Greg Mills and Thomas Vester Nielsen

‘A week is a long time in politics',

Prime Minister Harold Wilson's observation not only applies to South Africa . Just ask the Georgians.  

Since its Rose Revolution in 2003, under the leadership of Mikheil Saakashvili , Georgia has been a model economic reformer. This has been built on the back of increased freedoms and improving competitiveness: wholesale privatisation of 13,000 companies; reform of the tax code including a reduction in corporate tax from 47 percent to 15 percent, the abolition of capital gains, interest rate and dividend taxes, and lowered personal tax at a flat rate of 25 percent (scheduled to reduce to 15 percent within five years); opening markets to the point that Georgia is among the four countries with the least import tax (the others being Singapore, Hong Kong and Macau); easing regulations; improving tax collection (up fivefold in revenue in five years); and putting an end to widespread corruption.

In simple terms, Georgia is a country-wide economic libertarian project, and the results have been spectacular.   

Georgia was the top reformer worldwide in 2007 in terms of the ease of doing business, as measured by the World Bank, climbing from 112 th to 37 th place in one year, the biggest progress ever made, and moving up to 15 th (out of 178 countries) by 2008. The number of licenses required to do business has decreased nearly tenfold. Between 2002-05, according to the Bank it made the largest reduction in corruption among all transition countries. Georgia leads the world today in labor market freedoms.   Filling his country with young, Western-educated staffers, Saakashvili fired 80,000 state employees soon after taking office, including 60,000 security force members notably from the notoriously corrupt traffic police. The Ministry of Agriculture, which once had 6,000 employees, today has just 300, its building in the process of being converted into a luxury hotel.  

The results?

Economic growth rates around ten percent annually, large inflows of foreign investment ($2 billion in 2007), and increased government spending especially in infrastructure. Tourism is an increasingly significant part of the Georgian economy. Real estate development and tourism has boomed, with a million tourists visiting Georgia with its ‘ski and sea' offerings in 2006, bringing in more than $300 million. Poverty among the country's 4.5 million citizens has fallen dramatically from 54 percent in 2001 to 24 percent today. As Michael Davey, regional head of the European Bank for Reconstruction and Development (EBRD) has commented, because of these reforms Georgia has ‘being doing amazingly, exceptionally well.'

Economic reform is of course fundamentally a political business. Businessman-turned-politician Kakha Bendukidze, a great Buddha of a man, is regarded as the architect of the reforms, though he pooh-poohs any suggestion that any single person has been key. ‘The Rose Revolution was based on leftish rhetoric,' he notes, ‘but it was important to turn it from such rhetoric to rightish actions.'

For managing the politics of economic reform, as in other countries, is said to be like a violin: you pick it up with the left hand, but play it with the right. ‘When asked by MPs how long it would take to turn Georgia around, I said that at three percent growth it would take 70 years when they said it should take maybe three,' Bendukidze says. ‘High growth is thus important, but we needed to find a way to not only have growth but job creation given the job destruction inherent in this process. We needed not just to solve economic, but political and developmental issues.'

The government's aim was to provide the environment in which business could thrive, rather than promoting specific sectors – ‘picking winners' in developmental parlance.   This is why the government has avoided using sectoral incentives given the fast-changing nature of markets. Thus growth has not only come from services such as tourism, but unexpected areas such as hair transplants for a largely South Korean market. ‘Progress is about personal freedoms and taking opportunities,' says Bendukidze who holds a Russian PhD in biology. ‘In the Soviet Union it was very easy to have five year plans as one could be imprisoned for deviating. But fundamentally, governments destroy value and we cannot organize progress. We don't need a sector strategy, rather we need the market to work properly.'   Or as Prime Minister Lado Gurgendize notes, ‘We don't do subsidies, incentives, exceptions or industrial strategies of any kind.'

One reason for the reform approach taken has been the awareness that Georgia needs to stand out from others. As Gia Jandieri of the New Economic School think-tank argues, ‘Radical reforms were needed to make us attractive in a highly competitive global environment. We are competing against China and others, not just our neighbors.'  

Tbilisi also realized that no-one owed them a living. Bendukidze: ‘Why should Switzerland open its borders to our citizens. We have to care about our own country.' Georgia has unilaterally opened its border to developed countries, removing visa restrictions on 50 developed countries with more to follow. Foreigners do not require a work permit. It has adopted the technical regulations of ‘respected' countries, meaning that their goods and practices do not require regulatory certification by Georgia . It is now employing the same profiling procedures on financial regulations.   

The lessons for others, the erudite Gurgendize, who was recruited from the international banking sector, says in summary is: 'Have flat taxes, no currency or capital controls, full flexibility of labor markets, eliminate red tape, show zero tolerance for corruption, and ensure protection for investors.'

But as Bendukidze, now heading the Chancellery, notes, ‘nothing is forever – there are retreats and defeats'.  

This August it all went pear-shaped when conflict between Russia and Georgia broke out over the disputed regions, inside Georgian borders, of Abkhazia and South Ossetia .

