Turkey: Politics and Economics Come Together

In this edition of Iqtisadi: Middle East Economy, Dr. Paul Rivlin examines the interface between economic issues and politics in today's Turkey.

On June 7, 2015, Turkey will go to the polls in a general election to vote for the 550 members of the Grand National Assembly. The governing Justice and Development Party (AKP) aims for a fourth consecutive term in government and its leader, Ahmet Davutoğlu, will seek a full term as Prime Minister of Turkey in his own right, having taken over from Recep Tayyip Erdoğan who became president in August 2014. Erdoğan was elected president in the first round of the election with 51.79 percent of the vote. The AKP's goal is to win more than two thirds (367) of the seats so that it can make constitutional changes without having to call for a referendum. If it wins over 330 seats, but less than two thirds, it will have to call for a referendum. In the 2011 general election the AKP won 327 seats. Changing the constitution to give the president executive powers has been the central issue in the run-up to the June elections.

In April 2015, Erdoğan stated that Turkey was "spinning its wheels in the economy for the past three years," and the solution to the economic standstill was to adopt a presidential system of government. In the past, he also said that Turkey’s business community wished for “one party rule” for economic stability, but this was not enough and the solution was the presidential system (Hürriyet, April 19, 2015).

The economy has been experiencing slow growth, rising unemployment, persistent inflation, and balance of payments problems for three years. One consequence has been that the exchange rate of the Turkish Lira fell by 30 percent against the US dollar and 14 percent against the Euro in the fiscal year to mid-May 2015. This is in strong contrast with the impression that Turkey has become an economic tiger, like the countries of East and Southeast Asia. What has happened to change the picture? According to Daron Acemoğlu and Murat Üçer (Financial Times, April 15, 2015), beginning in 2002 reforms in institutions and changes in policies improved the environment for business and broadened the base of economic activity. The number of medium-sized companies grew and provincial cities far from Istanbul benefited. The trigger was a range of reforms that strengthened the banking system, including making the central bank more independent of government. These measures helped bring an end to chronically high inflation, reduced the large public sector deficit, and as a result the public debt-to-GDP ratio declined.

Public scrutiny and transparency of the corrupt government procurement process was introduced. Foreign direct investment (FDI) and short-term foreign capital began to flow into Turkey in larger quantities. Productivity in the manufacturing sector grew at approximately 6 percent a year between 2002 and 2007. These economic changes were underpinned, according to Acemoğlu and Üçer, by a process of deepening democracy. Turkey had been under a form of military supervision since the 1980 coup. The 2002 elections brought to power the Justice and Development Party (AKP) that encouraged a more open public sphere for civil society. The AKP adopted an orthodox economic approach, building on reforms that had started before it took office. It also invested in education, infrastructure, and healthcare for large segments of society that had been left behind by previous governments and continued to implement numerous reforms designed to meet the requirements of European Union membership that were being negotiated.

In recent years many reforms have been rolled back. The independence of the central bank has been reduced. Perceptions about corruption have deteriorated, with Turkey dropping 11 places to rank 64th globally in Transparency International’s latest Corruption Perception Index. A World Bank report suggests that after 2007, progress largely stopped across three measures of institutional reform: world governance, ease of doing-business ratings, and market regulation.

Turkey's media is now as constrained as it was when the military ruled and struggles to hold the government to account. The judicial system has lost the little independence it had gained, with the government putting loyalists in top posts. The state’s violent reaction to peaceful pro-democracy protests in Gezi Park, Istanbul in 2013 marked a turning point in the silencing of civil society.

The move towards a presidential system of government is seen by many as part of a retreat from democracy that has been going on for years. A more critical view of what is happening in Turkey is given by the Turkish-American economist, Dani Rodrik.

According to Rodrik, Turkey's institutional deterioration is not a recent matter. It started long before Erdogan’s responses to the Gezi Park protests in 2013 and to the corruption probe in the winter of that year. The harsh crackdown on the media during the past year is part of the repression of the independent press. Since the AKP came to power, executive involvement has been reinstated in the public procurement process, leading media owners to self-censor criticism of the government for fear of losing contracts. When the media criticized the government, it responded with arbitrary tax penalties such as the enormous fine it levied in 2009 on the publisher of the leading independent daily newspaper,Hürriyet. Litigation against private citizens was another channel of government repression; by 2005, Erdogan had already won nearly $500,000 from slander lawsuits. The AKP government has also become a leading imprisoner of journalists. Between 2007 and 2015, Turkey’s global ranking in terms of press freedom fell from 101 to 149 out of 180 countries (2015 World Press Freedom Index).

