CC BY
70
Kamran EYYUBOV
Ph.D. Candidate at Baku State University (Baku, Azerbaijan).
FACTORS DETERMINING THE DIFFERENCES IN FDI INFLOWS INTO AZERBAIJAN'S AND RUSSIA'S OIL SECTORS AFTER INDEPENDENCE
Abstract
T
his article examines the FDI inflows into Azerbaijan's and Russia's oil sectors between 1991 and 2006. It iden-
tifies the main reasons for Azerbaijan's advantage over Russia. The author first gives a brief explanation of FDI in general, then
identifies the different patterns of FDI inflow into the oil sectors of both Azerbaijan and Russia, and concludes his article by point-
ing out the main determinants of the differences in FDI inflow into the oil sectors of these two countries.
Introduction
Since the collapse of the Soviet Union, the former Soviet republics have been striving to become part of the global economy as new sovereign states. Among these states, the performance of Azerbaijan and Russia in terms of attracting foreign direct investment (FDI) in general and into the oil sector in particular, since this plays a very important role in both countries, seems to be the most interesting example.
Russia is the largest of the European transition and CIS countries, is well endowed with natural resources, and has a well-educated labor force and large potential market.1 Paradoxically, from the viewpoint of foreign investors, the country is one of the least attractive host countries in this region. During the 1990s-early 2000s, inward FDI into the oil sector remained low; the cumulative annual average figures for Russia's FDI inflows as a percentage of gross fixed capital formation (GFCF) between 1998 and 2001 amounted to only 7.2%, with FDI stock as a percentage of gross domestic product (GDP) for 2000 being at 12.4%.2
The contrast is particularly great when compared with another important transition country in the CIS region, namely Azerbaijan. Despite the fact that Azerbaijan differs greatly from Russia in the size of its market, education level, economic potential, etc., the country has been one of the most successful CIS countries in attracting FDI in general and into the oil sector in particular. Its figures for inward FDI as a percentage of GFCF between 1998 and 2001 were estimated at 33.5%. Moreover, FDI stock as a percentage of GDP in 2000 amounted to 70.8,3 which was almost 6-fold higher than Russia's figures. Its FDI inflows into the oil sector accounted for about 70% of GFCF during 1997-2001.4
FDI and the Main Reasons for Attracting FDI
In order to be able to discuss FDI inflow patterns into the countries of interest, first let us define the term FDI. According to the Organization for Economic Cooperation and Development, "Foreign direct investment reflects the objective of obtaining a lasting interest by a resident entity in one economy ('direct investor') in an entity resident in an economy other than that of the investor ('direct investment enterprise')."5 A direct investment relationship is established when the direct investor owns 10% of the ordinary shares or voting power of the direct investment enterprise. The lasting interest, according to the OECD, implies the existence of a long-term relationship between the direct investor
1 See: N. Fabry and S. Zeghni, "Foreign Investment in Russia: How the Investment Climate Matters," Communist and Post-Communist Studies, Vol. 35, 2002, pp. 289-303.
2 See: UNCTAD, "TNCs in Extractive Industries and Development," World Investment Report 2007, New York and Geneva, 2007.
3 See: Ibidem.
4 See: C. Shiells, "FDI and the Investment Climate in the CIS Countries," IMF Policy Discussion Paper, European II Department, 2003.
5 See: OECD, Benchmark Definition of Foreign Direct Investment, Fourth Edition, Paris, France, 2008, p. 17.
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and the enterprise and a significant degree of influence on the management of the enterprise, which does not require absolute control by the foreign investor.
According to A.T. Kearney, the main types of FDI in terms of mode of entry are acquisition of a subsidiary or production facility, participation in a joint venture, licensing, and establishment of a Greenfield operation, which is a direct investment in new facilities or the expansion of existing facilities.6
N. Campos and Y. Kinoshita provide another classification of FDI types, distinguishing between market-seeking, asset-seeking, and efficiency-seeking FDI.7
■ The first type, which is market-seeking FDI, is also called horizontal FDI, as it involves replication of the production facilities in the host country. The main driving forces behind this type of FDI are the size of the host market and its growth, as well as the impediments to accessing local markets, such as tariffs and transport costs.
■ The second type of FDI is called resource- or asset-seeking or vertical FDI, which happens when companies invest abroad to acquire resources that are not available in the home country, such as natural resources, raw materials, or low-cost labor. Factor-cost considerations become especially important in the manufacturing sector when multinationals directly invest in order to export. In contrast to horizontal FDI, vertical or export-oriented FDI involves relocating parts of the production chain to the host country.
