20 Jun 2012

The Political Economy of Georgia’s Transformation: Before and After the Rose Revolution

Posted by IFAIR

Nearly ten years after Mikhail Saakashvili took office and shortly before the Parliamentary elections in October 2012 it is time for an intermediate analysis of the political economy of Georgia’s transformation. This contribution aims to shed light on the so-called ‘success story’ of Georgia following the 2003 Rose Revolution. What are the upsides and downsides of the economic development under the Saakashvili administration and where does Georgia head?

“Georgia is the world champion in economic reforms. No other country and no other government in the world has done as much as the Georgian government did to improve doing of business and for creating opportunities”

Mikhail Saakashvili, President of Georgia, 8 November 2010 (Civil Georgia 2010)

I. Introduction

Over the past decade, the Republic of Georgia with its 4.4 million citizens has hit the headlines not only because of its war with Russia, but also because of a rapid economic and political transformation following the 2003 Rose Revolution. Nearly ten years after Mikhail Saakashvili’s inauguration as President, international organizations such as the World Bank continue to praise the country for its reforms and often showcase Georgia’s economic development as a prototype for successful transformation.
This contribution aims to shed light on the Georgian ‘success story’ following the 2003 Rose Revolution by analyzing two central questions through the lenses of institutional change theory (Acemoglu/Robinson 2008). Firstly, the characteristics of the Georgian economy of the 1990s and the following development under the Saakashvili administration are outlined to understand why Georgia’s transformation is repeatedly presented as a unique success story. Subsequently, the frequently overlooked downsides of the transformation will be presented. Finally, an intermediate conclusion on Georgia’s political economy one decade after the Rose Revolution will be drawn.

II. The Institutional Heritage of the USSR

Before the Rose Revolution, the Georgian economy went through a phase of devastating economic downturn that was typical for most former Soviet countries after their independence in 1991. The early 1990s in Georgia were marked by a nearly triple decline in production coupled with hyperinflation of almost 70 percent per month at the peak of the crisis (Papava 2006: 658). Politically, Georgia’s Soviet elites and the entire political class were “unprepared for the fall of the command economy and the transition to a market economy” (Papava 2011: 21). The country’s first post-Soviet president, Zviad Gamsakhurdia, led the country down a ruinous path inducing strong nationalism and regional isolation (De Waal 20011: 5). There were many reasons for the disasters of that time, among them a full-scale civil war in the country including the break away of South Ossetia and Abkhazia in 1993 and 1994 (Demetriou 2002: 860). However, the main problem for Georgia’s economy and the political system was the ‘heritage’ of a broad number of weak Soviet institutions, which soon became dysfunctional.[1]How did these institutions function after the nation’s independence and why was it so difficult to reach sustainable growth?
Georgia of the 1990s was characterized by centralization, non-existence of a legal framework and protection of property rights, strong vertical hierarchy of most political and economic structures as well as massive corruption and widespread existence of shadow economies. Gamsakhurdia’s successor Eduard Shevardnaze, ruling President of Georgia from 1995 until 2003, formally introduced a new institutional framework and Washington-consensus style economic liberalization, including further deregulation and reduction of the budget deficit. In spite of this, his administration did hardly change the de-facto institutions and social patterns inherited from the Soviet Union.
Eduard Shevardnaze, himself a former foreign minister of the USSR, and his several cabinets represented the core of the old Georgian Soviet elite and were neither able nor willing to overcome the corruption-prone patterns of the economy and politics they were socialized with during Soviet times. In 2001, USAID depicted the Caucasus Republic “simultaneously as the single most corrupt and reform-prone country in the post-Soviet space” (Christophe 2005: 1).

While the old elite clung to its power and the economy continued standing still, a young circle of mostly western-educated people backed by US and European support increasingly gained influence. Although this new elite was part of the Shevardnadze government until the early 2000s (i.e., Mikhail Saakashvili was Justice Minister from 2000 until 2001), they turned against the old regime and became a major opposition force. Finally, in 2003 these young elites – led by the incumbent President Saakashvili – peacefully overthrew the old administration with the support of a broad civil movement.

