent States. Citizens of Russia were allowed to enter Georgia visa free and stay for up to 3 months, despite the absence of diplomatic relations. Visas up to 1 year could be issued at border-crossing points. Foreign nationals in possession of valid multiple entry visas of the EU

76 D. Gvindadze

and Schengen countries and of the USA were allowed to enter Georgia visa free and stay up to 3 months, provided that their mentioned multi-ple-entry visas remained valid and that they had been used at least once. Visa extension rules and procedures of issuing temporary or permanent residence permits were simplified. No administrative sanction would apply if a delay in leaving Georgia did not exceed 10 days. Longer delays would trigger a fine, payable before or after exiting the country.

This—together with a substantially improved perception of the per-sonal safety, the “open skies” policy, popularization of Georgia abroad, development of hospitality infrastructure and enhanced cross-border connectivity—increased the number of international arrivals in Georgia from 310,000 in 2003 to 4,389,000 in 2012 (an almost 14-fold increase implying a compound annual growth rate of 34%). The World Bank Development Indicators database attributed Georgia to the global top five of the fastest growing international tourism destinations (inter-national inbound tourists, 2003–2011).

In the World Bank’s Doing Business Report, Georgia improved its global rank from 137th in 2004 to 9th in 2012, which was much higher than for any other neighboring country (Fig. 4.26).

According to the same Doing Business Report, in 2005–2012 Georgia progressed more than any other country in shrinking its “dis-tance to the frontier,” i.e., Georgia’s reforms across all “doing business” indicators were the most ambitious globally (Fig. 4.27).

In 2004–2012, Georgia’s global rank in the Index of Economic Freedom of the Heritage Foundation improved from 79 to 21. Georgia’s economy was upgraded from the “mostly unfree” to the “mostly free” category (Fig. 4.28).

By 2008–2009,Georgia’s senior private sector managers were spend-ing much less time dealing with requirements imposed by the govern-ment regulation than their regional peers (Fig. 4.29).

According to the World Governance Indicators, Georgia’s 2012 “regulatory quality” estimate was higher than in neighboring countries and much higher than in the Commonwealth of Independent States. Likewise, the improvement in the regulatory quality estimate in Georgia in 2004–2012 was much more pronounced than elsewhere. It was the highest globally (Fig. 4.30).


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78 D. Gvindadze

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25

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* Cross-country comparison: Georgia, Central and Eastern Europe, South- Eastern Europe, Commonwealth of Independent States, Turkey. The "distance to the frontier" measure "shows the distance of each economy to the “frontier,” which represents the highest performance observed on each of the indicators across all economies included in Doing Business since each indicator was included in Doing Business. An economy’s distance to frontier is indicated on a scale from 0 to 100, where 0 represents the lowest performance and 100 the frontier. For example, a score of 75 in DB 2012 means an economy was 25 percentage points away from the frontier constructed from the best performances across all economies and across time. A score of 80 in DB 2013 would indicate the economy is improving. In this way the distance to frontier measure complements the yearly ease of doing business ranking, which compares economies with one another at a point in time." Source: http://www.doingbusiness.org/data/distance-to-frontier

Fig. 4.27 Georgia—the shortest “distance to the frontier” according to the World Bank’s Doing Business 2013 and the fastest progress in shrinking distance to the frontier between 2005 and 2012*. Source: Doing Business database

GEO

RG

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Georgia's 2013 Economic Freedom score 72.2, world rank 21 out of 183,

classified as "MOSTLY FREE" economy.

Georgia's 2004 Economic Freedom score 58.9, world rank 79, classified as

"MOSTLY UNFREE" economy.

The Index of Economic Freedom covers 10 freedoms: property rights, freedom from corruption, fiscal freedom, government spending, business freedom, labor freedom, monetary freedom, trade freedom, investment freedom, financial freedom. The Heritage Foundation measures these ten components of economic freedom, assigning a grade in each using a scale from 0 to 100 where 100 represents the maximum freedom. A country's overall economic freedom score is a simple average of its scores on the 10 individual freedoms. The 2013 Index of Economic Freedom is based on data for the period covering the second half of2011 through the first half of 2012.

Fig. 4.28 Georgia: second highest Index of Economic Freedom (2013) score in the broader region (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey). Source: Heritage Foundation http://www.heritage.org

http://www.heritage.org


Figure 4.31 compares Georgia to other ex-Soviet economies along seven metrics which according to the Global Competitiveness Index define the “domestic competition”: intensity of local competition, extent of market dominance, effectiveness of anti-monopoly policy, number of procedures to start a business, time required to start a busi-ness, agricultural policy costs and total tax rate.18

On such composite metric of “domestic competition,” Georgia ranked higher than other countries in this dataset. By-product of the liberalization reforms since 2004, Georgia’s ranks were among the high-est globally in three categories: “number of procedures to start a busi-ness,” “number of days to start a business” and “total tax rate.” Georgia’s relatively more intense overall domestic competition was achieved despite lower ranks on the metrics of market dominance, effective-ness of anti-monopoly policies and agricultural policy. In other words, Georgia’s domestic competition and its de facto anti-monopolization drive was driven in the first place by the liberalized taxation and by the eased up regulation and not by formal anti-monopoly policies per se.

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Average for this group of countries: 11.95

* Proportion of senior management's time, in a typical week, that is spent dealing with requirements imposed by government regulations (e.g. taxes, customs,labor regulations, licensing and registration, including dealings with officials and completiing forms) .

Fig. 4.29 Senior management time spent dealing with requirements of gov-ernment regulation (%)* (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe and Turkey). Source: World Bank Enterprise Surveys http://www.enterprisesurveys.org

http://www.enterprisesurveys.org

80 D. Gvindadze

-0.4

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Regulatory quality in 2013 (LHS) Change in regulatory quality in 2004-2013 (RHS)

Georgia: highest increase in the regulatory quality in 2004-2013, globally. Higher 2013 score compared to neighboring countries and to countries in the Commonwealth of Independent States

* Regulatory quality reflects perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development.

Fig. 4.30 Regulatory quality estimate in 2013* and change in the regulatory quality estimate in 2004–2013* (Georgia, the Commonwealth of Independent States, Central and Eastern Europe, South Eastern Europe, Turkey). Source: World Bank. Worldwide Governance Indicators

4.28 4.274.20

3.98

3.67

3.58

70 7483

105

132137

3.20

3.40

3.60

3.80

4.00

4.20

4.40

0

20

40

60

80

100

120

140

160

Armenia AzerbaijanMoldova Russia Ukraine

Domestic competition (score), RHS Domestic competition (global rank)

GeorgGeorgia

Fig. 4.31 Georgia’s global ranking and score on “domestic competition”. Source: Global Competitiveness Index, World Economic Forum


Georgia’s experience in the domestic competition, therefore, cautions against viewing national anti-monopoly agencies as the remedy for the promotion of a level-playing field in small and open developing econ-omies. First, small size of a country may mean that economies of scale in certain sectors would entail oligopolistic and monopolistic behavior. Second, when operated in politically dynamic, technocratically immature or corrupt environments anti-monopoly agencies may become—unwit-tingly or otherwise—casual law enforcement entities trading verdicts. Third, an exercise of anti-monopoly powers requires deep understand-ing of the enterprise-level and sectoral dynamics; such understanding is in short supply in many developing economies. Fourth, excessive focus on the anti-monopoly agencies may deflect attention from what needs to be done in the first place: liberalization and simplification of processes, institutional optimization and the eradication of corruption. Domestic competition can often be promoted much better through the economic liberty than through additional layers of public intrusion.

