Retrospective Analysis and Solution Prospects

Rovshan GULIEV

Rovshan Guliev, Director, Institute of Systems Research, Editor-in-Chief, Sotsialnye Nauki journal (Baku, Azerbaijan)

On the eve of the latest presidential election in Azerbaijan, which took place in October 2003, all candidates and experts of different parties and movements were agreed that changes in the country were unavoidable. And whereas the main tasks in the sphere of government management are generally known (democratization of government, fight against corruption, etc.), the choice of a correct course for further economic reforms depends on many circumstances which are often beyond our control. For the development of a rational strategy and effective implementation of structural economic reforms it is necessary to carry out a retrospective analysis and to study the possible ways of integrating the country into the world economic system.

Historically speaking, ten years is a short period in the life of a country. But it is long enough to enable us to see the mistakes that have been made and to identify the earlier undetected sources of current problems. For a systems analysis of regional integration processes in the agroindustrial complexes (AIC) of transition countries we need to differentiate the current problems on various lines, dividing them into economic and noneconomic; objective, i.e., those connected with the transformational recession, and subjective, which can be resolved by available means; and problems of internal and external origin (endogenous and exogenous).

Let us take a look at these problems from different angles.

Internal Economic Factors

1. Transitivity. Together with the other republics of the former socialist camp, Azerbaijan has twice in the course of a century served as a testing ground for nationwide economic experiments: a massive nationalization of property in the 1920s and a diametrically opposite process in the final decade of the past century. Both these phenomena were unprecedented in human history. Hence the objectively conditioned economic cataclysms, which the well-known economist Janos Kornai has called a transformational recession.1 But these processes should not be identified with the mistakes or deliberate actions of governments, which are in the habit of attributing their own incompetence or unscrupulousness to the transition period. The same can be said of some international organizations and individual experts, who do not deny the miscalculations made with respect to the aforesaid countries in different periods. In this context, it is necessary to take the following measures:

(a) To establish the countrys transitivity criteria and set the time horizons for the transition process. This task is not a simple one, but the confusion resulting from the arbitrary use of the term transition period by representatives of different professions makes it clear that we have to resolve it as a matter of principle. Experience shows that the said time horizons must be differentiated for various areas of socioeconomic reform: property relations, economic development level, democratization of society, living standards, etc. In terms of many parameters, they may differ from country to country. The existence of such indicators will serve as a reference point for society in general and for responsible government bodies in particular, and will also facilitate public control over their activities.

(b) To distinguish between the objective and subjective aspects of social and economic recession. In the first group we include the lack of market skills among the population, low competitiveness of products due to the use of extensive technologies in the Soviet period, the initial lack of market infrastructure enterprises (such as supply and marketing, credit, consulting and other organizations in the countryside), etc. This group also includes certain external circumstances which do not depend on the government. On the other hand, actions (or inaction) of the countrys leadership that have entailed negative consequences must be classified as mistakes. Let us examine some of these mistakes of an economic nature.

To begin with, let us note three important points. First, many of these mistakes were probably inevitable in the early years of independence of the new countries. Second, widespread corruption is the main scourge of the post-Soviet states, and unless it is eliminated all economic and other reforms are doomed to failure. Third, the monopolization of the key sectors of Azerbaijans economy is one of the main obstacles to its development.

2. The states withdrawal from economic governance. This is a very serious mistake made by the governments of many transition countries, with the whole of society having to pay for that mistake. Some of the facts mentioned by World Bank President James D. Wolfensohn as regards the level of government intervention in the economy are most instructive in this respect. He writes that industrial countries expanded the welfare state and that much of the developing world embraced state-dominated development strategies. The result was a tremendous expansion in the size and reach of government worldwide. State spending now constitutes almost half of total income in the established industrial countries and around a quarter in developing countries.2 That is why even the most ardent advocates of the classical liberal approach do not deny the states major guiding role in this matter. Peter Berger, a well-known U.S. specialist, notes that the experience of East Asia disproves the thesis that extensive government intervention in the economy is incompatible with successful capitalist development.3

