Tamar Burduli - Economic Transitions in Georgia - On The Path From Shock Therapy Towards DCFTA

COLLEGE OF EUROPE
NATOLIN (WARSAW) CAMPUS

EUROPEAN INTERDISCIPLINARY STUDIES
ECONOMIC TRANSITIONS IN GEORGIA:

ON THE PATH FROM SHOCK THERAPY TOWARDS DCFTA
Supervisor: Kerry Longhurst Thesis presented by

Tamar Burduli
for the
Degree of Master of Arts in European
Interdisciplinary Studies
Academic Year 2013 – 2014

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in its entirety or in parts. Any parts, words or ideas, of the thesis, however limited, and including
tables, graphs, maps etc., which are quoted from or based on other sources, have been
acknowledged as such without exception.
Moreover, I have also taken note and accepted the College rules with regard to plagiarism
(Section 4.2 of the College study regulations).
Déclaration sur l’honneur
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Je déclare également avoir pris note et accepté les règles relatives au plagiat (section 4.2 du
règlement d’études du Collège).
1
Acknowledgments
Kerry Longhurst
Vladimer Papava
Quincy Cloet
Aleksandre Gvarjaladze
2
Abstract
The following thesis discusses the history of economic transitions in Georgia, starting
from restoration of independence in 1991 following the fall of the USSR, and progressing
towards efforts to establish a democratic state, to make a transition from command economy to
the liberal market-one, and to integrate closely with the European Union. The thesis also
overviews some political or societal factors, that influenced economic developments at the time.
First Chapter discusses the two main approaches of post-communist economic transition:
Shock Therapy and Gradualism, briefly describes a classical example of Shock Therapy
application in Poland, i.e. Balcerowicz Plan.
Second chapter examines the initial post-communist transition stages that took place in
Georgia in the nineties mostly during Eduard Shevardnadze’s presidency. It overviews
successful and unsuccessful reforms of Shock Therapy together with accumulated errors that set
foundation for Rose Revolution of 2003.
Third chapter overviews the political “package”, that Mikheil Saakashvili inherited from
previous administration and focuses on successful and infamous reforms carried out by his
administration.
Fourth chapter explores the history of EU-Georgia relations, Georgia’s recent political
developments and current stand on these relations, economic implications of signing DCFTA
agreement and how DCFTA is different from FTA, how Georgia complies with the EU
Economic Governance, and analyses the chances of Georgia’s preference of ECU over the EU.
The main conclusions are that domestic armed conflicts, declaration of independence by
Abkhazia and South Ossetia, post-war infrastructural and social problems, massive corruption,
inexistence of proper state institutions, lack of government’s cohesion and expertise on future
economic strategies contributed to failure of Shock Therapy, which contributed to the happening
of peaceful Rose Revolution. Even though the new government embarked upon a fast track of
reforms to liberalize the market, eradicate corruption and harmonize domestic legal system with
that of the EU, spontaneity, strategy inconsistency, populist programs, elite corruption and
massive violation of human rights resulted in change of government in 2012. Nevertheless,
Georgia has been dedicated to Eurointegration, especially after the Rose Revolution. Despite the
raised fears about Russia’s actual leverage in the ENP countries right before when Georgia is
about to sign Association Agreement with DCFTA component, Georgian government is positive
about successful outcome. However, EU’s enlargement fatigue has produced discussions on ENP
being a substitute for membership. Therefore, it should be kept in mind that the membership
should, by no means, be the ultimate goal of Georgia, but rather approximation with the EU
should be regarded as a means of becoming a truly European state or a state of European values.
3
Keywords: Georgia, Economic Transition, Shock Therapy, Rose Revolution, DCFTA
Wordcount: 21 284
4
Table of Contents
Introduction ............................................................................................................................... 6
1. Post-Communist Transition Theories: Two Approaches of Development ............................... 9
1.1. Shock Therapy ............................................................................................................... 10
1.2. Gradualism .................................................................................................................... 15
2. Post-Communist Reforms in Georgia ................................................................................... 18
2.1. Stage of Naive Comprehension ...................................................................................... 18
2.2. Stage of No Movement or Stage of Stagnation ............................................................... 18
2.3. Populist Stage of Reform or Shock Therapy ................................................................... 18
2.4. Stage of Delay or Stage of Accumulation of Mistakes .................................................... 21
2.5. Reforms Resumed or Stage of Correction of Errors ........................................................ 24
2.6. Leszek Balcerowicz - Economic Advisor in Georgia ...................................................... 26
3. Post-Rose Revolutionary Reforms in Georgia....................................................................... 29
3.1. What Was Right and Wrong Before the Rose Revolution? Political Inheritance of
Saakashvili ........................................................................................................................... 31
3.2. Successful Post-Revolutionary Reforms ......................................................................... 32
3.3. Questionable Post-Revolutionary Reforms ..................................................................... 36
4. Georgia and the EU .............................................................................................................. 42
4.1. Brief Chronology of EU-Georgian Relations .................................................................. 42
4.2. EU Assistance to Georgia .............................................................................................. 44
4.3. Georgia on the Path towards the EU and DCFTA........................................................... 45
4.4. Peaceful Transition of Political Power in Georgia .......................................................... 46
4.5. EU Economic Governance and Georgia ......................................................................... 49
4.6. What is FTA and when does it become Deep and Comprehensive? ................................ 51
4.7. Georgia and DCFTA: What Next? ................................................................................. 52
4.8. Georgia: Towards European or Eurasian Union? ............................................................ 56
Conclusions ............................................................................................................................. 60
Bibliography ............................................................................................................................ 63
5
Introduction
Georgia, located between the Black and Caspian seas on the geographical border of
Eurasian continent, is a one of the most ancient countries, first historical records of which can be
dated back to ancient Anatolian period. Georgia's history is full of struggles against invading
empires and nations like “Xenophon's Greeks, the Arabs, the invading Turks, the Crusades,
Chingiz Khan and Timur Lang, the Persian empire, the Russian empire, Soviet totalitarianism
[…] having one of the longest, most turbulent histories in the Christian or Near Eastern world” 1,
and which, “though small, stands at a crossroads between Russia and the Muslim world, between
Eastern Europe and Central Asia, and is a dramatic example of state-building and, also, of tragic
political mistakes.”2
This small country of 69 700 square kilometers, 1.87 times bigger than Netherlands and
0.68 times smaller than Iceland3, inhabited by almost 4.5 million people and with a GDP of
$15.75 million4, was under Russian rule since the 19th century and, after few years of
independence in 1918-1921, became ruled by the Soviet Socialist regime. After the revolutions
of 1989 and final dissolution of the USSR, Georgia declared its independence in 1991, held its
first democratic presidential elections and embarked upon the creation of proper statehood.
However, the civil unrest in the capital, war in two breakaway regions and the military coup
d’état between 1988 and 1993 substantially stalled the post-communist transition. Losing central
administration control over Abkhazia and South Ossetia caused irreversible damage to Georgian
population, infrastructure, social costs and economy, and still continues to do so. “There is no
doubt that the post-Soviet Caucasus republic of Georgia is one of those transformation societies
facing especially complex challenges. Geographically and culturally, Georgia is located in a
traditionally unstable geopolitical border zone between Europe and Asia. Add an ethnically
heterogeneous population, two active as well as several latent secession conflicts, and the fact
that Georgia has no opportunity to fall back on historic traditions of effective state coherence,
and one sees that the country’s process of political and economic transformation is struggling
under an enormous burden.”5
Georgia declared its western political direction already in the early nineties, while keeping
“warm” relations with Russia, mainly in trade, since Russia represented a major export partner
for Georgian products (mostly wine and mineral water). Furthermore, Post-Soviet Georgia
1
Donald Rayfield, Edge of Empires: A History of Georgia. Reaktion Books Ltd., London, 2012, bookjacket.
2
Reaktion Books, Edge of Empires: A History of Georgia. Available at:
http://www.reaktionbooks.co.uk/display.asp?K=9781780230306, (consulted on: 29.4.2014).
3
MapFight. Available at: http://mapfight.appspot.com, (consulted on: 23.4.2014).
4
World Bank Data: Georgia. Available at: http://data.worldbank.org/country/georgia, (consulted on: 23.4.2014).
5
Bertelsmann Transformation Index: Georgia Country Report, 2003, p. 1. Available at: http://www.bti-
project.org/fileadmin/Inhalte/reports/2003/pdf/BTI%202003%20Georgia.pdf, (consulted on: 18.4.2014).
6
immediately put its efforts to transition from command economy to liberal one, main example of
which was post-communist Poland and its famous Balcerowicz Plan. However, the lack of state
institutions, expertise of liberal market economy, criminal situations and other factors influenced
the unsuccessful outcome of Shock Therapy in Georgia. “Political and economic transformation
in Georgia clearly lacks a linear dynamic towards the consolidation of democracy and market
economy. Under the heavy burden of two unresolved ethnic conflicts and sharp economic
decline aggravated by pervasive corruption and extremely weak state structures, Georgia’s
development has been marked by a series of interruptions and setbacks.” 6
The aggravated dissatisfaction of Georgian population with the growing imprudence of

Shevardnadze's government brought the Rose Revolution and a new president to the country.
Elected by 97% of the population (with 83% of a turnout), Mikheil Saakashvili initiated
revolutionary and drastic reforms in all spheres, which brought about change quite rapidly after
dozen years of struggle of previous governments. The newly appointed, mostly young and
western-educated government actively engaged in massive market liberalization and facilitation
of state administrative procedures. However, many of these changes had drawbacks or were
flawed. Despite the elimination of petty corruption, stabilization of criminal situation and steady
economic growth, elite corruption, over-expenditure and non-transparency of state resources,
violation of human rights, Georgia-Russia war of 2008 and some additional factors contributed
to decreased trust and dissatisfaction with Saakashvili's government.
In spite of all the internal or external obstacles, Georgia has been keeping its European
direction and has been widely open to Eurointegration since 1992. As a part of Partnership and
Cooperation Agreement (PCA) and European Neighbourhood Policy (ENP) Action Plan, the
country has been adapting its constitution and regulations to the EU requirements. As for today,
Georgia has finalized negotiations on Association Agreement (AA), which involves Deep and
Comprehensive Free Trade Area (DCFTA), fate of which will be decided in summer 2014.
Based on the described political history of the country, the milestones of economic
development in Georgia's recent history include periods of:
1) 1989-2003 - from independence to Rose Revolution;

2) 2003-2012 - Rose Revolution and policies of the United National Movement; and
3) Initialization of the DCFTA agreement and prospects of signature.
The first two of these milestones are characterized by two almost full presidential terms
and having president's affiliated party as majority in the parliament: Eduard Shevardnadze with
6
Bertelsmann Transformation Index: Georgia Country Report, 2006, p. 2. Available at: http://www.bti-
project.org/fileadmin/Inhalte/reports/2006/pdf/BTI%202006%20Georgia.pdf, (consulted on: 18.4.2014).
7
Union of Citizens of Georgia during 1995-2003, and Mikheil Saakashvili with United National
Movement during 2004-2013. Georgia's first president Zviad Gamsakhurdia held the office
during 1991-1993. He died in unclear circumstances (while formally still holding the
presidential position) during the civil war of 1988-1993 and military coup d’état of December
1991 – January 1992. In both cases, having president and majority of parliament from the same
party and by taking into account the fact that Rose Revolution was directed against
Shevardnadze's politics, it is presumable that the two leaders had drastically opposing views on
certain crucial policies including economic policies. Currently DCFTA is proposing new
dimensions for economic development and at the same time is testing Georgia's readiness to
become part of European Economic Governance.
Therefore, the following thesis discusses the three stages of Georgian economic transitions
and development according to the policies of the ruling parties, by identifying underlying
theories or practices of transitions, lists successful and failed reforms and their consequences,
and tries to analyze prospects and implications of signing DCFTA agreement. The main purpose
of this thesis is to serve as a consolidated version or reference point for those interested in
Georgia's economic transition history and its contextual political factors.
8
1. Post-Communist Transition Theories: Two Approaches of Development
As a result of desovietisation, the revolutions and collapse of communism in 1989 and the
final dissolution of the Soviet Union in 1991 gave basis for formation and re-formation of 15
former communist and now independent countries7. One of the main characteristics of this re-
formation was transition from command economy to the liberal market economy. However, this
changeover still had components of or was on some level overshadowed by Soviet communism
economic system8. Additionally, transforming communist institutions into market institutions is
no piece of cake and, therefore, the process did not go without substantial mistakes. Especially if
we take into account, that some of these countries did not inherit public institutions necessary for
the transformation. Some academics refer to the process as “refolution” to integrate both
“revolution” and “reform” that are so characteristic to the post-communist transformation. 9 In
this sense, economic reforms undertaken by the government of Georgia were no exception to
this rule.
According to Joseph E. Stiglitz, post-communist transformation is one of the most

remarkable events of the end of the past century10 and according to Ivan T. Berend, it can even
be discussed as global transition to the market economy. 11 In the view of John Kenneth Galbraith
it can be looked at the same level as the two world wars, comprising together the three major
events in the past century.12
Currently, by looking at the history of transitions and the empirical data, it is already
feasible to perform scientific observations and draw up general theories on the process of post-
communist transformation. The academics, economists and reformists are divided into two main
“teams” or courses of reforms: “Gradualists” and the advocates of “Shock” in the economic
7
Paul Hare and Gerard Turley, “Introduction to the Handbook”, in: P. Hare and G. Turley (eds.), Handbook of the
Economics and Political Economy of Transition, Routledge, Abingdon, 2013, p. 3.
8
Richard E. Ericson, The Post-Soviet Russian Economic System: An Industrial Feudalism?, 28 June 2000, pp. 5-17.
Available at:
http://www.suomenpankki.fi/bofit_en/tutkimus/tutkimusjulkaisut/policy_brief/Documents/bon0800.pdf,
(consulted on 07.4.2014).
9
Timothy Garton Ash, Revolution in Hungary and Poland, 17 August 1989. Available at:
http://www.nybooks.com/articles/archives/1989/aug/17/revolution-in-hungary-and-poland/, (consulted on:
2.5.2014); Constitutional "Refolution" in the Ex-Communist World: The Rule of Law, 1997, p. 45. Available at:
http://digitalcommons.wcl.american.edu/cgi/viewcontent.cgi?article=1385&context=auilr, (consulted on:
2.5.2014).
10
Joseph E. Stiglitz, “Another Century of Economic Science”, in: The Economic Journal, No. 101, 1991, pp. 134-
141. Available at:
http://academiccommons.columbia.edu/download/fedora_content/download/ac:159591/CONTENT/10664.pdf,
(consulted on: 2.5.2014).
11
Tibor Ivan Berend, “End of Century Global Transition to a Market Economy: Laissez-Faire on the Peripheries?”,
in: Transition to a Market Economy at the End of the 20th Century, Eleventh International Economic History
Congress, Session A-3, September 12-17, 1994, Milan, Italy, p. 21.
12
Vladimer Papava, Necronomics: The Political Economy of Post-Communist Capitalism (Lessons from Georgia),
iUniverse Inc., Lincoln, 2005, p. 13.
9
system of the state. However, besides these two paths a third one by the name of “Third Path”
can be identified, which finds its origins in the Balkans and is also referred to as “Gradual
Gradualism” and entails slower transition to market economy than that of Gradualism, where
privatization occurs only to small enterprises in the sectors of trade, services and tourism. 13
From the following discussions on the two main strategies of transition it can be easily observed
that the main difference and subject of discussion among the supporters of the theories is the
“transition period” or the speed at which the reforms are being carried out. 14
1.1. Shock Therapy

