journal N2 2025 

DOI: 10.52340/ekonomisti.2025.02.02

Abstract: This paper aims to examine impact of the EU-Georgia Association Agreement (AA), including its integral part on Deep and Comprehensive Free Trade Area (DCFTA), on dynamics of the EU Foreign Direct Investments (FDIs) in Georgia. The EU-Georgia AA/DCFTA has political as well as economic dimensions and aims at political association and gradual economic integration of Georgia with the EU. To achieve higher level of economic integration with the EU, Georgia should attract more Foreign Direct Investments from the EU countries through effective implementation of the AA and therefore, increase capital integration dimension, which is essential prerequisite for gradual economic integration with the EU. Study period is divided into two parts: first, 2005-2014 (10 years before AA/DCFTA) and second, 2015-2024 (10 years after AA/DCFTA). Analysis of respective indicators of capital integration based on the data for the period of 2005-2024 proves that after 10 years (2015-2024) of the Association Agreement/DCFTA implementation the level of Georgia’s capital integration with the EU stays almost unchanged compared to the same period before Association Agreement/DCFTA (2005-2014). Georgia’s considerable progress achieved in the implementation of the respective trade related and sectoral provisions of the AA/DCFTA is crucial but not sufficient precondition to increase attractiveness of the country for the EU FDIs and therefore, to enhance level of capital integration with the EU. Consequently, as conducted analysis reveals, the impact of the AA/DCFTA on Georgia's capital integration with the EU is still insignificant.

Keywords: EU; Association Agreement; DCFTA; Foreign Direct Investments; Georgia. 

1. Introduction

 The EU-Georgia Association Agreement (AA) entered into force on July 1, 2016. Nevertheless, several parts of the agreement, including title IV - on Trade and Trade-related Matters, which envision the creation of the Deep and Comprehensive Free Trade Area (DCFTA), have been provisionally applied since September 1, 2014. According to the Association Agreement a formation of the DCFTA is a key mechanism to support Georgia’s gradual economic integration with the EU (EU-Georgia Association Agreement, 2014). Consequently, the major goals of the EU-Georgia DCFTA beside of intensification of trade relations, especially enhancing Georgia’s export to the EU also includes an increase of Foreign Direct Investments (FDIs) from the EU countries, with final goal to support economic growth in Georgia and its gradual economic integration with the EU.

The EU-Georgia AA/DCFTA has many dimensions, political, economic, legal, social, etc., however, this article focuses on the economic dimension of the agreement. The economic dimension of the AA/DCFTA, envisaged by the respective provisions of the agreement, could be divided into three parts: first, the provisions aimed at trade liberalization between parties and therefore, supporting trade integration, second, provisions on capital integration and finally, provisions enhancing sectoral integration. Moreover, the AA/DCFTA with Georgia envisage legal approximation and regulatory convergence in many areas, directly or indirectly related to economic integration, which should increase compatibility of Georgia’s economy with the economy of the EU. These features of economic dimension of the AA/DCFTA are essential for sectoral integration, which, among other things, should also support Foreign Direct Investment (FDI) inflows to Georgia and therefore, enhance Georgia’s capital integration with the EU.

It is clear, that trade and capital integration as well as sectoral integration are the basis for the gradual economic integration of Georgia with the EU, however, this article focuses on capital integration dimension. It is also worth mentioning that Georgia according to the decision of the European Council (2023, p. 5), is candidate for the EU membership, which should increase Georgia’s investment attractiveness and therefore, encourage the EU FDIs inflow to Georgia.

The purpose of this article is to examine the impact of the AA/DCFTA on Georgia’s capital integration with the EU achieved after 10 years of implementation of the agreement. Consequently, to observe the dynamics of capital integration of Georgia with the EU, study period is divided into two parts: 2005-2014 (10 years before Association Agreement/DCFTA) and 2015-2024 (10 years after AA/DCFTA). A division of study period is essential to identify the AA/DCFTAs impact on the EU FDIs in Georgia and therefore, Georgia’s capital integration with the EU. 

