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D Evelopm Entpolicy O Utlook k o No. 2 • June 2009 o l Georgia’s Search for Economic Liberty: t A Blueprint for Reform in Developing Economies u By Lado Gurgenidze O The global economic downturn is exacting a heavy toll on developing economies. The three engines of growth in the y past decade—exports of consumer goods to wealthy industrialized countries, exports of commodities, and private c capital inflows—have stalled. To improve their business and economic climates, developing nations should take i bold actions to roll back the size and role of the state in their economies. Now, more than ever, it is important to l document successful cases of reform from which they can learn. Given the breadth and scope of its reforms since o 2004, Georgia is one of those test cases. Its success is due to the coherent and comprehensive nature of the reform effort, and it offers a lesson from which reform-minded leaders in other developing countries can learn. P rior to the Rose Revolution in 2003, Georgia insurmountable bureaucratic barriers to doing t Pbore many characteristics of a failing state. It business and the inability of the sleepy domestic was saddled with stifling bureaucracy and wide- financial sector to supply them with capital. n spread corruption, little foreign investment, high From this inauspicious beginning, Georgia e unemployment, and a large rural population enjoyed real GDP growth rates of 8.5 percent or engaged in subsistence-level agriculture. Although higher from 2005 through the first half of 2008. m Georgia had high tax rates, the tax code was com- Nominal GDP grew from approximately $4 billion plex and inefficient, and tax revenue collection did to almost $13 billion over a five-year period, p not exceed 15 percent of GDP. The government with nominal GDP per capita increasing almost o was thus incapable of funding even the most basic 150 percent, from $1,188 in 2004 to an estimated l public services or maintaining critical infrastruc- $2,925 in 2008.1 Virtually all key sectors of the e ture. The energy sector was especially notorious for inefficiency and corruption, and blackouts were v Key points in this Outlook: a part of everyday life. The tourist infrastructure e was inadequate even for the few foreign visitors • Until 2003, Georgia was mired in economic and social stagnation. who cared to visit the country. The economy produced few competitive exports, the crime rate • Liberalization under President Mikheil D Saakashvili has generated economic was high, and corruption was rampant. About a openness, high private capital inflows, quarter of Georgian adults had voted with their and high growth rates. feet by emigrating. The entrepreneurial energy of • Key reforms in taxation, monetary policy, those who remained was squelched by the almost banking, privatization, free trade, trimming bureaucracy, and labor market liberalization Lado Gurgenidze ([email protected]) is a explain the turnaround. career banker who, upon returning to Georgia in 2004 after a decade at investment banks in Eastern Europe • Counter to what appears to be becoming and London, spearheaded the turnaround of Bank of conventional economic wisdom in the global Georgia, the dominant privately owned bank in the downturn, developing countries should follow country. He was the prime minister of Georgia from Georgia’s lead in liberalizing and growing. November 2007 to November 2008. 1150 Seventeenth Street, N.W., Washington, D.C. 20036 202.862.5800 www.aei.org - 2- economy have contributed to this growth, in contrast to agencies—such as the Public and Civil Registries and the development of countries richer in natural resources. the vehicle registration and driver’s license authority— This suggests that President Mikheil Saakashvili’s policy has improved dramatically, with consumer experiences at of increasing economic liberty was the decisive factor in these agencies now comparable, or in some cases superior, Georgia’s transformation. to those in industrialized countries.3 Exports grew at a cumulative annual rate exceeding Mikheil Saakashvili’s policy of increasing 20 percent, and the export base and geography of imports broadened considerably. The number of foreign visitors economic liberty was the decisive factor in grew by some 300 percent, exceeding 1 million in 2007. Georgia’s transformation. Many highly skilled professionals of Georgian origin returned to take leading positions in the private and public sectors. Crime is down significantly, with a Growth was fueled by the increasing availability of significant reduction in crime rates reported every year credit and large foreign private capital inflows. The assets for the past several years. Living standards have improved of the banking sector increased by a factor of nine, from considerably, a new middle class has emerged, and the approximately $600 million at the end of 2003 to almost country has experienced an entrepreneurial boom, with $5.4 billion at the end of 2008. Private capital inflows more than fifty thousand new businesses being registered reached $2.3 billion (approximately 23 