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Presentation of the OECD Economic Survey of Turkey, 2006 edition

 

by Angel Gurría, OECD Secretary-General
Speaking Notes
Press Conference for the release of the 2006 OECD Economic Survey of Turkey during Mr Gurría's official visit to Turkey
Ankara, 18 October 2006

First, I would like to congratulate Turkey for its outstanding economic performance. The recovery from the 2001 crisis has been impressive.  Between 2002 and 2006, output increased by a third, representing the strongest pace of growth among OECD countries. At the same time, annual inflation fell steadily, reaching single digits in 2004 for the first time in three decades. After the past decades with often short-lived economic booms followed by sharp downturns or recessions, Turkey has now a historical chance to achieve a transition to a more sustainable and stronger growth path. This promises to bring its living standards closer to that of the high income OECD countries.

What are the main reasons for Turkey’s good economic performance in recent years?

A whole set of reforms and policies have been implemented after the 2001 crisis. These addressed the key deficiencies which had “trapped” Turkey in the costly boom-and-bust cycles of the previous decades. Together, they considerably strengthened the macroeconomic and microeconomic framework under which the Turkish economy is operating: 

  • The Central Bank has become independent and succeeded in reducing inflation and stabilising the exchange rate. As a result, nominal and real interest rates declined significantly. 
  • Fiscal consolidation has become a top priority and fiscal transparency has improved. This, together with the lowering of interest rates, has permitted a spectacular reduction in the fiscal deficit from 19% of GDP in 2001 to 2½ % in 2005, and the level of government debt declined from 90% to 55% of GDP. 
  • The Banking sector was thoroughly cleaned and re-capitalised under modern prudential supervision. It stopped being a source of resource misallocation and now finances the growth of the economy instead of financing the government deficit. 
  • Major privatisations were achieved, and opened the way to massive foreign direct investment inflows, a most welcome development. 
  • Changes in corporate law, competition policy institutions and network industry regulations established a more open and pro-competitive environment for business. 

These macro- and micro-economic policies were backed by strong international anchors, provided by the IMF program and the preparation for EU membership negotiations. It was crucial, however, that the government under Mr. Erdogan remained committed to these reforms. It would not be an exaggeration to say that this new economic environment, if it is consolidated, will bring a systemic change for the Turkish economy. The business sector has already responded very positively. Confidence has improved not only among domestic firms but also among foreign investors, and all this resulted in higher growth and employment. 

In our report we emphasise Turkey’s reform efforts and the significant progress Turkey has made over the past years. We examine in depth Turkey’s current macroeconomic challenges and also the areas where we think further reforms are needed to sustain high growth over the medium-and-long term and to improve living standards for the whole population. I will briefly mention the main macroeconomic challenges and the main areas where we see need for more structural reforms.

Macroeconomic challenges

The recent weakening of the exchange rate and the inflation up-tick after the turmoil in the international markets highlight Turkey’s ongoing vulnerabilities. Turkey was not the only country hit by the reduced risk appetite of international investors last summer, but it was among the group of emerging market economies that was most affected. This high degree of vulnerability to the changing whims and risk appetite of international investors may be somewhat frustrating for Turkish policymakers after four years of sensible policies and good economic performance – and I would understand them. Yet, the factors behind this additional degree of vulnerability need to be identified and addressed to the extent possible. I think three among these factors deserve attention and I will rapidly comment on each:

  • A still very short history of new economic policies and institutions: The new monetary, fiscal (and banking supervision) institutions have been successful in the past four years but it is true that their resilience to cyclical, international, political changes has not yet been tested. In the Survey we recommend a set of measures to complete, reinforce and consolidate the implementation of the new policies and institutions (such as: regularly publishing general government accounts according to National Accounting Standards, adopting a multi-year expenditure ceiling at the general government level, full implementation of international recommendations on the governance and accountability of banking supervision etc.).
  • External imbalances: Under strong growth and with the additional contribution from international energy prices the current account deficit of Turkey attained historically very high levels, both by national and international standards. The deficit is largely funded by debt, and the total external debt/GDP ratio of the economy is on the rise. The new OECD Survey focuses on a set of measures which should help improve the competitiveness of the economy and the trade balance, even with a strong currency. We do suggest measures to increase the FDI part of external funding, which should help contain the growth of external debt.
  • Political risks:  It should be acknowledged that Turkey continues to be perceived as a country exposed to internal political risks. Lack of any severe political tensions in the past four years has been an asset. Also, external anchors, notably the programme with the IMF and the EU negotiation process, have played a key role in setting and monitoring benchmarks and reinforcing domestic and international confidence. “Life after IMF” should be prepared for the period following May 2008 and the EU negotiation process should continue to be actively drawn on. I know that there are risks in this area that the Turkish authorities do not control, but we think that everything should be done by all parties to preserve the dynamics and the benefits of this process.

