Turkey Economy: A Promising Start Towards Economic Stability

From the Economist's Turkey survey

IF IT were a member today, Turkey would be the poorest country in the EU--but not by a mile. Although its GDP per person is less than a third of the average for the 15 members before last year's round of enlargement, it is not far off that of Latvia, one of the ten new countries that joined in May 2004. And it is much the same as those of Bulgaria and Romania, which hope to become members in 2007. When they do, there will be an overland route from the Channel Tunnel to the Turkish border that never leaves EU soil.

Later this year Turkey's state statistical department will come up with revised figures for the country's GDP, based on the EU's statistical methodology. The economy minister, Mr Babacan, says that GDP figures could go up as a result. But even if they do, the size of the Turkish economy will remain considerably understated because of the huge black economy. Mr Babacan puts the size of this "informal" economic activity at over 30% of official GDP. One survey found that more than half of the people who claimed to be employed were not registered, meaning that they did not pay taxes or receive state benefits.

Whatever the absolute level of Turkey's GDP, there is no doubting the country's recent economic progress. Donald Johnston, the secretary-general of the OECD, has described it as "stunning". This success has come in three parts. First, growth. Turkey's GDP in 2004 was probably more than 8% up on the year before, a rate that no country in the EU came close to matching.

Second, inflation. Late last year the monthly year-on-year rate came down to single figures for the first time since 1972. The rate for the whole of 2004 was 11.4% (see chart 2). Last December, when Turkey signed a $10 billion three-year economic agreement with the IMF, the Fund's managing director, Rodrigo Rato, said that it would "help Turkey...reduce inflation toward European levels, and enhance the economy's resilience."

The economy could do with extra resilience. It has enjoyed rapid growth before, but this has usually been followed by severe recession and financial crisis. In the 1990s the growth rate went up and down like a yo-yo (see chart 3), with the economy shrinking by around 5% in both 1994 and 1999 and growing by slightly more in 1995 and 2000. Foreign investors mostly kept clear.

In the most recent crisis, in 2001, GDP plummeted by over 7%. In February that year the lira was devalued by about 40% in a week and short-term interest rates briefly touched an annual rate of 7,500%. On the IMF's recommendation Mr Ecevit, the then prime minister, called in Mr Dervis from the World Bank in Washington, DC, to become his finance minister. The government introduced an economic programme which Turkey has (unusually) held to, and which seems to be working. Mr Erdogan more or less adopted it as his own, if only to retain the IMF's support.

The government's third big success in recent years has been in fiscal policy. In 2004 its budget achieved a primary surplus (before interest payments) of 6.5% of GDP, which went a long way to keeping Turkey's international creditors happy. The budget has been helped by a sharp cutback in agricultural subsidies, from $6 billion a year three years ago to around $1.5 billion now, which has caused surprisingly little complaint from farmers. At the same time there has been a big shift from price support to direct income support.

The government is trying to reduce its role in the economy in several ways. For one, it is dismantling price controls. Since the beginning of January it has no longer had to decide on the right level of fuel prices every Monday morning. It hopes soon to stop setting electricity and gas prices too.

However, it has been less successful in getting rid of its extensive industrial and financial holdings. Privatisation has been promised for almost as long as low inflation. The government now says that this year it will revive the previously cancelled sale of Tupras, an oil refiner; Turk Telekom; Petkim, a petrochemicals firm; and the tobacco side of Tekel, the state-owned drinks and tobacco company. But would-be investors should not hold their breath. Previous plans have fallen through because of the state's inability to make the businesses sufficiently attractive to buyers.

When competition has been allowed to enter state-controlled areas, the results have been good. The opening up of the skies saw a number of private airlines (such as Onur Air and Atlasjet) take on the state-owned Turkish Airlines. This, says the OECD, has brought fares on some internal routes down by 60%. It has also increased passenger numbers, but it has not yet opened up new routes. Traffic is still concentrated on journeys to and from Istanbul. More flights between provincial towns would help reduce Istanbul's stranglehold on resources, as well as the stacking over its international airport.

After stability, the next priority for the Turkish economy is redistribution. The gap between the country's rich and poor is vast. Istanbul and Ankara alone account for about 30% of GDP. In the richest regions of the country, GDP per person is nearly six times what it is in the poorest--the region round the cities of Kars and Agri, towards Mount Ararat and the Iranian border. Many of the houses there are mud-roofed single-storey structures with improvised windows. Water is drawn from the nearest well and separate piles of dried dung for fuel and straw for animal feed are heaped outside the front doors to see the occupants through the winter. The lucky houses have a satellite dish on the roof to pick up the multiplying number of Turkish television channels with their soaps and chat shows. Most of the local community's economic opportunities lie in smuggling.

Redistribution could be helped by a change in the tax system. At present the country relies heavily on indirect taxes--which are non-redistributive, but easily collected--and more lightly on direct taxes, which are harder to collect. The government has started to shift the burden. In the 2005 budget, for example, VAT on various food, health and education items was cut from the standard rate of 18% to 8%.

The government is also drawing up legislation to restructure its inland-revenue service, making it a semi-independent authority with tax collection as its main task. "Our purpose is to establish a tax system to reduce the unregistered economy and collect taxes more efficiently," said Mr Erdogan at the end of last year. He hopes that cuts in the corporation-tax rate and in the top rates of income tax this year will encourage more people to fill in their tax returns honestly. Currently only 2% of returns are audited, so tax evaders are likely to get away with it. Even those who are caught are merely given a fine, although imprisonment to punish tax evasion is being considered.

Perhaps the most politically charged economic challenge for the government is unemployment. The official rate of 10% is widely acknowledged to be unrealistically low. There is considerable underemployment in farming, for example. Unemployment among Kurdish migrants in Diyarbakir is as high as 60%, says the city's mayor. As the OECD puts it, "continuously high unemployment could undermine the social and political support for reforms."

Where it hurts

Yet unemployment seems destined to get worse before it gets better. Mr Babacan explains that 500,000 new jobs need to be found every year to keep the unemployment level constant. That number is set to rise as the working population continues to grow. If the government meets its target of 5% growth for each of the next three years, says Mr Babacan, it will create 1.65m jobs over that period, just enough to mop up the increase in the working population.

But the labour force could be swelled further by large numbers of workers coming off the land as Turkey invests in its agricultural sector and increases productivity. Agriculture currently accounts for 32% of all jobs but only 13.4% of GDP. If the workforce was cut to match the sector's contribution to the economy, 4.4m jobs would have to be found elsewhere.

Some Europeans have nightmares about hordes of unemployed Turks roaming freely across the European Union and undercutting native workers' pay. But in reality there is little evidence that immigration harms the natives' job opportunities. Rather, EU countries should be welcoming young Turkish workers with open arms, especially where populations are declining. Those workers will help to make sclerotic economies more flexible and keep up contributions to state pay-as-you-go pension schemes.