Reforming post-war economy in four years

12 November 2013 05:30 am - 0 - {{hitsCtrl.values.hits}}

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By Kaushalya Attygalle, Research Assistant – IPS
“It has only been four years since the end of the armed conflict in Sri Lanka. The government needs more time to provide a business-friendly climate that would attract more investment”.

This was a remark by a panelist from a leading Sri Lankan corporate at a recent private sector forum titled ‘Creating Future-ready Enterprises’. This is an argument one hears often, at both formal events like this one, and at informal gatherings among professionals and friends. The argument often goes unchallenged as the country’s post-war track record has been impressive – the improvement of city infrastructure, building of new connective infrastructure like ports, airports and highways, and steady growth spurred mainly by construction, consumption and tourism. Yet, four years since the end of the war Sri Lanka appears to be struggling to boost domestic and foreign investment by an impressive magnitude and an important aspect of this challenge lies in creating a climate conducive for private initiatives to thrive.

In the latest Doing Business 2014 Report prepared by the World Bank and the International Finance Corporation, Sri Lanka has slipped down the rankings to 85 this year. In the four years following the end of the armed conflict, Sri Lanka jumped substantially in the Doing Business Index (DBI) rankings from 102 in 2009 to 81 in 2012. While the country has made reforms and improvements in the areas of obtaining construction permits, getting electricity, paying taxes and trading across borders over the last year – all reflected in the DBI with an increase in the ranks – it hasn’t fared so well in areas like starting a business, registering property and protecting investors. Yet, as the speaker at the earlier mentioned forum remarked, an argument can be made that it is not realistic to expect a government to get all its policies right in such a short time. Perhaps what we need is more time to bring about a more significant change in the economy?

This article does not answer this question for Sri Lanka. Rather, it examines the development process of another country that also emerged from a conflict era and made significant transformations within a short time span - Georgia. This article is not intended to be a comparative study between Sri Lanka and Georgia, though, but merely an exploration of the business-oriented reforms that took place in that country in the span of four years.

The Georgian Case
Under Soviet rule, the sole purpose of Georgia was to produce goods and services for the consumption of the Soviet Union. After gaining independence, like many of the countries that were previously a part of the USSR, Georgia’s economy struggled to stay afloat despite the shutting down of many factories, widespread unemployment and hyperinflation. Soon after independence (with the breakup of the Soviet Union in 1991), Georgia underwent several civil wars that resulted in the Georgian economy contracting to 10-15% of its pre-independence condition and left over 300,000 people displaced. These internal conflicts also caused the resident Georgian population to shrink by 30 percent due to outward migration.

The Georgian government attempted to stabilize the economy for over a decade but the ineffective policy measures only heighten the burdens of the country. The rapid transformation of the Georgian economy that we see now took place with the beginning of the Rose Revolution in 2003. The revolution brought about a public demand for rapid economic change along with the election of a new President – Mikheil Saakashvili.

Since the start of this new government in 2004, the Georgian economy saw rapid progress. In 2006, Georgia was ranked 112 among 185 countries listed in the DBI, but in just one year the country turned its economy and business environment around and improved its ranking to 37th (see Figure 1). The rankings continued to improve and in 2008 Georgia became one of the top 20 easiest countries in the world to do business, with a rank of 18. The World Bank named Georgia the number one economic reformer in the world as a result of its achievements. In the latest DBI (2013/14) Georgia holds strong by being ranked among the top 10 easiest countries to do business (ranked 8).

Getting the basics right
When the Saakashvili government took over, the country underwent extensive developments in less than four years. Like Sri Lanka, the Georgian government began by ensuring that the basic infrastructure needed to build the economy was in place. Heavy emphasis was given to providing stable electricity, construction of roads and buildings, improving communication networks and other areas of infrastructure development.

This proved to be extremely beneficial to the Georgian people who had experienced difficult living conditions for over a decade. Reforming the education system and the healthcare system were also primary policy priorities of the government. Healthcare was made accessible to low-income households and those living below the poverty line. Primary education enrollment rates increased significantly after education was made mandatory to all children aged 6-14. Admission into higher education institutions was more transparent and competitive.