■ The third type of FDI, called efficiency-seeking, occurs when a company can gain from common management of geographically dispersed activities in the presence of economies of scale. A. Bevan and S. Estrin, for example, found that prospective membership in the EU, which is conducive to the establishment of regional corporate networks, seems to have attracted more efficiency-seeking FDI into the first wave of EU accession countries after the initial announcement of the progress of EU accession.8
From this classification it is clear that FDI into Azerbaijan and Russia's oil sector could be defined as asset-seeking, when foreign firms invest in the sector in order to gain access to natural resources, namely oil, which is scarce in their home country but abundant in Russia and Azerbaijan. Thus, we think that since this type of FDI is vertical or export-oriented, one of the main motives for foreign investors were stable taxes, legal guarantees of their investment and ownership, favorable export rights, etc.
According to our findings, FDI is extremely advantageous for the host country, providing such benefits as compensating for shortfalls in domestic investments and creating spillover ef-fects.9 The latter occurs when foreign companies make use of domestic financial institutions and distribution networks, or when new supporting businesses are created as a consequence of FDI. In addition, FDI provides the country with know-how, especially regarding management and organizational skills.
To our mind, apart from the effective restructuring and overall economic gains caused by FDI flows, another important advantage for Russia and Azerbaijan's oil sectors during 1990s-early 2000s was the technological know-how used by foreign companies mentioned by M. Bradshaw.10 After the
' See: A.T. Kearney FDI Confidence Index, Global Business Policy Council, Vol. 8, 2005.
6 j
7 See: N. Campos, Y. Kinoshita, "Why Does FDI Go Where It Goes? New Evidence from the Transition Economies," IMF Working Paper, IMF Institute, 2003, pp. 10-18.
8 See: A. Bevan, S. Estrin, "The Determinants of Foreign Direct Investment into European Transition Economies," Journal of Comparative Economics, Vol. 32, 2004, pp. 775-787.
9 See: P. Westin, "Foreign Direct Investments in Russia," Russian Economic Trends, Vol. 8, No. 1, 1999, pp. 36-43 (8).
10 See: M. Bradshaw, "Foreign Investment in the Russian Oil and Gas Industry: Lessons from Sakhalin," in: Proceedings of the 2nd International Conference on Globalisation in Russia's Regions: The Regional Dynamics of Northeast Asia and Russia's Globalization in the 21st Century, Hankuk University of Foreign Studies, Seoul, Korea, 2004.
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collapse of the Soviet Union, Russia and Azerbaijan lacked sufficient knowledge, equipment, and technology to produce oil themselves, which is why FDI helped in terms of bringing qualified specialists, up-to-date equipment, and leading technology into these countries, which created the spillover effects necessary for further development of the countries' oil sectors.
The existing literature also focuses on the determinants for attracting FDI, taking Dunning's OLI Theory as a model.11 Dunning argues that three conditions must be satisfied simultaneously for FDI to occur. The firm must have both an ownership (O) advantage, which takes the form of firm-specific assets both tangible (e.g., products or technology) and intangible (e.g., patents or brands), and an internalization (I) advantage, meaning that benefits accrue to the enterprise from exploiting the ownership advantage by choosing to produce abroad internally, rather than through the market by franchising or licensing the product or process internationally. The foreign market, in turn, must offer a location (L) advantage, which is relevant in determining where the firm chooses to manufacture its products. These location advantages include factor prices, access to customers, government regulations with respect to trade, exchange rates, capital flows, and institutional and political stability, etc.
We consider the last determinant in the theory—location advantages—to be the most important, because it includes the notion of investment climate, which is the difference between Russia and Azerbaijan's performance in terms of attracting FDI into their oil sectors.
Speaking about location advantages, there are several determinants foreign investors are looking for in the host country. According to N. Fabry and S. Zeghni,12 the globalization era has moved competition from price to quality, thus multinational enterprises are seeking combined advantages: low cost but productive labor, technological competencies, local demand to increase market shares on a local or regional scale, reliable infrastructures, managerial capabilities, and a stable political and institutional environment.
This statement is proven by the survey of foreign direct investors conducted in Russia in 2000.13 According to the results, the dominant motive for investment was the large size of the Russian market. Overcoming trade barriers was an equally important reason, not only for those enterprises that produce industrial goods in Russia, but even more for those involved in distribution and sales or in transport activities. Moreover, enterprises reported the qualified labor force in Russia to be quite significant and the low labor costs, as well as the low general production costs, to be relevant to their investment decision.
