The growth acceleration and structural transformation have become major topics of interest as a result of economic shutdown due to the COVID-19 pandemic. The expectations that the global supply chains would be immediately disrupted and manufacturing would start relocating to other parts of the world (including to countries like Georgia) have yet to be realized. Relocating production is a lengthy process, which is kept secret and may be finalized years after the negotiations have begun. Therefore, we may still see changes in global supply chains as a result of COVID-19 come to fruition.
Nevertheless, the factors which determine the relocation of production remain valid and important even during the pandemic. Further, despite an advancement in world rankings, Georgia has a long way to go to increase its international competitiveness in order to attract FDI in manufacturing. The policies applied by a number of successful countries to develop sophisticated manufacturing (a state-led top-down approach, subsidies, tariffs and limitation of competition) is not feasible in the current globalized world, and is most often counterproductive. However, the strategy applied by these countries is valuable even today, that is, emphasis on the production of sophisticated products, maintaining competitive pressure, export orientation, a long-term policy, and prioritization. Instead of government intervention in the market processes, the modern industrial policy is focused on the development of a long-term cooperation between the State and private sector, where FDI can play a pivotal role.
In that respect, it is important to analyze the new strategy adopted by Georgia for attracting FDI. This article aims to do this and provide an additional approach, which entails the prioritization of a sophisticated industry, a focused educational policy, and a long-term strategy for developing the domestic capabilities.
FDI IN GEORGIA
The level of FDI and its ratio to GDP is frequently used as the measure of Georgia’s competitiveness and investment climate. Since 1996, Georgia has attracted $21 billion in FDI. By definition, FDI includes a foreign investor purchasing 10% or more of the voting powers in the domestic enterprise. The retained earnings of the domestic enterprise and the loans issued by the investor to the enterprise are also included in FDI. This definition is contrasted with popular imagination that FDI necessarily entails the creation of new production, hiring employees, transferring technology and other benefits.
It is true that FDI is very important in terms of the transfer of foreign currency to the country; however, purchasing 10% of shares in a Georgian company or retaining the earnings does not necessarily result in the creation of new jobs, or in launching a new enterprise. Therefore, identifying the true benefits of FDI requires not only quantitative but also qualitative and detailed analysis. FDI has both short and long-term benefits. In the short term, FDI brings in a foreign currency, increases tax revenues and helps improve the infrastructure. In the long run, FDI could facilitate the adoption of new technologies, creation of backward linkages and development of human capital. However, the FDI spillover effect is not automatically guaranteed, and as the experience of other countries demonstrates, additional supporting mechanisms by the State may be required.
THE SPILLOVER EFFECT
The long-term benefits of FDI depends on the spillover effects. This includes improving the capabilities of domestic firms by learning about new production techniques, management and business practices, through demonstration and imitation as well as through linkages between the investor and domestic companies, and by raising the skills and productive knowledge of employees. Countries have used different policies to generate an FDI spillover effect, which ranges from heavy intervention in the market processes by the State, to “softer” approaches.
Interventionist policies include domestic content mandates, joint venture mandates and/or other technology-sharing pressures. In contrast, public sector “support” takes the form of creating industrial parks, reliable infrastructure, and vocational training. In some countries, the interventionist approach has proved to be a success.
In developing an oil and gas suppliers’ cluster in the 1970s, Norway understood that the existence of market failures and the lack of government failures would not be sufficient to develop domestic firms in the oil and gas industry. The government thus intervened directly in the procurements of oil operators. The Norwegian Petroleum Code imposed that operators communicate their lists of bidders to the government, which in turn had the authority to impose Norwegian firms and even to change which firm was awarded the bid. In addition, the licensing process required foreign operators to come up with plans to develop the competencies of local suppliers. Lastly, the government imposed a minimum of 50% of R&D to develop a field to take place in Norwegian entities. Although the restrictions were lifted in 1994, when Norway signed trade agreements with the EU, the government continued to support the suppliers. Eventually the suppliers’ cluster became highly successful, including globally, spanning a large array of sophisticated industries such as subsea, geology, and seismic, developed the required skills, and employed directly about 114,000 workers in 2009, or more than five times the employment of the operators in the oil and gas sector.
