Introduction
Foreign capital's sudden interest in the extensive natural resources of
post communist states and the hopes of economic and political development
attached to it have brought to surface the long standing debate about the
effects of external capital inflows on political regimes. With a
macroeconomic crisis inherited from the Soviet state and the prominence of
state building, the structural power of foreign capital became especially
decisive in shaping both the economic and political trajectories of these
states. Azerbaijan and Kazakhstan, who based their projections of growth
on their oil resources, are especially vulnerable to foreign capital and
are likely to see its effects on their political systems faster than any
other in this region. Hence, whether or not foreign investment in oil is
creating an environment conducive to democracy in these states is the
question this paper seeks to answer.
The effect of external capital inflows on political structures is a
salient issue in the political economy literature. Some have argued that
external capital by disciplining the business environment and promoting
institution-building helps to curb the discretionary power of
authoritarian governments, advancing the democratic cause . The basic
reasoning behind this is the need for credibility to attract foreign
capital. Governments that are dependent on external capital will
deliberately limit their own sovereignty over economic policy in order to
win the confidence of potential investors. This will not only reduce state
discretion but will cut patronage , discourage rent seeking and strengthen
guarantees on private property rights.
Apart from enhancing the accountability of governments, foreign capital
inflows are also said to change state-society relations, often promoting
pluralism by affecting the composition , vitality and political character
of entrepreneurial groups and capital accumulation in the private sector .
As it is predicted in the modernization theory, such creation of
autonomous sources of power within the society produces a more variegated
society whose structural features are conducive to democracy.
However, this positive relationship between external capital flow and
democracy is not very straightforward. As suggested by several scholars,
the international pressures and constraints faced by governments vary by
asset type, risk structure, access to local information and number of
investors . Hence, different kinds of capital inflows have differential
effects on state institutions and balance of power in the society.
International investors in government bonds or equities, for example, can
normally sell them immediately on news of an unfavorable change in the
policy environment. It is this liquidity which increases pressure on
political leaders who desire international investment to reduce their
discretionary power. Foreign direct investment (FDI) , on the other hand ,
is the least responsive to changes in the general macroeconomic policy
environment since foreign direct investment cannot be quickly liquidated
and foreign investors will find their influence over policy limited once
they have invested in physical plant . Hence, FDIs' role in promoting
institution-building is confined to areas relating directly to the
security and profitability of their investment.
Moreover, the interests of foreign direct investment vis-`-vis recipient
countries are likely to be somewhat heterogeneous, depending on the sector
they operate in. A foreign investment in an extractive industry, such as
oil , has a different impact on the political structure since oil rents
and revenues are highly centralized and accrue directly to the state,
which then distributes or invests them. Hence, the degree of government
control is of crucial importance here. "Unlike welfare states, which are
'redistributive', rentier states do not exist by extracting surplus from
the local population" because oil revenues enable governments to stop
taxing altogether . These characteristics have two impacts on prospects
for democracy. With no revenue-gathering motive, these states are
financially autonomous from their citizenry and therefore are not
accountable to it. Second, "the state not only reorganizes or promotes,
encourages or disbands existing occupational groups but actually creates
entire sectors." Access to state-managed capital inflows alters not
only the resources that different domestic groups bring to bear on
struggles for political and economic power but even their ability to
engage in such contests, thus destroying pluralism that is necessary for
democracy.
The Argument
Taking all these theoretical arguments into consideration, I make the
argument that, in the case of Azerbaijan and Kazakhstan, where most of
the capital inflow has been through foreign direct investment and in oil
sector particularly, the chances that globalization of capital will
advance the democratic cause are very dim. Given the strategic nature
of the oil industry, the accumulation and allocation of external capital
are being 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 it also hinders
the socioeconomic differentiation that is crucial for democracy.
In this paper, I do not propose that foreign investors have certain
preferences for a certain regime type or lobby for certain political
objectives. In fact most studies have shown that as long as there is
political stability and legal protection of private capital, foreign
direct investment is indifferent to regime type. Therefore, instead of the
intentions of foreign capital, I am interested in the political
environment such inflows create. One way to analyze the political
consequences of foreign capital is to observe how the resource wealth is
allocated. Although, 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, the type of financial system that is
created is a good indicator of the government machinery that will manage
the oil wealth in the future.
Therefore, in this paper, the financial system is taken as an intervening
variable through which external capital inflows are channeled into
clusters of political power by ways of credit allocation. Examining and
comparing the financial systems of these countries will offer us "refined
indicators of the structural power of private capital and hence of the
potential for business lobbies to push for greater government
accountability."