In order to attract foreign investors, host countries, in turn, must develop proactively local and regional markets, stabilize the macro and political environment, develop institutions and legal stability, and promote qualitative upgrading of labor to create local conditions for the transfer of knowledge.14
Inward FDI Patterns into the Azerbaijani and Russian Oil Sectors
Taking into account our findings on the essence of FDI, we will now look at the patterns of FDI in the Russian and Azerbaijani economies in general and in their oil sectors in particular during the
11 See: J. Dunning, International Production and the Multinational Enterprise, Allen & Unwin, London, 1981.
12 See: N. Fabry, S. Zeghni, op. cit.
13 See: R. Ahrend, Foreign Direct Investment into Russia—Pain Without Gain? A Survey of Foreign Direct Investors, Russian Economic Trends, Vol. 9, No. 2, 2000, pp. 26-33 (8).
See: N. Fabry, S. Zeghni, op. cit.
1990s-early 2000s. According to Table 1, despite the fact that FDI inflows into Russia between 1990 and 2006 obviously exceeded those of Azerbaijan, these figures cannot be fully trusted, since they do not take into account the differences in the sizes of the economies. Therefore, we use FDI inflows as a percentage of gross fixed capital formation as the indicator. This indicator is more precise for the present research. Table 1 clearly shows that Azerbaijan's annual average for 1990-2000 exceeded Russian figures almost 8.4-fold. Later years also show a clear contrast between the FDI inflows of the two countries: in 2004, Azerbaijan was able to attract 72.0% of its gross fixed capital formation compared to only 14.3% in Russia; in 2005, the figures were 30.7% and 9.2% for Azerbaijan and Russia, respectively.
Table 1
Foreign Direct Investment Overview, Selected Years ($m)
FDI Flows
As a percentage of gross fixed capital formation
o 'S 0 m O ™ ■= -i <° O D S C O) c 2003 2004 2005 2006 1990-2000 (annu al avg) 2004 2005 2006
Russian Federation
Inward 2,373 7,958 15,444 12,766 28,732 4.4 14.3 9.2 16.3
Outward 1,582 9,727 13,782 12,763 17,979 3.0 12.8 9.2 10.2
Azerbaijan
Inward 450 3,227 3,535 1,679 -601 37.1 72.0 30.7 -9.6
Outward 2 933 1,205 1,221 705 — 24.6 22.3 11.2
S o u r c e: UNCTAD, World Investment Report 2007, Country Fact Sheets (Russia, Azerbaijan).
Figure 1 complements the general finding, showing that between 1993 and 2006 Azerbaijan received more inward FDI as a percentage of gross fixed capital formation than Russia.
The figures from Table 2 measuring FDI stocks as a percentage of gross domestic product complement the results of Table 1 and Fig. 1. According to the estimations by UNCTAD, inward FDI stock flows accounted for only 12.4% and 16.9% of GDP in Russia in 2000 and 2004, respectively, while the similar figures for Azerbaijan were estimated at 70.8% and 157.0% of GDP for the same years.
Moreover, speaking about the overall FDI performance and investment appeal of Russia and Azerbaijan, it is worth looking at the UNCTAD FDI index. The UNCTAD four-fold matrix of inward FDI performance15 places Azerbaijan among the front runners, confirming that it has both high present and potential FDI performance. As for Russia, it is in the "below potential" group, which is described as having low FDI performance, although possessing high FDI potential. According to UNCTAD, the In-
15 See: UNCTAD, Inward FDI Performance Index, available at [http://www.unctad.org/Templates/WebFlyer.asp? intItemID=2471&lang=1].
Figure 1
FDI Flows as a Percentage of Gross Fixed Capital Formation in Russia and Azerbaijan
100 80 60 40 20 0 -20
i
1
1993
1 I r 1995
1997
1 I r 1999
2001
2003
2005
EH Azerbaijan
Russian Federation
S o u r c e: UNCTAD, World Investment Report 2007, Major FDI Indicators.
ward FDI Performance Index, which is the ratio of a country's share in global FDI inflows to its share in global GDP, between 1993 and 2006 Azerbaijan was ranked among the first 35 economies of the 140 examined with an index value of 3.4 (1993-1995), 15.25 (1995-1997), 8.15 (1997-1999), 1.60 (19992001), 12.51 (2001-2002), 17.869 (2003-2005), and 5.43 (2004-2006).16 Russia's FDI performance is not so impressive, it was ranked 87th in 2004-2006, although it enjoyed considerable progress in 1991-1993, when it was ranked 107th with an index value of 0.28. Russia's other index values, compared to Azerbaijan's, are 0.37, 0.59, 0.48, 0.32, 0.32, 1.13, and 1.12 for the same years, respectively. Thus it is obvious that Russia's low figures complement the results of Table 1 and Table 2 and prove Russia's low and Azerbaijan's high performance in attracting FDI during the 1990s-early 2000s.
