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University of Economics in Prague Faculty of Finance and Accounting

Finance and Accounting

MASTER THESIS

Dutch Disease Effect of Oil and Natural Gas on the Economy of Azerbaijan Republic

Author: Kamil Mammadzada

Supervisor: Ing. Ondřej Šíma, Ph.D.

Academic Year: 2020-2021

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2 Declaration of Authorship

The author hereby declares that he compiled this thesis independently, using only the listed resources and literature, and the thesis has not been used to obtain a different or the same degree. The author grants to University of Economics in Prague permission to reproduce and to distribute copies of this thesis document in whole or in part.

Prague, date

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3 Acknowledgment

I am very grateful to my supervisor, Ondřej Šíma, Ph.D. from the University of Economics in Prague for the help and feedback for finishing my Master Thesis. My years University of Economics in Prague have been wonderful and probably it will reflect to my future career path considering the great foundation my study gave me.

Thank You.

Kamil Mammadzada

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Abstract

In this study, the Dutch disease, the main sectors of the Azerbaijani economy and the impact of the Dutch disease on the economy of Azerbaijan were examined. Thanks to the dense capital structure of the oil sector, the effect of resource allocation, which had the main impact on the Dutch disease, did not materialize. On the other hand, the effect of expenditures appeared as an increase in public expenditures in the Azerbaijani economy. At the same time, the economy of Azerbaijan is heavily dependent on the oil sector. But oil can also quickly disappear if used to meet its short-term needs. Naturally, it is a great advantage if the oil is used reasonably and to secure the long-term interests of the state. The experience of many oil countries shows that besides solving many social problems, a country can also pave the way for a serious economic decline.

From this point of view, if the increase in oil profits seems positive, then its rational use is one of the most important issues. This study reflects the spending direction and investment mechanisms of the State Oil Fund. Various scenarios for investment and their pros and cons were examined.

JEL Classification: Q32, Q33, F41

Key words: Dutch disease, oil sector, non-oil sector, export, investment

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Dutch Disease Effect of Oil and Natural Gas on the Economy of Azerbaijan Republic

Contents

Introduction ... 6

CHAPTER I: NATURAL RESOURCE WEALTH AND ECONOMIC PERFORMANCE: DUTCH DISEASE ... 8

1.1 Dutch Disease Definition and Theory ... 8

1.2 The Macroeconomic Effects of the Dutch Disease ... 12

1.3 Solutions for the Disruptive Effects of the Dutch Disease ... 16

1.4 The Place and Importance of Natural Resources in National Economies in the Context of Dutch Disease ... 19

CHAPTER II: AN OVERVIEW OF THE AZERBAIJANI ECONOMY AND THE COUNTRY'S NATURAL RESOURCE STRUCTURE ... 21

2.1 State of the Azerbaijani Economy Before and After Independence ... 21

2.2 Sectoral Structure of National Economy ... 28

2.3 Natural Resource Reserves of Azerbaijan ... 32

2.4 Development and Current Status of the Oil Industry in Azerbaijan ... 34

2.5 Establishment, Purpose and Economic Effects of Azerbaijan State Oil Fund and Investments Made ... 42

CHAPTER III: LITERATURE REVIEW IN THE CONTEXT OF DUTCH DISEASE, SELECTED COUNTRY EXAMPLES AND AZERBAIJAN ... 47

3.1 Literature Review on Dutch Disease ... 47

3.2 Norway as an example of Dutch Disease ... 50

3.3 Dutch Disease in Azerbaijan ... 54

3.4 The Effective Use of Non-oil Export Potential in the Development of The National Economy. ... 60

CONCLUSION ... 72

REFERENCE LIST ... 76

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Introduction

The effect of natural resource wealth of countries on economic growth is a subject that has been discussed in the literature. Although the surplus of natural resources is thought to lead to rapid growth and wealth, there are examples of fast-growing countries without natural resources, Hong Kong, Japan and Switzerland are the best examples. Contrary to the aforementioned thought, it is seen in the examples of certain countries that the discovered natural resources slow down the economic growth by decreasing the total production instead of increasing the economic growth.

The name of this condition, which is described as an economic disease, in the economics literature is the Dutch Disease. The effect of natural resources on economic growth is explained by two different approaches: first of all, it is accepted that rich natural resource equipment is a boon for the country's economy and the second approach is a misfortune. It is known that countries rich in natural resources show less growth than those with less or no reserves. This situation has come as a source curse in the literature. It should be noted that if the manufacturing industry deteriorates despite overall economic growth, the difference between the source of the disaster and the Dutch disease is the diversification of exports in Dutch disease. Although there is no serious consensus on the direction of the relationship between natural resource wealth and economic growth, there are different perspectives, modern and traditional, towards negative impact.

The negative effect of the Dutch Disease is basically the excessive strengthening of the national currency. On the other hand, economic change may occur in economies due to sudden developments in different sectors. In this context, one of the most common implications for growth is the discovery of new mineral deposits. The overvaluation of the currency becomes harmful in the long term and creates a disruptive effect on economic growth and macroeconomic stability of the country. The name of this effect was Dutch Disease. This disease got its name in relation to natural gas in the north of the Netherlands.

The aim of this study is to test the existence of the Dutch disease in the economy of Azerbaijan and to explain the economic disease in terms of the country's economy with the necessary macroeconomic changes. Having especially rich natural resources, Azerbaijan, which gained its independence after 1991, attracted the attention of many world companies and brought its oil and natural gas to the world market in line with the agreements. The fact that the economic

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development of Azerbaijan, which has been growing rapidly with significant oil revenues, depends on a single sector, is seen as a symptom of the Dutch Disease. In this study, the conceptual foundations of socio-economic development, the competitiveness of Azerbaijan in the world market, as well as the negative effects of the decline in world oil prices, and the strategic views and mechanisms aimed at diversifying the economy based on the further development of the non- oil sector of the economy were reviewed. Among the priority issues for the Azerbaijani economy are the effective use of the country's foreign exchange reserves to attract foreign investments, create a production structure, use human capital and regulate financial processes and investments.

These reasons increase the importance of discussing the macroeconomic effects of the Dutch Disease in the study and identifying the possible problems that a country may face.

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CHAPTER I: NATURAL RESOURCE WEALTH AND ECONOMIC PERFORMANCE: DUTCH DISEASE

1.1 Dutch Disease Definition and Theory

The existence of natural resources or excessive foreign exchange flows and an export boom in any industry constitute the Dutch disease. Dutch Disease is a phenomenon that negatively affects all macro variables in the long run.

