90509 v2 Integration, Inclusion, Institutions Report No. 90509 - TR Turkey’s Transitions Infrastructure Finance Fiscal Space Trade Welfare Enterprise Cities Labor December 2014 Integration, Inclusion, Institutions i Turkey’s Transitions © 2014 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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Edition March 2015 ii Integration, Inclusion, Institutions Contents FOREWORD ix ACKNOWLEDGEMENTS xi ABBREVIATIONS xiii OVERVIEW : TURKEY’S TRANSITIONS 1 CHAPTER 1 : TURKEY’S RISE 25 SPOTLIGHT 1 : ACCOUNTING FOR TURKEY’S GROWTH: PAST AND FUTURE 51 CHAPTER 2 : TRADE: BENEFITING FROM GLOBALIZATION 61 CHAPTER 3 : FINANCE: BANKING SECTOR RESTRUCTURING AND FINANCIAL INTEGRATION 85 CHAPTER 4 : ENTERPRISE: HARNESSING STRUCTURAL CHANGE FOR INTEGRATION AND INCLUSION 111 SPOTLIGHT 2 : INFRASTRUCTURE TO CONNECT AND FUEL THE ECONOMY 139 CHAPTER 5 : CITIES: MANAGING RAPID URBANIZATION 153 CHAPTER 6 : LABOR: CREATING JOBS FOR WOMEN AND YOUTH 179 CHAPTER 7 : WELFARE: ACHIEVING BETTER HEALTH AND EDUCATION OUTCOMES 203 SPOTLIGHT 3 : FISCAL STABILIZATION AND THE MOVE TO RULE BASED PUBLIC FINANCE MANAGEMENT 231 CHAPTER 8 : CROSSING THE THRESHOLD TO HIGH INCOME 245 SELECTED INDICATORS : ANNEX TABLES & SOURCES AND DEFINITIONS 265 COUNTRY CODES AND NAMES 297 iii Turkey’s Transitions Boxes Box 1 ............................................................................................................... 21 : Turkey’s Prospects. Box 1.1 ..................................................................................... 43 : Turkey’s Transitions – An Overview. Box 2.1 : Mavi Jeans – Made in Turkey, marketed globally................................................................. 63 Box 2.2 : Trade in services..................................................................................................................70 Box 2.3 : Measuring a country’s export sophistication....................................................................... 76 Box 3.1 : Restructuring the state banks.............................................................................................. 92 Box 3.2 : Corporate debt restructuring: The Istanbul approach and beyond.....................................95 Box 3.3 : Encouraging household savings by promoting voluntary private pension accounts.........107 Box 5.1 : A historical perspective on urbanization............................................................................ 157 Box 5.2 : Leveraging private sector participation for municipal solid waste services.......................175 Tables Table 1 : Policy Simulations................................................................................................................ 21 Table 2 : Turkey’s Transitions: Achievements, Lessons and Challenges.............................................. 22 .................................................................... 54 Table S1.1 : Real GDP growth and contributions of factors. .......................................................................... 57 Table S1.2 : Long-term projections - Baseline scenario. Table S1.3 : Policy Simulations................................................................................................................58 Table 2.1 : Decomposition of export growth: Turkey versus selected peers, 2005-2010 (in percent)..69 Table 4.1 : Productivity growth has increased over time.................................................................... 114 Table 4.2 : Productivity convergence between the West and the Tigers............................................ 121 Table 4.3 : Economic structures are similar in the West and the Tigers.............................................. 122 Table 4.4 : Manufacturing has been growing while retail trade has declined in both regions............ 122 Table 4.5 : Tiger firms in manufacturing have high productivity growth, reallocation dominates in the West....................................................................................................... 123 Table 4.6 : Manufacturing firms in the Tiger provinces have recorded extraordinarily high TFP growth......................................................................................... 124 Table 4.7 : Correlates of firm level productivity growth...................................................................... 129 Table 4.8 : Firm investments in innovation capabilities – R&D and KBC.............................................130 Table 4.9 : Correlates of total factor productivity in manufacturing in Turkey....................................134 Table 6.1 : Most jobs go to the better educated................................................................................. 183 Table 6.2 : More skills would increase growth and reduce informality...............................................197 Table 7.1 : Targeted spending contributed to leveling the playing field for more students................ 218 Table S3.1 : Decomposition of change in debt stock............................................................................. 237 Table 8.1 : Growth spells, growth slowdowns: Determinants of sustained growth in middle income countries, selected findings from the literature....................................................251 Table 8.2 : Turkey’s Transitions: Achievements, Lessons and Challenges............................................260 iv Integration, Inclusion, Institutions Figures Figure 1 : Steady growth over the decades brings Turkey to the threshold to high income.................6 Figure 2 : The middle class has doubled since 1993 in Turkey, although it remains smaller than expected...........................................................................................................6 Figure 3 : Prosperity shared in the 2000s - in Turkey and selected peers..............................................7 Figure 4 : Turkey’s rising global presence.............................................................................................. 7 Figure 5 : A robust banking sector has withstood the global financial crisis well.................................. 8 Figure 6 : Dramatic structural change in Turkey.................................................................................... 9 Figure 7 : Turkey’s enterprises have delivered strong productivity growth......................................... 10 Figure 8 : Turkey’s logistics performance compares favorably with other middle income countries . . 11 Figure 9 : Turkey’s regional productivity levels converged between 2004-2011................................. 11 Figure 10 : Turkey’s urbanization has been a driver of rising income.................................................... 12 Figure 11 : Fast job creation in Turkey since the 2008-2009 crisis, not so fast over a longer hoziron.....13 Figure 12 : Labor market outcomes have been central to Turkey’s shared prosperity.......................... 14 Figure 13 : Sharp reduction in health gap with OECD and within Turkey..............................................15 Figure 14 : The education gap has also been declining, though Turkey still lags behind.......................16 Figure 15 : Turkey’s fiscal consolidation was accompanied by fundamental public finance reform. .....17 Figure 16 : Turkey’s per capita income has hovered around US$ 10,500 mark since 2007................... 18 Figure 17 : Turkey and peers and the factors driving high income........................................................19 Figure 18 : Turkey remains mid-field on most comparative indices of institutional performance........ 20 Figure 1.1 : The center of gravity of the world economy is shifting east................................................27 Figure 1.2 : Turkey’s income lagged Europe since the 1600s but catch up started in the 1950s............ 28 Figure 1.3 : Turkey’s income per capita compared to its peers.............................................................. 30 ..........................................................................................................32 Figure 1.4 : Benchmarking Turkey. Figure 1.5 : The fruits of market-led structural change – a high level of total factor productivity.........33 Figure 1.6 : Trade and foreign exchange liberalization in the 1980s.......................................................35 Figure 1.7 : Turks are more entrepreneurial than the average European. ..............................................35 Figure 1.8 : Political and macroeconomic instability in the era of coalition politics...............................37 Figure 1.9 : Regulatory reforms during and after the 2001 crisis...........................................................39 Figure 1.10 : Fiscal consolidation created the space for growing social and investment spending after 2004............................................................................................................. 40 Figure 1.11 : Turkey has made significant progress in poverty reduction over the past decade.............. 44 Figure 1.12 : Shared prosperity in Turkey and peers................................................................................ 44 Figure 1.13 : Shared prosperity measures show variable performance over time...................................45 .........................................46 Figure 1.14 : The labor market drives improvements in income (2002-2012). Figure 1.15 : Shared prosperity is the pathway to the middle class.........................................................46 Figure 1.16 : Turkey’s middle class has increased in line with rising GDP.................................................47 Figure S1.1 : Drivers of growth in different political periods.................................................................... 55 Figure S1.2 : Turkish economy became more volatile relative to its peers in the last decade.................55 Figure S1.3 : Economic growth has been financed by foreign capital inflows..........................................56 Figure 2.1 : Turkey’s economy has dramatically opened up since 1980.................................................64 .......65 Figure 2.2 : The increase in Turkey’s openness since the 1970s is comparable to India and China. v Turkey’s Transitions Figure 2.3 : Tariffs for products covered by the Customs Union fell significantly...................................66 Figure 2.4 : FDI inflows to Turkey as a share of emerging markets.........................................................67 Figure 2.5 : FDI Inflows, 2002 - 2012 annual average............................................................................. 67 Figure 2.6 : Turkey’s share in global exports has increased fourfold since 1970....................................68 Figure 2.7 : In Turkey existing firms, existing products and existing markets contribute more to export growth than in other MICs....................................................................................... 69 Figure 2.8 : Turkey has more service exports than most peers.............................................................. 70 Figure 2.9 : Turkey has diversified its export markets more than other countries.................................71 Figure 2.10 : Exports to MENA are the mirror image of exports to Europe..............................................72 Figure 2.11 : Export survival of export relationships in different world regions.......................................73 Figure 2.12 : Vehicles increase, textiles decline........................................................................................ 74 Figure 2.13 : Medium-tech exports are up but high-tech exports remain small 2000-2010....................75 Figure 2.14: Turkey’s export sophistication has increased (EXPY) 2000-2010.........................................77 Figure 2.15 : Export quality as reflected in unit prices has also gone up (2000 and 2010)......................77 Figure 2.16 : Firms exporting higher quality goods and having greater reliance on imported inputs are more likely to survive..................................................................................................... 78 Figure 2.17 : Bilateral trade costs for Turkey and comparator countries................................................... 80 Figure 2.18 : Turkey ranks high in logistics performance compared to its neighbors….............................. 81 Figure 2.19 : …and performs better than countries with a similar per capita income. ............................. 81 Figure 2.20 : Turkey’s trade openness remains lover than in high-growth markets................................. 82 Figure 3.1 : Overnight borrowing rates during the 2000-2001 crisis......................................................89 Figure 3.2 : The ten most costly banking crises...................................................................................... 90 Figure 3.3 : Policy responses to banking crises....................................................................................... 93 Figure 3.4 : The results of the reforms are evident................................................................................ 94 Figure 3.5 : Turkey’s banks are among the strongest in emerging markets............................................96 Figure 3.6 : Post-crisis deleveraging in Europe - Continued inflows into Turkey.....................................96 Figure 3.7 : A credit boom and rising external imbalances in 2010-2011. ..............................................99 Figure 3.8 : Policy rate adjustments and the corridor. ............................................................................ 99 Figure 3.9 : Turkish financial markets came under severe pressure after the Fed’s tapering announcement.................................................................................................... 101 Figure 3.10 : Turkey: Financial market depth indicators......................................................................... 103 Figure 3.11 : Financial intermediation at the household level is lopsided in Turkey.............................. 104 Figure 3.12 : Financial intermediation is higher among men, and among the older and better educated.................................................................................................................105 Figure 3.13 : Domestic debt securities issued by banks and non-financial corporations.......................105 Figure 4.1 : Turkey had fast productivity growth over the past decade thanks to structural change...115 Figure 4.2 : Labor in Turkey has moved from agriculture to industry and services since the 1980s....116 Figure 4.3 : Structural change has contributed to productivity growth................................................117 Figure 4.4 : Regulatory improvements to support global integration. .................................................. 118 Figure 4.5 : Productivity levels have converged across regions in Turkey.............................................119 Figure 4.6 : Identifying the Tigers (in blue): Fast growth from a low base. ........................................... 120 Figure 4.7 : Average firm productivity is still higher in the West in spite of productivity convergence.124 Figure 4.8 : Explaining Tiger catch-up – Faster expansion by more productive mid-size firms.............125 Figure 4.9 : Explaining Tiger catch-up – Increase in Tiger exports, with exporters larger and more productive................................................................................................................126 Figure 4.10 : Firms in the Tiger regions export products of similar quality to firms in the West............127 Figure 4.11 : Increased public expenditures in physical and social infrastructure in Tiger and other regions. ..................................................................................................................... 128 Figure 4.12 : Measuring innovation capacities: Turkey vs. selected peers.............................................131 vi Integration, Inclusion, Institutions Figure 4.13 : Innovation scoreboard: Turkey and the European Union..................................................132 Figure S2.1 : The expansion of two lane highways in Turkey during the past decade............................ 141 Figure S2.2 : Turkey experienced considerable improvements in mobile and broad-band coverage in the last decade............................................................................................... 142 Figure S2.3 : Total electricity generation capacity increased rapidly after 1978.................................... 142 Figure S2.4 : Quality indicators show improvements in all dimensions of infrastructure......................143 Figure S2.5 : Public vs. private investments as percentage of GDP........................................................ 144 Figure S2.6 : Improving infrastructure – a timeline of reforms..............................................................150 Figure 5.1 : Development of Konya’s urban form as depicted in a series of urban planning schemes (1946-2020).........................................................................................................156 Figure 5.2 : Growth in share of urban population in Turkey and comparator countries (1950-2015).. 158 Figure 5.3 : Urbanization and growth around the world - a mixed picture (1980-2012)......................159 Figure 5.4 : Urbanization and population agglomerations................................................................... 160 Figure 5.5 : Economic activity moves inland to feed the Anatolian Tigers...........................................161 ....................................................162 Figure 5.6 : Zipf’s city rank-size power law and the system of cities. Figure 5.7 : Percentage share of total metropolitan municipality population, 2000 and 2012............163 Figure 5.8 : Water supply and sanitation service pricing and domestic consumption per capita in Turkey and comparator countries, 2011............................................................................ 164 Figure 5.9 : Firms locate in metropolitan municipalities...................................................................... 165 Figure 5.10 : Firm location across city area: Manufacturing and ICT firm comparison..........................166 Figure 5.11 : Distribution of Turkish cities based on diversity and ubiquity of products, 2012..............167 Figure 5.12 : Turkey’s cities have high density........................................................................................ 167 Figure 5.13 : Development of railways and population concentrations in Turkey in 2000.....................168 Figure 5.14 : Turkey housing starts to need ratio (1958-2010) and landmark housing legal and institutional initiatives..........................................................170 Figure 5.15 : Distribution of housing construction and occupancy licenses by ownership form............171 Figure 5.16 : Weekly trends in mortgage financing................................................................................ 172 Figure 5.17 : Rental share of housing market in Turkey and selected European countries (1994).........172 Figure 5.18 : Turkey substantially expanded public expenditures on water, wastewater and solid waste infrastructure between 2003 and 2008................................................................... 173 Figure 5.19 : Turkey’s water and sanitation service coverage (1991-2011)............................................174 Figure 5.20 : Meters of high transit capacity per capita for selected cities............................................177 Figure 6.1 : Labor force participation in Turkey is lower and unemployment higher than in most peers. ................................................................................................... 182 Figure 6.2 : Turkey’s remarkable post-crisis employment performance...............................................183 Figure 6.3 : The added worker effect.................................................................................................... 184 Figure 6.4 : Employment rates are up but still low............................................................................... 184 Figure 6.5 : The gender gap explains why employment rates are low..................................................185 Figure 6.6 : Younger women are more likely to be active..................................................................... 186 Figure 6.7 : The gender gap is declining............................................................................................... 186 Figure 6.8 : The U-curve of female LFP in Turkey.................................................................................. 187 Figure 6.9 : Women’s income does not (yet) contribute much to poverty reduction.......................... 188 Figure 6.10 : Job informality: declining but remains high....................................................................... 188 Figure 6.11 : Informality is higher among women and youth................................................................. 189 Figure 6.12 : Turkey’s labor markets are segmented because of high costs of formality.......................189 Figure 6.13 : Turkey reduced the tax wedge to boost job creation........................................................191 Figure 6.14 : Turkey increased spending on ALMPs................................................................................ 191 Figure 6.15 : İŞKUR’s coverage and placement are increasing fast.........................................................192 vii Turkey’s Transitions Figure 6.16 : Turkey is young and already relatively rich........................................................................ 193 Figure 6.17 : Turkey’s demographic window of opportunity.................................................................. 194 Figure 6.18 : Turkey is expected to have a lot more workers.................................................................. 195 Figure 6.19 : Educational attainment in Turkey is increasing.................................................................. 196 Figure 6.20 : Experience in peers shows that educational attainment can improve fast.......................196 Figure 6.21 : The gender gap declines as educational attainment goes up............................................198 Figure 6.22 : Enrollment in ECE is increasing.......................................................................................... 198 .....................................................199 Figure 6.23 : Few women work part-time, more may want to do so. Figure 7.1 : Health: The gap between Turkey and the OECD is shrinking, with improved equity.........206 Figure 7.2 : Education: Remarkable improvement in learning, particularly among low performers....207 Figure 7.3 : Increases in health human resources................................................................................ 209 Figure 7.4 : Investments in medical personnel and infrastructure have led to better coverage.......... 211 Figure 7.5 : Additional public financing for health was key for the reforms......................................... 212 Figure 7.6 : More efficient contribution collections have raised additional financing..........................213 Figure 7.7 : Reforms led to significant gains in coverage for the most vulnerable............................... 214 ...................................215 Figure 7.8 : Turkey performs impressively in immunizing its youngest citizens. Figure 7.9 : Turkey’s education workforce and infrastructure kept pace with growing education needs.................................................................................................... 217 Figure 7.10 : The equity of expenditures – increasing investment in underserved regions...................219 Figure 7.11 : Turkey’s investments in education rapidly increased enrollment rates............................. 220 Figure 7.12 : Turkey has improved its PISA scores faster than any other participating country............. 221 Figure 7.13 : Graduating more students into the global economy......................................................... 222 Figure 7.14 : The case for continued reforms–the pension system is projected to run deficits long ...................................................................................................................223 into the future. Figure 7.15 : Turkey has the lowest pensionable age in the OECD......................................................... 224 Figure 7.16 : Turkey has been closing regional gaps in terms of enrollment in secondary education....225 Figure 7.17 : More access to early childhood education is still needed.................................................226 Figure S3.1 : The unravelling of fiscal discipline between 1990-2001....................................................234 Figure S3.2 : The consequence of fiscal profligacy: rising public debt....................................................234 Figure S3.3 : The fiscal stabilization effort.............................................................................................. 235 Figure S3.4 : Turkey maintained fiscal discipline during the 2008-2009 crisis and beyond....................236 Figure S3.5 : The use of fiscal space in Turkey........................................................................................ 237 Figure S3.6 : The three pillars of public finance management reforms in Turkey post-2001.................239 Figure S3.7 : Credibility of the medium-term fiscal program................................................................. 241 Figure S3.8 : Turkey’s performance in the public expenditure and financial accountability assessment.242 Figure 8.1 : Benchmarking Turkey’s high income potential.................................................................. 248 Figure 8.2 : Turkey’s convergence to high income has slowed since 2007...........................................249 Figure 8.3 : Only a handful of countries have escaped the middle income trap..................................250 Figure 8.4 : The correlation between the quality of economic institutions and per capita income.....252 Figure 8.5 : Turkey remains mid-field on most comparative indices of institutional performance......253 Figure 8.6 : Worldwide governance indicators..................................................................................... 254 Figure 8.7 : Crossing the threshold to high income: Challenges and policy priorities..........................255 Figure 8.8 : Institutional reforms have slowed since the mid-2000s....................................................257 Figure 8.9 : The convergence machine starting up again?.................................................................... 259 viii Integration, Inclusion, Institutions Foreword The rise of the emerging markets is changing the global development landscape. For many developing countries the most pertinent lessons in development come not from the industrialized countries of Western Europe and North America, but from the dynamic emerging market economies well on the way towards high income status. In reflection of the growing role of emerging markets in the global economy, there is increased interest in the exchange of experiences among policy makers of developing countries with their peers facing similar or related challenges. This book responds to the growing demand for development lessons from the emerging markets. It focuses on Turkey’s experience in the transition from lower to higher middle income, a transition that has accelerated in the past decade and has gained Turkey many admirers. Indeed, with a per capita income of around US$10,500, Turkey is just a few years away from crossing the threshold to high income status, if past growth rates are sustained. According to the OECD, by 2060 Turkey will be the 12th largest economy in the world (up from 18th place in 2012), with a GDP of around 4 trillion USD or just around 20 percent less than the forecast GDP of Germany. Turkey’s economic rise has attracted attention and this book is an account of how it happened and what lessons others can learn from it. Another important reason for the increased attention on Turkey is its unique historical and geographic position between Europe and the Middle East. Apart from the oil-rich Gulf States, Turkey today is by far the wealthiest of the countries that emerged from the Ottoman Empire. Together with Malaysia it is the first country with a majority Muslim population on the cusp of achieving high income status without relying on oil and gas. In addition, Turkey has had free and fair elections since 1950 and is a candidate for accession to the European Union. Turkey may thus offer important social and political lessons as well. While the interest in Turkey’s experience outside the country is strong, opinion on evaluating Turkey’s recent economic and social history remains divided both within the country and among outside experts. There is no accepted narrative on what has worked and what might need to change, which leaves the country vulnerable to costly policy mistakes. Aside from lessons for third countries, this book also offers a narrative of Turkey’s transition experience as a contribution to the domestic policy debate. Two central themes have dominated Turkey’s economic development over the past three decades: integration and inclusion. A key message of the book is that Turkey’s economic integration (both into global markets and among advanced and backward regions in Turkey) has been a driver for economic progress. Moreover, both structural factors and policy choices have ensured that this progress has been socially inclusive, and hence the policy course chosen has been politically sustainable. But a second key message is that, in spite of the remarkable achievements so far, Turkey has yet to establish the institutional prerequisites of a high-income economy. In a less forgiving global economic context, the risk of the “middle income trap” looms for countries that let off on the reform efforts. Improvements in the rule of law, in public accountability and transparency, and in the climate for entrepreneurship and innovation will thus be needed for Turkey to complete the transition to a high income economy. ix Turkey’s Transitions Turkey is undergoing multiple transitions en route to a high income economy, some more advanced than others. We hope Turkey’s experience inspires policy makers in other emerging markets to aim for high income status. And we hope that by drawing up a balance sheet of Turkey’s achievements and challenges, this book will also inspire Turkey’s policy makers to redouble their own reform efforts and lift their country into the ranks of the advanced high- income economies. That would make Turkey’s lessons all the more convincing. Laura Tuck Vice President Europe and Central Asia Region The World Bank x Integration, Inclusion, Institutions Acknowledgements This book was written by a team led by Martin Raiser, Country Director for Turkey, and Marina Wes, Country Manager for Poland (who at the time of writing was Lead Economist for Turkey). Many people participated in the writing of the report. The main authors and contributors by chapter are: • The Overview and Chapter 1 (Introduction) were written by Martin Raiser, with contributions from Ayberk Yılmaz (Chapter 1) and Joao Pedro Azevedo (Annex to Chapter 1). • Chapter 2 (Trade) was written by Kamer Karakurum Özdemir and Marina Wes. • Chapter 3 (Finance) was written by Carlos Piñerúa, with contributions from Engin Akçakoca, Cevdet Çağdas Ünal, Alper Oğuz and Jose Guilherme Reis. • Chapter 4 (Enterprises) was written by Francis Rowe, with contributions from İzak Atiyas, Ozan Bakış, Mark Dutz and Stephen O’Connell. • Chapter 5 (Cities) was written by Stephen Karam. • Chapter 6 (Labor) was written by Altan Aldan, Rebekka Grun and Ana Maria Munoz Boudet. • Chapter 7 (Welfare) was written by Roya Vakil and William Wiseman. • Chapter 8 (Outlook) was written by Martin Raiser with contributions from Ayberk Yılmaz. • Spotlight 1 was written by Cevdet Çağdaş Ünal. • Spotlight 2 was written by Nancy Lozano Gracia. • Spotlight 3 was written by Mediha Ağar. • The annex tables were prepared by Ayberk Yılmaz. Special thanks are due to Ayberk Yılmaz, Pınar Baydar and Bilgen Kahraman for excellent research assistance and editorial support. Without them, this book would never have been completed. The team owes particular gratitude to colleagues in the Central Bank of the Republic of Turkey, the Ministry of Development, the Ministry of Economy, the Ministry of Finance, the Ministry of Labor and Social Security, the Undersecretariat of Treasury, and the Turkish Statistical Institute (TurkStat) for detailed comments on several drafts of this Report. A panel of advisors provided guidance to the team. The panel included Ahmet T. Kuru (Univer- sity of Utah), Can Paker (The Turkish Economic and Social Studies Foundation (TESEV)), Dennis Snower (Institute of World Economics, Kiel), Güven Sak (Economic Policy Research Foundation of Turkey (TEPAV)), Marc Pierini (Carnegie Endowment), Ömer Taşpınar (School of Advanced International Studies (SAIS) at Johns Hopkins University), Seyfettin Gürsel (Bahcesehir University Center for Economic and Social Research (Betam)), Hedi Larbi (Minister of Infrastructure and Sustainable Development of Tunisia, former World Bank Director for Iran, Iraq, Jordan, Lebanon and Syria) and Yavuz Canevi (Economy Bank of Turkey (TEB)). The team also benefited from the advice provided by three peer reviewers: Sinan Ülgen, Manuela Ferro and Stefan Koeberle; as well as comments from Mark W. Lewis, Cevdet Denizer, Indermit Gill and Hans Timmer. xi Turkey’s Transitions xii Integration, Inclusion, Institutions List of Abbreviations ABPRS Address-Based Population FAR Floor Area Ratio Registration System FDI Foreign Direct Investment AISS Annual Industry and Service Statistics FLFP Female Labor Force Participation AK Party Justice and Development Party FSC Financial Stability Committee ANAP Motherland Party FSI Floor Space Index ARPU Average Revenue per User FX Foreign Exchange BEC Broad Economic Categories GDP Gross Domestic Product BIMER Prime Ministry Communication GFS Government Finance Statistics Centre BIS Bank for International Settlements GNP Gross National Product BOT Build-Operate-Transfer GSM Global System for Mobile BRICS Brazil, Russia, India, China and GVCs Global Value Chains South Africa GWI Global Water Intelligence BRSA Banking Regulation and HBS Household Budget Survey Supervision Agency HEC Higher Education Council CBRT Central Bank of the Republic of HIPC High Indebted Poor Countries Turkey HS Harmonized Classification CCT Conditional Cash Transfer HTP Health Transformation Program CDS Credit Default Swaps ICT Information and Communication CGE Computable General Equilibrium Technologies CMB Capital Markets Board IFI International Financial Institution COMCEC The Standing Committee for IFPRI International Food Policy Economic and Commercial Cooperation of the Organization of Research Institute the Islamic Cooperation IMF International Monetary Fund CU The Customs Union IPR Intellectual Property Rights DALY Disability-adjusted LifeYear İSKİ Istanbul Water and Sewerage DB Defined Benefit Administration DC Defined Contribution IT Information Technology DHMI General Directorate of State Airports KBC Knowledge Based Capital DOTS Direction of Trade Statistics KGM Directorate of Roads DPT diphtheria-pertussis-tetanus KOSTAT Korean Statistics DSP Democratic Left Party KÖYDES Small Villages Water and EBA The Execution and Bankruptcy Act Sanitation Project EBFs Extra Budgetary Funds LDC Least Developing Countries EBRD European Bank for Reconstruction LOWESS Locally Weighted Scatterplot and Development Smoothing ECE Early Childhood Education LPI Logistics Performance Index EEC European Economic Community MENA Middle East and North Africa EFTA European Free Trade Association MHP Nationalist Movement Party EMRA Energy Market Regulatory Authority MICs Middle Income Countries ESI European Stability Initiative MoFSP Ministry of Family and Social Policies EU European Union MoH Ministry of Health EUAŞ Turkey National Energy Distribution Company MoLSS Ministry of Labor and Social Security EXPY Index of Export Sophistication, MoNE Ministry of National Education Country MPC Monetary Policy Committee xiii Turkey’s Transitions MTFP Medium-Term Fiscal Program SUKAP Water and Wastewater Project MVET The Modernization of Vocational SVET The Project on Strengthening the Education and Training Project Vocational Education and Training MW Megawatt System NACE Nomenclature des Activites SYDVs Social Assistance and Solidarity Generales Economiques Foundations NCD Non-communicable diseases TCA Turkish Court of Accounts TCDD Turkish State Railways NDP National Development Plan TEDAŞ Turkey National Energy Transmission NUTS Nomenclature of Territorial Units Company for Statistics TEİAŞ Turkish Electricity Transmission OECD The Organisation for Economic Company Co-operation and Development TEK Turkey National Power Company OKS High School Entrance Examination TEPAV Economic Policy Research OSYM Student Selection and Placement Foundation of Turkey Center TFP Total Factor Productivity PEFA Public Expenditure and Financial THY Turkish Airlines Accountability TIMSS Trends in International Mathematics PFM Public Finance Management and Science Study PFMCL Law on Public Finance Management TL Turkish Lira and Control TOBB The Union of Chambers and PISA Programme for International Student Commodity Exchanges of Turkey Assessment TOKİ Housing Development PMR Product Market Regulation Administration of Turkey PPA Public Procurement Authority TRACE Tool for Rapid Assessment of City PPL Public Procurement Law Energy PPP Purchasing Power Parity TSD Trade in Services Dataset PPP Public Private Partnership TTIP Trans-Atlantic Trade and Investment pps Points Partnership TurkStat Turkish Statistical Institute PRODY Index of Export Sophistication, Goods Basket UK United Kingdom PROST Pension Reform Option Simulation UN United Nations Toolkit UNCTAD United Nations Conference on Trade and Development PSBR Public Sector Borrowing Requirement UNESCAP United Nations Economic and Social Commission for Asia and The Pasific PSO Public Service Obligation UNESCO United Nations Educational, PWT Penn World Tables Scientific and Cultural Organization R&D Research and Development USA The United States of America RCA Revealed Comparative Advantage VA Value Added RDAS Research and Development Activities VET Vocational Education and Training Survey WB The World Bank RGDPo Real Gross Domestic Product Series WDI World Development Indicators ROCs Reserve Option Coefficients WEF World Economic Forum S&P Standard and Poor’s WGI Worldwide Governance Indicators SABİM MoH Communications Centre WHO World Health Organisation SBS Level Determination Exams WITS World International Trade Statistics SDIF State Deposit Insurance Fund YASED International Investors Association SME Small and Medium Enterprise SOE State-Owned Enterprise SPO State Planning Organisation SSI Social Security Institution xiv Overview Overview: Turkey’s Transitions Finance Fiscal Space Infrastructure Trade Welfare Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 1 Turkey’s Transitions: Integration, Inclusion, Institutions 2 Overview Turkey’s Transitions: Integration, Inclusion, Institutions T urkey has always been a country of strate- agement. For policy makers from these countries, gic significance. Its geographic position as Turkey’s lessons are valuable precisely because a bridge between East and West, its long they have been learned in a political and institu- and unique history of relations with the European tional environment that remains in flux. Union (EU), and the particular route the Republic of Turkey chose towards modernization after its foun- An objective assessment of what has worked well dation in 1923 have attracted the attention of his- and what needs to change is also important in torians and political scientists alike. More recently, the context of Turkey’s domestic policy debate. A Turkey’s economic success has become a source of failure to appreciate the roots of Turkey’s achieve- ments and understand the policies that contributed inspiration for a number of developing countries, to them may precipitate costly reversals. Turkey’s particularly, but not only, in the Muslim world. The policy framework needs to adjust if the country is rise of Turkey’s economy is admired, all the more to progress to high income but such adjustment so because it seems to go hand in hand with demo- should build on the pro-market and pro-European cratic political institutions and an expanding voice orientation adopted in the aftermath of Turkey’s for the poor and lower middle classes. In the wake crisis in the early 2000s. Turkey’s achievements of the Arab Spring, Turkey was seen by many as a have had several fathers. Turkey’s vigorous politi- possible model for successful modernization in the cal debate overshadows the fact that progress was Muslim world. based on a broad consensus in economic policy. Over the past two years, however, questions have This consensus should be nurtured. emerged over the lessons to be drawn from Tur- This book is, thus, addressed to policy makers both key’s experience. Economic growth has come down from other emerging markets and from Turkey it- to a modest 3-4 percent range from well over 5 self. To the former, it offers lessons in how Turkey percent during 2002-2011, and risks related to the progressed towards international integration and country’s large external financing needs have not increased social inclusion. To the latter, it offers a been banished. Critics have raised questions over narrative of the country’s achievements and re- the strength of Turkey’s legal and economic insti- maining challenges that may help define the reform tutions, and economists are concerned that Turkey agenda going forward. may remain “trapped” in its current middle income status. Our narrative starts in the early 1980s with the re- forms of Turgut Özal, who opened up the Turkish The recent gloom may be as exaggerated as the ear- economy to international trade and investment. lier euphoria. Turkey’s achievements in economic It considers the positive impact of these early re- development and social progress are noteworthy forms and the reasons they, nonetheless, fell short and neglecting them would be unfortunate for the and ushered in a period of economic and political many countries still looking for inspiration from suc- instability. The response to a major financial crisis cess stories among emerging markets. Indeed, the in 2001 led to a regime shift and a subsequent era interest in Turkey’s experience among other emerg- of rapid economic and social advancement, which ing markets remains strong despite slower growth today faces a new test of deepening reforms to and external criticism. In the past two years, with ease the country’s path to high income. While the the assistance of the World Bank Group, close to focus is squarely on Turkey, throughout the report, 20 delegations from countries as far flung as India, its performance is benchmarked against other Uzbekistan, Tajikistan, Malaysia, Mauritania, Iraq, emerging market peers in Europe, in the Middle Kosovo, Tunisia, Kenya, Pakistan and Ukraine have East and North Africa (MENA), and among the large come to Turkey to learn about topics as diverse as middle income countries around the globe. Where primary health care reform, the expansion of sec- appropriate, comparisons with the The Organisa- ondary education, the removal of energy subsidies, tion for Economic Co-operation and Development the regulation of telecommunications, banking re- (OECD), of which Turkey was a founding member, structuring, social housing and public finance man- are also made.1 1 The following peer groups are used throughout the Report: New EU Member States (Bulgaria, Czech Republic, Hungary, Poland, Romania, Slovakia), Accession Candidates (Albania, Serbia and Croatia – included in this group because our data stop mostly in 2012 prior to Croatia’s accession), MENA (Egypt, Jordan, Morocco, Tunisia and Syrian Arab Republic), the BRICS (Brazil, Russian Federation, India, China, and South Africa), and the Growth Markets (Indonesia, Malaysia, Mexico, Philippines and Republic of Korea; a group coined by Goldman Sachs). 3 Turkey’s Transitions: Integration, Inclusion, Institutions Multiple transitions macro management and healthy financial and fis- cal buffers. Turkey’s economic catch-up with Eu- Economic development goes hand in hand with rope over the past decade mirrors the experience fundamental changes in society. Most high income of other accession countries that benefited from countries today share broadly similar economic and Europe’s “Convergence Machine” (Gill and Raiser, social structures and political and economic insti- 2012). The combination of these international driv- tutions: their economies are market-based, inter- ers with Turkey’s unique national circumstances nationally connected, and largely urbanized; they makes up the story of Turkey’s transitions. Three have a highly skilled workforce, low fertility and main features of this story stand out: mortality rates, and offer extensive public services. Almost all high income countries are democracies • Economic growth driven by structural and all of them have strong economic and politi- change: The shift of employment out of agri- cal institutions based on the rule of law, the pro- culture into industry and services has brought tection of individual rights, and the establishment increases in productivity and rising income. of a competitive or “open-access” order (North, Structural change has been seen as an engine 1990; Acemoğlu and Robinson, 2012; Ferguson, of productivity growth in developing countries 2011; North, Wallis and Weingast, 2009)2. Among for many decades, going back to the work of developing countries, both middle and low income, Nobel Prize winning economist Arthur Lewis. there is much higher variation in the way econo- But as Dani Rodrik and Margaret McMillan mies and societies are organized. Far from a linear (2011) show, it is far from obvious that the en- progress on a well-trodden path, economic devel- gine actually works. That it did in Turkey has to do with the process of international and do- opment involves multiple transitions that lead to mestic market integration. Trade liberalization different configurations across countries and time. in the 1980s, followed by the Customs Union Turkey itself is undergoing multiple transitions, agreement with the EU in 1995, provided the some more advanced than others. It is open to price signals and competitive incentives for the foreign trade and finance, and yet domestic capi- modernization of Turkey’s industry. After 2001, tal markets remain underdeveloped. A majority of banking sector restructuring allowed financing its population has moved from their place of birth to flow to the business sector, and, together as Turkey has undergone a dramatic process of ur- with more business friendly regulations, fa- banization, yet traditional gender roles in the family cilitated the creation of jobs in manufacturing have largely stayed intact. Turkey has harmonized and services. Public and private investments in many of its laws and regulations with EU standards infrastructure, in particular transport and logis- and dramatically expanded access to public servic- tics, ensured that the benefits of international es, but concerns over economic and public sector integration were spread inland. Rapid urbaniza- governance persist. To many outside observers, tion, including in the secondary cities of Ana- Turkey is a country of contrasts. As this report il- tolia, created an attractive production base for lustrates, these contrasts result from uneven prog- investors and an economically efficient system ress along various dimensions of Turkey’s economic of cities emerged. and social development. They are also linked with These are Turkey’s lessons in integration and each other in ways that offer important lessons they are mainly associated with its achieve- on the sequencing and sustainability of economic ments in trade, finance, enterprises and infra- reforms.The drivers of Turkey’s progress since the structure. early 1980s are similar to trends in other emerg- ing markets. China opened up to the international • From debt service to public service: Turkey’s economy around the same time as Turkey; Eastern rising prosperity has been shared and inequali- Europe and India around a decade later. Russian ties in access to basic public services have been Federation and Brazil are prominent examples of greatly reduced. Turkey remains a country of countries that fundamentally overhauled economic unequal opportunities; yet, for many of Turkey’s management following financial crises at the end poor, the past decade, in particular, has brought of the 1990s or early 2000s and have subsequently unprecedented improvements in income, benefited – as Turkey has – from the “great moder- healthcare, education, housing and basic mu- ation” of abundant global liquidity thanks to sound nicipal services. Indeed, Turkey’s middle class3, 2 The term “open access order” is due to North, Wallis and Weingast (2009). It describes a set of political and economic institutions that ensure open competition on an even playing field, both for political power and for market share. 3 The middle class is defined here as the share of the population living on at least $10 per capita per day in Purchasing Power Parity (PPP) terms (Azevedo and Atamanov, 2014). 4 Overview while still a minority at just over 40 percent of flow of cheap money to Turkey in the wake of the the population, has more than doubled since global economic and financial crisis, Turkey’s un- 1993. Improvements in living conditions for the derlying competitiveness challenges have not been poorer segments of the population are not an addressed. A new growth model is needed based automatic outcome of economic growth. What on increases in firm-level productivity, as the gains makes Turkey’s experience interesting is that from structural change peter out. Moreover, re- improvements in the income of the poor have forms of the public financial management frame- not resulted from changes in the distribution work remain incomplete. The fiscal windfall from of income as for instance in Latin America (Aze- declining interest payments is almost exhausted vedo and Atamanov, 2014). Instead, they reflect and further improvements in the quality of public rising labor market earnings across the distribu- services will require greater attention to efficiency. tion, and public investment in the expansion of Last but not least, Turkey needs to satisfy the aspira- health, education and municipal infrastructure, tion of the new middle class while at the same time as well as the strengthening of Turkey’s social security arrangements. These investments were harnessing the resources and experience of the made possible by the fiscal consolidation in the traditional urban intellectual and business elites. A early 2000s which allowed spending to be re- renewed policy consensus in favor of competitive allocated from debt service to public services. markets, political and civil liberties and improved Turkey’s rapid urbanization has supported this economic governance would help Turkey consoli- process, because it has greatly reduced the unit date its institutions and thereby lay the foundation cost of access to health and education. While for the transition to high income. much remains to be improved in municipal planning and management, Turkey’s cities have Turkey’s achievements accommodated the flood of migrants from rural areas and provided them with housing, access Turkey’s average real income has risen fivefold to drinking water and sanitation. since the 1950s. Decade by decade, Turkey’s real Gross Domestic Product (GDP) has grown, never by These are Turkey’s lessons in inclusion and they less than 4 percent on average (Figure 1). While not mainly relate to the country’s achievements in spectacular, this is a solid performance, and it has urbanization, labor markets, health and educa- brought Turkey to the threshold of high income. In tion services, and in public finances. the 1960s and 1970s, Turkey progressed less quick- • A pro-market consensus, but contested insti- ly than its peers, but in the 1980s, 1990s and 2000s, tutions: Turkey’s transformation has been pre- Turkey’s performance was on par or exceeded aver- dominantly private sector led and sustained by age growth in the peer group. This is the period of a political consensus in favor of market-based Turkey’s integration into the global economy which solutions. The rise of a new generation of entre- is the focus of this report. preneurs from Turkey’s inland provinces – often Turkey’s progress towards high income has given referred to as the “Anatolian Tigers” – and the rise to a growing middle class (Figure 2). This has growth of an urban middle class has created a had important economic and political implications. political constituency for conservative social Economically, it has created a buoyant domestic and liberal economic policies. The deep politi- market and stimulated both domestic and foreign cal and economic crisis at the end of the 1990s catalyzed a series of institutional reforms aim- investment. Politically, it has created demand for ing to establish arm’s length relations between improved public services and support for pro-mar- the state and the private sector. These were ket policies as a means to open up new economic sustained and expanded by the Justice and De- opportunities. Turkey’s growth has also been asso- velopment Party (AK Party) after 2002, with the ciated with a sharp fall in poverty rates. While pock- prospect of EU membership and the process of ets of poverty remain in rural areas, by and large Accession negotiations providing an important economic conditions have improved for most peo- anchor for reform efforts. Turkey has been rich- ple. The rising tide of growth has lifted most boats ly rewarded for this choice. and Turkey’s prosperity has been shared (Figure 3). However, Turkey has yet to establish the institu- Solid growth and shared prosperity have their roots tional prerequisites of a high income economy. The in eight specific achievements which together rep- reform momentum has slowed since the global resent the story of Turkey’s transitions. We group economic and financial crisis and the EU reform an- them under the two central themes of integration chor has notably weakened. Hidden by the ample and inclusion. 5 Turkey’s Transitions: Integration, Inclusion, Institutions Figure 1: Steady growth over the decades brings Turkey to the threshold to high income 10% 8.3 8% 6.8 6.0 6% 5.3 5.1 4.9 4.6 4.5 4.1 4.1 4.0 4% 2.3 2% 0% 1950s 1960s 1970s 1980s 1990s 2000s Turkey Real GDP Growth (percent) Average GDP growth in peers (percent) Source: Penn World Tables (PWT), Turkish Statistical Institute (TurkStat), The World Bank (WB) staff calculations Note: Peers include the New EU Member States (Bulgaria, Czech Republic, Hungary, Poland, Romania, Slovakia), Accession Candidates (Albania, Croatia, Serbia), MENA (Egypt, Jordan, Morocco, Tunisia and Syrian Arab Republic), the BRICS (Brazil, Russian Federation, India, China and South Africa), and the Growth Markets (Indonesia, Malaysia, Mexico, Philippines and Republic of Korea). Period growth rates represent the average of the annual growth rates. GDP growth rates are calculated by using PWT database, which allows cross-country comparison in a consistent manner. Growth figures slightly change when calculations are made by using the Ministry of Development’s harmonized GDP dataset for the period before 1980; however, there is no significant divergence for the period following 1980. For reference, the average growth rates per decade using the Ministry of Development’s data are: 7.0 percent for the 1950s, 5.5 percent for the 1960s, 4.7 percent for the 1970s, 4.1 percent for the 1980s, 4.0 percent for the 1990s, 4.6 percent for the 2000s. Figure 2: The middle class has doubled since 1993 in Turkey, although it remains smaller than expected 100% HRV10 90% 80% HRV93 70% RUS10 R² = 0,4282 Share of the middle class 60% LVA10 CRI10 MYS10 CHL10 50% UKR10 POL10 BRA10 40% MEX10 T UR 2010 RUS93 PAN10 PRY93 CHL93 PER10 30% ECU10 UKR93 BRA93 ROM10 MEX93 20% PER93 T UR 1993 ECU93 ROM93 KAZ10 10% KAZ93 0% 3,000 7,000 11,000 15,000 19,000 GDP per capita, in PPP US$ Source: Azevedo and Atamanov (2014) Note: The middle class is defined as the population living on at least $10 per capita per day in Purchasing Power Parity (PPP) terms. Integration: and foreign exchange controls distorted relative prices. Only the rich could afford to pay the price economic liberalization and the for contraband imported luxury items, while the av- fruits of structural change erage consumer and business was stuck with inferi- or domestic quality. All this changed with the trade A rising global presence… liberalization introduced by Turgut Özal. Turkey’s In 1980, Turkey was virtually a closed economy. trade has exploded since then, growing around 50 Exports accounted for just 5 percent of GDP, trade percent faster than world trade in the last decade 6 Overview Figure 3: Prosperity was shared in the 2000s - in Turkey and selected peers 12% 10% 8% 6% Growth Rate 4% 2% 0% -2% -4% 2005-2009 2004-2009 2006-2011 2006-2011 2006-2010 2007-2010 2005-2011 2006-2009 2003-2009 2005-2010 2004-2008 2005-2010 2005-2010 HRV IDN MEX IND ZAF CHL BGR COL TUR BRA ROM CHN RUS Total Population Bottom 40 Source: Azevedo and Atamanov (2014) Notes: Welfare aggregate is consumption plus durables and health. Geometric mean is used to calculate average growth rate. alone. Consequently, Turkey’s share in global im- need for costly rules of origin (World Bank, 2014). ports has more than tripled since 1980 and its ex- The Customs Union also stimulated a wholesale port share has risen four times (Figure 4). modernization of Turkey’s customs administration. Public and private investments to improve Turkey’s The main policies that have made this possible were transport, communications and logistics infrastruc- the trade liberalization of the 1980s, the Customs ture have complemented these efforts and Turkey Union agreement of 1995, and in the 2000s, a con- today ranks among the top 30 countries globally scious commercial diplomacy to expand Turkey’s for the quality of its logistics. In recent years, Tur- presence in new markets. The abolition of import key’s exporters have also benefited from significant licenses and government support for exporters in state support in identifying and opening new target the 1980s created incentives for business to aim markets and bridging information gaps. Efforts to for international competitiveness and introduced strengthen export finance and insurance are under- many companies to foreign markets for the first way. time. The Customs Union agreement anchored Tur- key’s external tariffs at EU levels, greatly reduced The rise in Turkey’s global footprint is impressive, non-tariff barriers to trade through the alignment but it still has a long way to go to reach the lev- of technical standards and regulations and en- els of export performance of Eastern Europe or couraged vertical integration of Turkish firms into East Asia. In comparative terms, Turkey’s open- European production networks by eliminating the ness is not much higher than that of much larger Figure 4: Turkey’s rising global presence 1.4% 100% 90% 1.2% 80% 1.0% Share of Global Exports 70% Percent of GDP 60% 0.8% 50% 0.6% 40% 0.4% 30% 20% 0.2% 10% 0.0% 0% 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Turkey`s Global Import Share Turkey`s Global Export Share Openness (right axis) Source: World Development Indicators (WDI), WB staff calculations 7 Turkey’s Transitions: Integration, Inclusion, Institutions economies such as Brazil and India. Foreign Direct ue to attract funding from abroad, making Turkey’s Investment (FDI) inflows have risen dramatically financial integration a motor of the country’s eco- in nominal terms, but as a share of global flows to nomic convergence (Figure 5). emerging markets, Turkey’s position today is hardly better than a decade ago. While Turkey has shifted A radical macro and financial sector adjustment its product mix towards medium-tech goods, high and restructuring program, implemented in the af- tech products remain underrepresented in its ex- termath of the financial crises during 1999-2001 is port basket. Many opportunities remain for Turk- credited for the turnaround of fortunes for Turkey’s ish producers to move up global value chains and, banks. The program has served as a blueprint for a thus, further increase Turkey’s presence in the number of successive banking sector restructuring world economy. Simpler, more predictable and bet- efforts in other countries. It was based on the strict ter enforced regulations and investments in skills principle of not bailing out bank shareholders but would help Turkey attract more FDI and upgrade protecting depositors by quickly intervening insol- the quality of its exports. vent institutions and transferring their assets to the deposit insurance fund. The sector’s subsequent A robust financial sector… recovery owes much to the prudent and indepen- dent supervision by the Banking Regulation and Turkey’s financial sector used to be the economy’s Supervision Agency (BRSA) and the parallel mac- Achilles heel. Today, it is a key source of strength and roeconomic consolidation under an independent comfort for international investors and domestic central bank, which brought interest rates down business alike. Turkey’s financial sector problems in and allowed an expansion in private sector credit. the late 1990s were typical of many emerging mar- In short, what Turkey experienced after 2001 was a kets. Weak supervision and lax prudential norms change in the way of doing banking, for the benefit allowed commercial banks to engage in related of financial stability and the private sector’s access party lending, inconsistent macroeconomic policies to credit alike. crowded out private investment and encouraged excessive risk taking, and state-owned banks were With the global “great recession” at the end of the used to funnel public resources to the politically decade and the subsequent introduction of extraor- connected off-balance sheet and with little regard dinary monetary policies by leading central banks, to economic viability. Today, Turkey’s banking sec- new challenges arose for Turkey’s financial system. tor has left many of these problems behind. Turkish The monetary authorities and bank regulators were banks are well capitalized, non-performing loans faced with the conundrum of maintaining financial are low, and domestic financial institutions contin- stability while a wave of liquidity rolled into emerg- Figure 5: A robust banking sector has withstood the global financial crisis well Index of external loans of reporting banks vs. all sectors, December 2002 = 100 800 700 600 500 In million US$ 400 300 200 100 0 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Jun-13 Selected EU Average BRICS Average MENA Average Growth Markets Average Turkey Source: Bank for International Settlements, WB staff calculations Note: “MENA Average” refers to unweighted average of Egypt, Jordan, Morocco, Syrian Arab Republic and Tunisia. “New EU Average” refers to unweighted average of Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia. “BRICS Average” refers to Brazil, Russian Federation, India, China and South Africa. “Growth Markets Average” refers to Indonesia, Malaysia, Mexico, Philippines and Republic of Korea. 8 Overview Figure 6: Dramatic structural change in Turkey China -22.0 6.4 Turkey -24.0 4.6 Egypt -9.1 3.0 Brazil -5.8 -0.6 Growth Markets Average -11.7 -3.4 -9.2 New EU Members Average -8.5 Russian Federa tion -4.2 -12.3 -30 -25 -20 -15 -10 -5 0 5 10 Percentage Points Change in Agriculture Employment (1990-2009) (as a share of total employment) Change in Industry Employment (1990-2009) (as a share of total employment) Source: WDI, WB staff calculations ing markets. Turkey chose an innovative route in attitude even in adverse circumstances. Turkey’s response, introducing an interest rate corridor and business sector is a source of strength for its econ- vastly expanding the arsenal of macro-prudential omy and the agent of its structural transformation. tools. However, Turkey’s experiment with unortho- Between 1990 and 2009, employment in Turkey’s dox monetary policy has not prevented sharp credit agricultural sector fell by 24 percentage points, cycles and pressures on the currency and domestic faster than in most emerging markets, including prices as global investor appetite has waxed and China (Figure 6). At the same time, employment in waned. The return to a simpler and more ortho- industry increased by almost 5 percentage points, dox policy framework in late January 2014 suggests that much remains to be learned for Turkey, and in contrast with the experience of most of Latin other emerging markets, in handling the world’s America and Eastern Europe. The dramatic shift of post-crisis financial conditions. One lesson is clear: resources out of agriculture into industry and ser- monetary policy alone is no cure for fundamental vices is at the heart of productivity gains in Turkey. savings-investment imbalances. To address these, GDP per worker expanded at a rate of 3.6 percent fiscal policy and above all structural reforms are between 1995 and 2011 and two thirds of this im- needed. provement has come from the reallocation of labor across sectors (Atiyas and Bakış, 2013) (Figure 7). Turkey’s banking sector remains an asset as the country looks to high income. The policy agenda Turkey’s business environment has been “good has now shifted towards the development of non- enough” to allow entrepreneurial dynamism to bank financial institutions. The aim to turn Istanbul flourish. Over the past decade, improvements in into a financial center is symbolic for the weight regulations have made it easier to start a business, Turkey places on the modernization of its capital offered greater protection to investors and facili- markets. To do so successfully, however, Turkey will also need to address two legacies. It will need to tated cross-border trade. This does not turn Turkey follow macro-economic, financial and social secu- into an “Eldorado” of unfettered business activity. rity policies that encourage Turkish households to Indeed, ranked 55th on the World Bank’s overall Do- save; and it will need to continue to nurture the ing Business Index, Turkey’s business environment trust in Turkey’s financial system and protect the in- hardly stands out among upper middle income dependence of its regulatory institutions – the Cen- countries, but the obstacles have been outweighed tral Bank (CBRT), the Capital Markets Board (CMB) by the opportunities presented as a result of Tur- and BRSA. key’s dramatic structural transformation. Improve- ments in connectivity and urbanization policies that A dynamic private sector… facilitated the growth of an economically efficient From Central Asia and the Western Balkans to Cen- system of cities were key ingredients of the mix that tral Africa, Turkey’s entrepreneurs have earned a catalyzed entrepreneurship in Turkey’s inland prov- reputation for hard work, risk taking, and a can-do inces, the so-called “Anatolian Tigers”. 9 Turkey’s Transitions: Integration, Inclusion, Institutions Figure 7: Turkey’s enterprises have delivered strong productivity growth Productivity growth (GDP per worker) 1995 - 2011 EU Average 3.9% Turkey 3.6% BRICS Average 3.0% MENA Average 2.1% Growth Markets Average 0.7% 0% 1% 2% 3% 4% 5% Average Annual Compound Growth Rate Source: Penn World Tables Turkey’s structural transformation is not complete there has been a substantial expansion of capacity, but its pace is slowing. Turkey’s entrepreneurs to- from around 8,000 Megawatt (MW) in 1980 to al- day face new tasks. They need to shift their efforts most 60,000 MW in 2012, with a growing share for from satisfying the housing and shopping needs of a renewable energy resources. Improvements have rising urban population to producing and marketing also been realized in information and communica- the goods wanted by an increasingly sophisticated tion technologies (ICT), with a threefold increase in middle class and a demanding global economy. If mobile phone subscriptions after 2002 to over 90 Turkey’s businesses rise to this challenge, they will million today. unleash a new wave of productivity improvements, this time associated with technological upgrading Improvements in the quality of infrastructure have and innovation within sectors and firms. Turkey’s been an important component of Turkey’s rising structural transformation would continue but with international competitiveness. According to the a greater emphasis on international linkages, spe- World Economic Forum, Turkey is among the fastest cialization and innovation, and based on a business improving countries in the area of quality of infra- climate that favors know-how over know-who. structure and ranks in the top 50 worldwide for air- ports and roads. The World Bank’s Logistics Perfor- Improved connectivity thanks to private mance Index (LPI) ranks Turkey in the top 30, better investment… than predicted by its per capita income (Figure 8). For the casual visitor, the quality of a country’s Turkey’s achievements in improved connectivity transport and telecommunications infrastructure have come from a combination of investment and is often a first sign of its economic health. In this reform. Public investment has rarely exceeded 3 respect, Turkey leaves a good impression. The percent of GDP, comparatively low among emerg- foundations for substantial improvements in the ing markets (Growth Commission, 2008). However, country’s physical infrastructure were already Turkey has been an early pioneer in public private laid with a particular focus on road transport and partnerships (PPPs). Efforts in the 1980s were ill- power supply in the 1980s. Over the past decade, advised, with many contracts ultimately revoked by the positive trend accelerated. Turkey’s network of the courts and others resulting in poorly regulated double lane inter-city roads has grown more than private monopolies and significant costs to consum- three times to 22,200 km while Turkey’s road fleet ers or the budget. In the 2000s an environment was has been modernized. Turkish Airlines is one of the created for the effective mobilization of the private fastest growing airlines in the world and Istanbul’s sector, thanks to the creation of independent regu- Atatürk Airport is a major international transit hub. latory agencies, the introduction of cost-reflective Turkey’s seaports have been upgraded and now pricing, long-term concessions for ports and air- compete for global transshipment business in the ports and privatization of strategic assets such as eastern Mediterranean. In the energy sector, too, Turk Telekom, power generation and distribution. 10 Overview Figure 8: Turkey’s logistics performance compares favorably with other middle income countries 4.5 DEU 4.0 CAN ESP ITA MYS PRT CHN TUR CZE ZAF THA LPI Score 2014 3.5 POL ROM HUN IDN BGR HRV SVK GRC MAR UKR EGY IND MEX 3.0 SRB BRA PHL KAZ RUS ALB JOR MDA AZE TUN 2.5 GEO 2.0 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 GDP per capita 2012, PPP (current interna tional $) Source: WDI, World Bank LPI Figure 9: Turkey’s regional productivity levels converged between 2004 - 2011 9% MAR 2011 (Annual Average Compound Growth Rate) 8% Growth in Real Per Capita Value Added 2004- 7% 6% MAN 5% AGR ERZ BAL MAL KIR TEK SAM VAN HAT TRA 4% GAZ KAYKON KOC SAN TR ADA ANK IZM BUR IST 3% ANT ZON AYD 2% KAS R² = 0.2599 1% 300 400 500 600 700 800 900 1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800 Real Gross Value Added Per Capita in 2004 Constant TL Source: TurkStat, WB staff calculations Note: Regions are defined as ADA=Adana, Mersin; AGR=Ağrı, Kars, Iğdır, Ardahan; ANK=Ankara; ANT=Antalya, Isparta, Burdur; AYD=Aydın, Denizli, Muğla; BAL=Balıkesir, Çanakkale; BUR=Bursa, Eskişehir, Bilecik; ERZ=Erzurum, Erzincan, Bayburt; GAZ=Gaziantep, Adıyaman, Kilis; HAT=Hatay, Kahramanmaraş, Osmaniye; IST=İstanbul; IZM=İzmir; KAS=Kastamonu, Çankırı, Sinop; KAY=Kayseri, Sivas, Yozgat; KIR=Kırıkkale, Aksaray, Niğde, Nevşehir, Kırşehir; KOC=Kocaeli, Sakarya, Düzce, Bolu, Yalova; KON=Konya, Karaman; MAL=Malatya, Elazığ, Bingöl, Tunceli; MAN=Manisa, Afyon, Kütahya, Uşak; MAR=Mardin, Batman, Şırnak, Siirt; SAM=Samsun, Tokat, Çorum, Amasya; SAN=Şanlıurfa, Diyarbakır; TEK=Tekirdağ, Edirne, Kırklareli; TRA=Trabzon, Ordu, Giresun, Rize, Artvin, Gümüşhane; VAN=Van, Muş, Bitlis, Hakkari; ZON=Zonguldak, Karabük, Bartın. In the energy sector alone, since the creation of the However, the size of the projects under consider- independent regulator Energy Market Regulatory ation has raised the need for significantly increased Authority (EMRA) in 2001, the private sector is es- capacity in project screening, risk and contract timated to have invested around US$60-70 billion. management. Financial closure has often been reached only after considerable delay, while con- Turkey has high ambitions for attracting further pri- tingent fiscal liabilities related to the PPP portfolio vate investment into a pipeline of PPPs amounting have been increasing. to some US$150 billion over the coming decade. 11 Turkey’s Transitions: Integration, Inclusion, Institutions Inclusion: housing, jobs and an economically efficient system of cities and a process of urbanization that has propelled Turkey’s improved public services economy forward (Figure 10). A competitive system of cities… Turkey’s policy makers have facilitated rather than hindered urbanization. Three choices in particular Turkey’s cities are the motor of its economy and have helped. The first has been the use of publicly at the heart of the country’s economic and social owned land to help alleviate housing supply con- transformation. Turkey has experienced one of the straints, initially by allowing informal settlements fastest rates of urbanization of any country world- on Treasury land, and subsequently through mass wide. Over the past three decades, its urban popu- housing projects brokered by the state housing ad- lation has increased by 34.3 million people. Millions ministration, Housing Development Administration of migrants have left low productivity jobs on family of Turkey (TOKİ). The second policy choice has been farms and moved into services or manufacturing, the creation of consolidated metropolitan munici- driving up overall productivity. Together with their palities, able to coordinate city planning and the families, they have been housed, received access to provision of city services in large urban areas. water and sanitation services and connected with gas and heating systems. Their children have ben- Turkey was a pioneer among emerging markets in efited from improved access to schools and, gradu- this regard, offering important lessons for the man- ally, the quality of Turkey’s workforce has shifted agement of mega cities in countries like Egypt, India upwards. One quarter of urban jobs remains infor- or the Philippines. One important consequence has mal today but this is down from over one third a been the creation of incentives for improved man- decade ago. agement of municipal utilities, reflected in low lev- els of unbilled consumption and early success with Some Turkish cities, such as Istanbul, Izmir or An- private concessions in water, sanitation and waste kara already have high income economies. Employ- management. The third choice has been the central ment is dominated by services, including profes- provision of basic water and sanitation services in sional services such as ICT and finance. These cities small towns in rural provinces as a means to ensure are economically specialized, and congestion costs access for people unable or unwilling to move to mean only higher productivity firms survive. Lower large urban agglomerations. productivity activities have moved out of the city center and away from the coast towards the Anato- Turkey’s urbanization experience is not without lian provinces where the fastest growing cities such its discontents, however. The contracting model as Konya, Kayseri, or Gaziantep are located. Their for housing provision on public land has lacked economic advance has fuelled a process of conver- transparency. It has also failed to close the gap in gence of living standards between the more ad- low-income housing, as increasingly, investments vanced “West” and the dynamic “Anatolian Tigers” have been diverted to commercial developments. (Figure 9). Overall, the result is the emergence of Municipal planning remains ad hoc and short-term, Figure 10: Turkey’s urbanization has been a driver of rising income 50% BWA LH HH 40% GAB MYS Change in share of Urban Popula tion GMB IDN CHN 30% BTN KOR TUR JOR PRY ALB (in percentage points) NGA PRT NLD 20% SAU MAR BRA CHE JPN TUN BGR FRA CYP FIN BGD 10% PAK HUN CHL NOR ROM GRC ITA AUS Egypt ESP USA SWZ DEU 0% BLZ BEL AUT LCA -10% -20% LL HL -10,000 -5,000 0 5,000 10,000 15,000 20,000 25,000 Absolute Change in GDP per capita 1980 - 2012, PPP (constant 2005 interna tional $) Source: WDI, WB staff calculations 12 Overview with increasing risk of urban sprawl and inefficient during which the labor force participation rate of settlement patterns at the periphery of Turkey’s women was declining, as families moved from rural fast growing metropolitan areas. While service pro- to urban areas and farm workers became house- vision has greatly improved, much scope remains wives, female employment has been perking up for leveraging the private sector better and creating since the late 2000s. Younger and better educated more room for local accountability. Turkey’s cities cohorts of women benefit from improved employ- have been motors of the country’s economic trans- ment prospects in Turkey’s growing services sec- formation. They now need to become livable and tor, but employment rates have also risen among sustainable cities that are at the heart of Turkey’s middle-aged women as falling family sizes and social modernization. improved household amenities create the room for a return to the labor market. This is good news A post-crisis employment boom… for the whole family: Turkey’s buoyant labor mar- ket has been the main driver of improvements in At a time when the world rightly worries that it may household income (Figure 12). be running out of work for millions of young people coming into the labor market each year, Turkey can The pace of employment creation in Turkey has boast of an impressive record of job creation. Since much to do with the pace of post-crisis recovery the start of 2009, the country has created over 4 and the rapid rise of construction and urban ser- million jobs, an expansion of employment of al- vices. More moderate growth prospects and a cool- most 5 percent per year (Figure 11), and these jobs ing down of the construction boom will inevitably have increasingly been formal sector jobs. Turkey’s dampen the rate of job creation. However, Turkey’s job creation prowess is a new phenomenon, as the experience since 2009 holds useful lessons on the country’s labor market historically was character- impact of targeted reductions in payroll taxes and ized by high and persistent unemployment and the design of activation policies in emerging mar- large rates of informality. Over the longer period of kets. Turkey reduced the overall tax wedge by 7.0 1995-2011, employment creation in Turkey was still percentage points in 2008 (from 43 to 36 percent) a respectable 1.4 percent, but hardly sufficient to and waved social security contributions for unem- keep up with the growth of the working age popu- ployed youth and women. Simulations suggest the lation. latter measure in particular may have contributed to greater female employment rates. At the same The post-crisis dynamism is all the more welcome, time, lower payroll taxes and improved enforce- because it has drawn a growing number of Turkish ment have helped lower informality from 34 per- women into the labor force. After several decades cent in 2005 to 25 percent in 2012.4 Figure 11: Fast job creation in Turkey since the 2008 - 2009 crisis, not so fast over a longer horizon 4.9% Turkey 1.4% 2.4% Growth Markets Average 2.0% 1.8% MENA Average 2.3% 1.1% BRICS Average 1.3% -1.0% EU Average -0.2% -2% -1% 0% 1% 2% 3% 4% 5% 6% Growth in Employment 2009 - 2012 (Annual Average Compound Growth Rate) Growth in Employment 1995 - 2011 (Annual Average Compound Growth Rate) Source: TurkStat, Penn World Tables, WB staff calculations 4 Informality is calculated here from administrative data as the share of the labor force not registered for social security. See World Bank (2010) for an analysis of informality in Turkey, data sources and definitions. 13 Turkey’s Transitions: Integration, Inclusion, Institutions Figure 12: Labor market outcomes have been central to Turkey’s shared prosperity 120% Sources of Household Income 2002 - 2011 Pensions; 19,8 Pensions; 22,2 100% Social Assistance; 10,8 Social Assistance; 19,1 80% Labor Earnings; 32,7 60% Labor Earnings; 45,8 40% Share of Employed; 41,1 Share of Employed; 20% 21,8 Share of Adults; 9,7 Share of Adults; 7,4 0% -1,5 -7,8 -12.2 -9.1 -20% Total Population Bottom 40 Share of Adults Share of Employed Labor Earnings Social Assistance Pensions Remittances Agricultural Income Other Income Source: Azevedo and Atamanov (2014) Despite the recent track record in employment cre- In the education sector the gap with OECD stan- ation, the job for Turkey’s labor market reformers is dards has been falling too. Since 2003, Turkey’s not done. Given the buoyant economy, there was average Programme for International Student As- little need to tackle labor market rigidities, resulting sessment (PISA) scores improved more rapidly from disincentives against part time work and high than among any other country participating in the hiring and firing costs. However, these are likely to survey. Enrolment in primary education is almost become binding constraints to sustaining the pace universal today and the gender gap has disap- of job creation in the years ahead and, in particular, peared. In secondary education, enrolment rates to ensure that more Turkish women go to work. Tur- have almost doubled from 38 percent in 1998 to key will need around 700,000 new jobs each year 67 percent in 2012, and the gender gap declined to accommodate new labor force entrants among from around 9 percentage points to just 1.5 points. youth and women. Greater labor market flexibility, As in the case of health, inequalities in education through part-time work and a reform of severance outcomes across income quintiles have also dimin- pay arrangements, as well as targeted measures to ished (Figure 14). These achievements need to be help women combine work and family could help seen against the background of a legacy of poor sustain Turkey’s job miracle. education performance. Even today, Turkey’s work- ing population on average has benefited from less Improved health and education than 7 years of education, compared to 11 years in outcomes… most advanced countries. This legacy explains why education remains a top policy priority. Turkey’s economic progress has gone hand in hand with improved social outcomes, allowing the coun- Improvements in social outcomes have resulted try to significantly reduce the gap separating it from from increased spending as well as reforms. Health the rest of the OECD. For example, life expectancy in spending increased at a real rate of 10.7 percent Turkey has increased by 10.6 years since the 1990s, between 2002 and 2011, the second fastest expan- while infant mortality rates have fallen six times. sion in the OECD. Education spending increased Moreover, there has been a dramatic reduction in less rapidly, but still grew faster than GDP, allowing the inequality of health outcomes within Turkey for a significant expansion of capacity and declin- in the past decade (Figure 13). For a poor Turkish ing student-teacher ratios. The lesson to be derived family in a village or small town in eastern Turkey, from Turkey’s improvements in social services is the health services have never been so good. No won- importance of combining additional spending with der satisfaction rates with health services have shot carefully designed and sequenced reform plans. up from around 40 percent in the early 2000s to This is true, in particular, for the health sector. Tur- almost 80 percent today (Atun et al., 2013). key’s Health Transformation Program, launched 14 Overview Figure 13: Sharp reduction in health gap with OECD and within Turkey 45 40 38 35 30 Gap with OECD 25 20 21 20 15 13 10 10 7 7 5 5 5 0 Mortality rate, infant Mortality rate, neonatal Life expectancy at birth, total (per 1,000 live births) (per 1,000 live births) (years) 1990 2000 2010 50 47 45 Mortality Rate, Per 1000 Live Births 40 35 30 30 24 25 20 16 15 12 10 5 3 0 Gap Between Rural and Urban Gap Between East and West Gap Betweeen Poorest and Richest Quintile 1998 2008 Source: WDI, Atun et al. (2013) in 2003, is today seen as a flagship example of a education, improving teaching quality and further successful primary health care reform, based on reducing socio-economic segregation. With all the a combination of strengthened patients’ rights, noise, it is almost surprising that Turkey’s education decentralization of decision making, performance quality has improved so much. However, perhaps based incentives, and improved monitoring sys- the biggest challenge facing Turkey’s social services tems (Atun et al., 2013). In the education sector, is how to ensure quality with reduced fiscal space the expansion of compulsory education to 8 years as growth moderates and the windfall gains from in 1997 and 12 years in 2013, as well as targeted Turkey’s successful debt consolidation are largely measures to improve access, were important mile- exhausted. Increased welfare spending has built stones in Turkey’s long march to catch-up with the rigidities into the expenditure side of the budget, standards of the advanced economies. which may be difficult to reverse, as expectations of citizens adjust upward. A growing elderly popula- Turkey’s social services still have some way to go tion will put additional strains on public health bud- to fully close the gap. Education reform in particu- gets, on top of an already large social security defi- lar remains a topic of hot debate, burdened with cit caused by generous public pension provisions. historical and political baggage. Frequent changes of direction have diverted attention from impor- Turkey can face the challenges of reforming welfare tant priorities, such as expanding early childhood with the confidence of a “young” country. The de- 15 Turkey’s Transitions: Integration, Inclusion, Institutions Figure 14: The education gap has also been declining, though Turkey still lags behind 80 Gap between Turkey & OECD PISA scores 70 60 50 40 30 20 10 0 Reading Math Science Average 2003 2009 2012 600 500 Average Score (all disciplines) 400 300 200 100 0 1 2 3 4 5 Quintile of Socio-Economic Index 2003 2009 2012 Source: WB staff calculations based on OECD PISA dataset mographic window of opportunity created by de- rate policies were rendered inconsistent, and ulti- clining dependency rates will remain open for at mately, the credibility of the government’s macro- least another decade. Turkey should use this time economic framework was undermined. The failure judiciously to close the remaining gaps in health to contain the build-up of implicit and explicit lia- and education outcomes, but not neglect to pre- bilities among state enterprises and in the banking pare for the coming age of maturity. sector was at the core of the deep financial crisis that shocked the country in 2000-2001. The crisis, Solid public finances… in turn, proved to be a catalyst for fundamental re- One dimension of government policy that clearly forms of public finances, building an institutional divides the pre- and post-2001 periods in Turkey’s framework that remains by and large in place to recent economic history is the state of public fi- the present day. Turkey’s tax payers were rewarded nances. Turkey experienced repeated bouts of mac- with declining public debt levels, fiscal space for roeconomic instability during the 1980s and 1990s, increased spending on public services, and reduc- generally linked to weak fiscal management. Pri- tions in income and payroll tax rates, albeit at the vate investment as well as spending on core public expense of greater reliance on consumption based services was crowded out, monetary and exchange taxes. 16 Overview For students of Turkey’s experience in fiscal con- the economy was substantially reduced through an solidation, it is important to note that fiscal con- accelerated privatization effort, covering infrastruc- solidation was combined with a major overhaul ture, financial and other economic assets (such as of public financial management (Figure 15). Extra- in the food processing sector), and the introduction budgetary funds, which had proliferated during the of independent regulatory agencies to attract and 1980s and 1990s, were mostly abolished, the pro- guide private sector investment. vision of subsidies off-budget through state banks Although Turkey’s public finance management re- was contained, and the room for discretionary forms were far reaching, laying the foundation for spending greatly reduced through the 2002 Public significant improvements in public sector delivery, Finance Management and Control Law. Public pro- the job of revamping public sector governance curement was reformed in line with EU standards, has not been finished. The alignment of spend- and internal and external audit provisions were ing patterns with strategic priorities is weak, and strengthened. Public debt management was mod- the budget predominantly input based. New av- ernized, complementing efforts to improve macro enues for quasi-fiscal activities have been created fiscal discipline. In parallel, the role of the state in through the public housing administration, TOKİ, Figure 15: Turkey’s fiscal consolidation was accompanied by fundamental public finance reform STRATEGIC MACRO FISCAL OPERATIONAL ALLOCATION of DISCIPLINE RESOURCES ALLOCATION 2006 2006 2006 2000 2002 2001 Abolishment of extr R tion li tion of public En ctment of New Public bud et r funds investment pro r m le din Procurement L w R tion li tion of revolvin funds to si nific nt decline in Est blishment of Public Le isl tion on Preventin completion r tes Procurement Authorit Accumul tion of Dut Losses in St te B nks (for A ricultur l SOEs) 2006 2003 2006 2003 En ctment of Public Fin nce M n ement nd Control 2006 2001 Independence of Centr l B nk (PFMC L w) En ctment of PFMC L w Restructurin of public b nks 2006 2004 Introductuon of New 2006 2002 Public Fin nce nd Debt Metropolit n 2006 M n ement L w Municip lit L w New Corpor te Income T x nd Est blishment of Intern l 2006 Person l Income T x Le isl tion 2005 Amendment of Audit Units L w on Municip lities 2006 2003 Moderni ed debt m n ement s stem nd sep r te risk 2006 ccount est blished in Tre sur 2006 2010 New Bud et cl ssific tion in Line with GFS st nd rds 2006 Submission of Soci l Securit En ctment of New TCA L w nd Univers l He lth Insur nce Est blishment of Str te L w Development Units in ll Line A encies Introduction of Medium Term Expenditure Fr mework Introduction of Indic tive Institution l Ceilin s 2006 2008 Reform of Inter-Government l Fisc l Tr nsfers Source: WB staff 17 Turkey’s Transitions: Integration, Inclusion, Institutions which operates under limited public oversight. Ex- wards, sometimes sharply so. Some fear emerging emptions from the public procurement framework markets may be “trapped” at middle income, oth- have multiplied in the absence of clear legislation ers speak of being “stuck in transition”, as confi- covering activities of state owned enterprises and dence in the inevitability of economic convergence utilities. Capacity constraints have hampered the has been shaken from Eastern Europe to East Asia implementation of new internal and external audit and Latin America. Turkey, too, has yet to cross the rules. As Turkey’s public finances tighten with low- barrier to high income. Since 2007, per capita in- er growth and rising interest rates, these remain- come has hovered around the US$10,500 mark, ing loopholes present risks to fiscal performance. some 20 percent shy of the high income threshold A more general lesson can be derived from the ex- defined by the World Bank (Figure 16). perience of public finance management reforms. In times of crisis, political resistance against new, rule- Various definitions of the “middle income trap” bound governance is often muted. However, after exist, some focused on extended periods of low over a decade of continued economic success, the growth and the failure to close the gap in relative push for greater discretion inevitably grows. This income with the advanced countries (Gill and Kha- was the experience with the Maastricht fiscal cri- ras, 2007; Felipe et al., 2012; Bulman et al., 2012), teria in the Eurozone after the initial success of the some on the risk of economic slowdown after peri- common currency in the early 2000s. Turkey should ods of fast growth and convergence (Eichengreen, take note. The completion of public finance man- Park and Shin, 2011; 2013; Aiyar et al., 2013; EBRD, agement reform is critical; its reversal would exert 2013). Whatever the definition of the “trap” is, a high price on public finances and the economy there is broad agreement on the factors likely to more generally. help middle income countries escape from it: an economy open to trade and FDI, a sustainable mac- roeconomic framework that delivers low inflation Stuck in transition? and limits dependence on foreign capital inflows, The past three decades have led to unprecedented low demographic dependency and rising labor force increases in prosperity in the developing world and participation rates, a good skill base that facilitates Turkey is a prime example of this advance. Emerging the move towards more innovative production, a markets have dramatically increased their weight healthy business climate, and strong economic in- in the global economy and their growing economic stitutions that provide for the rule of law, effective heft, low levels of public debt, and often favorable and accountable government. It is also clear that demographics make the future seem bright. Yet just growth slowdowns are a lot less likely in countries as it looked as if emerging markets had de-coupled that still have room to industrialize and have not from the advanced economies and were poised to fully exhausted the gains from structural change. converge at ever increasing rates, growth prospects Some studies also suggest that more democratic for developing countries have been adjusted down- government improves the likelihood that economic Figure 16: Turkey’s per capita income has hovered around US$10,500 mark since 2007 14,500 GNI per capita, Atlas method (current US$) 12,500 10,500 8,500 6,500 4,500 2,500 500 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Mexico Brazil Thailand Malaysia Russian Federation Turkey Poland High Income Threshold (WB Definition) Source: WDI, TurkStat 18 Overview Figure 17: Turkey and peers and the factors driving high income Macro Risks Structural Potential Openness Governance Demographic Potential Business Regulation Innovation Inclusion BRICS Average New EU Members Average EU Candidate Average MENA Average Growth Markets Average Turkey Source: WB staff calculations based on data from WDI, Doing Business, Worldwide Governance Indicators, Transparency International, Open Budget Initiative, Fraser Institute and TurkStat. Note: Best in class analysis whereby the top performer in each category is indexed at 1 and all other countries are shown in relation to the top performer. Center of the diamond represents 0, whereas the outer edge of the diamond represents 1. When several indicators are used in one category, the indices are averaged and then normalized again to make the top performer equal to 1. Macro risks = inflation rate, net international investment position (percent of GDP), general government debt (percent of GDP); Openness = export + imports (percent of GDP), FDI inflows (percent of GDP), Logistics Performance Index; Demographic potential = old age dependency, labor force participation rate; Innovation potential = average years of schooling of the workforce, R&D investment (percent of GDP); Inclusion = Gini coefficient of consumption; Business regulation = Doing Business distance to frontier, Fraser Institute index of light regulation; Governance = Fraser Institute index of legal structure, Transparency International Corruption Perceptions Index, Open Budget Index, Worldwide Governance Indicators on rule of law, government effectiveness, voice and accountability; Structural potential = employment in agriculture (percent of total employment). institutions are modernized and, thus, lowers the base their economies on the strength of the rule risk of a growth slowdown (Berg, Ostry and Zettel- of law, effective and accountable government, and meyer, 2008; Acemoğlu et al., 2014; EBRD, 2013). transparent and arm’s length market regulation. Moreover, the correlation between the quality of Turkey’s prospects measured against this cross- institutions and per capita income is much higher country evidence are mixed (Figure 17). On one hand, Turkey has evident strengths in a young pop- at high income than among low and middle income ulation, solid infrastructure and reasonably good countries. The quality of Turkey’s economic insti- business regulations. Turkey’s economic struc- tutions is roughly as expected given its per capita ture is also a relative source of strength, though income but it would have to improve significantly a diminishing one. On the other hand, Turkey’s to match the levels of countries that have success- economy remains less open than those of its fast fully transitioned to high income in the past de- growing peers in East Asia or Eastern Europe, FDI cade, such as the Republic of Korea or Poland. Yet, inflows are low, labor force participation and edu- the reform process in Turkey has slowed in recent cation achievement are among the lowest in the years. For instance, after a period of rapid deregu- peer group, and macroeconomic stability remains lation during the early 2000s, Turkey has made at risk due to Turkey’s high dependence on exter- hardly any progress since 2007 and has seen many nal financing. Turkey’s structural and demographic competitors close the gap or even surpass Turkey potential is balanced by relatively poor innovation in the quality of business, product and factor mar- potential and significant macro risks. Policies to ket regulations. Similarly, the quality of economic increase openness, manage macro risks, promote governance has improved only marginally since the education and innovation, and improve economic mid-2000s after rapid reforms in the previous five institutions are needed for Turkey to fulfill its aspi- years. For a country aspiring to join the rank of the rations. top 10 economies in the world, it should be a con- Of all the challenges Turkey faces as it aims for high cern that Turkey does not make it to the top 40 on income, building the institutional prerequisites may any global ranking of the quality of economic insti- be the most important. All high income countries tutions (Figure 18). 