79282 GEORGIA: COMPETITIVE INDUSTIES TECHNICAL ASSISTANCE (P144844) BACKGROUND NOTE1 1. The objective of the project is to support the government in supporting key sectors that will drive competitiveness and growth in Georgia. The Government recognizes the need to go beyond basic business environment reforms to strengthen the competitiveness of Georgian industry and has asked for the World Bank to partner with it as it seeks to develop its competitiveness agenda. The CIIP program will go a long way in furthering this objective. I. Key development issues and rationale for involvement 2. Georgia has undergone extensive business environment reforms over the past several years and has achieved a remarkable turnaround in its investment climate. Over the past eight years Georgia pursued a consistent policy in market deregulation and liberalization, with significant progress in reforming its business regulatory, tax, and customs frameworks. Georgia was exemplary in its carrying out of rapid and efficient reforms, and is referred to as demonstrating the best global practice in the area of property registration. These efforts were reflected in the climb from 100th position in the 2006 Doing Business report to 9th position in the 2013 report and the country was ranked as the top reformer over the period 2005-2012 (see Table 1). Table 1: Georgia’s Doing Business 2013 Ranking Source: Doing Business 2013 3. The reforms had the desired effect with in rapid growth which was temporarily disrupted by the dual shocks of the August 2008 conflict and the global financial crisis, resulting in a sharp downturn in economic growth and rising unemployment and poverty. These reforms encouraged FDI and supported economic growth, especially in the pre-crisis period before 2008. Economic growth was in 1 Prepared by Feyi Boroffice, ECSPF with contributions from Jose Guilherme Reis, Gonzalo Varela, Mariana Iootty, Ife Onugha. 1 excess of 9% between 2005 and mid-2008, however the effect of the August 2008 armed conflict with Russia followed by the global economic downturn led to a sharp drop in investor and consumer confidence, contraction in foreign direct investment, exports, and remittances, and a cutback in bank lending. The economy contracted by 6.5 percent during the second half of 2008 and by 3.8 percent in 2009. FDI inflows dropped from 16.4 percent of GDP in 2007 to 6.1 percent in 2009, while exports fell from 31 percent of GDP in 2007 to 29.8 percent in 2009. Georgia found itself with thousands of new internally displaced persons and the livelihood of thousands more was threatened by the loss of jobs and income. Unemployment spiked upward from 13.3 percent in 2007 to 16.5 percent in 2008 and 16.9 percent in 2009. The incidence of poverty rose from 17.7 percent in 2008 to 21 percent by 2010. 4. Fortunately, the downturn was short-lived for Georgia as the government aggressively addressed the crisis with an effective stimulus program coupled with strong export growth and tourism inflows which led to an economic recovery in 2010-2011 with 7% growth in GDP in 2011 and expected 6% growth in 2012. Access to significant international financial support, combined with Georgia’s relatively low public debt at the outset of the crisis, allowed the government to put in place a strong countercyclical fiscal policy response—the total fiscal stimulus injected into the economy in 2008 and in 2009 was equivalent to nearly 10 percent of GDP. While exports rebounded and even surpassed pre-crisis levels at 36.6 percent in 2011 and projected to be 39.2 percent in 2012, FDI inflows remain lower than pre- crisis levels at 6.8 percent in 2011 and projected to be 6.1% in 2012 (Table 2). Table 2: Selected Macroeconomic Indicators (2006-2012) (in percentage of GDP unless indicated otherwise) Source: WB Competitiveness and Growth Development Policy Operation PD, retrieved December 2012. 5. The Georgian economy continues to expand despite the weaker external environment. Against the backdrop of the Eurozone crisis, the GDP registered 6.8 percent growth in the first quarter of 2012, 8.1 percent expansion in the second quarter, and 7.5 percent in the third quarter (according to the IMF WEO 2012). The acceleration is due to a sharp increase in private investments (37 percent real growth) while consumption remained stagnant. Sector-wise, strong growth was recorded in construction, manufacturing, financial intermediation, hotels and restaurants, and transport. Value added was moderate in agriculture and it contracted in mining. The large scale projects related to the construction of buildings, highways, and railways by both the public and private sectors resulted in a 24 percent upswing in construction, according to 2 statistics for the first half of 2012. The high growth in manufacturing (20 percent) was fueled by an expansion in food, wine, machinery, and chemical goods production. Both merchandise and services exports played a major role in sustaining strong growth in 2012. Exports of goods and services were up by 1.5 percentage points to 38 percent of GDP in the first quarter of 2012. 