In general, Shock Therapy entails implementation of a set of tight fiscal and monetary
policies involving exclusion of subsidies by the means of price liberalization, minimization of
budget deficit, strict regulation of money supply by limiting the credit issues, and short-term
restriction of income growth.15 Application of Shock Therapy strategy was most popular in
Central and East Europe: “The CEE transitional countries applied the rapid “shock therapy” to
put the economy on “automatic-pilot” and let the markets decide supply, demand, and prices and
economic transformation”. 16 Moreover, governmental sector does not have a crucial role in this
strategy and private sector, because of the “shift of economic decision making to the private
sector, and the exclusion of government intervention in the national economy” which is same as
“private enterprise operating in a framework of market-determined prices but abolishing the
need for public sector involvement at the macro-level in a national economy”. 17 To put it simply,
small and medium-sized enterprises or SMEs are the key to post-communist transition.18
However, “regardless of the political and cultural context, in the early stages of economic
transition process where institutional support and market conditions are not apparent, the state
and public sectors play key roles in development of above mentioned SME sector and capital
movement in this sector, also provision of free market and political and economic flexibility”. 19
“The Shock Therapy or “Big Bang”, or “Bitter Pill” is a strategy that consists of
maximization of radical transformations in the shortest possible period of time. The key
13
Ibid., p. 18.
14
Ibid., pp. 18-19.
15
Ibid., p 125; Vladimer Papava, “The Georgian Economy: From “Shock Therapy” to “Social Promotion””, in:
Communist Economies & Economic Transformation, Vol. 8, No. 2, 1996, p. 252; Vladimer Papava, Economic
Reforms in Post-Communist Georgia: Twenty Years After, Nova Science Publishers Inc., New York, 2012, p. 3;
Hare and Turley, op. cit., p. 3.
16
Quamrul Alam, Thanh Hai Nguyen and Namul Majumdar, “Shock Therapy versus Gradualism: The Central
Eastern Europe (CEE) and East Asia Comapared – A Review of Literature”, in: International Business
Research, Vol. 2, No. 2, 2009, p. 4. Available at:
http://ccsenet.org/journal/index.php/ibr/article/download/1109/1106, (consulted on: 2.5.2014).
17
Ibid.
18
Ibid.
19
Ibid., p. 3.
10
elements of Shock Therapy strategy include liquidation (or at least, minimization) of budget
deficit and pursuit of tight monetary policy under the conditions of fixed money supply or fixed
exchange rate. The Shock Therapy doctrine stems from the orthodox macroeconomic
stabilization scenario, which stipulates that budget deficit should be liquidated (or at least
minimized) and a tight monetary policy, coupled with a fixed money supply or fixed exchange
rate, should be established within a limited period of time.” 20 Hereby it should be remarked, that
the quoted framework is same as “Washington Consensus” and, therefore, sets foundation for the
approach that International Monetary Fund (IMF) has adopted towards transformational reforms
and developments21 (also should be emphasized the substantial role and involvement of IMF in
the post-communist transformations, especially in Georgia).
The program of Shock Therapy was first carried out in West Germany after the Second
World War. Its “second birth” took place in Poland and later on this method was applied in
several other post-communist and post-soviet countries but with different levels of success. 22
Poland's former chairman of National Bank and former Finance and Deputy Prime
Minister, economist Leszek Balcerowicz has identified four historical “transitions” 23:
1. Classical process of transition involving expansion of democracy in dominant capitalist

nations in 1860-1920;
2. Neoclassical transition characteristic to the democratic processes after the Second World
War in some European countries (West Germany, Italy, Spain, Portugal), Latin America
and Asia (Japan, South Korea and Taiwan);
3. Market-oriented reforms after the Second World War in non-Communist countries (West
Germany, South Korea, Taiwan, Chile, Turkey, Mexico, Argentina);
4. Asian model of post-communist transition (China and Vietnam). 24
However Leszek Balcerowicz is particularly famous for the “Balcerowicz Plan” or the
transition program of “Shock Therapy” that was carried out in Poland in the 1990s. This
transition from command economy to market-one is referred to as one of the most successful
post-communist transition stories (if not the most successful one). Success of Poland's current
European integration is also attributed to Shock Therapy as “the right policy set at the right
20
Papava, 2005, op. cit., p. 19.
21
Joseph Stiglitz, More Instruments and Broader Goals: Moving Toward the Post-Washington Consensus, 7 January
1998. Available at: http://www.globalpolicy.org/component/content/article/209/43245.html, (consulted on:
8.4.2014).
22
Naomi Klein, The Shock Doctrine: The Rise of Disaster Capitalism. Picador, New York, 2007, p. 101; Olivier
Jean Blanchard, Rüdiger Dornbusch, Paul Krugman, Richard Layard and Lawrence Summers, “Reform in
Eastern Europe”, in: Journal of Economics, Vol. 59, No. 1, 1994, pp. 118-126.
23
Leszek Balcerowicz, Socialism, Capitalism, Transformation. Central European University Press, Budapest, 1995,
p. 145.
24
Ibid.
11
time”. 25
In his book Necronomics, Georgian economist and former Minister of Economy of

Georgia, professor of economics and author of numerous works on the topic of post-communist
transition and economic reforms in Georgia, Vladimer Papava writes that “the practice has
shown that the Shock Therapy produces the best results in such countries where the status of the
economy before the reforms (or before the “shock”) was so bad that the people were ready to
tolerate whatever was deemed necessary to overcome the existing situation. In that case,
negative effects of the shock are disregarded. Whereas positive ones are so apparent that the
initiators of the Shock Therapy can feel secure from any political threat” 26 and refers to this
extreme action as “Minimal Shock with Maximum Therapy” or “Soft Big Bang”. 27
As already mentioned above, even though Shock Therapy was invented before 1990's, it is
uniquely associated with Poland and Balcerowicz Plan and can even be referred to as “classical”
form of Shock Therapy. 28 This “classical” strategy first of all assumes that the country in which
it is being applied has a form of nation state and possesses all institutions of a nation state. This
was the case for Poland, Hungary and Bulgaria, for example. However, some of the former
soviet republics, former Yugoslavia and Czechoslovakia countries 29, whose administrations were
extremely closely linked to the central one in Moscow and ended up in forming several states
afterwards, did not inherit these state institutions and had to build them from the scratch. Same
holds true for Georgia. The “classical” form of Shock Therapy or Balcerowicz Plan consisted of
eleven policy measures30:
1. Equalization of domestic prices to that of the world market level with acceptance of the
consequential inflation results;
2. Restriction of income growth during inflation;
3. Constraint of money supply and substantial interest rate growth;
4. Stimulation of personal savings by deposit interest rate increase (including cash
deposits);
5. Diminution of budget expenditures by reducing government investment and cutting off
25
Taylor Marvin, Shock Therapy: What We Can Learn from Poland, 11 November 2010. Available at:
http://prospectjournal.org/2010/11/11/shock-therapy-what-we-can-learn-from-poland/, (consulted on:
17.3.2014).
26
27
Ibid. Papava, 2012, op. cit., p. 14.
28
Papava, 1996, op. cit., p. 252; Papava, 2005, op. cit., p. 125 ; Papava, 2012, op. cit., p. 3.
29
Vladimer Papava, Leszek Balcerowicz and Georgia, Georgian Foundation for Strategic and International Studies,
Tbilisi, 2002, p. 4. Available at:
http://gfsis.org/media/activities/thumb1_/pub/files/publications_economics/papava_Leszek_Balcerowicz_And_
Georgia.doc, (consulted on: 2.5.2014).
30
Ibid., pp. 4-5.
12
subsidies from unprofitable business ventures;
6. Issue of government bonds in order to fund budget deficit of the government;
7. Regulation and integration of tax code;
8. Instituting a single rate of exchange for the national currency (in this case for zloty) and
its convertibility on the domestic market;
9. Establishment of a common customs tariff for restricting imports and stimulating
exports;
10. Establishment of a social assistance program to the population by taking into account
budget limits;
11. Rupture of monopolistic activities, promotion of competitiveness among enterprises and
elimination of state intervention in this competition.31
As it can be observed, the listed policies constitute to a “drastic neoliberal package of

liberalizing economic reforms”.32 However, even though this type of policy package is generally
regarded to as substantially aiding the economies in transition, it should be once again noted,
that Poland is exceptional case since its pre-existing conditions, including the “public
institutions, infrastructure, high human development levels and proximity to world markets that
were necessary to succeed in the world economy”33 made the Polish Shock Therapy a success
story. Jackson, Klich and Poznanska classify five central macroeconomic and social changes that
took place in Poland during Shock Therapy34:
1. Strict monetary policy was incorporated, aiming at reduction of money supply and thus
allowing for achieving interest rate that exceeds the inflation rate;
2. Government deficit was diminished mainly through the reduction of subsidies and tax
exemptions;
3. Substantial price liberalization resulted in a situation where market was responsible for
determining price for 90% of the prices and the prices for essential goods, like fuel and
rent were increased;
4. Convertibility, exchange rate and foreign trade for zloty were established and were set to
crawling peg in autumn 1991;
5. State control over the wage indexing was eliminated, allowing for private sector to
regulate the wages. Furthermore, high tax was imposed on wage growth in state
31
Ibid.
32
Marvin, op. cit.
33
Ibid.
34
John E. Jackson, Jacek Klich and Krystyna Poznanska, The Political Economy of Poland's Transition: New Firms
and Reform Governments. Cambridge University Press, New York, 2005, p. 25.
13
institutions (Popiwek).35
As there is no such thing as free lunch in this world, the results of these neoliberal reforms
certainly were not solely positive and the population of Poland had to pay short-term price for
this drastic change, especially when social reforms were being implemented at the same time.
Soon after passing Balcerowicz Plan in December 1989, Poland got swallowed up by a major
recession: increasing unemployment and inflation levels together with falling income levels and
national output. The unemployment reached 11% in 199136, as a result of numerous reasons:
with the decreasing output levels, large number of employees was fired; artificial demand of
communist regime was uncovered, unveiling the inefficiencies of the production firms,
incompatibility of supply-demand and inability of competition on the market;37 energy costs
were increasing due to the inexistence of Soviet subsidies. Nevertheless, it should be underlined,
that the drastic fall of employment statistics was not only due to the freshly incorporated
neoliberal policies of the Polish government. In Soviet Union regime informal workers or
unemployed population were not reported in the official statistics, therefore it is impossible to
speak about exact numbers. Moreover, Poland's GDP drastically fell in 1991, but got back on
track in 1992. Same holds true for the output and investment levels of agricultural and industrial
sectors: they plummet in the 199138 and regained positive growth ability only in 1992-1993.
Moreover, inflation managed to attain 584% in the initial year of Shock Therapy39 and 247% in
199040.
Nonetheless, these unfavorable results did not last long and all economic indicators were
back to “normal” for the beginning of 1992 – after around two years from initialing the
Balcerowicz Plan. Poles were quick to recover from the recession and to embark upon the track
of the market economy by stabilizing currency and inflation, stimulating foreign direct
investments, private industries and trade, which, in turn, contributed to declining unemployment
and rising income levels. Additionally, after more than 50 years of communist regime, its
proximity to European markets and encouraged FDIs allowed for close integration with the
European Union and most importantly, its single market.41
35
Ibid.
36
Kazimierz Z. Poznanski, Poland's Protracted Transition: Institutional Change and Economic Growth. Cambridge
University Press, Cabridge, 1996, p. 179.
37
Marvin, op. cit.
38
Stephen Engelberg, 21 Months of 'Shock Therapy' Resuscitates Polish Economy, 17 December 1992. Available at:
http://www.nytimes.com/1992/12/17/world/21-months-of-shock-therapy-resuscitates-polish-economy.html,
39
Poznanski, op. cit., pp. 193-195.
40
Historic Inflation Poland - CPI Inflation. Available at: http://www.inflation.eu/inflation-rates/poland/historic-
inflation/cpi-inflation-poland.aspx, (consulted on 09.4.2014).
41
Marvin, op. cit.
14
Poland: GDP Growth (%)
6.95 7.09 6.79

6.24 6.23
5.29 4.98 5.34 5.13
4.52 4.26 4.35
3.74 3.87 3.62 3.9
2.51
1.21 1.44 1.63
-7.02
Figure 1 Poland: GDP Growth Rate (%)42
1.2. Gradualism
Gradualism, by contrast to Shock Therapy, involves more “slow, but sure”, or gradual
application of reforms and has been mainly applied in Asian countries, like China (classical
example of gradualist transition), Vietnam, Uzbekistan, Thailand and Malaysia. As opposed to
“Big Bang” or Shock Therapy, Gradualism sees public sector as essential to the support of the
private one43, which, according to some scholars, should be done through privatization, small
and medium-sized enterprise (SME) development and restructuration of large-scale enterprises. 44
According to Vladimer Papava, there are two pivotal conditions that determine the
successful implementation of gradualist reforms 45: first of all, these are the political guarantees
that manage to get positive feedback from the population and allow the government to be in
charge of the national economy at the same time. Sadly, this was not the case in most of the post-
communist reformist countries. 46 Secondly and quite naturally, these are the financial resources
needed for the transition to happen. If the state does not possess enough finances, it is possible to
ask for international aid. One of these types of institutions is International Monetary Fund –
supporter of the Washington Consensus (i.e. Shock Therapy) and big contributor to post-
42
Poland – GDP Growth (Annual %). Available at: http://www.indexmundi.com/facts/poland/gdp-growth,
43
Alam, Nguyen and Majumdar, op. cit., p. 4.
44
Paul Cook, Colin Kirkpatrick and Frederick Nixson, Privatization, Enterprise Development and Economic
Reform. Edward Edgar Publishing, Cheltenham, 1998, p. 4.
45
46
World Bank, From Plan to Market: World Development Report 1996, Oxford University Press, New York, 1996,
p. 9. Available at: https://openknowledge.worldbank.org/handle/10986/5979, (consulted on: 2.5.2014).
15
communist reforms in Georgia. “This means that the gradualist approach, if applied, will require
a government to have huge reserves of its own financial resources, all other things being
equal.”47 Stemming from this theory and from empirical evidence, the success of classical
example of gradualist transition - China - was possible because of the following reasons:
Chinese government was substantially investing in the GDP of the country, consistently
following the gradualist policy approach. Additionally, Chinese companies in the third countries
were massively employing people with Chinese origins. Moreover, the share of population
employed by large state-owned enterprises (SOEs) was only 18%. 48 Therefore, it can be
stipulated that, as in case of Shock Therapy in Poland, Gradualist success in China was a result
of specific domestic context.49
Generally, transition from the command economy to the market-one is composed of six (or
seven, if we include demolition of the old system as a step50) essential steps51:
1. Macroeconomic stabilization;
2. Price liberalization;
3. Foreign trade liberalization and establishment of national currency convertibility;
4. Reform in the enterprise sector, most importantly by the means of privatization;
5. Introduction of the social security system;
6. Foundation of an institutional and legal infrastructure necessary for the market
economy. 52
These steps represent general frameworks and during the strategy implementation each of
them might be divided into several sub-policies (macroeconomic stabilization might be
comprised of monetary and fiscal policies), whereas some of the steps might be combined
together under one main framework53 (stabilization and price liberalization, like in the case of
Poland's policy, might be closely intertwined with each other, as macroeconomic stabilization
cannot be achieved without price liberalization54). However, the speed of implementation of
these steps varies by their sense. The first three steps can be carried out rapidly and thus are
more typical to Shock Therapy, whereas the latter three steps need more time and are regarded as
47
48
Ibid., p. 21.
49
Ibid., p. 22.
50
Hare and Turley, op. cit., p. 2.
51
David Lipton, Jeffrey Sachs, Stanley Fischer and Janos Kornai, “Creating a Market Economy in Eastern Europe:
The Case of Poland”, in: Brookings Paper on Economic Activity, Vol. 1990, No. 1, 1990, pp. 75-147. Available
at: http://earthinstitute.columbia.edu/sitefiles/file/about/director/pubs/brookings0490.pdf, (consulted on:
2.5.2014).
52
Ibid; Hare and Turley, op. cit.
53
Charles Wolf, Market or Governments: Choosing between Imperfect Alternatives (2nd edition). MIT Press,
Cambridge, 1993, pp. 170-176.
54
Marvin, op. cit.
16
relatively more longer-term policies55 (since establishing institutional and legal infrastructures
cannot be done overnight). Following this position, some will argue that the state should start
getting the Shock Therapy treatment only after having properly functioning reformed
institutions56 and that most appropriate transition strategy is the combination of the two
discussed paths.
As already mentioned, SME development is one of the crucial points of transition and the
two paths try to manage it in relatively different ways, varying by the level of importance of
public sector in the process. In the CEE countries the SME development policies have involved:
macroeconomic policy, institutional framework, administrative legal policy, sectoral, regional
and problem-oriented policy, financial support, and support through the provision of
information, consultancy and training 57 (in Poland the instruments were grouped in the following
manner: legal and regulatory, financial, organizational, and knowledge dissemination
instruments58). Because of the industrialized heritage from the communist and/or Soviet era and
the proximity to the EU (allowing for more financial or expert support), the SMEs in CEE
countries have been growing remarkably59. Asian experience involved the following key
policies: access to modern technology and scientific achievements, human resource
development, finances, global market and networking in the business world. 60 It can be
concluded that “irrespective of the country concerned, transitional approaches or industrial
background, SMEs still face familiar problems and need adequate aid from government policies,
because private enterprises cannot operate in an imperfect market without support from
institutions in general or government and the public sector in particular.” 61 Public sector is
responsible for preparation and development of all state institutions and infrastructure necessary
for free market environment.
55
World Bank, 1996, op. cit., pp. 9-11.
56
Joseph E. Stiglitz, Whither Reform? Ten Years of the Transition, World Bank Annual Bank Conference on
Development Economics, Washington D.C., 28-30 April 1999, p. 19. Available at:
http://siteresources.worldbank.org/INTABCDEWASHINGTON1999/Resources/stiglitz.pdf, (consulted on:
2.5.2014).
57
58
Aleksander Surdej, “Small- and Medium-Sized Enterprise Development in Poland after 1990”, in: Working Paper
No. 216, The United Nations University, World Institute for Development Economics Research (WIDER),
1990, pp. 15-21. Available at: http://www.wider.unu.edu/publications/working-papers/previous/en_GB/wp-
216/_files/82530864970541738/default/wp216.pdf, (consulted on: 2.5.2014).
59
60
Ibid.
61
Ibid.
17
2. Post-Communist Reforms in Georgia
Dr. Vladimer Papava, former Minister of Economics of Georgia in the years of 1994-2000
and a Member of Parliament in 2004-2008, is an author of more than two hundred publications,
including the ones on post-communist transitions in Georgia, and Caucasus. In number of these
works he identifies several periods of economic development or transitions in Georgia and
divides them in stages, depending on the reforms undertaken during each of the stages or stalling
of reforms.
Georgia regained independence from the Soviet regime in 1991 after the final
decomposition of the USSR, however, according to Dr. Papava and Ronald Grigor Suny, “the
period from 1989, when the idea of national independence embraced the whole society, should
be considered as a starting point for the post-communist reform reasoning in Georgia” 62. Starting
from this moment in the first period of transition (immediate post-communist transition) until
Rose Revolution, Dr. Papava identifies 5 main stages of reforms63:
2.1. Stage of Naive Comprehension

The first stage started with the dissolution of the Soviet Union with the first discussions on
new economic strategies of the country and a “turning point” “when the Georgian society
embraced the idea of independence”. 64
2.2. Stage of No Movement or Stage of Stagnation

The starting point of this stage is considered to be the election of the Supreme Council in
autumn of 1990, following which several new reformist economic laws were passed, however
with unsuccessful implementation. 65
2.3. Populist Stage of Reform or Shock Therapy

