Banking is better but public bodies and the ‘informal’ economy need work

By Tim King

Date: 30/09/04

THE big question hanging over the Turkish economy is whether it can shake off a reputation for instability.

When the Organization for Economic Cooperation and Development (OECD) publishes its report on Turkey next month, it will acknowledge considerable progress since the 2000-01 economic crisis.

But the OECD report will have to deliver an assessment of whether the changes are permanent.

For a country of Turkey's level of development, with close relations to the European Union, its risk premia have been very high.

Public borrowers in Turkey have had to pay much higher interest rates than, for example, their counterparts in central European economies.

The view of international observers, from the International Monetary Fund to the OECD, is that Turkey still has to improve public services, such as education, health and transport, and to improve public institutions, such as the commercial courts, the regulators and the framework of competition policy.

Existing resources have to be better used and the overall level of resources probably has to be raised.

A big problem for the Turkish state is the size of the informal economy, operating outside the tax and social security system and the norms of employment law.

In turn, this means that the formal economy suffers a disproportionate burden from high tax and social security payments.

Macro-economic stability has been strengthened since 2000-01. The central bank has become fully independent (it cannot lend to the government) and pursues a policy of price stability. Inflation has been brought down to around 10%.

There has been reform of the banking sector, both public and private, with greater supervision. Management of public spending has been improved by integrating the spending institutions of the state into one system.

Henry Loewendahl, of OCO Consulting, which specializes in advising on foreign direct investment (FDI), says that what has happened in the last three years has been "dramatic" in creating a more favourable environment for FDI in Turkey, with the most important step being controlling inflation.

If the EU decides at the Brussels December summit to begin accession negotiations, Turkey will see a significant increase in FDI, he predicts, giving impulse to investment plans that were put on ice in the late 1990s.

Loewendahl characterizes Turkey as a "dual economy". While 35% of the workforce is in a rural economy, the rest work in a highly industrialized and modernized economy, more advanced than some of its competitor economies in eastern Europe.

Turkish manufacturers produce 20% of the EU's market for white goods.

Several of the world's carmakers have invested heavily in setting up factories there, such as Renault's Mégane production.

But Turkey has not embraced privatization with the same enthusiasm as central Europe. Those challenges lie ahead.

Analysis of the Turkish economy and the question whether it can shake off its reputation for instability.