6. However, there are early warning signals of slowdown in economic activity, driven by weaker demand due to the increased uncertainty in the post-election period, worsened by the recent debate over the expiration of the Presidential term. The tension between the president and the newly elected Prime Minister has spilled over into the economy with the leading short-term indicators show noteworthy slowdown with a 9.6% decline in VAT turnover in December 2012 after a 5% increase in October and 2.5% in November. This has clouded the outlook for the private sector and has impaired business confidence. 7. Despite the far reaching regulatory reforms, competitiveness has remained modest. According to the World Economic Forum Global Competitiveness Index 2012-2013 report, Georgia ranked 77th out of 139 countries analyzed. While it relatively medium-positioned compared to its neighbors (Azerbaijan ranked 46th, Armenia 82nd, Turkey 43rd), in the sub-indexes Georgia ranked 113rd in business sophistication and 126th in innovation. Additional measures need to be taken to sustain future economic growth and create new jobs. II. A Preliminary Analysis of Trade Outcomes in Georgia 8. Trade has expanded dramatically in the last decade, driven mainly by increased imports. With imports almost doubling exports toward the end of the 1990s, higher average rates of growth for imports than for exports during the first decade of the twenty first century exacerbated the export-import gap. Export growth during between 2000 and 2005 averaged 7.5 percent, while import growth averaged 28.2 percent. During last half of the decade, growth rates dropped to a still impressive 12.2 and 18.8 percent respectively, brought down by the trade collapse of 2009 that led to a 32 percent drop in exports and a 28 percent drop imports (see Figure 1). 9. The steep increase in imports is most likely associated with sharp reductions in trade protection following accession to the WTO in 2000 while the increase in exports is mostly explained by increase in commodity prices. By 2009, the weighted average applied tariff rate for agricultural goods had fallen to 6.31 percent from 14.25 percent in 2002, while for industrial goods it had fallen to 9.43 from 0.25, making Georgia’s trade regime one of the most liberal among transition economies in ECA, both when comparing with countries at an earlier or later stage of development (Table 3). Exports also increased, in part due to increases in international prices of metals and minerals – the most important export products of Georgia. Despite the fact that Georgia is not a “resource rich� economy in the same way as Azerbaijan, Kazakhstan or Russia, its net exports of minerals have risen from around 6 dollars per person in 2000, to about 46 dollars per person in 2011. 3 Figure 1:Evolution of Trade in Goods in Georgia – Table 3: Tariffs in Georgia and other countries in 1999-2011 ECA Exports Imports Growth of Exports Growth of Imports Simple Weighted 8 80.0% Average Average 7 Georgia Agri 2002 12.92 14.25 60.0% WTO: June 2000 Agri 2009 5.85 6.31 Growth (Percentage) 6 Industrial 2002 10.3 9.43 Industrial 2009 0.31 0.25 Billions of USD 40.0% 5 Azerbaijan Agri 2002 12.66 10.25 WTO: Observer Agri 2009 12.73 6.8 4 20.0% Industrial 2002 8.13 5.61 Industrial 2009 8.14 5.93 3 0.0% Moldova Agri 2001 10.2 9.18 2 WTO: July 2001 Agri 2008 9.62 10.08 Industrial 2001 4.12 1.96 -20.0% 1 Industrial 2008 3.71 2.37 Turkey Agri 2003 42.2 13.08 0 -40.0% WTO: March 1995 Agri 2009 45.15 23.12 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Industrial 2003 5.22 3.77 Industrial 2009 4.21 3.31 Source: Authors’ calculations based on Comtrade data Source: TRAINS 10. Georgia’s exports are relatively diversified along the market dimension given its size and level of development. Georgian exporters reached close to 80 countries in 2010/11, while they only reached 50 towards the mid-1990s. During the first decade of the 2000s, exports to the European single market went from accounting for half of total exports to about a third (and from 56 percent to 35 percent if non-oil and gas exports are considered, Figure 2 & Figure 3). Georgia more than tripled its exposure to non-EU developed economies (especially the USA), which now account for 22 percent of non-oil and gas exports and 16 percent of the total, and substantially increased intra-ECA exports (excluding Russia), which contributed to offset the effects of the drop in exports to Russia. Figure 2: Export partners (all goods) Figure 3: Export partners (non-oil and gas exports) 1 1 Sub Saharan Africa Sub Saharan Africa 0.9 0.9 0.8 South Asia 0.8 South Asia 0.7 0.7 Latin America & Latin America & 0.6 Caribbean 0.6 Caribbean 0.5 East Asia Pacific 0.5 East Asia Pacific 0.4 0.4 Other Europe & Other Europe & 0.3 Central Asia 0.3 Central Asia MENA MENA 0.2 0.2 0.1 0.1 Developed (exc. EU + Developed (exc. EU + Japan) Japan) 0 0 EU-27 EU-27 Source: Authors’ calculations based on Comtrade data Source: Authors’ calculations based on Comtrade data 11. Although Georgian exports to its most important trading partners have grown in absolute terms, Georgia seems to have lost market share in many of them. Figure 4 & Figure 5 plot together the 4 annual average growth of total and non-oil and gas exports of Georgia (4 & 5 respectively) in the vertical axis, against the annual average growth of exports of the world to the same destination in the horizontal axis. The size of the bubble reflects the share of