INSTITUTIONAL GROUPS IN GEORGIA AND TRANSITION/POST-TRANSITION ECONOMIES

Tsotne  Zhghenti

Journal number 3 ∘ Tsotne Zhghenti ∘
INSTITUTIONAL GROUPS IN GEORGIA AND TRANSITION/POST-TRANSITION ECONOMIES

Summary

The institutional development is one of the actual topic in economic science. New trends and direction of institutional development is depended on its structure and framework. Transformation of institutions is important topic for every economy, especially for developing countries. First research goal is to measure a size for each institutional type transition/post-transition countries and compare to the Georgian economy. Considering both dimension of institutional structure (formal vs informal, internal vs external) we get four types of institutions. Using Global Competitiveness indexes it can be calculated size of each institutional types. Second aim of research is to determine interactions between institutions. We can use statistical methods to evaluate interactions between different types of institutions.

Keywords: Formal Institutions, Informal Institutions, Internal Institutions, External Institutions, Transition Economy, Georgian Institutional Development.

Introduction

Economic development is mostly determined by institutional foundations. Institutions mostly lead economic and other social activities. They are different by their importance, structure and nature. When we take analyze about institutions, it’s required their arrangement into different groups characterized by specific features.

Institutions are not permanent and institutional space is always transforming. Some of institutions are replaced by new institutions, some of them are changing their structure and keep living. Construction and destruction – economic and non-economic – do not occur vacuum, but are the result of people’s perception stemming from historically derived opportunities and values [North, 1981:14]. Changes in the institutional structure have its costs. Volume of costs is one of the important factor to promote transforming processes. The institutional framework will affect both transformation and transaction costs, first by influencing the technology employed and second because there are direct connections between institutions and transaction costs [North,1991:13]. In Western societies, over time, complex institutional (legal and corporate) structures have been devised to constrain the participants, to reduce the uncertainty of social interaction, in general to prevent the transactions from being too costly [Acemoglu..., 2005:957]. Exogenous institutional changes can occur when the rules of the game change, but studying endogenous change is inconsistent with the view of institutions as equilibria [Bardhan, 2005:512].

Besides that institutions are characterized with too much features, one of them has a major purpose in the economic science. This distinction between institutions is given from Nobel Prize laureate American economist Douglas Cecil North - formal vs informal institutions. What are characteristics of formal or informal norms? Informal institutions defined by codes of conduct, norms of behavior and conventions. They come from socially transmitted information and are a part of heritage that we call a culture. Unlike informal one, formal institutions are written; they include political (and judicial) rules, from constitutions, to statue and common laws, to specific bylaws, and finally to individual contracts defines constraints, from general rules to particular specifications [North,1991:14-17].

Other institutional distinction can be defined by not it is written or not, but about who is responsible for sanctioning when a rule has been reneged upon. Firstly, similar distinction was made by Ludwig Lachman in 1973 and it was answered question how institutions came about [Lachman, 1973:14]. German economist Stefan Voigt suggests two dimensional institutional structure (formal and informal, external and internal) where external and internal institutions are described as, if the state sanctions rule-breaking, the enforcement is external to society, if rule-breaking is sanctioned by members of society, institution is internal [Voigt, 2016:3]. Within the internal institutions category, more wide taxonomy focus on who does the sanctioning, unorganized actors or organizations [Voigt, 2009:4]. People perpetuate internal institutions because someone discovered them and found them useful, making interaction with others easier [Kasper, Streit, 1999:100-109]. State role in institutions is partially different determined by distinction – “Property rights institutions,” which protect citizens against expropriation by the government and powerful elites, and “contracting institutions,” which enable private contracts between citizens [Greif, 2006:7].

So, using institutional structure model mentioned above, we have two dimension of institutional structure:

1. Formal vs Informal;

2. Internal vs External.

If we combine them, we can get four groups (types) of institutions each with two institutional dimension. These groups are: Formal internal (FI), Formal external (FE), Informal internal (II) and Informal external (IE). Sum of these institutions should give us total institutional space. By theoretical foundations of both distinction each institutional groups should be shortly described as:

Formal external institutions - laws and official regulations which is controlled by state.
Formal internal institutions- formal rules controlled by society and business.
Informal external institutions – effectiveness and public trust in state policies.
Informal Internal institutions – unwritten norms in the society, such as ethics.

