Adjust font size:

Economic Diversification in Azerbaijan

CIIS Time: Sep 13, 2016 Writer: Bai Lianlei,Orkhan Baghirov Editor: Wang Jiapei

 

Azerbaijani economic development occurred against the complex geopolitical background.  Azerbaijan was caught into the Nagorno-Karabakh War with Armenia ever since independence.  During the war, Armenia occupied about 20% of Azerbaijani territory, more than 20,000 Azerbaijani people were killed, 50,000 injured[1]. As a resultof war, more than million Azerbaijani people were displaced. Also, the war interrupted the westward exporting route of Azerbaijani hydrocarbon products, therefore prevented both Azerbaijani investors and foreign companies from exploiting the export-oriented oil reserves.  At early 90th poor governance, political instability within the country also negatively affected economy. However, after 1993 when Azerbaijan National leader HeydarAliyev became the president his perspicacious reforms and vision has provided political and economical stability in the country andceasefire in Nagorno-Karabakh War. After ceasefire, the peaceful geopolitical condition positively contributed to Azerbaijan economy letting to implement oil strategy and to increase share of oil sector. Thanks to the booming oil sector, non-oil sectors of Azerbaijan grow fast after the temporary recession in the early age of independence. Agriculture grows slower than other sectors and has more labor-intensive character; the manufacture industry, despite developing swiftly, decreases comparatively,because of the much faster growth of oil industry; service sector plays the foremost role in creating jobs. Share of mineral products in export reached 92.5% in 2014[2]. However, oil dependence is just a proportional concept since non-oil exports actually grow fast and the expanding internal market,resulting from increasing national income. Overall,economic diversification in Azerbaijan is impressive and fruitful given the more than 10 folds growth of non-oil sector in Azerbaijan and the share of non-oil sector in GDP as high as 56% in 2014[3]. Azerbaijani economic diversification though faces some challenges still holds four opportunities:

Ø  Stable democratic politics

Ø  Preferential demographic structure

Ø  Depreciated Azerbaijani Manat (beneficial to non-oil sector) 

Ø  Sino-Azeri consensus on Silk Road.

 

For future development of diversifying the economy Azerbaijan could make more attention to the role of low-end manufactures, maintain the current favorable exchange rate and take the opportunity of Silk Road Economic Belt proposed by China, for which agriculture and rural industry, labor-intensive manufactures, the operation of special economic zones and industrial parks, and transportation infrastructures could be the major arena for Sino-Azeri cooperation.

 

Introduction

Up to now, the transferred income from oil fund currently comprises more than 60% of the national budget of Azerbaijan[4]. Oil revenue substantially boosts the economic growth of Azerbaijan, directly improves people’s living condition, and accelerates the construction of infrastructures. Thanks to the booming oil sector, non-oil sectors are also stimulated in the favorable economic situation.However, since the second half of 2014, the plummeting oil price hasnegative impacts on Azerbaijani economy. Moreover, to soften these negative impacts, Azerbaijani government depreciated the exchange rate of manat relative to US dollar and began shifting its monetary policy fromexchange rate targeting to inflation targeting. Since hydrocarbon-relative products are the main export items, industrial machines and equipment, agricultural inputs are mostly imported from abroad.

Azerbaijan has rich experience in hydrocarbon industries and petroleum-based industrialization and has long been aware of the risks from unstable oil wealth and hence created the state oil fund even before the oil revenue comes into being in 1999. One of the major missions of the state oil fund is sequencing the spending of oil revenue to safeguard the stable transition of Azerbaijan into competitive non-oil economy. Diversification of economy can involve more than one dimension, asDr.VusalGasimli puts forward diversification of economy reflects in diversification of GDP, exports, foreign trade partner, institutional endowments, and domestic economy of regions.[5]Among them, the fundamentality should be thefortune coming from diversified sectors rather than the few primary commodities, and a key standard to evaluate the diversification level should be the source of foreign exchange.

 

Ι   Development of Non-oil Sectors (2000-2014)

