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Evaluate of Georgia's Application the 'Shock Therapy' Method for Economic Development

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The case for free trade in Georgia has been a prolonged process ever since the fall of the Soviet Union. It geographically resides in the Caucasus region and has seen an increase in free-market economics in a bid to increase foreign investment and economic prosperity (Erikson, 2018). It has utilized this liberalization of economics after the disintegration of the Soviet Union; after that, the state has struggled with economic and governmental reforms. Nevertheless, 20 years after the fall of the Soviet Union, the restoration of Georgia’s independence with the application of the minimum shock/maximum therapy technique has brought about some detrimental changes. However, the first-generation post-communist reforms of shock therapy were less fortunate but were corrected for a minimum shock/maximum therapy approach (Papava, 2011). Georgia has been following in the steps of Poland and the ‘Balcerowicz Plan’. The transition to a market economy, according to Papava (2002), has been a significant social and economic development in the last decade, and several theoretical works were dedicated to this notion. Be that as it may, and notwithstanding the multiplicity of research and investigative examinations, numerous issues still must be discussed, and some perplexing issues–regardless of whether hypothetical or viable–still need solutions. By and large, these issues are common ones, which turns the building up of some universal approaches for their answer into an issue of particular significance. At the same time, it should be stressed that the practice of using uniform approaches to form economic policies (with total or almost complete disregard for the peculiarities of individual countries) is still quite widespread. By the way, this is one of the reasons (not the only one) because of which theoretically faultless schemes often fail to implement successful reform programs (Papava, 2002).

The former President of the United States, Harry Truman, once said he was searching for a ‘one-armed’ economist because, often, when he asked them for advice on economic matters, they would reply with “On the one hand…, On the other hand…” (Mankiw, 1998, p.27). However, a true economist cannot be ‘one-armed’ as, according to Papava (1998), “while applying universally proved approaches to the process of post-Communist transformation, one has to attach due importance to specific national context as well’ (Papava, 2002). The issue with a transition to a market economy has been an underlying factor of several interesting studies. Professor Leszek Balcerowicz stood as a ‘two-armed’ economist and was not only a renowned researcher but also an equally distinguished politician and statesmen (Papava, 2002). So far, as the issue of post-communist transformation is concerned, Balcerowicz follows the economic teachings of Ludwig von Mises, Leader of the Austrian Economic School, and Fredrich A. Hayek and Milton Friedman, Nobel Prize winners in economics. It is therefore not surprising that the phrase, ‘democracy requires capitalism’, appears as the crucial element of almost all Balcerowicz ‘s works (Papava, 2002). It is a common understanding that democracy primarily implies freedom of choice. A choice is a prerequisite for competition, while competition is an impetus for development.

Other countries in the region had already commenced the transition, and Poland embarked on a so-called ‘shock therapy’ model of transition to market economy under the leadership of Balcerowicz in the late 1980s (Balcerowicz, 1994, 1995; Blanchard, Dornbush, Krugman, Layard, Summers, 1994; Johnson, Kowalska, 1994; Lipton, Sachs, 1990; Sachs, 1993; Schaffer, 1992). However, ‘shock therapy’ as a term is not exclusive to any case and has had alternating names, such as, ‘bitter pill’ (Adams, Brock, 1993, p. XIII) or ‘big bang’ (Kowalik, 1994, p. 116). Generally, it means maximization in the shortest time possible; radical transformations are aimed at liquidating (or at least mitigating) state budget deficits and furthering strict monetary policy under nominal money supply or fixed exchange rate conditions. The ‘shock therapy’ concept derives from the ‘orthodox scenario of macroeconomic stabilization’ (Papava, 2002). However, Kiselva (1996, p. 113) suggests that the objectives of liquidating (or minimizing) the state budget deficit and working to ensure a strict monetary policy under the conditions of nominal money supply or fixed exchange rates should be accomplished very rapidly within a minimal amount of time. Simultaneously, success depends primarily on political stability (Jochem, 1999). It should also be noted that the concept of ‘shock therapy’ is the same as the so-called ‘Washington Consensus’, the basis on which the IMF’s transformative approach is built (Papava, 2002).

The ‘shock therapy’ method was first applied in West Germany shortly after the end of World War II. However, according to Papava, (2002) “Post-Communist Poland breathed ‘new life’ into the ‘shock therapy’ method and was then implemented by some post-Soviet republics with different variations and different levels of success” (Stroev, Bliakhman & Krotov, 1999). For instance, if the ‘Balcerowicz Plan’ was developed in Poland, the ‘Marcovic Plan’ was developed in Yugoslavia, the ‘Klaus Plan’ in Hungary, and the ‘Kupa Plan’ in Czechoslovakia. It should be noted that each such plan was virtually the same as the other, except for some insignificant details in which they differed (Papava, 2002). In January 1992, Russia decided to join the countries that had previously implemented the ‘shock therapy’ method and Egor Gaidar, vice-president of the Russian government, took the lead. What was different from other countries in Russia, however, was the fact that no one officially used the term ‘Gaidar Plan’ in regard to the actual transformations. After a month, the ‘Balcerowicz Plan’ of ‘shock therapy’ was also put on the agenda in Georgia in its Russian variant.