Most infrastructure sectors (transport, energy, etc.) cannot develop without government support. Such a state of affairs is mostly characteristic of problem economies, in which foreign investments are limited in view of the unstable political and economic situation, while domestic resources are either in short supply or their owners do not want to take the risk either for the same or for other reasons. World experience shows that in such cases the burden of public works is shouldered by the state and that this can stimulate economic prosperity (multiplier effect). In addition, the EU states have taken an active part in the establishment of large vertically integrated structures, financial institutions and other infrastructure facilities in the form of mixed enterprises. Finally, the funding of scientific research is an immediate duty of the state, especially since in contrast to the developed countries the few existing monopoly and oligopoly structures in transition economies can hardly be expected to engage in such activities in the near future. In Azerbaijan, where over 70% of GDP is produced in the capital and its suburbs, public works are particularly important in rural areas also for the following reasons: (a) it is known that in most developed countries a majority of rural dwellers, even those employed in farming, receive their main income outside that sector; (b) public works designed to upgrade the agrarian infrastructure (building of roads, water storage lakes, electric power stations, irrigation facilities, etc.) have a direct impact on the development of agriculture.

At the same time, one should note that in market conditions the main instrument of government economic regulation is indicative planning. Consequently, government promotion of structural reforms in the economy calls for a preliminary study and scientific justification of the countrys internal potentialities (with due regard for development trends in the analyzed segments of local and global markets).

3. The economic history of many countries shows that the role of the state in regulating the economy reaches its peak in times of crisis. Such was the case in the days of the Great Depression in the U.S.A. and after World War II in Germany and Japan. Active permanent regulation of the economy is one of the key functions of modern states. Meanwhile, the government of Azerbaijan has put its trust in the magic powers of the invisible hand of the market and has given up economic planning altogether. The negative consequences of such a policy are particularly pronounced in the most conservative agricultural sector, which is of great importance to the republic (in the final years of Soviet power, Azerbaijan accounted for 10% of the U.S.S.R.s total agricultural output). Having been used to centralized supply and procurement, agricultural enterprises entering domestic and foreign markets are confronted with numerous economic, organizational, legal, financial, information, consulting and crime-related problems. Recently established small and medium-sized private farms find it even more difficult to enter the market.

In fact, a combination of all these factors, which are believed to be transient, is what determines the transitional character of the period under review. Small and disunited private farmers, who are new arrivals on the agricultural scene and are used to centralized supply of machinery, seed and fertilizers and to government procurements, have been floundering about in the ocean of the market economy after the government pushed them overboard without a lifebelt. That has resulted in a degradation of the agrarian sector, which is increasingly oriented toward the more primitive branches (livestock, vegetable and grain farming), having abandoned the cultivation of highly profitable industrial and feed crops. In the period of reforms, output and yields fell (from 1990 to 2001) 24 and 2 times for grapes, 7 and 2 times for cotton, 4.5 and 1.7 times for tobacco, and 11.5 and 7.5 times for tea. A similar situation has taken shape in many other branches of the economy, some of which have ceased to exist altogether.

1. One of the manifestations of the policy of maximum economic liberalization is a tough monetarist approach to macroeconomic regulation. Carried away by the fight against inflation, the government seems to have forgotten its main economic mission: to develop the economy through rational structural reforms and integration into the world economic community that would enable the country to realize its competitive advantages in the best possible way. Many local economists regard restrictive monetary policy as one of the main sources of regress in the national economy and mass unemployment. Tight monetary policy worsens the situation in the sphere of consumer demand, which has already declined as the result of a fall in household incomes, on the one hand, and a rise in prices, on the other. In these conditions, many enterprises have had to switch to the production of cheap low-quality goods, and this, in turn, undermines their competitive capacity. True, over the past few years there has been a trend toward an improvement in the quality of food products, but even in this relatively well-off industry the situation is far from perfect.

2. Another macroeconomic problem is government debt. Azerbaijans external debt comes to 23% of GDP, which is dangerously close to the critical level for countries of this kind (25%). But with due regard for the government-guaranteed credits obtained for funding oil projects these debts add up to an amount comparable with total GDP. The republics domestic debt has even surpassed the critical level (30% of GDP). Household savings alone lost in savings banks are close to $2 billion.4 If we add to that internal premium bonds, short-term securities and arrears on pensions and wages, we shall find that the situation here is already critical.