According to Rodrik, Acemoglu and Üçer, the Turkish judiciary was never fully independent. Historically, it has acted as an instrument of secular elites and has been hostile to groups outside the Kemalist camp. When the AKP came to power in 2003, the party did not have its own cadres to replace the secular groups that had dominated the bureaucracy and judiciary. It therefore relied on the Gülen (or Hizmet) movement, which was all too willing to cooperate, having pursued a long-term strategy of placing its sympathizers in the state apparatus. The Gülen movement is a religious and social movement led by Turkish Islamic scholar and preacher Fethullah Gülen. It is active in education with private schools and universities in over 180 countries and has initiated forums for interfaith dialogue. It has substantial investments in media, finance, and for–profit health clinics. Some have praised the movement as a pacifist, modern-oriented version of Islam, and as an alternative to more extreme interpretations of Islam such as Salafism. It has also been criticized for being missionary, secretive, and unaccountable. The Gülenists in the police and judiciary ran the anti-military trials (Ergenekon and Balyoz) and anti-Kurdish (KCK) court cases during the latter part of the last decade. The Gülenists had a free hand until Erdoğan began targeting the movement. In 2007, Turkey’s global ranking in judicial independence was 56 out of 83 countries. In 2013 it was 85 out of 148, but in 2014 it fell to 101 out of 144. In the economic sphere, independent regulatory agencies in finance, telecommunications, and competition policy have been brought under tighter government control. New regulations and political appointments have practically abolished the autonomy of scientific bodies and universities.

Networks of rent-seeking and patronage have thrived in Erdoğan’s Turkey, and the May 2014 Soma tragedy, in which 301 coal miners were killed, threw into question the economy under AKP control. This incident revealed that miners were operating in appalling conditions with highly questionable practices involving business owners and state officials.

Erdoğan and the AKP remain popular among large sections of the Turkish population. Erdoğan has presided over a period of significant upward social and economic mobility among the previously disadvantaged poor and pious. He allowed some Kemalist political taboos to loosen, facilitating freer public discussion on such matters as Kurdish rights and the Armenian genocide. Erdoğan has also been responsible for major infrastructure plans and projects. These include a new bridge across the Bosporus, a tunnel under it and even a canal running parallel to it. There are also plans to build the world's largest airport in Istanbul and thousands of kilometers of high-speed railways. 

Yet the AKP’s rhetoric has exacerbated the Sunni-Alevi divide and encouraged xenophobia. Open antisemitism in pro-government media has reached unprecedented levels.

According to the Organisation for Economic Cooperation and Development (OECD), in the 2000s Turkey’s growth performance was mainly driven by domestic demand, partly financed by borrowing abroad that led to a widening deficit on the current account of the balance of payments. This reached $75 billion, equal to over 9 percent of GDP in 2011, and fell to $46 billion, over 5 percent of GDP in 2014. Short term foreign debt rose from $82 billion to $133 billion over the same period.

A loss of competitiveness, a sharp fall in private saving and increasing energy imports caused the deterioration of the current account. While Turkey has improved non-price competitiveness and diversified its exports towards medium-to-high technology sectors, the share of high-technology sectors remains very small. Low and middle tech sectors were more vulnerable to the erosion of price and cost competitiveness, due to higher average inflation and unit labor cost growth compared to trading partners and competitors, despite devaluations of the Turkish Lira during periods of financial turmoil. The fall in private saving mainly stemmed from a decline in household saving, encompassing all income groups. According to the International Monetary Fund (IMF)a range of factors explain the decline in private saving, one of which is increased consumption driven by a rise in credit flows in an environment of reduced interest rates and inflation. Economic growth, driven by the business sector, resumed after the global financial crisis of 2008 but was dominated by domestic consumption, funded by foreign borrowing. The resulting current account deficit forced the authorities to reduce domestic demand and this slowed economic growth. Consumer price inflation has been above government targets, as has unemployment.

In mid-2013, deeper financial turmoil in Turkey was triggered by the announcement of a reduction in United States monetary stimulus. This could have resulted in a rise in interest rates that would have made Turkish borrowing more expensive. Aggravated by domestic political tensions, the resulting financial stress was greater for Turkey than for a number of other emerging countries. Yet as a result of broad-based industrial development and massive job creation, growth became more inclusive in the 2000s, stimulating domestic demand. Income inequality, poverty and material deprivation all declined. Income gaps between regions narrowed. Relative income poverty also declined in Turkey’s all twelve regions between 2006 and 2012. Nonetheless, Turkey still compares unfavorably to other countries with similar income levels in education, work/life balance, and environmental factors.

The lack of high technology production and exports is partly explained by weaknesses in the Turkish education system. Educational enrollment remains far below the OECD average, as does its quality. Between 2003 and 2012, Turkey’s performance improved markedly in the three areas tested in the Programme for International Student Assessment (PISA): mathematics, reading, and science. Much of the improvement was concentrated among students with the greatest educational needs. The degree to which students’ socio-economic status predicts their performance also shrank. Students attending schools in smaller towns improved their performance more than students in cities. The official unemployment rate in the first quarter of 2015 was 10.2 percent, but among 15-24 years it was estimated at 30 percent.