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As in Russia, the Deputy Prime Minister of the Government of Georgia, Roman Gotsiridze, accepted responsibility for this plan. Although, like Russia, the Georgians did not call it the ‘Gotsiridze Plan’. The rational question it raises in this respect is: Was Georgia prepared to implement this renowned reform method at the time? To understand this question, an important difference between countries with and without statehood on their limit to affect regulations must be looked at. States without statehood include countries of Eastern and Central Europe such as Bulgaria, Poland, and Hungary; on the other hand, the new sovereign states were conceived as a result of the disintegration of the former USSR, such as Czechoslovakia and Yugoslavia. It is necessary to distinguish those who succeeded their disintegrated predecessors since they preserved almost all state attributes (e.g., independent monetary systems, embassies, customs). Russia retained all the attributes of its precursor after the breakdown of the former Soviet Union, which is why Russia could be identified with the first group of post-Communist countries. As for the others, they had to start rebuilding their government institutions from ground zero. Georgia could be identified as one of those. Indeed, it had to tackle two problems that are nearly equal in complexity: establishing its government institutions and commencing on a transition to the market economy (Schmitter, 1994; Balcerowicz, 1995; Papava, 1996; Milanovic, 1998). The consistent utilization of a government’s budgetary and monetary institutions is required for the ‘shock therapy’ model. Therefore, it is not worth considering that the ‘shock therapy’ model would succeed in the absence of such institutions (Papava, 2002). This assumption can be verified by the case of Georgia, comparing the initial ‘Balcerowicz Plan’ (considered to be the classical model of ‘shock therapy’ and the most recent) to the plan implemented by Georgia, which was seen through the Russian lens.

To execute the ‘Balcerowicz Plan’, Poland was required to implement the ensuing concurrent measures (Papava, 2002):

  1. Multiple increases in all types of prices and the deliberate encouragement of inflation with the aim of balancing the market.
  2. Imposing stringent restrictions on individuals’ incomes.
  3. Increasing interest rates dramatically and decreasing the amount of money circulating; increasing interest rates on savings and deposits in order to encourage people to save money.
  4. Reducing expenditure on the state budget by limiting central government investments and stopping the subsidization of loss-making companies.
  5. Distributing government bonds to liquidate the government’s budget deficit.
  6. Establishing a taxation system in order to achieve uniform taxes.
  7. Setting a uniform exchange rate of the zloty to the dollar and ensuring the convertibility of zloty in the domestic market.
  8. Implementing new customs tariffs in order to limit imports and promote exports.
  9. Within the limitations of the government’s actual capabilities, social benefits are provided to the groups that needed them.
  10. Finally, the elimination of monopolistic structures and abandonment of bureaucratic interference into enterprises by the government.

Now we will compare the initial ‘Balcerowicz Plan’ with the Georgian implementation of ‘shock therapy’, to see to what extent it was implemented (Papava, 2002):

