Investment

Georgia’s Investment Environment Will Further Deteriorate

Akaki Tsomaia
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Based on the analysis of statistical data, in a previous article, "Is Recession Likely," published in Tabula English Issue № 27 in March, I wrote that the Georgian economy was preparing to enter a new reality. Namely, I predicted an increase in unemployment in the short term and a rise in prices in the longer term, which means stagflation. Such a forecast was based on instant changes in direct foreign investments, the Gross Domestic Product (GDP), consumer spending, private and public savings, public expenditures and the downward trend in prices observed over the period November-December 2012. The National Statistics Office of Georgia has recently published the data of the first quarter of 2013, showing an increase in unemployment for 42,000 persons; the official data also shows a 0.7% rise in price levels in May as compared to the previous month. The National Bank of Georgia officially declared that the forecasted 6% growth of GDP must be downgraded to 3%. Judging by the downward tendencies in foreign investments, I think that this revised forecast is optimistic, which means that the economy in 2013 may not even increase on the 2012 indicators. My prediction of a recession is coming true. Inflation is also expected (among professional circles); this expectation is based on the amount of bank loans issued to the agricultural sector at a lower interest rate than the market rate (and this process continues). Moreover, there are backstage talks about the emission of money and the increase of the real annual inflation rate to a 6% target. In the above cited article I argued that this fact will create an imitation of the alleviation of recession in the short term, however, in the longer term the unemployment rate will recover to its initial levels, which will be compounded by the inflation. It is clear that a new reality is emerging in the economy and this needs to be acknowledged in a timely fashion. Short-term macroeconomic incentives are not a solution to this situation. Over time, the situation will become graver and the Georgian government will come to face the need to acknowledge a more acute problem. This is all mainly caused by a decrease in foreign direct investments that has resulted from 1) the world economy not developing and 2) the investment environment in Georgia deteriorating. The former factor is external and does not depend on us. Georgian society can do nothing about that. It can only be taken into account as an existing fact. As regards the latter factor, the International Monetary Fund believes that after the parliamentary elections of October 2012, investors prefer to wait and see how the change in power will be completed with the presidential election, after which economic activity will become enlivened and the economy will grow by 6% next year.

Political elections naturally affect economic indicators to some extent. As a rule, a government steps up its activity in the pre-election period, which results in an increase of infrastructure and social projects, economic incentives, and a rise in social costs through fiscal and monetary levers which, after the elections, affect the inflation rate. However, this factor does not influence investment activities. Instant changes observed in investment activity indicate a systemic crisis. Therefore, one should expect a further slowdown in economic activity in the next accounting period. The optimism about a 6% growth of the economy thus seems unfounded. I think we must seek explanations, not in the natural process of power change, but in the economic results of those political decisions which the new government made after coming to power. In particular:

1. Reinstatement of justice – I am far from thinking that anyone should be forgiven for having committed an illegal act. However, we should take into account what the cost of reinstating justice can be. We often associate the reinstatement of justice with retaliation and, in reality, it is precisely the longing for retaliation that damages not only the investment environment and the economy, but also estranges society from those declared principles and values which a developed state must be built upon. In 1789, the storming of the Bastille occurred in France. Subsequently, longing for retaliation, the Jacobins beheaded many royals and aristocrats. No one argues that the monarchy committed many crimes, but how did French society benefit from the violence of that period? Former Georgian President Zviad Gamsakhurdia was a dictator. He probably also made many mistakes and committed various offences. However, back then the desire to retaliate brought about civil war, which led to our estrangement from the developed world and left Georgia far behind the level of development of the Baltic States. The reinstatement of justice is associated with the construction of a legal state, but the reinstatement of justice can well disguise retaliation that works directly against the building of a legal state. The former government faced a similar problem. However, it is high time for the government that came to power via elections to analyze and learn lessons from past mistakes. That is why representatives of the diplomatic circles of the developed world often emphasize to us that the reinstatement of justice is a very delicate issue. It must be conducted in a very cautious manner, by observing all necessary procedures so as not to give rise to doubts. Acting otherwise will only hasten what has already started today: the investment environment will deteriorate and the economy will shrink. Investors are, at the very least, expecting a new redistribution of wealth. However, this is not the key issue; the key point is that we will drift away from the developed world and our ambitions towards joining the Euro-Atlantic space will be delayed for a longer period.

