Redistribution versus growth: Georgia at the crossroads

Redistribution versus growth: Georgia at the crossroads

The FINANCIAL -- One day in my village, I saw our neighbors carrying TV sets, refrigerators, parabolic antennas, and washing machines out of their house. Soon I found out that they were hiding all that stuff from the state audit agency that was about to check eligibility for social benefits.

Later, when I spoke with some other villagers, it turned out that some families had even sold their cows to become eligible for social assistance. “Cows are costly and do not give income on a permanent basis”, they said. Others avoided work contracts because official employment would make them lose their low but reliable welfare payments.

Readers not familiar with the Georgian welfare system may wonder why it is necessary to hide valuable objects if one wants to receive social benefits. When somebody applies for social assistance in Georgia, the government will send inspectors who assess the overall economic situation of the household. The availability of consumer electronics, household devices, and other expensive items make it less likely that support is granted. You better hide your flatscreen TV when the auditors come!

It may still be surprising that the humble amounts paid by the Georgian welfare system really give incentives to resort to such tricks. If assistance is granted, the oldest member of a family receives 60 lari per month, and each further member receives 48 lari. A standard family with two children thus receives 204 lari. Given the low income level, this is serious money for many Georgian families, and it can (illegally) be received in addition to other income, as long as that other income is not received through formal employment.

Incentive distortions, however, are not the only problem associated with a social welfare system.


IS IT THE RIGHT TIME TO REDISTRIBUTE?

In the graph, which is based on data provided by the ministry of finance, the bars show the evolution of the government of Georgia’s budget composition from 2010 to 2014 (values for 2014 are estimated). One can see that compared to the previous government led by the United National Movement (UNM), running the country until 2012, the new government significantly increased the expenditure on social benefits. The line with triangles shows the percentage change of the total budget over those years, and the line with circles shows how the growth of the welfare budget contributed to the change of the total budget (in percentage points). 

The state pension fund, the pecuniary social assistance (subsistence allowance), the universal health care program, and the new minimal tax refund policy are among the measures that were introduced or upgraded by the new Georgian government, aiming at improving the economic situation of low income and poor families. These redistributive policies are sharply criticized by the opposition.

According to UNM politicians, Georgia’s stage of development does not allow for a substantial welfare state. They claim that redistribution only makes sense if there is something to be redistributed, and if the gross domestic product (GDP) is as low as in Georgia, the focus should be on stimulating growth. Moreover, a low GDP implies a small and fragile tax base, and – as it happened in many countries around the world – in such a situation social welfare can become “budgetary dynamite”, as welfare payments usually go up exactly when the tax base shrinks (i.e. in a recession).


THE ASIAN APPROACH

The UNM arguments are more or less consistent with the Nobel Prize-winning theories of the Belorussian economist Simon Kuznets (1901-1985) on the relationship between inequality and growth. According to Kuznets, when a country starts its economic development, economic growth is almost inevitably causing high inequality. The reason is that in very poor societies almost everybody is poor, and hence there is not much inequality. When economic development picks up, there are opportunities to become rich, but these opportunities are in the beginning only available to a few people in the society.

However, when a country develops further, at some point Kuznets expects inequality to decrease again. The reason is that comprehensive economic development yields opportunities for almost everybody in the society, giving everybody the chance to improve one’s economic situation. 

Many Asian countries, like South Korea, Hong Kong, Taiwan, and Singapore, seem to support this theory. To this day, these countries lag behind other developing regions, like Latin America and the Caribbean, in their redistributive efforts. The Asian Development Bank’s Outlook 2014 highlights that the fastest developing Asian countries tended to use almost all of their fiscal resources for public investments rather than for income redistribution. According to the report, and in line with Kuznets’ predictions, the rapid economic growth over the past years reduced poverty in Asia. However, income gaps are not yet shrinking in most of these countries, suggesting that the tipping point of Kuznet’s theory, where inequality starts to decrease, has not been reached yet. But very recently, several Asian governments seem to start changing their priorities.  For instance, Thailand and India started to subsidize rice farmers, Korea upgraded its public pension system, and China introduced a concept termed Harmonious Society.

Should Georgia head the Asian way and give priority to growth over redistribution?

Every economic policy, if it is to be accepted by the population, must be compatible with the underlying values of a society. Perhaps, Georgian values too “European” to adopt Asian recipes. Moreover, the choice that has to be made may not be as clear-cut as it was presented so far. There is at least one example of a country that grew despite considerable welfare spending (Poland). And there are concepts that seem to resolve the contradiction between growth and redistribution. All of this will be discussed in next week’s continuation of this article.