ADVANTAGES OF FREE TRADE POLICY IN POST-COMMUNIST GEORGIA
Acad. Vladimir Papava
The influence of external trade policy on the development of industry is great, which is confirmed by experience of Georgia.
With the purpose of solving problems of Georgian industry we should point out to the fact that post-Soviet countries have inherited from the Soviet giant-mania such enterprises that can be justly called “pyramids of Soviet epoch” but, unfortunately, these enterprises contain non-perspective part of industry instead of Pharaohs. We can only wonder at their magnitude and admit the fact that many enterprises have lost their functional strength. It is considered a good achievement if any of them manages to work with 20% load, as it is difficult to sell expensive and low-quality production even in these conditions. The problem of realisation will become more acute if the load increases. We have conditionally singled out periods of slowdown and comparative recovery of which the years 1990-1995 are characterised by a tendency of decline with there being an annual decrease in industry. The volume of 1995 production equalled 14% of 1990 production including extractive industry – 43,3%, and processing one – 10,4%. This was, to a large extent, stipulated by a hard situation in electric power and fuel industries.
The volume of fuel production in 1995 was 96,8% down from 1990. Electric power production has insignificantly increased by approximately 1%. A sharp decrease of production is observable in the following industries: construction (96,2%), light (95,9%), chemical and petrochemical (91,25%), wood-processing and cellulose-paper (95,9%), iron, engineering and metal-processing (87,0%), food (86,9%), combinatory food – (78,6%).
A revival has been observed since the end of 1995 up to 2002. Production increased already in the first quarter of 1996. The years 1996-1997 were marked by production increase followed by a period of decrease in 1998-2001 (by 2,65 and 5,0%), though in 2001 production volume was up 30,2% from 1995 with the annual growth equalling 4,5% in 1996-2001.
Despite the achievements in 1996-2001, enterprises in the country failed to overcome fiasco of 1991-1995. Production of the country’s industrial enterprises was 5,4 times less than in 1990. Slowdown was observed in all main spheres of economic activity of the industry with the production volume of processing industries making up 13,8% of the Y1990 indices, that of mining – 39,7%, production and distribution of electric power, gas and water supply – 56,1%. Unfortunately, Georgia belongs to developing countries by the above-mentioned indices of economic development and ratio of internal gross products per head. Georgia differs from these very African countries by a higher level of cultural development, qualified labour resources, and by such a level of scientific technical potential when we have world-recognised achievements in different spheres of science. To the question about what measures should be taken for the most important branch of real economic sector to come out of the dead end we would answer that it is necessary to determine industrial-technological policy of the country and its practical implementation. But we would hereby note that it is not enough, it is necessary to eradicate unhealthy communist ideology and overcome corruption.
Industrial-technological policy can not be formed separately from the country’s general policy. We should note that under international practice industrial-technological policy, mainly, serves interests of “production elite”.
Such industrial-technological policy can, in its turn, stand in the way of forming a new progressive state policy. Unfavourable situation in Georgian industry stimulates interest of “industrial elite” so that integration process into CIS countries would become deeper: it has the illusion that development of production would be possible by means of “old ties”. At the same time, they do not take into account the fact that an industry with outdated equipment and technology would not be able to enter the market with all CIS countries trying to occupy their own place in the market by means of developing new technologies. Therefore, we can admit that Georgians have no other way out except orientation on the use of modern western technologies.
The viability of the Georgian State is much dependent on how quick it will be able to occupy its place in the civilised world, which is not so simple. It is necessary to correspond to European standards based on the introduction of democratic principles in society. Many steps were made in this direction – conclusion of an agreement between the Euro Union and Georgia. This creates a potential possibility for integration with the West.
In this case, an important issue is placed on the agenda: what is the extent of readiness of the Georgian industry to take part in the process of European integration. Unfortunately, the answer is negative on account of the above-mentioned reasons: with several exceptions (wine, mineral waters, etc.), our production is non-competent that is why it is impossible to find its potential consumer in Europe. It is necessary to overcome several objective and subjective difficulties with the purpose of Georgia’s accession into the process of European integration. Lack of investments within the country belongs to the first group. Realisation of modern technologies in production is impossible without it. As for subjective difficulties, they are reflected in world outlook of some representatives of “industrial elite”. We should hereby note that some of them are often not able to recover “traditional ties”.
