Azerbaijan needs to diversify its economy away from fossil fuels. This can be achieved, among other things, by investing in human capital in rural areas.
Azerbaijan has been a transportation hub since the Silk Road, and its strategic location on the Caspian Sea between Russia, Iran, Armenia and Georgia gave the country easy trade access to China, Central Asia and Europe even before the discovery of its vast fossil fuel reserves.
Marco Polo wrote that oil from the Absheron Peninsula was burned for heat and exported to the Middle East, and that the world’s first industrial oil production from a drilling site occurred in Azerbaijan in 1846.
Since Azerbaijan’s independence in 1991, its industry and population have become further concentrated in the greater Baku area on the Absheron Peninsula, which consists of Baku, Sumqayit and satellite towns and is in close proximity to the offshore oil and gas reserves of the Caspian Sea.
These oil fields produce 90 percent of the country’s exports and almost two-thirds of total budget revenue.
After the First Karabakh War, which ended in 1994, fossil fuel exports boomed, posting sustained growth of 11 percent from 2000 to 2015 before slowing. Since then, Azerbaijan has tried – without much success – to diversify its economy away from fossil fuels.
“The global transition to a low-emission economic model presents opportunities for Azerbaijan to be globally and regionally competitive,” said Sarah Michael, World Bank country manager for Azerbaijan. “To make the most of it, Azerbaijan must focus on decarbonizing and diversifying the economy, promoting innovation, and developing natural and human capital.”
Inequality and rural poverty
Poverty fell from 49 percent in 2004 to 4.9 percent in 2014, but inequality remained – a 2021 World Bank report found that Azerbaijan has more than twice as much inequality as any other country in Europe and Central Asia , with poverty concentrated in rural areas .
While over 40 percent of the population is involved in agriculture, the sector accounts for only 5.7 percent of the gross domestic product due to the undeveloped agro-processing industry, limited access to finance, poor market linkages and a lack of skills and knowledge in the field modern agriculture lacks technology.
The migration of educated and skilled workers from rural areas to Baku or other countries further exacerbates the human capital gap between urban and rural populations. Over a million Azerbaijanis have migrated for education and work to Russia, Turkey, the European Union, Ukraine, Israel, Central Asia and elsewhere.
“When the active and dynamic part of the population flows from the regions to the capital, the development of the regions weakens significantly,” suggested economist Rovshan Aghayev from the Baku Research Institute. “This is because the depopulation of rural regions is not related to production, migrants are also consumers and with increasing internal migration the regions lose their advantages as markets.”
outlook
Growth slowed in 2022 as inflation rose to 13.9 percent during the year and oil production fell. Inflation remained at ten percent in September 2023, and the Asian Development Bank forecasts that Azerbaijan will have the lowest gross domestic product (GDP) growth rate of all countries in Central Asia and the Caucasus, at just 2.2 percent.
Higher household incomes increased private consumption by 5.1 percent in the first half of 2023, but persistent double-digit inflation could dampen real incomes and consumption.
Although the war in Ukraine has strengthened the West’s interest in Azerbaijan as an energy source and as an important link in the Middle Corridor to bypass Russia, serious logistical and capacity issues still need to be resolved before this route will be ready to handle the same volume of trade as Russia’s Trans-Siberian networks.
Since Azerbaijan regained control of areas of Nagorno-Karabakh and its surrounding areas in the Second Karabakh War in 2020, extensive efforts have been made to rebuild areas damaged by the conflict before hundreds of thousands of internally displaced Azerbaijanis could return. Heavy government investments – including in pipelines, hydroelectric power plants and the restoration of historical structures in Karabakh – boosted construction growth from 8.7 percent in the first seven months of 2022 to 13.2 percent a year later.
Baku’s offensive in September against the remaining territories of Karabakh under the control of the breakaway state of Artsakh led to the tragic exodus of almost all of the region’s 120,000 Armenian residents, but also ended a conflict that has been a source of geopolitical instability for three and a half decades. All territory de jure recognized as Azerbaijan has de facto returned to Baku’s control.
However, a war with Armenia to seize a land corridor connecting mainland Azerbaijan with its exclave Nakhichevan would jeopardize this newfound political certainty and risk Western sanctions.
Prioritizing diversification and tourism, investing in human capital in rural areas, reopening land borders (closed since the Covid-19 pandemic), ensuring a significant improvement in the quality of life of internally displaced people, and completing a long-held goal A peace agreement with Armenia would enable Azerbaijan , address its structural challenges while ensuring peace and cooperation for future generations of Caucasians.
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