19 Turkey’s Transitions: Integration, Inclusion, Institutions Figure 18: Turkey remains mid-field on most comparative indices of institutional performance 200 189 177 177 180 152 Total Number of Countries 160 148 Turkey`s Rank out of 140 120 98 112 100 80 69 60 56 55 53 40 42 20 0 Open Budget WEF - Fraser - Light Heritage Corruption WB - Ease of Index Institutions Regulation Foundation - Perceptions Doing Business Index of Index Economic Freedom Total Number of Countries Turkey`s Rank Source: World Bank, World Economic Forum (WEF), Fraser Institute, Heritage Foundation, Transparency International Note: Prepared with latest available data The road to high income: es and agriculture and, thus, bring further produc- tivity gains. Turkey’s banks have learned to manage Integration, Inclusion, risks prudently and to attract funding from deposi- Institutions tors and international capital markets. Their suc- cess could be emulated by non-bank financial insti- Because of its young population, improving educa- tutions to provide risk capital for Turkey’s domestic tion attainment and remaining substantial invest- enterprises and develop new financial instruments ment opportunities, Turkey is likely to graduate to for the country’s infrastructure development high income status over the coming decade. With needs. Turkey’s cities have been the motor of eco- average growth rates of 3-4 percent, and assuming nomic growth, regional convergence and improved modest real exchange rate appreciation of 2 per- access to services for many people. They now need cent per annum, Turkey would cross the US$12,746 to transform themselves into centers for innovation threshold by 2017. The speed of convergence with and knowledge transfer, and find ways to combine the standards of living of the advanced economies economic efficiency with environmental and social will depend on the policies chosen (Box 1). concerns to become sustainable cities. Turkey’s Turkey’s 10th National Development Plan targets labor markets have excelled at creating jobs over an average growth rate of 5.5 percent per annum the past five years and brought rising prosperity to between 2013 and 2018. It lays out a vision of eco- a growing middle class. They need to continue to nomic development based on innovation, improve- do so to ensure Turkey reaps its full demographic ments in the country’s human capital base, and en- dividend. Fiscal consolidation has created space vironmentally and socially sustainable livelihoods. for increased spending on social services bringing To make this vision a reality, Turkey will need to ad- improved access even to Turkey’s most remote re- dress three key challenges: (i) sustain productivity gions. Now, the managers of Turkey’s public servic- growth but shift its source from structural change es need to shift their focus to increase quality and to innovation; (ii) boost participation to reap the improve efficiency while preparing for the coming full gains from the demographic dividend; and, (iii) age of demographic maturity. deepen institutional reform to encourage invest- ment and consolidate the gains in social inclusion. Nonetheless, Turkey’s past achievements will not suffice to propel the country to the ranks of the Turkey can build on its many achievements in meet- advanced high income economies. The process of ing these challenges (Table 2). Turkey’s experience reforming Turkey’s institutions needs a new boost. since the 1980s has shown the benefits of open Turkey’s entrepreneurs and foreign investors know markets and economic integration, in particular that to succeed in business, know-who still domi- with the EU. This could be widened to cover servic- nates know-how, relational contracting beats en- 20 Overview Box 1: Turkey’s Prospects A simple simulation helps to illustrate the importance of policies. Today, Turkey’s per capita income is around 50 per- cent of the EU average. If EU per capita income continues to grow at the recent average of 1.9 percent (1995-2012), Turkey could reach between 63 and 89 percent of the EU average by 2030. The difference is accounted for by chang- ing assumptions regarding investment rates, labor force participation rates and increases in educational attainment of the workforce. The biggest impact results from allowing Total Factor Productivity (TFP) to grow at twice the rate of Turkey’s own historical average of 0.8 percent per year. Policies that increase savings and investment rates, boost participation, expand educational attainment and promote innovation and higher rates of TFP growth will determine how quickly Turkey convergences to the standards of living of the advanced economies. Table 1: Policy Simulations Share of EU Real GDP Human Physical  (percent) TFP per capita Growth (Y) Capital (H) Capital (K) GDP Baseline (2014-2030) 4.2 1.8 1.5 0.8 63.5 (I) Savings rate increases to 19 percent of GDP by 2018 while investment reaches 4.5 1.8 1.9 0.8 66.9 24 percent (Ministry of Development) (2014-2030) (II) Female labor force participation increases to 53.1 by 2030 (OECD av.) 4.8 2.3 1.7 0.8 70.3 (2014-2030) (III) Average years of schooling is projected to reach 10.57 by 2030 (Korean case) 4.6 2.1 1.6 0.8 67.9 (2014-2030) Combined II+III (2014-2030) 5.2 2.6 1.8 0.8 75.2 Combined I+II+III (2014-2030) 5.5 2.6 2.1 0.8 79.1 Combined I+II+III+Double TFP Growth 6.3 2.6 2.1 1.6 89.7 (2014-2030) Baseline (2031-2050) 3.3 1.2 1.3 0.8 75.2 Source: WB staff calculations, WDI Population Database forcement through the courts, and access to land field in the economy, society and politics is needed zoning rights and lucratice public tenders offers to secure the gains of the past three decades and higher returns than innovation in new business pro- to sustain Turkey’s advance into the ranks of the cesses. While the fundamental governance reforms high income countries. The EU Accession negotia- introduced in the late 1990s and early 2000s have tions continue to represent a useful roadmap for formally insulated many economic institutions from the required reforms; but with Europe’s strength political pressures, de facto their independence as an anchor weakened, ultimately the commit- remains contested. Control over government still ment to competitive economic and political insti- conveys control over large parts of the state, with tutions needs to come from within Turkey. It will accountability mechanisms limited, particularly at not be credible or sustainable without a return to the local level. As a result, while unprecedented more consensual policy making. Such a consensus economic and political opportunities have opened arguably characterized the periods of the country’s up for Turkey’s lower and middle classes, many most rapid economic advance under socially con- feel that these gains are contingent on the current servative but economically liberal governments government remaining in power and not rooted in in the 1980s and 2000s. Turkey’s many admirers the guarantee of fundamental individual rights. At among other emerging markets are well aware of the same time, Turkey’s established elites feel their this, and are eager to study the country’s achieve- rights are being curtailed, and their voices ignored. ments. This report was inspired by their interest. Indeed, while economic growth has been socially in- May it also inspire a renewed consensus around clusive, Turkey’s society remains divided. Renewed what has worked and what has not within Turkey, commitment to greater government accountability so that the country continues to offer valuable les- and to creating and safeguarding a level playing sons as it transits from middle to high income. 21 Turkey’s Transitions: Integration, Inclusion, Institutions Table 2: Turkey’s Transitions: Achievements, Lessons and Challenges Lessons Learnt from Turkey’s Challenges to reaching Turkey’s achievements development experience high-income status INTEGRATION Turkey‘s integration into the European The liberalization of economic activity in Further increases in Turkey’s per capita and global economy has brought the the 1980s has created a powerful con- income will need to rely on investment in country to the threshold to high income. stituency for market-based solutions, and support of an expansion of Turkey’s asset unleashed Turkey’s entrepreneurial spirit. base. This will require further improve- The positive attitude towards the private ments in the investment climate and the sector is a distinguishing characteristic of rule of law, as well as continued invest- Turkey’s development reminiscent of the ments to upgrade Turkey’s skill base. It transition process in Central and Eastern will also require steps to boost domestic Europe. savings and manage the volatility associ- ated with dependence on foreign financ- ing. Trade: Turkey’s openness (the ratio of The initial liberalization efforts of the While Turkey has dramatically increased trade in goods and services to GDP) has early 1980s and their culmination in the its medium-technology exports, it has risen from 11 percent in 1970 to 58 per- 1995 Customs Union agreement with stagnated in high-tech exports. Higher cent in 2012. Over the past decade, ex- the EU have laid the basis for Turkey’s value added exports will require technol- ports of goods and services in US$ terms integration into the world economy. The ogy upgrading, innovation, and experi- grew by 15 percent annually. Medium- process of integration with the EU has mentation by large and medium-sized technology exports have increased as increased Turkey’s participation in global firms. Attracting more FDI would help Turkey has become more integrated in value chains and has resulted in higher move up the value chain which would European production chains. Diversifi- technology content and sophistication of also allow Turkey to more successfully cation of exports has allowed Turkey to exports. Investments in logistics and dip- compete in high growth markets in Asia. mitigate the slump in EU demand. lomatic outreach have supported the di- versification of Turkey’s trading partners. Finance: Turkey’s banking system is re- Governance reforms rooted in greater Turkey’s capital markets remain thin silient and was the only one in the OECD transparency and accountability, coupled compared to other countries at the same that withstood the headwinds of the with strong regulatory and legal steps level of development and further deep- global economic and financial crisis with- to limit moral hazard, have enabled the ening of financial markets would support out an injection of public funds. It boasts turn-around of Turkey’s banking sector. Turkey’s transition to high income. By strong capital buffers and the sector’s However, despite an unorthodox policy contributing to raise domestic savings, loan to deposit ratio, while increasing, is framework and the use of a large arsenal this would also make Turkey more resil- only around 110 percent. of macro-prudential tools, Turkey has had ient in the face of its dependence on ex- limited success to insulate itself against ternal flows. volatile international capital markets. Enterprise: Productivity growth has been Improvements in the business environ- For Turkey to move to high income, pro- strong, driven by a re-allocation of the la- ment, policies to support urbanization, ductivity gains will need to come increas- bor force out of agriculture and into ser- and the flexibility of labor markets due ingly from within each sector and within vices and manufacturing. Patterns of pro- to the informal sector have facilitated the firm. Regulatory red tape, legal ductivity growth are supporting regional structural change to date. Regional con- uncertainty, and segmented labor mar- convergence within Turkey, although pro- vergence can be linked to fiscal policy, kets may become greater constraints on ductivity levels in the Western part of the including per capita public expenditures productive labor reallocation within sec- country remain the highest. on transport and communications, as tors going forward. Despite rising R&D well as per capita expenditures on social spending, Turkey needs to strengthen the infrastructure. links between research and business ap- plications, improve patent and Intellec- tual property rights (IPR) protection, and boost the quality of its universities. Infrastructure: Turkey has improved the More than half of Turkey’s infrastructure Despite an ambitious PPP pipeline, deal quality of its infrastructure in transport, investments in transport, energy and closures have been slow, and financing telecoms and energy and ranks in the telecoms have come from the private needs exceed domestic capacity. Turkey top 30 worldwide for its logistics perfor- sector. Sector unbundling, privatization should use PPPs to attract greater long- mance. of assets and strong independent regu- term foreign financing given domestic lation have led to significant efficiency constraints. This will require improve- improvements and better, cost-effective ments in the regulatory framework, and services for Turkey’s citizens and busi- also in project selection and appraisal nesses. and risk and contract management prac- tices. 22 Overview Lessons Learnt from Turkey’s Challenges to reaching Turkey’s achievements development experience high-income status INCLUSION Turkey’s development model in the 2000s Turkey’s poverty reduction and social Sustaining improvements in social in- has become socially inclusive, as reflected inclusion story have primarily resulted clusion will require continued rapid job in a sharp decline in poverty, significant from sustained economic growth and job creation (including for women), further improvements in the welfare of the bot- creation. Turkey’s sustained fiscal con- reduction of the gap in access to and tom of the income distribution, and large solidation after 2001 has opened space quality of basic services, and a widening reductions in the inequality of access to for spending increases in health, educa- of targeted policies to assist the most vul- basic social services. tion and municipal services which have nerable. Over the medium-term, Turkey supported improved access and greater should prepare for an aging society even economic opportunities for rural-urban if the demographic window will remain migrants. open for some time. Urbanization: Turkey is one of the world’s Rural-urban migration was not restricted In fast growing secondary cities, lack of fastest urbanizers and has created a sys- but facilitated by public policy, with great planning capacity risks growing urban tem of cities that is economically efficient, economic benefits. City planning was sprawl. Turkey’s advanced cities are ef- whilst widening access to municipal ser- consolidated at the municipal level early ficient but could become more livable if vices to the whole population. on in the 1980s. Turkey’s privately-pro- second generation issues of public trans- vided social housing model avoided the port, green and recreational areas, and creation of urban slums. greater public consultation in city plan- ning are addressed. Labor markets: Employment growth since In addition to the strong cyclical upswing, Sustaining job creation at least at histori- the 1980s has roughly kept pace with in- reductions in the tax wedge on labor and cal rates is critical to ensure that Turkey creases in the labor force. Most of the new an expansion of active labor market pro- fully utilizes its demographic window jobs created have been of higher produc- grams contributed to Turkey’s labor mar- of opportunity. With growth likely to tivity, boosting overall growth and social ket performance post-2008. Structural moderate in the medium term, this may progress. The pace of job creation has change, improvements in education, and require targeted measures to boost em- accelerated after 2008, when Turkey cre- the pace of urbanization have ensured ployment, particularly among women, ated more than 4 million new jobs, many that the majority of new jobs created whose labor force participation remains of which at higher skill levels. have been productive ones. far below the other higher middle in- come countries. Creating high produc- tivity jobs going forward also requires steps to reduce the segmentation of labor markets between the formal and informal sectors, whilst increasing over- all labor market flexibility. Welfare: Health and education outcomes Rising spending as well as sector specific Turkey will not enjoy the fiscal divi- have improved significantly addressing eq- reforms have boosted social outcomes. dend of debt consolidation forever and uity as well as access, benefitting also the Extension of the mandatory school age needs to prioritize spending. In looking less well-off. and changes in the curriculum in the late for spending efficiencies, Turkey should 1990s and early 2000s has helped Tur- revisit its social security model, which key catch up on education. In the health is generous particularly thanks to a low sector, a large scale reform effort has age of retirement. Sustaining progress created performance linked incentives, in education will require more spend- supported a shift towards prevention and ing, and also reforms to boost quality in primary care, and vastly improved access the classroom and at the school level. In for the poorer parts of the population. health care, dealing with rising entitle- ments and technology driven cost in- creases present challenges for efficiency. Public finance: Comprehensive structural Conservative budget policies and com- Continued fiscal prudence would sup- reforms in the public sector have support- mitments to primary surpluses were port Turkey’s transition to high-income. ed a sharp and continuing decline in Tur- combined with a wholesale reform of Reforms on both the revenue and expen- key’s public debt to GDP ratio and created public financial management to escape diture side of the budget remain incom- fiscal space for improved public services. from the fiscal politics of patronage and plete, with a highly cyclical revenue base, create a rule-based system for spending growing social entitlements, and pockets allocations, as well as expanding the rev- of spending (particularly in infrastruc- enue base. ture) outside the scope of rule based fiscal governance representing the main challenges. INSTITUTIONS Turkey has recorded significant improve- The pace of institutional reforms has Turkey has yet to establish the institu- ments in institutional performance and slowed since 2007, with only marginal tional foundations for the transition to public sector governance, particularly af- improvements in overall governance, and high income. Improvements across the ter the 2001 crisis and anchored by the EU some concerns over reversals in selected board are needed, including in the busi- Accession negotiations process. areas such as voice and accountability or ness climate, the rule of law, regulatory independent regulators in finance and in- policies, the guarantee of civil and po- frastructure. litical rights, public sector accountability, and decentralized decision making. 23 Turkey’s Transitions: Integration, Inclusion, Institutions References Acemoğlu, D., & Robinson, J. (2012). Why Nations Gill, I., & Raiser, M. (2012). Golden Growth. Restor- Fail. The Origins of Power, Prosperity and Poverty. ing the Luster of the European Economic Model. New York: Crown Business. Washington, D.C.: The World Bank. Acemoğlu, D., Naidu, S., & Restrepo, J. R. (2014, North, D. (1990). Institutions, Institutional Change March). Democracy Does Cause Growth. NBER and Economic Performance. New York: Cambridge Working Paper, 20004. University Press. Aiyar, S., Duval, R., Puy, D., Wu, Y., & Zhang, L. North, D., Wallis, J., & Weingast, B. (2009). Violence (2013, March). Growth Slowdowns and the Middle and Social Orders. New York: Cambridge University Income Trap. IMF Working Paper, 13/71. Press. Atiyas, I., & Bakış, O. (2013a). Structural Change Rodrik, D., & McMillan, M. (2011, June). Globaliza- and Industrial Policy in Turkey. REF Working Paper, tion, Structural Change and Productivity Growth. 2013-3. NBER Working Paper, 17143. Atun, R.; Aydin, S.; Chakraborty, S.; Sumer, S.; Aran, The World Bank. (2014). Evaluation of the EU-Tur- M.; Gurol, I.; Nazlioglu, S.; Ozgulcu, S.; Aydogan, U.; key Customs Union. Ayar, B.; Dilmen, U.; Akdag, R. (2013, June). Uni- versal health coverage in Turkey: enhancement of The World Bank. (2010). Turkey Country Economic equity. The Lancet. Retrieved from http://dx.doi. Memorandum: Informality: Causes, Consequences, org/10.1016/S0140-6736(13)61051-X Policies. Report No. 48523-TR. Washington. D.C.: World Bank. Azevedo, J., & Atamanov, A. (2014). Pathways to the Middle Class. Washington, D.C.: The World Bank. Berg, A., Ostry, J., & Zettelmeyer, J. (2006). What Makes Growth Sustained? IMF Working Paper, March 2008, 8/59. Bulman, D., Eden, M., & Nguyen, H. (2012). Tran- sitioning from Low-Income Growth to High-Income Growth: Is there a Middle Income Trap? Mimeo- graphed. The World Bank. Eichengreen, B., Park, D., & Shin, K. (2011). When Fast Growing Economies Slow Down: International Evidence and Implications for China. Working Pa- per, 16919. Eichgreen, B., Park, D., & Shin, K. (2013, January). Growth Slowdowns Redux: New Evidence on the Middle-Income Trap. Working Paper, 18673. European Bank for Reconstruction and Develop- ment (EBRD). (2013). Stuck in Transition. Transition Report. London: European Bank for Reconstruction and Development. Felipe, J., Abdon, A., & Kumar, U. (2012). Tracking the Middle-income Trap: What Is It, Who Is in It, and Why? 715. Levy Institute of Economics. Bard College. Ferguson, N. (2011). Civilization. The West and the Rest. London: Allen Lane. Gill, I., & Kharas, H. (2007). An East Asian Renais- sance. Washington, D.C.: The World Bank. 24 1 Chapter 1: Turkey’s Rise Chapter Turkey’s Rise Finance Fiscal Space Infrastructure Trade Welfare Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 25 Turkey’s Transitions 26 Chapter 1: Turkey’s Rise Turkey’s Rise cording to Danny Quah, Professor of Economics at the London School of Economics, the center of “If the world was a single state, Istanbul would be economic gravity in the world economy has shifted its capital”, Napoleon Bonaparte is alleged to have from a point somewhere in the Atlantic in 1980 to said. Turkey’s largest city is also the largest city in a location not far from Turkey in the Southeastern Europe and vies to become a regional and perhaps corner of the Mediterranean Sea in 2008 (Figure even global center for commerce and finance. Is- 1.1). Of course the rise of giants such as China and tanbul’s geographic location is its biggest asset. It India and the dramatic transformation in much of is the only city stretching across two continents. East Asia over this period are behind this shift (Gill Over fifty countries in three continents are within a and Kharas, 2007). However, Turkey is also a part of four hour plane journey from Istanbul and Turkish it. Its share in global Gross Domestic Product (GDP) Airlines, Turkey’s rapidly expanding flagship carrier, has almost doubled from 0.6 percent in the early proudly states that it flies to more countries in the 1980s to 1.1 percent today. In less than a decade, Turkey is expected to have the largest population world than any other airline. Both the New York in Europe, overtaking Germany and, with contin- and Tokyo stock exchanges are open during the Is- ued convergence in productivity levels, is forecast tanbul bourse’s trading hours. The Bosphorus since by the Organisation for Economic Co-operation and times immemorial has been a strategic prize, whose Development (OECD) to have the world’s 12th larg- control made empires. Its shores with breathtaking est economy by 2060 up from 17th place in 2013. views and a mild climate today attract jet-setters from around the world, who have pushed residen- Turkey’s rise mirrors the pattern observed across tial property prices to dazzling height. the developing world over the past thirty years. Af- Figure 1.1: The center of gravity of the world economy is shifting east The global center of economic gravity has shifted east over the past 30 years (black dots), and could well shift even farther east over the next 30 years (red dots). Source: Quah (2011) Istanbul’s growing importance is perhaps the most ter World War II, many emerging markets, includ- prominent sign of Turkey’s economic re-emergence. ing Turkey, began to catch-up with the advanced Since the 1980s, emerging market economies like economies of Europe and North America after sev- Turkey have become more and more integrated eral hundred years of relative decline (Figure 1.2).1 into the global division of labor and increased their Initially, economic catch-up was based on import share of world trade and production, a pattern that substitution strategies but in the past thirty years, accelerated considerably over the past decade. Ac- the motor of emerging market growth has been 1 Turkey’s per capita income was 60 percent of England in 1500, but declined to just 15 percent (of the United Kingdom) in 1923 the year the Republic was founded. Today, Turkey’s per capita income stands at 22 percent of the EU15 average and 27 percent of the UK. 27 Turkey’s Transitions Figure 1.2: Turkey’s income lagged Europe since the 1600s but catch up started in the 1950s 25,000 22,500 20,000 In 1990 Interna tional Geary Khamis US$ 17,500 15,000 12,500 10,000 7,500 5,000 2,500 0 1500 1700 1820 1870 1913 1923 1930 1950 1960 1970 1980 1990 2000 2010 France England/GB/UK Spain Japan Iran Ottoman Empire/Turkey Holland/Netherlands Germany (Centre-North) Italy Polynomial trend (England/GB/UK) Polynomial trend (Ottoman Empire/Turkey) Source: Maddison Project Database, Bolt, J. and J. L. van Zanden (2013) international integration. Turkey, China and Latin opening chapter, we set the stage for an account America opened-up their economies around the of Turkey’s economic and social progress in recent same time in the early 1980s. India and Eastern Eu- times. The chapter addresses three questions be- rope followed a decade later. As Peter Blair Henry fore introducing the argument and structure of the (2012) argues, emerging markets “turned around” remaining report: in the past three decades and adopted market based policies and macroeconomic discipline at the • First, where does Turkey stand today in rela- same time as some advanced economies seemed tion to other emerging market peers? The short to neglect their importance. answer is that Turkey is closer than many of its peers to reaching the threshold of high in- Only a few countries have successfully made the come; but, in most structural respects remains transition to high income and, in the coming de- clearly a middle income country. Favorable de- cade, the pace of convergence of emerging markets mographics, relatively strong infrastructure and as a whole is projected to slow. Turkey is not im- logistics, an entrepreneurial private sector and mune to this trend. Large external financing needs a market-driven track record of rapid structural make Turkey vulnerable in times of volatile and change add to Turkey’s strengths. At the same more expensive capital flows. Political uncertainty time, a number of challenges still need to be ad- and weaknesses in the rule of law have affected dressed, such as the low depth of financial mar- investor confidence and highlighted that Turkey’s kets, the low average years of schooling of the transition to a high income economy and a mod- population (albeit increasing rapidly), the low ern society remains incomplete. In fact, it may be participation of women in the labor force and, more appropriate to speak of multiple transitions in perhaps, most importantly the need to com- Turkey, each at various stages of advancement and plete its institutional reforms to reach the stan- offering important lessons to policy makers else- dards of high income economies. Given its asset where. Turkey’s achievements have been a source base, Turkey’s level of per capita income is al- of inspiration for other developing countries and a ready relatively high. Increasing income further source of rising aspirations for many Turkish citi- requires investment and deepened reforms. zens. However, without addressing the remaining challenges, these aspirations may be disappointed. • Second, how did Turkey get to where it is today? This is, of course, a main focus of the report. This study addresses policy makers in other emerg- The answer given in this introductory chap- ing markets looking for lessons of experience in ter traces Turkey’s progress back to the trade how to advance towards high middle income. It and currency liberalization measures taken at also addresses policy makers in Turkey, who wish the beginning of the 1980s. These reforms un- to consolidate past achievements and forge ahead leashed Turkey’s entrepreneurial initiative and with economic and social modernization. In this established the private sector as the engine 28 Chapter 1: Turkey’s Rise of the country’s economic progress. They also Compared to its peers, Turkey’s growth perfor- catalyzed a process of structural change with mance is respectable albeit not spectacular. Be- Turkey’s rural population moving to the cities tween 1950 and 2011, Turkey increased its per to take more productive industrial and service capita income by slightly over five times and pro- sector jobs. Turkey’s initial liberalization efforts gressed at a similar rate as Bulgaria, Cyprus, Fin- failed to be supported with improvements in fis- land, Italy, Albania, Tunisia, and India. It grew faster cal and public sector management and, hence, than much of Western Europe, faster than Poland, ensued in rising corruption and a series of mac- Hungary and the Czech Republic, all of Middle East roeconomic and political crises. After 2001, this and North Africa (MENA) except Oman, Israel and shortcoming was rectified and improvements Tunisia, most of Latin America (except Chile), and in fiscal management and public sector gover- much of East Asia, with the notable exceptions of nance created fiscal space that allowed a sub- Republic of Korea, China, Malaysia and Indonesia. stantial expansion of government spending on One reason Turkey does well relative to many of its public services including in less advanced re- peers is that, despite a volatile growth pattern year gions. As a result, this report argues, Turkey’s on year, Turkey has not endured a prolonged crisis growth over the past decade has been inclusive. such as the ones in Latin America in the 1980s or • Third, does Turkey have the institutional re- Eastern Europe in the 1990s. Turkey may not be a quirements to sustain the transition to high world champion in growth (that place belongs to income? The short answer is that Turkey’s Republic of Korea), but it plays in the first division. achievements may be at risk without further steps to strengthen public and private sector Being part of Europe economically has helped Tur- governance and deepen institutional reforms. key’s advance. Europe has accounted for half of the Moreover, it appears that Turkey’s reform drive world’s successful transitions from middle to high has slowed over the past five years. Turkey has income since the 1960s (Gill and Raiser, 2012). This been riding the post-crisis wave of abundant is far from trivial: much is made of the difficulties global liquidity, leaving the country vulnerable of middle income countries to reach high income, to reversals in investor sentiment. These issues as growth rates tend to slow down after the ini- are taken up again in the closing chapter of this tial momentum of catch-up growth is exhausted book – how Turkey deals with them will be a key (Gill and Kharas, 2007; Eichengreen, Park and Shin, determinant of whether the achievements it 2012; 2013). Close trade and financial links account has made can be sustained. for the unprecedented convergence of income in Europe. With the conclusion of the Customs Union Turkey compared to its peers: agreement with the European Union (EU) in 1995, Turkey has deepened its trade and financial links quite rich but structurally middle with Europe and has become part of the “Conver- income gence Machine” (Chapter 2). As Europe recovers from the deep economic crisis of the last five years, Turkey is an upper middle income country: its Turkey is well advised to persist with the path of Eu- 2013 per capita income of around US$10,700 puts ropean integration as a well-honed path to escape it at some 85 percent of the high income thresh- the “middle income trap”. old in the World Bank’s classification of countries (around US$12,600 per capita). Turkey has steadily Before providing a brief historical account of the converged towards the income levels of advanced key economic policy changes that brought Turkey economies since the 1950s. In nominal terms, prog- to its current position, this section compares the ress during the period 2001-2008 was particularly main structural features of Turkey’s economy with impressive as per capita income increased three- that of other middle income countries. From the fold from a trough of US$3,058 in 2001. A large part large number of possible peers, five groups are se- of this is accounted for by an appreciating real ex- lected for this comparison. change rate. Since the global economic and finan- cial crisis of 2008-2009, the real exchange rate (as • The first group contains the new member states well as GDP growth rates) has been quite volatile of the EU and the second the EU Accession can- and US$ income have hardly changed as a result. didates.2 Both groups are of interest because, Measured in constant prices, Turkey’s growth per- like Turkey, they benefit from the momentum formance in the 2000s was better than in the 1990s of European integration, an asset other middle but somewhat worse than the record in the 1950s- income countries do not share to the same ex- 1980s (Spotlight 1). tent. 2 The chapter focuses on the larger of the EU member states and accession countries, excluding the Baltics, Slovenia, Bosnia-Herzegovina, FYR Macedonia, and Montenegro. Croatia is included in the group of EU accession candidates because our comparative data stops in 2012. 29 Turkey’s Transitions • The third group contains those countries in the peers builds on a stylized model of a modern mar- Middle East and North Africa (MENA) that do ket economy. Drawing on the large literature of the not have large oil and gas reserves.3 This group main correlates of successful economic growth and is of interest because they share a common his- development (see Growth Commission, 2008) the tory with Turkey, and many look to Turkey for framework looks at the way the basic activities in inspiration. any market economy are organized and distinguish- es the following main components: • The fourth group of countries contains the “BRICS” (Brazil, Russian Federation, India, China • Trade: The organization of trade is a key de- and South Africa). terminant of a country’s welfare (Frankel and Romer, 1999). Greater openness to internation- • The fifth group is a set of “growth markets” al trade and greater success in penetrating glob- among the middle income countries.4 These al markets characterize successful advanced, as peers are selected because by size, expected well as emerging, market economies. growth rates and levels of income they are – as is Turkey – likely to count among the heavyweight • Finance: The depth of financial markets is close- emerging markets in the coming decades. ly associated with the level of development in a country (Beck, Levine and Loayza, 2000; Figure 1.3 ranks these countries by their current Levine, 2004; Levine, Loayza and Beck, 2000; GDP per capita using purchasing power parity (PPP) Aghion, Howitt and Mayer-Foulkes, 2005). Well- adjusted exchange rates: Turkey ranks closer to the functioning financial markets contribute to eco- top – it is among those countries in the sample that nomic development by attracting national and are on the threshold (or beyond) to high income.5 international savings and allocating them to the most efficient uses. Financial market distortions The basic framework chosen to compare the struc- are also often at the heart of macroeconomic tural features of Turkey’s economy with that of its instability. Figure 1.3: Turkey’s income per capita compared to its peers GDP per capita 2012, in PPP (constant 2011 international US$) 30,000 25,000 Constant 2011 Interna tional $ 20,000 15,000 10,000 5,000 0 Russian Fed. Korea, Rep. Brazil Mexico Malaysia Hungary Bulgaria Czech Republic Philippines Egypt Slovakia Tunisia South Africa Turkey Croati a China Albania Indonesia Jordan India Morocco Romania Poland Serbia Source: World Development Indicators (WDI) Note: Color codes distinguish the various peer groups: blue for new EU member states, dark blue for Accession candidates, light blue for BRICs, brown for the Growth Markets, and lilac for MENA 3 This group includes Morocco, Tunisia, Egypt, Jordan, and Syrian Arab Republic. 4 The fifth group includes Republic of Korea, Mexico, Indonesia, Malaysia, and the Philippines. The label “growth markets” like the BRICS was coined by Goldman Sachs. Their sample of growth markets also includes Bangladesh, Pakistan, Viet Nam, Nigeria and Egypt. The latter is grouped with the MENA countries in this study, while the other four have presently much lower income levels than Turkey and are, thus, less useful for comparative purposes. 5 The World Bank typically defines the high income threshold in current US$. The ranking in Figure would hardly change if, instead of constant 2011 international US$, 2012 current exchange rates were used. Brazil would be richer, Malaysia poorer than Turkey. Recently most emerging markets, including Turkey, have seen their exchange rates depreciate but the relative ranking is unlikely to change much. 30 Chapter 1: Turkey’s Rise • Enterprise: Private entrepreneurs are the driv- what follows, we pick one or two summary indi- ers of economic progress in a market economy. cators that represent a country’s achievements in The quality of a country’s business environment each of the six components identified above and and the nature of economic competition deter- compare Turkey with its main peer groups. We mines the incentives for entrepreneurs to allo- then relate these achievements to differences in cate their talent to welfare enhancing ventures per capita income. The basic finding is that Turkey (or, alternatively, to rent-seeking) and thus is a ranks higher in terms of per capital income than in key component of a well-functioning economy terms of almost any structural feature of its econ- (Barseghyan, 2008; Dall’Olio, et al. 2013; Klap- omy. In other words, Turkey seems to be relatively per and Love, 2011). rich given its asset base. • Cities: Cities are increasingly recognized as key Figure 1.4 a-e provides a “best in class” analysis us- engines of economic growth (Glaeser, 2013; ing summary indicators, one for each of five of the Annez and Buckley, 2009). The clustering of en- main activities analyzed in this book and two for terprises around urban agglomerations allows welfare. Trade is captured by the ratio of exports them to benefit from the flow of knowledge and and imports to GDP, finance by the ratio of private ideas and from the economies of scale resulting sector credit to GDP, and enterprises by the aver- from proximity to a concentrated market. The age Doing Business score. The rate of urbanization organization of public services in cities is equally stands for the role of cities in the economy, labor critical for social welfare and for ensuring the force participation summarizes the organization of best and brightest are attracted and retained to labor markets and the average years of schooling contribute to a city’s economic success. and the rate of infant mortality are used as sum- mary indicators of welfare.6 In each of the five peer • Labor: Ultimately the story of economic growth group comparisons, the country with the highest in the modern era is a story of increases in labor score in a particular indicator is assigned a value of productivity. The labor market is the primary 1, and the scores of all other countries are normal- means by which the fruits of economic advance- ized relative to this “best in class” level. ment are shared. A well-functioning labor mar- ket not only ensures that talents and skills are Turkey is relatively less open than the EU members matched with the demands from enterprises, and accession candidates, in part because it is a but also that no-one is excluded from participat- much larger country. Its banking sector is smaller ing in economic activities (World Bank, 2013). in relation to its GDP and it lags Europe’s front- runners in the quality of business regulation. Tur- • Welfare: Governments play an important role key’s urbanization rate is among the highest in this in modern market economies. They provide group. However, its labor force participation rate is key public services, such as health, education, the lowest as is the average years of schooling of its and physical infrastructure. They also offer so- working age population. Turkey’s infant mortality cial security arrangements to ensure people rate is higher than that of all countries in this group against the risks of disease, unemployment except Albania. and old age. Moreover, they offer transfers to prevent those with no assets or income of their Compared with MENA countries, Turkey is the rich- own from falling into poverty. The scope of gov- est and has the lowest infant mortality rate. Yet, ernment activity, as well as the efficiency with Turkey is less open than the MENA countries and which governments deliver the tasks given to its banking sector is smaller than those of Jordan, them, are thus critical components of any eco- Morocco and Tunisia, the richer among the MENA nomic model (Romer, 1989; Barro, 2001). peers. Turkey does, however, score much better in the quality of business regulation, in labor force This simple framework draws on the analysis in participation and average years of schooling, ced- a recent review of Europe’s economic and social ing “best of class” only to Tunisia in business regu- model (Gill and Raiser, 2012) with one important lations and to Jordan in education. Jordan is also exception: it emphasizes the importance of urban- slightly more urbanized than Turkey. ization in accounting for Turkey’s economic and social transformation. The framework can also be interpreted as a means to describe an economy’s physical, human and institutional asset base. In 6 It turns out that several of these indicators also feature prominently in the empirical literature on the “middle income trap”. It seems that to grow to high income, countries need to become structurally high income as well. This theme is taken up again in the closing chapter. 31 Turkey’s Transitions Figure 1.4: Benchmarking Turkey (a) Turkey and new EU member states (b) Turkey and the EU candidates G G I C I C B U B U S L S L O Romania Poland Hungary Bulgaria O Czech Republic Slovak Republic Turkey Albania Croatia Serbia Turkey (c) Turkey and MENA (d) Turkey and the BRICS G G I C I C B U B U S L S L O O Egypt, Arab Rep. Jordan Morocco Brazil Russian Federation India Syrian Arab Republic Tunisia Turkey China South Africa Turkey (e) Turkey and the Growth Markets G I C G GDP per Capita C Domestic credit to private sector U Urban population L Labor Force Participation Rate B U O Openness S Schooling B Ease of doing business index I Infant mortality rate S L O Korea, Rep. Mexico Indonesia Source: WB staff calculations and WDI Malaysia Philippines Turkey Note: Indicators are normalized between 1 and 0, where 1 represents the best in class and 0 represents the worst in class. Center of the diamond represents 0, whereas the outer edge of the diamond represents 1. Latest available data is used. 32 Chapter 1: Turkey’s Rise The comparison with other middle income coun- drawing comparisons with other countries. None- tries shows much greater variation – not surprising, theless, the initial peer group analysis suggests that given the large geographical spread of this group. Turkey is relatively rich given the quality of its other Turkey’s openness is not much different from levels endowments. When we relate each of the above in the BRICS and large countries such as Indone- indicators to income per capita in a world sample, sia and Mexico, but much lower than in the other Turkey lies below the trend line for domestic credit, growth markets. Its financial depth is much lower for the quality of the business climate, for average than in China, South Africa, Republic of Korea and years of schooling, and for its labor force partici- Malaysia but comparable to Brazil, Mexico, India, pation rate. Turkey’s infant mortality rate and its Philippines and Indonesia. Turkey does relatively urbanization rate are in line with its per capita in- well among this group in the quality of business come. None of the benchmark indicators are above regulations – only Republic of Korea, Malaysia and levels predicted by Turkey’s GDP per capita.7 Mexico do better. Turkey shares a high degree of urbanization with Brazil, Mexico, Russian Federa- At the risk of simplification, Turkey may be said to tion, Republic of Korea, and Malaysia, but has low- use its existing assets in a rather efficient way. This er rates of labor force participation than any of the is further confirmed by calculating Turkey’s Total countries in this group. Only India and Indonesia Factor Productivity (TFP) level relative to that of the have lower average years of schooling, but Turkey USA, following a methodology introduced by Hall has lower infant mortality than most countries in and Jones (1998) and Caselli (2005). TFP is calcu- this group except Republic of Korea, Malaysia, and lated as the residual variation in income per worker Russian Federation. not explained by variations in physical capital and human capital assets. Turkey’s TFP level is close to Of course, this analysis is highly selective in the indi- that of the USA and much above levels of other cators used. Subsequent chapters of this book will middle income countries (Figure 1.5).8 While such go into much greater depth in analyzing Turkey’s comparisons should be taken with a large grain of achievements in each of the six dimensions and salt given the strong assumptions needed to derive Figure 1.5: The fruits of market-led structural change - a high level of TFP 120,000 100,000 USA GDP Per Worker, in PPP, 2011 80,000 R² = 0,7811 60,000 40,000 TUR BRA 20,000 0 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 TFP level at current PPPs (USA=1), 2011 Source: WB staff calculations, following Caselli (2005) and using data from Penn World Table Version 8 7 If we compare Turkey’s rank in the World Economic Forum’s Global Competitiveness Index as a summary measure of Turkey’s overall physical, human and institutional assets against its per capita income, its 2013 rank at 44th place in the world is just marginally better than what would be predicted given its per capita income but the deviation is not statistically significant. 8 Saliola and Şeker (2011) use enterprise survey data collected by the World Bank to conduct a similar exercise at the sectoral level. Turkey once again comes out among the countries with the highest aggregate TFP levels among emerging markets, albeit with very significant variation across firms. A few large, highly productive firms apparently co-exist with a large population of much less productive small and medium enterprises (see Chapter 4 for a related analysis and dynamics across firms over time). A related concept is the World Bank’s calculation of a county’s total wealth as the discounted value of sustainable future consumption. Once again, after subtracting the contribution of produced capital (physical stock plus urban land) and natural capital (rental income from existing natural resources), Turkey’s remaining intangible wealth turns out to be among the highest of its emerging market peers. Turkey is relatively rich given its limited asset base (see World Bank (2006)). 33 Turkey’s Transitions comparable TFP levels, it, nonetheless, highlights es (Öniş and Webb, 1992; Canevi, 2014). Özal was that Turkey has made good use of those assets kept by the military as the head of the economic which it has. team until 1982, and following the parliamentary elections of 1983, returned to power as the Prime By implication, however, further increases in per Minister at the head of the Motherland Party capita income will need to rely on an expansion of (ANAP), which was to dominate Turkish politics un- Turkey’s asset base. In other words, to continue to til the late 1980s. grow, Turkey will need to invest in physical and hu- man capital and upgrade its institutions. The mac- The Özal government’s economic policy rested on roeconomic constraints on investment are the sub- three main pillars. First, to tackle the chronic foreign ject of Spotlight 1. The institutional asset base that exchange shortages of the 1970s, the government is central to encouraging investment and, hence, liberalized the foreign exchange market, abolished sustaining the transition to high income is analyzed many domestic price controls and kept real wages in Chapter 8. low to ensure export competitiveness. Foreign ex- change liberalization was accompanied by financial How did Turkey become a relatively efficient mar- sector liberalization, with caps on interest rates ket economy? The next two sections trace the story lifted in 1980, and after a banking crisis in 1982, back to the initial liberalization efforts of the early the basic pillars of a financial market infrastructure 1980s (and their culmination in the 1995 Customs were put in place (the Capital Markets Board in Union Agreement with the EU) and to the regula- 1982, a Savings Deposit Insurance Fund in 1983, a tory reforms in the wake of the 2001 financial crisis new Banking Law in 1985). Second, the government in Turkey. These reforms have unleashed an entre- switched from a policy of import substitution to a preneurial private sector, the key driver of Turkey’s policy of export promotion, and after 1984, increas- progress. ingly liberal trade policies. This was accompanied by a general policy of support to the private sector Unleashing the private sector: and some initial steps to privatize state companies, Özal’s legacy and the liberalization by selling revenue share certificates to the general population. Third, Özal introduced a series of insti- of the early 1980s tutional reforms, which centralized economic pol- In the 1950s and 1960s, Turkey industrialized rap- icy making around a group of like-minded market idly. However, following a foreign exchange crisis in oriented technocrats in the Central Bank as well as the late 1950s and a military coup in 1960, under the newly created Secretariat of Treasury under a the leadership of the military, the country, as many Minister of State for the Economy (Öniş and Webb, of its emerging market peers at that time, embarked 1992; Canevi, 2014). Figure 1.6 provides a timeline on an import substitution industrialization strategy of the key reforms in the liberalization of foreign (Mango, 2004). This strategy came under increasing exchange, trade and capital account transactions. strains in the 1970s. Turkey increased foreign bor- These policies produced impressive results – but rowing in response to the first oil shock of 1973, but also rising corruption. The export drive led to a was cut off from capital markets in 1977. A series of International Monetary Fund (IMF) supported ad- fourfold increase in exports during the decade justment programs followed, the implementation 1980-1990 from just US$3 billion to US$13 billion of which was, however, haphazard and hampered (Chapter 2). Import growth was slower and Turkey’s by increasing domestic instability, with rival gangs current account deficit after 1983 never exceeded of left and right wing youths fighting street battles. 3 percent of GDP, after it had averaged over five Again, the military intervened in September 1980, percent during the 1975-1980 period. Economic dissolved parliament and banned political parties, growth averaged over 7 percent during Özal’s first put their most prominent leaders in jail, and sus- four year term of 1983 to 1987. The stepwise lib- pended many civil and political rights. eralization of the foreign exchange market and the abolition of most import licenses and the reduc- Turgut Özal, an engineer by training and a former tion in import tariffs provided market signals and World Bank official, entered the political limelight a competitive domestic environment. Özal’s vision as the Deputy Prime Minister and head of the eco- was decidedly pro-business as he encouraged Turks nomic team under the government of Süleyman to benefit from the new opportunities his policies Demirel, who came to power in November 1979. provided. “Turning the corner” – meaning getting Özal and his team introduced a series of economic rich quickly - became the catch-phrase of the age adjustment measures in January 1980, most impor- (Mango, 2004). Indeed, today, Turks are far more tantly devaluing the exchange rate by 33 percent entrepreneurial than most other people in Europe and abolishing most multiple exchange rate practic- (Figure 1.7). However, the drawback of the unregu- 34 Chapter 1: Turkey’s Rise Figure 1.6: Trade and foreign exchange liberalization in the 1980s Fraser Institute Indicators of economic freedom (range: 0 min - 10 max) Freedom to own foreign 10 currency bank accounts 8 Freedom to trade internationally 6 Controls of the capital and people 4 Capital controls 2 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 1980 - Reduction of import quotas, and unification of exchange rates 1985 - Opening of individual forex deposits allowed 1984 - Current account convertability and further trade liberalization 1989 - Capital account convertability Source: WB staff calculations, based on Fraser Institute Indicators lated expansion of private sector activity was an ture to manufactured exports, people moved into increase in corruption and conflicts of interest as the cities to seek their luck in textiles, light indus- powerful bureaucrats used the new-found entre- try and construction, as well as in the burgeoning preneurial freedoms to enrich themselves or con- tourism sector. This structural change was sup- nected parties. ported by major infrastructure initiatives, such as the modernization of telecommunications and the The Özal period also saw a dramatic increase in electrification of much of the country (Spotlight 2). the pace of structural change. Between 1970 and The 1980s also saw major road investments linking 1980, the rural population declined only marginally Turkey’s more developed coastal areas with the still from 61 percent to 56 percent. In the following ten predominantly rural inland. In 1984, a law on mu- years, it fell sharply to just 40 percent (Chapter 5). nicipalities was adopted, laying the foundation for As government support shifted away from agricul- urban development planning (Chapter 5). Figure 1.7: Turks are more entrepreneurial than the average European Results from the 2010 Eurobarometer % of people who have a positive view of entrepreneurs 80% 60% % of people who have a % of people who were 40% positive view of top- taking active steps to start a 20% managers in large new business 0% production companies % of people who would % of people who have start a business if they experience of starting up a inherited a large sum of business money New EU Members Average Turkey EU27 Source: WB staff calculations, Eurobarometer - The Gallup Organization Note: The “New EU Members” refers to Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia 35 Turkey’s Transitions The 1980s, thus, mark the birth of the “Anatolian control over fiscal policy decisions. The EBFs in- Tigers”, the rapidly growing cities in Turkey’s Ana- creasingly resorted to borrowing to cover deficits, tolian heartland, home to a new generation of en- which accounted for 25 percent of total spending trepreneurs (Chapter 4). Private entrepreneurship between 1988 and 1991 (Spotlight 3). in the two decades between 1960 and 1980 had grown largely as a result of state patronage and the The result of growing public sector wage pressures, government maintained a leading role in the alloca- rising subsidies and increasing deficits of the EBFs tion of resources. After 1980 – while government was increased fiscal imbalances. Fiscal deficits were support in the form of targeted subsidies remained partially monetized and, as a result, inflation stayed important and benefited mainly the existing large stubbornly high throughout the decade at above family owned holdings – there was greater appre- 30 percent, peaking at 74 percent in 1988. The ex- ciation and room for growth of the SMEs indepen- change rate was allowed to depreciate in line with dent of state largesse (Yavuz, 2009; Adaman, Akar- inflation, which maintained external balance, at çay-Gürbüz, and Karaman, 2013). the cost of further entrenching inflationary expec- tations. Growing macroeconomic instability began The reforms did create losers among organized la- to erode ANAP’s popularity and, with Özal’s move bor and agriculture. Yet, the military regime sup- to the Presidency in 1989, the party increasingly pressed the opposition and, thus, the reforms ini- fragmented, eventually losing power in the 1993 tially faced little political resistance, even if Özal parliamentary elections, which brought back coali- distanced himself from the military after 1983 (Öniş tion politics. and Webb, 1992). After 1987, political competition increased significantly with the two dominant po- The following decade was punctuated by the eco- litical leaders of the 1970s, Süleyman Demirel and nomic crises of 1994 and 2001 and characterized Bülent Ecevit returning to the scene after the ban by relatively frequent changes in governments, par- on their political activities was lifted. The increase ticularly towards the end of the 1990s. During the in political competition brought back distributional 1980s, there had been a total of three Prime Min- politics and with it, macroeconomic instability re- isters under two different governments; the 1990s turned. The decline in real wages was reversed af- saw six Prime Ministers and six different coalition ter 1986 at the same time as agricultural subsidies governments. Intense electoral competition and went back up. The two main losers of the 1980s sta- the return of the 1970s system of political patron- bilization, labor and agriculture, could no longer be age undermined macroeconomic stability with in- contained as ANAP expanded fiscal spending in the flation remaining above 50 percent throughout the run-up to the 1987 elections. decade (Figure 1.8). While the government was no longer the leading economic actor – the Özal period Growing economic populism in the late 1980s had irreversibly brought the private sector to the was reflected in increasingly discretionary spend- fore – the state had not developed arm’s length re- ing policies. The clearest manifestation of this was lations with business. Discretionary favors, directed the proliferation of Extra Budgetary Funds (EBFs), credits through the increasingly bloated public sec- which rose from 33 in 1980 to 57 by 1983 and to tor banks, and rampant corruption characterized 105 by 1990. The EBFs were funded through special the governance model of the 1990s and, eventu- earmarked taxes such as on consumer goods im- ally, led to the economic and political collapse of ports (alcohol, cigarettes, luxury goods), and their 2001 (Atiyas, 1995). resources used to support specific objectives. The most important of these funds were the Public Par- ticipation Fund, the Mass Housing Fund (both sup- A regime shift: porting the government’s extensive social housing Turkey after the 2001 crisis program, discussed in greater detail in Chapter 5), the Support for Price Stabilization Fund (providing The 2001 Crisis subsidies to agriculture) and the Defense Industries Support Fund. Smaller funds targeted the cement Turkey ended the 20th century in turmoil. The final industry, tobacco, justice administration, universi- government of the century was led by the veteran ties’ research and development, mosque construc- leader of the Democratic Left Party (DSP), Bülent tion, and improvements in metrology (Öniş and Ecevit. Ecevit became Prime Minister in January Webb, 1992). The product specific levies imposed 1999 at the head of an interim government. In the to fund the EBFs to some extent offset the liberal- subsequent elections of April 1999, the DSP won ization of the import licensing regime (which itself the most seats and Ecevit led a coalition of DSP, was partially reversed), and with more and more Nationalist Movement Party (MHP) and ANAP. The government agencies allowed to administer their first year of the coalition was marked by the dev- own EBFs, the central government started to lose astating Marmara earthquake in August 1999. In 36 Chapter 1: Turkey’s Rise Figure 1.8: Political and macroeconomic instability in the era of coalition politics 120% 14% Public Sector Borrowing Requirement, 12% 100% 10% 80% 8% Percent of GDP 6% 60% Inflation 4% 40% 2% 0% 20% -2% 0% -4% 2011 2012 2009 2010 2007 2008 2005 2006 2002 2003 2004 2000 2001 1999 1996 1997 1998 1994 1995 1992 1993 1989 1990 1991 1987 1988 1984 1985 1986 1982 1983 1981 Özal Governments Coalitions AK Party Infla tion (Left Axis) Public Sector Borrowing Requirement (Right A xis ) Source: WB staff calculations, CBRT; TurkStat the subsequent wave of international sympathy, the insurance of all bank deposits to prevent a bank the coalition managed to secure the EU’s commit- run, and securing additional IMF support, a politi- ment to open accession negotiations with Turkey at cal crisis in February 2001 led market confidence the Helsinki summit of December 1999. Neverthe- to collapse and forced the government to float the less, to many citizens, the poor preparedness of the Lira. authorities to deal with the disaster and the sense that its human cost with more than 10,000 casual- The result of the macroeconomic and banking cri- ses of late 2000 and early 2001 was a radical shift in ties had been exacerbated by lax planning controls economic policy and the beginning of a new model and numerous illegal settlements were symptoms of economic governance, laying the foundation for of the state’s gradual corrosion through patronage the subsequent revival during the first decade of and corruption (Mango, 2004; OECD, 2002). the 21st century. This shift is of central interest to The crisis came at the end of 2000. Under a 1999 the remainder of this book. Here, a very condensed macro program supported by an IMF stand-by ar- summary is provided to set the stage. rangement and flanked by a series of structural re- In March 2001, the Ecevit government brought in forms with the World Bank support, a crawling peg a new economic team under Kemal Derviş, up to exchange rate regime was introduced to try and that point Vice President for MENA in the World tame chronic inflation. However, the program failed Bank. Key personnel changes occurred in the com- to contain the further accumulation of losses in ing months, such as the head of the Central Bank state-owned banks, which were financed through and the Banking Regulatory and Supervisory Agen- short-term borrowing (Chapter 3). The crawling cy (BRSA), established under a new Banking Act in peg regime, in addition, brought a rise in domes- 1999 and operational as of January 2000. The new tic interest rates and growing liquidity problems in team swiftly moved to resolve the twin foreign ex- the banking sector, with weaker players gambling change and banking crisis with a three-pronged ap- for survival by rolling over liabilities at increasingly proach. short maturities.9 With inflation higher than fore- seen under the crawling peg regime, the result was First, the liquidity crisis in the banking sector was a loss in competitiveness and, finally, in November tackled through recapitalization of state banks, 2000, a banking crisis followed by capital flight. stress tests in all private banks, and the taking over While the authorities managed to control the situa- of banks with insufficient capital by the State De- tion initially by taking over failed banks, confirming posit Insurance Fund (SDIF, see Chapter 3). 9 As Chapter 3 further explains, the crawling peg also offered banks the chance to borrow in forex and onlend at high rates domestically, often to related parties, hiding a substantial underlying deterioration in the quality of their balance sheets. Poor governance in the banking sector was a key reason for the accumulating difficulties. 37 Turkey’s Transitions Second, fiscal policy was tightened by exerting con- Prime Minister Ecevit’s health failing, the coalition trol over the operations of the state-owned banks, government broke down in Spring 2002 and early embarking on a major retrenchment of state-owned elections were scheduled for November 2002. The enterprises through privatization and employment elections led to the emergence of a new leading po- reduction, and through measures to broaden the litical actor, the Justice and Development Party (AK tax base and increase revenue collection. Fiscal Party), which won the largest share of votes and a consolidation was central to reestablishing mac- majority in parliament and has governed Turkey as roeconomic credibility. Central Bank financing of a single party ever since. the budget was prohibited by the amendment of the Central Bank Law in April 2001 and Treasury’s The post-2002 come-back debt management improved under a new Debt Management Law (2002). Monetary policy under This most recent period in Turkey’s socio-economic a floating exchange rate regime shifted the focus progress is analyzed in greater detail in subsequent towards bringing down inflation, initially through chapters. Here, three aspects deserve to be high- implicit inflation targeting, and once monetary lighted. conditions had sufficiently stabilized, from 2005 The first is the considerable expansion in the role of onward through an explicit inflation target. Declin- the private sector in the economy, building on the ing inflation allowed nominal interest rates to come creation of independent regulatory agencies be- down, thereby, supporting fiscal consolidation tween 1999 and 2002. It is critical for understand- as well as real sector recovery. Primary surpluses ing Turkey’s post-2002 come-back that successive were recorded from 2003 onwards as the economy AK Party governments sustained the structural re- recovered and public sector debt came down from forms introduced during the crisis at the start of the 69.2 percent of GDP in 2002 to 39.8 percent in 2012 decade and oversaw their implementation (Atiyas, (Spotlight 3). 2012; Ülgen, 2013). Figure 1.9 shows the evolution Third, the 2001 program accelerated the pace of of key structural reform measures in five main ar- structural reforms, which had begun in 1999. These eas involving state-business relations: enterprise, reforms, in their essence, targeted a reduction in finance, infrastructure, cities, and public finance direct intervention of the state in the economy and management. The concentration of reform efforts the move towards independent regulatory agen- during the period of 2001 to 2005 can be clearly cies to both encourage more private investment seen. and better regulate economic activities in key sec- The shift in the role of the state to a regulator and tors such as banking, energy, telecoms, and agricul- facilitator of private investment is exemplified by ture. These steps were flanked by improvements in the steps taken to expand private investment in in- public sector governance, such as through (i) a new, frastructure (Spotlight 2): EU-compatible Public Procurement Law (2002), (ii) new civil service recruitment standards introduced • Turkish Airlines (THY) and Halk Bank were par- in late 1999 and tightened in 2004, (iii) a Law on tially sold through public offerings in 2004-2006 Public Finance Management and Control (PFMCL) and 2007-2012 respectively and several conces- (2003), (iv) a Law on Access to Information (2003) sions were tendered for the operation of air- and (v) the introduction of e-signature (2004). Self- ports and ports (World Bank, 2012). regulatory bodies were also strengthened, with measures like the foundation of the Turkish Ac- • The electricity sector was unbundled; and, counting Standards Board in 1999 (operational in distribution and some generation assets were March 2002). privatized in several stages, raising US$12.7 bil- lion in revenues. The deep crisis of 2001 provided an opportunity to introduce wholesale changes to Turkey’s gover- • The telecommunications market became com- nance model and to overcome the inconsistencies petitive with the issuance of mobile phone li- between macroeconomic measures and microeco- censes and the ending of the Turk Telekom mo- nomic regulation and to get rid of incentives which nopoly in 2003. had plagued repeated stabilization efforts through- • A new Railway Law, effective in May 2013, pro- out the late 1980s and 1990s. Vested interests were vides for unbundling of the state railways into a confronted head-on, sometimes at considerable state-owned line operator, and a commercially risk to public officials who were charged with en- oriented transport operator, the latter subject forcing new rules. Turkey did not waste this crisis. to competition from private freight and passen- Yet, the scars of the recession in 2001 and the po- ger companies. litical divisions and tensions created by steering the economy through troubled waters were deep. With 38 Chapter 1: Turkey’s Rise Fi ure 9: Regulatory Reforms during and after the 2001 crisis Figure 1.9: Regulatory reforms during and after 2001 crisis A new Energy Efficiency Strategy Secondary Offering of %23,92 of Halk Bank was approved 2012 The New Capital Market Law enacted 2011 New Turkish Commercial Code enacted New Turkish Court of Accounts Law enacted 2010 2009 Competition Act was amended Social Security Reform enacted 2008 The Energy Efficiency Law was enacted %24,98 of Halk Bank sold by IPO 2007 Sale of %55 of Turkish Telecom Public Offering of %28,75 of THY 2006 Law on Municipalities The Renewable Energy Law was enacted 2005 An Electricity Reform Privatization Strategy Law on Metropolitan Municipality was approved 2004 The Public Financial Management and Public Offering of %23 of THY Control Law was enacted 2003 Law on Public Debt Management Permission to the Government 2002 to sell > %51 of New Central Bank Law Turkish Telecom Corporation 2001 Closure of the budgetary and extra-budgetary The Gas Market Law was enacted funds in order to imporve budgetary transparency The Electricity Market Law was enacted 2000 Foundation of the Foundation of the Energy Market Regulatory Board Telecommunication Authority 1999 Increase in retirement age Foundation of the Banking Regulation 1998 and Supervision Agency (BRSA) 1997 1996 1995 1994 Foundation of the Competition Authority Vertical Axis: Financial Sector 2- Infrastructure 3- Fiscal/PFM 4- Cities 5- Enterprises Source: WB staff The EU Accession process, as well as successive IMF as well as domestic investors improved through a and World Bank supported programs, provided an series of steps to ease entry barriers and strength- important anchor to the reform effort particularly en the protection of property and contract rights. in the first half of the decade. The “tractor beam” The second critical element of Turkey’s reformed of institutional convergence with EU standards paid policy environment post 2001 was a shift in gov- important economic dividends as elsewhere in Eu- ernment policy towards greater emphasis on ac- rope. The level of foreign direct investment (FDI) cess to public services. The AK Party had acquired inflows multiplied from just around US$1 billion an- experience in managing public services through nually in the 1990s to an average of US$15 billion years of municipal government, for instance, Tur- during 2007-2012. A new law on FDI was enacted in key’s current President, Recep Tayyip Erdoğan was 2003 and the investment climate for international a mayor of Istanbul in the 1990’s. The successful fis- 39 Turkey’s Transitions cal consolidation during the first half of the decade fer program (2003), consolidating five different provided the fiscal space to expand spending on health insurance schemes under one government health, education and, to a lesser extent, on pub- program and extending of coverage to all citizens lic infrastructure investments, most prominently under the Green Card Program (2008). An increase roads. Interest payments declined from 16 percent in the retirement age was legislated in two steps of GDP (or over one third of total spending) in 2001 in 1999 and 2008, partially reversing the fiscally to around four percent of GDP a decade later, while disastrous decision of the Demirel government to non-interest current spending increased by around lower retirement age in 1993, although the pension five percentage points of GDP over the same pe- reform is phased in so gradually that social security riod (Figure 1.10).10 Greater spending facilitated deficits are projected to persist into the middle of improvements in the quality of services, across this century. The strengthened social security ar- health, education and infrastructure, as document- rangements were to prove critical during the 2008- ed in subsequent chapters. 2009 crisis in mitigating the effects on the poor Nevertheless, the reform of public services went (Aran and Hentschel, 2012). beyond simply spending more money. The flagship Reduced inequality in access to basic public ser- reform program in the social sectors was the Health vices was a key aspect of greater social inclusion Transformation Program introduced in 2003, which during the past decade. Socio-economic progress led to major improvements in health sector out- was also reflected in a major reduction in poverty comes as well as patient satisfaction (Chapter 7, (Annex 1). Income poverty measured against an Atun et al., 2013). Importantly, a big part of the suc- international poverty line of US$5 in purchasing cess of the health reforms resulted from reduced power parity terms fell from 42 percent in 2002 inequalities in access and substantial convergence to around half that level in 2011 and is expected in health sector outcomes across income quintiles. to have declined further since. With this reduc- Similar albeit less dramatic improvements were tion, Turkey counts among the top 25 percent of recorded in basic education although key reforms all poverty reduction episodes worldwide (Azevedo here date back to the late 1990s (OECD, 2013; and Atamatov, 2014). At the same time, income Chapter 6). The authorities also launched a major growth was “shared”, in the sense that the income reform of social insurance, introducing targeted of those at the bottom of the income distribution social assistance through a conditional cash trans- rose at least as fast as the average income in the Figure 1.10: Fiscal consolidation created the space for growing social and investment spending after 2004 Consolidated government spending as a share of GDP in percent 45% 20% 18% 40% 16% 35% 14% 12% 30% 10% 25% 8% 20% 6% 4% 15% 2% 10% 0% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total Expenditures (Left Axis) Non-Interest Current Expenditures (Left Axis) Interest Expenditure (Right Axis) Investment Expenditure (Right Axis) Source: Ministry of Development; World Bank (2014) 10 Social spending doubled its share of total spending from 13 to 25 percent between 2000 and 2011 and public investment increased from 6 to 10 percent (Spotlight 3). 40 Chapter 1: Turkey’s Rise country. As Annex 1 explains in more detail, the started to sustain growth and construction became main driver of shared prosperity in Turkey over the a main driver of the economy’s expansion. While past decade has been the labor market, as labor this has supported a rapid pace of job creation earnings increased and as Turkey started to benefit since 2009, productivity has stagnated and external from the demographic transition, with falling de- deficits have become stubbornly high.11 pendency ratios and a rising number of workers in Turkey needs to find new sources of sustainable each household. Unlike in Latin America, where the productivity growth to satisfy the aspirations of its last decade was characterized by major reductions growing urban middle class. These lie in technologi- in income inequality and where government redis- cal upgrading and innovation, which ultimately de- tribution drove improvements in the income of the pend on competitive markets and the quality of the poor, Turkey’s story of inclusive growth remained regulatory environment. However, recent interven- private sector driven. Government redistribution tions in independent regulatory institutions suggest played a modest role and overall income inequal- that the principles of arm’s length regulation have ity initially declined but then increased again after not yet put down deep roots (Atiyas, 2012; Özel, 2007. The role of the labor market and the govern- 2011). Government favors are no longer doled out ment’s social policies is examined in greater detail through trade licenses or extrabudgetary funds, in the second half of this book. but there is concern over the transparency in pub- lic tenders and the allocation of land development The third aspect of the post-2002 regime shift is rights. The anchor provided by the EU Accession the change in Turkey’s political economy (Yavuz, process has been weakening ever since the mid- 2009; Ülgen, 2013; Mahçupyan, 2014). The 2000s 2000s and Turkey has been losing market share in not only saw the first extended period of uninter- the FDI going to emerging markets as a whole since rupted one-party government since the 1950s, it 2007. Moreover, the fiscal windfall in the aftermath also witnessed a declining role for the military in of the 2001 consolidation is largely exhausted, and parallel with the growing political voice of the con- improvements in the quality of public services will servative Anatolian lower and middle classes – the be more challenging to achieve than the expansion main constituency for the ruling AK Party. The in- in access during the past decade. creasingly internationally active Anatolian small and medium enterprises (SMEs) furnished support Socially, among the new urban dwellers, traditional for pro-market economic policies, while the rise values rub against the opportunities of a modern of an urban middle class both demanded and re- market economy. This can be seen, for instance, in warded the government for the increased attention the changing role of women in urban families with to public services. The pro-market and pro-reform conservative social norms gradually accommodat- domestic policy consensus was further enhanced ing rising female employment. The resulting adjust- and anchored by the EU Accession process. This ments are complex (Mahçupyan, 2014) but create a explains how reforms were sustained and is at the potentially receptive ground for identity based poli- core of the fascination with Turkey’s mix of conser- tics (White, 2012). Meanwhile, among Turkey’s tra- vative social values and pragmatic, service-oriented ditional elites, the loss of political influence and the economic management. sharp public rhetoric have led to disenchantment. The consensus that has brought Turkey longlasting Turkey today: in need of a new reform stability and an overwhelming pro-market constitu- boost ency needs to be nurtured. After more than a decade of progress, Turkey’s eco- Turkey’s prospects, thus, depend on a return to the nomic and social achievements have lately come focus on structural reforms and improved public under scrutiny. The reasons for this are both eco- sector governance that characterized the post-2002 nomic and social. Economically, the global crisis come-back. Measures to boost competitiveness, and subsequent rapid recovery in Turkey has divert- a reinvigoration of Turkey’s EU Accession process, ed attention from remaining structural weaknesses and steps to reconfirm the commitment to arm’s and considerably complicated macroeconomic length regulation and the rule of law can set the management. As outlined in Spotlight 1 and Chap- stage for a new growth spurt taking Turkey to high ter 3, Turkey’s growth has become quite volatile as income. The economic and social challenges of pro- it succumbed to the ups and downs on the global gressing towards high income are well understood carry trade. In the past two years, public spending and addressed by the government’s 10th National 11 Kara and Sarıkaya (2013) argue that part of the post-crisis increase in external imbalances is due to low demand among Turkey’s main trading partners and booming demand at home. They estimate the cyclically adjusted current account deficit in Turkey to be around 5 percent of GDP. This corresponds to the “sustainable” deficit of 5 percent of GDP used in the long-term growth projections in Spotlight 1. 41 Turkey’s Transitions Development Plan, approved in 2013. The plan ments coped with the challenges of successful in- foresees a deepening of structural reforms across a tegration into world markets? What impact has this large number of areas, summarized in 25 develop- had on Turkish companies? Have Turkish enterpris- ment programs. Nonetheless, a heavy electoral cal- es adjusted and become internationally competi- endar in 2014 and 2015 has complicated structural tive? And is Turkey well positioned to benefit from reform efforts. the shifting patterns of global economic growth in coming decades? These are the key themes ad- Turkey’s transformation is not over yet, but the road dressed in the first part of the book. the country has travelled so far still offers rich les- sons to policy makers and reformers elsewhere. Yet Chapters 5 to 7 contain Turkey’s lessons in inclu- more lessons are bound to emerge from the way sion and cover urbanization, labor markets and so- Turkey grapples with the challenges of the transi- cial services. This part tells Turkey’s social inclusion tion to high income. To document the specific steps story. How much of Turkey’s social inclusion was taken by past and present Turkish governments, to driven by new economic opportunities opening up understand the context in which they worked and as a result of structural change, in particular, Tur- the challenges that remain yet to be addressed, key’s fast rate of urbanization? What role did gov- and to draw lessons for policy makers in other ernment redistribution play? How important were emerging markets is the objective of the remainder public investments in health and education? At the of this book. A brief summary of its structure con- same time, given low rates of labor force participa- cludes this chapter. tion (particularly among women), does the coun- try risk missing out on its demographic dividend by The structure of the book keeping women at home? These are the key ques- tions addressed in the second part of the book. Turkey’s story is one of a growing number of case studies among emerging markets of sustained, Chapters 2 to 7 are bracketed by three spotlights. rapid economic growth (Commission on Growth The first spotlight uses a variety of macroeconomic and Development, 2008). These stories collective- modelling tools (Computable General Equilibrium ly are changing the nature of the global economy (CGE) results and growth accounting) to understand and provide rich pickings for development practi- the sources of past and potential future economic tioners. No longer do the experiences of Western growth. A particular focus of the spotlight is to un- Europe or North America provide the benchmark derstand the extent to which Turkey’s relatively low against which developing countries measure them- investment rate and low labor force participation selves; neither are Japan and the Asian Tigers the rate present binding constraints on growth, as the only cases of successful, rapid convergence towards analysis in Box 1 of this chapter would indicate. If high income. The remainder of this book focuses the key to future growth is an increase in invest- on Turkey’s story in its own right. It moves beyond ment, how can this be financed, given low and de- benchmarking to zoom in on the specific lessons clining domestic savings? The spotlight looks at the emerging from Turkey – the “how to” of Turkey’s implications of both for macroeconomic manage- reforms and development outcomes. ment and structural reforms. As argued in the preceding two sections, Turkey The second spotlight – linking the chapters on enter- contains lessons in both integration and inclu- prises and urbanization – traces Turkey’s progress sion. The liberalizing reforms of the 1980s laid the in the provision of public infrastructure services. foundation for Turkey’s lessons in integration. The The spotlight focuses on the expansion of transport fiscal consolidation and new governance model links and improvements in logistics performance that emerged after 2001 have laid the founda- (an area in which Turkey has progressed signifi- tion for Turkey’s growth to become inclusive. The cantly over the past decade and now ranks above two themes of integration and inclusion provide many European countries), and the reforms in the an overall organizing principle for drawing lessons energy sector, where Turkey offers valuable lessons from Turkey. Box 1.1 provides an overview. in eliminating subsidies, unbundling the sector and creating the space for private investment. Turkey The structure of the book follows the analytical has significant further ambitions in this area with framework sketched in Box 1 of this chapter. In ad- a pipeline for public-private partnerships amount- dition to this introduction and a concluding chap- ing to some US$150 billion in areas ranging from ter, the book has six core chapters, covering the six transport to social services. The realization of these principal components of Turkey’s growth model: ambitious plans is not without challenges which trade, finance, enterprise, cities, labor, and social the spotlight will summarize. services. Chapters 2 to 4 cover Turkey’s lessons in integration. How have successive Turkish govern- 42 Chapter 1: Turkey’s Rise Box 1.1: Turkey’s Transitions - An Overview Introduction: After a decade of solid growth, Turkey today is on the threshold to high income. Turkey’s example is of considerable interest to many emerging markets and its prospects matter regionally and globally. Turkey’s success is based on economic integration and social inclusion. The roots are to be found both in the economic opening of the 1980s and the European integration process which accelerated after the late 1990s. Spotlight 1: Growth and Macro Policy: Turkey’s growth has been driven mainly by investment and a growing popula- tion. Going forward, raising savings rates, increasing labor force participation and boosting total factor productivity will be necessary to sustain growth. LESSONS IN INTEGRATION LESSONS IN INCLUSION Spotlight 2: Trade Finance Enterprise Cities Labor Welfare Infrastructure Turkey has Turkey has The Turkey has Turkey has Turkey has Turkey’s become part managed Anatolian significantly managed one created lots health and of Europe’s financial Tigers have improved the quality of the fastest of jobs after education Convergence integration spread the of public urbanization the crisis. outcomes Machine. prudently. benefits of infrastructure, rates in the are rapidly integration including by world. closing the inland. mobilizing private gap to high investment. income. Spotlight 3: Public Finances and Governance: Turkey’s fiscal consolidation after 2001 has opened the room for in- creased welfare spending. Improved public finance management has supported this shift but governance reforms remain incomplete. Outlook: As Turkey moves to high income, the sources of growth will need to shift from the adaptation of technologies and structural change towards innovation and TFP growth within enterprises. This will require Turkey to strengthen the rule of law and arm’s length government regulation and to promote social and economic progress through the free exchange of ideas. As Turkey faces the challenge of modernizing its institutions, to what extent is it emerging as an example for a modern Muslim nation? The third spotlight summarizes Turkey’s fiscal con- to high income (see also Acemoğlu and Robinson, solidation experience with a particular focus on the 2012). The chapter returns to the peer group analy- role of improved public finance management. It sis introduced in this chapter and demonstrates explains how fiscal consolidation was closely linked that Turkey’s institutions are mostly still those of a and supported by reforms that improved the alloca- middle income country. Moreover, institutional re- tion of government spending and enhanced public forms have essentially stalled since the mid-2000s finance controls. The spotlight acts as a bridge be- with some risks of reversals documented in Chap- tween the discussions of Turkey’s expanding social ter 8. Yet, the rise of a strong middle class and the services in the chapter on welfare and the conclud- corresponding demand for improved governance ing chapter, which focuses on Turkey’s remaining may provide a foundation for further institutional institutional challenges. reforms. If Turkey can build on this foundation, it has the potential to emerge as an example for a Having benchmarked Turkey’s income status and modern Muslim nation. asset base against that of its peers in Chapter 1 and reviewed the pace of progress in six principal areas in Chapters 2 to 7, the final chapter casts a look ahead. Few countries have successfully escaped the “middle income trap” and Turkey has yet to complete this transition. Chapter 8 summarizes the main challenges that remain to be addressed to put Turkey firmly on a path to high income. It argues that the quality of a country’s institutions ultimate- ly is a major determinant of a successful transition 43 Turkey’s Transitions Annex 1: Pathways to the middle comparison, the growth of consumption of the bot- tom 40 percent is quite respectable. However, it is class: How Turkey’s growth was also notable that unlike many of its middle income shared peers in Latin America (as well as in South Africa), Turkey’s progress in shared prosperity has taken Turkey has recorded rapid progress in poverty re- place in an environment of overall strong growth duction over the past decade, and economic growth and has not been the result of government led re- in Turkey has benefited all groups, including those distribution.12 This makes the Turkish case rather at the bottom of the distribution (Azevedo and Ata- more similar to the experiences in Asia and in most manov, 2014). As a result, Turkey – as several other of Eastern Europe. countries in Eastern Europe, Latin America and East Asia – has seen the emergence of a middle class, Figure 1.11: Turkey has made significant becoming an increasingly important economic and political actor. As illustrated in Figure 1.11 by using progress in poverty reduction over the the World Bank definitions of US$2.5 in PPP per day past decade as the threshold to absolute deprivation and US$5 60% in PPP per day as the threshold to poverty, Turkey 50% has made enormous progress in poverty reduction. 40% Poverty Rate Turkey’s growth has been shared. To measure 30% the extent to which growth and prosperity were 20% shared, the World Bank has developed a new 10% metric, building on Basu (2013): it calculates the 0% growth in income (or consumption) of the bottom 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 40 percent. If this growth is sufficiently high, and if ECATSD 2.5 USD PPP ECATSD 5 USD PPP absolute poverty has declined significantly, we may Source: WB staff calculations using Turkey’s household budget say that growth has lifted all boats. This metric of survey data. Welfare aggregate from ECAPOV is consumption shared prosperity does not require reductions in per capita (+health, + durables, +rent) inequality. Nonetheless, to put improvements of the bottom 40 percent into perspective, it is often The basic finding that growth was widely shared is compared with the average rate of progress in the not dependent on the welfare aggregate but it does country. Figure 1.12 shows that in international vary across time periods and the magnitudes also Figure 1.12: Shared prosperity in Turkey and peers 12% 10% 8% 6% Growth Rate 4% 2% 0% -2% -4% 2006-2010 2005-2009 2004-2009 2006-2011 2006-2011 2007-2010 2005-2011 2003-2009 2005-2010 2005-2010 2006-2009 2004-2008 2005-2010 HRV IDN MEX IND ZAF CHL BGR COL TUR BRA ROM CHN RUS Total Population Bottom 40 Source: Azevedo and Atamanov (2014) using Global Poverty Working Group Shared Prosperity database. Notes: Welfare aggregate is consumption plus durables and health. Geometric mean is used to calculate average growth rate. 12 In Latin America, around half of the reduction in poverty over the past decade came from redistribution against only 11 percent in Turkey. The balance is accounted for by economic growth. 44 Chapter 1: Turkey’s Rise differ (Figure 1.13). In particular, the period 2002- Two thirds of the increases in income of both the av- 2007 showed the greatest progress in shared pros- erage household and the bottom 40 percent come perity, while the bottom 40 percent did worse than from employment. Using data on the sources of the average during the years of economic crisis be- household income, we can decompose the growth tween 2007 and 2009. Furthermore, it is important in income and look at the main drivers of shared to note that while the metric of shared prosperity prosperity (Figure 1.14). In the total population, the is based on averages across quintiles, and some largest income driver is increases in the number of households have moved from the top 60 to the household members in active employment linked bottom 40 over the period, even these households to declining child dependency ratios and, to a lesser have experienced an increase in their welfare. In extent, increasing female labor force participation this sense, all boats have truly been lifted. since the mid-2000s. This accounted for 41 per- cent of total income growth, with increasing earn- Figure 1.13: Shared prosperity measures ings adding another 33 percent. For the bottom 40 show variable performance over time13 percent, the contribution of increasing labor force participation among household members is less and labor earnings contribute almost one half of Consumption total income growth. One likely reason is the shift 12% of jobs from agriculture to higher productivity ser- 10% vices and manufacturing. This has allowed poorer 8% households to part-take in overall economic devel- 6% opment, as described in Chapters 4 and 6 in this re- 4% port. In the bottom 40 percent, pensions and social 2% assistance payments make up another 40 percent 0% of total income growth, demonstrating that there 2009-2011 2002-2011 2002-2007 2007-2009 has been some role for redistribution in leading to shared prosperity, but not an overarching one. Growth of bottom 40 Growth of total population The across the board increases in income and wel- fare have led to a growing middle class in Turkey Consumption = health, durables and rent (Figure 1.15). While there are several definitions of the middle class, the one used in Figure 1.15 is 12% every person with an income above US$10 in PPP 10% per day, i.e., double the threshold to poverty. This 8% group has grown from 21 percent of the population 6% to 41 percent over the course of 2002 to 2011. In 4% international comparison, Turkey’s middle class has 2% grown roughly in line with the increase in its per 0% capita income and is comparable in size to coun- 2009-2011 2002-2011 2002-2007 2007-2009 tries such as Brazil or Ukraine (Figure 1.16). Be- tween 2002 and 2011, 98 percent of all those in Growth of bottom 40 Growth of total population the middle class stayed in the middle class, and 40 percent of those that were vulnerable moved up to Income the middle class. Clearly, Turkey has been an econ- omy with growing aspirations over this period. This 12% may have contributed not only to macroeconomic 10% outcomes, such as the decline in precautionary sav- 8% ings, but also to social outcomes, by stimulating the 6% demand for better quality services. To continue to 4% satisfy these aspirations and turn the middle class 2% into a majority will require Turkey to move out of 0% middle to high income (Chapter 8). 