Body of the paper

To measure institutional types indicated above is required several steps: find suitable indicators, sort and group them by their differences and last step to calculate new scores. Measuring of institutions is one of the main problem in the institutional economics, because most of variables are not quantitate. Most suitable for this 2 dimension model should be “Global Competiveness Index” which is provided by World Economic Forum on its “Global Competitiveness Report”. Global Competiveness Index include 12 pillar about competitiveness landscape of countries. It includes data about 140 economies and providing insight into the drivers of their productivity and prosperity.

From the 12 pillar for our research is interesting only 1st pillar of index which name is “Institutions”. Pillar “Institutions” include 7 sub-indexes and 21 indicators (property rights, intellectual property protection, Wastefulness of government spending, Burden of government regulation, Efficiency of legal framework in settling disputes, Efficiency of legal framework in challenging regulations, Transparency of government policymaking, Diversion of public funds, Public trust in politicians, Irregular payments and bribes, Judicial independence, Favoritism in decisions of government officials, Business costs of terrorism, Business costs of crime and violence, Organized crime, Reliability of police services, Strength of auditing and reporting standards, Efficacy of corporate boards, Protection of minority shareholders’ interests, Strength of investor protection, Ethical behavior of firms). Source of institutional indicators is executive opinion survey of World Economic Forum.

To sort and group indexes we must make attention to both dimension separately: Does index characterize formal institutions or informal ones? Does state sanctions institutions determined by this index (external institutions) or sanctions by society (internal institutions)? Pillar “Institutions” is grouped by A - Public Institutions and B - Private Institutions. Public institutions we can present as external type and private institutions as internal type.

Second dimension (formal vs informal) should be determine by specified characteristics of sub-indexes. To determine formal and informal institutions is used only sub-indexes, because coefficients in the one sub-index belongs to the same type of institutions. Scores for each type of institutions should be calculate as a simple average of sub-indexes, because they have equal weights in the total GCI index calculation.

Let’s, group the GCI sub-indexes into the two dimensional matrix. Every type includes at least one sub-index. Coefficients in every group is listed above.

Formal external institutions:

• Property Rights (incl. coefficients: property rights, intellectual property protection);

• Public Sector Performance (Wastefulness of government spending, Burden of government regulation, Efficiency of legal framework in settling disputes, Efficiency of legal framework in challenging regulations, Transparency of government policymaking).

Informal external institutions:

• Ethics and Corruption (Diversion of public funds, Public trust in politicians, Irregular payments and bribes);

• Undue Influence (Judicial independence, Favoritism in decisions of government officials);

• Security (Business costs of terrorism, Business costs of crime and violence, Organized crime, Reliability of police services).

Formal internal institutions:

• Accountability (Strength of auditing and reporting standards, Efficacy of corporate boards, Protection of minority shareholders’ interests, Strength of investor protection).

Informal internal institutions:

• Corporate Ethics (Ethical behavior of firms).

Next step is to calculate score for each institutional group with sub-indexes given above. We took a correlation analyze for transition economies for the 2016-2017 years (Appendix, Table III). List of transition economies is given from World Bank (2002). These transition/post-transition economies are: Albania, Armenia, Azerbaijan, Bosnia and Herzegovina, Bulgaria, Cambodia, china, Croatia, Czech Republic, Georgia, Hungary, Kazakhstan, Kyrgyz Republic, Lao PDR, Latvia, Lithuania, Macedonia, Moldova, Montenegro, Poland, Romania, Russian federation, Serbia, Slovak republic, Slovenia, Tajikistan, Ukraine, Vietnam. Some of these countries have already completed transition to market economy (especially countries of Central and Eastern Europe), but their institutional transformation is still active and interesting process, so they are include in the equation.

On the “2016-2017 Global Competitiveness Report” score for Georgia is 4.2 (1-7) and ranks 66th place in 140 economies. Score for 1th pillar institutions is 4.4 (A. Public Institutions - 4.4, B. Private Institutions - 4.3). For comparison, on the “2007-2008 Global Competitiveness Report” score of 1st pillar was only 3.6.

