Whos Going to Save Turkeys Economy?

The Turkish economy is in dire straits. But its leadership is

showing no interest in serious reform.

BY CENK SIDAR, EMRE TUNCALP-APRIL 3,

2015
For most of the past decade, Turkeys economy has enjoyed
remarkable success. Between 2002 and 2006, during the first term
of the Justice and Development Party (AKP), growth averaged 7.2
percent per year, making Turkey a star performer in an otherwise

difficult region. This economic growth story significantly benefited

the AKP, helping it to win three consecutive parliamentary elections
(in 2002, 2007, and 2011) with overwhelming majorities.

While external factors played some role in Turkeys success, one would be
remiss not to give due credit to the ruling party. The positive steps the AKP
took after winning power continuing the IMF-led reforms initiated by its
predecessors and maintaining a responsible fiscal and monetary policy
helped the country achieve the macroeconomic stability necessary to
attract foreign capital. In particular, after a decade marred by a series of
failed coalition governments, the new era of political continuity ushered in
by the AKP heartened both domestic and foreign investors.

This picture has changed significantly over the past few years, as Turkey
has turned from an exemplary emerging market into a country that grabs
headlines with stories of economic weakness and financial vulnerability. The
current list of problems is daunting: rising inflation, slowing growth, foreign
exchange pressure, rising fiscal expenditures, increased unemployment,
overall debt, and loss of export competitiveness. The IMF expects Turkish
GDP to grow only 3 percent in 2015 and 2016. The lira has lost over 10
percent of its value since the beginning of this year. Moreover, the country
is falling behind rival emerging markets. In 2014, India and China left
Turkeys 2.9 percent growth rate in the dust with impressive rates of 7.5

and 7.4 percent respectively.

Turkeys slowdown is mainly caused by longer-term structural factors,
pointing to an urgent need for fundamental reform. And this is where the
economic track record of President Recep Tayyip Erdogan and the ruling
AKP has begun to suffer. Even as the Turkish economy sputters, the AKP
government is focusing on unsustainable, and sometimes destructive,
short-term measures, such as pressuring the central bank to maintain a
loose monetary policy, jeopardizing its independence and legitimacy in the
process. Meanwhile, the structural reforms needed to ensure the countrys
longer-term development are being put off.

Among the most fundamental of Turkeys structural problems is its

overreliance on foreign investment. Turkeys excessive dependence on
capital inflows from abroad, as well as its persistently high current account
deficit (6 percent of GDP at the end of 2014) has left it deeply vulnerable to
external shocks. In fact, Turkey was one of the worst-affected countries
during the recent global economic crisis: its economy shrank by a
staggering 5 percent in 2009. This weakness also led Morgan Stanley
to list Turkey in 2013 as one of the Fragile Five emerging countries most
at risk of a downturn. The end of the U.S. Federal Reserves quantitative
easing program which could come as early as June 2015 could cause
the flow of hot money to dry up. Many expect Turkeys current account
deficit to remain in the unsustainable 5 percent territory despite the

positive effects of the global drop in oil prices.

Even the widely touted political stability brought by the AKP has proved, in
the end, illusory. Foreign investors and observers are growing increasingly
nervous about the increasingly authoritarian nature of President Erdogan
and the AKP government. Since the government crackdown on mass
protests in 2013, the countrys democratic trajectory has taken a marked
turn for the worse. Significant deterioration in crucial indicators such as rule
of law, freedom of speech, judicial independence, media freedom, and
checks and balances have further shaken the confidence of investors.
Turkeys rankings in corruption prevention and perception indices have
slumped. Freedom Housedowngraded Turkey from Partly Free to Not
Free in its 2014 report on press freedom around the world. The rising
political risk indicated by these developments does not bode well for
Turkeys economic and investment prospects.
Several open conflicts over economic policy have added to the jitters. In the
recent Bank Asya incident, Turkeys banking watchdog cited alleged
irregularities as the justification for its seizure of shares from an Islamic
lender though most informed observes saw the move as a politically
motivated outgrowth of the continuing rift between Erdogan and his bitter
rival, the Gulen religious movement. President Erdogan
also clashed publicly with Central Bank governor Erdem Basci on monetary
policy decisions, pressuring him to cut interest rates. These conflicts have

raised significant questions about the quality of Turkeys economic

policymaking at a time when the country desperately needs foreign
investment to keep flowing.
In order to tackle these challenges and to avoid the so-called middle
income trap, Turkey needs a more reformist attitude. Several structural
and policy-related reforms need to be taken to achieve this. First, the
independence of the central bank needs to be ensured. Erdogans public
attack on Basci demonstrated that political interference in central bank
policies can only have a detrimental effect. Long-term interest rates are the
ones that matter for a countrys financing but every time President
Erdogan spoke about his desire for lower interest rates, long-term rates
went up.

Furthermore, Turkey should move forward with a series of potentially costly

but necessary reforms. Turkey ranks 55th in the World Banks Doing
Business Index, lagging behind other developing-market success stories
such as Poland (32nd), Chile (41st), and South Korea (7th). Labor costs
remain high compared with Turkeys peers, and low productivity caused by
inadequate human capital is constraining growth. Measures increasing
accountability and funding for low-performing schools should be prioritized
in order to tackle disparities in the education system. Womens low
participation in the labor market must be addressed through incentive

mechanisms.
In order to address chronic high current account deficits, the country should
aim at boosting exports, particularly value-added ones, and reducing
imports. The countrys savings rate, one of the lowest among emerging
market economies (14 percent of GDP), also needs to be addressed in order
to reduce reliance on foreign capital inflows. Finally, rule of law should be
improved, and basic freedoms protected. Such measures would address
concerns about the arbitrary nature of decision-making and the formulation
of policy.

Finding solutions to these problems will not be easy even though the
need to tackle them has long been clear. International organizations such as
the IMF and World Bank have stressed the need for most of these reforms
on numerous occasions. And yet very little progress has been made on
these fronts by the AKP government. The AKP, which has single-handedly
ruled the country for over twelve years, has so far shown little interest in
pursuing corresponding measures, which are so crucial to the countrys
long-term development. The reform plan outlined by Prime Minister
Davutoglu at the end of 2014 underwhelmed observers, who saw it as a
mere wish list rather than a structured roadmap.
Governments around the world tend to be reluctant to tackle serious
structural reforms, which tend to be politically costly, since some segments
of society are likely to suffer over the short term. Turkey, for example, has

one of the most rigid labor markets among OECD members, hampering its
economic growth. Addressing this issue will require a transformation of the
labor market, inevitably causing job losses that will lead to disgruntled
voters.
But parliamentary elections are coming in June, and their outcome is
anything but clear. Over the past decade, the AKPs main political strategy
has been based on touting its economic success. As this storyline becomes
strained, the political future of the ruling party may depend on its
willingness and ability to lead Turkey through reforms to sustainable
economic development. But Erdogans 12 years in power so far offer little
indication that he and the AKP are willing to do what it takes.