Do we really need free economic area in Poti and Senaki?

Elza Jmukhadze

It has been a long time since we have known the abbreviation “FEA” and everybody knows that it means Free Economic Area or such place within the country where, compared to the legislation of the given country, considerable customs and tax privileges are effective.

FEA is a product of the last century, which was approved by the Western realities and finally it convinced everyone that its creation is a perfect way for attracting investments and rapid development of a country’s economy, and it was not strange when in Georgia, when it choose the path of independence, they started talking about FEAs openly.
From this point of view, at first the basis for it was laid by people who were knowledgeable in economic science. As a result in Georgian press there appeared publications the authors of which expressed their competent opinions about FEA. It is natural that this innovation had both supporters and opponents, and eventually the government of that time refrained from taking such a brave step, and the talk on this subject was temporarily “canned”.
Now it can be said why Shevardnadze’s government was so cautious, when the most real and practical of FEA’s supporters – the head of Ajara Autonomous Republic was denied creating a FEA in Ajara: under the conditions of an open boycott to the central budget, declared by the Ajara government, it was really hard to imagine the central government could control the processes and money flows within the FEA.
For well known reasons it was impossible to allow free economic areas in other parts of Georgia as well and this had purely political reasons: if the government had supported created FEA, for example in Poti, it would not have been able to explain to Ajara why it could not allow the same thing in Ajara which was under Georgia’s jurisdiction.
Taking into account a balancing style of Shevardnadze’s policy it was impossible to imagine that the President of Georgia of that time could withstand Abashidze who was nicknamed “Ajara lion” and tell him – I cannot control you. Thus it turned out in this case as if Shevardnadze would have acknowledged his own failure, but he could not let it happen.
It is difficult to say whether the political confrontation between Abashidze and Shevardnadze was real or not, but the fact is that Shevardnadze did not give Abashidze an opportunity to strengthen his economic positions. In other words, not having allowed to create FEA Shevardnadze he saved Georgia from a real danger of losing one more of Georgia’s regions.
Here we have to remember that creation of FEA is good near the sea gates of a country, but it is also possible where a country has a land frontier with another country or in the areas where there is an airport.
Proceeding from the above stated, it could not be ruled out at that time, that with allowing of FEA, such delayed-action political dangers, left from the communist times, like open or latent political claims of ethnical non-Georgians compactly residing on Georgia’s boundary territories, could have been activated.
It is difficult to say whether Georgia is so politically strong today not to be afraid of such political dangers, but the talk of FEAs in our country started again, and, according to our information, serious work is being done for creation of this concept. The specialists believe that the concept will be ready soon and before its consideration in parliament there will be a discussion either in the lobbies or an open public one.
It is natural that our magazine will also participate in this process, but for the time being our readers will have an opportunity, in connection with the prospect of creation of free economic areas, to familiarize themselves with the opinions of competent persons.
As far as FEAs are concerned, our readers had an opportunity to familiarize themselves with the specialists’ opinion on this subject. Speaking on this issue it is impossible not to mention the book “Technological Foundations of Customs” written by the editor of a specialized magazine – Emzar Jgerenaia that was published in 2002. In the b. subparagraph of the 3rd chapter there expressed interesting views on customs free trade, distribution of goods in free trade area, and on free bonded warehouses (FEAs), and we believe that we will familiarize ourselves with these views in details.
Mr. Emzar Jgerenaia believes that the above-mentioned issues are very important, though before their discussion the author singles out several factors. First of all in this context he pays attention to free trade shop, which, according to Georgian legislation, is a shop – customs regime, under which on the physical territory of the country there happens placement of special trade units, and these units are released from taxes. Here the question arises whether we can consider these shops as the regime. Mr. Emzar says, that according to the legislation, these units are considered as independent regime, though from the viewpoint of economic science the word “regime” is less applicable to such units. Practically we deal with goods that crossed the physical border of the country, but it has not yet crossed its economic border. Here, naturally, the question arises – who is a consumer, and who is a producer? It can be said that a producer is the country that produces similar goods and sends them to other countries. Here the difference is that this operation is considered as export, since the produce is located in the port. In short it must be a place from which citizens (both residents and non-residents) leave the country. This produce is considered to be exported or re-exported from the country, but taking into account the fact we deal with financial interrelations, this regime is conferred the status of the area free from taxes. This is just so called “duty free” that is a shop free from taxation.
