INTRODUCTION
The sudden appearance of 15 independent states from the wreckage of the
collapsed Soviet state at the end of 1991 has once again brought to
surface the debates over the necessity of neoliberal economic reforms for
the consolidation of democracy. Those who support the findings of the
modernization theory argue that an economic reform which would lead to
economic growth and higher standards of living is a critical prerequisite
for the successful consolidation of democracy in these countries. The
opponents of neoliberal reforms, on the other hand, emphasize that their
extremely high social and political costs would not only doom the reforms
but also undermine the fragile democracies which launch them.
Furthermore, the political elites whose interests have been firmly rooted
in these existing economic bureaucracies or state-owned enterprises could
design and implement these reforms in ways that undermine the
accountability and responsiveness of the government that is inherent to
democracy.
The immediate legacy of the disintegration of the Soviet state was a
macroeconomic crisis in each country, requiring the inexperienced new
governments and bureaucracies to formulate policies to deal with
collapsing consumer markets, rapidly accelerating inflation, failing
production, foreign trade and living standards and looming financial
collapse. With these structural legacies in the background, access to
foreign capital became very important, almost indispensable for the
leaders of these countries in pursuing economic growth. That is probably
why one of the first legislative acts adopted by these states after they
became independent was the law on protection of foreign investments.
Especially for the states that based their projections of growth on
extensive energy resources, the structural power of foreign capital became
decisive in shaping both the economy and the regime type.
Therefore, my first assumption is that the role of outside actors has been
strongly influential, even decisive in shaping and sustaining the ongoing
transformation process by either enhancing or eroding the capacity of the
state .Hence specifically, I aim to analyze the extent to which foreign
direct investment in the oil industry undermines or enables democracy.
Azerbaijan, where international oil contracts contributed to 80% of the
1996 foreign investment figure and where foreign investment provides over
70% of the total investment in the economy is a pertinent case to study
this relationship between foreign capital and regime type.
However, the picture I'm looking at is not that simple and
straightforward. On the one hand, given the type of foreign capital flow
and the particularities of the oil sector, one is likely to argue that
such economic growth does not necessarily translate itself into an
expansion of the middle classes , the accountability and responsiveness of
the government , the political liberalization of the society and thus to
democracy as the modernization theory predicts. First of all, foreign
direct investment, as opposed to other foreign capital flows to these
countries (such as bilateral and multilateral assistance) is non-debt
creating and directly linked to investment. In addition, it is a way to
import technology and know-how and it can facilitate exports . However,
foreign investment is not based on conditionalities and as long as there
is political stability, it is indifferent to regime type. In fact one may
even go further as to argue that authoritarian regimes in these states are
more preferable to foreign oil companies than feeble and unstable
democracies. Moreover, given the isolated and strategic nature of the oil
industry, the accumulation and allocation of profits are controlled by a
few persisting elites from the communist era with entrenched interests in
the existing power structures. This concentration of wealth in one
booming sector not only promotes excessive rent-seeking behavior and
inefficient use of resources but also hinders the socioeconomic
differentiation that is crucial for democracy.
On the other hand, although political elites pursue reforms in ways that
are compatible with their entrenched bureaucratic interests, they are also
constrained by the explicit and implicit conditionalities that are imposed
by foreign capital. Furthermore, these leaders seem to acknowledge that
oil growth could be an enormous opportunity to cement their independence,
to accelerate economic development and to build inter-regional ties. Given
that the developing world is strewn with countries where sudden
natural-resource booms turned out to hinder rather than help growth, these
elites cannot afford to create predatory states. The macroeconomic and
structural reforms that are being undertaken in the recent years confirm
the developmental incentives of these states . As much as these
authoritarian elites want to hold on to power, the unintended consequences
of economic reforms may be more political liberalization and
democratization of the state.