Using the method given above, we can calculate scores of institutional types for selected economies. Also, for clarification we proportionally modify scores to 0-100 range instead of 1-7. Rescaled scores of institutional groups for all transition/post-transition countries is listed in the table I. It should be said that data are less comparable country by country (if one country has better scores than other, it doesn’t mean that it has stronger institutions; but its institutional framework is more compatible of its socio-economic development level), because source of data is opinion survey and public opinion about purposes of institutions may be varied. But, from these indicators it can be understood how countries institutional development compare to its economic and social development. Most high coefficients for every institutional group are for Estonia, which have took major institutional reforms from 90s and is one of the innovative country in the world.

Table I shows average scores of coefficients for selected country groups (2016 year). From the data we see that formal internal institutions are most powerful in transition/post transition economies (55.2). Average coefficient is higher in EU post-transition countries (60.4). Formal external institutions have lower scores as in EU average as all transition countries. Private abbreviation and rules are more effective than government rules in most of countries in our research. Informal internal has lowest average coefficients and its logic because development of informal rules in the society dragged out in time. So, it is not huge difference between post-transition/transition countries about norms of corporate ethics.

Georgia has one of the best scores in GCI index about institutional level between transition/post-transition countries. So calculated coefficients by institutional types are too high for Georgia. From 4 institutional groups Georgia has a better score in 4 groups than all transition countries average score and in 3 groups than average EU post-transition countries average score. Institutional gap between Georgia and development world is mostly eliminated but there is a still big gap in incomes and GDP per capita is significantly lower than EU average GDP per capita.

Table I: Institutional groups and country groups (0-100), 2016 year

Institutional group	All transition/post-transition countries–		EU post-transition countries		Georgia
Institutional group	2007 year	2016 year	2007 year	2016 year	2007 year	2016 year
FE	38,7	44,1	48,2	45,3	40,3	53,6
FI	47,8	55,2	58,9	60,4	48,0	59,1
IE	37,8	47,1	46,1	49,4	46,0	58,7
II	42,1	46,4	51,5	46,9	43,5	48,0

To compare 2007 year (start period of GCI index data publishing) situation were different for some countries (Table I). In 2007, calculated Georgian coefficients for every institutional type was lower than same scores for EU post-transition countries. So major improvement in institutional level is clear.

Formal internal institutions is determined sub-index “Accountability”, which include four coefficients. Their scores for Georgia are: “Strength of auditing and reporting standards” - 4.6 from 7.0, “Efficacy of corporate boards” – 4.6 from 7.0, “Protection of minority shareholders’ interests” – 3.8 from 7.0 and “Strength of investor protection” - 6.1 from 10.0. From the formal external institutions group, one of the highest coefficient is “Burden of government regulation” – 4.7 from 7.0, which is a part of public sector performance sub-index. Important role for functioning Informal external institutions are security, which makes confidence for foreign investors (“Business cost of terrorism” (6.2 from 7.0) and “Organized crime” (6.2 from 7.0)). Besides the fact that Georgia is located in a region full of tension and military actions (also country have two occupied regions: Abkhazia and south Ossetia) it ranks 14th in the world by low costs of terrorism. We can said that high quality of informal external institutions is mostly caused by stable country policy and development course, and not from public opinion about the policy makers. Public trust in politicians has a lowest score with all the institutional indicators of GCI index, 2.8 from 7.0. Scores of indexes are growing over years in Georgia, but there is a decrease on the last year (2016) about of informal external and informal internal institutions. In general, it can be said that Georgian institutional development continues upward trend.

Table II: Institutional groups in Georgia (0-100), 2016 year

Year	FE	FI	IE	II
2007	38,4	48,0	46,0	43,5
2008	42,9	50,9	51,3	47,3
2009	42,0	51,3	49,1	46,8
2010	41,6	52,1	51,2	45,8
2011	41,2	54,1	53,8	49,2
2012	39,6	55,4	55,0	51,5
2013	41,2	54,7	54,5	50,1
2014	45,4	55,4	58,6	53,0
2015	50,5	57,0	61,2	52,1
2016	53,6	59,1	58,7	48,0

Second aim of the research is to measure interactions between different types of institutions. We make correlation analyze with scores of four institutional type for transition/ post-transition countries between 2007-2016 years. We include only countries which data are available for all years. So we must exclude Lao PDR, Bosnia, Moldova and Tajikistan from calculation. Analyze showed high correlations between scores of institutional types.