2007-2009 2009-2011 2002-2011 2002-2007 Growth of bottom 40 Growth of total population Source: Azevedo and Atamanov (2014) 13 In this Figure, the welfare aggregate includes imputed rent payments, whereas Figure does not include this in the international comparison. For the ECA region, comparisons including rent are available. Results are not much affected for either Turkey or other countries. 45 Turkey’s Transitions Figure 1.14: The labor market drives improvements in income (2002-2012) 120% Pensions; 19,8 Pensions; 22,2 Sources of change in household income 100% Social Assistance; 10,8 Social Assistance; 19,1 80% Labor Earnings; 32,7 60% Labor Earnings; 45,8 40% Share of Employed; 41,1 Share of Employed; 20% 21,8 Share of Adults; 9,7 Share of Adults; 7,4 0% -1,5 -7,8 -12.2 -9.1 -20% Total Population Bottom 40 Share of Adults Share of Employed Labor Earnings Social Assistance Pensions Remittances Agricultural Income Other Income Source: Azevedo and Atamanov (2014) Figure 1.15: Shared prosperity is the pathway to the middle class 100% 90% 80% Percent of the population 70% 60% 50% 40% 30% 20% 10% 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Poor Vulnerable Middle class Source: Azevedo and Atamanov (2014) Note: The middle class is defined as all households with an income per capita above US$10 PPP per day. The vulnerable are defined as below US$10 PPP but above US$5 PPP. 46 Chapter 1: Turkey’s Rise Figure 1.16: Turkey’s middle class has increased in line with rising GDP 100% HRV10 90% 80% HRV93 Share of the middle class 70% RUS10 R² = 0,4282 60% LVA10 CRI10 MYS10 CHL10 50% UKR10 POL10 BRA10 40% TUR 2010 MEX10 RUS93 PAN10 PRY93 CHL93 PER10 30% ECU10 UKR93 BRA93 ROM10 20% PER93 MEX93 TUR 1993 ECU93 KAZ10 10% ROM93 KAZ93 0% 3.000 7.000 11.000 15.000 19.000 GDP per capita, in PPP 2011 US$ Source: Azevedo and Atamanov (2014) 47 Turkey’s Transitions References Acemoğlu, D., & Robinson, J. (2012). Why Nations Commission on Growth and Development. (2008). Fail. Crown Business. The Growth Report : Strategies for Sustained Growth and Inclusive Development. Washington Adaman, F., Karaman, K., & Akarçay-Gürbüz, A. DC: The World Bank. (2013). The Political Economy of Turkey. Mimeo. Dall’Olio, A., Iootty, M., Kaneira, N., & Saliola, F. Aghion, P., Howitt, P., & Mayer-Foulkes, D. (2005). (2013). 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Cambridge University Press. 49 Turkey’s Transitions 50 1 Spotlight 1: Accounting for Turkey’s growth: Past and future Spotlight Accounting for Turkey’s growth: Past and future Finance Fiscal Space Infrastructure Trade Welfare Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 51 Turkey’s Transitions 52 Spotlight 1: Accounting for Turkey’s growth: Past and future Accounting for Turkey’s growth: Accounting for growth: the basic Past and future framework “Once one starts to think about [economic Growth accounting is generally based on a stylized growth], it is hard to think of anything else.” growth model that relates the output of an econo- my to a set of inputs, typically physical capital, hu- Robert Lucas1 man capital and “raw” labor (Solow, 1957). In this spotlight, we follow the methodology of Hall and Jones (1999) which uses the following standard S ince the 1950s, Turkey’s per capita income has Cobb-Douglass production function with constant been on a path of convergence with Europe. returns to scale: In this, Turkey resembles other countries at the European periphery that have been closing the gap with the advanced countries in Continental Yi=Kiα(AiHi)1- α and Northern Europe since World War II (Gill and where: Raiser, 2012). However, Turkey’s path was volatile and disrupted by repeated economic and political • Y is Gross Domestic Product (GDP) crises. Thus, at the end of 1950s the per capita in- • A is an index of Total Factor Productivity (TFP) come levels of Turkey and Spain were almost same at around 40 percent of the income level of the UK. • K is gross domestic capital stock (calculated us- While Spain steadily converged after joining the Eu- ing the perpetual inventory method) ropean Union (EU) and increased its income level to 90 percent of the UK in 2011, Turkey’s per capita • H is schooling adjusted labor input (human capi- income reached only 50 percent of the UK’s.2 tal) and defined as: H=LeρS To account for Turkey’s economic catch-up in recent • α is contribution of capital to output years and to analyze the country’s growth pros- • S is average years of schooling pects going forward, this Spotlight takes a look at the productive capacity of the economy as a func- • ρ is the Mincerian return to schooling tion of past and future savings and investments, the growth in the active population, and a productivity parameter that captures improvements in technol- The parameter alpha is set to 0.33 as in Caselli ogy and efficiency. The first section presents the (2005). This is a strong assumption, as several au- basic framework. The second section applies the thors have pointed that a higher capital share may framework to decompose Turkey’s past economic be appropriate for emerging market economies growth into its main determinants, while the third (see Altuğ, Filiztekin and Pamuk, 2008; Chen et section projects Turkey’s growth into the future al., 2010). Nonetheless, we choose a value of 0.33 consistent with the majority of growth accounting based on a series of assumptions about savings, in- studies in the literature.3 Returns to schooling are creases in human capital, and demographics. In the assumed to be decreasing with rising education lev- best case scenario, we find that Turkey could reach els, in line with Hall and Jones (1999):4 almost 90 percent of the EU’s average per capita income by 2030, roughly the level where Spain is today. 0.135 if S ≤ 4 ρ = 0.101 if 4 < S ≤ 8 0.068 if S > 8 1 Robert Lucas (1988), “On the Mechanics of Economic Development.” Journal of Monetary Economics, 22( 3-42), p. 5. 2 For an analysis of Turkey’s relative underperformance compared to other Southern European countries, see Adamopoulos and Akyol (2009). As shown by Gill and Raiser (2012), EU enlargement was the driving motor of Southern Europe’s accelerated convergence during the 1970s and 1980s, bringing some 50 million people to high income. The same motor in the 1990s and 2000s brought another 100 million to the threshold to high income or beyond in Central and Eastern Europe. The role of the EU Anchor in Turkey’s rise is emphasized in Chapter 1, even though in the wake of political obstacles, it has worked less strongly than in Southern and Eastern Europe. 3 A higher capital share would affect our TFP estimates. For the full 1960-2012 period, average TFP growth would decline to 0.3 percent, for the 2000s to 0.8 percent. Capital inputs on the whole have grown faster than labor inputs in the past, so the amount of growth left to be explained by TFP is lower if the capital share is higher. 4 For an analysis of returns to education in Turkey, see Tansel and Daoud (2011). 53 Turkey’s Transitions The analysis in the next, backward looking section country experienced long periods with low or nega- is based on the Penn World Tables (PWT) version tive growth. Nevertheless, the volatility of Turkey’s 8.0 by Feenstra et al. (2013) and the Barro-Lee Edu- growth rates was below that in a group of peer cational Attainment Dataset version 1.3 (Barro and countries over the period as a whole and in each Lee, 2010). Population projections for the third, for- decade with the exception of the 1950s and 2000s ward looking section are taken from World Devel- (Table S1.1). opment Indicators (WDI) (2013). We use the PWT as it includes longest series of investment and GDP Several episodes of economic development in post- (1950-2012). However, one should note that using war Turkey can be distinguished, marked by chang- other data sources such as the Conference Board, ing political circumstances. Turkey has had four the Ministry of Development, TurkStat or WDI, above average growth episodes. The country saw does not alter the obtained results significantly. the highest average growth rate during the Demo- crat Party Government (1950-1959). The main con- Looking back: Solid growth but tributor to average growth of 8.3 percent was TFP, which reached 6.4 percent growth reflecting the increasing volatility post-war recovery in demand and efficiency gains The Turkish economy has expanded by an average from agricultural reform (Figure S1.1). The second of 5.0 percent in real terms annually since 1950. best performance occurred between two military Excluding the 1950s, which is an outlier in almost interventions – the coups of 1960 and 1980. From all countries as a result of the post-war reconstruc- 1961 to 1977, the average growth rate reached 6.1 tion boom, average annual growth was around percent and growth never turned negative. This pe- 4.5 percent, somewhat lower than the average in riod was characterized by central planning and im- a sample of peers for which data is available.5 The port substitution. Public investments surged, boost- contributions of human capital and physical capital ing the contribution of the physical capital stock to to aggregate growth was equal at 1.8 percentage growth to 2.2 pps. Following the military coup of points (pps) while the contribution of TFP growth 1980, the Turkish economy entered another vigor- was muted at 0.8 pps (Table S1.1). ous growth episode under the Özal Government thanks to wide-reaching economic liberalization. In Turkey’s case, high average growth rates over The final above average growth episode occurred longer periods mark significant variations from year during the tenure of the current AK Party govern- to year. Turkey has not experienced sustained high ment, during which the country was enjoying an growth over several decades, but neither has the average growth rate of 5.2 percent. Structural re- Table S1.1: Real GDP growth and contributions of factors6 Real GDP Human Physical TFP Volatility (%) Average Average Growth (%) Capital Stock Capital Stock (pps) growth in volatility in (pps) (pps) peers (%) peers (%) 1950s 8.3 0.7 1.0 6.4 10.7 5.3 3.0 1960s 5.1 1.2 1.7 2.1 3.8 6.0 5.5 1970s 4.9 2.3 2.3 0.3 3.2 6.8 3.7 1980s 4.1 2.1 1.4 0.5 3.5 4.1 4.3 1990s 4.0 1.9 2.1 0.1 5.1 2.3 5.3 2000s 4.6 1.8 1.6 1.1 5.0 4.5 2.6                 1960-2012 4.5 1.8 1.8 0.8 4.1 5.3 4.7 Source: World Bank (WB) staff calculations, PWT 5 Peer group (with available data since 1960) includes South Africa, Philippines, Mexico, Romania, Brazil, Morocco, Jordan, Tunisia, India, Indonesia, Syrian Arab Republic, Egypt, Malaysia, Republic of Korea and China. 6 Both for Table S1.1 and Figure S1.1, period growth rates represent the average of the annual growth rates. GDP growth rates are calculated by using PWT database, which allows cross-country comparison in a consistent manner. Growth figures slightly change when calculations are made by using the Ministry of Development’s harmonized GDP dataset for the period before 1980; however, there is no significant divergence for the period follow- ing 1980. For reference, the average growth rates per decade using the Ministry of Development’s data are: 7.0 percent for the 1950s, 5.5 percent for the 1960s, 4.7 percent for the 1970s, 4.1 percent for the 1980s, 4.0 percent for the 1990s, 4.6 percent for the 2000s. 54 Spotlight 1: Accounting for Turkey’s growth: Past and future Figure S1.1: Drivers of growth in different political periods 10% 8.3% 8% 6.4% 6.1% 5.5% 5.2% 5.0% 6% Percentage Points 2.9% 4% 2.2% 2.2% 2.2% 2.2% 1.9% 1.9% 1.8% 1.8% 1.8% 1.7% 1.7% 1.7% 1.7% 1.6% 1.5% 1.4% 1.4% 1.1% 1.1% 1.0% 0.7% 2% 0.2% 0% -0.4% -2% -1.9% -2.9% -4% 1950-1959 1960-1961 1962-1977 1978-1982 1983-1990 1991-2001 2002-2012 1950-2012 Democrat Party Coup The Longest Domestic Crisis ANAP The "Lost AK Party All Times Uninterrupted and Coup Decade" Period of (Coali tion Growth Governments) Real GDP Growth (Y) Contribution of Human Capital (H) Contribution of Physical Capital (K) Contribution of TFP Source: WB staff calculations, PWT forms post-2001, strong macroeconomic manage- Throughout the post-war period, the country was ment, supportive global liquidity conditions and rocked by political instability or crises, resulting in rapid increases in human capital (particularly fol- substantial declines in TFP and reflected in low or lowing the 1997 education reforms, see Chapter 7) negative economic growth rates. This was the case were the main drivers of growth during this period. in the early 1960s, again in the early 1980s and The contribution of TFP was high during the first during the so-called “lost decade” in the 1990s. five years of the AK Party era, but has been volatile However, one should note that despite the loss in and low since. From 2009, growth has been driven growth momentum in 1990s, compared with other mostly by increases in labor force participation and emerging market peers, Turkey actually did reason- employment. This points to possible limitations of ably well. Elsewhere, the collapse of the centrally Turkey’s current growth model, which are taken up planned economies in Eastern Europe in the early again in Chapter 8. 1990s, the 1994 economic crisis in Mexico, the Figure S1.2: Turkish economy became more volatile relative to its peers in the last decade 10% 8.3 8% 6.8 6.0 6% 5.3 5.1 4.9 4.6 4.5 4.1 4.1 4.0 4% 2.3 2% 0% -2% -4% 1950s 1960s 1970s 1980s 1990s 2000s Real GDP growth (percent) Average growth in peers (percent) Difference in volatility between Turkey and the average of peers (percentage points) Source: WB staff calculations, PWT 55 Turkey’s Transitions Figure S1.3: Economic growth has been financed by foreign capital inflows 35% Ca pi tal Account Li beralization 30% 25% 20% 15% 10% 5% 0% -5% -10% 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Domestic savings (percent of GDP) GDP growth (percent) Net financial inflows (percent of GDP) Source: WB staff calculations, Ministry of Development, Central Bank of the Republic of Turkey (CBRT) 1998 Asian financial crisis, and the 1999 Russian fi- 16.1 percent of GDP in the last decade. With con- nancial crisis led to highly volatile conditions and, in tinued robust investment demand, and with Turkey some cases, negative growth rates over the decade. having gained access to international capital mar- kets after the 1980s, the difference was made up by While the results overall reveal a close link between foreign capital flows and Turkey’s current account political stability and average growth rates in Tur- moved progressively into deficit (Figure S1.3). key since the 1950s, political stability has not nec- essarily gone hand in hand with declining volatility. Thanks to solid macroeconomic management and In almost all peer countries, the volatility of growth strong corporate and financial balance sheets in the rates declined in the 2000s; in Turkey, it remained wake of the 2001 crisis and ensuing reforms, Tur- unchanged despite much greater political stability. key was able to maintain access to financing even As a result, although average growth rates in Turkey during the global economic and financial crisis of compared well with peers during the last decade, 2008-2009. Indeed, after shrinking 4.8 percent in the difference in volatility became positive (Figure 2009, the economy rebounded impressively, with S1.2). The result is not much different if we exclude an average growth rate of 9 percent in 2010 and the crisis years of 2000-2001 from this final pe- 2011. Nonetheless, growing concerns over the riod. Growth volatility was still high at 4.4 percent very large current account deficit of 10 percent of whereas it declined among peers to 2.7 percent. GDP in 2011, have motivated a search for innova- Political stability is likely to remain important for tive macro-prudential tools which would moderate sustained growth in Turkey, but reduced volatility economic volatility without breaking the growth will also depend on reducing Turkey’s reliance on momentum (Chapter 3). The result of these efforts volatile international capital flows, through boost- in 2012 was the first managed rebalancing which ing domestic savings and attracting more stable, reduced the current account deficit to 6.0 percent long-term Foreign Direct Investment (FDI). We of GDP from 9.8 in 2011 and broke the close tie be- briefly examine the first issue below. FDI is analyzed tween the capital inflows and growth (Figure S1.3). in Chapter 2. Going forward, it appears that the current account deficit and the associated sustainable level of ex- Domestic savings peaked at 29 percent of GDP in ternal financing represent a binding constraint on 1988, right before Turkey opened its capital ac- Turkey’s growth potential. If Turkey wants to reduce count. Since then, there has been a continuous the volatility of growth, policy makers may have declining trend which accelerated in the 2000s and to settle for more modest growth rates over the brought domestic savings down to an average of medium term.7 In the next section, this basic con- 7 IMF (2013) estimates that based on historical parameters, Turkey’s maximum growth rate consistent with no further deterioration in the current account deficit may lie somewhere between 2.8 and 3.5 percent. Changes in import and export elasticities in Turkey’s terms of trade, and in savings behavior would all affect these estimates. Our approach in this section is based on the long-term supply potential of the economy, but does include the foreign financing constraint by putting a ceiling on the feasible investment rate. 56 Spotlight 1: Accounting for Turkey’s growth: Past and future Table S1.2: Long-term projections - Baseline scenario Real GDP Human Capital Physical Capital Share of EU per TFP   Growth (Y) (H) (K) capita GDP 2014-2030 4.2% 1.8% 1.5% 0.8% 63.5% 2031-2050 3.3% 1.2% 1.3% 0.8% 75.2% Source: WB staff calculations, WDI Population Database straint is reflected in the assumption that Turkey’s using a cohort approach and reflecting the ex- sustainable current account deficit cannot exceed 5 tension of compulsory education to 12 years percent of GDP and that, as a result, the country’s from 2012. investment rate is limited. • Investment is constant at 20 percent of GDP and Looking ahead: Domestic savings, domestic savings amount to 15 percent of GDP implying an optimal current deficit of 5 percent human capital and demographics (IMF Article IV, 2013). and Turkey’s growth potential • TFP growth is constant at 0.8 percent (average What is the long-term growth potential of Turkey between 1960-2012). given the external financing constraint? What will • EU growth is taken from IMF’s World Econom- be the main drivers of growth? How quickly can ic Outlook Database till 2018 and, after that, Turkey converge to EU levels of income and does it is constant at 1.89 percent per year which the rate of convergence change over time? Which is equivalent to average EU growth between policies could increase the potential growth rate 1995-2012. and speed up the convergence process? To answer these questions, this section uses the growth ac- Based on these assumptions, Turkey’s potential counting framework described above together growth rate is estimated to be slightly lower than with some assumptions regarding the path of in- its historical average at 4.2 percent between 2014 vestment, human capital, labor force growth and and 2030. Growth will be driven by human capital TFP. The methodology is similar to one used in the and will lose momentum over time. The reason be- OECD’s Turkey Economic Survey (2012). hind the increase in the contribution of human cap- ital is the extension of compulsory years of school- The following assumptions are used to estimate a ing and improvements in FLFP. With this average baseline scenario for potential growth of the Turk- growth rate, Turkey continues its convergence to ish economy through the period of 2014-2050: income standards of the EU with its per capita in- • The population aged 15 and above reaches 79 come reaching 64 percent of the projected average million by 2050 as in WDI Population Database per capita income of EU in 2030 (Table S1.2). (2013). After 2030, long-term potential growth is projected • Female labor force participation (FLFP) increas- to decline to 3.3 percent given the slowdown in em- es to 50 percent by 2050 while the economy ployment generation as a result of population dy- creates enough jobs to stabilize the trend un- namics. Overall, in this baseline scenario, the Turk- employment rate at 9.2 percent by 2023 as in ish economy could reach to 75 percent of average Gönenç et al. (2012).8 As a result of the rise per capita incomes in the EU by 2050. Convergence in FLFP, the total labor force participation rate is fastest until 2030 thanks to the demographic divi- reaches 60 percent by 2050. dend. Of course, this dividend could be maximized with policies that allow even faster increases in • In line with the first two assumptions, average labor force participation and boost educational at- employment growth is 1.8 percent per annum tainment even more rapidly. Corresponding reform between 2014 and 2030 and 1.2 percent there- scenarios are analyzed next. after. Many reform priorities have been identified, which • Average years of schooling of the working age would boost growth by increasing TFP, including population are calculated to reach 11.2 by 2050 improving the business environment, increasing 8 For a detailed discussion of the recent improvements in FLFP, please see Chapter 6. 57 Turkey’s Transitions Table S1.3: Policy simulations Share of EU Real GDP Human Physical  (percent) TFP per capita Growth (Y) Capital (H) Capital (K) GDP Baseline (2014-2030) 4.2 1.8 1.5 0.8 63.5 (I) Savings rate increases to 19 percent of GDP by 2018 while investment reaches 24 4.5 1.8 1.9 0.8 66.9 percent (MoD) (2014-2030) (II) FLFP increases to 53.1 percent of GDP by 4.8 2.3 1.7 0.8 70.3 2030 (OECD av.) (2014-2030) (III) Average years of schooling is projected to reach 10.57 by 2030 (Korean case) (2014- 4.6 2.1 1.6 0.8 67.9 2030) Combined II+III (2014-2030) 5.2 2.6 1.8 0.8 75.2 Combined I+II+III (2014-2030) 5.5 2.6 2.1 0.8 79.1 Combined I+II+III+Double TFP Growth 6.3 2.6 2.1 1.6 89.7 (2014-2030) Baseline (2031-2050) 3.3 1.2 1.3 0.8 75.2 Source: WB staff calculations, WDI Population Database energy efficiency and easing access to credit. Sever- average (53.1 percent) by 2030; potential growth al of these areas are analyzed further in Chapters 4 would reach 4.8 percent (up 0.6 pps) bringing Tur- and 8. The policy simulations here focus instead on key’s per capita income up to 70 percent of the EU the growth impact of raising domestic savings, in- average. In a combined scenario, where there are creasing FLFP rate and increasing the average years improvements in savings, FLFP and average years of schooling. In a final scenario, we additionally of schooling, the potential growth rate would surge to 5.5 percent, one third faster than in the baseline simulate the impact of doubling Turkey’s historical scenario. Finally, if in addition TFP growth doubles, rate of TFP growth to 1.6 percent per annum, cor- average GDP growth increases to 6.3 percent and responding roughly to long-term average rates of Turkey reaches almost 90 percent of average EU in- TFP in high income countries (Table S1.3). comes by 2030. Raising domestic savings to 19 percent of GDP by Overall, results indicate that increasing domestic 2018, as targeted in the tenth Development Plan, savings, while critical to reduce volatility, is not suf- increases potential growth by 0.3 pps per annum. ficient to increase the growth significantly. Reforms Boosting average years of schooling to 10.6 by 2030 in education and labor markets are also needed to to emulate the Republic of Korea’s dramatic human accelerate the convergence process. Chapters 6 capital investment over the last three decades, and 7 in this Report analyze Turkey’s achievements would boost potential growth 0.4 pps per year. The in this respect and measures to maximize the de- biggest single impact results from faster increases mographic dividend in more detail. Chapters 2 to in FLFP to reach the current The Organisation for 5 suggest ways in which Turkey could further boost Economic Co-operation and Development (OECD) TFP and, thus, achieve even faster convergence. 58 Spotlight 1: Accounting for Turkey’s growth: Past and future References Adamopoulos, T., & Akyol, A. (2009). Relative Un- Hall, R., & Jones, C. (1999). Why Do Some Coun- derperformance A La Turca. Review of Economic tries Produce So Much More Output Per Worker Dynamics, 12, 697-717. 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Recent Productivity Developments and Statistics, 39(3), 312-320. in the World Economy: An Overview from the Con- Tansel, A., & Daoud, Y. (2011). Comparative Essays ference Board Total Economy Database. Interna- on Returns to Education in Palestine and Turkey. tional Productivity Monitor, 3, 3-19. ERC Working Papers 1102. Middle East Technical Feenstra, R. C., Inklaar, R., & Timmer, M. P. (2013). University Economic Research Center. The Next Generation of the Penn World Table. Re- World Development Indicators. (2013). World Bank. trieved from available for download at www.ggdc. net/pwt Gönenç, R., Rohn, O., Koen, V., & Saygılı, S. (2012). Structural Reforms to Boost Turkey’s Long-Term Growth. OECD Economics Department Working Pa- pers No: 987. OECD Publishing. 59 Turkey’s Transitions 60 2 Chapter 2: Trade: Benefiting from globalization Chapter Trade: Benefiting from globalization Infrastructure Finance Fiscal Space Welfare Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 61 Turkey’s Transitions 62 Chapter 2: Trade: Benefiting from globalization Trade: Benefiting from ment policies have supported the creation of global brands. For example, with the government’s sup- globalization port and guidance regarding branding and market D eveloping a global brand is perhaps the most access, Turkish brands such as Beko (home appli- visible sign of a country’s transition to high ances), Hidromek (construction machinery) and income. Republic of Korea’s meteoric rise Çilek (furniture) became globally recognized. Over from low to high income in less than two genera- the past three decades Turkey has seen its exports tions is vividly encapsulated by Samsung’s com- share in global imports increase more than fourfold petition with the mighty Apple for the top spot in (from 0.2 percent to 0.9 percent). Turkey’s econom- the tablet market. Plane maker Embraer stakes out ic opening is comparable to similar developments Brazil’s claim to compete among the best in global in India and China over the same period, and has air transport technology. Car manufacturer Skoda’s been much more extensive than the experience turnaround from the butt of jokes about Commu- in many Latin American countries. As this Chapter nist engineering to a premium brand within the will argue, Turkey’s deepening trade relations with Volkswagen Group symbolizes the proud return of the EU have had a key role to play. Indeed, Turkey’s the Czech Republic into the ranks of high income trade performance mirrors the experience of the economies. Samsung, Embraer and Skoda are fol- new EU member states in Eastern Europe, which lowing in the footsteps of German and Japanese car saw their role in the world economy transformed as makers, French and Italian fashion designers, and a result of European integration. By becoming part Scandinavian home outfitters in creating valuable of the European “Convergence Machine” Turkey, global brands. too, has transformed itself from a largely closed and predominantly rural economy into a major in- Turkey’s most notable branding successes are not dustrial power and integrated into global manufac- in the area of high technology. But in a sure sign turing value chains (Gill and Raiser, 2012). of the economic transformation the country expe- rienced over the past three decades, Turkey too In an attempt to document the reasons behind Tur- has developed global brands, like jeans maker Mavi key’s strong trade performance, this Chapter spe- (Box 2.1). The company, established in 1991 as a cifically addresses three questions: family owned business, rapidly moved up the ranks of global design and marketing. In its 10th year, Mavi • First, how did Turkey improve its export perfor- became the first ever Turkish brand which adver- mance? The short answer is that the initial trade Box 2.1: Mavi Jeans - Made in Turkey, marketed globally “If you aren’t already wearing Mavi, your kids probably are – the company sells hundreds of millions of dollars’ worth of high end, slim fitting denim all over the world. Building a global luxury brand is tough, especially for an emerging market firm that doesn’t have the cache of European heritage. But Mavi has managed to do it, in part because they kept an ownership stake in their factories, which allows them to have enough supply chain flexibility to respond quickly to market trends. If Mavi had outsourced production to Asia, where labor is half the price it is in Turkey, they wouldn’t have been able to get the product to market on time or on budget. But since they kept what’s known in trade as a “vertically integrated supply chain” (meaning, production, marketing, and sales are done in the same place) they’ve managed to thrive, and are now worn by the likes of Kate Winslet and Chelsea Clinton.” Source: From Time.com, Three Economic Lessons Imported From Turkey. 1 1 http://business.time.com/2012/02/09/three-economic-lessons-imported-from-turkey/#ixzz2pcbQotAv tised on US TV channels. In 2005, it featured in the liberalization efforts of the early 1980s and Zagat magazine as New York City’s best jeans store. their culmination in the 1995 Customs Union The company has had many special collections de- (CU) with the EU have laid the basis for Turkey’s signed by some of the most well-known Turkish fashion designers. rapid integration into the European and global economy. As later chapters will show, Turkey’s Turkey’s textile industry is not the only sector to economic opening went hand in hand with an have dramatically increased its global presence. accelerated shift of labor from agriculture into Turkey exports a large variety of goods to an in- manufacturing and services which boosted Tur- creasingly diversified set of markets, from vehicles key’s overall productivity. The easy access to the and vehicle parts to specialized foodstuffs, and from world’s largest consumer market complement- the European Union (EU) to the shores of West Af- ed Turkey’s own liberalization efforts in assuring rica. Turkish entrepreneurship as well as govern- this positive outcome. 63 Turkey’s Transitions • Second, how did Turkey diversify its export Turkey’s integration into the global markets? The main reason for Turkey’s success in diversifying its export markets is that Turkey economy had goods to sell that many countries wanted Like many other countries in the world, Turkey has to buy. Thanks to the CU, Turkish exports meet integrated substantially into the global economy EU quality standards. This has helped export- during the final decades of the 20th and the first ers penetrate new markets. In addition, invest- ments in logistics and diplomatic outreach have decade of the 21st century. Turkey’s economy has supported the diversification of Turkey’s trading opened significantly since the 1980s, when exports partners. Turkey’s geographic location means it amounted to only five percent of Gross Domestic is well placed to benefit from the growing eco- Product (GDP). As shown in Figure 2.1, the pace at nomic integration on the Eurasian continent. which the economy has opened to trade has varied significantly over the past few decades, with the • Third, how did Turkey upgrade its exports? Once fastest increase occurring during the 1980s, stag- again, the answer points towards European in- nation during the 1990s, and a reacceleration over tegration. The process of integration with the the past decade. During the 2000s, Turkey’s ex- EU has increased Turkey’s participation in Glob- ports increased by an average 15 percent annually al Value Chains (GVCs) and has resulted in high- in US$ terms, 6 percentage points above the global er technology content and sophistication of ex- annual average growth rate of exports, and more ports. Foreign Direct Investment (FDI) has been than twice the growth rate of The Organisation for a driver of growing intra-industry trade as has Economic Co-operation and Development (OECD) been the reduction in trade costs that resulted countries. Nevertheless, Turkey’s exports have re- from the harmonization with EU standards, the mained relatively constant over the past decade as elimination of tariff and most non-tariff barriers a share of GDP, unlike in most peers, with Turkey’s to trade, and the improvement in Turkey’s logis- GDP measured in US$ terms tripling over the past tics performance. decade as the real exchange rate appreciated. The chapter closes by casting a look ahead. Sustain- Turkey’s openness - the ratio of trade in goods and ing Turkey’s export performance into high income services to GDP - has risen from 11 percent in 1970 and beyond will require significant technological to 58 percent by 2012. This reflects a pick-up in the upgrading. While Turkey has dramatically increased export share by 22 percentage points and a 25 per- its medium-technology exports, it has stagnated in centage point rise in the import share of GDP. The high-tech exports. Higher value-added exports will change in the share of trade to GDP is similar to require more skilled labor, greater efforts to attract that in other integrating Middle Income Countries FDI, and more innovation and experimentation by (MICs), like India and China (Figure 2.2). Turkey`s large and medium-sized firms. Moving up the val- pace of trade integration has however not been as ue chain should allow Turkey to more successfully fast as in Republic of Korea or in some of the new compete in high-growth markets, including in Asia. EU member states such as Hungary. Figure 2.1: Turkey’s economy has dramatically opened up since 1980 60 1980- Trade Liberaliza tion 55 50 45 40 Percent of GDP 35 30 25 20 15 10 5 0 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Imports of goods and services (percent of GDP) Exports of goods and services (percent of GDP) Openness (Sum of imports and exports of goods and services, percent of GDP) Source: World Development Indicators (WDI) 64 Chapter 2: Trade: Benefiting from globalization Figure 2.2: The increase in Turkey’s openness since the 1970s is comparable to India and China 200% 180% Sum of Exports and Imports in GDP 160% 140% 120% 100% 80% 60% 40% 20% 0% Brazil China Hungary India Korea, Poland Turkey Republic of 1970 1990 2011 Source: WDI While increases in Turkey’s openness in the 1980s shift from import substitution to export promotion were driven by very rapid export growth, increas- and reduction in import quotas and tariffs. During es in Turkey’s openness over the past decade are this period, various export promotion policies were linked to significant import growth, with the trade introduced, ranging from legislative changes for tax deficit widening sharply. This has led to some con- rebates and tax exemptions to credit and insurance cern over excessive import dependence of Turkey’s mechanisms. In 1987, Turkish Eximbank was estab- economy and its exports in particular. However, as lished to help Turkish exporters compete in exter- we argue further below, the rise in import penetra- nal markets and support Turkey’s exports strategy.1 tion has been intimately linked with Turkey’s inte- Export subsidies were a critical component of the gration into GVCs and has allowed Turkish produc- reforms in the early 1980s, and included a variety ers to increase the quality of their exports. In other of incentives. Subsidies in the early 1980s averaged words, import growth and export success have about 22 percent of export value (Milanovic, 1986; been closely linked in Turkey, as well as in many Bateman and Arslan, 1989), and they were initially other emerging markets. Indeed, while Turkey did largely in the form of export credits (which ran as increase imports 50 percent faster than the world high as 40 percent for industrial exports in 1980- average, and 75 percent faster than the OECD aver- 1981). The subsidy varied widely and some sectors age, Turkey’s rate of import growth was only half received subsidies of over 100 percent. At the same the rate observed in China over the decade. time, import taxes on raw materials and intermedi- Trade policy has played an important role in boost- ate goods imported for use in Turkish exports were reduced to zero, thus further shifting relative prices ing Turkey’s export performance, especially in the in favor of export goods. 1980s when exports grew at a higher rate than in comparator countries. Trade policy and exchange Turkey’s initial mix of export subsidies with selec- rate reforms were central to the stabilization and tive import restrictions was overall successful, but adjustment program launched in January 1980, in- created considerable distortions. As these distor- cluding an upfront 33 percent devaluation of the TL, tions became increasingly apparent, Turkey dur- the elimination of multiple exchange rate practices, ing the 1980s gradually dismantled its system of and liberalization of access to foreign exchange in non-tariff barriers on imports. In 1989 and 1990, particular for exporters and banks involved in the a major liberalization of import licenses and tariffs export business (Öniş and Webb, 1992). This was was undertaken and full convertibility of the TL was accompanied by a sharp reduction in real wages established, greatly reducing the opportunities for as nominal wages did not keep up with inflation. rent-seeking. This was combined with an opening Özal’s private-sector focused policies included a of the capital account and financial sector liberal- 1 T.C. Başbakanlık Devlet Planlama Teşkilatı. 9. Kalkınma Planı 2007-2013, Özel Ihtisas Komisyonu Raporu: Dış Ticaret, Ankara 2007. 65 Turkey’s Transitions Figure 2.3: Tariffs for products covered by the Customs Union fell significantly 250% Products not covered Products covered by by the Customs Union the Customs Union 200% 150% MFN Tari ff 100% 50% 0% Source: World Bank (WB) staff calculations at Harmonized Classification (HS)-8 digit level based on United Nations Conference on Trade and Development (UNCTAD) Trade Analysis Information System (TRAINS) Note: Dark shaded bars reflect tariff increases, light shaded bars reflect tariff reductions relative to the pre CU level. ization. The rapid liberalization of the 1980s and substantial functioning CU with a non-member early 1990s without concomitant tightening of bud- state and was one of the earliest attempts by the get constraints for state-owned enterprises (SOEs) EU to share its legal system with a non-member and strengthening of regulatory institutions creat- country. While originally seen as a stepping stone ed growing imbalances which led to repeated mac- towards full membership and hence suffering from roeconomic crises in 1994, 1999 and again in 2001 a number of design flaws which have caused in- (Atiyas, 2012), and which are discussed elsewhere creasing irritation over the years, the CU has, none- in this volume (Chapter 1; Chapter 3). However, the opening up did lay the foundation for closer eco- theless, delivered major benefits to both parties nomic integration with the EU, which was to prove and must be considered a critical driver of Turkey’s critical for trade performance in the 2000s. emergence as a global trading power. The culmination of trade policy reform efforts was The CU and increased integration with the EU also the establishment of a CU between Turkey and the played a role in the rise in FDI to Turkey during the EU on December 31, 1995. The CU covers trade in last decade. The EU, led by the Netherlands, Aus- industrial goods (including the industrial compo- tria, UK, Luxembourg, Germany and Spain, is the nents of processed agricultural products) and ex- largest foreign investor in Turkey accounting for cludes primary agriculture and services. Although three-quarters of total FDI inflows during the last Turkish exports of many industrial goods to the EU five years. EU firms were attracted by the prospect had been mostly duty free since the 1970s, in Tur- of regulatory harmonization and accessing highly key, the CU drove a considerable reduction in tariff skilled labor with lower wages. Firms based in third and non-tariff barriers and locked in Turkey’s liberal countries that wished to export industrial goods to regime for manufacturing trade (Figure 2.3). the EU market duty-free saw an opportunity. The CU being considered a stepping stone in Turkey’s The CU has been a major instrument of integration accession process towards full EU membership was of the Turkish economy into European and global another positive factor. More recently, countries markets. The value of bilateral trade between Tur- in the Gulf and Middle East are also becoming sig- key and the EU has increased considerably. Be- nificant investors in Turkey, especially in the health tween 1996 and 2011, Turkey’s exports to the EU sector and private equity, accounting for 12 percent increased almost fourfold while Turkey’s imports of FDI inflows in 2012. Foreign investment into Tur- from the EU increased nearly threefold. Bilateral key is mostly for services and manufacturing. Large trade between the EU and Turkey reached US$148 investors include Bosch, Mercedes and Toyota. billion in 2012 making Turkey the EU’s sixth largest However, investments in agro-processing are sig- trading partner and the EU Turkey’s biggest (World nificant and growing, accounting for 7 percent of Bank, 2014a). The EU-Turkey CU was the EU’s first FDI inflows since 2007. 66 Chapter 2: Trade: Benefiting from globalization Figure 2.4: FDI inflows to Turkey as a share of emerging markets 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 FDI Inflows to Turkey as a share of Total FDI Inflows to Emerging Economies FDI Inflows to Turkey as a share of Total FDI Inflows to Middle Income Developing Economies Source: UNCTAD Note: “Emerging Economies” and “Middle Income Developing Economies” are UNCTAD’s definitions. While FDI has increased since 2003, Turkey contin- regularly conducted by the International Investors ues to lag behind large emerging market peers in Association (YASED), the main barriers to FDI in Tur- attracting foreign investors (Figure 2.4). FDI peaked key are microeconomic. In the most recent survey at US$19.1 billion in 2007, but fell sharply during (2013, 1st half), lack of legal assurance, economic the subsequent global financial crisis, and has since instability and tax and incentive policies are the top failed to recover both in absolute terms in as a three factors, followed by the size of the informal share of total FDI inflows to peer developing coun- (unregistered) economy. At the same time, Turkey’s location is a key attraction, and its young popula- tries. During 2002-2012 period, the average level tion and improving infrastructure and logistics are of FDI inflows to Turkey was modest, at US$11 bil- assets. lion, compared to over US$20 billion in India and Mexico, and over US$30 billion in Russian Federa- The CU has also proved to be a powerful force of tion and Brazil (Figure 2.5). According to surveys regulatory convergence, providing a significant im- Figure 2.5: FDI Inflows, 2002 - 2012 annual average 100 87 90 80 70 In Billion US$ 60 50 40 33 36 30 21 22 20 11 13 5 5 6 6 7 8 10 2 2 2 2 2 3 4 4 1 1 0 Russian Fed. Korea, Rep. Syrian Arab Rep. Mexico Brazil Malaysia Hungary Bulgaria Philippines Egypt Slovakia Turkey Tunisia Croati a South Africa Czech R. China Albania Jordan Romania Poland India Morocco Source: UNCTAD 67 Turkey’s Transitions petus for trade facilitation and customs moderniza- the export of products with a dynamic global im- tion. The CU has helped the alignment process with port demand. Exporter performance can be re- the EU’s acquis, improving the quality infrastruc- ferred to as “push” effects, while (ii) and (iii) can ture and facilitating reform of technical regulations be referred to as “pull” (or compositional) effects. in Turkey to the benefit of Turkish consumers. It A country’s competitiveness can usefully be mea- has also provided a significant impetus for trade sured by looking at the contribution of push factors facilitation and customs reform in Turkey including to overall export growth. As the decomposition in through modernization of the Turkish Customs Ad- Table 2.1 shows, Turkey does well here. However, ministration. Turkey’s current export basket is concentrated in sectors (like automobiles and textiles) that are not As a result of policy changes since the early 1980s, experiencing strong global import demand. De- Turkey’s exports have become globally competitive. mand factors are “pulling down” Turkey’s overall Turkey’s global export share rose from a paltry 0.2 export performance. Interestingly, pull factors are percent of total global exports in 1970 to 0.9 per- negative not because of the geographical composi- cent in 2012. This is a more than fourfold increase tion of exports, but rather because of the kinds of in relative terms. Only Republic of Korea and China, products Turkey exports. whose global export share rose 11 and 19-fold re- spectively, managed a faster ascent to global export Further insights into the impact of product and mar- prominence. Turkey’s increase in global market ket composition on Turkey’s export performance share is comparable with the dramatic emergence can be gained from a firm-level analysis. Such an of EU’s new member states after the early 1990s analysis suggests that companies in Turkey have (Figure 2.6). Over the same period, Turkey’s share chosen conservative export strategies, in terms of in global GDP increased much more slowly, from markets served and products offered. Nearly two- 0.6 percent to 1 percent. thirds of export growth during 2002-2011 resulted Figure 2.6: Turkey’s share in global exports has increased fourfold since 1970 14% 12% 10% Share of Global Exports 8% 6% 4% 2% 0% Brazil China Hungary India Korea, Poland Turkey Republic of 1970 1990 2012 Source: Direction of Trade Statistics (DOTS), International Monetary Fund (IMF) A closer look at the sources of Turkey’s export from existing companies’ increasing the amount growth confirms that the country has experienced they were already exporting in existing product a strong increase in its competitiveness. The World categories and markets (this is sometimes referred Bank has developed a set of indicators to measure to as the “intensive margin”). By contrast, growth the relative competitiveness of a country’s exports through new markets, new products and new firms by decomposing export growth into its major com- accounted for 15 percent, 9 percent, and 11 per- ponents: (i) exporter’s performance: overall capac- cent respectively (the “extensive margin”). This is ity to export any good to any market; (ii) geographic in line with the analyses in Aldan and Çulha (2013), structure of exports: capacity to export to destina- which suggest the increase in the extensive margin tion markets with booming import demand; and, of exports during 1993-2011 mostly comes from (iii) sectoral structure of exports: specialization in entering new markets. Figure 2.7 shows that the 68 Chapter 2: Trade: Benefiting from globalization Table 2.1: Decomposition of export growth: Turkey versus selected peers, 2005-2010 (in percent) Export Export Performance Pull factors Push factors Growth market (export (specialization, (“performance”, i.e., export market share growth composition effects), of share growth without composition change without which: effects), of which: composition effects) Geographical Sectoral Overall Price Volumes (Value) component component Turkey 11.8 2.4 13.1 1.0 -2.4 3.6 0.6 3.0 Brazil 14.9 5.6 11.7 2.1 1.1 1.8 2.6 -0.8 Russian 12.4 3.0 8.4 0.9 3.1 -1.2 0.6 -1.8 Federation India 14.9 5.5 14.4 0.4 0.0 4.6 -1.7 6.4 China 17.3 7.9 20.1 -0.2 -2.6 10.3 1.4 8.8 S. Africa 12.1 2.7 10.6 0.9 0.6 1.0 0.1 0.8 Germany 6.1 -3.2 6.8 -0.5 -0.2 -2.3 -1.3 -1.1 USA 7.4 -1.9 5.6 1.6 0.3 -3.6 -0.4 -3.2 Source: WB staff calculations based on data from Turkish Statistical Institute (TurkStat), Gaulier, Guillaume & Santoni, Gianluca & Taglioni, Daria & Zignago, Soledad, 2013. “In the wake of the global crisis : evidence from a new quarterly database of export com- petitiveness,” Policy Research Working Paper Series 6733, The World Bank, and Gaulier, G. & Santoni, G. & Taglioni, D. & Zignago, S., 2013. “Market Shares in the Wake of the Global Crisis: the Quarterly Export Competitiveness Database,” Working Papers 472, Banque de France. Note: Figures are for the average annual growth in exports from 2005q1 to 2010q4. countries with the highest contribution of the in- the group of countries reliant on commodity ex- tensive margin to export growth are all intensive in ports – rather than to countries with more similar the production and export of commodities, where patterns of specialization. A strategy to sustain Tur- experimentation may be slower. Turkey, despite key’s strong export performance into high income being intensive in manufacturing and at the upper should focus on boosting product and process in- end of the middle-income scale, stands closer to novation at the firm level to open up new markets. Figure 2.7: In Turkey, existing firms, existing products and existing markets contribute more to export growth than in other MICs 100% Share of export growth from intensive margin CHL PER 80% ECU PAK ZAF NIC JOR TUR 60% 40% MKD COL MEX 20% y = -0,258x + 2,7124 0% 7.5 8.0 8.5 9.0 9.5 10.0 Log GDP per capita, Purchasing Power Parity (PPP) (Constant 2005 Interna tional Dollars) Source: WB staff calculations based on data from TurkStat, World Bank’s Exporter Dynamics Database and WDI Note: Due to data availability constraints, data for each country are an average across different years. See World Bank (2014b) for details. 69 Turkey’s Transitions Turkey’s services trade presents a potential oppor- Despite the prevalence of conservative export strat- tunity to develop new fast growing exports. Tur- egies, Turkey’s exports have become much more di- key’s service sector is well developed and services versified over the past decade. This covers both the exports account for a high share of total exports composition of exports by product and – perhaps when compared with other middle income peers most conspicuously – the diversification of trading (Box 2.2). However, service exports in Turkey are partners. The success Turkey has had in export di- highly concentrated in traditional services such as versification is examined next. transport and tourism. To some extent, this reflects Turkey’s geography, with a long attractive coastal Trading partners and strip and a substantial cultural heritage, as well as a location on the main East-West transit routes. Yet, the role of the EU global trade in professional services – such as In- Turkey has significantly diversified its export mar- formation and Communication Technologies (ICT), kets over the past decade. Whereas Turkey had finance, accounting and legal services – has been a relatively high level of market concentration in growing rapidly but largely without Turkey’s signifi- 1995, it was the most diversified country in a sam- cant participation. This is, therefore, another area ple of emerging market peers by 2008 (Figure 2.9). for potential growth opportunities at the extensive Over this period, Turkey’s index of export market margin. concentration halved. Turkey’s exporters also in- Box 2.2: Trade in Services Services are an important part of Turkey’s economy and services exports are reasonably well-developed. Their overall importance in exports compares favorably to that of BRICS and regional peers. The share of services in the total goods and export basket is higher in Turkey than in all other comparators, with the significant exception of India (Figure 2.8). However, if traditional services are excluded, other private sector services (business, professional and financial services) remain among the lowest vis-à-vis comparators. The tourism sector dominates services exports to an unusual extent, accounting for roughly two-thirds of total services exports in recent years (three times the global average). Turkey also does well in construction and transport service exports. Figure 2.8: Turkey has more service exports than most peers 60% 1.000 50% 800 Share of goods exports 40% 600 30% US$, 2010 400 20% 200 10% 0% - Russian Federation Turkey South Africa Romania Poland India Brazil China Commercial services exports as share of goods exports Per capita commercial services exports (US$, 2010), right axis Source: World Bank’s Trade in Services Dataset (TSD) Although the globalization of services has resulted in a growing share of traded GDP in services globally, Turkey’s share of services trade in GDP has remained largely unchanged. Outside of tourism, Turkey’s services exports have been growing slower compared to other upper-middle income countries. Modern producer-related services still account for a relatively small part of Turkey’s exports while travel and transport account for 85 percent of Turkey’s services exports. Nevertheless, exports in a few producer-related sub-sectors (e.g. insurance and computer and information- related services) have experienced double-digit annual growth during the period of 2000-2011. 70 Chapter 2: Trade: Benefiting from globalization Figure 2.9: Turkey has diversified its export markets more than other countries 45 40 Export Market Destination 35 Concentration Index 30 25 20 15 10 5 0 Russian Federation Brazil Hungary South Africa Turkey China Korea, Republic of Romania Poland India 1995 2000 2008 Source: World Trade Indicators (WTI), World Bank creased their market access, with significant levels 2008 global financial crisis and the resulting slump of exports going to 137 countries by 2010.2 At a in Europe in particular, there have also been con- country level, too, the significant diversification of certed efforts by Turkish companies to enter new Turkish exports over the past decade is apparent. markets, for instance in Africa, in the former Soviet For example, Germany’s share of Turkey’s total ex- Union and to a lesser extent in Asia and Latin Amer- ports was reduced by almost half over the decade ica. Government policy, especially since 2007, has (from 20.7 percent to 10.5 percent). Within Middle contributed to these outcomes. East and North Africa (MENA), exports became less reliant on Israel (although it remains one of the Market diversification has been significantly helped main destinations in the region) and more depen- by government policy. In the aftermath of the ma- dent on Iraq, Islamic Republic of Iran, and the Unit- jor economic crisis in 2001, the contraction in do- ed Arab Emirates. Other non-traditional trading mestic demand and devaluation of the TL formed partners that have become more important des- the basis for the move towards export-orientation. tinations for Turkish exports over the past decade New policies were introduced to expand exports are Russian Federation, Azerbaijan, and China. As to selected “target markets”, attract more FDI and shown in Table 2.1, thanks to successful diversifica- develop a global “Made-in-Turkey” image. Among tion of markets, Turkey’s exports benefited from a support programs were those for trade missions strongly positive geographic pull effect over the pe- abroad and international trade fair participation. riod 2005-2010 despite being significantly exposed The “target markets/countries” approach contin- to the underperforming European market (World ued into the 2010s. In the context of the Market Bank, 2014b). Access Committee established for new market pen- etration, studies have been carried out to identify To a large extent, market diversification has fol- target countries as well as a different set of “prior- lowed a well-trodden path. As exports to the EU ity countries”. For example, for the period of 2012- declined, exports to MENA increased, in a pattern 2013, 17 target countries and 27 priority countries reminiscent of the late 1970s (Figure 2.10). The EU were approved by the Market Access Committee. has been a major trading partner for Turkey ever Exporters to the target countries can receive ad- since the European Economic Community (EEC) ditional support according to two circulars issued was established in 1957 and especially since the by the Ministry of Economy.3 The selection of these CU went into force in 1996. It has generally been countries was based not only on the size of the Turkey’s largest trading partner, with the MENA market and openness of the country, but also on a region taking second position. However, after the comprehensive macroeconomic analysis, the com- 2 Includes destinations with exports of more than US$10 million. 3 2009/5 and 2010/6. 71 Turkey’s Transitions Figure 2.10: Exports to MENA are the mirror image of exports to Europe 70% 60% Share of Turkey`s Total Exports 50% 40% 30% 20% 10% 0% 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Africa Developing Asia European Union Middle East and North Africa Sub-Saharan Africa Source: DOTS, IMF. Note: All the group definitions are from DOTS’ petitiveness analysis of Turkish exports within each serving multiple destinations, such as establishing market, the judicial and trade infrastructure, the distribution networks, complying with standards, state of services trade and strategic considerations and dealing with cross-border trade finance is- such as energy links.4 sues and customs.6 This is not unusual and data for countries such as Chile, South Africa and France Logistics and business networks have also helped. show that aggregate exports are largely driven by The impressive expansion of Turkish Airlines (from a few leading exporters that supply several foreign 66 international destinations in 1998 to 199 in markets. This notwithstanding, market penetration 2013) facilitated the outreach of Turkey’s exports by Turkish firms increased overall and the average and exporters. Turkish Airlines now flies to over 240 number of exporters per destination almost dou- destinations (including domestic flights) compared bled between 2002 and 2010 (World Bank, 2014b). to 215 destinations for Lufthansa and about 200 for Air France. Turkey has also entered markets per- The diversification of exports away from the EU is ceived as high risk by European suppliers, helped by thus, largely a story of existing exporters diversify- the flexibility of Turkish exporters in business pro- ing their customer base. Only four percent of the cesses, receiving and delivering orders (frequently firms exporting to the EU in 2009, switched to other cited by exporters as a distinguishing feature), in- markets in 2010 (meaning they stopped exporting creasing business networks, as well as increased to the EU and started exporting to other markets). social and cultural ties. Turkey’s exports also ben- The share switching to the MENA region was one efited from the good quality reputation Turkish percent. By contrast, the share of exporters ex- companies have acquired by successfully exporting panding to other markets in 2010 was 13 percent, to the EU market.5 of which 3 percent added MENA. A full 71 percent of the exporters that entered MENA for the first The drivers of Turkey’s expansion into new markets time in 2010 expanded there from the EU (World have generally been firms with solid export experi- Bank, 2014b). This is consistent with the finding in ence in the EU. Micro-level data analysis for Turkey Ulu (2014) that the search costs of entering new shows that market expansion and diversification foreign markets fall with the number of countries a have been driven by a few leading exporters, i.e., firm is already present in. Nonetheless, for some of those able to face the trade costs associated with the fast expanding enterprises in Turkey’s Anatolian 4 T.C. Başbakanlık Devlet Planlama Teşkilatı. 9. Kalkınma Planı 2007-2013, Özel Ihtisas Komisyonu Raporu: Dış Ticaret, Ankara, 2007 and Ministry of Economy website. 5 One Ambassador from an African country in Ankara told the authors why his country likes Turkish exporters: “They offer European quality at Turkish prices.” 6 Large exporters are measured as those with more than 200 employees. The breakdown of small, medium, large sized firms used on the source of this analysis (World Bank 2014b) differs slightly from the definition used by OECD, for example, which considers firms with less than 250 employees “SMEs”. 72 Chapter 2: Trade: Benefiting from globalization provinces, the geographic proximity to the MENA Diversification of export markets improves firm sur- market as well as the substantial investments in vival (Figure 2.11). It seems firms use the EU and transport infrastructure has opened access to ex- European Free Trade Association (EFTA) market as port markets for the first time (Chapter 4). a testing ground before aiming at more difficult markets. Figure 2.11 shows that only 22 percent of One reason that EU exporters have been more suc- exporters to the EU and EFTA remained in business cessful in diversifying into other markets is that seven years after entry in the market. For exports to exporting to the EU is associated with higher pro- other regions, the 7-year survival rate was higher: ductivity. Cebeci (2013) evaluates the role of export 29 percent to MENA, 27 percent to the rest of Eu- destinations on productivity, employment, and rope and Central Asia, and 23 percent to the rest of wages of Turkish firms by comparing the perfor- the world. A higher degree of churning – or mortal- mance of firms that export to low-income destina- ity – in given destinations can be a symptom of low- tions and those exporting to high-income destina- er fixed costs to that destination and higher compe- tions with those that do not export. Beginning to tition in that market. Since the non-EU neighboring export to the EU market enhances firm productivity markets are relatively more uncertain and fraught in Turkey: significantly increasing total factor pro- with higher fixed costs, only more competitive ex- ductivity (TFP) by 7.4, 8.1 and 9.7 percent (com- porters have the resources to test markets, face pared to non-exporting firms) in the first, second uncertainties and absorb fixed costs.7 Government and third year of exporting to the EU, respectively. support may thus play a particularly important role In contrast, beginning to export to MENA does not in encouraging firms to move to these more diffi- bring significant benefits to firms’ TFP. For average cult destinations. But ultimately, to enter the high wages, the impact of exporting to the EU is estimat- growth markets of Asia, Turkey needs to move up ed to be 1.3, 3.5 and 3.8 percent (relative to non- the value chain. We now look at the progress the exporting firms) for each the first three years of ex- country has made in this regard over the past de- porting whereas the impact of exporting to MENA cade and the challenges still ahead. is not statistically significant. Figure 2.11: Export survival of export relationships in different world regions 60% Share of firms s till expor ting to the region a fter 50% 40% n years 30% 20% 10% 0% 1 year 2 years 3 years 4 years 5 years 6 years 7 years EU MENA Rest of Europe and Central Asia Rest of the World Source: WB staff calculations based on data from TurkStat Note: Survival after 1 year is the average of survival rates between 2003 to 2010, survival after 2 years is the average of survival rates between 2004 to 2010, survival after 3 years is the average of survival rates between 2005 to 2010, survival after 4 years is the average of survival rates between 2006 to 2010, survival after 5 years is the average of survival rates between 2007 to 2010, survival after 6 years is the average of survival rates between 2008 to 2010, survival after 7 years is the survival rates for 2009. All the region definitions are TurkStat’s. 7 Both facts are supported by evidence that the average and median value of exports for entrants in the first year of exporting activity is lower for firms going to EU or EFTA countries than for those going to MENA countries. One caveat is that due to the more informal nature of trade – including suit- case trade – with non-traditional partners, export flows to MENA may not capture the most short-lived trading relationships and thus underestimate the degree of churning that actually takes place. 73 Turkey’s Transitions Figure 2.12: Vehicles increase, textiles decline 40% 35% 30% Share of Total Exports 25% 20% 15% 10% 5% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Other Vegetables Foodstuffs Textiles Metals Machinery Vehicles Source: Comtrade (via World International Trade Statistics (WITS)) Trading products: source-based export sectors including those related to metals (e.g. iron and steel), agricultural products technology-content, sophistication, (sugar, tobacco, fruit and vegetables), as well as in and quality textiles, and some chemicals, while simultaneously developing an RCA in new sectors such as road ve- Increasing export quality, however hicles, dying, tanning and coloring of materials. measured In parallel with the shift in sector composition, Tur- There has been a significant change in the sectoral key’s export basket has become more diversified, composition of Turkey’s exports over the last de- much like its export destinations. Turkey’s export cade. The share of the textile and apparel sector, basket is extremely diversified both relative to the which accounted for 40 percent of exports at the BRICS and regional peers (Hungary, Poland, Czech beginning of the decade, declined dramatically (Fig- Republic, and Romania). Among this group, Turkey ure 2.12). It was replaced, in particular, by the au- has the lowest level of export product concentra- tomotive sector, which grew rapidly during this pe- tion, and along with Hungary is the only country to riod, but also by the machinery and metals sectors. have diversified over the past decade. While the This decade-long pattern of structural transforma- top 10 products in Turkey’s export basket account for about the same share of exports in 2010 as they tion slowed from 2007, however. Indeed, while the did in 2000 (26.4 percent in 2010 and 27.5 per- global financial crisis may have contributed to Tur- cent in 2001), there has been an increase in both key’s export market diversification, it has also co- the range of products being exported and in the incided with a period of relative stagnation from a strength of some of the non-traditional products.8 sector and product perspective. The vehicles sector Turkey exports 2.5 times as many products than was the most affected by the crisis and the slow- it did a decade earlier; a faster expansion than all est to recover from it. Export growth after the crisis BRICS other than India (World Bank, 2014b).9 has been less dependent on vehicles and transport equipment and more dependent on metals, ma- Turkey has significantly increased its medium-tech- chinery, and textiles, as well as food and beverag- nology exports. The share of medium technology es and chemicals (especially plastics), which have exports in total exports increased by more than re-emerged as important export sectors. Indeed, half over the last decade from 22 to 34-35 percent, Turkey over the past decade maintained a revealed although it recently declined to 30 percent in 2012 comparative advantage (RCA) in a number of re- most likely linked to the decline in automotive ex- 8 This result applies at the 4-digit level of the Harmonized Classification (HS). 9 This result applies at HS 6-digit classification. 74 Chapter 2: Trade: Benefiting from globalization Figure 2.13: Medium-tech exports are up but high-tech exports remain small (Medium-tech exports, Share of total, 2000-2010) 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 BRIC Average (South Africa is excluded) MENA Average (Syrian Arab Republic & Tunisia are excluded) New EU Members Average EU Candidate Average Growth Markets Average Turkey Figure 2.14: (High-tech exports, Share of total, 2000-2010) 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 BRIC Average (South Africa is excluded) MENA Average (Syrian Arab Republic & Tunisia are excluded) New EU Members Average EU Candidate Average Growth Markets Average Turkey Source: WB staff calculations based on data from Comtrade (via WITS) Note: “MENA Average” refers to unweighted average of Egypt, Jordan, Morocco, Syrian Arab Republic and Tunisia. “EU Average” refers to unweighted average of Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia. “EU Candidate Average” refers to unweighted average of Albania, Croatia and Serbia. “Growth Markets Average” refers to unweighted average of Indonesia, Malaysia, Mexico, Philippines and Republic of Korea. Technological classification is based on Lall (2000). ports. High-technology, however, have failed to The sophistication of Turkish exports also improved gain a foothold in the export basket (Figure 2.13). through 2007. After increasing almost 20 percent Indeed, Turkey compares unfavorably in this re- between 1997 and 2007, the index of export so- spect with its BRIC competitors and with other EU phistication (EXPY, see Box 2.3) declined between candidates, which seem to have benefited far more 2007 and 2009, but regained most of this ground from technology transfer through FDI and the inte- again after 2010 (Figure 2.14). The increasing im- gration into European production networks. portance of mid-tech exports (mainly automobiles 75 Turkey’s Transitions Box 2.3: Measuring a country’s export sophistication In addition to indicators of technology content, economists recently have started to measure the sophistication of a country’s export basket. Hausmann, Hwang and Rodrik (2007) argue that exporting more sophisticated products leads to faster growth, due to the prospect of benefitting from higher spillovers of knowledge and technology embodied in these products. The sophistication of a particular export is measured by looking at which countries tend to specialize in its production. If a product, such as, an internal combustion engine, is largely produced by rich countries, that product would be revealed to be ‘rich’ and sophisticated. Similarly, coffee beans would be classified as having low sophistication, as low income countries dominate coffee bean production worldwide. The sophistication of a country’s export basket – denoted as ‘EXPY’ – derives from the sophistication of the basket of individual products (denoted as ‘PRODY’) it exports.13 More recently, Hausmann, Hidalgo et al. (2011) have improved on this measure by moving away from the reliance of PRODY and EXPY on the income levels of countries. Under the new approach – ‘The Product Complexity Index’ – complexity is a function not of income of countries but is calculated through an iterative process based on the network of relationships of countries and the products they export. Specifically, under this new approach, the complexity of a country’s export basked is a function of two concepts: i) The diversity of products it produces (i.e., the number of distinct products that it makes); and, ii) the ubiquity of those products (i.e., how many other countries make that product). Countries that have complex export baskets are more specialized and can fetch higher values for their exports. and auto parts) played an important role in the the quality range, including 28 percent in the top evolution of Turkey’s EXPY as they replaced less third of the destination-adjusted price distribution sophisticated products (garments and textiles) as (double the level of 2002). Thus, in less than a de- the top export sectors and allowed the country to cade, Turkey’s export quality distribution improved narrow the gap with countries such as Poland and significantly.14 Mexico until 2007. The complexity measure reveals a broadly similar pattern to EXPY. The decline in ex- A more detailed analysis reveals that quality im- port sophistication and complexity after 2007 can provements have not been uniform across prod- be at least partially attributed to the commodity ucts and destination markets. For such an analysis, price boom of 200812 and to the decline in automo- the concept of quality ladders is useful.15 To see tive and other mid-tech exports to the EU. where a country is positioned in a differentiated product space, one looks at all the exporters selling Indicators of product quality, as reflected in unit a particular product in the same destination mar- prices, also confirm the substantial upgrading of ket, and compares unit prices across this specific Turkey’s export basket. Figure 2.15 shows that market. Low quality, and cheap products are at the while in 2002 two-thirds of exports were concen- bottom of the ladder, high quality, and expensive trated in products which were sold at a unit price products at the top. Turkish exporters have gener- in the bottom third of the price distribution, i.e., ally climbed up the quality ladders but the patterns compared to the price of all competitors selling to differ across product categories and destination the same destination market, by 2010 the majority markets. Specifically, across the main product cat- of products were sold at the middle or high end of egories, the following trends can be established: 12 The commodity price boom affected Turkey’s EXPY by increasing the value (and share in total exports) of raw materials and commodity exports, because commodities are less sophisticated than other products (e.g. manufactures). The decline of world trade in 2009 affected Turkey’s EXPY by reducing disproportionally exports to developed countries (especially the EU-27, the main destination of more sophisticated goods). 13 Hausmann, Hwang and Rodrik (2007) show that countries with high EXPY tend to have higher growth rates in the future, supporting the idea that countries ‘become’ what they export by converging to the income level implied by their export baskets. Yet, this may only be part of the story because the same final product could be produced in different ways that embody more or less technology and because the production of one good may be separated into a variety of tasks, each requiring different levels of technology and knowledge. How you export may matter as much as what you export. 14 Unit price differences across products of the same category intuitively reflect differences in product quality. Thus a BMW is not the same as a Geely and does not cost the same, even though both are counted as a vehicle in standard product classifications, even at highly disaggregated level. A number of other factors may however account for unit price differences, and hence careful interpretation is in order. For references establishing an empirical link between product quality and unit values of exports, see Crozet et al. (2012), Manova and Zhang (2012). 15 Data on unit prices is used to develop analyses of quality ladders, measuring the relative quality of a country’s exports against all other countries that export a specific product (worldwide or to a specific market) and the evolution of Turkey’s exports over time. Quality ladders are a tool to benchmark an exporter’s position in a differentiated product space across products and destination markets. 76 Chapter 2: Trade: Benefiting from globalization Figure 2.14: Turkey’s export sophistication has increased (EXPY) (2000-2010) 21,000 20,000 19,000 (SUM) EXPY 18,000 17,000 16,000 15,000 14,000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 BRIC Average (South Africa is excluded) MENA Average (Syrian Arab Republic & Tunisia are excluded) New EU Members Average EU Candidate Average (no data point is available for Serbia in 2003) Growth Markets Average Turkey Source: WB staff calculations based on data from Comtrade (via WITS) Note: “MENA Average” refers to unweighted average of Egypt, Jordan, Morocco, Syria and Tunisia. “EU Average” refers to unweighted average of Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia. “EU Candidate Average” refers to unweighted average of Albania, Croatia and Serbia. “Growth Markets Average” refers to Indonesia, Malaysia, Mexico, Philippines and Republic of Korea. Figure 2.15: Export quality as reflected in unit prices has also gone up (2000 and 2010) 70% Share of export by rela tive unit value, measured 60% 50% 40% at HS6 level 30% 20% 10% 0% low unit value mid unit value high unit value 2000 2010 Source: WB staff calculations based on data from Comtrade (via WITS) • Agri-food sector: Turkey has been in the lower • Other Vehicles: The positioning of Turkey im- part of the quality ladder during the entire pe- proved substantially from 2000 to 2008 both in riod and for exports to both the EU and MENA. the EU and MENA. In the latter, its positioning is The quality ladder is significantly longer in the at the top of the range along with France, Swe- EU than in MENA, but the difference between den, Canada and Japan. the two was reduced by one third between 2000 and 2008. • Electrical and mechanical machinery: In both sectors, the ranking of Turkey improved dra- • Auto and auto-parts: The ranking of Turkey matically in the MENA market. Its ranking in the went up in the EU between 2000 and 2008, but EU market, on the other hand, remained at the decreased somewhat in the MENA region due bottom of the range. to the entry of many more competitors mainly from East Asia. • Textiles and Clothing: The ranking remained un- changed in both regions. 77 Turkey’s Transitions Drivers of quality improvement: and reductions in trade costs are important contrib- European integration and GVCs utors to moving up the quality ladder (see below). The upgrading of Turkey’s export quality has been Import content and higher unit values contribute closely linked to the country’s European integration to firm survival. Figure 2.16 shows that the survival and the rising prominence of Turkish producers in rate of firms exporting goods with higher relative unit values is much higher than for firms exporting GVCs. Those concerned with Turkey’s limited pres- lower value products. And once again, firms with ence in high tech goods exports have sometimes ar- higher import content16 have higher survival rates. gued for a targeted national policy to support high Interestingly, the relationship between quality and tech sectors and reduce dependence on imports, imported inputs decays over time, suggesting that thereby boosting the value added generated in Tur- exporters may, over time, shift to domestic suppli- key’s export sector. However, an analysis of GVCs ers. It is also worth noting that investments in qual- reveals that Turkey’s increased economic integra- ity pay off more quickly for larger firms than for tion and increased quality imports have been at the smaller firms. The latter need a longer time before core of this export quality improvement. seeing the beneficial effects on export growth. Firm level analysis shows that companies exporting The benefits of European integration are also re- higher than average quality goods are larger, tend flected in the increase in intra-industry trade. Intra- to have higher reliance on imported inputs and industry trade is a measure of the extent to which are more likely to be fully foreign owned. The CU domestic producers are integrated into production with the EU has opened Turkey up to higher qual- networks with trading partners. The CU has closely ity imports as well as to European FDI. This has integrated Turkish companies into European pro- been an important driver of quality improvements. duction networks in sectors such as automobiles High unit values are also negatively associated with and clothing. Consequently, intra-industry trade trade costs. Turkish companies seem to be selling between Turkey and the EU has increased from 30 the highest value products to the most accessible percent in 1990 to over 50 percent in 2012. The markets. In this sense, improvements in logistics reduction in trade costs associated with the CU in- Figure 2.16: Firms exporting higher quality goods and having greater reliance on imported inputs are more likely to survive 60% 50% 40% Survival rate 30% 20% 10% 0% Quality Import content Low to medium Medium to high All firms Source: World Bank (2014b), WB staff calculations based on Turkstat data 16 Import content is defined as “value of intermediate goods import/total sales” per firm-year. Intermediate goods include the following categories based on Broad Economic Categories (BEC) classification: 111 - Primary food and beverages, mainly for industry, 121 - Processed food and bever- ages, mainly for industry, 21 - Primary industrial supplies not elsewhere specified, 22 - Processed industrial supplies not elsewhere specified, 32 - Processed fuels and lubricants, 42 - Parts and accessories of capital goods (except transport equipment), 53 - Parts and accessories of transport equipment. 78 Chapter 2: Trade: Benefiting from globalization cluding the harmonization of standards is likely to come, it will need to move up GVCs and specialize have promoted growing intra-industry trade along in higher value segments. GVCs, which are known to be particularly sensitive to trade costs (WEF, 2013). Duty-free access to the One of Turkey’s advantages as a source country for EU markets has helped to increase the sophistica- production facilities is its good connectivity, partic- tion and quality of Turkey’s exports. Between 2001 ularly with European markets, while trade costs for and 2008, Turkey’s total intra-industry trade in distant markets remain higher. Differences in size manufacturing has increased significantly; only be- and endowments of national economies are not low the increase in Iceland, and considerably faster the only explanation for differences in the volume than in Hungary, Mexico and India (OECD, 2010, of trade and in its complexity, in terms of export p.211). participation and diversification of trade patterns. Distance and supply-side constraints and inefficien- Turkey’s participation in GVCs is comparable with cies play a large role. Bilateral trade costs between that in larger high income countries. The partici- countries capture the price equivalent of the re- pation index17 measures the foreign value added duction of international trade as compared with embodied in gross exports and the domestic value the potential implied by domestic production in the added embodied in third countries gross exports.18 origin country and consumption in the destination OECD (2012) finds that Turkey’s participation rate markets (Anderson, 2002; Novy, 2010).19 Higher bi- is just below 50 percent. The participation rate of lateral trade costs result in smaller bilateral trade Turkey is about the same as the one of India, Italy, flows. the UK and Japan. It is higher than the participation of comparable mid-sized emerging countries such Turkey has relatively low trade costs when com- as Mexico, Brazil and Argentina, and also slightly pared to competitors in the region (Figure 2.18, first higher than that of China, but lower than that of graph). Trade costs vis-à-vis EU markets – in partic- smaller high income and middle income countries. ular with France and Germany - are lower for Tur- key than for Romania, Bulgaria or Greece although Within GVCs, Turkey specializes in lower value seg- Turkey is not an EU member. With respect to Italy, ments, such as final product assembly. Typically, on the other hand, Greece, Bulgaria and Turkey the highest value segments are at the origination have about the same level of bilateral trade costs. and design stage, or in marketing and consumer With distant markets, such as the United States, service. Assembly is labor intensive and, hence, China, Brazil or Japan, Turkey does unequivocally tends to dominate in MICs. Other countries with better than Greece or other Black Sea countries but strong presence in assembly are the Dominican its trade costs are almost twice as high as those of Republic, Honduras and Mexico in the Americas; the larger EU members (Figure 2.17, second graph). Germany, Hungary, Slovakia, Slovenia and Tunisia Turkey would need to narrow these differences to in the European and Mediterranean region; China, effectively compete with high income European Cambodia, Thailand and Viet Nam in Asia (Gangnes suppliers in the fast growing markets of the Pacific et al., 2012). Taymaz et al. (2011), dividing the pro- region. duction process of traded goods into five different categories according to The United Nations (UN) Low trade costs are also reflected in Turkey’s rela- Broad Economic Category (primary good; semi-fin- tively good logistics performance. The performance ished products, intermediate inputs, parts and ac- of international supply chains is measured using the cessories, and consumption goods), also find that Logistics Performance Index (LPI). It is based on the Turkey specializes in downstream labor intensive assessment of logistics professionals located in the segments of the value chain. Turkey exports mostly country’s major trading partners, and is a weight- consumption goods and semi-finished products ed average of six components that are critical for as intermediate inputs and imports semi-finished logistics performance. Turkey compares well with products, capital goods and primary goods. It spe- its neighbors and current competitors in logistics cializes in sectors and production processes that performance (Figure 2.18). It is 27th in global rank- are labor intensive. As Turkey moves up to high in- ings, just below China and above Portugal, which 17 See Koopman et al. (2011) for a definition of the participation index. 18 The higher the foreign value added embodied in gross exports and the higher the value of inputs exported to third countries and used in their exports, the higher the participation of a given country in the value chain. The OECD (2012) has computed this indicator for OECD countries and se- lected non-OECD countries. Country size – in particular relative to regional peers – appears to matter. Both in advanced and emerging economies, smaller countries such as the Czech Republic, Singapore, Estonia, the Slovakia and Taiwan, Province of China post participation rates between 60 percent and 80 percent. By contrast larger countries have a lower participation index. 19 The recently published World Bank- United Nations Economic and Social Commission for Asia and The Pasific (UNESCAP) dataset (Arvis et al. 2013) proposes comprehensive measures of trade costs for 178 countries over the 1995-2010 period using the inverse gravity methodology due to Novy (2013). 79 Turkey’s Transitions Figure 2.17: Bilateral trade costs for Turkey and comparator countries Vis-à-vis select EU markets 120% 100% 80% Ad valorem equivalent 60% 40% 20% 0% Greece Bulgaria Romania Turkey Germany France Italy Vis-à-vis large non-EU countries 250% 200% Ad valorem equivalent 150% 100% 50% 0% Greece Bulgaria Romania Turkey Germany France Italy USA China Brazil Japan Source: Trade Costs Database, World Bank (data for Greece is 2008) occupy the 26th and 28th position respectively. The Trading up to high income comparison is even more favorable when the LPI is adjusted for the level of development as measured Policy reform measures starting in 1980, including a by the gross national income per capita; Turkey per- major liberalization of trade policies, have laid the forms better than countries with similar per capita basis for Turkey’s integration into the global econo- income (Figure 2.18 and Figure 2.19). Spotlight 2 my and its solid export performance since 1980. A reviews in more detail Turkey’s investments in in- relatively favorable global economic environment, frastructure and in particular the policies that have with healthy import growth demand, has helped allowed the country to leverage significant private Turkey increase its openness. Özal’s private-sector sector investments in improving connectivity. Tur- focused policies included a shift from import sub- key’s integration with the European market has stitution to export promotion and reduction in im- both provided an incentive and, in turn, been facili- port quotas and tariffs. During this period, various tated by investments in connectivity and logistics. export promotion policies were introduced, rang- 80 Chapter 2: Trade: Benefiting from globalization Figure 2.18: Turkey ranks high in logistics performance compared to its neighbors… 140 116 120 110 LPI Country Ranking, 2014 100 90 85 80 61 62 63 65 60 54 55 58 47 49 40 43 44 40 31 32 33 34 35 24 26 28 30 15 18 20 21 20 9 13 1 2 5 0 Russian Fed. Korea, Rep. Brazil Singapore Hong Kong Spain Hungary Portugal Germany Finland Czech Republic Bulgaria Ukraine Lebanon Egypt United States France Cyprus South Africa Slovakia Turkey Croati a Tunisia Greece Georgia China Italy Poland Romania India Netherlands Thailand Saudi Arabia Serbia Source: LPI Database Note: In the chart, a smaller number indicates better performance. Figure 2.19: …and performs better than countries with a similar per capita income 4.5 DEU 4.0 CAN ESP ITA MYS PRT CHN TUR CZE ZAF THA LPI Score 2014 3.5 POL ROM HUN IDN BGR HRV SVK GRC MAR UKR EGY IND MEX 3.0 SRB BRA PHL KAZ RUS ALB JOR MDA AZE TUN 2.5 GEO 2.0 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 GDP per capita 2012, PPP (current interna tional $) Source: WDI, LPI Database Note: In the chart, a higher number indicates better performance. ing from legislative changes for tax rebates and tax deepened, and the CU has closely integrated Turk- exemptions to credit and insurance mechanisms. ish companies into European and global produc- tion networks for automobiles and clothing. It has Turkey has become part of the European conver- gence machine. Closer economic integration with helped raise the quality and sophistication of Tur- the EU, including through the CU that went into key’s exports. Moreover, exporting to the sophis- force in 1996, has helped Turkey integrate into ticated EU market has been an important spring- both European and global markets. Trade and in- board for Turkey’s companies to facilitate their vestment linkages between the EU and Turkey have entry into MENA and other non-EU markets. 81 Turkey’s Transitions Despite its remarkable integration, Turkey still re- But while exports to MENA have grown fast, the mains less open than other upper middle income MENA market as a whole is likely to remain limited. countries. Turkey`s openness ratio (at 58 percent) MENA’s total imports amounted to US$830 billion now compares favorably with the “BRICS”, yet it in 2010. Germany imported US$1,100 billion from is well below that of many smaller MICs in East the world in the same year. The market in the EU as Asia or Eastern Europe (Figure 2.20). Moreover, a whole is more than 6.5 times larger than that of exports of goods and services as a share of GDP MENA. This means that even with growth of as little have remained roughly constant throughout the as 1-2 percent a year, the additional market poten- past decade, whereas, for example, exports to GDP tial generated in the EU will be greater than what is increased from 10 percent to 25 percent in India generated in MENA (World Bank, 2014b). and from 21 percent to 41 percent in Poland. FDI inflows are also relatively lower than in comparator But most importantly, to continue to benefit from countries. diversification of markets, Turkey should aim at the fast growing markets of Asia. Turkey is likely to face While Turkey has performed well, sustaining ex- increasing competition in the EU market, not only port growth going forward cannot be taken for from China, but also from countries with whom the granted. The external environment is currently less EU has recently concluded free trade agreements favorable with suppressed global import demand or is in the process of negotiating free trade (includ- growth. Moreover, Turkey’s current export basket ing Mexico, Republic of Korea, South Africa, and, is concentrated in relatively slow-growth and mid- going forward, Canada, Japan, and USA). The ero- tech sectors, with limited high-tech exports. And sion of Turkey’s preferential access to the EU and so far, export growth has been by-passing Turkey’s the slow-down in MENA import demand mean that smaller and medium-sized companies, linked to the increases in competitiveness to withstand com- high fixed costs of engaging in trade. petition in the EU and diversification into markets beyond MENA may be critical going forward. The As the advanced economies of Europe and North Government’s support of efforts to increase trade America finally recover from the 2008-2009 global with Africa and East Asia may be able to play a role economic and financial crisis, Turkey’s close links in this regard. with the European economy may again turn to an advantage. In the wake of the crisis in the EU, a lot Turkey’s move towards high-income will require has been made of Turkey’s successful export mar- greater trade and investment integration into the ket diversification as a key risk mitigation strategy. global economy as well as an upgrading of the Figure 2.20: Turkey’s trade openness remains lower than in high-growth markets Exports + Imports of goods and services 160 134 140 120 Percent of GDP 100 92 78 80 68 70 57 59 60 49 40 41 40 28 31 19 20 11 0 BRICS Average Turkey MENA Average Growth Markets New EU Members (Excludes Russia in (Morocco & Tunisia Average Average 1970, but includes & Egypt) later) 1970 1990 2011 Source: WDI, World Bank. Note: “MENA Average” refers to unweighted average of Egypt, Jordan, Morocco, Syrian Arab Republic and Tunisia. “Growth Markets Average” refers to unweighted average of Indonesia, Malaysia, Mexico, Philippines and Republic of Korea. The “New EU Members” refers to Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia. 82 Chapter 2: Trade: Benefiting from globalization export basket. Turkey should aim to significantly data suggests that a one percent increase in firm boost its share of global FDI, building on its exist- or product entry leads to a 1.9 percent increase in ing integration into European value chains. There export growth. By contrast, a one percent increase is considerable scope for moving up these value in market reach only leads to 0.25 percent export chains, as well as benefiting from new opportuni- growth. ties in the booming trade in global professional and medical services. Going forward, having more Growth will need to be increasingly driven by fron- dynamic mid-sized firms with better access to ex- tier innovation. While higher rates of product inno- porting and a greater focus on not only quantity but vation come primarily from larger firms, with the also the quality of exports will be key. capacity and range of skills necessary to invest in R&D, experience from other countries shows that There is clearly scope for creating an even more dynamic base of exporters in Turkey. International the contribution of smaller firms is quite important. experience shows that dynamic firm and product Moreover, although Turkey currently specializes entry is critical for overall export growth. World mostly in activities in the middle of GVCs, focusing Bank (2014b) shows that Turkey’s exports have on standardized labor-intensive manufacturing ac- grown fastest when new firms enter into the export tivities, it specializes in sectors with relatively long market and existing firms introduce new products. value chains. 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Uluslar- Sorting and Trade: Firm-level Evidence for French arasi Üretim Zincirlerinde Dönüşüm ve Türkiye`nin Wine. Review of Economic Studies, 79(2), 609-644. Konumu. Çalışma Raporları Serisi. TUSIAD-Koç Üni- versitesi Ekonomik Araştırma Forumu. Foroohar, R. (2012, Feb. 09). Time. Retrieved 2013, from http://business.time.com/2012/02/09 Ulu, M. (2014). Heterogeneity and Uncertainity in three-economic-lessons-imported-from- the Dynamics of Firm Selection into Foreing Mar- turkey/#ixzz2pcbQotAv kets. Working Paper No 14/01. Central Bank of Tur- key. Gangnes, B., Ma, A. C., & Assche, A. V. (2012, June). Global Value Chains and the Transmission of Busi- WEF. (2013). World Economic Forum. World Com- ness Cycle Shocks. Asian Development Bank Eco- petitiveness Report. Geneva. nomics Working Paper Series No.29. Asian Devel- World Bank. (2014a). Evaluation of the EU-Turkey opment Bank. Customs Union. World Bank. Gill, I. S., & Raiser, M. (2012). Golden Growth: Re- World Bank. (2014b). 