The effect of foreign capital on regime type is contingent upon how the
resource wealth is managed. Apparently, it is still too early to come to a
conclusion about resource wealth with only early oil production in
progress and relatively little accumulation of wealth. However, an
analysis of the government machinery in preventing the so called 'Dutch
Disease' will hopefully provide me with enough information to test my
argument . The general trend of the economy, structure of the non-oil
sectors, financial-sector reforms , and the structural power of private
capital ,even in this early stage, can tell us a lot about the
relationship between foreign capital and regime type.
AZERBAIJAN
Political Background
Azerbaijan became an independent republic in 1991. Until then, except a
brief period of independence between 1918-20, Azerbaijan was a full Union
Republic in the USSR. It was incorporated into the Soviet economic system
with its specialized role being oil production. Nevertheless, despite the
industrial development and urbanization, income levels in Azerbaijan were
the lowest in the USSR outside Central Asia.
During the Brezhnev era, Azerbaijan exhibited the quasi-feudal
characteristics seen in other southern republics of USSR. Geidar Aliyev
ran the republic as a personal fief from 1969 to 1987. Although being one
of the first republics to declare independence , the political apparatus
did not differ much from the Soviet rule. This time with different status
and titles, a handful of elites ruling the country continued holding on to
power. The obvious being Aliyev, who before re-imaging himself as an
Azerbaijani nationalist was the leading Azerbaijani communist and the
fourth ranking leader in the Soviet Union during the Brezhnev era.
Azerbaijan's system of government grants broad powers to the President.
President Aliev came to power in 1993 when the Popular Front government of
Abulfaz Elchibey fell when a warlord from central Azerbaijan marched on
Baku. After several coups in 1994-95, Azerbaijan's political system has
remained stable for the past two years. The elected parliament closely
follows initiatives from the President's office.
Elections for that parliament in November 1995 were marred by widespread
irregularities. The President's New Azerbaijan Party, other parties loyal
to the President and independent deputies loyal to the president have an
overwhelming majority in the parliament. Opposition parties have less than
10 percent of parliamentary seats but criticize the government openly and
maintain a lively but partially censored, opposition press . The coming
elections this week is sure to reinforce Aliyev's power for another term.
Although most Central Asian countries have elected presidents and
parliaments, the elections have neither consolidated nor legitimized the
current political leadership. The countries have strong leaders but weak
governments with only embryonic democratic institutions. Widespread
corruption plagues the governments, causing cynicism among the rulers and
a sense of hopelessness and apathy among the ruled.
The Economy
It is oil that dominates the Azerbaijan economy and is the industry on
which hopes for a richer future are pinned . Azerbaijan's proven oil
reserves are about 3 billion barrels. Some experts put ultimate potential
as high as 40 billion barrels. It is one of the oldest oil producing
regions of the world, but like most of the FSU, its industry suffers from
outdated technology and poor planning which have resulted in
underproduction, waste and severe environmental degradation.
The development of Azerbaijan's economy will be largely driven by the
activities of foreign oil companies which are signing production sharing
agreements with the government. Azerbaijani oil production is forecast to
peak at between 1.5 and 2 million barrels per day between 2010 and 2015.
Oil revenues are projected to be roughly over $80 billion over the thirty
year life of the Azerbaijan International Operating Company (AIOC) and the
Azerbaijani government will realize 80% of these revenues . Hence, steps
have been taken by the government to produce an environment conducive to
foreign investment. These include the Law on Protection of Foreign
Investments(1992) and certain tax incentives which reduce corporate taxes
on foreign shares of profits. As a result foreign direct investment has
increased from $15 million in 1993 to $545.5 million in 1996.
The economic and political future of Azerbaijan depends on how the
government of Azerbaijan proceeds with economic reform and uses the
revenue from Azerbaijan's energy sectors. One way to promote growth is by
improving productivity in industry and agriculture, both through
privatization and restructuring. The other is by encouraging savings
through macroeconomic reforms. Another is by reforming the financial
system that will play a critical role in a decentralized system of
mobilization and allocation of resources. And finally by reforming the
public sector and setting up transparent systems to deal with oil wealth.