Azerbaijan had diversified economy from the early time of independence. The mining industry accounted for 87.9% of the total industry in 1991, and the top position of manufacture replaced by petroleum industry in 1999 when the share of oil and gas extraction surpassed that of manufacture the first time (chart 1). The changing shares of manufacture and oil industry are brought out by the super-speed growth of mining sector though the manufacturing also developed quickly.Despite fact that war footing jeopardized the manufacture, the internal demand succeeded in maintaining a moderate manufacturing production. Development of non-oil sector always was the priority of Azerbaijan. Developing oil sector and gathering sufficient funds from oil exports Azerbaijan provided opportunity for developing non-oil sector. In order to diversify economy,recent years presidentIlhamAliyevsigned many decrees and endorsed several development programs such as “Socio-economic development of regions in 2014-218 years”, “Azerbaijan - 2020: outlook for the future”, “State  program for development of industry in 215-2020 years”. Main goal all of these programs and decrees is to support development of small and middle businesses and provide them with affordable soft loans, technologies and subsidies in order to diversify economy in all regions. In 2014, “National fund for entrepreneurship support” granted 295 million manat soft loans to more than five thousand entrepreneurs[6]. With support of fund’s soft loans during 2014, thirty nine new enterprises were opened, which expected to lead to more than 12,500 new job openings. Along with development programs, 2014th year announced as “Year of industry” and 2015th year as a “Year of agriculture”. During these years implemented measures both in industry and agriculture lead to increase of non-oil industry about 7% in 2014[7]and 8.4% in 2015 and agriculture about 6.6% in 2015[8]. During the “Year of industry”, more than 230 new industrial enterprises were opened, and production potential of existed enterprises was increased. More than a hundred of those new enterprises were opened in regions. For building 28 new bread factories in 14 provinces fifty million manat soft loans were issued.  As a result, all reforms, programs and decrees non-oil sector increased 9% in 2013 and 7% in 2014[9]. Moreover, the according to the Statistical Committee of Azerbaijan Republic, proportion of non-oil sector in total GDP increased from 47% to 60% in 2009-2014 years. In last eleven years non-oil sector increased more than 2.5 times[10]. 

Chart1                        Share of sectors in total industrty

Source: State Statistical Committee of Azerbaijan

 

1. Agriculture: big growth within transition period

Agricultural production in Azerbaijan experienced serious recession at the early period of independence. During 1990-1995 years production of agricultural products decreased about 58% (1, page 4).However, after 1996 (expect 1997) production volume in agriculture began to increase every year. Growth rate was 7%, 12.1%, 11.1% respectively in 1999-2001 years (1, page 6).

However, as the large-scale excavation of oil and gas after signing the “Contract of Century”, agriculture experienceda recovery growth. The agricultural output of Azerbaijan surpassed the level of 1991in 2008, and has grown 22.7% since then (figure 1).

Figure 1: Indices of agricultural output by types of holdings (1990=100%)

Source: State Statistical Committee of Azerbaijan

The achievement to a large extent could be owed to the growth of fixed assets, which increased 40 percent since 2000[11]. After Azerbaijan got its independence, limited input of several production factors like machines and mineral fertilizerswas made in agriculture. In comparison with the input level in late Soviet era of Azerbaijan, the mentioned factors have lower volume. As figure2 shows, in 2014 the number of tractors was 23,000 while in 1990 it was 40,900. Compare to 1990 the number of grain combines has decreased more than 50% and the input of mineral fertilizer shrank about 21.8%. First of all, this declining trend observed because of the war in Nagorno-Karabakh, as we mentioned Armenian forces occupied about 20% of territory of Azerbaijan, which had great resources for developing agriculture. In Sovietera, this region had significant contribution to agriculture. Second reason of this declining was the shift of Azerbaijan economy from state owned control to market economy. Doing that government decreased state control in economy and in agriculture as well and made market environment for the local and foreign entrepreneurs to invest in agriculture. Realization of advantages of the market economy in agriculture began to be noticeable after 2005 when input production factors began to increase (figure2).

Another factor, which offset the results of the decreased application of machine and mineral fertilizer, was the rapid increase in labor input resulted from swift growth of rural population. Consequently,the agriculture sector of Azerbaijan has become more labor intensive. As shown in figure 3, the labor input in agricultural enterprises has generally increased since independence. During the period from 1992 to 2014, two kinds of agricultural products (wool and sugar beets) witnessed a more labor-efficient trend compare to other products. 

 

Figure 2: the input of key production factors

Source: State Statistical Committee of Azerbaijan

 

Figure 3: the labor input in agricultural enterprises (hours per 100 kg of products)

Source: State Statistical Committee of Azerbaijan

Thanks to the reforms in agriculture since dissolution of Soviet Union, the productivity of Azerbaijani agriculture grows 40% since 1992.[12]First period of agricultural reforms took place between 1995-2003 years. During this period the willingness of the population toward the independent agricultural activities increased, new production relations formed, elements of market economy deepened and technological network expanded. National leader Heydar Aliyev accepted more than 50 regulatory documents and signed numerous decrees within 1995-2003 years. With his 2 march 2001 dated decree “Program of food security in Azerbaijan republic” was accepted (1, page 7). Main goal of this program was to deepen economic reforms, increase production of agricultural products and improve provision of population with agricultural products. All other accepted programs and regulatory documents by President Ilham Aliyev for the socio-economic development of the country after 2004 were the continuation of this program. During 2003-2012 years, 10 projects with the cooperationof international companies and with the value of 390.97 million U.S. Dollars were conducted. For the implementation of those programs during 2003-2012, 180.91 million U.S. dollars were invested. The share of Azerbaijan government in these investments was 65.14 million U.S dollars (1, page 10).In 2004 “Agro leasing” OJS was founded. The aim of this company was offering affordable leasing terms for entrepreneurs in order to purchase fertilizers, breeding animals, technological equipment, irrigation systems, and provide agro services forentrepreneurs and individuals with affordable prices. With the financing of government and other sources through “Agro leasing” OJS 493.32 million manat was invested. 190.72 million manat of this investment was used for purchasing agricultural technology, 113.79 million manat for purchasing technological equipment, 114.55 millionmanatfor purchasing mineral fertilizers, 22.86 million manatfor purchasing breeding animals, and 50.5 million manat was used for construction (1, page 9). Along with all mentioned reforms and decrees in 2008 “State program for reliable provision population with food products in Azerbaijan Republic”has been adopted.

