CC BY
52
Nodar KHADURI
Ph.D. (Econ.), Full Professor at Ivane Javakhishvili Tbilisi State University
(Tbilisi, Georgia).
THE CENTRAL CAUCASUS-REFORMS AND THE ROAD TO EUROPE
Abstract
T
he author examines the economic and political reforms in the Central Caucasian countries. He focuses particular at-
tention on an analysis of the role and place of these countries in world geopolitics and their integration into the European community.
I n t r o d u c t i o n
Three independent states, the Azerbaijan Republic, the Republic of Armenia, and the Republic of Georgia, were established in the Central Caucasus after the disintegration of the Soviet Union.1 Unfortunately, the last years of the Soviet era were marked by an aggravated situation in the Caucasus in general and in the Central Caucasus in particular, along with the emergence of centrifugal processes.
The disintegration of the Soviet Union (and its collapse, in the case of the Caucasus) took place against the background of serious problems. The hostilities in the Northern Caucasus and between
1 In the opinion of Professor Eldar Ismailov, the term “Central Caucasus” covers the three independent states located beyond the Greater Caucasus, while the term “Southern Caucasus” covers that part of the Caucasus which is located to the south of the borders of these states and also constitutes part of Iran and Turkey (see: E. Ismailov, V. Papava, The Central Caucasus: Essays on Geopolitical Economy, CA&CC Press, Stockholm, 2006).
Armenia and Azerbaijan, as well as the conflicts in Georgia’s two breakaway regions, proved that the Caucasus was at war. Whereas in the past there had been a lot of discussion about various forms of Caucasian integration (such as the establishment of the United States of the Transcaucasus, a Common House of the Caucasus, and so on),2 now the hostilities have postponed the integration process for a long time to come, if not forever.
Today, new cooperation opportunities are emerging in the Central Caucasus that are mostly based upon economic rather than political principles. The unfortunate reality remains, however, that it is impossible to engage the entire Central Caucasus within common economic principles and create a uniform economic area.
Nevertheless, the key trends of the reforms are analogous in the three states of the Central Caucasus and the declared principles of each of them are quite similar despite their tactical differences. The reforms in both the political and economic systems, however, are currently being implemented by means of different methods. Furthermore, those economic capabilities which distinguish the states of this region from one another should be kept in mind.
Presently, the interests of the Caucasian states—and especially of the countries located around it—are very diverse from the economic point of view. Along with Russia, the United States, and the EU member states, Turkey also plays a significant role in settling the problems in the Caucasus. It recently became clear that Russia and Turkey are striving to dominate in the Caucasian region, although the influence of the EU is increasing in the region in both economic and political terms.
Neither an economic, nor a political, nor any other confrontation is new for the Caucasus. Since the times of Ancient Rome and Greece, the Black Sea and the Caucasus have had serious potential for expansion, the Greek colonies discovered in the Caucasus and during the Argonauts’ trip to Colchis (present-day Western Georgia) being cases in point.
Geopolitical Role of the Central Caucasus and Its Importance for Europe
On the whole, the Caucasus—including the Central Caucasus—is a developing market which has high potential for economic growth and energy and transport links. The population of the Central Caucasus of 16.5 million3 lives on 186 thousand sq/km4 of the territory occupied by Georgia, Armenia, and Azerbaijan, where GDP of $65.6 billion (at current prices) was produced in 2009. GDP of $4 thousand5 was produced per capita at current prices, which is an extremely low parameter.
It should also be kept in mind that significant growth was observed during the last nine to ten years. Whereas GDP was $651 per capita by 2000, at present, nominal GDP has increased 6.1-fold per capita in USD. According to the statistical data of all three states, GDP (at current prices, USD) increased 6.4-fold. For quite understandable reasons, Azerbaijan is leading in terms of its growth parameters (by 8.2-fold).
2 Ibidem.
3 The statistical information about the countries is taken from the websites of their respective statistical services, as well as from the website of the CIS Statistical Committee [http://www.cisstat.com], and the Asian Development Bank [http://www.adb.org].
4 [http://www.adb.org].
5 [http://www.adb.org].