Non-Oil Sectors
The main sections of the Azerbaijani economy are the branches of heavy
industry and industry on the whole. More than half of the national
gross-production is created in industry. Heavy industry consists of :
petroleum extraction and refining equipment, metallurgy, aliminium mining
and refining, petrochemicals and chemicals production. Light industry
consists of food processing, textiles and wine production. While
industrial production grew during the 1980's, by 1989-1990 it began to
slow. By 1992, output has declined by 50% in the petrochemicals and
machine-building industries, with less dramatic decline in the light and
food industries . Azerbaijan's dependence on neighboring Soviet
Republics for raw materials is a significant factor in this slowdown.
With about 37% of the labor force, agriculture is a critically
important sector for Azerbaijan. Cotton is its leading cash crop,
followed by wine grapes, fruits, vegetables and tobacco. Much of that
production, however, never gets to foreign markets because the dissolution
of the SU deprived it of a huge portion of its market and its development
was further undercut by wartime blockades. According to the new
legislation(early 1997) on the privatization of agriculture 45% of arable
land will belong to the government, 33% will belong to municipalities and
22% will become private land . The government's overall agricultural
policy aims at the creation of a market-oriented agricultural sector. In
this regard, complete liberalization in output prices of perishable
products has taken place, which has led to their production
taking place almost exclusively in the private sector. Yet this is a good
example of the superficiality and insignificance of legal status changing
if substantial financing is absent. With inadequate financial system, the
people to whom the land has been returned have no resources to farm it
Macroeconomic Stabilization
The Azerbaijani economy declined significantly after the country became
independent in 1991. Factors causing this decline were: the war with
Armenia over Nagarno-Karabakh, the disruption of trade ties within the
former Soviet Union and the collapse of large parts of the state
manufacturing sector. Improvement has been noted in GDP growth , the
decline of which has slowed since its low point in 1993. Real GDP fell by
23% in 1993, 22% in 1994, 17% in 1995 and only 0.9% for the first 11
months of 1996.
During the last half of 1994, Azerbaijan was on the brink of
hyper-inflation. During November and December of 1994, monthly retail
price increases exceeded 50%. During the last quarter of 1994, the
Government of Azerbaijan worked closely with the IMF on a Structural
Transformation Facility program. The Central Bank tightened credit
policies of state-owned banks and halted interest-free loans to moribund
state enterprises. The Ministry of Finance put together a restrictive
budget for 1995 which Parliament passed. The government also eliminated
huge consumer subsidies on gasoline and bread. As a result, the rate of
retail inflation has fallen dramatically. The consumer price inflation
has continued to decline from a high of 1664% in 1994 to 412% in 1995 and
19% in 1996 .
Economic reforms have continued over the past two years, supported
first by a stand-by arrangement with the IMF in 1996 and then by a three
year arrangement under both the extended Fund facility and the enhanced
structural adjustment facility. The reform program has also been
supported by the World Bank, including through a structural adjustment
credit. Macroeconomic policies have achieved a rapid stabilization of the
economy. The general government deficit amounted to 1.75% of GDP in 1997
and was significantly lower than expected during the first quarter of
1998. The Azerbaijan National Bank refrained from financing the deficit
through monetary creation and kept the growth of manat reserve money
consistent with low inflation, despite the impact of large capital
inflows.
In response to these policies twelve month consumer price
inflation has been close to zero since
late-1997, while the manat's strength has continued. At the same time,
the recovery gained momentum in 1997 with real GDP growth increasing to
5.75% from 1.25% in 1996, fueled by a surge in foreign direct investment.
In late 1997, exports of the first new-oil production began. The current
account deficit
remained large at 24% of GDP, reflecting imports connected to oil sector
development, but official reserves more than doubled to 16 weeks of import
cover. During the first quarter of 1998 the pace of economic activity
accelerated further, with annual growth rising to around 9%, as the
revival in economic activity spread to both agriculture and industry .