percent of GDP) every year. in 2007 and an estimated $2.15 billion (approximately While a discussion of the geopolitical and territorial 17 percent of GDP) in 2008. The diversity of foreign integrity challenges Georgia faces is beyond the scope direct investment (FDI) has increased considerably. No of this Outlook, it is important to note for the record that single country accounts for more than 12 percent of the the progress and development described above have been cumulative 2004–2008 FDI. The share of the top ten achieved despite both Georgia’s continuing inability to countries in the annual FDI inflows shrank from 89 to assert control over its two breakaway provinces and its 79 percent of the total in the same period. For the first deteriorating relationship with Russia, its erstwhile princi- time in history, Georgian issuers were able to access pal trading partner, culminating in the armed conflict in Western equity and debt capital markets, with close to August 2008. Although the Georgian economy has suf- three hundred international portfolio investors having fered a serious setback as a result of the conflict, followed invested in Georgian debt and equity securities by by the global economic downturn, it has proven resilient mid-2008—a nearly unprecedented breadth of institu- to these shocks, growing at 2 percent in 2008 and forecast tional investor coverage for a $13 billion economy. to grow by 1 percent in 2009. There have been no Foreign currency reserves grew, from a very low base bailouts, subsidies, or other assistance involving a transfer of less than $200 million in 2003 to almost $1.5 billion of public funds to any private-sector firms (including the at year-end 2008. Tax revenue collection grew by some banking sector, which remains in decent shape, albeit 400 percent since 2004 as the country rode the Laffer with a reduced appetite for new lending). Curve, enabling a massive upgrade of critical infrastruc- The government’s countercyclical policy responses ture. External public debt decreased from 56 percent of have focused as much on further deep tax cuts as on GDP in 2003 to 21 percent as of year-end 2008. new (largely donor-financed) investment in infrastruc- Aggressive privatization was pursued, as the state ture. Rather than rolling back the progress of freedom retreated in virtually every sector of the economy. achieved over the past few years under populist and The energy sector was revitalized, with the country special-interest pressure, the government has seen the becoming a net exporter of electricity (over 80 percent economic downturn as an opportunity to consolidate lib- of which is generated from clean, renewable sources, eral economic reforms. namely hydropower) and one of the most energy-efficient economies (measured by energy consumed per unit of Rising Economic Liberty and the GDP) among the post-Soviet countries. Retreat of the State Public services were improved significantly, and corruption was suppressed to one of the lowest levels in The principal effect of these reforms has been a dramatic Central and Eastern Europe.2 The efficiency of public increase in the degree of economic liberty enjoyed by - 3- individuals and firms. In terms of having the freest Another approach to achieving the same objective economy, Georgia has moved from 112th place in 2005 to through means other than legislation includes the use of fifteenth place in 2008 in the World Bank’s rankings— international commitments to make certain reforms ahead of virtually all emerging markets and most Euro- nearly irreversible. For example, when import tariffs were pean Union (EU) economies.4 Georgia’s progress in the largely abolished, Georgia reported these new tariff rates Heritage Foundation’s Index of Economic Freedom has been to the World Trade Organization (WTO) as “bound directionally similar, rising from ninety-ninth place in rates,” thereby significantly reducing the scope of any 2005 to thirty-second place in 2008.5 upward revision of the tariff rates in the future. While many of the aforementioned reforms have been tried—with varying degrees of success—by many Rather than rolling back the progress of developing economies worldwide, it is rare that all have been pursued simultaneously and comprehensively, freedom achieved over the past few years over a relatively short time, with a focus as unrelenting under populist and special-interest pressure, as Georgia’s. The rising economic liberty in Georgia has had virtu- the government has seen the economic ous cyclical effects, such as the massive increase in pro- downturn as an opportunity to consolidate ductivity due to infrastructure upgrades made affordable by rising tax revenue, itself a result of the fiscal reform. liberal economic reforms. In many low-to-middle-income economies, structural impediments to economic growth are so high that similar As the perception of the near-permanent nature of reforms attempted in a piecemeal fashion or implemented these reforms strengthens, economic agents have modified inconclusively typically result in less impressive outcomes.
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