1.1.1 Dutch Disease Definition

With the discovery of natural resources in the Netherlands in the 1950s, the increase in natural gas and fuel exports led to inflation and unemployment. For this reason, it has meant the fact that within the framework of the growth theory of states that dominate important resource reserves, other things are equal, have more production capacity compared to other countries, and that the per capita GDP of countries rich in this resource is higher. It has been possible to take advantage of opportunities due to accelerating economic growth. However, it shows the lower economic growth rates of states that actually have natural resources. Most of these, compared to developed countries that have a lower GDP per capita, and these studies have shown the country's natural security and resources create a number of problems, one of the consequences of slowing economic growth.1 In the Netherlands, which is the origin country of the Dutch Disease concept, with the discovery of natural gas reserves and the rapid increase in exports in the 1950–1960 period, the domestic currency has greatly appreciated and export-oriented sectors have been negatively affected by this situation. In order to benefit from natural gas reserves and develop the natural gas industry, investment and employment resources have started to be directed to this industry intensively.

The labor force has started to be employed in the natural gas industry rather than in the agriculture or manufacturing sector. The reason for this is the increase in wages and profitability in the natural gas industry with the acceleration of capital flow to the natural gas industry and related industries. On the other hand, the Dutch government's use of some of its foreign currency revenues to increase the welfare of the society is considered as another reason. Even the unemployment benefit amount was higher than the wages earned in agriculture in the relevant

1 Sachs, J. D., and Warner, A. M. (2001). The curse of natural resources. European Economic Review, 45(4-6), pp. 827-838

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period. With the effect of all these factors, the development of other sectors in the country has weakened or stopped completely. As a result, the country's economy started to develop unilaterally. General symptoms of Dutch Disease can be listed as follows:2

 With the entry of foreign exchange revenues obtained as a result of the increase in oil production and exports into the foreign exchange market of the country, the appreciation of the domestic currency;

 As a result of the appreciation of the domestic currency, the decrease in the competitiveness of traditional export products and the gradual decrease in exports;

 Labor and financial opportunities shifting to other sectors (such as the service sector and the petroleum sector) due to the loss of competitive power of the exporter sectors in both domestic and foreign markets;

 With the rapid increase in the amount of crude oil production, the production structure of both the economy and the industry changes and the unilateral development in the economy emerges;

 The increase in the dependence of the economy on imports as a result of the appreciation of the domestic currency and structural changes in the economy (the decline of non-oil industries and the development of the oil industry);

 With the increasing dependence of public revenues on the oil industry, the degree to which public revenues are affected by fluctuations in oil prices in the world market.

It is not easy to think that it can automatically ensure economic development, although there are examples showing that having rich natural resources will affect the economy positively.

Even the opposite results have been observed. In many studies examining the economic performance of countries rich in natural resources, remarkable determinations are made in this respect and it is stated that being rich in natural resources can have negative effects. The term Dutch disease is used in economics to explain these negative effects on the economy.3

The cause of Dutch Disease is that oil and other natural resources often do not create jobs for them and often exclude other economic areas. The large amount of foreign currency obtained from oil and natural gas exports is used by the currency of the country and increases the country's

2 Arezki, R. (2012). The Natural Resource Curse: A Survey of Diagnoses and Some Prescriptions in Commodity Price Volatility and İnclusive Growth in Low-İncome Countries.

3 Lederman, D. (2008). In Search of the Missing Resource Curse. Economia Fall, pp. 1-58.

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production, causing the country to lose its competitiveness in foreign markets. At the same time, currency valuation has a negative impact on imports of goods and the state of the domestic market.

Exports of important resources such as oil and natural gas have a negative impact on the manufacturing industry and in many domestic sectors, especially in industry and agriculture. As a result of the currency valuation, the country is getting richer and dependent on natural resources.

Dutch Disease can occur in different ways. The factors that trigger the foreign exchange flow, such as the revival in the natural resources sector, sudden changes in capital inflows and outflows, and foreign aid, lead to the rise of the national currency, the distribution of production factors from the beginning, and a decrease in the output of the manufacturing industry.

1.1.2 Discussions on the Natural Resource Curse and Dutch Disease

In 1975, former Venezuelan oil minister and founding member of OPEC (Organization of Petroleum Exporting Countries) Juan Pablo Perez Alfonso said: “Ten years from now, twenty years from now, you will see that oil will bring destruction to us.” Oil contributed greatly to the Venezuelan economy at that time and oil revenues were very high. Although this statement was regarded as strange at that time, Juan Pablo Perez Alfonso's predictions proved correct and after a short-term economic prosperity, per capita income in Venezuela returned to the level of the 1960s.

Although this situation may appear as an anomaly, it is actually not an exception. In many countries rich in oil, minerals and other natural resources, economic growth tends to slow in the long run compared to economic growth in other countries that are not as rich in natural resources. This phenomenon is called the Curse of Resources in the economic literature.4

There are also studies showing that basing the natural resource curse hypothesis solely on natural resource richness and dependency may be erroneous or incomplete. Since the publication of Sachs and Warner's (1995) work, the development of scientific and analytical approaches to natural resources has gone through several stages. In the 1990s, most economists shared a common view: The raw curse was really circulated by an economist who was interested in solutions to the impact of natural resources on economic development. However, beneficial minerals were thought

4 Sergeeva, Z. Kh. (2011). Hydrocarbons: a development factor or a resource curse? Bulletin of Kazan Technological University, (8).

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to have a negative effect on the growth effect. Hence, various ideas have emerged that highlight the different phenomena in which resource dependence inhibits growth.5

In their studies, Sachs and Warner argued that natural resource richness is not a real condition for low growth, and that this should be considered together with climate and geography factors. In the post-World War II period, the curse of natural resources, which came to the fore especially in Latin American countries, is the role of decreasing global demand and prices.6 It is argued that the wealth of natural resources creates compression effects at the general level of prices through demand expansion in non-tradable sectors and thus price increases. The basic principle of Dutch Disease is that the country exporting natural resources allows significant foreign currency to flow into the national economy. According to the Dutch Disease theory, capital movements cause an overvaluation of the real exchange rate and have a negative effect on economic growth.

This means the appreciation of the national currency, so tradeable sectors other than the natural resource sector (manufacturing sector) cannot compete in international markets. As a result, this sector shrinks by causing structural changes in the economy and unemployment.7

On the other hand, K. Fremer thought that the main goal of innovative development on the role of economic growth and economic structure based on natural resources is to get rid of resources. An unexpected decline in relation to the production of resources and changes in marketing conditions (eg the discovery of new natural resources or the use of production technologies) lead to instability of private sector investment and public revenue. The so-called Dutch disease is associated with the idea that unexpected resource income is negative. It affects other sectors of the economy due to the increase in real exchange rates.8 The classical economic model of his disease was developed in 1982 by W. Max Corden and J. Peter Neary. This model is

5 Buyanov, V. (2011). BP: 2011 statistical review of world energy. Economic Policy, 4, pp. 38-55

6 Sachs, J. D., and Warner, A. M. (2001). The curse of natural resources. European Economic Review, 45(4-6), pp. 827-838

7 Bulte, E. H., Damania, R., and Deacon, R. T. (2005). Resource intensity, institutions, and development.

World Development, 33(7), pp. 1029-1044.