III. The Georgian ‘Success Story’

After the Rose Revolution, Saakashvili and his new cabinet took office and immediately implemented reforms aimed to tackle the main impediments to Georgia’s economic development. Among the most important steps in this regard were anti-corruption measures such as a broad police reform. For instance, in 2004 “the entire staff of the notoriously corrupt traffic police (…) was fired and a much smaller, better-paid, more honest organization was created in its place” (De Waal 2011: 6). Other measures aimed to reduce corruption were introduced at the same time, transforming Georgia from one of the most corrupt countries in the region to a role model for other transforming nations. In the Transparency International 2010 Barometer on Corruption, 78% of the respondents stated that corruption would have ‘decreased a lot’ or ‘decreased’ over the past years (Transparency International 2010).
Furthermore, many oligarchic figures dominating the economy during the previous Shevardnadze rule were arrested and following, “most of them agreed to plea bargains in which they offered millions of dollars to the state budget in return for their freedom” (De Waal 2011: 6).
Thanks to such measures, additional institution building efforts, and new business-friendly economic legislation (especially a remarkable simplification of the tax code, see OECD 2011: 146), the Georgian economy began to flourish to an extent previously unimaginable (Rinnert 2011: 4). With constant GDP growth rates of around 10% from 2005 until the war with Russia in 2008, the small South Caucasian nation attracted an increasing number of foreign investors (Civil Georgia 2009). The World Bank awarded Georgia the title of ‘top reformer of the year’ both in 2006 and 2008. World Bank officials and economists enthusiastically stated that Georgia “made enormous improvements to many areas of its business regulations” (World Bank 2006) which were reflected in the country’s noteworthy rise in the World Bank’s “Doing Business Report” from 112th place in 2005 to 11th place in 2010 (Doing Business 2010).
As a consequence of the improved economic climate, the number of registered companies rose to 51,000 in 2007 from 36,000 in 2005 (OECD 2011: 125). USAID praised Georgia for having implemented “the broadest, deepest, fastest business climate reforms of any country in the last 50 years” (USAID 2009: 3).

In general, it seemed to many experts as if Georgia managed to create a reinforcing upward economic spiral based on free market reforms combined with effective institution building measures. However, the consequences of the war with Russia in 2008 as well as economic and political crackdowns revealed that the Georgian ‘success story’ has its flaws below the glittering surface. What are these flaws and what have been the general downsides of the Georgian transition since 2003?

IV. The Downsides of Saakashvili’s Reforms

While the main reason for the enormous contraction of Georgia’s economy after 2008 (see figure 1) has been the war with Russia, there were additional problems slowing down economic growth and at the same time hindering democratic transformation. In general, Saakashvili’s once celebrated market-friendly reforms have turned out to be not as perfect as depicted by some analysts. Taking into account current circumstances, the political economy of the Georgian transformation is confronted with three main problems.

a) Deregulation: Not quite the panacea it was promised to be?

First, while the economic reforms of the Saakashvili administration were extremely business-friendly and indeed improved the overall economic situation as outlined above, the deregulation reforms came with numerous problematic side effects. One of the most outspoken Georgian libertarians, Kakha Bendukidze, Minister for Reform Coordination from 2004 until 2008, stated with respect to the deregulatory reforms that “we will sell everything, except our conscience”  (Human Rights Georgia 2011). While legal deregulation was implemented swiftly, Georgia did not turn into the “the Switzerland of the Caucasus with ‘elements of Singapore’” (Eurasianet 2010) that Saakashvili wants it to be. Georgia’s repeatedly praised open business climate, underlined by the country’s high score in the World Bank ‘Doing Business’ indicator, rather reflects the new state of formal institutions (e.g. in form of laws such as reduced regulations) than the de-facto overall economic climate. In broader economic indicator studies such as the WEF’s Global Competitiveness Index, Georgia “rates badly on property rights, judicial independence, and protection of minority shareholders’ interests – an indication of how the government’s hand is much heavier than its liberal economic reputation suggests” (De Waal 2011: 30). The full-scale formal deregulation and liberalization in Georgia is not likely to increase economic efficiency if informal power structures and judicial decisions continue to hinder the guarantee of property right protection.

b) Social Inequality and Poverty – Few Changes Since 2003?

Another downside of Saakashvili’s business-friendly reforms is the fact that they did not affect Georgians equally. On the contrary, the transformation has hardly improved the situation of the country’s quarter of the population still living in poverty (see figure 2). According to the World Bank, there are several reasons for that. Firstly, the rapid growth after 2003 “happened against the background of declined employment” (World Bank 2009: 72) due to privatization and public service reforms. At the same time, those with relatively high incomes profited massively from the reforms of the Saakashvili administration while a major economic gap between rural and urban areas of the country prevailed. Considering the Gini-coefficient, Georgia can be placed among one of the most unequal countries in transition today (Ibidem: 77).