Following the coup d’état of 1991-1992 Georgian government started carrying out several
redistributive policies which turned out to have unforeseen negative effects: the policy of the
state of transferring land and accommodation to the population for free, harmed agricultural and
residence building sectors. The absence of legal basis for privatization and of payments for
dwellings deteriorated supply and employment of the agricultural equipment. It was exactly
during this phase of populist policies that the Shock Therapy approach was put into practice in
Georgia in February 1992 (nearly simultaneously with Russia's application of Shock Therapy
62
63
Papava, 1996, op. cit., pp. 251-262; Papava, 2005, op. cit., pp. 123-136; Papava, 2012, op. cit., pp. 1-14.
64
Papava, 1996, Ibid., p. 251.
65
Ibid., Papava, 2005, Ibid., pp. 123; Papava, 2012, Ibid., pp. 1.
18
and with quite identical framework).66 In order to assess the success or failure of this method in
Georgia, we can analyze the 11 steps of reforms of the Balcerowicz Plan listed in chapter 1.1.
Shock Therapy:
1. With the aim of achieving market balance, domestic prices were equalized to that of the
world market level through the introduction of liberal prices for certain types of goods
starting from spring 1991 (first stage) through February 1992 (second and more
extensive stage). For number of products and services the prices were liberalized, while
for the other group controlled prices notably grew.67 “If the consumer price index stood
at 1.8 in 1991, it rose to 25 in 1992. At the same time, it is noteworthy that the regulated
consumer prices increased sixty-eight times in 1992 in comparison with those of 1991
(100 times for bread, the main food product in Georgia).”68 Therefore, the first step was
successfully implemented.
2. In 1991 the minimum wage and social security benefits of Georgia were adjusted for the
changes in the world economy. In 1992 the indexation was performed six times because
the price liberalization was already in action. “In 1991 the minimum wage and the
average wage of employees increased in comparison to the previous year by 1.85 times
and 1.26 times, respectively; and in 1992 compared with 1991 by 13.14 times and 17.94
times, respectively.”69 In contrast with Poland, Georgia did not employ austere control
measures for wage increases, however the level of wage and social security benefit
growth was not in accordance with the overall price level growth, “thus, it can be
considered that item two of the Balcerowicz Plan was also, to a certain extent, more or
less fulfilled in Georgia”.70
3. “In 1992 in comparison with 1991, the interest rate on deposits increased from 2% 71 to
5% per annum, and the interest rate increased from 9% to 80% for ten-year deposits.
Such an increase of interest rates was still far from reflective of the actual inflation
rate.”72 Old rubles from USSR and newly issued Russian rubles operated on Georgian
territory, the country did not possess its own monetary system, therefore constraining of
money supply could not be achieved.73
66
Papava, 1996, Ibid., pp. 251-252; Papava, 2002, op. cit., p. 5; Papava, 2005, Ibid., pp. 123-124; Papava, 2012,
Ibid., pp. 1-2.
67
Papava, 1996, Ibid., p. 253; Papava, 2002, Ibid; Papava, 2005, Ibid., p. 126; Papava, 2012, Ibid., p. 4.
68
Papava, 2012, Ibid.
69
Ibid; Papava, 2005, op. cit., pp. 126-127.
70
Papava, 2005, Ibid., p. 127; Papava, 2012, Ibid., pp. 4-5.
71
“Percent“and “per cent” were substituted by “%” in all quotes for the consistency of the thesis.
72
Papava, 2005, Ibid; Papava, 2012, Ibid., p. 5.
73
Ibid; Papava, 1996, op. cit., pp. 253-254; Papava, 2002, op. cit., p. 6.
19
4. In July 1992 there was an attempt of stimulation of personal savings: the decision to
increase all cash deposits by doubling the devalued ones and assigning them a deferred
account property was made, meaning that the savings could grow on a tax-free basis until
their withdrawal. The logical answer to this decision was increased cash deposition by
the Georgian population which was followed by extension of deposition period by
additional 10 days. Withdrawal of the cash deposits was allowed only in one year after
being doubled. However, it came as a big downside that it was impossible to procure
necessary amount of ruble banknotes from Moscow in a timely manner, therefore the
salaries and pensions were paid from these banknotes on the deposits, meaning that the
state could not impose tight policy on money supply. 74 Therefore, the stimulation of
personal savings could not be achieved either.
5. The state did not diminish the budget expenditures by reducing government investment in
1992 and it stayed in the range of 20%-25%. Despite the fact that the subsidies in the
same year had a fivefold growth compared to preceding year, percentage of subsidies in
the state budget expenditures was reduced to 30.1% from 47% of 1991. However, this
cutback was not enough, therefore this step was also unsuccessfully implemented. 75
6. Issue of government bonds was fulfilled already in 1992, however they were issued for
sale in the second half of 1993 with the general purpose of converting Former Soviet
Union bonds into brand new Georgian ones. Utilization of these bonds in order to fund
budget deficit of the government did not happen for several years from their issue. 76
7. Even though it still needed reworking and re-regulation, reform and integration of new
tax code of Georgia started already in 199177, so this step was also achieved.
8. Instituting a single rate of exchange for the national currency and its convertibility on
the domestic market was simply impossible to achieve because of nonexistence of
Georgian national currency at the time. 78
9. In the year of 1992, 2% on imports and 8% on exports customs tariffs were set in
Georgia, which is completely contrary to the aim of establishment of a common customs
tariff for restricting imports and stimulating exports. So this goal also failed to be
achieved.79
74
Ibid.
75
Papava, 1996, Ibid., p. 254; Papava, 2002, Ibid; Papava, 2005, Ibid., pp. 127-128; Papava, 2012, Ibid.
76
Papava, 1996, Ibid; Papava, 2002, Ibid; Papava, 2005, Ibid., p. 128; Papava, 2012, Ibid., p. 6.
77
Ibid.
78
Ibid.
79
Papava, 1996, Ibid; Papava, 2002, Ibid., pp. 6-7; Papava, 2005, Ibid; Papava, 2012, Ibid.
20
10. As already noted in the second point of the 11-point plan, wage indexation was already in
action in Georgia starting from 1991. “All incomes were adjusted by the same
proportionate amount, so that the poorest paid got a smaller increase than the higher paid.
Since price raises were particularly heavy on basic items, such as bread, the poor suffered
more than those with higher incomes.”80 “As a result, the real minimum wage in 1992
amounted to only 86% of that of 1991. [...] Targeted assistance to the families most in
need was inadequate.”81
11. There was a first attempt of rupture of monopolistic activities and promotion of
competitiveness in 1992 by legal and governmental resolutions and decrees, however
they were not successfully applied. Despite its rupture, quite a number of features of
Soviet centralized procurement were still in place, one of them being state interference in
the enterprise functioning.82 Therefore, this last step of Balcerowicz Plan also failed to be
achieved.
To sum up, only three steps (first, second and seventh points) of Balcerowicz Plan were
realized in Georgia in the 90’s. Nonexistence of own national currency, of autonomous monetary
system and basing Shock Therapy approach solely on price liberalization was simply “doomed
to failure”83, which, in turn, caused extensive delays in the economic development of the
country.84
2.4. Stage of Delay or Stage of Accumulation of Mistakes

Criminal and Military Situation
Lasting from 1993 until autumn 1994, the stage of delayed economic reforms in Georgia
occurred on the one hand due to incorrect economic policies and on the other hand – due to
erupted criminal and military situation. Georgian economy severely suffered from the Abkhazian
war, the civil war and the military coup d’état, all in 1988-1993. Together with general amnesty
in winter 1992, the country experienced major increase in the criminal operations at the time.
The described situation made it extremely difficult to approve the national budget in a timely
manner, while also harming the budget itself. The market operations were almost impossible to
conduct, therefore many businesspeople fled to foreign countries, which, in turn, had a declining
impact on the financial capital of the country. Racketeering reached unprecedented levels, while
not generating wealth for the country since most of these criminals were addicted to drugs and
80
Papava, 1996, Ibid.
81
Papava, 2012, op. cit.
82
Ibid; Papava, 2002, op. cit., p. 7.
83
Papava, 2012, Ibid., p. 7.
84
Ibid; Papava, 1996, op. cit., p. 255; Papava, 2005, op. cit., 129.
21
the income generated from selling stolen goods was mostly going outside the country to acquire
more illegal drugs. 85 “This criminal activity deepened and prolonged the agony of civil war and
impeded the resumption of economic activity and reform.” 86
Currencies and Credits
The single solution to fund the severe budget deficit was to issue more money. Because of
past experience of inability to procure rubles from Moscow, Georgian government anticipated
the same scenario and decided to substitute ruble by its own temporary currency “coupon”,
issued by the National Bank of Georgia (NBG)87. “The coupon was a supplement to the rubles in
circulation and was priced to exchange one-for-one with the ruble. It could be used for all
purchases except for those goods originally purchased with rubles (e.g., petrol and other imports
from Russia).”88 The decision seemed feasible and could be seen as a first step towards
approving the Georgian national currency, however the coupon was simply the banknote
substitute for ruble and in addition to nonexistence of small banknotes, and population had no
other choice but to accept change in rubles. 89 The National Bank was unable to control the
circulation, so the drastic devaluation could not be avoided (at one point one bread would cost
five million coupons). In fact, they believed that they would be able to stay in the ruble zone
forever and regarded coupon as a solely temporary measure. However, Russia withdrew all the
banknotes at the end of summer 1993 following their currency reform. Only then the Georgian
government and National Bank realized that they had no other choice but to issue own national
currency. 90
“Uncontrolled credit emissions were the foundation of the inflationary process in Georgia.
Attempts to solve agricultural problems (e.g., the procurement of agricultural products in autumn
1993 and carrying out essential agricultural work in spring 1994) from a budget that had been
practically nonexistent since the autumn of 1993 had resulted in initially unreported budgetary
emissions that finally ruined the financial system of the country. Georgia developed a
hyperinflationary spiral, with the inflation rate proceeding at some 60-70% per month from 1993
until autumn 1994. In the long run, this money was not, unfortunately, used for agricultural
purposes. In conditions of such high inflation, the coupon could not perform the normal function
of sustaining commercial turnover because the real value of the coupon supply was constantly
85
Papava, 1996, Ibid; Papava, 2005, Ibid., p. 130; Papava, 2012, Ibid., pp. 7-8.
86
Papava, 1996, Ibid.
87
The Incredible Shrinking Ruble, and the Introduction of the Lari. Available at:
http://www.unc.edu/~pconway/teccours/lari.htm, (consulted on: 14.4.2014).
88
Ibid.
89
Ibid.
90
Papava, 2005, op. cit., p. 131; Papava, 2012, op. cit., p. 9.
22
falling. Other things being equal, this promoted wider use of the ruble instead of coupon as a
means of payment.”91 Inexperience of the NBG in handling currency and credits resulted in
decline of cash and limitation on even the liquidity of bank deposits. 92 “A considerable
discrepancy developed between the value of cash and non-cash money. At the same time the
provision of easy overdraft facilities by the state banks promoted hidden credit emission. The
subsidies for bread, gas, electricity and transport further extended the budget deficit and the
requirement for credit.”93
Foreign Trade
The single solution to procure gas from Turkmenistan was believed to be barter, price of
which, as well as of some of the Georgian low-grade products, was artificially boosted,
therefore, the economists of that time thought that the barter would be a good idea to encourage
businesses. But the problem with gathering enough goods for this barter was the “non-payment
network”94 which meant that due to the budget deficit the Georgian government was unable to
purchase this low-quality production (which was supposed to be the case at the time for the
production). The additional money issue by NBG in order to finance this acquisition contributed
to the further currency inflation. Majority of these goods were obtained by the “state order
system” whereby the government promises the businesses to pay them for the obtained
production in future for the respective price. The business owners faced difficult financial
circumstances, causing a series of non-payments.95
In addition to all the economic trouble, a couple of railroads got blocked because of the
war in Abkhazia and the tense situation in Azerbaijan, making the above mentioned barter with
Turkmenistan hopeless. Consequently, Georgia's slightly more than two-year debt to
Turkmenistan equaled to approximately $0.5 billion, by which the total external debt reached $1
billion.96
Other Problems
Using credits designed for energy sector development for other causes put the country in
even worse situation: the constant breakdowns of the electricity power plants, overly frequent
theft of the electric hardware (mostly for copper which was later being sold in Turkey 97), no
91
Papava, 2005, Ibid., pp. 130-131; Papava, 2012, Ibid., p. 8.
92
Papava, 2005, Ibid., pp. 131; Papava, 2012, Ibid., pp. 8-9.
93
Papava, 1996, op. cit., p. 256.
94
Papava, 2005, op. cit., p. 131; Papava, 2012, op. cit., p. 9.
95
96
Papava, 1996, Ibid; Papava, 2005, Ibid., p. 132; Papava, 2012, Ibid.
97
Iza Natelauri, “Georgia's External Sector: Current State and Problems”, in: The Caucasus and Globalization, Vol.
1 (4), 2007, p. 58. Available at: http://cyberleninka.ru/article/n/georgia-s-external-sector-current-state-and-
problems, (consulted on: 3.5.2014).
23
repair or maintenance of the damaged equipment.98
The privatization process was disrupted in 1992 and 1993 because of disregard of worker's
right and code, consequently the enterprises ended up transforming into joint-stock companies.
Also, the mass illegal activities and black-booking made it practically impossible to control the
enterprise actual capital movement and easier for these firms to hide taxes and contribute even
more to the economic recession of the country. 99
Dr. Papava describes this stage as “characterized by extremely imperfect recordings of

foreign economic activities, inefficient customs procedures, extensive commodity stock waste,
decline in the economic role of normal wages, unrecorded expansion of the shadow economy,
and the uses of humanitarian aid for purposes other than those intended. Overall, the picture of
the Georgian economy was exceedingly bleak.” 100
2.5. Reforms Resumed or Stage of Correction of Errors

Georgia could not stay in this “bleak” situation for a long time, so the state president at
time, Eduard Shevardnadze, instigated the development of a program to fight the crisis in spring
1994, however it was impeded by non-economic factors. Even though the Abkhazian war was
already left behind, its consequences still had to be dealt with, including social protection and
housing for internally displaced persons (IDPs). Criminal situation was still a big issue in spite
of the increased combat against the criminals. Economic production was kept low by many
enterprises just because they were afraid to seem too attractive to the robbers.101
At the same time, the question of national currency finally was coming to a solution. Even
though coupon had its supporters and opponents, several internal and external factors (including
standard policy of IMF on aiding only the states with own national currencies, extensive support
of Kutaisi city authorities in favor of coupon, strengthening of the coupon and increased
devaluation of ruble) resulted in more focus on coupon by Georgia. In 1994 the National Bank
imposed control on money emission and on banking system according to widely applied Western
methods, and, under the IMF insistence, lifted up the constraints on the cash deposit
withdrawal. 102 These measures “prevented state-owned commercial banks from continuing to
work in overdraft conditions”103 and resulted in a situation where “cash and non-cash money
values drew considerably closer to each other [and in] commercialization of government-owned
98
Papava, 1996, op. cit., 257; Papava, 2005, op.cit., p. 132; Papava, 2012, op. cit., p. 10.
99
Ibid.
100
Papava, 2005, Ibid; Papava, 2012, Ibid.
101
Ibid; Papava, 1996, op. cit.
102
Papava, 1996, Ibid., p. 258; Papava, 2005, Ibid., p. 133; Papava, 2012, Ibid., pp. 10-11.
103
Papava, 1996, Ibid.
24
banks.”104
Involvement of IMF in the reforms of this period were crucial, since Georgian experts and
economists lacked experience and expertise needed for transition to the market economy.
Therefore, it was again part of the IMF’s plan to liberalize prices of gas, electricity and bread
(which increased by 285 in order to bring it to equivalent level as the market). Share of social
assistance and pensions in the budget also grew, however it did not correspond to the changes in
the above-mentioned prices.105 “This enabled a great reduction in the budgetary subsidies needed
to cover the discrepancies between consumer and producer prices, or between producer prices
and actual costs. A substantial strengthening of the Georgian coupon rate thus followed. Whereas
one dollar was worth 5.3 million coupons before the price rise on bread, one dollar was already
valued at 2.4 million coupons after the price rise [...] At the end of 1994 the price of bread
increased again by 40% and as a result a stable coupon exchange rate was established (one
dollar= 1.3 million coupons)”.106 But, unfortunately the coupon decline was subject to
speculation by many organizations, including banks. Also, the prices of gas and electricity were
increasing perpetually. However, in spring 1995 these prices were reduced by 35% and 25%,
respectively and a state-owned energy enterprise Sakenergo was designated with gas
procurement. In 1995 the quota system was annulled, and the licensing got limited to certain
goods.107
In the first half of 1995 Georgian national budget was approved after two years of “break”.
One of the main successes was that extra money was not issued to finance the budget deficit. 108
“In 1995, only 47% of the expenditures of the national budget were covered by taxes, and the
remaining 53% had to be covered through the monetization of wheat and flour received as
humanitarian aid (mobilizing proceeds of sales in the national budget).”109 This would have been
unattainable without the external financial aid and loans from IMF, World Bank and donor
countries. However, the scheduled achievements did not took place, so the loans (one billion
USD external debt110) had to be restructured: $44 million from as a second tranche and $113
million as a stand-by credit from IMF, all for more stabilization and emission of new Georgian
currency “lari” with more caution than the coupon. 111
In the mid-summer of 1995 bread price grew by 7%, compared to state budget employees
104
105
Ibid; Papava, 1996, op. cit; Papava, 2005, op. cit.
106
Papava, 2012, Ibid., p. 12.
107
Ibid; Papava, 1996, op. cit., pp. 258-259; Papava, 2005, op. cit., pp. 134-135.
108
Papava, 1996, Ibid., p. 259; Papava, 2005, Ibid., p. 135; Papava, 2012, Ibid., p. 13.
109
110
111
Ibid.
25
wage increase of 50% (minimum wage equaled to $2.69 and the maximum wage – to $12.69,
compared to almost ten cents and a bit more than one dollar, respectively, in autumn 1994).
Following the end of state monopoly in bread prices, final price liberalization was supposed to
happen soon.112
Regarding the reforms in other spheres, health insurance program was initiated. Also,
privatization was encouraged, involving distribution of social property vouchers for free 113, with
the objective of giving equal chance of asset acquisition to everyone. 114
Dr. Vladimer Papava refers to the Georgian Shock Therapy program of 1994-1995 as
“Minimal Shock with Maximum Therapy” or “the Soft Big Bang” and regards is as necessary in
a case where a country's future seems very blurred and questionable. 115
2.6. Leszek Balcerowicz - Economic Advisor in Georgia

