Georgia’s growth has slowed down, IMF. Why?

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The FINANCIAL — Average productivity growth of Georgia decreased from around 5 percent in 2004-08 to 1.5 percent in 2011-15. Business surveys indicate that labor skills have increasingly become an obstacle to growth. While Georgians are highly educated, they do not have the relevant skills demanded by businesses, said IMF. 

Georgia climbed the rankings of the Doing Business Indicators reducing the distance to the frontier to about 20 percent in 2017. At the same time, Georgia was aided by growth in trading partners, which supported the country’s net exports. However, as the gains from the first wave of structural reforms declined and the external environment deteriorated after the 2008 global financial crisis, productivity growth in Georgia slowed down.

The years of high TFP (measured with total factor productivity (TFP) growth were accompanied by marked improvements in the business and regulatory environments as well as robust growth in trading partners.

However, Georgia has potential for higher growth, IMF believes. There is an opportunity to increase productivity, given that (1) the production and export base can be broadened; (2) unemployment is high and employment is concentrated in low-productivity sectors; and (3) the business environment can be further improved. Additionally, the quality and stock of human capital can be further improved, and physical capital can be increased to fully exploit the country’s comparative advantage as a platform for markets and as a tourist destination in the region.

Improving education and skill matching is key to increasing growth potential. As a small open economy, Georgia needs to fully reap the benefits of tighter global integration and competitiveness.

As a small open economy, Georgia needs to fully reap the benefits of tighter global integration and competitiveness. Improving key infrastructure is crucial to leveraging Georgia’s strategic position as a logistic hub for the region. Enhancing the business environment will help attract private capital and will strengthen the role of the private sector in generating sustainable and inclusive growth. Finally, bolstering the quality of human capital will support the diversification of production and exports toward more complex and higher value-added goods.

Improving education and skill matching is key to increasing growth potential.

According to the Global Competitiveness Report, an “inadequately educated workforce” is generally ranked as among the most problematic issues for businesses. In Georgia, the quality of education must be improved, especially in rural areas where educational outcomes are particularly bad, which contributes to high unemployment. Enrolment in universities is about 50 percent of Georgian students, lower than 60 percent in Central and Eastern Europe and 70 percent in Western Europe—and vocational training is not popular. As a result, there is considerable skill mismatch in the labor market, and businesses lament the lack of technical specialists in various fields, from agriculture to engineering.
”Addressing all these challenges requires a comprehensive reform package. Since the 2016 Parliamentary elections, the governing coalition has united around a robust reform agenda—the so-called 4-Point Plan. This is composed of an improvement in tax administration and the tax system to enhance the role of private sector activity; an increase in infrastructure investments to leverage Georgia’s strategic position; improvement in government efficiency to enhance the business environment; and education reform that addresses the skill mismatches in the labor market.” ”The government has made clear its plans and has already taken some actions toward the implementation of its reform agenda. To improve government efficiency and the business environment, the government plans to set up a Business House to provide a one-stop shop for public services to enterprises; introduce International Financial Reporting Standards for corporations; and reform insolvency law. To increase the stock of human capital, the government has embarked on a path to implement comprehensive education reform that includes curriculum standards, the introduction of a new framework for teachers, vocational training, and adult learning. However, more must be done in terms of upgrading the quality of early childhood education, improving learning outcomes, enhancing vocational training, and strengthening education in science and technology.
Finally, to improve the stock of physical capital, the government aims at scaling-up infrastructure spending to transform Georgia into a transport and logistics hub connecting Europe and Asia”.

Modeling the Policy Package

The effects of the reform package are analyzed using the IMF’s Global Integrated Monetary and Fiscal (GIMF) model, calibrated to key stylized facts of the Georgian economy. The parameters governing the steady-state properties of the model were calibrated to match basic stylized, facts for the Georgian economy (that is, structure of GDP, labor and capital share of income, structure of government expenditure and revenues, etc.).

The components of GDP were calibrated to match the April 2018 World Economic Outlook, and the trade structure was calibrated to match Georgia’s trade with its main partners. As for the fiscal policy block, debt to GDP was anchored at 45 percent in the long run, and the long-run output elasticity of public investment was calibrated to 0.25 (as in Bom and Lighthart 2013).

The inflation target is calibrated to 3 percent—as per the “Main Directions of Monetary Policy” published by the National Bank of Georgia. The parameters governing the dynamics of the model (that is, the degree of price and wage rigidities, investment adjustment costs, and others) were calibrated following the standard calibration for emerging market economies (EMEs). Such parameters do not affect the long-run outcomes of the model. We assume that structural reforms affect economy-wide productivity, and we borrow from a large body of literature on macro-structural linkages to calibrate their quantitative effect.

Fiscal Policy Package

The government’s fiscal package has positive effects on GDP and growth (Figure 3). The scaling up in productive public investments and public capital stock allows for higher productivity in private firms. Moreover, by replacing taxes on capital with taxes on consumption, the government moves to a less distortionary way of financing its spending. As a result, real GDP increases by 3 percent in the new steady state. In converging to the new steady state, GDP growth increases by about 0.4 percentage point in the medium term. In the long run, the growth of the economy remains driven by productivity and population growth.

The lower tax burden on firms generates higher private investment.10 Private investment increase steadily both in levels and as a share of GDP, and in the new steady state investment share to output ends up being about 1 percentage point of GDP higher than in the baseline. The dynamics are further helped, at least temporarily, by a moderate decrease in the cost of borrowed funds.

Because higher consumption taxes do not fully cover higher government spending and the revenue losses from lower capital taxes, public debt initially goes up.

“The public debt-to-GDP ratio increases by about 3 percentage points with respect to the baseline, and then progressively declines back to 45 percent of GDP in the new steady state—it is assumed that the government does not want to increase its debt-to-GDP ratio. As government investment progressively declines to a level only slightly higher than in the baseline and current spending remains contained, the fiscal balance deteriorates only mildly in the medium run. Moreover, higher consumption taxes—together with a higher tax base—support the fiscal adjustment”.

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