Scoping note on subnational Public Disclosure Authorized competitiveness in Georgia July 24, 2020 World Bank Group1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized 1 The note was prepared by Austin Kilroy (Senior Economist) and Ceylan Oymak (Consultant), under the guidance of Marialisa Motta and Ilias Skamnelos (Practice Managers), Sebastian Molineus (Country Director), and Evgenij Najdov (Program Leader). The team is grateful for inputs and advice from Mariam Dolidze (Senior Economist), Tengiz Gogotishvili (Senior Urban Specialist), Gabriel Goddard (Lead Economist), Dmitry Sivaev (Urban Specialist), Ifeyinwa Onugha (Private Sector Specialist), Nadeem Karmali (Senior Economist), Conor Kearney (Regional Economic Development Consultant), the Tbilisi-based team of the United Nations Development Programme, and most of all to the National Statistics Office of Georgia – Geostat for graciously sharing data for the analysis. None of the detailed analysis in this document could have been done without the excellent firm-level data collected by Geostat each year. 1 Executive Summary The objective of this scoping note is to inform decisions between the World Bank Group and the Government of Georgia on engagements related to subnational growth and economic development. The note is intended to be an initial review of the policy landscape and economic situation, using readily available information and data. It provides information to determine if the topic of subnational competitiveness could be pursued further within the partnership between the World Bank Group and the Government of Georgia. The note consists of three sections: 1. Review of the policy environment related to subnational competitiveness; 2. Benchmarking and recommendations for subnational competitiveness; 3. Estimating the impact of Covid-19 at subnational level. 1. Policy environment • Georgia’s subnational competitiveness agenda is established by the Regional Development Programme (RDP) 2018-2021. The RDP 2018-2021 aims to address competitiveness of Georgia’s regions, leading to increased equality of economic outcomes in regions. It outlines five key priorities for action: infrastructure; economy; human resources; endogenous development (local initiatives and specializations); and institutional development. The RDP 2018-2021 is a relatively comprehensive document and includes proposals for economic specialization of each of Georgia’s regions. • In preparation for the next RDP, a few key questions can illuminate issues to explore further. Are the proposed economic specializations realistic? Will they be sufficient to guide investment choices? Will the investments be effective in achieving their goals? A second set of questions relates to the emphasis of the RDP on the regional scale (mkhare) for analysis and action. Georgia’s subnational economy, like those in other countries, is driven by urban hubs. Does the RDP leverage these growth drivers in its approach? The analysis in the subsequent section of the document aims to provide information and ideas that can inform preparation of RDP 2022-2025, and/or substantiate a discussion between the World Bank Group and Government of Georgia on subnational competitiveness issues more broadly. 2. Benchmarking and recommendations for subnational competitiveness • The Government’s emphasis on addressing inequalities between Tbilisi and other regions in Georgia seems well-founded. Regional inequality of GDP per capita is substantially higher in Georgia than in comparator countries such as Armenia, Turkey, Poland, or Hungary. Tbilisi accounts for 32 percent of Georgia’s population, but 67 percent its gross value added, and 81 percent of its foreign investment. The structure of economic activity is dramatically polarized: in Tbilisi, 70 percent of the population are formally employed, but outside Tbilisi only around 30 percent of the population have formal jobs. The severity of the disparity means that regions outside Tbilisi even lack enterprises that can generate economic growth. Large firms have been the strongest drivers of economic growth in Georgia, and these large firms are concentrated in Tbilisi and a few other cities. • The regional economic specializations proposed by the RDP could be more selective, more specific, and should be appraised before investment decisions are made. The RDP proposes that some sectors (tourism, agro-processing, and renewable energy) have an economic potential in most or all Georgia’s regions, yet economic data shows that agro-processing is mostly concentrated in four regions. Wine-making, higher education and innovation, and mining and renewable energy 2 are concentrated in fewer regions than indicated in the RDP. Meanwhile light manufacturing is not mentioned at all despite being successful in several regions. Overall, a more selective set of specializations may be more realistic. The competitiveness requirements for each of these sectors will need to be defined in more detail, and then appraised, before investment decisions can be taken. Numerous industry studies and value chain studies have been carried out in Georgia, so the results of those studies could be consolidated and leveraged. • Georgia does have secondary nodes of economic activity outside Tbilisi—particularly at the municipal level. These secondary cities can be leveraged in regional development efforts. Examining the spatial distribution of sectors within regions can help focus public investments in nodes of competitiveness. According to data from Georgia’s firm-level survey, agro-processing is concentrated in Georgia’s cities, while 38 out of 64 municipalities have negligible or zero activity in agro-processing. Agriculture is concentrated in some municipalities, with substantial variation even between rural municipalities. High-value subsectors are concentrated in Tbilisi and a few other municipalities: meat and dairy processing is focused in Tbilisi; high value manufacturing is found mainly in Tbilisi, Rustavi, and Zestafoni. This analysis of high-value subsectors is useful to indicate locations where each industry is most advanced and competitive. Such geographic concentrations have increased over time. Existing nodes of activity in each sector have grown further, while other municipalities have shrunk. New investment has focused on municipalities that are existing nodes of economic activity (see Figure 1). Figure 1: Sales (above) and investments (below) in high-value subsectors are concentrated in a few municipalities Source: World Bank analysis of Geostat survey data • The next RDP could be sharpened by focusing on nodes of growth within and across regions. Georgia’s constraints on competitiveness and growth are likely to vary by sector, region, and municipality. The current RDP focuses on economic specializations for each region, which may 3 have a strong basis in the political economy in Georgia, and resonates with the way Georgians consider the geography of their country. However, this regional lens misses crucial elements of economic development, particularly the concentration of economic activities in municipalities within each region. The next RDP could focus on Georgia’s urban centres with populations above 40,0002, and the functional economic areas around them. Existing nodes of economic activity would be the natural locations for specific investments to release those constraints, balancing the objectives of economic growth and spatial equity. This approach would reach 80-90 percent of Georgia’s population. 3. Estimating the impact of Covid-19 at subnational level • The impact of a Covid-19 downturn will differ across Georgia, and therefore may require a subnational lens on economic support measures. We estimated the likely effect on each municipality, based on the mix of sectors in each municipality’s economy, and an estimate of the impact of the pandemic per sector. Overall the economic shock induced by the pandemic will likely impact most severely the smaller municipalities, because they have a higher share of sectors more heavily affected by the downturn—especially tourism and transportation. Municipalities in Adjara, Kakheti, plus Samtredia and Guria, are estimated to be affected most. The analysis is summarized in Figure 2. Figure 2: Estimated impact of Covid-19 at the municipality level Source: World Bank analysis of Geostat survey data Next steps On the basis of these observations, some recommendations can be made for next steps on subnational competitiveness work. These recommendations are: I. Combine sectoral and regional studies to assist in prioritizing subnational investments and interventions. Consolidate and leverage the industry and value chain studies for ‘economic 2 Tbilisi, Batumi, Kutaisi, Rustavi, Gori, Zugdidi, and Poti. 4 potential’ sectors to identify a more specific, targeted and appraised set of proposed regional investments. For example, a lack of cold storage and packing facilities in fruit producing regions; a need for training in emergency response in tourism regions; managerial capabilities in firms in municipalities with concentrations of light manufacturing firms. Some constraints may affect many regions—such as access to banks and finance, which may be a constraint in most municipalities outside Tbilisi and some other cities. The approach should nuance the understanding of subnational competitiveness by focusing on nodes of economic activity in municipalities within each region. II. Assign specific responsibilities amongst government bodies to