Strengthening revenue
Fiscal policy reform was another significant focus of the post-war Georgian government. With the assistance from the IMF and a few other institutions, Georgian government officials identified that one of the main issues in relation to estimating the potential tax revenue was the lack of reliable data. The inaccurate projection of tax revenue was a huge burden on the actual tax collection process. State officials were educated on estimating government revenue and given special training on estimation methods.

Tax rates were reduced and ineffective taxes were removed– the number of taxes was reduced from twenty to six. Effective advertising that portrayed the importance of paying taxes as means by which to improve public goods for all proved to be successful in encouraging the public to fulfill their civil duty. After various extensive reforms, tax revenue increased by 450 percent in 2008 and tax revenue amounted to 25 percent of GDP (see Fig.2). This was an impressive achievement given that the government actually increased tax revenue despite the reduction of tax rates.

Attracting FDI Inflows
The Georgian government then focused on improving the business climate of the country and to enhance local and foreign investment. Policy reforms based on research findings steered the government towards deregulation of the economy. The number of licenses and permission needed to start or run a business was reduced from 944 to 150.

Businesses only had to visit one counter to complete all procedures which drastically reduced the time required to start a business. Employer – employee relations were strictly confined to contractual agreements ensuring protection to both parties. In response to these and many other measures, investment in the country increased within the span of just two years. By 2006, FDI inflows had soared to 158 perecent over the previous year and by 2007 FDI inflows amounted to 18.6 percent of GDP from 8.4 percent in 2003. In just four years (2004-2008) FDI net inflows increased from USD 4.9 million to USD 15.1 million – a threefold increase in FDI.

Weakening governance?
Fighting corruption came under the spotlight of the Georgian government as well, and an Anti-Corruption Interagency Council was established to develop a new national anti-corruption strategy. Both active and passive bribery and corruption was criminalized, particularly in the public sector. But one of the main complaints against the Georgian government was that the relationship between the government and the business community was strained due to the government ordering businessmen to make payments that were not included in government accounts, violating the property rights of owners and intimidating and arresting businessmen. The government claimed that these measures were taken to correct the mistakes made by previous governments that allowed for large-scale corruption and exploitation within the business community. However, the unconstitutional nature of these acts cannot be overlooked.

The government also took measures to weaken the local governments by centralizing power at the centre. While the intention behind this – to ensure easier implementation of reforms and new policies – can be argued as necessary for faster results, it made local governments less accountable to its population. Had the measures improved efficiency of local government this would have been justified but no conceivable improvement was seen. Meanwhile, in 2004, the President was able to enforce certain constitutional amendments that drastically increased the power of the executive presidency and the judiciary was made overly dependent on the Executive President.

The Government of Georgia has undoubtedly made significant improvements in terms of economic and social reform to transform its economy in a short time span. But unfortunately in this reform process it has also weakened important independent bodies like the judiciary and has alienated the business community. As a result of these shortcomings, there have been various mass protests by the public against the undemocratic actions of the government. While efforts to ensure much needed economic reform is highly commendable, the decisions made by the Georgian government have intentionally or unintentionally sacrificed democracy in the name of nation-building.

Lessons for Sri Lanka
Much like any country emerging out of conflict, the issues faced by post-war Georgia with regard to finding the right balance between economic development, peace building and preserving democracy are delicate and challenging. While Georgia still has more to do before it can be considered a developed country, in the two significant four year time spans of both Sri Lanka (2009 – 2013) and Georgia (2004 – 2008), unlike Sri Lanka, Georgia has been exceptionally successful in transforming its business environment through extensive economic reforms.

While a direct comparison between Sri Lanka and Georgia would be unfair, the story of Georgia provides instructive lessons. While circumstances differ from country to country, the Georgian case demonstrates that coherent and focused efforts can bring about significant transformation and it can in fact happen in just four years. But it also demonstrates that sustaining the positive trajectory requires a focus beyond aggressive reform to also include important elements of economic governance and institutional strengthening.

(In 2012 the Saakashvili government lost the parliamentary elections to the Georgian Dream party. Mikheil Saakashvili ended his two term presidency in October 2013 when he was constitutionally barred from running for a third time. Last month, Giorgi Margvelashvili, won the presidential elections with 62% of the vote.
(To comment on this article and view references visit www.ips.lk/talkingeconomics. Background research by Dulara De Alwis (Project Intern) contributed to this article)

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Reforming post-war economy in four years

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