  1. The price formation reform began in Georgia in the spring of 1991, when free prices were first enacted for certain types of goods. Since February 1992, many radical changes have been made to Georgia’s pricing system: government-controlled prices for a certain group of goods and services have been dramatically increased. This was all done in order to balance the market. If the consumer price index was 1,82 in 1991, it grew to 25 in 1992. We can, therefore, state that the first item of the ‘Balcerowicz Plan’ in Georgia has been adequately fulfilled.
  2. In 1992, the Georgian government indexed the minimum wage and social benefits significantly. If indexing took place only once in 1991, in 1992, in the course of comprehensive price liberalization, income indexation was carried out six times. In 1991, the minimum and average wages were increased by 1.85 and 1.26 times, and by 13.14 and 17.94 times in 1992 compared to 1991, respectively. The government of Georgia has never taken preventive measures to control wage increases, such as Poland, where the wage increase of up to 2 percent of payroll would require the company under discussion to pay a penalty of 200 percent of the increase in wages, and increases over 2 percent would lead to penalties ranging from 300 to 500 percent. The wage growth rate and social benefits were lagging behind that of prices; it could, therefore, be recognized that item two of the ‘Balcerowicz Plan’ has also been implemented to some extent.
  3. In 1992, compared with 1991, annual interest rates increased from 2% to 5%, and from 9% to 80% on demand deposits and up to 10-year deposits. However, even that rate of interest rate growth did not match inflation. However, it must be acknowledged that no interest rate increases could help to control the amount of money in circulation since the country did not have its own monetary system at the time. Georgia, at the time, was using the ruble of the former Soviet Union and the, only just established, Russian ruble. In the summer of 1992, the administration decided to ‘double deposits on an ahead-of-time basis’ (Papava, 2002, p. 9), especially on July 25, when the government declared that due to the devaluation of deposits, they would double by August 1, 1992. The people directly responded by rushing to banks to make more deposits. However, the government decided on August 1 to lengthen the doubled deposit period till August 10, 1992. A surplus obtained as a consequence of doubling may only be withdrawn after the expiry of a one-year period. However, it could be used without any restrictions for privatization purposes. Moreover, the privatization process was actually at a deadlock at the time. During the second half of 1992, it became significantly more challenging to get the necessary amount of Russian ruble bills from Russia in a convenient fashion. Besides, only Russia, of course, can issue Russian currency. The deposit accounts mentioned above were paid as salaries and pensions. Such conditions practically prevented the reformist government from regulating the amount of money in circulation. We can, therefore, conclude that item three of the ‘Balcerowicz Plan’ has not been fulfilled in Georgia.
  4. The share of central government investments in accumulative state budgetary expenditure did not decrease in 1992 and fluctuated anywhere between 20% and 25% by 1992. Moreover, compared with 1991, the total sum of subsidies increased almost 5.1 times in 1992. However, the share of government subsidies in state budgetary expenditures in 1992 fell to 30.1% from 47% in 1991. This proposition is not sufficient to persuade us that the fourth requirement of the ‘Balcerowicz Plan’ has been met due to many increases in the actual number of subsidies.
  5. In 1992, domestic government bonds were issued; they were only offered for sale in the fall of 1993. Besides, this was mainly done in order to replace the old bonds of the former Soviet Union with new Georgian bonds. As regards the use of state bonds to fill the government budget deficit, at that time, such a tool had not been used at all. Clearly, item 5 of the ‘Balcerowicz Plan’ had also not been implemented.
  6. The reform of the tax system, following the demands of the market economy, began in the summer of 1991. Accordingly, item six of the ‘Balcerowicz Plan’ should generally be deemed gratified; nevertheless, it should be acknowledged that, as in many countries around the world, the optimization of the tax system in Georgia is a somewhat gradual process.
  7. In 1992, Georgia did not have a national currency, so it was virtually impossible to attain item seven of the ‘Balcerowicz Plan’.
  8. Uniform customs tariffs were established in 1992. Imports and exports were taxed by 2% and 8%, respectively. Of course, with this policy in action, neither exports could be encouraged nor imports controlled. That mere fact proves that Georgia did not enact item eight, either.
  9. As stated previously, the government carried out income indexation in 1992, as it did in 1991. During that period, there was no particular social program for the benefit of low-income families. That is to say; the national social security model lacked a mechanism to separate social benefits by income levels. Under such circumstances, if wages doubled, for instance, the difference between low-income and high-income household earnings would also double. Indeed, the status of low-income families perished even further at the outset of general indexation. As a direct effect of this indexation in 1992, the real minimum wage amounted to only 86% of the wages in 1991. Since the 1992 income indexation program in no way helped achieve the objective of allocating focused assistance to the poor, we must acknowledge that Georgia has also failed to comply with prerequisite nine of the ‘Balcerowicz Plan’.
  10. In 1992, the legislative and executive authorities of Georgia took the first decision to constrain monopolistic practices and promote competition. From the beginning, however, these decisions could not function adequately. Even though the Soviet centralized resource system had already collapsed in 1991, the practice of bureaucratic interference by the government with companies managed to survive. This suggests that item ten of the ‘Balcerowicz Plan’ has not been enacted adequately in Georgia.

The Georgian government, in its attempt to implement ‘shock therapy’, ended up with only three of the ten requirements being actually implemented. However, there was a major drawback since Georgia lacked a monetary system of its own at the time (Papava, 2002). The extensive anti-reform steps taken by the government ran for a year-and-a-half and defined the periods from 1993 to the first half of 1994 (Gurgenidze, Lobzhanidze, Onoprishvili, 1994). However, after 1994, Georgia reignited cooperation with the World Bank and the IMF. Although a significant factor in the resumption of the economic reform was aimed at filling the gaps left behind by the badly executed ‘Balcerowicz Plan’, which by that time seemed an achievable goal since Georgia had established suitable governmental institutions and more significant offices in the state were undertaken by professional economists (Wang, 1998).

All in all, the case for a free market in Georgia is a strong one because it is a post-communist state that is lacking statehood and significant governmental institutions. However, the ‘shock therapy’ method would not succeed in a state that is witnessing fruition, as Papava (2002) argues that the method worked in Georgia because the people of the state were experiencing an impoverished economic environment, which then, in turn, allowed them to accept such extreme governmental reforms. Georgia, today, has seen a large amount of foreign investment from countries and individuals from all around the world, trade deals with the EU, and a bite out of the Chinese belt and road initiative, proving that it is capable and accepting of the free market and globalization.


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