Turkey Economy: Ten-Year Growth Outlook

In 2010-30 the Economist Intelligence Unit expects Turkey's macroeconomic environment to be considerably more stable than in the 1990s or in 2000-01, helped by the IMF-backed stabilisation programme covering 2005 to early 2008 and reforms to be introduced under EU membership negotiations, which were formally opened in October 2005. Real GDP is forecast to grow by 4.4% per year in 2006-30, compared with 7.5% per year in the four years since the 2001 financial crisis. After averaging over 5% a year in 2006-10, the pace of growth will slow to around 4% in 2011-30. This is well above the average rates expected for the EU25. Turkey's GDP per head is projected to rise from about US$8,000 at purchasing power parity (PPP) exchange rates in 2005 to just under US$40,000 in 2030. However, catch-up with the EU25 is likely to be slow, given that in the five years to 2010, Turkey's GDP per head at PPP exchange rates is only forecast to rise from 29% of the EU25 average in 2005 to about 32% in 2010.

Initial conditions: If the relative stability of exchange rates, interest rates, growth rates and prices implied by our forecasts for 2007-10 comes to pass, some obstacles to high and stable growth will be removed during the long-term forecast period. Economic growth should be on a more sustainable path after the boom-and-bust performance of the last ten years, and although real interest rates may remain relatively high, we expect fears about market volatility and debt sustainability to recede. We also expect the current-account deficit to fall to more manageable levels than at present and inflation to be lowered permanently to single-digit figures. The public finances and the business environment are also expected to be greatly improved. Deficiencies will remain in infrastructure and educational achievement, but the government and private sector may be better placed financially to start tackling these problems.

Without underestimating the difficulties facing Turkey in EU accession negotiations, we assume that by 2010 Turkey will have made some progress towards closer integration with the EU. This should help to attract greater foreign direct investment (FDI) inflows than has been the case until now or is forecast in 2006-10, which should help to boost productivity further through improved management and technological spillover. However, improvements in this area will still be limited by the relatively low level of skills and quality of the workforce compared with Turkey's main competitors for FDI in central and eastern Europe.

Demographic trends: Turkey's demographic profile is generally favourable, but a marked deterioration is expected in the second decade (2021-30) of the forecast period. Population growth will continue to be faster than in most developed economies, although it will gradually slow over the forecast period, as birth rates decline. Unlike in most European economies, Turkey's working-age population will continue to grow, rising at an annual average rate of almost 1% in 2006-30. However, a sharp slowdown is expected after 2010, in line with overall population growth. As a result, in 2021-30 the difference between annual average growth in the population of working age and that of the total population will turn negative, dampening economic growth.

Throughout the forecast period, we expect an upward trend in the labour force and employment because of increases in participation rates, given the low starting levels. With the workforce continuing to expand at a steady rate, it will be a challenge to produce sufficient jobs to bring the unemployment rate down sharply, although we expect it to trend downward slowly from about 10-10.5% recorded in 2002-05.

External conditions: The Turkish economy will remain dependent on wider international developments--particularly in international financial markets, in the slow-growing EU, Turkey's main export market, and in global terms of trade. With export-led industries playing an increasing role, Turkey should benefit from the (sometimes unsteady) trend toward greater global trade liberalisation. However, as a supplier of the developed economies, Turkey will face intense international competition, since low-value-added manufactured goods are likely to remain its main product line. Its technology potential is relatively limited, and it is not well placed to become a major supplier of services (other than tourism). Sharing borders with countries like Iran, Syria and Iraq, Turkey's immediate regional environment is challenging. Yet, it should continue to benefit from its close relations with the EU and the US.

We assume in our baseline forecast that despite the periodic ups and downs expected in Turkey's relations with EU during the next 10-15 years, Turkey will maintain its commitment to the goal of EU membership and eventually accede to the EU. The EU accession process should help to foster a more stable domestic political environment, as well as provide an anchor for Turkey's economic reform programme (although a less effective one than the IMF accords since 1999) and its relations with the rest of the world. However, negotiations will be long and difficult. Therefore, there is a substantial risk even in the short term that Turkey's commitment will wane and the political and economic reform process will stall or go into reverse. Even assuming that Turkey maintains its goal of EU membership and continues to carry out the reforms required to bring domestic legislation and implementation into line with EU norms (this is significantly more important for Turkey's long term economic stability than actual membership), the open-ended nature of the negotiations and strong opposition to Turkish accession in several EU member states also means that eventual accession is far from certain. It is unlikely at present that Turkey will be able to join the EU in 2015, the semi-official target date for accession. Accession some time between 2020 and 2030 appears to be a more realistic goal. Eventual membership will also depend to a large extent on the situation within the EU. Public opinion is largely unfavourable, and France and Austria are expected to hold referendums on Turkish accession at the end of negotiations. As things stand today, they would almost certainly vote "no". If the EU were to loosen its structure, although this is not expected, opposition to Turkish accession would probably ease, increasing Turkey's chances of joining. Also, if by the time Turkey is ready to join, the EU has failed to address its political and economic problems, Turkey may well decide that full membership is no longer in its interests and opt for a looser "privileged partnership", which some opponents of Turkish accession in the EU have already been advocating.

Institutions and policy trends: We expect economic policy to be tailored to maintaining macroeconomic stability and continuing to improve the business environment. By 2010, Turkey's fiscal position should be much improved, which may allow the government some room to increase public investment in infrastructure and possibly reduce tax rates further. Although expected to improve substantially as a result of its EU prospects, the problems of unpredictability and inefficiency in Turkey's domestic legal and regulatory environment may not have been overcome entirely.

The prospect of EU membership may also not be sufficient to ensure domestic political stability, as high unemployment and income inequality will continue to feed social tensions in increasingly crowded cities. However, assuming EU accession negotiations are still on track in 2010, we expect reforms to improve human rights will be better implemented. This should help to reduce tensions between the state and Turkey's Kurds, and therefore between the executive and the military, the influence of which in the political sphere is likely to continue until EU accession is actually achieved.

Long-term performance: Turkey's economic growth performance is expected to surpass that of the EU as a whole, as a result of its favourable demographic profile and large increases in productivity. We project labour productivity growth to be 3.1% a year in 2011-20, rising to 3.3% in 2021-30, whereas capital stock growth will be around 5.5% a year in both decades. GDP growth will average just over 4% a year during the two decades, with growth in GDP per head averaging around 3.5%, reflecting the expected rise in the total population. Greater improvements in the policy environment could produce even better results, but there is still considerable uncertainty about Turkey's political and institutional framework and whether the government will maintain its commitment to the reforms envisaged as part of the EU accession process.