The policies adopted by the Norwegian government may have been appropriate due to its position on the global market: the foreign companies were ready to accommodate the rules of operation in exchange for a potential big win (the right to extract oil). In the absence of such a market position, the acceptance of interventionist policies by a foreign investor is less likely. Besides, in the modern globalized world, it has become much harder to carry out interventionist policies.
Cheap labor is more easily accessible than before, and transnational corporations can largely pick and choose outsourcing locations. In addition, the interventionist trade measures are largely prohibited by TWO. From this standpoint, for countries like Georgia, a more sensible approach is FDI attraction and the development of domestic capabilities with less interventionist policies. The question is to what extent the ‘softer’ approach is actually effective in order to develop domestic capabilities. The experience of other countries, which have been in a similar position to Georgia, proves that this approach is feasible.
In 1996, Intel, the global producer of semiconductors and microchips, built a $300 million plant in Costa Rica, employing more than 2000 people. Three years after Intel entered Costa Rica, it tripled its FDI to $1.3 billion. 72% of 61 multinational companies operating in Costa Rica reported that Intel’s decision to build a plant had played an important signaling role for them to invest (36 in electronics, 13 in medical devices, three in business services, and nine in other sectors). Within 10 years of Intel’s investment, Costa Rica’s investment agency managed to attract new investments from 56 electronics fi rms, employing 11,000 workers.
The country also targeted medical devices investors, attracting 23 firms, and employing 6,000 workers. Western Union chose Costa Rica to be its technical support center, and Proctor and Gamble for its back-office services.
As of 2014, there were some 250 multinational corporations operating in Costa Rica, and the country competes with Chile as the most export-intensive economy per GDP in Latin America. In terms of population size, territory and resources, Costa Rica is comparable to Georgia. In 1996, when Intel entered the country, the population of Costa Rica was 3.6 million. The area of the country is 51,100 square kilometers. It does not have natural resources, nor a populous, rich diaspora abroad. However, unlike Georgia, Costa Rica has the experience of long-term peace and stability (since 1948, the country has had no regular army).
Costa Rica is an example how a small country can attract a high technology fi rm. Costa Rica’s success, which resulted in the development of the electronics cluster, has become the subject of much research and debate. Debora Spar, Senior Associate Dean of Harvard Business School Online, prepared a great case study of how Costa Rica managed to attract Intel and develop the electronics sector. In the following section, we will draw on a small part from this case study which concerns the priority sector and the education policy.
PRIORITY SECTOR AND THE EDUCATION POLICY
Once a developing country has liberalized its economy and begun to attract FDI, a common mistake is to view the FDIs as isolated incidents. In such circumstances, states can fail to appreciate the positive spillover effects the right kinds of investments can generate. Costa Rica combated this by adopting a long-term view of the economic growth, and evaluated the impact of each FDI to the country’s overall economic development.
In the 1980s, Costa Rica focused its investment promotion efforts on the apparel industry; however, rising wages rendered this strategy uncompetitive. Instead, Costa Rica targeted the electronics sector, and specifically aimed to attract investment from medium-and high technology foreign fi rms. On the one hand, there is nothing new in Costa Rica’s strategy for attracting high technology FDI. Many developing countries have tried this to increase employment, capital flows, and technological spillover. Costa Rica differed from those countries in that it not only had low-cost labor, but that it also had a well-educated low wage labor pool.
Costa Rica has always invested heavily in education and technological training. The country spent around 5% of its GDP on education and had an active bilingual ESL (English as a second language) curriculum. After prioritizing the electronics sector, high schools and colleges were urged to develop higher technology curricula, with a focus on electronics. However, Costa Rica never tried to define precisely what the schools should teach. Instead, the government’s strategy was to wait for firms from a particular sub-industry (for instance, semiconductors or disk drives) to come to the country, and only then to focus additional promotion and training efforts in those areas. This enabled the country to fully utilize and expand its educated labor potential, without risking all its resources on a single, narrow specialty.