The first time Leszek Balcerowicz visited Georgia was in autumn 1995 in the beginning of
introduction of a new currency lari which represented final step of the Shock Therapy
application in Georgia. The first visit involved consultations with the government agencies and
ministries about the issues and progress of the transition process and reforms. According to
Vladimer Papava, who held a position of Minister of Economy of Georgia at the time,
Balcerowicz was positively surprised by the fact that the older people who were holding higher
positions in the ministry and who have worked for State Planning Committee in the soviet times
were so open-minded and flexible towards market economy, while in Poland the Planning
Committee was never transformed into Ministry of economy, but rather was exterminated. One
of the exceptional steps that Georgian Ministry of Economy, or more precisely by the Minister of
Economy Mikheil Jibuti, made in 1992-1993 was the initiation of indicative planning, at the
time unprecedented in the post-communist area.116 It involves conducting market analysis by
observing the economic production and input, in order to distribute the analysis and forecasts to
the private sector, which acts independently. 117 “It was assumed that under the conditions of
market economy, indicative plan would play a role of economic development program and that
every interested person would find in such a plan some “food” for the economic sector of his
112
Papava, 1996, Ibid; Papava, 2005, Ibid; Papava, 2012, Ibid.
113
Avtandil Silagadze and Teimuraz Beridze, “Note on Privatization in Georgia”, in: B. Kaminski (ed.), Economic
Transition in Russia and the New States of Eurasia, Vol. 8, M. E. Sharpe, New York, 1996, p. 356.
114
Papava, 1996, op. cit., p. 260; Papava, 2005, op. cit., p. 136; Papava, 2012, op. cit., p. 14.
115
116
Papava, 2002, op. cit., pp. 9-10.
117
Charles F. Schwarz, Edward C. Thor and Gary H. Elsner, “Wildland Planning Glossary”, in: General Technical
Report PSW-13, Berkeley, California, U.S. Department of Agriculture, Forest Service, Pacific Southwest Forest
and Range Experiment Station, pp. 98-99. Available at:
http://www.fs.fed.us/psw/publications/documents/psw_gtr013/psw_gtr013.pdf, (consulted on: 3.5.2014).
26
interest”.118 According to Mr. Papava, at the time of Balcerowicz's first visit, Georgian “Ministry
of Economics was, […] the best model of good government, as it played the least possible role
in economic life and provided maximum liberty to competitive market forces for the benefit of
economic development.”119
Following the presidential elections held in 2000, Georgian government decided to invite
Leszek Balcerowicz as an economic advisor for the state president. Funding for this was
provided by the government of the USA120. Balcerowicz took the position of a president of a
central bank of Poland right after his approval as an economic advisor for Georgia, therefore his
visits were not frequent. Though, his presence was not so necessary since his advisory team of
highly qualified professionals was always in Georgia and therefore he had the access to all the
necessary information. It is crucial to remark, that most of the recommendations that
Balcerowicz made to Shevardnadze were kept under secret and only few were revealed to the
public121:
 Identify as soon as possible the desirable economic direction and system of the country.
Georgian government made this decision in 1995 by adopting the constitution and then in
2000 by voting in the elections, but because of Georgians' lack of knowledge of the
electoral program, nobody in the Balcerowicz team was informed about it and there were
still inconsistencies within the government on desirable strategies;
 Achieve more coordination inside the Georgian government. This could not be achieved
because of the very opposing views on the policies within the government, several
examples of which are provided in the following recommendation points;
 Substitute progressive income tax (12%, 15%, 17% and 20% tax rates) by proportional
system (fixed 15%). This would extremely benefit two major points: simplification of tax
operations and population's willingness not to hide taxes anymore (or hide fewer taxes, at
least). Vladimer Papava also supported this idea of “Tax Therapy” 122, however the
utilitarian views of other government officials, and mostly of the Minister of Finance,
this did not happen and in fact, the upper limit of the income taxed was increased;
 Annul the decree of 2000 according to which state companies were transferred from the
Ministry of State Property Management to corresponding ministries. This kind of transfer
obviously was causing conflict of interests and represented a “clearly Communist-style
118
119
Ibid.
120
Macroeconomic Policy Advice to Georgia. Available at: http://www.case-research.eu/en/node/52046, (consulted
on: 3.5.2014).
121
Papava, 2002, op. cit., pp. 11-13; Papava, 2012, op. cit., pp. 36-37.
122
Papava, 1996, op. cit., p. 261.
27
decree”. Ministers of Economy, Health and Social Protection at the time were against this
decree and were openly denouncing it even before its approval, but in vain.
 Create a private pension scheme. By taking into account the limitations of Georgian state
budget, this idea seemed more feasible. However, the government was more in favor of
doing two things at the same time: formation of the private pension scheme and
restructuring of current state one. Again, because of the budget deficit and debts making
the two happen was impossible. Therefore, the decision to maintain the already-in-
progress restructuring of the state pension scheme was made. 123
It is highly possible that even more recommendations of the Balcerowicz team were not
taken into account by the Georgian government, especially if we recall that they were strictly
confidential and it’s highly possible that the reason why they were kept so was not to incite more
public criticism towards the Georgian government.124
These recommendations were not taken into account first of all because of the lack of
above-mentioned coordination among the government officials on the desired direction of the
economic policies, and secondly, because of possible lack of economic knowledge or expertise
of the market economy (despite Mr. Balcerowicz's astonishment with Georgian economists'
open-mindedness).
123
Papava, 2002, op. cit; Papava, 2012, op. cit.
124
Papava, 2002, Ibid., p. 13; Papava, 2012, Ibid., p. 37.
28
3. Post-Rose Revolutionary Reforms in Georgia
“The Rose Revolution in Georgia was quickly hailed in the West as a democratic success
story, inspiring a series of other “people-powered revolutions,” such as the ones in Ukraine,
Lebanon, and Kyrgyzstan.”125 Rose Revolution in Georgia took place on 22-23 November of
2003 and was “a hybrid of spontaneity and careful preparation” 126. Georgia's history is full of
bloodshed and wars, Tbilisi has been burnt down more than three dozen times and Rose
Revolution was the first revolution without this kind of experience. 127 Country's newly elected
(2004) western-educated, active, charismatic leader, who speaks several foreign languages
fluently, appeared as a sign of rescue and hope. Georgian nation always had hope and trust in the
one and only leader who should have been a shepherd of the nation towards better life and
comfort, visualization of which we can see by examining the Caucasus Barometer time-series
dataset for the following question: ”Please tell me which of the following statements you agree
with:
1. People are like children, the government should take care of them like a parent;
2. Government is like an employee, the people should be the bosses who control the
government.”128
Nearly half of the Georgian population still believes that government should be like a
parent, rather than an employee. Unfortunately, the dataset for the pre-revolutionary period or for
the following several years does not exist, but the trend of the attitude of the population is not
hard to guess. (Also, the decline in the demand for government's “parenting” in 2008 can be
attributed to the five-day Georgia-Russia war in the August of the same year, especially taking
into account its immediate post-war effect, since the survey is being conducted in October-
November every year).
125
Devi Khechinashvili, Georgia After the Rose Revolution: An Opportunity Lost?, Center for International Private
Enterprise, Washington D. C., 2005, 5. p. Available at: http://www.cipe.org/sites/default/files/publication-
docs/103105.pdf, (consulted on: 3.5.2014).
126
Neal Ascherson, “After the Revolution”, in: London Review of Books, Vol. 26, No. 5, 2004, p. 4. Available at:
http://www.lrb.co.uk/v26/n05/neal-ascherson/after-the-revolution, (consulted on: 3.5.2014).
127
Ibid.
128
Caucasus Barometer Time-Series Dataset Georgia: Government as Parent vs Government as Employee (%).
Available at: http://caucasusbarometer.org/en/cb-ge/GOVTROL/, (consulted on: 23.4.2014).
29
GOVTROL: Government as parent vs government as
employee (%)
Parent Employee DK/RA
54
52
47 48 48
42 43
41 40
37
35
16
12 11 12
10 9
2008 2009 2010 2011 2012 2013
Figure 2. Caucasus Barometer: Government as Parent vs Government as Employee (%)129
“Mikheil Saakashvili is 36 years old, dark and already a bit joufflu, wildly talkative and
often indiscreet. His own rhetoric is ebullient. He will break down Georgia’s monstrous
corruption, bring order to the chaos of state finances, set the nation on a course towards the
European Union, get rid of the Russian military bases, deal (we don’t yet know how) with the
ten-year-old secession of Abkhazia. At the presidential election on 4 January (clean, barring
irregularities described by foreign observers as “frequent but not systematic”), he got 97% of the
votes on an 83% turnout. Everybody wants to share his optimism, and to believe in their own
vaulting expectations. But Georgians have seen a lot of false dawns. Their deepest expectation,
currently repressed, is that their expectations will be disappointed. They talk lovingly about “our
baby president” and his pretty Dutch wife, Sandra, who has learned Georgian. But they want to
see results as well as words.”130
After presidential elections of 2004, doubts have been raised regarding the new
government's and president's capabilities. However, Georgia's former Prime Minister Zurab
Zhvania “sought to dispel these doubts regarding the ability of Georgia’s new government to
make good on its promises to improve political and economic life in Georgia.” 131
129
Ibid.
130
Ascherson, op. cit.
131
Zurab Zhvania, “After the Rose Revolution: Building Georgia’s Future”, CSIS Statesmen’s Forum, Center for
Strategic and International Studies, Washington D. C., 26 April 2004, p. 1.
30
3.1. What Was Right and Wrong Before the Rose Revolution? Political Inheritance
of Saakashvili
The revolutions happen for a reason. Therefore it would not be a surprise if we said that
there was little good news in Georgian economy in the pre-revolutionary era. Monetary system
(exchange rate for lari) and economic growth were the only stable economic indicators.
However, compared to the first half of the 90's (where inflation reached even 70% per month in
1994 and GDP declined by three), consistent improvement of indicators can be observed (Figure
3). The downfall of GDP growth in 1998 and inflation increase in 1998-1999 were the result of
Russia’s default spillover, therefore internal decisions cannot be blamed for these. The launch of
Tbilisi-Baku-Ceyhan oil pipeline resulted in the GDP growth up to 11.1% for 2003.132
1995 1996 1997 1998 1999 2000 2001 2002 2003
GDP 2.6 11.2 10.5 3.1 2.9 1.8 4.8 5.5 11.1
End-of-period
57.4 13.7 7.2 10.7 10.9 4.6 3.4 5.4 7.0
Consumer Prices
Figure 3. Annual Growth of GDP133 and Inflation Rate in Georgia, 1995-2003 (%)134
On the other hand, the black market was still playing a substantial part in practically all
economic spheres: for the same year the annual GDP missed out on 67.5% of taxes on average
just because of shadow economy in the country.135 This untaxed income was not to the large
extent comprised of legitimate activities without official incorporation.
Additionally, the forecasted inflation for 2003 equaled to maximum 7%, whereas in the
first half of the year the actual observed rate was 1.9%. Increase in the inflation in November
happened due to the pre-revolutionary heat, political ambiguity and 136 “provocative statements
made by the government officials about the diminished supply in the Georgian market and the
inevitable growth in prices of consumer goods because of the approaching revolution”.137 Even
so, the actual inflation did not exceed forecasted 7%, mainly because of the Georgian National
Bank's stable monetary policy. 138
Consequently, it can be concluded that the economic indicators did not contribute that
132
Papava, 2012, op. cit., p. 38-39.
133
GDP Growth (Annual %). Available at: http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG, (consulted
on: 3.4.2014).
134
Wojciech Maliszewski, Modeling Inflation in Georgia, IMF Working Paper, WP/03/212, November 2013, p. 4.
Available at: http://www.imf.org/external/pubs/ft/wp/2003/wp03212.pdf, (consulted on: 3.5.2014).
135
136
Ibid.
137
Ibid.
138
Ibid.
31
much to the Rose Revolution, especially because of the fact that supply and demand were in
good terms with each other. But there were other problems, budgetary ones. The effect of
Russian default in 1998 was devaluation of lari, which, in turn, created considerable holes in the
state budget. 1999 budget deficit amounted to $150 million (30% of forecasted tax revenues).
This had a couple of additional reasons besides under-collection of forecasted taxes: under-
collection of non-tax revenues, and inability to collect grants and loans from international donors
(mainly because of misimplementation of IMF programs, causing suspension of the programs).
Moreover, the tax code got so ambiguous and puzzling after numerous amendmends, that
corruption became a popular way out. Furthermore, some territorial parts of Georgia were not
under control of the central government, which also created holes in the tax revenues. 139
Consequently, the state government itself engaged in illegal activities in order to make ends
meet: “the practices of compelling companies to pay taxes in advance, returning collected taxes
to taxpayers by means of forged documents, filing fictitious offsets, and artificially raising prices
of public procurements so that they could pocket the difference between official and actual
prices, [...] fictitious increases in planned non-tax revenues of the national budget.”140
In the year of 2003, state budget deficit amounted to $90 million (15% of forecasted
budget revenue) and at the end of the year it was unable to pay salaries and pensions (internal
debt amounted to $120 million, 57% of which was the share of unpaid pensions despite the fact
that monthly pension was $7 at the time). Consequently, the national poverty reached 52%.141
Naturally, the energy crisis responsible for many cold and unheated winters, the budgetary
failures, followed by related corruption, irresponsibility of the government towards the
population and their social security, increased poverty level and lost control over some parts of
Georgian state territory, contributed to the happening of the Rose Revolution and represented the
“package” that Saakashvili and his government assumed from Shevardnadze's presidency.
3.2. Successful Post-Revolutionary Reforms

Reinstating control over Adjara
The first successful change that Saakashvili brought to the country happened in May
142
2004 when he reinstated state control over the region or the Autonomous Republic of
Adjara143, which was headed by Aslan Abashidze, wealthy Georgian with close ties with
139
Ibid., pp. 40-42.
140
Ibid., p. 42.
141
Ibid., p. 43.
142
Saakashvili's Ajara Success: Repeatable Elsewhere in Georgia? Europe Briefing No. 34, 18 August 2004.
Available at: http://www.crisisgroup.org/en/regions/europe/south-caucasus/georgia/b034-saakashvilis-ajara-
success-repeatable-elsewhere-in-georgia.aspx, (consulted on: 18. 4. 2014).
143
Other versions of English spelling for the Georgian region of “Adjara” (like “Achara” or “Ajara” have been
32
Russia. 144 Even though Adjara had not declared independence unlike two other regions of
Georgia, Abashidze had major control over it, quite independently from central government.
“Saakashvili's administration intentionally framed their autonomy policy for Adjara as a test case
for subsequent autonomy options for South Ossetia and Abkhazia. Therefore, the mechanism of
bringing the region under Tbilisi's control and the actual division of power between center and
Adjara might presage subsequent offers made to those regions.” 145 However, even before the
“takeover”, Abashidze had changed its strategy towards newly established central power when in
January 2004 sent customs dues worth of 2.4 million laris to Tbilisi and resigned after he fled to
Moscow in May of the same year. 146 With this restitution of central power, “new opportunities
for arranging normal budgeting processes between the central government and this region of
Georgia had emerged.”147 “The Georgian government took over all the commercial banks in
Adjara and liquidated the Georgian Maritime Bank, which housed the Adjarian budget, alleging
corruption in lending. [...] In a nationwide poll conducted June 2004, 31% of the respondents
named “solving the Adjara porblem” as “the most significant achievement of the new Georgian
government.” It was the top response, followed by “fighting corruption” (10%) and “don't
know” (21%).”148
Improvement of Criminal Situation and End of Petty Corruption
Another very visible change brought by the post-revolutionary regime was considerable
improvement in the criminal situation of the country by “zero tolerance policy” towards the
“thieves in law”149 and corrupted and/or criminally active administration or bureaucracy workers
from previous government 150. Rapid substitution of the Soviet-heritage traffic police by more
western-style patrol police finally ended corruption on this level and set a precedent for
combating corruption in all spheres, causing the end of the energy crisis, thanks to which “as of
the winter of 2006-2007, the whole Georgia has been enjoying about a 100% supply of
electricity.”151 Reforms in the educational system, mainly the abolition of bribery for getting
diplomas and for university entrance exams by introduction of country-wide national exams
substituted in quotes for the consistency of the paper.