the export value to that destination on total exports in 2005, to inform on the importance of each destination for Georgia. When the bubble is above the red light, that implies that Georgian exports to that destination have grown faster than world exports to that destination, which means that Georgia has increased market share in that destination (and the converse is true as well). The figures reveal that Georgian exporters gained market share in 4 of their top 10 trade destinations while they lost market share in the other 6. Figure 4: Growth Orientation of Markets (all) Figure 5: Growth Orientation of Markets (non oil and gas) GEO: Growth Orientation of Markets GEO: Growth Orientation of Markets Top 10 Markets Top 10 Markets 40 40 USA BGR ESP GEO: CAGR of Exports 05-10(%) CAN UKR CAN UKR 20 20 DEU AZE DEU AZE ARM TUR TUR 0 0 ITA ITA FRA FRA -20 -20 -40 -40 RUS RUS -40 -20 0 20 40 -40 -20 0 20 40 W LD: CAGR of Exports 05-10(%) W LD: CAGR of Exports 05-10(%) Source: Authors’ calculations based on Comtrade data Source: Authors’ calculations based on Comtrade data Table 4: Most important destinations for non-oil & gas exports Georgia World Exports Exports CAGR CAGR Market in 2005 in 2010 2005- 2005- 2010 2010 Armenia 38187.98 43493.11 3% 16% Azerbaijan 45494.83 50052.07 2% 9% Bulgaria 38787.06 203573.9 39% 10% Canada 39327.29 125192.4 26% 4% France 44488 51559.61 3% 6% Germany 33380.11 15827.49 -14% 5% Italy 40871.34 24970.25 -9% 6% 157732.4 Russian Federation 11075.73 -41% 18% Turkey 228426.3 245346.6 1% 9% Ukraine 38818.33 125056.6 26% 11% Source: Authors’ calculations based on Comtrade data 12. Georgia appears to be adequately exploiting its natural export opportunities in terms of destinations. Both for commodities and differentiated goods, almost all trading relationships fall within 95 percent confidence intervals for the prediction. However the analysis of its destinations reveals some interesting patterns. While Georgia continues to under-trade with China & Japan in commodities, over the 5 last five years it has tapped into the trading opportunities for differentiated goods in these two markets. Figure 6 and Figure 7 display the predicted versus the actual exports of Georgia in commodities in 2005 and 2010 respectively, while Figure 8 and Figure 9 do the same for differentiated goods.2 For commodities, it is possible to see that Japan and China appeared relatively far away from the predicted line in 2005, and closer to it in 2010. This suggests that exporters in Georgia tapped into increased trading opportunities in commodities with these two destinations in the period 2005-2010. Bulgaria appears as a destination with which Georgia overtrades significantly while it under-trades with Russia (not surprisingly given the history). Figure 6:Predicted vs. Actual Exports - Commodities Figure 7:Predicted vs. Actual Exports - (2005) Commodities (2010) Figure 8: Predicted vs. Actual Exports - Figure 9: Predicted vs. Actual Exports - Differentiated (2005) Differentiated (2010) Source: Authors’ calculations 13. Aggregate trends suggest that the reliance on the top five exported products remained relatively unchanged. The top five exported products accounted for 52.8 percent of total export revenue in 2000/01, and accounted for 54.1 percent in 2010/11. Over the same period, Georgia incorporated 252 new products into its export bundle, representing an increase of 62 percent (Figure 10).3 2 Goods are classified according to Rauch (1999) as “commodities� and “differentiated�. The former group includes products that are traded on international exchanges and products not traded on international exchanges but with relevant ‘reference’ prices. The latter include s total merchandise exports that are not commodities. A global gravity model for 213 countries over the period 2000-2011 is used to assess whether Georgia under-trades or over-trades with a particular destination. Bilateral trade flows are expressed as a function of distance, GDP of exporters and importers, dummies for contiguity, common languages, colonial ties, and common colonizers after 1945, and control both for zero trade flows and for self-selection into export markets. Then actual exports of Georgia are compared with those predicted by the model. When actual exports are greater than those predicted, the exporter is said to over-trade with that particular destination (and the converse is also true). 3 A product is an export category defined at the 6 digit-level of disaggregation of the HS classification. 