 

2. Rapid growing manufacture with the support of oil industry

Manufacture declines relatively but grows absolutely. The share of manufacture in total industry began to decline since independence, but it never means the manufacture is shrinking. To the contrary, manufacture is only declining on its share but is really increasing on its real output value. As is shown in figure 8, the added value manufacture created in Azerbaijan increased 8.3 times from 2000 to 2014. However, with the super-speed growth of 18.7 times, mining industry undoubtedly dominates the expansion of the whole industry making the share of manufacture rarely more than 20%[13]. Thanks to the contribution of mining industry, the per capita GDP of Azerbaijan has taken off with windfall oil revenue, which increases more than 20 times in comparison with that in 1990[14].

Figure 8: The developing industrial structure of Azerbaijan

Source: State Statistical Committee of Azerbaijan

 

Manufacture benefits from booming mining industry. The exploitation of hydrocarbon reserves is mainly oriented to exportation. Firstly, the revenue from petroleum export plays an indispensable role in importing the necessary producing materials for non-oil sector, especially for manufacture.  Secondly, when mining industry creates values, it is really enriching the people, therefore helps to expand and exploit the internal markets, and the growing domestic market is no doubt a necessary condition for the growing up of non-oil producers. Thirdly, the oil revenue fund both state budget and great projects and infrastructures, therefore indirectly helps to improve doing business condition, which is indispensable for non-oil development.

Figure 7: Share of industry in the total economy

Source: State Statistical Committee of Azerbaijan

The industry has shrunk but manufacture is expanding absolutely. Mainly due to the faster growth of service sectors, the share of industrial output in GDP roughly declined ever since 2007, while the absolute value of the industry in the meanwhile went on witnessing a continuouslysurging growth dating from 2005 marked by the “Contract of Century”. But since 2011, the absolute value of industry has gradually declined mainly prompted by the overall shrinking outputs of mineral sectors. Nevertheless, the manufacture basically maintains a stable proportion in the total economy and since the economy of Azerbaijan has doubled since 2007, the absolute added value of manufacture actually has increased 50%[15].This divergent growth of manufacture is partially due to its insulation to oil sector so that it can be immune to the fluctuating oil price and production.

Manufacture is showing the potential as a leading engine in Azerbaijani industry. During the past two decades, the index of mining industry always runs ahead of other industries. However, if using 2010 as the base year, the industry sector as a wholehas shown some clues of stagnation with the mining sector as the foremostin relative recession, but manufacturing industry has begun the moderatebooming era whose annum growth rate has maintainedabove 7%. This is an optimistic sign since it implies the leading force of mineral sector has decreased but the independent development of other sectors has been consolidating.

 

 

Figure 10: output of industry according to ownership

Source: State Statistical Committee of Azerbaijan,6.1 Distribution of industrial products (works, services) by types of ownership activity, million manat, Volume of industrial products (works, services), at factual price, available at: http://www.stat.gov.az/source/industry/indexen.php, acceded May 172016.

 

 Since independence,the index of private production has always maintained a booming momentum and the joint property enterpriseswitnesses a gradually growth as well, however, both the state owned property and foreign enterprises beginshrinking since 2011 while the private sector expands proportionally.Foreign capital currently comprises 64%, state-owned capital 21% of the total industry production respectively.[16]Private enterprises are growing in terms of scale while foreign enterprises are decreasing. As the overall production of foreign enterprises decreases, the number of them is really increasing from 133 to 177 during the period of 2009-2014 resulting in the shrunk average scale of foreign companies by 60% in comparison with the peak average scale in 2011.  On the contrary, the private enterprises have witnessed a decrease in number from 1989 to 1717, while the average scale has increased 131%. [17]This is a favorable trend that the private sector may have begun the concentration as well as expansion, and foreign capital is becoming more diversified and will sooner or later meet with the competition of national capital. What's more,foreign capital mainly concentrates in mineral sector while state capital mainly exists in non-mineral sector.Both mining industry and non-state industry comprises more than 70% of the all industry products. And non-state sector comprises the share as large as 94.1 percent of the mining sector in 2014[18], while the share of private sector is no more than 15%.[19]It can be concluded that the output of foreign property companies owed nearly 80% to mineral sector, while 60% of non-mineral production belongs to state-owned capital.  [20]

Table 1: the growth of different property-type industry enterprises

the index with 2009 as the base year

2009

2010

2011

2012

2013

2014

All types

100

123.99

155.22

153.17

150.22

142.30

State

100

110.70

135.36

136.51

127.03

133.98

Non-state

100

127.81

160.94

157.98

156.90

144.71

Private

100

131.97

148.53

184.60

186.09

199.60

Joint(mixed)

100

134.64

108.26

122.55

132.62

148.46

Foreign

100

127,04

164.29

155.58

153.81

137.29

Source: State Statistical Committee of Azerbaijan, the same source as Figure 1.