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Hong Kong Institute for Monetary Research. 84 3 Chapter 3: Finance : Banking sector restructuring and financial integration Chapter Finance: Banking sector restructuring and financial integration Infrastructure Fiscal Space Trade Welfare Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 85 Turkey’s Transitions 86 Chapter 3: Finance : Banking sector restructuring and financial integration Finance: Banking sector ing to around a third of the country’s Gross Domes- tic Product (GDP). This chapter draws the lessons restructuring and financial from Turkey’s banking sector restructuring experi- integration ence and asks whether the country is well placed B to benefit from and manage the risks of today’s dy- ankers are often seen as the villains of the namically changing global financial landscape. Spe- modern economy. The collapse of Lehman cifically, the chapter asks and answers three main Brothers, an investment bank, stood at the questions: beginning of the global economic and financial crisis in 2007, banks fuelled the housing bubbles • First, how did Turkey overcome the deep finan- from Ireland to Spain (and some worry continue cial and banking crisis of 2001 and what are the to do so in China), banks required large injections lessons for other countries dealing with the af- of public funding when these bubbles burst and in termath of a banking collapse? The answer is turn found themselves at the heart of the sovereign that far from being merely a technical exercise, debt crisis in Europe. Bankers have been accused of the reason for the lasting success of the 2000- greed and recklessness, and fined heftily for misin- 2001 reform was a root and branch change in forming their customers and manipulating the in- the “way of doing banking”. Bank owners paid a terbank market. In emerging markets, particularly high price for previous reckless behavior, regu- in Central and Eastern Europe, banks lubricated the lators were given true independence and used it even at considerable political and sometimes European convergence machine during the 2000s, personal risk, and macroeconomic, financial by financing large external deficits and breaking and fiscal policies were closely coordinated. But the link between savings and investment that had perhaps the most important lesson is that un- held many developing countries back in the past. derlying governance weaknesses were squarely However, in the aftermath of the global economic addressed. and financial crisis, as parent banks struggled to re- build their capital buffers, capital has flown out of • Second, how has Turkey managed the surge in Europe’s periphery again and forced a painful ad- capital inflows since the global economic and justment. financial crisis, in the context of loose interna- tional liquidity? This question is of considerable Among their much maligned international peers, interest in many emerging markets, initially af- Turkey’s banks today stand out as beacons of sta- fected by the dramatic expansion of the balance bility. Turkey’s banking system was the only one in sheet of the world’s reserve banks and – since the The Organisation for Economic Co-operation May 2013 – by the prospect of tapering of ex- and Development (OECD) that withstood the head- traordinary monetary interventions. The chap- winds of the global economic and financial crisis ter shows that Turkey has experimented with a without an injection of public funds. It still boasts range of monetary and macro-prudential tools, enviably strong capital buffers –the risk-weighted but the verdict on their effectiveness relative to average capital-asset ratio in the system stood at more conventional instruments is still out. 16 percent at the end of 2012 – and while many • Third, as the benefits of excessive reliance on banks have retreated from Central and Eastern foreign savings are being reconsidered, how Europe, the Turkish banking system experienced well is Turkey placed to mobilize domestic sav- a continued increase in inflows after 2007. But de- ings and broaden its financial sector beyond the spite relatively rapid, and to a considerable extent strong reliance on banks? Turkey’s experience foreign-financed credit growth in recent years, the with premature financial sector liberalization sector’s loan to deposit ratio is still a moderate 110 in the late 1980s, before strong independent percent. Foreign investors and analysts alike point regulation had been firmly established, has cau- to Turkey’s banking system and strong, stability- tioned policy makers against opening up new oriented regulation, as an element of strength in segments of the financial sector too quickly. Turkey’s macroeconomic outlook and international However, for the past three or four years, Tur- competitiveness. key has started to reform its capital market and taken active steps to encourage greater domes- It was not always so: much like in many financial tic savings and offer a wider range of domestic crises before and after, Turkey’s banks were at the savings instruments. The fruits of these efforts heart of the economic convulsion that seized Tur- are yet to be collected. As the chapter shows, key in 2000-2001. Turkey’s banking and foreign ex- Turkey’s non-bank financial sector and its capi- change crisis at that time was the deepest and cost- tal markets remain far less developed than liest of several crises the country has experienced. those of many peers. But the dynamics point More than a quarter of all banks were intervened, in a promising direction. In the meantime, Tur- merged or closed down, the overall costs amount- key is well-served with policies that continue to 87 Turkey’s Transitions monitor the build-up of leverage in the econ- Bank (CBRT) equivalent to 8 percent of the excess omy carefully and that accept more balanced, over the required limit. Finally, the regulation ap- moderate growth over the medium-term as the plied on a bank-solo basis, providing an additional corollary of safeguarding Turkey’s hard-earned incentive for banks to cover their spot short posi- financial stability. tions with hedge contracts signed with subsidiaries or affiliates. By end-October 2000, the short foreign Lessons in bank restructuring – currency position in the banking system exceeded Turkey’s 2001 crisis US$20 billion, or about 10 percent of GDP and twice the system’s total equity. The years before the banking sector collapse1 While the banking sector was considerably liber- alized, the quality of institutions did not improve The experience with economic liberalization in Tur- commensurately. The number of banks increased key is relatively short. Turkey’s post-war inward- from 40 in 1980 to 80 by the end of 1999. How- looking economic policy strategy focused on heavy ever, with relatively lax licensing requirements, a government intervention in economic activity and large share of the new banks was owned and run by sheltering domestic markets from foreign competi- families with little or no sector qualifications, which tion. This all changed in the early 1980s with the set them up with the aim of financing their own political ascendance of Turgut Özal, who came to companies. These banks were allowed to flaunt power with the goal of liberalizing and modernizing the rules in a fractured regulatory and supervisory a sclerotic economy plagued by high and chronic in- environment. Whereas the CBRT had responsibility flation and tightening external constraints (Chapter for offsite supervision, the Turkish Treasury had re- 1). Özal’s reforms were initially successful in boost- sponsibility for onsite evaluation and inspections. ing economic growth, but from the mid-1980s, con- The combination of a monetary authority lacking trol over fiscal policy weakened generating macro- functional independence and a fiscal authority economic stop-and-go cycles and rising inflation. concerned more with covering its financing needs Following Özal’s move to the Presidency in 1989 and proved to be a dismal recipe for the stability of the the loss of power of his Motherland Party (ANAP) system. More than half of the new entrants (22) in the 1991 general election, the political environ- would eventually be taken over by the banking su- ment became increasingly fractious. Turkey went pervisor. through nine separate government changes in the 12 years prior to the 2002 elections, all of which re- Corporate governance weaknesses in private banks sulted in either coalitions or minority governments. were further compounded by the corrosive role Populist economic policies resulted in chronic and played in the market by public sector banks. Three increasingly higher budget deficits, financed to a state-owned banks had traditionally operated out- large extent by monetization of government debt, side commercial rules, providing subsidized loans leading in turn to stubbornly high levels of inflation, to key constituencies in the agricultural, Small bringing the country into a vicious cycle of high real and Medium Enterprises (SMEs) and housing sec- interest rates and higher budget deficits, eventually tors, and were effectively run by the main political putting it on the brink of hyperinflation (see also parties in power. They also did not have to make Spotlight 3). proper provisions for bad loans and were in reality exempt from supervision or any compliance with The environment of macroeconomic instability also regulations. The accumulated losses from subsi- brought about perverse incentives for the behavior dized lending, so called “duty losses”, were only of banks. With high (and climbing) real local cur- rency interest rates and an open external capital partially covered by the Government and only after account, most banks sought to profit from borrow- a long lag with government papers issued at below- ing short term internationally and investing in lon- market rates, which in a highly inflationary envi- ger term government securities and questionable ronment meant a quick deterioration of their bal- related party lending. This strategy was facilitated ance sheets and increasing funding problems. With by an existing foreign currency position regulatory duty losses reaching US$26 billion at end-2000 (3 limit that was looser than accepted best practice percent of GDP), and with the state banks fund- (50 percent as supposed 20 percent of equity). ing their increasing liquidity needs in the overnight Moreover, banks could actually exceed even this interbank market (US$21 billion at end-2000), the loose position by placing a deposit at the Central brewing of a perfect storm was at hand. 1 This sub-section is based on a background note written by Engin Akçakoca, former Chairman of the Banking Regulation and Supervision Agency (BRSA) and a consultant for the World Bank. 88 Chapter 3: Finance : Banking sector restructuring and financial integration 2000-2001: A failed stabilization effort supervision were slowed by political bickering over the selection of BRSA’s board and management. As The International Monetary Fund (IMF) supported a result, BRSA did not become operational until the stabilization program approved in late 1999 was fall of 2000, when developments were already in successful at first, but success would not last. The motion to derail the stabilization effort. program focused on stabilizing expectations and bringing fiscal accounts under control. The ex- The beginning of the end came in late October change-rate based stabilization program, accom- 2000. Already concerned over the deterioration of panied by quasi-currency board rules, quickly led the external accounts, foreign investors started to to a sharp drop in interest rates and a slowdown pull out; this in turn led to fears that some banks in inflation, though not commensurate with the might be facing rollover problems with their foreign drop in nominal rates. The program also supported currency lines. These concerns were validated with the establishment of the independent BRSA and BRSA’s takeover of two banks on October 27, 2000. the tightening of prudential regulations, including In the weeks after that, interest rates climbed, hit- the takeover of six insolvent banks. Regarding the ting in excess of 300 percent, which led to signifi- financial performance of state banks, while some cant marked-to market losses, particularly for those recapitalization was contemplated in the program, banks holding large government bonds portfolios. corporate governance issues were not directly ad- Specifically, Demirbank, a bank holding almost 20 dressed—this omission would later come to haunt percent of all government securities exceeding policymakers and the designers of the program. one-year maturity, was intervened by the BRSA on December 6, 2000.3 After losing its access to fore- With real interest rates falling sharply, credit ign lines turned to the overnight repo market for boomed and growth accelerated, which increased funding The bank, could no longer generate enou- vulnerabilities. The authorities were unwilling to gh collateral to cover its funding requirements and use fiscal policy to slow demand pressures and the eventually failed to meet its obligations. It was a current account deficit widened by about 5 per- case of the supervisory regime focusing too much centage points of GDP in 2000. Moreover, commer- on credit risk (zero-rated government securities) cial banks, taking advantage of the pre-announced and not enough on market risk (foreign currency exchange rate system, continued to fuel the credit and interest rate). boom by borrowing short term abroad and extend- ing longer term TL loans and acquiring government Despite a funding enhancement to the IMF-sup- paper, thus widening their short foreign currency ported program, confidence in the stabilization positions.2 Moreover, efforts to improve banking program began to wane until its eventual collapse Figure 3.1: Overnight borrowing rates during the 2000-2001 crisis 4,500% 4,000% 3,500% 3,000% 2,500% 2,000% 1,500% 1,000% 500% 0% Nov-98 Nov-99 Nov-00 Nov-01 Sep-98 Sep-99 Sep-00 Sep-01 May-99 May-00 May-01 Jul-98 Jul-99 Jul-00 Jul-01 Mar-99 Mar-00 Mar-01 Jan-99 Jan-00 Jan-01 Interbank O/N Interest Rate Source: CBRT 2 While regulations had been tightened to limit foreign exchange exposure risks, some banks would hedge their positions with forward contracts with affiliated companies, which were never meant to be honored, or with fictitious counterparties. 3 The bank had received a B+ rating from Standard and Poor’s (S&P) just three weeks before. 89 Turkey’s Transitions Figure 3.2: The ten most costly banking crises 100% 90% Fiscal cost as a share of GDP 80% 70% 60% 57 55 50% 44 44 44 43 41 40% 32 32 31 30% 20% 10% 0% 1997 1980 2008 1996 1997 1981 2008 1993 2001 1997 Indonesia Argentina Iceland Jamaica Thailand Chile Ireland Macedonia, Turkey Korea, the Former Republic of Yugoslav Republic of Source: Laeven and Valencia (2012) in February 2001. Liquidity shortages continued in maining in the system fully transparent, while en- early 2001, and economic policy uncertainty in- couraging their owners to bring in fresh capital to tensified when a constitutional crisis broke out on strengthen their equity position. February 19, 2001, immediately increasing interest rates and heightening demand for foreign exchange Turkey post-2001 financial crisis: in an attack on the peg (Figure 3.1). As CBRT tried A change in incentives to defend the TL, overnight interest rates surged to 4,000 percent on February 21, 2001. As a re- Prior to 2001, political forces in Turkey, like in many sult, after selling in vain close to US$5 billion to the other countries before, used and shaped financial markets, the CBRT opted to let the TL float, which sector policies and the operation of the financial would end up losing 40 percent of its value in just system for political gain and influence, to the detri- 10 days. Given the significant post-devaluation for- ment of economic performance and welfare. More- eign exchange losses from the banks’ short foreign over, early on in the implementation of the new re- exchange position (about US$15 billion as of Feb- ruary 19, 2001) and the massive overnight funding form effort, and despite the significant costs of the needs of state banks (about US$22 billion, or 100 crisis, some powerful segments of society were still percent of the monetary base), capital losses were betting on their failure. The implementation and substantial. The 2001 crisis came to be one of the success of the reforms, therefore, required not only ten most expensive ever in terms of fiscal costs (Fig- their proper design but also steadfast determina- ure 3.2). tion to see them through, which at times came at high political and personal costs. A rethinking of the whole stabilization strategy became necessary, including a renewed focus on The basic aim of the reforms was to develop a cred- restoring confidence in the banking system and in ible policy framework that would provide the prop- monetary institutions. The new program agreed er incentives for the financial system to thrive and with the IMF in May 2001 centered on the imple- benefit the population in general. The approach fol- mentation of measures to bestow the required lowed, based on greater transparency and account- functional and operational independence to the ability in policymaking, increased sector competi- CBRT and the recently established BRSA—not an easy task considering the absolute lack of institu- tion and strong regulatory and legal steps to limit tional credibility. Moreover, in order to reestablish moral hazard, appears to have worked in fostering confidence in the banking system, a comprehensive a stable, more efficient, and trustworthy financial effort was put in place to restructure state banks, sector. Taken as a whole, all these reforms contrib- both financially and operationally. Finally, a scheme uted to a major change in the way of doing banking was designed to make the accounts of banks re- in Turkey. 90 Chapter 3: Finance : Banking sector restructuring and financial integration The reforms focused on four key areas:4 state bank overnight liabilities while simultane- ously mopping up the liquidity generated.6 The • The enhancement of the CBRT independence. corporate governance of the state banks was With all other options essentially exhausted, also completely revamped (Box 3.1). the monetary policy framework was diametri- cally changed with a move to inflation targeting. • The establishment of an independent regulator Switching to an inflation targeting regime was (BRSA) and the prompt resolution of failed pri- never going to be easy, however. After all, the vate banks. By the time the BRSA became op- choice of an exchange rate-based stabilization erational in late 2000, a significant number of strategy (with quasi-currency board rules) only banks were in difficulties and might have been, 18 months earlier recognized the limits of mar- to a large extent, already insolvent. BRSA’s ap- ket trust in the CBRT. Two aspects of the tran- proach was based on the recognition that sition helped strengthen the credibility of the banks, whose owners were not willing to pro- regime switch. The first was the replacement of vide additional capital, needed to be resolved the CBRT Governor with a well-respected tech- quickly. The main concern was that a gradual nocrat. His own credibility was tested early on in approach to resolution created the wrong in- the crisis, however, when, with the banking sys- centives and actually magnified eventual losses. tem facing severe liquidity pressures and even- With that in mind, BRSA reduced the time gap tual runs by depositors, he opted to signal that between when banks were put under enhanced the CBRT would be providing enough liquidity supervision and their eventual intervention to to maintain the payments system from failing. less than one year, from up to five years prior to In his mind, it did not make sense to safeguard its establishment. BRSA also moved to quickly an inflation target when the cost would be the resolve the banks taken over and recoup losses. failure of the financial system. As it turns out, he After significant efforts to restructure them fi- was absolutely right. The second element came nancially and operationally, 20 banks were sold with supporting measures to eliminate (or at to new owners or merged into existing institu- least mitigate) the temptations for monetiza- tions. Since most of the losses in these banks tion—most critically cleaning up the banking came about because of fraudulent transactions sector in a transparent way.⁵ This would entail on the part of shareholders (close to US$14 bil- steps to make state banks run on a more com- lion), the resolution agency (the Savings Deposit mercial basis (after significant recapitalization) Insurance Fund (SDIF)) was given special pow- and to save the core of the banking system in a ers to enforce claims, including the ability to go transparent manner, not only by resolving failed after former shareholders’ private assets and banks but also by recapitalizing the remaining holdings in other companies to compensate for institutions in a credible way. their banks’ losses. This “no-bail-out-of-own- ers” policy was to be the most critical element • The restructuring and (partial) privatization of of BRSA’s strategy to change the incentives in state-owned banks. The restructuring of the the system and bring market discipline to it. It state banks was a difficult task, both technically would also be the most politically difficult to and politically. The single most important im- implement. mediate step was to get the state banks out of the overnight interbank market. This required • The transparent recapitalization of the core of not only a significant recapitalization effort by the banking system. The restructuring of the pri- the government to cover duty losses and other vate sector banks presented an equally difficult, nonperforming assets (by issuing government if different, challenge. While six additional insti- bonds at market terms), but also monetary tutions were taken over by BRSA after February policy actions geared towards the liquidation of 2001, there was still little clarity in the market 4 The May 2001 economic reform program, of course, went beyond financial sector reforms, including, most importantly, measures to address fiscal sustainability concerns. On the latter see Spotlight 3. 5 There were, of course, legal changes that supported the move to a more independent CBRT, including central law amendments that called for the CBRT to focus exclusively on price and financial stability. Most crucially, though, these changes freed the CBRT from conducting off-site banking supervision, thereby removing it from a task that might have put pressure on it to abandon its monetary policy goals. 6 In retelling this story, most times little credit is given to the CBRT. Having been just granted functional independence, its management nonetheless agreed to act as a creditor to the state banks and mop up the liquidity generated using reverse repo operations, which could have resulted in signifi- cant losses should interest rates had failed to drop. 91 Turkey’s Transitions Box 3.1: Restructuring the state banks Restructuring of the state banks was conducted in two major steps: financial restructuring and operational restructuring. Financial restructuring was completed in 2001 immediately after the crisis. This was followed by operational restructuring with the ultimate target of privatizing the state banks. Financial restructuring focused on clearing duty losses, decreasing short-term liabilities, recapitalizing the state banks, ensuring effective management of the loan portfolio, and normalizing deposit interest rates in line with market conditions. Duty loss receivables exceeded 50 percent of the state banks’ assets by the end of 2000 (50 percent in the case of Ziraat Bank and 65 percent in Halk Bank), sapping the financial strength of these banks significantly. By the end of 2001, duty losses amounting to US$17.5 billion were liquidated and regulations allowing duty losses were abolished. New regulations were issued requiring proper allocation of resources for subsidies in the budget and transferring the funds to state banks before the actual disbursement to the beneficiaries. The authorities introduced measures to improve state banks’ liquidity positions and strengthened their capital base. Until the end of 2001, capital support provided to the state banks totaled TL 3.6 billion, mostly in the form of government securities. In addition, state banks were provided liquidity through repo and direct sales transactions by the CBRT in return for special issue bonds they received from the Treasury. This improved the transmission channels for monetary policy as it made state banks sensitive to interbank market rates and reduced their dominance in the inter-bank market, thus pushing rates down. Operational restructuring focused on organization, technology, products, human resources, financial management, risk management, strategic planning and service quality of the state banks to prepare them for commercial based operation in line with the requirements of modern banking and international competition. As a first step, Ziraat Bank, Halk Bank and Emlak Bank were converted into corporations and were subject to operate on commercial basis by removing all the legal exceptions they had been enjoying. Second, management of Ziraat Bank and Halk Bank were transferred to a joint executive board, headed by a banking professional, which was authorized to prepare for restructuring and privatization. As the third step, Emlak Bank’s assets were transferred to Ziraat Bank and Halk Bank was merged with Pamuk Bank. There were significant reductions in the number of branches and in staff. The restructuring of Halk Bank and its merger with Pamuk Bank, a mid-sized private bank specialized in retail banking, gave Halk a commercial orientation and is considered an international success case of bank resolution and operational restructuring. Following the first wave of reforms targeting financial and organizational restructuring, state banks continued to internalize these changes and to adopt a market based focus. As a result, they widened their client base, diversified their funding sources and two of them attracted private capital. Ziraat Bank, Halk Bank and Vakif Bank (a partially state- owned, partially employee owned bank, originally founded to hold the wealth of Ottoman foundations –waqfs) have enlarged and diversified their loan portfolios considerably towards more corporate, SME and retail clients. Starting with Vakif Bank and Halk Bank, towards the end of the last decade, state banks tapped international markets mainly through syndications and Eurobond issuances. More recently, the authorities accelerated privatization attempts: 25 percent of Vakif Bank shares and 50 percent of Halk Bank shares were quoted on the stock exchange, while Ziraat Bank is also being prepared for a public listing and eventual privatization. However, to date, the authorities have preferred to retain ultimate control – leaving the state banks exposed to accusations of political influence peddling. The reform and privatization of Turkey’s state banks, thus, remains incomplete. Ultimately, the benefits of full privatization in terms of transparency and competition in the financial sector must be weighed against the potential benefits of state banks as providers of countercyclical financing during times of crisis and as risk takers to develop frontier markets. While Turkey’s state banks have been able to some extent to play a countercyclical role during the 2008-2009 crisis, the risk of a return to politically motivated lending remains and on balance would argue for a further reduction of government ownership in the sector. about the full extent of the impact of the cri- losses to be reflected in a write down of their sis on the remaining banks’ balance sheets. As equity in the banks and for the government to a result, the government put in place a public take an equivalent participation (fully collateral- support scheme that would, under very strin- ized with owners’ assets). In order to enhance gent conditions, make funds available to those transparency, the first stage of the scheme con- banks unable to meet capital requirements on sisted of a three-stage audit process. Indepen- their own. Consistent with the no-bail-out-of- dent auditing teams would look sequentially at owners policy, the scheme called for discovered the quality of loan portfolios and provide views 92 Chapter 3: Finance : Banking sector restructuring and financial integration Figure 3.3: Policy responses to banking crises (Percent of countries using measure) Deposit Freeze 100 75 Guarantees on Bank Expansionary Fiscal Policy Liabiliti es 50 25 0 Expansionary Monetary Liquidity Support Policy Recapitaliza tions Nationaliza tions Advanced Economies Emerging Economies Turkey Did Use Turkey Did Not Use Source: Laeven and Valencia (2012) on potential losses and capital needs, which also being prepared for a public listing and even- would be then certified by the BRSA. At the end tual privatization. However, to date, the authorities of the process, most owners preferred to bring have preferred to retain ultimate control – leaving in fresh capital than to have to share ownership the state banks exposed to accusations of political with the government. Only one bank asked for influence peddling. an injection of public funds (in the form of sub- The reform and privatization of Turkey’s state ordinated debt) and the fourth largest bank was banks, thus remains, incomplete. Ultimately, the taken over when the audit process showed that benefits of full privatization in terms of transpar- it was insolvent due to nonperforming related ency and competition in the financial sector must party loans. be weighed against the potential benefits of state Following the first wave of reforms targeting fi- banks as providers of countercyclical financing nancial and organizational restructuring, state during times of crisis and as risk takers to develop banks continued to internalize these changes and frontier markets. While Turkey’s state banks have to adopt a market based focus. As a result, they been able to some extent, to play a countercyclical widened their client base, diversified their funding role during the 2008-2009 crisis, the risk of a return sources and two of them attracted private capi- to politically motivated lending remains. A further tal. Ziraat Bank, Halk Bank and Vakif Bank (a par- reduction of government ownership in the sector tially state-owned, partially employee owned bank, would thus seem warranted. originally founded to hold the wealth of Ottoman foundations –waqfs) have enlarged and diversified The response of the Turkish authorities to the crisis their loan portfolios considerably towards more was not atypical in design to those implemented in corporate, SME and retail clients. Starting with Va- other emerging economies (Figure 3.3), except for kif Bank and Halk Bank, towards the end of the last two key implementation aspects.7 The first one had decade, state banks tapped international markets to do with the legal changes to recover the costs of mainly through syndications and Eurobond issu- the crisis from the “culprits.” Rather than recapital- ances. More recently, the authorities accelerated izing a going concern, intervention took place only privatization attempts: 25 percent of Vakif Bank after previous shareholders had been written down shares and 50 percent of Halk Bank shares were and losses fully reflected in bank balance sheets (no quoted on the stock exchange, while Ziraat Bank is bail out).8 Most importantly, however, was the le- 7 The Turkish authorities also put in place a blanket guarantee of bank liabilities. Given the lack of a counterfactual, there is still a debate whether it helped at all in restoring confidence, or that it just increased the eventual cost of the cleanup of the system. 8 Previously, before the transfer of the SDIF to the BRSA, banks under enhanced supervision had been allowed to receive liquidity support from it. Moreover, those owners, rather than placing additional capital into their banks, had been allowed to place deposits instead, in the expectation that losses would not be imposed on them. 93 Turkey’s Transitions Figure 3.4: The results of the reforms are evident 60% 56 50% 54 52 40% Number of Banks 50 30% 48 20% 46 10% 44 0% 42 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Securities as a percent of total assets Credit in percent of total assets Bank nonperforming loans in percent of total gross loans Number of Banks (right axis) Source: World Bank, BRSA gal ability to recover losses from owners by going out, new out-of court settlement procedures were after their assets in other companies if those losses put in place, the so-called “Istanbul Approach” (Box could be traced to fraudulent regulatory violations. 3.2). By late 2002, already the strategy had begun This single step not only served to signal a change to bear fruit, with interest rates coming down, in- in incentives and, thus, a reduction in moral haz- flation stabilizing, growth returning quickly, and ard, but also served to assuage taxpayers’ concerns foreign investment moving into the sector (Figure over the bailout of politically connected wealthy 3.4).9 individuals. The second had to do with the design and implementation of the recapitalization pro- The post-2008 global environment - gram. The BRSA had recognized that the conduct of stress tests on its own would not readily improve Lessons in managing integration credibility in the system. The three-step auditing As Turkey became more integrated into internation- procedure, which required significant legal changes al capital markets post-2001, it reaped the benefits and the design of transparent and careful valuation of its resolute bank restructuring process. Freed rules, was put in place as a tool to certify the qual- from the constraints of poor governance, weak reg- ity of the loan portfolio. Once again, the principle ulation and crowding out by profligate government followed all along in the strategy—that no share- borrowing, the banking system was ready to meet holder would be bailed out—was key to providing the demands for services from potential clients the incentives for capital to be raised while remov- who for years had been affected by a high degree of ing unfit and improper owners from the system. financial repression. With improved risk manage- ment and underwriting systems, increased compe- The post-crisis strategy was immediately followed tition due to the entry of international banks, and by steps to further strengthen the regulatory and in the presence of a much stronger supervisory and supervisory framework. Most importantly, the regulatory framework, the expansion into “real” BRSA put in place a phased-in reduction in related banking activities went hand in hand with healthy party lending from 70 to 25 percent of capital, and profits, low non-performing loans and the build-up required capital from then on to be measured on of solid capital buffers. a consolidated basis. In addition, accounting stan- dards were tightened (including through the cre- When the global economic and financial crisis hit ation of the Turkish Accounting Board); new prin- Turkey in 2008, the economy experienced a sharp ciples of independent auditing were issued; and the fall in output, but its banking sector withstood the BRSA started relying more on risk-based supervi- shock well and growth quickly recovered. Turkey sion procedures. To assist the process of debt work- was the only country in the OECD which did not 9 Over the following five years, 13 foreign banks would acquire equity positions in Turkish banks, with seven of them becoming majority owners. 94 Chapter 3: Finance : Banking sector restructuring and financial integration Box 3.2: Corporate debt restructuring: The Istanbul Approach and beyond Among the elements of Turkey’s response to the banking crisis of 2001 were the adoption of Law 4743 to create asset management companies and establish the Istanbul Approach, and amendments to the Execution and Bankruptcy Act (EBA) in 2003 and 2004 designed to improve efficiency and promote corporate restructuring through formal court supervised proceedings. Corporate financial distress reached epic proportions during the 2001 crisis, with nearly all sectors of the economy reflecting a steep decline in business activity, rapidly declining net profitability, and insufficient cash flow to meet interest expenses. Following the approach of workout models adopted in Asia, the Istanbul Approach relied on a framework agreement signed by 34 financial institutions that outlined terms and a process to encourage consensual multi-bank debt restructuring. The program resulted in the restructuring of debt in excess of US$6 billion for 322 companies. While most restructured debt carried long-term maturity dates of 15 years, commercial banks estimate that 55-60 percent of loans have been recovered or are performing. The Istanbul Approach lasted only for 3 years and has not been replaced by another corporate workout framework. The EBA was amended in 2003-2004 to promote more efficient formal proceedings for liquidation or corporate restructurings. Reforms were designed to rectify shortcomings contributing to delays and abuses in the enforcement of rights, streamline administration and concordat proceedings for distressed enterprises, and introduce new procedures to accelerate reorganization of distressed enterprises. The 2003 reforms also made the creditor agreement (concordat) process more attractive for corporate restructuring by extending the scope of application to secured creditors. Other amendments to the liquidation process were intended to streamline procedures and improve efficiency and effectiveness. However, notwithstanding many positive changes to the bankruptcy process, it continues to be little used due to strong cultural stigmas against bankruptcy, the restrictive application of the new rules, and in view of the excessive reliance on the post-2003 bankruptcy postponement option. Delays in bankruptcy proceedings continue to result from unenforced time limits by courts, which can trigger cross-defaults under agreements with other creditors. Moreover, amendments to EBA Article 179 to introduce an extended bankruptcy postponement provision have created pernicious distortion in the rights of creditors and normal debtor-creditor relations. This device has been widely abused since first introduced and remains highly controversial. In practice, debtors routinely request (and courts have routinely granted) deferrals up to the maximum allowed period of five years. A whole range of alleged abuses have been attributed to the bankruptcy postponement, including forum shopping, undue influence by courts, corruption, and bad faith activities to defy repayment of debt. To deter abuse, the Supreme Court has elaborated the requisites for granting a bankruptcy postponement, in response to which debtors have turned to other forms of abuse, such as obtaining interim precautionary injunctions to block creditor enforcement actions. Effective non-bankruptcy enforcement mechanisms play a vital role in promoting access to credit. Most bank loans in Turkey are done on a secured basis and are generally guaranteed by a major shareholder. Security in movable assets has proven somewhat challenging in Turkey, however, as there is no registration system for movable assets and the law requires possession to perfect the security interest. Although the 2003 EBA amendments attempted to close loopholes in the law contributing to delays in the execution against collateral, procedures continue to be protracted and cumbersome. Foreclosure proceedings in relation to real property are quicker than the process of obtaining a judgment to initiate bankruptcy proceedings. Given the problems in enforcement, lenders prefer individual debt collection over ineffective multi-creditor actions. inject any public funds into its banks since 2008, Turkey has experienced further inflows since (Fig- and, on a range of indicators, its banking sector ure 3.6). Indeed, with relatively healthy corporate looks solid today compared to emerging market and financial sector balance sheets, Turkey seems peers (Figure 3.5). Compared to the 2001 domestic well placed to continue to benefit from Europe’s crisis, short term market rates hardly budged dur- “Convergence Machine”, as it begins to restart the ing 2008-2009. Moreover, Turkey’s state-owned engines after five years of retrenchment. However, banks, once a major concern for macro-economic the global economic environment has continued to and financial stability, were able, to some extent, to pose new policy challenges in managing financial provide counter-cyclical funding to the real sector integration. The chapter now turns to examine the during the years of the crisis, helped by significant lessons from Turkey’s policy experiments to deal provision of long-term loans from International with the wall of global liquidity in the aftermath of Financial Institutions (Box 3.1). And while capital the global crisis. withdrew from the European periphery after 2008, 95 Turkey’s Transitions Figure 3.5: Turkey’s banks are among the strongest in emerging markets Bank credit to bank deposits (%) Bank return on assets (%, after Bank nonperforming loans to tax) gross loans (%) Bank regulatory capital to risk- Bank return on equity (%, after weighted assets (%) tax) BRICS Average New EU Members Average EU Candidate Average MENA Average Growth Markets Average Turkey Source: Global Financial Development Database Note: The Chart uses a “best in class” normalization, where the highest (lowest for non-performing loans and loan/deposit ratios) is given the value of unity and all other regions are measured relative to this best in class level. The size of the resulting diamond reflects the strength of the banking system. As can easily be seen together with the Growth Markets, Turkey has the strongest banking sector among all the peers. The Chart uses 2011 data for all indicators, except Poland, Hungary, Bulgaria, Czech Republic and Syrian Arab Republic have 2008 as the latest available data for `Bank credit to bank deposit` indicator. Morocco has 2008 as the latest available data for `Bank regulatory capital to risk-weighted assets` indicator. Tunisia and Syrian Arab Republic do not have data for `Bank nonperforming loans to gross loans` and `Bank regulatory capital to risk-weighted assets` indicator`, therefore, excluded from the Middle East and North Africa (MENA) average for these indicators. The “European Union (EU) Members” refer to Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia. “EU Candidate Average” refers to unweighted average of Albania, Croatia and Serbia. “MENA Average” refers to unweighted average of Egypt, Jordan, Morocco, Syrian Arab Republic and Tunisia. “Growth Markets Average” refers to unweighted average of Indonesia, Malaysia, Mexico, Philippines and Republic of Korea. Figure 3.6: Post-crisis deleveraging in Europe - Continued inflows into Turkey External loans of reporting banks vis-à-vis all sectors 800 700 600 500 In million US$ 400 300 200 100 0 Dec.02 Dec.03 Dec.04 Dec.05 Dec.06 Dec.07 Dec.08 Dec.09 Dec.10 Dec.11 Dec.12 Jun.13 Selected EU Average BRICS Average MENA Average Growth Markets Average Turkey Source: Bank for International Settlements (BIS) Database Note: The “EU Average” refers to Bulgaria, Croatia, Czech Republic, Greece, Hungary, Poland, Portugal, Romania and Spain. “MENA Average” refers to unweighted average of Egypt, Jordan, Morocco, Syrian Arab Republic and Tunisia. “Growth Markets Average” refers to unweighted average of Indonesia, Malaysia, Mexico, Philippines and Republic of Korea. 96 Chapter 3: Finance : Banking sector restructuring and financial integration The global crisis and a policy conundrum CBRT made an adjustment to its monetary policy framework in late 2010 with the aim of reducing The monetary policy response in advanced coun- vulnerabilities and lessening risks to financial sta- tries to the 2008 global crisis has presented new bility.11 challenges for emerging markets.10 Historically low interest rates and quantitative easing policies in the A new compass for the CBRT US, Europe and Japan have stimulated significant short-term capital inflows into emerging markets. The new “unorthodox” monetary policy strategy The attractiveness of the so-called “carry trade” has was announced in the fall of 2010. In the CBRT’s raised concerns that the host countries may pay the view, relying exclusively on a single instrument for price with overheated economies, overvalued cur- monetary policy was sub-optimal. The CBRT ar- rencies, and inflationary pressures. For countries gued that increasing the policy rate to fight infla- dependent on foreign financing because of large tion would only provide further impetus to capital current account deficits, and for countries with inflows and, thus, more pressures for currency ap- weak financial regulations, the volatility of global preciation and/or higher inflation. The CBRT added capital flows risked to amplify domestic credit cy- the goal of financial stability in addition to price cles and exacerbate macroeconomic vulnerabilities stability to its mandate more explicitly.12 The inter- should investor sentiment turn or monetary policy mediate goal of the new framework was to “deter in the advanced economies be tightened. excessive short-term capital inflows, while chang- ing their composition from short-term to long-term In these circumstances, central banks which, for and from debt to equity and insulating domestic the most part, had been relying on a specific short- demand from excessive swings (CBRT, 2013)”. term policy rate to manage inflation, were faced with a conundrum: raising the policy rate to slow One key element of the new policy framework was down domestic demand, mindful that this could an interest rate corridor. While the use of an inter- attract further capital inflows, and, thus, put addi- est rate corridor—a symmetric and narrow band tional upward pressure on the currency; or leaving to keep interbank market rates around the pre- interest rates unchanged to stem nominal currency announced policy rate—had started in May 2010, appreciation at the cost of current and future in- the CBRT’s revamped variation centered on having flation. Moreover, monetary policymakers became a more proactive (and asymmetric) approach to increasingly concerned about the financial stabil- changes in the floor and ceiling of the corridor— ity implications of these developments. The big formed by the CBRT’s overnight borrowing and question was: should central banks use monetary lending rates. The width of corridor would be ad- policy levers to avoid the potential buildup of vul- justed as warranted—and even asymmetrically— around the policy rate to fit the desired policy goals. nerabilities in the financial sector, even if inflation The thinking was that, by generating some degree was low? Central banks needed a new “compass” of uncertainty around interbank interest rates, the (Borio, 2011). incentives for carry trades would diminish. Turkey was not exempt from these policy chal- The new policy framework was accompanied by lenges. While the economy recovered fast from the other supportive monetary policy instruments. global financial crisis with growth reaching almost 9 These included: percent in 2010, a foreign financed credit boom en- sued (World Bank, 2013). Prior to 2008, the major- • Repo operations through quantity and price ity of capital inflows consisted of Foreign Direct In- auctions, with quantity auctions held on days vestment (FDI), but during the post-crisis recovery deemed “ordinary,” and price auctions on days short term flows came to dominate (about 60 per- deemed “extraordinary.”13 cent of inflows had maturities of one year or less), increasing rollover risks. These developments left • A special funding facility for primary dealer the economy exposed to the risk of a sudden capi- banks, in which liquidity is provided through a tal flow reversal. With credit to the private sector quantity auction, with the possibility of further booming, by far exceeding the growth of nominal injection of liquidity via price auctions on ex- GDP, and the current account deficit widening, the traordinary days. 10 For excellent discussions on the “new” post-crisis role of central banks, see Goodhart (2010) and Borio (2011). See also Dell’Aricia et al. (2012) amd Osiňski, Seal and Hooguin (2013). 11 The following description of the new monetary policy strategy (and its implementation) by the CBRT is derived from several documents, including Başçı (2012); Kara (2012); IMF (2012 (a)); and several issues of the CBRT’s financial stability report. 12 This mandate was already embedded in the CBRT Law (Article 4, Part I). 13 For quantity auctions, maturity is 1-week, with the interest rate set by the CBRT (policy rate). Price auctions maturities are 1-week, 1-month and 3-month. 97 Turkey’s Transitions • Since September 2011, the CBRT also allows for FX). By May 2011, the required reserves (RRs) for reserves required on domestic currency li- on short-term TL liabilities had been increased to abilities to be met in foreign currency and gold, 16 percent, from 5.5 percent in October 2010. with varying reserve option coefficients (ROCs) further influencing liquidity conditions in the Initially, the strategy did not have the desired ef- domestic money market.14 fect. Credit growth continued unabated, reaching 31 percent (adjusted for valuation changes) in 2011 • No further remuneration of required reserves in barely below the 34 percent growth in 2010. More- domestic currency (October 2010), and differ- over, there was an acceleration in inflation to 10.4 ential reserve requirements by maturity (Janu- percent against the target of 5 percent and, while ary 2011). economic growth remained strong at 8.8 percent, the current account deficit widened significantly to • Guiding market expectations by announcing around US$75 billion or 10 percent of GDP (Figure certain limits on the flow and stock of liquidity 3.7). Banks were able to continue to meet the con- that can be injected via the different facilities. tinued demand for credit by increasing their reli- • Purchase (and later) sales of foreign exchange ance on non-core funding sources, especially inter- through auctions, sometimes accompanied by bank foreign exchange loans (World Bank, 2013). direct unannounced interventions in the market. In 2011, non-core liabilities of the sector increased by 48 percent in 2011. In addition, the increase in The policy-induced uncertainty in short-term mar- reserve requirements was met by net injections ket rates was the cornerstone of this strategy and of the CBRT funding, thus nullifying the credit ra- the key signaling device. As the corridor would be tioning effect of those changes (IMF, 2012 ; CBRT, widened, the volatility of market rates would be al- 2012). lowed to increase proportionally with it, even if on average they continued to remain close to the pol- Post-October 2011: A soft landing but no icy rate. Thus, now it would be the floor of the cor- safety yet ridor that came to indicate a “guaranteed” rate of return. This, it was hoped, would deter short-term In the second half of 2011, driven by external inflows and reverse appreciation pressures on the events, the monetary framework was adjusted. Re- TL. The CBRT would also make more proactive use flecting market turbulence related to the Euro crisis, of reserve requirements (using levels, composition capital inflows weakened from mid-2011 and the TL and remuneration) to temper credit growth. depreciated. In an effort to stem capital outflows, the CBRT raised the borrowing rate back to 5 per- November 2010-October 2011: Limited cent (in August) and the lending rate from 9 to 12.5 success in reigning in the credit boom percent (in October) (Figure 3.8). The CBRT also started foreign exchange selling auctions and low- Towards the end of 2010, the imbalances in both ered reserve requirements (which have remained domestic and external demand put financial stabil- unchanged since January 2012). Moreover, on oc- ity at risk. Consequently, the CBRT lowered the bor- casion, the CBRT delivered “additional monetary rowing rate (the low end of the corridor) from 6.5 tightening in order to prevent undesired exchange percent in October to 1.75 in November, with the rate movements from deteriorating the inflation aim of limiting short-term capital flows by reducing outlook via pass-through and expectations”.15 On risk-adjusted returns. The CBRT accompanied this those occasions, funding supplied via quantity auc- move with unannounced changes in the volume of tions at the policy rate was reduced or eliminated. liquidity provided via the repo auctions, thus gener- ating volatility in the overnight market rate. In ad- Instead, the market was funded via market price dition, on the premise that credit was inelastic with based auctions, and hence, the overnight rate set- respect to changes in interest rates, the CBRT raised tled close to the upper bound of the interest rate reserve requirements (from April 2010 for Foreign corridor. Finally, in June 2012, the CBRT introduced Exchange (FX) denominated liabilities and October the ROCs mentioned above, which contributed to 2010 for TL), ceased to remunerate them (October an accumulation of gross foreign reserves and a 2010), and finally started to differentiate them by lowering of net funding from the CBRT to banks maturity (since January 2011 for TL and May 2011 (World Bank, 2013; IMF, 2012a). 14 Reserve option coefficients modulate the amount of mandatory reserves to be held in foreign currency and gold, creating incentives for foreign exchange accumulation if set below 1, and incentives to sell foreign exchange if set above 1. From November 2012, for foreign currency, the ROCs are 1.4 for 0-40 percent of deposits; 1.7, 2.0, 2.2, and 2.3 for increments of 5 percentage points until 60 percent. For gold, ROCs are 1 for 0-20 percent, 1.5 20-25 percent, and 2.0 for 25-30 percent of deposits. 15 Akçelik, Y., E. Ermişoğlu, and A. Oduncu (2013). 98 Chapter 3: Finance : Banking sector restructuring and financial integration The changes in the monetary policy framework • higher risk weights for new general purpose were complemented with macro-prudential mea- (consumer) loans (from 100 to 150 and 200 per- sures introduced by the banking regulator from cent for loans of under or over 2 years of final late 2010.16 Specifically, the BRSA introduced (IMF maturity, respectively); 2012(a)): • higher general provisioning requirements (from • loan-to-value limits on real estate loans to con- 1 to 4 percent) and specific provisioning re- sumers (at 75 percent) and for commercial de- quirements (from 2 to 8 percent) for banks with velopments (at 50 percent) (December 2010); high levels of consumer loans (exceeding 20 Figure 3.7: A credit boom and rising external imbalances in 2010-2011 90,000 45% 80,000 40% 70,000 35% 60,000 30% Percent Change In million US$ 50,000 25% 40,000 20% 30,000 15% 20,000 10% 10,000 5% 0 0% Sep.12 Sep.09 Sep.10 Sep.11 Nov.09 Nov.10 Nov.11 Nov.12 Jan.09 Jan.10 Jan.11 Jan.12 Mar.09 Mar.10 Mar.11 Mar.12 Jul.09 Jul.10 Jul.11 Jul.12 May.09 May.10 May.11 May.12 Current Account 12-month rolling sum (US$) Credit growth (right axis) Source: CBRT Figure 3.8: Policy rate adjustments and the corridor 14% 12% 10% 8% 6% 4% 2% 0% Oct-13 Oct-10 Oct-11 Oct-12 Jul-13 Jul-14 Jul-12 Jul-10 Jul-11 Apr-13 Apr-14 Apr-11 Apr-12 Apr-10 Jan-12 Jan-13 Jan-14 Jan-10 Jan-11 (O/N) Borrowing (O/N) Lending Policy Rate (1-Week Repo) Weighted Average Cost of CBRT Funding Source: CBRT 16 Additionally, in June 2011, the authorities created a financial stability forum, which is headed by the Deputy Prime Minister and serves as a policy coordination body for macro-prudential issues. The forum comprises of the CBRT, the Turkish Treasury, BRSA, SDIF and the Capital Markets Board (CMB). 99 Turkey’s Transitions percent of their portfolio) or high level of non- Domestic demand responded positively to mon- performing consumer loans (above 8 percent of etary stimulus, but with it the current account outstanding consumer loans) (June 2011); deficit also widened and inflation started creeping up again. When, in late May 2013, the Federal Re- • regulatory changes forbidding cash advances serve (Fed) announced a gradual winding down of and increases in credit limits until outstanding extraordinary monetary policies, Turkey on account balances had been fully repaid (June 2011); of its large external imbalances, was among the these measures were supplemented by an in- most impacted emerging markets (Figure 3.9). The crease in the required minimum monthly amor- initial response of the CBRT to capital outflows was tization payment in October 2013; to increase the number of exceptional days and in- • capital surcharges for large exposures to inter- tervene in the foreign exchange market by selling est rate risk and maturity mismatches, thus around US$23 billion between May 2013 and Janu- discouraging excessive duration gaps (August ary 2014 reducing net reserves to just US$43 billion 2011); and, as of January 2014. Subsequent steps to tighten liquidity through further changes in the complex • amendments to the capital adequacy regulation range of price and quantity instruments failed to linking minimum capital requirements for banks stem TL depreciation, although efforts to curb con- with strategic foreign shareholders to mar- sumer loans through a range of additional macro- ket factors such as Credit Default Swaps (CDS) prudential measures were effective.19 Nonetheless, spreads of the parent and the country of origin with net reserves too low to mount an effective (effective January 2012).17 defense of the currency, and as domestic political uncertainty and a heavy electoral cycle added to The change in monetary policy strategy, the macro- the pressure, the CBRT belatedly changed course. prudential measures listed above, together with On January 28, 2014, at an interim (unscheduled) a nonbinding nominal credit growth target an- Monetary Policy Committee (MPC) meeting, it in- nounced by the government, contributed to the sharp slow-down in credit growth in late 2011 and creased key policy rates by 550 basis points imply- all of 2012.18 Credit slowed to almost half of the ing a rise in effective borrowing costs of 350 points previous year’s rate in 2012 (15.6 percent). The (Figure 3.8). In essence, the CBRT had returned to reduction in domestic, and to a lesser degree ex- monetary orthodoxy. As market conditions have ternal, demand dampened GDP growth from 8.8 stabilized in recent months, the CBRT has started to percent in 2011 to 2.2 percent in 2012. Moreover, lower the policy rate again but with inflation run- the current account deficit contracted sharply and ning at almost twice the 5 percent target, concerns end-year inflation dropped to its lowest levels in are that higher inflationary expectations may be- decades. Turkey had achieved the first successful come engrained. “soft landing” of the post 2001 period. Despite considerable policy experimentation, the However, the cycle of monetary expansion and sub- CBRT does not seem to have found a silver bullet sequent, belated tightening repeated itself in 2013 to insulate the domestic economy from changes in and early 2014. With domestic demand sharply cur- global financial conditions. While growth seems to tailed and global financial conditions easing in 2012 be settling in a moderate 3-4 percent range, infla- and the first quarter of 2013, the CBRT cut short- tion has consistently exceeded the CBRT’s target term interest rates and narrowed the interest rate and it could be argued that the CBRT has taken on corridor. In January and February 2013, overnight too much responsibility for management of the lending and borrowing rates were reduced by 25 economy, leaving fiscal policy largely off the hook. basis points each. In March, the interest rate corri- Ayşan, Fendoğlu and Kılınç (2014) summarize the dor was narrowed with a 100-basis-point cut in the CBRT’s policy framework and argue that it helped overnight lending rate. In April, the policy rate and correct exchange rate overvaluation in 2011 and the overnight lending and borrowing rates were cut subsequently reduced exchange rate volatility again by 50 basis points each. As a result, domes- compared to other emerging markets. The same tic credit growth accelerated again, exceeding by a authors (Ayşan, Fendoğlu and Kılınç, 2013) also substantial margin the government’s indicative 15 suggest that following the introduction of the un- percent growth target for 2013. orthodox policy framework, the Turkish economy 17 Separately, in September 2011, the SDIF introduced a surcharge on deposit insurance premiums for large banks. 18 In the spring of 2011, the government made a public announcement that they expected the growth rate in credit not to exceed 25 percent in an exchange rate-adjusted basis in 2011. 19 The measures, introduced in October 2013, comprise inter alia tighter verification requirements on the income of credit card holders, maximum maturities for consumer loans, and length of instalment payments, greater risk weights on credit card receivables, and required minimum down- payments for automobile loans. Consumer credit has slowed significantly in 2014, contributing to a gradual external rebalancing. 100 Chapter 3: Finance : Banking sector restructuring and financial integration Figure 3.9: Turkish financial markets came under severe pressure after the Fed’s tapering announcement 150 Stock Market Index, 22 May 2013 = 100 140 130 120 110 100 90 80 70 60 25-Jun-14 12-Jun-13 24-Jul-13 23-Apr-14 12-Mar-14 18-Dec-13 4-Jun-14 3-Jul-13 2-Apr-14 29-Jan-14 27-Nov-13 25-Sep-13 19-Feb-14 14-May-14 22-May-13 8-Jan-14 6-Nov-13 16-Oct-13 14-Aug-13 4-Sep-13 Turkey Brazil Mexico South Africa India Poland Indonesia 130 Exchange Rate Index, 22 May 2013 = 100 125 120 115 110 105 100 95 90 85 80 12-Jun-13 25-Jun-14 24-Jul-13 23-Apr-14 12-Mar-14 18-Dec-13 4-Jun-14 3-Jul-13 2-Apr-14 29-Jan-14 27-Nov-13 22-May-13 25-Sep-13 19-Feb-14 14-May-14 8-Jan-14 6-Nov-13 16-Oct-13 14-Aug-13 4-Sep-13 Turkey Brazil Mexico South Africa India Poland Indonesia 190 180 170 10-Year Bond Yield Index, 22 May 2013 = 100 160 150 140 130 120 110 100 90 25-Jun-14 12-Jun-13 23-Apr-14 24-Jul-13 12-Mar-14 4-Jun-14 18-Dec-13 2-Apr-14 3-Jul-13 29-Jan-14 27-Nov-13 19-Feb-14 14-May-14 25-Sep-13 22-May-13 8-Jan-14 6-Nov-13 16-Oct-13 14-Aug-13 4-Sep-13 Turkey Brazil Mexico South Africa India Poland Indonesia Source: Bloomberg Notes: The period May-September 2013 was a period of concern among all emerging markets about the impact of “tapering”. These concerns subsided as it became clear that the Fed would taper very gradually and there was time to adjust. The period December 17-January 28 was characterized by heightened pressure on Turkish assets due to a combination of turning global investor sentiment and domestic political uncertainty. 101 Turkey’s Transitions became less susceptible to changes in global inves- 2009). A positive relationship is posited based on tor sentiment, whereas before 2010, the Turkish the financial system’s ability to: mobilize savings, al- economy had experienced greater sensitivity to the locate resources to productive uses, facilitate trans- volatility of global capital flows than other emerg- actions and risk management, and exert corporate ing markets. IMF (2013) research does not confirm control. A country providing an environment con- this finding. Using an index of exchange rate pres- ducive to greater financial development is expected sures, they find Turkey consistently more sensitive to have higher economic growth rates, with much to global sentiment than other emerging markets of the effect coming through greater productivity and little impact of the new policy framework. The rather than a higher overall rate of investment (IMF, IMF also found that the Reserve Option Coefficient 2011). At the same time, different types of finan- acts asymmetrically during the cycle, with banks ac- cial instruments may be needed at different stages cumulating foreign exchange as capital flows in, but of development, with equity and risk capital par- hoarding it during an episode of capital outflows, ticularly important as countries aim to shift from forcing the CBRT to draw down net reserves to limit technology adaptation to innovation-based growth depreciation pressures. The most recent return to a (Aghion, Howitt and Meyer-Foulkes, 2005). more orthodox policy framework may be an accep- tance that, despite the willingness to experiment, Despite a strong record of economic performance much remains to be learned in emerging markets over the last decade, Turkey’s financial sector re- about ways to mitigate the impact of volatile global mains relatively shallow. Specifically, while mon- conditions on the domestic economy. We return to etary and credit aggregates have increased to lev- some basic policy lessons in the conclusion. els comparable with other middle income peers, capital markets remain thin in comparison (Figure In the end, countries such as Turkey that rely in for- 3.10). Turkey’s financial sector remains very much eign capital inflows may have to live with the risks bank-centric and at the shorter end of the maturity these flows bring, for the benefit of supporting in- spectrum, with significant implications for savings vestment and, thus, more rapid convergence. On allocation and the financing of investment. Pro- balance, the ability of Turkey to attract foreign capi- moting financial sector development, especially tal is an asset that needs to be nurtured, while risk encouraging bond market and specifically longer management is further strengthened. The strength tenor financing, would help open up additional and of banking and public sector balance sheets pro- more stable channels for funding supply. vides some insurance that even in the event of a change in investor sentiment, a full blown financial More financial depth: crisis is not – for now – on the cards. However, in International lessons parallel, Turkey could undertake efforts to diver- sify its funding away from short-term bank lending There are some common aspects (if not precon- and develop a greater range of domestic financial ditions) associated with higher levels of financial instruments to attract savings from its own house- depth (Luengnaruemitchai and Ong, 2005; Chami, holds and enterprises. Indeed, it appears that Fullenkamp and Sharma, 2009; Goyal et al., 2011). countries that have a stronger domestic funding While there is wide consensus that deepening is a base are also those countries that have managed gradual and largely organic process, and policy rec- the risks of attracting global capital flows more ef- ommendations need to account for country-specif- fectively.20 How to diversify sources of funding and ic circumstances and institutions, some basic areas promote domestic savings are issues to which the of emphasis emerge: chapter now turns. • Macro policy framework. A sound policy frame- The search for sustainability – work is essential for macroeconomic and finan- cial stability. It supports demand for domestic Lessons for Turkey’s financial deep- assets, and enhances the credibility of the gov- ening efforts ernment as an issuer of debt securities, which typically serve as the low risk benchmark for the There is strong evidence of a link between financial market. In this connection, a benchmark yield depth and economic development and macroeco- curve is a key requirement for market develop- nomic stability. There is an extensive literature, for ment and facilitates the reliable valuation of fi- example, on the financial development growth nex- nancial assets. This, in turn, necessitates sound us (Levine, 1997; Demirgüç-Kunt and Levine, 2008; public debt management policies. Conversely, 20 See Chapter 4 of IMF (2013) for a detailed analysis of factors behind the resilience shown by a group of countries to fluctuations in foreign capital inflows. 102 Chapter 3: Finance : Banking sector restructuring and financial integration Figure 3.10: Turkey: Financial market depth indicators Liquid Liabilities to GDP Public Bond Market Life Insurance Premium Capitalization to GDP Volume to GDP Private Bond Market Non-life Insurance Capitalization to GDP Premium Volume to GDP S tock Market Total Value S tock Market Traded to GDP Capitalization to GDP B RICS Average G rowth Markets Average New EU Members Aver age Turkey Source: Global Financial Development Database Note: The chart follows the best in class methodology introduced earlier (see Figure 3.5). “Growth Markets Average” refers to unweighted average of Republic of Korea, Mexico, Malaysia and Philippines. “New EU Members Average” refers to unweighted average of Hungary, Poland, Slovakia and Czech Republic. countries with unsustainable fiscal policies duct without hindering development: too rapid struggle to establish monetary policy credibility, deregulation risks engendering instability (Reinhart as Turkey’s pre-2001 experience illustrates. and Rogoff, 2008), but highly restrictive rules may hinder financial market development. Issues of • Legal framework and market infrastructure. A regulatory capacity need to be considered, as well strong and transparent legal framework is criti- as the country’s own financial history and resulting cal for property and creditor rights to be pro- risk preferences. Before aggressively seeking to de- tected. The existence, and proper enforcement, velop new financial markets, it is important to un- of accounting and standards is sine qua non for derstand the demand for new types of investment confidence in the execution of financial transac- such as equity, or even venture capital, as other- tions. There is also a need for a financial infra- wise supply will chase a limited number of available structure such as exchanges and credit bureaus deals, leading to low profits and potentially higher and a robust payments and settlements system, risks. Likewise, the demand for new financial instru- often with significant private sector involve- ments and the possible sources of funding for capi- ment. Finally, a transparent and timely execu- tal markets need to be considered. All in all, this tion regime will bring clarity to expected returns calls for nationally specific strategies to sequence and costs of investment. capital market development, even if the overall aim • Regulatory and supervisory regime. A sound for greater diversification and depth of financial regulatory and supervisory system needs to be markets is generally accepted. established with the capacity to ensure finan- cial stability. Such a regulation needs to address Where does Turkey stand? disclosure and transparency among market par- Turkey’s shallow financial sector is in part a reflec- ticipants, limit market dominance, and enforce tion of the continued aversion of private savers to risk management practices, without inhibiting innovation. enter into long term financial contracts, though structural and regulatory constraints may be factors Promoting financial sector deepening thus entails a as well. Risk aversion brought about by a history of broad agenda of reforms. However, the sequencing crisis is reflected in a preference for shorter term of reforms is much less clear. A balance is needed deposits and financing instruments, with signifi- whereby regulation fosters prudent market con- cant repercussions for financial innovation.21 Most 21 Countries like Brazil have been pointed out as “successful” in addressing this problem, allowing it to build its capital markets. However, the reality is that most financial contracts in local markets remain indexed to short-term (overnight) rates, inflation or the exchange rate (Park, 2012). Thus dura- tion, the relevant measure for risk diversification, remains largely unchanged. In a recent “Free Exchange” column, the Economist quotes research that suggests the personal experience of a financial crisis has long-lasting effects on individual risk aversion. See “Risk Off”, Economist.com/blogs/ free exchange, January 25, 2014. 103 Turkey’s Transitions deposits are held for no longer than three months financial system as savers or borrowers is only 16 and investment financing is correspondingly mostly percent.22 Lack of confidence in banks, unattractive short-term, thus carrying significant refinancing returns on financial savings vs. other instruments risk. This funding constraint appears to be further such as real estate, pent up consumer demand and exacerbated by the fact that merely 50 thousand low real interest rates may ultimately contribute depositors (the equivalent of the people attending more to the low level of financial intermediation a football match) control 90 percent of total depos- than lack of financial literacy or access barriers to its in the system, making it highly susceptible to the the formal financial system. whims of a small section of the population. At the same time, public policy can make an im- Compared with other high end middle income portant contribution to encouraging financial countries, Turkish households seem to save less deepening. One recent example concerns the cor- but also borrow less from banks. The 2012 Finan- porate bond market. This market has remained cial Inclusion Survey carried out by the Gallup Cor- constrained by years of fiscal dominance, strict in- poration on behalf of the World Bank shows that a vestment requirements, high underwriting costs, strikingly low number of Turkish respondents hold technological limitations, and possible weaknesses any savings with banks or have a bank loan, but a in the execution regime. However, in 2010, the high number of Turkish respondents have a bank BRSA clarified the regulatory framework for the account and a credit card (Figure 3.11). The results issuance of corporate bonds by banks, which led confirm that financial intermediation at the house- to a dramatic increase in obligations (Figure 3.13), hold level is lopsided in Turkey, with an emphasis though maturities—1-year for the most part—re- main relatively short.23 on sight deposits and consumer credit but little medium-term intermediation, perhaps more so In 2012, Turkey took additional steps towards deep- than in peer countries. A further breakdown of the ening its financial markets through the enactment data by gender, age, education and urban vs. rural of a new Capital Markets Law and a new private respondents suggests that structural factors mat- pension scheme. The passage of the new law, in ter in explaining this pattern, with the differences particular, together with the earlier adoption of a in financial inclusion by gender as striking as the new Commercial Code and a Code of Obligations, absence of any notable difference by location (Fig- is a major step towards the implementation of best ure 3.12). However, even among older men with a international practices in regulating commercial good education, the degree of participation in the and contractual relationships in Turkey. Figure 3.11: Financial intermediation at the household level is lopsided in Turkey Account at a formal financial insti tuti on (% age 15+) Saved at a fi nancial insti tuti on in the past year (% Credit card (% age 15+) age 15+) Loan from a financial insti tuti on in the past year (% age 15+) Brazil Czech Republic Egypt Mexico Morocco Poland South Africa Turkey Source: Findex Database Note: The chart follows the “best in class methodology”, where top performer in each category is indexed at 1. Center of the diamond represents 0, where as the outer edge of the diamond represents 1. 22 The total sample in this case is only 48 people. In other words, 8 out of 48 older men, with tertiary education in the sample either saved or bor- rowed from a financial institution. 23 While listed banks already could issue corporate bonds, as regulated by the CMB, the BRSA regulation clarified exposure limits, including by linking the issuance of obligations to the equity positions of those institutions. 104 Chapter 3: Finance : Banking sector restructuring and financial integration Figure 3.12: Financial intermediation is higher among men, and among the older and better educated (a) Financial intermediation by gender (b) Financial intermediation by rural vs. urban 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0% 0% Account at a Credit card Loan from a Saved at a Account at a Credit card Loan from a Saved at a formal financial financial formal financial financial financial institution in institution in financial institution in institution in institution the past year the past year institution the past year the past year Male (% age 15+) Female (% age 15+) Rural (% age 15+) Urban (% age 15+) (c) Financial intermediation by age groups (d) Financial intermediation by level of education 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0% 0% Account at a Credit card Loan from a Saved at a Account at a Credit card Loan from a Saved at a formal financial financial formal financial financial financial institution in institution in financial institution in institution in institution the past year the past year institution the past year the past year Older adults (% age 25+) Young adults (% ages 15-24) Primary education or less (% age 15+) Secondary education or more (% age 15+) Source: Findex Database Figure 3.13: Domestic debt securities issued by banks and non-financial corporations 16 14 12 10 In billion US$ 8 6 4 2 0 Dec.09 Dec.10 Dec.11 Dec.12 Financial Corpora tions Non-financial Corporati ons Source: BIS Database 105 Turkey’s Transitions Moreover, the passage of the law is part of the EU Directives. The law also includes extensive government’s strategy and is consistent with its ul- penalty provisions for violators of these prohi- timate goal of making Istanbul an international fi- bitions. In addition to monetary penalties and nance center. Additional steps to promote financial trading bans, insider traders and market ma- market development and diversification include a nipulators can face imprisonment of two to five new leasing and factor law, and the initial issuance years. of a sovereign sukuk, part of a general effort to de- velop Islamic finance. • Other important provisions relate to the cre- ation of an Investor Compensation Center, also The key changes brought about by the new Capital modeled after EU examples, which replaces Markets Law include, among others: the old Investor Protection Fund, and the new ability to offer products that are not specifically • The creation of a new securities exchange (Borsa regulated by the law, provided that certain addi- Istanbul) to replace the existing Istanbul Stock tional disclosures are made with respect to the Exchange and merge it with the Gold Exchange description of the securities and the risks asso- and Turkish Derivatives Exchange (TURKDEX). ciated with them. This new joint-stock company is expected to become a publicly traded company, which will While the impact of these legal reforms is likely to open it up to private and possibly foreign invest- take some time, the reform of the private pension ment, and, thus, to significant improvements in system in late June 2012 has already started to bear technology and infrastructure. fruit. The key element of the reform is a matching contribution by the government, effective January • A prospectus review process aligned with EU 1, 2013. Until the end of 2015, the new regulations requirements. This process is expected not only also allow transfers from defined benefit (DB) to to accelerate the issuance of securities but also defined contribution (DC) plans without incurring serve to emphasize issuers’ responsibilities. tax, providing more favorable tax treatment of dis- Moreover, the law enables issuers to use a base tributions at retirement. These changes are being prospectus which, once approved, will remain made as a way to encourage more savings among effective for 12 months instead of having to go employees and create larger asset pools to be man- through a full review process for each issuance. aged by the financial services industry, which the Issuers will also be permitted to incorporate by government hopes will promote Turkey as a region- reference in the prospectus certain previously al financial services center (Box 3.3 describes the publicly filed information such as financial state- pension reform in detail). ments, audit reports and previously approved prospectuses, provided that the information Early results are encouraging. As of July 4, 2014, contained in such documents is up to date. 4.65 million participants were enrolled in the pri- vate pension scheme up from 3.1 million in January • Enhancement of investor protection. The law ex- 2013. Assets under management by private pension pands disclosure requirements for issuers, and funds have grown 45 percent over the same period. significantly increases their liability for inaccu- With pension funds accounting for almost half of rate or misleading information and omissions all assets under management by mutual funds, this in their disclosed documents. In cases where increase was instrumental in boosting mutual fund damages cannot be collected from the issuer, assets by TL 6.8 billion to TL 56.7 billion, despite the selling shareholders, the lead intermediary challenging financial market conditions. However, institution, any guarantors and members of the given how prickly Turkish investors are about both issuer’s board of directors will, to the extent of liquidity and interest rate risks, some more time is their culpability and as the circumstances war- needed to assess whether these changes are per- rant, be liable for damages that can be linked manent or not.24 to them. Further, independent auditors, credit rating agencies and others whose reports are included in the offering prospectus are respon- sible for any inaccurate or misleading informa- tion and omissions in such reports. • Strict limits on related-party transactions. The law introduces definitions of insider trading and market manipulation that reflect the relevant 24 Özel and Yalçın (2013) estimate that the impact of the reform, given its voluntary nature, is likely to be marginal (about 1.5 percent of GDP). 106 Chapter 3: Finance : Banking sector restructuring and financial integration Box 3.3: Encouraging household savings by promoting voluntary private pension accounts The pension reforms introduced in Turkey contain a number of important tax incentives and other rules to encourage Turkish household to increase voluntary retirement savings. The most important measures include: • Tax relief will be revised. Employers can claim a tax deduction on pension contributions up to 15 percent of employee income, with a cap on contributions that equates to the national minimum wage. • Tax relief will be available on employee contributions through a direct matching contribution from the government. Employee contributions up to the national minimum wage will receive a 25 percent government match. • Tax on distributions at retirement declines from a minimum tax rate of 3.75 percent of the total account value to 3.75 percent of the portion of the account that represents investment income. It is also applicable to early retirement distributions. • Employees can save in an effective three-policy framework: the new government contributions, the employer-sponsored contributions and the employee contributions. This is in addition to the basic social security system, which is DB. Each policy component will be subject to separate vesting rules: o The government matching contributions will be accessible at retirement. Prior to retirement, they are partially vested: 15 percent after 3 years of participation, 35 percent after 6 and 60 percent after 10. o Employers will determine vesting of the employer-sponsored contributions, with vesting of up to seven years of participation. Under the previous regulations, vesting was up to five years. o Employee contributions can vest immediately. • Government matching contributions are available not only to employer-sponsored retirement plans but also to retirement plans established by individuals on their own. • Transfer of funds from DB to DC plans can be made immediately (until the end of 2015) with no tax liability. Conclusion: Lessons learned and challenge. The reforms not only required a major re-thinking of how policies were conducted—rely- remaining challenges ing on operationally and functionally independent Turkey’s financial sector reforms offer rich lessons to institutions for policy design and implementation— emerging as well as advanced economies. Indeed, but also a major break in the political economy of Turkey’s approach to banking sector restructuring the financial sector. The catalyst for reforms was has inspired the design of reforms in countries such not a sudden recognition by politicians that a major as Ukraine in 2008-2009. Turkey’s extensive use policy change was needed—a rare historical event of macro-prudential measures to regulate credit anywhere, to be sure—but rather the emergence growth continues to add to the growing experience of a major economic dislocation that could only be among emerging markets with these new tools, addressed with “real” reforms. Sometimes there is even if the experiment with an unorthodox mon- nothing better than bad times for good policies to etary policy framework has arguably proven less be implemented. With memories of the crisis fad- convincing. Turkey’s concerted attempt to boost ing, its lessons should not be forgotten. domestic savings and widen the range of available The cleanup of the system required powerful legal financial instruments while at the same time avoid- tools and the determination to use them—going ing the risks of excessively fast financial deregula- after the culprits was key. The move to put state tion is likely to generate valuable experiences in the banks under more professional management and future. Here we offer some general conclusions on having them run on a commercial basis, including lessons learned and remaining challenges. preparing them for privatization, signaled a major On banking restructuring: break from the past. The political patronage system sustained by these institutions had not only proven The reforms of 2001 were an all-hands-on-deck immensely costly to the Turkish state but had also response to a longstanding and complex policy led to distortions in the market that had hampered 107 Turkey’s Transitions the development of the sector. Wresting control of gree. In that regard, the degree of enhanced policy these institutions from “the politicians” was central coordination brought about by the creation of the to the credibility of the effort. On the private sector Financial Stability Committee (FSC) is clearly a key side, the focus was on recovering the cost of the achievement. The success of the BRSA with the cleanup without bailing out owners. The key (inno- use of macro-prudential tools to slow down credit vative) element of the reforms was that failed bank also provides valuable lessons to other emerging owners were made responsible for all losses linked markets. The critical challenge ahead remains how to fraudulent transactions, even if their value ex- to collectively address emerging vulnerabilities, ceeded their equity participations in the banks. The particularly in a policy environment where institu- logic was that if owners used their banks to benefit tions are operationally independent and may not their other businesses illegally, then those compa- individually have all the tools to deal with such fi- nies were fair game for the state to seek compen- nancial stability concerns. In this regard, improving sation from. This element had a particular positive the operational procedures of the FSC (who does effect on mitigating moral hazard and strengthen- what, when, how decisions are reached, and how ing market discipline, with those banks remaining in the system showing a significant degree of risk they are communicated to the public) remains an aversion that served them well during the recent outstanding policy issue in Turkey. global financial crisis. The evidence regarding the impact of CBRT’s un- While there is no question that the 2001 reforms orthodox toolkit on macroeconomic volatility is had the intended effects, the reform agenda is still mixed. Research by the CBRT suggests that the unfinished to some degree. The operational inde- framework has contributed to relative exchange pendence of BRSA, while not questioned so far, rate stability (compared to other emerging mar- remains at risk because its budget is still subject ket economies’ currencies), a slowdown in credit to parliamentary approval.25 Furthermore, the cen- growth, and a narrowing of the current account. terpiece of the cleanup effort—pushing out those The IMF (2013) presents evidence that suggests owners that did not meet fit and proper criteria for the policies may have had limited impact. Either a bank license and enforcing repayment of losses way, it seems the unorthodox framework helped to related to fraudulent transactions—came at a high abate the foreign financed credit boom only after economic and also personal cost. The lack of spe- it was accompanied with other macro-prudential cialized courts at times made the process a pro- measures. Their earlier introduction might have tracted and costly one.26 Moreover, and perhaps contributed to mitigate the extent of the boom in more importantly, supervisors endured years of 2011 and facilitated a smoother adjustment. economic and personal duress by being subjected More importantly, the ‘experiment’ may have come to largely frivolous lawsuits for their actions.27 at the cost of a significant loss in the CBRT’s cred- On managing financial integration: ibility. The task of addressing financial stability concerns falls unto central banks not only because The CBRT was diving into unchartered waters when of legal requirements but rather because they are it introduced its unorthodox monetary policy strat- more adept in assessing risks and can react more egy in late 2010. The policy conundrum triggered quickly to emerging events. The policy instruments by the massive capital inflows clearly required a re- at their disposal can be activated rapidly since they sponse—inaction was not an option. Nevertheless, usually do not require legislative approval or exter- while innovative, the early lack of success showed nal consultation. The risk is that in taking on too that perhaps the CBRT was trying to address too many objectives, central banks may compromise many goals—inflation, current account deficit, ex- the credibility of their core price stability mandate. change rate stability and capital inflows composi- Thus, the CBRT, while compelled to act by circum- tion—with too few instruments.28 It was not until stances, might have been better served by calling more macro-prudential measures were introduced early on for tighter fiscal policy to help reign in the in mid-2011 that success was achieved to some de- boom in domestic demand. The cost of the CBRT 25 In addition, rigidities in the salary structure may be putting BRSA at a disadvantage relative to private sector compensation packages. 26 At least in one case, a court reversed an intervention decision, years after the bank had been transferred to the SDIF and it had actually been sold to new owners. 27 While the law allows BRSA to pay for the legal fees incurred by their employees in addressing such legal actions, it does not explicitly protect them from liability for actions taken in the conduct of their duties. 28 It was not entirely clear either that policy actions were completely consistent, given that higher reserve requirements were matched by higher borrowings from the CBRT by commercial banks. 108 Chapter 3: Finance : Banking sector restructuring and financial integration pro-activity has been a policy framework that is dif- sector has limited access to alternative sources of ficult for market participants to understand, and by finance), but also lead to inefficient resource alloca- consistently failing to achieve the CBRT’s inflation tion and lower rates of growth, as risks cannot be target, may have damaged its credibility.29 Indeed, properly diversified. to some market participants, the whole episode has looked like a complex attempt to disguise the The biggest stumbling block for quick progress in importance of interest rates as a tool for monetary this area appears to be addressing the “credibility” policy in view of the intense domestic debate. Un- gap. As in many other countries with a history of der stress, the unorthodox framework proved in- macroeconomic instability, Turkey’s savers remain sufficient and interest rate policy returned center wary of moving into longer tenor and more sophis- stage. Instead of finding the silver bullet, the CBRT ticated financial instruments.30 There is, thus, an may have “brought a knife to a gun fight”. important link between the success of the mac- roeconomic policy framework in achieving price On deepening markets: stability and the development of capital markets. Moreover, while experience in other countries has Turkey has made initial steps to enhance the depth shown that reversing risk perceptions does take a and diversification of its financial sector. For years long time, this should not preclude setting up the not much was done on this policy front in order to infrastructure for market development. From fur- shield the government debt market from compe- ther improvements in the quality of supervision, to tition for funds by the corporate sector. However, eliminating tax distortions that favor bank deposits with public debt declining and with the recognition over investments in capital market instruments, to that reforms in this area would help address one of rules aimed at boosting market liquidity to mobi- Turkey’s major remaining structural weaknesses— lize greater interest by institutional investors – the the lack of private sector savings—the government policy agenda is considerable. Patience and perse- has rightly turned its focus to their enactment. verance will be needed – as Turkey’s own experi- Shallow markets not only increase the amplitude ence with turning around the banking sector amply of the impact of external shocks (the corporate demonstrates. 29 As with any other policy strategy, communication is of the essence, particularly in the introduction of complex “innovative” instruments. The lesson here is that explaining “the why” is as important as to explaining “the how.” 30 Perhaps ironically, the market uncertainty created by the widening of the interest corridor appears to have generated the interest volatility that keeps net savers in the shorter end of the maturity spectrum. 109 Turkey’s Transitions References Aghion, P., Howitt, P., & Mayer-Foulkes, D. (2005). IMF. (2012). Turkey: Selected Issues. IMF Country The Effect of Financial Development on Conver- Report No: 12/339. IMF. gence: Theory And Evidence. 