6 Figure 10: Product Diversification Indicators Number of Products Share of Top 5 Products in Herfindahl Export Revenue 700 0.12 600 0.6 0.1 500 0.5 0.08 400 0.4 0.06 300 0.3 0.2 0.04 200 100 0.1 0.02 0 0 0 Source: Authors’ calculations based on Comtrade data 14. Diversification played a significant role in Georgia’s export growth performance over the period 2000-2010. Figure 11 shows Georgia’s export growth decomposed into the margins of trade, and displays it for total export growth, and for export growth with the European single market (EU-27) and with countries in the East Asia Pacific region (EAP). This decomposition shows the portion of export growth explained by increased sales of the same products to the same markets (intensive margin), and the portion explained by increased sales of the same products to new markets, new products to the same markets, or new products to new markets (extensive margin). Most of export growth is associated with diversification (growth in the ‘extensive margin’), and mainly along the market dimension (about 60 percent). Typically, relatively small countries like Georgia, with diversification opportunities yet untapped, tend to display higher growth at the extensive margin than larger economies that have already diversified extensively. Therefore Georgia’s performance in this respect is in line with countries of comparable economic size in the region. Interestingly, extinction of products (that is, products that stop being exported by Georgia to any destination) are relatively high with the EAP region, which may be hinting to difficulties that exporters may have in sustaining export flows to that destination. Figure 11: Decomposition of Export Growth along the Extensive and Intensive Margins 1 0.8 0.6 0.4 All EU 27 0.2 EAP 0 Old products in old Fall of old products Extinction of New products in New products in Old products in markets in old markets products new markets old markets new markets -0.2 -0.4 7 Source: Authors’ calculations based on Comtrade data 15. Georgia has been losing market share for its most important export products, a worrisome trend. To understand how Georgia’s most important export products are faring in international competition, Figure 12 and Figure 13 plot Georgia’s export growth for the top ten products for the period 2005 -2010 against the average rates of growth of world demand for the same products (for non-oil and gas exports – Figure 12, and for all exports – Figure 13). While Georgia has gained market share in important products, such as Copper ores, Ferro-silico manganese, Gold, and Ammonium nitrates, it has lost market shares in non- mineral and non-metal products such as spirits, hazelnuts, waters and wine, and even in some metal-related products, such as ferrous waste. Interestingly, these graphs show that within the top export products, importance is relatively evenly distributed, as suggested by the relatively similar size of the bubbles (whose size is an indicator of the importance of the product in Georgia’s export bundle) (see Table 5 for the list of products, the value of exports and the rates of export growth). Figure 12: Growth Orientation of Products (Non-oil Figure 13: Growth Orientation of Products (all) and gas) GEO: Growth Orientation of Products GEO: Growth Orientation of Products Top 10 Products Top 10 Products 30 Copper ores 30 Copper ores Ferro-silico-manganese Gold Ferro-silico-manganese Gold GEO: CAGR of Exports 05-10(%) 20 20 Ammonium nitrate Ammonium nitrate Petroleum oils 10 10 Spirits Petroleum oils 0 0 Ferrous waste Ferrous waste Hazelnuts w.o. shells Mineral waters Hazelnuts w.o. shells Mineral waters -10 -10 Waters (incl. mineral and aerated) Wine Wine -20 -20 -20 -10 0 10 20 30 -20 -10 0 10 20 30 W LD: CAGR of Exports 05-10(%) WLD: CAGR of Exports 05-10(%) Source: Authors’ calculations based on Comtrade data Source: Authors’ calculations based on Comtrade data Table 5: Most important products for non-oil & gas exports Georgia World Product Exports in Exports in Share in CAGR CAGR Description Code 2005 2010 Exports 2005- 2005- 2010 2010 720449 Ferrous waste 146,336.20 141,917.50 15.5% -0.6% 10.8% 220421 Wine 80,674.40 31,012.74 8.6% -17.4% 5.4% 720230 Ferro-silico-manganese 67,540.37 214,057.50 7.2% 25.9% 12.1% 260300 Copper ores 61,458.56 215,921.90 6.5% 28.6% 22.9% 80222 Hazelnuts w.o. shells 59,216.19 54,151.88 6.3% -1.8% 0.7% 310230 Ammonium nitrate 43,942.50 99,653.77 4.7% 17.8% 10.0% 220110 Mineral waters 36,014.86 32,159.29 3.8% -2.2% 1.3% 710812 Gold 34,740.61 110,787.40 3.7% 26.1% 24.8% 220210 Waters (incl. mineral) 31,822.22 16,534.69 3.4% -12.3% 8.2% 220820 Spirits 28,734.18 31,525.76 3.0% 1.9% 8.6% 8 Source: Authors’ calculations based on Comtrade data Note: “CAGR� stands for the Compound average annual growth rate. Table 6: Change in Georgia’s shares of Merchandise Exports Average 2000/01 Average 2010/11 Sector Exports % of total RCA Exports % of total RCA CAGR (%) 01-05 Animal 10,310.26 1.3% 0.61 26,431.60 0.9% 0.51 9.9% 06-15 Vegetable 47,603.76 6.0% 2.22 142,159.00 4.9% 1.6 11.6% 16-24 Foodstuffs 73,237.75 9.3% 3.2 162,271.10 5.6% 1.91 8.3% 25-27 Minerals 351,834.30 44.5% 3.98 1,272,078.00 44.1% 2.26 13.7% 28-38 Chemicals 42,559.30 5.4% 0.65 234,041.30 8.1% 0.86 18.6% 39-40 Plastic / Rubber 6,766.82 0.9% 0.21 10,221.93 0.4% 0.08 4.2% 41-43 Hides, Skins 2,973.92 0.4% 0.44 4,397.21 0.2% 0.26 4.0% 44-49 Wood 25,348.01 3.2% 0.86 25,573.66 0.9% 0.36 0.1% 50-63 Textiles, Clothing 9,752.69 1.2% 0.21 46,991.65 1.6% 0.41 17.0% 64-67 Footwear 1,441.38 0.2% 0.18 1,181.14 0.0% 0.05 -2.0% 68-71 Stone / Glass 16,881.05 2.1% 0.69 127,905.30 4.4% 1.24 22.4% 72-83 Metals 130,312.90 16.5% 2.56 627,769.70 21.8% 2.91 17.0% 84-85 Mach/Elec 56,864.36 7.2% 0.24 123,797.10 4.3% 0.17 8.1% 86-89 Transportation 5,753.70 0.7% 0.07 52,013.08 1.8% 0.21 24.6% 90-97 Miscellaneous 8,791.45 1.1% 0.18 27,332.09 0.9% 0.17 12.0% Source: Authors’ calculations based on Comtrade data 16. The sophistication of Georgia’s export basket is relatively low given Georgia’s level of development and has shown no