This research project is intended to analyse the opportunities that have been created by Georgia’s signing of the Association Agreement with the EU. It is undertaken by GeoWel Research and will contribute to EBRD’s Country Diagnostic development process.
Country diagnostics are a flagship product of the European Bank for Reconstruction and Development and are used as a tool to help shape the Bank’s strategic priorities and policy selection within new country strategies and to coordinate the Bank’s policy engagement with the authorities. The diagnostics are also an important part of the implementation of the Bank’s six qualities of transition (Competitive, Green, Inclusive, Integrated, Resilient and Well Governed). Country diagnostics are produced by the Country Economics and Policy (CEP) team of the Economics, Policy and Governance (EPG) department in collaboration with many other teams. The EBRD has been working on the Georgia Diagnostic in September 2020 and will be finished in 2021.
This study is being conducted because EBRD would like to help Georgia better take advantage of an apparent opportunity. The Association Agreement between Georgia and the EU was signed in June 2014. A large part of the agreement is the Deep and Comprehensive Free Trade Area (DCFTA) which is designed to provide increased access to the EU markets at the same time as requiring Georgia to align with EU standards in a range of areas. As a result of the agreement, coming into alignment with the Association Agreement and DCFTA has become the biggest driver for legislative reform in the Georgia, particularly as it relates to business environment issues.
It was hoped that as these reforms came into effect, Georgian business people would be able to seize the opportunity presented by increased access to the 500-million-person EU market, so that the Georgian export of products to the EU and foreign direct investment into Georgia would increase. This opportunity would seem to offer a pathway for accelerated economic growth, of the kind enjoyed by South Asian countries that gained access to the US market in the 60s and 70s, and EU accession states, that gained access to the EU in the early 2000s.
This project is important, since detailed and in-depth analysis of this kind has not been done before. Therefore, EBRD believes that a systematic and practical analysis is needed, that looks at why growth in EU-export orientation and export-related FDI has not occurred, what opportunities might exist that are being missed, and what barriers are there to Georgia taking better advantage of any increased access.
This report should inform the reader about the composition and direction and dynamic of Georgia’s trade patterns, of Georgia’s current FDI, of the current state of implementation of the Association Agreement, particularly as it relates to trade issues and should provide a detailed overview on a sector-by-sector basis of the current composition of Georgia’s exportables sector and the challenges facing its possible expansion, particularly vis-à-vis the EU market.
The ultimate goal is to provide the EBRD with an independent overview of trade and trade-related issues within the context of the Association Agreement. This should assist the team in identifying strategic priorities to be implemented over the coming country strategy period aimed at developing a more competitive and sustainable corporate sector in Georgia.
In spite of the Association Agreement and considerable efforts by the EU, if copper and hazelnuts are extracted, then exports to the EU in 2019 were only 13% of Georgia’s total exports. This is slightly lower than the 16% average for the last 10 years, and significantly down from the 2015 high of 24%. Between signing the Association Agreement and 2019, these exports have gone down in absolute terms.
This is clearly not what was hoped for. The Association Agreement between Georgia and the EU was signed in June 2014. As a result of the agreement, the push to bring Georgia into alignment with EU standards has become the biggest driver for legislative reform in the Georgia, particularly as it relates to business environment issues.
As these reforms came into effect, it was hoped that Georgian business people would seize the opportunity presented by the 500-million-person EU market. If that happened, Georgian exports to the EU and foreign direct investment into Georgia related to those products would increase.[1] This would seem to offer a pathway for accelerated economic growth, of the kind enjoyed by South-Asian countries that gained access to the US market in the 60s and 70s, and EU accession states that gained access to the EU in the early 2000s.
This has not happened partly because the Association Agreement has not changed Georgia’s terms of trade with the EU very much, but mostly because of the inherent challenges of producing for the EU-market. Georgian producers find the EU a very difficult market to orient towards, and the foreign partnerships that might facilitate this process have been rare.
Producers who want to export to the EU are competing with a well-developed eco-system of existing companies. They need to produce according to EU standards, understand particular national tastes and develop networks of clients for their products. They then need to make products and get them to market in consistent quality and volume for those clients. Each of these challenges – production, standards, marketing, client-relations, transport and logistics and much more – are made more difficult by Georgia’s physical distance from the EU and lack of networks in the region. Given the challenges, it is perhaps unsurprising that relatively few Georgian companies have managed it so far.
One of the clearest routes to overcoming these challenges is through partnership and investment from foreign companies. Developing new export-oriented sectors often starts with international production relationships since the foreign partner has the production understanding, client-relationships, understanding of the EU market environment, the certification to produce according to EU standards and much more.
But generating foreign investment in the tradable sector has been slow. Georgia’s ‘sales pitch’ as the best country for investing and doing business in the region is often repeated. This usually highlights Georgia’s strong business environment, low tax environment, free trade agreements with many countries and regions (including the EU), cheap labor costs and low utility costs.
This ‘sales pitch’ is right, but misses the weaknesses, in particular poor transport infrastructure, low labour skills, lack of value chain penetration, financing which is focused on bank loans, and challenges with the competence of the judiciary and government bureaucracy.
These challenges take different forms in different sectors and do not negate the positives that are usually highlighted. However, the challenges that are often discussed, do start to clarify that the value proposition offered by Georgia to investors is not as simple, nor as unqualified, as those promoting the country would often like to suggest.
From the point of view of our research question, one of the main reasons why Georgia does not export more to the EU is that Association Agreement alignment, by itself, is not sufficient to make Georgia attract large foreign companies that are looking for new supply-chain extensions. This therefore necessitates efforts on the part of the Georgian Government to strongly support existing and new investors in the tradable sector.
This is already happening to some degree. Enterprise Georgia has a range of products and services to attract investors and support investments. However, until recently, these efforts have not particularly targeted the tradable sector and have had a fairly limited set of tools for providing support, risk-abatement and public-private partnership.
This has changed with the recent addition of FDI grants. These aim to attract and support export-oriented FDIs in particular sectors. These provide interest-rate subsidies and grants to resolve specific issues (like human resources and physical infrastructure). Ideally, this should be supplemented with support to accelerate processes for cutting through red-tape on land sales, approvals for construction and factories and developing training programmes as well as opportunities for PPP and government equity involvement. It is too soon to say whether the current formulation is aggressive or generous enough to create a sea-change in FDI attraction, but it is certainly a step in the right direction.
[1] For the purpose of this report, we will act as though the UK is still in the EU, since most of the report predates the country’s departure, and the terms of trade agreed with the UK in 2019 have given the country a very similar level of access to that agreed upon under the Association Agreement.