Pillar 3—Efficient Banking Sector

In 2004–2012, Georgia’s banking sector established itself as the impor-tant contributor to the macroeconomic stability and growth, itself helped by the economic openness and by the reasonably sound legal and execution environment. The sector progressed to the highest level of sophistication, IT savviness and service and product quality in the region. Banks withstood the combined pressure of the global financial crisis in 2008–2009 and of the war with Russia in 2008. Thanks to the sound capital base and liquidity positions, no bank requested a bailout from the sovereign. Georgia did not introduce liquidity or withdrawal restrictions. Proper cross-sectoral asset dispersion helped as sectors with different betas offset each other.

In February of 2012, the Bank of Georgia—at the time Georgia’s largest bank accounting for approximately one-third of the sector—became only the second foreign bank to obtain the premium listing on the London Stock Exchange (LSE). The Bank of Georgia first listed its shares in the form of GDRs in November 2006—very early in the

82 D. Gvindadze

game, and was the first-ever entity from the Caucasus region and the second-ever bank from the former Soviet Union to have done so. This was the pioneering deal, with the mentioned premium listing in 2012 building upon it.

Fast forward into 2016, and Georgia’s two largest banks—TBC Bank and the Bank of Georgia—representing close to two-thirds of the sector assets are premium listed on the LSE, which entails stringent financial disclosure, transparency and corporate governance standards, and offers significant development opportunities, increased liquidity of the stock and the investor base expansion. Quality foreign shareholders are repre-sented in other banks.

Georgia’s key bankers are also important opinion leaders on eco-nomic and political matters. They have, on balance, developed relative resilience to electoral cycles and can, therefore, plan long term.

This became possible in the context of the organizing principles listed below. In pursuing these principles, Georgia did not reinvent the wheel. It only followed the best practice.

• Strength of the central bank and operational autonomy of its financial sector supervision arm. Like all central banks, the National Bank of Georgia (NBG) operated in the political context which influenced its margins of maneuver. In all multistakeholder discussions, however, NBG always had an upper hand in its core decisions related to the monetary, exchange rate and financial sta-bility policies. As much as this was the by-product of the character, professionalism and dedication of the NBG’s top management, the proper exercise of the regulatory function also benefited from a rather broad political consensus.

• Transparent ultimate beneficial ownership (UBO), no related party lending, no conflict of interest and proper governance. Shareholding structure of Georgia’s banks is fully transparent, and no bank is captive to larger commercial or industrial conglomerates. The regulator has all information about banks’ UBOs, and all existing and new investors are compliant with “fit and proper” requirements. Thanks to the established political consensus, to the law enforcement and to the regulatory framework in place, Georgia has proved itself


immune from international and domestic raider attacks and from fraudulent domestic and transnational schemes which usually tar-get inadequately supervised banking sectors. The NBG’s leadership has no conflicts of interests and hence cannot be held to ransom by vested interests. Box 4.4 explains how non-transparent ownership in the banking sector resulted in material economic and political risks in Ukraine and in Moldova.

Box 4.4: Ultimate beneficial ownership (UBO), related party lend-ing and conflict of interest

Integrity and transparency of shareholders is at the core of the sound banking. Non-transparent and irresponsible shareholders can act reck-lessly, engage in fraudulent behavior, expose banks to money-laundering schemes, channel bank liquidity to their related businesses (related party lending). Such related businesses may be located domestically or abroad, and they may be shell companies with no de facto collateral assets if the aim is to steal and then run a bank into ruins. Related party loans may, e.g., be “bullet loans” with one-off payment at the end of a repayment term, designed to temporarily disguise asset impairment and thus push the day of reckoning into the future. Such related loans may be also “ever-greened” to disguise the extent of the loan book impairment. In absence of a proper collateral, related party borrowers may end up hold-ing a leverage over a regulator willing to arrest non-transparent shares or replace non-transparent shareholders with fit and proper investors. Non-transparent shareholding is correlated with insufficient modernization, deficient corporate governance and lack of checks and balances.

Until reforms which started in Ukraine in 2014 after the “Revolution of Dignity,” one of the problems in Ukraine’s banking sector was that some banks were used by their owners as appendices to their larger commer-cial interests. In such scenario, banks are not considered—or created—as viable long-term businesses in their own right but rather as conduits for money laundering or for channeling liquidity, including depositors’ money, to their other core cash-generating assets. Some were creating their own banks for fear of relying on banks owned by rivals.

The reform of Ukraine’s banking sector started in 2014, against the backdrop of the significant economic, structural and geopolitical shock due to the escalation of the fighting in Ukraine’s Donbas region. Spearheaded by the new courageous and reformist management team in the central bank, the reform led to the liquidation of close to 90 licensed banks by January 2017: from approximately 180 banks in 2014 to less than 100 banks in 2017.

84 D. Gvindadze

As I write this book, the transformation of Ukraine’s banking contin-ues, spearheaded by the central bank which itself went through a thor-ough overhaul to reestablish its credibility.

Restoration of the banking system soundness represented the impor-tant priority under the IMF program approved for Ukraine in March of 2015. Under the program, the authorities undertook to identify, monitor and unwind above-limit loans to insiders, through measures aimed, inter alia, at (1) introduction of unlimited liability of bank owners on losses from loans granted directly or indirectly to the benefit of bank sharehold-ers holding 10% or more of the voting shares, (2) revision of the central bank’s regulations on related parties to close loopholes and thus prevent the circumvention of lending limits to insiders, (3) reporting by banks of their related loans and in-depth review of these reports by the cen-tral bank with support of the big-four accounting firms, (4) bank recapi-talization and resolution strategy with the gradual unwinding of related loans.19

The UBO intransparency, related party lending, insufficient regula-tory muscle and the influence of vested interests over the administration of justice enabled the massive frauds in and through Moldova’s banking sector which damaged the image of the country and came at the direct public cost of approximately 10% of GDP. Between 2010 and 2014, close to US$ 20 billion were reportedly moved through Moldova in the series of large transnational money-laundering operations collectively called “global laundromat.” In a separate instance, abuse by the bank sharehold-ers and flaws in the regulatory framework led to the failure, in 2014, of Moldova’s three banks collectively amounting to one-third of the sector assets. Moldova’s central bank’s emergency loans to these three banks contributed to the increase of the domestic public and publicly guaran-teed debt from 36% of GDP in 2014 to close to 44% of GDP in 2016 as these emergency loans were then securitized to become the liability of the ministry of finance to the central bank. The banking sector fraud increased Moldova’s vulnerability in the context of the deteriorated exter-nal environment, resulting in the temporary freeze of the international budget support, in significant tightening of monetary conditions and in pressure on the foreign exchange reserves. Weakened confidence and enhanced risk aversion reduced lending opportunities in the banking sec-tor, with large banks increasing their exposures to high-yielding treasury securities and thus interlocking the mutual exposure between the sover-eign balance sheet and the banking sector.

Banking sector reform through strengthening of the regulatory, supervisory and resolution frameworks, effective implementation and timely enforcement of actions to end supervisory forbearance in the face of shareholder or manager misconduct were at the core of the IMF’s program for Moldova approved in November 2016. The authori-ties undertook to enhance the central bank’s powers and capacity to identify banks’ UBOs and related party lending. Three largest banks


representing almost two-thirds of the sector assets were placed under special supervision of the central bank on the grounds of the intrans-parent shareholding and were required to implement time-bound and strong remedial action plans.20

This IMF program, together with the political stabilization from 2016, the appointment of the modern, knowledgeable and reformist top management in the central bank, and the joint leverage exercised by Moldova’s main international development partners, allowed to improve the legal framework, to start enforcing the UBO transparency, to raise quality of the regulatory oversight and to launch the search for new stra-tegic and financial investors into the banking sector. Successful completion of all these reforms depends on a continuous, strong and high-level politi-cal consensus.

