2011

Capital and Conflict: Georgia

Project Director: Benjamin Graham Research Team: Maya Baramidze, Amiran Chanchibadze, Anna Gogokhia, Anastasia Laitadze, Giorgi Mekerishvili, and Giorgi Tarkhan-Mouravi. Project Consultants: David Kokiashvili, Alexandre Kukhianidze, Maia Mestvirishvili, and Anna Sekowska-Livny. This research was funded by the Rohr Chair of Pacific International Relations at the University of California, San Diego and supported in Georgia by the Georgian Foundation for Strategic and International Studies, with additional assistance from the Caucasus Research Resource Center. Please direct all comments and inquiries, to Benjamin Graham: bagraham@ucsd.edu.

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About the Survey

The Capital and Conflict: Georgia survey was conducted from February - June 2010, and

captured the responses of the owners and managers of 174 foreign-owned firms operating in Georgia.

Interviews were conducted face to face, in both English and Georgian, and lasted approximately 45

minutes. Topics covered included the firms’ plans, profitability, and reasons for investing in Georgia, the

2008 war between Russia and Georgia, the global financial crisis, Georgian government policy, and

business strategy, including the use of social networks.

The firms surveyed were a random sample of those foreign firms that registered to do business

in Georgia after the year 2000, drawn from a list of all the foreign-owned firms in Georgia, provided by

the Ministry of Finance. Researchers contacted 377 firms, 203 of which declined to participate in the

survey.

Among the firms that

responded to the survey, most

were from Western Europe,

with a mixture of firms from

neighboring states in the

Former Soviet Union, the

United States, Australia, and

countries in the Middle East.

Most of the firms in the sample

were small firms with less than 25

employees. The largest firm had

over 1000 employees.

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Over 75% of the firms in the

survey entered Georgia via

Greenfield investment,

meaning that the firm started

a new business in Georgia,

rather than buying or joining

an existing business. Ten

percent of firms entered

Georgia by buying an existing

domestic company (this

includes foreign firms that

purchased formerly state-

owned-enterprises).

The graph below gives the distribution of firms by sector. While some of the firms in the natural

resources sector are very large, the number of firms in the sector is modest.

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Georgia’s Competitive Advantages

One of the most policy-relevant tasks of this survey is to identify the factors that drive foreign

firms to select Georgia for investment. Respondents were asked to identify which of 11 factors

positively or negatively affected their initial decision to invest in Georgia. They were then asked to rank

the most important factors. Three quarters of respondents chose either the ease/difficulty of starting a

business in Georgia, their firm’s family and/or friendship ties to Georgia, or Georgia’s geographic

location as the most important positive factor.

The Factors

1. Georgia’s tax rates. 2. Georgia’s court system. 3. Georgia’s business regulations. 4. The ease/difficulty of starting a business

in Georgia. 5. Your firm’s family and/or friendship ties

to Georgia. 6. Domestic political stability/instability in

Georgia. 7. The situation in South Ossetia and

Abkhazia. 8. Your firm’s level of familiarity with the

local business environment in Georgia. 9. Georgia’s geographic location. 10. The supply of skilled labor in Georgia. 11. Labor costs in Georgia.

The most important negative

factors were Georgia’s tax rates,

domestic political stability/instability

in Georgia, the situation in South

Ossetia and Abkhazia, and the supply

of skilled labor in Georgia.

The results from this question

indicate that business regulations in

Georgia are viewed quite favorably,

but that political instability, both

domestic and international, is major

concern of foreign investors and may

deter potential entrants.

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Georgian Government and Policy

Respondents were also asked a number of questions about recent changes in government policy, as well

as their views on the overall direction of Georgian policy. They were asked whether they agreed or

disagreed with the statement: “The

legal environment for business in

Georgia is currently developing in a

positive direction.” A majority of

respondents believed that it was.

Opinions were more mixed, however,

with regard to specific recent reforms.

The survey asked about two

reform packages in particular: the set

of laws titled “Global Competiveness in

the Financial Sector”, which were

introduced in April 2008, and a set of

customs reforms introduced in

December 2009, just two months

before the survey began. While most

firms reported that these reforms did

not affect their investment plans,

slightly more than half of those

affected by the financial sector reform were affected positively, while slightly less than half of those

affected by the customs reform were affected positively.1

1 Firms were also asked about the effects of these reforms on their profitability and the responses were almost

identical to the responses regarding investment.