Oil and energy resources are among Russia and Azerbaijan's main exports and FDI in this sector is very important for both countries. According to J. Cukrowski, the oil industry provides a considerable share of state budget revenues and convertible currency earnings.17 He goes on to say that the share of oil is about 31% in total primary energy production in the Russian Federation, and about 50% in primary energy exports. It is estimated that the oil sector is responsible for about 20% of the total revenue of the state budget and 40% of total earnings from exports in Russia.
Judging from Fig. 2, we can say that during 1998-2002 the Russian oil sector was not receiving sufficient FDI, since the majority of FDI went to Russia' secondary and tertiary sectors. As it is evident from Fig. 3, Azerbaijan's oil sector, on the contrary, attracted more FDI than its other non-oil sectors. Comparing the figures, we can also conclude that Azerbaijan's performance after the 1998 crisis was more impressive than Russia's. While Russia steadily increased its FDI figures to about
16 Ibidem.
17 See: J. Cukrowski, "Russian Oil: The Role of the Sector in Russia's Economy," Post-Communist Economies, Vol. 16, No. 3, 2004, pp. 285-296.
Table 2
FDI Stocks as a Percentage of Gross Domestic Product (GDP) by Region and Economy (%)
1990 2000 2004
Russian Federation
Inward — 12.4 16.9
Outward — 7.8 14.0
Azerbaijan
Inward — 70.8 157.0
Outward — 9.0 30.9
S o u r c e: UNCTAD, World Investment Report 2005.
Figure 2
FDI Flows by Industry, Russia, 1998-2002 ($m)
3,000 -i 2,500 -2,000 1,500 -
1,000 -500 0
1998 1999 2000 2001 2002
Primary Secondary 0 Tertiary
S o u r c e: UNCTAD, World Investment Report 2007, FDI in Brief.
Figure 3
FDI Flows by Industry, Azerbaijan, 1995-2002 ($m)
1995 1996 1997 1998 1999 2000 2001 2002
Primary Unspecified
Note: Primary refers to the oil sector.
S o u r c e: UNCTAD, World Investment Report 2007, FDI in Brief.
$650-700 million by 2002, Azerbaijani's oil FDI increase was more drastic, reaching $1 billion by the same year.
These results are well complemented by A.T. Kearney's FDI Confidence Index survey, which tracks the impact of political, economic, and regulatory changes on foreign direct investment intentions and preferences.18 In 2005, it ranks Russia ninth among primary sector investors, whereas Azerbaijan is positioned second, clearly representing a more attractive climate for investment.
Main Determinants of the Differences in Inward FDI Flows into the Oil Sectors
Our research has shown that during the 1990s-early 2000s Azerbaijan managed to attract more FDI than Russia into its economy in general and into its oil sector in particular. We think that such difference in FDI inflow patterns into the Russian and Azerbaijani oil sectors during the period stated
18 See: A.T. Kearney FDI Confidence Index.
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was determined by the differences in investment climate, namely political regime, legal guarantees, including production sharing agreements (PSA) and property rights protection, legislation in export rights and taxes, interest group policy, and cultural uniqueness.
The political system is one of the determinants of investment climate, which greatly determined the differences in FDI inflows into the oil sectors governed by Russia's hybrid and Azerbaijan's leadership-based policy. At the beginning of the 1990s, Azerbaijan was faced with political turmoil; the war with Armenia put Azerbaijani's independence at risk. The arrival of Heydar Aliev united the nation and gave a big boost to Azerbaijan's political motives. The nation believed in its leader and had complete trust in its president. According to Bayulgen, during the period under review institutionalized competition for power and influence in the political system was very limited in Azerbaijan, state power was highly concentrated and political order was dominated by the figure of President Heydar Aliev.19 Political groups and the Azerbaijani nation completely supported Heydar Aliev and his decision-making. The opposition groups did not have society's support to oppose Heydar Aliev's decisions.