144
Khechinashvili, op. cit., p. 2.
145
Julie A. George, The Politics of Ethnic Separatism in Russia and Georgia. Palgrave Macmillan, New York, 2009,
fp. 174.
146
Ibid.
147
148
George, op. cit., p. 175.
149
Alexander Kupatadze, Political-criminal-business nexus in Georgia and Kyrgyzstan: Comparative analysis.
Available at:
http://kms1.isn.ethz.ch/serviceengine/Files/ISN/32364/ipublicationdocument_singledocument/538b9f3c-fd80-
465c-9fa8-c9a698849daa/en/Report_Aleko_Kupatadze_eng_19June.pdf, (consulted on: 21.4.2014).
150
151
33
were one of the few biggest successes of Saakashvili’s government. The national budget revenue
increased four times thanks to a specific anti-corruption tool by the name “price of liberty”, that
arrested officials or their relatives from Shevardnadze's government had to pay to the special
extra-budgetary “law enforcement development accounts”.152 However, as we will see in chapter
3.3, the latter reform had some substantial drawbacks.
Easing of Doing Business
Today (2014) Georgia ranks as 8th among 189 economies of the world in “Ease of Doing
Business”153 (in 2013 – 9th154, in 2006 - 100th155). Since 2003 “the World Bank has recognized
Georgia as one of the world’s fastest reforming economies and as a leader in fighting
corruption”156. Georgia was one of the top reformers in 2006-2007157, involving ease of starting
a business, dealing with licenses, employment and registering property158, together with making
investment safer, holding 18th position in the World Bank ranking in 2007-2008.159
Other Successful Reforms
 Increased training and readiness of the Georgian military force; 160

 Initiation of massive privatization program, including full privatization of agricultural
land, enabling the farmers to become actual landowners instead of just renting them.161
This reform was “a very important step in the creation of a property-owning class, which
is essential in a democratic society”. 162
 Adoption of simplified licensing system for businesses, reducing the activities which
need licensing from 909 to 159.163 “A one-stop shop was created for license applications,
so that now businesses can submit all documents there, with no verification by other
152
Ibid.
153
Economy Rankings. Available at: http://www.doingbusiness.org/rankings, (consulted on: 22.4.2014).
154
Ease of Doing Business in Georgia. Available at: http://www.doingbusiness.org/data/exploreeconomies/georgia
155
World Bank and International Financial Corporation, Doing Business in 2006, p. 92.
http://www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual-
Reports/English/DB06-FullReport.pdf, (consulted on: 22.4.2014).
156
Doing Business in Georgia: 2013 - Country Commercial Guide for U.S. Companies. Available at:
http://photos.state.gov/libraries/georgia/749756/zavrashviliex/2013-CCG-Georgia.pdf, (consulted on:
22.4.2014).
157
Doing Business 2008. Available at:
http://www.acci.gr/acci/Portals/0/Departments/keme/international/DOING%20BUSINESS%202008.pdf,
158
Business Reforms in Georgia. Available at: http://www.doingbusiness.org/reforms/overview/economy/georgia,
159
Doing Business 2008, op. cit.
160
Papava, 2012, op. cit., pp. 48-49.
161
162
Ibid.
163
Doing Business in 2006, op. cit., p. 1.
34
agencies required. And the time to register property fell by 75%, and the cost by 70%.” 164
 Adoption of a more simplified and generally acceptable tax code of 2004, eventually
cutting 12 of 21 taxes, one of them being turnover tax, which was imposed in addition to
VAT.165 The VAT itself was reduced to 18% from 20%, the payroll tax - to 20% from
32%, and the old progressive income tax was substituted by a flat income tax of 12%.166
“Reducing the import-tax base for agricultural products and construction materials, as
well as annulling the import taxes for other goods, have made Georgia much more
competitive.”167
New reforms of Saakashvili's government resulted in generating 300 times more cash
inflow into the budget in two years, then ever before. This inflow involved collected taxes,
international aid and FDIs, The GDP per capita more than doubled in 2007 compared to 2003.
Furthermore, the state capacity, measured by tax revenue as a percentage of GDP, considerably
improved. Also, steering capability (the extent to which the reforms are managed effectively and
to which the political priorities are maintained) and resource efficiency (the extent to which the
government makes use of the available resources) have increased over the years.168
2003 2004 2005 2006 2007 2008

169
Human Development Index - - 0.713 0.719 0.732 0.730
GDP per capita (current USD)170 922 1187 1470 1765 2318 2920
GDP growth (annual %)171 11.1 5.9 9.6 9.4 12.3 2.3
172
Tax revenue as a % of GDP 7.0 9.9 12.1 15.4 17.7 23.8
173
Steering capability 2 - - 6.3 - 7.3
Resource efficiency174 2 - - 5.7 - 7.0
Figure 4. Georgian State Capacity Indicators
The new government was finally able to pay off outstanding pensions and wages inherited
from the previous one.
164
Ibid., p. 1-2.
165
Ibid.
166
167
Ibid.
168
169
Georgia - Human Development Index – HDI. Available at: http://countryeconomy.com/hdi/georgia, (consulted
on: 18.4.2014).
170
GDP per Capita, PPP (Current US$). Available at: http://data.worldbank.org/indicator/NY.GDP.PCAP.CD,
171
GDP Growth (Annual %), op. cit.
172
Tax Revenue (% of GDP). Available at: http://data.worldbank.org/indicator/GC.TAX.TOTL.GD.ZS, (consulted
on: 18.4.2014).
173
Georgia, The Management Index. Available at: http://www.bti-
project.org/atlas?share=1*2014*CV:CTC:SELGEO*CAT*GEO*REG:TAB, (consulted on: 18.4.2014).
174
Ibid.
35
3.3. Questionable Post-Revolutionary Reforms
Super-Presidential System
One of the initial reforms of “Rosy”175 government, was designed to further combat
decentralization of the state power “justifying it by a need to reinstate the country's territorial
integrity”176, which, in February 2004, ended up in president having constitutional power to
dismiss the government, parliament, to appoint extraordinary parliamentary elections in case of
conflict between the two,177 and constitutional power to designate and dismiss all of the judges
in the Georgian Constitutional Court178. Thanks to this new “Russian-style super-presidential
system [...] the parliament was reduced to a rubber-stamping body, rather than an independent
and equal branch of government”.179
Extra-Budgetary Accounts or Elite Corruption
Despite the successful combat against corruption in many areas (see chapter 3.2), only
petty corruption (or corruption at low and middle hierarchical levels) was eliminated. The
aforementioned extra-budgetary accounts, set for arrested former government officials (and their
relatives) to collect their “price of liberty”, was supposed to serve as an example of how would
the corruption be treated or punished. However, only part of this “price” went to the “revenue”
entry of the budget balance sheet, the rest was accumulated on extra-budgetary accounts. The
exact amount of money and the expenses of these accounts were impossible to track even by the
Georgian Parliament or the Chamber of Control because it was under the exclusive competence
of the government and were not publicly accessible180.
Naturally, after some time, the paid “price” substantially decreased with the limited
number of charged former officials and the price of liberty was substituted by the “voluntary
contributions” that wealthy businesses had to pay to the same account. After having worked for a
while, the business owners felt great pressure and finally started complaining about it, after
which IMF demanded closure of these accounts. Following some resistance from the
government, the result was achieved in 2006. 181
Property Rights
During the state property deprivatization process “certain objects that had been privatized
before the revolution were forcibly taken back by the government and later offered for
175
Papava, op. cit., p. 73.
176
Ibid., p. 45.
177
Ibid., p. 46.
178
179
180
Papava, 2012, op. cit., pp. 73-74.
181
Ibid.
36
privatization. Throughout the process, the law-enforcement organs (the General Prosecutor's
Office and the Ministry of the Interior) got involved, pressuring the owners to “voluntarily” give
up their property for the government's benefit. [...] The actual goal of government was to
redistribute property for the benefit of the newly formed elite”. 182 Destruction of private houses
on the ground of improving the city looks further violated the property rights in Georgia. 183 And
all this was happening whilst Georgia was quickly progressing to the top rankings of World
Bank in “Doing Business”184.
Large Russian, Kazakh, and Arab capital was poured into Georgian market due to the
massive privatization process initiated in 2004, with violation of property rights along the way.
Besides the official contracts not reflecting actual price paid for the properties, making it
impossible to track where the difference was actually going 185, “firms with dubious founders and
dubious capital were created for the purpose of privatizing certain objects, and it was precisely
these firms that won the corresponding tenders”.186 “In June, 2006 the Georgian government
chose the Czech company’s privatization bid out of eight proposals submitted by other
companies after Energo-Pro offered $312 million187 for the six hydropower plants and two
electricity distribution companies. But under the final agreement, which has only now been
finalized, the price tag on the auctioned items is $132 million.”188
Populist Programs
The largest scale populist program of Saakashvili’s government was the National
Employment Program of 2006 designed to combat unemployment by hiring 50 000 people and
worth of $12.7 million from the national budget. Business establishments would hire jobseekers
for three months, for which the employee would receive $85 per month. Since the wages were
not going out of their own pockets, the entrepreneurs would sign a contract with almost any
jobseeker (mostly they were employing on the grounds of nepotism, first-come first-served
basis, or on some occasions on the promise to divide the salary between the employer and
employee), the newly hired person would get their three-month salary and leave, so the program
did not benefit employment in the long-term. In fact, it did cause inflation because this huge
182
Ibid., pp. 51-52.
183
Ibid., p. 52.
184
Doing Business 2007: Georgia is Top Reformer in the Commonwealth of Independent States and Jumps up the
Global Rankings. Available at:
http://www.doingbusiness.org/press/~/media/FPDKM/Doing%20Business/Documents/Press-Releases06-
09/2007/DB07-PR-CIS.pdf, (consulted on: 21.4.2014); Business Environment Snapshots: Georgia. Available at:
http://rru.worldbank.org/BESnapshots/Georgia/default.aspx, (consulted on: 27.4.2014).
185
186
Ibid.
187
For the consistency of the paper, “$” sign is used almost everywhere to denote US dollars.
188
Czech Company Takes over Majority of Georgia’s Energy Market, 5 February 2007. Available at:
http://www.civil.ge/eng/article.php?id=14566, (consulted on: 21.4.2014).
37
influx of cash did not produce or offer any goods or services to the market.189
Another populist program was a five-year poverty eradication program elaborated to fulfill
the pre-election (2008) campaign promises. However, eradicating poverty in 50 days seems
highly unlikely and naturally, was not fulfilled.190 Furthermore, the classification points for
assigning a person status of living below poverty line were easily manipulated for improving
statistics.
Emission of Eurobonds
In 2008 the foreign debt of Georgian state increased by emission of Eurobonds (2008)
worth $500 million which the government should have bought back in 2013 at an interest rate of
7.5%.191 Later in 2011 ten-year Eurobonds with the value of $527 million and maturing in 2021
were issued and 83.4% of the previous batch was bought back.192 The purpose or utilization of
the money received from bonds in 2008 remains ambiguous, along with the question of only
partial buy-back in 2011. 193
Other Notorious Reforms
 Elimination of state monopoly service, therefore hindering the competitiveness and

encouraging monopolies on the market;194
 Incorporation of State Statistics Department into the Ministry of Economic Development,

therefore making it dependent on the state and quite open to manipulation of statistical
data (so characteristic to the Soviet regime);195
 Media control, especially of the most popular and large-scale Georgian TV channels; and
closure of several independent TV channels shortly after the change of government; 196
 Confiscation of the banking monitoring functions from the National Bank of Georgia,
met with disapproval by IMF and resulted in elimination of IMF programs by 2008;197
Also, the same year, the famous 50-Day Action Plan designed to make Georgia more
189
Papava, 2012, op. cit., pp. 49-50; 76.
190
Ibid., 58.
191
Georgia Starts Eurobonds Road-Show, 02 April 2008. Available at:
http://www.civil.ge/eng/article.php?id=17503, (consulted on: 22.4.2014); Georgia Issues Debut Bonds, 13 April
2008. Available at: http://www.civil.ge/eng/article.php?id=17570, (consulted on: 22.4.2014); Papava, 2012, op.
cit., pp. 59-60; 79.
192
Ibid; Georgia Plans Eurobond to Refinance Previous One, 22 March 2011. Available at:
http://www.civil.ge/eng/article.php?id=23263, (consulted on: 22.4.2014); Gov't Proposes Amendments to 2011
Budget, 29 March 2011. Available at: http://www.civil.ge/eng/article.php?id=23288, (consulted on: 22.4.2014).
193
194
Ibid., pp.75-76.
195
Ibid., pp. 51; 63; 76.
196
Ibid., p. 49.
197
Ibid., p. 79.
38
attractive for the investors and financial activities, involved institutional changes to
subordinate NBG to the government, and to further increase its responsibility in the
monetary policy (the president of NBG should have resigned if the inflation would have
reached 12% annually).198
 Adoption of a new Labor Code which clearly made the environment for business
nourishment better, but significantly broadened the employers' rights at the expense of
the employees. 199
 Non-transparency of Cheap Credits (part of 50-Day Action Plan) issued to help small
businesses development.200
Post-War Crisis and Anti-Crisis Reforms
The five-day war between Russia and Georgia in August 2008 had a massive impact on
Georgia's economy. “Bank of Georgia share price on the London exchange fell sharply
immediately after the August war but prior to the onset of the current worldwide financial
crisis.”201 Besides the enormous infrastructural damage, the question of 138 000 IDPs 202 and
related social costs, the war caused a drastic inflation (reported by NBG)203 and massive
withdrawal of bank deposits. In September 2008 only 30% of the withdrawn money ($0.5
billion) was redeposited, which added to the banking crisis. Moreover, the global crisis
decreased the remittances, and the political instability of the country resulted in reduced FDIs
and trade imbalance where imports exceeded exports by four times.204
To combat the banking crisis, NBG limited reserves available for the commercial banks
and reduced interest rate for deposits in order to keep the banks off from borrowing from NBG.
While avoiding the banking crisis by these actions, the inflation grew further 205, since more
money was circulating on the market.206
198
Controversy over Proposed Central Bank Reform, 8 February 2008. Available at:
199
Ibid., p. 47.
200
Ibid., p. 58.
201
The Georgian Economy under Saakashvili, 21 April 2009. Available at:
http://www.messenger.com.ge/issues/1838_april_21_2009/1838_article.html, (consulted on: 22.4.2014).
202
Protection of Internally Displaced Persons in Georgia: A Gap Analysis, July 2009. Available at:
http://www.unhcr.org/4ad827f59.pdf, (consulted on: 23.4.2014).
203
Georgia Inflation Rate. Available at: http://www.tradingeconomics.com/georgia/inflation-cpi, (consulted on:
23.4.2014).
204
Papava, 2012, op. cit., pp. 61-64.
205
Georgia Inflation Rate, op. cit.
206
Papava, 2012, op. cit.
39
Figure 5. Georgia: Inflation Rate 2008-2009
In June 2009 Georgia's Prime Minister Nika Gilauri announced that the state was about to
receive $200 billion as loans from European Bank for Reconstruction and Development (EBRD)
and the Asian Development Bank (ADB) in addition to the international aid of $4.5 billion
received right after the war207 for helping commercial banks and for post-conflict reconstruction
and development. Among other actions of the New Financial Package of 2009, a plan to issue
treasury bills worth of 260 million laris (around $155 million) and ease of administration in the
banking sector, which would bring a relief around 700 million laris (around $415 million) to the
banks, as “an important stimulus for the banking sector to activate issuing of loans”, was
announced.208 However, according to some economists, this anti-crisis measure reduced the
credit resources needed for state development, therefore its productivity is arguable 209. Again in
2011, the government proposed the issue of 100 million laris (around $60 million) worth of
treasury bills domestically from the national budget.210
With some positive and the other relatively arguable consequences, the New Financial
Package of 2009 was not designed to address increased social costs of Georgia.
By looking at the macroeconomic indicators, it can be observed that the war and global
financial crisis brought a major hit to the Georgian economy, however it managed to recover
from it. But, we can see that the unemployment rate still remains higher than that of pre-war
period. The steep increase in unemployment can be observed since 2004 (Figure 6) with massive
207
USD 4.55 bln Aid Package Priorities, 23 October 2008. Available at:
208
Government Offers New Plan to Boost Economy, 30 June 2009. Available at:
http://www.civil.ge/eng/article.php?id=21180, (consulted on 23.4.2014).
209
210
Gov't Proposes Amendments to 2011 Budget, op. cit; 2011 State Budget Amended, 8 April 2011. Available at:
40
state bureaucratization and introduction of online state administration services. Together with
number of cases of selective justice and violation of human rights it was overshadowing the
successful changes brought by the Saakashvili's government (ex: Figure 7).
Figure 6. Georgia: Inflation Rate 2004-2012211
Figure 7. Georgia: Annual GDP Growth Rate 2006-2012212
211
Georgia Unemployment Rate. Available at: http://www.tradingeconomics.com/georgia/unemployment-rate,
212
Georgia GDP Annual Growth Rate. Available at: http://www.tradingeconomics.com/georgia/gdp-growth-annual,
41
4. Georgia and the EU
4.1. Brief Chronology of EU-Georgian Relations
Relations between Georgia and the European Union date back to the early nineties right
after Georgia regained its independence following the collapse of the Soviet Union. 213 Georgia
declared its western political direction, while keeping “warm” relations with Russia, mostly in
trade sector, since Russia represented a major export partner for Georgian products and was still
substantially dependent on Russia for energy resources. However, with years Georgia has been
taking more western, or rather European-oriented political course and declared Eurointegration
as one of the most crucial political strategies of the country.
In 1993-1996 the main spheres of assistance were solely economic: financial, humanitarian
(mainly food) and technical. Besides economic sector, Partnership and Cooperation Agreement
(PCA), (signed in 1996 and in force since 1999, included political sphere and advanced the
relationship to collaboration on customs matters).214 The EU delegation has been present in
Georgia since 1995.215 In 1997, soon after the signature of PCA, Georgia started the long process
of harmonization of national legislation to that of the EU. In 1999, Georgia became a member of
Council of Europe and World Trade Organization (WTO). Two years later the EU Cooperation
Council was founded with the responsibility of reviewing EU-Georgia relations and developing
recommendations for further harmonization. 216
The relations intensified after Rose Revolution and arrival of more western-oriented
Saakashvili in the state presidency. In 2004 Georgia founded a state ministerial post for
European and Euro-Atlantic Integration together with the creation of Commission for Georgia's
EU integration. In 2006, after three rounds of talks and seven EU-Georgian Cooperation Council
meetings, the European Neighbourhood Policy (ENP) Action Plan 217 was adopted. Since then,
the EU-Georgian relations have gotten even closer and include frequent official visits, talks,
committee and council meetings and consultations on conclusion of agreements (for example,
series of meetings in the early 2000's on bilateral agreement on mutual recognition and
protection of agricultural products and other foodstuff). 218
213
European External Action Service: Georgia. Available at: http://eeas.europa.eu/georgia/index_en.htm, (consulted
on: 25.4.2014).
214
Chronology of Basic Events in EU - Georgia Relations. Available at:
http://www.mfa.gov.ge/index.php?lang_id=ENG&sec_id=462, (consulted on: 25.4.2014).
215
Delegation of the European Union to Georgia. Available at:
http://eumm.eu/en/eu_in_georgia/delegation_of_the_eu_commission, (consulted on: 25.4.2014).
216
Chronology of Basic Events in EU - Georgia Relations, Ibid.
217
EU/Georgia ENP Action Plan. Available at: http://www.mfa.gov.ge/index.php?lang_id=ENG&sec_id=461,
218
Ibid.
42
Eastern Partnership, as an ENP framework, took off in 2009 and includes six Easter
European and South Caucasian countries, including Georgia and nowadays represents the main
strategic framework for EU-Georgia relations. “The initiative aims at tightening the relationship
between the EU and the Eastern partners by deepening their political co-operation and economic
integration. The EaP neither promises nor precludes the prospect of EU membership to the
partner states. It offers deeper integration with the EU structures by encouraging and supporting
them in their political, institutional and economic reforms based on EU standards, as well as
facilitating trade and increasing mobility between the EU and the partner states. [...] EaP goes
beyond the original ENP package as it deepens bilateral co-operation, and introduces new
mechanisms for regional co-operation. The bilateral track is mostly concerned with concluding
bilateral association agreements, developing sectoral co-operation in a wide range of areas,
facilitating visa regimes, and lifting them in the longer term. It also introduces Comprehensive
Institution Building Programmes, which are intended to enhance the capabilities of the partner
states' public institutions.”219 In addition, the EaP encourages strengthening and promotion of
civil society and their role in all of the above mentioned processes. 220 With the launch of this
framework, Georgia-EU Visa Facilitation Agreement was initialed. 221 Up to now, several stages
of visa facilitation have resulted in non-requirement of visas for the EU citizens to travel to
Georgia, and drop of visa fees for Georgian citizens applying for visas for educational or
professional purposes.
It is worth mentioning that the EU and its Member States support Georgia's Territorial
integrity, do not recognize Abkhazia and South Ossetia as independent countries 222 (compared to
Russia who recognized state independence of both breakaway regions on August 26, 2008,
shortly after the war against Georgia 223).
At Vilnius Summit on November 28, 2013, after several rounds of negotiations, Georgia
and Moldova initiated Association Agreements with DCFTA component224. The fate of signing
this agreement will be decided in summer 2014, according to the advancements in reforms made
by respective countries.
219
What Is EaP? Available at: http://www.easternpartnership.org/content/eastern-partnership-glance, (consulted on:
26.4.2014).
220
European External Action Service: Georgia, Ibid.
221
Chronology of Basic Events in EU - Georgia Relations, Ibid.
222
Ibid.
223
Russia Recognizes Abkhazia, South Ossetia, 26 August 2008. Available at:
http://www.rferl.org/content/Russia_Recognizes_Abkhazia_South_Ossetia/1193932.html, (consulted on:
26.4.2014).
224
Georgia and Moldova Initial Association Agreements with EU at Vilnius Summit, 29 November 2013. Available
at:
http://www.europeanforum.net/news/1810/georgia_and_moldova_initial_association_agreements_with_eu_at_v
ilnius_summit, (consulted on: 26.4.2014).
43
4.2. EU Assistance to Georgia
“European Union assistance to Georgia mainly takes the form of Annual Action
Programmes under the European Neighbourhood and Partnership Instrument (ENPI). Other
funding sources are the thematic assistance programmes which focus on specific sectors such as
human rights or civil society. Total budget for 2007-2010 amounted to €225117.4 million and
total budget for 2011-2013 - to €180.7 million. In addition to this, extra funding of €22 million
was made available for Georgia via the Eastern Partnership Integration and Cooperation (EaPIC)
programme.”226
The financial assistance from EU to Georgia, for ENPI and additional programmes, can be
summarized as following 227:
Time Amount Sector