THE CAUCASUS & GLOBALIZATION
Today, there are certain specific factors that are arousing the European Union’s interest in the Caucasus. The United States and Europe are trying to find alternative energy resources to those in the Persian Gulf and the Russian Federation. The political will for making these changes based mainly upon economic interests is manifested in the fact that the Caucasus is now situated at the crossroads of important energy flows. Regional cooperation in the Caucasus is quite fragile since the economic and political interests of Europe and the United States collide with those of Russia. The 2008 August war, as well as Russia’s intensified efforts to settle Armenian-Azerbaijani relations prove once again that an increase in Russia’s economic and predominantly political ambitions is harbinger to a serious redistribution of power in the Caucasian region.
Despite the so-called reset policy pursued by the U.S. administration, it is quite obvious that both Europe and the United States are trying to ensure that Russia does not acquire alternative transport routes to prevent it from restoring its earlier monopoly when the only route for transporting Russian, as well as Central Asian and Caspian energy resources passed through Russia owing to the absence of corresponding infrastructure in any other country.
Russia’s dominant role is strengthened by the fact that there are three conflict zones along the Central Caucasian route—Abkhazia and South Ossetia in Georgia and Nagorno-Karabakh in Azerbaijan—which is an alternative to the Russian route and obviously decreases the interest of investors in developing regional transit routes, while significantly increasing the risks.
Despite the abovementioned, the Caucasus is still very important for the world and especially for the European Union because of its transit function. The region is an important link between the resource-rich Central Asian states and Europe with its increased demand for resources.
The region’s geographical location is unique. Its geographical and geopolitical location alone prompted Georgia’s initiative to restore the Great Silk Road through its territory. Of course, the striving to restore the Great Silk Road is aimed at much more than simply facilitating oil transit. In fact, this road is supposed to link a new world economic giant, i.e., China, to Europe.
For the transport corridor to function properly, railway and sea transport must be developed. Furthermore, its political significance as a transport corridor is huge, its development promoting further enhancement of the idea to form a so-called Belt of Southern Democratic States in the territory of the countries of Central Asia and the Central Caucasus, as well as establish an alternative corridor in the world market.
The Caucasus is not only a transport artery for Europe, but with the accession of Bulgaria and Rumania to the European Union, this region has practically become a neighbor. For this reason too, therefore, more attention has been focused on the reforms going on in these countries.
Reforms in the Caucasus
In the early 1990s, following the disintegration of the Soviet Union, Georgia, Armenia, and Azerbaijan managed to gain independence for the second time in the twentieth century, which enabled them to make independent decisions. Independence, which was first declared in 1918 (the three Caucasian republics declared their independence on 26-28 May, 1918 in Tbilisi), proved quite brief. Azerbaijan and Armenia lost their independence in 1920, while Georgia fell a year later, in 1921, when all three countries were annexed by the Russian Red Army. In late 1921, they were incorporated into the Soviet Union, first as the Transcaucasian Federation and later as “independent republics.” After the Soviet Union collapsed in 1991, issues of economic and political reconstruction, as well as the restoration of statehood were put on the agenda after many countries of the world recognized the independence of Georgia, Armenia, and Azerbaijan.
Although the road was more or less smooth for the republics of the Central Caucasus (then called the Transcaucasus) during the existence of the Soviet Union, the first years of independence turned out to be a serious test for the three countries, which was manifested in civil or patriotic wars and ethnic conflicts, as well as transport and energy blockades. This was followed by a crisis situation in each of the three countries, so they began to work on solving two interlinked problems: the formation of an independent state and the implementation of market economy principles.
It should also be noted that none of the Caucasian states had any experience in governance or in implementing economic or other reforms. Previously, all decisions were made in Moscow, so along with other important problems, the necessity for implementing reforms in the education system, for example, was put on the agenda to train personnel for national, economic, social, and other spheres in order to ensure that they would become both good executives and good policy-makers.
Transformation of the labor market, health care, and the social system in general was also very important. Although the standard of living dropped during the last years of the Soviet era, the social guarantees and the availability of education and health care (although of low quality) remained intact but there was a threat that a further reduction in these packages would trigger serious social problems in the country.
The education, social, healthcare, and other systems proved uncompetitive and the collapse of the uniform system caused a sharp regress in their quality and availability. Accordingly, after the disintegration of the U.S.S.R., the three Caucasian countries launched reforms envisaging, at least theoretically, the formation of independent states (with all the individual attributes), the creation of their own judiciary, the implementation of democratic reforms, the dismantling of the planned economic system, property pluralism with consequent private property supremacy, the breakup of the directive price formation system, and the creation of independent fiscal, customs, and monetary institutions.