Azerbaijan and Kazakhstan, with substantial oil reserves, depend on
external capital inflows as the engine for their economic and political
development. Especially because their state building coincides with
extensive foreign capital inflows, they provide a suitable setting to
study this relationship between foreign capital and regime type. Although
with very little variation, they can be compared in two grounds: the type
(and distribution) of external capital and the degree of financial
liberalization. Kazakhstan, with relatively less dependence on foreign
direct investment and more financial liberalization seems more conducive
to democracy than Azerbaijan. However, by making this argument, I do not
mean to downplay the importance of other factors that affect the chances
for democracy. Especially in these countries, ethnic composition, clan and
kinship relations, the type of institutions, electoral systems and civil
society all play an important role in shaping the prospects for democracy.
Moreover, it is difficult to predict at this moment how Kazakhstan will
develop-whether along democratic lines or through a reassertion of
authoritarian rule and personal power. Hence, despite new reforms that are
aimed at curbing state power and enhancing the development of autonomous
sources of power within the society, it is still too early to assess the
success of these reforms.
KAZAKHSTAN
Kazakhstan has declared its sovereignty from the Soviet Union on October
25, 1990 and became an independent country on December 16, 1991.
Disintegration of the Soviet Union, which put an end to dictates from a
single center made possible an economic transformation and created new
opportunities for access to world markets and the development of economic
cooperation with other countries.
Kazakhstan is richly endowed with oil, gas, and mineral resources,
including gold, iron ore, coal, copper, chrome, wolfram and zinc. The
extractive branch accounts for 30%of all industrial output but
manufacturing branches , by contrast, are far less developed (6.4%). The
industrial sector is largely geared towards developing Kazakhstan's rich
natural resource base. The country also has a vast area of arable land,
with agricultural sector's share of GDP at an estimated 15% .
The disintegration of the Soviet Union led to a breakdown of the all-union
Soviet market, which had negative repercussions for the economy in all of
the newly independent states. Dissolution of the USSR was in fact a
principal reason for the very sharp fall in production, which was
particularly intense in Kazakhstan. The economic slump resulted directly
from the fact that the republic was strongly oriented towards the
production of raw materials and thus heavily dependent on the other Soviet
republics for other goods.
External Capital Inflows
In order to begin a comprehensive structural reform program aimed at
moving toward a market economy, Kazakhstan attracted substantial foreign
capital. Only in 1997, the total amount of foreign capital entering the
country has been 2.5 billion. Of this amount 51% has been in the form of
foreign direct investment (40% of which is in oil industry) and 46% in the
form of official (16%) and private credits(30%). The composition of
external resource flows is significant in that they allow for comparisons
in their effects on government strategies. For example, while in
Kazakhstan official and private loans(46%) have by explicit and implicit
conditionalities pressured the government to signal creditworthiness, in
Azerbaijan official and private loans with only 4% of the total foreign
capital have given considerable leeway to the government. Moreover, the
structural power of foreign capital in shaping government strategies has
been relatively stronger in Kazakhstan with foreign direct investment
amounting to only 51% of the total , as compared to 87% in Azerbaijan .
Kazakhstan has been quite successful in attracting foreign capital through
macroeconomic reforms since 1994. Inflation has dropped from an annual
rate of 1,1605 in 1994 to 29% in 1996 and only 11% in 1997. After falling
sharply in the initial years, output stabilized in 1996 and began to grow
again. In 1996, GDP growth was estimated as 0.5% and in 1997 as 2% . In
addition, by the end of 1997, majority shares of virtually all of eligible
small and medium sized enterprises had been sold; share packages in most
enterprises for mass privatization had been offered and all but a few of
2000 state and collective farms had been privatized. As of 1997,
substantial equity ownership in two of the three Kazakhstani oil
refineries and most of the large state oil companies have been transferred
to foreign operators. Moreover, 204 large industrial enterprises producing
over 80% of industrial output have been privatized with foreign buyers
numbering heavily among the new owners . Finally, the central bank
charter adopted in 1994 guaranteed the independence of the central bank
and limited the credit extended to the government to three months.
Furthermore, starting from 1998, the National Bank of Kazakhstan will no
longer extend credit to finance the budget deficit, hence strengthening
the securities market in the country . In addition, NBK has allowed the
national currency (tenge) to float; the tenge is fully convertible with
the US dollar and has been falling only 2.8% against the dollar in 1997.
Apart from these macroeconomic reforms to bolster its creditworthiness,
Kazakhstan took many steps to strengthen its investment environment. This
is mostly because Kazakhstan has depended heavily on oil privatization
revenue as a major source of funding for its internal development. As of
1997, foreign firms had invested about 2 billion in the industry and
committed an additional $40 billion. Furthermore, the development of the
offshore deposits could bring an additional $100 billion in investment .