3. The government has been making active efforts to hold down the exchange rate of the national currency, which is regarded as a popular measure giving the country an advantage in international trade. But, as the post-default course of events in Russia has shown, for a country with a low level of industry this is by no means a cure-all. Moreover, first, this facilitates the export of raw materials from the country at low prices and, second, hinders the import of modern machinery and technology. Finally, a decline in the import of competing foreign goods as the result of an undervalued exchange rate of the national currency is a temporary phenomenon: in accordance with Le Chateliers Principle, things tend to fall back into place very soon. In Russia, for example, prices in terms of hard currency have already reached their precrisis level. Consequently, exchange rate manipulation leading to social upheavals is not always effective in economic terms, to say nothing of the fact that deviation of exchange rates from purchasing power parity, like any other kind of government intervention, distorts international trade. The only benefit here is the respite that a competent government can turn to good account in order to take measures stimulating rapid growth in promising sectors of the national economy up to a competitive level, at least in domestic markets. But in Azerbaijan, unfortunately, we have seen nothing of the kind.

4. Special note should be taken of the state of affairs in the field of education. The importance of this factor for the countrys economy (not to mention its role in the cultural and ethical development of the nation) is hard to overestimate. According to the endogenous growth theory of Robert Lucas and Paul Romer, in the absence of fixed capital investment over a fairly long period it is possible to increase output per unit of capital through an increase in knowledge. On the other hand, market relations make their own adjustments to the education system, in which an exceptional place belongs to the following factors: general outlook; an ability to answer for the consequences of the measures being taken; an ability to analyze processes, foresee their possible results and make a decision in contingency situations; teamwork skills; a need and ability to keep reading and self-improving. In addition, in times of global change in the production sector particular importance attaches to additional education. The reform of the education system announced in the country cannot resolve not only the newly arisen tasks, but even the problems of the past compounded by recent developments.

5. Finally, a logical consequence (and a cause) of the described approaches to state regulation is the lack of a comprehensive government program of economic development. Its priority lines have not been specified (except for the oil sector), while the plans drawn up for some branches of the economy are largely declarative, since they do not provide for any concrete implementation mechanisms. True, such a state of affairs can partly be explained by the shortage of public funds. But one should also note, first, the possibility of applying in such a situation various low-cost mechanisms of government support for the economy (with due regard for the vast experience gained in this area throughout the world) and, second, the currently inefficient use in the country of allocated and borrowed funds. Such are the reasons for the slow pace of institutional reform which the national economy so badly needs.

Owing to the lack of a systems approach, virtually any stopgap policy (i.e., one-sided measures taken by frequently changing governments) produces no more than a temporary effect while leaving a legacy of painful side effects. Thus, the 60% privileges granted in 1998 to agricultural producers for the purchase of fuels and lubricants led to corruption: the benefit was mostly enjoyed by corrupt officials.

External Factors

1. The main exogenous factor slowing down the development of Azerbaijans economy is undoubtedly the occupation of about 20% of the countrys territory, with several thousand industrial enterprises, educational institutions, fertile agricultural lands and other major facilities. The economy is also burdened by huge government outlays on the maintenance of refugees. These problems constitute Azerbaijans main distinction from other transition countries.

2. At the same time, the liberalization of foreign economic activity has confronted the republic with the problem of competition in domestic markets. Even in potentially competitive branches of the economy locally produced goods have been squeezed out of the market by low-priced imports. Without government protection, foreign investments and low-interest credits domestic producers cannot break the vicious circle. For example, a country which used to be one of Europes major producers of wine products has now become an importer of such products.

3. The current level of cooperation with industrial countries is not conducive to the development of the production sector either. Tied loans made available by the leading states (mostly the U.S.A.) which bind the recipient to purchase specified products in the creditors home country are increasingly reminiscent of Greek gifts. Such an attitude on the part of developed states shows a deliberate attempt to hold back the development of competitive branches of production in the new countries. Back in the past century Latin American economists argued that such a policy pursued by industrial countries is among the main causes of the vicious circle of poverty in the so-called peripheral states.