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The 2008 War between Russia and Georgia

In 2008, firms in Georgia were buffeted by twin crises: the war between Georgia and Russia, and

the global financial crisis. We were only able to survey those foreign firms that were still in business in

the spring of 2010, meaning we were unable to speak with those firms actually driven out of business by

these events. Not surprisingly, almost all the firms in the sample reported that they were less profitable

in 2009 than they had been in 2007. While it was primarily the war that damaged firms’ profitability in

2009, the global financial crisis contributed to firms’ inability to access credit for additional investment

in Georgia.2 Firms were divided and uncertain about the likelihood that conflict would break out again,

but almost all reported that the risk of future conflict weighed heavily on their business plans.

2 It is interesting to note that two firms, one in aviation and one in security, mentioned that a future violent

conflict between Russia and Georgia would increase the profitability of their firm.

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Firms’ Use of Social Networks

This survey revealed that social networks are important to many of the foreign firms doing

business in Georgia. The survey focused on one task in particular that must be undertaken by firms in

almost every sector: the acquisition of real estate.3 Roughly one third of firms report having used social

networks to help them rent or purchase real estate; in separate questions they acknowledged that these

relationships were helpful both with the location of property, and with price negotiations.

Question 32: Has your firm ever rented or purchased real estate with the help of a family member of one of your firm’s owners or managers?

Question 33: Has your firm ever rented or purchased real estate with the help of a friend of one of your firm’s owners or managers? If a firm answered “Yes” to either of these questions, they are shown in the “Yes” column in the graph on the left.

3 Firms in the real-estate sector were omitted from analysis on this question.

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Respondents were asked to assess the overall importance of social networks to firm profitability.

Responses varied widely. Relatively few firms reported that family relationships are important to

profitability, with more firms reporting that friendships are important. Questions 27 and 28 read: “How

important are your owners’ and managers’ friendships (family relationships) to increasing the

profitability of your firm?”

The Georgian Diaspora

The Georgian diaspora (Georgians living abroad), sent home over $730 million in remittances in

20084 and are emerging as an important force in Georgia’s development. Two of the major questions

posed by the project were: 1) what proportion of the foreign firms in Georgia are owned by members of

the diaspora; and 2). do the diaspora-owned firms behave any differently than other foreign firms?

Fifteen percent of the randomly sampled firms in the survey reported that at least one of their owners

was a member of the Georgian diaspora. In terms of demographics, these diaspora-owned firms are

very similar to their non-diaspora-owned counterparts: similar in size, similar in distribution across

sectors, similar in mode of entry. However, the survey uncovered an important difference between

diaspora and non-diaspora-owned firms: diaspora-owned firms use social networks in business much

more than do non-diaspora-owned firms.

These results are discussed in much greater detail in an academic paper titled “The Diaspora

Difference: Firm Level Evidence,” which will be presented at the annual meeting of the International

Studies Association taking place in Montreal, Canada, March 2011. However, a table summarizing the

4 World Development Indicators, http://databank.worldbank.org/ddp/home.do?Step=12&id=4&CNO=2, Accessed

November, 2010.

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main results is shown below. Diaspora-owned firms are more likely to report using friends and family

members to rent/purchase real estate, more likely to report that friends and family are important to

firm profitability, and more likely to report that friendship and family ties to Georgia were an important

factor in their firm’s initial decision to invest in Georgia.

The units on the x axis in the graph above are standard deviations. The blue lines represent 95%

percent confidence intervals – hence lines that do not cross zero indicate a statistically significant

difference between diaspora-owned firms and non-diaspora-owned foreign firms.

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Conclusions

The results in this survey indicate that while foreign firms generally view the regulatory

environment in Georgia favorably, the cost of political instability, both domestic and foreign, is large.

There is no consensus among owners and managers regarding the likelihood of renewed conflict in

South Ossetia and Abkhazia, but almost all report that the risk of future conflict affects their plans.

When it comes to foreign investment, stability matters, and it matters a lot. It is also worth noting the

importance firms placed on the supply of skilled labor in Georgia: these results suggest that investment

in education and job training have the potential to pay off in terms of attracting foreign capital.

This paper presents only a small fraction of the results from the survey. For additional

information, please consider reading the aforementioned academic paper, or contact the project

director with specific inquiries.

Notes and Thanks:

Thanks to all the anonymous firm owners and managers who took the time to answer the survey, and

to the government officials who took the time to meet with us and to help us obtain the necessary lists

of firms. Thanks also to Tata Tsereteli and Salome Kikvadze for assistance with translations, to the

staff and workshop participants at CRRC who helped fine-tune the survey text.

The photo of Donald Trump and Mikhail Saakashvili on the cover page of this document is taken from

Caucasus Regional News (www.dailygeonews.blogspot.com), photographer unknown. The tank

photograph is taken from the Boston Globe, photo by Dmitry Kostyukov, AFP.