The novelty of this study is that it empirically tests four hypotheses of the Dutch Disease in the Azerbaijan economy while systematically controls for other possible explanations of the observed processes over the period 2000–2007. The study concludes that an “absolute de-industrialization” has not taken place in Azerbaijan, rather the country suffers from a “relative de-industrialization” in the non-oil tradable sector. Additionally, the paper shows that the non-tradable sector has substantially expanded during the 2000–2007 period. Analysis also presents that the government expenditures have created a “spending effect”, which is more crucial than the “resource movement effect”. Furthermore, it was found that rapid increases in the wages and the non-tradable prices have led to appreciation of the real exchange rate in Azerbaijan. Finally, the study reveals that foreign direct investments inflow to the oil sector is harmful for non-oil exports and therefore, it contributes to deepening of resource, or oil, dependence. Findings in this paper support the view that to obtain a diversified economy with a long-term balanced growth development of the nonoil tradable sector should be of the major focus for the policymakers.

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