• Level-playing field and intense competition. Retention and increase of the market share were contingent on the quality and transparency of corporate governance, on relevance of financial mod-els and products, on development of new channels and on continu-ous technological innovation. Simplified mechanics of borrower switch from one bank to another worked to level the playing field, exerting pressure on intermediation margins and compressing service fees. Helped by positive international narrative on Georgia’s reforms, the banking sector attracted quality foreign capital, both equity and debt, although foreign banks—including international brand names—not ready to establish themselves in Georgia for the long term and to commit to their Georgian operations their top talent would be unable to outmaneuver domestic banks which are innova-tive, professional and competitive. For example, management boards of Georgia’s two largest banks listed on the London Stock Exchange have a predominantly Georgian composition while supervisory boards represent an amalgamation of Georgian and foreign finance, investment and management professionals.

• Private ownership; no state-owned or development banks engaged in directed and subsidized lending or in other quasi-fis-cal operations. Ideas to create a development bank to develop “stra-tegic sectors” of the economy emerged several times and were quickly

86 D. Gvindadze

turned down. This helped to ensure that Georgia’s sovereign balance sheet was free from quasi-fiscal liabilities and from misallocation of resources which tend to accompany existence of the state-owned banking in developing economies. Developing economies with state-owned banks run three risks: (1) Such banks may invite rent seeking from vested interests; governments may be unable or unwill-ing to confront it and may thus end up providing long-term cheap finance for projects which can be funded commercially or must not be funded at all; (2) Governments may use state-owned or develop-ment bank to “enter” economic segments which are normally best served by the private sector. Because both incumbent and prospec-tive private investors in such economic sectors would be scared off by a competition from a new quasi-public entrant, they would retrench, rethink their further expansion or not enter the segment at all; (3) Governments may use state-owned or development banks to circum-vent fiscal rules (e.g., retain the headline general government budget deficit within certain limits while de facto increasing it through directed lending via state-owned banks which is not classified as part of the general government). These risks can, in theory, be miti-gated through sound corporate governance and stringent safeguards

0%

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20%

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1,000,000,000.00

2,000,000,000.00

3,000,000,000.00

4,000,000,000.00

5,000,000,000.00

6,000,000,000.00

7,000,000,000.00

8,000,000,000.00

9,000,000,000.00

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Jan-

04

May

-04

Sep-

04

Jan-

05

May

-05

Sep-

05

Jan-

06

May

-06

Sep-

06

Jan-

07

May

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Sep-

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Jan-

08

May

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Sep-

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Jan-

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May

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Sep-

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Jan-

10

May

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Sep-

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Jan-

11

May

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Sep-

11

Jan-

12

May

-12

Sep-

12

Total assets (year end) / GDP, % Net Loans (US$) Total Assets (US$) Deposits (US$) Equity Capital (US$)

War with Russia, global

crisis

Fig. 4.32 Georgia’s banking sector trends in 2004–2012. Source: National Bank of Georgia, IMF World Economic Outlook, 2016


(which development banks in some advanced countries possess). In developing economies, such safeguards are much less waterproof. Therefore: (1) If state-owned banks do not exist, do not create them because such banks’ loan portfolios will inevitably end up as mirrors of a country’s politics; (2) if they exist, try to corporatize and pri-vatize them; (3) do not listen to “experts” extolling virtues of state-owned banks in the developing country context.

• No deposit guarantee scheme. Pros and cons of such scheme were debated on a number of occasions, although key stakeholders ended up agreeing that transformation and modernization of Georgia’s banking sector—at the given stage of development—would be best served by the market discipline and rigorous supervision rather than by a potentially underfunded deposit guarantee scheme. Empirical evidence of virtues of deposit guarantee schemes in developing econ-omies with fast-changing banking sectors is inconclusive. In develop-ing countries where banking sectors are fragmented, non-transparent and fluid and supervision is lax, an excessive reliance on underfunded deposit guarantee schemes can create smoke screens and false sense of normalcy standing in the way of scrutiny which depositors, lenders and investors are normally expected to exercise in respect of banks with which they transact. Deposit guarantee schemes may thus end

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Serb

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atia

Bosn

ia H

erz.

Lith

uani

a

Turk

ey

Rus

sia

Slov

ak R

ep.

Uzb

ekis

tan

Mac

edon

ia, F

YR

Latv

ia

Bulg

aria

Esto

nia

Kos

ovo

Hun

gary

Pol

and

Rom

ania

Cze

ch R

ep.

Geo

rgia

Geo

rgia

Fig. 4.33 Bank capital-to-assets ratio, Georgia, Central and Eastern Europe, the Commonwealth of Independent States, 2012. Source: World Bank Financial Sector Database; IMF Global Financial Stability Report

88 D. Gvindadze

up enhancing moral hazard and perturbing the “creative destruction” in a banking sector.

• Restraint and avoidance of excessive intrusion. Banking is the con-fidence-driven business vulnerable to random statements, swings in popular mood, changes in economic models and in government tool kits to implement such models. Public discourse, if not properly cali-brated, can cause collateral damage. Hence the importance of a skilled communication to prevent finger pointing, especially in times of eco-nomic or exchange rate tensions when populist politicians and cer-tain local experts are keen to single out bankers for negative treatment they do not deserve. It is also important to ensure that conservative regulation does not result in excessive intrusion into private contracts

18.6%18.2%

17.6%16.6%16.5%

16.0%15.2%

14.8%14.5%

13.8%13.5%

10.1%8.7%

7.4%6.0%

5.7%5.5%5.2%5.2%5.2%

3.7%3.7%

2.7%2.6%

0.0% 5.0% 10.0% 15.0% 20.0%

SerbiaRomania

MontenegroBulgariaUkraine

HungarySloveniaLithuaniaMoldova

CroatiaBosnia Herz.

Macedonia, FYRLatvia

KosovoRussia

AzerbaijanBelarus

Czech Rep.Slovak Rep.

PolandGeorgiaArmenia

TurkeyEstonia

Fig. 4.34 Bank non-performing loans to total gross loans in 2012, percent (Central and Eastern Europe). Source: World Bank Financial Sector Database, IMF Global Financial Stability Report


between banks and clients. As an example, driven by both volume and valuation effects, deposit dollarization in Georgia decreased from 86% in 2003 to 64% in 2012 and loan dollarization decreased from 87% in 2003 to 68% in 2012. It took the decade of growth, reforms, rela-tive price and exchange rate stability to shift from the very high to the still high level of the dollarization. As much as the central bank was seeking to promote local currency lending, the dedollarization dynam-ics was driven by the overarching confidence factor. Any forced dedol-larization measures (bans on new dollarized loans, forced conversion of dollarized loans into local currency, etc.) may represent an unnec-essary encroachment on contract between private economic agents, triggering economic distortions, disrupting flow of credit and eventu-ally creating contingent risks for the regulator and for the sovereign. Such forced dedollarization would then quickly unravel with next round of exchange rate pressures. Above all, excessive regulatory intru-sion would upset Georgia’s liberal economic franchise, with possible knock-on impact on, e.g., international debt rollover rates in the real and financial sectors. In the context of the structural current account deficit and of the negative net international investment position, such intrusion may thus trigger adverse balance sheet impact stretching beyond the stock of loans singled out for the dedollarization.