This kind of units exist in all ports and airports of the world, they operate at the land frontier as well. In this kind of shops home appliances and so called essential goods are sold, which a passenger may need any time. This is one of possibilities by means of which a country tries to create conditions for tourism and make real comfort for passengers. This practice is applied at Tbilisi airport, Poti and Batulmi ports, and also on Kazbegi and Sarpi customs areas.
It can be said that existence of such units brings no benefit for the country. Often it happens just the contrary: if control is weakened goods enter the country through different channels. There are cases when the border is not strictly determined and smuggled goods cross it, which is an outrageous factor for both the budget and the industrial market. Any person who has permission for business activities can open a shop of customs free trade based on the decision of the Customs Department, and so called “red order”. The goods bought at this kind of units can be taken outside the country, but if it is brought into the country it will be liable to taxation. As to the storing of goods in temporary storage warehouses, it is tantamount to transferring of the goods to the warehouses of customs free trade shops, but it should happen according to the rules of transferring of goods under the supervision of the customs authorities. This means that placing of goods to the warehouse should take place in presence of the person authorized by the customs authorities, or based on their permission. It should be stressed that for customs free regime importation of the goods prohibited in the country is not allowed. The goods that fall under state control or need special permission also belong here. Customs declaration should be presented to the customs authorities along with corresponding documents (way-bill, certificate, invoice). The goods that are not included in customs free declaration cannot be brought to the shop or warehouse. This must be controlled be customs authorities and corresponding office of the Department, though it is not a secret that such control is often formal or does not exist at all.
According to Mr. Emzar Jgerenaia, taking into account all these factors, in Georgia warehouses for temporary storage can be created, FEA’s principles imply the same, though, in the author’s opinion, political and economical issues are intermingled here.
When Ajara declared its intention to create a free economic area, it was implied that it would serve as basis of rapid economic development. From the polemics of that time we can remember reasons of Mr. Givi Gamsakhurdia, according to which in the process of statehood formation none of FEA’s models would not be suitable for Georgia. He said that creation of FEAs should not be implemented without taking into account of economic specificity of the country, and until the restoration of the territorial integrity of the country. Creation of FEAs is financing of the economy by the state, but, according to Mr. Givi Gamsakhurdia, the state could not afford it at that time. Speaking of the tendencies in the world, he wrote that if we still wanted to think of creation of FEAs in Georgia, we should speak about not territorial direction, but about such kinds of FEA which are functionally regime FEAs, or move in the direction of creation of off-shore areas.
Of course there were other authors who supported FEA, but at that time there appeared the third opinion, according to which FEA, to the extent in which it should exist, had already been in Georgia, and the main thing was to use the existing situation completely.
The issue of FEAs is meticulously considered by foreign experts and specialists. According to their opinion, creation of FEA in Georgia requires analyzing of the reality…
With such a variety of opinions, it is difficult but possible to formulate what FEA is as economic category:
In the opinion of Mr. Emzar Jgerenaia, FEA, first of all, is a place of privileges in taxation and business undertakings, and FEA, as an economic phenomenon, is based on three postulates: it is a regional lever in the international integration process and a base for conquering regional markets. It is also an epicenter of economic relations and spreading of goods, services, and investments in different regions. If we consider it in details – it is free port principle, that is a customs warehouse that is free from taxes. On the same territory an economic area can exist, which gives an opportunity of making products in this area without taxation. This is a free customs production area and, correspondingly, the goods produced here can both freely exported abroad and get into the internal market, and that is what the principle of free selling, correct production and storage implies.