The Russian version is that, emboldened by Washington , Georgia launched an assault on South Ossetia, only the heroic efforts of Russia rescuing the Ossetian people in a ‘peace-enforcement' mission. But, the Georgians claim, this was carefully orchestrated by Russia and that far from acting against aggression, Moscow 's aims were to openly remove Georgia 's president and its government and control Georgia 's transit routes, ensuring its grip on the region. All this is a flashback to earlier times. Georgia declared independence in May 1918 in the midst of the Russian civil war. When British protection ended in 1920, Georgia was attacked in February 1921 by the Red Army which quickly crushed any opposition and installed a Bolshevik government for 70 years.

What is for certain is that, instead of turning the other cheek to continued Russian provocation, and running out of choices, President Saakashvili took the bait, misjudging both the ethnic differences within his own borders and Russian linkages and intent. Why Russia would attack relates not primarily to the status of the Ossetian and Abkhazian minorities in Georgia (indeed, this action might actually promote secessionism inside Russia itself), but resurgent Russian nationalism and a reassertion of its presence in the Caucuses. The outcome today is that an estimated 7,600 Russian forces still operate as ‘peacekeepers' in so-called buffer zones inside Georgia and the two disputed regions declared ‘independence' on 26 August, so far recognized only by Russia and Nicaragua.  

All this sent the Georgian economy into a temporary tailspin. There was a run on the banks as depositors withdrew funds in a panic, some 15 percent of the total. Growth this year is estimated to be just four percent from nearly 13 percent in 2007.

The damage to Georgian infrastructure from the conflict is estimated at around $1 billion, the damage to the economy harder to discern. Tourism has slowed, the banking sector has suffered losses while proving resilient overall, and real estate development is troubled. Realizing that growth without national security is difficult at best, Tbilisi is hoping that it will acquire Membership Action Plan status for NATO membership this December, which it hopes will act as a security guarantee against further Russian actions. But it should place at least equal stock over the longer-term in economic diplomacy.

Harold Wilson also said, ‘ I'm an optimist, but an optimist who carries a raincoat '.

Georgia 's insurance policy remains its stunning economic progress and pro-Western orientation. For that reason there is a $3+ billion bailout plan by bilateral donors and international financial institutions and including the International Finance Corporation and EBRD substituting the loss in foreign direct investment and shoring up the banking sector. But much of this money will be allocated to infrastructure spending on refurbishing ports, building a new rail links, and investing in hydropower facilities. Georgia is developing into an international transport corridor through its Black Sea ports of Poti and Batumi , an oil pipeline from Baku and Azerbaijan through Tbilisi to Ceyhan in Turkey , and the parallel South Caucuses gas pipeline.

These all form part of a strategy to capitalize on Georgia 's strategic location at the cross-roads between Europe and Asia . With abundant water supplies (but no oil or gas), hydro is another cheap advantage Georgia possesses. Every cloud has a silver lining: With donor money funneled into productive investment, infrastructure which might have taken 5-6 years to complete could now be done in just 3-4.   With extraordinarily liberal policy measures covering tax and resident status in place, Georgia is pitching itself as a regional financial services sector hub for the Middle East and Central Asia .

But how to deal with Russia and the breakaway republics? While most Georgian political and business leaders would like to see this resolved in their country's favor, more important to all is clarity and stability from which a new set of relationships can be built with economic reintegration as the tool to deal with differences, not military means.   President Saakashvili will also have to remove himself over the medium-term as a figure of Russian opprobrium.   

No doubt these are tough and uncertain political and economic times. The global financial crisis has had ripples throughout the region. In neighboring Turkey consumer spending on ‘white goods' dropped 25 percent this August. Its car industry is reeling from a downturn in European orders.  

Georgia will also have to wean itself off imports.   For example, three-quarters of items carried by the major supermarket chain are imported. This has to go down in the next five years, without which the balance of trade deficit is unsustainable. To do so, the economy has to become more self-sufficient in terms of food and other necessities. This will help to transform Georgia from a very impressive to an amazing story.

But there are few options for Georgia – like emerging economies in Africa – to plough on with reforms, the mind focused by its relatively high unemployment rate of nearly 13 percent, absence of significant natural resources apart from water, and low income compared to other East European countries.

Georgians have seen the alternative of the Soviet era, and it's not pretty. As Prime Minister Gurgendize succinctly puts it, ‘There is nowhere else to go.'

This stark realization and the hunger it produces combined with a well-educated and high energy population plus a strengthening infrastructure, means that Georgia will likely weather these political and financial storms. In so doing it teaches others, in Bendukidze's words, that ‘For poor countries like Georgia and those in Africa , reforms are about going to another league, about profound change. For richer countries, it is only about grades of happiness. We not only should be part of the developed world,' he muses, ‘we must be.'

Dr Mills heads the Johannesburg-based Brenthurst Foundation; Nielsen is with Bankinvest in Denmark and is an Associate of the Foundation.

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