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BIS Working Paper No: 326. Goyal, R., Marsh, C., Raman, N., Wang, S., & Ahmed, S. (2011). Financial Deepening and Inter- national Monetary Stability. IMF Staff Discussion Note: SDN/11/16. IMF. 110 4 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Chapter Enterprise: Harnessing structural change for integration and inclusion Infrastructure Finance Fiscal Space Trade Welfare Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 111 Turkey’s Transitions 112 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Enterprise: Harnessing structural • Second, the chapter asks whether the positive impact of structural change at the aggregate change for integration and level is mirrored at the enterprise and regional inclusion level in Turkey. In other words, have resources H simply shifted from backward inland provinces acı Boydak, an entrepreneur in his mid-50s to the advanced coastal regions, or has the from Kayseri in Central Anatolia presides over structural transformation of Turkey’s economy a multibillion-dollar conglomerate, whose vi- opened up new opportunities for enterprises in sion is focused on continued innovation.1 This Turk- Anatolia? The assessment of this chapter is that ish success story began in his father and uncle’s structural change in Turkey has been associated small carpentry workshop in the late 1950s. In the with regional convergence. Productivity growth 1980s, the Boydaks, together with many other Ana- in the more dynamic inland provinces – regions tolian entrepreneurs, used the space provided by which we define as the “Anatolian Tigers”2 – has economic liberalization to grow rapidly from infor- been higher than in the advanced western prov- mal micro-firms to increasingly professional, export inces. Moreover, in all provinces there is a shift oriented enterprises. By integrating with, collabo- in the within-industry structure of employment rating and learning from the rest of the world, he and production from less productive micro firms and other entrepreneurs in Turkey’s “Anatolian to more productive small and medium-sized en- Tigers” have injected additional momentum into terprises (SMEs). Turkey’s economy has become the economy. The opening of economic opportu- more integrated with global markets and more nities in these new centers of growth has also led open to competition as a result of regulatory re- to greater inclusion, as more productive jobs have forms both in the 1980s and again after 2001; in been created for workers who beforehand had this process micro-firms have grown into SMEs, stagnant below-average income in the traditionally and their growth has been an important factor driving the convergence in productivity across poorer Anatolian heartland. regions in Turkey. Targeted regional invest- This chapter examines the structural transforma- ments in physical and social infrastructure have tion of Turkey’s economy over the past three de- promoted regional convergence and connected cades. It takes three different perspectives to tell the inland provinces to foreign trade. Structural the story of Turkey’s enterprise sector and the change and market integration have made eco- leading role business has played in advancing their nomic growth in Turkey more inclusive. country to the doorstep of high income. • Third, we ask whether the forces that drove pro- • First, the chapter asks to what extent increas- ductivity performance in the past are likely to es in aggregate productivity in Turkey have propel the country all the way to high income. The short answer is that they will not suffice been the result of between-industry structural on their own. When productivity differences change. The short answer provided in the first across sectors and firms have narrowed suffi- section of this chapter is that the shift of labor ciently to limit the benefits of further realloca- out of agriculture and into higher productivity tion, the role of structural change as a driver of manufacturing and service industries has ac- growth diminishes. As Eichengreen, Park and counted for around two thirds of the overall Shin (2013) show, at that point many middle in- productivity growth in Turkey over the past two come countries experience a marked slowdown decades. In this sense, Turkey’s experience with in economic growth – a slowdown sometimes structural change echoes the productivity push referred to as the “middle income trap” (Gill experienced by Asian countries over the same and Kharas 2007; see also Chapter 8). To escape period. It is distinct from the experience of Latin this trap, countries must find ways to generate America and Eastern Europe, where the process productivity improvements from within existing of structural change led to declines in both ag- enterprises or through churning – the exit of ricultural and industrial employment, and the lower productivity firms and the entry of higher shift into services did not always result in higher productivity competitors. In other words, at productivity as a whole (McMillan and Rodrik, higher levels of income, productivity growth 2011; Raiser, Schaffer and Schuchhardt, 2000). must be driven by a process of Schumpeterian 1 See European Stability Initiative (2005) and www.boydak.com. 2 We should note that the literature has tended to associate the term “Anatolian Tigers” with fast growing secondary cities, rather than economic re- gions, as we do in this Chapter. We lack comparable data to repeat our analysis at the city level, although the story of Turkey’s urbanization presented in Chapter 5 is entirely consistent with the story of structural change and regional convergence, driven by private entrepreneurial activity, told in this Chapter. 113 Turkey’s Transitions innovation and competition (Aghion and How- feature of this growth performance is that growth itt, 2005). This implies a different set of policies in productivity has been high both in comparison and a different set of structural requirements to Turkey’s performance in earlier decades and in than the process of economic catch-up through international comparison. Table 4.1 shows average the adoption of existing technologies and the growth of labor productivity and total factor pro- reallocation of labor from lower to higher pro- ductivity (TFP, reflecting the increased efficiency ductivity activities. Turkey’s ability to generate with which all measured inputs are used) over the productivity growth from within the firm has 1980s, 1990s and 2000s. The first period (1981- remained mixed to date, but the correlates of 1989) covers the reform period prior to the liber- firm-level productivity point to the way forward: alization of the capital account. The second period more investment in R&D and knowledge-based covers up to the end of 2001, including the crisis capital, greater attraction of Foreign Direct In- year, which appropriately belongs to the regime of vestment (FDI), deepening of financial markets the 1990s. The third period covers the years when to improve access to finance, and further im- the Justice and Development Party (AK Party) has provements in connectivity. been in government. The 1980s appear to be a pe- riod of relatively high growth of labor productivity Growing companies in Anatolia have shown that Turkish businesses are dynamic in exploiting new and TFP, albeit part of that is a rebound effect from economic opportunities when given the chance. the crisis years in the second half of the 1970s. They now need to demonstrate that they are equal- Growth in average labor productivity almost dou- ly good at creating new opportunities through in- bled in the 2000s relative to the 1990s. The calcula- novation. If they meet this test, they will carry their tion of growth in TFP is sensitive to whether Turkish country over the doorstep to high income and al- Statistical Institute (TurkStat) or Penn World Tables low the “Anatolian Tigers” to emulate their East (version 8.0) data are used (see notes to Table 4.1), Asian cousins. but the basic story remains the same: TFP growth in the 2000s is higher than in earlier periods. Turkey’s structural transformation: The other two rows of Table 4.1 provide a de- Sources of aggregate productivity composition of labor productivity growth into be- growth tween-industry and within-industry components.3 Between-sector structural change has made a sig- Turkey has been one of the faster growing middle nificant contribution to overall productivity growth, income countries in the last decade. An important as labor moves from sectors where productivity is Table 4.1: Productivity growth has increased over time Average growth of productivity (percent change per annum) 1980-1989 1990-2001 2002-2010 Aggregate Labor Productivity 2.33 2.13 3.38 Growth Decomposition of Total Labor Productivity Growth Between sector 1.28 2.22 Within sector -0.03 1.28 TFP Growth (1) 0.08 -1.08 1.18 TFP Growth (2) 1.56 0.61 2.38 Source: World Bank (WB) staff calculations Notes: Aggregate labor productivity growth is calculated as the average of log differences of Gross Domestic Product (GDP) in 1998 prices divided by employment, both from TurkStat. Decomposition of labor productivity growth is calculated on the basis of 9 sectors (agriculture; mining; manufacturing; public utilities - electric, gas, water; construction; wholesale and retail trade; trans- port, communication and storage; finance, insurance, real estate and business services; community, personal and government services), using the McMillan and Rodrik (2011) approach. See Atiyas and Bakış (2013a) for details. Note that labor productivity calculated from aggregate data does not equal that calculated from sectoral data. That is because the sum of sectoral GDP does not equal aggregate GDP, the difference being “financial intermediation services indirectly measured” plus “taxes and subsidies”. TFP Growth (1) is calculated from Penn World Tables (PWT) version 8.0, as average of annual log differences of the variable “rtf- pna”. TFP Growth (2) is calculated using national accounts data of TurkStat; see Atiyas and Bakış (2013b), Table 4.2. The difference in the TFP calculations results from a different capital series as well as a higher labor share in the case of TFP (2). 3 Additional calculations show that the result that the within component accounts for about 1/3 of overall productivity growth is robust to the methodology used in the decomposition of aggregate productivity growth between 2002 and 2010. When one concentrates on the “high growth” period of 2002-2007, the contribution of the within component increases to about 50 percent irrespective of which type of composition is used. The contribution of the within component is negative in the period 2007-2010. 114 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion low (especially agriculture) to those where produc- the share of agriculture in total employment is re- tivity is relatively higher (especially manufacturing versed. and “finance, real estate, insurance and business services”). For the 1990s, almost all productivity The lackluster overall productivity performance growth is due to between-sector structural change. since the global economic and financial crisis in Tur- In the 2000s, between-sector structural change still key emphasizes the importance of the shift towards accounts for close to two thirds of overall produc- greater within-sector productivity increases to sus- tivity change. Turkey resembles Asian countries, tain the gains of the past decade. The second graph where the between-sector structural change com- of Figure 4.1 shows the low contribution in Turkey ponent is often positive, rather than Latin American of the within-sector structural change component countries, where this structural change component to labor productivity growth over the years 1988- is typically negative. The implication is that this is a 2005. Relative to all other comparator countries worthy achievement and not an automatic devel- with positive labor productivity growth over this opment.4 period, Turkey had the lowest share of within-sec- tor productivity growth, suggesting the potential Overall productivity growth in the 2000s has been for unexhausted gains in the future with appropri- high relative to other countries. The first graph of ate policy support. Figure 4.1 shows that Turkey in the 2000s had one of the highest annual labor productivity growth The key to productive resource reallocations was rates among middle-income countries. Turkey was the shift of labor from agriculture to the manufac- only surpassed by Romania, India and China. How- turing and service sectors. Figure 4.2 highlights the ever, Turkey’s productivity performance tapered off strong growth of the manufacturing employment towards the end of the decade. Our calculations share over the same period during which the ag- based on Atiyas and Bakış (2013b) show that TFP ricultural share fell drastically, with Turkey’s overall aggregate growth for the period 2007-2011 is zero manufacturing employment in 2012 significantly or negative, depending on the methodology used. higher than indicated by a global trend line. Fig- This is also the period when the steady decline in ure 4.3 further shows the major shift of labor into Figure 4.1: Turkey had fast productivity growth over the past decade thanks to structural change 5% 130% 4% 110% Growth in Labor Productivity (in percent) Growth in Labor Productivity, 1988-2005 90% 3% 70% 2% 50% 30% 1% 10% 0% -10% -30% -1% -50% IND BRA TWN SGP KOR PER COL THA ARG TUR HKG PHL VEN MEX MYS CHL CRI -2% Between Within Total real productivity growth CHN CHL SWE USA IRN IRL THA ITA BGR POL IDN EGY KOR PRT ARG FRA TWN TUR PER HUN ROM ISR FIN IND BRA MEX 1990-1999 2000-2011 Source: Penn World Tables version 8.0 Source: WB staff calculations using U. Groningen 10-sector Note: Labor productivity calculated as “Real Gross Domestic database and TurkStat data Product series (RGDPo)” divided by “employment”. Growth Note: Countries are sorted ascending on within-component calculated as log differences. percent of total. 4 Raiser, Schaffer and Schuchhardt (2004) review structural change in the transition economies of Eastern Europe. Inherited over-industrialization has meant that structural change in many transition economies was initially associated with a decline in aggregate productivity. Since then, however, Eastern Europe has benefited from substantial growth in TFP thanks to the elimination of inefficiencies in the enterprise sector – a process that seems now to be coming to an end (EBRD, 2013). 115 Turkey’s Transitions Figure 4.2: Labor in Turkey has moved from agriculture to industry and services since the 1980s Source: World Development Indicators (WDI) Notes: The solid lines describe a fitted global trend line relating sectoral employment shares to GDP per capita 116 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Figure 4.3: Structural change has contributed to productivity growth 2 FIRE Natural log of sectoral produc tivity / total PU 1 TSC MIN MAN produc tivty 0 CONS WRT CSPSGS -1 AGR -2 -0.15 -0.10 -0.05 0.00 0.05 Change in employment share (2001-2011) Source: WB staff calculations based on national accounts data. Note: Size of circle represents employment share in 2001. AGR=Agriculture, CONS=Construction, CSPSGS=Community, Social, Personal and Government Services, FIRE=Finance, Insurance, and Real Estate, MAN=Manufacturing, MIN=Mining, PU= Public Utilities, TSC=Transport and Communication, WRT=Wholesale and Retail Trade. services from less than 40 to roughly 55 percent of dance during the 2000s. This liquidity provided total employment. Turkey, thereby, converges to the financial resources for private sector growth. the international trend line from below, suggesting Together macroeconomic stabilization at home and the process of structural change may slow down the “Great Moderation” in the world economy en- going forward but is not quite over yet. Figure 4.3 hanced access to finance and lowered barriers for provides a sense of the productivity implications of new firm entry and expansion. these shifts of labor across sectors. It shows that the significant shifts of labor to manufacturing At the same time, Turkey benefited from the grad- were to higher-than-average productivity activities. ual emergence of “European Union (EU)-anchored” It also shows that some labor went into lower than competition-based regulations and institutions. average productivity service activities over the pe- Over a period of two decades of learning and in- riod. A significant increase in employment was also stitution-building, Turkey’s governments began to recorded in construction, which has around aver- accept constrains on political and administrative age productivity. While these activities are clearly discretion in favor of relying more on productivity- of higher productivity than agriculture, it does raise enhancing rules. The traumatic impact of the 2001 questions about the extent to which future labor crisis catalyzed a decisive shift towards rule-based reallocations from agriculture (and possible manu- economic governance, even though this shift is in- facturing if Turkey follows high income trends) into complete in many ways and rule-based regulation services will be able to sustain productivity growth. remains contested (Atiyas, 2012). The process of EU In other words, Turkey will need to find the sources accession also played a significant role in the adop- of productivity gains within sectors once it reaches tion of these institutions, particularly in the pe- high income. riod between the establishment of the EU-Turkey Several key changes in the policy and institutional Customs Union (CU) in late 1995 and the opening environment played a critical role in the accelera- of accession negotiations in 2005. Since then, the tion of productivity growth in the last decade. One momentum has been gradually lost and the pace of important factor was macroeconomic stabilization. regulatory and business environment reforms has Fiscal prudence and sustained declines in inflation slowed. But the adoption of generally pro-market and real interest rates led to a major restructuring trade, financial and regulatory policies – together in the balance sheets of the banking system and with infrastructure and urbanization policies that increased credit to the private sector (Chapter 3). supported domestic market integration (as docu- Turkey’s perceived country risk also declined sig- mented in Spotlight 2 and Chapter 5) – have creat- nificantly so that Turkey could benefit from the in- ed the basis for productive labor reallocations over crease in global capital inflows that were in abun- the past three decades. 117 Turkey’s Transitions Specific policies promoting market integration in- close to the best performers in the world in terms cluded: trade liberalization in the 1980s, the 1995 of starting a business and registering property. Red EU-Turkey CU, the competition law that was ad- tape related to trading across borders has also de- opted in 1994 and finally became operational in clined significantly likely as a direct result of imple- 1997, a new privatization law in the mid-1990s, as mentation of the CU with the EU. Nevertheless, well as regulatory reforms in telecommunications, improvements in the areas of enforcing contracts, power, and transport. The root and branch reform protecting investors and resolving insolvency cases of financial market regulation also played a critical are needed. Indeed, improvements in these specific role, initiated by the banking law enacted in 1985 areas must go hand in hand with the Government’s and solidified by the Banking Regulation and Su- ambitions to improve flows of FDI going forward pervision Agency (BRSA) bank recapitalization and (see also Chapter 8). capital strengthening program of January-August 2002 (Chapter 3). These were supplemented by the While macroeconomic stability created an environ- independence of the Central Bank and reform of ment which encouraged private sector develop- institutions of public financial management in the ment, institutional changes made it more likely that early 2000s (Spotlight 3). Finally, one should also these gains would be sustained and shared more or mention extensive privatization that took place in less equally by private sector actors. In particular, they ensured that competition would take place on the last decade. Privatization was especially wide- a level playing field and helped install the percep- spread in infrastructure industries, such as telecom- tion that productivity would be more important munications, energy and ports. Privatization both than political connections for entrepreneurial suc- increased efficiency in the provision of public ser- cess.5 Successful structural change based primarily vices and reduced the burden on the public purse of on resource reallocation from agriculture to higher new investments in these areas (Spotlight 2). productivity sectors underlines Turkey’s success at As a result of these multifaceted regulatory re- integration with the rest of the world and, in par- forms, Turkey progressively reduced the gap to the ticular, the EU. We now turn to an analysis of how frontier in the World Bank’s Doing Business indica- structural change has transformed the economies tors (Figure 4.4). Select indicators show significant of the less advanced Anatolian Regions and, as a improvements during the 2000s. Turkey is now result, made economic growth in Turkey inclusive. Figure 4.4: Regulatory improvements to support global integration Distance to the frontier (best = 100) 100 90 88 Distance to Frontier (best =100) 80 78 76 70 70 64 63 63 65 60 53 54 50 40 30 24 20 10 12 0 Star ting a Registering Protecti ng Trading Across Enforcing Resolving Business Property Investor Borders Contracts Insolvency 2004 2014 Source: Doing Business 2014 Note: Starting year for Registering Property is 2005. For Protecting Investors and Trading Across Borders the starting year is 2006. From the 2015 release onwards, a change has been introduced in the methodology and “distance to the frontier” measures for 2015 are not comparable across time. 5 There were exceptions to these trends. For instance, the exclusion of substantial public spending from the scope of the public procurement law has arguably increased the level of discretion and reduced transparency in this important area. The allocation of construction permits and land zoning changes have also suffered from a lack of transparency and allegations of political rent-seeking. 118 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Inclusive growth and the rise of the The benefits of Turkey’s greater integration with the rest of the world were spread throughout the coun- Anatolian Tigers try. The relatively high productivity growth of the The structural changes in Turkey described in the last decade partly reflects a story of catch-up and previous section have been associated with im- inclusion. Indeed, Turkey experienced a substantial portant shifts in economic and political power. It is amount of convergence in regional productivity often argued that the economic opening under Tur- over the last decade. Figure 4.5 shows that those gut Özal led to opportunities for the emergence of (NUTS2) sub-regions that had low average manu- a new, socially conservative class of businessmen, facturing (log) TFP in 2005 experienced higher TFP which drew its strength from the growing integra- growth between 2005 and 2009.6 This convergence tion of Turkey’s inland provinces into Turkey’s do- is most critically reflected in the emergence of new mestic market and rising international trade (ESI, growth centers in the traditionally poorer and less 2005; Yavuz, 2009). The rise of this new business industrialized Anatolian Regions, often dubbed elite created a strong constituency for pro-market “Anatolian Tigers”, which have started to play an reforms, which found its reflection in the specific increasing role in both the domestic economy and brand of socially conservative and economically lib- exports. eral politics championed by the Justice and Devel- opment Party (AK Party). Since then, the argument Yet, like other mythical creatures, the “Anatolian Ti- goes, Turkey’s growth model has become more ger” has been difficult to study in its natural habitat inclusive. In the words of Acemoğlu and Robinson because of lack of data. We try to overcome this (2013): “One hypothesis – which of course needs informational gap by first going to the available to be investigated more systematically—is that the data to clearly define what we mean by “Anatolian beginning of the AKP government saw an opening Tigers” and then using this objectively defined set of economic opportunities to ‘Anatolian Tigers’…”. to investigate their characteristics. The data dictate There is no question that politically the program of that our analysis is at the regional level, rather than socially conservative but economically liberal poli- the city level. This means that our analysis broad- cies has been a winning combination – earning the ens the concept of the “Anatolian Tigers” from the AK Party three successive general election victories city to the regional level – thus we will refer from with rising margins of popular support. In this sec- now on to “Anatolian Tiger Regions”. We divide the tion, we examine the economic basis for the change regions of the country at the NUTS2 level into sub- in Turkey’s political economy. regions. We identify as Tigers those sub-regions Figure 4.5: Productivity levels have converged across regions in Turkey 1.0% Average growth in Ln (TFP) 2005-2009 0.5% 0.0% -0.5% R² = 0,3193 -1.0% -1.5% 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 Ln (TFP), 2005 Source: TurkStat Annual Industry and Service Statistics (AISS) Note: Manufacturing TFP at the NUTS2 level calculated as value added weighted average of firm-level TFP estimated from TurkStat’s AISS. For details on the calculation of firm-level TFP, see the Data Appendix. 6 Regional manufacturing TFP is calculated as the value added weighted average of firm-level TFP estimated from TurkStat’s Annual Industry and Ser- vice Statistics (AISS). Firm-level data from the Annual Industry and Service Statistics are available only for the 2003-2010 period. We start with 2005 because data issues with 2003 and 2004 render comparisons to other years invalid. In 2009, TurkStat switched to NACE Rev. 2 from NACE Rev.1.1. Since we compute TFP using factor shares estimated at 2 digit industries, we cannot use 2010 along with the 2005-2009 period. 119 Turkey’s Transitions that had relatively low value added per capita in tep, Kastamonu, Kayseri, Malatya and Van, among 2004 and which have experienced high job growth others. Sub-regions that had high value added in between 2004 and 2012.7 As shown in Figure 4.6, 2004 are identified as belonging to the “West” re- these sub-regions selected purely on economic gion, representing provinces that have traditionally criteria actually map quite closely with the geo- acted as industrial growth centers. The rest of the graphic Central Anatolian Region of the country sub-regions are identified as the “Other” region. indicated in blue and including the cities of Gazian- Figure 4.6: Identifying the Tigers (in blue): Fast growth from a low base Employment growth (2004 - 2012) vs initial Value Added (VA) per capita (2004) KAS KOC HAT MAL 0.4 VAN KAY ZON ANK ADA ANT IZM GAZ KON TEK IST AYD BUR 0.2 AGR SAN KIR MAN BAL MAR 0.0 TRA SAM -0.2 ERZ 40 60 80 100 West, Anatolian Tigers, Others Source: WB staff calculations using per-capita value added and employment data at the NUTS2 level obtained from the TurkStat website Notes: Each label in the figure on top refers to a NUTS2 region as defined by TurkStat. Regions are defined as: ADA=Adana, Mersin; AGR=Ağrı, Kars, Iğdır, Ardahan; ANK=Ankara; ANT=Antalya, Isparta, Burdur; AYD=Aydın, Denizli, Muğla; BAL=Balıkesir, Çanakkale; BUR=Bursa, Eskişehir, Bilecik; ERZ=Erzurum, Erzincan, Bayburt; GAZ=Gaziantep, Adıyaman, Kilis; HAT=Hatay, Kahramanmaraş, Osmaniye; IST=İstanbul; IZM=İzmir; KAS=Kastamonu, Çankırı, Sinop; KAY=Kayseri, Sivas, Yozgat; KIR=Kırıkkale, Aksaray, Niğde, Nevşehir, Kırşehir; KOC=Kocaeli, Sakarya, Düzce, Bolu, Yalova; KON=Konya, Karaman; MAL=Malatya, Elazığ, Bingöl, Tunceli; MAN=Manisa, Afyon, Kütahya, Uşak; MAR=Mardin, Batman, Şırnak, Siirt; SAM=Samsun, Tokat, Çorum, Amasya; SAN=Şanlıurfa, Diyarbakır; TEK=Tekirdağ, Edirne, Kırklareli; TRA=Trabzon, Ordu, Giresun, Rize, Artvin, Gümüşhane; VAN=Van, Muş, Bitlis, Hakkari; ZON=Zonguldak, Karabük, Bartın. The x-axis represents per-capita value added in 2004 relative to the per-capita value added in Istanbul in 2004. The y-axis represents NUTS2 level employment growth between 2004 and 2012. 7 The classification methodology is inspired by Gönenç et. al. (2012). 120 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Defined in this way, the contribution of the Tiger is located in manufacturing, retail and wholesale regions to overall economic activity in Turkey has trade, transport, storage and communications and increased over time. This can be seen by looking at real estate, renting and business activities. The firm-level data from the AISS. The AISS data set cov- shares of these sectors in employment are quite ers all firms with 20 or more employees and rep- similar across the two regions, except for real es- resentative samples of firms with less than 20 em- tate which has a higher share in the West relative ployees in non-agriculture, non-financial sectors.9 to the Tiger Regions. The share of manufacturing As shown in Table 4.2, which is based on all firms in value added is also similar across the West and in the dataset, the Tiger Regions share in sales and the Tigers. Looking at the evolution of employment value added in non-agriculture and non-financial and value added shares between 2005 and 2010 economic activities had an increasing trend be- (Table 4.4), we find a sharp decline in the share of tween 2005 and 2010, while its share in employ- wholesale and retail trade and an increase in the ment has remained at around 22 percent, suggest- share of construction as well as real estate services. ing an increase in relative productivity in the Tiger Manufacturing increased its share in value added Regions. These developments provide a deeper ex- in both regions, but saw a significant decline in its planation for the economy-wide productivity gains share in employment in the West. Generally, Table experienced over the last decade. In the Tiger Re- 4.4 confirms anecdotal evidence of a construction gions, the reallocation of resources out of agricul- and real estate boom in Turkey. This may not con- ture and into manufactures and services has been tinue, requiring Turkey to look for new sources of accompanied by an increase in the productivity of structural change going forward. the non-agricultural sector relative to the nation- al average. In other words, there has been within We now return to the question of productivity con- sector productivity growth and – at the national vergence and within industry productivity growth level – within sector productivity convergence. This using firm-level data. Table 4.5 shows that the Ana- is an important qualification of the finding in the tolian Tigers have exhibited labor productivity con- previous section of a relatively small contribution vergence over time with the West Regions. Average of within sector productivity growth to overall pro- labor productivity growth in manufacturing indus- ductivity growth in Turkey as a whole. tries has been faster in the Tiger Regions (7.4 per- cent per annum relative to 5.1 percent in the West As of 2010, the composition of (non-agricultural Regions) and virtually the same in non-manufac- and non-financial) economic activity in the West turing industries (a drop of 3.0 percent per annum and Tiger Regions were quite similar, as shown in relative to a drop of 2.8 percent per annum in the Table 4.3. In both regions, the bulk of employment West Regions) over the period 2006 to 2010. Pro- Table 4.2: Productivity convergence between the West and the Tigers Regional distribution of employment, value added and sales (percent) Account Region 2005 2010 Change Employment West 71 70 -1 Tiger 21 22 1   Other 8 8 0 Value added West 83 77 -6 Tiger 14 18 4   Other 4 4 0 Sales West 82 78 -4 Tiger 13 17 4   Other 5 5 0 Source: WB staff calculations using AISS Notes: Calculations are based on all firms (including firms with less than 20 employees which are weighted with the appropriate sampling). Firms assigned to regions according to the location of plant with the highest share of employment. Once a firm is as- signed to a region, all employment and value added of the firm is treated as belonging to that region. However, calculating regional shares on the basis of plants does not change the results. See the Data Appendix for details. 9 The AISS dataset includes all industries except agriculture, fishing and forestry, financial intermediation and a number of other service industries. Hence, the dataset provides information about a large part of the non-agricultural and non-financial industries. The dataset also provides informa- tion on location at the NUTS2 level, which is used to assign firms to the three regions in this study. See the Data Appendix for a detailed description. 121 Turkey’s Transitions ductivity growth in manufacturing using the AISS the reallocation of labor between firms (positive if data is extremely high, whereas the decline in pro- labor is reallocated from low productivity to high ductivity in the non-manufacturing sectors (which productivity firms); (iii) the contribution of new exclude agriculture) is somewhat concerning. entrants (positive if entrants’ productivity is higher than the overall average); and, (iv) the contribution By using firm-level data, we can further investigate the relative importance of churning vs. firm-level of exiting firms (positive if exiting firms’ productiv- improvements for overall productivity growth. The ity is lower than the overall average).10 Note that first four columns of Table 4.5 decompose total this decomposition requires following firms over labor productivity growth into four components: time. Entry and exit is defined as entering into and (i) the contribution of productivity growth within exiting from the data set; entry could be true entry firms; (ii) the contribution of productivity growth of or it could be a firm growing to have more than 20 Table 4.3: Economic structures are similar in the West and the Tigers Distribution of employment and VA across main economic activities (2010, in percent)   West Tigers Sector Empl. VA Empl. VA Mining and quarrying 0.80 0.56 1.96 2.32 Manufacturing 28.62 46.26 30.29 50.41 Electricity, gas and water 1.29 3.05 1.59 12.91 Construction 8.60 7.57 7.45 7.67 Wholesale and retail trade, repair 25.13 20.78 28.73 16.09 Hotels and restaurants 6.86 2.60 6.75 2.31 Transport, storage and communication 10.25 12.20 9.44 3.66 Real estate, renting and business activities 12.25 4.26 7.54 2.47 Education 1.92 0.83 1.90 0.47 Health and social work 2.23 1.45 1.93 1.33 Other community, social and personal ser- vice activities 2.05 0.44 2.42 0.36 Source: WB staff calculations using AISS Table 4.4: Manufacturing has been growing while retail trade has declined in both regions Changes in employment and VA shares (2005-2010, in percentage points)   Employment Value added Sector West Tiger West Tiger Mining and quarrying 0.19 0.12 0.18 -0.56 Manufacturing -1.78 0.83 5.87 1.18 Electricity, gas and water 0.49 -0.12 -1.06 1.52 Construction 2.33 1.68 1.85 0.94 Wholesale and retail trade, repair -6.61 -6.37 -8.18 -4.83 Hotels and restaurants 0.81 1.00 0.64 0.57 Transport, storage and communication -0.71 0.29 -0.59 1.26 Real estate, renting and business activities 4.24 1.35 0.93 0.06 Education 0.57 0.38 0.06 -0.19 Health and social work 0.70 0.11 0.57 -0.01 Other community, social and personal service -0.23 0.73 -0.28 0.05 Source: WB staff calculations using AISS 10 There are various approaches that can be used to decompose overall productivity growth. The approach used in this chapter is due to Griliches and Regev (1995). For details of the calculation and a discussion of different approaches, see the Data Appendix, where we also provide results for an alternative decomposition of productivity growth, namely the approach proposed by Foster, Haltiwanger and Krizan (2001). 122 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Table 4.5: Tiger firms in manufacturing have high productivity growth, reallocation dominates in the West Decomposition of labor productivity growth, 2005-2010 Region Within Between Entry Exit Total Manufacturing West 2.20 2.63 -3.00 3.30 5.12 Tiger 5.94 1.68 -2.70 2.47 7.40 Other -0.70 3.62 -4.64 3.43 1.71 Non-manufacturing West 3.21 -5.55 -3.43 2.99 -2.78 Tiger -1.36 -0.30 -4.59 3.22 -3.04 Other -2.55 6.67 -7.26 5.50 2.36 Source: WB staff calculations using AISS data, firms with at least 20 employees employees. These data limitations impose some ca- ing, both in the Tiger regions and in the West, the veats on the robustness of the results and call for contribution of entering firms is negative, suggest- further research.11 ing new entrants are less productive than the man- ufacturing averages, and the contribution of exiting The decomposition of productivity growth at the firms is positive, indicating that exiting firms are firm level reveals different trends in the West and generally of low productivity.13 the Tigers. In manufacturing in the West, the within and between components make almost equal con- The story in non-manufacturing industries is rath- tributions to overall growth. This contrasts with in- er different. Overall productivity growth between ternational evidence which shows that in most high 2005 and 2010 is negative for both the West and income countries, the contribution of the within- the Tiger Regions, although it is positive for the re- firm component to overall productivity growth maining provinces. The more surprising result is the is substantially higher than that of the between large negative between effect in the West, suggest- component.12 In the Tiger regions’ manufacturing ing that employment has been moving from high industry, the contribution of the within component to low productivity firms. Understanding the dy- is higher. This dynamic is encouraging as it indicates namics behind result requires further research but that Tiger firms are in the process of catching up it echoes the cautionary remark about the shift of with those in the West in terms of productivity. The resources towards lower than average productivity causes of the contrasting patterns between the service activities made in the previous section (see West and the Tigers are not entirely clear. However, Figure 4.3).14 to sustain productivity growth, the West (and in- deed the lagging “Other” regions) would need to The results are similar if TFP, rather than labor pro- become more like the Tigers and generate higher ductivity is used as the indicator of productivity. within sector productivity growth. In manufactur- Table 4.6 shows that in the Tiger region the growth 11 OECD (2014) perform a similar exercise using the same dataset, but uses a balanced panel of firms that were included in the survey in all years. OECD also extend the period to 2011. In this case, there are only within and between effects. OECD show that using this alternate methodology and one additional year, productivity growth is completely driven by within firm productivity increases rather than reallocations across firms. OECD attribute limited between firm contributions to productivity growth to rigidities in factor markets that limit productive resource reallocations. This is in contract to the emphasis in this chapter. It should also be noted that a closer look at a decomposition of productivity growth on an annual basis shows that the within component is highly volatile, and, consequently, that conclusions are sensitive to periodization. For example, dropping the year 2005 brings the within component of productivity growth in west-manufacturing to -0.4. By contrast, the between component is much less volatile across years, always positive, and more robust to changes in periodization. This could be due to measurement errors or it could indeed reflect correctly the underlying volatility of productivity growth at the firm level. Clearly allowing for churning effects as well as the use of time period influences results. 12 For evidence that overall productivity growth is largely driven by within-firm performance, see, for example, Bartelsman et. al. (2004) pp. 34-36. 13 The combined contribution of entry and exit is close to zero. This pattern is unusual in international comparison where net entry usually makes a positive contribution to productivity growth (Bartlesman et. al., 2004). The situation in Turkey may be partly reflecting an anomaly in the data: in 2010, the number of firms employing at least 20 people increased from about 38 thousand to 59 thousand, reflecting a huge number of new entrants, possibly reflecting a large number of firms that did exist in 2009 but were not captured by the survey or simply were (or looked) inactive. More than 80 percent of the new entrants are in the 20-49 size category, and have relatively low labor productivity. This large amount of new entry pulls average labor productivity in 2010 downwards. Indeed, the contribution of entry to productivity growth is especially large (and negative) in 2010. Dropping the year 2010 makes the overall contribution of net entry positive. While this anomaly reduces productivity in 2010, the pattern is uniform across the three regions (about 80 percent of new entrants employ between 20-49 people in all three regions), so that the comparison across the three regions does not seem to be affected. 14 Chapter 2 explains that Turkey’s service trade remains focused on traditional, lower value added activities such as tourism and transport, whereas professional services feature far less prominently than in other MICs. There may be unexploited opportunities to boost overall productivity through the development of professional services. 123 Turkey’s Transitions Table 4.6: Manufacturing firms in the Tiger Provinces have recorded extraordinarily high TFP growth Decomposition of manufacturing TFP growth, 2005-2009 Region Within Between Entry Exit Total West 1.31 1.67 -0.30 0.45 3.12 Tiger 1.99 8.59 0.87 -1.08 10.37 Other -5.73 2.69 0.68 -0.57 -2.94 Source: WB staff calculations using the AISS data, firms with at least 20 employees. See the Data Appendix for details in total factor productivity (at 10.4 percent per an- The Tigers still have some way to go in their catch- num) is even more impressive, reflecting an even up. Figure 4.7 shows that, in spite of the produc- faster convergence with the West (where average tivity convergence, enterprises in the West Regions growth of TFP was 3.1 percent per annum).15 The are still more productive across most industries in most important part of TFP growth in the Tiger 2010. By 2010, the productivity gap of the Tiger Re- Regions comes from the between-industry com- gions relative to the West was significantly smaller ponent, namely from the reallocation of resources in manufacturing industries relative to service in- from low to high TFP firms. While this is expected dustries; it remained particularly large in transport, given the aggregate trends noted in the first sec- storage and communications industries. tion of the Chapter, it tempers somewhat the op- What is behind this Anatolian Tiger catch-up? One timistic conclusion regarding the sustainably of the reason is that employment in the Tiger Regions has past productivity dynamics in the Tiger Regions. shifted from micro to small and medium-sized firms Diminishing returns to reallocation between firms (Figure 4.8). This preliminary evidence suggests at will begin to set in and TFP growth at the firm level least part of the Tiger productivity catch-up is due will need to take over. The table also shows that the to the growth of micro firms into SMEs and a cor- contribution to total TFP growth of entering and ex- responding increase in their productivity, just as in iting firms is rather small, suggesting that TFP levels the Boydak success story mentioned at the begin- of entering and exiting firms were not very different ning of this Chapter. These findings potentially miti- from manufacturing averages. The decline of TFP in gate concerns expressed about the “missing mid- the “Other” provinces is consistent with their over- dle” in Turkey’s population of enterprises, although all under-performance. more work is needed on how enterprises grow over Figure 4.7: Average firm productivity is still higher in the West in spite of productivity convergence Ratio of average labor productivity between West and Tiger Regions, by sector 4.5 4.0 Between West and Tiger Regions 4.0 Ra tio of Average Produc tivity 3.5 3.0 2.5 2.3 1.9 2.0 2.0 1.4 1.4 1.5 1.1 1.2 1.3 1.0 0.8 0.4 0.5 0.0 Electricity, gas & water Mining & quarrying Health & social work Construction Manufacturing Real estate, renting & business activities Hotels and restaurants Other community, and Wholesale & retail trade; repair Education Transport, storage & comm. social Source: WB staff calculations using AISS data 15 Because we cannot calculate firm-level TFP for 2010, results are reported for the period 2005-2009. Also, the analysis covers only the manufactur- ing industries, since calculating TFP for non-manufacturing industries is problematic. 124 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Figure 4.8: Explaining Tiger catch-up – Faster expansion by more productive mid-size firms 70% Employment Share by Firm Size Classes (2010) 60% 50% 40% 30% 20% 10% 0% s1-19 s20-49 s50-99 s100-249 s250-500 s500+ West Tiger Other 10% Changes in Employment Shares (2005-2010) 5% (in percentage points) 0% -5% -10% -15% -20% s1-19 s20-49 s50-99 s100-249 s250-500 s500+ West Tiger Other 60,000 50,000 Labor Produc tivity by Size Category (2010, in constant 1998 TL) 40,000 30,000 20,000 10,000 0 s1-19 s20-49 s50-99 s100-249 s250-500 s500+ West Tiger Other Source: WB staff calculations using AISS data 125 Turkey’s Transitions Figure 4.9: Explaining Tiger catch-up – Increase in Tiger exports, with exporters larger and more productive 1.0 200 0.89 181 177 0.9 180 0.82 0.8 160 Mean Employment per firm (persons) Regional Shares in Total Exports 0.7 140 134 0.6 120 101 0.5 100 92 81 0.4 80 0.3 60 0.2 0.16 40 0.09 0.1 0.02 0.02 20 0.0 0 West Tiger Other non-exp exporter non-exp exporter non-exp exporter 2002 2012 West Tiger Other 9.9 9.4 9.8 9.8 9.3 9.3 9.7 9.2 9.2 9.6 ln (labor productivity) 9.6 9.6 9.1 9.1 9.0 9.5 ln (TFP) 9.5 9.4 9.0 9.0 9.4 9.4 8.9 8.9 9.3 8.8 9.2 8.7 9.1 8.6 non-exp exporter non-exp exporter non-exp exporter non-exp exporter non-exp exporter non-exp exporter West Tiger Other West Tiger Other Source: WB staff calculations based on TurkStat data Notes: Export shares in the first figure are calculated form TurkStat export data broken down by provinces, obtained from the TurkStat website. Data for the rest of the figures are calculated by the WB staff by merging the AISS data set with the firm level Foreign Trade Statistics also compiled by TurkStat. Calculations are based on manufacturing firms with 20 or more employees and averaged over 2006-2009. 126 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion time to substantiate this result.16 Nevertheless, it perhaps reflecting higher entry costs for exporters is worth highlighting that the employment share from those two regions. of the least-productive, smallest firms in the Tiger regions is still much higher than that in the West, Given the importance of exports not only to the implying much more of a shift in this direction is Tiger story, but to the overall growth story of the needed. country, it is worthwhile to look a little closer into the exports of the Tiger regions. We focus on the Another possible explanation of the Tiger produc- quality and technological content of exports. A tivity catch-up is that Tiger firms are exporting measure that is often used to compare different more. The reverse may also be true: increases in qualities of the same product is unit values.17 While productivity may have enabled Tiger firms to in- there are some differences, the results in Figure crease their exports. In any case, more productive 4.10 show a high degree of similarity in the relative firms in most countries tend to be more closely unit values between the West and Tiger regions. integrated into global markets. This is the case in Turkey also (see Chapter 2). Figure 4.9 shows that This is a good indication that recent trends of catch- the share of the Tiger Regions in total exports has up in the Tigers are sustainable. However, the Ti- increased from about 9 percent in 2002 to 16 per- gers still have much lower shares of employment cent in 2010. It also shows that in all three regions and value added in medium and high technology exporters are larger (in terms of employment) and sectors than the West. The process of convergence more productive than non-exporters. Interestingly, is not complete and, even in the West, the share the average employment of exporters in the Tiger of sectors with high technology content is still very and Other Regions is larger than those in the West, small. Figure 4.10: Firms in the Tiger regions export products of similar quality to firms in the West 0.7 Unit Values for Main Export Categories 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Beverages Other manufacturing Furniture Motor vehicles Fabricated metal products Pharmaceuticals Paper and paper products Textiles Other transport equipment Machinery and equipment, nec. Electrical equipment Computer electronic, optical Basic metals Other non-metallic mineral Wood except furniture Tobacco Rubber and plastic Chemicals and chemical products Printing and repr.record. media Leather Wearing apparel Food Coke and refined petroleum West Tiger Source: WB staff calculations using the TurkStat AISS and Foreign Trade Statistics data sets Notes: Unit Calculations based on manufacturing firms with more than 20 employees. Unit values calculated at the HS6 level. The West composition of exports at the Statistical Classification of Economic Activities in the European Community (NACE) two digit level assumed to be equal to that of the Tigers. 16 For a discussion on the ‘missing middle’ evidence, see World Bank (2010) Chapter 3. Using data from the 2008 Enterprise Survey, the report shows that employment growth in smallest firms (1-10 employees) and largest firms (more than 250 employees) was higher than that in middle-sized firms between 2007 and 2010. While we cannot follow firms with less than 20 employees over time (and, therefore, cannot calculate their growth rates) our findings suggest that changes in the distribution of employment were favorable towards middle sized firms. 17 Following Reis and Farole (2012) for each HS6 export product, we calculate the unit value of that product relative to the 90th percentile of the unit value distribution of the same product across all countries exporting that product. This exercise is carried out for firms in the manufacturing indus- tries for 2010. We then aggregate relative unit values to the region-2 digit manufacturing sector level using the share of each firm-HS6 product in total exports of the region-manufacturing industry. In order to make the comparison meaningful, we assume that at the two digit level, the West has a similar composition of 6 digit HS products to that in the Tiger Regions. 127 Turkey’s Transitions What policies have contributed to regional con- that traditional investments in physical and social vergence in productivity? This question is a matter infrastructure and improvements in the quality of of ongoing debate in Turkey, where policy makers public services in the inland regions have made an have experimented for some time with regionally important contribution to convergence. In this re- targeted investment incentives. There is limited gard, Turkey’s experience is similar to the findings systematic analysis of the effect of these incen- from other countries, which by and large suggests tives, because of an absence of data. One such that investments in connecting and social infra- structure, and limited barriers to labor mobility are analysis (Betcherman et. al., 2010) has found that often more effective than targeted regional subsi- employment subsidies directed to relatively under- dies in achieving convergence (World Bank, 2009). developed provinces did lead to faster growth in employment (between 5-15 percent, depending on There has been a significant increase in invest- the program).18 However, there is ample evidence ments in connecting and social infrastructure in Figure 4.11: Increased public expenditures in physical and social infrastructure in Tiger and other regions 0.045 0.07 0.040 0.06 (in hundreds of 1998 constant TL per capita) Stock of road Infrastructure (km per capita) 0.035 0.05 0.030 Spending on energy 0.025 0.04 0.020 0.03 0.015 0.02 0.010 0.01 0.005 0.000 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 West Tiger Others West Tiger Others 0.035 0.08 (in hundreds of 1998 constant TL per capita) (in hundreds of 1998 constant TL per capita) 0.030 0.07 Spending on education 0.06 Spending on health 0.025 0.05 0.020 0.04 0.015 0.03 0.010 0.02 0.005 0.01 0.000 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 West Tiger Others West Tiger Others Source: WB staff calculations using TurkStat data. Note: Spending measures are in TL at 1998 prices. 18 The same study also finds that this occurred at the expense of sizeable deadweight loss, that is, some of the jobs subsidized under the programs (between a quarter and three quarters, depending on the program and estimation technique) would have been created anyway. 128 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Anatolia over the past decade. As shown in Figure are summarized in Table 4.7 and point to the way 4.11, spending in Tiger Regions relative to the West forward for Turkey (see Annex 1 for details of the Regions was higher in both physical and social in- regression results). The following lessons can be frastructure. This higher spending on both physical drawn: and social infrastructure in Central Anatolian urban areas no doubt also increased the appeal of these First, in line with numerous studies for other coun- cities for enterprises, attracting entrepreneurs from tries exports, firm age, size and FDI are the most im- the West to settle and start new enterprises or shift portant correlates of firm level productivity. Export production to these now better-integrated and bet- intensity is a significant source of learning about ter-serviced locations (see Chapter 5). better global practices and changes in foreign de- mand, and is associated with higher TFP across all Looking ahead – How to boost specifications. The positive contribution of age also reflects learning effects, with those firms that de- firm-level productivity growth fend or extend their market position able to learn Turkey’s productivity performance over the past over time not only about what products the firm’s decade has been relatively robust thanks to a struc- capabilities are best suited for but how to improve tural as well as spatial transformation of Turkey’s those capabilities. In our preferred specification economy. Nonetheless, the relatively modest con- (model (3)), firm size is also positively associated tribution of within firm productivity growth to over- with higher TFP.19 In that specification, foreign own- all productivity growth raises the question whether ership also is positively associated with higher TFP. the recent progress can be sustained once the ben- In addition, a number of regional variables influ- efits of structural change are exhausted (Eichen- ence firm-level productivity, including the stock of green, Park and Shin, 2013). capital in infrastructure and social services and the ease of access to finance. The policy implications In this final section, we cast a look ahead and iden- point to the importance of further international tify the likely main drivers of future within-firm pro- integration in terms of greater exports as well as ductivity growth. Specifically, we analyze the main more efforts to attract FDI and further domestic in- correlates of firm-level TFP in the 2005-2009 pe- tegration to spread the story of the Tigers to those riod and postulate that these are the likely drivers provinces where productivity convergence has yet of future productivity growth as well. The results to take hold. Table 4.7: Correlates of firm level productivity growth Dependent variable: log total factor productivity Model 1 Model 2 Model 3 Export Intensity + + + Log KBC per Worker + + + Log R&D per worker + + + Foreign Ownership     + Age     + Log Employment - - + Log per capita transport utilities   +   Log per capita health expenditures   + + Share of investment financed externally     + Constant + + + Firm fixed effects Y Y N Year effects Y Y N Industry fixed effects N N Y Source: Summary based on Table 4.9. Note: “+” reflects positive and significant coefficient; whereas, “-” reflects negative and significant coefficient. For detailed regression results, see Annex 1, Regression Results. 19 Although larger firms seem to have lower TFP when all firm level unobservable effects are controlled for in models (1) and (2), firm size (proxied by employment) is positively associated with TFP in the smaller sample where data are available on whether firm investment is financed externally. 129 Turkey’s Transitions Table 4.8: Firm investments in innovation capabilities – R&D and KBC Share of R&D Share of KBC personnel investments R&D expenditures in Ratio of R&D in total Ratio KBC KBC expenditures total personnel expenditures investment expenditures investments     per worker expenditures to sales expenditures to sales per worker West 133.14 0.61 0.11 4.96 0.23 290.84 2005 Tiger 49.11 0.26 0.07 1.38 0.07 51.49 Other 2.07 0.02 0.00 0.96 0.06 37.07 West 311.21 1.52 0.24 14.23 0.91 1,183.71 2010 Tiger 77.65 0.56 0.09 8.12 0.45 393.69 Other 8.05 0.07 0.01 11.42 0.58 417.96 Source: WB staff calculations using AISS and R&D Activities Survey. See the Data Appendix for details. Second, there is a close association between invest- knowledge absorption and collaboration assets, ments by firms in innovation capabilities and pro- and investment in a few specific types of intangible ductivity upgrading and TFP levels. The coefficients assets (Figure 4.12). A summary of the peer group of two variables that capture research and develop- comparison suggests that: ment (R&D) and broader knowledge based capital (KBC) intensity are highly significant in all examined • Turkey’s business environment as it relates to in- specifications.20 novation can be significantly improved. Turkey’s high costs of redundancy are an impediment to Firms in the West are ahead of those in the other the reallocation of resources across firms, as regions in terms of their innovation investments. are weaknesses in the insolvency framework Table 4.8 summarizes enterprise-level expen- (see also Chapter 3). Turkey also lags behind all ditures on R&D and KBC in the regions of Turkey comparators in terms of ease of access to mi- over time.21 The KBC variable covers the following crofinance, which is presumed to play a critical expenditures on intangible assets by individual en- role in facilitating innovation among new SMEs. terprises: computer software, rights (concessions, Despite these weaknesses, however, we note patents, trademarks, licenses, etc.) and other intan- that given the significant evidence of churning gible investments (goodwill, organizational expen- in Turkey, these weaknesses may be less of an ditures, R&D, etc.).22 The table shows substantial in- impediment than the peer comparison would creases in both types of expenditures in all regions, suggest. though large gaps still exist between the West on the one hand, and the Tiger and Other regions on • Regarding ICT, Turkey ranks better than Indone- the other.23 sia and Mexico in terms of access to infrastruc- ture such as fixed and mobile phones as well as International comparisons underscore the need computers and the internet, but ranks worse for Turkish firms to improve their innovation capa- than all comparators in e-participation, which bilities. According to the Global Innovation Index measures the use of the internet in the provi- 2013, Turkey still lags considerably behind leading sion of government information to citizens.24 innovators across a number of areas such as the Turkey lags behind its peers in the extent of business environment, human capital and Informa- investment in human capital, captured here by tion and Communication Technologies (ICT) access, the level of expenditure per student. Despite 20 KBC captures investments in the “soft” or intangible technologies of software and databases (digital capital), R&D, designs, and Intellectual Prop- erty Rights (IPRs) (intellectual capital), worker skills and management upgrading (managerial capital), branding and advertising (marketing capital), organizational change and new business models (organizational capital), as well as networking and peer-to-peer learning from value chains, consult- ants and other transmitters of global knowledge (collaboration capital). For an overview of the relevance of KBC for development, see Dutz (2013). 21 Data on R&D expenditures are taken from the Research and Development Activities Survey (RDAS) dataset, which has been merged with the AISS through firm codes. 22 Note that R&D expenditures are reported both in the AISS (as part of KBC) and RDAS data sets. According to TurkStat officials, R&D data in the RDAS data set are more reliable. In principle, it would have been desirable to subtract R&D expenditures from the definition of KBC. Unfortunately this is not possible as R&D expenditures are reported not separately but as part of “other intangible investments”. 23 An important element of KBC investments is investment in enterprise skills, such as expenditures on worker and management training. Unfortu- nately, there is no information on such expenditures in the TurkStat data sets. Availability of data on this dimension of KBC would provide a valu- able input for improved policy making. 24 Industry sources also point out that despite significant spending on hardware, there is little investment and little demand among Turkey’s firms in ICT services and software applications. This may be linked to relatively poor management quality in Turkey’s still predominantly family-owned businesses as the preliminary results of a management survey commissioned by the World Bank suggest. 130 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Figure 4.12: Measuring innovation capacities: Turkey vs. selected peers ICT access * Micro finance institutions' Public expenditure on gross loan portfolio education per pupil Ease of resolving insolvency * Online e-par ticipation * Employment in knowledge- Cost of redundancy dismissal intensive services University/industry research Joint venture/strategic alliance collab. + deals Comm., computer & Comm., computer & information services imports information services exports Intangible assets Turkey Malaysia Brazil Poland Source: The Global Innovation Index 2013, http://www.globalinnovationindex.org. Note: The diamonds indicate each country’s rank out of 142 countries for each of the indicators reported. A larger diamond reflects a lower innovative capacity. A lower ranking reflects a better innovative capacity. Most indicators are based on quantitative measures; indicators with “*” are based on indices (such as Doing Business) whereas a “+” reflects a survey question. rapid improvements in recent years (see Chap- states whereas the EU 12 represents the average ter 7), the low level of human capital remains of countries that became members in the last de- a critical constraint to more innovation-based cade.25 The EU comparisons confirm some of the growth. findings of the Global Innovation Index. For in- stance, Turkey lags behind significantly both the • In terms of the capacity for knowledge absorp- EU27 and the EU12 with respect to human resourc- tion and collaboration, Turkey is an outlier when es: new doctorate graduates per 1000 population it comes to university-industry collaboration. aged 25-24 and percentage of population aged 30- Turkey also ranks relatively poorly in terms of 34 having completed tertiary education. Collabora- imports and exports of communications, com- tion between public and private researchers is also puter and information services (as percentages low relative to the EU. Turkey’s scores are also very of total imports and exports, respectively), both low the following areas: Collaboration between reflecting the capacity to participate in inter- SMEs engaged in innovation activities, number of national diffusion of knowledge. On the other new community trademarks and design applica- hand, Turkey does better than other middle-in- tions; number of persons employed in knowledge come countries like Mexico, Indonesia, Poland intensive activities as percent of total employment; and Brazil in terms of joint ventures and strate- knowledge intensive services exports (as percent of gic alliances. Finally, in terms of intangible as- total services exports) and license and patent rev- sets (which measures national and international enues from abroad (as percent of GDP). trademarks registrations as well as the extent to which new technologies create new business However, on a number of dimensions, Turkey com- and organizational models), Turkey together pares relatively well to the new EU member states. with Poland does worse than the other peers in For instance, public R&D expenditure (as percent of this group. GDP) is almost equal to the average of EU12. The share of SMEs introducing product, process or orga- The EU’s Innovation Union Scoreboard 2013 also nizational innovation, the share of SMEs innovating provides some relevant benchmarking for Turkish in-house (as percent of all SMEs) and sales of new- firms’ innovation capabilities. Figure 4.13 shows to-firm and new-to-market innovations (as percent the ratio of Turkey’s score to two EU averages: the of total sales) in Turkey even compares well rela- EU27 represents the average of all EU member tive to the EU27. While these latter indicators are 25 Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovakia, and Slovenia. 131 Turkey’s Transitions Figure 4.13: Innovation scoreboard: Turkey and the European Union Ra tio 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 Human Resources New doctorate graduates Populati on completed ter tiary educati on Finance and Support Public R&D expenditure Firm Investments Business R&D expenditure Non-R&D innova tion expenditure Linkages & Entrepreneurship SMEs innova ting in-house Innova tive SMEs collabora ting with others Public-private co-publications Intellectual Assets Community trademarks Community designs Innovators SMEs introducing product or process innovations SMEs introducing marketing/organisational innovations Economic Effects Employment in knowledge-intensive ac tiviti es Knowledge-intensive services exports Sales of new to market and new to firm innovati ons Licence and patent revenues from abroad TR/EU27 TR/EU12 Source: WB staff calculations based on IUS2013 database of the Innovation Union Scoreboard 2013 available at http://ec.europa.eu/ enterprise/policies/innovation/files/ius-2013-database_en.xls. Note: For each indicator, TR/EU27 represents Turkey’s score for that indicator divided by the EU average, while TR/EU12 represents Turkey’s score divided by the average of countries that became members in the last decade (i.e., Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovakia, and Slovenia). perception, based they reveal an SME sector that ing of R&D in recent years, encouraged venture reports relatively high levels of product and process capital financing through favorable tax treatment, innovation despite poor scores on measures of the and are working on a new patent legislation. More quality of the national innovation system. It is ulti- research is needed to understand whether these mately the interaction between the supply of and measures to improve the capacity of the national demand for innovation that determines the returns innovation system on the supply side will find ready to R&D. The authorities have increased public fund- demand among Turkish companies. 132 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion Conclusion less likely in countries where the population has a relatively high level of secondary and tertiary Turkey has achieved fast productivity growth education and where high-technology products thanks to structural change and regional integra- account for a relatively large share of exports. Sus- tion. Horizontal, pro-market policies, starting with tained growth into high income is also more likely trade liberalization in the 1980s, improvements in in countries that have more open economies, at- macroeconomic and financial stability after 2001, tract greater amounts of FDI, and have stable mac- and the establishment of largely rule-based regu- roeconomic conditions (see Chapter 8 for a detailed lation have created an environment conducive to discussion of the literature on growth slowdowns in enterprise growth and regional convergence. Tar- middle income countries). geted regional investments in physical and social infrastructure have also helped. Overall, Turkey’s The analysis in this Chapter confirms the cross- enterprises have delivered productivity growth and country findings on how to sustain growth in mid- rising exports, and created jobs, and this not only dle income countries. Turkey’s most productive en- in Turkey’s already advanced coastal provinces, but terprises are those that have grown over time from critically also in the Anatolian heartland. This has small, domestic market oriented workshops to me- made Turkey’s growth model more inclusive and dium or even large-scale companies, linked to the has created a strong constituency for continued global economy. These companies invest more in pro-market policies (Ülgen, 2013). R&D, they require more information technologies, they hire more skilled workers and are better man- The main challenge that Turkey faces looking into aged. Like the Boydak group, they are enterprises the future is to increase within-industry and, espe- that are ready to compete with the best and have cially, within-firm productivity growth. As empha- shifted to a model of innovation-based growth. Tur- sized in the literature, avoiding the middle income key needs more of them if the productivity gains trap entails moving up the technology ladder (see, of the past decades are to be sustained and if the among others, Canuto et al. 2010). Slowdowns are country is to cross the threshold to high income. 133 Turkey’s Transitions Annex 1: Regression results Table 4.9: Correlates of total factor productivity in manufacturing in Turkey Dependent variable: log total factor productivity (1) (2) (3) Firm level variables Export Intensity 0.0551** 0.0547** 0.0806* (0.0259) (0.0259) (0.0429) Log KBC per worker 0.009*** 0.0098*** 0.0336*** (0.0009) (0.0009) (0.0026) Log R&D per worker 0.0062*** 0.0064*** 0.0393*** (0.0021) (0.0021) (0.0056) Foreign ownership 0.0061*** (0.0005) Age 0.0088*** (0.0013) Log employment -0.123*** -0.122*** 0.0863*** (0.0115) (0.0115) (0.0195) Regional (NUTS2) Variables Log per capita transport expenditures 257.92*** 325.4 (82.03) 341.0 Log per capita health expenditures 737.26** 5354.2*** (322.94) (556.0) Share of investment financed externally 0.602*** (0.104) Constant 9.423*** 9.383*** 8.047*** (0.063) (0.048) (0.075) N 78740 78740 14141 R-sq 0.019 0.015 0.154 Adj. R-sq Firm fixed effects Y Y N Year effects Y Y N Industry fixed effects? N N Y Standard errors in parentheses. Error terms clustered at the firm level in columns (1) and (2) and at the regional (NUTS2) level in column (3). 134 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion References Acemoğlu, D., & Robinson, J. (2013). The Political Griliches, Z., & Regev, H. (1995). Firm Productivity Economy of Turkey. Retrieved from http://whyna- in Israeli Industry: 1979-1988. Journal of Econo- tionsfail.com/blog/2013/2/27/the-political-econo- metrics, 65(1), 175-203. my-of-turkey.html Mcmillan, M., & Rodrik, D. (2011). Globalization, Atiyas, İ., & Bakış, O. (2013a). Aggregate and Sec- Structural Change and Productivity Growth. NBER toral TFP Growth in Turkey: A Growth Accounting Working Paper 17143, June 2011. Exercise. REF Working Paper No: 2013-1. Istanbul. OECD. (2014, July). Turkey Country Survey. Chapter Atiyas, İ., & Bakış, O. (2013b). Structural Change 3. and Industrial Policy in Turkey. REF Working Paper, Raiser, M., Schaffer, M., & Schuchhardt, J. (2004). 2013-3. Benchmarking Structural Change in Transition Bartelsman, E., Haltiwanger, J., & Scarpetta, S. Countries. Structural Change and Economic Dy- (2004). Microeconomic Evidence of Creative De- namics, 15 (1), 47-81. struction in Industrial and Developing Countries. Reis, J., & Farole, T. (2012). Trade Competitiveness WPS 3464. Diagnostics Toolkit. Washington, D.C.: The World Betcherman, G., Daysal, N., & Pages, C. (2010). Do Bank. Employment Subsidies Work? Evidence From Re- Ülgen, S. (2013, February). The Political Economy gionally Targeted Subsidies in Turkey. Labor Eco- of Reform in Turkey and Its Relevance for the Arab nomics 17 710-722. World. World Bank Mimeo. Washington, D.C.: The Canuto, O., Dutz, M., & Reis, J. (2010). Technologi- World Bank. cal Learning and Innovation: Climbing a Tall Ladder. World Bank. (2009). Reshaping Economic Geogra- Chapter 2 in The Day After Tomorrow: A Handbook phy. World Development Report 2009. Washington, on the Future of Economic Policy in the Developing D.C.: The World Bank. World. (O. Canuto, & M. Giugale, Eds.) Washington, D.C.: The World Bank. World Bank. (2010). Turkey Investment Climate As- sessment. Dutz, M. A. (2013). Investments in Productivity: Knowledge Capital as a Driverof Structural Change World Bank. (2011). Running a Business in Turkey. and Growth - Growth FAQ: 10 Frequently Asked Enterprise Surveys Country Note Series, Country Questions on KBC. PRMED. Washington, D.C.: The Note 1. Washington D.C.: The World Bank. World Bank. Eichengreen, B., Park, D., & Shin, K. (2013). Growth Slowdowns Redux: New Evidence on the Middle-In- come Trap. NBER Working Paper 18673. Cambridge MA. ESI (European Stability Initiative). (2005, September 19). Islamic Calvinists: Change and Conservatism in Central Anatolia. Berlin and Istanbul. Retrieved from http://www.esiweb.org Foster, L., Haltiwanger, J., & Krizan, C. (2001). Ag- gregate Productivity Growth: Lessons from Micro- economic Evidence. New Developments in Produc- tivity Analysis. (E. Dean, M. Harper, & C. Hulten, Eds.) Chicago: University of Chicago Press. Gönenç, R., Röhn, O., Koen, V., & Saygili, S. (2012). Structural Reforms to Boost Turkey’s Long-Term Growth. OECD Economics Department Working Pa- pers, 987. Paris: OECD Publishing. 135 Turkey’s Transitions Data Appendix A division of S - “Activities of membership organiza- tions” in Other service activities (section S) is not Annual Industry and Service Statistics covered. (AISS, 2003-2010) Unfortunately, the change in the classification from The AISS data provides detailed information on rev- NACE Rev. 1.1 to NACE Rev.2 creates a discontinuity enue, costs, employment, investment, sector of ac- in the data set and makes it impossible to under- tivity (at 4 digit detail, NACE Rev. 1.1 for 2003-2009 take analysis that involves data at the sub-sectoral and NACE Rev.2 for 2009-2010) and the region of (say 2 digit) level. Hence in the text, any such analy- location (NUTS2 level). NACE Rev. 1.1 sections from sis is carried out either for the period 2005-2009, or letter C to I, and letters K, M, N and O are covered. for the year 2010. The AISS does not cover the following sectors: To deal with outliers, we trim the data as follows: A - Agriculture, hunting and forestry first, we compute labor productivity (LP) for each firm (real value added divided by number of em- B - Fishing ployees). Then we trim firms with an average LP J – Financial Intermediation (over years the firm appears in the data) 2 stan- L - Public administration and defense; compulsory dard deviations above or below the mean LP. Using social security 3 standard deviations or trimming 1 percent from top and bottom yield similar results. For calculating O - Other community, social and personal service real variables, we used 2-digit producer price index activities (published by TurkStat) for manufacturing and sec- P - Activities of households toral GDP deflator (letters A to Q according to NACE Rev. 1.1 classification) for other sectors. Q - Extra-territorial organizations and bodies It was stated above that firms with less than 20 The AISS dataset covers all firms with 20 or more employees, and a representative sample of small employees are covered on a sampling basis. AISS firms with 1-19 employees. However, all firms with also reports sampling weights. For some analysis more than one plant (regardless of number of em- in the text, it makes sense to use the whole data ployees) are covered if they are in one of the sec- set (i.e., including firms with less than 20 employ- tors C (mining and quarrying), E (electricity, gas and ees) along with the appropriate sampling weights. water supply) or I (transport, storage and commu- For example, the analysis of employment shares of nications). firms in different size classes uses the whole data set. Other questions, for example decomposition of For NACE Rev. 2 (years 2009 and 2010) sectoral cov- productivity growth, require to focus only on firms erage is similar to the NACE Rev. 1.1. Here, the sec- with at least 20 employees (“20+ firms”). Whether tors that are not covered are: the whole data set or only 20+ firms are used is in- A - Agriculture, forestry and fishing dicated in the text. K - Financial and insurance activities The AISS data set does not contain information on physical capital stocks. We use depreciation allow- O - Public administration and defense; compulsory ances to impute capital stocks at the firm level. Un- social security fortunately, for almost half of the firms reported T - Activities of households as employers; undiffer- depreciation is zero. We find that implausible, as- entiated goods- and services-producing activities of suming that the depreciation rate is some nonnega- households for own use tive number. Thus, we impute depreciation allow- U - Activities of extraterritorial organizations and ances for such firms using sector (4 digit NACE Rev. bodies 1.1), year dummies along with value added, num- ber of employees, electricity and oil expenditures. A division of J - “Programming and broadcasting ac- We assume that depreciation rate is 10 percent in tivities” in Information and Communication activi- the baseline specification. In the baseline specifica- ties is not covered. tion, we estimate a Cobb-Douglas production func- tion with constant returns to scale at 2 digit NACE Two classes of L - “Buying and selling of own real es- Rev. 1.1. Then, for each firm TFP is computes as a tate” and “Renting and operating of own or leased real estate” in the Real Estate Activities (section L) residual, using value added, capital and employ- are not covered. ment at the firm level. TFP is computed only for firms in the manufacturing industry for the years 2003-2009. 136 Chapter 4: Enterprise: Harnessing structural change for integration and inclusion The data set contains information on geographic lo- The Research and Development Activities cation at the NUTS 2 level, which we use to assign Survey (RDAS) firms to the regions West, Tiger and Other. Some firms have multiple plants (units) in different NUTS The RDAS data set contains information on R&D 2 regions. At the plant level, only information on expenditures and R&D personnel. The following the share of the plant in total employment and enterprises are covered according to the survey sales of the firm are available. To assign a geograph- frame: Enterprises funded by government agencies ic location for such firms, we use the employment that provide R&D support, the top 500 enterprises shares. Specifically, we assign each multi-plant firm in industry and services sectors by turnover and in every year to the region where the plant with the VA, enterprises in Technology Development Zones highest employment share is located in that year. and Technoparks, enterprises benefiting from the Because plants do not have unique ID codes that are constant over time and because not all informa- insurance Premium support (article 3/3) stated in tion is available at the plant level, we cannot carry the Law on Supporting Research and Development, out the whole analysis on the basis of plant level No.5746 and enterprises which are known as R&D information. However, we have calculated regional performers from the AISS survey, public and private shares of employment and sales using plant level universities. Again, we can link this data set to the information as well, and the shares turn out to be AISS data set via unique firm ID. The RDAS data set very close to those calculated on the basis of firms contains about 15 thousand observations over the assigned to regions in the way described above. period 2003-2010. The merging operation results in about 9000 matches. We note that the AISS data “Technological content” is defined for the manu- set also reports R&D expenditures at the firm level, facturing industry. We follow the classification and these numbers do not match those reported in published by Eurostat. High technology (HT) indus- the RDAS data set. According to TurkStat officials, tries include sectors such as “basic pharmaceuti- R&D data in the RDAS data set is more reliable. Be- cal products”; medium-high technology (MHT) cause of this reason, for firms in the AISS that do industries include sectors such as “chemicals and chemical product”; medium-low technology (MLT) not get matched to the RDAS data set, we assume industries produce products like “coke and refined that their R&D expenditures are zero. petroleum”; finally low technology (LT) industries include sectors like “food, beverages, tobacco, tex- Calculation of Relative Unit Values tiles, wearing apparel etc.”26 of Exports The Foreign Trade Statistics (FT) Since there is no directly observable quality mea- sure in FT data, the literature uses unit values as The FT data set covers all exports and imports a proxy for “quality” of similar products. Follow- transactions by all firms in Turkey since 2002 on a monthly basis. The data are collected by the Turk- ing Reis and Farole (2012), for each export product ish Customs Authority and processed by TurkStat. (classified according to 6 digit Harmonized System), Thanks to the unique firm ID, one can follow indi- we calculate the relative unit value of that product vidual firms through time. For any firm, we know as follows: We divide its unit value to the 90th per- each transaction’s (export and import) value, its centile of the unit value distribution of the same quantity and destination at product level. In Turkey, product across all countries exporting that product. product codes are 12 digit- the first 8 of which cor- When we report regional aggregates such as West respond to the Combined Nomenclature classifica- or Tigers, we calculate such aggregates as weighted tion, and the last 4 digits are national. Hence, for averages where weights are export shares of these international comparisons, one has access to 6 digit products (at 6 digit Harmonized System level). Harmonized System classification. Thanks to the When doing sectoral comparisons, say 2 digit in- firm ID, we can merge the FT data set with the AISS dustries, across regions this may yield biased re- data set. This gives detailed information on sales, sults because of “composition effects”: the compo- VA, costs, location, employment alongside exports sition of exports at the two digit level are not likely and imports at firm level. The match between the two data sets is not perfect, because while the FT to be the same in the West and the Tiger Regions. data set covers all firms that have export and im- As a result, what is being compared is not the qual- port transactions, the AISS covers only a sample of ity of the same basket of products, but the aver- firms with less than 20 employees. However, the age quality level of exports at the two digit level. In match is quite reliable: total exports in the matched order to obtain comparable indicators, we need to data amounts to 83 percent of total exports in the control for such composition effects. This is done by FT data set in 2010. using the same basket across regions. For this, we 26 For the full list, see http://epp.eurostat.ec.europa.eu/cache/ITY_SDDS/Annexes/htec_esms_an3.pdf 137 Turkey’s Transitions compute regional relative unit values using export with 20 and more employees and, therefore, enters shares of the Tigers (at 2 digit industry level) for all the data set. The same is true with exit. regions. This way, regional differences, if any, can be interpreted as quality differences of the same An alternative approach is that developed by Fos- basket of products across regions. ter, Haltiwanger and Krizan (2001, the FHK ap- proach, for short), differs in the weights used. Decomposition of Productivity Growth Instead of using weights that are averages of the beginning and end of the period, the FHK approach There are various approaches that can be used to uses beginning of the period weights. This changes calculate the contribution of continuing, entering formulas for the “within” and “between” compo- and exiting firms to overall productivity growth.27 nents. In addition, the contribution of continuing The approach used in this paper follows Griliches firms gains a third term (in addition to the “within” and Regev (1995; “GR” for short). This approach and “between” components), which is the “cross decomposes change in aggregate productivity P term” (sum, across continuing firms, of the product between periods t and t - t in the following way: of changes in productivity and changes in employ- ment shares). �� ∆,− = � − ,− � + �� − ,− �( �) � ) + � ( − � − ∈ ∈ ∈ �) − � ,− (,− − ∈ Here sit and pit are the employment share and pro- Bartelsman et. al (2004) show a preference for the ductivity for firm i at period t and C, E and X stand FHK approach. Even then, they argue that the GR for the set of continuing, entering and exiting firms, approach would likely produce more robust results respectively. Bars over a variable indicate averages when the data is likely to suffer from measurement of the variable over base and end years. Hence the errors. terms sl and pl stand for averages over periods t and t - t and P is the mean of productivity for the In this paper we use the GR approach, both because industry or the economy over periods t - t . Hence we believe the AISS data likely contains substantial productivity growth is decomposed into four terms. measurement errors and because the “cross effect” The first term, called the “within-firm” effect, is the in the FHK approach is very difficult to interpret. sum of productivity growth in each firm weighted by By contrast, the GR terms are more intuitive and the mean share in employment. The second term is easier to interpret. We further think that averaging the “between-firm” effect expressed as the sum of shares across time makes sense and gives a more changes in the employment share of the firm multi- intuitive description of productivity dynamics. plied by the difference between average firm-level productivity and average industry-level productiv- We have, nevertheless, calculated productivity de- ity, averages being taken across beginning and end composition for the three regions using the FHK ap- of period. The third term captures the contribution proach as well. The results are as follows: of entry and is positive if the productivity of new entrants is higher than the industry average. Finally, Comparison with Table 4.5 in the text will show that the last term is minus the contribution of exitors the qualitative results are very similar. One impor- and increases aggregate productivity growth if the tant point revealed by the FHK decomposition is productivity of the exitors is less than the industry that for non-manufacturing what appeared as large average. Entry and exit are defined relative to the negative between effects under the GR composi- whole data set. tion appears as relatively small positive between Since decomposition of productivity growth re- effects and very large negative cross effects under quires to follow individual firms over time, calcula- the FHK decomposition. tions are carried out on firms with at least 20 em- ployees. Entry and exit are defined as entering into We have also undertaken decompositions of overall and exiting from the data set. Hence, an entry could TFP growth for the manufacturing industry. These represent true entry into the market, or it could re- decompositions use VA rather than employment flect the employment growth in a firm such that a shares. The GR decompositions of TFP growth are firm with less than 20 employees becomes a firm reported in the text (Table 4.5). 27 See Bartelsman et. al. (2004) for a discussion of various approaches. 138 2 Spotlight 2: Infrastructure to connect and fuel the economy Spotlight Infrastructure to connect and fuel the economy Finance Fiscal Space Infrastructure Trade Welfare Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 139 Turkey’s Transitions 140 Spotlight 2: Infrastructure to connect and fuel the economy Infrastructure to a matter of pride for Turkish citizens who have ventured across their country’s borders. Not only connect and fuel the economy Eastern Europe, but also large parts of Middle East and North Africa (MENA) and many other emerging “A rising tide doesn’t raise people who don’t have markets find their growth aspirations constrained a boat. We have to build the boat for them. We by a lack of physical infrastructure. This spotlight in- have to give them the basic infrastructure to rise vestigates how Turkey has managed to upgrade its with the tide”. infrastructure over the past three decades, empha- sizing the role of the private sector. It argues that Rahul Gandhi1 infrastructure to connect and fuel the economy has been a key factor behind Turkey’s successful inte- gration experience. It has also been a key factor in T he traveler entering Turkey from Bulgaria by facilitating the spread of economic dynamism from road will immediately note with satisfaction Turkey’s coastal areas inland (see Chapter 5). But the large, smooth highways leading towards while the expansion of physical capacity and the Istanbul and beyond. Indeed, the same traveler leveraging of private investment have been im- would find that she could cross Turkey in almost pressive, there are concerns related to efficiency, all directions and, for the most part, find double transparency and value for money, which Turkey lane highways in good condition (Figure S2.1). The will need to address going forward if its ambitious quality of the road network in Turkey is justifiably further development plans are to be realized. Figure S2.1: The expansion of two lane highways in Turkey during the past decade Source: Ministry of Finance 1 Indian politician. Retrieved September 8, 2014, from BrainyQuote.com Web site: http://www.brainyquote.com/quotes/quotes/r/rahulgandh518463. html 141 Turkey’s Transitions Figure S2.2: Turkey experienced considerable improvements in mobile and broad-band coverage in the last decade Turkey ICT INFRASTRUCTURE INDICATORS 35.6 28.9 0.03 2002 mobile telephone fixed telephone broadband subscriptions per lines per 100 pop. Internet 100 pop. subscribers/100 pop. fixed broadband 88.5 26.0 6.8 2007 Internet mobile telephone fixed telephone broadband 7.9 millions subscribers in 2012 subscriptions per lines per 100 pop. Internet 100 pop. subscribers/100 pop. 67.7 mobile telephone 90.8 18.6 10.5 2012 mobile telephone fixed telephone broadband millions subscriptions in 2012 subscriptions per lines per 100 pop. Internet 100 pop. subscribers/100 pop. Source: World Development Indicators (WDI) 2002-2012 Infrastructure can be a powerful tool to connect the potential to promote growth, increase equity, and fuel the economy. Over the last two decades, and, hence, reduce poverty (Calderon and Serven, empirical work has found evidence of the contribu- 2010b). tion of infrastructure to growth and productivity In Turkey, too, infrastructure is likely to have con- (see Aschauer, 1989; Canning 1999; Demetriades tributed to rapid productivity growth. Focusing on and Mamuneas, 2000; Calderón and Servén 2004; investments in road, communications and energy 2010a, Vu, 2004 among others) and poverty and infrastructure, Fedderke and Kaya (2013) find a inequality (e.g., Estache, Foster and Wodon, 2002; positive and significant relationship between infra- Calderon and Chong 2004). While the debate on structure and productivity between 1987 and 2006. the size of the impacts is still very much alive, there Their findings suggest that a 1 percent increase in is consensus that infrastructure development has the road network led to around 0.5 percentage Figure S2.3: Total electricity generation capacity increased rapidly after 1978 60,000 50,000 40,000 MW 30,000 20,000 10,000 0 1913 1925 1928 1931 1934 1937 1940 1943 1946 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 Total Generati on Capacity (MW) Source: TEİAŞ (Turkish Electricity Transmission Company; www.teias.gov.tr) 142 Spotlight 2: Infrastructure to connect and fuel the economy Figure S2.4: Quality indicators show improvements in all dimensions of infrastructure Quality of overall infrastructure 5.5 5.0 4.5 4.0 Quality of electricity supply Quality of roads 3.5 3.0 Quality of air transport Quality of port infrastructure infrastructure 2006-2007 2009-2010 2013-2014 Source: World Economic Forum, Global Competitiveness Report 2013-2014. point increase in productivity. Similar estimates for creased rapidly in the last 10 years. The number of energy capacity and Information and Communica- mobile telephone subscriptions nearly tripled be- tion Technologies (ICT) connections range between tween 2002 and 2012 (Figure S2.2). And the num- 0.3 and 0.55 percent and 0.2 and 0.56, respectively. ber of broadband internet subscribers increased Coşar and Demir (2014) find that increases in four dramatically from less than 11 thousand in 2001 lane expressways between 2003 and 2012 generat- to over 67 million in 2012. In 2012, Turkey had al- ed a stream of additional export revenues ranging most 19 broad band connections per 100 individu- between 9 and 19 percent of the value of the in- als, slightly lower than Brazil and China (around 22) vestment. Further, investments led to considerable and higher than Poland (16) and Tunisia (10) (World increases in employment and revenue shares of Bank, 2012a). Similarly, capacity in energy increased transport-intensive industries. So, how did Turkey from only 17 MW in 1913 to over 407 MW in 1950s expand its physical infrastructure? To answer this and more than 57,000 MW in 2012 (Figure S2.3) question, we first document the increase in assets and annual power generation increased from 8,623 that has taken place. MWh in 1970 to more than 239,000 MWh in 2012. Quality indicators also show important improve- A substantial expansion of capacity ments in the last five to six years. Figure S2.4 sum- A close look at both the levels and quality of in- marizes a set of quality indicators for different in- frastructure in Turkey indicate considerable im- frastructure variables. Movements along the radius provements through time. The road network has of the pentagon and towards its exterior indicate continuously expanded since the 1950s. By 1995, improvements in quality over time. Turkey has seen Turkey had nearly 59,770 kilometers of all-weather improvements in all dimensions. According to the highways, of which about 27,000 kms were paved latest indicators from the Global Competitiveness (World Bank, 1991). Today, the road network reach- Report, Turkey’s road and airport infrastructure es almost 65,000 kms (Ministry of Transport and ranks above those of Poland, Russian Federation Communications, 2011) and road density (46.9 km and Brazil and in the top 50 worldwide. In ports, per 100 sq km of land area) is higher than that of Turkey still ranks above these three competitors, China and Brazil (41.8 and 18.6 respectively).2 but is ranked 63rd globally. However, Turkey is ex- panding port capacity at a rapid clip in a bid to uti- The picture is similar for ICT infrastructure: mobile lize its strategic location to become a major trans- and broadband internet subscriptions have in- shipment hub between Europe and Asia.3 2 World Bank (2012a). 3 Focus on Turkey: Ports Investment Will Ease Access to the Middle East and Asia. The Wall Street Journal, November 6, 2013. 143 Turkey’s Transitions Figure S2.5: Public vs. private investments as percentage of GDP Transport and communications 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Private Public Total Energy 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 Private Public Total Source: World Development Indicators (WDI) 2002-2012. A legacy of continuous investment spending on infrastructure of about US$252 billion between 1991 and 2010.5 No expansion of infrastructure capacity and qual- ity can happen without investment. Total invest- Yet, public investment in infrastructure as a per- ment in transport, communications and energy centage of Gross Domestic Product (GDP) appears accounted for about 18 percent of investments in low compared to international benchmarks. Pub- the 1960s, increasing to about 25 percent on av- lic investment in infrastructure remained around erage in the 1980s, over 30 percent in the 1990s, 3 percent of GDP in the 1970s and 1990s. In the and above 25 percent over the last decade.4 Turkey 1980s, ambitious infrastructure plans brought pub- is also among the top ten spenders in infrastruc- lic investment up to an annual average above 4 per- ture among emerging economies, with estimated cent of GDP. In China, Thailand and Vietnam, total 4 Ministry of Development and TurkStat. 5 Royal Bank of Scotland (2011). The Roots of Growth. Projecting Emerging Markets Infrastructure Demand to 2030. 