Научная статья на тему 'Economic reform in Azerbaijan: achievements and problems'

Economic reform in Azerbaijan: achievements and problems Текст научной статьи по специальности «Экономика и бизнес»

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The Caucasus & Globalization
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AZERBAIJAN / ECONOMIC REFORMS / ECONOMIC SOVEREIGNTY / FINANCIAL SELF-SUFFICIENCY / MARKET ECONOMY / THE INFORMAL ECONOMY

Аннотация научной статьи по экономике и бизнесу, автор научной работы — Hajiev Shamsaddin, Muzaffarli (imanov) Nazim, Mamedov Ruzi, Nabieva Susan

This article takes a look at the main results of the economic reforms in Azerbaijan since the country gained its state independence. The most important result is the country’s economic sovereignty, which is expressed, first, in sufficient independence to choose its own model of economic development, second, in the financial self-sufficiency of the national economy, and, third, in the state’s (in the form of the government and private companies) retention of its right to own most of the country’s economic potential. The transfer to mainly market methods of economic regulation is analyzed from the viewpoint of forms of ownership, the establishment of free price formation and fair competition, and the liberalization of foreign economic interactions. All of these problems are viewed in the context of interstate comparisons. The economic progress of recent years is analyzed separately. The authors show that the main factors directly or indirectly hindering the country’s efficient economic development are related to regional political contradictions and primarily to Armenia’s occupation of part of Azerbaijan’s territory. In the immediate future, the main efforts will be put into gradually moving away from competitive advantages based on material factors of production and transferring to competitiveness based on investments and efficiency; reducing the size of the informal economy; and enhancing the sectoral and territorial make-up of the economy.

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Текст научной работы на тему «Economic reform in Azerbaijan: achievements and problems»

THE CAUCASUS & GLOBALIZATION

Shamsaddin HAJIEV

D.Sc. (Econ.), professor, rector at the Azerbaijani State University of Economics

(Baku, Azerbaijan).

Nazim MUZAFFARLI (IMANOV)

D.Sc. (Econ.), professor, Editor-in-Chief of the journal The Caucasus & Globalization (Baku, Azerbaijan).

Ruzi MAMEDOV

Expert at the Azerbaijan Association of Banks

(Baku, Azerbaijan).

Susan NABIEVA

Ph.D. candidate

at the Azerbaijani State University of Economics

(Baku, Azerbaijan).

ECONOMIC REFORM IN AZERBAIJAN: ACHIEVEMENTS AND PROBLEMS

Abstract

This article takes a look at the main results of the economic reforms in Azerbaijan since the country gained its state independence. The most important result is the country’s economic sovereignty, which is expressed, first, in sufficient independence to choose its own model of economic development, second, in the financial self-sufficiency of the national economy, and, third, in the state’s (in the form of the government and private companies) retention of its right to own most of the country’s economic potential. The transfer to mainly market methods of economic regulation is analyzed from the viewpoint of forms of own-

ership, the establishment of free price formation and fair competition, and the liberalization of foreign economic interactions. All of these problems are viewed in the context of interstate comparisons. The economic progress of recent years is analyzed separately.

The authors show that the main factors directly or indirectly hindering the country’s efficient economic development are related to regional political contradictions and primarily to Armenia’s occupation of part of Azerbaijan’s territory. In the immediate future, the main efforts will be put into gradually moving away from competitive

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advantages based on material factors of production and transferring to competitiveness based on investments and efficiency;

reducing the size of the informal economy; and enhancing the sectoral and territorial make-up of the economy.

I n t r o d u c t i o n

After state independence was restored in 1991, a time of intensive political, economic, and cultural reform began in Azerbaijan. Two enormous tasks—building the national economy and transferring to market methods of its regulation—had to be solved at the same time, which made carrying out economic reform extremely difficult. In the ensuing years, impressive results have been achieved in each of these areas. The short-term tasks facing the country are of an entirely different nature, although they are just as difficult.

Economic Sovereignty

It can be said in all confidence that Azerbaijan’s greatest success can be seen in the achievement of its economic sovereignty. Compared with political sovereignty, which has been studied in sufficient depth and has precise conceptual features, economic sovereignty is a much vaguer concept and less conducive to research, since it is deprived of all meaning when interpreted as the economic independence of states from one another. In today’s world, international division of labor and spheres of activity and, consequently, global economic integration have become so intense that any attempt by an individual country to lower its economic dependence on the rest of the world, another name for which is economic self-isolation, does practically nothing to enhance its own economic development.

So compared to political sovereignty, which is very close conceptually to state independence, economic sovereignty is less related to independence. Consequently, the degree of relativity of economic sovereignty is higher than that of political sovereignty, although we are aware that all concepts associated in any way with freedom and independence are relative.

We need to distinguish among at least three attributes of economic sovereignty, which can and should be used as criteria when evaluating the degree of a country’s economic independence.

The first criterion is the state’s degree of independence when choosing its model of economic development. Economic independence implies that a state, taking into account its historical experience and culture in the broadest sense, chooses and develops its own economic system, with only the will of its own people in mind. It also determines the way its economy will be managed and which methods will be used to regulate it, as well as the long-term priorities of economic progress itself.

In terms of this criterion, the level of Azerbaijan’s economic independence is quite high. The state independently chose to transfer to a market system of economic regulation at the beginning of the 1990s on the basis of a national consensus. Essentially all the political organizations, ethnic groups, and regions without exception were in favor of active and deep-reaching market reforms despite the very natural differences among them with respect to specific parameters of the country’s economic future, as well as the methods and rates of reform.