Privatization
Azerbaijan's private sector accounts approximately 30% of GDP and
25% of employment, excluding companies with below 50% private ownership.
However, it is difficult to tally the private sector precisely because of
the unofficial economy, which is projected at 40% of GDP. Private sector
activities include services, construction, trade and agriculture.
Privatization has progressed more successfully at the level of
small-scale enterprises. At a series of cash auctions beginning in March
1996, 4000 small enterprises were sold. The privatization program allowed
citizens, largely employees of shops, trade or service groups, gas
stations, small manufacturing companies and restaurants to obtain legal
confirmation of de facto arrangements. The privatization of these
small-scale enterprises was virtually complete in June 1997. Privatization
of large enterprises has proceeded more slowly. However, the government
mandates that by 1999, some 70% of all enterprises must be privatized.
One other positive note on the attempts of the government to
privatize is the elimination of subsidies to enterprises beginning in
1995, with assistance from the IMF. In addition, an EBRD-assisted
Bankruptcy Law, enacted in 1997, and a Secured Transactions Law will help
ensure financial responsibility on the part of private firms, although it
may mean closure of firms as privatization continues .
Although progressing slowly, there is an attempt on the side of
the government to stabilize the economy. Whether through voluntary
adaptation or as a result of conditionalities, once again we see the
role of international actors in assisting Azerbaijan in its transition to
market economy. The scope and pace
of privatization raises the possibility that a genuine middle class of
small property holders will arise in
Azerbaijan. The socioeconomic differentiation that privatization and
other economic reforms are inducing
may help to produce a more variegated society and one whose structural
features might be more conducive
to the growth of intermediary societal organizations which are
indispensable for democracy.
The Financial System
In the socialist framework, the banking system was used mainly for
distributing, collecting, and controlling the flow of resources based on
central plans. Thus banks did not perform the functions associated with
banks in a market economy- in a centralized planning system, banks were
mainly extensions of different government ministries, performing
budgeting, accounting, treasury and taxation functions.
As in the other transition economies, the financial system in
Azerbaijan is dominated by the banking system. A two-tier banking system
was created in 1992 consisting of the National Bank of Azerbaijan and
commercial banks dominated by 4 specialized state-owned banks. Foreign
banks, although legally permitted, have very limited presence. Of the four
state-owned banks, only International Bank of Azerbaijan is a
fully-functioning commercial bank. The other three are technically
bankrupt, going through a World Bank-designed restructuring program and
are unable to lend money .
The Baku Interbank Currency Exchange holds interbank auctions for foreign
exchange. It also has conducted auctions of Treasury bills for the
Ministry of Finance. No private pension, investment funds, mutual funds
or other non-bank financial institutions exist in Azerbaijan. No stock
markets or security exchanges are in place, although a law regulating them
was passed in 1997.
Measures of financial depth are among the lowest in transition
economies. Broad money as a percent of GDP declined from 79% in 1991 to
14% in 1995- the comparable ratios for OECD and the advanced reformers
among transition economies were 72% and 50 % respectively. Domestic
credit as a percent of GDP in Azerbaijan fell from 36% in 1993 to 13% in
1995.
Local currency outside banks as a percent of Manat broad money has
more than doubled- from 30% in 1992 to 63% in 1995. Distrust of banks is
very high due to the use of banking and payments systems as instruments of
control by the authorities, the fragility of the banking system and the
regulations limiting cash withdrawals .
The banking system is characterized by concentration and fragmentation.
As of 1995, there were
180 banks, of which four were state owned, 10 were majority owned by state
enterprises and the rest were controlled by private investors. The state
owned banks- the Agroprom Bank, the Prominvest Bank, the Savings Bank, and
the International Bank- accounted for 80% of total banking assests, 83% of
total outstanding loans, 82% of deposits, 67% of branches and 70% of
employment in the banking system. While all licensed banks are free to
enter any authorized activity, the state owned banks specialize in certain
sectors (industry, agriculture ) and services (savings depository and
international transactions). The state owned banks lend mainly to state
owned enterprises while the private banks generally focus on private
sector clients.
