Minimum Wage Policy of Azerbaijan

With a decree on November 5th, the minimum wage in Azerbaijan has been increased from 250 AZN to 300 AZN per month. With this post, I am going to analyze the minimum wage policy of Azerbaijan and try to come up with suggestions on how to improve it.

AN OVERVIEW OF MINIMUM WAGE POLICY

Minimum wages (MWs) are adapted by many governments around the globe in hope of combatting poverty and ensuring fair compensation for the labor of low-skilled workers. The essence of the idea is to establish a price floor for the compensation of laborers. Although on paper this sounds like a wonderful idea, an ill-designed minimum wage policy can have unintended detrimental effects on unemployment and poverty that far outweigh its supposed benefits.

Minimum wages come in all shapes and sizes. Some countries do not have a national/federal minimum wage but instead rely on trade unions to bargain with the employers, such as Denmark. Certain countries have different minimum wage rates at separate levels of government, such as the United States. Some differentiate the rate by location, such as Malaysia. Imposing different rates for specific sectors is also a common practice, followed by Costa Rica, Kenya, etc. In Hungary, the MW rate (MWR) is determined by whether the employee is skilled or unskilled, while countries such as New Zealand and the UK introduced different rates on specialized groups (for example, teenagers and adults).

The foremost problem of minimum wages is that it can push low-skilled workers (the people who these policies are supposed to protect the most) out of the labor market. That is because if the marginal productivity offered by the worker is less than the MWR, then private entities will have no incentive to hire him/her. This is particularly a more overwhelming (and often overlooked) issue for teenagers, who enter the labor market with minimal skills and experience. The same thing can also be said about minorities as they can be underprivileged when it comes to access to decent education and learning.

The second trouble brought by minimum wages, especially in developing countries, is pushing employers to hire workers illegally to avoid higher costs. Employees can also be stripped from company-provided transportation, lunch, or other benefits.

The rate of minimum wage is a crucial factor in its effectiveness. If the rate is too low, then the law practically means nothing. If it is too high, then a lot of the unskilled people will either lose their jobs or will be hired illegally. According to OECD, in more economically developed countries, the ratio of the minimum wage to average wage varies mostly between 35 – 50%, with the notable exception of the United States (21%).

MINIMUM WAGE IN AZERBAIJAN AND ITS PROBLEMS

In Azerbaijan, the minimum wage is established by the central government on a national scale. As the constitution has not delegated the setting MWR power to any specific institution, it rests with the president (Article 109, point 32 of the Constitution), without the participation of the Parliament. There is only one rate, and it applies to all groups of employees in all sectors regardless of their location. Furthermore, the Labor Code mentions that (article 155, point 2) MW is applied to unskilled labor only. This means that in conduct, the employers are required to pay at least marginally higher for skilled labor, even though this is not distinctly mentioned in the code.

When following the policy discussions and decisions regarding minimum wage around the world, we must be cautious as not to apply their practice/conclusion directly to Azerbaijan, because even minor disparities in economic/social/political environments can lead to vastly contrasting results. One primary factor to consider here is the role of monopsonies in Azerbaijan. It is no secret that monopolies are an integral part of our economy. In the labor market, these monopolies turn into monopsonies – the single buyer of labor in a given sector. Due to their enormous size and unchecked power, these companies can comfortably dictate salary and benefit negotiations. The customary “enemy” of large employers, namely the trade unions, unfortunately only exists on paper in Azerbaijan. For that reason, inasmuch as I usually advocate for a limited government in the economy, the lack of a competitive free market in Azerbaijan makes the presence of minimum wage laws comparably more justifiable from a purely economic point of view.

In the next section, I am going to identify some of the flaws in Azerbaijan’s current MW policy, which will be followed by policy recommendations to potentially tackle them.

Problem #1 – Arbitrary Timeline

In Graph 1 below you can see how MW rate and annual inflation have varied in Azerbaijan since 2006. The orange line (second vertical axis) represents annual inflation, and the blue line (primary vertical axis) is the rate of Minimum Wage. There are a couple of noteworthy points here. First, it is observed that changes to the rate of MW have been carried haphazardly. In certain cases, the same MWR has been in place for more than 3 years (2013-2016) whilst in other cases, it has been amended twice in the course of just 6 months (February 2019 – June 2019). This inconsistency is, for glaring reasons, undesirable, as it obstructs companies in planning, and hampers economic institutions in forecasting.