Resultant TrendsFigure 4.32 compares year-end metrics in 2003 and in 2012 (all

metrics converted from GEL to US$). Total assets of the banking sec-tor increased from US$ 650 million to US$ 8.7 billion (CAGR 33%). Ratio of the total banking assets (year-end) to GDP increased from 18% in 2004 to 55% in 2012. Net loans increased from US$ 350 million in 2004 to US$ 4.9 billion in 2012 (CAGR 34%). Total deposits increased from US$ 370 million to US$ 4.9 billion (CAGR 33%). Net loans thus remained nearly equal to total deposits. Shareholder equity increased from US$ 170 million in 2004 to US$ 1.44 billion in 2012 (CAGR 27%). Outstanding mortgage loan portfolio—zero in 2003—became US$ 2.6 billion in 2012. Number of debit cards outstanding increased from less than 100,000 to more than 4 million. Number of credit cards outstand-ing increased from zero to 800,000. Number of ATMs increased from

90 D. Gvindadze

approximately 100 to approximately 1900. Number of POS terminals increased from less than 500 to almost 14,000. Loan book expansion in 2004–2012 was mainly deposit-driven with, on balance, healthy non-deposit funding structure and limited exposure to volatile funding. In 2012, the non-deposit funding structure consisted of the equity capital (42%), borrowing from international financial institutions (38%), domes-tic borrowing (9%), borrowing from non-resident parent banks (4%) and borrowing from private external sources (7%).

Through acquisitions and organic development, Georgia’s leading banks advanced their franchise in broker dealership, insurance, asset and

80%73%

70%68%67%

65%58%

55%51%50%50%50%

47%47%47%

45%40%40%

38%34%

22%20%

0% 50% 100%

SloveniaEstoniaUkraineCroatia

BulgariaLatvia

TurkeyBosnia Herz.

HungaryPoland

Czech Rep.Serbia

Macedonia, …Slovak Rep.

LithuaniaRussia

MoldovaArmeniaRomaniaGeorgiaBelarus

Azerbaijan

Fig. 4.35 Domestic credit to private sector, percent of GDP in 2012 (Central and Eastern Europe). Source: IMF International Financial Statistics, World Bank and OECD GDP estimates


wealth management, card and payment processing, investment advisory, securities and underwriting business and economic analytics. This con-tributed to the bottom line profitability against the backdrop of con-servative capital adequacy standard which, by capping the sector-wide leverage (approximately six times total assets to equity ratio in 2012, up from four times in 2004), was limiting the returns on equity.21 In 2012, Georgia’s banking sector had one of the highest average bank capital-to-assets ratios in Central and Eastern Europe (Fig. 4.33).

The ratio of banks’ non-performing loans to total gross loans—at 2.34% in 2002—decreased to less than 1% by 2007 and then increased to close to 6% in 2009–2010 before decreasing again to less than 4% by 2012—one of the lowest levels in the region (Fig. 4.34). Domestic credit to the private sector grew from less than 9% of GDP in 2003 to 34% of GDP in 2012 (Fig. 4.35). This level of the credit penetration in 2012 pointed to further growth opportunities for the sector.

Notes

1. IMF staff reports on Armenia provide information on the central gov-ernment operations. Because total central government expenditure in these staff reports equals total general government expenditure in the IMF’s World Economic Outlook database, I use central government capital expenditure/acquisition of non-financial assets reported in these staff reports to calculate ratios in Figs. 4.4 and 4.5.

2. IMF Government Finance Statistics Yearbook and data files. Compensation of employees consists of all payments in cash, as well as in kind (such as food and housing), to employees in return for services rendered, and government contributions to social insurance schemes such as social security and pensions that provide benefits to employees.

3. Average consumer price inflation, index. IMF World Economic Outlook database.

4. Geostat, Integrated Household Survey. 5. World Health Organization Global Health Expenditure database,

http://data.worldbank.org/indicator/SH.XPD.TOTL.ZS retrieved in April 2017.

6. From 2004 till 2012, the period focused on in this book, Georgian Lari (GEL) appreciated against the US$ by close to 20%, from approximately

http://data.worldbank.org/indicator/SH.XPD.TOTL.ZS

92 D. Gvindadze

2.1 GEL per US$ in the beginning of 2004 to approximately 1.66 GEL per US$ at the end of 2012. Within this 9-year period, however, GEL’s gradual appreciation against US$ lasted from 2004 till the end of October of 2008, at which point GEL depreciated abruptly against US$ under the combined weight of Georgia’s war with Russia and of the global financial crisis. The gradual GEL depreciation lasted till the mid-dle of 2010, at which point the GEL appreciation started again.

7. Reinhart and Rogoff (2009). 8. In Georgia, the difference between domestic and external public debt

is based on the currency of denomination. Domestic public debt is GEL-denominated, owed largely to local residents and governed by the domestic law. External public debt is denominated in foreign cur-rencies, owed to foreign residents and governed by foreign laws. The currency of denomination-based definition thus ensures de facto con-sistency across all standard economic and legal definitions of difference between domestic and external public debt.

9. At the time of the observation, Russia was rated BBB and Ukraine B, and hence these two countries were not in the BB/BB—group to which other countries in the Fig. 4.20 belong.

10. Georgia Pocket Tax Book (2012). 11. L. Gurgenidze (2009). 12. N. Beruashvili, O. McGill (2010). 13. Fighting Corruption in Public Services: Chronicling Georgia’s Reforms

(2012). 14. Georgian Reform—Success Stories (2009). 15. L. Gurgenidze (2009). 16. Public Service Hall home page (www.psh.gov.ge). 17. Doing Business (2013). 18. Extent of market dominance indicator description—Q&A: In your

country, how do you characterize corporate activity? [1 = dominated by a few business groups, 7 = spread among many firms]; effectiveness of anti-monopoly policy indicator description—Q&A: In your country, how effective are anti-monopoly policies at ensuring fair competition? [1 = not effective at all; 7 = extremely effective].

19. IMF Country Report No. 15/69, March 2015, attachment 1, Memorandum of Economic and Financial Policies.

20. IMF Country Report No. 16/343, November 2016, Memorandum of Economic and Financial Policies.

21. L. Gurgenidze (2009).

http://www.psh.gov.ge

Abstract This chapter explains the outcome of the reforms—and of the political economy of such reforms in 2004–2012—discussed in the previous chapters. Despite significant external and internal challenges, Georgia posted one of the highest real growth rates, attracted signifi-cant foreign investment and made important strides in its fight against corruption. The author applies a cross-country perspective to compare Georgia’s performance to the broader neighborhood and beyond.

Keywords Growth · Investment · Corruption · FDI · Law Governance

Despite the war with Russia in 2008, continuous geopolitical and security challenges and several spikes in domestic political tensions, Georgia’s real economic growth in 2004–2012 was one of the high-est in the broader neighborhood. Figures 5.1 and 5.2 provide regional comparison of growth rates in the real economic output (i.e., in volume terms, economy-wide and per capita) from 2004 till 2012.

In 2004–2012, Georgia attracted significant foreign direct invest-ment (FDI). Cumulative FDI in the given period amounted to

5The Outcome: Sound Growth, Significant

Inbound Investment, Substantially Reduced Corruption


93

94 D. Gvindadze

approximately US$ 10 billion (Fig. 5.3). Of total FDI in 2004–2012, 11% came from the UK, 9% each from the Netherlands and Turkey, 8% from the USA, 7% from the UAE, 6% each from Azerbaijan and Virgin Islands, 4% each from the Czech Republic, Russia, Cyprus and Germany, 3% each from Denmark, Kazakhstan and international organizations. The remaining 20% of the total FDI which Georgia received in 2004–2012 relates to 59 countries and jurisdictions, with

13.2%7.2%

6.1%6.1%

4.9%4.4%4.3%4.3%

4.1%3.5%3.4%3.4%3.3%3.2%3.1%3.0%2.9%2.9%2.7%

2.4%1.6%

0.9%0.9%

0.0% 5.0% 10.0% 15.0%

AzerbaijanBelarusArmeniaGeorgiaTurkey

Slovak RepublicPolandRussia

MoldovaFYR Macedonia

MontenegroBulgaria

LithuaniaRomania

SerbiaBosnia Herz.

