Georgia – gateway to Caucasus and central Asia regions – Time to Act

  • Anaklia City, CEO; Former Vice Minister, Ministry of Economy of Georgia; Young Global Leader of WEF The tectonic process of shifting in supply chains, particularly in the manufacturing industry, has started even before the coronavirus spread, so pandemic will just accelerate the process.
  • Georgia can become the frontier business destination for logistics, trade, light manufacturing and service industries for immediate and wider regions. Georgia is a primary gateway for transportation between Western Countries and the regions of the Caucasus and Central Asia (in total about 160m population and USD 800 billion worth economies).
  • Georgia could have unparalleled opportunities for the US and EU companies to use its grounds as a platform to expand business in the region. Initially, we should attract international 3PL (third-party logistics) providers in Georgia, and focus on logistics, warehousing, assembling, and distribution activities. In a medium-term, this can be expanded into manufacturing and transferring the MNEs’(multinational enterprises) regional activities to Georgia.
  • Georgia should not become a cheap place, where the attraction of the International companies is only based on low salaries, free land, and/or tax incentives, with no linkages with the national economy.
  • Soft infrastructure (international arbitration, quality infrastructure, international regulations, one-stop-shop, investment protection, and aftercare services etc) coupled with the investments in hard infrastructure (deep seaport, modernizing railway, road, and airports) and modern industrial & logistics parks managed by the leading international operators will create Georgia as a platform to develop the logistics, transportation and trade clusters with significant participation of foreign companies. This will lead not only to the enhancement of connectivity but also to the integration with local and regional economies.

Currently, many experts are raising the topic of the post- COVID19 world, citing among other outcomes the global changes in supply chains, particularly in the manufacturing industry. However, it’s worth to mention that the tectonic process of shifting production chains has started even before the coronavirus spread, so pandemic will just accelerate the process. After the decades of the globalization and outsourcing of manufacturing to low-cost countries, especially to China, which as of 2019 accounted to about 30% of the global manufacturing industry, recently there have been signs of the reversal processes. One of the best sources to prove this was the report published by the research arm of the Banks of America published in February 2020[1] and it doesn’t incorporate the aftermath of the COVID19. Critically, this report is based not on the top-down theoretical approach but on the worldwide survey covering 3,000 companies with the total market capitalization of USD 67 trillion.

[1]https://www.bofaml.com/content/dam/boamlimages/documents/articles/ID20_0147/Tectonic_Shifts_in_Global_Supply_Chains.pdf

The findings of the report suggest that companies in up to 10 out of 12 global sectors representing USD 22 trillion market capitalization have already stepped on a journey of shifting their supply chains from remote locations, mainly from China. Among the key driving forces for companies to initiate the re-shoring processes are the ones which would only be exacerbated by the pandemic aftermath such as national security, carbon footprints, and proximity to the consumer markets. As an outcome of the pandemic to be followed by the global recession, the topic of national security will be augmented with the intent of developed countries to return manufacturing back home since the sector plays important role in jobs creation, has a multiplier effect on other industries and most importantly expands the tax revenue base for state budgets.

What are the key takeaways of the report which Georgia could use as foodfor thought in developing a strategy that would benefit from this situation?

The first takeaway is that even before the pandemic, the process of supply chain shifts has started with about 12 sectors already on the move. Among these manufacturing subsectors are: technology, hardware and equipment, semiconductors industry, consumer durable and apparel products, automotive and spare parts, capital goods, materials, healthcare equipment, food & beverages, household and personal care products. Importantly, the industries and companies are moving closer to their epicenters of consumption. Fortunately for Georgia,a similar trend has been reported for the European companies. Even Chinese companies have started to locate their productions bases closer to the final consumer markets, and not only in response to the trade war with the United States. 

The second takeaway is that companies to offset the higher costs in new locations will heavily invest in automation to stay competitive. Yet, according to the paper, this topic is more important for the North American market. We should consider this as a mid-term strategy to be employed by many companies in different sectors as mitigation against margin compressions. The selling point of having low-skilled and cheap labor might soon become negligible.

A third and, probably the most important takeaway is that the process of shifting supply chains and leaving China is not easy. Companies used to advantage of China as a global factory, competitive advantages such as cost-efficient labor, supreme infrastructure and logistics chains, efficiency and friendly-regulatory environment for manufacturing - they will seek for these in other locations. Surveyed companies expect the new location to offer financial, regulatory and tax incentives to alleviate the impact of rising costs. Just as a piece of evidence is the recent initiative of the Japanese government to subsidize the companies leaving China to move to new destinations.