8 Gylfason, T. (2001). Natural resources, education, and economic development. European Economic Review, 45(4-6), pp. 847-859.

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still considered a large model. According to the model, there are three conditions for Dutch Disease:9

1. To increase the share of the export sector 2. Excessive appreciation of the national currency

3. Loss of competitiveness through transition to other developing sectors

According to the model, the economy of the Dutch Disease is different from three sectors:

 Natural resource or explosive sector

 Remaining export products sector

 Non-export products sector

The Dutch disease is caused by the economy being more open and the relatively high natural resources. Natural resources from Australia and the Netherlands to Guyana and Zambia have exceeded the pace of the economic development of the country with rich natural resources.

With this, the resource curse has emerged with the problem of sharing funds generated by resources, so that you can create new technologies.

1.2 The Macroeconomic Effects of the Dutch Disease When it comes to Dutch disease, three sectors stand out;

 Natural resource boom industry (oil sector),

 Trade sector (manufacturing)

 Non-commercial areas (health, education, service).

While two of the three sectors (oil and commodities sector) are estimated in the international market, the prices of non-commercial areas are determined in the national market.

The Dutch Disease has various effects on the domestic economy, especially the resource allocation effect and the expenditure effect. The negative effects of the technologically developing parts of the industrial sector in Japan in the 1960s on the less dynamic tradable sectors including agriculture. The excessive increase in the issuance of Swiss bonds and currency led to the real appreciation of the Swiss franc in the 1970s and its negative effects on other Swiss export and

9 Corden, W. M. (1983). The economic effects of a booming sector. International Social Science Journal, 35(3), pp. 441-54.

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import competing industries. For example, steps have been taken towards capital controls to soften this development in Switzerland. The discovery of gold mines in Australia in the 1850s resulting in Dutch Disease-like effects on the industries of this economy. In Australia, a four-fold increase in wages and domestic price pressures have been observed. High wages have led to the decline of the competitiveness of Australia's tradable agricultural sector. When the gold mines were exhausted, agricultural production in Australia started to increase again. Historically, it is possible to mention the transformation in the industrial structure that occurred as a result of the flow of American precious metals to Spain in the 16th century. In this respect, it is important to examine the effects that cause sectoral transformation. The Dutch Disease theory, in a way, provides information about the direction of the structural change in the economy. That is, if some industries experience contraction while other industries experience expansion, the total capacity of the economy to produce goods and services will expand. It will be observed that a sectoral export boom will lead to adverse general equilibrium effects in the tradable industries of the economy.10 1.2.1 Resource Allocation Effect

People, tribes, nations and states that had competed and fought with each other for grasslands where their animals could be well fed 4-5 centuries ago have been waging the same war and race in order to have more energy resources than they have since the industrial revolution. However, energy is one of the main inputs required to produce. Countries that have energy resources can use their power in international politics and direct world policies.11

When a country has natural resources, the explosion of excavations in the country's natural resource sector increases the marginal product of the factors used in this sector. Increase in oil prices increases the demand for labor and capital in the oil sector. Of course, the salary is growing.

This demand pushes labor and capital from the manufacturing and service sectors to the oil sector.

As a result, production and employment in the oil sector will increase. As the prices in the production sector are determined in the international market, the demand for decrease in production will not change. Decreased production in the service sector will cause excessive demand. As a result, prices in the service sector will increase. Also, the real exchange rate will be

10 Corden, W. M., and Neary, J. P. (1982). Booming sector and de-industrialisation in a small open economy. The economic journal, 92(368), pp. 825-848.

11 Kovusova, Sh. (2018). The Republic of Turkmenistan and its macroeconomic structure before and after independence. Details Magazine, 5 (58).

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evaluated.12 In a sense, the Dutch Disease hypothesis provides information on the direction of the structural change in the economy.

The decline of the non-oil sector in the economy and the structural changes in the development of the petroleum sector cause the deterioration in the domestic supply and demand ratio on imports, and this affects the production competitiveness of the country negatively. There are many examples showing that the developing sector did not affect other sectors negatively.

1.2.2 Spending Effect

The different macroeconomic effects of Dutch Disease are known as expenses. If some of this demand is directed to the services produced in the country, the prices of the other two sectors will not change in the foreign market, so the service prices will increase. Increasing demand for the service sector causes an increase in the service supply. This increases prices in the service sector.

Such a situation will encourage production and oil sector workers to move into the service sector.

The spending effect stems from the increase in wealth created by the high additional profit caused by the rich resource. The increase in income is spent on non-tradable goods and services, and thus their relative price (relative to tradable goods) increases. This increases the value of the real exchange rate. Thus, the spending effect refers to the shrinkage in the tradable goods sectors parallel to the rise in the real exchange rate. Managing the spending impact is of particular importance for developing countries. The principle of the development of the Dutch disease consists of the booming resource sector of the country's economy. These are all products traded on the world market (excluding raw materials) and non-traded products (eg services). When the price of the products of the resource sector rises for a long time, they are under the influence of the wage increase in the commodity sector. It is observed that there is an outflow of labor resources and capital outflow from the trade sector. Due to the inflow of foreign exchange earnings into the country, the increase in real income makes the products of this sector less competitive, which has a number of negative consequences. An important aspect of Dutch Disease is its spread over time.

The sharp decline in production and employment in trade in the tradable goods sector means the emergence of unprofitability and bankruptcy of manufacturing enterprises, agriculture and high- tech industries; this leads to high structural unemployment and low wages in categories of workers,

12 Magud, N., and Sosa, S. (2013). When and why worry about real exchange rate appreciation? The missing link between Dutch disease and growth. Journal of International Commerce, Economics and Policy, 4(02), 1350009.

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particularly in sectors with high knowledge. Additionally, commodity markets are characterized by strong price volatility. This leads to strong macroeconomic instability.13

In order to avoid the damage of the Dutch Disease, it has not been possible for the countries to direct their revenues from the high earnings boom towards long-term targets. What is important here is that the spending effect causes the loss of profits in the short term. Moreover, if the energy sector, which is experiencing a boom in income, consumes relatively little of the resources employed in other parts of the economy, then the resource allocation effect will be used to a negligible volume. The main effect of the recovery in the economy will be seen through the expenditure effect. Higher real income from the revenue boom in the energy sector will make it possible to spend more on the services sector, raising the prices of these products (ie real appreciation), which will require further adjustments to the economy. The importance of the spending effect will be positively correlated with the marginal propensity to consume service products. This is the real evaluation. As a result of this real appreciation, resources will shift from tradable sectors that experience and does not boom profits to the non-tradable sector.14

1.2.3 Total Effect

It is unclear how and in what direction these two effects affect output and employment in the oil and service sectors, as the resource allocation effect and the expenditure effect, which have two important effects, operate in opposite directions. The relative increase in the prices of services will cause the exchange rate to appreciate. Since the distribution of raw resources and the spending effect on the output and employment of the manufacturing sector will have negative consequences, there will be a net shrinkage in the manufacturing sector.