Roughly the same picture was seen in most of the other new states that formed after the disintegration of the socialistic camp. The extremely low social efficiency of the economy under the admin-istrative-command system, especially in the last decades of its existence, was so obvious that public opinion in the post-socialist countries even somewhat overestimated the importance of market reforms. It was convinced that denationalization of property, price liberalization, and foreign economic

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interaction would lead to ubiquitous prosperity. Despite the naivety of these expectations, they gave rise to almost complete public support of the market reforms, at least in the Central Caucasian countries: Azerbaijan, Georgia, and Armenia.

Consequently, beginning in the mid-1990s, the reforms in many post-socialist countries, including in the Central Caucasus, were largely carried out in keeping with the recommendations of international financial institutions (IFIs), primarily the World Bank (WB) and International Monetary Fund (IMF). Due to the extreme shortage of financial resources in these countries for restoring the economy, reconstructing infrastructure facilities, and implementing social programs, the recommendations offered by international financial institutions for managing and reforming the economy became essentially mandatory since these institutions made the granting of cheap targeted loans incumbent on their performance.

The IMF’s recommendations were mainly rightist-centrist in orientation and, as a rule, corresponded to the long-term interests of the countries undergoing reform. An example of Azerbaijan’s especially successful cooperation with the IMF was stabilization of the national currency, the manat, in the mid-1990s.

The Azerbaijani manat, which was put into circulation in the fall of1992 (a year after official declaration of state independence), remained stable for almost six months. In the early spring of 1993, it began to devaluate with respect to both goods and services and to foreign currencies, primarily the Russian ruble, to which it was initially tied. The political clashes of mid-1993 that brought the country to the brink of civil war dealt a severe blow to the economy as a whole and to the monetary and financial system in particular. The destructive influence of the Armenian aggression also took its toll. By the end of1993 inflation began to skyrocket and 1994 went down in the country’s economic history as a year of hyperinflation. Consumer goods rose in price by almost 20-fold during the year. The galloping inflation had a pernicious effect on all the economic processes.

Azerbaijan followed the IMF’s recommendations and at the beginning of 1995 began implementing a tight monetary policy which was anti-inflationary in essence. The money supply was restricted in every way, centralized lending resources were frozen, and the chaos that reigned in loan issuing was eliminated. By mid-1995 the manat had stabilized. Inflation decreased abruptly during the last months of the year and amounted to less than 100%, which could justifiably be considered a great achievement. In 1996-1998, the tight monetary policy was continued. As a result, the manat even rose in value compared with international hard currencies, which naturally also had a positive effect on the price dynamics. In 1996, the GDP deflator dropped to 1.26 and in 1997 to 1.08.

At the beginning of the new millennium, when the oil contract signed with the leading oil companies in 1994 began to yield its first big profits, Azerbaijan was no longer in such dire need of IFI loans. The very nature of the interrelations between these institutions and the country, which was now quite financially solvent, changed. The IFIs, just as large investment companies and the world’s banks, began to invest their money more willingly in Azerbaijan, regarding it as an area of propitious and, most important, reliable placement of capital. It became must easier for commercial banks and other private Azerbaijani companies to attract financial resources from foreign sources.1 Moreover, the country and its commercial structures began to export capital in large amounts and assimilate foreign markets.

Although loans from the WB, IMF, and other international financial institutions are still important for Azerbaijan, they are no longer strictly bound to any economic management recommendations. These recommendations are now purely advisory in nature. Azerbaijan is independently build-

1 By the beginning of 2008, the total amount of financial resources attracted by banks from foreign sources amounted to approximately 600 million mantas or 710 million dollars and continues to rapidly decrease (see: Analit-icheskiy balans kommercheskikh bankov Azerbaidzhana, available at: [http://www.nba.az/download/statistika/

pul_kredit_gostericileri/k_banklarin_analitik_balansi.pdf]).

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ing its fiscal, monetary, structural, and investment policy. The country, keeping in mind its own economic development priorities, is controlling all levers of economic regulation itself and is not allowing other states, interstate associations, or international organizations to have an influence on them. In this sense the degree of Azerbaijan’s economic independence is clearly higher than that of the other new states, at least of the other Central Caucasian states—Georgia and Armenia.

The second criterion of the state’s economic independence is the degree of its financial selfsufficiency. A state cannot be considered successful if it is unable to ensure its own maintenance and development.

The degree of economic independence in terms of this criterion can be judged on the basis of several indices. The two main ones are: (i) the ratio of international reserves to the external debt and (ii) the ratio of the export volume of goods and services to the external debt. These indicators provide the best way to make an interstate comparison of the level of state self-financing.

As of 1 January, 2008, Azerbaijan’s international reserves, calculated as the total funds of the State Oil Fund, the government’s foreign deposits, and foreign assets of the National Bank, topped 7.4 billion dollars.2 In so doing, according to the Ministry of Finance, on the same day, the external national debt amounted to only 2.4 billion dollars (284 dollars per capita).3 Azerbaijan’s foreign trade turnover in 2007 amounted to 11.8 billion dollars, including export, which totaled 6.1 billion dollars.4 So the ratio of international reserves to the external debt was equal to 3.08 and of export to the external debt to 2.54.

These coefficients are much higher than similar indices for Georgia and Armenia during the same period calculated on the basis of the data of these countries’ official state structures. In Georgia the ratio of international reserves to the external debt was equal to 0.56 and of export to the external debt to 0.63. In Armenia the first coefficient amounted to 1.14 and the second to 0.69.

From this it follows in particular that if Georgia and Armenia had entirely curtailed imports, all other things being equal, they would have had to have used almost two years’ worth of export earnings to settle the entire external national debt. Azerbaijan, on the other hand, only needs to use less than five months’ export earnings to cover its external debt.

It goes without saying that the degree of Azerbaijan’s independence on foreign financial sources is much higher than that of neighboring regional states.

The third criterion is the extent to which the state owns its own economic potential, i.e., the extent to which this potential is controlled by its government and private companies. The matter primarily concerns the country’s natural resources, its main infrastructure facilities, and the so-called key economic sectors of the economy. It is not merely a matter of legislative enforcement of this property rather of its realization as national property.

