Over the last weekend I was invited by an international development bank to run a workshop in the nice Hotel Eden in Kvareli, Kakheti. The topic of the workshop was “Georgia’s economic future”.

We started the workshop by discussing the great promise of development economics: “Do the right policy, and you’ll be fine”. Economists like Thorvaldur Gylfason like to show the growth paths of pairs of countries with somewhat similar characteristics, like Mauritius and Madagascar, Singapore and Malaysia, Botswana and Nigeria, and Ireland and Greece. In these pairs, one country followed the textbook approaches as advocated by Gylfason while the other adopted some inferior ideas like protectionism or socialism. In these comparisons, the growth of those countries which adopted textbook policies always skyrocketed, while those who did stupid experiments showed stagnation at best. In 2008, Gylfason carried out the same analysis for Estonia and Georgia for the time before the Rose Revolution, and – as one may have expected – Estonia was the champion, while Georgia in that time was an economically failed state.

In my opinion, even more striking is the comparison between Poland and Georgia. According to World Bank Data, in 1991 these two countries had almost exactly the same per capita income, namely $1,693 in Poland and $1,611 in Georgia (in today’s dollars). Until 2003, the year of the Rose Revolution, Polish income had gone up to $5,674 and Georgian income had gone down to $922 (as a side remark: these numbers are so stunning that I am surprised again and again why so many Georgians are full of clemency for the Shevardnadze regime, while the very same people have no clemency whatsoever for Saakashvili).

Doing a Gylfason comparison for the time after 2003, the picture looks utterly different. For example, Guatemala had per capita income of $1,817 in 2003 (Georgia, as mentioned, $922). In 2013, Guatemala had grown to $3,478 while Georgia had achieved an income of $3,602. In 10 years, Georgia, starting with approximately half of Guatemala’s income, had overtaken Guatemala while the Central American country had itself roughly doubled its per capita income in this time!

A MATTER OF POLICY?

Gylfason uses such numbers to support his general stance that growth is simply the consequence of following the “right policy”. However, there is another possibility to interpret the data. To illustrate this alternative, one may ask why there was no “Hotel Eden” – a newly built hotel with a fancy spa area, bowling alley, and other entertainment facilities – in the Shevardnadze era. There is a simple answer: under Shevardnadze, the hotel investor would not have kept a fair share of the returns. If the hotel would have been successful, the government would have found its ways to extract the profits and channel them into the pockets of some officers and politicians. And if the government would have missed this opportunity, then – due to a high degree of lawlessness – the mafia would have taken hold of the investment returns. Anticipating this, the willingness of investors to engage in Georgia was very limited. The willingness of anybody to engage in economic activity that would generate profits was very limited. This point really does apply not only to fancy hotels but to all economic activity. Why should one start a business that – if successful – would be robbed by the government or other gangsters?

In the years following 2003, the government was largely freed from corruption, the police started doing its job again, bureaucracy was reduced, and laws were streamlined. What do we expect to happen?

Of course there would be growth just for the simple reason that suddenly it did pay off to start a business, be it a repair shop for cars, a restaurant, a grocery store, or a luxury hotel. Nobody doubts that this part of the story, the return to normal economic circumstances, can be brought about by following the right policy. Yet at some point all repair shops, restaurants, grocery stores, and hotels that were missing in the economy are established. What happens then? Will good policy guarantee that growth continues?

Looking at those countries which grew for a very long time, e.g. Korea or Poland, one will find that all of these countries at some point successfully became exporters of something. Fast growth for an extended period of time seems only be possible if a country integrates into the world market and delivers something others want to have.

While it is relatively easy to say what a country must do to enter the first stage of growth, when it is just about returning to normal economic circumstances, it is much more difficult to give advice how to develop exports. To export something, a country needs to have an advantage in producing something. Korea and later China offered the world masses of diligent, humble, and studious workers during times when the upcoming electronics industry was looking for exactly that kind of labor. Similarly, Poland in the 1990's offered to companies the possibility to produce at much lower costs than in Germany or France without any geographical disadvantage.

Policy does matter – up to a certain point. Afterwards, a country has to find its niche in the world market, something which is very difficult and which is not really under the control of the government. Before Georgia can start exporting, it needs to develop products or services the rest of the world is interested in.

At this point of our workshop, people started looking out of the windows, and the beautiful colors of the Kakheti autumn forest reminded everybody of the vanity and futility of human existence. So, we had a coffee break, intending to develop a positive vision for Georgia afterwards.

GEORGIA’S NICHE IN THE WORLD MARKET

As everybody knows who gave some thought to this question, it is not so easy to say which products or services could drive Georgian growth in the years to come.

If one wants to manufacture simple goods like textiles, other countries are much cheaper than Georgia. If one wants to go for sophisticated goods, other countries are far ahead on the learning curve.

What about agriculture? The Georgian agricultural sector has an extremely low productivity and there is a huge potential for development, but if one is successful with this, then in future agriculture will absorb just a small fraction of the people currently working in that sector. In developed economies, the share of the labor force employed in agriculture is typically between one and three percent. In Georgia, it is around 50%. What happens with the 47 to 49 percentage points of people who will not work in agriculture anymore in future? If no other jobs are provided, these people will migrate to the cities, in particular Tbilisi, without really having much to do there. Rural depopulation already has started, and the development of real estate prices in Tbilisi may be an indicator of this. Agricultural development must be accompanied by the development of other sectors, otherwise it may even aggravate social problems.

What about trade? Can Georgia integrate into the world market as a trading hub, making money by purchasing at low prices and selling at high prices? As the development bank was particularly interested in the expected consequences of the Deep and Comprehensive Free Trade Agreement concluded with the European Union in June 2014, we investigated this possibility.

In theory, every country has a comparative advantage in producing something (this results from the way comparative advantage is defined). However, as the late Nobel Prize Winner Paul Samuelson pointed out in a remarkable article in 2004, not every comparative advantage is equally profitable for a country, and it all depends on where a country has its comparative advantage. The relevant question therefore becomes whether Georgia’s comparative advantages are lucrative or useless.

To get an idea of the answer, we looked at the experiences made with the free trade agreement that was concluded with Turkey in 2008. This agreement greatly helped the Turkish economy to sell its produce in Georgia. Below one billion dollars in 2008, imports from Turkey went up to about 1.4 billion dollars in 2012. The Georgian exports to Turkey, on the other hand, slightly declined. While just one example, it suggests that in the bilateral trade with Turkey, Georgia has its comparative advantages in low-value products, and Turkey has the more desirable comparative advantages.

Free trade alone does not solve the problem. Georgia needs to come up with products or services that are demanded by the world. Without them, Georgia will not move upwards, whether or not there is free trade.

REASONS FOR HOPE

This rather pessimistic workshop was concluded by a discussion about what Georgia could deliver to the world, where it could find its niche, which profitable comparative advantages it could develop. The discussion extended into the dinner conversations.

While the falling leafs and the melancholic November sun reminded us of the depressive state of Georgian economic affairs, the clash of practical development finance expertise with academic theories led to a couple of hopeful, positive ideas. These ideas were related to our visit of the museum of Ilia Chavchavadze and our conversations about Kakha Bendukidze who had just passed away. Throughout history, Georgia was home to great people who made a difference for their country. Out of this sprang an unorthodox idea for Georgia’s development, to be discussed at this place in one or two weeks from now…