2. Free Trade Agreements and Capital Integration: a short review of key concepts

The impact of the Free Trade Agreements (FTAs) on trade performance and Foreign Direct Investments has been widely discussed among scholars since the 1950s.Balassa (1961) differentiates 5 stages of economic integration, where initial 2 stages such as Free Trade Area (FTA) and Customs Union (CU) are forms of trade integration, while other forms of economic integration also envisage additional dimensions of integration, such as capital, institutional, policy integration, etc. On the economic effects of integration, scholars distinguish the static and dynamic effects of integration. According to Viner (1950) “static” effects of economic integration are the immediate or short-run welfare effects, such as trade creation or trade diversion. Balassa (1961) discusses dynamic effects of economic integration and argues that long-term effects of economic integration include economies of scale, technological change, productivity growth, as well as the impact of integration on competition, risk and uncertainty, investment activity, etc. About investment activities, including foreign investments Balassa concludes that because of integration “…both the volume of investment and the allocation of investment funds can be affected” (ibid., p. 180).Consequently, Economic Integrations Agreements (EIA) are not only about trade but also on other issues directly or indirectly related to trade such as capital movement, competition policy, labour market, environment, etc.

Most of the Economic Integration Agreements (EIA) such as FTAs and CUs signed before 1990s were described as "shallow" trade agreements focused on issues related to tariffs and other trade barriers occurring at the border. Since the 1990s, the composition of the FTAs has changed and most of the FTAs are referred to as “Deep” Trade Agreements (DTAs). In contrast to “shallow” FTAs “deep” FTAs include not only trade issues, but also cover trade related areas. According to the World Bank (WB) publication on deep trade agreements, these agreements “... are reciprocal agreements between countries that cover not just trade but additional policy areas, such as international flows of investment and labor, and the protection of intellectual property rights and the environment, amongst others” (Mattoo et al. 2020, p. 3). Moreover, while analyzing the USA and the EU preferential trade agreements Horn et al. (2009) divided areas covered with these agreements into WTO+ and WTO-X areas, where “…WTO+ corresponds to those provisions of PTAs which come under the current mandate of the WTO…. By contrast, WTO-X category comprises those PTA provisions that deal with issues lying outside the current WTO mandate” (p. 4).

Research results on the impact of the FTAs and Deep Trade Agreements (DTAs) on the Foreign Direct Investments are controversial. According to Bergstrand and Egger (2007), as well as Mistura and Roulet (2019), FTAs reduce FDIs between country-pairs and FDI flows. In contrast, according to Buthe and Milner (2014), FTAs increased the FDIs. According to this study, Preferential Trade Agreements (PTAs) which are ratified as well as PTAs with investment clauses and dispute settlement mechanisms attract more FDIs. About the impact of the Deep Trade Agreements on FDI as Grounder et al. (2019) research concludes depth of provisions in DTAs did not significantly affect pairs of countries’ FDI. However, according to other research (Kox and Rojas-Romagosa, 2019), the deepest trade agreements, that according to data on the Design of Trade Agreements (DESTA) have an index of seven, positively affect FDIs. Moreover, according to Laget, et al. (2021) “In general, WTO-extra disciplines matter more for FDI than WTO-plus” (p. 22).

It is worth mentioning that the EU DCFTA with Georgia belong to more advanced forms of trade agreements. The European Commission describes DCFTA as “a unique type of trade agreement” (European Commission, 2017, p. 14). The DCFTA with Georgia goes beyond trade-related “border issues” and includes “behind the border” areas. Moreover, the DCFTA includes so-called “Singapore issues” (trade and investment, trade and competition policy, transparency in government procurement, and trade facilitation), which makes DCFTA as a proper instrument to advance the EU’s trade policy priorities on a bilateral level. As Woolcock (2014) pointed out “the EU has generally succeeded in including the Singapore issues in the PTAs it negotiates with middle-income and developed economies” (p.727). Consequently, many recent Free Trade Agreements of the EU, including the EU-Georgia DCFTA includes WTO+ as well as WTO-X provisions. In addition, the DCFTA part of the EU-Georgia AA envisages the regulatory convergence and legal approximation in many areas and therefore, according to data on the Design of Trade Agreements (DESTA), the "depth index" of the EU DCFTA with Georgia is 7, the highest possible index. The DESTA measures the depth of trade agreements taking into consideration the areas covered by the Agreements (Dür et al, 2014). Consequently, the EU-Georgia DCFTA includes all essential features of a “Deep Trade Agreement” and therefore, according to above-mentioned studies on impact of the DTAs on FDIs, should enhance capital integration with the EU.