LatviaEstonia

Czech RepublicUkraine

SloveniaHungaryCroatia

Fig. 5.1 CAGR GDP, constant prices, 2004–2012. Source IMF World Economic Outlook, 2016

5 The Outcome: Sound Growth, Significant Inbound … 95

nine of which Georgia’s net FDI balance in the given period was negative.

At close to 10%, Georgia’s average gross and net inbound FDI to GDP ratios for 2004–2011 were higher than for many countries in the region (Table 5.1). In this FDI push, all layers of the government acted as one consolidated investor relations machine.

12.1%7.6%7.5%

6.4%4.9%

4.4%4.4%4.4%4.3%4.3%4.2%

4.0%3.6%3.5%

3.3%3.3%3.3%

3.0%2.9%

2.4%1.3%1.1%1.0%

0.0% 5.0% 10.0% 15.0%

AzerbaijanBelarusGeorgiaArmenia

LithuaniaRussia

Slovak RepublicPoland

MoldovaLatvia

BulgariaRomania

TurkeySerbia

MontenegroEstonia

FYR MacedoniaBosnia Herz.

UkraineCzech Republic

SloveniaHungaryCroatia

Fig. 5.2 CAGR GDP per capita, constant prices, 2004–2012. Source IMF World Economic Outlook, 2016

96 D. Gvindadze

According to the Transparency International’s Global Corruption Barometer 2010–2011 (the latest report in the period 2004–2012), Georgia had the highest percentage of people, globally, who believed that corruption decreased.1 Perception of corruption in public insti-tutions in Georgia was the fifth lowest globally, after Denmark, Switzerland, Finland and Norway. Percentage of Georgians who reported paying bribe to public institutions (around 3.5%) was one of the lowest globally, putting Georgia into the same league with

8.5%9.7%

7.0%

15.4%

19.8%

12.2%

6.1%7.0%

7.7%

5.8%

0.0%

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10.0%

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20.0%

25.0%

0

1000

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10000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Annual FDI, US$ mln Cululative FDI, US$ mln

Annual FDI / GDP

Fig. 5.3 Annual and cumulative FDI to Georgia (2003–2012). Source Geostat

5 The Outcome: Sound Growth, Significant Inbound … 97

Denmark, Norway, UK, Switzerland, Finland, Germany, Australia, South Korea, Netherlands, Iceland and Portugal. Some 77% of respondents in Georgia thought that their government was “effective or very effective” in its fight against corruption—the second highest per-centage globally.

According to the Worldwide Governance Indicators (Fig. 5.4), in 2004–2012 Georgia had the third best improvement—globally—in the “control of corruption” estimate and the second-best improvement—globally—in the “rule of law” estimate.

Table 5.1 Cross-country comparison: Average gross and net FDI/GDP ratios. Source: IMF Datamapper, 2016

98 D. Gvindadze

Note

1. Percentage of Georgians that think corruption has increased, stayed the same or decreased in the past 3 years: 78% decreased; 13% stayed the same; 9% increased (TI Global Corruption Barometer dataset).

GEORGIA

-1.00

-0.80

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

-1.50 -1.00 -0.50 0.00 0.50 1.00 1.50

Cha

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in th

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e fro

m 2

004

to 2

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Change in the 'control of corruption' estimate from 2004 to 2012

* Reflects perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as "capture" of the state by elites and private interests.** Reflects perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence.

Fig. 5.4 Georgia—highest improvement in the “control of corruption” * and in the “rule of law” ** estimates in 2004–2012 (global dataset, higher figure means improvement). Source World Bank Worldwide Governance Indicators

Abstract This chapter discusses the virtues and the limitations of the pub-lic action. The author shares thoughts on how to enhance the value added per worker in Georgia’s agriculture and to create additional more produc-tive jobs in the industry and services. The author’s key message is that the real structural transformation—increase in the aggregate productivity and in the agricultural value added—can only be triggered through a conflu-ence of factors and circumstances: rapid growth, proper global economic positioning to attract investment, and development of functional well-managed cities which provide learning opportunities and employ addi-tional labor force. Centered around the agriculture, this chapter explains how to best think of and conceptualize public policies in other areas.

Keywords Agriculture · Productivity · Value added · Structural Transformation

Starting from 2004–2005, productivity in Georgia’s services and indus-try sectors increased fast, although in 2012 almost half of the workforce was still locked in the agriculture with stagnant productivity, accounting for around one-tenth of the GDP in 2012 (Figs. 6.1 and 6.2).

6The Limits and the Virtues of the Public

Action: The Example of Agriculture


99

100 D. Gvindadze

What kind of the government action can address this? How to enhance the value added per worker in the agriculture and create more productive jobs in the industry and the services—the two segments

Fig. 6.1 Georgia—labor productivity at constant 1996 prices, GEL. Source Geostat

Fig. 6.2 Georgia—employment, in thousand persons. Source Geostat

6 The Limits and the Virtues of the Public Action … 101

which in advanced economies represent larger share of employment than in Georgia?

The story of increasing the agricultural value added in Georgia is the story about the limits and the virtues of the public action. Many analyses on the agricultural development suffer from a major flow: They examine agricultural development in the narrow context of the agricul-tural development and miss the broader picture.

Georgia’s government needs to internalize pros and cons of two thought frameworks explained below. It needs to pursue a realistic strat-egy and manage expectations. Such strategy would necessarily import—for political and social inclusion reasons—certain elements from the framework one. Still, the challenge of the agricultural productivity must be acted upon in the much broader context of the framework two. Anything short of that is unlikely to trigger the fundamental structural transformation which Georgia needs.

Thought framework one prioritizes subsidization. Machinery and irrigation is in short supply, know-how is missing, arable land is frag-mented, farm size is sub-optimal, elections need to be won. Therefore, the government helps, annually, to seed, plough, cultivate and harvest around one-third of Georgia’s land area which is the agricultural land. Palpable as it can be in the short run for those on the receiving end, this thought framework—if not part of the thought framework two explained below—is rudderless and not consequential in the long run. Can addiction to the heavy agricultural subsidization subtract from, rather than add to, the total factor productivity of an economy?

Thought framework two seeks to harness parallel and consecutive circumstances and events, as follows: (1) Sound public finances, friendly business environment and stable and effective banking foster investment and growth. (2) Stock of wealth is enhanced as Georgia attracts rapidly increasing numbers of international tourists. (3) Modern food retailing develops (including entries by international retailers who unlock export opportunities for Georgian products within their regional or global retail chains). (4) This multiplies vertical retailer-driven agricultural value-added chains in Georgia. (5) Retailers increasingly source prod-ucts from local farms that they own or back through contract farming arrangements and offer more predictable off-takes to local commercial

102 D. Gvindadze

and subsistence farmers. (6) People increasingly realize that agriculture is the business. (7) In parallel, urbanization moves people in the direc-tion of the cities (ubiquitous global phenomenon). (8) Assuming that cities are managed properly (boldly, efficiently, with strategic urban foresight and with due understanding of environmental risk mitiga-tion strategies) and that the economic growth is sustained, the urbani-zation improves living conditions and enhances learning opportunities. (9) Resultant increase in intra-household remittances from urban to rural areas benefits the village. (10) Middle class grows and so does the demand for locally sourced organic agricultural products. (11) Farmers—both commercial and subsistence—enjoy more reliable off-takes and higher prices. (12) Lower rural concentration fosters agglom-eration of small land plots into larger commercially managed farms.1

In the context of the thought framework two, agriculture can be best helped by rapid growth, proper global economic positioning to attract investment and tourists, and development of functional well-managed cities which provide learning opportunities, soak in additional labor force and foster increase in Georgia’s urban population as a percentage of the total from 53% in 2012 (Fig. 6.3).