3. Service Sector as the backbone of providing jobs

The output value of service sector increased more than five folds during 2005-2014, which is the fastest in the whole economy. From 2000 to 2014,there are 4 sectors in the economy that grow more than 10 times, and among them 3 sectors belong to service sector, i.e., real estate (17.4 times), accommodation and food service (17.1 times), arts and entertainment (10 times). What’s more there are still six sectors grow more than 5 times and all of them are of service sector, i.e.,  Financial and insurance (7.2 times), Education (5.9 times), Administrative and support service (5.8 times), Construction (5.6 times), Humanhealth and social work (5.4 times),trade and repair of transport (5.1 times).[21]

This achievement is gained mainly under expanding input of both labor and fixed assets. During 2000-2014, the labor force of Azerbaijan has increased from 4.7 million to 6.3 million[22], while employees servingin service sector accounted for 84.7% of the total[23].As the largest employer in service sector Trade and Repair absorbs employees as many as 22.2% of the whole service sector and 18.8% of the total economy. And the branch of Construction as the most expensive contributes the value of production as large as 21.6% of the service sector and 12.5% of the total economy.On the other hand, the fixed assets in service sector also grow in fastest rate, which expands close to 3 folds during 2005 to 2014 (Table 2). Therefore, the marginal effect of investment on service sector could reach 1.88 and the developing cycle of service sector is just maintaining on the ascending trend, or in the other words, the marginal productivity of capital in service sector is quite high. The main reason could be the relatively low capital-labor ratio in current-stage service sector, or in the other words, the service sector is running on the labor-intensive stage particularly in light of it created around 57.8% of the total GDP with over 84% of the total employees.

Table 2: Development of different sectors (2005 -2014)

Growth of production (%)

Growth of fixed assets(%)

Dynamics of share of employees (%)

Service

402

198

18.3

Mining

286

171

-12.3

Manufacture

247

91

-11.9

Agriculture

173

95

-6.1

Source: State Statistical Committee of Azerbaijan

Service sector could not exist without the support of concrete sectors especially when the service sector has not gained international competitiveness. The biggest contributor of economic sectors in Azerbaijan is mining sector creating 34.6% of the total GDP. As is known mining sector is capital or even knowledge intensive sector to which the service sector could not play the role as important as to manufacturing and agricultural sectors. And to some extent, the functioning of mining sectors could survive or develop without connection with other sectors. This is also the reason why the mining sector could sustainably maintain its share of added value as high as over 70% of industry. Currently, since agricultural and manufacturing sector takes the share of 5.3% and 4.8% in GDP respectively, these two sectors do not provide strong support to populous and efficient service sector. In other words, the market will make a tradeoff between the scale of employees and the salary level of them. As table 2 shows, while the share of employees in other sectors decreases, the service sector is expanding, implying the working opportunities are being created in service sector to absorb workers emigrating from concrete sectors.

Figure 11: share of employees and value created by the different branches of service sector (%)

Note: private peasants may not be included in calculation.

Source: State Statistical Committee of Azerbaijan

 

Figure 12: volume of investment in fixed by sector

Source: State Statistical Committee of Azerbaijan

 

4. Foreign Trade: Diversified Partners and Simplified Export

(1) Export of Non-oil Sector Grows Fast Despite of the Small Proportion

In foreign trade of Azerbaijan, oil sector plays essential role. As can be seen in figure 13, trade deficit occurs in non-oil exportation items. However, because of the oil-related export in general Azerbaijan enjoys pleasant trade surplus. Concerning foreign trade of Azerbaijan, there are three facts worth attention.

Figure 13: the structure of trade in 2014 (thousand US dollar in value)

Source: State Statistical Committee of Azerbaijan

First, given the rapid growth of non-oil exports, oil dependence is just a proportional concept. Up to 2014, Azerbaijani export is mainly supported by oil sector, which accounts for 92.4% of the total. In the latest 2014, production of mining sector amounts to 21.981 million manats, while 72% of which was exported to foreign markets. Non-oil products for exportation, has staggered swiftly since 1994 and shrinks to the least of 2.9% in 2008. But, after 2008 its proportion has continuously increased from 5.9% in 2010 to 7.6% in 2014. Big share of oil sector in export and in total economy never means that oil sector impedes the growth of non-mineral export. As figure 14 shows, the non-oil export expands over five folds since 1994.