The first years of the reforms proved extremely difficult for the three Caucasian states. The difficulties were mostly triggered by the hostilities and their consequences rather than by the ideology or the content of the reforms.
The Caucasian countries launched their reforms almost simultaneously, with some of the reforms being implemented under an identical plan and often following Russia’s example with respect to political, social, economic, judicial, and other reforms. After almost 20 years of launching reforms, however, a gap emerged between their ideologies. The goal in each of the three states (at least the declared goal) is that each is aspiring toward Europe, although there are many obstacles blocking their way to achieving this goal.
Unfortunately, the ideology of the reforms often changes. Whereas during the first years of the reforms, all three states declared a social market economy as their key goal, this coincidence later changed to a significant degree.
Economic Reforms
The Soviet Union fell apart against the background of the important ideological transformations that began in 1985 and removed the Iron Curtain, thereby showing the population that the standard of living, of which they were so proud, was in fact not so high. So the society that had been building communism became interested in building capitalism.
Unfortunately, there is not a single country in the world that has had any theoretical or, especially, practical experience of moving from socialism to capitalism. The reforms implemented under the guidance of Ludwig Erhard in West Germany after World War II were perhaps the closest, although
THE CAUCASUS & GLOBALIZATION
in a radically different way.6 Consequently, there emerged two very different ways of implementing economic reforms; namely, those implemented in Poland under the Balcerowicz Plan and those implemented in China.7
The three states of the Central Caucasus are still debating whether or not it is possible to follow the Chinese way of reforms. Each of the countries, however, applied a so-called “Russian version of the Polish experience” as a reform ideology.
Georgia, Armenia, and Azerbaijan started using “shock therapy” at the same time as Russia, which meant financial stabilization, price liberalization, a reduction in the budget deficit, the implementation of a tight credit policy, the introduction of a moderate tax system, and a reduction in state expenditures. The Georgian, Armenian, and Azerbaijani reformers, however, failed to take account of several important factors. In particular, not one of the Central Caucasian governments had a real macroeconomic tool, nor did they have their own monetary systems or real levers to implement a tax-budgetary policy. Instead of taking care of establishing such tools, they started implementing “shock therapy” without any due preparation.
As mentioned above, the economic reforms implemented in Poland—which are associated with the name of ex-finance minister and now President of Central Bank Leszek Balcerowicz and are known as the Balcerowicz Plan—have become a notable example of “shock therapy.”
Under the Balcerowicz plan, a tight fiscal and monetary policy was carried out in Poland, which was reflected in price liberalization, a significant reduction in the budget deficit through rejecting budgetary donations and subsidies, and limiting the population’s income and the money supply.8 The shock therapy carried out in Poland envisaged the simultaneous implementation of 11 different measures. In particular:
—Artificial stimulation of inflation for establishing a balance in the market; multiple price growth.
— Strict limitation of the income of the population.
— Significant growth of interest rates and limitation of the money supply.
—Increase in interest on deposits in order to encourage the population to save more.
—Reduction in budgetary expenditures at the expense of capital investments and donations.
—Issuance of state bonds in order to cover the budget deficit.
—Enhancement and unification of the tax system.
—Introduction of a zloty exchange rate against the USD and providing for zloty conversion in the domestic market.
—Introduction of a single customs tariff in order to restrict imports and stimulate exports.
—Rendering social aid to the population within the framework of real capabilities.
—Liquidation of monopolist structures and saying no to administrative interference of the state in business activities.
Unfortunately, as previously mentioned, implementation of shock therapy in keeping with the pattern of the Russian reforms began at the same time as the processes launched in Russia and was carried out in Azerbaijan beginning on 6 January, 1992 and in Georgia from February 1992. For the
6 See: L. Erhard, Wohlstandfur alle (Welfare for Everybody), Econ-Verlag, Dusseldorf, 1957.
7 To receive detained information about these process, see: V. Papava, Necroeconomics, The Political Economy of Post-Communist Capitalism, iUniverse, New York, 2006.
8 See: L. Balcerowicz, “Poland, 1989-1992,” in: Political Economy of Economic Reform, ed. by J. Williamson, Institute for International Economics, Washington, 1994; L. Balcerowicz, Socialism, Capitalism, Transformation, Budapest, 1995.
above-mentioned reasons (hostilities, transport, economic and energy blockades, absence of basic macroeconomic tools), however, it had no significant effect in these countries.