1.2.4 Low Economic Growth Impact

Countries rich in natural resources have less access to natural wealth. If the natural resource sector has a great advantage over any country's exports, that country will be more affected. In a country rich in natural resources, many studies have been conducted on the negative effects of these resources. In the 1990s, the Economic Status of the Countries (Netherlands, Norway etc.) with

13 Kubar, Y. (2015). Economical dimension of curse of natural reserce (CNR). Energy and Sustainability:

Theoretical and Applied Perspectives, 69.

14 Corden, W. M., and Neary, J. P. (1982). Booming sector and de-industrialisation in a small open economy. The Economic Journal, 92(368), pp. 825-848

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regard to natural resources was reviewed by the World Bank in 2002. The share of the natural resources sector in total exports declined from 15 percent to 6 percent in the 10-year period. At the same time, GDP per capita in countries ranging from 15 to 50 percent fell by 1.1 percent. GDP per capita showed an average decrease of 2.3 percent in GDP per capita.15 The increase in the amount of goods and services produced in countries shows its effect on economic growth. This effect depends on the level of interest rates and whether the foreign resources obtained are effectively utilized.

1.3 Solutions for the Disruptive Effects of the Dutch Disease

It is clear that the public authority should take some precautions against possible negativities of the natural resource richness, especially the negative consequences of Dutch disease Dutch disease. It affects the formation of natural resource wealth with good policies to be implemented.

Norway, which is the world's leading oil exporter, is the most distinctive example in this regard.

Norway's oil wealth has become a joint property right legally, and the government has chosen to collect about 80% of its oil gains through taxes and fees. With a kind of expropriation practice in oil revenues, the Norwegian government has invested oil revenues in foreign assets to split oil revenues between the current generation and the next generation. Contrary to what was done in other countries, Norwegians directed their oil revenues in a way not to neglect education and within this framework, they increased the public share in high school and higher education from 26% in 1980 to 62% in 1997. At this point, as a result of the measures and practices taken on the Norwegian Krone, the share of Norway's oil exports in total exports remained below the level when oil was first discovered.16 Structural changes are also inevitable due to establishing economic stability. In addition, through privatization and restructuring, non-tradable sectors will be supported and resources will be channeled to the training of the workforce. In addition to supporting traditional export sectors, policy implementations such as increasing diversity in order to reduce vulnerability in exports, reducing dependence on the rapidly growing new sector and

15 Alexeev, M., and Weber, S. (Eds.). (2013). The Oxford handbook of the Russian economy. Oxford University Press

16 Gylfason, T. (2001). Natural resources, education, and economic development. European Economic Review, 45(4-6), pp. 847-859

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thus reducing sensitivity to external shocks such as the sudden drop in consumer prices can be implemented.17

1.3.1 Stabilization Funds

The negative effects of his illness on the economy due to the excessive amount of foreign currency entering the country have been expressed in previous chapters. Since this mechanism basically leads to the overvaluation of the country's currency, the first solution will be to change the direction of the international money entering the country to other areas. It reduces the ability to prevent and resolve social conflicts, and makes it difficult to provide public services such as education and health. After a while, it becomes difficult for the state to maintain order and dominate the region.

This situation increases the danger of civil war. Countries with rich natural resources in this situation are trying to achieve social peace by implementing populist policies or suppressing domestic rivals (unless there is terrorism or international intervention). Powerful energy importers do not hesitate to provide military aid to ensure political stability in these countries, ignoring anti- democratic practices and human rights violations in these countries. It is considered that these effects are behind the support of the regimes in Guinea and the Persian Gulf for a long time, and the uncertainty in raw material prices will be manageable through stabilization funds. While raw material prices are high, this will not pose much of a problem for economies. However, unexpected decreases in prices can cause serious problems. These unexpected declines can be compensated for through stabilization funds. For example, on January 1, 2004, the Russian Federation established the Russian Federation Stability Fund, which is a share of the federal budget and will be used to balance the federal budget if oil prices fall below a certain price. The main purpose of this fund is to absorb excess liquidity, reduce inflationary pressure, and protect against volatility in raw material export earnings.

These saved funds help to improve the management mechanism, especially by contributing to the transparency regarding the areas where the resource revenues are used. It also helps secure revenues (by accumulating reserves) against foreign assets, thereby protecting the country from the Dutch disease problem. In this way, the decrease in international competitive power as a result

17 Razavi, S. M., and Habibi, N. (2014). Decomposition of gender wage differentials in Iran: an empirical study based on household survey data. The Journal of Developing Areas, pp. 185-204.

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of the appreciation of the exchange rate is prevented. Finally, government spending is shaped by these fund revenues and thus fiscal discipline is increased.

1.3.2 Diversification and Liberalization in Foreign Trade

One of the most important methods for countries dependent on natural resource income to avoid the phenomenon of curse of resources is to diversify their economies. As stated before, not every country rich in natural resources is subject to a curse. Despite the high capital intensity of the resource sector, localization has played a role by taking significant strides in creating new jobs.

Almost half of the source countries use localization requirements that are widely established in all sectors of the economy. Countries with strong economic structures and healthy institutions can be protected from the negative effects of the curse of resources. In this sense, countries rich in natural resources should diversify their economic activities and not be dependent on a single source in foreign trade. In this way, both the phenomenon of the curse of resources can be avoided and it can be more sheltered in the natural resource market.18 Diversification can be made towards sub- sectors in the oil and mineral sector. It has made a great contribution to economic development due to extraction of resources, growth of employment, professional development and the formation of supply chains and supplies. Mining companies in the oil and gas and mining sectors spent exactly 40% to 80% of their revenues on purchases of goods and services. In some cases, these charges exceeded the amount of tax payments and royalties.19

More added value can be created by using the raw materials extracted in the country in these sub-sectors. On the other hand, many sub-sectors tend to have large amounts of cheap labor and it is known that the poor people benefit from opportunities. However, sub-sectors of the natural resource sector frequently fail. The most important reason for this is that developed countries apply customs tax to processed products in order to protect their own production sectors. While OECD countries do not impose customs duty on raw materials, they subject processed products to customs duties at various rates. In this case, while natural resource rich countries do not meet any obstacle to export their raw materials without creating added value, they are stuck with the tariff and non- tariff barriers of the OECD in sectors where they can produce added value and thus solve their

18 Larsen, E. R. (2005). Are rich countries immune to the resource curse? Evidence from Norway's management of its oil riches. Resources Policy, 30(2), pp. 75-86.