In contrast to Azerbaijan's stable leadership-based system, Russia's hybrid regime, which was stuck between authoritarianism and consolidated democracy, was characterized by political instability, weakness of the state, and numerous veto players who could challenge the government's investment policy. From the beginning of the 1990s, Russia was in a state of permanent political crisis and extreme uncertainty about future government policies, about the stability of political institutions, about the outcome of a seemingly endless cycle of elections, and about the succession to Yeltsin.20 Moreover, according to McFaul's criteria, the state itself was very weak due to its lack of internal ideological and institutional cohesiveness, its low involvement in social and financial decision-making, and its inability to implement policy effectively.21 According to J. Watson, there have been frequent oscillations in policy within the government, due both to fast changing circumstances and to ideological battles between reformists and conservatives.22 Decision-makers could not overcome the opposition of the veto players by totally excluding them because the challenges tended to be both formally legal and widely perceived as legitimate.23 All of these conflicts and the high rate of turnover of government officials hindered policy continuity and development of a coherent regulatory framework for the oil industry. For example, the dissolution of the parliament in 1993 was particularly disruptive for the passage of the law on oil and gas. Thus, the result was policy instability, deadlock, and, in most cases, chaos in the investment environment. Foreign investors had to cope with frequent oscillations in policy in the present, facing arbitrary, conflict-prone, and aggressive investment terms, as well as remaining mindful of the possibility of destabilization in the future with regard to the direct impact it might have on their own particular project.24 Thus, many foreign investors preferred to make investments in Azerbaijan rather than in Russia because of the greater stability and more centralized political authority of the former.
In order to gain a clearer and more detailed picture of the legislative differences between the Azerbaijani and Russian systems, which determine the differences in FDI flows into the countries, we continue by focusing separately on the four main legislative factors (PSAs, property rights, export rights, and taxation systems) that directly affected the investment decision of an oil investor.
19 See: O. Bayulgen, "Facing the Dilemma of Global Capitalism: The Case of Azerbaijan," Central Asian Survey, Vol. 22, No. 2/3, 2003, pp. 209-220.
20 See: W. Tompson, "Financial Backwardness in Contemporary Perspective: Prospects for the Development of Financial Intermediation in Russia," Europe-Asia Studies, Vol. 52, No. 4, 2000, pp. 605-625.
21 Ibid., p. 610.
22 See: J. Watson, "Foreign Investment in Russia: The Case of Oil Industry," Europe-Asia Studies, Vol. 48, No. 3, 1996, pp. 429-455.
23 See: O. Bayulgen, "Foreign Investment, Oil Curse, and Democratization: A Comparison of Azerbaijan and Russia," Business and Politics, Vol. 7, No. 1, 2005, Art 3.
24 See: J. Watson, op. cit.
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The attitude of the Azerbaijani and Russian governments toward the adoption of PSAs, which allowed foreign oil companies to agree on individual approaches to their projects with the governments, therefore insuring themselves against any fluctuations in tax regulations and establishing stabilization in fiscal and legal terms, was extremely different. Since acquiring its independence, Azerbaijan has been keen on attracting foreign investors to its oil fields. The rapid adoption of PSA regimes helped the country to accomplish this goal. There were 21 successful PSA contracts between foreign oil companies and the Azerbaijani government before 2001.25 As Bayulgen puts it, many oil investors viewed PSA in Azerbaijan as "one-stop shopping."26 All negotiations between interested parties would start only after direct approval from President Heydar Aliev, and his approval was considered direct support of moving on to contract adoption. The PSA regime in Azerbaijan was very "company-friendly," as it provided good tax breaks and guarantees on financial security of the oil companies' investments. This ease in PSA regimes resulted in high FDI inflows into the oil sector, not to mention the fact that almost 2/3 of the total $9 billion investments in the oil sector came via FDI performed before the beginning of this millennium.27
In sharp contrast to Azerbaijan, Russia had many problems with PSA regime adoption. Despite the fact that President Yeltsin had signed a decree on legislation for regulating PSAs by late 1993, the Duma did not pass the legislation until late 1995 after two years of fierce battles among the political groups.28 The newly adopted legislation was not complete and resulted in ratification of a 1999 amendment to it, which introduced more demands on the investor. Moreover, some of the amendments became law in 2003, which complicated identification of projects with PSA status. As a result, many foreign investors did not think the legislation on PSAs to be sufficient for stimulating FDI and joked about it as being "Progress Stalled Again."29 Although Russian legislation was generally not restrictive toward foreigners, it should be noted that de jure and de facto business laws were different,30 the actual implementation of laws was very weak and still in need of improvement.