About the impact of the DCFTA on FDIs in Georgia, according to study conducted by Ecorys/Case (2012) before signing the agreement, DCFTA envisioned reforms will increase investment attractiveness, especially in the long run. Moreover, as Kawecka-Wyrzykowska (2015) pointed out, legally binding nature of the Association Agreement “…will increase the attractiveness of Georgia as an economic partner for foreign investors” (p. 88). In addition, Adarov and Havlic (2016) discusses key determinants of the Foreign Direct Investments such as macroeconomic environment, market size, income levels, etc. and argue that “while the DCFTA countries have been lacking many of these elements, the AA/DCFTA will help bridge many important gaps in attractiveness to foreign investors (p. 35). However, along with optimistic studies on the impact of AA/DCFTA on the FDI in Georgia, there are also mostly skeptical studies focusing on the increasing costs for both private and public sectors to comply with relevant EU norms and standards in many areas (Messerlin, et al, 2011; Dreyer, 2012).

A brief review of the relevant literature on the FTAs and Deep Trade Agreements (DTAs) effects on the Foreign Direct Investments as well as reviewing key features of the EU AA/DCFTA with Georgia indicates that the agreement could have a positive impact on increase of FDIs in the country. Therefore, effective implementation of the AA/DCFTA is seen as an essential condition for gradual economic integration of the country with the EU.

3. Dynamics of the EU FDIs in Georgia during 2005-2024

 The EU-Georgia AA/DCFTA is considered as the most effective mechanism to increase investment attractiveness of the country and therefore, to support inflow of Foreign Direct Investments from the EU Countries as well as from the non-member states. Accordingly, increased volume of the EU FDIs along with growth of Georgia’s export to the EU are viewed as the most important economic results of the agreement.

As mentioned before, the EU-Georgia AA/DCFTA envisages regulatory convergence and legal approximation (including dynamic approximation) in many trade and trade related areas such as intellectual property rights, sanitary and phytosanitary measures, trade in services and electronic commerce, public procurement, technical barriers to trade, standardization, accreditation and conformity assessment, competition policy, etc. Moreover, the EU-Georgia DCFTA includes provisions on capital movement and dispute settlement. It should be noted that according to recent reports by the European Commission on implementation of the EU-Georgia Association Agreement/DCFTA as well as reports on implementation of the EU’s Free Trade Agreements, Georgia has achieved significant progress in legal approximation and regulatory convergence in areas related to trade and sectoral integration with the EU (European Commission, 2021a; 2021b; 2022a, 2022b, 2023). Consequently, the effective implementation of the EU-Georgia AA/DCFTA, and advancements in sectoral integration, should be reflected in an improvement in the country's investment attractiveness and, therefore, in an increase of Georgia’s capital integration with the EU.

In general, various indicators are used to analyze capital integration between parties and within integration groups. However, the most applied indicators of capital integration are the average annual growth rate of FDI, as well as the share of FDIs from member countries in total investment (Asian Development Bank, 2021).Therefore, to evaluate Georgia’s capital integration with the EU above mentioned two indicators as well as the EUs average share in total FDIs are analyzed for the period of 2005-2024. It is worth mentioning that these indicators do not capture all features of capital integration, however, annual average growth rates and share as well as average share in total FDIs clearly indicate a major trend in capital integration between parties.

According to the data of the National Statistics Office of Georgia (Geostat) in 2005, the EU FDIs in Georgia amounted to 112.2 Mil. USD. Since 2005 until 2014 the EU FDIs to Georgia has an increasing trend and in 2014 the EU FDIs reached 727.1 Mil. USD. Moreover, in 2014 the EU FDIs share in total FDIs in Georgia was 39.5 compared to 24.7 in 2005. During 2005-2014 the average annual growth rate of the EU’s FDIs was 49%. It is worth noting that in 2007 the EU Foreign Direct Investments in Georgia reached an unprecedented volume of 906 Mil. USD, which amounted to 51.3% of total FDIs in Georgia and is the highest volume of the EU FDIs in Georgia in the history of the EU-Georgia economic relations. This data clearly illustrates that in 2005-2014 Georgia’s capital integration with the EU had increasing trend in terms of absolute as well as average annual growth rates.  

Figure 1. The EU FDIs (Mil. USD), the EU FDIs growth rate (%) and share of the EU FDIs in total FDIs in Georgia in 2005-2014

Source: Author’s elaboration based on data from the National Statistics Office of Georgia