Recall the concept of “communicating vessels”: liquid added to only one vessel will vanish into other empty vessels and the system will set-tle at the same low aggregate level. Same in the realm of public policies:

98 94 92 89 89 87 85 84 82 81 81 80 80 79 79 77 75 75 75 74 74 74 73 73 72 70 69 69 68 68 67 67 66 63 63 62 62 61 58 57 55 54 54 54 54 53 5045

39

0

* Urban population refers to people living in urban areas as defined by national statistical offices. The data are collected and smoothed by United Nations Population Division.

10

20

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and

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Bela

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Turk

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nia

Aus

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Mon

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Arm

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Irela

ndP

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Pol

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Cro

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Mac

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ia, F

YRSe

rbia

Alb

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Slov

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Rom

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Aze

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jan

Geo

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Slov

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Mol

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Fig. 6.3 Urban population, percent of total *. Source: United Nations, World Urbanization Prospects; World Bank, World Development Indicators

6 The Limits and the Virtues of the Public Action … 103

no individual communicating vessel can retain a high level of the liq-uid (i.e. no standalone sectoral policy–including the agricultural policy–can succeed on its own) unless the liquid is added simultaneously to all vessels (i.e. unless visionary leaders accelerate to the “escape velocity of reforms” through a comprehensive state-building process).

Note

1. For more detail on density of population, urbanization and growth, see World Development Report (2009) and McKinsey research on urbanization.

Abstract This chapter explains the level of Georgia’s GDP per capita at the time of the writing in 2016 and provides four possible growth scenarios under different assumptions on the real GDP growth rate. Despite the rapid growth in the period covered in this book, Georgia needs to sustain high growth in order to catch up with the rest of Europe. Beyond the economic decisions which must be technically sound and reasonably ring-fenced from the political cycles, such con-vergence depends on the continuous success in the process of the state building.

Keywords Growth · Convergence · State building · Politics · Security Leadership

Georgia’s GDP per capita increased from US$ 924 in 2003 to US$ 4130 in 2012 and remained at approximately US$ 4000 level in 2012–2016 due to the depreciation of GEL against US$. This level of GDP per capita is much lower than in Central Europe and in the Baltics (Fig. 7.1).

7Riding the Bicycle


105

106 D. Gvindadze

The catch-up game ahead is significant. Figure 7.2 shows growth of Georgia’s real GDP per capita (measures growth in the volume of pro-duction per capita, assuming constant prices) under four scenarios: 3, 5, 7 and 10%. Of these, 3% is clearly on the downside, the range of 5–7% represents the target range which under certain assumptions on endogenous and exogenous economic and political factors is realis-tic, and the 10% real growth sustained through years looks too optimis-tic given Georgia’s geopolitics and internal factors. The target range of 5–7% entails increase in the volume of production per capita by 2030 by 2.3–3 times, which can have a significant poverty mitigation impact.

Figures 7.3 and 7.4 depict growth paths of Georgia’s US$-denominated GDP per capita assuming constant GDP deflator of 5% and the real growth rates (annual growth of the volume of output per capita) of 3, 5, 7 and 10%.

• In the 10% real growth scenario, Georgia’s GDP per capita will be close to US$ 15,000 in 10 years and close to US$ 30,000 by 2030. US$ 30,000 is Italy’s GDP per capita in 2016. Such scenario rests on a confluence of various benign factors: geopolitical stability, regional economic growth and absence of adverse spillovers or exchange rate

2137018326

1789616648

1489914141

1230911903

94397091

3908

0 5000 10000 15000 20000 25000

SloveniaCzech Republic

EstoniaSlovak Republic

LithuaniaLatvia

PolandHungaryRomaniaBulgariaGeorgia

Fig. 7.1 GDP per capita in Georgia, Central Europe and the Baltics (US$, 2016f). Source IMF World Economic Outlook, Oct. 2016


pressures, domestic political stability and the succession of strongly reformist‚ brave and visionary governments.

• In the 5% real growth scenario, Georgia’s GDP per capita will be at around US$ 9500 in 2025 and US$ 15,400 in 2030. In a 7% real growth scenario (which is ambitious but not unrealistic in case of an alignment of domestic and regional factors), Georgia’s GDP per cap-ita will be at around US$ 11,000 in 2025 and US$ 20,000 in 2030. Within a decade, the 5 and 7% growth scenarios can, therefore, allow Georgia to get closer to the current levels of the GDP per capita in Central Europe (by that time, however, Central Europe will have moved further up, plus purchasing power of a dollar today is stronger than it will be in 10 years).

• The 3% real growth scenario does not provide a sufficient economic uplift. Poverty and unemployment will remain the problem; internal stability will suffer due to social dissatisfaction. Hence the vicious cycle where low growth will lead to turbulent and disenchanted domestic politics which will, in turn, subdue growth even further.

1.51.71.8

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Fig. 7.2 GDP per capita, constant prices, 2012 = 1. Source World Economic Outlook, 2016

108 D. Gvindadze

Leaving aside the exogenous factors and uncertainties (regional geopol-itics and Russia, challenges within the EU, policy stance of the USA, global economic problems, anti-globalization sentiments and the rise in the “post-truth” politics), Georgia’s sustained high growth scenario can only materialize if:

• Politicians compete without trespassing red lines, without hollowing out each other’s—and their supporters’—living space in the after-math of elections, and without compromising on the reasonable political neutrality and on the integrity of key public institutions.

• Economic decisions are technically sound by way of being reasonably ring-fenced from the political cycles.

• Politics is geared toward the promotion of individual economic free-doms and toward the alignment of social entitlements with economic fundamentals.

• The authorities succeed in striking—and maintaining—the right socially and culturally acceptable balance between preservation of

1.9

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Fig. 7.3 Four growth scenarios of Georgia’s nominal GDP per capita in US$ terms, assuming constant GEL-US$ exchange rate (“r” is real GDP growth; “i” is change in GDP deflator). Source World Economic Outlook, 2016


such individual freedoms and facilitation of growth through activist and visionary infrastructure development and investment promotion policies.

• National security, law and order and anti-crime measures at all times represent the unconditional overarching state priority underpinned by a resilient multistakeholder consensus.

• Leaders lead and inspire, keeping faith with the people, imbuing hope, fighting ideological agnosticism and apathy, staying beyond reproach and progressively reinforcing Georgia’s reformist and liberal franchise which it took almost a decade to build.

Georgia is riding a bicycle. Any slowdown makes balancing harder. Any stoppage leads to a fall.

4130

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Fig. 7.4 Nominal levels of Georgia’s GDP per capita in US$ terms under three growth scenarios in 2012, 2025 and 2030. Source World Economic Outlook, 2016

Erratum to:D. Gvindadze, The Transformation of Georgia from 2004 to 2012, https://doi.org/10.1007/978-3-319-59201-5

The original version of the book was inadvertently published with 6 endorsements instead of 8 in Frontmatter. The erratum book has been updated with the change.

