Overview of Azerbaijans Economy - Research Paper Example

1. Overview of Azerbaijan's economy. Azerbaijan inherited a lot of problems from the Soviet period. It was one of only two Soviet Republics which didnot receive subsidies from the centre (the other being Russia), and it ranked tenth in terms of living standards among the 15 Soviet Republics. In 1990, average monthly wages were approximately 30% below the average for the Soviet Union, and were 50% lower than those of the Baltic republics. Official statistics from 1990 show that 35% of the population had per capita incomes below the national minimum subsistence level. (Maharramov, 2003). Recently, Azerbaijan has witnessed solid economic growth over the last 5 years. This growth has been driven by domestic demand including non-oil private investments, public investments, government expenditures, consumption expenditures or households and oil exports. Real GDP has also witnessed tremendous growth owing to growth in the non-tradables sectors including transportation, construction, and public utilities. The capacity constraints however did not enable the supply to grow as rapidly as demand leading to inflationary pressures. The objective of this paper is to provide a discussion of the labour cost drivers, labour demand drivers, and labour supply drivers in Azerbaijan. 2. Labour cost drivers in Azerbaijan According to macroeconomic theory the wage rate usually depends on the price level. The higher the price level the higher will be the real wage rate demanded by workers. Azerbaijan is currently suffering from high rates of unemployment. As a result the wage rates are very low. According to the Human Development and Central Unit (HDCU) and European and Central Asia Region (ECAR) (2005) a vast majority of people in the city of Mingachevir an Industrial city have become redundant as a result of lack of demand for products, which has culminated in production stoppage, bankruptcy, liquidation and corporate restructurings. This has driven the wage rates to very low levels. Based on this one can say that a major determinant of labour cost on Azerbaijan is the demand. The demand for labour in Azerbaijan is currently very low and as such people are willing to supply labour at very low wage rates. The survey by the ECAR and HDCU (2005) suggests that only 3% of the unemployed left their job voluntarily. While some workers are not being paid at all, there is also a high degree of wage arrears.s In 2001 exports accounted for 44% of GDP in Azerbaijan with hydrocarbon products being the dominant export activities, contributing to 91.5% of total exports in 2001. The remaining share of exports consists of raw and processed food products, mechanical equipment and chemical product. (Navaretti, 2003). The largest share of imports is made of machinery for the oil industry, food products, other mechanical equipment and luxury consumer goods for the high-income part of the population. Many of the country's traditional products in the domestic market have been replaced by imports because they are unable to withstand the competition of import products. (Navaretti, 2003). Figure 1 below shows that the real wages have taken a downward trend since 2005 to record low levels over the period 2001 to 2006. The figure also indicates that the non-oil sector is lagging behind. Since imports have become higher than exports, it is likely that the country is witnessing slow growth in aggregate demand, which in turn leads to a slow down in the growth in real GDP. This in turn creates a recessionary gap, high unemployment rate and therefore low wage rates. (CFA, 2008). From the foregoing one can therefore rightly say that the wage rate in Azerbaijan depends on the growth in Aggregate demand which has a multiplier effect on the price level, real GDP growth, and therefore wage rates. Figure 1 3. Labour Demand Drivers in Azerbaijan Macroeconomic theory posits that the demand for labour depends on three factors. These include the price of the firm's output, other factors and technology. The higher the price of the firm's output, the higher will be the demand for labour. The price of output affects the demand for labour through its influence on the marginal revenue product of labour. A higher price for the firm's output increases marginal revenue, which in turn increases the marginal revenue product of labour. (CFA, 2008). The demand for labour also depends on the prices of other factors of production. This is however, only possible in the long-run when all factors of production are varied. The effect of a change in the price of some other factor on the demand for labour depends on whether that factor is a substitute or a complement of labour. For example, computers are substitutes for telephone operators but complements of word processor operators. Therefore, if computers become less costly to use, the demand for telephone operators decreases but the demand for word processor operators increases. (CFA, 2008). The effect of technology depends on whether an advance in technology changes the marginal product of labour. Advances in technology destroy some jobs, while at the same time creating others. According to microeconomic theory, an advance in technology creates more jobs than they are destroyed. Consequently, an advance in technology leads to an increase in the demand for labour. (CFA, 2008). In Azerbaijan, the main investments have been in the oil sector. Figure 2 Source: Maharramov (2007). Figure 2 above indicates that most of the focus in Azerbaijan has been on the oil sector. One can observe that most of the exports are from the oil sector. The oil sector is capital intensive, which reduces the need for human labour. This has led to a decrease in the demand for labour in Azerbaijan. 4. Labour Supply Drivers in Azerbaijan The supply of labour is driven by the wage rate. When the wage rate is high, more labour will be supplied. On the contrary, a low wage rate leads to a lower supply of labour. the supply of labour should also depend on the state of the business cycle. The wage rate is likely to drive the supply of labour at full-employment and above-full employment. At full-employment the unemployment rate is equal to the natural rate of unemployment and real GDP is equal to potential GDP. An increase in aggregate demand is likely to lead to an increase in the demand for labour. At this point one should reasonably expect the supply of labour to depend on the wage rate since the demand is likely to be higher than the supply. In Azerbaijan's case, the country is currently below full employment and this economic model discussed above is likely not going to hold for this country. More people are willing to supply labour in Azerbaijan a low wage rates. In addition, the capital intensive nature of the oil sector is making matters worse because it is the main economic activity of the country. Other sectors such as agriculture and food processing are lagging behind with less investments by the State in these sectors. 5. Conclusions and Recommendations. Based on the foregoing discussion, one can conclude that Azerbaijan is a mineral-based economy with a lot of dependence on the oil sector. Most investments are in the oil sector which is capital intensive. This has led to a slowdown in other sectors such as agriculture and food processing, therefore leading to a decrease in the demand for labour. It has also led to a low wage rates and thus low incomes. The paper therefore recommends that the State should invest funds to other sectors of the economy so as to boost income from these sectors, which will in turn fuel economic growth through increase exports, decrease in unemployment and growth in real GDP. Bibliography HDSU and ECAR (2005) Poverty and Social Impact Analysis AZERBAIJAN Enterprise Restructuring and Labor Redeployment VOLUME I. Human Development Sector Unit; Europe and Central Asia Region. Available online at: http://siteresources.worldbank.org/INTECAREGTOPSOCPRO/Resources/AzerbaijanPSIvol1.pdf Navaretti, G. B. (2003). AZERBAIJAN TRADE AND TRADE FACILITATION REVIEW, Governance, Finance and Trade Division; East and Central Asia Department. Available online at: http://www.adb.org/Documents/Reports/Trade_Facilitation/trade_facilitation_review_AZE.pdf Maharramov R. (2007). Public Investments in Azerbaijan: Ramifications for Economy & Employment CFA (2008). Economics. CFA Institute. Pearson Publishing Ltd. Read More