144 Spotlight 2: Infrastructure to connect and fuel the economy infrastructure investments exceed 7 percent of GDP changing from merely 25 percent in the 1950s to and history seems to suggest that this is the appro- over 75 percent by the mid-1980s. In the early priate level of investments for fast growing econo- eighties, with World Bank assistance, the govern- mies (Growth Commission, 2008). Turkey falls short ment focused on the rehabilitation of the Trans- of this level, but thanks to increasing private invest- Turkey Highway, to respond to the increased traffic ment, the gap is not very large. between Europe and the Middle East. Important investments were made also to build roads to con- Private infrastructure investment has played an nect coastal areas with the still very much rural increasingly important role, particularly after the inland. In 1985, the Government started a large 1980s. As shown in Figure S2.5, public investment motorways program that included improvements in transport and communications hovered around along 1200 km of the most heavy transport corri- the 2 percent of GDP mark from the early 1970s dors in Turkey. These included the segment from through the early 1990s, before declining to around the Bulgarian border through Istanbul (including 1.5 percent. However, private investment made the Second Bosphorus bridge) to Ankara; the sec- up more than the slack, peaking at over 4 percent tion between Mersin and Iskenderun through Ad- of GDP in 1997 and staying above 2 percent of ana; and around Izmir (World Bank, 1991). GDP thereafter except the crisis years in the early 2000s. In the energy sector, the public sector has Importantly, investments were accompanied with remained more dominant, but here, too, there is a critical institutional reforms and capacity building shift towards greater private investment after the programs. There was a strong emphasis on train- mid-1990s. Transport, communication and energy ing of the General Directorate of Highways (KGM) are typically at the forefront of attracting private personal and modernization and rationalization of investment in infrastructure. But in recent years, road maintenance through the acquisition of new other sectors such as health care, are also attract- equipment and parts, as well as the development ing increasing private sector interest. of an equipment management program and adop- tion of methodologies for investment analysis. In However, the real answer to Turkey’s successful parallel, KGM started a process of modernization expansion of infrastructure is linked to efforts that and reorganization with the assistance of the U.S. go beyond investments. While investments are key, Federal Highway Administration and worked close- international experience indicates that investments ly with the Ministry of Education and the police to are more successful when: (i) regulations are in improve road safety. place to support competitive markets; (ii) coordina- tion across sectors and administrative units exists, Regulatory reform also accompanied road invest- and (iii) efforts are made to leverage private sector ments in more recent years. Large transport invest- participation in infrastructure. In what follows, this ments continued through the first decade of the spotlights provides insights on how Turkey has tak- 2000s as public expenditures in the sector almost en steps along these three directions, and through doubled as a share of GDP, reaching 1.92 percent these, ensured that spending was in fact reflected of GDP in 2010 (World Bank, 2012b). In parallel, in the creation of new infrastructure, maintenance the Road Transport Law introduced in July 2003 of existing assets, and overall improvement of qual- and the subsequent Road Transport Regulation en- ity. Figure S2.6 at the end of this Spotlight provides acted in 2004 regulated access to the market and a timeline and overview over the critical reforms the profession with the objective of bringing opera- taken over the three and half decades since 1980 tors to international standards. Operators had to grouped by these three interlinked policy areas. obtain a license, based on criteria consistent with the European Union (EU) regulations: (i) profes- Laying the foundation –regulation sional competence, to ensure safety; (ii) financial and institutions sustainability to ensure viability of the business; and (iii) good repute to ensure that those that do Infrastructure investments can be wasted if invest- not respect rules and regulations are weeded out ments are not coordinated with policy and regula- of the system. Managerial and professional com- tory efforts. Turkey has understood the importance petence were also highlighted in this new law as of coordinating infrastructure investments with ap- requirements for licensing, designating institutions propriate regulatory policies. One example where for training and accreditation of operators, with the Turkey has made parallel efforts in investments and main objective of improving overall quality of op- regulation is in its connective infrastructure. erators and enhancing road safety. Large investments in road infrastructure responded While the road sector has made advances in build- to increased demand in the 1980s. Truck transport ing a regulatory framework and creating key institu- became the dominant mode for freight transport, tions, other infrastructure sectors such as ports and 145 Turkey’s Transitions railways lag behind. Currently, ports are not sub- Telecom’s monopoly was first broken, when two ject to any technical or economic regulation that private firms received the rights to offer GSM ser- can help improve efficiency and quality of services vices through revenue sharing agreements with while promoting a more competitive environment. Turk Telekom. By 1998, the government had sold Because competition in some of Turkish ports is two operator licenses through a concession agree- very limited, a strong and independent regulator ment for their GSM 900 networks for 25 years for may be required. Similar changes to railway legisla- US$500 million each. tion will be required to bring the sector to EU stan- dards towards a competitive cost structure (World An important reform process followed in the early 2000s, taking steps towards enhancing competi- Bank, 2012c). tion and building institutional capacity. In 2000, a Today, Turkey is in the process of overhauling its new telecommunications law (No. 4502) opened railways sector to improve efficiency by promot- the door for moving toward opening fixed lines for ing competition and private sector participation. competition and established the Telecommunica- Turkey’s railways sector lags well behind its road in- tions Authority, laying the foundation for the sepa- frastructure in terms of efficiency of operation and ration of policymaking, regulation, and operation. quality of service (World Bank, 2012b). Indeed, re- In May of the same year, the first licenses were is- cent research suggests that poor railways services sued for the provision of voice telephony services may actually be a drag on productivity (Fedderke by alternative operators (World Bank, 2005). Price and Kaya, 2013). The Law on Liberalization of Rail- cap regulation was introduced in 2001 to ensure way Transportation, which became effective May 1, that prices were below a maximum set by the 2013, sets out to significantly change performance government. For GSM tariffs, a maximum yearly of the sector by authorizing private train operators increase of 3 percent was set as part of the opera- to compete using access to the national railway tors’ concessions agreements. For Turk Telekom, infrastructure. Over a five year transition period, the maximum increase was fixed at 7.5 percent for the Government of Turkey will be putting in place 2002 and 2003 and then reduced to 4 percent in the regulations necessary to implement the law 2004 (World Bank, 2005). More recently, the Elec- and Turkish State Railways (TCDD) will complete tronic Communications Act came into force in 2008 its transformation into an infrastructure and train to streamline the legal framework, foster further operating company. By the end of the transition pe- competition in the sector, lessen the uncertainties riod, TCDD Trains will compete with private opera- for operators, and increase allocation of resources tors for freight service, and passenger services will to research and development. The move towards be provided under public service obligation (PSO) increased competition in the broadband market contracts. has been slower and benefits could still arise from similar efforts to foster competition through effec- Turkey has also applied the principle of accompa- tive design and enforcement of regulation (World nying large investments with changes in regulation Bank, 2011). and market structure in the ICT sector. In the early 1980s, network infrastructure buildup was iden- In the energy sector, reforms started in the early tified as a priority and public investments led to 1990s. In 1994, the state electric utility, Turkey access lines growing by 14 percent on average be- National Power Company (TEK), was restructured tween 1980 and 1985, and by 20 percent on average leading to the separation of distribution from trans- per year between 1985 and 1994. Significant infra- mission and generation. Initially, generation invest- structure investments were made by Turk Telekom ments were attracted with the help of generous (which, at the time, was a wholly publicly owned take or pay contracts often tendered in less than company) as early as the 1980s with Turk Telekom fully transparent ways, saddling the government investments increasing from 0.3 of Gross National with large contingent liabilities. But in the 2000s, Product (GNP) in 1980 to 1 percent by 1987 (Yılmaz, the approach changed to emphasize competition 2000). Investments, then, declined again to 0.3 per- and arms’ length regulation (Atiyas, 2012). In 2001, cent of GNP in the second half of the 1990s given a new law for the electricity market (No. 4628) and the financial constraints the government was facing related secondary legislation (including the Elec- and the fact that Turk Telekom’s profits were used tricity Market Licensing Regulation of 2002) created to contribute to the general government budget an independent Energy Market Regulatory Author- (World Bank, 2005). ity (EMRA) and provided a new legal framework for the sector. The new EMRA was created to oversee Important steps toward liberalization of mobile the sector, including licensing; preparing, publish- phone (Global System for Mobile, (GSM)) services ing and applying new legislation and codes; per- and building the sector’s regulatory capacity were forming tenders for city gas distribution networks; taken in the early 1990s (Öniş, 2006). In 1994, Turk regulating tariffs for transmission and distribution; 146 Spotlight 2: Infrastructure to connect and fuel the economy protecting customer rights; following the perfor- Working beyond silos –coordinating mance of all actors in the market and sanctioning parties that violate the rules (World Bank, 2005; efforts for more 2013a). efficient investments The new legislation enacted in 2002 promoted Coordination across sectors was also apparent in changes both on the demand and supply sides of early efforts to extend and improve quality of infra- the energy sector. On the demand side, it allowed structure. To a great extent, Turkey’s policymakers appear to have acknowledged that working in silos open access to the transmission and distribution limits the impact of both investments and regula- grids by eligible consumers. Eligible consumers tory changes. were initially defined as those exceeding a con- sumption threshold of more than 9 GWhs per year. In the transport sector, investments in road connec- These thresholds were then reduced gradually. On tivity in Turkey went hand in hand with efforts on the supply side, it provided entry opportunities into safety and monitoring that required collaboration the generation, wholesale trade, distribution, retail across sectors and institutions. In 1989, KGM was given the authority to introduce technical inspection trade, import, and export of electricity. The new of road vehicles including emission control. Later, legislation also opened the door for the creation of this function came under the Ministry of Transport joint ventures between distribution and generation which has since put in place more than 200 fixed companies and promoted unbundling of genera- and 70 mobile stations to control the weight and tion, wholesale and transmission into three inde- dimensions of commercial vehicles. Road accidents pendent legal entities (World Bank, 2013a). due to overloading or non-compliance with techni- cal standards are estimated to have decreased by The Energy Market Law of 2008 also brought sever- about 30 percent since 2004 when the Road Trans- al improvements to the electricity market, including port Regulation was introduced (Ministry of Trans- important changes to the pricing structure. In 2008, port and Communications, 2011). a cost-based pricing mechanism was implemented, allowing electricity tariffs to reflect costs. Efforts Also, as early as 1989, KGM worked closely with the Ministry of Education and the police to improve to improve collection led to considerable improve- road safety. Road safety has been a concern for ments in 2009, finally achieving 100 percent collec- some time since the number of accidents has been tion in 2010. This change in the pricing mechanism growing at a rate equal to the growth of traffic. led to state-owned utilities achieving profitability While fatalities have decreased, injuries continue and being able to pay their arrears to private sec- to grow at a rate of 1.3 percent annually. Further, tor generators (World Bank, 2013a; 2013b). Market the current rate of fatalities (eight per 10 thousand pricing also paved the way for the entry of the pri- vehicles) is four times higher than the EU average. vate sector into power generation, including impor- Conscious that this is a problem that has to be tant renewable energy investments. tackled from different angles, the government has promoted the collaboration of different ministries The regulatory and institutional frameworks to pro- with a single objective: improving road safety. In mote energy efficiency have recently been set up that regard, the General Directorate of Security of (World Bank, 2012c). Secondary legislation final- the Ministry of Interior is responsible for regulating ized in 2011 opened the door for the supply of ex- road safety, the Ministry of Transport is responsible cess energy to the distribution grid. The launch of for regulating and monitoring transport of danger- ous goods, the Ministry of Education for training the electricity trading mechanisms between 2009 drivers, and the Ministry of Health for guaranteeing and 2012 also marks a turning point in the electric- driver health conditions (Togan, 2010). ity market. Today, about 75 percent of the electric- ity in Turkey is traded through bilateral contracts Today, Turkey is also leveraging the impact of its between generators and distributors, the remain- investments in connective infrastructure by rede- ing being traded in the day-ahead and balancing signing and modernizing its customs. Customs re- markets (World Bank 2013a). The New Electricity forms started after the Customs Union (CU) agree- Market Law was introduced to further support the ment with the EU entered into force in 1995 and included efforts to improve the efficiency of Turkish liberalization process in the sector in March, 2013. Customs, reduce waiting times, and improve the Among other changes, this Law combines whole- capacity of personnel. Efforts were focused along sale and retail companies under a single supply li- three lines (i) modify customs legislations accord- cense, allowing firms to perform wholesale and/or ing to EU and international standards; (ii) develop retail sale activities without restrictions (Ergun and and implement computer systems; and (ii) organize Gökmen, 2013). the administration to balance efforts to control cus- 147 Turkey’s Transitions toms with those to facilitate trade. As part of the resources and investment needs and balance com- trade facilitation efforts, the Turkish Customs built peting demands for resources (opportunity cost of in a specialized selectivity module into the new investment); second, it can increase the efficiency customs management software that checked each of service provision by strengthening market forc- declaration against pre-selected risk assessment es; third, it can contribute to transferring some criteria. Such assessments assign the shipments commercial risk to the private sector. to green, yellow, red or blue channels where red shipments required full inspection and companies Turkey was a pioneer in aiming to leverage private cleared for the blue channel do not have to attach investment in infrastructure as early as the 1980s. paper documents to their declaration. Coordinated The first law to allow private sector involvement efforts were required to modify legislation to allow was enacted in 1984 targeting the electricity sec- for paperless trade and e-signature of official docu- tor (Law No. 3096 of 1984). This law introduced the ments (Togan, 2012). build-operate-transfer (BOT) concept, allowing con- cessions to private companies that would build new Additional efforts include cooperation with inter- facilities and then operate them for up to 99 years national platforms, signature and ratification of (later reduced to 49). The law also introduced the bilateral and international transport agreements. possibility to transfer operating rights for existing Today, beyond the CU with the EU, Turkey has free generation and distribution assets to private com- trade agreements with 22 countries and has a re- panies under a lease-type agreement. Through this laxed legal framework enabling investors to export regulatory reform, Turkey also opened the door to to different markets without customs duty. These allow private companies to produce their own elec- efforts are also reinforced through treaties to pre- tricity. Regulatory efforts continued through the vent double taxation with 80 countries and bilateral 1990s, with laws introducing the possibility of the agreements with 75 countries to promote and pro- Undersecretariat of Treasury to grant guarantees tect investments (Gürsu, 2013). Further, efforts to and provide tax exemptions to render BOT projects build 19 logistic centers are underway. These are more attractive for the private sector. However, no expected to become intermodal terminals where framework was put in place to promote competi- road, rail, and port services will be linked and sup- tive tendering of projects, limiting the early ben- plemented with warehousing and light manufac- efits of private participation (World Bank, 2005). turing (Ministry of Transport and Communications, Starting in the late 1980s, steps were taken to- 2011). wards private participation in the road sector. In Another example of cross-sectoral coordination is 1988, Law 3465 removed the monopoly of the KGM the recent effort to consider energy efficiency, en- on undertaking road projects. In 1994, a new law ergy security and environment as part of an inte- provided the framework for BOT schemes in the grated energy program. Improvements in energy transport sector. Today, Turkish law also provides efficiency have been accompanied by important guidelines for the implementation of agreements, changes in regulation and coordination in envi- including dispute resolution mechanism provided ronmental management. With the support of the either through arbitration or the courts (Rodrigues, World Bank, the government is currently making Inal and Cankorel, 2013). efforts to bring these three areas together under These early efforts toward regulatory reform in the a single framework. An inter-ministerial Climate 1980s and 1990s laid the foundations for the suc- Change Coordination Board and a Climate Change cessful move towards privatization in the 2000s. Department at the Ministry of Environment and Privatization revenues between 2005 and 2009 Urbanization (MoEU) were established in the first rose dramatically to around US$30 billion, after less half of 2011 and are working on coordinating and than a third of this amount was raised in the twen- ensuring complementarity between sector specific ty years before. Legal and institutional weaknesses climate actions (World Bank, 2013a). Implementa- and macroeconomic instability posed challenges tion of these coordination arrangements has how- to privatization in the early years. Further, at that ever, been slow. time, the government tried to implement privati- zation narrowly through the issuance of Cabinet Leveraging the private sector for fi- decrees. While the objective was to bypass oppo- nancing and efficiency sition, weaknesses in the nascent legal framework were used by opponents to slow down privatiza- When financial sources are limited, thinking about tion. The Privatization Law of 1994 and the creation ways of attracting private participation is essen- of the Competition Board were important steps to- tial. Opening the door to private participation in ward transparency and accountability in privatiza- infrastructure can serve several purposes. First, it tion deals and, ultimately, aided the move to more can help bridge the gap between available public competitive markets. Legislative efforts continued 148 Spotlight 2: Infrastructure to connect and fuel the economy in the 2000s with the Foreign Investment Law of In the ICT, sector the number of operators has in- 2003, which removed many of the bureaucratic creased continuously after liberalization. As of restrictions on foreign direct investments (Palmer, 2012, there were 422 operators holding 668 autho- 2010). From the 1990s onwards, Turkey favored a rizations to provide a full complement of services model of introducing independent regulators as in Turkey. The share of alternative fixed telephony part of a strategy to separate policy development, service operators in total outgoing call volumes ownership, and day to day regulatory oversight, reached 17.9 percent in 2012, and 39.9 percent for and to ensure that regulation was isolated from outgoing calls abroad, indicating vibrant competi- political influence. However, political wrangling tion in the sector. Today, the market share (in terms over the appointment of board members to these of subscribers) of mobile operators, Turkcell, Voda- agencies highlighted that the concept of regulatory fone and Avea are respectively 51.9 percent, 28.2 independence remained contested (OECD, 2002). percent and 19.9 percent. Strengthening of mar- This changed after 2001, with regulatory indepen- ket forces has triggered a wave of investments by dence more strongly enshrined in legislation. the four companies under concession agreements (incumbent fixed operator Turk Telekom and three The energy sector is perhaps the most striking ex- mobile operators Turkcell, Vodafone and Avea6) ample of successful reforms to leverage private in- amounting to TL29.479 billion between 2004 and vestment. The restructuring and unbundling of the 2012. Demand for convergent voice and internet sector have led to an increase of nearly 60 percent services led to an increase in the average revenue in both electricity transmission and peak capacity per user (ARPU) from 15.70 TL in 2005 to 21.99 in between 2002 and 2010. These steps towards a 2012 providing a sound foundation for further de- more competitive market represented an impor- velopment of the ICT sector. tant move away from the contracts awarded in the 1990s, which, in some cases entailed monopoly To promote private participation in infrastructure the government has offered a variety of demand rights and government take or pay guarantees and and debt assumption guarantees (World Bank were later cancelled by the Turkish Court of Ac- 2012b). Debt assumption and traffic guarantees counts. Today, 43 percent of the electricity genera- have been used as a central feature of early PPPs tion comes from the state-owned Turkey National for the larger road and bridge PPPs, while availabil- Energy Distribution Company (EUAŞ), 14.8 percent ity payments are part of the proposed health PPPs. from BOT agreements, 1.5 percent from compa- Debt assumption guarantees have been offered by nies operating under Transfer of Operational Rights Treasury, traffic guarantees by the highways agency agreement, 35 percent from independent produc- (KGM), and revenue guarantees for the new air- ers and the remaining 5.6 percent from auto pro- port by the General Directorate of State Airports ducers (Ergun and Gökmen, 2013). The distribution (DHMİ). These guarantees enhance the ability of sector is divided into 21 regions of which 13 were major deals to reach financial closure. However, go- transferred to the private sector in 2012 and the re- ing forward, it would be necessary for the Govern- maining eight in 2013. The state distribution com- ment to invest more time and effort into adequate- pany Turkey National Energy Transmission Compa- ly evaluating and managing the risks given that the ny (TEDAŞ) remains the owner of the assets but no portfolio of guarantees is likely to grow rapidly as longer operates any distribution company. The dis- private participation increases. tribution privatization program alone has attracted US$12.7 billion from the private sector. Beyond expansion – ensuring More recently, in 2012, the Government adopted efficiency and value for money an Energy Efficiency Strategy, targeting a 20 percent reduction in energy intensity by 2023. Energy-effi- With the acquired experience and success Turkey ciency credit lines have been put in place with Gov- has achieved over the last three decades, the coun- ernment and international financial institutions (IFI) try is well placed to continue to meet rising infra- support to help realize these targets. Incentives have structure demands. Turkey’s aspirations are high, also been provided to foster increased participation and to achieve them, additional investments in of the private sector in the production of electricity infrastructure will be required. However, Turkey’s from renewable sources. Over a span of eight year, ambitious PPP pipeline has so far failed to attract electricity produced from privately owned renew- large-scale international and domestic term fund- able generation facilities increased more than nine ing is likely to be insufficient. Moreover, concerns times, from 1,490 gigawatt hours (GWh) in 2002 to have been voiced over the lack of a unified frame- 13,773 GWh in 2010 (World Bank, 2012c). work across sectors, the strength of feasibility stud- 6 Following privatization the incumbent fixed operator was obliged to provide mobile services via an arms’ length subsidiary called AVEA. The same applies to broadband internet services via arms’ length subsidiary called TTNET. 149 Turkey’s Transitions Figure S2.6: Improving infrastructure – a timeline of reforms New Electricity Market Law 2013 Energy Efficient Strategy 2012 Inter-ministerial Climate Change Climate Change Department at the Coordination Board Minitsty of Environment and Urbanization 2011 Movement to Increase Opportunities and Technology (FAITH) Energy Efficiency Secondary Legislation finalized 2010 2009 Electronic Communictions Act Energy Market Law 2008 Turk Telecom maximum increase Road Transport Regulation fixed (4%) 2004 Law on Liberalization of Railway Transportation Foreign Investment Law 2003 Creation of the independent Energy Electricity Market Licencing Regulation Market Regulatory Authority 2002 Turk Telecom monopoly broken: Electricity Market Law No. 4628 Turk Telecom maximum increase fixed (7.5%) 2001 Price Cap Regulation 2000 First Licences issued for the provision Telecommunications Law No. 4502 of voice telephony services 1998 Telecom Concession Agreement Turk Telecom monopoly broken 1994 TEK Restructuring Privatization Law and creation of Competition Board 1989 KGM and Ministry of Education Directorate of Roads given the authority partnership for Road Safety to introduce technical inspection 1988 General Directory of Highways monopoly broken 1984 Opening up participation in electricity sector Law 3096 Telecommunications (ICT) Laying the Foundations Transport Coordinating Across Sectors Energy and Electricity Capacity Building Leveraging Private Sector Source: World Bank staff ies, project selection, and management of the ten- be essential. Increased coordination across sec- dering process. The 2011 decree law resubmitting tors will be necessary to achieve goals of climate independent regulatory agencies to inspection by change mitigation and to ensure Turkey’s economy the relevant line ministry has also raised concerns is on a path of sustainability. And finally, promoting that the political commitment to strong arms’ the cohesion in private participation government- length regulation may be wavering (Atiyas, 2012). wide will require the harmonization of all legisla- Altogether, these concerns represent potential tion across sectors; improving the quality of bid- risks for Turkey’s ambitious infrastructure goals. ding documents, contracts and feasibility studies Turkey should address remaining regulatory and in- to move toward international standards; and bet- stitutional weaknesses to ensure value for money ter management of risk and coordination with the in its upcoming infrastructure pipeline. 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İstanbul: TESEV. 152 5 Chapter 5: Cities: Managing rapid urbanization Chapter Cities: Managing rapid urbanization Infrastructure Finance Fiscal Space Trade Welfare Enterprise Labor Turkey’s Transitions: Integration, Inclusion, Institutions 153 Turkey’s Transitions 154 Chapter 5: Cities: Managing rapid urbanization Cities: a factor of five. Such a concentration of people led to the need to develop navigational tools and Ça- Managing rapid urbanization talhöyük lays claim to having the oldest city map in R ising like an ancient skyscraper some 20 me- the world. Extensive murals excavated on structure ters above the Konya plain in Turkey’s Central walls also testify to a thriving form of cultural exp- Anatolia, Çatalhöyük is considered one of the ression that cities and the proximity of human capi- oldest human settlements in the world. At its peak, tal tend to promote to this day. These innovations this Neolithic era settlement, dating as far back as and cultural expressions of an ancient Anatolian the 9th millennia BC, hosted 10,000 people on no society lie at the heart of what we know about ur- more than 12 hectares of land. The settlement owes banization. But developing countries need not look its extraordinary height and compactness to its suc- back that far in history to learn lessons from Turkey. cessive occupational layers, an estimated 13 tiers The country’s recent urbanization experience, in in total, under each of which ancestors from previ- fact, reflects many of the foundations of successful ous generations are buried. For archaeologists, its urbanization experiences past and present. discovery in 1958 re-opened debates on the origins Lying some 38 kilometers northwest of Çatalhöyük, of settled life and the motivation of once nomadic the thriving metropolitan city of Konya is modern hunter-gatherers to seek a communal foothold in a day Turkey’s heir apparent to this ancient settle- place of permanence. John Mellaart, the British ar- ment. Its pristine tree-lined boulevards, unconges- chaeologist who discovered Çatalhöyük, describes ted streets, and generally reputable service provisi- it as an “early metropolis.” Other archaeologists, on define it as one of Turkey’s more liveable cities. such as Ian Hodder, ponder the question of what brought so many people together on this isolated Today’s Konya carries forward the legacy of many plain (Balter, 2008). past civilizations. As the former capital of the Ana- tolian Seljuk Sultanate and home to Mevlana Jalal The novelty of Çatalhöyük is not simply that it was ad-Din Rumi, one of the greatest Islamic poets, phi- an ancient and populous city, extraordinary as that losophers and scholars, its place in history is well may be. Rather, it is the density of its settlement secured. The key for Turkey’s 7th largest city is to pattern against the backdrop of a sprawling plain preserve a cultural patrimony so rich and unique that confounds today’s archeologists. Indeed, the that it will continue to sustain its vibrant tourism level of density that the Çatalhöyük settlement rea- industry, while maintaining a diverse economy. The ched at its peak dwarfs that of its modern day Tur- city’s commitment to urban planning will be a criti- kish comparator – the metropolis of Istanbul – by cal factor in this effort. Images of Konya: Restored Ottoman structures in the old city and the oldest boulevard tram system in the country 155 Turkey’s Transitions Figure 5.1: Development of Konya’s urban form as depicted in a series of urban planning schemes (1946-2020) Source: Yenice, M., and C. Çiftçi. “Sustainable Development and Urban Form: Planning Experiences of Konya City.” International Journal of Enviromental, Cultural, Economic and Social Sustainability, 2011 Despite its layers of history, Konya features many of Konya is but one example of Turkey’s ability to the important elements of a planned city that ma- adapt to rapid demographic and economic trans- kes it both liveable and enduring. Four successive formation. Like many cities experiencing rapid ur- urban planning periods spanning more than 70 ye- banization across the developing world, Konya has ars reflect the vision and effort of nearly three ge- faced extraordinary pressures to adjust its planning nerations of city leadership and planners. Starting and administrative regime to accommodate new in 1946 as a modest settlement of no more than growth. A key element to Konya’s success has been 45,000 people and monocentric1 in form (Figure a concerted and sustained planning regime that an- 5.1), Konya was declared a metropolitan municipa- ticipated demographic growth. But there were sev- lity in 1989 and today has over 1.1 million residents eral other elements to Konya’s success that need to – nearly 25 times its size in 1946. This remarkable be further examined. urban population growth was anticipated in early planning efforts and initial thoughts of the city de- In what follows, we explore Konya’s and Turkey’s veloping in a poly-centric pattern emerged in the urbanization experience to draw lessons for other 1983 plan. One rationale for this was the impact of late urbanizing countries. To do so, this chapter is rapid urbanization after the early 1980s and, with framed around three main questions: it, the need to provision for new residential areas to • First, how does Turkey’s urbanization experi- accommodate this in-migration. As a result, Konya ence compare with other countries? In this sec- has little evidence of gecekondu, or informal hou- tion we illustrate the economic efficiency and sing “built overnight” during the peak periods of inclusiveness of Turkey’s urbanization process, rapid urbanization. And mobility within the city has factors that made it overall quite successful rel- generally been good, as it features an integrated ative to comparator countries. public transport system and was the first Anatolian city to introduce a tram network on its main bou- • Second, what policies and institutions contrib- levards, a system that other Anatolian cities strive uted to Turkey’s successful urbanization pro- to replicate to this day. As a leader among Anatoli- cess? Here we explore (i) the market enabling an cities, earning the accolade of “Anatolian Tiger,” policies that allowed, rather than hindered, mi- and benefitting from its flat geography, Konya was gration to cities, (ii) the metropolitan municipal- also one of the first Turkish cities to invest in alter- ity regime that facilitated inter-jurisdictional co- native transport infrastructure, featuring over 150 ordination necessary for Turkey’s fast growing km in bike path networks and one of the country’s cities, (iii) the combination of housing market first city bike-share programs. enabling policies and social housing interven- 1 A monocentric city has one core central business district as seen in the 1946 urban plan of Konya (Figure 5.1) versus a polycentric city, which has more than one center, as seen in the 1999 Konya urban plan. 156 Chapter 5: Cities: Managing rapid urbanization tions that expanded housing supply to accom- Bank, 2010). Given the challenges countries such as modate new migrants, and (iv) interventions to Britain and France faced with urbanization nearly ensure the provision of basic services in places two centuries ago (see Box 5.1), is its accelerated that did not benefit from growing city econo- pace in developing countries a positive signal or yet mies. another obstacle to development? • Third, we explore the question of how livable Urbanization poses a conundrum for policy mak- and sustainable Turkey’s cities are today. Turkey ers. Economics tell us that urbanization will bring has virtually no evidence of slums of the type needed agglomeration economies – the stuff that found in Latin America and South Asia, but still makes industrialization possible – through the con- faces long-term sustainability challenges in the vergence of production and consumption markets, need to improve urban transport planning and the concentration of human capital that can fuel systems, employ effective means of social en- interactions, and the exchange of know-how and gagement to broaden the benefits of urbaniza- tion to all city residents, and reinvigorate spatial innovations that matter most to development and planning measures that will safeguard against growth. Indeed, as stated in the World Develop- sprawl and inefficient, uncontrolled develop- ment Report 2009 - Reshaping Economic Geogra- ment. Taken together, these key challenges rep- phy, “no country has advanced to middle income resent Turkey’s second generation agenda for status without urbanizing, and none has grown to sustainable urban development. high income without vibrant cities.” (World Bank, 2008) but many countries resist urbanization. They How does Turkey’s urbanization view it as unmanageable, creating congestion costs, social dislocation, and rising crime and violence. experience match-up with other What insights can Turkey’s urbanization experience countries? offer other developing countries, particularly late urbanizers? To answer this question, let us consider The backdrop: Urbanization and its discontents. the experience of some of the BRICs. Urbanization is one of the most vexing develop- ment challenges of the 21st century. Some would Different policy responses to urbanization gener- argue it is the most important policy arena for gov- ate different outcomes: The case of China. In Chi- ernment decision-makers in developing countries na, the prevailing Hokou system, a household regis- today. Demographic projections underscore this tration system that tied people to places is claimed claim by suggesting that 90 percent of all popula- to have its roots in the family registration system tion growth in the next 20 years will take place in of the Xia Dynasty dating as far back as 2100 BC. developing countries. Perhaps more importantly, By the late 1950s, it was used by the Communist urbanization is expected to take place at a pace ten regime as a means of regulating labor markets to times faster than in developed countries (World support stated-owned enterprises. People living Box 5.1: A historical perspective on urbanization To appreciate the merits of Turkey’s urbanization experience, consider its precursors in the cities of Brit- ain and France. Not unlike Turkey, both Britain and France experienced an upsurge in urban population growth that coincided with their respective industrial revolutions in the early 19th century. Neither country was prepared for the wave of new migrants to their cities. Britain’s experience was particularly brutal: cholera outbreaks in British cities were widespread. By 1841, the crude death rate in British cities was 5.6 per thousand higher than in rural areas and infant mortality rates were 25-50 percent higher than in Britain’s rural hinterland, earning them the unsavory title of “killer cities.” A major factor in Britain’s dif- ficult urban transition was an under investment in infrastructure. According to Williamson (1990), in the midst of industrialization and urban growth, social overhead capital stocks in Britain actually declined over the 70 years leading up to 1830. In France, the experience was no better. The population of Paris doubled over 50 years during the course of the 19th century with inadequate infrastructure and housing to accom- modate the new migrants, causing miserable living conditions for city residents. Three cholera epidemics plagued the city, the worst of which, in 1832, claimed the lives of 20,000 people, or nearly 3 percent of the city population. These two historical perspectives on urbanization underscore the needed emphasis on effective city planning and access to finance to invest in infrastructure necessary for an urban society. Source: Williamson (1990) as cited in Urbanization & Growth, Commission on Growth and Development, 2009 157 Turkey’s Transitions Figure 5.2: Growth in share of urban population in Turkey and comparator countries (1950-2015) 85% 75% 65% Share of Urban Population 55% 45% 35% 25% 15% 5% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Brazil Republic of Korea Turkey South Africa China India Source: World Development Indicators (WDI), World Bank (WB) staff calculations outside of their Hokou area of registration were not in the 1990s, state-owned industries were rapidly entitled to grain rations, education and health ben- abandoned and their urban hosts – known by their efits, and employer-provided housing, which cer- sobriquet of “mono-cities” or single industry cities tainly would have an influence on people staying in – have become “shrinking cities”, i.e., cities whose place. In short, access to state-delivered or spon- economic function has contracted to the point that sored benefits was restricted to a person’s place of they are shedding their population base. registration. Through a series of reforms and legal Urbanization is resisted in some countries as a acts coinciding with economic liberalization in the force that uproots traditional values: The Case of 1990s and in recognition of villager movements to India. Was it that Gandhi had it so wrong or that Chinese cities even with these restrictions, China future generations interpreted his meaning wrong- began to relax, though never fully abandoned, its ly when he asserted that “the future of India lies Hokou system prescriptions. This unleashed an un- in its villages?”. Whatever one’s take on Gandhi’s precedented surge in urbanization beginning in the views, despite substantial human capital, India re- 1990s (Figure 5.2), fueling China’s rise in produc- mains dramatically behind other BRICs and emerg- tivity and competitiveness witnessed over the last ing market economies in its rate of urbanization twenty-five years. (Figure 5.2). Other forces, possibly shaped by this supposition, have been at work as well. Mumbai, Urbanization as misguided regional planning: The for instance, deliberately lowered its Floor Area Ra- case of Russia. During the period of the communist tio (FAR)2 which resulted in the very flat, sprawled regime in Russia, urbanization was recognized as an out city it is today. The FAR was first introduced at essential ingredient for industrialization and, much 4.5 in 1960, but, in 1991, Mumbai lowered its FAR like in China, labor markets were strongly shaped to 1.33 in the central city and 1 in the suburban ar- by the state to support state-owned enterprises. eas. By comparison, cities such as New York, Tokyo, However, in Russia’s case, urban settlements and Hong Kong and Shanghai have FAR limits that range urbanization were viewed as essential to the state’s between 10 and 15. This had the effect of distorting policy of promoting industrialization, and were the city’s land market and driving up housing costs planned across the country around state-initiated to staggering levels. Real estate prices in Mumbai industries that once formed the backbone of its today rival those of Manhattan, and the city is host command economy. Access to natural resources to one of the largest slums in the world – Dharavi. and military considerations led to planned urban Traveling across two areas of the city can take well settlements in far flung corners of Russia’s vast ter- over two hours during rush hour, causing conges- ritory, with little regard for economic or social vi- tion that surely makes the average Mumbai resident ability. With the liberalization of Russia’s economy question the merits of urbanization. (Bertaud, 2010) 2 FAR or FSI (Floor Space Index), the term used in India, is an urban planning regulation governing building heights and is the ratio of a building’s total floor area to the size of the parcel of land on which it is built. 158 Chapter 5: Cities: Managing rapid urbanization Figure 5.3: Urbanization and growth around the world - a mixed picture (1980-2012) 50% Change in share of Urban Population (percent of total) BWA LH HH 40% GAB MYS GMB IDN CHN 30% BTN KOR TUR (in percentage points) JOR PRY ALB NGA PRT NLD 20% SAU MAR BRA CHE JPN TUN BGR FRA CYP FIN BGD 10% PAK HUN CHL NOR ROM GRC ITA AUS ESP USA SWZ DEU 0% BLZ BEL AUT LCA -10% -20% LL HL -10,000 -5,000 0 5,000 10,000 15,000 20,000 25,000 Absolute Change in GDP per capita 1980 - 2012, (constant 2005 PPP $) Source: WDI, WB staff calculations Notes: GDP data in Purchasing Power Parity (PPP) US$ has recently been updated to 2011. However the series has been backdated only to 1990 in the WDI database. Hence for this chart, the previous 2005 based PPP estimates are used. Historically, urbanization is highly correlated with economies. During the country’s most rapid period reductions in poverty and inequality and improve- of urbanization, from 1960-2013, Turkey’s industrial ments in access to services.3 Turkey provides a and services shares of the economy increased from poignant illustration of this global phenomenon 17.6 percent and 26.4 percent to 27 percent and in practice. Over the past six decades, Turkey has nearly 64 percent respectively. From 1980-2012 transformed itself from a predominantly agrarian Gross Domestic Product (GDP) per capita more economy with 75 percent of its population in ru- than doubled.4 Early and substantial investments ral areas in the 1950s to the globally competitive in transport infrastructure (see Spotlight 2) helped industrial economy it is today with over 75 percent connect Turkey’s large land-mass country, enabling of its population residing in urban areas. Some 92 a “system of cities” to take root over the course of percent of Turkey’s gross value added is produced the second half of the last century. Today, new firms in cities today. And Turkey’s concomitant rise across are increasingly moving toward dynamic secondary most human development indicators has been cities, capturing economic spillovers from Turkey’s equally remarkable. Among comparator countries, large primary cities, while taking advantage of low- only the Republic of Korea managed a faster rate er land-rent values and labor costs. Turkey’s lead- of urban growth over the same period, while India ing cities, meanwhile, are diversifying and innovat- still lags far behind, and China, with a major push ing to remain competitive. Indeed, Turkey features by its policy makers in the 1990s, is now dramati- a system of cities today that remarkably matches cally surging forward (Figure 5.2). The question the rank-size distribution prediction of a country’s is how rapid urbanization fueled agglomeration cities. Turkey’s cities largely perform above average economies across Turkey’s system of cities and how in achieving density, suggesting efficient land use negative externalities were mitigated, if not fully and higher productivity; and informality in housing avoided. is well below what would be expected for a country that went through such a rapid demographic trans- Turkey’s urbanization experience offers important formation. lessons for policy makers across the developing world. Recognizing the importance of urbanization Turkey presents a classic example of a country ben- to the country’s ambitions of becoming a modern, efiting from agglomeration economies. In principle, industrialized economy as far back as the early days urbanization and economic growth should move in of the Republic, Turkey has encouraged rural-to- tandem (Spence, Annez and Buckley, 2009) and Tur- urban migration flows that fueled agglomeration key’s development experience illustrates this point 3 See Ravallion, et al. (2007) and Spence (2009) 4 From 1980 to 2012, per capita GDP rose from US$5,986 to US$13,737 (PPP based GDP per capita in constant 2005 international dollars as provided by World Development Indicators). In nominal GDP per capita terms using current US$, the figure rose from US$1,567 in 1980 to US$10,666 in 2012. 159 Turkey’s Transitions Figure 5.4: Urbanization and population agglomerations Spatial distribution of Turkey’s population in cities and provinces in 2012 Source: Address-based Population Registration System (ABPRS) and TurkStat, WB staff calculations with striking precision. Figure 5.3 demonstrates where market size and access was a determining clearly how Turkey has been able to harness the force in a firm’s choice of location. It was not un- benefits of agglomeration economies, which paid til the Republic period, starting in the 1920s, that significant dividends for its overall growth. In the conscious efforts by the state to promote national figure, Turkey’s economic performance (in increas- integration and balanced development resulted in ing GDP per capita terms) is measured alongside demographic growth shifts inland. As the second its increase in urban share of population during largest city by population size, Ankara is the nota- the period from 1980-2012. When compared to a ble exception to Turkey’s spatial landscape, which, set of countries globally for which data is available, as the nation’s capital, explains its size and signifi- Turkey is positioned among the high performers. cance (Figure 5.4). The HH Quadrant (High Urbanization and High GDP per Capita Change), where Turkey is located, repre- Urbanization in Turkey has followed economic log- sents countries that performed above the mean on ic. Unlike China and India, which used formal and both measures, and benefitted from agglomeration informal means to reduce the pace of urbanization, economies, such as China, Malaysia, and South Ko- Turkey did not impose any distortionary policies to rea. By contrast, the LH Quadrant (Low GDP Growth prevent migration and allowed its markets to work. per Capita/High Urbanization) includes countries This policy approach enabled Turkey to vastly out- that have rapidly urbanized during the same period perform many other countries in achieving both as Turkey, but which have not been able to lever- higher urbanization and economic growth rates. age the full benefits of urbanization, including sev- The benefits of urbanization economies have be- eral African countries. The HL Quadrant (High GDP, come particularly apparent over the past decade. Low Urbanization) countries typically present the As illustrated in Figure 5.5, new enterprises have “steady-state” model, or countries in an advanced sprung up in the inland cities of Anatolia, and have state of urbanization whose urban growth took spread the benefits of international trade and inte- place largely before the 1980s yet continue to ben- gration more equally across space. efit from agglomeration economies. Quadrant LL reflects countries in the incipient stages of urban- Turkey’s System of Cities illustrates a stable and log- ization (or those that are deurbanizing) that have ical ordering of different sized cities. Debates still yet to take full advantage of agglomeration econo- rage all over the world about city size. Some argue mies as a contributor to national economic growth. there is an optimal maximum size for cities, above Why is this so? which cities grow at their own peril. Turkey has not been immune to this debate and demographics be- Turkey was an early urbanizer among developing hind Figure 5.3 have led many to question whether countries. Dating back to the turn of the last cen- Istanbul is just too big – a mountain among mole- tury, market forces in Turkey were already deeply hills. Certainly the question can be raised as to rooted in places that one would expect – cities such whether cities are equipped to manage themselves as Istanbul, Izmir and, to a lesser extent, other cit- as they grow in size beyond a certain point. But ies along the Aegean and Mediterranean Coast – there is little question as to whether Tokyo, which 160 Chapter 5: Cities: Managing rapid urbanization Figure 5.5: Economic activity moves inland to feed the Anatolian Tigers Spatial distribution of firms created between 2007 and 2012 Source: The Union of Chambers and Commodity Exchanges of Turkey (TOBB) Survey Data, 2012; WB staff calculations. is nearly twice the size of Istanbul, is able to man- to a blend of higher value-added service and manu- age itself efficiently. What other insights might be facturing activities. For obvious reasons, services gained about city size in a given country? Nearly a become more prominent a feature of metropolitan century ago, a linguist named George Kingsley Zipf city economies because they generally require less discovered a striking pattern in word usage where space to operate. In short, metropolitan cities at- he observed that the frequency of a word’s use is in- tract firms that can compete in a higher cost market. versely proportional to its rank in a frequency table. This reality is borne out not only through the lens This relationship follows the power rank principle of population shifts, but also by the spatial trans- commonly known as Zipf’s Law and has been used formation of firm location. Accordingly, Figure 5.5, to understand and predict rankings in city size as based on a TOBB database of 60,000 firms in 2007, well. In the case of cities, the natural logarithm of illustrates a very different spatial pattern than the a city’s rank in population size and city population earlier image of Turkey’s population distribution. In generates a log-linear graph of a country’s city rank other words, factoring in the dynamics of change in size. When applied to Turkey’s cities, Zipf’s power firm location and population movements across the law is strikingly accurate (Figure 5.6). Turkey’s Zipf last two decades, Turkey looks today much more coefficient for 2000 was -1.01, very close to the -1 spatially distributed than it did only a decade ago. predicted by the law. For 2012 the coefficient be- Istanbul is no longer a mountain among molehills, comes -0.93. In other words, a nearly perfect linear but rather a city among many that are able to draw relationship exists among Turkey’s cities when com- and attract firms in Turkey. paring their rank and size accordingly to Zipf’s Law. Figure 5.6 shows how Turkey compares favorably What policies and institutions with South Korea, whose top 9 cities record a Zipf Rank-Size Distribution of -1.04 in 2010. mattered most in Turkey’s quest for Turkey’s system of cities is not only logical in rank efficient and inclusive ordering, but also evolving in accordance with eco- urbanization? nomic principles. As illustrated in Figure 5.7, over the last decade, the populations of Turkey’s largest Several factors contributed to Turkey’s growth- agglomerations – Istanbul, Ankara, and Izmir – have oriented and inclusive urbanization process. First, actually declined in their share of urban population. Turkey allowed its markets to work: policies in the Cities such as Bursa, Gaziantep, Kocaeli, and Kay- 1980s promoting economic liberalization attracted seri, among others often referred to as the “Anato- the flow of new domestic and foreign private in- lian Tigers”, have increased their share of the urban vestment that created a critical pull factor for rural population during the same period and continued migrants, enabling the convergence of production to experience modest growth over the past decade. and consumption markets that promoted agglom- This is largely explained by market forces. As land- eration economies in Turkey’s cities. Second, a rent values and labor costs rise in larger metropoli- metropolitan municipality regime adopted in 1984 tan cities, their economies evolve in function within provided the administrative framework necessary the system of cities from primarily manufacturing to effectively manage fast growing cities across 161 Turkey’s Transitions Figure 5.6: Zipf’s city rank-size power law and the system of cities (a) Turkey rank-size distribution (2000 and 2012) 4.5 4.0 3.5 3.0 Log of City Rank 2.5 2.0 1.5 y = -0.9341x + 15.766 1.0 R² = 0.9237 0.5 y = -1.0125x + 16.799 0.0 R² = 0.9091 11 12 13 14 15 16 17 Log of City Size 2012 2000 Linear (2012) Linear (2000) Source: 2000 Census and ABPRS, TurkStat, WB staff calculations (b) South Korea’s rank-size distribution (2010) 2.5 2.0 Log of City Rank 2010 1.5 1.0 y = -1.0365x + 16.568 R² = 0.9455 0.5 0.0 13.5 14.0 14.5 15.0 15.5 16.0 16.5 -0.5 Log of City Size 2010 Source: KOSTAT, Statistics Korea 2013 Data, WB staff calculations their economic footprint. Third, a permissive ten- tions through national programs to support the ure regime granted squatters on urban public land expansion of access to water, sanitation and other legal status that prompted both households and basic municipal services helped fiscally-constrained host municipalities to invest in their dwellings and localities meet national coverage targets through neighborhood infrastructure. Fourth, efforts to the use of matching grant subsidies. Sixth, policies scale up housing supply through state brokering that promoted market-based pricing of municipal services triggered a private sector response that helped accelerate the expansion of the housing services helped attract private equity to share the stock, while, on the demand side, mortgage-based financial burden, while private sector management finance was expanded, particularly over the last know-how enabled innovation and efficiency gains decade, with extended maturities that allowed the in service delivery. These lessons from Turkey’s ex- housing sector to go down market. Fifth, interven- perience are further explored below. 162 Chapter 5: Cities: Managing rapid urbanization Figure 5.7: Percentage share of total metropolitan municipality population, 2000 and 2012 45% 40% Share of Total Metropolitan 35% Municipality Population 30% 25% 20% 15% 10% 5% 0% İzmir Antalya Konya Adana Diyarbakır Gaziantep Bursa Ankara Sakarya Kayseri Kocaeli İstanbul Eskişehir Samsun Mersin Erzurum 2000 2012 Source: Turkstat 2000 Census Data, ABPRS (2012) and WB staff calculations Note: The sharp increase in Kocaeli’s population share from 2000 to 2012 is partially explained by the expansion of the Metropolitan Municipality area to the provincial boundaries as per the Metropolitan Municipality Law No. 5216 in 2004. Developing a system of cities: Turkey’s Metropolitan Municipality Law also pro- The Metropolitan Municipality Law visioned for more efficient management of water supply and sanitation services. Among develop- Turkey’s Metropolitan Municipality Law was a ing countries, Turkey was one of the innovators in game-changer for managing cities. It was precisely thinking through efficient ways of providing water during the period of economic liberalization and a supply and sanitation services. Faced with growing surge in urbanization in the first half of the 1980s populations in its cities, it needed to find an insti- that the Government of Turkey adopted a new mu- tutional model that would achieve greater scale nicipal administrative regime. Not only in Istanbul, efficiency and it looked for a solution at the met- Turkey’s megacity, but also in newly emerging ur- ropolitan scale. In 1981, Istanbul initiated the first ban conurbations, there was a need for a regime successful corporatization of water supply and sani- that would enable more effective metropolitan tation services. Doing so helped Istanbul to more management across a broader footprint. Turkey’s effectively manage and monitor its water supply landmark legislation – the Metropolitan Munici- and sanitation services, particularly by removing pality Law passed in 1984 – provided the legal and such expenditure outlays from its municipal books administrative basis for managing cities at a met- and shifting them to İSKİ, Istanbul’s corporatized ropolitan scale that so many developing countries water utility. This arrangement helped ensure cost are lacking. Sixteen metropolitan municipalities were elevated to that status between 1984 and recovery in pricing of water, sanitation and waste- 2012, and in December 2012, an amendment to water treatment services and avoid cross-subsidies the Metropolitan Municipality Law created 14 from other municipal revenue sources. Istanbul’s more, for a total of 30. The Law contains many key successful corporatization experience was then for- provisions that enable metropolitan municipality mally adopted within the Metropolitan Municipal- regimes to formulate policies and take decisive ac- ity Law in 1984, requiring all of Turkey’s metropoli- tion that support linkages across a city’s administra- tan municipalities to establish a corporatized water tive boundaries and in line with its economic foot- utility and to operate them at arm’s length distance print. For instance, the Law enabled metropolitan on the principles and practices of cost recovery. As municipalities to undertake their own higher scale of 2011, Turkey compares very favorably with peer territorial planning (1:50,000 scale) that provides a countries in its market pricing of water supply and strategic framework to plan city development. Ur- sanitation services and cost recovery, and this has ban transport planning and investment functions5 also had a favorable impact in discouraging waste were also consolidated at the metropolitan munici- and promoting conservation (Figure 5.8). Market pality level, enabling planners to ensure access and pricing has also helped Turkey to attract the private mobility across a metropolitan municipality’s entire sector in the provision of water supply and sanita- footprint (Bahl, Linn, Wetzel, 2013). tion services. 5 With the exception of interior roads, which remains the responsibility of district municipalities. 163 Turkey’s Transitions Figure 5.8: Water supply and sanitation service pricing and domestic consumption per capita in Turkey and comparator countries, 2011 3.0 600 Combined Water Tari ff (US$ /m3) 2.5 500 Domestic Use: Liter/Person/Day 2.0 400 1.5 300 1.0 200 0.5 100 0.0 0 India China Mexico Korea, Russian Italy Turkey Spain Republic Federati on of Combined Water Tariff (U SD/m3) Domestic Use: L iter/Person/Day (right axis) Source: Global Water Intelligence (GWI) Market Report, vol. 12, Issue 9, September 2011 Inter-jurisdictional coordination at the city level is can help a city administration to promote mobility a key challenge in many developing countries that across a metropolitan area and ensure connectiv- lack a metropolitan regime. For instance, in Cairo, ity for prospective businesses. In that regard, the a metropolitan city of nearly nine million people, Metropolitan Municipality regime can have an im- there is no enabling legislation that supports inter- portant impact on economic performance and city jurisdictional management and coordination across competitiveness. Figure 5.9 illustrates this “metro- the metropolitan area’s economic footprint. While politan effect” in practice; that is, the ability of the the core city of Cairo (Cairo Governorate) compris- metropolitan regime to disproportionately attract es a land area of 450 km2, the metropolitan area firms and generate agglomeration economies. This of Cairo spans an estimated 1,700 km2 (over three phenomenon is illustrated by the heavy concentra- times the Cairo Governorate), and is administered tion of firms in Turkey’s metropolitan municipalities by four different Governorates with essentially in comparison to non-metropolitan municipalities. four different administrative and decision making This was true for the 60,000 firms registered in the authorities and structures. Attempting to forge a TOBB database6 in 2007 (old) and for those regis- cohesive metropolitan transport plan or to deliver tered in 2011 (new) as well, and suggests economic water/sanitation and other city services in a coher- “stickiness” of metropolitan municipalities. In other ent fashion is a major challenge. Another example words, their ability to attract and retain firms over is Manila, whose metropolitan area comprises nine- time has remained relatively constant over the teen different municipalities without a higher tier span of a five year period. Metropolitan municipali- mechanism for coordinating policy, planning and ties also compare favorably to non-metropolitan investment decision-making across jurisdictions. municipalities in attracting firms across all major in- Turkey’s Metropolitan Municipality regime pro- dustry classifications, particularly Information and motes economic growth. Every city’s desire is to Communication Technologies (ICT) industries. remain vibrant as its economy evolves with the ability to attract and retain firms and human capital The metropolitan effect has a significant influence and to gravitate over time to higher value-added not only in the attraction and retention of firms, activity. The Metropolitan Municipality Law pro- but also in promoting a sorting of economic activ- vides a critical planning framework for Turkey’s ity across a system of cities. Figure 5.10 provides a metropolitan areas that has a direct impact on in- snapshot of firm locations within concentric areas frastructure provision and coordination in the de- of Turkish cities based on the 2011 TOBB company livery of services. Used effectively, its provisions registration data. It demonstrates the consistency 6 Firm location, employment and branch of economic activity data were obtained by TEPAV for the Urbanization Review from TOBB. This data consists of more than 60,000 observations. The data used in this study comes from a register of all Turkish firms. It contains their activity, their number of employees and economic activity, their location, and, for many, their date of establishment. 164 Chapter 5: Cities: Managing rapid urbanization Figure 5.9: Firms locate in metropolitan municipalities Average number of firms per km2 by municipal administrative and major industry classification, 2011 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 All Old New Manufacturing Total Metro Non-metro Rural 0.016 0.014 0.012 0.010 0.008 0.006 0.004 0.002 0.000 Construc ti on ICT Services Total Metro Non-metro Rural Source: TOBB and ABPRS, TurkStat, WB staff calculations of Turkish city performance with economic prin- ing the inevitable shedding of firms that are less ciples. As land rent values and labor costs rise, competitive. Figure 5.11 provides yet another ex- manufacturing activities begin to hollow out from ample of Turkey’s system of cities at work. Along a city’s core and are able to better compete operat- the y axis, the graph measures the relative “ubiq- ing at the periphery of the city or through reloca- uity” of a city’s products and services. The higher a tion to secondary cities. New, higher value-added city locates along this axis, the more dependent it activities that are reliant more on know-how and is on producing products or services that are ubiq- human capital than manufacturing space seek to uitous in nature and, thus, produced by many other locate close to a city core or central business dis- cities, making them relatively less competitive. By trict where proximity to universities, other busi- contrast, along the x axis, a Turkish city’s diversity nesses and knowledge-generators are essential to of products and services is measured. The scatter their business. plot of cities presents a very intuitive and economi- cally logical position of cities where Istanbul, Ankara For cities to remain competitive, they must strive and Izmir evidence high diversity and low ubiquity for diversification of their economies, while accept- of products and services.7 Smaller towns and cities 7 Note Konya’s relatively high diversity, as highlighted in the introduction. 165 Turkey’s Transitions Figure 5.10: Firm location across city area: Manufacturing and ICT firm comparison Manufacturing 0.0012 0.0010 Firms per Squared km 0.0008 0.0006 0.0004 0.0002 0.0000 Core Ankara>100km Ankara 50 - 100km <10km 10 - 20km 20 - 50km Ankara<50km ICT 0.00006 0.00005 Firms per Squared Km 0.00004 0.00003 0.00002 0.00001 0.00000 Core Ankara>100km Ankara 50 - 100km <10km 10 - 20km 20 - 50km Ankara<50km Source: TOBB and ABPRS, TurkStat, WB staff calculations ride high along the average ubiquity scale, but low well as higher productivity and tax value of land in the diversity of products and services. In sum, assets. Cities reliant on property tax as their main their competitiveness over time will be determined source of revenue have a built-in incentive to make by their ability to diversify their product and service efficient use of their land and typically seek to pro- offerings. mote density in their development planning. As illustrated in Figure 5.12, Turkey’s system of cities Urban form has an important impact on the eco- has achieved a high degree of density, suggesting nomic viability of a city and its sustainability. In principle, achieving urban density can yield mul- an economically efficient pattern of urbanization. In tiple economic benefits. It can lower the cost of the chart, selected Turkish cities are compared to infrastructure provision, or, put another way, in- an international database of 1500 cities worldwide. crease the number of beneficiaries per unit cost of The trend line maps out the expected density for infrastructure. It can reduce carbon emissions by cities of a given population size, where cities below making mass-transit more feasible as an alternative the line have densities below the average, while to private vehicles. And it can also maximize the ef- those above have densities higher than the aver- ficiency of land use, reducing land costs per built age. Most of the Turkish cities rise above the aver- area, which translates into lower housing costs, as age, while the remaining hover at the mean. 166 Chapter 5: Cities: Managing rapid urbanization Figure 5.11: Distribution of Turkish cities based on diversity and ubiquity of products, 2012 50 ARDAHAN BİNGÖL 40 KARS ERZURUM Ubiquity ŞANLIURFA 30 DİYARBAKIR EDİRNE K-MARAS MALATYA TRABZON MERSİN KAYSERİ 20 ADANA DENİZL İ MANİSA KONYA KOCAEL İ GAZİANTEP BURSA ANKARA İZMİR İSTANBUL 10 0 500 1,000 1,500 2,000 2,500 Diversification Source: TEPAV Analysis Report (2013) Turkey Urbanization Review Notes: Data drawn from PRODCOM codes of companies by city registration in TOBB database (2012). A high diversity score signals a wide range of products produced by the city, while a high ubiquity score signals that the city is producing products that are widely produced by other cities, often by firms in easy-entry industries with limited innovation. Figure 5.12: Turkey’s cities have high density 40000 Diyarbakir Gaziantep Population Density (pop/sq mile) Adana 30000 Izmir Istanbul Mersin Konya 20000 Ankara Kayseri Antalya Eskisehir 10000 0 10 12 14 16 18 lnpop lowess: Density_per_sqmile Density_per_sqmile Source: Data from Demographia (2008) and Urbanization Review team calculations Notes: LOWESS (Locally Weighted Scatterplot Smoothing) plotting was used to find the non-linear relationship between population and density. LOWESS enables robust locally-weighted time series and scatter plot smoothing for both equi-spaced and non-equi- spaced data. Population and density data are drawn from 1500 cities globally. For any given population level, the trend line indicates the average or expected density of the city. Cities above the trend line have densities above the international average for their population size, while cities below the line have densities below the international average. Connecting the hinterland: Early goods and human capital that fueled Turkey’s ur- infrastructure and settlement planning ban economies. Connecting cities with an efficient railway system starting in the early days of the Re- Connective infrastructure was a hallmark of Tur- public had not only the political objective of link- key’s nascent system of cities, enabling the flow of ing settlements across the country in an effort to 167 Turkey’s Transitions Figure 5.13: Development of railways and population concentrations in Turkey in 2000 District Population of Turkey in 2000 100.000 to 1.000.000 50.000 to 100.000 20.000 to 50.000 10.000 to 20.000 0 to 10.000 Railways in 2000 Districts Source: Ministry of Transportation, Maritime Affairs and Communications promote national cohesion, but also the motive of tion. Twenty-three settlements were planned over improving accessibility and connectivity that pro- a decade starting in 1923 (Tekeli, 2009). vided a strong economic foundation for Turkey’s cities. Turkey’s railway network and, eventually, its Turkey’s planning system evolved during the transi- tion years of the 1960s and 1970s. It was during the highly developed road network provided the eco- two decades of the 1960s-1970s that full-fledged nomic backbone that support vibrant local econo- urban planning took hold. In 1966 an Istanbul Mas- mies, even within the interior of the country. As ter Plan Office was established and the city’s Mas- Figure 5.13 illustrates, Turkey has used transport in- terplan completed, followed shortly thereafter by frastructure to connect population concentrations Izmir and Ankara in 1968 and 1969 respectively. across the country. Large public works projects of a monumental scale Turkey’s early investment in settlement planning, were undertaken across numerous cities. However, dating back to the founding of the Republic, set an during the late 70s, the State’s role as a technocrat- important foundation for the future of Turkey’s cit- ic agent of development shifted. During this period, the state began to recede from its active interven- ies. It was during the Republic Period (1923-1950) tionist mode to more of an enabler of the private that a nation-wide industrialization and urbaniza- sector. Between 1968 and 1972, the private sector tion process firmly took root beyond Istanbul. To re- had already become the primary investor in manu- alize this vision, policy makers recognized the need facturing (Tekeli, 2009). to actively promote the planning and development of settlement areas. Given its geographical location A further key action of the Turkish Government in the interior of the country without the typical en- was to ensure its cities were adequately financed. dowments that would attract people and firms, Tur- As many developing countries have experienced, key’s capital city of Ankara is a prime example of a it is one thing to plan a city and devolve functions planned city. A metropolis of 4.5 million people to- to local governments; It is quite another to ensure day, Ankara owes its modern day existence to such they have adequate financing to fulfill those func- planning efforts. Across Anatolia, planners in the tions and build the needed infrastructure. Turkish early days of the Republic selected small Anatolian policy makers were keenly aware of this need and cities for the development of industrial enterprise with private banks not able or willing to provide at a time when the State was a majority owner of long term finance for infrastructure, Iller Bank, or commercial activity. State manufacturing invest- the Bank of Provinces/Municipalities, was founded ments, public enterprises and transport invest- in 1933. Iller Bank’s mandate was to provide the ments were designed and executed to expand de- long-term financing necessary for newly prepared velopment eastward. The Marmara Region actually municipal development plans and infrastructure experienced a population decline during this period service needs. Iller Bank remains to this day a criti- in favor of the Anatolian hinterland. This spatial cal institution in the financing, planning and devel- transformation was spearheaded by state interven- opment of cities. 168 Chapter 5: Cities: Managing rapid urbanization Managing rural-urban migration: tions to local governments in planning processes, A permissive policy stance on informal while the state turned its hand to regional plan- ning, focused on economic zones and leveraging settlements of economic endowments of a trans-jurisdictional While urbanization was steadily increasing during nature. It was at this time, particularly in the early the 1950s-1970s, it was during the 1980s that Tur- 1980s, that metropolitan cities turned to an “incre- key experienced a major surge of rural migrants to mental planning” approach (Tekeli, 2009)9. cities, causing rapid expansion of informal areas in urban settlements. Many cities were unable to Meeting housing needs: Social housing accommodate this growth, and the influx of mi- and evolution of the TOKI model grants took place so quickly that these informal The mid to late 1980s were also an important period settlements became known as gecekondu, literally in which other key institutions were established to “houses erected overnight”. Estimates of informal more effectively manage rapid urbanization, which housing in major cities during that period ranged at this point, had reached its peak. A key measure between 30-60 percent of all urban housing stock. was the passage of the Housing Development and Most in-migration during this phase was concen- Public Participation Law (No. 2985) in 1986. This trated in large cities along the coast (Istanbul and law helped to shape formal state interventions into Izmir) and Ankara. the housing policy arena. The law recognized the Turkey adopted a permissive policy toward rural urgency of responding to rapid urbanization, which migration and this policy stance likely encouraged was peaking, provisioning for financing of low in- come housing at nominal rates with long-term pay- migrants to flock to cities. Over the period from back periods. The Law also called for the establish- 1949-1990, eight amnesties were issued by the ment of a Housing Agency, which came to pass in Government of Turkey legalizing informal and un- 1990 when the Housing Development Administra- registered residences (Buğra, 1998). The prevailing tion, otherwise known as TOKİ, was established. attitude of the Turkish Government at the time, and tacitly accepted by the general public, was the no- From 1984-2002 over 940,000 housing units were tion that all citizens have a right to some form of ba- delivered under the Government housing program. sic housing. The amnesties gave residents the right Initially, this was supported through a Mass Housing of usufruct and removed the fear of eviction. With Fund (1984-1990) and subsequently by TOKİ (1990- security of tenure, as witnessed in other develop- 2002). Figure 5.14 illustrates the housing permit ing countries, residents of informal areas began to (supply) to need ratio movements from 1958-2010, invest in their housing, in some cases adding rooms showing an overall upward trend. The Inadequacy that were subsequently rented to new migrants.8 of housing permits during Turkey’s peak period Turkey was also in a fortunate position to take such of urbanization from 1980- 1984 (reflected in the decisions as the vast majority of land on which the downward trend during this period) was reversed informal settlements took shape was public land. by Government intervention, raising the housing These circumstances, perhaps, helped circumvent permit to need ratio to 35 percent by 1986 and property rights criticisms from private land owners. over 50 percent by 1996. With the exception of the late 1990s, when Turkey’s economy was volatile, a By the 1980s, as rural in-migration was peaking, ur- likely factor impacting new housing starts, Turkey’s ban planning responsibilities were devolved to local housing permit to need ratio remained relatively authorities and planning regulations were relaxed high, reaching over 60 percent in 2006 and nearly to accommodate rapid urbanization and changes in 70 percent by 2010. land use patterns. With the emergence of the pri- vate sector during this period of economic liberal- The entry of TOKİ to the housing supply market ization, development plans lost their dominant role was significant. TOKİ, founded in 1990, created a and were not directly led by the central govern- “wholesaling” mechanism for the large scale sup- ment. This was a period of enormous significance ply of housing for both low and middle income for urbanization, as the largest shift in population market segments during Turkey’s most pressing from rural to urban settlements took place during period of urbanization. Its purpose and orientation this time. The Development Law (No. 3194), which was never to replace Turkey’s predominant pri- was enacted in 1985, delegated increasing func- vate housing model with public provision. Rather, 8 Turkey’s attempt to address supply-side housing challenges was similar to what Mexico attempted to do. Both countries recognized what Spence argues, namely that “only a greater supply of serviced land and housing can lower costs, because it helps to solve the problem at its root as well as contain the fiscal burden of subsidies”. According to Spence, Mexico offered an upfront subsidy combined with efforts to provide better infrastruc- ture and security of tenure, allowing households to make investments in their home on their own. 9 For many analysts, this planning juncture marked the beginning of the decline of Turkish cities. They argue that the flexibility granted to cities and large-scale private developers ultimately undermined effective city planning, contributing to urban sprawl and unplanned development. 169 Turkey’s Transitions Figure 5.14: Turkey housing starts to need ratio (1958-2010) and landmark housing legal and institutional initiatives 10 70% Passage of Housing Decree 412 creating TOKİ - Ra tio of Housing Permits to Housing Needs Development and Public Housing Development 60% Participation Law No.2985 (1985) Administration (1990) 50% 40% 30% 20% 10% 0% 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: WB staff calculations using TurkStat Annual Building Construction Statistics (for permits); Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat, World Population Prospects: The 2010 Revision and World Urbanization Prospects: The 2011 Revision, August, 2012 (for housing need) its role was to create the enabling environment to ects were criticized for poor quality and location promote the entry of large scale housing supply by choices, as well as the absence of amenities and the private sector. This was largely accomplished surrounding infrastructure, TOKİ factored these through TOKİ’s brokering role, which helped to cut considerations into later models. Many later devel- red-tape, streamline administrative procedures opments also considered mixed income facilities. into an effective “one-stop-shop”, facilitate the as- The mixed income feature of many TOKİ housing sembly of public land at a scale sufficient for large projects was made possible through cross-subsidies scale housing development, and mobilize housing derived from the auction of development rights for finance. This, in turn, created investment opportu- the benefit of low income groups. The feature of nities for large contractors and real estate develop- mixed income housing has also enabled Turkey to ers, and the scaling up from the traditional coop- avoid clustering the poor in low income housing erative housing model that could not keep pace projects that can lead to vertical slums. with increasing housing demand. This could only be achieved because Turkey’s approach to low income The entry of TOKİ into the housing market went housing was not to supply it directly by the public beyond the provision of low and middle-income sector but to use market mechanisms to encourage housing. TOKİ’s housing model enabled Turkey’s real estate developers and building contractors to housing supply market to scale up by mobilizing the go down market. To do so, TOKİ relied on the lever- land developing and financing, and a private sec- aging of public land which factored in as a subsidy tor delivery mechanism that promoted the emer- to make housing affordable to low income groups. gence of larger-scale real estate developers and Provisioning for low income housing was based on construction companies. This was critically needed limited space housing models (often around 50-100 during Turkey’s period of rapid urbanization, as the m2 units) that developers would not have devel- prevailing cooperative housing model which facili- oped without the State’s intervention. tated pooling of savings among individuals and in- vestor groups and an incremental housing supply TOKİ’s approach to housing evolved over time and approach was no longer adequate to keep up with benefitted from lessons learned. While early proj- demand.11 Figure 5.15 illustrates how the housing 10 Housing supply to need ratio is calculated using housing permit data and population growth. Need is calculated based on an average household size of 4.5. 11 Ministry of Development indicates that TOKİ initially supported the market through a loan mechanism from its inception to 2002. Prior to this, 940,000 housing units were financed by a Mass Housing Fund between 1984-1990. TOKİ reports to have delivered 88,593 units under its “shanty transformation program” between 2003 and March 2014 and reports that 392,327 units were built for low and middle income groups overall. TOKİ ceased providing mass housing loans after 2007. 170 Chapter 5: Cities: Managing rapid urbanization Figure 5.15: Distribution of housing construction and occupancy licenses by ownership form 350 Distribution of construc tion permits among 300 250 producers (`000) 200 150 100 50 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Private Coopera tive Socie ties 90 Distribution of building occupancy permits 80 70 among producers (percent) 60 50 40 30 20 10 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Private Coopera tive Socie ties Source: TurkStat, Construction License data, WB staff calculations. construction market evolved following the estab- participation of all stakeholders. In addition, there lishment of TOKİ. As the chart shows, following a have been demands for greater public scrunity gestation period in which TOKİ experimented with of TOKİ’s financial accounts and the financials of different business models, the separation in market specific transactions. In short, while the concept share of cooperatives and large scale private con- of combining functions into a single agency made tractors began to be felt in earnest in the first half good sense and delivered over 500,000 housing of the last decade. Substantial market share gains/ units in the span of less than seven years, greater losses were experienced by the private sector and transparency and accountability would strengthen cooperatives respectively by 2010. the sustainability of the TOKİ model. Despite these positive contributions, TOKİ’s estab- Developing of housing finance and rental lishment law provides it with extraordinary powers, markets to improve Access including the ability to develop land without adher- ing to the city’s masterplan, and, in several instanc- Development of Turkey’s Mortgage Market was es, its developments in scale and design are clearly also a critical policy measure over the last decade at odds with the urban character of the surround- in making housing more affordable. Turkey’s mort- ing area. Community consultations have been fault- gage finance market today is still in its early stag- ed by critics for being perfunctory and without full es. However, the problem of accessing long-term 171 Turkey’s Transitions Figure 5.16: Weekly trends in mortgage financing 60% Percentage Share of Total Mortgage Loans 50% 40% 30% 20% 10% 0% Oct-11 Oct-10 Oct-09 Oct-08 Oct-07 Jul-12 Jul-11 Jul-10 Apr-12 Jul-09 Apr-11 Jul-08 Apr-10 Apr-09 Apr-08 Jan-12 Jan-11 Jan-10 Jan-09 Jan-08 Less than 3 years 3 to 5 years 5 to 10 years 10 to 15 years 15 to 20 years Source: Central Bank of the Republic of Turkey and WB staff calculations mortgage finance had been a persistent problem years and 3-5 years loans) being replaced by longer over the first half of the last decade. In the absence term (5-10 years and 15-20 years). of long-term financing, many new housing devel- opments were also beyond the reach of middle Housing options beyond ownership have proven income households. This has meant that accessing to be critical for many rapidly urbanizing countries. long-term financing for housing has been a real con- Because of demand pressures, land and property straint on demand, and possibly a factor in holding values rise quickly during intense periods of urban- back the housing supply market overall. Figure 5.16 ization. Accordingly, developing countries often illustrates how this trend is changing over the past need to consider other housing options to address five years with shorter term maturities (less than 3 affordability problems for the lower income seg- Figure 5.17: Rental share of housing market in Turkey and selected European countries (1994) 60% Rental Share of Housing Market 50% 40% 30% 20% 10% 0% Czech Rep. Latvia Spain Denmark Hungary Lithuania Portugal Finland Slovakia Germany Cyprus France Turkey Slovenia Sweden Greece Austria Ireland United Kingdom Italy Estonia Malta Poland Luxembourg Netherlands Belgium Source: Cited in Özdemir (2011): MGI, 2003:298. Fribourg, 2006:24 172 Chapter 5: Cities: Managing rapid urbanization Figure 5.18: Turkey substantially expanded public expenditures on water, wastewater and solid waste infrastructure between 2003 and 2008 3.5 3.2 3.0 2.5 2.5 In billion TL 2.0 1.5 1.0 0.9 0.9 0.7 0.5 0.3 0.0 Water Wastewater Waste 2003 2008 Source: TurkStat Public Expenditure Data, WB staff calculations ments of the market. In that regard, dating back to that most have become permanent features of the provisions in a 1965 Condominium Law, Turkey was urban landscape in many cities. As a result, many able to promote a “build and sell” model that of- of Turkey’s informal settlements look and are much fered middle income households a way of storing more habitable, sanitary and livable than the slums wealth during periods of high inflation and curren- that persist in parts of Latin America and South cy volatility. This led to households investing and Asia. In addition, Iller Bank provided financing to building in multiple residences and rental property. larger cities for infrastructure network expansion as By 1994, Turkey was second only to Germany in the they grew, enabling many to keep pace with rapid percentage of rental housing (28 percent) to home urbanization. But there were also acknowledged ownership (72 percent) in comparison to 25 Euro- pean Union countries (Figure 5.17). Importantly, gaps in service coverage, particularly among small Turkey’s highly developed rental market provided towns and villages, that generally had a very low additional housing options for Turkish city residents economic base and insufficient revenue streams to and likely improved housing affordability, particu- service debt. In response to this market failure, spe- larly in earlier periods when long-term mortgage cial programs were initiated by the Government to finance was not available in the market. ensure that water, sanitation and solid waste servic- es were provided in these fiscally dependent areas. Addressing regional inequities: Targeted provision of municipal services in small For small towns and villages, development pro- grams initiated by the Ministry of Development, rural towns and engaging with the such as KÖYDES and SUKAP, were designed to fill private sector in advanced cities a critical gap. KÖYDES, or the small villages water Interventions at the national government level in and sanitation project, spanned in its first phase a cases of market failure have been a hallmark of period of eight years (2005-2012). The main aim Turkey’s approach to support its system of cities. of this program was to ensure broad-based ac- Beyond the Government’s foray into Housing Policy cess to water and sanitation services across all of in the 1990s, efforts were also made to shore up Turkey’s settlements, particularly small villages in the provision of basic urban services. Municipalities remote rural areas. A companion program, SUKAP, from their own resources and those supplied by was established in 2011 and through Iller Bank has the central government, began over time to regu- reached millions of beneficiaries in a span of only larize informal settlements, including the provision three years. Its target has been small municipalities of road infrastructure, as well as network water, and involves a 50 percent subsidy to municipalities sanitation, and wastewater treatment to the point to encourage them to borrow from Iller Bank and 173 Turkey’s Transitions Figure 5.19: Turkey’s water and sanitation service coverage (1991-2011) Water 100 99 100 98 97 100% 94 93 94 86 86 Percent of popula tion with access 90% 83 81 80% 70% 60% 50% 40% 30% 20% 10% 0% Turkey EU Members Growth Markets MENA Average BRICS Average EU Candidate Average (excl. Average Average Romania & Poland) Improved water source 1991 Improved water source 2011 Sanitation 100% 100100 96 91 90 92 90% 84 Percent of popula tion with access 83 80% 77 69 70% 65 60% 50 50% 40% 30% 20% 10% 0% Turkey EU Members Growth Markets MENA Average BRICS Average EU Candidate Average (excl. Average Average Romania & Poland) Improved sanitation facilities 1991 Improved sanitation facilities 2011 Source: WDI and WB staff calculations invest in critical infrastructure service needs. As Turkish cities have also benefitted from an innova- reflected in Figure 5.18, investment in water, sani- tive and enabling national policy environment that tation and solid waste infrastructure rose dramati- facilitates private participation in the provision of cally from 2003 to 2008, due in part to programs municipal services. Conventional approaches to like SUKAP. solid waste disposal followed by many cities involve the development of sanitary landfills through the Programs supporting fiscally-constrained munici- city’s own resources and the operation and main- palities with matching grant subsidies helped dra- tenance of such facilities by municipal staff over matically expand water supply and sanitation ser- time. Indeed, that is the approach that the City vice coverage, particularly over the past decade. of Ankara took in the 1980s when it developed its These programs, taken together with a national first landfill in a peripheral district called Mamak. system that provides financing for municipalities However, some 20 years later, in 2002, Ankara Met- through Iller Bank and commercial banks, have con- ropolitan Municipality decided to test the market tributed to raising Turkey’s access to water supply for a private sector solution. Its main aim was to to nearly universal coverage by 2011, and sanita- shift the commercial risk to the private sector for tion services coverage to 91 percent (Figure 5.19). developing and operating the landfill, attract pri- 174 Chapter 5: Cities: Managing rapid urbanization Box 5.2: Leveraging private sector participation for municipal solid waste services ITC-Ankara was established in 2002 as a branch office of a Swiss originating company – Invest Trading and Consulting AG – which specializes in construction of infrastructure and superstructure projects, including recycling plants. Its ability to bring financing, assume commercial risk, and apply innovative solutions to landfill management provided a perfect opportunity for Ankara Metropolitan Municipality to partner with this private sector firm in addressing its solid waste disposal needs with a growing urban population now exceeding 4.5 million. Structured as a 49 year concession, Ankara’s partnership with ITC was initiated through a competitive selection process. ITC was selected as the preferred bidder to redevelop the Mamak landfill starting in 2005 with a commitment to realize a total investment by the private operator of US$260 million in return for operating rights. A classic win-win initiative, the partnership features multiple benefits for Ankara’s residents, the municipality, the private sector concessionaire and the environment. For residents, sanitary conditions and land values in the vicinity of landfill have substantially improved in the years since the private sector operator took over. The picture below shows the plant operating across the street from a high-end shopping mall with IKEA as the anchor tenant, and the landfill provides all of the hot water needs for the mall through the biogas operation. Through the project, the municipality was able to shift the initial US$29 million and all subsequent capital investment costs to ITC. It also saved on the landfill operating costs and tipping fees. For the operator, the project offered the opportunity to earn a profit while entering a market in which it now has operations in seven Turkish cities (see map below). The partnership also had substantial co-benefits for the environment. Methane gas, which is generated by the decomposition of solid waste, is 20 times more potent as a greenhouse gas than carbon dioxide. The facility design features a methane gas capture technology that dramatically reduces methane gas emissions. The facility then harnesses this gas to produce electricity, generating revenue streams for the firm, while providing an alternative renewable energy source for Turkey, an energy dependent country. The anaerobic gestation system processes organic waste to compost in addition to generating methane gas. The energy plant linked to the operation generates 120 million kWh of renewable energy annually with total installed power of 22.4 MW. The facility also features a waste sorting plant to recycle plastic, glass and other materials. Source: Invest Trading and Consulting AG and World Bank project files Mamak Landfill Site ITC Operations in 7 Turkish Cities vate financing for landfill development, and hold it was managed by the municipality. Turkey’s liber- a contracted entity responsible for efficient opera- alization of electricity pricing, enabling cost recov- tion and maintenance of the landfill over time. One ery by providers including of biogas, as well as legal of its key concerns was the expansion of the city provisions that anticipated private provision of mu- built-up area to the perimeter of the landfill loca- nicipal services offered an entry point for a private tion, causing local residents to complain about the sector solution (Box 5.2). unsightly and odoriferous landfill operation when 175 Turkey’s Transitions How livable and sustainable are Law also provides for all metropolitan municipali- ties to have their boundaries expanded to the limits Turkey’s cities today? of the province. In short, this would create a plan- Turkish cities today offer a range of attractive fea- ning area that in many cases well exceeds the met- tures that make many of them both livable and a ropolitan footprint. This will pose a major planning pleasure to visit. They have a wide range of cultural challenge as it implies that the same infrastructure heritage endowments and many have modern, service standards would need to be applied uni- versally across the entire provincial area, includ- award-winning museums. They generally feature ing both urban and rural settlement areas, which clean and well-maintained streets; solid waste col- is not economically feasible. A second critical chal- lection is carried out daily in many of the larger cit- lenge will be in managing urban land expansion and ies; taxi and public buses are frequently available sprawl, as it would appear that conversion of rural and affordable; and there is virtually no evidence to urban land would be less constrained under a of slums of the type found in Latin America and single regime. These circumstances make effective South Asia. However, they still face a host of long- strategic land use planning of metropolitan munici- term sustainability challenges, such as the need palities a paramount policy priority. to improve urban transport planning and systems, effective means of social engagement to broaden Turkish cities have underinvested in public transit the benefits of urbanization to all city residents, systems and personal vehicle use is on the rise. and the spatial planning measures that will safe- During early stages of urbanization, most cities guard against sprawl and inefficient, uncontrolled have the financial means only to address basic ser- development. Taken together, these key challenges vice needs of their growing populations, and that represent Turkey’s second generation agenda for has generally been true in Turkey as well. Devel- sustainable urban development. oping mass transit systems and other larger scale infrastructure needed by larger cities requires With a few exceptions, Turkish cities have effectively significant planning, a robust tax base and larger developed without plans over the last two decades. scale investments linked to well integrated land use Turkish planning legislation allows for maximum planning. In past decades, many Turkish cities have planning flexibility by provisioning for amendment relied on Turkey’s entrepreneurial private sector, plans – a feature that is very rare in planning legisla- including taxis and dolmuş mini-buses, which are tion of developed countries. Many of the concerted no longer adequate for larger scale cities. Conse- planning efforts before the 1980s have diminished quently, many are only now beginning to address in substance and application. The impetus to be their growing urban transport needs in terms of flexible is understandable during a period of rapid planning and investing in public transit systems. urbanization. However, a 2008 Council of Europe Going forward, several fast growing cities will need report indicates that in a single city as many as 250 to take steps to avoid congestion costs and other amendment plans may be approved in a single year. negative externalities. This reality is underscored by What this means is that there is maximum uncer- the relatively low capacity of Turkey’s mass transit tainty about the planned expansion of a city, how systems, as reflected in Figure 5.20. to link transport and other strategically important infrastructure to new residential and commercial Without proactive policy and planning measures, needs and locations, which contributes in some the positive externalities of agglomeration econo- instances to a mismatch of infrastructure services mies that Turkey has benefitted from over the years with development patterns – a very costly and in- may turn into negative externalities of congestion efficient, not to mention unsustainable, future for and sprawl, depriving cities of the vitality that their cities. city cores once knew. Rising land rent values and labor costs of Turkey’s cities have pushed out the The recently amended Metropolitan Municipality boundaries of development as manufacturing firms Law expands the number and geographical area seek lower cost locations to remain competitive. of Turkey’s metropolitan municipalities, and this Improving policy coordination between institu- will present a critical challenge for Turkey’s cities. tions, strengthening the medium-term planning While the Metropolitan Municipality Law overall horizon of city governments and their accountabil- has had a positive impact on Turkey’s develop- ity to citizens are critical priorities. This will become ment, as noted earlier, the Law was amended again of even greater significance now that 14 municipali- in 2012 (Law No. 6360) to add 14 new metropolitan ties have been granted metropolitan status, which municipalities. This measure may very well enable took effect at the end of March 2014, following these cities to enjoy the “metropolitan effect” that local elections. Effective planning measures will their predecessors currently enjoy and the agglom- need to be put in place fairly rapidly to integrate eration economies that come with it. However, the planning across the entire provincial area. In that 176 Chapter 5: Cities: Managing rapid urbanization Figure 5.20: Meters of high transit capacity per capita for selected cities 250 Meters of High Transit Capacity Per Capita 197 200 178 152 150 92.5 100 83.5 62.6 59.6 50 35.3 33.5 26.3 16.1 15.3 13.7 10.8 10.1 5.5 0 Budapest Gaziantep Eskisehir Baku Bucharest Ankara Yerevan Paris New York Rio De Janeiro Belgrade Istanbul Sarajevo Samsun Amman Warsaw Source: Tool for Rapid Assessment of City Energy (TRACE) Gaziantep Report and selected city data from TRACE database regard, Turkey could benefit from lessons of other represents the next development frontier for Tur- countries and policies that were adopted to man- key’s cities. age urban land expansion and prevent deteriora- tion of city central business districts or those that The next development frontier for Turkey’s cities were required to promote urban renewal. is well-captured in Turkey’s recently issued Tenth National Development Plan. Many of the critical Turkey’s development planning and implementa- development challenges for Turkey’s cities noted tion programs also do not sufficiently emphasize above are addressed in the Tenth Development public consultation. Turkey’s rapid urbanization Plan, including a critical emphasis on creating “Liv- was, metaphorically, the tide that lifted all boats in able Spaces and Sustainable Environment.” The economic terms, improving the lives of urban resi- Plan places appropriate emphasis on policies aimed dents as well as new rural migrants to cities across to promote (i) structural and functional improve- the board. But urbanization in Turkey, as in most ments to the development planning system, includ- other countries, also brought key challenges of so- ing spatial planning and urban design; (ii) improving cial dislocation and the often “un-neat” juxtaposi- value capture from the conversion of rural to urban tion of urban and rural cultures in a city setting that land in development planning (and using associ- have yet to fully meld together into a civic culture ated revenue streams to develop social infrastruc- and discourse. This phenomenon is inevitable and, ture, including the expansion of public and green managed well, can benefit all city residents through areas); (iii) using urban transformation to enhance the diversity and co-mingling of different cultures city competitiveness and improving the efficiency and mindsets that spark creative energies, innova- of urban land management; and (iv) promoting tive ideas, and effective solutions. But this takes social harmony, urban integrity, aesthetics and cul- hard work and a dedicated commitment to public ture in Turkish cities. All of these policy measures consultations in order to avoid the increasing criti- will need effective planning and monitoring of city cisms of top-down interventions for which TOKİ is performance and establishing the monitoring sys- sometimes criticized. Engagement of community tems necessary to promote livable and sustainable groups and development of a new social contract cities in Turkey. 