19 Kurbanov, T. (2012). Directions of national economic development in Azerbaijan. Black Sea Studies, (34), pp. 37-45.

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problems such as unemployment and economic development. At this point, removing all obstacles, which is the ultimate goal in foreign trade, will help countries rich in natural resources to diversify their economic activities and get rid of the curse of resources. 20

1.3.3 Transparency

Corruption is the enemy of the free market and democracy. Corrupt countries feed corrupt business circles, and corrupt business communities feed corrupt countries. This is a vicious circle, and because of being able to break it, people and investors fight corruption, wherever they are; they need to raise their demands for transparent and accountable government.21 Countries abuse the profits of natural resources as they use very high amounts and these gains are collected in ways that people cannot watch. Most of these funds go into extra-budgetary funds or the pockets of country officials and these funds are never heard from again. The full specification of the natural resource profit will be considered a major step forward in the natural resource sector. Although this negative relationship has been proven by many studies as mentioned above, it is not clear why having abundance of natural resources creates such a disadvantage. But the critical point here is that disclosure of revenues is comprehensive and mandatory. Applying a partial profit disclosure can make things worse.22 If some firms that are responsible for transparency decide to disclose profits, these companies will have no chance of doing business in countries with high corruption.

Responsible firms will be replaced by other firms that do not cooperate in transparency, and the situation will worsen: responsible firms will be driven out of the country, and irresponsible firms will be able to work more easily with corrupt governments.23

1.4 The Place and Importance of Natural Resources in National Economies in the Context of Dutch Disease

Natural resources are considered as indispensable elements in meeting many needs of people.

Especially a significant part of the wealth of developing countries and regions is their natural

20 Young, A. (1991). Learning by doing and the dynamic effects of international trade. The Quarterly Journal of Economics, 106(2), pp. 369-405

21 Palley, T. I. (2003). Lifting the natural resource curse. Foreign Service Journal, 80(12), pp. 54-61.

22 Rautava, J. (2004). The role of oil prices and the real exchange rate in Russia's economy—a cointegration approach. Journal of Comparative Economics, 32(2), pp. 315-327

23 Ross, M. (2003). The natural resource curse: How wealth can make you poor. Natural resources and violent conflict: options and actions, pp. 17-42

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resources besides their young and dynamic populations. Most of the developed countries have turned to natural resources in other countries in order to prevent the reduction of their natural resources. Although the fact that obtaining natural resources is cheaper in countries other than developed countries also plays a role in this, the fact that developed countries do not want to consume their own natural resources is also effective. Today, the importance of natural resources in economic and social development is well understood by developing countries. The current natural resources, together with the population they have, make up the main economic wealth of these countries. The fact that industrialized countries have largely accumulated capital and a high level of technology reveal that they attach less importance to natural resources than developing countries. Natural resources are an important factor in determining the economic development of countries. Factors that make up the economy; agriculture, industry and service sectors. These sectors are established and developed depending on natural resources. Therefore, there is a close relationship between national economies and natural resources. Countries that are poor in natural resources but rich in capital, labor and technology are closing their gaps by purchasing and processing raw materials from abroad. For example, although Japan is very poor in terms of natural resource types and reserves, it has used its features mentioned above to close its gap in this area.

Underdeveloped countries such as Mongolia and Afghanistan, on the other hand, cannot benefit effectively from their already scarce resources due to lack of technical and capital. The main factors that add importance to natural resources are the increase of the world population and technical developments in the industry. While population growth has created a market space, technical inventions and system changes in production have increased the need to focus on different natural resources. Unlimited human needs have been met by the operation of limited natural resources. The increase in production in natural resources played an important role in the development of world industry and trade.

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CHAPTER II: AN OVERVIEW OF THE AZERBAIJANI ECONOMY AND THE COUNTRY'S NATURAL RESOURCE STRUCTURE

2.1 State of the Azerbaijani Economy Before and After Independence

In the twentieth century, the more extensive and vaster rise of the Azerbaijani economy coincided with the Soviet era, which covers more than 70 years. During these years, most of the Azerbaijani economy has grown rapidly and complexly and has a strong industrial potential compared to previous periods. The share of Baku in the industrial production of the country decreased by 11%

in 1985 compared to 1970 due to the development in other regions of Azerbaijan since the 1970s.

The products purchased by the country were imported in the other republics of the USSR instead of domestically manufactured in the USSR, as well as from the import of raw materials to Azerbaijan. This type of planning made countries dependent on each other.

Although the revenue generated from the sale of these products was collected in a single center, the country did not have the right to own property in its own resources. The development of the Azerbaijan economy in the USSR over the last 20 years has not been a stable period. For example, while the average economic growth rate in the country during the 1960-1970 period was 5.2%, it increased to 7.4% from 1970 to 1980. Between 1980-1990, a sharp reduction trend is noteworthy. In the economy, an average decrease of 4.9% was observed in the years 1981-1985 and a decrease of 5-6% in the 1986-1990 period. Prioritizing areas such as natural resources, energy sector based on more intensive use of cheap and abundant labor, economic the structure has created a suitable environment for the crisis. After the collapse of the USSR, the problems that the planned economy has inherited to the national economy are listed below.24

1. Greater regional differences. This situation began to emerge from the first years of the USSR.

90% of the companies that supplied other production and raw materials were in Baku.

2. Both the quality of the goods produced and the per capita amount were below the average of the USSR. For example, in the early 1990s only 50% of the consumption in Azerbaijan was obtained from domestic production.

24 Muradov, Elman (2012). Comparative Analysis of Regional Development Policies of Azerbaijan and Germany. Nigde University Journal of FEAS, 5 (1): 103-115.

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3. The fact that the economic structure was significantly dependent on the USSR left the country in a difficult position immediately after independence.