In Azerbaijan, both formal (titular) ownership of natural resources, oil and gas being the main ones, and their actual management fully meet the third requirement. Despite the broad representation of foreign capital in the energy resource production and transportation sector and in other branches of the economy, the government and its private companies have control over the way most of the country’s capital functions. Admittedly, certain problems are encountered with economically realizing state property as national, as well as with economically realizing the right to private property, but they are not so deeply rooted that they countermand national ownership of economic property.

Considering economic sovereignty in terms of this criterion reveals serious problems in the other Central Caucasian states, particularly in Armenia. In 2003, RAO UES Russia acquired the right to

2 Data of the National Bank of Azerbaijan (NBA), available at [http://www.nba.az/download/statistika/ makroiqtisadi_g/b_investisiya_balansi.pdf].

3 Data of the Azerbaijan Ministry of Finance, available at [http://www.maliyye.gov.az].

4 Data of the Azerbaijan State Statistics Board, available at [http://www.azstat.org/publications/azfigures/2008/az/ 018.shtml].

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own and manage Armenia’s main energy enterprises in exchange for writing off their debts. After RAO UES Russia was restructured in 2008, its legal successors acquired the right to own and manage Armenia’s energy enterprises. Many Armenian politicians and experts believe that ownership of Armenia’s energy, communication, and other enterprises as well as pipeline transport by Russian companies is not in keeping with the country’s national interests and is creating a serious threat to its security.5 It is particularly important that, in most cases, the Russian companies controlling these branches in Armenia do not belong to the private, but to the state sector. This makes Armenia’s economic sovereignty even more vulnerable by intensifying its political context.

Summing up the above it can be concluded that at present Azerbaijan’s economy meets the basic requirements of the state’s economic sovereignty. In addition, the degreg of Azerbaijan’s economic independence in terms of all three criteria is higher than in the neighboring regional countries. This is an extremely important achievement, for without economic independence national-state sovereignty cannot be considered full-fledged.6

The most vulnerable aspect of Azerbaijan’s economic sovereignty is that it is not yet a nationwide reality since a large part of its territory (Nagorno-Karabakh and contiguous regions) is still occupied by Armenia. This vulnerability, however, is of a military-political, not economic, nature.

The following must definitely be kept in mind: economic independence relates to those properties of statehood that must be constantly reproduced, which poses (and will always pose) new tasks for Azerbaijan. Some of them will be discussed below.

The Market Economy

Transferring from the administrative-command system of economic regulation to the market system is another of Azerbaijan’s fundamental achievements during the years of independence. It goes without saying that an economy can never be “purely market” or “purely administrative” since its management always features both administrative and market methods. The gist lies precisely in which methods predominate. Economic reform of society can only mean one thing—a transfer from the almost absolute domination of administrative methods to the domination of market regulations. Whether or not such a transfer has taken place can again be judged on the basis of several specific indicators.

Property. The main criterion determining the nature of the economic system is the composition (quantitative ratio) of and equality among the forms of ownership. Denationalization and privatization of property, which essentially began right after Azerbaijan restored its state independence, led to impressive results. Although the privatization of large state enterprises is still limited, small and medium privatization is almost fully complete. The share of the private sector in the GDP exceeds 84% (in 1995 it was 30.3%), in industry it amounts to 76.7%, in the supply line and communication sphere to 72.4%, and in freight shipments to 58.9%.7

Special mention should be made of the privatization of land property. The Law on Land Reform adopted in 1996 was and remains one of the most revolutionary and progressive in the whole of Eastern Europe and creates all the necessary conditions for realizing the right to private ownership of land, right down to its alienation. The land reform conducted on its basis is complete and a new structure for the agricultural sector has ultimately been formed, although not always in entire fairness. Incidental-

5 See, for example: V. Dallakian, “V Armenii mnogie otrasli ekonomiki okazalis v rukakh Rossii, chto ugrozhaet bezopasnosti strany,” Day.az, 6 February, 2007, available at [http://www.day.az/news/armenia/69689.html].

6 Issues of a state’s economic independence, and Azerbaijan’s in particular, are reviewed in more detail in: N. Muz-affarli (Imanov), Ekonomicheskie etiudy, Shusha, Baku, 1999, pp. 7-28.

7 The ratio of the state to the private sector can also be judged by the number of those employed, the share in national income, percentage in investments, and so on.

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ly, social discontent over the course of land reform is universal in nature and typical of most countries, whereas in Azerbaijan it was manifested sporadically. At present all of agricultural production (100%) is produced by private enterprises.

We can see that the percentage of private property in essentially all branches of the economy is quite high and this makes it possible to claim that the transition has successfully taken place in terms of this indicator.

Since the percentage of the state sector is one of the most important indices of the level of state interference in the economy, the ratio of the state to the private sector quite accurately characterizes the degree of liberalness of the market economy. It is a well-known fact that the command economy is the left pole in the liberal spectrum of the economy. But the market system, which largely manifests the right pole, is also heterogeneous. Even in those countries where private property clearly dominates, the ratio of the state to the private sector can significantly differ. Interstate comparisons of these indices for countries with a stable market system reveal the degree of “leftism” and “rightism” in their economies, in other words the degree of relative leftism and rightism within the framework of the rightist pole. Based on the ratio of the state to the private sector of the economy, it can be claimed that Azerbaijan’s economy is currently much more rightist than in many other countries with a market system, including European.

Price formation. Liberal price formation is one of the most important attributes of a market economy since the right to private ownership is not full-fledged if enterprises cannot independently establish the prices for their own products and services. It so happened that the liberalization of price formation in Azerbaijan began even before it declared its state independence. It was of a forced nature to a certain degree since it was a reaction to the price liberalization in other Soviet republics (particularly Russia) which were Azerbaijan’s main trade partners. Not until a few years later was liberal price formation regarded as one of the goals of the economic reforms being carried out in the country.