Under these circumstances, there arises a question about the industrial technological policy of the country; what measures a country should take for the recovery of economy and, partly, industry of Georgia, which, in the long run, will be reflected in an increase of demand for our production in international markets, i.e. increase of country’s export potential.
It is necessary to find reasonable ways of solving strategic and technical tasks with the purpose of determining industrial technological policy of Georgia. Integration into the Western European market is a strategic task of the development of industry. As a rule, much time is necessary for the attraction of foreign investments. A tactic task of industrial development is maintenance of its viability for which the former Soviet market should be used in a rational way. It implies its use and by no means its accession. Besides, in these markets only goods that are known to customers and are able to compete with local as well as goods from the third world countries should be brought to the market. Two alternative ways are used for solving these importance tasks.
The first way implies protection of home market from differential customs tariffs and imposition of low excise on home production while exempting import of raw materials and semifinished goods from customs taxes (and value added tariff). At the same time, export of ready-made production should not be liable to taxes whereas a high tax rate should be imposed on export of raw materials and semifinished goods.
The second way implies that excise on home and imported production as well as customs tariffs on all kinds of imported goods should be equal and comparatively low while export should be tax-exempt. Benefits can only be envisaged for the equipment and technologies, but only on a temporary basis. The first way also envisages for different prohibitions, quotation and such minimisation of prohibitions and licenses as to provide elementary safety requirements of the country.
Despite the fact that Georgia has been a member of the International Trade Organisation the first way is supported by “industrial elite” that is quite influential in different echelons of power. Unfortunately, this opinion is shared by some of our scientific economists. Representatives of authorities plan development of the country in accordance with the second way. Their views are supported by recommendation of international financial organisations that are based on rich international experience. Undoubtedly, competition improves production quality and decreases expenses. All this is achieved by realisation of new technologies. This situation is true not only for internal market, but also for markets in general and, therefore, for international markets. Any restrictions that a country resorts to with the purpose of protecting internal market, limits favourable influence of international competition as far as increase of the quality of desirable economic stimulus within the country and decrease of expenses is concerned. That is why economic theory says that the best trade policy is aimed at zero customs tariffs on import in the conditions of exempting export from all kinds of taxes, cancellation of quotations, prohibition of export and import and minimisation of licensing. Integration of internal market into international one can only be achieved by means of observing these conditions. Despite the advantages of such trade policy, it is not still realised in any country of the world. True, such trade policy is practically realised in relationships among member countries of the Euro Union, but different trade barriers in relationships with non-members of this organisation are traditionally characteristic of all countries.
Why does this deviation from the ideal regime of external trade take place almost in all countries. Why is not the above-mentioned influence of international competition on economy of country used?
It is common knowledge that all countries have different natural climatic conditions for the development of various branches as well as appropriate historic traditions that make governments of many countries choose protective regime of trade with regards to these branches, which, eventually, hampers the development of these branches. Besides, almost all other countries have opponents of full integration of countries into international competition. Authoritative representatives of industry and some other branches lobby creation of beneficial, “oasis” conditions for these branches. In some cases, lobbyists do not realise that such policy, in the long run, turns out to be destructive for the branch the interests of which they are called upon to defend. When demanding imposition of customs prohibitions, lobbyists usually make the following two arguments:
1. Industry needs support and recovery as production expenses are larger than the cost of similar imported production. As a result of it, our production does not sell well, which makes no sense to produce it. High customs tariffs on some kinds of goods serve to increase cost of imported goods, which enables home producers to expand production of comparatively lower quality and gain extra profit.
2. Reduction of non-competitive production. In some cases, closedown of production leads to job cuts. As a rule, population’s incomes and purchasing ability decreases. Despite the seeming expediency of well-grounded arguments, such protective policy will bring much harm to industry and can make it difficult to restore.
First and foremost, it is almost impossible to choose a certain sub-branch of industry that needs customs benefits with almost all branches of our industry being in a difficult technological and financial situation. Beneficial regime in one particular branch encourages all other branches demand the same benefits. So we soon discover that all our industries became included in a protective environment. This will “give an appetite” to other spheres of economic activity, and this chain reaction” will envelop the whole of our economy and isolate it from the outer world.