In contrast to the pre-AA/DCFTA period (2005-2014), the rate of Georgia's capital integration with the EU has not accelerated after the signing of the agreement (2015-2024), despite expectations on mostly positive impact of the AA on Foreign Direct Investments to Georgia. In 2015, the EU’s FDIs to Georgia amounted to 417.1 Mil. USD, while in 2024, 10 years after the AA/DCFTA implementation was just 311.3 Mil. USD. During 2015-2024, in 2022 the EU’s FDIs reached its maximum - 847.3 Mil. USD, which is smaller than maximum volume of the EU FDIs in the period of 2005-2014 (906 Mil. USD in 2007). Moreover, in 2015-2024, the average annual growth rate of the EU FDIs to Georgia decreased significantly compared to the pre-AA/DCFTA period and amounted to 3.5%. Furthermore, in 2015, just one year after of the AA/DCFTA implementation, FDIs from the EU countries declined and the share of the EU FDIs in total FDIs in Georgia fell from 39.5% to 24.1%. Since 2015, the growth rate of the EU FDIs was uneven, reaching its historic largest share in 2020 (58.1%). However, it should be noted that in 2020, total FDIs in Georgia has dropped sharply due to COVID-19 and the EU FDIs amounted to 339.2 Mil. USD. In addition, since 2020 the share of the EU Foreign Direct Investments to Georgia declined and in 2024 it was just 23.3% (Figure 2). 

Figure 2. The EU FDIs (Mil. USD), the EU FDIs growth rate (%) and the EU FDIs share in total FDIs of Georgia in 2015-2024

Source: Author’s elaboration based on data from the National Statistics Office of Georgia

Analysis of the EU FDIs in Georgia for the period 2005-2024 shows that impact of the EU-Georgia Association Agreement/DCFTA on Georgia’s investment attractiveness to the investors from the EU countries is moderate. The share of the EU FDIs has increased from 2005 (24.7%) to 2014 (39.5%), but since then it declined and in 2024 was smaller than in 2005 (23.3%). Moreover, since 2014, the average annual growth rate of the EU FDIs compared to pre-AA/DCFTA period decreased dramatically from 49 to 3.5%. In addition, in 2015-2024, 10 years after implementation of the AA/DCFTA average share of the FDIs from the EU countries is nearly the same as in 2005-2014 (Figure 3).

Figure 3. The EU FDIs share (%), the EU FDIs average growth (%) and average share (%) in 2005-2024.

Source: Author’s elaboration based on data from the National Statistics Office of Georgia

As conducted analysis display 2 indicators out of 3, such as share of the EU FDIs in total FDIs in Georgia as well as and average share of the EU FDIs after the AA/DCFTA implementation (2015-2024) is almost the same as for 10 years (2005-20014) before AA/DCFTA. Moreover, in 2015-2024 one of the most important indicators of capital integration, such as the average annual growth rate has declined significantly.

4. Concluding remarks

The EU-Georgia AA/DCFTAs one of the major goals is Georgia’s gradual economic integration with the EU, which among other dimensions (trade, sectoral, etc.) of the overall economic integration includes capital integration dimension. According to the AA/DCFTA to achieve high level of capital integration with the EU, Georgia should effectively implement all obligations under the agreement, especially in areas related to capital movement as well as other sectoral obligations to make Georgia’s business and investment environment close to the EU’s economic system. Consequently, effective implementation of the Association Agreement/DCFTA is seen as an instrument to attract more Foreign Direct Investments from the EU and therefore, enhance the level of capital integration and overall economic integration in general.

However, it should be noted that despite the considerable progress in the implementation of the Association Agreement/DCFTA, as described in the relevant reports of the European Commission, Georgia's capital integration with the EU has not changed significantly since 2014, after signing the Association Agreement. In 2005-2014, during the 10 years before the AA/DCFTA, Georgia's capital integration with the EU was increasing significantly in terms of absolute growth, the share of FDIs from the EU in total FDIs and the average annual growth rate of the EU FDIs. On the contrary, during 2015-2024, for 10 years after signing the Association Agreement/DCFTA Georgia's capital integration with the EU displays only modest growth. In addition, the average share of the FDIs from the EU in total FDIs in Georgia in the post-AA/DCFTA period (2015-2024) is about the same as in 2005-2014, in the pre-AA/DCFTA period.

Despite the expectations and forecasts that existed prior to the signing of the EU-Georgia Association Agreement, analysis of data on the EU’s Foreign Direct Investments in Georgia for the period of 2015-2024, shows that progress in implementation of the Association Agreement, namely its sectoral provisions and therefore, enhanced sectoral integration has not been followed by an increase in capital integration. The convergence of Georgia's regulatory framework as well as legal approximation with the EU, which makes Georgia's business and investment environment largely similar to the EU and therefore, increases economic compatibility between Georgia and the EU, is not a sufficient condition for attracting increased volume of Foreign Direct Investment from EU states as well as from non-EU countries.

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