China's interests in the industrialization of the South Caucasus: comparative analysis of labor productivity in the manufacturing sector

Due to their strategic location and relatively developed economies, the three countries of the South Caucasus, namely Azerbaijan, Armenia, and Georgia, have cooperated with China since 2015 to leverage their economic growth. China has significantly invested in these countries to boost their productive capacity and integrate them into China-centered global value chains. However, are these countries ready to launch into cooperation with advanced economic powers such as China? To address this question, the current paper integrates overall trends in aggregate and sectoral productivity to evaluate the readiness of the South Caucasus for a new phase of industrialization using Chinese investments and projects as new and important developments in the region’s economic life. Overall, the results indicate a downward trend in manufacturing value added in the South Caucasian economies. While lagging trends raise concerns, Chinese foreign directed investment may resolve issues related to incomplete capacity utilization in the South Caucasus through infrastructure investments. In contrast to the existing literature on China’s economic presence in the South Caucasus, this paper examines Azerbaijan, Armenia, and Georgia in both intraregional and interregional terms by comparing them to the Visegrad and Baltic countries, respectively. This approach enables the South Caucasian countries to be situated in the context of Chinese foreign direct investments influx, as the South Caucasus shares a similar history and prospects with the Baltic countries and the Visegrad countries, respectively. The results of a one-sample t-test indicate that, on average, capital deepening and aggregate labor productivity are higher in the South Caucasus than in the Visegrad and Baltic regions. However, manufacturing labor productivity was significantly lower in the South Caucasus than in the benchmark regions. Moreover, the estimated effect sizes at the sectoral level - as measured through eta squared - illustrated the strength of the obtained differences. These findings document the need for improved economic reforms and policies to keep pace with the regions that are driven by foreign direct investments and that have successfully integrated into global value chains. Otherwise, China-led economic development may fail to industrialize the South Caucasus, misguiding the respective parties’ beliefs and expectations. Thus, further research is needed alongside specific sectoral policy strategies to document country- or region-specific challenges related to the increase in Chinese projects and foreign direct investments in the South Caucasus.