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Is Turkey at a crossroads?
After hitting the most severe crisis of its recent history in 2000-01, the Turkish economy bounced back and is now among the fastest growing economies in the OECD. At the same time, the inflation rate has declined sharply and could fall to a single digit annual rate in 2005, for the first time in three decades. A new institutional framework for monetary and fiscal policies as well as for product, labour and financial markets, infrastructure industries and agricultural support has opened a window of opportunity to escape from the boom and bust cycle of the past and embark durably on a path of higher growth and stronger employment. But seizing this opportunity requires fully implementing the new policy framework and further advancing the reform process. So far, the convergence with the EU acquis, and the close co-operation with the IMF and the World Bank have contributed critically to the momentum of policies. The recent recommendation by the EU commission to start EU accession negotiations – if confirmed by the European Council in December – promises to strengthen the international anchors and could underpin Turkey’s shift to a stronger growth path.
After slumping by 7½ per cent in 2001, GDP recovered by around 8 and 6 per cent respectively in 2002 and 2003 and should rise by more than 8 per cent in 2004, exceeding government targets. It is driven by strong productivity gains and by robust private consumption, investment and exports, and has not been hindered by cuts in government consumption and investment. Tight macroeconomic policies, based on a high primary surplus and on strict monetary conditions which have kept inflation on a steep downward path, have significantly improved confidence and have proved to be expansionary. However, imports are growing faster than exports and the current account deficit could exceed 4 per cent of GDP in 2004; should foreign direct investment inflows remain weak, the deficit will be funded almost entirely by additional foreign debt which could raise concerns about its sustainability. Given the strength of the economy and the risk of a further widening of the current balance deficit, the government should resist any temptation to loosen the fiscal stance and aim at devoting additional revenue gains from stronger growth to debt reduction.
Output growth has led to little improvement in the labour market in aggregate, as job losses from ongoing restructuring were only very partly offset by job creation in new activities. Employment thus remains subdued in spite of its most recent improvement. The unemployment rate, at more than 9 per cent by mid 2004, was 3 percentage points above its 2000 level, and has reached almost 13 per cent in urban areas and 17 per cent for youths. In addition, labour force participation declined as many job-seekers became discouraged. Employment growth is expected to pick up somewhat as the recovery continues, but high structural unemployment and low labour force participation will remain key policy issues. Indeed, improving labour market conditions is urgent as continuously high unemployment could undermine the social and political support for reforms.
What structural traps does Turkey needs to overcome?
Only strong and sustained growth together with structural reforms can help absorb the growing working age population into employment. Indeed, Turkey has an enormous potential for catching-up and job creation. The employment rate, at 46 per cent of the working age population, remains the lowest in the OECD area and labour productivity is currently around 35 per cent of the OECD average. On the basis of favourable assumptions of progressive convergence with the productivity and labour utilisation performance of the southern and central European countries, it is estimated that Turkey could grow at a trend rate above 7 per cent per year. In the past, Turkey could not seize this catch-up potential because it was caught in a vicious circle characterised by three traps:
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Low confidence in political and macroeconomic stability together with high government deficits and debt levels led to very high real interest rates, bouts of depreciation and inflation (a confidence trap).
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Shortcomings in core public services and institutions with mismatches in employment, wages, resources and duties undermined the quality of services and the efficiency of enforcement in the public sector (a governance trap).
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This adverse environment incited private businesses to shift more activities to the informal sector while, with a narrowing of the tax base, an increasing burden was imposed on firms that stayed in the formal sector (an informality trap).
Addressing these problems would make it possible for Turkey to enter into a virtuous circle of improved confidence, strengthened governance and increased formalisation that could underpin a sustained period of strong growth.
Turkey's income level relative to the EU-15 under alternative growth scenarios
Per capita GDP, in purchasing power parities
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