Erratum to: The Transformation of Georgia from 2004 to 2012

E1© The Editor(s) (if applicable) and The Author(s) 2017 D. Gvindadze, The Transformation of Georgia from 2004 to 2012, https://doi.org/10.1007/978-3-319-59201-5_8

The updated online version of this book can be found at https://doi.org/10.1007/978-3-319-59201-5

Dimitri Gvindadze

http://dx.doi.org/https://doi.org/10.1007/978-3-319-59201-5

http://dx.doi.org/https://doi.org/10.1007/978-3-319-59201-5

111© The Editor(s) (if applicable) and The Author(s) 2017 D. Gvindadze, The Transformation of Georgia from 2004 to 2012, DOI 10.1007/978-3-319-59201-5

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1965–2000”, HarperCollins Publishers.P. Pomerantsev, G. Robertson, J. Ratkovic and A. Applebaum (2014),

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113© The Editor(s) (if applicable) and The Author(s) 2017 D. Gvindadze, The Transformation of Georgia from 2004 to 2012, DOI 10.1007/978-3-319-59201-5

ATMs 89Automation 70Aviation market 71Azerbaijan 15, 45

BBalance 6Baltics 105Banking 4, 13, 20, 28, 39, 44Bank of Georgia 81Bank recapitalization and resolution

84Bankruptcies 13Batumi 37Belarus 44Bicycle 107Black Sea 15, 75Borders 70Borrower switch 85Bound tariff 68Broker-dealership 90

AAbkhazia 12Achievements 1Action plans 25Activism 6, 9, 17Adding value 28ADF 49Administration 4Administration of justice 19, 84Agglomeration 102Agricultural value added 101Agriculture 5Anaklia 37Anchors 20Anti-crime 107Anti-monopolization 79Anti-monopoly agencies 81Anti-monopoly policy 79Architects 37Architecture 37Armenia 33Asian Development Bank 49

Index

114 Index

Commonwealth of Independent States 29, 67, 73

Communication 88Communist Party 2Communists 10Competition 27, 85Competitiveness 60Concentric circles 59Conceptualization 8Concessional 50Confidence 12, 35, 88Conflict of interest 82Conflicts 12Confrontation 12Connectivity 33Consensus 4, 6, 19, 31Consolidation 7, 21, 33Constant prices 107Consumer price inflation 15Contingent liabilities 38Contract farming 101Contraction 15Control of corruption 98Controversial 7Corporate governance 85Corporate income tax 62Corporatization 65Corruption 4, 13, 15, 96Country Policy and Institutional

Assessments 49Coupon 13Credit cards 89Credit rating 43Crime 4, 13Crimea 44Crisis 12Cross-border 68Cross-sectoral 4, 15, 28

Budget deficit 36Budget revenues 46Budget support 57, 84Budget 32Bullet loans 83Business environment 4Business 28

CCAGR 94Capitalism 12, 17Capital gains tax 63Capital markets 27, 28, 45Capital mobility 65Capital spending 33, 35, 36Capital-to-assets ratio 87, 91Car business 71Cash tender 52Caspian Sea 75Catch-22 59Catch-up 17Caucasus 82Central and Eastern Europe 29, 32Central bank 19, 82, 84Central budget 64Centralized planning 12Checks 11Checks and balances 5, 33Choice 10Civil Registry 73Civil servants 24, 61Collateral 83Collective bargaining 74Commercial and subsistence farmers

101Commercial banks 53Commercial profits 67

Index 115

Cross-sectoral asset dispersion 81Culture 10Currency 15Current account 13, 43Current account deficit 44, 89Current expenditures 35Customs 27, 61Customs Clearance Zones (CCZ) 70Customs checkpoint 68Customs officers 68Customs throughput capacities, trade

turnover 70Cycles 5

DDatabases 65Debt 27Debit cards 89Debt rollover rates 89Debut Eurobond 52Decentralization 7Decisions 5De-dollarization 52, 89Deep and Comprehensive Free Trade

Agreement 70Defeatism 20Deficits 43Deflator 104Demonopolize 61Deposit guarantee scheme 87Depositors 83Depreciation 44Deregulation 27, 61Destination 8Developing economies 45Development banks 85Development partners 7, 59Directed lending 20

Disbursement rates 57Discretionary 36Dislocation 13Disruption 12Distance to the frontier 76Distortions 10Diversifying 20Dividend 63Dividend and interest income tax 62Doing Business Report 76Dollarization 45, 89Domestic competition 61, 79Domestic debt 50Domestic market 43Donbas 83Donor coordination 27, 28, 58Donors 57Donor pledge 56Downfall 13Downsized 73Downstream 21, 28

EEconomic Freedom 72Economic fundamentals 108Economic positioning 6Effectiveness 31Efficient 33Elections 21Electoral cycles 31Electricity 13Embargoes 12Emergency Loans 84Employment 100Energy 6, 13Enforcement 11Entitlements 38Entrepreneurship 9, 17

116 Index

Fiscal-monetary interaction 52Fit and proper 82Flaws 7Floating rates 46Food retailing 101Foreign aid 55Foreign direct and portfolio inves-

tors 54Foreign direct investment (FDI) 93Foreign exchange reserves 84Frauds 84Free floating 63Free tourist zones 63Freedoms 6

GGDP 13GDP per capita 15, 72, 103GDRs 81General budget pool 64Geopolitical 7, 12, 19Georgia 10, 28Georgian Dream 22Georgia-sourced income 63Georgian Lari (GEL) 13, 43Georgian Oil and Gas Corporation

53, 75Georgian railways 53, 75Georgian State Electrosystem 75Global economic crisis 34Goderdzi 37Golden List 70Good will 19, 24, 25Gorbachev 9Government 8, 21, 31Government action 100Government activism 60Government consumption 35

Equality of the opportunity 17Equality of the outcome 17Equity capital 90Equity securities 63E-solutions 65Establishment 20Ethnic 6Euribor 49Euro 45Euro-Aatlantic integration 20Eurobond 52, 75European 20European Union (EU) 29, 70, 73Eurozone 75Ever-greened 83Evolutionary 21Exchange rate risk 50Exchange rate 44Excise 64Exempted 63Exogenous factors 106Expectations 19, 24Expenditures 13Experts 25Export promotion agencies 61External assistance 56

FFarmers 102Fatigue 8Feasibility studies 59Financial sector supervision 82First-generation reforms 56Fiscal 60Fiscal consolidation 36Fiscal decentralization 64Fiscal rules 86Fiscal stimulus 35, 48

Index 117

Government effectiveness 32Government regulation 79Government revenues 63Government securities 43Grants 57Growth scenario 106, 108Growth 15Guarantees 20

HHard currency 11Headline general government budget

deficit 86Heavy-handed 68Heritage Foundation 71, 72High growth scenario 106High-level corruption 26High-yielding treasury securities 84Highway 36, 37, 59Hryvnia 44Hurdles 8Hurdle rates 28Hydrocarbons 45Hydropower 36Hyperinflation 13

IIDA 49Idiosyncratic 7Implementation units 59Imported 11Import tax 63In intra-household remittances 102Incentives 5Income brackets 62Indexation 32, 38Index of Economic Freedom 72, 106

Individual freedoms 107Individualism viiiIndustrial conglomerates 82Industrial integration 12Inertia 31Infant industries 61Inflation 13, 32Infrastructure 9, 17, 30, 33, 36, 56Infrastructure loans 59Inheritance tax 63Inner circle 21Innovation 5, 27, 61Inspection agencies 73Institution-building 68Institutional transformation 19, 57Institutional 4, 5Institutions 15Insurance, asset and wealth manage-

ment 90Integrated public finance 52Integrity 24Interest rate 50Intermediation margins 85Internally displaced persons 12, 56International 57International arrivals 76International assistance 50International experts 7International financial company 63International financial institutions 49International markets 55International Monetary Fund (IMF)

8, 85Intrusion 88Investability 28Investment 5, 6, 33Investment advisory, securities and

underwriting 91

118 Index

Loan-book impairment 83Lobby groups 62Local and secondary roads 37London Stock Exchange 75, 81Loopholes 62, 65, 84

MMafia 22Mainstay 6Manat 45Mandatory 44Mandatory private saving 43Mandatory spending 35, 36Marathon 8Margin of manoeuver 24Market dominance 79Market share 85Maturity 53Means-testing 43Media 22Medium-term expenditure frame-

work 47Meritocracy 15Micro- and small businesses 64Middle class 102Middlemen 68Minimum wage 74Ministries of economy 58Ministry of Finance 57, 58, 62, 70Ministry of Interior 70, 73Ministry of the Regional