The second principle is repatriation, which will be created in customs area, and this is a necessary detail, since the objective of economic activities in this area is obtaining of profits, as result of which an investor should have an opportunity of its exporting. Protection of the principle of freedom of the capital’s repatriation is necessary, which, in its turn, requires free converting of currency and its unhampered circulation.
The third principle, according to Mr. Emzar Jgerenaia, is tax privileges, or such tax oasis that implies release of the investor from VAT, and conferring him of other privileges. When it comes to post communist or communist realities (China E. J.), Emzar Jgerenaia believes that military and political peculiarities should be taken into account – western business and private property are striving for penetration into these areas, and this will contribute to economic prosperity of these areas. Its goal is China (the strongest power in the region) which should turn into market economy state, where the appearance of mentality of striving for private property will eradicate the danger of emerging of hotbeds of nuclear or other wars.
From the viewpoint of economic and political peculiarities, Chinese or Arabian FEA are diametrically opposite to the western realities, where there are quite different economic relations. By their nature and content, these peculiarities are not very different from those rules which FEA requires. In this situation the question arises: what reality should we offer to Georgia? Mr. Emzar Jgerenaya gives the following answer to this question: – The analysis of the current situation in Georgia shows that we are trying to open the open door, that is what we ask for is already introduced in the laws, it is just necessary to read these laws carefully.
Mr. Emzar is convinced that, if we act this way, nothing will hamper creation of FEA in Georgia. If we take into account that after publishing of “Technological Foundations of Customs”, the “Revolution of Roses” happened in Georgia, and the tax legislation was simplified (that is it became liberal), it will become understandable that the current realities give more opportunities for legalization of FEAs.
Now we should think of what kind of FEAs we need, since, from this point of view, specialists single out 4 directions (some of them – 6):
1. Areas with special customs and tax regime (for example such as Dubai E.G.), or areas where only profit tax is paid, though it is reduced. There are no other taxes, but if they exist – they are fixed.
2. Areas of economic development in the region with production depression, stagnation, or in economically backward areas, where investors are granted various privileges concerning capital outflow, its returning, and also in infrastructure.
3. Technological parks technopolices, whose improvement is especially important for accumulation of costly technics, its selling, and creation, and there are plenty of such areas in the Middle East.
4. Special areas where banking, insurance, informational, and other zones exist, which are equal to off-shore zones. We can speak of customs free trade, customs free export and import, customs free industrial export, and also – about foreign trade areas, free ports, free territories, scientific and technical areas, free towns, etc.
When we speak about these privileges, and about creation of “simplified” liberal tax environment, we cannot but say a few words about off-shore areas: a heavy tax burden makes tax payers to look for various mechanisms of privileged tax economy. Those countries where for some concrete reasons serious tax discounts are introduced are called “tax havens”. It is a quite different notion than “a tax oasis”, or the territory (with low level of industrial development) within the territory of a country, where with the purpose of investments attraction, constantly or temporarily there acts the regime of privileged taxation. Ports, economic areas, free business zones, etc. are referred to this kind of “oases”. Term “off-shore” first appeared in 1950s when on the Eastern coast of the US they started to talk of the financial organization which, using its geographical situation, got out of the state control. According to the specialists (in particular A. Trotsenko and E. Karmanov) the term off-shore is an economical and geographical notion, but not a legal one. The essence of off-shore mechanism’s use is transition from the jurisdiction with high taxes to the jurisdiction with low taxes. Creation off-shore companies can be called fiction allowed by both national and international legislation.
The are following opportunities of turning a territory into an off-shore area:
1. Complete tax exemption
2. Introduction of fixed annual taxes
3. Introduction of low tax tariffs
4. Introduction of a fixed tax for company’s registration under the condition of absence of other taxes
5. Introduction of other special terms under the conditions of absence of taxes (for example the tax for opening a bank account), etc.