Despite the far greater advocacy of PSA contracts in Azerbaijan compared to Russia, legislation on property rights was actually more favorable for foreigners in latter than former, however with drawbacks in terms of actual property rights protection. The Law on Property of 1991 and the 1996 Land Reform Law in Azerbaijan prohibited foreign citizens from owning land or property in the country. Nevertheless, foreigners were allowed to lease both urban and rural land.31 Many of the foreign oil companies were able to secure long-term leasing contracts on the land and property where they operated.32 Oil giants BP and Chevron, which were the main participants in the BTC pipeline, secured leasing contracts until the end of the project. Azerbaijani property law was not really favorable in long run, but in the short and mid term it was quite conducive and meant that many foreign investors could actually enter 20-30- year lease contracts with the government or private entities. The biggest disadvantage of the property legislation was that it increased operation costs since there were constant rental charges.
25 See: OECD, "Investment Climate in Azerbaijan. Investment Climate and Prospect in Azerbaijan," OECD Global Forum on International Investment, Mexico City, Mexico, 2001.
26 See: O. Bayulgen, "Foreign Investment, Oil Curse, and Democratization: A Comparison of Azerbaijan and Russia."
27 See: OECD, "Investment Climate in Azerbaijan. Investment Climate and Prospect in Azerbaijan."
28 See: J. Watson, op. cit.
29 See: O. Bayulgen, "Foreign Investment, Oil Curse, and Democratization: A Comparison of Azerbaijan and Russia."
30 See: M. Schaffer, P. Hare, A. Shabunina, "The Great Transformation: Russia's Return to the World Economy," CERT Discussion Paper, 2004.
31 See: IMF, Azerbaijan Republic: Recent Economic Developments, IMF Staff Country Report, Washington, D.C.,
1997.
32 See: Azerbaijani Government, Information for Investors: Azerbaijan, Azerbaijan, 1995.
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Russian legislation on property gave more benefits to foreign companies. The 1993 Constitution allowed foreign subjects to own property in Russia.33 This made it easier for companies to move from one project to another. It also cut costs, provided some legal guarantees, and was a good source of protection for the company's long-term stay in the country. From the purely legal point of view, Russian property law was perfect for foreign investors, but it was not so perfect in real life. Protecting property rights was a real problem, since many companies had to pay private security companies in order to protect their property.34 Private protection was costly and had a negative effect on the overall evaluation of any economic project. However, it should be mentioned that during Putin's presidency the volatility of property security dropped significantly and became more like de facto legislation rather than de jure. However, despite the fact that during the period under review Russia had better legislation than Azerbaijan in the field of property rights, actual protection of property was absent in Russia, which has a negative impact on the decisions of oil investors.
The next legislative fact that determined the difference in FDI inflows into Russia and Azerbaijan during the period under review is export rights. It is essential to have a transparent and simplified exporting system from the foreign oil investor's perspective because oil sector investors usually want to export the obtained crude oil to the world markets. So significant quotas on oil exports and expensive exporting licenses are not very helpful in attracting FDIs into the oil sector. Azerbaijan had very low quotas on oil exports. Those quotas were primarily focused on securing the demand of local consumers. On the other hand, joint ventures with a share of more than 30% of foreign participation were exempted from obtaining export licenses.35 Also, the strategic export tax was set at 70% of the difference between domestic and contracted prices of the exported products.36 This margin of difference actually made it possible for oil companies to make a profit, which would keep them interested in investing in the region. In general, all of these factors in Azerbaijan's export legislation contributed to the country's appeal to foreign investors and ensured economic profitability.
Russia, on the contrary, imposed significant limits on oil export quotas at the beginning of the 1990s. The government introduced a regulation on export trade in 1992. The biggest problem of this regulation was that export tariffs were imposed on revenues and not profits, therefore the high costs and low margin of profit left a lot fields without investment. Also, according to this regulation, the Ministry of Fuel and Energy set the figures of individual and whole quotas on oil exports, which was a huge obstacle for companies. Despite the fact that joint ventures with more than 30% foreign ownership were exempted from export duties, foreign companies faced difficulties in identifying what proportion of production actually belonged to them in order to be able to export the full extent of their share.37 Yeltsin's decree No. 1385 actually put an end to export licenses and quotas at the beginning of 1995, but due to rationalization of the pipelines used to transport oil so-called limits on the capacity of exports had to be adopted, which were essentially quotas. Chernomyrdin's government went back on its decision and eliminated export tariffs by 1996.38 This exemption remained until 1999 when the government returned to export tax adoption.39 Thus, Russia has changed its position on oil export duties many times and is still uncertain about its position on export regulating taxes. This fact made Russian legislation in the field of export rights inferior to the low-tax better-regulated Azerbaijan oil export legislation.