Development and Infrastructure 64

Misappropriation 5Mismatch 10Mistakes 7, 20Mitigation of poverty 15Mitigation 9

Investor base 52Investor pitch 57Investor 8Irreversibility 23

JJustice 23

KKutaisi 37

LLabor code 74Labor freedom 74Labor legislation 65Labor productivity 100Large institutional investors 54Launderers 20Law enforcement 4, 7, 19Leaders 6, 107Lean 32, 33Level-playing field 60Leverage 83Liberal economic franchise 89Liberalization 57, 65Liberalize 61Liberty Act 30, 64Libor 46Licensed financial institutions 63Licenses 73Limited government 20Limits and the virtues of the public

action 101Line ministries 57, 64Linkages 45Liquidation 83Liquidity positions 81

Index 119

Non-transparent shares 83

OOECD 73Off-takes 101Old age pensions 42Oligopolistic 81On-demand services 65One-stop-shops 73Openness 70Operating balance 34, 35Order 6Organic development 90Organized crime 20Outreach 19, 24Outsourced 1, 7Over-promise 24, 33Overdrive 22Overhaul 4Ownership 56

PPaperwork 70Paradigm 19Parliament 30, 64Parliamentary elections 2Patrol Police 70Pay-as-you-go 42Payroll or social insurance tax 63Pension fund 43, 45Pension reform 44Pension scheme 44Pension system 42, 43Pensions 20, 32Perestroika 10Permits 73Personal income tax became 62

Modern 23Modernization 20Moldova 33, 84Monetary stimulus 60Monetary 60Monetization 47Money-laundering 83Monopolies 74Mortgage loan portfolio 89Mostly free category 76Mostly unfree 76Motor cars 70Multidimensional 21Multiple-entry visas 76Multiple 1Multistakeholder consensus 109Municipal Development Fund 59Municipal infrastructure 36Municipalities 57, 64

NNational Bank of Georgia (NBG) 82National Movement 21National champions 62National interest 20National security, law and order 109National security 4National taxes 64Net exports 60Net international investment posi-

tion 43, 45, 89Net loans 89Non-deposit funding 90Non-linear 7Non-performing loans 91Non-sovereign 55Non-sovereign issuances 53Non-tariff barriers 68

120 Index

Petty corruption 26Pharmaceuticals 73Pillar-2 of the pension system 43Pillar-3 44Plain vanilla privatization 74Platform 20Police 23Political capital 7Political cycles 36, 108Political economy 4, 20Politicians 5Politics 31POS terminals 90Ponzi 13Populism 24Pork barrel 20, 32, 33Positioning 21Post-Soviet transition 9, 10Post-electoral\“honeymoon 73Post-truth 108Poverty gaps 13Power transmission 36Preferential tax treatment 62Premature welfare states 32Presidency 22Price escalation 60Prime ministers 58Priority 6Private ownership 85Privatization 27, 65Procurement Agency 73Productive constraints 60Progressive taxation 62, 64Project cycle management 59Projects 35Proper governance 82Property transfer tax 63Prosecution 62

Protectionism 68Public Registry 73Public administration 12, 23Public debt 28, 45Public expenditure 28Public finances 13Public institutions 30, 96Public safety 22Public safety, health care 6Public services 4, 19Public spending 30, 33Public-private partnerships 37Punishments 22

QQuasi-public 86Queues 10Quotas 12, 68, 71

RRace to the bottom 62Radical 1, 24Raider attacks 83Railway tariffs 71Re-licensing 73Reagan 9Rebound 35Rebrand 65Red lines 5, 33, 108Red tape 68Redemption path 48Redundancy 74Re-certification 73Referendum 64Refinancing risks 46Reforms 2, 6, 20, 24, 33Reformist 25

Index 121

Regional 12Regional hub 70Regulations 74Regulatory capacity 73Regulatory muscle 84Regulatory outsourcing 73, 74Regulatory quality 76Related party borrowers 83Related party lending 82, 83Remuneration 74Reproach 24Reputation 24Reputational risks 56Retailers 101Retirement age 42, 44Returns on equity 91Revenues 13Revenue Service 65, 70Revolution of Dignity 44Revolutionary 21Re-exporting 63Reykjavík 9Rhetoric 22Risk aversion 84Risk management modules 70Risk-based audits 65Risks 4, 19Road maintenance fund 64Road usage taxes 64Roads Department 59, 64Roads 36Rose Revolution 2, 10, 21Ruble 44Rule of law 98Rural concentration 102Russia 34, 44

SSafety valve 31Salaries 20, 32Samachablo 12Sameness 10Sanctions 44Savings 43, 44Scenarios 106Schengen 76Second-hand cars 70Secondary market performance 53Sectoral tax 64Sectoral 6Security and, law 6Service fees 85Service orientation 65Severance pay 74Shareholders 83Shareholder equity 89Shareholding structure 82Sighnaghi 37Silence 73Sillicon valley 61Simultaneously 1, 25Singapore 74Single windows 73Size of the government 28, 30Slippages 22Small and medium enterprises

(SMEs) 61Smuggling 70Social backlash 56Social entitlements 108Social services 30Social tax 62Society 8

122 Index

Systemic 5

TTariff liberalization 69Tariff 68Tax 27Tax administration 68Tax and customs administration 65Tax avoidance 62Tax burden 62, 64Tax code 62Tax evasion 63Tax exempt 63Tax liberalization 63Tax policy reform 64Tax reform 61Taxation became flat 62TBC Bank 82Tbilisi 9, 37Technical non-tariff barriers 68Technical standards and codes 73Technocrats 19Telavi 37Tightening of monetary conditions

84Tolerance 4Total banking assets 89Total deposits 89Tourism 22, 37Tourists 10Trade 15, 27, 61Trade links 12Trade unions 74Transactional 5, 74Transfer of power 8Transformation 2, 4, 8, 20Transformative leadership 4, 19, 20

Sound banking 83South Ossetia 12Sovereign 28Sovereign balance sheet 4Sovereign ceiling 43Sovereign risk 53Soviet 4Soviet Union 9, 10Special taxes 63Stabilization 15Stamp duty 63Start-ups 61Starting position 1State builder 3State building 1, 6, 25State property 65State-owned assets 74State-owned banks 47State-owned companies 74State-owned enterprises (SOEs) 39,

47Statistics 13Status quo 1, 6Stimulus 29Strategic sectors 85Strategies-2020 56Strategies 25Structural reforms 36, 60Structural transformation 12Structural 5Students 13Sub-investment 43Subsidies 20, 61Subsidization 101Subsidy schemes 61Subsistence minimum 42Sustainability 46Svaneti 37

Index 123

Voluntary product standards 68

WWage 38War 13, 34, 56Water sector 59Wealth tax 63Welfare state 15Welfare 32White elephant projects 36Window-dressing 20Withdrawal restrictions 81World Bank 49World Bank’s Doing Business 73World Governance Indicators 76World Trade Organization (WTO)

68Worldwide Governance Indicators

97

YYield curve 50Yields to maturity 54

ZZero tolerance 19, 22, 65

Transit barriers 71Transition 12Transmission lines 36Transparency International

Global Corruption Barometer 96Transparency 83Transportation 61Transshipment 71Treasury securities 50Treaty of Maastricht 45Trust 24Turkey 13Turkish lira 45Two-tier tax dispute resolution 62

UUBO intransparency 84Ukraine 33, 44, 83USA 29, 74US dollar 45

VVAT 62Vectors 20Vested interest 2, 20, 32, 84Visa and residence permit 75Visa-free 75, 76

The transformation of Georgia from 2004 to 2012 : state building, reforms, growth and investments

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