Figure 15: the structure of exports since 1994. (Thousand US dollar in value)

Source: State Statistical Committee of Azerbaijan

Second, Azerbaijani non-mineral export generally grows slower than the other two Caucasus countries because of expanding internal market.Up to 2014, the leading export item of non-mineralsector is food and live animals (US $ 648 million), vegetable oils,fats and waxes(US $ 139 million). What’s more, the absolute value of non-mineral export does not grow faster than that of the other two Caucasus countries even though the growth rate of the total foreign trade in Azerbaijan is close to 3 times of that in the two neighbors. However, it never means Azerbaijan is mired in so-called Dutch disease. On the contrary, it is the result of enhanced residents’ purchasing power. On the one hand, now that oil export makes huge foreign exchange reserves, Azerbaijan does not have to make foreign exchange by stimulating non-oil exports; on the other hand, revenues from oil related exports boosts the expansion of domestic market, non-oil sector does not have to make money in foreign market. While for Georgia and Armenia, the case is just the opposite.

Third, Russia is still a leading partner in diversifying export though Europe has replaced CIS countries as foremost trade partner. At the early years of independence, CIS countries played the role of main importer of Azerbaijan products and bought 92 percent of Azerbaijan’s exports. While as the extraction of new oil fields, especially with the completion of Baku-Tbilisi-Ceyhan oil pipeline, crude oiland gas mainly flowing to European market begins prevailing in Azerbaijani export, the share of CIS countries in Azerbaijan export decreases to 4 percent while that of EU increases to around 53% as of 2014.What’s more, the change of leading trade partners never implies the trade between Azerbaijan and CIS has decreased or becomes less significant. On the contrary, the value of their trade has increased 39% since 2005 and Russia has played a more important role in supporting Azerbaijan’s non-oil exports. Russia’s share in Azerbaijan’s crude petroleum exportation has been mere 0.004%, which means nearly all of Russian imports from Azerbaijan are non-oil products, accounting for 38% of Azerbaijani non-oil exports. It is the same case for Azerbaijan’s trade with the whole CIS group who takes the share of Azerbaijan’s non-oil exports as huge as 53%. CIS countries still plays basic or buffer role for Azerbaijani export diversification.

Figure 9: performance of non-mineral sector in foreign trade since 1994

Source: State Statistical Committee of Azerbaijan

 

(2) Internal investment has outnumbered foreign investment but oil sector is still the

preferential destination.

 

With economic development, both foreign and internal investment grows continuously. After the initial stage for capital accumulation, internal investment surpassed foreign investment at 2008 implying Azerbaijan has gained more potential on self-driven investment. However, foreign capital still plays the irreplaceable role in providing foreign exchange reserves and maintaining trade and financial balances. Foreign investment reaches 16 billion US dollars in 2014, and of which FDI reaches over 8 billion. 83% of FDIand 58% of foreign investment flowed to hydrocarbon sectors.[24]

 

Figure 16: investment directed to economy (million US $)

Source: State Statistical Committee of Azerbaijan

Azerbaijan suffered from economic crisis over the world since 2008, which both directly and indirectly resulted in the fluctuation of foreign investment in term of financial credits. Oil industry seems much safer than other sectors in terms of market performance and environment, therefore more foreign investors show interest on oil industry. During 2009 to 2014, the total foreign investment to Azerbaijan has kept a nearly same growth as the investment on oil industry.

 

 

Figure 17: Foreign Investment of Azerbaijan (mln.US dollar)

Source: State Statistical Committee of Azerbaijan

 

If we look to investments based on countries, we can see that Turkey plays the key role in investing in Azerbaijan economy. In 2004, the share of Turkey is as high as 77%, and after one decade, the absolute value of Turkey investment has increased from 80.1 million US dollars to 481.4 million US dollars and the corresponding share is often the largest. Britain investment is also a significant source for Azerbaijan. Due to the hydrocarbon cooperation with Britain companies represented by BP, Britain investment took the largest share in 2008 (146.4 million US $), 2009(160 million US $) and 2011(148.8million US $). However, the preeminent role of Turkey has never been replaced with Britain since its share currently is still as high as 37%.

5. Evaluation of the Achievements

Economic diversification process of Azerbaijan has big growth but does not completed yet. Since the growth rate of oil sector was faster than non-oil sector during the last two decades, the economic structure seems more oil-reliant.  However, in recent years proportion of non-oil sector in the economy increased significantly.

(1) Differentiating diversification and modernization.

Diversification is the process of diversifying economic sectors, internal and foreign investment as well as trade in order to decrease the vulnerability of economy to fluctuating commodity prices and depletion of resources reserve, andfor Azerbaijan, the target is to expand non-oil sector. Hence, diversification is a horizontal development. Modernization means upgrading the technological and service level of an economy specifically implying the process of acquiring the ability of innovating new technology or management mode, the high efficiency of production, and the rich and high-quality living condition for residents. Hence, modernization is a vertical development.

Modernized economy is the destination of almost all the economies over the world, but diversification is notso urgent. What's more, economic diversification is more difficult for countries with small population.Therefore, it is more general for them to select a limited number of economic sectors to modernize.Moreover, in this process elevating technological and educational ability is necessary.Since Azerbaijan is not an industrialized economy according to current standard, it faces the double tasks of modernization and diversification, i.e. modernize both oil sector and non-oil sector and in the meantime expanding the share of non-oil sector.Diversification of economy is not asdifficult as modernization. The natural diversification of economy is a long-term transformation and if without modernization, this diversification is a backward diversification. Neither low technological diversification nor slow diversification is what Azerbaijan wants.

