FREE-market supporters are often asked to show concrete examples of countries where the policies they advocate have been successfully tried. Georgia, formerly part of the Soviet Union, offers a little-known economic success story.
Recently, after peaceful elections, President Mikheil Saakashvili handed power to Giorgi Margvelashvili, a candidate from the party elected by a majority in last year’s parliamentary elections. While controversy exists over Saakashvili’s 10-year term in office, the economic effects of his "Rose Revolution" have been widely praised. Inheriting a moribund economy corrupted by post-Soviet cronyism, his party of young, market-friendly politicians set about reversing the decline with reforms remarkable not only for boldness but their speed of implementation.
Georgia has a complex history. It has been the prize of empires since the 13th century, invaded by Mongols, Ottomans, Persians, and multiple times by the Russians. After the First World War, its economy was geared to serving its colonial Russian masters. When the Iron Curtain came down, its centrally planned economy was corrupt, unproductive and in conflict with a more efficient black market.
After 1991, Georgia struggled with its integration with the rest of the world. Socialist inefficiency was exposed and thousands of factories closed. Gross domestic product (GDP) dropped 85%. Georgian politicians and citizens struggled to come to terms with market concepts such as private property, while the government was characterised by cronyism, corruption and abuse of power. A new constitution was adopted in 1995, offering free speech and religious choice. But the economy still struggled to perform.
Notable problems involved customs, where importers were held hostage to bribery and corruption by their own officials. High tax rates led to bribery of tax collectors and state revenue fell precipitously, and salaries and pensions could not be paid.
By 2003, the public had lost complete faith in public institutions, then president Eduard Shevardnadze resigned and a reform government was elected in what came to be known as the "Rose Revolution". The new government saw its country at rock bottom and decided radical reform of the business environment was required.
The priorities for economic recovery and reform included liberalising the tax system, deregulation, making the process of starting a business easier, high-speed privatisation and public-sector reforms that included eliminating corruption, lowering the number of state agencies and downsizing the rest.
In the area of tax reform, personal income tax was decreased from 20% to a top, flat rate of 12%. Social taxes went from 31% to 20% and were then abolished. Value-added tax was lowered from 20% to 18%. Corporate tax was reduced to 15%, while dividend tax came down to 5%. The total number of taxes was reduced from 22 to six. In 2011, Georgia adopted the Economic Liberty Act, which prohibits government spending of more than 30% of GDP, a budget deficit of more than 3% and public debt of more than 60% of GDP.
Impressive reforms were made at customs. All procedures were simplified to allow importers to cross the border in a few hours, while most tariffs were eliminated. Top rates were brought down from 32% to 12%, with the average tariff rate at 1.3%.
In 2005, the government adopted enabling legislation for business licensing, competition, labour, electricity production and supply. More than 800 licences and permits were abolished. New rules of competition prohibited any governmental intervention that would result in artificial monopolies. Legislation in the energy sector allowed for vertical integration, unregulated pricing and unrestricted export opportunities. In health, the government eliminated most licences, allowed for a total opening of the market to medicines produced and licensed in Organisation for Economic Co-operation and Development nations and removed restrictions on vertical integration in the industry.
Production of medicines was also deregulated, supporting the sector’s development and competitiveness. The result of the reform saw the total number of health-sector companies increase 10 times, while the number of chain pharmacies increased from three to six. Last year, the Curatio International Foundation survey found standard treatment prices were 50%-60% lower than in 2009.
Drastic steps were taken to root out corruption in the public sector. The Georgian government fired thousands of corrupt officials and, in an amazing singular political event, fired its entire police force of 40,000, completely abolishing the traffic department. About 15,000 officers were gradually hired back after investigation and interviews. Zero tolerance towards crime and corruption has helped Georgia become one of the safest countries in the world.
In 2004, economy minister Kakha Bendukidze announced full-scale privatisation, saying: "We are going to sell everything except our honesty." Georgia sold the ports to private companies, which were allowed to on-sell. The entire telecommunications industry was privatised, along with the energy and distribution sector. Most hospitals were placed in private hands, along with public buildings, which the government leased back on the outskirts of cities rather than in the centre. Land privatisation included law amendments eliminating discrimination in certain types of land ownership. Public servants were cut from 400,000 to 280,000.
The results of the "Rose Revolution" are impressive. In terms of economic growth, real GDP doubled between 2004 and last year (8% year on year), while average salaries quadrupled. The number of registered companies went from 50,000 in 2003 to 400,000 last year. Bank deposits increased eightfold, renewing trust in the financial sector.
Georgia is now ranked eighth on the World Bank’s Doing Business report and lifted its Transparency International ranking (on corruption) from 130th (2005) to 51st (2012). On the Fraser Institute’s Economic Freedom of the World index it rose from 73rd (2004) to 25th (2011). Despite the lower tax rates, total tax collected went up tenfold.
Georgia’s incredible transformation has not been without difficulties. Political pressure was put on the government by a public little exposed to business competition. Protests from farmers and other lobby groups led to growing subsidies in certain sectors. The judiciary’s independence is questioned and important reform remains to be done.
The extent of the policies instituted by the executive function of government created constitutional concerns. Limitations on the function of president were enacted last year, with most powers transferred to parliament and the presidential role becoming more ceremonial. The centralisation of government power has been criticised, as it led to a weakening of local government.
South Africa can learn much from the story as it has many parallels to our own history. The apartheid economy inherited in 1994 was heavily planned by a centralist government, with a market hamstrung by legislation that forced the economy to be inward-looking. There is still distrust of market forces and an uncompetitive labour force remains militant and unwilling to work with business. Georgia has shown how limited government, low taxes, and a light regulatory environment can transform an economy and a people overnight. South Africa is ready for its own "Rainbow Revolution".
• Emerick is an associate of the Free Market Foundation. Jandieri is vice-president of the New Economic School in Tbilisi, Georgia.