improvement over the last decade. Goods that embody greater value addition in terms of ingenuity, skills, and technology, fetch higher prices in world markets. Furthermore, countries producing goods that are more sophisticated than what their income levels would suggest tend grow at faster rates. According to Haussman, Hwang and Rodrik (2006), the upgrade of product quality can thus be a secure source of both export and economic growth.4 Here we use the EXPY indicator to measure export sophistication. To construct the EXPY, one needs first to associate each export product with the average per capita income level of the countries that produce that good. That initial average is called PRODY. Then, one needs to average the PRODYs for the export bundle of the relevant country (for a formal definition of this indicator, see Box 1). Figure 14 plots the evolution of sophistication indicators for export bundles of Georgia and comparator countries for the period 2000-2011. Countries like Ukraine, with a similar level of income per capita, show a much more sophisticated export bundles. In addition, other relatively poorer countries, such as Moldova show an impressive upgrading of their export bundle, contrasting Georgia’s stagnancy in this respect. 4 Hausmann, R., J. Hwang & D. Rodrik (2006), “What you export matters�. 9 Figure 14: Evolution of Sophistication Indicators for Selected Countries 9.6 08 11 10 09 03 0709 08 11 07 10 03 05 04 06 02 04 0506 02 01 01 07 09 9.4 1011 06 08 09 07 02 03 05 Log EXPY 04 03 0506 10 08 01 04 11 0811 0910 07 9.2 06 10 0405 01 0203 01 02 04 06 09 07 9 08 01 03 05 02 6 7 8 9 Log GDP per capita Georgia Poland Lithuania Slovakia Moldova Ukraine Source: Authors’ calculations based on Comtrade and WDI data Box 1: Measuring Export Sophistication Calculating export sophistication, denoted by EXPY, is a two-stage process. The first stage is to measure the income level associated with each product in the world, termed “PRODY�. The PRODY of a particular product is the GDP per capita of the typical country that exports that good. Typical GDP is calculated by weighting the GDP per capita of all countries exporting the good. The weight given to each country is based on “revealed comparative advantage�, defined as the share of its exports that comes from that good relative to the “average� country. The PRODY for a single product is calculated by weighting the GDP per capita of all countries exporting that product. Therefore, a product that typically makes up a large percentage of a poor country’s export basket will have stronger weights towards poor countries’ GDP per capita. This will be less the case for a product that makes up a small percentage of a poor country’s exports but is a significant component of many rich countries’ export baskets. The second stage is to measure the income associated with a country’s export b asket as a whole; this is its EXPY. From the first stage, each product that a country exports will have a PRODY. The EXPY is calculated by weighting these PRODY by the share that each good contributes to total exports. If butter makes up 15 per cent of a c ountry’s exports, its PRODY will be given a weight of 0.15. Countries whose export baskets are made up of “rich -country goods� will have a higher EXPY, while export baskets made up of “poor -country goods� will have a lower EXPY. 10  x jk    Xj   x  PRODYk    Y and EXPYi   ik PRODYk x jk j k  Xi  j j Xj III. Sector selection methodology 17. Two of the approaches used to identify sectors for further focus include: i) an analysis of the quality of exports for the larger export sectors and, ii) product space analysis. The first approach involves comparing how Georgian exports fare in their main exported market along two dimensions, gains in market shares and relative quality. By increasing the quality of products, exporters typically can obtain higher prices per unit exported, which leads to growth in export revenues, and generally to the creation of better quality and better paid jobs. The objective of this analysis is to reveal which sectors are declining in quality compared to their peer and are therefore in need of upgrading. The second approach is a product space analysis (Hidalgo 20095), which involves mapping products into four categories (classics, emerging champions, disappearances and marginals).6 Empirically, countries move through the product space by developing goods close to those they currently produce. Product space analysis suggests that it is easier to transform and update their productive structure in those products that are “close� to those in which the country currently has a comparative advantage i.e. the emerging champions. 18. A preliminary analysis of the quality of exports has showed that some of the largest export sectors (as chemicals and transport equipment) have gained market share and also managed to increase relative quality vis a vis its competitors in the EU market. Other large exporters have showed mixed results. While minerals have been unsuccessful both at gaining market share and improving relative quality, the food sector has manage to increase the quality of their products but have lost market share. An in-depth analysis of what hinders quality upgrading in these sectors may uncover the constraints to export competitiveness in Georgia. Figure 15: Changes in Relative Quality and in EU Market Shares – 2003-2008 5 César A. Hidalgo, December, 2009, The Dynamics of Economic Complexity and the Product Space over a 42 year period 6 This is based on a measure created by Hausmann, Hwang and Rodrik (2007) measuring the sophistication of a product by averaging the income per capita of the countries that exported that product, weighted by the Revealed Comparative Advantage (RCA) that each country had in that product. 