“One of the great mistakes is to judge policies and programs by their intentions rather than their results” – Milton Friedman
The journey Georgia took to become an independent, free, economically and politically stable country was far from peaceful and straightforward. Following the breakup of the Soviet Union in 1991 and the ensuing civil war, the Georgian economy contracted by 65 percent over three years until 1993 — a dramatic economic collapse even by the standards of other former Soviet Union states.
From 1992 to 1994, inflation averaged nearly 7,000 percent. As Georgia’s relationship with the Russian Federation deteriorated, Moscow tightened its grip on the economy, severing trade connections and imposing sanctions that caused a sharp decline in Georgia’s GDP.
This was exacerbated as Georgia’s pro-Western aspirations meant the withdrawal of access to cheap energy from Russia. Since these two economies were deeply intertwined, Georgia grappled with the Russian Federation’s 1998 economic crisis and increasing corruption levels.
According to 2002 World Bank data, Georgia had the largest shadow economy in the world. The problem was so significant that not even the positive economic trend of 2003 was sufficient to prevent the Rose Revolution, whose main slogan was ‘fight against corruption.’
The root causes of corruption in Georgia
Before discussing the reforms that saved the country, we first need to examine the reasons why Georgia had become such a corrupt country to begin with.
Although the transition from socialism improved general transparency, both politicians and tax officials were still biased when designing the tax system. In 1999, to achieve the projected budget revenues on paper, the government resorted to deceptive accounting techniques such as ‘‘forwarding’’ budget funds from one budget line to another and making fictitious tax offsets.
This was because Georgia had an almost-empty treasury due to the previous government’s interventions and mistakes. Newly formed democracies are often vulnerable to corruption as politicians focus on the tax system’s appearance to voters rather than its effectiveness, supporting hidden taxation. Corrupt tax officials take advantage of discretionary situations.
The Rose Revolution brought meaningful reform
The 2003 Rose Revolution marked a pivotal moment in Georgia’s political and economic history. Following new presidential and parliamentary elections, significant governance reforms were instituted to address the severe economic condition. The government, determined to eradicate corruption, focused on robust tax collection and prosecuting corrupt figures.
After the Rose Revolution, which was fueled by anti-corruption sentiment and a longstanding mistrust of state authority dating back to the Soviet period, the new government started this process by establishing a liberal deregulation program. These changes reduced state control, facilitating drastic privatization and shifting economic advantages from formal to informal sectors. The introduction of pro-liberty reforms proved crucial for the entire economy and national well-being.
High marginal tax rates were recognized as hindrances to productivity, prompting the government to adopt a new Tax Code in late 2004. Notably, the number of taxes was significantly reduced, from over twenty to only seven, simplifying the tax code. VAT and payroll taxes were lowered, and a flat income tax replaced the old progressive system.
The reforms extended beyond taxes to public registries, business regulations, customs, traffic police, and higher education entrance examinations. These comprehensive changes aimed to enhance economic dynamics, making it more attractive for individuals to engage in productive endeavors and fostering a more stable, protected environment for business activities.
The results were remarkable. Tax collections surged from 12 percent of GDP in 2003 to 25 percent in 2010 due to the successful reforms. Moreover, Georgia’s global rankings improved significantly, establishing the country as a leader in the post-Soviet business sphere.
Even The Economist noted that the reduction in the size of the state, minimizing opportunities for graft, naturally led to a decline in corruption in Georgia. Furthermore, tax cuts played a crucial role in ensuring that the government’s newly hired, young, and predominantly Western-educated workers received competitive wages, reducing the temptation for corruption.
A realization of Mises and Hayek’s economic theory
Scholars propose that Georgian politics during the post-Rose Revolution period can be viewed as the realization of Mises and Hayek’s liberal economic theory. Indeed, the Georgian economy thrived under a comprehensive deregulation program, coupled with a reduction in the state’s obligations to offer a neutral and minimal regulatory framework.
This departure from the historical notoriety for corruption and high criminal activity in the region propelled Georgia into the spotlight. The World Bank recognized Georgia as the leading global reformer for five years (2005-2010), a testament to the continual improvement in economic conditions. In 2007, Georgia achieved an unprecedented GDP growth rate of 12.5 percent, one of the top three growth rates that year, widely attributed to strategic tax reduction and simplification.
Economic freedom is not exclusively tied to democracy. Hong Kong, despite the constant erosion of its civil liberties and democracy, maintains a comparatively open market. Conversely, democracy does not automatically ensure economic freedom, as demonstrated by India’s pre-1990 era when it had a democratic structure but one of the least free economies globally.
Nevertheless, it would be simplistic to disregard the interplay between these factors. Georgia’s example reaffirms the correlation between economic and political freedom, highlighting that while economic freedom is integral to overall freedom, it also contributes significantly to political freedom.
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A version of this article was originally published on Speak Freely. Go check out their content!
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