At present, the level of price formation freedom in Azerbaijan can be described as average. Free price formation is already performing an important regulatory function in the economy by prompting businessmen to expand or cut back production of particular goods and services, thus promoting the capital flow and equalization of rate profit among the different branches of the economy. Along with other market mechanisms, it ensures much more efficient use of economic resources than under the administrative system.

Nevertheless, despite the fact that the state has already been long steering a course toward gradual narrowing of the range of regulated prices, in some branches of the economy so-called natural state monopolies continue to dominate. The prices for their products and services are administratively determined and usually set at an artificially low level for social reasons. Internal prices for petroleum products and energy are subjected to particularly tight control. Price formation in the municipal services sector remains primarily administrative. When justifying the need for the state’s continued ownership of municipal enterprises, the government refers precisely to the possible increase in prices in the event of their privatization.

All the same, it can be said with confidence that price formation in Azerbaijan is mainly of a market nature.

Competition, as one of the most effective mechanisms of market self-regulation, is derivative with respect to the diversity and equality of the forms of ownership and management and original with respect to free price formation. In most sectors of Azerbaijan’s economy it performs an important regulatory function.

The country still has to carry out rather serious reforms in order to exclude, or at least keep to a minimum, ongoing unfair competition. In addition to the fact that normal (perfect) competition is greatly restricted by the above-mentioned natural state monopolies, it also suffers at present from political interference in the economic processes. We have in mind cases when access to a particular economic activity is predetermined by a businessman’s contacts with high-ranking state officials.

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But, in contrast to the restricting influence of natural monopolies, which can only be eliminated by carrying out complicated structural reforms, this kind of artificial restriction on competition is relatively easier to eliminate since it only requires administrative measures.

Foreign economic interactions. A market economy is open by nature not only in the sense of free access to the business activity of the country’s citizens, but also with respect to its openness to the outside world. As a result of the unprecedented globalization of the world economy, the concept of a country’s economic self-sufficiency has lost its meaning even with respect to large states, and as far as relatively small countries are concerned, of which Azerbaijan is one, with their limited territory and resources, they have no other choice but to build an economy that is open to the world.

The specifics of the problem applied to resource-exporting countries lie in the fact that the freedom of their foreign economic activity cannot be measured by the absolute and relative indices of foreign trade volumes.8 This is also absolutely true of Azerbaijan. So economists are constructing more refined indices of foreign trade liberalism.

One of them is the foreign trade freedom index, which is based on the weighted average tariff rate used during the import of goods and services. As the results of the last comparative interstate study carried out every year by the Heritage Foundation and Wall Street Journal show, Azerbaijan’s weighted average tariff rate amounts to 5.8% and is close to the average world index. The main factors hindering foreign trade are associated with non-tariff barriers, the most significant of which, according to the study’s authors, are the selective approach of customs offices to the participants in foreign trade transactions, as well as the restrictions on the export of certain goods. Nevertheless, according to the 2008 Index of Economic Freedom report, foreign trade in Azerbaijan is 78.4% free, which is higher than the average world level.9

Introduction—in compliance with President Aliev’s decree of 11 November, 2008—of the principle of a “one-stop solution” is helping to further improve the situation and alleviate the nontariff barriers. Transfer to the new system, which is planned for the beginning of 2009, is aimed at eliminating the artificial barriers that are revealed during the inspection of goods and transport means crossing the state border.

It should be kept in mind that foreign economic interactions do not boil down to foreign trade alone, but includes a whole range of various kinds of foreign economic interstate partnership. One of the most important among them is freedom of interstate investment. Although there are also certain problems in this sphere (particularly in creating favorable conditions for the functioning of foreign companies in the non-petroleum sectors of the economy), Azerbaijan is among the world leaders both in import and export of capital in terms of this parameter.

Thus the conclusion can be drawn that, with respect to the clear prevalence of indirect economic regulation methods over direct, the transition to a market economy has already taken place in Azerbaijan, although naturally there is room for further improvement of economic management and enhancement of the business milieu. Some of these problems will be discussed separately below.

Economic Progress in Recent Years

The GDP growth rates in Azerbaijan since 1998 have invariably been some of the highest in the world. Only in 1999 and 2001 did they drop below the 10% mark, and in the last three years Azerbaijan’s economy has been the most rapidly developing in the world. In 2005-2007, Azerbaijan headed

In particular, the ratio of export and import volumes to the GDP is classified as a relative index.

8 I

9 See: 2008 Index of Economic Freedom, p. 92, available at [http://www.heritage.org/index].

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the world rankings in terms of GDP growth rates, far outstripping those countries in second place. In 2005, Azerbaijan’s GDP rose by 26.4%, in 2006 by 34.5%, and in 2007 by 25.4%. In 2008, an approximately 20% increase is expected (the IMF’s forecast is 18.6%).10

The main factors predetermining the high GDP growth rates were, first, the sharp increase in Azerbaijan’s oil production and, second, the spasmodic increase in oil prices on the world markets. It is also obvious that revenue from oil and gas export will generate a less significant rise in the GDP over time, since the percentage of the annual increment in the GDP in its total volume will gradually drop. So it will probably not be possible to retain such high growth rates in the economy in upcoming years. An additional factor that had a certain negative influence on the dynamics of the GDP in 2008 was the hindrance to oil export through Georgia due to Russia’s armed invasion and its recognition of South Ossetia and Abkhazia as independent states, which somewhat raises the level of political risk during the transportation of oil and gas to the world market.