According to the institutional change theory, institutions are crucial for reducing poverty and inequality and “the quality of the institutional transformation has significant explanatory power for understanding the divergent outcomes of inequality in transition countries” (Nickel 2005: 101). In light of prevailing socio-economic structures in Georgia, one could argue that extremely neoliberal members of the Saakashvili administration, such as former businessman Bendukidze, advocated certain deregulatory reforms partly aiming to strengthen also their own positions in the market thereby reproducing existing social structures. This is underlined by the fact that low tax rates for large corporations were immediately implemented after 2003 but monopoly and oligopoly structures, for instance in the oil industry, are still hardly tackled. Until today, “none of the state bodies have ever started persecution of certain entities on the basis of [pro competition policies] or even investigation of any issues concerning monopolistic activities (Sakevarishvili 2011: 66).

c) The Democratization Paradox: Reproducing Old Patterns?

In addition to the challenges related to economic reforms after 2003, the political transformation of Georgia has also shown cracks, culminating in the events of 7th  November 2007, when peaceful demonstrations against the Georgian government erupted into violence as police forces tried to clear demonstrators (Chivers 2007).
Although the many reforms passed since the Rose Revolution have induced visible change of the social and political institutions of Georgia, they eradicated some existing problems only superficially. For instance, while corruption has mostly disappeared from every day life in Georgia, high-level corruption continues to flourish. This is underlined by the emergence of a clientelistic political system with the country’s leadership allocating “resources in order to generate the loyalty and support it needs to stay in power“ (Kaputadze 2011: 2). Earlier in 2012, the Parliament has passed new legislation seriously constraining the funding of opposition parties (Radio Free Europe 2012).
In general, Georgia remains a hybrid regime according to the Democracy Index characterized by a one-party system, strong governmental media control and intransparent decision-making (see figure 3). Governmental elites often mention external constraints (mainly the ongoing conflict with Russia and break-away regions Abkhazia and South Ossetia) as an excuse for prioritizing stabilization before democratization. Whether this excuse is legitimate or not, over the past years President Saakashvili “has created a situation where there is no alternative to him, and the intellectual part of society is in apathy” (De Waal 2011: 21).

V. Conclusions

Taking into account the overall development of the political economy of Georgia since 2003, it can be concluded that the ‘success story’ of the country’s transformation is not as shiny as framed by many. While the Rose Revolution has without doubt led to numerous remarkable changes of the economic and political institutions, many of the previously existing problems have prevailed below the surface of Georgia’s transformation. Although more effective economic policies were introduced in several areas, this often happened at the cost of democratic governance mechanisms.
Institutional economists have outlined that “in order to reach a considerable level of human development and to make development less uneven, three conditions are fundamental, together with GDP growth. They are 1) management of social conflicts, 2) reducing inequality, 3) giving economic opportunities and to exploit those opportunities” (Tridico 2006: 37). In Georgia, the third condition has partly been met after Saakashvili took office, however, conditions 1 and 2 need to be further tackled. In the coming months and years, it remains to be seen if the Georgian transformation may go beyond formal reforms and can further influence also problematic informal institutional structures such as ongoing high-level corruption. The upcoming parliamentary and presidential elections and Saakashvili’s related actions (Civil Georgia 2011) will be a litmus test in this regard.

David Rinnert is a fellow of the Berlin Studies Centre 2011/2012 (Studienkolleg zu Berlin) and pursues his Master of Public Policy with a focus on development in the post-Soviet space at the Hertie School of Governance in Berlin.

[1] In this contribution, institutions are understood as “the rules of the game in a society or, more formally, (…) the humanly devised constraints that shape human interaction” (North 1990: 3). According to the institutional change theory, institutions can be seen as “the fundamental cause of economic growth and development” (Acemoglu/Robinson 2008: 1) and are determined mainly by de-jure and de-facto political power. Besides, belief systems and ideology as an additional factor can help to explain why institutional change can be so difficult and societies so ‘rigid’ (Hoff/Stiglitz 2010: 146). Consequently, “in order to change institutions (…) prevalent social rules need to be changed” which is not easy since “interaction between new formal rules and old social customs will affect the evolutionary path of institutions” (Tridico 2006: 6).

Literature and sources

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