Cyclical conditions play a major role in Turkey’s current account developments. The sharp deterioration in 2010/11 reflected the swift rebound in domestic activity fuelled by capital inflows on the back of highly expansionary monetary policy in advanced economies. Demand remained subdued, especially in Europe, Turkey’s largest export market, and the terms-of-trade deteriorated as commodity prices increased. Since then, cyclical conditions have normalized as domestic demand slowed in 2012 and external demand picked up somewhat in 2013. Current account deficits are to be expected in emerging economies with a young population such as Turkey's. However, estimates relating the current account to fundamentals such as demographics, GDP per capita, and natural resource abundance and policies such as fiscal, social, and financial policies indicate that Turkey’s structural current account deficit in 2012 may have been 1.5-3.0 percent of GDP larger than implied by fundamentals and desirable policy settings. Policy or market distortions may therefore account for at least part of Turkey’s current account deficit. In addition, the financing structure of the current account deteriorated after the crisis, with a growing share of more volatile short-term debt-creating inflows, which are more prone to sudden reversals. Since 2012 the share of long-term inflows increased again, helped by policy measures, but the share of foreign direct investment (FDI) inflows remains low.

Turkey’s growth performance since 2002 has been much praised. While the 50 percent increase in real per-capita GDP was impressive, it was still below what Sri Lanka, Bangladesh, Uruguay, Peru, Argentina, Ghana, Indonesia, Philippines and many others – not to mention China and India – have achieved. Poverty rates and inequality have fallen under Erdoğan, but again that is typical for this period among the middle-income countries that serve as comparators for Turkey. Comparative experience suggests that Turkey benefited from an unusually favorable external environment. In particular, financial globalization and the availability of cheap foreign capital seem to have played a critical role.

This was significant for Turkey because low domestic saving has always been a major constraint. Turkey has overcome this constraint by short-term borrowing designed to maintain domestic consumption and investment. This strategy typically bears fruit as long as finance is cheap and available. But it comes at the cost of accumulating fragility and increased vulnerability to reversals in financial market sentiment. It often ends up in crisis as the funds dry up.

Under the AKP that strategy was modified in two respects. First, there was much greater reliance on foreign capital inflows and less reliance on printing money. Second, there was a switch from public sector to private sector borrowing.

Turkish economic growth has always been dependent on the availability of external finance. The faster the economy grows, the larger the current account deficit (which needs to be financed by some kind of capital inflows) will be.

The counterpart of the current account deficits of the last decade is a private sector imbalance rather than a public sector imbalance. The AKP government was able to move the public sector into surplus (except for the crisis year of 2009), an achievement for which it receives great credit. But this improvement was more than offset by a substantial deterioration in the private sector balance. The private sector has been encouraged, through easier access to credit, to go on a borrowing binge. Financial indiscipline and recklessness have not disappeared; they have moved from the public to the private sector.

Politics and Economics
The Turkish economy is in urgent need of reform. Domestic savings need to be increased so that the economy becomes less reliant on short term capital imports. This requires reform in the capital markets and the banking system. An independent central bank is the sine qua non for this. The second change that is needed will be more difficult to implement. In order to raise the technological level, and thus the value added in production and exports, improvements in education are needed. These need to move the system away from learning by rote towards greater creativity. This, in turn, requires a more open political environment than now prevails. In fact, Turkey may be moving in the opposite direction.

Deputy Prime Minister Ali Babacan, who is the minister responsible for the economy and is considered an anchor of foreign investor confidence in Turkey, has repeated his concerns about the rule of law in Turkey, saying that if the situation continues to deteriorate, the country would suffer. He has stated, "Our economy is only as successful as we are in the area of the judiciary. If the [current] weak picture [with regard to the rule of law] continues, we will end up in a place where we long for the situation that we currently have, both in the areas of democracy and the economy. The rule of law is a fundamental necessity for prosperity and democracy, just as food and water [are to sustain life].” In Turkish-American economist Dani Rodrik's view, the AKP government did not make any fundamental changes in its economic strategy. It simply gave Turkey’s traditional macroeconomic populism a modern makeover by relying more on foreign capital markets and by boosting private expenditures. Neither of these changes rendered Turkish growth healthier or more sustainable.

President Erdoğan has blamed the political system for Turkey's economic problems. Many would agree but see the solution in increased democracy and transparency in government, greater press freedom, and a more independent judiciary. On the basis of recent trends, it is clear that this is not what Erdoğan intends.

 Written with assistance from Duygu Atlas and Hay Eytan Cohen Yanarocak.