Despite the indisputability of the decisive contribution the oil and gas industry has made to the increase in the GDP, the significant progress achieved in recent years in other branches of the economy cannot be underestimated. In 2006, the real growth in the non-petroleum GDP (keeping in mind agriculture) amounted to 11.9% and in 2007 to 11.3%. In the next few years the non-petroleum GDP is expected to retain these growth rates. In particular, the Asian Development Bank is forecasting a 10% increase in the non-petroleum GDP in 2008, which should probably be regarded as the lowest level keeping in mind the unprecedented increase in the reconstruction dimensions of infrastructure facilities, particularly transport infrastructure. The supply line and communication sector, as well as transport, is another driving force behind its growth. In 2003-2007, the information-communication technology market burgeoned by an average of 35-37% a year. During this period, more than 200 local and foreign companies entered this sector.

The state budget of Azerbaijan swelled by 55.3% in 2007. In recent years, Azerbaijan has also occupied one of the leading places in the world in terms of this index—growth rates in state budget revenue. Suffice it to say that in 2003-2007 the state budget increased 10-fold.

Investments have played a decisive role in raising the GDP and consequently the budget revenue, on the volumes and structure of which not only the rates but also the quality of economic growth depend. The total volume of investments in Azerbaijan’s economy in 2006 topped 6.7 billion dollars, amounting to 44.9% of the GDP. According to the data of the CIA—The WorldFactbook, the country ranked first in the world in terms of this index. In 2007, total investments increased by another 17.5%, reaching 7.9 billion dollars.

Foreign direct investments (FDI), which bring state-of-the-art high technology and advanced business organization and management into the country are of vital importance for relatively young states. In recent years, Azerbaijan has invariably occupied one of the leading places in the world in terms of FDI indices. The most popular among these indices is the InwardFDIPerformance Index, which is published annually by the U.N. Conference on Trade and Development—UNCTAD. These indices are calculated as the ratio of the share of foreign direct investments in the total world investments made in the country’s economy to the share of the country’s GDP in the total world GDP. In order to eliminate occasional annual fluctuations, UNCTAD uses the average index for the last three years.

In 2005 and 2006 Azerbaijan ranked first in the world in terms of the Inward FDI Performance Index and in 2007 it ranked twelfth, which was related to the end of capital-intensive work to develop new oil and gas fields and completion of the building of the main oil and gas pipelines. Among the Central and Eastern European countries, Azerbaijan has invariably been among the leaders in terms of FDI per capita.

10 See: IMF World Economic Outlook Database, April 2008, available at [http://www.imf.org/external/pubs/ft/weo/ 2008/01/weodata/weoselgr.aspx], September 2008.

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In 2007, some new trends appeared in capital investments that significantly changed the overall investment situation. Primarily, for the first time in many years, the volume of local investments was higher than the foreign. For all intents and purposes this trend appears to be long-term. In the next few years, local investments will continue to prevail over foreign and stride even further ahead. The data for the first six months of 2008 make this perfectly clear. The volume of investments in Azerbaijan’s economy during the first six months amounted to 4.4 billion dollars, 3.1 billion of which (that is, more than 70%) were invested through local sources.11 The second trend was the increase in state investments, largely in infrastructure projects. In 2007, they rose 22-fold and reached 2,235 million dollars. Finally, the third complete trend was that Azerbaijani companies, both state and private, began to actively invest abroad. Particular mention should be made of the investments by the State Oil Company of Azerbaijan Republic in Georgia, which have already reached 500 million dollars. Moreover, the SOCAR announced several large, including multi-billion, investment projects in Turkey.

Competitiveness of Azerbaijan’s Economy

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In order to make full-fledged interstate economic comparisons, such integral indices should be used that make it possible to directly or indirectly measure a whole range of economic parameters. One of them can be considered the competitiveness of the state’s economy.

A correctly constructed index of a country’s overall economic competitiveness should synthesize its ability to compete with other states (in the case of relatively small countries this primarily implies their competition with neighbors) in a wide range of parameters, i.e. act as a kind of “aggregate competitiveness.” Every country tries to be competitive with respect to:

■ the sustainability and efficiency of its political system, which are invariable prerequisites of dynamic economic development,

■ the level of physical infrastructure (including transport and energy),

■ the quality (the qualification level) of the workforce,

■ favorable conditions for business activity, including for foreign investments,

■ and comfort and diversity of the social-cultural milieu.

Each of the listed parameters can in turn be viewed as the “aggregate competitiveness” of a more specific attribute. For example, competitiveness of the business environment is formed from competitiveness in terms of guarantee of the right to private property, level of development and efficiency of the monetary system, the tax burden, profit transfer conditions, ease of creating a new business, and so on. Depending on the specifics of the tasks facing the country, a particular characteristic of the business environment can become of greater or lesser significance for it. The fact is that now the world’s states are competing with each other even in individual parameters of the business environment.

One of the internationally recognized studies in interstate comparisons of aggregate competitiveness of the world’s countries is carried out by the World Economic Forum (WEF). In 1979 it began publishing an annual Global Competitiveness Report in which, since 2005, it, along with the

11 See: Introductory speech by President Aliev at a meeting of the Cabinet of Ministers on the results of socioeconomic development in the first half of 2008, available at [http://www.president.az/articles.php?item_id=20080806101804 228&sec_id=11] (in Azeri).

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competitiveness of economic growth of companies, has also been evaluating and comparing the overall economic competitiveness of states.