Georgia indeed is strategically located to be attractive in terms of nearshoring (location production close to the final consumer market) or to be used as part of the supply chain for onshore productions in Europe.  Its location on the crossroad of Europe and Asia is a natural shortcut for transportation between different regions. The country’s strategic geographical location enables to serve as vital transportation node between South and North (MENA region/Turkey and Russia, South to West from India to Europe, Europe and Asia via established Middle Corridor, China and Turkey, Caucasus/Central Asia and Europe).

Besides, Georgia as a primary gateway for transportation between Western Countries and the region of the Caucasus and Central Asia (in total about 160m population and USD 800 billion worth economies). In five hours flight from Georgia outreach are the whole Europe, MENA region including Gulf states, key urban areas of CIS and major cities of Russia, North-West of China). In two weeks railway – China, CIS, EU, and Turkey. Maximum two days trucking – whole Caucasus region, major urban areas of the European part of Russia, Turkey, North-West of Iran.

Based on studies that were implemented by the leading professional consultancy consortium of the UK based Buro Happold Engineering and Moffatt & Nichol for Anaklia Special Economic Zone, the following sectors were identified as competitive in Georgia: logistics, food and beverages, construction materials, cosmetics and beauty, automotive components (tier 2 and3), cleaning products, pharmaceuticals, household appliances, and electronics.  Even with low case projects, by 2030, the total import of these products to primary and secondary markets will increase above 220 Bln. In the base case, by 2030 the market will achieve up to 308 Bln.

In addition to the geographical location, Georgia is a world-renowned reformer and leader in terms of ease of doing business and streamlined bureaucracy. The achievements of Georgia are attested by the reputable institutions: 7th in the world in Doing Business by the World Bank, 16th freest economy by the Heritage Foundation, 44th by Corruption Perception, and 9th with the lowest tax burden by the World Economic Forum. The reforms and innovations of the country’s customs system are recognized as a role model for other regional economies due to transparency and efficiency.

Georgia (particularly ports infrastructure) has a primary role as a transit corridor for the US trade with the region of Caucasus and Central Asia. According to the transportation assessment prepared by the Moffatt & Nichol, in 2017-year trade balance (non-energy products) between the USA and Central Asia in tonnage equaled to about 250 thsd. tons (150 thsd. export from the US and c.100 thsd. import to the US), out of which 61% was transited through Georgia mainly using ports (c.98%) Overall export of the US to the Central Asian markets in 2017 has accounted to USD 1 billion. Georgia also has almost 100% transit share for the export of the US to Caucasus market, which equaled to USD 0.8 billion (2017). 

Georgia could have unparalleled opportunities for the US and EU companies to use its grounds as a platform to expand business in the region, utilize the cost-efficient operations and logistics, export their products without import duties to the markets with over 2.3 billion population through Georgia’s Free Trade Agreements with the EU28, EFTA, CIS region, Turkey, Ukraine and China (incl. Hong Kong).

While Georgia certainly has the opportunity to benefit from the commenced changes in supply chains, both in term of onshoring and nearshoring, the country has to wisely use existing advantages and develop the missing ones. Georgia should not become a cheap place, where the attraction of the International companies is only based on low salaries, free land, and/or tax incentives, with no linkages with the national economy. This approach is no more enough in the modern world. It is hardly sustainable and has a limited impact on national economies.  Instead, we should aim at the sustainable and inclusive way of economic growth which will have a catalytic effect on trade and industries, which will create additional spillovers from FDI, will bring knowledge and innovation, skills development, and will be the platform to enhance the national economy. Therefore, it is not only what we already offer, but something we have to work further to create.

What actions should be taken? What is realistic to achieve? Are we ready for this challenge?

