IN THE 'MIDDLE-INCOME TRAP'

Baku was selected as the venue for the presentation of the World Bank's annual global report for 2024, which focused on the issue of the "middle-income trap." This term refers to a situation where middle-income countries experience a slowdown in growth and struggle to transition into high-income economies. For Azerbaijan, which is currently in this transitional phase, the discussion of this matter is particularly pertinent.

Challenged Growth

According to Roland Price, World Bank Regional Director for the South Caucasus, Azerbaijan has made significant progress over the past 30 years. While in 1993 the gross national income (GNI) per capita was only $110, by 2023 this figure has risen to $6,660. However, the transition to high-income status requires a more comprehensive approach that encompasses investment in infrastructure, human capital development, support for innovation, and institutional strengthening. As highlighted in the World Bank report, only 34 countries have successfully overcome the middle-income trap since the 1990s, while 108 countries continue to encounter this challenge at the end of 2023. The primary factors complicating the transition to high-income status include high debt levels, ageing populations, and increasing global protectionism.

Shahmar Movsumov, Assistant to the President of Azerbaijan on Economic Affairs, has remarked that over the past 30 years, Azerbaijan has shifted from poverty to becoming a sustainable and economically robust country, now classified among 54 middle-income countries. This achievement was made possible through a consistent economic policy that not only solidified the country's position in the region but also established a solid foundation for restoring territorial integrity and sovereignty.

He indicated that the country has already established the necessary infrastructure and foundation for innovative development. Active capital expenditures in energy, technology, and digitalisation are essential for future growth, but to further strengthen the economy, it is crucial to enhance private sector development and continue diversification. Despite these successes, the structure of investments remains unbalanced. Deputy Economy Minister Samed Bashirli has highlighted that public investment dominates the economy, while private capital still plays an insufficient role. To address this imbalance, it is essential to create favourable conditions for private investment, especially in non-oil sectors such as the automotive, banking, service industries, and innovative technologies. Concurrently, economic diversification is yielding positive outcomes. While the non-oil sector constituted 49 percent of GDP in 2011, it is projected to reach 68 percent by 2024. According to Shakhmar Movsumov, this transformation signifies a gradual transition to a more balanced and sustainable economic model. Consequently, the welfare of the population has improved; minimum wages, pensions, and employment rates have increased; and measures have been undertaken to reduce poverty. The significance of these transformations is particularly pronounced in the context of international cooperation. Since joining the World Bank in 1992, Azerbaijan has advanced from being an aid-dependent country to becoming a donor to the International Development Association, thus underscoring not only economic sustainability but also the Republic's growing role in the global investment landscape.

The Role of the Central Bank

Taleh Kazimov, Chairman of the Central Bank of Azerbaijan, noted that the Central Bank of Azerbaijan plays a key role in maintaining macroeconomic stability, developing the financial sector, and stimulating investment activity. The financial strategy will prioritize the diversification of financing instruments, the digitalization of banking services, and the promotion of financial inclusiveness in 2024-2026.

The development of the financial sector during this period will be centred on supporting households and businesses, with plans to expand the range of financial instruments and actively implement sustainable finance principles. A key area of focus will be transitioning from traditional channels to digital financial intermediation, enhancing the accessibility and efficiency of financial services. Significant attention will also be directed towards improving the financial literacy of both the population and businesses. This initiative will enhance personal and corporate financial management, mitigate financial risks, and increase trust in financial institutions. Concurrently, measures will be implemented to strengthen the stability of the banking sector and develop insurance, stock, and payment markets. These actions will enable the financial system to play a more substantial role in financing the economy by channelling capital to competitive sectors and supporting both domestic and foreign investments in innovative projects.

A robust financial sector will be a crucial component of Azerbaijan's strategy to overcome the "middle-income trap." It will ensure long-term sustainable growth while creating conditions for expanding exports of both goods and services.

"We believe that long-term stable growth is only achievable through an active increase in exports and attracting foreign direct investment, which not only ensures capital inflow but also facilitates technology transfer and innovation. Another key element of sustainable growth will be to reform the fiscal system based on strict budgetary discipline and counter-cyclical economic policies," Kazimov concluded.

How To Avoid the "Trap"?

Ivaylo Izvorski, the World Bank's chief economist for Europe and Central Asia, has stated that in several Central Asian countries, 70-80 percent of state-owned enterprises operate in competitive sectors such as retail trade, thereby hindering private business development. Limited access to long-term capital and inefficient allocation of financial resources also impede company growth.

"If enterprises remain small, they cannot adopt foreign technologies or achieve the scale required for innovation. This limitation can be attributed to the narrow domestic markets, underscoring the critical importance of integration into global and regional markets. In many countries across Europe and Central Asia, companies often remain small even five years after their establishment," he explained. He further highlighted that the distinction between regions lies in their level of competition. In Central Europe, where countries have successfully transitioned into high-income categories, the competitive environment remains dynamic. In contrast, competition is significantly weaker in the Caucasus and Central Asia countries, hindering business growth.

"States that have attained high income levels have undergone two stages: first investment growth followed by innovation growth. Currently, most countries in Europe and Central Asia are in this second stage. They need not only to attract investment but also to adapt technologies. Meanwhile, access to finance—especially venture capital—remains a challenge. Banks tend to avoid risks, but innovative projects require a willingness to confront uncertainty," noted the economist. Azerbaijan faces similar challenges as it seeks to accelerate its economic development and integrate into the group of high-income countries. Deputy Minister of Economy Samed Bashirli has identified three key areas that will assist the country in overcoming the "middle-income trap."

The first of these focuses on increasing private investments and developing the non-oil sector, with a particular emphasis on creating large local corporations and changing investment structures to boost private capital's share. The second is the expansion into international markets, a process which will be facilitated by the country's strategic location and the transport corridors of Baku-Tbilisi-Kars and North-South.

The second avenue focuses on enhancing the investment environment, with the understanding that competition for foreign direct investment within the region is intensifying. While this was less pronounced five to ten years ago, neighbouring countries are now actively seeking capital, and Azerbaijan must consider this factor and increase its attractiveness for investors. The third avenue pertains to developing human capital, and this involves reforms in education, support for science and technology initiatives, and improving migration policies to attract highly qualified specialists.

As Bashirli stated, Azerbaijan is already on course to join high-income countries, with a GDP per capita of $7,284 that exceeds the average for middle-income nations. However, further growth necessitates additional incentives for trade and economic diversification, as well as technological advancement alongside strong human capital formation, given that technology alone does not enhance productivity; proper integration into the economy is vital.

Azerbaijan has a good opportunity to transcend the middle-income trap; however, this will require modernization of its economic model: public investment must give way to a dynamic private sector where innovation and human capital serve as primary drivers of growth.