The WEF calculates the Global Competitiveness Index on the basis of ten main factors. They include the quality of public institutions; the extent and quality of the infrastructure; the macroeconomic climate; the level of public health and primary education development; the level of secondary and higher education development and advanced personnel training; the market efficiency (goods and services, labor and financial markets); the level of technological readiness of enterprises; the level of business sophistication and strategic planning in companies; and innovative activity. Each of these factors is acquiring a different significance depending on the level of economic development. So the countries of the world are divided into three groups depending on what their economic growth is based on (factors of production, productivity [efficiency] or innovation), and differentiating “weight coefficients” of subindexes are applied to each of these groups.12

On the basis of this methodology, the WEF compiled a ranking of 131 countries of the world in its last report called the Global Competitiveness Report 2007-2008, among which Azerbaijan ranks 66th with a score of 4.07. It is noticeably ahead of other states of the region—Georgia and Armenia— both in terms of overall competitiveness of the economy and in terms of each of its three parameters, whereby in terms of innovative potential it holds quite an impressive position (48th and 36th, respectively). In terms of the Global Competitiveness Index of the CIS countries, Azerbaijan is only behind Russia (58th place), Kazakhstan (61st), and Uzbekistan (62nd). This result could be considered very successful were it not for the fact that Azerbaijan has all the necessary resources to claim even higher competitiveness.

The short-term task is to gradually move away from competitive advantages based on material production factors (primarily natural resources) and transfer to a higher level based on investments and efficiency. At the enterprise level, this requires improving the production process on the basis of modern technology, market research, and long-term planning, while at the government level, the emphasis must be placed on improving the infrastructure and raising the quality (that is, the feasibility of targeted precepts and efficiency) of economic policy.

It should be noted in particular that infrastructure implies not only physical (traditional) but also so-called soft infrastructure. The latter includes technological infrastructure (highly qualified workforce plus applied research centers orientated toward introducing innovations), a favorable social climate (democracy characterized by the absence of acute internal conflicts in society), an efficient institutional economic management structure, and a state structure based on cooperation among citizens, enterprises, the nongovernmental sector, and the government. In recent decades, those countries that focused mainly on improving their soft infrastructure achieved the greatest success in raising the level and quality of their competitiveness. The best examples are Singapore, Israel, Ireland, and several other states that raised their competitiveness ranking in a relatively short amount of time.

Short-Term Tasks

Regional Political Contradictions

The political contradictions among the Caucasian states,13 between them and other countries with interests in the region, as well as among the latter, are currently the main obstacles to Azerbai-

12 For more detail on the WEF’s methodology, see: N. Muzaffarli, “Comparative Economic Competitiveness of the Central Caucasian States,” The Caucasus & Globalization (Journal of Social, Political and Economic Studies), Vol. 1 (4), 2007, pp. 61-84.

13 In addition to the Central Caucasian states—Azerbaijan, Georgia, and Armenia—they also include Russia, Turkey, and Iran.

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jan’s economic development. The country is essentially in a state of war with Armenia, in which only a ceasefire regime has been declared (1994). During the past three years, the hostilities have been revived: during 2007 Azerbaijani population settlements and military positions were fired upon 575 times (in 2006 220 times), and 17 Azeri servicemen were killed and 9 injured.14 Armenia has occupation over approximately 20% of Azerbaijan’s territory, most of which is outside Nagorno-Karabakh. There are approximately one million refugees and forced migrants in the country, about half of whom live below the poverty line. Azerbaijan is striving to ensure its territorial integrity by peaceful means, but in so doing is forced to augment its military potential, which is putting an additional burden on the economy.

Other regional political contradictions, and particularly the armed clashes between Russia and Georgia that occurred in mid-2008 and were provoked by Abkhazia and South Ossetia’s desire to separate from Georgia and integrate with Russia, are also creating serious obstacles to Azerbaijan’s economic development, which chose Georgia as the main transit country for exporting its oil and gas resources to the world market. It can be presumed that the total volume of the Central Caucasus’ connected markets will shrink even more as a result of this conflict since Armenia, which is a member of the Collective Security Treaty Organization (CSTO) and essentially acts as Russia’s outpost in the Caucasus, has been forced in one way or another to support it, and this will objectively lead to a deterioration in relations, including economic, between it and Georgia. In addition, we cannot ignore Armenia’s ever frequent and insistent territorial claims on Georgia with respect to the Samtskhe-Ja-vakhetia Region where Armenians compactly reside.

We are gleaning hope from the fact that two Central Caucasian states, Azerbaijan and Georgia, are successfully developing political-economic partnership, jointly participating in several major regional projects, primarily energy, and are the co-founders of GUAM and active supporters of integration into the Euro-Atlantic space.

It should be kept in mind that resolving regional political problems could open up essentially new, incomparably more favorable possibilities for economic development not only for Azerbaijan, but also for the other Central Caucasian states, whereby this might have an even more significant effect on their economies.

The Informal Economy

The informal economy usually implies any economic activity that is not registered and not regulated by official management structures. It is not incorporated into taxation (which is the main stimulus for its establishment and expansion), official statistics do not keep tabs on it, and it is not taken into account in the general economic indices such as the GDP, GNI, or level of employment.

Essentially every state has an informal economy to a certain extent, but as current studies show, the higher the level of economic freedoms in a country, the lower, as a rule, the percentage of the informal economy. This thought can also be formulated as follows: the more severe the political and economic conditions that prevent normal business activity, the greater the volume of the informal economy.

The informal economy differs from illegal economic activity, to which the illicit production or sale of weapons and armaments, drugs, and so on belongs, in that it includes ordinary types of economic activity. There are widespread cases when enterprises, both private and state, formalize only a certain part of their activity, in so doing remaining partially in the official and partially in the informal arena.

It is rather difficult to measure the size of the informal economy in a specific country since the matter concerns a quantitative evaluation of unregistered activity. Nevertheless, there are several

14 For more detail, see: Central Eurasia 2007, Analytical Annual, CA&CC Press, Stockholm, 2008, p. 85.

THE CAUCASUS & GLOBALIZATION

methods for indirectly measuring it. The results obtained on its basis show that in the near future Azerbaijan will have to carry out systemic reforms that will make it possible to lower the share of the informal economy in the GDP. In this respect, drawing resource consumption into the officially registered economic turnover, formalizing the labor market, and increasing the part of monetary circulation which occurs within the banking system, are acquiring priority significance.