Secondly, there seems to be no connection between inflation and minimum wage. Variation in price levels is the leading factor that the governments traditionally base their MW decisions upon. In the Azerbaijani case, however, the actual correlation between these two variables is -0.4, meaning that they often move in opposing directions. Although the reliability of inflation figures in Azerbaijan is dubious (which is likely playing some role in this anomaly), it still is not enough to explain the negative correlation.

Graph 1: Timeline of Minimum Wage[1] and Annual Inflation in Azerbaijan

Graph 1 - Timeline

Source: E-qanun, Central Bank of Azerbaijan

Problem #2 – No Regional Differentiation

The table below demonstrates another compelling shortcoming of the minimum wage policy of Azerbaijan. As mentioned above, countries with substantial differences in economic development among their regions/provinces/states tend to set minimum wages at the sub-national levels as well, either by the central government or by local authorities themselves. That is not the case in Azerbaijan, which to me renders the MW policy quite incompetent.

That is because, while 250 AZN[2] represented only 27% of the average salary[3] in Baku, the corresponding indicator for Barda, Aghdam, and Qakh sits at 63%! I do not have the necessary information/data to argue whether the rate is too low for Baku or too high for Barda/Aghdam/Qakh. Nonetheless, what I can assert is that the colossal discrepancy between the labor markets in the capital (and other top regions) and the underdeveloped regions menaces the logic of forcing the same rate over them. Whatever impact the prevailing MW policy has for one part of the country, be it negative or positive, it will have the exact opposite influence over the rest. So, if the current MW rate is affecting the labor market in Baku positively, it will have a negative effect in Qakh, or vice-versa.

Table 1: Top and Bottom Regions in terms of Minimum Wage to Average Salary ratio[4]

Table 1 - Top n Bottom Regions

Source: State Statistical Committee

Problem #3 – No Occupational Differentiation

The equivalent argument above can also be extended into different sectors of the economy. Unfortunately, the data provided by the State Statistical Committee cannot be utilized here to demonstrate the point, because the information is rather vague. It categorizes income earners based on the industry that they work in, rather than the actual job that they are doing. The impediment with this approach is that an oil/gas engineer and a janitor working in British Petroleum surely do not do comparable work and hence get paid at highly varying amounts, but the Statistics Committee puts them both under the sector of “mining”. Although we do not have the exact data here, we can still quickly understand that one rate does not work for all occupations. Not differentiating between unskilled (waiters, for example) and skilled workers (mechanics, operators, chefs) jeopardize the functionality of the policy.

Problem #4 – Lack of Public Participation

As mentioned above, the rate of the MW is determined solely by the president. Even with the best economic knowledge and most skilled economic advisers, it is unreasonable to expect the decisions to be effective. That is because, without hearing the position of interest groups (such as the trade unions, members of Parliament, and relevant NGOs) in this matter, the executive authorities can not grasp the situational realities on the ground. As a result, their steps might seem good on paper but lead to a dire situation when executed.

Problem #5 – Shadow Economy

A 2018 study by Medina and Schneider puts Azerbaijan at 14th place in the world for the size of the shadow economy. They estimate that for the year 2015 (the latest year with available data), the size of the underground economy was 43.7% in the country. We know that the figure for 2021 is going to be slightly lower due to meager attempts at legalization in recent years, but it is guaranteed that Azerbaijan still has a sizable shadow economy. Considering that, it becomes even more vital to be utmost vigilant when designing the minimum wage policy.

Many employers in Azerbaijan tend to give minimum wage on paper and pay the rest of the salary under the table (as “envelope payments”) to avoid taxation. It is common to see employees with de-facto salaries of 400-500 AZN receiving only 250 AZN as legal payment. When faced with elevated rates of minimum wage, these employers will simply raise the “official pay” and reduce the “envelope payment”, meaning that nothing changes for the employee at the end of the day.

SUGGESTIONS

Suggestion #1 – Minimum Wage Commission

Timely reviews are an essential part of MW policy in many countries. Azerbaijan should employ a similar practice where the rate is reviewed annually (or bi-annually) by a commission consisting of economic experts. The commission’s principal responsibility would be to submit recommendations and guidance to the central government about MWR. It would draw its decisions from inflation, expected short-term fluctuations, business environment, as well as positions of interest groups. Implementing this idea, on the other hand, depends on the participation of trade unions in the process. It is therefore imperative for the Azerbaijani government to reform the trade unions and make them functioning entities. The Commission, coupled with reformed trade unions, would largely settle the issues outlined in problems #1 and #4 above.