An incident that occurred in the economic life of Kazakhstan in early 2003 is characteristic in this respect. When the president of that country enacted a law equalizing the possibilities of local and foreign investors (prior to that foreigners had enjoyed privileges for ten years), the latter met that move with annoyance. Even Alan Larson, Under Secretary of State for Economics, Business and Agricultural Affairs, expressed his indignation over the matter, saying that the law was a manifestation of economic nationalism5 and openly calling on the countrys leadership to abandon the adopted course. And that despite the fact, first, that incentives to investment in priority sectors (agriculture, non-primary industries, infrastructure, etc.) were maintained and, second, that local experts described the new law as giving hope for the development of promising branches of the economy. There are many other examples of such aggressive behavior by foreign states and companies.

4. One should also note some aspects of the activities of international organizations that are detrimental to the economies of the new countries. For example, the agreement of the World Trade Organization (WTO) on the agrarian sector provides for special and differentiated treatment of the least developed countries. In 1997, this treatment was applied to Singapore, where per capita income was $32,810, whereas to Kyrgyzstan ($319 per capita in 1995) and Georgia ($665 in 1996) it has not been applied.6 Given such rules of the game, there can be no simple answer to the question of whether it is worthwhile for a country to join the WTO, which requires candidate states to ensure even greater openness of their economy to exporters. The record of other integration groupings shows that the most effective approach is to combine the advantages of the WTO and regional integration. In this respect, an instructive example is set by the EU, which has skillfully protected the interests of the Union against the negative effects of membership in international organizations. Generally speaking, recommendations by highly skilled experts of international organizations have often led to unexpected and sometimes negative results. The reason here is that they ignore the specific features of the national economies, the national mentality and other specific factors which should be taken into account in adapting the experience of foreign countries. For example, a future increase (at the insistence of the IMF) in the prices of energy resources in transition economy countries up to the level of world prices could put domestic producers in a very difficult position, to say nothing of the population at large, whose incomes are incomparable with household incomes in the developed countries. Incidentally, one should note the use of double standards both by international organizations and by the governments of transition countries. In the matter of levies from the population (taxes, duties, prices for the products of natural monopolies, etc.) they tend to use criteria applied to the developed countries, but when it comes to social security and government protection of the population there is a tendency to switch to African standards.

Prospects for International Economic Integration

Among the general integration problems one should first of all note the contradiction between the governments commitments to protect domestic producers and to ensure integration with partner countries. An effective solution of this problem is crucial to the protection of the interests of domestic producers and consumers. Although this problem is common to all states, it is particularly acute in countries with a poorly developed industrial sector, among which one could include the CIS republics.

The determining factor in Azerbaijans economy today is the package of oil contracts signed in 1994 with 33 major oil companies representing 15 leading countries of the world economy. Owing to the implementation of these projects, since 1992 the republic has significantly surpassed the other CIS countries in fixed capital investment (see Table 1), with foreign investments constituting over two-thirds of the total.

Table 1

Fixed Capital Investment (1991 = 100%)






CIS average






share of foreign investments in total volume, %





















































Sources: Sodruzhestvo Nezavisimykh Gosudarstv v 2001 godu, Statistical Yearbook, Moscow, 2002 [].

The high rate of economic growth in Azerbaijan declared by official statistics and international organizations is largely due to capital investments in the oil sector. In 2000 and 2001, 77% and 87.6% of all direct investments went into that sector and its infrastructure.7 Minerals and mineral products constitute an overwhelming part of the countrys exports: 91.5% and 88.9% in 2001 and 2002, respectively.8 These facts are indicative of the Dutch disease that obstructs the development of other branches of the economy in which Azerbaijan has undeniable potential competitive advantages. Let us examine some characteristic manifestations of this phenomenon.

Foreign exchange flowing into the country mostly from the sale of oil and oil products is used in three areas:

(1) Imports. The second place in Azerbaijans relatively diversified imports (19.5%) belongs to mineral products (electrical and household equipment is in first place with 23.8%),9 which means that exported crude oil returns to the country in the form of finished products. Food products are another major import item (14.3%, fourth place), and this includes products of some branches of agriculture and the food industry which hold great promise for the countrys economy.