In the past two years, the government has undertaken several measures to formalize the labor market, particularly in the construction business, which is undergoing a period of intensive development. Due to the sharp increase in state control many construction companies were forced to transfer their relations with hired workers onto a legal basis by entering work contracts with them. Control has also increased in the industry in order to officially pay workers their entire salary (not only that part that does not fall under taxation according to current legislation). These measures have probably reduced the volume of the informal economy somewhat, but they must be continued.

In the sociological and economic studies of recent years, the informal economy is usually analyzed along with corruption. There is no doubt a certain correlation between them, which is also of a rather complicated multifaceted nature. On the one hand, corruption is one of the most important reasons for the emergence of the informal economy: enterprises disappear into the shadow sector in an effort to avoid not only the official obstacles to business, but also the informal, the main one of which is corruption. On the other hand, corruption (and some of its forms in particular) generates an important part of the informal economy. Nevertheless, the attempts of some research centers to evaluate the volume of the informal economy in different countries by means of the dimensions of corruption that have developed in them can hardly be deemed justified.15 The most recent studies empirically confirm that the correlation between the informal economy and corruption is much more complicated. For example, F. Schneider established on the basis of a factual analysis that in wealthy countries (that is, in countries with a high per capita income), the informal economy reduces corruption, while in poor countries it increases it.16

This may be one of the factors of corruption in Azerbaijan. Corruption, just like the informal economy, cannot be measured directly. The most well-known methodology for indirectly measuring it was drawn up by Transparency International, which publishes the results of its studies annually in its Corruption Perceptions Index reports. These reports rank the countries of the world, based on expert polls, in accordance with the prevalence in corruption among government officials and politicians. It should be kept in mind however that the matter does not concern the actual corruptive nature of countries, but only the level of its perception by the public, which could distort (and usually does distort) the actual picture both by enhancing and deteriorating it.

After improving its corruption perceptions index slightly over the past few years, which at present is 2.1 (in 2003 it was 1.8), Azerbaijan ranks 150th among 179 countries in terms of this index. 17 The IMF also notes that in Azerbaijan the frequency with which companies pay bribes has significantly dropped.18

Nevertheless, corruption, along with the informal economy as a whole, continues to be one of the factors hindering Azerbaijan’s economic development. So President Aliev said that the anti-

15 Such attempts are particularly made in the above-mentioned Index of Economic Freedom reports. The invalidity of such a simplified understanding of the informal economy and its correlation with corruption are discussed in detail in:

N. Muzaffarli, Reiting Azerbaidzhana, Kavkaz, Baku, 2006, pp. 379-381.

16 See: Fr. Schneider, Shadow Economies and Corruption All Over the World: What Do We Really Know? Institute for the Study of Labor, Bonn, 2006, pp. 29-32, available at [http://www.iza.org/index_html?lang=en&mainframe=http% 3A//www.iza.org/iza/en/webcontent/personnel/photos/index_html%3Fkey%3D206&topSelect=personnel&subSelect=fellows].

17 See: 2007 Transparency International Corruption Perceptions Index, available at [http://www.transparency.org/ policy_research/surveys_indices/cpi/2007].

18 Recent Policies and Performance of the Low-Income CIS Countries, April 2004, p. 26, available at [http:// www.imf.org/external/np/oth/042304.pdf].

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corruption measures were some of the most important priorities of the country’s economic policy for the immediate future. They should be comprehensive in nature and include improving legislation, developing market methods of regulation, raising the efficiency and transparency of state management, implementing propagandistic and educational programs, and carrying out repressive methods. Close interaction must be established among the government, private sector, civil society, and mass media with respect to combating corruption.

Sectoral and Territorial Make-Up of the Economy

In recent years, Azerbaijan has invariably been one of the world leaders in industrial production growth rates. In 2007, Azerbaijan’s industry increased by 25%, which put the country in second place in the world ranking of this index (in 2005 it occupied 4th place).19 These achievements were primarily due to the oil factor, which was also the reason for the unproportionately high share of the mining industry (in 2007 it was 68.0%) in overall industrial production and the low share of the processing industry (24.9%).20

On the whole, industry is currently the dominating branch in the economy: in 2007 it produced 59.1% of the GDP. Moreover, in the present-day world, the economic development of states is not achieved by the prevalence of material production in general and industrial production in particular. An exponential analysis shows that as the economy develops, which is measured by the growth in the per capita GDP, the increase in the share of industry gradually slows and stabilizes at a level of 30%.21 With Azerbaijan’s current per capita GDP, a 23-25% share of industry in the economy can be considered normal for the country (if proportions typical for most economies of the world are regarded as “normal”).

Other conclusions follow from an analysis of the development of agriculture, the percentage of which (5.9% in 2007) corresponds—with respect to the per capita GDP—to the general world governing laws. But world exponential trends show that as the per capita GDP grows, the percentage of agriculture, as well as of industry, gradually drops and ultimately stabilizes at a level of 1-3%. So despite the fact that one of Azerbaijan’s economic priorities in the next 10-15 years will be agricultural development, it cannot be regarded as the country’s strategic choice.

This priority should go to the service sector. In more than half of the countries with an annual per capita GDP of more than 5,000 dollars and in most countries where this index is higher than 10,000 dollars, the service sector accounts for more than 50% of the economy (in Azerbaijan it constituted approximately 30% in 2007). As for developed states, it can be said that their economic success is based on services: in Austria, Australia, Germany, Holland, Denmark, Canada, Japan, and many other developed countries, the service sector forms approximately 70% of the GDP, in Belgium 74.4%, in Great Britain 75.7%, in France 76.7%, and in the U.S. 78.5%. The average index for the European Union is equal to 70.7%, and the average world share of the service sector in the GDP (64%) is more than double Azerbaijan’s index.22

An exponential analysis makes it possible to draw an extremely important conclusion and Azerbaijan should proceed from it when formulating its long-term strategy: those countries which

19 See: CIA: The World Factbook, Rank Order—Industrial Production Growth Rate, available at [https://www. cia.gov/library/publications/the-world-factbook/rankorder/2089rank.html], September 2008.

