Ankara faces innumerable challenges ahead

The Turkish economy has followed a rollercoaster ride in recent decades. Following an anaemic performance with severe imbalances in the 1990s and a debilitating financial crisis in 2001, Turkey enjoyed five years of rapid economic growth. GDP per capita increased at almost 6 per cent a year – its highest ever rate since the 1960s – accompanied by structural changes, productivity growth and a broadening base of economic activity, both geographically and socially. But from about 2007 onwards, growth slowed significantly.

What happened? One view is that Turkey’s experience is just another example of the ‘stop-andgo’ cycles so typical of emerging economies. In contrast, our analysis indicates that the economy’s ups and downs during this period reflect two developments: first, institutional improvements in the immediate aftermath of the 2001 financial crisis; but then subsequently, an ominous slide in the quality of these economic and political institutions. Why did Turkey undergo unusually rapid institutional improvements from 2001? The answer emphasises a confluence of factors, partly external and partly internal. Perhaps most importantly, the 2001 financial crisis forced Turkey’s lethargic and conservative political system to accept a slew of fairly radical structural reforms imposed by the IMF and the World Bank.

These reforms not only brought under control persistently high inflation and succeeded in reducing budget deficits. They also imposed discipline on the budgetary process; shifted decision-making and regulatory authority towards autonomous agencies in an effort to cultivate rules-based policy-making; and introduced transparency into notoriously corrupt procedures for government procurement. In the background, these economic reforms were undergirded by major political changes. Having been introduced by a caretaker government, the reforms were overseen by the AK party (the Justice and Development Party), ending the tutelage of the military over Turkish politics, which had held primacy at least since the founding of the Republic.

This political process, as well as the accompanying economic reforms, received a substantial boost from the general warming of relations between Turkey and the European Union (EU), and blossoming hopes among the Turkish population that accession to the EU was a real possibility. The EU process not only provided a powerful institutional anchor for many of the reforms, but it also brought the promise of membership so long as the economic and political reforms continued. This account of the 2002-2006 period as one of high-quality growth is not uncontroversial. Neither is it possible to establish with any certainty whether a five-year growth spell reflects the flourishing of an economy under new economic institutions and reforms or simply the first phase of another stop-and-go cycle.

Yet not only were the changes in economic institutions potentially far-reaching, but evidence suggests that the nature of economic growth was very different during this period than both before and after. Not only was productivity high by the standards of what came before and what was to follow (as well as by international comparisons), but the notorious macroeconomic imbalances of the 1990s subsided. Moreover, about half of productivity growth was driven by efficiency gains, while private investment as a share of GDP rebounded sharply from its lows of the late 1990s to reach almost 22% by the mid-2000s.

Equally important was the broadening base of Turkey’s economy. Economic growth was in part driven by newer regions and firms than had been the norm in Turkish economic history. Moreover, there were improvements in health indicators and schooling among the most disadvantaged segments of the Turkish society, while inequality contracted significantly, fuelled by employment and income growth. So why did Turkey’s institutional improvements come to an end, bringing down both the rate and quality of economic growth? We must argue that the institutional change emanated from the political realm. To start with, the ruling AK party, which had earlier supported economic reform, made an aboutface once it became sufficiently powerful, as the twin constraints of a strong opposition and the threat of military intervention disappeared.

Gradually, the control of the ruling cadre of the AK party intensified, amplifying corruption and arbitrary, unpredictable decision-making. In addition, EU accession talks collapsed, undermining both the anchor tying the AK to the reform process and undermining the support that had built up for institutional change within a broad segment of the Turkish population. The slide in economic institutions followed the political reversal quite closely. The reforms initiated by the IMF and the World Bank gradually came to be reversed, with Turkey’s recently institutionalised rules-based policy framework increasingly shifting back towards discretion. The procurement law introduced in 2002 under the auspices of the IMF and the World Bank, which at first reined in corruption, perhaps tells the story most vividly.

More and more industries and items were declared exempt from the law by the ruling AK party, removing this substantial barrier against corrupt practices. The increase in corruption was not confined to procurement, and came to permeate the Turkish economy. As the powers of autonomous agencies were clipped, taxation and regulation decisions became increasingly arbitrary. The macroeconomic framework also worsened, reflected in near zero or negative real interest rates while the economy was booming, and increased government spending as a way to prop up the economy. This low-quality growth also led to a relatively large current account deficit and an inflation rate stuck at high single digits, markedly higher than Turkey’s trade partners. The prospect of a resurgence of institutional reforms and high-quality growth in Turkey looks dim at the moment, but ours is still a hopeful story for other emerging market economies.

Our analysis underscores the ability of economies with weak institutions to reform quickly and enjoy the fruits of these institutional improvements in terms of rapid economic growth. We are of course aware that the process of institutional change in Turkey was triggered by a deep financial crisis. That experience left few other choices to the political elites, who otherwise would not have dreamed of mending the institutional ills that served their interests. Perhaps more ominously, the Turkish spring of institutional revival did not last, and appears to have given way to autocratic one-party rule.