Among the legislation to improve foreign investment climate, some are as
follows: 1)Introduction of a new tax code in 1995, under which natural
resource taxes are negotiable on a contract by contract basis, 2) the
establishment of the State Committee on Investments in 1996 to support
investments and a favorable investment climate , 3) State Support of
Direct Investments in 1997 to provide legal protections for investors and
their contracts, 4) Amendments in summer 1997 to the 1994 Foreign
Investment Law to provide tax privileges in priority sectors of the
economy and clarify settlement of investment disputes, 5) Criminal Code
with Article 184, which provides fines and punishment for violation of
Intellectual Property Rights, 6) Law on Joint Stock Companies in 1998 and
7) application for WTO membership to provide foreign investors with the
consistency expected as a result of the WTO's trade-related measures .
However, despite a certain institutional discipline FDI inflicts on the
government, its role in promoting institution-building remains confined to
areas relating directly to the security and profitability of the
investment. The government of Kazakhstan still remains both an implicit
and explicit player in attracting foreign investment. Foreign investment
proposals are screened by government officials, sometimes at the highest
level. Major projects, such as the Caspian offshore production sharing
agreement bear the President's personal imprimatur, often with
non-transparent decision-making. Furthermore, government directs foreign
investment to priority sectors by means of incentives and alters not only
the resources that different domestic groups bring to bear on struggles
for political and economic power but even their ability to engage in such
contests, thus destroying pluralism that is necessary for democracy.
Finally, the fact that foreign firms are able to purchase a significant
part of the stock in enterprises can have the effect of excluding the
country's own entrepreneurs from its national resources and retarding the
growth of its own pool of managers.
Although an authoritarian type regime has proven effective in attracting
foreign investment both in Azerbaijan and Kazakhstan, the centralized
control of such huge amounts of capital do not bode well for the future of
democracy in these states. One needs to look at the financial system to
depict the ways governments channel these external capital inflows into
sources of political power by means of credit allocation. Political
elites whose interests are firmly rooted in existing economic
bureaucracies or state-owned enterprises are often unwilling to liberalize
their financial systems so as not to create autonomous sources of power
that can challenge them. With 87% of its total foreign capital inflows in
FDI, Azerbaijan has been less willing to liberalize its financial system.
Kazakhstan, on the other hand, due to falling oil prices, inadequate
transport links for its oil and probably for domestic reasons that are not
explored here, has chosen to diversify its sources of foreign capital and
engaged in a more extensive financial liberalization. Albeit with small
steps and unwillingness on the part of the persistent elite, Kazakhstan
is creating a vibrant economic society conducive to democracy. The
personnel changes and government reorganizations of 1997 and 1998 where
older bureaucrats have been replaced with younger reform-minded appointees
to senior government posts is a clear example of this positive change .
Financial System
Kazakhstan's banking industry was created on the basis of a law
enacted in April 1993. That law created a two-tiered system with the
National Bank of Kazakhstan ,charged with overall supervision of all banks
in the country, and the second tier commercial banks. The introduction
of a modern banking system has not progressed smoothly however. Scandals
have involved swindles by bank employees, questionable loans and the
maintenance of heavy portfolios of nonproductive loans. Several bank
failure scares have also occurred.
As a result, major modifications of banking regulations have been
introduced several times. In June 1994, Kazakhstan instituted a
fifteen-month program of financial and economic reform, tightening banking
and credit laws, liberalizing price policies and ending the granting of
credits to state-owned institutions. Another reform was introduced in
March 1995 in order to tighten regulation of capital requirements and to
increase the professionalism of the existing bank's operations .
In 1994 five large, state-owned banks controlled 80% of financial assets.
Of the 200 small commercial banks in operation in 1994, the majority were
initially owned by state-owned enterprises but the privatization of these
enterprises in 1995 made these banks largely private. With the withdrawal
of more than 120 bank licenses since, the number of banks in the country
stood at 76. By March 1998, five out of these 76 functioning banks were
state banks, one was an interstate bank and 22 were banks with foreign
participation (12.9% of the total assets) As a result of a policy of
reducing the state's interest in the charter capital of banks, several of
the state banks have been fully or partially privatized. State-owned
Turan-Alem, one of the country's largest banks, was sold to a consortium
of local investors in March 1998. At the same time the government sold
18% of its shares in Halyk Savings Bank, Kazakhstan's largest bank., with
an intention to lower its stake to a minority interest by 2001. In
addition, the state-owned Eximbank has been corporatized, exchange of the
state's interest in the Kazagroprombank is completed and privatization of
the Zhilstroybank by tender will occur in second half of 1998 .
Assets of the banking system comprised 169.0 billion tenge by the end of
1997 compared to 141 billion tenge by the end of 1996. The largest share
in the asset composition belongs to net lending (48%), investments into
government securities (16%), currency and deposits with the NBK (13%) and
deposits with banks and other assets (6% each category). The general
analysis of the asset mix shows that financial stabilization has resulted
in a decrease of the relative importance of currency and bank deposits,
including correspondent accounts balances, relative to total assets (21%
in 1997 as opposed to 28% in 1996). Concurrently, the amount of funds
placed in loans and government securities increased. Nonetheless, the
composition reflects the general underdevelopment of the national
financial markets and insufficient degree of financial and banking
intermediation .