The opinion on whether or not it was possible to pursue the Chinese road of reforms, taking things gradually, proved inconsequential since China differed significantly from these Central Caucasus states—and the entire former Soviet Union—in many ways and is in fact still quite different. As mentioned above, Georgia, Armenia, and Azerbaijan had to solve two major problems simultaneously.
Building an independent state and implementing economic reforms should have occurred concurrently, so it is clear that many mistakes were made on the way to implementing the reforms. Since neither their individual experience nor their financial state enabled the three Caucasian countries to carry out these processes independently, each of them turned to international financial institutions for assistance; in particular, to the International Monetary Fund and the World Bank. Along with the above-mentioned preconditions for the formation of a macroeconomic policy, the institutions defining the world financial order largely contributed to policy formation.9 Providing important methodical, methodological, and financial aid can be considered a merit of these institutions in executing the post-Communist transformation processes along with the more or less coordinated actions of the Georgian, Armenian, and Azerbaijani governments.
Price reform was implemented in each of the three Central Caucasus countries (all prices were liberated apart from certain exceptions in the so-called spheres under regulation). The countries implemented land reform (unfortunately, land privatization in fact triggered land fragmentation and a reduction in the share of agriculture), privatization, and liberalization of foreign economic relations.
Significant changes were also carried out from an institutional point of view. All the countries abandoned the Russian ruble zone and created their own monetary systems (they took important steps toward forming independent economic systems by introducing a National Bank coupon and then the national currency, namely, the lari in Georgia, the dram in Armenia, and the manat in Azerbaijan). Privatization of the banking sphere was also carried out (practically all state-owned commercial banks, except for Azerbaijan’s International Bank, were privatized).
It was important to establish an optimal budgetary system to enable the establishment and functioning of an independent economic system. Particular steps were taken to optimize the tax and customs systems.
One of the most important issues not only for the economic development of these countries, but also for their rapprochement with the European Union is to bring the institutional structure of their economies closer to the European economy. During the first years of reforms, the formation of European-type regulatory institutions began as a result of serious consultation and assistance. Later, the regulations were minimized in Georgia, which distanced the country from its European goal.
Certainly, economic reforms are still underway, since the process of post-Communist transformation is not over. It should be emphasized, however, that the main backbone of the process has already been formed and now only needs its body.
Reforms in the Labor Market and in the Social Sphere
It bears repeating that the post-Communist transformation, which started two decades ago, has been going on, and is still going on, against a very difficult social background. The disruption of the
9 See: V. Papava, “Post-Communist Transformation of the Georgian Economy: Experience and Main Directions of Reforms,” in: VI World Congress for Central and East European Studies, 29 July-3 August, 2000, Tampere, 2000.
uniform Soviet economic expanse, along with the political, military, and natural cataclysms, has significantly reduced production volumes.
Chart 1
GDP Dynamics of Georgia, Armenia, and Azerbaijan in 1969-2009 (in 2005, in billion USD)
30.00
25.00
20.00 15.00
10.00
5.00
0.00
S o u r c e: World Bank World Development Indicators; International Financial Statistics of
the IMF; Global Insight; Oxford Economic Forecasting; as well as estimated and projected values developed by the Economic Research Service all converted to the 2005 base year, available at [http://www.economicswebinstitute. org].
As seen from Chart 1, a significant decline in real GDP was observed in the three states beginning in 1990. The greatest decline was observed in Georgia’s economy and, unfortunately, Georgia is the only country from among the Central Caucasus states that has failed to achieve the pre-reform figures.
Obviously, such a decline aggravated the social background in all the countries and triggered an increase in unemployment. Today, the unemployment level reaches almost 17 percent in Georgia and 6.9 and 6 percent in Armenia and Azerbaijan, respectively. It is important, therefore, to reform the labor market and social protection systems, as well as introduce insurance mechanisms.
Labor legislation is a serious problem for the Caucasian states and, especially, for Georgia. Whereas the legislation is more or less balanced in Armenia and Azerbaijan, the role of trade unions is provided and the rights of both employees and employers are protected, according to expert assessments, Georgia has an “ultraliberal” labor legislation and is one of the most liberal countries in terms of hiring and dismissing employees.10 As for improving labor legislation, this primarily means modifying the institutional framework and bringing it into harmony with that of Europe.
