Georgia's Economic Collapse
Moving on from central planning was painful
Note: I was just on vacation in Georgia, the former socialist soviet republic. This post is based on research I did for the trip. It reflects on centrally planned economies, market economies and how the transition between the two can cause economic collapse.
Things had been going well for Georgia, the former socialist Soviet republic of five million people. Couched between Russia, Armenia and Azerbaijan and the Black Sea, the country had been a major cultural hub and transport link in the Russian Empire and later the USSR since the early 1800s.
In the 1960s, 70s and 80s, living standards had climbed as the country industrialized, adding textiles, machine parts and other manufactures to its agrarian economy. For a time, the capital Tbilisi had the newest subway system in the USSR.
But then the Soviet Union fell apart and the economic gains evaporated. Between 1988 and 1994 Georgia’s GDP per capita collapsed from the peak of almost $15,000 to just $3,500, a decline of 76%:
Just how large was this collapse? One thing we can look at is how long it’s taken to recover. It's been 33 years since the peak prosperity of 1988 and Georgia still hasn’t quite recovered as of 2021, the last year in my dataset1. In the World Bank’s data, Georgia regained its peak income in 2019. Either way, it’s getting close.
Another thing we can do is multiply the duration of the crisis by the depth of the crisis, which results in an “area” of lost economic activity; in Georgia’s case, fifteen entire years of pre-collapse annual income:
These numbers help size the collapse but not much, not unless we compare with other episodes. Here’s the Great Depression of 1929, the worst crisis in US economic history:
As the graphs show, Georgia’s economic collapse after the Soviet Union fell apart was profoundly worse. Georgia lost 15 years of pre-collapse annual income versus two in the US Great Depression and the 76% peak-to-trough drop in Georgia was over twice the 33% drop in America.
Here’s Georgia’s collapse alongside every crisis2 from the 20th and 21st century where GDP per capita fell at least 30%. Total economic losses (the pink areas above) are on the x-axis, the peak-to-trough drops in income (the gray lines above) are on the y-axis and the size of the circles is proportional to the recovery time in years.
At the bottom right, you can see Liberia's bloody civil war (LBR), the worst crisis of the 20th century that has cost the country 25 years of pre-collapse annual income (so far). Just to the left is Iraq (IRQ), which had a war with Iran in 1980-1988 after the Iranian revolution. After that, there’s Georgia. Their collapse (in red) is in the top five of the last hundred plus years of data.
There’s certainly the question of how reliable economic statistics are in a command and control economy where misreporting was endemic and the fact that GDP doesn’t tell the whole story anyways (there’s also unemployment, debt accumulation, migration, etc). Still, why was Georgia’s collapse so large?
The Soviet Economy
The Soviet Union’s economy was centrally planned. Firms and workers didn’t spontaneously self-organize to produce goods and services for the free market. Economic agents didn’t observe market prices and find ingenious ways to add value and make profits by combining cheap inputs into more valuable outputs3.
For the most part, there were no (legal) markets. There were no (free floating) market prices. There weren't any private firms. Instead, the state allocated land, labor and production inputs to cooperatives and state owned enterprises, which were in turn organized around production targets. Moscow would send factories in Georgia iron ore from Ukraine, natural gas from Turkmenistan and expect a certain output quota of steel. The steel would then be transported to Russia to produce tanks and rockets, etc.
Economic activity and supply chains were organized around 5-year plans and measured in grain, oil, textiles, etc, not units of currency. Soviet rubles functioned more like coupons than modern money; they could only be used at state shops to buy a limited selection of foodstuffs and official goods at fixed prices.
Before the Collapse
In the early 1970s, the Soviet economy slowed into what historians call the era of stagnation. As the world globalized and the USSR became more complex, the quality of central planning deteriorated and micro and macroeconomic inefficiencies deepened.
Labor was systematically misallocated and unproductive. The economy systematically underproduced consumer goods (famously denim jeans) and over-produced other goods, leading to waste. Incentives for misreporting and meeting production quotas were backwards. Uncompetitive industries and factories were never shut down. There was excessive military spending and an over-reliance on hydrocarbons.
When oil prices fell and the USSR’s economy took a turn for the worse in the 1980s, Gorbachev tried to introduce market mechanisms to quell shortages and reverse the decline but it was too little, too late. Widespread discontent intensified and led to independence and nationalist movements across the USSR.
