The production of the constraints analyses posted on this website was led by the partner governments, and was used in the development of a Millennium Challenge Compact or threshold program. Although the preparation of the constraints analysis is a collaborative process, posting of the constraints analyses on this website does not constitute an endorsement by MCC of the content presented therein. 2014-001-1569-02 GOVERNMENT OF GEORGIA CONSTRAINTS ANALYSIS GEORGIA Final Draft July 2011 1 Content Executive Summary ............................................................................................................ 4 Introduction ......................................................................................................................... 5 General Overview ............................................................................................................... 8 Overview of Economic Performance ............................................................................ 11 The External Sector....................................................................................................... 13 Tourism ......................................................................................................................... 14 Agriculture Sector Overview ........................................................................................ 15 Overview of the Social and Healthcare Sector ............................................................. 21 Summary ....................................................................................................................... 25 Growth Diagnostics .......................................................................................................... 25 1. Is it Low Returns to Economic Activity? ................................................................. 29 1.1.Is it Low Social Returns? .................................................................................... 29 1.1.1.Is it Natural Capital/Geography? ................................................................29 General Overview of Geography ....................................................................29 Transportation Routes and Links to Markets ..................................................31 Natural Capital Conclusion .............................................................................31 1.1.2. Is it Human Capital? ..................................................................................32 1.1.2.1. Lack of Skilled Labor ........................................................................32 Human Capital Summary ................................................................................49 1.1.3. Is it Infrastructure? .....................................................................................50 General Overview ...........................................................................................50 1.1.3.1. Roads Infrastructure ..........................................................................55 1.1.3.2. Energy ...............................................................................................61 1.1.3.3. Water Supply Infrastructure ..............................................................69 1.1.3.4. Telecommunications .........................................................................72 Infrastructure Summary ..................................................................................78 1.1.4. Is it Innovations? ........................................................................................79 1.1.4.1. The Export Basket Size and Composition ........................................79 1.1.4.2. Export Sophistication level ...............................................................84 1.1.4.3. Innovations at the Enterprise Level ..................................................85 Innovations Summary .....................................................................................87 1.2. Is it Low Appropriability? ................................................................................. 87 1.2.1. Is it Macro Risks? ......................................................................................87 1.2.1.1. GDP Growth and Inflation .................................................................88 1.2.1.2. Fiscal Policy .......................................................................................91 1.2.1.3. External Position ................................................................................93 Macro Risks Summary ....................................................................................96 1.2.2. Is it Micro Risks? .......................................................................................96 2. Is it Finance? ........................................................................................................... 103 2.1. Is it Local Finance? .......................................................................................... 104 2.1.1. Regulatory Environment ..........................................................................104 2.1.2. Competition .............................................................................................105 2.1.3. National Savings .....................................................................................107 2.1.4. Interest Rates ..........................................................................................108 2.1.5. Lending Practices ....................................................................................109 2.1.6. Products ..................................................................................................111 2.2. Is it Foreign Finance? ....................................................................................... 112 2.2.1. Country Risk Rating ................................................................................112 2.2.2. Foreign Direct Investment and remittances .............................................113 2 Finance Summary ..............................................................................................116 Conclusion ...................................................................................................................... 117 Bibliography ................................................................................................................... 119 Annexes........................................................................................................................... 121 3 Executive Summary Georgia‖s Constraints Analysis (CA) paper was prepared according to Millennium Challenge Corporation (MCC) guidelines as a first phase in the framework of Georgia‖s future second compact with the MCC. The Constraints Analysis is based on the Growth Diagnostics methodology developed by the Professors Rodrick, Hausmann and Velasco at the Kennedy School of Government, Harvard University. The analysis is performed by the MCC Georgia Core Team, which includes the representatives of state institutions, relevantly experienced non-governmental organizations and business groups. The Constraints Analysis paper aims to identify constraints that hinder economic growth and poverty alleviation in the country. The idea of the CA is based on the assumption that the main driver of economic growth of a country is private sector development and entrepreneurship, and thus creating favorable conditions for the latter would contribute to the growth of the economy and complement poverty alleviation efforts. The study examines various factors that can potentially drive growth. The analysis is broadly divided in two parts. Namely, in the first part CA provides general overview of the country, including economic performance, with particular stress on tourism and agriculture sectors, which are very important for country‖s development, especially for regional development. The analysis also includes the overview of external sector and social and healthcare sectors, which are not generally covered by the growth diagnostics methodology, but are relevant for Georgia because part of its population has not yet been able to benefit from growth and development and government designed special policies to address the needs of the most vulnerable parts of the population. In the second part the CA further discusses particular factors and aspects according to the Growth Diagnostics Model. This part first analyses whether the low social returns hinder economic growth in the country. In this regard examination is focused on the natural capital (including geography, transit potential, etc.), human capital, quality of infrastructure and level of innovations in the country. Secondly, CA examines whether the low appropriability hinders economic growth, by analyzing macro and micro climate in Georgia, with all its components. Lastly, CA examines financial sector of Georgia, taking into consideration both foreign and local finance, access to finance, level of national savings, etc. Overall the analysis closely follows the growth diagnostics model and constructs the growth diagnostics tree. Local context and specific features of Georgia‖s economy at its current level of development are also taken into account where appropriate. Each part of the CA consists of comprehensive analysis of the respective factor with the conclusion identifying whether this factor constitutes a constraint for growth and development of the country. As a further step a constraint optimization effort is undertaken with the aim of identifying