Although commercial lending has been low due to high interest rates, this
past year loans to nonfinancial enterprises and organizations increased by
18.1% to a figure of 71.9 billion tenge, of which 41.8 billion tenge (58%)
were tenge loans. Short term lending increased by 39.9% and medium-long
term lending increased by 18.6 %. Medium-and long-term loans in national
currency accounted for 12% of the credit extended, foreign exchange loans
accounted for 42% and short-term credits in national currency accounted
for 46%. In addition, credit to small businesses was 43% of the total
foreign exchange loans and 57% of the total tenge-dominated loans.
Meanwhile, the volume of lending to households increased last year by
88.3% .
Although commercial bank loans are the major source of financing for local
capitalists, unlike Azerbaijan, there are increasingly alternative sources
of financing available for both local and foreign investors. For example,
starting in 1996, the government securities market began dominating
financial markets of Kazakhstan. 95 auctions were held last year to float
government securities totaling 53.5 billion tenge, which exceeded the
volume of government treasury bonds placed in 1996 by a factor of 1.8. In
1996-97, the demand for government securities regularly exceeded supply.
The investors' share increased from 21.7% in 1996 to 26.7% in 1997.
Despite the relatively low yield and the consequences of the Asian
financial crisis in late 1997, foreigners' share in the total volume of
all issued government securities increased from 2.4% in 1996 to 9% in
1997.
In addition to the securities market, in 1997, the preconditions for the
appearance of full-fledged institutional investors were created. The
State Pension Savings Fund and five non-state pension savings funds were
set up pursuant to the Law "On Pension System in the Republic of
Kazakhstan." Moreover, the adoption of the Investment Funds Law launched
the process of transforming investment privatization funds (IPFs) into
investment funds, and emergence of mutual funds and investment companies .
Of all the financial liberalization reforms, development of a stock market
is a major step in curbing the power of the state and creating local
capitalists because "as the capital pie expands, governments may become
less able to control its allocation either directly through public sector
banks or indirectly through their crony capitalist conglomerates."
Although largely inactive since its founding in September 1996,
Kazakhstan's stock market nevertheless promises to be a source of
alternative financing for local and foreign investors. So far 28
non-governmental securities, including 14 so called "blue chip" securities
were accepted for trading at the exchange . Notwithstanding certain
problems arising in connection with the financial crisis in Asia, there
are strong grounds for believing that the "Blue Chips" program will be
implemented successfully, Kazakhstan will derive maximum income from the
sale of state interests and sale of state interests at the stock exchange
will have a positive impact on the development of an active entrepreneur
class in the society.
Conclusion
In the aftermath of the dissolution of the Soviet empire, the
newly independent states engaged in a state building rhetoric with
foremost emphasis on economic development. Against a background of
ceaseless social and economic crisis and criminalization of the economy
and and society at large, ruling elites have attempted to justify the
reestablishment of an authoritarian regime during the transition period.
They would do so under the pretext of restoring law and order by means of
powerful presidential authority. In both Azerbaijan and Kazakhstan, the
presidents bypassing the legislature and judiciary, ruled the country by
presidential decrees. Adopting the economics first approach, Nazarbaev has
himself claimed that "the path from totalitarianism to democracy lies
through authoritarianism."
However, given the type of external capital inflow, the idea that
'authoritarian regimes promoting economic prosperity are more likely to
give way eventually to democratic regimes' is questionable. As it is
claimed in this paper, to the extent that countries relied heavily on
foreign direct investment in their extractive industries, the old
authoritarian elites have clung to power, "engaging in a rhetoric of
economic and political liberalization and co-opting foreign as well as
local capitalists into their patronage networks."
Although it is fairly difficult to compare Azerbaijan and Kazakhstan in
terms of their degree of democraticness, one can still see the emergence
of certain patterns that may inform us about the future trajectories of
these states. Although with little variation, Kazakhstan differs from
Azerbaijan both in the level of reliance on foreign direct investment and
the degree of financial liberalization. To the extent that Kazakhstan has
been successful in diversifying its alternative sources of foreign
capital, the alternative sources of financing for local capitalists have
diversified as well , making it difficult for the state to control the
political order by credit allocation. At least if not extensively at the
moment, Kazakhstan has created the opportunities for greater
accountability on the part of the government and more pluralism of the
society. Controlling for other factors in affecting democratization, I
may conclude that the retreat of the state from the economy creates an
environment conducive to democracy in Kazakhstan.
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