Period
1992-2007 €530.8 million Various
2008-2010 €500 million Post-war reconstruction:
 IDPs
 Infrastructure
 Economic stabilization
2011-2013 €180 million  Democratic development, Rule of law, Good governance
 Trade and investment, Regulatory alignment and reform
 Regional development, Sustainable economic and social

development, Poverty reduction
 Peaceful settlement of conflicts
225
“Euro” and “Euros” were substituted by “€” in all quotes for the consistency of the thesis.
226
European External Action Service: Georgia, Ibid; EuropeAid: Georgia. Available at:
http://ec.europa.eu/europeaid/where/neighbourhood/country-cooperation/georgia/georgia_en.htm, (consulted
on: 26.4.2014).
227
Delegation of the European Union to Georgia, Ibid; Summary on EU-Georgia Relations. Available at:
http://eeas.europa.eu/georgia/eu_georgia_summary/index_en.htm, (consulted on: 26.4.2014).
44
4.3. Georgia on the Path towards the EU and DCFTA
“Prior to the Rose Revolution, Georgia already had adopted a western-oriented stance and
enjoyed strong relations with the United States and Europe.”228 “I am Georgian, and therefore I
am European” - declared Georgia’s Prime Minister and Parliament Speaker Zurab Zhvania at the
European Council in 1999.229 With the years we can observe the gradual increase of EU’s
involvement and interest in the Caucasus region and in Georgia, as well as in Georgia's
commitment towards the EU's norms and values. As noted before, this happens mostly through
ENP and EaP frameworks. Naturally, closer integration with the EU depends on the extent to
which Georgia (or any other partner country) fulfills its obligations under the agreements. So far
EU's “more for more” principle has been relatively successful with Georgia. However, this
Eurointegration path has not been bump-free.
Following the Georgia-Russia war in 2008, the EU condemned Russia’s recognition of

independence of Abkhazia and South Ossetia and declared own readiness to integrate Georgia
more into the EU by visa facilitation and “possible establishment of a full and comprehensive
free trade area as soon as the conditions are met”.230 In particular, the conditions involved
ratification of anti-monopoly legislation (in accordance with EU norms), food safety legislation
and a new Labor Code. Both of the first two legislations were eliminated after the Rose
Revolution, and the existing Labor Code (also adopted by Saakashvili's government) was
empowering employers at the expense of employees. 231 Therefore, naturally, the EU conditioned
the regulation of these sectors. However, in a week after the Extraordinary European Council,
Georgia signed a Letter of Intent with International Monetary Fund, stating with regard to
structural reforms:
“40. In order to maintain the competitiveness of the Georgian economy and to encourage
further capital inflows, we will avoid introducing any laws or regulations that may reduce
labor market flexibility, including the labor code.
[…]
45. In order to avoid an unnecessary regulatory burden on enterprises operating in Georgia,

in the aftermath of the conflict with Russia we will avoid any amendments to or new
legislation or regulation in the areas of anti-trust policy and consumer protection, as we
228
The Georgian Economy Under Saakashvili, op. cit.
229
“I am Georgian, and therefore I am European” – Zurab Zhvania’s Historic Speech at the European Council, 10
September 2013. Available at: http://www.georgianews.ge/politics/25618-i-am-georgian-and-therefore-i-am-
european--zurab-zhvanias-historic-speech-at-the-european-council.html, (consulted on: 4.5.2014).
230
Extraordinary European Council, Presidency Conclusions, 12594/2/08 REV 2, The Council of The European
Union, Brussels, 2008, p. 3. Available at:
http://www.consilium.europa.eu/ueDocs/cms_Data/docs/pressData/en/ec/102545.pdf, (consulted on: 3.5.2014).
231
45
believe any such measures would be meaningless for a small open economy like
Georgia.”232
Therefore, the Georgian government promised the IMF that it would not to carry out (in 2008-
2009) the structural reforms that in fact represented the EU conditionalities. Regarding the food
safety measures, they are still one of the main points to be reformed in Georgia: “In 2013, only
1.3% of registered Georgian food business operators were inspected by the food safety
authorities.”233 The draft law “On Free Trade and Competition” was introduced to the
parliament only in 2011, which happened in order to satisfy the DCFTA requirements. Together
with Comprehensive Strategy in Competition Policy (adopted in 2010), it proposed to create two
competition agencies that will monitor the competition on the market and be in charge of state
procurement.234 The Law on Free Trade and Competition was adopted in 2012 235 and the new
Labor Code – in 2013236 by the current (post-Saakashvili) government.
Together with the aforementioned legislative delays, Saakashvili was more captivated by
the Singaporean model of economic development and has publicly referred to Georgia as future
“Switzerland of this region with elements of Singapore”237. Despite the visible advancements,
the speed of Georgia's Eurointegration was being negatively affected by the inconsistency of
Georgia's economic transition strategy, or rather the attempt of combining the two of them.
4.4. Peaceful Transition of Political Power in Georgia

October 2012 was the date of parliamentary elections in Georgia. As usual for past two
parliamentary elections, United National Movement did not have much competition. However,
the balance of power was questioned when in 2011 out of the blue Georgian multibillionaire
businessman Bidzina Ivanishvili (currently with wealth of $5.2 billion estimated by Forbes238)
announced that he would compete with Saakashvili (an therefore with his party) in the following
elections. In no time, Ivanishvili's Georgian citizenship was annulled by Saakashvili, the reason
232
Georgia and IMF, Georgia: Letter of Intent, Memorandum of Economic and Financial Policies, and Technical
Memorandum of Understanding, International Monetary Fund, 2008, pp. 10-11. Available at:
https://www.imf.org/external/np/loi/2008/geo/090908.pdf, (consulted on: 3.5.2014).
233
Public-Private Dialogue on Food Safety Begins in Georgia, 5 February 2014. Available at:
http://www.fao.org/investment/newsandmeetings/news/detail/en/c/213586/, (consulted on: 26.4.2014).
234
Georgian Government’s New Legislative Initiative– Universal Competition Agency Without Sector Regulator?,
28 September 2011. Available at: http://transparency.ge/en/node/1389, (consulted on: 26.4.2014).
235
Competition Policy in Georgia, 2012. Available at:
http://transparency.ge/sites/default/files/post_attachments/Report%20-
%20Competition%20Policy%20in%20Georgia.pdf, (consulted on: 26.4.2014).
236
Highlights of the recently adopted amendments to the Georgian Labor Code, 25 September 2013. Available at:
http://www.lexology.com/library/detail.aspx?g=7d5e5381-d045-4be0-b064-83a9990f99fd, (consulted on:
26.4.2014).
237
Saakashvili: “Georgia Switzerland with Elements of Singapore”, 9 March 2010. Available at:
238
#282 Bidzina Ivanishvili, 27 April 2014. Available at: http://www.forbes.com/profile/bidzina-ivanishvili/,
46
being the former’s additional French and Russian citizenships. 239 The Businessman annulled his
Russian citizenship and applied for the revocation of the French one as well. Since Saakashvili's
action was not met with international or local approval, the changes to constitution were made,
permitting the EU citizen, who has lived in Georgia for past five years, to be elected. However,
Ivanishvili stated that he would only take part in elections as a Georgian citizen. 240
Another constitutional change was the prohibition of contributions to the political parties
by corporations or their employees, obviously directed against utilization of the huge financial
resources of Ivanishvili for the election campaign. “Also in late 2011, a new electoral code
provided for 77 members of the 150-seat legislature to be elected through proportional voting
and the remaining 73 through constituency voting in single member districts, replacing the
previous election of 50% of the members by each method. Another provision guaranteed that a
party that gained a minimum of 5% of the vote would get at least six seats in the legislature.” 241
In February 2012, Ivanishvili announced the composition of his newly founded political
party Georgian Dream – Democratic Georgia, chaired by himself, although he would have to
regain his Georgian citizenship to be able to do this242, which he tried to fulfill by naturalization
process, but was denied. However, later in October, “Ivanishvili’s citizenship was restored by the
President based on a provision of law, which allows Georgian President to grant citizenship if
such a move originates from “the state interests”.243 Again in February, Ivanishvili announced
the launch of political coalition Georgian Dream (GD) which included several other opposition
parties and individuals. 244
“In June-July 2012, the State Audit Chamber obtained court rulings levying substantial
fines on GD and its campaign donors, and authorities seized tens of thousands of satellite dishes
belonging to two Ivanishvili-related television stations, alleging that the provision of dishes to
customers represented illicit vote-buying. Domestic and international criticism of these moves
may have contributed to the reduction or deferral of some of the fines and the enactment of a
“must carry” law that allowed programs from Ivanishvili-related stations to be carried by cable
239
Civil Registry: Ivanishvili not Citizen of Georgia, 11 October 2011. Available at:
240
Georgia’s October 2012 Legislative Election: Outcome and Implications, 15 October 2012. Available at:
http://www.fas.org/sgp/crs/row/R42777.pdf, (consulted on: 27.4.2014).
241
Ibid.
242
Ivanishvili Unveils Core Team of His Planned Party, 15 February 2012. Available at:
243
Saakashvili Restores Citizenship for Ivanishvili, 16 October 2012. Available at:
244
Ivanishvili Launches Coalition, 21 February 2012. Available at: http://www.civil.ge/eng/article.php?id=24468,
47
providers until election day.” 245
The turning point during the campaign was the dissemination of prison surveillance videos
by Georgian Dream several days before the elections, showing the maltreatment and sexual
abuse of the prisoners by the guards. Trust towards the president drastically fell from 58% in
2011 to 27% in 2012.246 Additionally, unemployment has been becoming the biggest concern for
slightly more than 50% of Georgia's population. 247
The UNM lost the parliamentary elections, receiving 40.34% of the votes, while Georgian
Dream got 54.97%.248 “The October 1, 2012, legislative election is the first in the South
Caucasus resulting in a competitive and peaceful transfer of power. As such, the election meets
Saakashvili’s pledge in his state of the nation address in early 2012 that it would be the “freest,
most transparent and most democratic [...] ever held in Georgia. Also for the first time during
Saakashvili’s tenure as president, he will face a legislative majority from an opposing party.”249
Following this transition of political power it did not come as a big surprise that the 2013
presidential elections were won by a member of Georgian Dream coalition Giorgi
Margvelashvili.
In the beginning there was a major ambiguity about the new government's politics towards
Russia and the West. Especially since the UNM members were intensively campaigning
Georgian Dream's pro-Russian direction. However, both the new president and the government
have taken active steps towards the EU integration and have succeeded in finalizing negotiations
and initiating Association Agreement with DCFTA (kick-started by Saakashvili and UNM). State
Minister of European and Euro-Atlantic Integration Aleksi Petriashvili has been very clear and
has held a solid position on the question in numerous of his public appearances. “Mr Petriashvili
describes EU as one of the two largest international organizations that we strive to become
members of. Political and economic assistance that we receive from EU is of vital importance.
European Union’s monitoring meeting is the only international institution presented in occupied
territories of Georgia.” 250
245
Georgia’s October 2012 Legislative Election: Outcome and Implications, op. cit.
246
Caucasus Barometer Time-Series Dataset Georgia: Trust towards President (%). Available at:
http://caucasusbarometer.org/en/cb-ge/TRUPRES/, (consulted on: 27.4.2014).
247
Caucasus Barometer Time-Series Dataset Georgia: Most Important Issue Facing Georgia (%). Available at:
http://caucasusbarometer.org/en/cb-ge/IMPISS1/, (consulted on: 27.4.2014); Poll Shows Georgians
Increasingly Concerned over Economy, 6 April 2011. Available at:
248
Elections 2012. Available at: http://results2012.cec.gov.ge/, (consulted on: 27.4.2014).
249
Georgia’s October 2012 Legislative Election: Outcome and Implications, op. cit.
250
The Vilnius Summit and Georgia, 28 November 2013. Available at:
http://www.messenger.com.ge/issues/3000_november_28_2013/3000_cgs-group.html, (consulted on:
27.4.2014).
48
4.5. EU Economic Governance and Georgia
Global crisis of 2008 hit the EU hard and revealed inconsistencies within the financial and
economic legislation of the single market. Therefore, the EU laid out intensified legislation
composed of four main components251:
1. Stronger commitment towards medium-term budgetary objectives (MTO) in order to

better monitor the budgetary expenditures and level of objective attainment. The strategy
involves imposition of a fine for non-compliant countries worth of 0.2% of GDP in a
form of interest-bearing deposit.252
2. “Member States should ensure that their fiscal frameworks are in line with minimum
quality standards and cover all administrative levels” 253 and that medium-term budgetary
objectives should be taken into account while assuming multi-annual budgetary
strategy. 254
3. The Excessive Deficit Procedure (EDP) requires the Member States having debt-to-GDP
ratio of not more than 60% and budget deficit – not more than 3% of GDP. If the debt-to-
GDP ratio exceeds 60%, the governments should reduce it (according to the TFEU
provisions). Fines will be imposed for non-compliant countries.255
4. Adopt preventive measures for macroeconomic risks and instabilities, as well as

correcting the already existing ones by implementing proper policies. Member States will
be sanctioned for repetitive non-compliance. 256
However, it should be noted that the mentioned sanctions and fines mostly operate in
Euro-area. The EU Economic Governance mechanism is in force since December 2011. 257 Let's
see the extent to which Georgia, a non-EU state, complies with these requirements:
1. In 2006 Georgian government formulated and implemented a Medium-Term Expenditure