177 Turkey’s Transitions References Bahl, R., Linn, J., & Wetzel, D. (2013). Financing Met- ropolitan Governments in Developing Countries. Cambridge, MA: Lincoln Institute of Land Policy. Balter, M. (1998, November). The First Cities – Why Settle Down? The Mystery of Communities. Science Magazine, Vol: 282 No:5393, 1442. Bertaud, A. (2010, May). Land Markets, Govern- ment Interventions, and Housing Affordability. Working Paper 18. Washington, D.C.: Wolfensohn Center for Development at Brookings. Bugra, A. (1998). The Immoral Economy of Hous- ing in Turkey. Insternational Journal of Urban and Regional Research, 22(2), 303-317. Global Water Intelligence. (2011, September). GWI Market Report. Vol. 12, Issue 9. Ozdemir, D. (2011). The Role of the Public Sector in the Provision of Housing Supply in Turkey, 1950- 2009. International Journal of Urban and Regional Research, 35(6). Ravallion, M., Chen, S., & Sangraula, P. (2007, April). New Evidence on the Urbanization of Global Pov- erty. World Bank Policy Research Working Paper 4199. World Bank. Spence, M., Annez, P., & Buckley, R. (2009). Urban- ization and Growth. Commission on Growth and Development. The World Bank. Tekeli, I. (2009). Cities in Modern Turkey. London School of Economics and Political Science. TEPAV (Turkish Economic Policy Research Institute). (2013). Working Papers submitted for Turkey Ur- banization Review. TOBB. (2007 and 2011). Enterprise Survey Data- base. World Bank. (2008). Reshaping Economic Geogra- phy. World Development Report 2009. Washington, D.C.: The World Bank. World Bank. (2010). Systems of Cities: Harnessing Urbanization Growth and Poverty Allevation. World Bank Urban Strategy. Washington, D.C.: World Bank. World Bank. (Forthcoming 2014). Turkey Urbaniza- tion Review: Rise of the Anatolian Tigers. World Bank. Yenice, M., & Ciftci, C. (2011). Sustainable Devel- opment and Urban Form: Planning Experiences of Konya City. International Journal of Enviromental, Cultural, Economic and Social Sustainability. 178 6 Chapter 6: Labor: Creating jobs for women and youth Chapter Labor: Creating jobs for women and youth Infrastructure Finance Fiscal Space Trade Welfare Enterprise Cities Turkey’s Transitions: Integration, Inclusion, Institutions 179 Turkey’s Transitions 180 Chapter 6: Labor: Creating jobs for women and youth Labor: is that Turkey’s labor market performance since 2009 has been remarkable. The country cre- Creating jobs for women and youth ated some 4.2 million jobs between 2009-2013 N while, during the same period employment in ejla was a housewife until recently, but now her life and that of her family have changed. the European Union (EU) declined by 2 million. She works as an assistant nurse in the local Employment growth during this period was medical center in Nevşehir, a mid-sized Anatolian 4.9 percent per annum, compared with less town. Her income is not very high but high enough than 2.5 percent in the growth markets, less to set some money aside to buy presents for her than 2 percent in Middle East and North Africa grandchildren. This is the biggest change in her life (MENA), just 1.1 percent in the BRICs, and a de- and makes her immensely proud, even though the cline of 1 percent in the new EU member states. work is physically demanding. Nejla’s husband at These trends are also remarkable compared to first, did not want to let her work outside the house. Turkey’s pre-crisis performance. Throughout Nejla had heard that the medical center needed the 1990s and 2000s, Turkey’s unemployment nurse assistants and that they would provide basic rate was stubbornly high and employment re- training. She wanted to try but her husband said sponded only moderately to economic growth. no. In fact, he worried about her leaving the house Whether Turkey going forward, will continue to even to go shopping. Eventually, however, Nejla’s create jobs at the pace it did in 2009-2013 or son in law convinced her husband to let her go and whether it will fall back to earlier, slower job work. Today Nejla is proud to share her story and growth trends will be a key determinant of the most importantly, how she can now help her grand- country’s pace of transition to high income. children with her own income.1 • Second, what factors contributed to Turkey’s The story of Nejla illustrates the close linkages be- rapid employment creation after 2009? The tween socio-economic change and the labor market chapter provides only a tentative answer to this in Turkey. It shows how urbanization changes the question, as the evidence is not yet conclusive. working lives of women and initially keeps them A key factor seems to have been the continued tied to household chores, while men remain en- process of structural change, which has promot- gaged in paid work (see Chapter 5). Over time, how- ed the creation of service sector jobs in Turkey’s ever, as the labor market tightens, more and more growing cities, including in the less advanced women get drawn back into the labor force.2 This, regions (Chapter 4). The booming construction in turn, encourages their neighbors to do the same. sector has also added to job creation, while ag- The story also shows how family roles are shifting riculture has experienced a temporary halt in across generations and there is greater acceptance worker outflows. Government policy has helped of women working among the younger generation. through targeted reductions in social security This and the increase in educational attainment of contributions, while employment restrictions girls have helped reverse the trend of declining fe- that appear onerous on paper have presented male labor force participation (LFP) in Turkey. less of a binding constraint than might have been expected thanks to weak enforcement in The labor market is also at the center of changes the still large informal economy. in people’s living standards over the past decade. As Chapter 1 illustrates, significant declines in pov- • Third, is Turkey’s young and growing population erty and increases in the income of the bottom a challenge or an opportunity? The answer is a 40 percent in Turkey (a phenomenon the World bit of both. It is an opportunity because Turkey Bank Group calls “shared prosperity”) have been is going through the most productive part of the associated with rising labor earnings as well as an demographic transition, where birth rates have increase in LFP rates among household members. already tailed off and dependency rates are fall- Work and welfare have been closely linked in Tur- ing. It is also an opportunity because, as Chap- key. It is, therefore, critical to understand the func- ter 7 elaborates, the young are far better edu- tioning of the labor market to account for Turkey’s cated than their parents and this should further inclusive growth story and assess its sustainability. boost Turkey’s productive potential. It is a chal- Against this background this chapter asks and an- lenge because the need to create jobs for new swers three questions. labor force entrants is compounded by the need to find employment for the growing number of • First, how does Turkey’s recent labor market women entering the labor force. The chapter performance compare with historical trends summarizes policy options that could turn these and other emerging markets? The short answer challenges into a double demographic dividend. 1 Nejla was one of the participants at an Adım Adım Anadolu Event organized by the Ministry of Family and Social Policy, TUSIAD and the World Bank. Her story is printed here with her permission. 2 Tony Judt (2005) describes a similar phenomenon in his account of post-war Southern Europe. 181 Turkey’s Transitions Turkey’s job-rich growth – both official and hidden – relatively high (Figure 6.1). Heavy labor market regulation led to signifi- after the crisis cant segmentation between the formal and infor- Turkey’s labor market historically exhibited many of mal sectors (World Bank, 2010). It was, thus, not clear whether Turkey’s labor market offered posi- the features of dual labor markets in other middle tive lessons for others to study. income countries. The shift from agriculture to manufacturing and services was combined with the Yet, Turkey’s recent ability to create jobs at a re- growth of an informal urban sector, employing re- markable pace warrants a reappraisal. Turkey was cent arrivals to the city in low skilled jobs. Female among the hardest-hit countries by the global LFP declined as women left active employment in economic and financial crisis but its labor market the rural economy to look after the household and weathered the storm extremely well and Turkey the children in a less accommodating urban setting. stands out as an exemplary case of employment As a result LFP rates were low and unemployment creation in the past few years. Despite a temporary Figure 6.1: Labor force participation in Turkey is lower and unemployment higher than in most peers 70% 60% 50% Labor Force Par ticipation Rate 40% 30% 20% 10% 0% MENA EU Candidates Turkey New EU OECD BRICS Growth Members Members Markets 1990`s average 2000`s average 2010-2012 average 20% 18% 16% 14% 12% Unemployment Rate 10% 8% 6% 4% 2% 0% Growth OECD BRICS New EU Turkey MENA EU Candidates Markets Members Members 1990`s average 2000`s average 2010-2012 average Source: World Development Indicators (WDI) Note: Comparisons are drawn with The Organisation for Economic Co-operation and Development (OECD) averages in this chapter in addition to the peer groups used throughout the report. Categories are overlapping to some extent. 182 Chapter 6: Labor: Creating jobs for women and youth Figure 6.2: Turkey’s remarkable post-crisis employment performance 150 140 130 Index 2004=100 120 110 100 90 80 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 GDP Employment Source: TurkStat spike to 15 percent during the crisis, unemployment declined to around 18 percent after the crisis, and declined to below pre-crisis levels and Turkey’s em- female LFP began to climb, albeit from low levels. ployment in 2013 was 25 percent higher than it had Employment creation remained strong even as been in 2007 (Figure 6.2). Increasing employment growth decelerated in 2012 and 2013. Monthly importantly has benefited both youth and women, growth rates in employment remained above 3 per- two groups that have traditionally had lower than cent in the first half of 2013, even though growth average employment rates. Youth unemployment, momentum slowed down in 2012 and 2013. This which hovered around 20 percent before the crisis, pace of job creation is significantly above pre-crises Table 6.1: Most jobs go to the better educated Employment Employment Contribution     Share in WAP Rate Informality Growth (thsnd) (percent)     2004 2012 2004 2012 2004 2012 (2004-2012) (2004-2012) Total 41.3 45.4 50.1 39.0 5189 Less than 61.5 51.6 37.9 39.3 66.4 58.2 18 0.3 Total secondary Secondary 31.7 36.9 42.0 45.7 36.0 31.8 2893 55.8 Higher 6.7 11.5 69.2 71.1 9.3 6.4 2278 43.9 Total     62.7 65.0 44.3 32.7 2926   Less than 52.5 43.2 64.6 63.3 57.1 45.9 -518 -17.7 Male secondary Secondary 39 43.3 57.3 62.3 34.7 29.4 2066 70.6 Higher 8.5 13.6 76.0 78.9 10.3 7.4 1378 47.1 Total     25.2 26.3 67.1 54.2 2263   Less than Female 85.1 59.7 18.8 22.5 89.3 82.5 536 23.7 secondary Secondary 8.8 30.7 64.3 23.1 42.3 40.8 827 36.5 Higher 6.1 9.6 58.3 60.4 7.0 4.7 900 39.8 Source: TurkStat 183 Turkey’s Transitions Figure 6.3: The added worker effect 5.0 4.5% 4.5 4.0% 4.0 3.5% 3.5 3.0% 3.0 In million 2.5% 2.5 2.0% 2.0 1.5% 1.5 1.0 1.0% 0.5 0.5% 0.0 0.0% 2005 2006 2007 2008 2009 2010 2011 Husbands are unemployed Husbands are employed or out of labor force Percent of married women who work and whose husbands are unemployed (right axis) Source: Labor Force Survey (LFS), TurkStat rates. Indeed, the growth elasticity of employment Good jobs are created … increased to 0.76 during 2009-2013, up from 0.26 during 2004-2007, and this increase was observed The formal service sector for highly educated across all sectors3. We look at the types of jobs cre- workers has been the main driver of employment ated in Turkey next, which suggest a large propor- growth. Of the new net employment generated tion of job creation is due to structural factors, al- between 2005 and 2011, 76 percent was in non- though more temporary factors such as an increase agricultural sectors and close to half (49.1 percent) in construction employment and some reverse job came from an increase in the services sector. Out- flows into agriculture also contributed. side agriculture, net new job creation benefited Figure 6.4: Employment rates are up but still low Employment rate (percent of total population 15+), 2007-2012 65% Employment of population 15+ 60% 55% 50% 45% 40% 35% 2007 2008 2009 2010 2011 2012 BRICS EU Members EU Candidate MENA Growth Markets OECD Members Greece Spain Turkey Source: WDI 3 Population statistics were updated starting from 2004. According to TurkStat, statistics before and after 2004 should not be merged. Therefore, we use 2004-2007 as a proxy for the pre-crisis period. 184 Chapter 6: Labor: Creating jobs for women and youth Figure 6.5: The gender gap explains why employment rates are low Labor force participation in Turkey and OECD by gender 90% Share of total population, age 15-64, 2011 80% 70% 60% 50% 40% 30% 20% 10% 0% Male Female Total Turkey OECD Source: OECD higher education graduates (half of all new jobs).4 6.3). This is a small proportion of the total increase Overall, almost 44 percent of employment growth in female employment in 2009, which was up by came from university graduates who have a lower 276,000, of which 156,000 in the informal sector. informality rate compared to other education lev- els (Table 6.1). On the other hand, since most of ..if not yet for everyone the employment growth in agriculture was due to women, less educated women also contributed sig- The success of Turkey in job creation after 2009 not- nificantly to female employment growth. withstanding, Turkey’s employment rate remains below that of most peers. The employment rate for Crisis-related increases in labor supply do not ex- the working age population (WAP) (15+) is around plain the increases in Turkey’s employment rate 45 percent, significantly lower than the OECD aver- since 2007. An increase in the labor supply of mar- age of around 55 percent (Figure 6.4). Interestingly, ried women (the “added worker effect”) can often the gap between Turkey and Southern European be observed when their husbands become unem- countries hard hit by the economic crisis, such as ployed. Married women are often secondary work- Greece and Spain, has shrunk in recent years as the ers with a less permanent attachment to the labor employment rate in Turkey has increased at the market than their partners. Karaoğlan and Ökten (2012) find a significant added worker effect on same time as it declined in Southern Europe.6 In in- married women’s LFP in the period of 2000-2010 ternational comparison, Turkey’s employment rate in Turkey. Başkaya and Şengül (2012) analyse the is above that in MENA countries but lower than in relation between business cycles and LFP of wom- other peers. en and men and find that women’s LFP increases in economic downturns in contrast to men’s. An The low level of female LFP lies behind Turkey’s po- upper bound estimate of the added worker effect sition with respect to its peers (Figure 6.5). Male would be the increase in the number of married LFP was recorded as 76 percent in 2012, only 3 per- women who are working and whose husbands are centage points lower than the OECD average. On unemployed5. There is a 21 percent (or 38,000 in the other hand, female LFP is only 30 percent, less numbers) increase in such women in 2009 (Figure than half of the average of OECD countries at 62 4 World Bank (2013 d, chapter 2). 5 If husbands of women that are already working anyway become unemployed during the crisis, the women would be counted in the analysis as well. In the absence of panel data that follows the same woman over time, this upper bound estimate is the best alternative. 6 Figure 6.4 is based on employment rates for the population aged 15 +. Since Turkey has a relatively large share of elderly (above 64) in agriculture who are still employed, this accounts for the fact that its employment rate in 2012 exceeded that of Spain and Greece, where much fewer in the 64+ age group still work. If we had limited comparison to the 15+-64 age group, both Greece and Spain would have higher employment rates than Turkey, although the gap would still be declining rapidly over the past four years. 185 Turkey’s Transitions Figure 6.6: Younger women are more likely to be active Labor force participation by age and birth cohort7 45% Labor Force Par ticipation Rate of Urban Women 1983-87 40% 1978-82 1973-77 1968-72 35% 30% 1963-67 25% 20% 1958-62 15% 10% 1953-57 5% 0% 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 Age Source: TurkStat LFS (1992, 1997, 2002, 2007, 2012). Data labels represent year of birth percent, and 17 percentage points lower than the that the LFP rate of women that were born 1963-67 second to lowest OECD member (Mexico, with 47 equaled 20 percent when they reached age 30-34. percent). The comparison to non-OECD peers is not This rate almost doubles to about 38 percent for much different (see also Chapter 1). the same age group in the younger generation born However, a generational shift may be under way. between 1978 and 1982. The four youngest birth Women from younger birth cohorts participate cohorts (females born between 1968 and 1987) ex- more often in the labor market than their coun- perienced a tremendous increase in LFP in the past terparts from older birth cohorts. Figure 6.6 shows five years. From 2007 to 2012, female LFP for these Figure 6.7: The gender gap is declining 120% 100% Labor Force Par ticipation Rate 80% 60% 40% 20% 0% 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 65+ Age Male 2000 Male 2012 Female 2000 Female 2012 Source: TurkStat 7 The findings presented in this Chart were first notified to the team by Dr. İnsan Tunalı. 186 Chapter 6: Labor: Creating jobs for women and youth Figure 6.8: The U-curve of female LFP in Turkey GDP and female labor supply in Turkey (1989-2010) 50 1980 45 1985 Female Labor Force Participation GOAL: - High Female LFP 40 - High GDP/capita - Enough jobs for (in percent, 15+) high-and low 35 19881989 1990 skilled workers 1991 1992 1995 1994 1996 1999 30 1997 2001 2002 1998 2010 1993 2000 2003 2009 25 2008 2004 2005 2006 2007 20 Change 2007 - 2010: Increased female LFP and GDP/capita 15 0 2,000 4,000 6,000 8,000 10,000 12,000 GDP/capita (current US$) Source: International Labor Organisation (ILO), WDI four birth cohorts increased by about 10 percent- Since then, the pace of job creation among better age points. educated females has begun to exceed the decline in female employment as less skilled women move The changing demographic profile of working wom- from rural areas to the city and employment rates en may herald a change in trend towards sustained are increasing. However, Turkey is still at a relatively increases in female LFP. The composition of the fe- shallow end of the ascendant part of the U (Figure male labor force changed significantly compared 6.8). Policies to further increase female LFP are dis- to the male labor force in the 2000s (Figure 6.7). cussed further below. For both males and females, LFP declined for the youngest (15-19) and oldest (55+) age groups. In Because of low attachment to the labor market, the the prime age group (20-54), male LFP did not al- contribution of women’s earnings to the reduction ter much. On the other hand, there is a significant of poverty and shared prosperity in Turkey has been rise in female LFP for the 20-44 year age groups. low to date. As shown in Chapter 1, work and wel- The increase in female LFP in the prime age group fare have been closely linked. Since many women is consistent with the improvements in educational do not work, their contribution to household wel- outcomes as well as demographic changes such as fare has been marginal (Figure 6.9). In fact, because delayed marriage and fertility (Dayıoğlu and Kırdar, women from richer households are more likely to 2010). As the retirement age also gradually in- have joined the labor force over the past decade, creased, the share of the high-participation group this has contributed marginally to higher inequal- can be expected to increase in the upcoming years. ity. However, if the trend towards rising female LFP is sustained and women from lower income brack- Turkey seems, thus, to be following the U-shape ets join the labor force, this will, over time, make pattern for female LFP typical of past development a significant contribution to poverty reduction and paths in many emerging markets (Goldin, 1994; to reduced inequality – as the experience of some Mammen and Paxson, 2000). Agricultural shedding Latin American countries over the past decade sug- and urbanization were the main drivers of decreas- gests. Work and welfare will, thus, continue to be ing female LFP rates through the middle of the linked, with women playing a key role in the future. 2000s. Female workers, who were mostly unpaid family workers in agriculture, could not participate Some jobs could still be better in the urban labor force after migration to cities, contrary to their husbands (World Bank, 2009.a), Overall formality has improved measurably but primarily due to low levels of education. In addi- informality is still high. Job informality (defined tion, the lack of child care in cities as opposed to as jobs without social security benefits) has come the availability of family members in rural areas down remarkably from 48 percent in 2005 but it was another constraint that rural migrants faced. still affects 37 percent of workers in 2013 (Figure 187 Turkey’s Transitions Figure 6.9: Women’s income does not (yet) contribute much to poverty reduction 2 Poverty reduc tion, percentage points 0 -2 -4 -6 -8 -10 -12 Share of Share of Wage Private Wage Public Pensions Other Income Share of Adults Employed Adults Female Male No gender dissagregation Source: Azevedo and Atamanov (2014) Note: The Figure decomposes the main factors behind Turkey’s 22 percentage point reduction in the absolute poverty rate between 2002 and 2011. 6.10). Most informal workers are in agriculture Women and youth are affected disproportionally and the processes of urbanization and agricultural by informality. Informality among women (52 per- shedding helped the decline of job informality. But cent) is much higher than among men (30 percent) there is also a significant decline of informality in due to unpaid work in agriculture (Figure 6.11). In non-agricultural sectors. International comparisons non-agriculture sectors, informality among wom- of informality suggest that Turkey’s shadow econo- en is only 5 percentage points higher than among my is comparable to that in countries with similar men. On the other hand, informality among young income levels, such as Mexico, Bulgaria or Romania workers is significantly higher than the popula- (Elgin and Schneider, 2013). tion average even in non-agriculture sectors as the Figure 6.10: Job informality: declining but remains high 60% 50% In percent of employment 40% 30% 20% 10% 0% 2005 2006 2007 2008 2009 2010 2011 2012 Total Non-Agricultural Employees Source: TurkStat (Labor Force Survey data) 188 Chapter 6: Labor: Creating jobs for women and youth Figure 6.11: Informality is higher among women and youth 60% Percent of Total Employment 60% 50% Percent of Total Employment 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% Total Non-Agriculture Total Non-Agriculture Male Female Total 15-24 Source: TurkStat Note: Informality is defined as the ratio of workers without social security registration to total employment. young often experience entry barriers to formal might induce informality (Loayza et al., 2005). Firms employment (Tansel and Kan, 2011). Informality may choose to hire workers informally in order to may cause an earnings gap between workers with escape the cost of hiring or firing due to rigid regu- similar observable characteristics and the gap ap- lations. Moreover, the minimum wage, as a ratio of pears to be higher among women and young work- the median wage, in Turkey is highest among the ers compared to prime age males (Başkaya and Hu- OECD countries, which might increase informality lagu, 2011). among low skilled workers. Turkey’s rigid employment legislation could be one Another factor behind informality in the Turkish factor behind informality. Turkey has the strictest labor market might be the low retirement age. employment legislation among OECD countries Despite the pension reforms that will gradually in- according to the employment protection index crease the retirement age to 65 for both men and created by the OECD (Figure 6.12). Cross country women, workers today can still retire before the evidence suggests that a heavier regulatory burden age of 50. Retirees do not pay taxes on their pen- Figure 6.12: Turkey’s labor markets are segmented because of high costs of formality 4.0 Employment Protec tion Legisla tion Index 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Korea, Rep. Canada Italy Norway Switzerland Israel Hungary Japan Greece Turkey France Iceland Austria Belgium Latvia Estonia Slovakia Ireland Slovenia United States Czech Republic Denmark OECD Chile New Zealand Luxembourg Mexico Netherlands Spain Poland Sweden United Kingdom Germany Portugal Finland Australia Source: OECD, World Bank (WB) staff calculations Note: The index is calculated as a simple average of 3 indices created by OECD; strictness of employment protection legislation for collective dismissals, regular employment and temporary employment. 189 Turkey’s Transitions sions and have access to full health insurance with- and June 2010. These employment subsidies were out having to pay contributions, inducing workers found to be effective. World Bank (2013) simulates who retire early and work informally. Tansel and that the reductions in social security contributions Kan (2011) find that being in the age group 45 to caused 0.65 and 0.46 percent increases in female 64 significantly increases the probability of working and youth employment (aged 15-29), respectively, informally. World Bank (2010) estimates that 2 mil- whereas the effect of similar reductions across the lion pensioners worked informally as of 2008. board on total employment would have been just 0.21 percent. Balkan, Başkaya and Tümen (2014) While informality is a symptom of restrictive formal find that the targeted incentives increased the employment regulations, it is also a factor mitigat- probability of employment among women in the ing the impact of these regulations. This may ex- prime age group by 2-2.5 percent, with the effect plain why despite of restrictive labor market poli- strongest among women above age 30. In 2011, cies, employment creation has been so rapid. Over the reductions were extended till 2015 and new a longer period, Taşkın (2013) finds little difference target groups were added. More specifically, firms in employment adjustment patterns in the US and which hire new workers, who either attended train- Turkey during 1955-2012, although the two coun- ing courses of Turkish Labor Agency (İŞKUR) or who tries sit at opposite extremes of OECD’s Employ- have vocational training certificates or were reg- ment Protection Legislation Index. In a similar vein, istered as unemployed in İŞKUR, can also benefit OECD (2014) argues that because of strict regula- from the reductions. tions but lax enforcement, firms satisfy growing demand by taking on additional workers informally. Reductions in labor costs for targeted groups were At the same time, however, government policy has found to be more cost effective compared to across- tried to lower barriers to formal employment with the-board reductions. This is because workers from some effect. This is to what we now turn. categories in high demand in the labor market may bargain away payroll tax reductions resulting in What did the Turkish government higher wages, and, thus, muting the intended ef- fect on lower labor costs and higher employment. do right? – Policies that supported Simulations suggest that less than 50 percent of employment creation reductions in social security contributions are translated into reduced labor cost in an across-the- Turkey showed a sensible policy response board scheme, compared to a 75 percent reduc- to the crisis tion in case of social security contribution subsidies targeted to minimum wage earners (World Bank The government implemented several measures as 2009.b). In a similar fashion, World Bank (2013.b) a response to the global financial crises in 2008.8 In estimates that the cost per employee of across-the- January 2008, a minimum living allowance for per- board reductions is more than three times the cost sonal income tax was introduced which reduced the for targeted groups. tax wedge by between 2.5 and 6 percentage points depending on the family status and income level of The government expanded a short-time work the worker. Furthermore, social security contribu- scheme in order to prevent job losses and intro- tions for employers were reduced by 5 percentage duced public works in order to create jobs for the points in October 2008, which reduced the average unemployed. A short-term work scheme, which tax wedge by another 2.5-3 percent (World Bank, was introduced in 2005, was expanded from 3 2010).9 As a result, Turkey’s ranking among OECD months to 6 months in order to partially compen- countries improved considerably (Figure 6.13). sate workers in firms with reduced working hours. The income loss of workers who worked fewer than In addition to across the board reductions in the the usual hours due to the crisis was compensated labor tax wedge, several incentives were imple- by the unemployment insurance fund, allowing mented to induce employment in targeted groups. firms to retain workers and avoid the costs of re- Social security contributions were paid by the un- dundancies and, later, the cost of rehiring. Around employment insurance fund up to the level due for half a million workers benefited from the scheme the minimum wage for young workers (18-29 years in the crisis year 2009. Another measure was a old) and all women above 18 that were not formal- public works scheme where unemployed workers ly employed in the last 6 months and constituted registered at İŞKUR could work for 6 months (9 net hires for firms in the period between July 2008 months since 2012) in public works and be paid the 8 For the full set of government response to crisis in the labor market, see World Bank 2013.a. 9 The reductions in social security contributions were implemented in the form of incentives to firms which paid their social security contributions fully. 190 Chapter 6: Labor: Creating jobs for women and youth Figure 6.13: Turkey reduced the tax wedge to boost job creation 60% 56 54 Tax Wedge in Percent of the Net Wage 52 49 49 50% 46 45 44 44 43 43 43 42 41 39 39 38 40% 37 36 34 31 30 30 29 28 28 30% 22 22 20 20% 15 10% 0% Korea, Rep. Mexico Denmark New Zealand Hungary Spain Portugal Japon Finland Germany Czech Republic Slovakia France United States Canada Sweden Greece Iceland Austria Ireland Austria United Kingdom Switzerland Italy Luxembourg Belgium Poland Netherlands Turkey - before Source: World Bank (2010) Turkey - after minimum wage. In 2012, 197,182 people benefited İŞKUR increased coverage of the unemployed and from the public works scheme. the number of participants in active labor market programs after 2008. The government’s crisis pack- Turkey also allocated a considerable amount of fi- age included the expansion of active labor market nancial resources to active labor market policies programs to all registered unemployed. Also, most (ALMPs) during the crisis. Expenditures on ALMPs, of the above mentioned subsidies to employers or which were very small in 2002, started to rise af- employees can be enjoyed only in case workers are ter 2004. However, it is after 2008 that ALMP ex- registered at İŞKUR, which fosters a higher registra- penditures grew considerably, to 4 percent of non- tion rate. Since 2008, İŞKUR has increased vocation- interest public expenditures in 2012 (Figure 6.14). al training, introduced Job and Vocation Counseling Expenditures on unemployment benefits rose to 4 (JVC) and, recently, linked social assistance ben- percent of total non-interest expenditures during eficiaries to registration with İŞKUR (World Bank, the crisis and declined in 2010, as expected. 2013.c). Figure 6.14: Turkey increased spending on ALMPs 8% As a share of non -interest budget expenditures 7% 6% 5% 4% 3% 2% 1% 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Unemployment Benefits ALMP Source: İŞKUR, Small and Medium Enterprises Development Organization (KOSGEB), Ministry of Family and Social Policy (MOFSP) 191 Turkey’s Transitions Figure 6.15: İŞKUR’s coverage and placement are increasing fast 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 Share of registered unemployed in total unemployed Placement over registered unemployed Placement over vacancy Source: İŞKUR, TurkStat Consequently, the share of the total workforce Targeted government support is one factor to ex- and unemployed registered with İŞKUR increased plain how Turkey’s growth became job-rich after strongly after the crisis. The share of the unem- the crisis. Simulations suggest that 15 percent of ployed registered with İŞKUR increased from 34 employment growth can be attributed to declining percent to 94 percent between 2004 and 2012 social security contributions in 2008 (World Bank, (Figure 6.15). During the same period, the share 2013.b). In addition, public employment, which did of all unemployed registered with İŞKUR that was not contribute to the employment growth in the matched with a new job also increased from 4 per- years before the crisis, started to increase after the cent to 23.5 percent. At the same time, the number crisis (Ceritoğlu et al., 2012). Around 10 percent of vacancies registered in İŞKUR increased nine fold of new jobs came from the public sector between from around 110,000 to 992,000. As a next step, 2009 and 2011 (World Bank, 2013.d). The targeted İŞKUR should focus on improving placement rates policy measures to combat informality have further as the ratio of placements over vacancies has actu- shifted relative incentives towards employment ally moderately declined. creation in the formal sector. Public policy, thus, made important contributions to Turkey’s employ- Government policies have also contributed to the ment creation story after the crisis. decline in informality. In 2009, the Government launched an action plan against informality, which However, government policies alone cannot explain the strength of the labor market. Arguably, a key includes measures such as strengthening the ca- reason for rapid employment growth has been the pacity of tax and social security audits, sharing da- strength in domestic demand for relatively labor tabases among agencies, and moving towards a risk intensive activities such as services and construc- based inspection system. These measures, togeth- tion, at the same time as labor supply has become er with a lowering of corporate income taxation, more skilled. As is discussed in Chapter 4 in detail, as well as the targeted reductions in payroll taxes, this has driven reallocations of labor across sectors may have contributed to the decline in informality. in a way that has been productivity enhancing at Interestingly, business statistics show a spike in the least until quite recently.10 Not only has structural number of firms with more than 20 employees af- change led to regional convergence and the rise of ter 2010, which may be one indication of the suc- a new class of increasingly competitive enterprises, cess in enticing firms over the threshold of infor- it has also supported the creation of “good jobs”. mality (World Bank, 2013.d). In addition, Chapter 5 shows how the process of 10 With growth slowing in 2012 and 2013 and employment creation continuing apace, productivity has been flat over the past two years. This effect may be cyclical or, in part, reflect the predominance of lower than average productivity construction jobs in recent employment growth. These recent patterns require continued analysis to see if they indicate a new trend. 192 Chapter 6: Labor: Creating jobs for women and youth Figure 6.16: Turkey is young and already relatively rich 12 Logarithm of GDP per capita (in 2005 US$) 11 R² = 0,6247 KUWAIT 10 TURKEY 9 8 AZERBAIJAN 7 6 VIETNAM 5 4 15 20 25 30 35 40 45 Median Age Source: WDI, United Nations (UN) structural change went hand in hand with a fast tered a demographic window of opportunity where rate of urbanization, which is creating the demand more than two thirds of its population is of work- for jobs in services. One area of concern, however, ing age (between 15 and 65). Only after 2050 will is the increasing role of construction and real estate this window close as the share of the elderly in the in urban job creation. Relatedly, since 2012, rapid population increases (see also Hoşgör and Tansel, job creation has gone hand in hand with stagnant 2012). productivity. The sustainability of recent patterns thus, remains an issue. Parallel to the rise in the WAP, labor supply in Tur- key will significantly increase. Even with no increas- Opportunities (and challenges) for es in LFP rates, Turkey’s labor force is expected to increase by 20 percent over the next 50 years. In the future addition, LFP (especially among women) will in- Turkey’s population is young, and the country is rel- crease as younger cohorts participate more actively atively rich given its youth. Turkey compares very in the labor market. Allowing for increases in the favorably to other nations in terms of per capita overall LFP to the levels seen in the Nordic coun- Gross Domestic Product (GDP) considering its me- tries, assuming female LFP converges to the cur- dian age (Figure 6.16). If Turkey manages to sustain rent LFP of men, and assuming the working life is the recent pace of job creation whilst ensuring that extended by 10 years (as foreseen by the pension this goes hand in hand with higher productivity, the reforms) increase the projected growth in labor country could experience a virtuous cycle resulting supply to about 120 percent in the combined best in a large demographic dividend over the coming case (Figure 6.18). Of course, the flipside of this de- decades. mographic boon is the need to ensure that all these new entrants into the labor force find productive Turkey will have a rapidly growing WAP over the jobs. The next section looks at policies that would next decade. According to Government estimates, help Turkey maximize its demographic dividend. the WAP which is around 52 million today, will rise We focus on policies that determine the quality by 6 million in the next 10 years, and increase to of labor supply. Labor demand, and, in particular, around 68 percent of the total population in 202311 policies to increase demand for productive jobs are (Figure 6.17). Starting around 2005, Turkey has en- discussed in Chapter 4. 11 Turkstat provides two sets of demographic scenarios. The base case assumes no future increase in fertility and is the one reported in this Chap- ter. The alternative scenario assumes fertility rebounds to above 2 children per female as a result of targeted family support measures. 193 Turkey’s Transitions Figure 6.17: Turkey’s demographic window of opportunity Population by age groups (in percent of the total population) 100% 7,7 10,2 90% 20,8 80% 70% 60% 67,8 68,6 50% 63,4 40% 30% 20% 10% 24,5 21,2 15,7 0% 2013 2023 2050 0-14 15-64 65+ Source: TurkStat Notes: A cohort-components method was utilized for these projections. A slight decrease in fertility and a declining infant mortality rate are assumed. This assumes Turkey follows the typical demographic transition path of other older countries. Policies to sustain the pace of job SA beneficiaries is sent to İŞKUR by the Ministry of Family and Social Policies (MoFSP). Almost 30 per- creation cent of the 6.4 million SA beneficiaries are men of working age, for whom a direct link between the Improving the employment rate receipt of SA and registration at İŞKUR may pro- Recent increases in the retirement age will gradu- vide significant incentives to return to job activity ally increase employment rates among older age (World Bank, 2013.c). This could help boost place- groups. The 2008 reforms in the pension system ment rates above the current level of around one will increase the average retirement age by about 2 fifth of all unemployed registered with İŞKUR. months per year (World Bank, 2013.b; Chapter 7). While this pace is slow by international standards, Improving formality it will over time, nonetheless, provide some impor- An adjustment of the minimum wage might induce tant benefits. First, to the extent that an increase formal employment, especially among low skilled in the average age of retirement reduces budget and young workers. The minimum wage in Turkey transfers to the social security institution for pen- is 71 percent of the median wage, the highest ra- sion payments, the funds saved could be allocated tio in the OECD. Earlier studies find that the mini- to ALMPs or to investments to improve the skills of mum wage is binding for formal sectors, whereas the labor force. Second, an increase in the retire- almost half of workers in the informal sector earn ment age will retain experienced workers in the less than the minimum wage (OECD, 2008; World labor force for longer and reduce informal employ- Bank, 2013.b). There are several options to make ment post-retirement, thus, leveling the playing the minimum wage less binding, such as not taxing field for younger workers. Accelerating the transi- it, allowing regional variation or providing regional tion to a higher retirement age would bring higher employment subsidies. Turkey’s investment incen- benefits. tives already recognize the case for regional varia- tion by providing differentiated payroll tax deduc- Linking the social support system to employment tions, which are more generous for less advanced will help inactive people find their way back into regions. Whether these incentives are sufficient to the labor market. An action plan adopted in 2010 induce greater formality remains to be seen as the establishes a link between the social assistance (SA) system is relatively new. system and İŞKUR’s employment programs with the objective of accelerating the economic activa- Further shifting the tax burden away from payroll to tion of SA beneficiaries. Since 2012, information on other taxes might also induce formal employment. 194 Chapter 6: Labor: Creating jobs for women and youth Figure 6.18: Turkey is expected to have a lot more workers 140% 121 Change in Labor Supply 2010 -2060, Percent 120% 100% 87 80% 67 60% 40% 28 26 17 20 20% 7 1 0 0 0% -2 -20% -8 -13 -16 -40% Constant participation Convergence to Female to male Increase in work life by Combined maximum rates benchmark countries convergence 10 years scenario Turk ey Greece S pain Source: WB staff calculations based on UN, ILO and Eurostat Data Note: See World Bank (2012.a) for detailed discussion of the scenarios and methodology. A World Bank report (2009.a) finds that employ- Investing in Human Capital ment in Turkey is responsive to labor cost with an elasticity of 0.4 to 0.6 percent and, hence, declin- Improving the skills of the labor force is crucial to ing labor taxes might increase employment12 Tur- increase employment together with productivity. key has made good experiences with targeted pay- The majority of the Turkish labor force has only up roll tax reductions for women, youth and workers to 8 years of education. Younger cohorts have sig- registered with İŞKUR. These schemes have been nificantly higher levels of schooling, and Turkey is, repeatedly extended, which, on the evidence pre- thus, likely to gradually converge to levels reached sented, seems well justified. in other OECD countries (Figure 6.19). The so-called “4+4+4” education reforms, which increase com- Increasing the coverage and generosity of unem- pulsory education to 12 years, and recent invest- ployment benefits might increase worker protec- ments in tertiary education will contribute to this tion and support efficiency-enhancing turnover convergence.13 However, countries like the Repub- as well as, encourage workers to join the formal lic of Korea have managed to dramatically increase sector. Turkey has the second lowest unemploy- educational attainment from around 40 percent of ment replacement rate among OECD countries af- the cohort aged 55-64 to almost 100 percent a gen- ter the Republic of Korea. Besides, the percentage eration later. Compared to this performance, Tur- of unemployed receiving unemployment benefits key’s improvement historically looks modest (Fig- is much less compared to the OECD average; Tur- ure 6.20). In other words, more progress is needed. key’s coverage rate is around 11 percent compared Beyond increasing years of schooling, the quality to the OECD average of close to 50 percent (OECD, and relevance of education will be crucial to en- 2011.b). Because formal workers hardly benefit sure diplomas translate into job relevant skills. The from greater unemployment protection than infor- nature of the skills required in jobs in Turkey has mal workers, there are few incentives for workers changed over the last decade (World Bank, 2013.c). to ask for formal jobs. At the same time, the high The need for routine cognitive skills is on the rise costs of current severance pay arrangements cre- while jobs that require non-routine manual skills ate disincentives for firms to hire formal workers. are on the decline. At the same time, Turkish em- A reform of Turkey’s unemployment and severance ployers experience difficulty in filling jobs due to pay arrangements could, thus, yield benefits for em- the unavailability of the right skills. According to ployment creation as well as reduced informality. the Talent Shortage Survey 2013 implemented by 12 Üngör (2013), similarly, finds that time varying taxes on consumption and labor play important roles in explaining the aggregate hours worked in Turkey. 13 See Chapter 7 for more details. 195 Turkey’s Transitions Figure 6.19: Educational attainment in Turkey is increasing 100% 0 11 8 9 8 7 14 16 13 90% 22 19 6 13 9 13 13 80% 17 Schooling Distribution of WAP 70% 28 23 22 60% 50% 83 87 40% 78 76 78 78 70 30% 58 59 62 20% 10% 0% 15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 At most 8 years High school Ter tiary Source: World Bank (2013.c) Manpower Group, 58 percent of Turkish employers as skills mismatch as reasons for not being able to experience difficulty filling jobs, compared to 35 hire. Thus, expanding programs that help the WAP percent at the global average. Similarly, 56 percent increase the relevance of its skills, while adjusting of Turkish employers with vacancies mention that overall education goals so they prepare for a rapidly one reason for not filling them is the lack of skills, changing economic structure, will help the growing which is the highest share in a list of comparator workforce find good jobs. countries (McKinsey, 2012). In a recent survey by The economic benefits of investments in skills the Ministry of Science, Industry and Technology, could be very large. World Bank (2013.b) simulates one third of Turkish employers in manufacturing that a 25 percent rise in the share of high skilled report unfilled vacancies. In a qualitative assess- labor could increase the growth rate of real GDP by ment, these employers point to issues in the edu- 2.5 percentage points (Table 6.2). Increasing skills cation system such as lack of internships, as well in the workforce is also associated with declining Figure 6.20: Experience in peers shows that educational attainment can improve fast 100% 90% Share of labor force who have a ttained at 80% 70% least secondary educa tion 60% 50% 40% 30% 20% 10% 0% Canada Russian Fed. Norway Italy Switzerland Israel Hungary Turkey China France Greece Austria Slovakia Iceland Estonia Belgium Slovenia Ireland Brazil United States Czech Republic Denmark Chile Luxembourg New Zealand Mexico Poland Sweden Netherlands United Kingdom Germany Spain Finland Australia Portugal Korea, Rep. 25-34 years-old 55-64 years-old Source: OECD (2012) 196 Chapter 6: Labor: Creating jobs for women and youth Table 6.2: More skills would increase growth and reduce informality ∆ Growth ∆ Employment ∆ Informality Scenario Rate High Skilled Low Skilled Total Female 25 percent rise in high-skilled labor 2.5 17 -12 -10.4 -12.7 Source: World Bank (2013.b) informality, especially for women. Beyond educa- But more can be done in particular to make it easier tion, what other measures could help Turkey boost for women to reconcile work and family. Labor force female LFP? This is the final issue investigated in participation among urban women drops off signifi- this Chapter. cantly after each additional child that is born, par- ticularly among lower skilled women. For instance, How can Turkey get more women in 2003, according to the Demographic and Health survey, labor force participation among low-skilled into work faster? urban women declined from 32 to 15 percent af- Female LFP constraints are multi-faceted. They re- ter the birth of their first child (Uraz et al; 2010). fer to markets, laws and institutions, and social While participation rates have increased since, life norms (World Bank, 2012.b). Fostering female LFP events still have an impact on women’s participa- requires lifting more than one barrier at the time. tion. In the same Demographic and Health Survey For example, women may have fewer opportunities for 2008, two thirds of women cited childcare and for formal work because of deep seated gender dif- household duties as the main reasons for not work- ferences in time use and allocation (reflecting social ing, and the 2006 Time Use Survey shows that em- norms about who does house and care work), in the ployed women devote twice the amount of time workings of markets (reflecting employers’ prefer- to home-related task than men do. Increasing the ences for certain skills and workers), and in the for- availability of childcare, by expanding the supply of mal institutions of the state (such as labor codes). services, is likely to have a doubly beneficial effect: on the one hand, it will release women’s time and Turkey has made progress in increasing women’s open opportunities for new labor market entrants, skills, and education of females has eased their way and on the other, it might allow for women who are into the labor market. Since the nature of employ- already working to work more hours or move into ment has transformed itself from agricultural – of- ten non-paid – to white collar jobs, females need better jobs (for example out of informality) higher skill levels to succeed in the labor market. International experience shows that availability of However, Figure 6.21 shows that, to date, only affordable child care and female LFP are positively higher education has a notable effect on female correlated. Countries with extensive female LFP, employment rates. Short of sending all girls to uni- such as France or Sweden, also have an extensive versity, other policies will be needed for Turkey to child care system. Further, countries where large in- be able to close the gap in female LFP. vestments in early childhood education (ECE) have Turkey’s legal and regulatory framework, in prin- been newly undertaken have seen changes in their ciple, promotes gender equality. Turkish law has levels of female LFP.14 been adapted to prevent discrimination on the basis of gender, and facilitate access to the labor Enrollment in ECE in Turkey has been increasing market for women. In 2003, a new labor law was rapidly in recent years but is still low by interna- enacted that forbids discrimination on the basis of tional standards (Figure 6.22). Government plans gender (Gökşen et al., 2013). Five years later, the envisage several steps to increase ECE. For exam- Committee on Equality of Opportunity for Women ple, in the new tax law draft submitted to Parlia- and Men was founded to ensure equal treatment ment, it is stated that, establishment and construc- in pay, hiring, promotion and termination of job tion costs are fully exempt from income tax for contracts. Since 2004, an addendum to the Turkish establishments that will exclusively operate as a constitution defines gender equality as an explicit kindergarten or creche and for firms that establish responsibility of the state. In addition, the govern- kindergarten/creche classes for their employees. ment has implemented policies such as covering Furthermore, private investments in ECE are given social security contributions for women entering priority in the new investment incentive system of the labor market. the government.15 14 Such as Argentina (Berlinski and Galiani 2007), Mexico (3iE 2012 and Calderon 2012), and Brazil (Barros et al 2011) 15 For details of new investment incentive system: see http://www.ekonomi.gov.tr/upload/0B146D5C-F9DF-DB01-B7F8DD3B1391DCD5/web%20 sayfas%C4%B1_ing.pdf 197 Turkey’s Transitions Figure 6.21: The gender gap declines as educational attainment goes up Employment rate by gender and educa tion, 2012 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Overall Men Women Illiterate Less than Secondary Secondary Voca tional Secondary Higher Educati on Source: TurkStat Flexible work arrangements (FWAs) can also have pecially in countries where the supply of full-time a positive effect on female LFP. FWAs refer to flex- child care is restricted, working part-time can help ibility in terms of work time and workplace e.g. balance work and family responsibilities. However, part-time work, flexible start- and finishing times, part-time workers are less likely to be unionized annualized hours, telecommuting etc. (Farré, and concentrate often in less valued occupations 2013). Career flexibility and support during career with low wages and social security benefits. Hence, breaks are also key. Policies such as maternity leave part-time jobs might affect female labor supply protection can prevent negative impacts of child negatively. Del Boca et al. (2009) use data from rearing on women’s career paths and facilitate re- seven European countries and show that only part- entry into the labor force. Part-time employment time jobs that provide a reasonable level of job pro- and maternity protection and return policies are tection, social benefits and earnings have a positive the most common FWA in the EU since 1980s. Es- effect on female employment. Figure 6.22: Enrollment in ECE is increasing 60% 50% Gross enrollment rate 40% 30% 20% 10% 0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Turkey World Source: United Nations Educational, Scientific and Cultural Organization (UNESCO), Institute for Statistics (www.uis.unesco.org) 198 Chapter 6: Labor: Creating jobs for women and youth Figure 6.23: Few women work part-time, more may want to do so Female part-time employment / female total employment Female part-time employment / total part-time employment 30% 80% 24 24 24 24 70% 25% 23 60% 20% 50% 15% 40% 10 30% 10% 8 6 6 20% 5 5% 10% 0% 0% 1990 1995 2000 2005 2012 TUR OECD TUR (right axis) OECD (right axis) Source: OECD There is room for Turkey to increase female em- maternity and paternity leave has “transformative” ployment via FWAs. The share of part-time em- potential by giving men incentives to take on more ployment among women (8 percent) is quite low care duties, and also changes employers’ views. compared to the OECD average (24 percent) (Figure 6.23). On the other hand, half of part-time work- Social norms and views about women’s work in ers are female. Although this ratio is low compared Turkey could be evolving to facilitate greater fe- to OECD countries, it is higher than the share of male employment. Fernandez (2007) and Fogli and females in total employment, which is around 30 Veldkamp (2008) show how beliefs can change by percent. Hence, part time jobs attract women rela- observation of local peers; first locally and then tively more than men. Consequently, increasing regionally. For example, observing the effects of part-time jobs may increase female employment if maternal employment on children via nearby em- remuneration levels, social benefits and job secu- ployed women, other mothers start participating rity are considered. in the labor force, first locally; and as localities be- come homogenous within themselves but differ- Changing informal institutions and social ent from each other, convergence starts happen- norms ing across regions. Güner and Uysal (2013) make a similar analysis for Turkey, and show that moth- Gender norms and female employment are strongly ers adapt to peers locally, and practices observed interrelated. Culture and norms have a strong effect in the mother get transmitted to the daughter, as in determining households’ investments in skills, measured by labor force engagement.16 Qualitative tasks distribution, but also on the way markets and data for Turkey also shows that compliance with even the state will perceive women. Often gov- traditional gender roles is negatively correlated ernments follow societal norms when drawing up with non-agricultural employment among women policies and implementing them. Less frequently, (Gündüz-Hoşgör and Smits, 2008). Comparative governments take a “transformative” approach and data over time from the World Values Survey show seek to foster change. For example, maternity leave an inconsistent picture, however. Attitudes towards policies can increase women’s prospects of partici- gender equality in the household and in the labor pating in economic activity, but they risk reinforcing market were improving through 2007, but in the the norm that women are the primary household 2012 wave, a moderate reversal can be observed. care providers. Parental leave that guarantees both The same can be observed in the Family Structure 16 Güner and Uysal find that, women who were born in regions with low female employment rate at their time of birth (a proxy for their mothers’ employment) have low female LFP even if they migrate to regions with high female employment. Assuming that employment rates of mothers’ and daughters’ who live in different regions are correlated only due to transmission of cultural norms, they argue that culture plays a significant role in female employment. 199 Turkey’s Transitions Research: between the 2006 and 2011 round of the is sustained. If the additional labor force entrants survey, a slight increase in the percentage of peo- can continue to be matched with good jobs, Turkey ple that thought it was inappropriate for women to will reap a significant demographic dividend start- engage in paid work could be observed, mostly due ing from an unusually high level of income. Most to an increase in this opinion among male respond- other countries with similar demographic profiles ents (MOFSP, 2013). The issue of social norms and are considerably poorer than Turkey, and most oth- how they could be changed to facilitate greater er higher middle income countries are aging con- female employment and gender equality deserves siderably faster. additional research. However, sustained employment creation and a Conclusion maximum demographic dividend are not foregone conclusions. Government policy will need to pro- Turkey’s rapid employment creation post-crisis is vide support as recognized in the National Employ- a remarkable achievement. Government policies, ment Strategy that was recently approved. But the such as targeted payroll tax reductions, an increase key will be to move from strategy to implementa- in ALMPs, and measures to combat informality, tion in a number of critical areas, such as allowing have all combined to encourage formal job cre- greater flexibility in labor market contractual ar- ation. At the same time, Turkey has benefited from rangements, including part-time work, expanding a structural transformation of its labor market, childcare facilities and introducing parental leave with demand for skills increasing at the same time regulations that provide equal incentives for men as new cohorts of better educated young workers, and women. Greater differentiation of minimum including women, entered the labor force. The key wages by region (or targeted regional wage sub- lesson is that government policies were effective sidies) as well as more aggressive increases in the because they supported and enhanced the process retirement age could support current policies to of structural transformation. Labor market policies combat informality, which focuses on beefing up on their own cannot account for the pace of job labor and tax inspections. An improvement in the creation after 2009 – combined with the dynam- business climate will be needed to sustain the cre- ics of Turkey’s enterprise sector and the economic strength of its cities, however, they proved a potent ation of higher productivity jobs once the current combination for job rich growth. forces of structural change and the shift of jobs from agriculture to services runs out of steam. Fi- Against this background, Turkey seems well poised nally, and perhaps most importantly, Turkey will to benefit from its large demographic window. need to continue to invest in upgrading the skills The labor force will continue to grow by around of its workforce to ensure it meets the standards of 2.5 percent each year over the coming decade, as- high income. This is a topic to which we turn in the suming the recent trend in increasing female LFP next Chapter. 200 Chapter 6: Labor: Creating jobs for women and youth References 3iE: Gustavo Angeles, P. G. (2012). The Impact of Elgin, C., & Schneider, F. G. (2013). Shadow Econo- Day Care on Maternal Labor Supply and Child De- mies in OECD Countries: DGE vs. MIMIC Approach- velopment in Mexico. 3iE Series Report. es. Working Papers No: 2013/13. Bogazici Univer- sity Department of Economics. Azevedo, J., & Atamanov, A. (2014). Pathways to the Middle Class. Washington, D.C.: The World Bank. Farré, L. (2013). 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World Bank. 202 7 Chapter 7: Welfare: Achieving better health and education outcomes Chapter Welfare: Achieving better health and education outcomes Infrastructure Finance Fiscal Space Trade Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 203 Turkey’s Transitions 204 Chapter 7: Welfare: Achieving better health and education outcomes Welfare: Achieving better health system that has significantly raised the welfare of the population today, with the promise of hand- and education outcomes some economic rewards in the future. A couple of İ nci and her family migrated to Ankara from Ispar- figures illustrate the magnitude of these improve- ta in 2000. Her husband, with only five years of ments. Figure 7.1 shows the gap between Turkey’s primary education, couldn’t find a formal sector health outcomes and those of the average in the job and worked in the informal sector while İnci, OECD. These gaps have been falling rapidly. At the a high school graduate, stayed at home to look af- same time, the equity of outcomes has also im- ter the kids. In 2004, at the age of 40, İnci had a proved. In 1998, infant mortality in the poorest stroke. Her husband did not want to take care of his quintile of the population was 47 per thousand live wife and two children, Akın and Şirin, and left them births higher than the rate in the richest quintile. without support. Fortunately, İnci’s sister was able By 2008, this difference had declined to 12.2 per to move in to take care of her sister and the kids. thousand. Turkey has also made impressive gains in İnci and her kids were able to get access to health improving access to quality education. Turkey has services through the Green Card Program, ensuring recorded among the largest improvements in edu- that İnci got the drugs she needed, and İnci’s sister cation outcomes among participants in the OECD was eligible to receive social assistance as she was Programme for International Student Assessment taking care of her incapacitated sister full-time. In (PISA) study (Figure 7.2). This average improvement 2006, the family became eligible for the Condition- has gone hand in hand with significant reductions al Cash Transfer (CCT) program and received cash in the inequality of educational achievement, with benefits for Akın and Şirin’s attendance at school. the lowest quintiles of the socio-economic index İnci registered with the Ministry of Health (MoH)’s registering much faster improvements than the homecare system and now receives family doctor better-off. and physiotherapist visits once a week and is vis- ited by a neurologist and psychiatrist every month. The improvement in health and education out- She was also provided a wheelchair. Both of İnci’s comes have been supported by many dynamics children passed the university entrance exam and already explored in this book. Economic transfor- were eligible for a Prime Ministry scholarship. Akın mation and structural changes have significantly recently graduated from the Middle East Technical improved household income for all segments of University and enrolled for a Master’s degree. Şirin society, rapid urbanization has facilitated the more is still studying at the Ankara University, Faculty of efficient and effective delivery of public services Law. and macro-economic stabilization has created fis- cal space for increasing public financing in these The experience of İnci and her family is not unique. sectors. But there have also been several waves of Over the last decade or so, the improvements in ac- policy reform that have sought to improve health cess to and the quality of basic services in Turkey and education systems. These reforms have been have been impressive. Between 1985 and today, the going on for many decades, but accelerated from life expectancy of girls has increased by 13 years, the 1980s onwards. Increasingly the quality and eq- maternal mortality rates have fallen eight times, uity of the provision of public services has become compulsory basic education has been increased from 5 to 12 years, and tertiary education has been a primary objective of reforms, as progress has dramatically expanded. The improvements in edu- been made in closing access gaps. In this Chapter, cation and health outcomes experienced by İnci’s we review these reform processes and their impact family are likely to continue into the next genera- on the welfare outcomes of the Turkish population. tion. But a new problem will be facing the children While many reforms in health and education date of Şirin and Akın: they will live in a country with a back several decades, the Chapter emphasizes im- lot more elderly people. This will require adjust- provements in the equality of access as a particular ments to Turkey’s welfare system as challenging characteristic of the past decade or so. As a result, and far-reaching as those that have brought better it argues, Turkey’s economic model since the turn public services and improved economic opportuni- of the millennium has become more inclusive. But ties to İnci and her family. the Chapter also cautions that new challenges are on the horizon for Turkey’s welfare system, related This chapter chronicles the changes in Turkey’s ba- with Turkey’s demographic transition and the fu- sic public services over the past 20 years. It shows ture prospects of an aging population. how Turkey has progressively narrowed the gap in health and education outcomes with the advanced In the rest of this Chapter, we examine both the Organisation for Economic Co-operation and Devel- context and substance of Turkey’s social service re- opment (OECD) countries and built a social service forms and seek to answer three broad questions. 205 Turkey’s Transitions Figure 7.1: Health: The gap between Turkey and the OECD is shrinking with improved equity 45 40 35 30 Gap with OECD 25 20 15 10 5 0 Mortality rate, infant (per 1,000 live births) Mortality rate, neonatal (per 1,000 live Life expectancy at birth, total (years) births) 1990 2000 2010 50 45 Mortality Rate, Per 1000 Live Births 40 35 30 25 20 15 10 5 0 Gap Between Rural and Urban Gap Between East and West Gap Betweeen Poorest and Richest Quinti le 1998 2008 Source: World Development Indicators (WDI) and Atun el al. (2013) • First, how has Turkey achieved the improve- incentives to ensure that the quality of service ments in overall welfare outcomes? The short provision improved throughout the system and answer is that reforms in public service delivery across the country. In the education sector, as well as significant increases in budget allo- the Basic Education Law increased from 5 to 8 cations have contributed equally. In the health years the mandatory years of schooling in 1997, sector, the Health Transformation Program, recently further extended to 12 years by the launched in 2003, initiated a decade of root 4+4+4 reform. The subsequent Basic Education and branch reform of the health system. Prob- and Secondary Education Programs supported lems of access were comprehensively tackled the construction and refurbishment of a large through supply-side initiatives (to improve the number of schools and classrooms, the provi- quantity and quality of health infrastructure sion of equipment and materials, and lunches and human resources) and demand-side ini- for poor students. There was also a rapid in- tiatives (the creation of universal health insur- crease in salaries, recruitment and training of ance). This was supported by an increased focus additional teachers. As part of the reform, there on improving primary, preventive care and on were a number of initiatives to address regional 206 Chapter 7: Welfare: Achieving better health and education outcomes Figure 7.2: Education: Remarkable improvement in learning, particularly among low performers 80 Gap between Turkey & OECD PISA scores 70 60 50 40 30 20 10 0 Reading Math Science Average 2003 2009 2012 600 500 Average Score (all disciplines) 400 300 200 100 0 1 2 3 4 5 Quintile of Socio-Economic Index 2003 2009 2012 Source: World Bank (WB) staff calculations based on OECD PISA dataset and gender inequalities in access to education. Strategy and the expansion in the supply of Related curriculum reforms and changes to vo- tertiary education will mean that the average cational training further supported improved years of schooling for those entering the work education outcomes. The reforms in both the force will continue to increase (from relatively health and education sectors have led to rapid low levels) for some time to come. But Turkey’s improvements in health and education out- education investments are still relatively low comes for Turkey’s citizens. compared with other middle income countries and the quality gap to the advanced economies • Second, is Turkey taking advantage of its “de- is still large, despite fast improvements. Build- mographic dividend”? The short answer is that ing on the gains over the past decade, further Turkey has increased investments in education initiatives will be needed to increase the quality just in time to ensure future cohorts entering of education at all ages so that those entering the workforce benefit from increased school- the workforce have the skills necessary for a ing. A number of recent initiatives, such as the modern knowledge-based economy. This would 4+4+4, the Early Childhood Education (ECE) include a focus on life-learning to ensure that 207 Turkey’s Transitions people are able to continue to build their skills poor performance on key indicators in absolute and adapt to changing circumstances once they terms was compounded by regional and socioeco- enter the workforce. nomic inequity. Turkey noticeably lagged behind the OECD and other middle-income countries. • Third, how is Turkey preparing for an ageing In 2002, life expectancy at 71.9 years was signifi- population? Turkey is part of a cohort of young cantly lower than the OECD country average of 78.6 countries that will see a tripling of the percent- years and the infant mortality and maternal mor- age of elderly in their population over the com- tality rates were some of the highest among mid- ing 40 years. Improvements in health services dle-income countries (Menon, Mollahaliloğlu, and with a focus on prevention and public health Postolovska, 2013). Health outcomes were mark- have helped rapidly improve life expectancy as edly different between the east and the west of the well as the quality of life in old age. The Gov- country, among the richer and poorer segments of ernment has begun to shift its focus to address- the population, and across rural and urban areas. ing Non-Communicable Diseases (NCDs), which For example, in 1998, under-5 mortality rates were now represent the bulk of the disease burden in 63.3 per 1000 live births in the east and 33.1 in the Turkey. In terms of income security in old-age, west of Turkey (Atun et al., 2013). pension reform through the 2006 Social Secu- rity Institution Law helped rebalance the pen- In 1992, the Government established the Green sion system and improved both equity within Card Program for the Poor. The goal was to provide the system and long-term sustainability. Yet, health benefits to the poor who were not covered looking forward, challenges remain. Demo- through formal means of insurance and who were graphic and epidemiological changes, as well unable to pay for health services. The initial phases as increased demand for new technologies, will of implementation of the program are illustrative exert strong upward cost pressure on the health of the state of public health care provision before sector, threatening sustainability. At the same reform: by 2003, after ten years of implementation, time, although pension reform helped stabilize only 2.5 million people were registered under the deficits in the pension system, these deficits will program, far lower than the potential number of remain long into the future. There is also a need eligible beneficiaries. Moreover, the program was to address old age support for a large number not effective at reaching the poorest—only 12 per- of people currently not covered by the pension cent of the lowest income decile was covered. As system, mostly those who work in Turkey’s large a result, only 66.3 percent of the population was informal sector. covered by health insurance (Atun et al., 2013). Service provision was highly fragmented, with Health and Social Security: five different health insurance schemes including The context in the early 2000s the Sosyal Sigortalar Kurumu (SSK) (covering ac- tive and retired workers from the formal sector), Turkey has undergone successive waves of health Emekli Sandığı (ES) (covering retired civil servants), sector reform over many decades. Starting in the Bağ-Kur (BK) (covering the self-employed), the Ac- 1960s, universal health care became an objective tive Civil Servants Insurance Fund (covering civil in all five-year state plans. The Law on the Socializa- servants in work and their dependents), and the tion of Health adopted in 1961, promoted the es- Green Card scheme (for poor households). Each of tablishment of an integrated health service scheme these schemes had different benefit packages and with a three-tiered health system. The 1982 Con- disparate contractual arrangements with provider stitution went further by providing a state guar- organizations, and there was little coordination antee for citizens’ rights to health insurance and between the MoH and the Ministry of Labor and health services – aimed at accelerating initiatives to Social Security (MoLSS), which were both providers achieve universal health care. This was followed in and financiers of the health system (Menon, Mol- 1987 with the Basic Law on Health to operational- lahaliloglu, and Postolovska, 2013). ize these rights. It was, however, never fully imple- mented. By the 1990s, as successive governments Even for those who were insured, adequate access grappled with political instability, economic shocks, to quality health services was a major challenge. rising unemployment and social discord, reform Turkey suffered from an absolute shortage and in- of the health sector had faded as a policy priority equitable distribution of physical infrastructure and (Atun et al., 2013). health human resources, which created inequali- ties in health service delivery and access. In 1990, By the time the Government launched compre- there were 0.9 physicians per 1000 population. By hensive health sector reform in 2003, Turkey found 2000, this had increased to 1.3 per 1000 popula- itself confronted with a health landscape whose tion, but the gap with the OECD actually increased 208 Chapter 7: Welfare: Achieving better health and education outcomes Figure 7.3: Increases in the health sector human resources 3.0 2.5 No. of physicians per 1000 people 2.0 1.5 1.0 0.5 0.0 Turkey OECD members Upper middle income 1990 2000 Source: WDI over the period (Figure 7.3). Low salaries and inef- are very significant. Given these features of the la- fective performance management established an bor market, the formal social security system has environment of low productivity, leading to poor traditionally not been able to adequately provide use of available capacity. The low levels of health effective social protection. In the absence of mean- staff combined with these low salaries and limited ingful social assistance schemes, many households, incentives created difficulties in attracting and re- especially those in the informal sector, have had no taining health workers in the poorer east. choice but to rely on family ties in risky situations (Buğra and Keyder, 2006). Specialists working in hospitals routinely engaged in private practice in addition to their public duties Prior to the reforms initiated in 2006, the Turkish to augment their income. By 2002, around 89 per- social security system was made up of three sepa- cent of specialists engaged in this “dual practice” rate social security institutions: SSK, for private (Atun et al., 2013). This substantially reduced the and public sector workers; ES, for civil servants; availability of public services for the insured, with and Bağ-Kur, for self-employed workers and farm- many patients diverted to private practice – even ers. Pension entitlements, conditions of eligibility for interventions for which they were entitled. Not to health-care services and the provision of those surprisingly, between 1995 and 2000, out-of-pocket services were defined differently by distinct laws expenditures accounted for 28-30 percent of total for each category of worker: those employed un- health expenditures, almost two times higher than der a service contract; the self-employed; civil ser- the OECD average.1 vants; farmers; and agricultural workers. Complex legislation, heavy bureaucracy, insufficient Infor- Turning to social security, the system in Turkey is mation Technology (IT) infrastructure and person- predominantly based on a social insurance model nel issues prevented the social security institutions and has become both comprehensive in terms of from functioning effectively, making the system dif- coverage (old age, disability, survivor, maternity, ficult to coordinate and to ensure the uniformity of medical and unemployment) as well as relatively norms (ISSA, 2012). generous in the benefits it offers, particularly with regard to old-age benefits. It has, however, only Further exacerbating the situation, Turkey did not been available to those in the formal sector, his- have a poverty benefit – a cash transfer that is torically leaving those in the large informal sector targeted to the vulnerable – which could be used uncovered. This system has coexisted with a labor to help those negatively affected by reforms. So- market structure where self-employment, unpaid cial assistance in Turkey was limited to ad hoc as- family labor, and informal employment practices sistance in kind channeled through the 931 Social 1 Source: WDI. 209 Turkey’s Transitions Assistance and Solidarity Foundations (SYDVs), and function and with each health outcome and de- limited programs for the elderly and disabled under velop solutions to address them. As a result, HTP Law 2022, as well as institutional care for children involved comprehensive and carefully sequenced and the elderly. Turkey had no other cash transfers changes following a two-pronged implementation that could help the vulnerable, unlike many neigh- approach. The first prong emphasized incremen- boring countries of Western and Eastern Europe, tal and tactical changes aimed at rapid and visible which had universal child allowances (World Bank, health sector improvements; the second prong fo- 2001). cused on strategic activities to achieve structural The social security system was plagued by finan- reforms that required major legislative changes. cial difficulties. Revenue was constrained by the These changes were implemented systematically high level of informal employment in the country, over a ten-year period, with a flexible approach de- the under-declaration of earnings used to calculate termined by regular feedback on the receptivity of contributions, and the low level of contribution the health system to the changes being introduced. collections. Expenditure rose primarily because of The design of HTP was informed by emerging evi- a trend towards early retirement, longer duration dence and global experience from countries such of pension payments due to increased life expec- as Belgium, Cuba, Denmark, Estonia, Finland, Mexi- tancy, and a loose link between the level of con- co, Thailand and the UK (Atun et al., 2013). tributions made and actual pensions paid (ISSA, 2012). The pension system had been running defi- As one of its first measures, the HTP focused on cits for more than a decade before the Government expanding access to services for the poor and un- implemented its most significant reforms in 2006. derserved as well as ensuring a significant increase It is estimated that the cumulative value of the defi- in their financial protection. To achieve this, the cits from 1994-2004, plus their debt servicing cost, HTP rapidly increased coverage of the Green Card amounted to roughly 110 percent of Gross Domes- scheme among the poorest deciles and expanded tic Product (GDP) or 1.5 times total public debt the benefit package. In order to address inequities (Verbeken, 2007). The burden of these transfers on and fragmentation, the HTP gradually harmonized an already fragile fiscal balance and the looming benefits across the five different health insurance demographic transition were instrumental in rais- schemes with the aim of moving toward unified ing the importance of social security reform on the general health insurance (Atun et al., 2013). Ad- Government’s agenda (Buğra and Keyder, 2006). ditional targeted support to the poor was also provided. In 2001, the government initiated a CCT The Health Transformation Program program, providing direct cash assistance condi- Recent efforts at reform of the health system in tional on the use of education and health services Turkey emanate from the “Urgent Action Plan,” is- targeted to the poorest 6 percent of the popula- sued by the Government in 2002. As a result, the tion. By 2007, around a million children benefited Government developed the Health Transforma- from the CCT health program and a similar number tion Program (HTP) as a comprehensive strategy of children continue to benefit from the CCT today for achieving universal health coverage. Adopt- (MoFSP, 2014). ing a rights-based philosophy, the HTP set out to At the same time, the government worked on sev- change key health system functions in the areas of eral fronts to improve supply; that is, the overall governance, financing, resource allocation and ser- availability and quality of health infrastructure. A vice delivery in order to develop a patient-centered critical element of this was the introduction of the health system. The HTP sought to address two ma- Family Medicine Program. Focusing on the need jor shortcomings in particular. The first was the low to significantly expand and restructure the prima- level of health expenditures, and the second was ry care system, the Program was piloted in Düzce the inequality and fragmentation of the health in- in 2005 after which it was rolled out nationwide. surance system, which had resulted in the poorest Family medicine providers now deliver “integrat- populations having low levels of coverage and high ed health services” covering a wide range of pri- out-of-pocket expenditures (Menon, Mollahaliloğlu mary care services, with an increasing emphasis and Postolovska, 2013). on prevention of chronic diseases. They have also From the beginning, the HTP enjoyed strong com- assumed the responsibility for conducting vaccina- mitment from the Prime Minister, the Cabinet tions, prenatal care, and infant follow-up, activities and the Minister of Health, which proved critical that were previously conducted primarily by mid- for the implementation and success of the reform wives. This Program was coupled with other signifi- process. The political leadership sought to system- cant investments to increase the quality and avail- atically identify problems along each health system ability of tertiary care infrastructure. 210 Chapter 7: Welfare: Achieving better health and education outcomes Figure 7.4: Investments in medical personnel and infrastructure have led to better coverage 3.0 No. of physicians and hospital bedds 2.5 2.0 per 1000 people 1.5 1.0 0.5 0.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 Physicians per 1000 people Hospital Beds per 1000 people Source: TurkStat Increases in physical capital and human capital also The reforms under the HTP also sought to improve helped. The number of physicians and hospital the experience for patients. The Directive on Pa- beds increased by 33 and 25 percent respectively tients Rights – introduced in 2003 and enacted in between 2003 and 2011. As a result, the number of 2005 –introduced new accountability measures to doctors and beds per capita improved (Figure 7.4).2 enable service users and citizens to directly express A number of policies supported this process at the their views on the quality, responsiveness and avail- same time as addressing the inequitable distribu- ability of health services, including the challenges tion of health staff. First, the HTP sought to greatly encountered, their satisfaction levels and their increase the capacity of universities to train medical expectations. These new mechanisms included di- personnel. The annual intake of medical students rect communication of complaints and suggestions increased from 4,803 in the 2002/2003 to 10,009 in to the MoH Communications Centre (SABİM), the 2012/2013.3 New graduates were required to per- Prime Ministry Communication Centre (BİMER), to form compulsory service in different regions of Tur- Patient Rights Units in public hospitals, and Patient key, in areas of greatest need, particularly the rural Rights Communication Units at primary care level. East and South-East. Second, the HTP introduced As Atun et al. note these new mechanisms helped enhance the accountability of healthcare providers higher salaries and performance-related incentives to citizens – accountability that was all but absent for primary care providers that overall offered the prior to HTP. opportunity to greatly increase take-home pay. Thirdly, the HTP introduced new personnel con- The institutional components of the reform, per- tracts for health staff and allowed outsourcing of haps the most complex and contentious, centered health services with the aim of expanding staff on the Social Security Institution Law and Social availability in regions where recruitment and reten- Security and General Health Insurance Law, which tion was a challenge. Again, these new contracts of- were initiated in 2006 and finally approved in 2008. fered higher salaries and performance related pay. The legislation achieved three important objec- Finally, in 2010, the government introduced a law tives: (i) it merged the fragmented health insur- that required doctors employed in the public sector ance programs into one universal health insurance to work full time and not to engage in private prac- program providing a standard and comprehensive tice. Through these measures, the HTP effectively benefits package with reimbursement for a range addressed both supply constraints and incentive of preventive, diagnostic, and curative services; problems (Atun et al., 2013). (ii) it created the Social Security Institution (SSI) 2 The significant increase in health infrastructure is not fully reflected in the per capita figures shown in Figure 7.4 as the population increased by 11 percent over the same reference period. 