Suggestion #2 – Differentiation

On problems #2 and #3, we have endorsed the economic sense to differentiate the MRW among various geographic regions, as well as employment types. The corresponding solution is evident: the government should stop imposing the same rate on such diverse economic circumstances.

With the help of the Commission, we can move to a new system where we take location and skill level into account. Having a distinct MWR for each region and each occupation would be unnecessarily complicated. Instead, we can merge regions into 4-5 groups based on their level of economic development and the cost of living[5]. For instance, group 1 would have Baku, and group 5 would include Barda, Aghdam, and Qakh. Apart from the group, we can also differentiate the rate between skilled and unskilled labor.

Hence, we can move to a scheme where the MWR is derived from the base amount (decided by the central government upon recommendations by the commission) multiplied by group coefficient (set by the commission) and skill coefficient (set by the commission). Under an ideal situation, the base amount and the coefficients should be confirmed by the Parliament to incorporate them in the process.

ON SHADOW ECONOMY

Problem #5, which is about the ineffectiveness of MW policy caused by Shadow Economy, is a broader headache for the Azerbaijani economy. The answer here is apparent: move businesses from underground economy and formalize their activities. For the past couple of years, the government has been trying to achieve that, with limited success. I say limited because I believe that the current approach cannot solve the issue completely.

So far, the plan to combat shadow economy has focused on heightened penalties, stricter checks by authorities (such as State Tax Service), and slight incentives to population (the most successful case here would be the VAT refund program, where 15-20% of VAT is returned to the customer using the QR code on the check). However, more meaningful changes in this matter require more compelling measures. Here is why.

When talking about Shadow Economy we tend to forget one major factor – competition. Albeit some sectors in Azerbaijan are predominantly ruled by monopolies, some others (restaurants, cafes, grocery stores, farmer markets, etc.) still have a decent amount of competition between many businesses that are owned by different people/companies. It is therefore impossible for one entity in relatively competitive sectors to legalize all its activities, even if it wants to, solely because it would levy a hefty cost disadvantage compared to its rivals. Such a disadvantage is undoubtedly enough to drive a company out of business. Small and medium enterprises are particularly vulnerable in this sense, as they lack the “valuable” ties to the government bureaucracy enjoyed by larger companies. In other words, if it is not enforced strictly sector-wide, “voluntary” legalization means bankruptcy for many individual businesses. Instead of risking their business, many small owners prefer to either hide their activities or bribe the officials to ignore the unreported revenues/costs of their businesses. From my own experience, this is a particularly acute problem in the regions.

CONCLUSION

Minimum Wages can be a useful tool in Azerbaijan for safeguarding the rights of workers if implemented correctly. There are, however, severe deficiencies with the current policy. These include not having a pre-determined timeline for minimum wage decisions, no regional or occupational differentiation, serious lack of public participation in the process, and presence of a large shadow economy.

In my opinion, the government can take certain steps to partially address these issues. The policy answers include establishing a commission of economic experts with the responsibility of preparing timely recommendations to the government on everything related to minimum wage. A new scheme that includes regional differentiation (based on grouping regions upon the development of their labor markets) and separation of skilled/unskilled rates can be utilized to overcome most of the problems outlined above.

Mitigating the adverse influence of the shadow economy on minimum wage policy requires more broad-based reforms. These reforms must account for the discouraging effect of legalization for small and medium enterprises due to its cost-disadvantageous nature.

NOTES

[1] The values for Minimum Wage Rate correspond to the month in which the raise has been announced, as opposed to the month in which the raise takes effect.

[2] I am using the previous minimum wage in this example because the corresponding data for average salary is also for the year of 2020. It would be wrong to use the minimum wage of 2022 to average salary of 2020.

[3] Using median wage instead of average salary is more appropriate in this case. Yet, since regional median wage statistics are not available, I am forced to use average salary instead.

[4] AS = Average Salary, MW = Minimum Wage to Average Salary ratio

[5] I chose cost of living here because if we went exclusively by economic development, regions such as Gadabay and Dashkasan must be merged with Baku. This, however, does not work for our purpose, because the reason behind Gadabay’s and Dashkasan’s economic indicators being almost on par with the capital is not about the productivity of labor of local population, but rather about the gold mining in the area. Outside of the population employed at that sector, the life standard of the remaining population is more or less the same with the groups 4 or 5.

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