What are the main areas where further structural reforms are needed?

It is true the level of labour productivity in Turkey still remains far below that of other OECD countries and this is the main reason for the lower standard of living. Only in Mexico, my country, average labour productivity is lower. Another reason for Turkey’s relatively low living standards is the low level of utilisation of labour potential, which is in fact the lowest among OECD countries. The employment rate of the working age population is very low and female labour participation is extremely low. Turkey has therefore an immense potential to catch-up in both its labour productivity and labour utilisation performance. The new OECD Survey argues that there are in particular three areas where further structural reforms may bring a major contribution, to both the productivity and employment performance.

The first is: Overcoming the duality in the business sector by facilitating formalisation.

We found that there is a large productivity gap between formal and informal enterprises. While informality reduces firms’ costs and provides them with the flexibility to survive under difficult conditions, it also limits their access to capital markets, their investment capacity and their ability to develop international partnerships, therefore restricting the potential efficiency gains that they could achieve. Informality thus reduces the overall growth potential of the Turkish economy and it reduces the tax base. Improving framework conditions for firms in the formal sector would enable more firms to expand and become formal, thus narrowing the large productivity gaps between firms and sectors, and raising the average productivity level of the Turkish economy.

Enlargement of the formal sector will require a carefully planned combination of reforms in various areas   as policies are closely inter-related. We recommend: 

  • Further reducing tax distortions - including a significant cut in the labour tax wedge.
  • Easing labour market regulations - Turkey’s labour market regulations appear to be the most rigid in the OECD.
  • Reforming pension rules so that middle-aged workers are not pushed into the informal sector. According to the analysis of the Survey the pension system continues to provide, even after the major recent reform, strong incentives to employers and employees to operate outside the formal system, and further changes in contribution and benefit parameters would reduce them.
  • Improving competition in product markets, and facilitating access to bank and equity financing.

A successful formalisation strategy would lift the growth potential of the whole economy and broaden the tax base, permitting a reduced burden on formal sector firms and a levelling of the playing field for doing business in Turkey. These reforms would also increase foreign direct investment, which would contribute to stronger long-term growth and improved macroeconomic stability and resilience.

Another area which needs reform is the education system.

As was recently investigated in detail in an OECD review of education policy, Turkey has an education system that focuses on providing a good education to the most able students, who are channelled towards university and work in the formal sector. To address the human capital shortages which arise in the middle and low-end of the labour market, notably in the informal sector, and to give Turkey’s entire youth population access to good quality education, we think that the objectives and priorities of education policy should be re-focused.  We recommend that the purpose of basic education should be reoriented away from the sorting and selecting of students for the elite schools, to a broader objective of providing the majority of young people with the basic literacy and numeracy skills that are necessary for the modern workforce. A more efficient and equitable education system would provide Turkey with a significantly higher-skilled labour force in the future, which would permit a higher pace of productivity growth and a significant increase in the average standard of living.

Finally, we suggest further reforming agriculture. 

The agricultural sector continues to employ as much as one third of the Turkish workforce, almost entirely in informal activities. Productivity has been constrained to date by various socio-economic weaknesses in rural areas, and a protective regime of subsidies and trade protection which has entrenched a status quo of highly fragmented, low-skilled, low technology and domestic-market-oriented farming. By contrast, Turkey possesses remarkable agricultural land resources and this large sector could potentially contribute much more to productivity, growth and exports.

We argue that establishing a more competitive environment would free the potential for commercial and competitive farming, help to modernise agriculture and raise output growth and productivity.

We think that the important reform introduced in 2000-2001 which aimed at reducing agricultural subsidies and privatising the marketing channels went in the right direction. This reform should be revitalised and accompanied by additional policies to encourage the transition to commercial agriculture. Notably, ensuring that the legal framework is adequate for the creation of larger and more productive farms, and improving framework conditions for more private investment in irrigation are particularly important.

We also know, like the authorities, that given the large population working on small farms and the absence of a social safety net, this process will pose significant social challenges. The best way to address these is to implement the comprehensive structural reforms needed to enhance job creation in the other sectors of the economy, including in the rural areas. Additional social policies may also be needed to facilitate the transition, such as an increase in the means-tested public pension. 

These are in a nutshell our recommendations which we think would help the Turkish economy to definitely exit the boom-bust cycle of the past and would help transform the economy from one with a low average level of human capital and a significant duality between relatively few highly productive enterprises and a large number of low productivity enterprises, to one that operates with a more even playing field, permitting a more rapid catch-up in living standards. 

From the viewpoint of Turkey’s negotiation process with the European Union, our suggestions for additional reforms would also enhance perceptions of Turkey as a country that can absorb and productively employ its rapidly growing working age population and contribute to Europe’s prosperity. I think that implementing such reforms would therefore facilitate the EU negotiation process in the coming years.


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