(2) Local businessmen (just as their foreign colleagues) prefer to invest the petrodollars they have earned into the lucrative oil industry. Residents in possession of easy petrodollars are not interested in investing them in other industries, partly because of low returns, high competitive pressure and high risks, and also because of the incompetence of the new oligarchs in these areas.

Foreign investors from developed countries are also in no hurry to invest in non-oil sectors. Here is a typical example from the agroindustrial sphere. At a time when tea growing in the republic is steadily declining and highly productive tea plantations cultivated by several generations of tea growers are about to disappear altogether, world tea magnates prefer to follow the trodden path, supplying raw materials to the country from Sri Lanka, India and China. As a result, Azerbaijans tea-packing factories utilize a minute part of their capacity in packing imported tea, while the domestic tea growing industry is degrading. There is a similar situation in tobacco, wine and cotton growing and in other branches.

(3) The National Bank of Azerbaijan uses foreign currency going into the treasury to pursue an active interventionist policy in the countrys foreign exchange market in order to maintain the exchange rate of the manat (the republics currency), so reducing the export opportunities of domestic producers.

As we see, the monetary policy followed by diverse market participants limits the development of potentially competitive branches of the economy: imports compete against domestically produced goods, the channeling of investments into the oil industry deflects them from other promising areas, and the artificially maintained stable exchange rate of the local currency reduces export opportunities, which has an adverse effect on the weaker industries in the first place.

So, Azerbaijans international economic ties that have taken shape within the framework of oil projects are far from the traditional format of interstate economic integration, which implies rational mutually beneficial use of the partner countries resources. Moreover, they hinder the countrys effective integration, including integration into regional economic structures.

In these conditions, there are different options for the development of the republics international economic relations. Let us take a look at the most likely ones, which also enjoy a measure of support in society.

1. Integration with developed countries (EU and/or US). Azerbaijan has relatively close contacts with these countries, and also growing trade and other economic ties. The main advantage of such integration is the possibility of quick and easy access to the latest production and management technologies. But there are weighty arguments against that option.

First of all, Turkeys example shows that the EU is not planning to enlarge by admitting countries of the Asian region. Nor should one expect closer multilateral economic contacts with the U.S., which has not been active even within NAFTA (U.S., Canada and Mexico), a more natural regional organization established back in 1994.

On the other hand, in the conditions of tough competition in international markets the hope for access to the latest technological achievements is evidently illusory. At best, easy access will be provided only to obsolete technology.

Consequently, an orientation toward the West may give an initial impetus to economic growth, but subsequent economic development controlled by these countries will be limited to a peripheral level.

2. Integration on an equal footing with a group of countries having a similar level of economic development. The most promising partners here could be the CIS countries, Turkey, Iran, members of the Council for Arab Economic Unity (CAEU), etc. This option can constitute an alternative to the one considered above only if such an alliance aims to achieve the level of the developed countries. Its main advantage is the absence of internal impediments to integration or barriers to economic development, and its shortcoming is unequal competition on the part of the developed countries. Given dynamic development of the new alliance, such competition could pass into open confrontation. In order to accomplish the aforesaid tasks, the coalition should meet certain requirements:

  • The alliance should include several states with a high potential of competitive advantages in relation to the developed countries, both in terms of natural resources for production in the real sector and in terms of the skill standards of labor power and intellectual resources.
  • Noneconomic problems within the coalition should not hinder economic integration.
  • The partners should ensure parity in the use of joint achievements in the field of science and technology and in other areas.
  • For the sake of the communitys highest goals (given a certain development level), the stronger countries of the alliance should resign themselves to the role of donor.

However, today there is no international integration grouping in the region fully meeting these requirements. The most realistic prospect is the CIS, in which disintegration processes are on the wane. This is evident, among other things, from Azerbaijans intensifying trade relations with some countries of the Commonwealth, especially with Russia, as confirmed by the dynamics of Azerbaijan imports in recent years (see Table 2).

Table 2

Main Partners for Azerbaijan Imports









Total imports








































United Kingdom















Source: Azerbaijans Foreign Trade Relations.

