Press Releases

Economic Freedom and Georgias Rose Revolution

(Archived Content)


John B. Taylor Under Secretary for International Affairs United States Treasury Remarks at the Caucasus Business School Tbilisi, Georgia

It's a pleasure to be back in Georgia.  I thank you for this opportunity to speak at the Caucasus Business School and to discuss economic issues with the future business leaders of Georgia. 

When I last visited Georgia in July 2002, there was real concern about the future of the country and the economy.  Now, at the one year anniversary of the Rose Revolution, Georgia is a very different country.  The Rose Revolution itself stands as a tribute to the commitment of the Georgian people to peaceful democratic change.  Your actions during that period were an inspiration. 

My focus on this visit is on the economic change that has emerged in the year since the Rose Revolution.  I have had the opportunity to meet the economic team of the Saakashvili government, and I am continuing this engagement during my visit to Tbilisi. We are very impressed both by the economic leaders and by the agenda they are pursuing.  I believe that the economic reform agenda of the Saakashvili government represents a fundamentally new direction for the country.  The reform agenda will increase and sustain economic growth and thereby raise living standards and reduce poverty significantly.  I believe the Rose Revolution was not only a political revolution, it was also an economic revolution.

Today I would like to explain why we are so positive about this economic reform agenda and describe a novel way that we in the United States can support it.

The Economic Reform Agenda

I think it is useful to think about the economic agenda in four inter-related parts: improving government finances; cutting tax rates; reducing the size of government; and fighting corruption.

Improving Government Finances

One of the Saakashvili government's first and most impressive actions has been to improve government finances and arrest the deterioration of basic government services.  The government of Georgia hadn't been paying its bills or keeping its commitments to government workers and pensioners.  Public infrastructure had been deteriorating.  According to a 2002 business climate survey, Georgian businesses lost an average of 110 business days a year because of infrastructure failures, largely in the energy sector. 

Much of the problem involved an unwillingness to crack down on tax evasion.  Unfair application of the tax laws meant well-connected individuals and businesses avoided taxes, often by bribing tax inspectors.  Tax collections were very low.

By taking action on tax evasion, the government has significantly improved tax collection.  In fact, tax revenues have already increased by 4 percent of GDP.  As a result, this year the government has kept its budget commitments for the first time since 1997.  It has cut the stock of budget arrears in half and is on track to eliminate them completely by the end of 2005.  Moreover, it has begun to rebuild the country's infrastructure and renewed investments in health and education.

We saw that similar improvements in public finances in Russia in 1999-2000 led to an immediate boost in confidence which supported increased investment and growth.  As wage and pension arrears were cleared, people had the income to increase consumption.  Such economic benefits from higher confidence can be expected in Georgia.

Cutting Tax Rates

A second part of the reform agenda is tax reform.  According to a 2003 business survey, Georgia businesses cited high tax rates and the unpredictability of the tax system as the primary obstacle to doing business.  To reduce these obstacles the government is now pushing forward an impressive tax reform package.  The reform would eliminate over 2/3 of existing taxes and significantly lower remaining tax rates.  It would include a 12 percent flat income tax.  Through greater simplification and uniformity, these changes will lower administration burdens and reduce opportunities for corruption.  This gives domestic businesses greater incentives to operate openly in the formal sector and make investments.  It will also lower barriers to greater foreign direct investment.

The link between lower taxes and higher economic growth is well established.  In Russia and Ukraine, the reduction of personal income and corporate tax rates boosted formal business activity, increased compliance, and spurred investment.  Another example, frequently cited in Europe, is Ireland where the government sharply lowered corporate and personal income tax rates.  Labor force participation increased by an amazing 40 per cent in the 1990s as workers were able to take home a greater share of their pay.  Foreign direct investment soared.  In the central European economies, corporate tax reductions have also supported sizeable foreign investment flows.

Reducing the Size of Government

A third area of reform is the reduction of the size and scope of government.  This makes a great deal of sense because by almost any comparison, the government sector is too big and the private sector too small in Georgia.  The private sector accounts for only 40 percent of total employment in Georgia compared to 75 percent in Armenia and 80 percent in Estonia. 

To begin to rectify the situation, the government has already reduced government employment by an estimated 50,000.  The Economy Minister plans to eliminate his own ministry by 2007.  Such actions will also allow pay increases for remaining civil servants, reducing the incentive for corruption.

At the same time, Georgia still has too many state-owned enterprises tying up valuable human capital.  The Economy Ministry plans to privatize 1,800 state enterprises employing 180,000 people by 2007.  Such privatizations further support a market-based allocation of capital and job creation in the economy.

International comparisons show that reducing the size of government has dramatic positive effects.  Considering Ireland again, a reduction in the size of government was a fundamental part of the Irish success story.  The government reduced expenditures implementing a hiring freeze, accelerating retirements, cutting subsidies to state enterprises, and imposing a 10 percent across the board cut in all department budgets.  As a result government expenditure as a share of GDP fell by 20 percent by the end of the 1980s.