The main task of the post-Soviet countries is to move from the old, economically inefficient system to a complete market economy. It is possible to divide the economic development up to three main stages since independence. The first phase covers the period of 1991-1995 and this period is the period of collapse. The second stage, 1996-2003 macroeconomic balance period. The third phase began in 2003 and continues so far. As mentioned in the table 1, the formation of the economy in the early stages was aggravated by political and military events. Until 1995, the price of food products increased during the liberalization process: in 1991 it increased by 2.07 times, by 10.12 times in 1992, by 12.3 times in 1993 and by 17.65 times in 1994 compared to the previous year. The table below shows the annual FDI (Foreign Direct Investment) inflows for the period 1995-2017 and their percentage distribution in the oil and other sectors. Starting in 1995, 65% of foreign investments turned to the oil sector. The total amount of foreign capital invested in 2016 was 10161.1 million dollars and 55.3% of the total direct investments were made in the petroleum sector.25

Table 1. The investment amounts over the period of 1995-2017

Years

Foreign direct investments

(Million, USD)

Oil sector (Million,

USD)

Oil sector % (share of investments in oil sector)

Other sectors (Million,

USD)

Other sectors %

1995 375.1 139.8 37.3 235.3 62.7

1996 620.5 416.2 67.1 204.3 32.9

1997 1307.3 780.1 59.7 527.2 40.3

1998 1472 891.8 60.6 580.2 39.4

1999 1091.1 544.5 49.9 546.6 50.1

2000 927 546.1 58.9 380.9 41.1

2001 1091.8 820.5 75.2 271.3 24.8

2002 2234.9 1966.3 88.0 268.6 12.0

2003 3371 2972.4 88.2 398.6 11.8

2004 4575.5 4088.1 89.3 487.4 10.7

25 Petroleum Revenues of Azerbaijan, Baku, Ministry of Finance Publications, 2017

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Table 1. The investment amounts over the period of 1995-2017

2005 4893.2 3799.9 77.7 1093.3 22.3

2006 5052.8 3422.3 67.7 1630.5 32.3

2007 6674.3 4003.3 60.0 2671 40.0

2008 6847.4 3350.7 48.9 3496.7 51.1

2009 5468.6 2412.7 44.1 3055.9 55.9

2010 8247.8 2955.3 35.8 5292.5 64.2

2011 8673.9 3407.8 39.3 5266.1 60.7

2012 10314 4287.8 41.6 6026.2 58.4

2013 10540.9 4935.2 46.8 5605.7 53.2

2014 11697.7 6730.7 57.5 4967 42.5

2015 10719.1 6622.7 61.8 4096.4 38.2

2016 10161.1 5617.4 55.3 4543.7 44.7

2017 9976.2 4900.8 49.1 5075.4 50.9

Source: Azerbaijan state statistical committee

Economic recovery was supported by an extremely high level of capital investment as a result of foreign direct investment in the oil sector. 77.8 billion dollars directed to the economy of Azerbaijan in 2000-2017. 66.8 USD bln of foreign direct investment or 85.9% were put in the oil sector, while remaining 19.9 bn. dollars (14.1%) in non-oil sectors. The amount of direct foreign investment in the oil sector over the years is always higher than the non-oil sector.

The interest of oil companies in Azerbaijan begins in 1989 when the president of Ramco S.Rimp came to Baku. With this, the new history of Azerbaijani oil began, and Baku oil attracted the attention of Western investments as in the beginning of the century. After that, representatives of the Pennzoil, BP/Statoil, Amoco companies came to the country and negotiations began. These negotiations resulted in the signing of oil agreements. However, in accordance with the agreement, negotiations in London in June 1993 could not be realized due to the emergence of military- political crisis in the country in the same month of 1993. Between 1991 and 1993, no strategic investment project could be realized due to the current turmoil in the country. After the establishment of permanent and relative stability in Azerbaijan after 1993, the oil negotiations were resumed. On September 20, 1994 the contract containing the joint development and production sharing of Azeri, Chirag and Gunashli (deep water) fields in the Azerbaijani sector of the Caspian Sea was signed, which was later called the Contract of the Century. According to this agreement, oil fields namely - Azeri, Chirag, Gunashli were planned to develop. In fact, within

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this agreement Azerbaijan government gained a chance to develop relations with Western countries and in this way to avoid from Russia pressure. As a result of the contract, a consortium was created and the participant were followings: SOCAR (Azerbaijan) with 20% share, BP (UK) with 17.127% share, Amoco (USA) with 17.01% share, Lukoil (Russia) with 10% share, Pennzoil (USA) with 9.82% share, Unocal (USA) with 9.52% share, Statoil (Norway) with 8.563% share, McDermott International (U.S.) with 2.45 %share Ramco (Scotland) with 2.08% share, Turkish State Oil Company (Turkey) with 1.75% share, Delta-Nimir (Saudi Arabia) with 1.68% share.

This consortium was named Azerbaijan International Operating Company (AIOC). These 28 contracts based on PSA (Production sharing Agreement), which means that oil company cover the costs of exploration and mining, then compensating its expenses from profit. The government can control whole property under the contract after finishing of the repaying period. 80% percent of oil revenues were received by Azerbaijan and 20% of the oil revenues were separated by countries in terms of the contract. In 1999, significant event was happened among participated companies.

Firstly, BP bought the USA Company AMOCO and increased its share in consortium to 34% and became operator of the project. Then, Lukoil sold its shares to Inpex (Japan) company, as a result share of companies slightly changed. Initially, reserves of these contracted oil fields were estimated approximately 511-640 million tons. Whereas, in 2007 it was accounted again and announced that oil reserves in Azeri-Chirag-Gunashli fields were 1 billion tons. On the other hand, quality of Azerbaijan crude oil is considered one of the lightest oil in the world. The second PSA was signed with Western countries to develop Shah-Deniz field in 1996. Initially, big amount of oil reserves was expected from this field, after exploring significant volume of gas reserves were found. Overall reserves were estimated at 1.2tcm of natural gas and 240mln t of gas condensate.

BP, Statoil, Iranian OIEC, Russian-Italian joint company and TPAO were participated in new created consortium. The big share belongs to BP (25.5%) and Statoil (25.5%), Iranian and Russian companies and SOCAR follow them with 10% share for each. TPAO (Turkey) with 9% share also participates in this consortium. This field was one of the important projects for Europe, because its geographical nearness makes transportation easy with comparing to other Eurasia fields. All resources of Azerbaijan belong to the state according to the constitution and management of energy resources controlled by SOCAR. According to the Presidential Decree No. 200, SOCAR was

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created in September 1992 as a result of merger of two big Azerbaijan State companies, there were Azerneft and Azneftkimiya.26

Table 2. Some economic indicators, 1995-2002

Indicators Years

1995 1996 1997 1998 1999 2000 2001 2002 GDP (million dollars) 2415.2 3180.8 3960.7 4446.4 4583.7 5272.8 5707.7 6235.9 GDP per person

(dollars)

310.3 416.1 513.2 570.6 582.9 662.9 710.5 768.9 Unemployment rate

%

4.6 4.5 6.7 7.2 5 11.8 11 10

Inflation rate % 411.76 19.8 3.67 -0.78 -8.5 1.8 1.55 2.78 Gini coefficient 0.459 0.458 0.462 0.462 0.506 0.501

Source: Azerbaijan state statistical committee

In 1991, GDP in the country was 2.7 billion manats (1 US dollar equals 16 Azerbaijani manats). The salaries of workers, which are indicative of the standard of living, have actually decreased by 3.6 times. In 1994 inflation reached its highest point - 1763.5%. Almost all the main indicators of the economy tended to decline in the 1991-1995 period. False reforms and other unsystematic economic arrangements during this period have had negative consequences: the financial and banking system was shaken, budget deficits have risen. In 1994, the interest rate of the Central Bank reached 250%, the national currency manat began to depreciate, foreign trade volume decreased by 42%, until 1994, the Azerbaijani economy was closed to foreign investments.