11 Source: Authors’ calculations based on data from COMEXT Box 2: Measuring relative quality of exports using highly disaggregated trade data We rely on the COMEXT database from EUROSTAT to characterize the relative unit values of imports in each EU member country. As in Schott (2004), unit values were calculated simply as the quotient of general imports values and quantities. Within any product (8-digit Combined Nomenclature code) for any given year, we then have a distribution of unit values of imports from the different source countries. For each good and exporting country , in time year , we generate a measure of relative quality as: Where denotes de unit value of the good and denotes the value at the 90th percentile of the unit value distribution across countries for that product. denotes the relative quality of the country’s export of that good, i.e., quality relative to other countries exporting the same good. These relative quality indicators are then aggregated at the sector level by weighting each product by its importance on the export basket of the relevant country. 19. The product space analysis as presented by the Observatory of Economic Complexity7 run by the MIT Media Lab – is displayed at Figure 16. The colored nodes reflect products with (revealed) comparative advantage; while the node size is proportional to trade volume for that product. The map pointed some products in which Georgia has (revealed) comparative advantage and that are located in the denser area of the map; these are Cars; Wire of iron or non-alloy steel, Plaster Articles, Plaster Board, Tanks, Bovines, among others map. Also noteworthy is the ‘clustering’ of “Textiles� nodes (green) in a very dense area of the map. In principle, products that are ‘close’/ ‘related’ to these products constitute the potential for Georgia export diversification. Figure 16: Product Space Map of Georgia’s Exports: 2010 7 atlas.media.mit.edu/ 12 Source: http://atlas.media.mit.edu/explore/product_space/export/geo/all/show/2010/ 20. While this preliminary mapping is useful in identifying products that are in the dense core with potential to diversification, further analysis will be conducted and stakeholders consulted in order to begin to identify the final set of sectors into which Georgia could diversify. A combination of product space analysis with an analysis of the quality of exports through the combined analysis of sophistication (PRODY) and density8 measures – will show how feasible it is for Georgia to export products that are more sophisticated but close to its major exports. Most importantly, public-private dialogue and stakeholder engagement must take precedence over any desk analysis both to verify results and also gauge appetite and capacity for development in these sectors and the feasibility of their development. IV. Preliminary assessment of Georgia’s Innovation Ecosystem 21. The State Commission for Regional Development is responsible for the development of innovation policy and schemes to support new technologies and entrepreneurship in Georgia. The commission is chaired by the Minister for Regional Development and Infrastructure, and is supported by the Task Force for Regional Development and seven well-structured working groups. The working group on Innovation, new technologies and entrepreneurship forms recommendations for the strategic direction of innovation policy in Georgia by bringing together policymakers, experts from the task force secretariat, and representatives from Georgian universities and public institutions. 22. Elements of Georgia’s approach to innovation policy are included in the Regional Development Strategy of Georgia for 2010-17, developed by the Governmental Commission on Regional Development. Within the Ministry of Regional Development and Infrastructure, the Department of Reforms and Innovations supports the implementation of this strategy. In addition, the National Intellectual Property Center (SAKPATENTI) implements projects in the fields of technology transfer and intellectual property rights, and the Ministry of Economy and Sustainable Development develops targeted initiatives to support innovative start-ups. However, there is currently no comprehensive innovation strategy in Georgia, and increased institutional co-ordination is needed to develop a coherent and effective strategic approach to innovation policy. 