Wednesday, October 1, 2014

The Right Way to Rebuild Georgia

NEW YORK – At the recent donors’ meeting on Georgia, aid pledges rolled in, totaling $4.5 billion – about $1,000 per citizen of Georgia. That’s the good news. The bad news is that the meeting was restricted to donors and Georgia’s government, with Transparency International criticizing its opaque decision-making process.

Lack of transparency and accountability in how money is spent in wars, and in the rebuilding that takes place after them, no longer play well with taxpayers. In light of increasing global demand for aid and falling supply (down 12% over the last two years), its effective and transparent use is becoming more imperative. And governments that are not accountable to their citizens will most likely fail in this regard.

Before these “pledges” become “commitments,” donors should carefully examine Georgia’s economic development strategy and assess its plans for humanitarian and reconstruction aid. They should ask whether aid for Georgia contributes to peace and stability or, on the contrary, whether it will impede a political solution to the conflict and keep investors away.

Russia’s recent recognition of Abkhazia and South Ossetia as separate republics, despite their de facto autonomous status within Georgia since the early 1990’s, will make it more difficult to find solutions to the problems of internally displaced persons (IDPs), returnees, and the resident population in the conflict zones. But reintegration of conflict-ridden groups into productive activities is a sine qua non for political, economic, and social stability. The UN reckons that countries that fail in this endeavor have an even chance of reverting to conflict.

So, has Georgia’s development model been conducive to dynamic and inclusive growth, that is, growth that leads to productive investment, innovative practices, and widespread job creation?

To be sure, the International Monetary Fund and United States officials have recognized Georgia’s unquestionable success in adopting sound macroeconomic policies and reforms to improve the business climate. Foreign investors have responded by pouring resources into the country. With capital inflows amounting to 20% of GDP in the years before the war, annual economic growth jumped to over 12% in 2007, with the country experiencing almost 40% growth since 2003.

But rapid growth is not enough. Georgia has failed to create the jobs, dynamism, and inclusion that are necessary for a peaceful society. Despite some recent diversification, investment flows have been heavily tilted to construction of oil and gas pipelines and other large international projects. Moreover, military expenditure has increased from 1% to 7% of GDP since 2003, drawing resources away from human development into unproductive investment.

Unemployment is high, income disparities have worsened, and corruption remains widespread, notwithstanding important improvements in recent years. Despite official statistics that place less than a third of the population below the poverty line, experts reckon that roughly half the population is trapped in poverty, amid a large urban-rural gap.

The challenge for Georgia is to find a solution to the IDPs by rehabilitating infrastructure, housing, and other services, and by facilitating job creation so that the conflict-affected population’s living conditions can improve. The UN High Commission for Refugees forecasts that 73,000 of the roughly 127,000 IDPs created by the South Ossetian crisis will probably return to their place of origin by early winter. Given 220,000 IPDs from previous conflicts in the 1990’s now face fading prospects for a return to Abkhazia and South Ossetia, Georgia’s authorities must find a viable and permanent solution for roughly 6% of the population.

Moreover, capital flows, upon which Georgia is highly dependent, have been interrupted since the conflict started. Without a solution to the IPD problem, efforts to strengthen political stability and security will fail. And, in the absence of stability and security, the objective of the IMF’s $750 million stand-by arrangement to cover the “temporary external financing gap” and to sustain “the confidence of markets and investors” will not be met.

The challenge now is to redesign Georgia’s aid package to focus primarily on the provision of “reconstruction aid” that promotes investment and employment. While “humanitarian aid” cannot be neglected, it should be recognized that such aid promotes consumption rather than investment, creating price distortions and work disincentives. Georgia must be weaned from humanitarian aid as soon as the situation allows it.

Reconstruction aid to improve infrastructure, promote start-up companies, and reactivate micro- and small enterprises, services, mining, and other sectors, and to improve agricultural yields and irrigation, should start right away and should be the main focus of international aid commitments. Laissez-faire will not do it.

Georgia’s government and donors should consider using aid to provide subsidies to private enterprises to encourage and lower the cost of employing IDPs. Without inclusive and dynamic growth, sustainable peace will remain elusive, and, in the current environment of higher scrutiny and significant competing needs, donors will be hard pressed to justify committing the large financial aid package that they have pledged.

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