However, this gives few grounds for optimism. The aforesaid goal cannot be achieved within the framework of trade relations alone. This requires, at the very least, the establishment of a full-fledged common market, which implies the pursuit of a common economic policy in the main areas. The policy of the leading Western powers aimed to draw some countries of the region into their own orbit is not conducive to CIS integration either. But, on the other hand, the recently created Eurasian Economic Space (Belarus, Kazakhstan, Russia and Ukraine), which is open to other countries and which, in contrast to the CIS, is mostly focused on economic rather than political factors, turns these potentialities into a realistic prospect.

3. The difficulties in implementing the aforesaid international integration options induce Azerbaijan to follow a symptomatic foreign economic policy of balanced relations with the West and with Russia while in effect remaining a nonintegrated country. This status appears most likely for the period ahead. Such an approach has certain positive aspects.

  • Devoid of close ties with other countries, such an economy is least susceptible to the influence of crises in these countries. For example, the August 1998 devaluation of the Russian ruble had virtually no effect on Azerbaijans financial markets (its only tangible consequence was an increase in imports from Russia).
  • The country is free from group commitments on a whole range of domestic and foreign policy issues.
  • Membership of an alliance requires additional government expenditures of an organizational character.
  • The republic is spared the effort and expense connected with problems arising in mutual relations within an alliance.
  • The prospects of any alliance are far from obvious.

Such a state of affairs is preferable to hasty integration. In addition, as we noted above, Azerbaijan has no valid program of economic development required to outline the contours of foreign economic cooperation.

At the same time, all these advantages of economic neutrality cannot compensate its main disadvantage. The point is that Azerbaijan, despite its huge economic potential, is a small state in need of stable long-term economic ties. They are necessary, first, for guaranteed realization of initially noncompetitive but promising domestic products and, second, for equally guaranteed imports in order to avoid ineffective import substitution.

There are two main ways of developing integration processes. The first is technological, aimed at expanding production and cutting costs. In this case, cooperation develops mostly between enterprises. Technological integration engenders such organizational forms as horizontal and vertical cooperation, joint ventures, international holding companies, transnational corporations, etc. The second way is economic, which means the implementation of infrastructure measures ensuring both production growth and production efficiency. It implies a pooling of material, financial, labor and intellectual resources, with a mutual adjustment of national economies and legislations on terms agreed by the parties. The main driving force behind this kind of integration is the state.

To sum up the above, one could say that the government of Azerbaijan faces two crucial tasks, interconnected and complementary. First, to identify the priority branches of the economy and to draw up a comprehensive program for its development. And second, to set the reference points for sustained and rational foreign economic integration based on the principles of parity and mutually beneficial use of competitive advantages.

In addressing these and other problems, the state should play a part that would enable it, first and foremost, to rule out or minimize traditional negative phenomena (corruption, undue lobbying, etc.); second, to focus the governments attention on the most effective use of resources, both domestic and those of the partner countries; and third, to make use, as a rule, of indicative methods of governance while applying directive methods only as an exception.

1 Janos Kornai, Sistemnaia paradigma [The System Paradigm], Voprosy ekonomiki, No. 4, 2002, pp. 4-22.
2 See: James D. Wolfensohn, Gosudarstvo v meniaiushchemsia mire [World Bank Report 1997. The State in a Changing World], Voprosy ekonomiki, No. 7, 1997, p. 7.
3 See: C. Jackson Grayson Jr. & Carla ODell, Amerikanski menedzhment na poroge XXI veka [American Business: A Two-Minute Warning. Ten Changes Managers Must Make to Survive into the 21st Century], Ekonomika Publishers, Moscow, 1991, p. 312.
4 See: Ieni musavat, 14 March, 2003.
5 See: Nezavisimaia gazeta, 16 January, 2003, p. 5.
6 See: E.N. Krylatykh, O.G. Strokova, Agrarnye aspekty vstuplenia stran SNG v VTO, in: Entsiklopedia rossiiskikh dereven, Moscow, 2002. Transactions of VIAPI RASKhN (All-Russia Institute of Agrarian Problems and Informatics, Russian Academy of Agricultural Sciences), Issue 6.
7 See: Natsionalniy bank Azerbaidzhana. Godovoi otchot 2001, Baku, 2002.
8 See: Azerbaijans Foreign Trade Relations. January-December 2002, Azerbaijan State Statistics Committee, Baku, 2003 (in Azeri).
9 [] (data for 2001).

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