Compared to 1990, the production volume of the industrial sector decreased by 30% in 1995, while the mining industry decreased by 53%, the manufacturing industry by 28%, and the supply of electricity, natural gas and water decreased by 64%. All these have had negative effects on other industrial sectors.

In 2002, the share of private sector in GDP was 72%, industrial production was 50% and agriculture was 99%. More than 3 thousand new facilities were opened in 2003. The successful implementation of new programs in 2001 led to the creation of 94,000 new businesses and 35,000 new enterprises, which accounted for 96.3% of the private sector. In a short period of time, oil revenues played a major role in increasing the state's budget. At the same time, in the period 2000- 2008, government expenditures increased 10 times: from $ 965.5 million to $ 11.9 billion. These

26 Aras, O. N. (2003). Economics of Azerbaijan. Baku: Eastern-Western printing house.

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costs were not for the development of the human factor (education, health, science) but for infrastructure, security and government regulations. Despite the growth of absolute demonstrators, the share of social expenses allocated from the budget was gradually decreasing. For example, while the share allocated to social security in 2003 was 18.2% of all expenditures, it decreased by 9.7% in 2008. Education costs decreased from 23.7% to 11.6% and health services from 5% to 4.3%. Social expenses have increased in absolute terms and this has led to an increase in oil prices and budget. However, the share of relative social expenses has decreased.

In the period of 2014-2018, it was easy to display the result of the fall in oil prices to the exchange rate of Azerbaijan national currency manat (AZN). The variations in oil prices affected the Azerbaijani economy due to the depreciation of the manat. Since a large portion of the country's revenue comes from oil and natural gas sales and diversification of the economy have occurred in times of high oil prices, leading to economic problems at low oil prices. In fact, the decrease in oil prices in the world market directly affects the exchange rate of the manat because this process creates a balance of goods deficit in the balance of payments of Azerbaijan. The exchange rate of the Azerbaijani manat increased sharply in February and December 2015, as the result of two sharp devaluations. Due to devaluation, the manat lost almost half of its value and had the worst currency ever at the end of 2016. The exchange rate of manat continued to rise in February 2017, increasing the US dollar to 1.92. However, nowadays, the downward trend of manat is recorded as 1.70 against the US dollar.27

The change in the policy of the Central Bank of the Republic of Azerbaijan (CBAR) from a fixed exchange rate from floating currencies has a significant impact on the stabilization of manat. In addition, some institutions, such as the Central Bank of the Central Asia and the State Oil Fund of the Republic of Azerbaijan (SOFAZ), began to participate in foreign exchange auctions to prevent further depreciation of the Azerbaijani manat. The price of oil in the world market affects the rate of manat and the economy of Azerbaijan in general. Considering that a significant portion of the country's exports and revenues come from oil and gas sales, the relationship between oil price and manat rate becomes clear. Low oil prices have a negative effect on the balance of payments of the country, which reduces the trade balance. Therefore, the trade deficit leads to an increase in the exchange rate. As a result, the main suppliers of foreign

27 The Central Bank of the Republic of Azerbaijan, AZN Rates, 2017 https://en.cbar.az/other/azn-rates

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currencies such as the Central Bank of Russia and the State Oil Fund of Azerbaijan begin to sell foreign exchange reserves in auctions to prevent further depreciation of manat. As a result, this leads to the rapid depletion of strategic foreign exchange reserves that lead to economic difficulties in the country. The highest price of Brent crude oil in 2014 was $ 114.25 per barrel and then fell sharply until the end of the year. By the middle of January 2015, the price was $ 45.13 a barrel.

As this is a long-term process, the impact of falling oil prices on manat was only seen after February 2015. As a rule, oil prices fluctuated in 2015 and 2016, followed by a significant decrease in 2016. On March 16, 2015, the price of oil was $ 52 per barrel and exceeded $ 64.93 in two months and then fell sharply again in a year. As a result, the exchange rate of manat increased to US $ 1.55 per manat, and on February 21, it was US $ 1.05 per manat. These fluctuations became even sharper in 2016. At the beginning of the year, oil price fell to its lowest level on January 18, 2016 at $ 28.55 a barrel, but doubled in the last month of the year to reach the US dollar. 56.82 barrel. In 2016, the average price for Brent oil was $ 43.73 per barrel, the lowest annual price since 2014.28 As a result, the manat faced difficulties in the global market; however, starting from the last three months of 2016, the rate of the manat started to decrease, reaching 1.7707 against the US dollar in the end of the year.

Figure 1. The effect of Oil Prices on the national currency of Azerbaijan 29

Source: Azerbaijan State Statistical Committee and Central Bank of Azerbaijan

28 BP, Statistical Review, 2016 https://www.bp.com/en/global/corporate/energy-economics

29 Macrotrends and the Central Bank of the Republic of Azerbaijan, 2017

0 20 40 60 80 100 120

0 0.5 1 1.5 2

oil price AZN/USD CR

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In 2017, there was no significant change in oil prices in the world market. On November 6, 2017, there is a growing trend, with a maximum of $ 64.27 per barrel. By November, the lowest oil price was fixed in June and was $ 44.82 per barrel. The overall decline in oil prices in 2016 affected the manat rate at the beginning of 2017, especially in February, when the manat rate was the highest in February, rising to US $ 1.92 per manat. However, the manat was then fixed at 1.70 against the dollar.

Figure 2. Dynamics of rate of the Azerbaijani manat, USD/manat

Source: The Central Bank of the Republic of Azerbaijan, 2020

2.2 Sectoral Structure of National Economy

Azerbaijan has known as the one of main oil-gas producer in the region. Furthermore, the Azerbaijan economy experiences it’s the most difficult time in the last decade. The main factor is the recent drops in the world oil prices and it has negative impact on the oil-dependent economies.

Therefore, the situation has induced the Azerbaijan government to reconsider its fiscal and monetary policies. Azerbaijan's economic policy led to a marked increase in national income per capita in Azerbaijan. According to the World Bank (Atlas methodology) classification, Azerbaijan was included in the category of poor countries in terms of per capita income in 2004, while it was below the average in 2005 and was included in the countries category in 2009. With income above average. The current economic growth model successfully completed its life cycle and allowed it to achieve its goals. The low oil prices created significant problems for the Azerbaijani economy.30 As can be seen from Figure, since 2014, in the country's total strategic foreign exchange reserves (a combination of CBAR and SOFAZ reserves), there has been a downward trend in the measures taken by CBAR and SOFAZ to prevent further depreciation of manats. In 2014, the cumulative

30 CESD, “Currency market in Azerbaijan”,http://cesd.az/new/wp-content/uploads/2016/08/

0.501 1.52 2.5

AZN/USD rates

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foreign exchange reserves of the State Oil Fund of the Central Bank of Azerbaijan and the State Bank of Russia decreased to USD 50.86 billion and the following year to USD 38.59 billion.