(2) The achievements of Azerbaijan in diversification

Economic diversification in Azerbaijan is a time consuming business since a high-level diversification, or in the other words, the equal modernization of both oil sector and non-oil sector is a formidable task for all countries across the world. Even though, Azerbaijan has made big progress on economic diversification.

Firstly, non-oil sector now occupied a bigger share than oil sector. The share of non-oil sector in Azerbaijan's GDP was only 37% in 2007, but up to 2014, it has increased to 56%.This is both a big growth and a high level in oil-reliant economies since even in UAE, which is a well-known successful model on economic diversification, the share of oil and gas in GDP up to than latest record in 2012 is just 59.2% slightly higher than that of Azerbaijan. What's more, the absolute value of non-oil sector has grown sustainably and faster than oil sector and oil sector in fact has come into a retreating cycle indicating the non-oil sector has gained a favorable foundation to emerge despite the oil-related products still dominate Azerbaijani export. These are great achievements in Azerbaijan's economic diversification.

Figure18: share and value of oil sector and non-oil sector

Note: oil sector include gas sector.

Source: State Statistical Committee of Azerbaijan

Second, oil sector contributes to rather than impedes the development of non-oil sector. Even before the big-scale exploration of oil reserves since independence, Azerbaijani government has set up state oil fund to manage oil revenue and make a perfect use of the limited oil.Since the establishment of SOFAZ, roughly, 1/3 of the oil revenue has been accumulated and the major part has been invested in the national and strategically projects which in the long-term play the important role in economic development, and the revenue from SOFAZ always accounts for more than 50% of the annual fiscal income. On the other hand, thanks to the expanding oil sector, Azerbaijani people benefit from the oil revenue and improve their living condition largely. Thus, the enhancing purchasing power of internal consumers provides a strong impetus to the expansion of non-oil production.What's more, as aforementioned, the oil dollars also plays an indispensable role in importing key equipment and technologies, which fundamentally improves the producing capability of non-oil producers.

 

II Opportunities and Policy Suggestions

 

1. Opportunities for Azerbaijani Economic Modernization

Stable Democratic Politics with Strong Leadership

Azerbaijan has stable politics and strong political leadership. As the beneficiary,the public security and social order in Azerbaijan are quite satisfactory even in comparison with some European countries. As is well known, strong political leader and stable social order is always the precondition of economic development, and this law has been testified by the experiences of successful eastern Asian economies like Taiwan of China ruled by Chiang and his son, Republic of Korea under Park Chung-Hee as well as Singapore under the rule of Lee KuanYew. [25]

The strong leadership is necessary for a catching up economy. According to the experiences of political development of other countries, the catching-up countries always need a strong government to rationally design and carry out modernization strategy. Because backward economies without a strong leadership are often unable to concentrate resources and capital in making breakthroughs on fundamental industries and technologies, which is indispensable for backward ones to catch up with advanced countries in a relatively short time. Azerbaijan without the strong men presidents undoubtedly could not gain the economic development since 2000 without the pragmatic and implemental policy of presidents Aliyev.

Preferential Demographic Structure

Economic performance is intimately connected with demographic structure. The East Asian countries achieve great economic achievements based on demographic dividends on the high share of labor force and low share of dependent population. [26]Since 1990 the leader on economic growth has changed from Japan to four tigers, i.e. ROK, Taiwan of China, Hong Kong of China, Singapore, and then to Chinese Mainland. The most reasonable and stable impetus is the huge share of working age population. Since 1990, the labor force share of OECD members have decreased to the average level of the world, therefore the relative slow economic growth of these countries is difficult to surpass the average growth of the world.

Figure 19: the share of working population in different regions

Source: World Bank

While the dynamic of Azerbaijan is perfect since its share of working people has been growing since independence and now is not only higher than average level of the world but exceeds that of East Asian and Pacific developing countries (Figure 19). The preferential demographic structure not only implies huge potential in labor force, but also big potential of market since the consumption demand of working people is also far larger than retired people. What’s more, the increasing labor force participation rate implies there will be more and more qualified labors who -would like to take part in production activities and this in the long term will play a decisive role in economic take-off of Azerbaijan.

Depreciated Azerbaijani Manat

The oil revenue creates purchasing power for Azerbaijani but does not create the corresponding producing capability. In this context,it is reasonable to maintain strong Manat in order to guarantee domestic consuming ability of importing goods. However, the cheap imports no doubt make negative effects on domestic producers making their products less competitive.