Framework (MTEF). “The MTEF aims to ensure targeted spending of scarce state
resources in line with the government priorities, and to strengthen the link between
policies and expenditure estimates over a period of four years (the budget year plus three
subsequent years).”258
251
EU Economic Governance. Available at:
http://ec.europa.eu/economy_finance/economic_governance/index_en.htm, (consulted on: 28.4.2014).
252
Ibid.
253
Ibid.
254
Ibid.
255
Ibid.
256
Ibid.
257
Ibid.
258
Dirk-Jan Kraan and Daniel Bergvall, “Budgeting in Georgia”, in: OECD Journal on Budgeting, Vol. 5, No. 4,
49
2. Despite some technical difficulties with the innovative framework, OECD concluded that
“it brings the consideration of policy and expenditure together in a multi-annual
perspective. On the one hand it necessitates the timely consideration of the multi-annual
budgetary consequences of new legislation and policy initiatives, and on the other hand it
necessitates the timely preparation of new legislation and policy initiatives to achieve
medium-term budgetary objectives.”259
3. In the second half of 2009, Saakashvili introduced Economic Liberty Act which had
several major points260:
 Liberalization of the market;
 Ban on creation of new regulatory agencies;
 Ban on introduction of new licenses and permits;
 Referendum on tax increase (except excise tax);
 Ban on state having shares in any bank;
 Expenditures-to-GDP ratio – maximum 30%;
 Debt-to-GDP ratio – maximum 60%;
 Budget deficit - maximum 3% of GDP. 261
The Act entered into force in 2014 with having a tax referendum and the long-term upper
limits enshrined in the constitution, however the government retains the right to request
alteration of the taxes temporarily. 262 Price and market liberalization was into force since the
introduction of Shock Therapy in Georgia in 1995. Prohibition of additional regulatory agencies
was putting the EU single market under question, since it is a regulated market with a number of
agencies263. On the other hand, the mentioned ceilings for debt-to-GDP ratio and budget deficit
are part of Stability and Growth Pact of the EU Member States according to the Article 126 of
the Treaty on the Functioning of the European Union (TFEU) and annexed Protocol 12264, which
2006, p. 74. Available at: http://www.oecd.org/gov/budgeting/40139928.pdf, (consulted on: 3.5.2014).

259
Ibid., p. 76.
260
Saakashvili Lays Out “Act on Economic Freedom”, 6 October 2009. Available at:
http://www.civil.ge/eng/article.php?id=21541, (consulted on: 23.4.2014); Georgia Adopts Economic Liberty
Act, 11 July 2011. Available at:
http://government.gov.ge/files/34_32577_661550_GEORGIAADOPTSTHEECONOMICLIBERTYACT.pdf,
261
Ibid.
262
Georgia Adopts Economic Liberty Act, Ibid.
263
Agencies and other EU bodies. Available at: http://europa.eu/about-eu/agencies/index_en.htm, (consulted on:
26.4.2014).
264
Consolidated Version of the Treaty on the Functioning of the European Union, 9 May 2008, Official Journal of
the European Union C 115/01.
50
brought Georgian state constitution more in accordance with the EU treaties.
4. MTEF also involves a budgetary strategic paper with the following points: “a
macroeconomic overview; a forecast of macroeconomic indicators (GDP, inflation,
balance of payments deficit, exchange rate, monetary indicators); a sustainability
analysis concerning macroeconomic shocks; detailed estimates of tax, non-tax and donor
grant revenue. [...] Both revenue forecasts and expenditure forecasts are supposed to be
based on policy priorities and on past budget trends and cross-country comparisons.”265
It should be noted, that these technical and institutional reforms were funded by the EU
itself (in the framework of several assistance programs like Tacis, TEMPUS, Policy Advice,
Food Security Programme and Macroeconomic Assistance, etc.) and the US government
(through Agency for International Development, USAID). 266
4.6. What is FTA and when does it become Deep and Comprehensive?
Generally, free trade agreements imply elimination of trade barriers among the countries
and creation of free movement of goods, services, people and capital (four freedoms of EU
Single Market267) and thus giving the partner countries preferential treatment. “A free trade
agreement (FTA) is a legally binding agreement between two or more countries to liberalize
trade and bring about closer economic integration.”268 WTO glossary refers to free trade area as
a situation where “trade within the group is duty free but members set their own tariffs on
imports from non-members (e.g. NAFTA).”269 Reuters financial glossary defines free trade zone
as “a designated area within a country in which businesses can operate free of customs duties or
currency restrictions. Profits are usually tax-free for a set period.”270 Moreover, Article XXIV of
GATT reads as: “A free-trade area shall be understood to mean a group of two or more customs
territories in which the duties and other restrictive regulations of commerce […] are eliminated
on substantially all the trade between the constituent territories in products originating in such
territories.”271 Therefore, elimination of import-export tariffs among the agreement countries is
the key determinant of FTA.
265
Kraan and Bergvall, op. cit., p. 78.
266
Ibid., p. 68.
267
The EU Single Market: General Policy Framework. Available at:
http://ec.europa.eu/internal_market/top_layer/index_en.htm, (consulted on: 27.4.2014).
268
Free Trade Agreements (Trade in Goods): Guide for SMEs, June 2005. Available at:
http://www.spring.gov.sg/Resources/Documents/Guidebook_FTA_Guide_Goods.pdf, (consulted on:
27.4.2014).
269
Glossary: A guide to “WTO Speak”. Available at:
http://www.wto.org/english/thewto_e/glossary_e/glossary_e.htm, (consulted on: 27.4.2014).
270
Financial Glossary: Free Trade Zone. Available at:
http://glossary.reuters.com/index.php?title=Free_Trade_Zone, (consulted on: 27.4.2014).
271
World Trade Organization, General Agreement on Tariffs and Trade: Part III, XXVI. Article XXIV, GATT,
Geneva, 1986, p. 43.
51
The European Union has concluded FTAs or is in the process of negotiations with a
number of third countries. However, as nowadays worldwide import duties are quite low, since
2006 EU has been trying to go further than just elimination of custom tariffs and to address non-
tariff barriers or restrictive regulations and standards272 “such as procurement rules, intellectual
property, sustainable development or competition, in which the EU seeks to find common
ground with trade partners and foster bilateral trade. This is what is called “comprehensive”
negotiations.”273 Furthermore, DCFTAs are offered to the countries who seek to be “associated”,
in other words, to have closer economic relationship with the EU than FTAs allow for. 274 Since
the agreement represents 80% of EU acquis communautaire (or EU legislation) 275 and seeks to
abolish “behind the border” obstacles, it will be “deep”. In case of successful implementation of
relevant reforms and signature of the AA, the concerned country (in this case Georgia) will
operate in the EU Internal Market in trade areas mentioned in the agreement. “The removal of
barriers faced by economic operators, as well as the introduction of high standards of consumer
protection is the main foundation of the EU. It is widely acknowledged that the Internal Market
has created enormous benefits to its members.”276
Now, as Georgia is on the verge of signing DCFTA agreement, it is essential to know, what
benefits it would bring to the Georgian economy and trade.
4.7. Georgia and DCFTA: What Next?

Trade Sustainability Impact Assessment (TSIA)277, financed by Directorate General for
Trade (DG Trade) of the European Commission and conducted by independent research
companies Ecorys and Center for Social and Economic Research (CASE), lays out the detailed
prospective impacts of DCFTA for the ENP countries (in this case, for Georgia and Republic of
Moldova).
According to the report, the macroeconomic estimates for Georgia with reduction of tariffs
and non-tariff barriers are as follows: in the long-run, Georgia's will experience national income
272
Free Trade Agreements. Available at: http://ec.europa.eu/enterprise/policies/international/facilitating-trade/free-
trade/index_en.htm, (consulted on: 27.4.2014).
273
EU Georgia Trade Insight, Issue 1, 1 November 2012. Available at: http://www.enpi-
info.eu/files/publications/tradenewsletter_n1_2012_en.pdf, (consulted on: 27.4.2014).
274
Ibid.
275
Agreement on Deep and Comprehensive Free Trade Area. Available at: http://www.ei-lat.ge/vin-vin-
aris/saqarthvelos-da-evrokavshiris-savatcro-urthierthobebi/363-shethankhmeba-ghrma-da-yovlismomcveli-
thavisufali-vatcrobis-shesakheb.html?lang=ka-GE, (consulted on: 27.4.2014).
276
EU Georgia Trade Insight, op. cit; Georgia: Moving Towards DCFTA, 2012. Available at:
http://eeas.europa.eu/delegations/georgia/documents/eu_georgia/dcfta2012_01_en.pdf, (consulted on:
27.4.2014).
277
Ecorys and CASE, Trade Sustainability Impact Assessment in Support of Negotiations of a DCFTA between the
EU and Georgia and the Republic of Moldova: Final Report, Client: European Commission - DG Trade,
Rotterdam, 27 October 2012. Available at:
http://trade.ec.europa.eu/doclib/docs/2012/november/tradoc_150105.pdf, (consulted on: 3.5.2014).
52
of €292 million, 4.3% growth in GDP, increase of imports and exports by 7.5% and 12%,
respectively, increase in average wages by 3.6%, decrease of Consumer Price Index by 0.6%.
These figures imply that Georgia's purchasing power is expected to augment, trade balance - to
improve, while trade deficit is expected to continue to grow,278 “given that exports expand from
a much lower baseline than import”279. As for the EU, the forecasted benefits are less
impressive, equaling to almost 0% growth in GDP, and insignificant changes in average wages
and purchasing power.280 Figure 8 illustrates macroeconomic results of Georgia-EU DCFTA
agreement. It is essential to remark, that “the short- and long-run does not refer to a specific time
period, but to the time it takes for economic effects to adjust.”281 The main difference between
short-run and long-run effects is the moment when actual capital movement and capital
reallocation between the EU and Georgian markets take place (which would be in the long-
run.282
As for the sector-specific effects of DCFTA (Figure 9), the biggest change is expected in
chemicals, rubber and plastic sector, whose share in economy is only 0.5%, therefore the gross
effect of this increase would not be major. It is important to look at figures for agriculture,
because agriculture employs 50% of the total labor force in Georgia. 283 “The table shows that
while the agricultural sector will come under pressure due to increased competition from abroad,
some subsectors are still expected to expand due to the DCFTA. This is the case for vegetable
oils and fats, vegetables, fruits and nuts, and animal products.”284
278
Ibid., pp. A13-A14; A70; A101;
279
Ibid., p. A14.
280
Ibid., pp. A13-A14. A101.
281
Ibid., p. A26.
282
Ibid.
283
Agriculture and Rural Development. Available at:
http://eeas.europa.eu/delegations/georgia/projects/overview/agriculture_and_rural_development/index_en.htm,
284
Ibid., pp. A40; A101.
53
Figure 8. Macroeconomic Results of an EU-Georgia DCFTA285
Azerbaijan
Moldova
Armenia
Ukraine
Georgia
Variable/
Turkey
Russia
China
RoW
Country
EU
Short run
National Income, 79.1 114. -0.1 3.3 -1.8 -0.8 0.3 0.2 10.4 9.1
mln € 4
GDP, % change 0.0 1.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Consumer Prices, 0.0 -1.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
% change
Wages, less skilled 0.0 1.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
% change
Wages, more 0.0 1.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
skilled
% change
Terms of Trade, 0.0 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
% change
Total Imports, 0.0 4.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
% change
Total Exports, 0.0 8.9 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
% change
Long Run
National Income, -47.0 291. 2.1 113. - 16.3 53.0 3.3 -17.8 -118.5
mln € 9 2 110.
8
GDP, % change 0.0 4.3 0.0 0.0 0.0 0.0 0.3 0.0 0.0 0.0
Consumer Prices, 0.0 -0.6 0.0 0.0 0.0 0.1 0.4 -0.1 0.0 0.0
% change
Wages, less skilled 0.0 3.6 0.0 0.0 0.0 0.0 0.5 0.1 0.0 0.0
% change
Wages, more 0.0 3.6 0.0 0.0 0.0 0.0 0.5 0.1 0.0 0.0
skilled
% change
Terms of Trade, 0.0 -0.6 0.0 0.0 0.0 0.0 -0.1 0.0 0.0 0.0
% change
Total Imports, 0.0 7.5 0.0 0.0 0.0 0.0 0.5 0.0 0.0 0.0
% change
Total Exports, 0.0 12.4 0.0 0.0 0.0 0.0 0.5 0.0 0.0 0.0
% change
Source: CGE modeling calculations
285
Ibid., p. A37.
54
Figure 9. Georgian Sector-Specific Shares of Total Value Added (VA), and DCFTA Effects by Sector286
Share of Value Output, Total Total
Total VA Added, % change, exports, imports,
in baseline % change, long rum % change, %
long run long run change,
long run
Veg, fruits, nuts, oilseeds 5.9 2.7 3.4 21.9 19.1
Other crops 0.4 -2.3 -2.0 3.0 15.1
Animal products 10.0 2.5 3.1 5.7 19.8
Livestock and meat producst 1.0 -14.7 -14.8 169.9 17.8
Vegetable oils and fats 0.0 5.4 6.7 6.5 3.4
Sugar 0.2 -2.5 -2.4 -1.5 1.6
Other processed foods 1.1 -6.2 -8.8 14.5 13.0
Beverages and tobacco 1.9 -1.1 -4.0 2.5 22.5
Petrochemicals 0.0 -1.4 -1.0 16.5 1.8
Chemicals, rubber, plastics 0.5 46.5 62.2 64.5 -2.7
Primary metals 1.0 7.3 7.9 8.5 4.9
Fabricated metals 0.2 -3.5 -3.2 6.6 6.1
Motor vehicles 0.4 -3.8 -3.5 8.3 5.9
Electronics, computers 0.1 -8.1 -9.3 16.3 8.8
Other machinery and equipment 0.4 18.8 23.7 48.1 4.1
Other manufacturing 0.1 -20.2 -24.0 -13.8 14.3
Construction 5.6 4.1 4.5 7.7 6.6
Trade 14.8 2.9 3.1 8.2 14.0
Water transport 0.6 3.8 4.1 2.9 2.5
Air transport 0.7 -4.6 -4.4 21.1 7.9
Communications 2.2 2.1 3.6 4.8 5.4
Business and ICT 3.1 0.2 0.4 12.0 4.2
Public and other services 28.0 1.5 1.7 1.8 20.6
Note:Total exports and imports refer to Georgia’s total exports to and imports from the world, not only the EU
Source: Shares GTAP, IIDE CGE modeling calculation
286
Ibid., p. A39.
55
As mentioned before, AA involves close approximation of EU and Georgian legislation.
The TSIA report also lays out recommendations for achieving this and for further integration.
Not only the legislation has to be adapted, but non-governmental sectors should become
knowledgeable about these changes, and they have to be assisted in order to adapt to the
changes. Moreover, the government has to make sure that the new legislation is enforced at all
levels. Since, as we saw, some sectors would be disadvantaged from signing DCFTA, it is
recommended to introduce the new regulations gradually, or phase them in. This would also
allow for better monitoring and forecasting of current and future effects of approximation. The
report underlines the necessity to increase competitiveness for the Small and Medium
Enterprises (SMEs) since they will have to compete with increased number of importing
companies on the Georgian market. “Enhancing or mitigating measures may include business
education, export promotion and support for innovation. Finally, attention could be paid to the
links between SMEs and larger exporting companies: while not all SMEs will be able or willing
to export themselves they could supply their products to larger exporting companies – provided
they meet the export quality criteria set by these companies.”287
The gradual approximation of the legislations and integration with the EU Single Market
would bring in more transparency, competitiveness and protection of intellectual property, better
monitoring of product quality standards, therefore making Georgia more attractive for investors,
trustworthy for consumers.288 Furthermore, the enlargement experience shows, that “more for
more” principle is more or less working in the EU, therefore further institutional and economic
development is expected after signing the DCFTA.289
4.8. Georgia: Towards European or Eurasian Union?