Figure show average correlation coefficients for selected countries. Most high correlation coefficient is between formal external and formal internal institutions (0.69). Effectiveness of general rules causes synergy effect on the private and state side. Lower correlation scores are between informal internal institutions and other institutions. Also from the theory we know that unwritten norms of society is not correlated to recent changes immediately.

As total institutions pillar index is increasing year by year for Georgia, all correlation coefficients are positive. Most high correlation coefficients is between formal external and informal external institutions (0.93). Its means that formal improvement in property rights and government efficiency causes same effect in informal side of state (for example: decrease corruption, which was one of the most important success of 2000s economic policy in Georgia).

Between correlation coefficients lowest score is between formal internal and informal internal institutions in Georgia (same for average coefficients for all selected countries). Changes in formal state laws can’t be immediately correspond from informal side of society. Time lags play an important role to change Informal institutions, especially internal informal institutions. Georgia was a soviet country for 70 years and some of alive informal mechanisms were formed in the different social-economic reality. Informal norms of the planned economy is not suitable in the market economy, but their transformation is a long-run process. Incompatibility causes barriers for effective functioning of the formal norms. In this our practical two-dimension model informal internal institutions are determined by the coefficient “Ethical behavior of firms”. Source of the coefficient is a question in the Executive Opinion Survey of World Economic Forum – “In your country, how do you rate the corporate ethics of companies (ethical behaviors in interactions with public officials, politicians, and other firms)? Indicator don’t show important progress over time, because corporate ethics is formed by society where it is not yet fully defined rules of positioning of the companies in the market economy.

Figure: Correlation coefficients between institutional groups, 2007-2016 years (0-1)

Conclusion

Institutional analyze shows important correlation between developments of different institutional groups. Formal internal institutions are most powerful in transition/post-transition countries. These institutions are more successful in post-transition EU economies where arbitration of private sector is too effective. Same in other transition countries formal internal institutions are powerful in Georgia, also formal external institutions such most legislation have positive effect on the development of state efficiency.

Quality of informal internal institutions are too low as in Georgia as in other countries, because informal norms of society weakly corresponds to formal institutional environment. Public opinion about business-making is formed only after desolation of Soviet Union and its still in transition.

Dynamics of formal internal institutions development is same of informal external institutions in Georgia. So efficient policy of government and stable business environment causes formation of strong corporate ethics. But it is a long-run process and has not instant sharp impact. In the overall, quality of the institutional space are improving with close connections and synergy effects of different institutions.

ACKNOLEDGMENTS

Research funded by Shota Rustaveli National Science Foundation (Grant number: PhD2016_135).

APPENDIX

Table III: Institutional groups in transition/post-transition countries (0-100), 2016 year

Country	FE	FI	IE	II
Albania	42,2	60,3	44,7	55,0
Armenia	47,9	57,3	49,5	40,8
Azerbaijan	52,2	57,0	54,2	53,7
Bosnia and Herzegovina	29,9	45,0	37,2	35,0
Bulgaria	39,8	60,0	38,3	43,8
Cambodia	37,8	46,7	39,9	47,1
China	54,9	53,0	56,7	51,4
Croatia	35,3	56,5	46,0	43,5
Czech Republic	52,1	65,6	51,2	46,9
Estonia	66,5	66,7	71,8	64,0
Georgia	53,6	59,1	58,7	48,0
Hungary	32,6	52,7	41,7	27,4
Kazakhstan	52,6	59,3	53,6	52,2
Kyrgyz Republic	38,7	49,6	37,4	39,8
Lao PDR	47,0	46,3	52,1	50,3
Latvia	46,7	56,9	50,4	49,1
Lithuania	48,0	63,2	53,9	54,6
Macedonia, FYR	47,4	60,9	47,8	50,4
Moldova	32,4	48,8	32,2	35,5
Montenegro	44,4	52,2	46,0	48,3
Poland	44,3	61,4	50,2	49,9
Romania	40,9	52,2	43,7	37,9
Russian Federation	39,2	53,1	43,2	48,6
Serbia	33,0	49,5	38,9	38,8
Slovak Republic	40,1	60,4	38,0	37,8
Slovenia	46,1	59,7	54,0	48,3
Tajikistan	55,7	56,4	57,5	57,5
Ukraine	33,0	44,6	30,4	39,6
Vietnam	44,1	45,9	48,1	43,9

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