The depreciation of manta in February and December 2015 has reduced the price of Azerbaijan’s exports nearly 2/3 denominated in dollar.[27]Devaluation of Manat qualifies non-oil sector with stronger international competitiveness in term of price and weakens competitiveness of imports in domestic market.Nonetheless, the increased price of imports has not brought out exorbitant inflation in Azerbaijan, and given the common sense, that modest inflation is beneficial to economic growth; the devalued Manat is no doubt a big favor to the growth of non-oil sector. In this way, the challenge of low oil price also implies opportunity at the same time. With the depreciated currency, people have to pay high price for domestic produced goods rather than otherwise cheap imports and at the same time, people pay more efforts to take part in non-oil, especially low-value added industries as a start, and resilient industries will bring a brighter future for the country.

China-Azerbaijan Consensus on Silk Road

The ancient Silk Road stretching from China to Mediterranean area and Europe are stitched with leading junctions including Azerbaijan. As the Eastern Asian countries emerge as the newly developed regions of Europe-Asia continent, the interaction between the two regions increased constantly. China put forward the strategic initiative of Silk Road Economic Belt in 2013 in order to rejuvenate the ancient Silk Road and realize cooperative development with countries along the line.[28]China’s ambition mainly focuses on mutually beneficial economic cooperation rather than geopolitical influence. Thus, peaceful and development-oriented countries like the Azerbaijan are especially preferred.  What’s more, Chinese Silk Road belt stresses streamlining trans-Eurasia transportation, which is just what Azerbaijan takes interest in.

Azerbaijan has actually paid attention to the revival of Great Silk Road no later than China. Azerbaijan is quite aware of her prosperous history is closely connected with ancient Silk Road. [29]Given the remaining geopolitical significance, a rational option for Azerbaijan is to regain the historic status in east-west association. Thus, Azerbaijan actively props up the trans-Eurasia initiative was firstly put forward by EU in 1991 that emphasized the international transport between Europe and Asia. By vigorously supporting TRACECA program, Baku-Tbilisi-Kars railway, Trans-Eurasian Information Super Highway, trans-Caspian transport system, etc., Azerbaijan actually plays an active role in rejuvenating ancient Silk Road on the near east like China does in the far east.

Except for happening to coincide in reviving ancient Silk Road, the two countries also share so many similarities as if the both suffer from territory problems, enjoy stable politic situations and share the same endeavor to modernize their countries and enrich their peoples. All these similarities could safeguard the cooperation between the two significant countries alongside Great Silk Road.

2. Policy Suggestions on Economic Development

The relativelyeasy income from extraction of natural resources is likely a temptation for both decision makers and general people to linger on old development mode rather than to reenergize the economic system, for which post-Yeltsin Russian economy could be a good example. This could be called Resource Curse. Oil fortunesthough valuable as source of investment is not sufficient condition to create sustainable economic catch upuntil the internal impetusand driving forces could generate by itself. And currently the core point should be replacing non-renewable minerals with renewable labor resource and attaching the same, if not larger, importance to human capital as to physical capital.

1.  Highlight the Role of Low-endManufactures in Incipient Industrialization

The full use of human resources should be the priority, thereforeurbanization is a must. Meanwhile, carrying out industrialization in both rural and urban areas is indispensable. What industry should be chosen must be based on a pragmatic calculation, and the basic variable should be the technique level of Azerbaijan. Moreover, the newly transferred labor force from rural areas always lack of skills for complex industrial production. Therefore, the labor-dependent low-end industries for which simple and short training could qualify a new worker should be the priority. Nowadays the major importation of Azerbaijan is non-oil products and many of which are daily necessities. Capitalizing on domestic ability to compete with foreign products and kick out imports could be the necessary steps for every emerging economy.The first import-substitutionindustrial sectors for Azerbaijan should be textile, cloth, low-end electric appliances. The generally recognized development mode involves Eastern Asian countries like Japan, Taiwan, Singapore, as well as the most recent Chinese Mainland all started economic miracle from low-end andlabor-intensive industries. Now most of them have made big progress in industrialization and even founded the knowledge-based economy.

Industrialization, urbanization, and modernization of agriculture are interconnected and must be synchronized and maintained dynamic balance.  There is also a question about whether Azerbaijan should put the services as the priority. The answer is not easy to make. The third industry is always the biggest in developed countries; however, there has never been such a country that could mainly depend on services to become a developed economy without industrialization. India may be a supportive example, but it still need time to decide whether the so-called India path could succeed. As for the suitable industries, it should be bore in mind that the environment constraint always defines the choice of industry types.

2.Maintaining a Favorable Exchange Rate for Non-oil Sector

The dynamics of Manat’s exchange rate is fundamentally decided by the competitiveness of export sectors. Before 2014 when oil price began falling down, Azerbaijan government kept the exchange rate of Manatstrong relative to U.S. dollars in order to promote oil sector and improve purchasing power of general people.  Increasing purchasing power of people expands consuming demand and supports growth of non-oil sector. Generally, final end of diversification should be diversified exports. Agriculture is the strategic sector supporting food security and provides materials for industrial production; service is a non-tradable sector thus is not reliable in diversifying the economy; the only valid is to modernize and diversify the economy through manufacturing sector. Undervalued currency could be the universal measure to boost exports at the first stage of industrialization.