The Collapse
Georgia was the first non-Baltic country to declare independence in 1991, months before the Soviet Union unraveled.
At the time, the country didn’t have a modern tax collection system to fund government spending. It had never needed one before. If a factory used ₽1M in wheat and ₽0.3M in labor to make ₽2M in flour, its effective earnings were ₽0.7M. The government took all the flour though, so the factory was effectively taxed for 100% of its profit. Georgia didn’t need modern taxation if it just took all the producer surplus with output quotas.
With expensive subsidies and dismally low tax revenue from factory closures and privatizations, the budget deficit ballooned to over 20% of GDP. The government started financing expenditures with external borrowing and unbridled central bank money printing, which led to a hyperinflation that added six zeros to all prices and lasted four years, crippling the economy. It was a monstrously inefficient inflationary tax on income and savings, much worse than the distortions from central planning.
Aside from monetary chaos, there were other compounding problems. For one, there was a civil war in the South Ossetia and Abkhazia regions in 1992-94 that introduced major uncertainty and distracted the government from the economy.
Also, after the USSR collapsed, there were fewer markets and buyers for Georgia’s industrial output, since the country’s main trade partners had also just left the Soviet Union and collapsed. Plus, the trade relations that outlived the USSR were deeply problematic.
Georgia was locked into barter based trade agreements with Turkmenistan, Russia, Azerbaijan, Kazakhstan, Armenia, etc, which forced it to send a certain quantity of goods (usually agricultural) in exchange for other goods, notably gas. If Georgia failed to meet barter quotas, which happened often amid hyperinflation and privatizations and collapse, it would rack up huge debts denominated in foreign currency and would have its gas turned off by Turkmenistan.
The transition out of central planning was ruinous. Amid rampant inflation, there were no reliable market prices to reflect the relative scarcity of intermediate and final goods, so it often wasn’t even clear which industries had positive value added and which destroyed economic value when their inputs and outputs were properly accounted for.
The idea that “the market” would just sort everything out on its own and start allocating land, labor, knowhow and capital efficiently was deluded. There were no private firms, no markets, no prices, no functional trade relations and supply chains. Market institutions were new and fragile. The ecosystem and infrastructure for the economy to spontaneously and productively self-organize with market mechanisms didn’t exist.
After three disastrous years, a new currency was introduced in 1994-95 in the context of an IMF-sponsored stabilization program. Inflation eventually slowed and the economy stabilized at 25% of its pre-collapse GDP per capita.
Post Collapse
Since the economy bottomed almost thirty years ago, living standards have climbed an impressive 5% per annum (doubling every 14 years). Manufacturing and heavy industry never restarted, but the country developed a large and vibrant tourism sector, an agriculture sector that competes internationally in wine, nuts and fruit and IT exports, among other activities.
Exactly how and why Georgia recovered is the subject of another post, but the fact is it did recover, even if it took three decades. The fact is it’s a safe, organized, lovely country that hosts ten million tourists a year and exports wine to Europe and America.
Their turnaround offers some hope to Lebanon, Venezuela and other places that have had major economic catastrophes in the last few decades. If Georgia clawed back a -76% contraction, one hopes that other countries with similar collapses might one day do the same.
For a detailed account and analysis of Georgia’s economic collapse, see George Fane and John Nash (1998). “Georgia's economic collapse, 1991-1994: the role of state orders and inflation.” Journal of Economic Policy Reform.
For more reading on growth collapses, see Ricardo Hausmann, Francisco Rodríguez, and Rodrigo Wagner (2006). “Growth Collapses.” CID Working Paper No 136.
If you extend the GDP per capita data from the Maddison project that ends in 2018 with more recent World Bank data through 2021 (by applying the % changes from the WB data to the Maddison data), Georgia still hasn’t recovered its 1988 income.
I am excluding Qatar 1973 and Kuwait 1971 from the chart, as these collapses are a little odd. In the 70s, Qatar and Kuwait had tiny populations and giant oil industries. As their populations grew rapidly and their oil production declined or only grew modestly, GDP per capita fell precipitously (from a very high level). These are not collapses in the sense we are interested in, so I excluded them.
Not all socialist systems in the Eastern Bloc had this degree of central planning. Notably, Yugoslavia controlled land, labor and production inputs the same way the Soviet Union did, but Belgrade often allowed worker-owned cooperatives to sell consumer products into markets at free-floating prices and earn profits.