“Tax haven” should meet other conditions as well: first of all it is safe keeping of bank and commercial secrets. Very important factors are: absence of agreements with other countries concerning information exchange, less strict currency exchange regulation, political stability, guarantees of business’s safety and security. In off-shore areas investors are attracted by the fact that there the procedure of registration is very easy; there are no limits of currency export and import; the procedure of firms management is easy and often relative; breaches of customs and tax legislation are not considered as a criminal offence.
This kind of policy gives an opportunity of existence for the countries that do not have natural resources or a considerable economic potential. Appearance of multinational companies contributed to the rapid development of off-shore areas. By means of their international production and sales network of brunches, they managed to channel their profits to the countries with low taxes. Creation of the system of international branches and subsidiary companies and through them carrying out of operations of large companies gives an opportunity for large-scale activities in an off-shore area.
By means of this mechanism the economically developed countries lose multi billion tax incomes. Eventually, these sums are accumulated in off-shore areas and then return to the country in the form of foreign investments, which, in their turn, have tax and other privileges. In this case the state budget suffers double losses, since, at first, national
income leaves the country without any taxation, and then it returns to the country having various privileges..
To cope with these problems a state has nothing left to do to proclaim the reputation of the companies operating in off-shore areas as doubtful. This means that they will not have customs privileges, cheap credits, or some other support from the state. Often the companies that operate in off-shore areas have to certify the legality of the investments.
Mr. Emzar Jgerenaia points out that off-shores differ from FEA by the fact that the companies operating in off-shores are the residents of the country. They basically pay a fixed tax for their registration. Though off-shore is really the place of investments, concentration and distribution of capital, in this kind of areas often takes place laundering of the money obtained from politics and other activities (corruption, drugs trade, porno business, arms business, etc.), which then gets to terrorists. For the known reasons the talk of such things in Georgia must not be allowed.
As for FEAs (from the viewpoint of their diversity), they are the source of capital, a perfect tool of its concentration and the place of origin of international financial oligarchies. That is why at the end of 19 and in the beginning of 20 centuries the American Congress passed the law on FEAs. In 1980s there were 140 FEAs in this country, now their number exceeds 200.
We have decided to ask the chairman of Georgian Chamber of Commerce and Industry – Mr. Jemal Inaishvili to express his opinion concerning FEAs. Even if we do not take into account his present status, he is a man who has not only thought about FEA but he has made many practical steps in this direction along with foreign specialists when he was the director of Poti port.
– Mr. Jemal, in your opinion, why the talk of FEAs started in Georgia, why this issue was “canned”, and why issue of creation of FEA is on the agenda again today?
– FEA itself is a serious economic phenomenon and international experience has proved its advantages. That is why we started thinking of creation of FEAs in Georgia. But it turned out that at that time the country, as a post soviet one, was not yet ready for it from the viewpoint of its mentality, and did not want to run such a great risk. You may remember that the idea of FEA’s creation was actively supported by Aslan Abashidze, but it will not be a secret if we say that he had quite another aim. Abashidze wanted to make Ajara economically independent, but it could not be allowed. After Abashidze’s factor was eradicated and Ajara has a government that has national position, there is a strong basis for implementation of this idea in Georgia. FEA exist in all developed countries of the world and it proved itself everywhere. It enough to draw an example of China or United Arab Emirates, let alone the US, and European states. FEA was that “magic” thing that gave a very solid foundation for the economies of these countries. It known that in FEAs customs and tax procedures are very simple. In those countries where FEAs exist, there is special legislation that envisages tax privileges, which eventually serves for attraction of foreign investments to the country. For Georgia, as a transit country, FEA will be very convenient and, in my opinion, we have no right to leave this factor, important for the development of the country’s economy, without attention. In spite of the fact that we have ports and necessary infrastructure, the goods turnover is not so big as it could be. It happens because there are restrictions at the customs, because of which Georgia, as a transit country, loses attraction. FEA will lift these restrictions and it will increase the goods turnover. Besides that, on the FEA territory new enterprises and warehousing will appear, and new jobs will be created.