According to Zysman's typology of financial systems, Azerbaijan
represents a credit-based system in which the allocation of funds are
left to executive discretion. Given the absence of capital markets, firms
must turn to lending institutions for the funds they need. Credit is at
the core of the system of corporate finance and the banking system's
ability to extend industrial credit is therefore critical . Holding
around 80% of the market, public sector banks dominate credit allocation
and the fragmented private sector banks remain locked into the public
oligopoly. Hence, the structural power of local private capital is
minimal, reflecting its fragmentation and subordination to the public
sector . The system resembles a French etatist variety of capitalism.
Although there have been attempts under the guidance of IMF and World
Bank to restructure the banking system, the existence of highly insolvent
state owned banks and distress borrowing from state owned enterprises
create an environment that increases the likelihood of further resource
misallocation. Although the IMF ensured that the early oil bonus payments
and revenues go into a special account in the central bank and are kept in
dollars until they are fed into the budget , the pressure to finance
certain state owned enterprises may incline these states to distribute oil
revenues inefficiently throughout the society in the future.
In addition, the weak structural power of private capital also cripples
the power of the business groups in lobbying for specific policy changes.
Because of few independent resources, business lobbies lack autonomy and
depend largely upon their connections with influential cronies and
political leaders for credit and other favors . This kind of a financial
system not only enhances the power of the state visa via the business
groups but it also prevents accountability of the ruling elites to the
society in large.
CONCLUSION
Azerbaijan is far from being a democracy. It is still ruled by
persisting communist elites and ex-KGB general, Aliyev, in particular.
The prospects for greater accountability on the part of these elites and
for the development of middle classes depend more on foreign capital and
external pressures than anything else. Given the weak structural power of
private capital, flow of foreign capital seems to be the only way to
challenge the existing balance of power within the society, reinforcing
local capitalists and other elements of civil society and curbing the
authoritarian power of the government.
However, the type of foreign capital, mostly being foreign direct
investment in the oil industry, complicates the picture for Azerbaijan.
While loans and grants from international financial institutions call on
the Azerbaijani government to restructure the economy and reinforce market
forces, the foreign direct investment in oil - without any
conditionalities attached to it- provides havens for the ruling elites to
control mobilization and allocation of the economic resources to
entrench their power. The dominance of the state sector , the fragility of
the private sector, burgeoning corruption and rent-seeking behavior of
the state do not bode well for the political trajectory of Azerbaijan.
Hence, resource wealth, if and when accumulated in the near future, may be
a barrier to democracy in this country.
A generation from now, will resource-rich Azerbaijan look more
like Norway or like Nigeria? It all depends on how the Azerbaijani
government copes with the oil revenues. Learning from the experiences of
Venezuela, Ecuador and Nigeria, which became rich overnight but found
their wealth become a curse, Azerbaijan has taken major steps with
assistance from international financial institutions to create a
government machinery to effectively deal with this kind of money. Albeit
incremental, macroeconomic reforms have been relatively successful. The
privatization of small enterprises has created autonomous power sources
within the society and the privatization of large enterprises are under
way. There are also attempts to restructure the non-oil sectors, through
privatization and price liberalizations. Although not implemented yet,
reform of the public sector reform is a priority. Simplification of the
tax and regulatory systems is deemed necessary to provide less
opportunity for corruption.
Therefore, despite this seemingly inverse relationship between oil
revenues and prospects for democracy, Azerbaijan is not destined to stay
this way. Change is still possible and it is possible through foreign
capital. However, the decline in oil prices and abundance of oil resources
today beg the question whether that bonanza will indeed materialize, and
how big it will be.
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