Let us admit that we will be able to postpone the expansion of the mentioned “chain reaction” and grant benefits to one or several sub-branches. As a result of it, these branches will lose economic stimulus to produce high quality production and take measures for decreasing expenses. By means of “chain reaction” this process will spread in branches that provide these privileged sub-branches of industry with raw materials, semifinished goods, etc. True, in this case, the percentage of employed population will increase, but incomes from the realisation of low-quality production will not give an enterprise a possibility to give high salaries to employed staff, which will not serve to grow population’s incomes in the conditions of an increased number of employed population. Such increase of employment is the clearest manifestation of country’s backwardness; it should by no means be encouraged. Besides, conferment of customs benefits to one or several sub-branches of industry will cause “distortion” of investment environment, which will entail wrong decision making in accordance with “retroaction” principle.
From the viewpoint of reduction of population’s well-being, no less attention should be attached to population’s losses through low quality and expensive production. According to the international practice, decrease of the level of national well-being ranges from 1 to 10 in the conditions of customs protectionism. The mentioned negative results of customs protectionism are based not only on theory, but also on international experience. We should note that already in the 19th century I. Chavchavadze spoke about the advantages of free trade as compared with a protective one from the viewpoint of Georgian people’s national interests. Protective policy of the Georgian Government that is based on different customs tariffs will be tantamount to a well-meant action with opposite effects. What should be our approach to customs tariffs?
Imposition of zero customs tariff on import is not justified, first of all, because of problems in fiscal policy of the budget.
Undoubtedly, it would be better to impose the so-called optimal tariff, but theory proves that the optimal value of customs tariffs as well as amount of money paid by a foreign supplier constitutes a reciprocal value of import elasticity. Due to the changeable ratio of elasticity, an appropriate change of customs tariffs will make taxation system unstable, which is not desirable. At the same time, frequent measurement of elasticity ratio of all imported goods and appropriate changes in tariffs turned out to be a labour-intensive process in the result of which expenses for this measure will exceed profit from it.
According to international practice, a system of non-differential tariffs is considered the best customs system. It implies imposition of equal and not very high customs tariffs on all kinds of imported goods. In this case, all branches of national economy participate in international competition on equal terms, which does not distort the above-mentioned useful influence of the latter on the increase of domestic production competitiveness. At the same time, a zero tax tariff, in its own way, is a protection of home producer from the outer world and one of the sources of budget revenues. Does the above-mentioned mean that protection in our industry (and other branches) should be completely excluded? Certainly, but it should not be irrational and harmful as it was mentioned above. This kind of protectionism consists of the following elements:
– Export should be tax exempt, which will serve as a great stimulus for export production (it is the way in Georgia).
– Taxes for import of raw materials and semifinished products that are used in export production should be repaid to an exporter in the conditions of comparatively low non-differential customs tariffs.
– State should attract investments by means of recognising priority of this or that branch (in our case, the best example is energy power). If there are budget means, it would be expedient to create a state investment (not subsidy or dotation) fund.
– These protective measures make it possible to pursue an industrial-technological policy. In the result of it, Georgia will be oriented on creation of possibilities for participating in the processes of western integration while it also does not rule out the possibility of our enterprise’s entering the markets of CIS countries (in case our businessmen show an appropriate initiative).
– Investment legislature has a great importance for the pursuance of right industrial technical policy that should create equal conditions for both home and foreign investments. Besides, bureaucratic procedures should be minimised.
Different temporary tax benefits for foreign investors create a danger of the increase of a number of notorious firms and weak companies as world recognised firms usually do not require any tax benefits. First of all, they raise an issue of decreasing repatriation possibilities of profits and agricultural property where an investment object is located so as to avoid possible undesirable measures from a government. Under the international practice, temporary tax benefits serve to create such conditions for foreign investors that after the expiration of the date of these benefits most of investors go from the country leaving local entrepreneurs back where they started. Unfortunately, Georgia had to pass through it.
Protection of the country from smuggling, first of all, depends on organised work of customs service. Some of our compatriots demand that the customs service should work on a high taxation rate. Apart from the above-mentioned arguments, this measure is unacceptable as increase of taxation rate, first of all, makes it possible to evade taxes by means of “bribe effect”.
As for the protection of citizens from falsified goods, it should be based on the law “About consumer’s rights”. At the same time, we should note that tax and customs legislature requires perfection so that there would be equal conditions for co-operation between the State and entrepreneurs.