23. The European Neighborhood Policy (ENP), which was outlined by the European Commission in the ‘Communication on Wider Europe’ document in March 2003, demonstrated the high priority of the EU to shape its future relations with its neighbors. ENP is an outcome of the Lisbon Strategy, which includes a variety of policy measures to enhance research, innovation and business development. These factors are important not only for those countries that have moved very closely to the technology frontier, but also for those that are implementing the principles of free market economy. The new EU Strategy Paper, published in 2006, elaborated on these thoughts and laid foundation for the new policy. It set out in concrete terms how the Union could work more closely with its neighbors and extend to them some of the benefits of 8 According to Hausmann and Klinger (2006), the density of commodity j, a product not exported with comparative advantage, is the sum of proximities between product j and all products that are exported with comparative advantage, scaled by the sum of all proximities leading to product j: ∑ ∑ where and f denotes the proximity between goods i and j. The density of any product lies between 0 and 1. The higher the density of a product not exported with RCA, the closer its required capabilities are to the country’s existing capabilities. 13 enlargement. Today, the Commission provides an assessment of bilateral relations between the EU and Georgia, reflecting progress under the existing Partnership and Co-operation Agreement and describing the current situation in different areas including economic and social reforms that will create new opportunities for development and competitiveness9. 24. There are a limited number of donor-financed initiatives in place to provide technical assistance to support innovation and entrepreneurship in Georgia. For instance, the EBRD provides advisory and consulting services to SMEs within the framework of its TurnAround Management (TAM) and Business Advisory Services (BAS) programs. Financial support schemes for innovative SMEs are limited but available through various programmes to foster R&D partnerships between scientists and industry. Examples include the Joint Business Partnership Grant Programme, supported by the Georgian National Science Foundation (GNSF) and the Science and Technology Entrepreneurship Program (STEP), financed by the Georgian Research and Development Foundation (GRDF). Notably, in co-operation with GIZ, SAKPATENTI opened the Georgian Technology Transfer Center (GTTC) in February 2012. However, there is still a limited co-operation between universities, technological centres and industry in the development and commercialization of innovative knowledge and ideas. 25. Based on the WEF Global Competitiveness Index 2012–2013. Georgia’s economy was identified as efficiency-driven economy, being placed in between factor-driven and innovation-driven economies. Georgia’s Global Competitiveness Index is 77th/144 with a score of 4.07 on the scale from 1 (worst) to 7 (best) going down one position compared to 2011-2012. Among all 12 pillars that comprise the aggregated GCI, Georgia has the lowest scores on Business Sophistication (Figure 18) followed by the Innovation pillar (Figure 19), both of them are also below the average for the efficiency-driven economy group exhibited on Figure 17. Figure 17: Georgia's Ranking in Global Competitiveness Report 2012-2013 9 Ivaniashvili-Orbeliani (2009), Globalization and National Competitiveness of Georgia, Caucasian Review of International Affairs, Vol. 3 (1) –Winter 2009. 14 Source: WEF Global Competitiveness Report 2012-2013 Figure 18: Georgia's Business Sophistication Pillar - Figure 19: Georgia's Innovation Pillar - GCI 2012-2013 GCI 2012-2013 Notes: *Indicator is not derived from the GCI survey Source: values derived from the WEF Global Competitiveness Report 2012-2013 26. The WBI Knowledge Assessment Methodology (KAM 2012) reflects that Georgia’s innovation system parameters are behind the selected comparator countries within the ECA region ( Figure 20), with the exception of FDI inflow. The Innovation Index of the WBI Knowledge Economy Index (KEI) further shows that Georgia’s relative position is significantly lower than the ECA average (Figure 21, Figure 23). The methodology includes three key variables: (i) Total Royalty Payments and Receipts, (ii) Patent Applications Granted by USPTO, and (iii) Scientific and Technical Journal Articles. It has even shown a slight deterioration from 1995 levels while countries like Latvia which were initially behind have surpassed Georgia. Figure 20: Georgia’s Innovation System Scorecard (KAM 2012) Source: World Bank. Knowledge Assessment Methodology (KAM 2012), www.worldbank.org/kam, retrieved January 2013. 15 Figure 22: Knowledge Economy Innovation Index Figure 21: Knowledge Economy Innovation Index – Georgia and selected countries (1995-2012), – Georgia and selected countries (1995-2012), Cross-country comparison group: World Over time comparison group: World Figure 23: Knowledge Economy Innovation Index Figure 24: Knowledge Economy Innovation Index – Georgia and selected countries (1995-2012), – Georgia and selected countries (1995-2012), Over time comparison group: ECA Cross-country comparison group: ECA Source: World Bank. Knowledge Assessment Methodology (KAM 2012), www.worldbank.org/kam, retrieved January 2013. 