20 Data of the Azerbaijan State Statistics Board (see: Azerbaijan in Figures-2008, available at [http://www. azstat.org/publications/azfigures/2008/en/012.shtml]).

21 Degree of correspondence of the structure of the Azerbaijani economy to the general world structural trends is analyzed in detail in: N. Muzaffarli, Reiting Azerbaidzhana, pp. 188-203.

22 See: CIA: The World Factbook, Guide to Country Profiles, available at [https://www.cia.gov/library/publica-tions/the-world-factbook/rankorder/2089rank.html], September 2008.

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choose services, particularly intellectually intensive services, as the main priority in their structural policy will achieve the greatest economic prosperity in the next few decades among all those states whose per capita GDP is approximately at the same level as in Azerbaijan.

The disproportions existing in the sectoral make-up of Azerbaijan’s economy are to a certain extent of an objective nature. After restoring its state independence, Azerbaijan essentially had no other alternative but to develop its oil and gas industry, which as early as the end of the 1980s (that is, since before independence) was regarded as the country’s starting competitive advantage and also promised certain foreign political dividends. But oil pressure on the economy has currently almost exhausted itself. The oil and gas sector provides more than three quarters of its entire industrial production, more than half of its state budget revenue, and more than 80% of its total export. According to UNCTAD, Azerbaijan is among the countries of the world that is most dependent on the production of energy resources.23

All of this testifies in favor of the fact that in the tactical respect Azerbaijan accepts any changes in the sectoral make-up of the economy aimed at decreasing the influence of the oil factor. The government is exerting active efforts to develop the non-petroleum branches in which, however, the main emphasis is placed on a sharp increase in state investments. Along with this, it is evidently worth aiming for more radical improvement of the political-economic environment of private business by giving preference to reforms that least require the social protection of hired workers.

Due to the fact that the production of oil and gas resources, which is the main branch of the economy, is mainly concentrated around Baku, economic activity is extremely unevenly distributed throughout the country. Suffice it to say that more than 93% of the budget revenue is formed in the capital and less than 7% in other regions of the country.24

Unequal distribution of economic activity nationwide greatly restricts the possibility of rational use of the country’s economic potential and creates serious obstacles to efficient employment. In addition, it should be kept in mind that it has, among other things, great political significance for Azerbaijan, which is a multinational state, since the differences in level of economic development and particularly the disproportion in the distribution of infrastructure facilities can be interpreted by certain forces as infringement on the rights of compactly residing ethnic minorities.

Unfortunately, it will be extremely difficult in the next ten years to achieve more or less equal territorial distribution of the economy. Nevertheless, this should be one of the most important priorities for the near future and this is the aim of one of the most important government programs of recent years—the State Program of Socioeconomic Development of Azerbaijan’s Regions in 2004-2008. The second part of the program designed for 2009-2013 is at the development stage. In these programs, the country’s territory is divided into ten economic regions, specific measures for each of which (with the exception of the Verkhne-Karabakh and the Kalbajar-Lachyn economic regions which are occupied by Armenia) have been drawn up for developing the physical infrastructure and creating new jobs.

Improvement of the economy’s territorial make-up, to the same extent as the sectoral make-up, should be carried out not so much by means of direct state interference, which is typical of the present stage, as by creating favorable conditions (including infrastructure) for developing private business with a simultaneous increase in the economic powers of the local power structures. This approach will step up the process of natural economic specialization of the country’s regions and areas keeping in mind their natural resources, climatic conditions, labor resources, sales markets, interregional ties, and economic traditions.

23 See: UNCTAD World Investment Report 2007, p. 87. It is interesting to note that Georgia occupies 16th place in

the world in terms of dependence on the export of non-fuel mineral resources with an average annual, for the five years

between 2000 and 2004, percentage of their export of 24.9% (see: Ibidem).

24 This ratio naturally forms under the influence of the fact that at present many types of economic activity in the

agrarian sector are completely or partially exempt from taxation.

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C o n c l u s i o n

Over the past twenty years Azerbaijan has been experiencing a difficult time of radical economic transformation. After achieving political independence it also acquired economic sovereignty, since it now controls its own resources and potential and independently determines the models and priorities of its own economic development, thus confirming its own financial validity. During this period Azerbaijan essentially completed the main reforms aimed at transferring to market methods of economic regulation, achieving predominance of the private sector in the economy, establishing a sufficiently liberal system of price formation, and ensuring acceptable freedom of foreign economic interactions. The country has managed to create a more competitive economy than its neighbors, particularly with respect to the material conditions of business activity.

Nevertheless, in the short and medium term, more complicated tasks will have to be solved. The main one is to remove the political restrictions on economic development. This applies in particular to liberation of the currently occupied territories with their subsequent full-scale socioeconomic rehabilitation. Reducing the informal economy to a minimum and improving the sectoral and territorial make-up of the economy are among the priority goals for the near future.

Mikhail TOKMAZISHVILI

D.Sc. (Econ.), professor, member of the board of the National Bank of Georgia, researcher at the Case-Transcaucasus Foundation

(Tbilisi, Georgia).

Avtandil SILAGADZE

D.Sc. (Econ.), professor, Corresponding Member of the National Academy of Georgia

(Tbilisi, Georgia).

THE CENTRAL CAUCASIAN COUNTRIES: TRENDS IN FOREIGN TRADE RELATIONS

Abstract

T

his article presents an analysis of the institutional changes in the foreign trade policy of the Central Caucasian coun-

tries and reveals the special features of their foreign economic activity at the current stage. The authors also look at the main

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