– It is true, Mr. Jenmal, but you have just mentioned post soviet mentality, and probably because of it we should not forget that still in Georgia no one knows when people stop looking for the ways of getting round the law. Correspondingly, we cannot rule out that for those wishing to evade taxes FEA will turn to a desirable oasis, is not it so?
– No, it is not, since registration of companies in FEA will be strictly controlled. FEA, first of all, implies an isolated territory and it will not be difficult to find out what is going on there.
– Let us say that we will achieve transparency of private companies operating on FEA’s territory, but at least we have to tell the investor that he is free from profit tax and from VAT, and what benefit will the state budget have out of it?
– When I worked as a director of Poti port I thought on this issue a great deal, since at that time the talk of FEA already started, and it could not be ruled out that idea could be implemented then if the above mentioned political background would have been eradicated. That is why I had active meetings and discussions in relation to FEA with western, in particular American specialists. I know it for sure that the situation on the FEA’s territory should be controlled by one state owned Ltd, which will lease the lots on the FEA’s territory to those who wish it and collect from them taxes for registration, lease and services. Correspondingly, only this Ltd. will be answerable to the state budget. Here we must take into account that this Ltd. should not be levied with high taxes so that it should not increase prices for everything. Only in this way in FEA a favorable conditions for the investors will be created: simplified customs and tax procedures thanks to release from profit tax and VAT, considerably more cargoes will get into the FEA’s territory compared to the current volume of cargoes coming to the territory of Georgia. Besides that companies prefer to cut transportation expenses that is to bring into FEA not only finished commodities but also raw materials that will be repacked and only after that they will be imported via Georgian territory, or from Georgia to other states. Of course these operations will be levied with taxes according to the ordinary order, which will bring additional income to the Georgian budget.
– Is it necessary that FEA should be situated at the territory adjacent to a port?
– Port is necessary for FEA’s territory since a big freight flow goes through it. It can not be ruled out that FEA will be created on the territories adjacent to airports. Anyway, it is necessary for FEA to be situated near sea, land or air gates and availability of corresponding transportation or other infrastructure. If we take an example of the United Arabian Emirates, there the government first allocated lands for FEA, and then when FEA’s proved their efficiency, that is when serious investments were made, construction of ports became necessary in many places. Power supply, water, roads – are technical matters without which the existence of FEA is impossible, but the main thing is tax legislation which will create favorable conditions for the investors. Here, naturally, it is implied that a country that will create these laws should not change them often and an investor should not worry that some his capital will become unprotected. The risk factor constantly exists in business, that is why it is always up to an investor to decide whether this or that risk is worth taking, but unforeseen risks is a quite another thing – they are created by changeable legal environment. That is what should be ruled out if we want to create FEAs in such a serious competitive environment in which Georgia is…
– I am sorry for interrupting you, but what kind of competition do you mean?
– In the neighboring Turkey FEA already exist and soon this idea will be implemented in Russia as well, that is why, if we do not create better conditions we will not be able to attract investors. It is true that Georgian market is very small but investors will also think about Armenia and Azerbaijan where he will get through Georgia, and this is a 15 million market and entering it is a serious business for any investor!
– What does our legislation look like from this point of view?
– Introduction of corresponding changes into our legislation will be necessary and the list of these changes is not very long. Serious work is already underway and we hope that soon the Georgian parliament will be considering this issue. The main thing is to make exact calculations from the very beginning, or we will get a stillborn idea the implementation of which will be practically impossible. I repeat it once more that a risk that, as a rule, is in store for an investor should not be caused by wrong customs and tax administration implemented in FEA, and also – by sluggish legislation that does not correspond to modern requirements!