Figure 3. Foreign exchange reserves, USD billion

Source: SOCAR, 2016 Annual Report, 28, http://www.oilfund.az/ Annual_Report_2016_ENG.pdf

In total, the private sector holds about 80% of the gross output of the economy. In the industry the private sector produces more than 85% of the industrial products and services. The private sector holds the main part in construction too. Thus, this percentage changed between 72%

and 90% during the last decade. Besides that, in the agriculture and trade activities the private sector almost produces all of the output. However, subsequently, this situation changed favour of the private sector with about 80%. Apart from these, the private sector operates with approximately 80% share in the communication.

Table 4. Share of the private sector in GDP, current prices of the previous years, as % Indicators 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 GDP total 77.8 81.0 84.0 84.5 81.2 81.7 82.5 81.5 82.5 81.9 81.2 Industry 84.5 87.5 90.3 89.9 85.9 87.4 88.1 87.3 87.4 86.1 83.0 Construction 90.4 81.8 77.3 87.0 76.1 72.0 75.3 76.0 84.5 84.3 84.5 Agriculture 97.8 96.9 99.4 99.0 99.2 99.7 99.3 99.4 99.4 99.8 99.8 Trade and

services

97.8 99.3 99.0 99.1 99.0 99.2 99.7 99.7 99.8 99.8 99.6

Transport 37.5 46.1 76.8 82.0 75.4 75.3 78.1 77.7 77.1 78.5 81.7 Communication 80.2 79.6 80.3 72.9 80.4 78.6 76.3 76.6 76.8 80.0 81.0 Source: Azerbaijan State Statistical Committee

13.76

5.02 3.97 4.33 4.43 5.03 5.17

0

33.57 33.15 32.8 33.2 35.5 36

50.86

38.62 37.12 37.13 37.63 40.53 41.17

0 10 20 30 40 50 60

2014 2015 2016 Jan-17 Mar-17 Jul-17 Sep-17

Central Bank Sofaz Total

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Indeed, the mining sector produces the main part of GDP. This share was 42%, reached to 53% in 2007 and held more than 40% of GDP between 2009 and 2012. It demonstrates that from 2013 to 2014 the share of the mining sector has decreased due to the reduction in the crude oil production. The construction sector has played the second largest role (increased from 9% to 12%).

Not only these activities, but also the share of the trade (from 6% to 7.8%), financial and insurance (from 1.4% to 2.4%), tourism (from 0.6% to 2.2%) sectors increased respectively. In spite of these growth, agriculture (from 9% to 5%), manufacturing (from 6.5% to 4.8%), transportation (from 5.2% to 4.5%), information and communication (from 2.2% to 1.8%) lost their previous position.

Table 5. Production of the GDP by types of economic activity, percentage of GDP

Sectors 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Mining 42.20 50.86 53.66 52.73 42.39 45.88 47.96 43.06 39.17 34.62 Construction 9.00 7.71 6.44 6.98 7.17 8.10 7.95 10.06 11.61 12.54 Trade 6.07 5.37 4.94 5.48 6.69 6.42 6.30 6.67 7.13 7.88 Agriculture,

forestry and fishing

9.09 7.09 6.70 5.60 6.12 5.52 5.08 5.14 5.37 5.27

Manufacturing 6.49 5.77 4.98 4.71 5.53 4.74 3.99 4.24 4.22 4.77 Transportation

and storage

5.20 4.67 5.65 5.14 6.75 5.58 5.11 4.92 4.42 4.50

Financial and insurance Activities

1.38 1.33 1.51 1.77 2.14 1.16 1.37 1.97 2.17 2.40

Accommodation and

food service activities

0.56 0.54 0.57 0.76 0.97 1.04 1.45 1.64 1.84 2.17

Information and

communication

2.13 1.96 1.67 1.54 1.88 1.86 1.59 1.73 1.74 1.81

Source: Azerbaijan State Statistical Committee

One of the key areas of sustainable and dynamic development of Azerbaijan's economy is non-oil industry. The country's socioeconomic development is based on only one factor, and the economy's dependence on only one factor can not be considered as an expedient and threatens the crisis. In this regard, as a result of the dynamic development of the non-oil sector, the dependence on the oil sector in the country's economy will be substantially reduced. The development of the oil sector plays a key role in the development of the non-oil sector, and the development of the

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non-oil sector's income from the oil sector in the country's economy paves the way for its development. As a result of the purposeful and consistent economic policy carried out in the country, the country's development has been consistently characterized in recent years. Thus, the non-oil sector grew by 7.9% in 2010, including 29.7% in information and communication sector, 4.3% in transport and warehousing and 20.3% in construction, increased. An analysis of the 2015- 2018 results shows that during this period, along with the general economic development, sustained development was also observed in the non-oil sector, and the non-oil GDP was relatively stable.

In the non-oil sector of the country in 2015, an additional value of 37.7 billion manat was created, and in general, 59.0% of them fell on social and other services, trade, repair of vehicles and construction sites. In 2015, the value added in the non-oil sector of the country's economy increased by 1.1% compared to the same period of the previous year. In 2016, the non-oil industry produced 6075.4 million manat and increased by 3.6% compared to the same period of the previous year. The share of added value created in the non-oil industry was 36.1%. During the reporting period, the share of non-oil products in total industrial products in the country was 26.4%, while non-oil industry contributed 1.0 per cent to the industry's growth. In the mining sector of the non- oil industry, 131.7 million manat, 4525.2 million manat in the manufacturing industry, 1224.6 million manat in the production, distribution and supply of electricity, gas and steam, water supply and waste disposal products were produced in the amount of 193.9 million manat.

In order to protect domestic production, to increase non-oil exports and to diversify exports, imports for goods of 84 items have been applied for a two-year specific period. Imported customs duties have been provided for the transition to a slow-moving system. Import duties on heading 3661 were reduced. The import duties on heading 690 have been increased. The main reason for the rise was the protection of domestic goods from external influences. According to the State Statistical Committee, in January-June 2018, 6331.7 million manat was allocated from all financial sources for the development of the country's economic and social spheres, or 14.1 percent less than in the corresponding period of the previous year. This decrease was due to the decline in investment in the oil sector, while the volume of funds directed to the non-oil sector was 21.5 percent, including non-oil investments.

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