After the significant decrease in oil sector began,Azerbaijan government evaluated the new formed situation and depreciated Manat about 70% against US dollar since February 2015.Devaluation of Manatis quite beneficiary to the long-term development of Azerbaijani economy, thoughtfinancial difficultiesthat Azerbaijan can confront. Despite Azerbaijan has established a free-floating exchange regime, which improves the resilience of financial regime, also government leaves interspace for policy makers to maintain a favorable exchange rate of Manat for non-oil sectors.

3. Strengthen Azeri-Sino Economic Cooperation

China put forward the initiative of Silk Road Economic Belt in 2013 and now it has become one of the most important foreign strategies of China. As the key hub alongside ancient Silk Road, Azerbaijan plays an increasingly significant role. The Silk Road Economic Belt of China could be one of the most ambitious Silk Road initiatives during the last decades, and under the spirit of connectivity, China and Azerbaijan could carry out full-fledged economic cooperation.

(1)   Sino-Azeri cooperation on agriculture and rural industry

The cooperation areas could include small agricultural machines and equipment, mineral fertilizer, experience sharing and staff training, as well as the processing industry around agricultural products, which can help to decrease share of imported agricultural machines like tractors, combines and processing equipment and mineral fertilizers by producing them locally.

China is good at equipment production and has rich experience on the use and production of agricultural machines and equipment, especially on small machines, which can be helpful for Azerbaijan. China, as the first producer of mineral fertilizer in the world, produced 71 million tones mineral fertilizer in 2013 comprising 37% of the world, and has the manufacturing ability to help Azerbaijan to capture cheap and high-quality mineral fertilizers. Therefore, Both China-Azerbaijan joint ventureand solely Chinese investment on agricultural equipment and machine and mineral fertilizer will undoubtedly help Azerbaijan to consolidate its supporting ability to agricultural mechanization. Furthermore, concerning the significant geographic location of Azerbaijan, the investments from China no matter on mineral fertilizer or agricultural equipment could also benefit the neighboring regions, like central Asian, Middle East,European countries and Russia or even reversely boost the agricultural development in China.     

(2) Cooperation on labor-intensive manufacturing industry

The priorities include textile and apparel manufacturing, electric products assembling, household appliance and food industry. In the future, international competitive manufacturers must replace the oil industries in boosting Azerbaijani export and the first step should be boosting labor-intensive manufacturing industry. China is well-known for its achievement on making full use of cheap labor force to modernize the industrysystem. After more than 30 years of development, the price of labor in China has increased a lot, and industry transformation and elevation has been across developed regions, rendering a great deal of labor-dependent but modernized and high-quality factories to be transferred outward. It is well known that Azerbaijani population sharethe peculiarities like hardworking, high literacy rate, disciplinary, pragmatic and politically neutral etc with Chinese people, and Azerbaijan actually enjoys the vicinity of European market. All these qualify Azerbaijan as a natural and ideal cooperator of China on economics.

(3)  Cooperation on industrial parks and special economic zones

The economic take-off of China originated from the special economic zone in Shenzhen, and numerous industrial parks have been built and made great contribution to China’s economic miracle. Azerbaijan has begun building kinds of industrial and agricultural parks to promote industrialization and agricultural modernization. Special economic zones have also established in new Baku international seaport. The scenario always reminds observers of what happened in China in 1990s and what is still happening in four free trade zones of eastern China. [30] China actually has rich experience in special economic zones and industrial parks and is still accumulating new experiences, whichcould be referredto by Azerbaijani counterparts. And Chinese enterprises especially the European-targeted companies could be preferential partners. Undoubtedly, if Chinese experience in industrial development, labor training and exploitation of European market is combined with high-quality labor force, efficient management and preferential business environment of Azerbaijan, a great number of internationally competitive enterprises will mushroom across Azerbaijan contributing to the prosperousness of modern Silk Road.

(4) Cooperation onTransportation Infrastructures

Transportation could be one of the foremost priorities of Silk Road Economic Belt and is also the priority of Azerbaijani great Silk Road project. China has advocated and led to set up Asian Infrastructure Investment Bank (AIIB) of which Azerbaijan is the founding member state. For decades, China put huge resources into construction of infrastructure and has built up advanced and large-scale infrastructure system, which not only facilitates residents' everyday life but also boosts economic activities and contributes to the improvement of investment environment. Azerbaijan as the key country in both ancient and modern Silk Road is fully aware of the key role of transportation infrastructures and this is also the reason Azerbaijan independently promoted the establishment of Baku-Tbilisi-Kars railway. Azerbaijan has vigorous demand for transportation infrastructure and optimistic prospect of economy, and China has rich experience, full-fledged technology and reliable capability.The combination of the two sides is not only mutually beneficial and beneficial to the whole country group along Silk Road.

 

 

 

Bai Lianlei is a researcher at China Institute of International Studies; Orkhan Baghirov is a researcher at Center for Strategic Studies Under the President of Azerbaijan.


1   2