Since the break-up of the USSR, Russian leaders have been thinking about reuniting the
former soviet countries once again under the Moscow dominance.290 One and most recent of
these is Russian-led Eurasian Customs Union (ECU) with Belarus and Kazakhstan as current
members, 291 common external tariff of which was launched in January 2010. 292 Nowadays ECU
287
Ibid., A16; 107-108.
288
Georgia: Moving Towards DCFTA, op. cit.
289
Georgia Ranked 8th in World for Ease of Doing Business, in: Georgia Today, Issue #688, 2013, p.1. Available at:
http://www.georgiatoday.ge/article_details.php?id=11638, (consulted on: 29.4.2014).
290
Rilka Dragneva and Kataryna Wolczuk, “Russia, the Eurasian Customs Union and the EU: Cooperation,
Stagnation or Rivalry?”, in: Russia and Eurasia Programme Briefing Paper, REP BP 2012/01, 2012, 16 p.
Available at:
http://www.chathamhouse.org/sites/default/files/public/Research/Russia%20and%20Eurasia/0812bp_dragneva
wolczuk.pdf, (consulted on: 3.5.2014).
291
A Brief Primer on Vladimir Putin's Eurasian Dream, 18 February 2014. Available at:
http://www.theguardian.com/world/shortcuts/2014/feb/18/brief-primer-vladimir-putin-eurasian-union-trade,
292
Dragneva and Wolczuk, op. cit., p. 4.
56
market includes population of 165 million with estimated combined GDP of $2.3 trillion293,
compared to the EU with population of 500 million and GDP of more than €13.075 trillion.294
“Putin's plan is for the ECU to grow into a "powerful, supra-national union" of sovereign states
like the European Union, uniting economies, legal systems, customs services and military
capabilities to form a bridge between Europe and Asia and rival the EU, the US and China by
2015.”295
The following map shows that Georgia, together with Ukraine, is a potential candidate for
the Eurasian Union membership, with Armenia, Tajikistan and Kyrgyzstan as candidate
countries. 296 Armenia announced its preference to join ECU on September 3, 2013, for the sake
of national interests and due to their Collective Security Treaty Organization (also Russian-led
military alliance) membership.297 While stating, that this decision would not affect its relations
with the EU, it is quite obvious, that this is just a political statement.
Figure 10. European Union vs the Eurasian Customs Union Map298
Ukraine did the same thing right before the Vilnius Summit in 2013, where its chances
for finalizing six-year negotiations on Association Agreement were quite high since Ukraine was
regarded as the best student in the ENP.
293
A Brief Primer on Vladimir Putin's Eurasian Dream, op. cit; This Map Shows The Huge Scale Of Vladimir
Putin's Eurasian Plan, 6 December 2013. Available at: http://www.businessinsider.com/eurasian-union-map-
2013-12, (consulted on: 28.4.2014).
294
Gross Domestic Product at Market Prices. Available at:
http://epp.eurostat.ec.europa.eu/tgm/refreshTableAction.do;jsessionid=9ea7d07d30dbaf26632810ff44089c75fb
2ee4aeb5f0.e34MbxeSaxaSc40LbNiMbxeNb3iQe0?tab=table&plugin=1&pcode=tec00001&language=en,
295
A Brief Primer on Vladimir Putin's Eurasian Dream, op. cit.
296
Ibid; This Map Shows The Huge Scale Of Vladimir Putin's Eurasian Plan, op. cit.
297
Armenia to Join Russian-Led Customs Union, 3 September 2013. Available at:
http://www.rferl.org/content/armenia-customs-union/25094560.html, (consulted on: 28.4.2014).
298
A Brief Primer on Vladimir Putin's Eurasian Dream, op. cit.
57
Currently Georgia is close to signing the AA, scheduled in summer 2014. With the Russian
invasion in Ukraine and takeover on Crimea, there are suppositions that Russia might repeat
what it did already several times and exert high pressure on Georgia right before the turning
point. The experience gives us three general development scenarios:
1) Yanukovychian scenario - rumors about new Georgian government's pro-Russian

direction might turn out to be true, or become true with certain financial incentives (or
simply, bribes).
2) Armenian scenario - Russia might exert pressure on the government to change the
direction;
3) Crimean scenario - Putin might use problem of minority groups once again (just like for
Abkhazian and South Ossetian regions), in this case Armenian minority in Javakheti
region of Georgia;
First scenario is less likely to happen because even though multibillionaire Ivanishvili is
no longer in the government, the current members of the state administration are still in good
relations with him and have less experience with connections with Moscow than Yanukovych.
To put it in easer words, the problem of finances is less likely to exist with having a
multibillionaire as a friend.
The Second scenario is even less likely, since Georgia is much less dependent on Russia in
any sector, than Armenia, especially after Russian embargo of 2006, thanks to which
“Azerbaijan, which accounted for 10% of Georgia's total exports in 2005, now accounts for
more than 20%, while the U.S. now accounts for 10% of Georgia's total exports, up from 3% in
2005”299. And, regarding the main export goods, mineral water and wine: “in 2012, Ukraine,
Kazakhstan, Lithuania, Belarus, and Azerbaijan accounted for the bulk of mineral water exports.
Exports of mineral water to Ukraine increased from 15% of the total in 2005, to nearly 50% in
2012. [...] Exports to neighboring countries such as Ukraine, Kazakhstan, Belarus, and
Azerbaijan have leapt by 270% in nominal terms and 180% in volume terms. Ukraine, for
instance, now accounts for more than 40% of Georgia's wine exports, while China accounts for
10%.”300
Additionally, Socio-Economic Development Strategy Project “Georgia 2020” clearly states

that “Georgia aspires to become a state based on European values and to commit to political and
economic integration with Europe. Successive and effective implementation of measures
299
Georgia: Lifting of Russian Wine Embargo to Have Limited Economic Impact?, 14 August 2013. Available at:
http://www.eurasianet.org/node/67391, (consulted on: 28.4.2014).
300
Ibid.
58
foreseen by Association and Deep and Comprehensive Free Trade Area agreements between the
EU and Georgia is a prerequisite of further deepening of Eurointegration process” 301. Therefore,
we would not expect radical change of situation from the Georgian side.
Regarding the third scenario, Crimean population is more pro-Russian than Armenian
minority in Georgia. The factor of language also plays a role here, whereas Crimeans speak
Russian, 95 000 people from the population of Javakheti region are Armenian speakers. 302
However, the low level of integration causes dissatisfaction and migration to Armenia or
Russia. 303 Even though Georgian public opinion states that Russia would not use Crimean
scenario against Georgia once again, after having successfully exercised it in Abkhazia and
South Ossetia, it might not be assumed that Moscow lacks creativity regarding scenarios.
Therefore, from the three listed scenarios, the Crimean scenario has the highest probability of
happening and causes doubts and fear of one more Russian invasion in summer 2014 in Georgia.
By history we have learned that Russia definitely is not a rational player, therefore none of
the international relation theories or analysis can claim with credible probability what Moscow's
next step could be.
301
Ministry of Finance of Georgia, ქ ც -
ქ 2020, [Socio-Economic Development Strategy Project: Georgia 2020], Government of Georgia,
Tbilisi, 2013, p. 3. Available in Georgian at: http://mof.ge/common/get_doc.aspx?doc_id=10742, (consulted on:
28.4.2014). [Translation by the author].
302
Georgia: The Javakheti Region’s Integration Challenges, 23 May 2011. Available at:
http://www.crisisgroup.org/en/regions/europe/south-caucasus/georgia/b063-georgia-the-javakheti-regions-
integration-challenges.aspx, (consulted on: 4.5.2014).
303
Ibid.
59
Conclusions
Since the restoration of Georgian independence from the Soviet regime in the early
nineties, the country has devoted its efforts to become a society of democratic values. However,
the path of transition from command economy to the market-one has been bumpy for a number
of reasons. In slightly more than two decades Georgia has experienced several domestic wars,
has been affected by internal and external economic crises, has had 20% of its territory occupied
by a third country, while part of the rest is still being taken day-by-day by the Russian border
control.304 Furthermore, the stages of economic transition themselves were characterized by lack
of consistency on the transition strategies and reforms, by implementation of spontaneous
reforms over the years, by lack of vision of desired economic strategy of the country or by
attempt to combine different approaches, and at times by inexperience of the people in charge of
decision-making. But, most importantly, the root of inconsistencies and unsuccessful reforms
was nonexistence of proper state institutions necessary for the initial post-communist transition.
In comparison with Poland, which is the main reference point and example of successful
Shock Therapy, Georgia did not inherit proper state institutions after the break of communist
regime, which made it impossible to succeed and sometimes even to carry out vital reforms.
Price liberalization, indexation of minimum wages and social security benefits, and tax reform
were the only successful reforms of Georgian Shock Therapy. Others failed or mostly failed due
to the lack of proper state institutions and lack of expertise, especially because of inexistence of
own national currency, further increasing the negative effects of the economy. Formation of
these institutions took valuable time, resources and experience full of mistakes, in order to
understand what was really needed. But, even so, criminal situation and corruption still stood as
major obstacles for proper economic development.
Rose Revolution of 2003 brought on drastic changes to the criminal situation of Georgia,
as well as in social and economic spheres. While Georgia was reaching higher ranks in Ease of
Doing Business charts of World Bank, receiving more and more Foreign Direct Investments,
while the tourism was nourishing, petty corruption was being totally eliminated, and state budget
was recovering from elite corruption, violation of human rights, selective justice and infamous
political, legal, social or economic reforms were accumulating. The story of spontaneous
reforms, inconsistencies on the desired economic system was repeated during Saakashvili's
304
Georgian MFA Slams Expansion of “Border Zone” deeper into Abkhazia, 21 January 2014. Available at:
http://www.civil.ge/eng/article.php?id=26872, (consulted on: 4.5.2014); Georgian President Concerned over
Abkhaz “Border Zone” Expansion, 22 January 2014. Available at:
http://www.civil.ge/eng/article.php?id=26879, (consulted on: 4.5.2014); NATO Reps Russia for Expanding
Border into Georgia, 5 February 2014. Available at: http://news.yahoo.com/nato-raps-russia-expanding-border-
georgia-170915120--spt.html, (consulted on: 4.5.2014).
60
regime. However, as the government was devoted to massive privatization, market liberalization,
non-interference of the state in the market, and other reforms so characteristic to Shock Therapy,
it was investing intensively in sectors that would have had largest effect on GDP growth
indicator - characteristic of Gradualist approach. As noted before, combination of the two
approaches is considered to be the best strategy, but it also has to be successive, gradualist
approach must be taken only after forming proper institutions and only after the “shock” is gone.
Saakashvili’s government had no strict direction regarding the strategy. The reform pattern was
rather inconsistent, at times spontaneous and was combining the two approaches at the same
time. The most significant success of this government in the economic sphere was the
minimization of state administration bureaucracy, facilitation of doing business (SMEs being
one of the crucial points of Shock Therapy strategy), and minimizing tax gaps by eliminating
petty corruption.
The peak of dissatisfaction with Saakashvili's government occurred when the prison
surveillance videos were spread by UNM’s rival party several days before the parliamentary
elections in 2012. It served as a turning point in people's political or rather, party preference.
Coalition headed by Georgian multibillionaire businessman Bidizna Ivanishvili won the
elections and took majority seats in parliament, as well as the government seats. This was
referred to as the most democratic transfer of political power in Georgian history. Even though
the new government was accused of being overly pro-Russian, especially because they restarted
talks about lifting the Russian embargo after six years, the new government extensively engaged
in finalizing the negotiations on Association Agreement and Deep and Comprehensive Free
Trade Area with the EU and declared Eurointegration as its main political direction in the Socio-
Economic Development Strategy “Georgia 2020”.
Since the initiation of EU-Georgian relations in 1992, Georgia has been becoming closer
and more integrated with the EU, mostly by the Neighbourhood Policy and Eastern Partnerhsip.
Georgia initialed Association Agreement with DCFTA component at Vilnius Summit in
November 2013, signing of which is scheduled in summer 2014, depending on the extent to
which Georgia fulfills its obligations by that time. On the path towards DCFTA Georgia has
carried out a large number of approximation measures, including constitutional changes to be
more or less in accordance with EU Economic Governance and its corrective arm. According to
the analysis financed by the European Commission and conducted by independent institutions,
in the long-term DCFTA has to bring significant increase in Georgia's imports and exports, GDP,
average wages and purchasing power of the population. However, in the short-term this will take
a lot of resources because of the legislation approximation technicalities and static short-term
61
effects. Unfortunately, not all of the Georgian export products will benefit from entering
DCFTA: some of the agricultural products will experience decrease in exports. The future of
small farmers in Georgia where agriculture employs 50% of the labor force, 95% of which
represent small farmers305, still remains ambiguous, since they would face numerous technical
and financial obstacles related to new legislations. For these reasons, it is recommended that the
approximation takes a gradual form, in order to avoid short-term losses and to better monitor and
forecast future development.
Georgia's State Minister of European and Euro-Atlantic Integration Aleksi Petriashvili is

positive about the signature of AA in summer 2014, however current international political
situation and Russia's leverage in the neighbourhood, as well as its hypothetical leverage in
Georgia, make the future of the AA and even the future of the country ambiguous and indefinite.
Armenia's and especially Ukraine's (former best ENP student) decisions to turn to Russian-led
Eurasian Customs Union pose question of actual level of Moscow's pressure on the ENP
countries. And, since Russia and Putin can be, by no means, regarded as rational players, so far
nothing can be said for sure.
Even though Georgian governments over the years have clearly and numerously expressed
their interest and determination to join the EU, this seems very futuristic goal first of all because
of low readiness of Georgian state and society itself, and secondly, because of the EU's
enlargement fatigue after the Big Bang of 2004. It has been discussed, that European
Neighbourhood Policy is a substitute for the enlargement because of the aforementioned
fatigue.306 However, Georgia has to remind itself that, while keeping EU membership as a long-
term goal, it should more focus on building a state based on European values. The main goal
should not be the membership per se, but rather the development of the state and Georgian
society to the point where it becomes a truly European state.
305
Agriculture and Rural Development, op. cit.
306
David Cadier, Is the European Neighbourhood Policy a Substitute for Enlargement?, 6 December 2013.
Available at: http://www.lse.ac.uk/IDEAS/publications/reports/pdf/SR018/Cadier_D.pdf, (consulted on:
27.4.2014); Deniz Devrim and Evelina Schulz, Enlargement Fatigue in the European Union: From
Enlargement to Many Unions, Working Paper 13/2009, 2009, pp. 1; 16. Available at:
http://www.realinstitutoelcano.org/wps/wcm/connect/99cc28804f018b15ae7bee3170baead1/WP13-
2009_Devrim-
Schulz_Enlargement_European_Union.pdf?MOD=AJPERES&CACHEID=99cc28804f018b15ae7bee3170baea
d1, (consulted on: 29.4.2014).
62
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129. What Is EaP? Available at: http://www.easternpartnership.org/content/eastern-
partnership-glance, (consulted on: 26.4.2014).
130. World Bank Data: Georgia. Available at: http://data.worldbank.org/country/georgia,
131. 2011 State Budget Amended, 8 April 2011. Available at:
132. #282 Bidzina Ivanishvili, 27 April 2014. Available at:
http://www.forbes.com/profile/bidzina-ivanishvili/, (consulted on: 27.4.2014).
74

Tamar Burduli - Economic Transitions in Georgia - On The Path From Shock Therapy Towards DCFTA

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Tamar Burduli - Economic Transitions in Georgia - On The Path From Shock Therapy Towards DCFTA

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COLLEGE OF EUROPE

NATOLIN (WARSAW) CAMPUS

ECONOMIC TRANSITIONS IN GEORGIA:

Supervisor: Kerry Longhurst Thesis presented by

Academic Year 2013 – 2014

Déclaration sur l’honneur

The aggravated dissatisfaction of Georgian population with the growing imprudence of

1) 1989-2003 - from independence to Rose Revolution;

According to Joseph E. Stiglitz, post-communist transformation is one of the most

1.1. Shock Therapy

1. Classical process of transition involving expansion of democracy in dominant capitalist

In his book Necronomics, Georgian economist and former Minister of Economy of

As it can be observed, the listed policies constitute to a “drastic neoliberal package of

6.95 7.09 6.79

Figure 1 Poland: GDP Growth Rate (%)42

2.1. Stage of Naive Comprehension

2.2. Stage of No Movement or Stage of Stagnation

2.3. Populist Stage of Reform or Shock Therapy

2.4. Stage of Delay or Stage of Accumulation of Mistakes

Currencies and Credits

Dr. Papava describes this stage as “characterized by extremely imperfect recordings of

2.5. Reforms Resumed or Stage of Correction of Errors

2.6. Leszek Balcerowicz - Economic Advisor in Georgia

2008 2009 2010 2011 2012 2013

Figure 2. Caucasus Barometer: Government as Parent vs Government as Employee (%)129

1995 1996 1997 1998 1999 2000 2001 2002 2003

3.2. Successful Post-Revolutionary Reforms

Improvement of Criminal Situation and End of Petty Corruption

substituted in quotes for the consistency of the paper.

Easing of Doing Business

Other Successful Reforms

 Increased training and readiness of the Georgian military force; 160

2003 2004 2005 2006 2007 2008

Extra-Budgetary Accounts or Elite Corruption

Other Notorious Reforms

 Elimination of state monopoly service, therefore hindering the competitiveness and

 Incorporation of State Statistics Department into the Ministry of Economic Development,

Post-War Crisis and Anti-Crisis Reforms

Figure 6. Georgia: Inflation Rate 2004-2012211

Figure 7. Georgia: Annual GDP Growth Rate 2006-2012212

Time Amount Sector

1992-2007 €530.8 million Various

2008-2010 €500 million Post-war reconstruction:

2011-2013 €180 million  Democratic development, Rule of law, Good governance

 Trade and investment, Regulatory alignment and reform

 Regional development, Sustainable economic and social

 Peaceful settlement of conflicts

Following the Georgia-Russia war in 2008, the EU condemned Russia’s recognition of

45. In order to avoid an unnecessary regulatory burden on enterprises operating in Georgia,

4.4. Peaceful Transition of Political Power in Georgia

1. Stronger commitment towards medium-term budgetary objectives (MTO) in order to

4. Adopt preventive measures for macroeconomic risks and instabilities, as well as

1. In 2006 Georgian government formulated and implemented a Medium-Term Expenditure

 Liberalization of the market;

 Ban on creation of new regulatory agencies;

 Ban on introduction of new licenses and permits;

 Referendum on tax increase (except excise tax);

 Ban on state having shares in any bank;

 Expenditures-to-GDP ratio – maximum 30%;

 Debt-to-GDP ratio – maximum 60%;

 Budget deficit - maximum 3% of GDP. 261

2006, p. 74. Available at: http://www.oecd.org/gov/budgeting/40139928.pdf, (consulted on: 3.5.2014).

4.7. Georgia and DCFTA: What Next?