Vision and Promotion: The government is on the verge of repeating a mistake of many developing countries by prioritizing import substitution agenda in response to the crisis instead of positioning Georgia as an export-driven economy. This means sending wrong messages to potential foreign investors and Georgian companies. As a 3.7 million population country with low purchasing power, we are not an interesting destination just for the local consumer market. In contrast, we have to be aggressive in promoting a country as a destination for the export-oriented manufacturing and production location to be integrated into new supply chains. Manufacturing is unlikely to grow much in the volume of production if it remains domestic-focused, but its value can grow by developing higher value premium products and premium grade products are needed to tackle export markets. At the same time, export has remained our only source of foreign income (not counting international loans and aid) after cessation of FDI, remittances and tourism expenditure as a result of the pandemic. Being low in foreign income means weaker national currency and fewer dollars to buy goods and services a country cannot avoid consuming. Georgia simply has no enough resources, either natural or manmade, to economically sustain itself without integration into the global economy. Georgia lacks business sophistication, quality and digitalization of services. For this we need more international players with their know-how and solutions.   Initially, we should attract international 3PL providers in Georgia, and focus on logistics, warehousing, assembling, distribution activities.  In a medium-term this can be expanded into manufacturing and transferring the MNEs’ regional activities to Georgia.

Energy: One of the topics signified by the abovementioned surveyed companies is energy, which is certainly an important factor for most of the manufacturing sectors. Unfortunately, Georgia has again become dependent on the import of electricity. In 2019 our trade deficit in electricity grew by 24.2% to record high USD 70 million. Moreover, for the first time, Georgia imported energy in July and August months, with 32% of imported electricity being from Russia. This raises significant concerns on future prices of electricity in Georgia and national energy security. Obviously, the country with such an abundant potential in hydro energy as Georgia, shall invest in its own generation facilities, guarantying a stable supply of energy for investors.

Labor force: As explicitly indicated in the report, the availability of cost-efficient and skilled labor force remains an important factor for the companies for selecting new destinations for production. This means low salaried but at the same time a productive workforce. The topic is very “painful” for Georgia. We have to employ the strategy of other countries, offering to support companies with the training of future employees both in terms of co-financing and with infrastructure.

Bureaucracy: This will be a critical selling point for the investors, ability, and flexibility of the Government to support companies in the quick setup in the country. Should the local bureaucracy machine drag the companies’ initiatives into the lengthy process of obtaining licenses, permits and negotiating with state authorities, the country would lose investors to other, more efficient destinations. The country needs a one-stop-shop entry point for new investors, efficient process management, and strict deadlines for any state authority to serve the needs of the investors. This also requires expediting decision-making and management by the high-level public officials, personally leading the process. It is very important to have the International regulations and ecosystem, which allows to follow SDGs (Sustainable Development Goals).  Proper Enforcement of Legislation; Transparency; No Corruption, Stability are few among other factors that investors are paying attention.

Modern Real Industrial Zone: As we have discussed, Georgia is strategically located to be attractive in terms of nearshoring or to be used as part of the supply chain for onshore productions in Europe. However, in addition to the location, Georgia has to offer supreme infrastructure and efficient logistics. Currently, it’s almost impossible to find in Georgia the modern industrial real estate areas and facilities, while most of the existing fixtures are old Soviet properties, part of which have undergone the renovation. Meanwhile, the 2018 year was the record high for the Central and Eastern European region with up to 4 million sqm. of new builds in industrial & logistics spaces supplied to the market. At the same time, the vacancy rate at such properties has decreased to a historic low of 5%, which reflects the significant demand for such facilities. The Covid19 will have a controversial impact on industrial and logistics properties. Initially due to the shrunk from demand-side the occupancy might decrease, but then will come robust demand from e-commerce and returning manufacturing companies. [1]It is important to create a new concept and value proposition of modern industrial & logistics parks fully integrated with the multimodal transportation (deep-sea port, rail, road and airport), powered by the attractive regulatory framework/incentives and managed by the leading international operator. Leading industrial real estate developer and an operator will ensure that future facilities and infrastructure meet the demand of local and international companies.  This model is to create the platform to attract the existing, new and emerging industries, currently not presented in Georgia and to ensure the future expansion and evaluation of these industries. 

It is well known that the bottleneck of expansion to Georgia is the low recognition of the country and the small market. Thus, improving transportation and logistics infrastructure, raising recognition as a logistics hub, and expanding the market are urgent issues to overcome.

Most likely, in the short-term policy, MN companies will be putting the priority to reconstruct national businesses.  Once after domestic business operation is normalized, they will review the overseas business policy basing on the several factors. Caucasus and Central Asian countries are currently observed and, if the market of those countries shows the development after the coronavirus crises, those countries can attract more attention of MNs/ compared to the past. Foreign investors are seeking global distribution networks and division of work that they need better logistics services. There is big competition who will grasp these opportunities and Georgia is expected to perform better than other countries in order to emerge in international competition.

[1]https://bbj.hu/special-report/industrial-demand-in-central-europe-continues-to-rise_163444

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