2. The Labor Code and talks about a law setting a minimum wage rate – The proposed amendments to the Labor Code caused different reactions in Georgia. The government initiated these on the premise that currently the rights of employees are violated because employers can dismiss employees without any grounds. In reality, the proposed changes will grant unqualified employees stronger protection, thus lowering competition in the labor market and worsening the investment environment. The labor relationship between an employer and an employee exists on the basis of a voluntary agreement. Such an agreement can be either verbal or written in the form of a contract. The aim of an entrepreneur (i.e. an employer) is to gain maximum profit from the activity conducted. An employee helps him/her achieve this aim by performing a certain type of work for the entrepreneur. An entrepreneur needs a qualified person who is able to contribute to the achievement of his/her aims. Thus, it is in the entrepreneurs' interest to maintain, take care of, motivate, and ensure the professional growth, et cetera, of their qualified human resources. An entrepreneur needs qualified human resources much like quality raw materials are needed for the production of competitive products/services. By losing qualified resources, an entrepreneur loses the likelihood of gaining maximum profit. The risk of qualified human resources being employed by a rival entrepreneur is also high. In reality, the dismissal of a qualified person harms the entrepreneur more than the qualified person being dismissed. Qualified people thus do not need any additional protection and the proposed amendments to the code do not give them any additional privileges, nor do they foster a sense of longer term stability among such people. However, those people who lack the relevant qualifications or experience look forward to such privileges. The essence of the proposed amendments to the Labor Code is that such underqualified people may get life-long employment contracts. This fundamentally changes the situation in the labor market. Qualified people lose the chance of moving to better-paid jobs because unqualified people are employed in those jobs. An entrepreneur who wants to increase profits and employ people with the relevant qualifications cannot do so because the law protects unqualified employees. Consequently, the entrepreneur refrains from making investments. The proposed changes to the Labor Code thus worsen the investment climate.

The National Statistics Office of Georgia has recently published the data of the first quarter of 2013, showing an increase in unemployment for 42,000 persons.

As regards the law on the minimum wage level, this aims at equalizing the minimum wage limit with the minimum subsistence level. The methodology of calculating this is ambiguous and disputable. For the sake of argument, let's make the assumption that this approach is fair and analyze the likely economic results of such a political decision. Salary rates in the economy depend on the demand on labor and the supply of the labor force. Demand on labor is created by investors who announce vacancies and seek people with the corresponding qualifications. Labor supply is created by those people who are willing to perform certain jobs for certain remuneration for the entrepreneurs. The higher the demand for labor and the lower the supply of labor, the higher the salary rates. And vice versa, the lower the demand and the higher the supply of labor, the lower the salary rates. This is the principle of the market economy. Price is determined by supply and demand. When a lower limit of price is established that exceeds the market price, entrepreneurs have no other choice but to pay higher salaries to employees than they would have done in a free market. In this case, entrepreneurs come to face the objective of optimization. Moreover, they more actively try to cut jobs in their unqualified workforce, which decreases the demand and, at the same time, increases the supply in the labor market. Apart from the fact that this worsens the investment environment, it increases unemployment too.

3. Xenophobic manifestations among government circles and society – in the article "Why Are You Against Progress and Economic Development?" published in the previous Tabula English issue, I argued about the absurdity of the decision concerning the prohibition of the sale of land to foreigners. In that article I said: "I have a suspicion that the opinions on this issue expressed by several representatives of parliament and government contain signs of xenophobia. There is nothing alarming in foreigners buying agricultural land in Georgia." The strongly xenophobic sentiments of society were proven once again by the events of 17 May, when a horde of religious activists violently attacked a peaceful rally in Tbilisi to mark the international day against homophobia. How much does that factor affect the investment environment? The point is that anyone can be an employer, regardless of his/her ethnicity, skin color, citizenship, religious beliefs or sexual orientation. When an employer feels aggression from society, he/she refrains from investing. Furthermore, in the 21st century information spreads rapidly and, consequently, this factor also risks scaring off other potential investors who had been thinking about investing in the country.

The Georgian economy does not develop because we lag far behind developed countries in the level of professional education. We cannot invent new technologies, conduct competitive scientific research or offer innovative products to the international community. There are up to 200 countries in the world today that have low living standards and a cheap labor force. All these countries are trying to attract foreign capital. Investors have a vast choice and competition in this area is very high. Under such conditions, the public statements of politicians have a strong impact on entrepreneurial activity, and the examples discussed here harm Georgia's investment climate. It is precisely these circumstances that make me think that the recession is not accidental. We are dealing with signs of a systemic crisis that we need to thoroughly think about.

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