In transition economies like Georgia, the response to privatization in terms of higher growth can be quick.  In Hungary, for example, the privatizations of the early 1990s helped increase growth sharply by the mid 1990s.  In Armenia, a renewal of the privatization process in 2001-2002 was followed by annual economic growth rate above 13 percent in 2003-2004. 

Fighting Corruption

Now let me consider the fourth area: fighting corruption.  Georgia ranked 133 out of 145 in Transparency International's Corruption Perceptions Index. That President Saakashvili was elected on a strong anti-corruption platform has given his government the opportunity to address this serious problem.

In fact, fighting corruption is fundamental to the whole economic reform agenda.  Public finances can't be improved without fighting corruption among tax inspectors.  A simpler, low rate tax code uniformly applied provides fewer incentives to evade.  Fewer bureaucrats mean fewer bribes.  Private ownership of business means success is determined by the company's bottom line and not its political connections.  Finally, battling corruption requires accountability of the government to the people.  The new government demonstrated its commitment to this principle by working hard to ensure free and fair elections following the Rose Revolution and not simply accepting the immediate outcome of the Rose Revolution as the final say of the people.

United States Support through the Millennium Challenge Account

These recent developments in Georgia show that good economic policy reforms don't just "happen".  You need to understand the problem you are trying to solve, come up with a proposed solution, and then get the solution implemented.  You need political will perhaps most of all.  I think this is what the government has been doing since the Rose Revolution and it is clearly leading to good results. 

The challenge for the international community, which has provided over $3.4 billion in assistance to Georgia since its independence, is how to support successful cases like Georgia after the Rose Revolution.  To this end, I believe the Millennium Challenge Account (MCA) represents a revolution of sorts in the way we think about development assistance.     

The MCA was designed to address impediments to economic growth in poor countries by rewarding governments implementing policies to remove those impediments.  These impediments can be grouped into three areas: 

  1. Poor governance, including the lack of rule of law or enforceable contracts and the prevalence of corruption, raises the cost of doing business and creates disincentives for the private sector to create high-productivity jobs.
  2. Inadequate investment in the development of human capital.  Workers without adequate education do not build the skills to take on high-productivity jobs or adopt new technologies to increase the productivity of the jobs they do have.  Better health care reduces absenteeism from work, which improves productivity.
  3. Restrictions on markets prevent labor and capital from flowing to their most productive use and they restrict consumers' access to low cost goods and services.  Lack of openness to international trade, monopolistic state marketing boards, and excessive regulations and red tape are all examples of restrictions that create disincentives for the private sector to invest and innovate so as to boost productivity.

Hence, the main principle underlying the MCA: focus economic development assistance on nations that (1) govern justly, (2) invest in people, and (3) encourage economic freedom.  Policies promoting these goals underpin successful growth, catalyze private investment, and increase the effectiveness of aid.   We have developed 16 indicators that are used to assess countries' performance against these three goals and then the Board of the Millennium Challenge Corporation (MCC) selects countries for MCA-eligibility after analyzing their performance.

In Georgia's case, the country was selected as eligible to receive MCA assistance in 2004 having surpassed the median in at least half of the indicators in the "investing in people" and "economic freedom" categories.  In the case of the "ruling justly" category, the MCC Board felt the "Corruption" indicator, which showed Georgia performing poorly, did not capture the substantial progress made by the newly elected government.  The Board cited as evidence: the creation of an anti-corruption bureau; a new bureau to investigate and prosecute corruption cases; a single treasury account for all government revenue to ensure transparency and accountability; and the revamping of procurement legislation to ensure an open and competitive process.  I believe the steady progress made by the government since then shows that the MCC board decision was the correct one.

The MCA indicators are a useful guide for areas of improvement.  For Georgia, the indicators show relatively poor performance on the health and primary education expenditure indicators in the "investing in people" category.  On health expenditures, Georgia was in the 8th percentile relative to the 74 other countries used to assess performance.  On primary education expenditures, Georgia was in the 7th percentile.  Partially in response to the poor outcomes identified by the MCA indicators, the government has made increasing social expenditures a priority.  In the case of health, expenditures are expected to increase by almost three times to 1.3 percent of GDP the exact kind of response that MCA was designed to elicit.


From my discussions with President Saakashvili's economic team, it is clear that the government of Georgia has a vision of economic freedom that matches their commitment to democracy.  They are endeavoring to implement that vision through a bold economic reform agenda of improved government finances, low marginal tax rates, a dramatic reduction in the size of government, and vigorous anti-corruption efforts. 

Economic reforms like these are never easy to implement, and the benefits are not always are immediate.  But as I have indicated in these remarks such a reform agenda is the proven way to raise incomes and reduce poverty.  It is a reform agenda that warrants our support, and one which we hope to see replicated in many other parts of the world.