33 See: M. Schaffer, P. Hare, A. Shabunina, op. cit.
34 See: N. Fabry, S. Zeghni, op. cit., pp. 292-293.
35 See: Azerbaijani Government, Information for Investors: Azerbaijan.
36 See: IMF, Azerbaijan Republic: Recent Economic Developments.
37 (
38 See: OECD, Investment Guide for the Russian Federation, Paris, 1996.
' See: J. Watson, op. cit., p. 439. 1 See: OECD, Investment Gi See: J. Cukrowski, op. cit.
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The differences in taxation legislation significantly determined the FDI investment climate of the countries of interest as well. The overall taxation system in Russia was complicated. The oil enterprises paid an average of 30 different taxes to federal and local budgets.40 It was no surprise that unexpected changes in the tax law and the tax law itself were ranked as the biggest problems for foreign investors in Russia according to a survey of 46 enterprises operating in Russia in 2000.41 The entire taxation system was based on revenue rather than on profit. This meant that companies had to pay taxes to the government before knowing whether they were making a profit or operating at a loss. On top of this, there was a lot of corruption involved in the system. Local governments imposed taxes on oil companies that were not envisaged in the federal legislation.42 The tax code did not set forth the exact number of taxes that could be imposed on oil companies or the limit on the total amount of taxes. In short, the Russian tax system placed a heavy burden on businessmen. In 2000, the government started lowering the tax rates and creating a better tax environment,43 but it still needed to be simplified with a clear division between federal and local taxes and take account of all the problems previously mentioned.
Despite the fact that Azerbaijan's taxation system was detrimental to the overall macroeconom-ic situation, oil sector tax legislation was favorable for foreign investors. Like all of its legislation, Azerbaijan created its first tax code on the basis of the Soviet tax code. Due to the social aspects of the communist system, Azerbaijan imposed large tax bills on companies. The tax system was based on automatic debiting of companies' bank accounts. This practice provided the shadow economy with many transactions that occurred outside the banking sector.44 The corruption level also rose due to growth of the shadow economy. Some economists advised foreign investors to keep up to 30% of profits for "unexpected guests from the tax office."45 Although these irregularities had a bad effect on the overall macroeconomic situation, they did not affect the oil sector investors much, since most of them enjoyed a separate taxing system through PSAs, thus the taxation environment in the oil sector was more favorable in Azerbaijan than in Russia.
This big difference in the FDI-promoting legislation of Azerbaijan and Russia can be explained by the influence of political interest groups, which determined the different FDI patterns as well. The political interest groups could not object to foreign involvement in the oil sector in Azerbaijan. They had very little influence over any decisions taken to attract FDI into the oil sector. The power of veto was almost invincible, so any PSA submitted to the parliament was approved the same day with no more than an hour of debates prior to voting.46 None of the active environmentalist groups were actually able to express their feelings. Attracting foreign investors into the oil sector also fell in line with Azerbaijan's geopolitical objectives since Azerbaijan wanted to bolster its independence from Russia and gain wider recognition of its problem in the Nagorno-Karabakh region.47
Such smooth interaction between the government and oppressed political interest groups does not apply to Russia. Since Soviet times, oil has been viewed as the country's national treasure. This ideology continued into present-day Russia, where different political interest groups constantly oppose legislation that allows foreign involvement. The oil lobby, which is supportive of domestic oil
40 See: OECD, Investment Guide for the Russian Federation.
41 See: R. Ahrend, op. cit.
42 See: M. Ogutcu, Attracting Foreign Direct Investment for Russia's Modernization. Battling Against The Odds, OECD-Russia Investment Roundtable, St. Petersburg, Russia, 2002.
43 See: J. Cukrowski, op. cit., p. 293.
44 See: IMF, Azerbaijan Republic: Recent Economic Developments.
45 See: L. Abrahams, T. Dragadze, "Azerbaijan" (Ch. 1), in: Investing in the Caspian Sea Region: Opportunity and Risk, ed. by M. McCauley, Cartermill, London, 1996.
46 See: O. Bayulgen, "Foreign Investment, Oil Curse, and Democratization: A Comparison of Azerbaijan and Russia;" P. Rutland, "Lost Opportunities: Energy and Politics in Russia," NBR Analysis, Vol. 8, No. 5, National Bureau of Asian Research, 1997.
