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Fadi Farra

AZERBAIJAN - Economy

Private Sector Priorities

Head, OECD Eurasia Competitiveness Program

Bio

Fadi Farra leads the OECD Eurasia Competitiveness Program, which focuses on enhancing investment, competitiveness, and private sector development in Eastern Europe, the South Caucasus, and Central Asia. The program includes supporting regional policy dialogue, advising countries on how to enhance their competitiveness, and building capacity. It builds on the experience, key instruments, and practices of OECD member states. Prior to joining the OECD, Fadi Farra worked in strategic consulting with the Boston Consulting Group and AT Kearney, where he was Principal.

Azerbaijan’s economy has fundamentally changed since 2006, when oil started to be dispatched through the Baku-Tbilisi-Ceyhan (BTC) pipeline and a new phase of reforms were initiated. Industry, construction, and services […]

Azerbaijan’s economy has fundamentally changed since 2006, when oil started to be dispatched through the Baku-Tbilisi-Ceyhan (BTC) pipeline and a new phase of reforms were initiated.

Industry, construction, and services showed strong turnover and wages growth. Foreign currency inflows, especially US dollars, boosted the state budget and fuelled inflation, which averaged 18% in 2007-08. The role of the State Oil Fund (SOFAZ) during this period allowed a tight control of revenues and expenditures in the oil sector, which prevented Dutch Disease. The rise in oil prices allowed the government to engage in large-scale infrastructure projects to pave the way for the non-oil sectors—a real challenge for the country’s future development. The government has engaged in the important modernization of social services programs mostly since 2000, which have played an important role in reducing poverty. With the major expenditures of SOFAZ being transfers to the state budget (50% of budget revenues), the government was able to increase pensions and wages and to invest in schools, universities, and hospitals. Consequently, poverty decreased from 49% to 11% between 2001 and 2009. The national poverty line indicator increased by 3.7 times from AZN24 to AZN89.5 over the same period.

Although the country managed to record positive growth in 2009, nearly all macroeconomic indicators were affected by the global downturn. The reduction of the nominal GDP to AZN34.6 billion was caused by falling oil prices and moderate rates of non-oil sector development. Indeed, the oil sector contributed to a rise of 14% in GDP, while the non-oil sector contributed only 3%. Azerbaijan returned to high growth in the second half of 2009 with an increasing oil price. The country’s GDP increased by 9% over this period. As a consequence, the end of the “transition period” was officially announced by President Ilham Aliyev in the first quarter of 2010. The impact of the financial crisis on Azerbaijan was indeed less severe than in other countries of Eastern Europe and the South Caucasus (EESC). High GDP growth was directly linked to the contribution of the oil sector, thanks to increasing oil exports and higher global oil prices. FDI inflows also recovered during this period.

However, for a return to former growth rates, Azerbaijan will need to enhance the competitiveness of its economy, which calls for policies that stimulate private-sector development and foster diversification outside the energy sector.

PRIVATE SECTOR A PRIOIRITY

The private sector is a source of knowledge, skills, and resources, and a key engine of growth for industrial development. In this context, the role played by micro, small, and medium-sized enterprises (SMEs), which, on average account for over 90% of enterprises in the world and contribute 50-60% of employment in developing countries, is particularly important. Efforts to foster private sector growth could focus on improving the business environment for SMEs by providing a regulatory framework conducive to entrepreneurship through better policy design including improving business regulation, strengthening the education system, and providing access to finance for SMEs that would encourage the entry of new firms as well as increase their share of employment and contributions to GDP in the private sector.

Currently, the private sector represents 75% of GDP in Azerbaijan and employs about 64% of the workforce, which is lower than in most countries in the region. Due to the extensive oil production in Azerbaijan, which is dominated by large enterprises representing almost half of GDP with 1% of employment, the SME share in GDP is relatively low. SMEs contributed to only 15% of GDP growth in 2006. The presence of an extensive and prosperous oil sector affects the economy, and small businesses in particular. The strong position of the gas and oil industry also underlined impressive growth rates in the non-oil sector, even more than in the oil sector. On the other hand, the excessive dependence on oil and gas products makes the economy particularly sensitive to price shocks within the oil industry, and represents a risk for non-oil-related manufacturing through increases in the real exchange rate. The capital-intensive oil sector also means that income generation is concentrated in this sector and distribution is uneven. Moreover, many small enterprises related to the oil sector depend on large firms, rather than on internal competitive advantages.

Today, the SME sector mainly consists of individual entrepreneurs and SMEs that fall under the “small business units” definition. In 2007, only 4,945 new micro, small, and medium enterprises registered as new businesses, fewer than in 2005, and at a lower rate, 7%, compared to the 10% business entry rate of the Europe and Central Asia region. According to the 2008 Statistical Yearbook of Azerbaijan, 13,465 small enterprises and 195,732 individual entrepreneurs were registered in 2007, which represent 7% and 93% of the total registered business population, respectively. At the same time, if individual entrepreneurs are excluded, small enterprises represent 92% of the total number of enterprises and account for 62% of employment. It is important to note that the informal sector is relatively large, which is why any statistics on the private sector size and contribution to GDP need to be regarded with care. According to BEEPS 2009, only 85% of firms were registered when starting operations. Therefore, the estimates for the number and share of employment of the SME sector are most likely underestimated.

HUMAN CAPITAL DEVELOPMENT

Strengthening human capital and skills development has been identified by the OECD as one of the key contributors to competitiveness and private sector development. Razzak and Timmins report a strong positive relation between the increase of university-qualified workers and the levels of labor productivity as measured by GDP per person. It is believed that relying on natural resources, cost competition, and strategic alliances do not suffice for reaching sustainable development. Enhancing competitiveness in Azerbaijan will require a higher commitment to investing in human capital as well as introducing reforms that will ensure that the educational system produces skills that match the demand of the labor market and further support private sector development. As a result, three areas should be addressed as priorities by Azerbaijan:

•Developing a comprehensive human capital strategy involving different ministries and consultation with the private sector

•Focusing much further on vocational education and training (VET) and continuing education and training (CET)

•Assessing on a regular basis the level of skill gaps in different sectors of the economy.

Overall, despite a recovering economy, private sector development should now be a key priority for policy makers. With this regard, human capital development policies should be on top of the list.

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