Despite the high levels of education in Costa Rica, Intel feared that the country’s workforce did not meet Intel’s requirements. The company required a low-cost but highly trainable workforce and highly qualified engineers. In particular, in was necessary to train 800 technicians for an assembly and testing plant. Further, competencies in the English language, physics and chemistry were lower than expected. Costa Rica knew that without addressing these challenges, it would have been impossible to convince Intel to invest in the country. As a result, a team consisting of Intel Human Resources staff, Costa Rica’s investment agency, the Minister of Education, the Minister of Science and Technology, and officials from national institutions of higher education, was formed to spend considerable time identifying Intel’s workforce requirements and matching those against the curricula of the country’s technical high schools and advanced training programs. In addition, a group of four professors and two teachers made a six-week trip to Intel facilities in Arizona, New Mexico and Santa Clara. By speaking at great length to operators and technicians at the plants, they identified in specific terms the education and skills required to support an Intel workforce. After this, Costa Rica devised a number of one-year certificate programs to raise the level of technical skills, physics, chemistry, and English language in the country.
A LONG-TERM STRATEGY
Costa Rica’s electronics cluster was not created overnight, but developed gradually. After the country declared this sector a priority, small companies started to relocate to Costa Rica. Before Intel’s arrival, other multinationals, such as DSC Communications, Motorola, Conair, and Baxter Healthcare, were already operating in Costa Rica. The recommendation from these companies played a decisive role for Intel to invest in the country.
Despite the success in the development of the domestic electronics cluster in Costa Rica, important challenges remain regarding the low capabilities of domestic firms and the limited spillover effect from foreign investments. However, Costa Rica’s long-term strategy could be a good example for countries like Georgia. Obviously, Georgia cannot repeat Costa Rica’s path. There are important differences between the two countries which render any comparison limited at best. However, this does not prevent Georgia from adopting a long-term strategy to increase the level of STEM subjects in the country. Besides, it is not necessary to prioritize the electronics cluster or start attracting Intel itself. Nonetheless, a priority sector would help with better coordination, mobilization of resources, and ensure long-term cooperation between the State and the private sector.
GEORGIA’S NEW INVESTMENT STRATEGY
In December 2019, the agency Enterprise Georgia presented an updated strategy to attract investments to Georgia. According to the strategy, the priority sectors include hospitality and real estate, business process outsourcing (BPO), apparel and footwear, electronic equipment components, automotive and aerospace components. The Agency aims to study 7000 companies, identify 700 from those, and establish direct communication with them, including by visiting these companies. They hope to attract up to 10 big and 20 medium size enterprises within the next three years. In addition, the Agency plans to establish a guarantee mechanism to help investors with employee training costs. Selecting priority sectors and mobilizing resources to that end was a necessary step, which may indeed result in some of the enterprises relocating to Georgia.
The compensation mechanism to train employees would be an additional benefit for investors. At the same time, these measures are for the short-term, and are not sufficient to develop the domestic cluster. It is true that the compensation mechanism to train the employees is of great benefit for the investor; however, it should be kept in mind that the investors primarily look at whether employees are trainable and what the overall level of education is in the country. In light of the above, in addition to short-term policies aimed at attracting a diverse set of enterprises, it is necessary to have a long-term strategy, the key elements of which include a priority sector, education policy, and FDI. In that respect, the State policy must be more active and synergetic.
One of the main challenges for developing the domestic sophisticated cluster is the adoption of new technologies and the diffusion of the productive knowledge. Technology is not only machines (equipment and devices) or codes (recipes, formulas, algorithms, etc.), but primarily know-how which is hard to acquire. Advanced manufacturing in Georgia could seem like a long shot, but the seeds towards that end must be planted now, as the fusion of the priority sector, education policy and FDI is realistic.
Other benefits of the proposed strategy are that it may overcome the problem of continuity in public policy making. In particular, foreign direct investment and education are viewed as the most important drivers of growth in Georgia, which means that this strategy has a better chance to withstand the changes within the government.
BY BAQAR PALAVANDISHVILI
First published on Geocase, reproduced here with permission.