47 Ibidem.
THE CAUCASUS & GLOBALIZATION
production, is very strong and has an influence on all levels of government.48 During the period under review, the Our Home is Russia party that ruled the country at the end of the last millennium was the main instrument in the hands of these lobbyists. This party was even seen as Our Home is Gazprom for representing the interests of the oil company.49 Still, the local oil lobbyists faced two major obstacles. First of all, the sector was in need of modern technology, so they could not completely block foreign involvement.50 Also, there was no organizational and ideological unity within the group. Despite the difference in opinion among different ministries on foreign investment, the government in general was interested in attracting FDI into its oil sector, since this would increase government revenue through taxes. However, it faced stiff opposition in the Duma. Many parliamentary deputies were used by the local oil lobbyists as means of protection from foreign involvement,51 which clearly represented a clash of interests. So while political interest groups in Azerbaijan succeeded in taking fast and significant steps to open up the way for oil sector FDI, Russian political parties could not reach a single decision on FDI into the country's oil sector.
Some scholars have tried to give a different explanation of the differences in the influence level between the interest groups rather than present the plain interest determinants in these two countries. They believe it is not merely political interest, but cultural and historical factors that generate the difference, which we also view as factors influencing the differences in the countries' FDI inflow patterns. Russia's cultural uniqueness is seen as the primary factor of its "inhospitable attitude toward foreign involvement."52 At least at the beginning of the 1990s, Russians viewed foreign involvement as hostile and an attempt to take over the country, which was completely contrary to the historical pride that Russians have gained throughout history by being one of the strongest nations. A good number of politicians saw the idea of "Western colonization" by foreign investors as a threat to Russia's natural resources and a way for foreigners to gain those resources at knockdown prices.53 The effects of the Cold War were still present in economic terms. Although the government understood the importance of foreign involvement in the oil sector, many politicians objected to it on the misleading basis of cultural uniqueness and independence.
Azerbaijan, on the other hand, did not have any ambitions of the same magnitude. It has historically been under the influence of other nations and, as a result, never viewed foreign involvement as a threat to its independence. Azerbaijan's interaction with other nations actually promoted foreign investment, since people viewed this as a way to open up relations with other nations. The Azerbai-janis wanted to bolster their independence from Russia, which had colonized Azerbaijan for more than 200 years, and any parallels to Russian heritage were not welcomed in the new state.54 FDI was seen as a good way of attracting foreign attention and becoming free of excessive Russian influence. Contrary to Russian politicians, the Azerbaijanis viewed foreign involvement as a way of showing the world they were independent and did not rely on any particular country.
Conclusion
The above discussion brings us to the conclusion that, during early independence, Russia and Azerbaijan differed greatly in attracting FDI in general and into their oil sector in particular.
48 See: O. Bayulgen, "Foreign Investment, Oil Curse, and Democratization: A Comparison of Azerbaijan and Russia."
49 See: P. Rutland, op. cit.
50 See: A. Heinrich, J. Kusznir, H. Pleines, "Foreign Investment and National Interests in the Russian Oil and Gas Industry," Post-Communist Economies, Vol. 14, No. 4, 2002, pp. 495-507.
51 See: J. Watson, op. cit., pp. 429-455.
52 See: Investment Opportunities in Russia and the CIS, ed. by D. Dyker, The Royal Institute of International Affairs, London, 1995.
53 See: J. Watson, op. cit.
54 See: L. Abrahams, T. Dragadze, op. cit.
Despite the fact that Russia was one of the largest oil producers in the period under review, it failed to attract sufficient FDI into its oil sector, which was in great need of investments, losing to Azerbaijan, which outperformed Russia's FDI inflows manifold. According to our findings, these differences in FDI performance were determined by differences in the political regimes, with Azerbaijan's leadership-based regime being more favorable to foreign investors than Russia's hybrid one. Moreover, legislation on PSA, export rights, and taxation was more advantageous for foreign oil investors in Azerbaijan than in Russia, providing them with more protection and guarantees, lower taxes, and more favorable export regulations. Despite the fact that Russia did have better legislation on property rights than Azerbaijan, in reality actual property rights protection, particularly in the oil sector, was weak or entirely absent and had a negative effect on Russia's investment climate in general. Finally, such factors as the differences in interest group policy and the cultural and historical uniqueness of both countries also influenced the differences in FDI patterns, making Azerbaijan better governed, more stable, and more hospitable than Russia for oil foreign investors.