– Mr. Jemal, there are so called off-shore areas. In your opinion, is it possible to create this kind of areas in Georgia?
– It will not work in Georgia since off-shore area implies that liberal tax legislation should be effective on the whole territory of the country. Very small countries of the world were proclaimed off-shore areas, they have neither armed forces nor police. The population of such countries is occupied in the sphere of services and tourism. Besides that, the states proclaimed as off-shore areas the financial sector is developed very well. That is these countries can provide for themselves, since the problems (like social sphere, education, science, healthcare, etc.) that we have. We inherited these problems from the previous state authorities, that is why we need much money and a solid budget, which we will never fill under the kind of liberal tax legislation that should work in off-shore area.
– Last time we were speaking about Ajara and said that Shevardnadze’s government did not dare to legalize FEA because of big political ambitions of the head of Ajara Autonomous Republic, and Georgian government was afraid of economic strengthening of the region. I wonder what will happen if we legalize FEAs before Georgian jurisdiction is reestablished in Abkhazia?
– It is true that in the time of Abashidze’s rule the political situation was difficult, that is Ajara’s authorities showed contempt towards the central authorities, but we can not compare this situation to that one in Abkhazia. Taking into account the fact that the international community considers Abkhazia as a part of Georgian territory, until the final settlement of the conflict no one will allow creation of FEA in Abkhazia. Correspondingly, the fact of appearance of FEA’s in Georgia will probably be very interesting for Abkhazia. Here we can draw the example of Cyprus, the Southern part of which has strengthened thanks to FEAs and today Cyprus is a member of the EU. Now the Northern part of the country is striving to unite with the South, and this is stipulated by the increase in the living standard. If Georgia rationally uses all those opportunities which, thanks to the God, we have, sooner or later Abkhazia’s return to the single state space will turn out to be desirable for Abkhazia.
– Mr. Jemal, to your mind, what will be the priority for Georgian FEA – free trade, warehousing, or new processing enterprises?
– I am convinced that for us, first of all, the transportation function will be a priority. I also see an interesting prospect in creation of food products processing enterprises and light industry enterprises in FEAs. It is supposed that here the main emphasis will be placed upon on the things that are not produced in Georgia.
– Why?
– Because any produce brought to FEA in the form of raw materials, after its processing on FEA’s territory will go outside it in any direction only as import, or will pass as transit in the direction of the neighboring states. As to the export, it has tax privileges in Georgia anyway, that is why, for example, it will be senseless to bring grapes to FEA for processing. Though the enterprises existing in FEA are released from VAT and profit tax, the same wine-maker, if he decides to process raw material in FEA, firstly he will have double transportation expenses, and secondly the produce made in FEA will leave it only in import mode, that is he will suffer losses.
– I wonder how are Georgian customs and tax systems ready for assuming such an important mission and fulfill it competently and honestly?
– We should by all means equip these structures with technique, professional staff and provide strict administration mechanism. After all a day should come in Georgia when we will depend on a corrupted and uneducated customs or tax officer! Only in this way we will attract serious investments. Each good investor is a real treasure for us, since it will bring new investors. New technologies will be introduced and our people will be employed, for in FEA which, let us say, will be created in Poti, a Poti resident will work who will earn money, and then he will spend them in Poti. So the living standard in Poti and in the whole country will gradually rise.
– Mr. Jemal, all positive points of FEA are clear, but each medal has its reverse side. What about FEA?
– You may be surprised but I do not see big risks connected to the legalization of FEA:
both in political and economic sense FEAs will contribute to the development of the country at high rates.
– If it is so attractive, can it be ruled out that one day it will become overfull and the necessity of its enlargement will emerge; what shall we do then?
– The enlargement of FEA is possible.
– But is there a possibility that some day Georgia’s small territory will be divided not into regions but into FEAs?
– In the world there exist both free economic areas, which imply confined territories, and special economic areas which are functioning without any borders, and this is of no less interest to the economy of the country…