27. Georgia was categorized as an ‘inefficient innovator’ (Figure 25) according to the INSEAD- WIPO Global Innovation Index 2012 where Georgia was ranked 71st/141 (34.3/100). In particular while the country was rated 57th in Knowledge and technology outputs which include indicators such as patents and new businesses, it was ranked 105 in creative outputs such scoring poorly in areas such as ICT. 16 Figure 25: INSEAD-WIPO Global Innovation Index Figure 26: INSEAD-WIPO Global Innovation Index 2012 scores vs. GDP per capita in PPP$ (bubbles 2012 scores - Innovation Outputs sub-index – sized by population) Georgia (value 1-100, rank 1-141) Georgia Source: INSEAD-WIPO Global Innovation Index 2012 report 28. An examination of patents in Georgia shows that a significant portion of patents are granted to non-residents, an indication that foreign collaboration is driving a significant portion of patenting. Patenting activity appears to be similar to comparator countries with the number of patent applications submitted in 2010 to EPO at similar levels with Latvia and Slovak (Figure 30). The top 5 fields of technology per the WIPO filed patent applications are (i) pharmaceuticals, (ii) food chemistry, (iii) other special machines, (iv) engines, pumps, turbines, (v) civil engineering, (vi) materials, metallurgy, (vii) transport, (viii) medical technology, (ix) measurement, and (x) mechanical elements (Figure 29). 17 Figure 27: WIPO Patent Applications - Georgia Figure 28: WIPO Patent Grants - Georgia Source: WIPO statistics database, updated December 2012 Source: WIPO statistics database, updated December 2012 Figure 29: WIPO Patent Applications by Top Fields Figure 30: EPO Applications, residents - Georgia and of Technology – Georgia (1997-2011) selected countries Source: WIPO statistics database, updated December 2012 Source: WDI, retrieved January 2012 29. Based on the World Bank Business Enterprise survey 200910, the top 5 sectors where innovative enterprises (product and process) are consolidated in Georgia are (i) retail and wholesale trade, (ii) food sector, (iii) construction, transportation, etc., (iv) other services and (v) other manufacturing. Across all comparator countries the composition of top sectors of the innovative firms is very similar (Figure 31). Most innovative firms in Georgia innovate around process (76% of respondents) as opposed to products (35%) (Figure 35). As should be expected, innovative firms export more than non- innovative peers (Figure 36). 10 Kuriakose, Seker, et al. (2012) Southern Caucasus Innovation Study. Preliminary Findings Using Enterprise Surveys. 18 Figure 31: Sectoral Distribution of Firm Innovators (Product or Process), relative values (%) Non-metallic and plastic materials Chemicals and pharmaceuticals Electronics Food Garments Hotels and restaurants Metals and machinery Other manufacturing Other services Other: Construction, Transportation, etc Retail and wholesale trade Textiles Slovakia 6 3 10 3 10 26 17 18 19 89 2 Latvia 6 21 7 9 9 42 23 25 104 2 Georgia 17 46 1 16 12 24 25 41 97 1 Czech 11 7 11 1 7 36 20 27 16 51 4 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Source: BEEPs 2009 Figure 32: Firm Innovators (Product or Process) by sector, absolute values Czech Georgia Latvia Slovakia 120 100 80 60 40 20 0 Source: BEEPs 2009 Figure 33: Sectoral Distribution of Firms spent on R&D, relative values (%) 19 Chemicals and pharmaceuticals Electronics Food Garments Hotels and restaurants Metals and machinery Non-metallic and plastic materials Other manufacturing Other services Other: Construction, Transportation, etc Retail and wholesale trade Slovakia 2 1 2 1 9 2 7 2 2 13 Latvia 7 2 2 9 7 4 17 Georgia 13 2 1 7 3 8 15 Czech 2 5 5 1 19 4 10 8 5 10 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Source: BEEPs 2009 Figure 34: Sectoral Distribution of Firms using foreign-licensed technology, relative values (%) Chemicals and pharmaceuticals Electronics Food Garments Metals and machinery Non-metallic and plastic materials Other manufacturing Other: Construction, Transportation, etc Textiles Slovakia 2 4 1 13 8 1 Latvia 5 5 3 1 13 Georgia 25 1 5 2 1 Czech 1 5 4 4 1 1 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Source: BEEPs 2009 20 Figure 35: Innovation Rates11 Armenia Azerbaijan Georgia ECA-10 ECA -25 80% 76% 70% 60% 50% 40% 35% 30% 20% 16.2% 16.8% 10% 0% % Firms Product Innovators % Firms Process Innovators % Firms Invested in R&D % Firms using technology licensed from a foreign- owned company Source: BEEPS 2009 Notes: ECA-10 countries: Czech Republic, Poland, Estonia, Hungary, Latvia, Lithuania, Slovakia, Slovenia, Russia, and Turkey. The ECA-25 group includes countries in the ECA-10 as well as Belarus, Bosnia & Herzegovina, Bulgaria, Former Yugoslav Republic of Macedonia, Kazakhstan, Kosovo, Kyrgyzstan, Moldova, Mongolia, Montenegro, Poland, Romania, Serbia, Tajikistan, Ukraine, and Uzbekistan. Figure 36. Exporting Activity Comparisons12 % of Exporter Firms 50 40 30 20 10 0 Armenia 2008 Azerbaijan Georgia 2008* Czech Poland 2008* Russia 2008* Turkey 2008* 2008 Republic 2008 Non- Innovators Innovators Note: * indicates a statistically significant difference in the means at the 0.01 level. A firms is an exporter if at least 10 % of annual sales are derived from direct exports. A firm is considered to be an innovator if it participated in either product or process innovation. Source: Enterprise Surveys. 11 Kuriakose, Seker, et al. (2012) Southern Caucasus Innovation Study. Preliminary Findings Using Enterprise Surveys 12 Ibid. 21