From the economic viewpoint, the Azerbaijan Republic has more opportunities than Armenia and Georgia as a result of its rich resources, which enable the allocation of more state financing for the
10 [http://www.doingbusiness.com].
social sphere. As far as Armenia and Georgia are concerned, the emphasis should only be placed on institutional reforms under their conditions of more limited resources.
From the social point of view, it is also important to implement reforms in the pension system. Although the pension system of the three states (or, more correctly, the social welfare system for the elderly and disabled) is in the process of being formed, a traditional system is functioning, in which pensions are granted from social transfers (as happens in Armenia and Azerbaijan) or from tax revenues of the state budget.
The pension system, therefore, is still undergoing transformation and formation. The average pension is $54 in Georgia, $67 in Armenia, and $125 in Azerbaijan.
The debates continue as to the type of pension system that should be established in these countries. It should be noted that even if the pension system of any country changes today and a pension insurance mechanism is introduced, it will take approximately 45 years to operate the pension system at its full capacity.
On the whole, the Caucasian countries are taking steps toward transferring their healthcare systems to insurance principles, although the insurance system is not very popular owing to traditional and conservative views and resistance to change.
Integration in the Central Caucasus
As discussed above, all three Caucasian states, despite their different resource capabilities and current economic state, belong to the category of small markets, not only separately, but also together. A total of 16.5 million people live in the Central Caucasus, with Azerbaijani citizens comprising one half of them, while approximately 4.4 million people are registered in Georgia and 3.2 million in Armenia. Unfortunately, their purchasing power is very low, amounting to approximately $4,000, while it is approximately $7,200 per year according to purchasing power parity (PPP).11
Certainly, it is important to establish an integrated market under such conditions in order to ensure that both foreign and local investors have more impetus owing to the comparatively larger size of the market. As for the different types of international integration, it is obvious that they cannot be implemented in the Central Caucasus at this stage. Having said that, some points of contact can be found in order to draft a plan for a common Caucasian market.
The probability of integration is especially difficult against the background of Armenian-Az-erbaijani relations. Considering the fact that both Armenia and Azerbaijan are parties to the CIS Free Trade Agreement, however, there is still some possibility of integration. However, certain conditions must be observed to make integration more qualitative. First of all, free movement of people, commodities, and resources must be promoted. Georgia has this free movement regime with both Armenia and Azerbaijan, although the latter do not have it at the bilateral level. Furthermore, Georgia has signed a free trade agreement with the both of its neighbors, which provides custom-free export and import opportunities.
There are some additional preconditions, the implementation of which is a compulsory condition for integration12:
11 [http://www.imf.org].
12 See: L.E. Ismailov, V. Papava, The Central Caucasus: Essays on Geopolitical Economy, CA&CC Press, Stockholm, 2007. K.A. Semenov, Mezhdunarodnaia ekonomicheskaia integratsiia, Iurist-Gardarika, Moscow, 2001.
THE CAUCASUS & GLOBALIZATION
—Tax equalization,
—Cancellation of budgetary subsidies,
—Harmonization of national legislation,
—Standard unification,
—Coordination of social protection systems,
—Introduction of similar market regulation mechanisms, and —Coordination of financial and credit structures.
Of course, it will be difficult to select a common model from those operating in the three states. A better choice would be if European legislation and European regulations are selected as a common goal. Caucasian integration, therefore, will promote further Euro-integration for the three Caucasian states.
C o n c l u s i o n s a n d R e c o m m e n d a t i o n s
The first years of independence proved to be extremely difficult for the Central Caucasus countries. The hostilities, as well as transport and energy blockades, put them in a very complicated situation.
The difficult political situation was followed by aggravation of the economic situation and a drop in the standard of living. It triggered the need for implementing urgent reforms.
Although each of the countries pursued independent policies, the stages of the reforms were often similar. They launched the establishment of state institutions, the formation of independent economic systems, and an economic revival.
The independent states managed to create their own budgetary, monetary, tax, and customs systems, as well as elementary mechanisms of social protection. The process for introducing market regulation institutions was also launched.
Despite the serious resistance among the states of the region, certain features of the region’s integration are already visible today.
Certainly, the quality of integration cannot be deep at the first stage. The economic factor and harmonization of the institutional, tax, and other sectors with the EU may become the basis for integration.
In the event of integration and the establishment of a uniform market, the standard of living may significantly improve.