3 Source: Student Selection and Placement Center (ÖSYM). 211 Turkey’s Transitions Figure 7.5: Additional public financing for health was key for the reforms 14 SVK Annual Average Compound Growth Rate of Health Expenditure Per Capita 2002-2011 12 TUR KOR 10 EST POL 8 NLD ESP CHL IRL NZL BEL MEX CZE 6 JPN CAN NOR USA HUN GRC DNK FIN AUS CHE LUX SVN DEU 4 GBR PRT AUT SWE ITA FRA ISR 2 R² = 0,4221 ISL 0 0 1,000 2,000 3,000 4,000 5,000 6,000 Health Expenditure Per Capita 2002, PPP (constant 2005 interna tional $) Source: WDI which separated the roles of purchaser and pro- (Memiş, 2013). Global budgeting for MoH facilities vider in the health system, with SSI established as began to be implemented in 2006 in order to con- the purchaser of health services from providers in trol expenditures (Akyürek, 2012). A co-payment the public and private spheres. Which also served scheme for outpatient care in hospitals was initiat- the purpose of creating a unified risk pool to more ed in 2009 and various incentives were introduced effectively share across all income groups the risks to avoid unnecessary visits to specialist tertiary associated with health-care costs and catastrophic care. As a result of improved incentives, internal payments; and (iii) it introduced important para- efficiency also improved. For example, the num- metric reforms to the pension system. These are ber of outpatient visits per doctor in primary care discussed in more detail in the section below. increased from 16 in 2002 to 27.4 in 2010 (WHO, 2012). Many of the reforms described above necessitated additional public financing and, as a result, health Social security reform spending increased rapidly. Per capita health spend- ing increased from US$464 in 2002 to US$1,160 in Since 1990s, a primary objective of social security 2011 in constant (2005) Purchasing Power Parity reforms has been to widen coverage and unify pro- (PPP) terms. This translates into a rate of increase vision under one national scheme for both pensions of 10.7 percent annually – one of the fastest growth and social assistance. At the same time, the need to rates among OECD countries (Figure 7.5). The share make parametric changes to the pension system in of out-of-pocket expenditures as a ratio of GDP order to address fundamental sustainability issues stayed constant, at around 1 percent, much lower came to the fore. A reform passed in 1999 created than the OECD average of 1.7 percent.4 But public a two-pillar system in which current social security health expenditures as a percentage of GDP rose institutions (the first pillar) were maintained after sharply from 3.8 percent to 5 percent. The share of overhauls to their structures, along with private health expenditures in total government expendi- pension schemes (the second pillar) to provide ture rose from 9.1 percent to 12.8 percent. voluntary additional support.5 The 1999 reform in- creased the minimum retirement age in addition While spending increased significantly, there were to the length of service and length of membership also a number of initiatives to contain costs and in- requirements. A gradual rise in minimum retire- crease efficiency in the system. Reference pricing ment age and contribution days was planned (SPO, for pharmaceuticals replaced the cost-plus model 2007). The 1999 law also brought down the accrual in 2004, reducing the price of drugs significantly rate, the benefit an individual accumulates per year 4 Source: WDI 5 The law on private pension schemes was approved in 2001 by the Parliament. 212 Chapter 7: Welfare: Achieving better health and education outcomes Figure 7.6: More efficient contribution collections have raised additional financing 250 Real Premiums and Payments of SGK 200 150 (2003=100) 100 50 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Premiums Pension Payments Health Payments Source: SSI of service. Also, the wage base on which pensions and resulted in a considerably higher growth rate were calculated was extended from average salary of premium collections than pension and health of the last 5 years in the case of SSK to the full ca- payments thereafter (Figure 7.6). Notwithstanding reer average wage. these reforms, the social security system continues to run a sizable structural deficit. However these measures were only partially suc- cessful at reducing the deficit and a more funda- Expansion of Social Assistance mental reform followed in 2008. The Social Security Institution Law and the Social Security and General From 2003 onwards, the Government made Social Health Insurance Law introduced in 2008 made fur- Assistance a consistent priority. Beyond the expan- ther significant strides in overhauling the system. sion of the Green Card Program and establishment The most significant change introduced was the of the CCT program noted above, a large num- gradual increase in the retirement age, which will ber of new programs targeted to the poor were be phased in starting in 2036 to reach age 65 for started. Coal and food were periodically provided both men and women by 2048. The number of days to vulnerable households. A number of education of contributions required to qualify for a pension programs were implemented in order to facilitate was also increased from 7,000 to 7,200 for employ- access to basic education including free textbooks, ees under service contracts. The new law also fur- school lunches and a transport and shelter subsidy. ther reduced the accrual rate. The previous accrual In 2005, following the adoption of the Turkish Dis- rate was one of the highest among OECD countries ability Act, the disability pensions under Law 2022 and it decreased as the length of the working pe- were significantly increased and a new Home Care riod increased, thereby encouraging early retire- Support program for those caring for incapacitated ment and jeopardizing the sustainability of the sys- relatives at home was implemented. Housing pro- tem. The rate was revised to a standard 2 percent grams were implemented in 2006 and 2009. New for each year, providing more incentive for insured pensions for widows and families of soldiers serv- persons to stay longer in the system, thereby help- ing compulsory military service were implemented ing to increase the system’s revenue and reduce its in 2012 and 2013, respectively. Coverage of the expenditure (ISSA, 2012). Turkish population has, therefore, rapidly increased with programs now covering around 35 million In 2011, a series of laws were passed to advance people (although the number of discrete beneficia- the social protection agenda further. The pension ries is much lower). services and the collection of contributions were separated from each other. A restructuring of con- As in other social sectors, this has led to a prodi- tribution debts and a partial contribution amnesty gious increase in spending for social assistance. for debtors to the social insurance system were im- Spending has more than tripled in real terms since plemented by Law No. 6111. Thanks to the amnes- 2003, albeit from very low levels. Spending as a ty, contribution collections increased immediately percentage of GDP has grown from around 0.37 213 Turkey’s Transitions percent in 2003 to 1.26 percent in 2013. Programs Postolovska, 2013). As a result of the expansion of for the disabled have grown particularly rapidly and health insurance, the percentage of households in- now account for 30 percent of all social assistance curring catastrophic health expenditures declined spending, up from negligible levels before 2003. from 1.1 percent in 2003 to 0.6 percent in 2011. Notwithstanding the significant increases in spend- Along with the expansion of coverage, the Green ing and coverage, the value of benefits provided to Card Program also improved its targeting. In 2003, households remains relatively low by international 55 percent of Green Card beneficiaries were in the standards. poorest quintile. By 2011, this had risen to 65 per- cent (Aran and Chakraborty, 2013). Health and social security The improvement of supply in health infrastruc- outcomes ture, the family medicine program and the CCT rapidly improved vaccination outcomes. The CCT Improving the equity of access for a program alone was found to increase the full im- healthier Turkey munization rate for pre-school children in the pro- gram by 13.6 percent (IFPRI, 2007). As of 2012, In 2003, 2.5 million people were covered under the Turkey reached almost full coverage of immuniza- Green Card Program for the Poor. By 2011, the num- tion against diphtheria-pertussis-tetanus (DPT) and ber of beneficiaries had risen to 9.1 million people. measles, catching up and even surpassing the OECD As a result, health insurance coverage for the poor- average (Figure 7.8). est decile increased from 24 percent in 2003 to 85 percent in 2011 (Figure 7.7). The Green Card pro- One of the main objectives of the organizational gram and the increasing coverage of contributory reform was to strengthen local access and bring insurance pushed the share of the total population health services closer geographically to clients. covered by any kind of insurance from 64 percent in Primary care and preventive care services are now 2003 to 90 percent in 2011. Benefits were expand- delivered through family health centers with family ed to cover both outpatient and inpatient services medicine practice doctors and family heath person- at MoH and university hospitals and outpatient nel (mainly nurses and midwives) and community prescription drugs were included in the benefits health centers. The results have been impressive. package. Identification of the poor to be covered In 1993, only 69 percent of births in Turkey were by the state budget was now based on a national attended by skilled staff; by 2008, this figure had system called the “Integrated Social Aid Services increased to 88 percent. The most significant in- System,” managed by a newly established MoFSP. creases in birth attendance by skilled staff were for The system is also used to determine the beneficia- the poorest quintile and in rural/Eeastern regions. ries of scholarships, homecare for the elderly, CCT, For the poorest quintile, the probability of a birth and disabled benefits (Menon, Mollahaliloğlu, and being attended by trained staff increased from 43.1 Figure 7.7: Reforms led to significant gains in coverage for the most vulnerable 100% Share of poorest decile covered by insurance 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2003 2004 2005 2006 2007 2008 2009 2010 2011 Green Card Obligatory Insurance Source: Aran and Chakraborty (2013) 214 Chapter 7: Welfare: Achieving better health and education outcomes Figure 7.8: Turkey performs impressively in immunizing its youngest citizens 100 Immunization Rate (DPT 12 -23 months, Percent) 90 80 70 60 50 40 30 20 10 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Gap T urke y OECD 100 Immunization Rate (Measles 12 -23 months, Percent) 90 80 70 60 50 40 30 20 10 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Gap Turke y OECD Source: WDI percent in 1993 to 70.4 percent in 2008, with much As a result of over a decade of reforms and target- of the progress achieved between 2003 and 2008 ed interventions, Turkey’s citizens and families are (Atun et al., 2013). now far healthier and less vulnerable to catastroph- ic health events and resulting impoverishment than With improvements in access and quality, not sur- they were in the 1990s. A joint assessment con- prisingly, people started using health services con- ducted by the World Health Organisation (WHO), siderably more. The number of primary health care the World Bank, and the Turkish MoH confirmed visits increased more than threefold from around the significant improvements, not only in the scope, 75 million in 2002 to 244 million in 2011, and pa- but also in the depth of coverage – especially for tients’ experience of the system also improved. poor households. Countries seeking to expand uni- Atun et al. note that, between 2003 and 2011, user versal coverage through a health insurance system satisfaction with health services increased signifi- can draw important lessons from the Turkish expe- cantly from 39.5 percent of the population to 75.9 rience (WHO, 2012). The future challenge will be percent. In 2003, the population was least satisfied to continue to address the fiscal vulnerabilities of with the health services compared to any other the social security system, and to ensure Turkey’s public service (including social insurance, educa- sustained progress towards a healthier and more tion, legal and judiciary, and public security). By secure citizenry. 2011, satisfaction increased more than in any other sector and the health sector was ranked second, close behind public security. 215 Turkey’s Transitions Education the poorer East of the country that suffered more from a lack of educational infrastructure. In particu- The context in the late 1990s lar, rural schools had problems with high turnover of teachers, availability of educational materials, Turkey entered the new millennium with an under- school attendance, and educational performance powered labor force in terms of educational attain- (World Bank, 2008). ment. In 1997, almost 75 percent of the total labor force had less than secondary education, as com- The government reform program pared with 29 percent on average in OECD coun- tries. The average years of schooling for the pop- Since 1997, Turkey has pursued an education re- ulation over 15 was estimated as 6 years in 2000, form agenda focused on two objectives: improving much lower than the OECD average of 10 years.6 the quality of education and equalizing the popula- Around 15 percent of the population of 15 and over tion’s access to it. The Government has passed a did not have any schooling. Moreover, there was a series of laws to support the improvement of edu- considerable gender gap in educational attainment; cation outcomes, to make the educational system the average years of schooling for women was 5.1 more efficient, and to increase the participation years and around 25 percent of women did not of girls. These reforms have been accompanied by have any formal education at all. the construction of new schools; the renovation or expansion of existing schools; a massive provision Moreover, enrollment rates did not support signifi- of computers, educational equipment, and edu- cant increases in educational attainment. Although, cational materials; and recurrent spending on the by 1997, almost full enrollment for mandatory edu- remuneration of teachers and other educational cation had been accomplished, education was only staff, as well as new recruitment and additional mandatory for 5 years. The gross enrollment rate staff training (World Bank, 2005). The expansion of dropped to 65 percent in the second stage of pri- primary and secondary schooling has also been ac- mary education (from grade 6-8) and declined fur- companied by the development of new curricula, ther to around 53 percent in secondary education especially since 2004. (from grade 9-11 at the time). Moreover, a signifi- cant gender gap still remained in enrollment, even The first major contemporary education reform in primary education. was the Basic Education Law, passed in August 1997, which extended the period of compulsory Due to macroeconomic instability and high interest basic education from five years to eight years, and payments, Turkey did not have the fiscal space to raised new tax revenues to finance a significant ex- allocate sufficient public resources to education. pansion of the education infrastructure to accom- In 1999, public financing to education was 3 per- modate the expected increase in basic education cent of GDP; low compared to the OECD average enrollments. Enactment of this law was followed of 4.8 percent.7 This fed into a lack of educational by the launch of the Government’s Basic Education inputs. For example, in 1997, the average number Program to support the objectives and provisions of students per teacher in secondary schools in Tur- stipulated by the law. key was 22 compared to an average of 14 in OECD countries. To meet growing education needs, Turkey’s teacher workforce increased by 70 percent between 1997 Exacerbating the situation further were the re- and 2012. The Government achieved this by in- gional disparities in educational resources. The av- creasing salaries, and offering incentives to improve erage number of students per teacher across both teachers’ professional and career development. As primary and secondary education in 1997 was 26.8 a result, teachers’ salaries in Turkey doubled in real However, this varied widely across the country. In terms in the 2000s, one of the highest increases the least developed provinces, mostly in Eastern seen among OECD countries (OECD, 2013a). These Turkey, the number of students per teacher was interventions rendered the teaching profession more than 40. In addition, migration to large cit- more attractive, encouraging a better pool of ap- ies and especially to Istanbul caused the number plicants to apply for teaching positions. Together of students in these cities to increase rapidly, put- with the shift to teacher recruitment based on the ting significant pressure on educational infrastruc- results of a central examination in 2002, this should ture. The student/teacher ratio in Istanbul reached have resulted in an overall increase in teacher qual- 36 in the mid-1990s. However, in general, it was ity, even though data gaps make it difficult to evalu- 6 Estimates by Barro R.J. and Lee J.W. (www.barrolee.com) 7 Source: WDI 8 In the preceding paragraph, we use data on student teacher ratios from WDI in order to draw comparisons with the OECD. Figures for Turkey at primary level are not available in the WDI. In this paragraph, we use data from TurkStat to allow regional comparisons within Turkey. However, data from TurkStat and WDI are not comparable. 216 Chapter 7: Welfare: Achieving better health and education outcomes Figure 7.9: Turkey’s education workforce and infrastructure kept pace with growing education needs 200 180 160 Index 1998=100 140 120 100 80 97/98 98/99 99/00 00/01 01/02 02/03 03/04 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 Academic Year Number of Teachers Number of Classes 33 31 29 Number of Students 27 25 23 21 19 17 15 97/98 98/99 99/00 00/01 01/02 02/03 03/04 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 Academic Year Number of students per teacher Number of students per class Source: TurkStat and MoNE Note: Data covers both primary and secondary levels combined. ate the impact of teacher quality or performance were observed in the number of students per on overall education outcomes. teacher and average class size (Figure 7.9). Efforts were also made to improve the supply of Complementing these efforts, the Government schools and classrooms. Through a combination of launched targeted interventions to further level the Government resources and private contributions, educational playing field for students. The Basic Ed- Ministry of National Education (MoNE) constructed ucation Program was providing free textbooks and 103,983 new basic education classrooms during school meals, and daily bussing for 600,000 stu- 1997-2001, bringing the total stock to 264,776. dents from villages without a school to larger popu- This created additional capacity for more than lation centers offering grades 6 to 8 (World Bank, 3 million basic education students. The Govern- 2002). The shift in the equity of public spending ment launched a massive increase in new boarding that these initiatives produced was quite marked. schools for children in rural areas, renovated hun- Table 7.1 shows that the share of public spend- dreds of rural and central village schools, and reha- ing on education going to the poorest quintile in- bilitated and extended schools in low-income areas creased by 42 percent between 1994 and 2001 and around large cities, known as gecekondus (World that this happened entirely at the expense of the Bank, 2002). As a result, significant improvements richest quintile. 217 Turkey’s Transitions Table 7.1: Targeted spending contributed to leveling the playing field for more students Incidence of public spending on education: Improvements between 1994 and 2001 Household income quintiles (Percent) 1 (poorest) 2 3 4 5 (richest) 1994 Basic Education Spending (8 years) 15.8 21.1 22.2 20.6 20.3 Secondary Education Spending 8.7 16.2 22.3 25.4 27.5 Total Education Spending 13.5 19.5 22.2 22.2 22.7 2001 Basic Education Spending (8 years) 21.7 21.4 21.0 22.0 13.9 Secondary Education Spending 13.0 14.6 25.4 22.8 24.2 Total Education Spending 19.2 19.4 22.3 22.2 16.9 Source: World Bank (2005) As already noted, in 2001, the government launched The new curricula not only changed the content of the CCT program which helped increase enrollment, school education, but also encouraged innovative particularly for girls. By 2011, around 1.9 million chil- teaching methods with an emphasis on student- dren were enrolled in the program (MoFSP, 2012). centered-learning. This provided a more active Econometric results suggest that, after controlling role for students instead of simply memorizing in- for family background, the net primary school atten- formation, which had historically been the primary dance rate increased by 1.3 percentage points for learning method and remains prevalent in practice girls as compared with a control group. Notably, the (OECD, 2013.b). CCT increased net secondary school attendance for girls by 10.7 percentage points (World Bank, 2008). To strengthen completion rates and develop skills A number of other programs to increase girls’ enrol- suitable for the labor market, Turkey has focused ment were also implemented. on improving vocational education and training (VET). Through various projects and programs, the To strengthen secondary education, in 2000, under Government has sought to tighten the link between the auspices of the Eighth Five-Year Development students’ skills and the demands of the job market, Plan and MONE’s Secondary Education Develop- and improve teacher quality and the curriculum. In ment Project, the Government set new targets for 2001, the Government passed a law establishing secondary education: (a) increasing compulsory ed- the Board of Vocational Education at the central ucation from 8 to 12 years (a longer-term goal); (b) level with representatives from government, em- enrolling 95 percent of basic education graduates ployees, employers and other social partners, while in secondary education (which was to start in the a Provincial Board of Vocational Education was also 2001 academic year); and (c) increasing secondary established within each province. In 2002, the Gov- education from 3 to 4 years. MONE also initiated ernment initiated The Project on Strengthening the several related technical reforms, including: (a) Vocational Education and Training System (SVET), a making grade nine a common core general educa- five year project with support from the European tion program for all secondary education students Union (EU), to design new national vocational stan- to ensure all graduates have good basic skills; (b) dards developed in co-operation with the indus- delaying vocational specialization until grade 10; trial sector and other social partners. The creation and (c) reducing the number of vocational subjects of institutional development programs to provide from 130 specialty programs to 30 broad vocational high quality education for school administrators programs. and teachers and a new certification system to en- In 2004, the Government began the process of re- sure quality were also among SVET’s goals (OECD, forming the educational curriculum to change the 2007). The Modernization of Vocational Education focus and content of the whole national curriculum and Training Project (MVET, 2003-2006) included in three phases. After piloting, the first phase was initiatives to improve VET teacher quality, such as implemented nation-wide from September 2005. the introduction of VET teacher competencies; de- The second phase was to develop a new curricu- velopment of modular curricula based on compe- lum for grades 6–8. The third phase was to design a tencies; seminars on student-centered education new curriculum for the new 4-year high school, the and basic skills in selected provinces; and quality ninth grade of which is a common year for general assurance based on the European Network System and vocational high school students (Aksit, 2007). (OECD, 2013b). 218 Chapter 7: Welfare: Achieving better health and education outcomes Figure 7.10: The equity of expenditures - increasing investment in underserved regions Geographical distribution of per capita government investment expenditures in education Source: Ministry of Development Throughout this period, the Government focused US$7 billion project will equip secondary schools on the need to ensure that Turkish students have around the country with smart boards and tablet strong and relevant Information and Communica- PCs. tion Technologies (ICT) skills. It conducted a review of curricula and textbooks in order to put a focus In 2006, the Government announced its aim to on ICT in education (OECD, 2005) and by 2011, all develop a lifelong education strategy to meet the schools in secondary education and 98 percent requirements of a changing and developing econo- of schools in primary education were connected my and labor market. This led to the Higher Educa- to the internet (MONE, 2012). Building on this, in tion Strategy for Turkey (2007), developed by the 2012, the Government launched the pilot phase Higher Education Council (HEC). The strategy iden- of the Movement to Increase Opportunities and tified increased expectations for higher education Technology Project (known as the Fatih Project) in a global, knowledge economy. The national High to integrate state-of-the-art computer technology School Entrance Examination (OKS), taken by thou- into Turkey’s public education system. The planned sands of eighth graders competing for places in the 219 Turkey’s Transitions Figure 7.11: Turkey’s investments in education rapidly increased enrollment rates 80% Net Enrollment Rate (Secondary Educa tion) 70% 60% 50% 40% 30% 20% 10% 0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Gap Total Males Females Source: TurkStat country’s top high schools, was replaced by three shifted markedly from developed Western Regions Level Determination Exams (SBS), which were tak- to underdeveloped Eastern Regions between 2001 en at the end of sixth, seventh and eighth grades. and 2011. Recently, SBS was replaced by separate central ex- aminations in the eighth grade in 6 courses. Education outcomes The extension of mandatory education to 8 years Turkey’s investments in education yielded a sig- required a substantial increase in the education nificant increase in educational coverage. After the budget. As a result, the ratio of the MONE budget enactment of the Basic Education Program, the to the overall government budget increased from net enrollment rate in primary education jumped 9 percent in 1997 to 10.9 percent in 1998 and re- sharply from 85 percent to 95 percent within three mained high in subsequent years. More striking years and almost universal coverage was achieved was the increase in the share of education capital in the education year 2011-2012. More strikingly, investments as the expanding education system re- the gender gap, which was as high as 11 percent quired additional physical infrastructure. The share in 1998 disappeared as of 2012. Turkey was even of education in total public capital investments more successful in expanding secondary education, jumped from 15 percent in 1997 to 37 percent in supported by the success in achieving universal 1998 and remained above 20 percent through 2002 enrollment in primary education. The net second- (World Bank 2004). ary enrollment rate jumped from 38 percent in the 1997-1998 education year to 77 percent in the Public expenditure on education continued to 2013-2014 education year (Figure 7.11). Parallel to grow through the decade. According to Ministry the gains made in primary education, the gender of Finance data, public per capita expenditure on gap fell significantly, although a small gap of 1.2 education increased in real terms by 7.4 percent percent remains as of 2012. Given that secondary annually between 2004 and 2012. As a result, by education became mandatory in 2012, further ex- 2012, Turkey spent almost 80 percent more on edu- pansion in enrollment can be expected in the com- cation per capita in real terms compared to 2004. ing years. The ratio of public education expenditure to GDP continues to follow an upward trend rising from 3 In addition to rapidly expanding education access, percent in 2006 (before which comparable data is Turkey also improved the quality of education sub- not available) to 4 percent in 2012.9 It is also impor- stantially. OECD evaluates education systems world- tant to note that there was an important equity di- wide by testing the skills and knowledge of 15-year- mension to public spending. As Figure 7.10 shows, old students using the PISA. Turkey’s results still lag per capita public capital investment in education the OECD average but, between 2003 and 2012, 9 These figures include expenditures of the central government only. 220 Chapter 7: Welfare: Achieving better health and education outcomes Figure 7.12: Turkey has improved its PISA scores faster than any other participating country 4 TUR TUN POL Annualised Score Change (2003-2012) 3 BRA MEX PRT SRB DEU IRL HKG 2 RUS ITA THA ESPNOR LUX USA LVA MAC JPN 1 IDN DNK GRC AUT CHE KOR CAN HUN NLD 0 FRA BEL LIE ISL AUS -1 CZE NZL FIN URY SVK -2 SWE -3 350 400 450 500 550 600 Average PISA Score in 2003 Source: WB staff calculations based on OECD PISA dataset the gap narrowed significantly, especially in read- Turkey also invested significantly in higher educa- ing (Figure 7.2 in the introduction of this chapter). tion in the last decade. The number of universi- Turkey’s initially low level of PISA scores was one ties increased from 69 in 1997 to 176 in 2014. As factor behind the decline in the gap with the OECD a result, the net enrollment rate in tertiary educa- average as countries with poorer PISA results have tion increased from 10 percent to 35 percent in 15 more scope to improve. However, a comparison of years. Supporting the increase in supply, demand the correlation between initial average PISA scores for tertiary education also increased. Due to in- in 2003 and growth rates reveals that Turkey did creasing enrollment at secondary education level, much better than one would expect based on its graduation rates from secondary school increased initial results. In fact, Turkey has the highest annual from 37 percent in 2000 to 56 percent in 2011. And change in average PISA scores between 2003 and with the expansion in the number of universities 2012 among any participating country and it did the capacity to accommodate this increasing num- better than countries that had poorer results than ber of secondary school graduates has also been Turkey in 2003, such as Brazil, Mexico or Indonesia created. The number of new admissions in tertiary (Figure 7.12). education has more than doubled, increasing from While achieving substantial improvement in aver- 176,000 to 380,000.10 Graduation has followed. age PISA scores, Turkey also managed to reduce the Graduation from tertiary-type A education institu- effect of socioeconomic background on students’ tions11 reached 23 percent in 2011. The gap with success. The variance in mathematics results that the OECD has narrowed, yet remains significant can be explained by the parental socioeconomic (Figure 7.13). But we would expect it to decline background of students fell significantly between further in the coming years as a result of increased 2003 and 2012, and it did so at a faster rate than for demand via the extension of mandatory education almost any other country in the PISA sample (OECD, to 12 years and through increased supply via newly 2013.c). Related to this, PISA scores of students formed universities. Little is known about the qual- from poorer families continued to improve faster ity of university education and complaints by the than the scores of students from richer families. All private sector regarding the relevance of skills of of these results highlight the returns that Turkey new entrants into the labor force have persisted. has reaped from its investments in improving the Nonetheless, returns to education in Turkey remain equity of the education system. high by regional comparison (World Bank, 2013.a). 10 Two year vocational programs after high school are not included in the number of admissions to tertiary programs. 11 According to the OECD, tertiary-type A programs (ISCED 5A) are largely theory-based and are designed to provide sufficient qualifications for entry to advanced research programs and professions with high skill requirements, such as medicine, dentistry or architecture. The graduation rate is calculated as the ratio of number of graduates to the total population in the theoretical age group. 221 Turkey’s Transitions Figure 7.13: Graduating more students into the global economy 90% 83 80% 76 70% 60% 56 Gradua tion Rates 50% 37 39 40% 28 30% 23 20% 9 10% 0% Turkey OECD Turkey OECD Upper Secondary Ter tiary-A 2000 2011 Source: OECD (2013.c) Sustaining momentum – obstacles health sector, and, in turn, on public expenditures, which will necessitate efficiency gains and/or alter- and opportunities native sources of financing to sustain the system (World Bank, 2011). Optimizing health spending and ensuring sustainability As significant progress has been achieved in ad- dressing communicable diseases, NCDs have Turkey still has space for further improvement emerged as the primary public health issue (WHO, in health outcomes. The provision of high quality 2012). It is estimated that around 6.5 million dis- health care is still constrained by a number of fac- ability-adjusted life year (DALYs) a year (disability tors including a deficit of health care personnel. adjusted life years) are currently lost in Turkey due Turkey lags behind the OECD average in the num- to NCDs, which are the cause of mortality in around ber of doctors per capita. In addition, only about 70 percent of all cases. Attributing a DALY value a fifth of the doctors working in Turkey specialize of US$10,000 (the approximate Turkish per capita in primary/generalist family care and this distribu- GDP) implies a current gross total value of life and tion almost certainly limits community-wide access ability foregone of US$65 billion. This represents a to medically prescribed treatments for NCDs linked lost welfare value comparable to 8-10 per cent of risk management and care (Carter et al., 2012). The current GDP (Carter et al., 2012). government has recognized this and, as stated in the 10th National Development Plan, it intends to Although there has been a slight improvement, air increase the number of health personnel and con- pollution is still a severe problem and a major risk tinue to equalize the distribution of health care factor for NCDs. Chronic exposure to particulate professionals throughout the country. While it ex- matter contributes to the risk of developing cardio- pands the supply capacity of the system, however, vascular and respiratory diseases, as well as lung Turkey will need to pay even more attention to cost- cancer. In 2012, air pollution in Ankara and İstanbul effectiveness, as health care demand will increase. exceeded the maximum acceptable limit set by the WHO and air pollution in Turkey is about twice as Several external factors will affect future demand high as the European average. Shifting to clean en- for health services and, thus, health expenditures ergy sources as well as improved mass transit and in the medium- to long-term. While still relatively urban planning, as discussed in the Urbanization young, the Turkish population will age faster than Chapter, will help reduce current levels of air pol- many of its OECD counterparts. The demographic lution. and epidemiological changes implied by this, along- side increased demand for new technologies that Data on another main cause of NCDs, namely obe- will arise from a more economically empowered sity, are not promising either. Obesity among adults population, will exert upward cost pressure on the in Turkey has increased sharply from one in five in 222 Chapter 7: Welfare: Achieving better health and education outcomes 1998 to one in three in 2010, parallel to develop- ertheless, in 2010, 25.4 percent of the population ments in European countries. The rate of obesity was daily smokers, one of the highest rates in the among women, at 40 percent, is particularly alarm- OECD (WHO, 2012). ing (WHO, 2012). There is evidence from other Mediterranean countries that obesity and related In order to reduce the effect of NCDs, more efforts are needed to understand the risk factors behind disease burdens in women impact particularly NCDs in the Turkish context, to monitor trends, in- heavily on less economically and socially advan- crease public awareness and expand early diagno- taged groups and individuals. Problems such as il- sis and access to treatment. literacy are known to be concentrated in the poorer Turkish female community, who may have special Preparing social security for the difficulties in access to health related advice and care in both rural and peri-urban settings. The Turk- demographic transition ish government’s obesity prevention and control Over the last decade or so, Turkey implemented program (MoH, 2010) includes objectives such as two important pension reforms in an attempt to increasing public awareness of the health conse- stem the rise of pension spending and reduce in- quences of obesity and encouraging healthier life- equalities inherent in the old pension system. The styles through media campaigns, school and work- reforms brought retirement ages, contribution pe- place initiatives (Carter et al., 2012). riods, accrual rates and indexation rules closer to international norms and were estimated to achieve Another major risk factor for NCDs is smoking. In significant savings over the long term. While re- the 1980s, 47 percent of the Turkish adult popu- forms slowed the growth, they did not stabilize lation was smoking. As a result, the incidence of pension spending in the short run partly due to the smoking related trachea, bronchus and lung can- slow pace of reform implementation, which will cer increased rapidly from 5 per 100,000 people in only fully play out by 2075. Total pension spend- the 1980s to 20 per 100,000 today (Carter et al., ing has still grown from 4.1 percent of GDP in 2002 2012). There has since been a marked decline in to 7.1 percent of GDP in 2010, more than half of smoking prevalence in Turkey. Government policies which is financed from the state budget. Moreover, to cut smoking have included cigarette advertising as Figure 7.14 shows the system is projected to run restrictions, prohibiting smoking in public places, a deficit of around 3 percent of GDP even into the and increased tax on tobacco. Since 2009, the Law long run. on Tobacco and Tobacco Products has prohibited smoking in all public indoor places and, as a result, Pension system parameters remain more generous exposure to second-hand tobacco smoke has since in Turkey than in other countries even after taking decreased substantially (Carter et al., 2012). Nev- the 1999 and 2006-2008 reforms into account. The Figure 7.14: The case for continued reforms–the pension system is projected to run deficits long into the future 0.0% -0.5% -1.0% -1.5% -2.0% -2.5% -3.0% -3.5% -4.0% 2070 2075 2060 2065 2045 2050 2055 2035 2040 2025 2030 2010 2015 2020 ES, reformed BK, reformed SSK, reformed Source: WB staff Pension Reform Option Simulation Toolkit (PROST) calculations, 2011 223 Turkey’s Transitions Figure 7.15: Turkey has the lowest pensionable age in the OECD 70 Pensionable age in OECD countries, 2010 60 50 40 30 Korea, Rep. Canada Italy Norway Switzerland Japan Hungary Turkey Greece France Iceland Austria Slovakia Belgium Ireland United States Czech Republic Denmark Luxembourg New Zealand Mexico Netherlands Poland Spain Sweden United Kingdom Australia Germany Finland Portugal Men Women Source: OECD (2011) differences can be seen in pensionable ages (the outside of the system, particularly those who have age where people can first draw full benefits), con- been employed in the informal sector. This raises in tribution period requirements, accrual rates and the future both equity concerns, as many may fall the generosity of the minimum pension guarantee. into poverty in old age, as well as fiscal concerns, if Figure 7.15 shows the average pensionable age in non-contributory social assistance programs need Turkey was the lowest among all OECD countries. to expand to provide additional support to the el- In addition, the replacement rate (the ratio of the derly uninsured. Second, according to the OECD, pension to the wage prior to retirement) for a me- despite its comparatively young population, Turkey dian earner in Turkey is well above the OECD aver- already spends 6.8 percent of GDP on public pen- age (OECD, 2011). sions. This expenditure exceeds that of Denmark, the Netherlands, the UK and the United States, de- Despite favorable demographic conditions, Turk- spite the fact that these countries have 2-3 times ish pension system continues to be burdened by a as many citizens over the age of 65 relative to their very high beneficiary to contributor ratio. The past population as Turkey (OECD, 2013.d). When one reforms temporarily arrested the growth of this ra- considers that pension spending per elderly per- tio, but could not reduce or prevent it from grow- son in Turkey already exceeds 100 percent of GDP ing in the long run. Importantly, thanks to widen- per capita, the fiscal implications for Turkey’s de- ing coverage that was also part of the reforms, the mographics present a compelling case for reform proportion of the elderly population with access to (World Bank, 2013.b). pension benefits will double. While undoubtedly positive from the perspective of income protection Options for further increasing contributions in Tur- in old age, this development will apply new fiscal key in order to reduce the fiscal pressure are lim- pressures on the pension system counterbalancing ited given its already high tax wedge. Thus, other the savings achieved by past reforms. parametric reforms will need to be considered. These could include a faster increase in the statu- Despite falling dependency rates overall, Turkey tory retirement age, a change in the application of is already seeing an increasing share of elderly in the minimum contribution period, diversion of the its population.12 The population aged over 65 is minimum and average pension values and imposi- projected to triple by 2050. This raises two relat- tion of actuarially fair reduction of benefits in the ed concerns. First, despite recent increases in the case of early retirement. coverage of pensions, a large and growing number of elderly people (all else being equal) will remain 12 See Chapter 6 for more details. 224 Chapter 7: Welfare: Achieving better health and education outcomes Figure 7.16: Turkey has been closing regional and gender gaps in terms of enrollment in secondary education 100% 90% 80% 70% Enrollment rates 60% 50% 40% 30% 20% 10% 0% Central East Anatolia Aegean East Marmara East Black Sea West Anatolia Mediterrannean South East Anatolia Central Anatolia North East Anatolia West Marmara West Black Sea Istanbul 2007 2013 16% Gender gap in enrollment rates 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% Aegean Central East Anatolia East Marmara East Black Sea West Anatolia Mediterrannean South East Anatolia Central Anatolia North East Anatolia West Marmara Istanbul West Black Sea 2007 2013 Source: TurkStat Improving educational outcomes conducted in 2010, more than 40 percent of Turk- ish citizens would prefer extra government expen- Although public education spending has increased diture on education, compared to a Western Euro- by over one third as a share of GDP since 2006, it pean average closer to 25 percent (EBRD, 2011). is still low by OECD standards and will need to rise This could present an opportunity, and mandate, further. The recent 4+4+4 legislation is expected to for the Government to continue to prioritize public increase the number of students in the secondary spending in this area. What should be the priorities education system. The OECD estimates that this for increased spending? will lead to a rise in the average schooling of the Although universal enrollment in primary education adult population by ona year as of 2030 (OECD, has been achieved, enrollment in secondary educa- 2012). The government is in a favorable position tion only stands at around 70 percent. As a result in the sense that there is strong domestic support of initiatives described in this Chapter, the gap be- in Turkey for increasing investments in education. tween regions in terms of enrollment in secondary According to a joint European Bank for Reconstruc- education has fallen. However, enrollment remains tion and Development (EBRD)-World Bank survey notably low in some, mostly Eastern Regions (Fig- 225 Turkey’s Transitions Figure 7.17: More access to early childhood education is still needed 90% 80% Gross Enrollmemt in ECE (Percent) 70% 60% 50% 40% 30% 20% 10% 0% 1998 2000 2002 2004 2006 2008 2010 Turkey OECD Source: United Nations Educational, Scientific and Cultural Organization (UNESCO) 800 70 700 Children in decile (in thousands) 60 Households (in thousands) 600 50 500 40 400 30 300 20 200 100 10 0 0 1 2 3 4 5 6 7 8 9 10 Per capita expenditure deciles Number of children in decile (Ages 4-6) Number of households where at least one child a ttends kindergarten or preschool Source: WB (2011.b) based on HBS (2003) data ure 7.16). Moreover, despite achievements in re- Results of the latest TIMSS (Trends in International cent years, girls are particularly disadvantaged in Mathematics and Science Study) in 2011 confirm enrollment in these same regions. Going forward, that teacher characteristics play an important role further efforts are needed to improve enrollment in learning outcomes; achievements are higher in the Eastern Regions not only by increasing the for students whose teachers apply more effective supply of education services, but also by promoting teaching strategies and are more satisfied with the attendance of girls. their job. Moreover, the effect of teacher satisfac- tion is more important for poorer students (World Beyond access there is a need to further improve Bank, 2014). As a result, increasing the quality and the quality of education. Teacher characteris- motivation of the teacher workforce is crucial to tics play a vital role in student success. In Turkey, further improve education outcomes. teachers’ job satisfaction is low compared with in- ternational benchmarks, which can translate into Expanding ECE should be a top priority in the com- negative behaviors that affect student learning. ing years. The literature on the economics of edu- 226 Chapter 7: Welfare: Achieving better health and education outcomes cation highlights that ECE has the highest rate of Conclusion return among all levels of education (Carnerio and Heckman, 2003). According to PISA data in 2012, at- Turkey’s reforms in the health and education sec- tending preschool education increases PISA scores tors over the last decades have led to an impressive by 15 points in OECD countries and 25 points in Tur- overall improvement in the welfare of its popula- key after controlling for family socioeconomic sta- tion, underpinned by increased spending, but un- doubtedly accompanied by important policy ini- tus effects (OECD, 2013.d). Despite improvements tiatives. In many cases, improvements have been in recent years, enrollment in preschool education rapid and are happening at a pace faster than in is still very low by international standards (Figure many of Turkey’s peers. There is much that other 7.17). Importantly, and perhaps not surprisingly, countries could learn from Turkey. In the health children from richer families currently benefit far sector, Turkey’s long-term and carefully sequenced more from ECE meaning that policies that promote HTP offers important lessons in achieving universal widespread access to ECE will not only improve health coverage. Turkey’s experience with address- education outcomes in general but will also help to ing inequalities in service delivery by using financ- further improve equity. ing and incentives is also particularly relevant. Finally, given the long time horizon needed for edu- The agenda going forward is framed by Turkey’s cation reforms to pay benefits, the need for a stra- demographic transition. The demographic changes tegic vision for the sector and a steady course re- that took 100 years in developed countries will take main paramount. Several of the education reforms place in Turkey in only 30 (Apakan, 2012).13 Accord- launched over the past 15 years need to be sus- ing to current demographic trends, Turkey’s elderly population will double by 2032 and triple by 2045. tained to realize their full impact. Education reform This ageing population presents a challenge for Tur- has been a topic of hot debate in Turkey over many key in terms of both health and social protection. decades and this has led to frequent course correc- The ageing population and the shift in the burden tions. But these are not costless. Some of the re- of disease to NCDs will put rapidly increasing pres- cent measures, such as an extension of the manda- sure on the health system. At the same time, this tory period of schooling, were a natural extension ageing population necessitates further thinking of of the system and perhaps long overdue. Others, how to support the income of the elderly without such as the reintroduction of early streaming and pension coverage, as the evolving family structure frequent changes to the secondary school exami- in Turkey, shaped by urbanization and employment nation system appear to do little to either reduce trends will mean that the extended family can no the still high level of socio-economic segregation in longer be relied upon to be the sole provider of the education system or address fundamental is- support. sues of education quality. Instead, the reform focus The demographic transition also has implications of the early 2000s should be sustained, with atten- for Turkey’s youth. Turkey has the youngest popula- tion to a modern curriculum and interactive class- tion in Europe (by median age). By 2020, Turkey’s room teaching practices, teacher training and ca- population is projected to overtake Germany’s to reer management, quality assurance mechanisms become the largest population in Western Europe. and reforms of school financing and management This presents an opportunity for Turkey’s young practices to strengthen accountability. Indeed, the labor force, but one that they will only be able to improvements recorded to date in student learning seize if they are well educated and equipped with outcomes argue for consistency and continuity in the skills that the labor markets need. Turkey’s lon- ger term prosperity necessitates investments in im- the direction of education reforms. proving the quality and access of the educational system from early childhood education all the way to life-long learning in order to ensure that a large workforce is also a productive one. 13 www.cfr.org/content/publications/Apakan-Intro-and-Comments.pdf 227 Turkey’s Transitions References Aksit, N. (2007). Educational Reform in Turkey. in- MOFSP. (2012). Sosyal Yardimlar Genel Mudurlugu ternational Journal of Educational Development, Faaliyet Raporu (Annual Report if DG of Social As- 27(2), 129-137. sistance). Ministry of Family and Social Assistance. Akyürek, C. (2012). Sağlıkta bir geri ödeme yöntemi MONE. (n.d.). 2011 Yili Faaliyet Raporu (Annual Re- olarak Global Bütçe ve Türkiye (Global Budget as a port, 2011). Ministry of National Education. reimbursement method in health and Turkey). So- OECD. (2005). 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World Bank. 229 Turkey’s Transitions 230 3 Spotlight 3: Fiscal stabilization and the move to rule based public finance management Spotlight Fiscal stabilization and the move to rule based public finance management Finance Fiscal Space Infrastructure Trade Welfare Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 231 Turkey’s Transitions 232 Spotlight 3: Fiscal stabilization and the move to rule based public finance management Fiscal Stabilization and The Move the backbone of growing access as documented in Chapter 7. Third, we argue that reforms of Turkey’s to Rule Based Public Finance public financial management institutions were criti- Management cal in supporting fiscal stabilization and making it sustainable. Finally, we look at some of the unre- “Fiscal discipline was the cornerstone of our solved challenges in public financial management. economic program. … Political stability, structural The authorities’ proclivity to create greater room reforms, coupled with the prudent fiscal and for government discretion to handle possible po- monetary policy have paved the way for litical opposition echoes some of the tendencies of uninterrupted growth periods of 27 quarters up to the 1980s. Turkey’s own experience, thus, arguably the last quarter of 2008.”1 holds lessons for Turkey’s policy makers today. The Ali Babacan consolidation of institutional changes is a long-term process and requires continued effort and commit- C ment. This is a lesson for Turkey, as well as many urrency crises typically come in two variet- other middle income countries. ies. “First generation” types – so-named be- cause they tended to prevail until the end The public sector origins of the of the 20th century – are driven by an underlying public sector imbalance, which is funded by print- 2001 crisis ing money, leading to the build-up of inflationary Poor public finance management was at the heart pressures and, ultimately, the collapse of money of growing imbalances in the 1990s. Created in the demand and the currency. “Second generation” 1980s to give the government greater discretion in crises follow a sudden shift in private sector port- the pursuit of its export oriented policies, the prolif- folio allocations out of domestic assets. This may eration of extra-budgetary funds and the financing be triggered by political events, concerns over gov- of their deficits through state-owned banks led to ernance or changes in international risk appetite. the progressive loss of fiscal control (Figure S3.1). The Asian financial crisis in the late 1990s is a good Interest rate subsidies to Small and Medium Enter- example of the second type, as private rather than prises (SMEs) and agricultural enterprises led to the public imbalances were at the root of the sharp cur- accumulation of so-called “duty losses”, annually rency depreciations. compounded and reflected nominally in the bal- ance sheet as perpetual claims on the government. Turkey’s financial history abounds with first genera- This recourse to quasi-fiscal financing directly un- tion type crises, most prominently the cataclysm dermined financial sector stability. When interest of 2001. Driven by the politics of patronage and rates shot up in the late 1990s, the value of govern- rent-seeking, governments struggled to keep pub- ment bonds held by the state banks to compensate lic spending under control and Turkey repeatedly for these duty-losses plummeted and the necessary went through the cycle of government stimulus, recapitalization of the banking sector contributed rising inflation, pressures on money demand and to the doubling of Turkey’s public debt stock to 95 the currency and, ultimately, the need to introduce percent of Gross Domestic Product (GDP) by 2001 a stabilization package to reassure Turkey’s foreign (Figure S3.2; see also Chapter 3). creditors and stop the fall of the currency. After 2001, this cycle stopped. As the above quote from Little progress was made in addressing the structur- Deputy Prime Minister Ali Babacan makes clear, a al causes of public sector deficits in banking, ener- policy shift occurred as a result of the deep eco- gy, agriculture, and pension system. In the banking nomic, financial and political crisis at the turn of the sector, commercial banks, both state and privately millennium and the risk of a first generation type owned, borrowed abroad to purchase government crisis has been effectively banished in Turkey today. securities and on-lend funds locally, often to relat- ed parties. Large open foreign exchange positions This Spotlight reviews Turkey’s experience with fis- were allowed to build, while the authorities turned cal stabilization and the transition to rule-based a blind eye to connected lending practices. In the public finance management after 2001. First, we power sector, lucrative build-operate-transfer con- chronicle the fiscal origins of the 2001 crisis and the tracts were awarded without open bidding. Long- authorities’ response. Second, we show how the term take-or-pay contracts committed state-owned fiscal space resulting from successful stabilization distribution companies to purchase power at high was used to expand welfare spending, particularly tariffs from private generation facilities, while do- in health but also in education and, thus, forms mestic final user tariffs often failed to cover the 1 Speech at the London School of Economics, August 27, 2009. Available at: www.lse.ac.uk/publicEvents/events/2009/20090827t1705z001.aspx 233 Turkey’s Transitions Figure S3.1: The unravelling of fiscal discipline between 1990-2001 Consolidated public sector borrowing requirement (PSBR) in percent of GDP 30% Hidden Fiscal Cost of State Banks 25% Increased PSBR 20% Percent of GDP Stabilization Package 15% 10% 5% 0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 PSBR Total Interest Payments (percent of GDP) Source: Undersecretariat of Treasury, World Bank (WB) staff calculations Note: The red bars refer to currency crises years Figure S3.2: The consequence of fiscal profligacy: rising public debt 100% 93.9 90% 80% Net public debt, Percent of GNP 70% 61.0 58.3 60% 50% 44.7 46.5 42.9 43.7 41.3 40% 30% 20% 10% 0% 1994 1995 1996 1997 1998 1999 2000 2001 Source: WB Turkey Country Economic Memorandum, 2000 and 2003 Note: Net public debt includes Government securities issued to recapitalize the Savings Deposit Insurance Fund (SDIF) and state Banks. The new GDP series of TurkStat does not extend back to 1994. Hence, the old Gross National Product (GNP) series is used as the denominator. costs. Large subsidies were also channeled through The public expenditure management system was the state banks to agricultural SOEs. In the area of failing in three key areas. First, aggregate fiscal social security, a generous pension reform intro- management was compromised by the significant duced in 1993 which lowered the effective retire- growth of off-budget activities, particularly quasi- ment age in Turkey to less than 50 and left a large fiscal operations, as explained above. There was a hole in the system. These structural deficiencies major discrepancy between the official and actual are discussed in greater detail elsewhere (Chapter fiscal stance and lack of budget comprehensive- 1, Chapter 3, Chapter 7). ness and transparency meant that the framework 234 Spotlight 3: Fiscal stabilization and the move to rule based public finance management was effectively failing to exercise fiscal discipline. World Bank adjustment policy loans as well as the Second, strategic decision making was neglected government’s strong commitment to reaching the and policies and plans were not linked to budgets. European Union (EU) standards anchored reform This was a legacy of the tendency in the 1980s to efforts. circumvent parliamentary control through the cre- ation of discretionary off-budget spending vehicles At the core of the fiscal adjustment was a commit- ment to persistent primary fiscal surpluses. The to finance priority projects, but these increasingly public sector primary surplus targets defined in the developed their own dynamics undermining stra- IMF Stand-by Arrangements played a critical role as tegic relevance and coordination (Atiyas, 2012). a kind of proxy for a fiscal rule. As reflected in Fig- Third, in spite of stringent controls over budget ure S3.3, the cumulative fiscal adjustment was over execution, the government failed to prevent waste 30 percent of GDP with an average primary surplus and inefficiencies. Extremely rigid and compliance of 4.4 percent of GDP between 2001-2007. Primary based financial controls, ex-ante approval functions surpluses were much lower after 2008 in part not of the central government with no delegation of only because of the impact of the 2009 global fi- authority to the line agencies, non-transparent pro- nancial crisis and the sharp decline in GDP Turkey curement systems, and lack of an effective account- experienced in its wake, but also because of grow- ability framework meant that effort was directed at ing rigidities in Turkey’s spending commitments to circumventing ineffective rules and exploiting the which we come back below. Still, with a public debt rents from their inconsistent implementation. to GDP ratio comfortably below 40 percent, Tur- key’s current fiscal stance presents no risk to hard- Starting in the late 1990s, the authorities progres- earned fiscal stability. sively addressed the structural origins of the public sector imbalances. Initial efforts (with International Turkey’s fiscal stabilization, thus, has had lasting Monetary Fund (IMF) support) had limited success, positive effects and can serve as an inspiration for in part because of inconsistent exchange rate and other countries facing the difficult task to reign in financial policies, but after 2001, a series of mac- after years of weak discipline. In reviewing 32 case ro-economic and structural adjustment programs studies of positive reform experiences to guide finally achieved lasting fiscal stabilization. Address- Europe as it works to restore the luster of its eco- ing citizen demand for better service delivery was nomic model, Gill and Raiser (2012) select Turkey as at the core of these programs designed around a case study in fiscal stabilization. Figure S3.4 con- fiscal adjustment, financial stabilization, disinfla- firms that Turkey sustained one of the strongest fis- tion, and structural and institutional public sector cal performances among any of its peers through- reforms. A series of IMF Stand-By Arrangements, out the crisis years and subsequent recovery. Figure S3.3: The fiscal stabilization effort Public sector primary balance (program definition), percent of GDP 6% 5.4 5.2 5% 4.8 4.5 4.3 4% 3.4 3.1 3% Percent of GDP 1.9 1.9 2% 1.6 0.8 0.8 0.9 1% 0% -1% -1.1 -2% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Ministry of Development 235 Turkey’s Transitions Figure S3.4: Turkey maintained fiscal discipline during the 2008-2009 crisis and beyond 50 GRC GBR Change in general government gross debt 40 (2007 - 2010), Percentage points USA 30 PRT ESP JPN ROM FRA CAN 20 ITA CHN CZE DEU POL ZAF 10 KOR MEX RUS BRA 0 TUR IDN IND -10 ARG -20 -30 -2 0 2 4 6 8 10 12 14 Change in general government budget deficit (2007 - 2010), Percentage points 250 JPN General government gross debt 2012, Percent 200 GRC 150 ITA PRT of GDP 100 CAN FRA USA ESP DEU BRA GBRIND ARG 50 KOR TUR ROMPOL CHN ZAF RUS MEXCZE 0 IDN -4 -2 0 2 4 6 8 10 12 General government budget deficit 2012, Percent of GDP Source: IMF, World Economic Outlook Database Fiscal stabilization, fiscal space and In addition to the reduction in interest payments, increased revenues from a growing tax base con- improved public services tributed to fiscal adjustment. Total government rev- enues increased by around 6.7 percentage points Primary surpluses combined with falling interest of GDP between 2002 and 2012, with a rise in con- rates and the impact of economic recovery cut tributions to social funds accounting for around Turkey’s public sector debt in half between 2002 four fifths of this increase. The creation of 6.3 mil- and 2007 (Table S3.1). Interest payments declined lion formal sector jobs during the 2002-2012 period from 11.3 percent of GDP in 2002 to 2.1 percent drove the increase in social security contributions, in 2007 and 0.1 percent in 2012. This progressively while a shift in the structure of taxation towards in- diminished the need for large primary surpluses to direct taxes (in particular an increase in excise du- generate debt reduction and created fiscal space to ties on fuel, alcohol and tobacco, as well as some fund new government priorities. luxury import good items) boosted tax revenues by 236 Spotlight 3: Fiscal stabilization and the move to rule based public finance management Table S3.1: Decomposition of change in debt stock (Percent of GDP) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 General Government 74.0 67.7 59.6 52.7 46.5 39.9 40.0 46.1 42.3 39.1 36.1 Debt Stock (EU Definition) Change in debt stock -3.9 -6.3 -8.1 -6.9 -6.2 -6.6 0.1 6.1 -3.7 -3.2 -3.1 (percentage points) Interest payments 11.3 6.1 6.1 2.4 2.6 2.1 2.3 1.4 0.5 0.3 0.1 Growth Effect -4.5 -3.7 -5.8 -4.6 -3.4 -2.1 -0.3 2.0 -3.9 -3.4 -0.9 Primary Balance (Excluding privatization -4.4 -5.3 -6.0 -6.5 -5.9 -4.3 -2.9 0.2 -1.2 -2.7 -2.1 revenues) Privatization revenues -0.1 -0.1 -0.3 -0.6 -1.6 -1.4 -0.9 -0.5 -0.4 -0.3 -0.5 Revaluation effect -1.1 -0.1 -0.1 -0.1 0.1 -0.2 -0.1 -0.7 -0.1 0.1 0.3 Other -5.2 -3.2 -2.1 2.5 2.0 -0.8 1.9 3.6 1.3 2.8 0.0 Source: Ministry of Development Note: (-) sign represents reduction in debt stock around 2.4 percentage points of GDP over the same ernment agencies. The use of fiscal space to fund period.2 the expansion of welfare and the improvement in public services is at the heart of Turkey’s progress in The resulting fiscal space made room for a rap- social inclusion documented in Chapter 7. Howev- id increase in non-interest central government er, it is also creating some spending rigidities which spending. The bulk of this increase has gone to will need to be carefully managed should revenue social spending, enabling the expansion of health growth slow with a shift towards more moderate care and social security coverage (Figure S3.5). In growth in the economy overall. Investment spend- addition, there has also been significant growth ing has increased but only modestly with private in spending on personnel, driven in part by the sector investment in infrastructure accounting for growth in the number of teachers, but also the ex- a substantial share of improvements in transport, pansion of administrative personnel in central gov- telecoms, and power services (Spotlight 2). Figure S3.5: The use of fiscal space in Turkey 2000 2013 Other 13% Other Personnel 21% Invest. Personnel 6% 24% 28% Social 13% Invest. 13% Interest 12% Interest 44% Social 26% Source: Ministry of Finance 2 The large informal economy and the cost of collecting direct taxes have influenced the shift of tax revenues towards indirect taxes as pointed out by M. Üngör (2014). 237 Turkey’s Transitions Improved public financial port policies to the budget, although as a result of high external tariff barriers and some remain- management institutions and the ing government support schemes, Turkey’s ag- sustainability of fiscal stabilization gregate support level is still among the highest in the Organisation for Economic Co-operation Fiscal stabilization was sustained because the post- and Development (OECD) (around 2.1 percent 2001 policy framework included measures that of GDP).4 went to the heart of public sector governance. Previous stabilization attempts were characterized • Fourth, contingent liabilities resulting from by a sequence of initial fiscal retrenchment, fol- a variety of public private partnership (PPP) lowed by renewed expansion often in the context contracts, particularly in the energy sector, of pre-election hand-outs. The post-2001 approach were reduced through deregulation and tariff instead introduced rule-based governance. Fiscal reform and future fiscal commitments better gains resulted from reforms in five areas in particu- controlled through the issuance of transparent lar. guidelines for financial and project guarantees under the new Public Debt Management Law. • First, in 2003 and again in 2008, the authori- While the legacy of poorly designed privatiza- ties moved to contain the deficit of the Social tion contracts in the energy sector took well Security Institution through institutional and over a decade to overcome, Turkey, during the parametric reform of the social security system. 2000s achieved a significant increase in genera- While the deficit has not been eliminated, bal- tion capacity including from renewable sources, looning contingent liabilities have been avoided. thanks largely to private investment in a more transparent regulatory environment. In the con- • Second, the state withdrew from direct involve- clusion we return to the lessons from this expe- ment in productive activities by re-launching rience for the new generation of PPP contracts the restructuring and privatization of SOEs. and the importance of adhering to sound regu- While this process had started in the 1980s, it latory frameworks. had initially proceeded in a haphazard way. The Privatization Law of 1994 introduced a unified • Fifth, measures to contain spending commit- framework and allowed the government to re- ments were supported on the revenue side double privatization efforts, including the par- through tax policy changes and a substantial tial sale of flagship assets such as Turk Telekom, strengthening of revenue administration. A Turkish Airlines and Halk Bankasi. At the same medium-term tax reform strategy was put in time, employment in existing SOEs was sharp- place to improve the stability, transparency and ly reduced from 420,000 in 2001 to around equity of the tax system. The taxation of corpo- 130,000 in 2013.3 The total SOE payroll declined rate income and income from financial invest- from around 2.5 percent of GDP to less than 1 ments was simplified and the corporate income percent over the same period. tax rate reduced from 30 to 20 percent. While Turkey has continued to use income tax credit • Third, agricultural support policies and subsi- extensively as part of various investment in- dies to SMEs were overhauled to eliminate one centive schemes, the system has become more source of fiscal risk. Under the Agricultural Re- transparent and rule based. On the tax admin- form Implementation Project (2001-2008), the istration side, the Revenue Administration was government moved to a more market oriented made semi-autonomous in 2005 and has since agricultural policy. This included the abolition of made efforts to ease compliance costs. In the administered output prices and the elimination global paying taxes index produced by Price- of most input subsidies, including subsidized waterhouseCoopers (PwC) for the World Bank credit; the restructuring of agricultural SOEs Group, Turkey ranked 71 in 2014, and improved and the Agricultural Sales Cooperatives Unions; its distance to frontier to 23 percentage points and the introduction of direct income support in 2014 from 32 points in 2006.5 decoupled from production levels. This signifi- cantly reduced the burden of agricultural sup- 3 According to the Undersecretariat of Treasury Public Enterprises General Directorate statistics available at www.hazine.gov.tr 4 OECD estimates of total support in 2012 were 0.5 percent of GDP in Brazil, 0.8 percent in Russian Federation, and 0.9 percent on average for all OECD members. Only China and Indonesia have higher support levels than Turkey among the sample covered. 5 Turkey is ranked 5th in the comparator group used throughout this study, after South Africa and the Republic of Korea (with a distance to the frontier of 14 percentage points), and Malaysia and Croatia (with a distance of 18 percentage points). Turkey ranks above almost all new EU Member States and all BRICs. 238 Spotlight 3: Fiscal stabilization and the move to rule based public finance management Figure S3.6: The three pillars of public finance management reforms in Turkey post-2001 STRATEGIC MACRO FISCAL OPERATIONAL ALLOCATION of DISCIPLINE RESOURCES ALLOCATION 2006 2006 2006 2000 2002 2001 Abolishment of extr R tion li tion of public En ctment of New Public bud et r funds investment pro r m le din Procurement L w R tion li tion of revolvin funds to si nific nt decline in Est blishment of Public Le isl tion on Preventin completion r tes Procurement Authorit Accumul tion of Dut Losses in St te B nks (for A ricultur l SOEs) 2006 2003 2006 2003 En ctment of Public Fin nce M n ement nd Control 2006 2001 Independence of Centr l B nk (PFMC L w) En ctment of PFMC L w Restructurin of public b nks 2006 2004 Introductuon of New 2006 2002 Public Fin nce nd Debt Metropolit n 2006 M n ement L w Municip lit L w New Corpor te Income T x nd Est blishment of Intern l 2006 Person l Income T x Le isl tion 2005 Amendment of Audit Units L w on Municip lities 2006 2003 Moderni ed debt m n ement s stem nd sep r te risk 2006 ccount est blished in Tre sur 2006 2010 New Bud et cl ssific tion in Line with GFS st nd rds 2006 Submission of Soci l Securit En ctment of New TCA L w nd Univers l He lth Insur nce Est blishment of Str te L w Development Units in ll Line A encies Introduction of Medium Term Expenditure Fr mework Introduction of Indic tive Institution l Ceilin s 2006 2008 Reform of Inter-Government l Fisc l Tr nsfers Source: WB staff At the heart of the new approach to fiscal policy system in Turkey. The Law addressed a number of and public finance management was the 2001 Stra- weaknesses that had undermined fiscal discipline tegic Framework for Public Expenditure Manage- prior to 2001. First, it incorporated a comprehen- ment Reform. The framework contained three pil- sive definition of public revenues and expenditures lars: i) macro-fiscal discipline, ii) strategic allocation and introduced a definition of the general govern- of resources, and iii) operational efficiency. Figure ment. This overcame the fragmentation and lack S3.6 chronicles public sector reforms introduced of transparency of the previous system. Second, it after 2000 in each of these three priority areas. In provided the Ministry of Finance with clear legal what follows, we highlight only the most important authority to issue budget classification, accounting steps. and reporting standards for all government agen- cies again increasing budget transparency. Third, The enactment of a new Public Financial Manage- it introduced strategic planning and performance ment and Control Law (2003) formed the corner- budgeting to strengthen the linkages between stone of the new public financial management government policies and resource allocation and 239 Turkey’s Transitions increase the efficiency of public spending, and 2002 modelled after EU standards and subsequent mandated the government to prepare three-year steps to align the framework with the EU Acquis rolling budgets to drive strategic resource alloca- helped to address earlier shortcomings. Second, tion. Fourth, the Law provided a clear definition of in 2007, internal control and internal audit func- the accountability of ministers and heads of public tions were introduced and the public accounting administrations. Fifth, it delegated financial control framework modified to an accrual based chart of and internal audit responsibilities to public agen- accounts. This strengthened the basis for ex post cies, thereby overcoming the problems associated monitoring of line agency spending and commit- with excessive and centralized compliance based ments, although there remain significant needs controls, which, in turn, had motivated the pro- to improve line agency capacity to effectively dis- liferation of off-budget vehicles as a means to get charge their internal audit responsibilities. Third, as anything done. Sixth, it strengthened government a further step to strengthen accountability a new accountability by extending the scope and mandate TCA Law was enacted in 2010. The new TCA Law in- of external audit to cover all government agencies troduces performance and financial audit require- as well as SOEs. ments in addition to the traditional compliance based external audit system. Transition to the new The consolidation of fiscal reporting and the ra- external audit requirements has been challenging, tionalization of medium-term fiscal planning were however, because of the need to build capacity critical in asserting the government’s overall fiscal for financial and performance audits in the TCA, control. The authorities proceeded in several steps. to introduce necessary accounting systems in cen- Most extra-budgetary funds were abolished to- tral government agencies, and to create the space gether with the system of earmarked revenues and in Parliament for a substantial discussion of audit revolving funds, which had allowed line agencies findings in the budget and finance committee. to retain, own revenues for discretionary spend- ing (such as bonus payments to employees).6 Ad- Turkey’s public debt and liability management to- ditionally, as early as 2001, a comprehensive public day is recognized among best practice examples investment review was undertaken by the State among emerging markets. The Law on Regulating Planning Organization to rationalize the public in- Public Finance and Debt Management enacted in vestment portfolio. As a result, the average comple- 2002 created sound foundations for more efficient tion period of the public investment program was asset and liability management. With this legisla- reduced from over 10 years in 1999 to 4.6 years tion, the scope and objectives of public debt man- in 2010. Subsequently, in 2006, a functional bud- agement were defined and the Undersecretariat get classification consistent with the IMF’s Manual of Treasury became the single borrowing authority on Government Financial Statistics was introduced for the central government. In addition, an efficient together with medium-term fiscal planning based framework was set up for decision making on and on a three year rolling macroeconomic framework. monitoring of Treasury guarantees and receivables, This established institutional expenditure ceilings borrowing and cash management. for government line agencies upstream in the bud- get preparation process and constituted a first step The improvement in the Undersecretariat of Trea- in a transition towards performance based bud- sury’s risk management capacity is particularly geting and greater spending autonomy at the line noteworthy. A “Debt and Risk Management Com- agency level. mittee” was established within the Undersecretar- iat of Treasury, as a new high-level body to formu- The new institutional framework in the public sec- late debt management strategy and policies. As a tor also involved changes in the system of account- result of these efforts, the exposure of the central ability. The Public Finance Management and Con- government debt stock to exchange rate, interest trol (PFMC) Law of 2003 involved a fundamental rate and liquidity risks was significantly reduced. A shift from ex-ante controls to ex-post monitoring. middle office was also created, and new risk mea- This shift built on three interrelated reform efforts. surement techniques were introduced, including First, the government had to tighten the regulatory for the assessment and management of contingent framework for discretionary public spending, in- liabilities. Thus, annual limits on Treasury guaran- cluding revamping the public procurement system. tees were introduced within the Annual Budget Prior to 2003, public procurement was discrimina- Law. Undersecretariat of Treasury charges a fee tory, non-transparent and riddled with exclusions up to 1 percent of the total guaranteed amount and varying qualification requirements. The enact- depending on the underlying credit risk. A partial ment of the Public Procurement Law which was in guarantee mechanism was also introduced to limit 6 Social Solidarity Fund, Promotion and Publicity Fund, Saving Deposit Insurance Fund, Defense Fund and Privatization Fund were excluded from the legislation abolishing all other EBFs passed in 2000 and 2001. 240 Spotlight 3: Fiscal stabilization and the move to rule based public finance management risk, while reserves to redeem potential liabilities in however, plans and budgets are linked only in gen- case a guarantee is called have been accumulated eral terms and the requirement for performance in a special risk account since 2003. Recently, Trea- based budgeting introduced by the PFMC Law re- sury has introduced debt assumption guarantees mains to be fully implemented. The Ministry of Fi- to support big infrastructure projects managed by nance has been working on a new program budget central government institutions under PPPs. De- classification with the purpose of strengthening the spite these improvements, the management of implementation of performance based budgets. contingent liabilities remains a challenge, particu- In addition, the credibility of the medium-term larly with respect to refinancing risk and demand fiscal program has been undermined by a combi- guarantees or other obligations provided by gov- nation of conservative revenue projections and ernment agencies and SOEs to private concession- significant spending increases beyond the levels aires without Undersecretariat of Treasury back-up. originally intended (Figure S3.7). To some extent, Moreover, the upstream process for project plan- this is explained by the unusually volatile economic ning and selection can be strengthened to mitigate circumstances after 2006, but it also reflects a po- risks and ensure value for money. litical preference to maintain a certain amount of budget flexibility through the year, as Parliament Preserving rule-based public has delegated spending authority over mid-year adjustments to the Ministry of Finance. Significant finance management – the contingencies (about 10 percent of total appropria- challenge ahead tions) and a trend increase in spending from revolv- ing funds are symptoms of a preference for fiscal The transformation of Turkey public sector man- elbow room beyond what was originally envisaged agement notwithstanding, the reforms initiated by the PFMC Law. At the same time, increasing ri- after 2001 remain incomplete. For instance, the gidities have crept into the budget as a result of budget remains only imperfectly linked to medium- rising personnel expenditures and social entitle- term strategic planning, weakening the relevance ments. Should the growth in revenues slow down and credibility of the planning tools. The Tenth as the economy moves into a moderate growth National Development Plan adopted in 2013 for cycle, these spending rigidities would place signifi- the first time introduces target economic outcome cant pressure on discretionary spending such as for measures that in principle lay the foundations for public investment, particularly if such spending is performance driven budget allocations. In reality, reliant on mid-year allocations of surplus revenues. Figure S3.7: Credibility of the medium-term fiscal program could be improved Percent devia tion from original MTFP, average 2006 - 2012 25 22.1 20 15.5 15 10 10 5.9 6.4 4.2 5 0 -5 -1.7 -10 -9.1 -15 -12.1 Y Y+1 Y+2 Expenditure Revenue Balance Source: Ministry of Finance and IMF Article IV 241 Turkey’s Transitions Figure S3.8: Turkey’s performance in the public expenditure and financial accountability assessment Budget Credibility Comprehensiveness and External Scrutiny Transparency Accounti ng and Repor ting Policy Based Budgets Predictability and Control in Execution EU Accession Candidates Turkey Selected UMIC Source: PEFA Secretariat and WB staff calculations Public sector reforms also remain incomplete in mostly compliance-based audits to a system of ex the area of accountability and external scrutiny. post monitoring oriented at value for money and In the area of public procurement, the exclusion improved performance takes time and the transi- of PPPs, revenue sharing arrangements under the tion is, thus, likely to take several more years to be public housing agency TOKİ, and defense spending complete. During this transition period, shortcuts greatly reduce the scope of the public procurement should be avoided and, instead, political capital law (PPL).7 In addition, public utilities and SOEs should be invested in ensuring all parties work co- have been exempted from the law for tenders be- operatively. low certain thresholds and for specific operations through ad hoc amendments instead of complet- While the role of SOEs in the economy has been ing the legislative framework with the adoption of greatly reduced, further improvements could also be made in their governance to improve perfor- specific utilities procurement legislation in line with mance and limit fiscal risks. Many SOEs are ham- EU Directives. Domestic price preferences and high pered in their operation by limited autonomy and thresholds for competitive bidding further limit the burdensome rules and regulations. At the same scope of the PPL. Completion of procurement re- time, they often lack professional management forms could, thus, unlock significant value for tax and governance, including through management payers and potentially help attract much needed boards. Many SOEs are, thus, performing below Foreign Direct Investment (FDI). In the area of in- their potential and the government is compelled to ternal and external audit, significant additional in- make budget transfers or, in some cases, intervene vestment in capacity building at all levels is needed in markets to protect SOEs from potential private to ensure line agencies adopt appropriate internal competition. Transfers now make up almost 100 controls and the TCA produces performance and percent of SOE capital spending up from 75 percent financial audits that provide a basis for holding in 2007, and more than half of SOEs’ total payroll is all public entities to account. This should include covered by government subsidies. The completion an assessment of value for money in the increas- of SOE reforms could unlock significant efficiency ing portfolio of PPP and revenue sharing arrange- gains and, at the same time, lay the foundation for ments in transport, housing and health sector. At an alignment of state aid provisions with those of the same time, the move from ex-ante control and the EU Acquis. 7 Benchmarking total public procurement spending reported by the Public Procurement Authority (PPA) to OECD averages suggests the exclusions mentioned above may account for up to 5.5 percent of GDP in value falling outside the scope of the PPL. 242 Spotlight 3: Fiscal stabilization and the move to rule based public finance management In 2009, the authorities carried out a Public Ex- sector reforms. Turkey’s achievements in this area penditure and Financial Accountability (PEFA) as- have allowed the country to sustain strong fiscal sessment to benchmark the quality of their pub- management during the 2008-2009 global financial lic financial management system against peers crisis and greatly reduce the burden on the budget among middle income countries. As Figure S3.8 of quasi-fiscal activities, SOEs and subsidies to vari- demonstrates, Turkey’s performance at that time ous sectors of the economy. Over this period, the was above the average for the Europe and Central state has retreated comprehensively from direct Asia Region and other upper middle income coun- intervention in the economy to become a regulator tries. Turkey’s greatest weakness relative to these of private sector investment. However, the transi- comparators was in the area of external scrutiny, tion to rule based governance in the public sector where the new TCA Law, once fully implemented, remains incomplete. The temptation for politicians should allow Turkey to make significant headway. to maximize the room for discretion and to limit the In absolute terms, Turkey’s PEFA ratings were also extent of public scrutiny over their decisions will be low (below 3) in the areas of budget credibility, pre- there as long as politics exist. Turkey has demon- dictability and control. These comparative ratings strated the benefits of constraining such discretion, – while dating back several years – chime with the whilst at the same time decentralizing decision analysis of this Spotlight. Reforms in public finan- making to levels much closer to the ultimate ben- cial management have slowed in recent years and eficiaries of public policies. From housing policies acceleration is required to close the gap to interna- tional best practice benchmarks. to the management of municipal enterprises and from the development of large scale infrastructure Over the past decade, Turkey has turned a major fis- to the allocation of state support to SMEs, these cal crisis into an impulse for comprehensive public lessons should not be forgotten. 243 Turkey’s Transitions References Atiyas, İ. (2012). Economic Institutions and Institu- tional Change in Turkey during the Neoliberal Era. Gill, I., & Raiser, M. (2012). Golden Growth: Restor- ing the Lustre of the European Economic Model. World Bank. Ungor, M. (2014). Average Effective Tax Rates on Consumption for Turkey: New Data and a Compara- tive Analysis. CBT Research Notes in Economics, 2014-02. 244 8 Chapter 8: Crossing the threshold to high income Chapter Crossing the threshold to high income Finance Fiscal Space Infrastructure Trade Welfare Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 245 Turkey’s Transitions Photo Credit : G20 Taskforce, Department of the Prime Minister and Cabinet. 246 Chapter 8: Crossing the threshold to high income Crossing the threshold to high continue? Indeed, just as the advanced economies are emerging from the economic doldrums of the income past five years, many emerging markets are strug- T he dominance of the economies of Europe gling to sustain high rates of growth (Åslund, 2013). and North America over the rest is coming to Will Turkey share their fate and see its convergence an end. For almost five centuries, since the to high income interrupted? This concluding chap- mid-1500s, the “West” pulled ahead of the “rest” ter offers some thoughts on how Turkey can con- (Ferguson, 2011). However, in recent decades, tinue to progress. The discussion proceeds in two countries from Asia to Latin America seem to have steps. First, we ask what can be learned from the experience of other middle income countries, both learned from earlier mistakes and introduced eco- those that seem to have gotten stuck in a “middle nomic policies conducive to catch-up. They have income trap” and those that have successfully “es- become economies of interest for global investors caped”. Second, we ask what challenges can be and the policy lessons from their “turnaround” are derived from an analysis of Turkey’s own achieve- being studied by economists in poor and rich coun- ments over the past three decade as chronicled in tries alike (Henry, 2013). previous chapters of this book. The story of Turkey is in many ways representative It turns out that the two steps lead to the same of the economic ascent experienced by emerging conclusion: to propel its economy forward and markets over the past three decades. Turkey’s re- progress to high income, Turkey will need to ad- emergence as a global economic player begins with dress three inter-related challenges. the economic opening in the early 1980s under Turgut Özal. Since then, as this book has argued, • First, Turkey will need to find a way to sustain Turkey’s economy has been transformed in many productivity growth once the positive contribu- ways. It has stepped up to become an important re- tion of the shift of labor out of agriculture slows gional economic hub and a global exporter of some down. Addressing this challenge involves poli- significance. It has overcome a series of domestic cies to boost innovation, attract more foreign financial crises to stand as the only Organisation for direct investment (FDI), and deepen financial Economic Co-operation and Development (OECD) markets. country that did not have to recapitalize its bank- ing system using public funds. It has emulated the • Second, Turkey’s demographic transition will Asian economies in productively reallocating agri- deliver greater prosperity only if Turkey contin- cultural labor to industry and services and making ues to create jobs at a pace sufficient to accom- structural change a key engine of economic growth. modate the rising inflows of women and youth It has invested in connecting infrastructure to open into the labor market. Policies to do so encom- up its inland economy to competitive markets at pass making labor markets more flexible, invest- home and abroad, and harnessed the economic ing in upgrading the skills of the workforce and benefits of urbanization to pull up the more under- measures to support women (and men) as they seek to combine work and family life. developed regions. The move from rural, infor- mal jobs to urban employment in manufacturing • Third, Turkey needs to deepen institutional re- and services has brought rising income to poorer forms to firmly establish the rule of law and households and led to the growth of middle class. arm’s length regulation of the market. Turkey’s Having long suffered from inflexible and segment- most recent growth spurt came after a wave of ed labor markets, Turkey has, nonetheless, found a fundamental institutional reforms. As in many way to accelerate job creation in recent years and other emerging markets, the reform momen- its economy has added more jobs since the global tum slowed in the wake of the global economic crisis than many much larger competitors. Turkey’s and financial crisis. Sustained progress towards fiscal consolidation after 2001 offers lessons for high income will require closing the gap in the highly indebted countries today; and Turkey’s use quality of economic institutions. of fiscal space to boost health and education out- comes has begun to close the large gap that sepa- These structural challenges are compounded by rated Turkey from OECD standards in the access to the need to address macroeconomic vulnerabilities and the quality of public services. Together, these resulting from Turkey’s reliance on foreign capital many transitions have contributed to lift Turkey to inflows to finance investment. In the short run, a the threshold to high income. period of moderate growth may be unavoidable to rebalance the economy and reassure savers and in- Other countries wishing to study Turkey’s achieve- vestors of Turkey’s commitment to macroeconomic ments will find many policy lessons in the preced- stability. In the medium run, sustained economic ing pages. But they may also ask: will Turkey’s rise growth and macro stability will require renewed 247 Turkey’s Transitions emphasis on strengthening Turkey’s growth po- The “middle income trap” tential. To do so, Turkey could do worse than learn some lessons from the experience of other Euro- Relative income levels around the world are highly pean economies. Over half of the world’s success- persistent. As Figure 8.1 demonstrates, countries ful “escapees” from middle income are in Europe. that were low income in 1960 –– were still pre- But unlike their East Asian peers, these escapees dominantly low income in 2011.1 Similarly, middle did not grow to high income by boosting domes- income countries – defined as countries with per tic savings and adopting ferocious export oriented capita incomes between 10 and 50 percent of the policies. Rather, they grew thanks to the benefits US level – have by and large remained middle in- of trade and financial integration, which attracted come. The club of the high income countries has direct investment and brought modern technolo- admitted only a handful of new members, and has gies. By reinvigorating the momentum behind Eu- lost even fewer. Turkey is solidly in the middle in- ropean integration, Turkey could equally benefit come camp, although it has improved its standing from Europe’s “Convergence Machine” just as the relative to the US from 27 percent of per capita in- European economies are showing renewed signs come in 1960 to 34 percent in 2011.2 of life. The excesses and subsequent deep adjust- ment crises of the Southern European economies The transition to high income is difficult even when also offer a warning: even in Europe, convergence measured in absolute terms. Figure 8.2 takes a is neither automatic nor irreversible. To maintain closer look at Turkey’s progression towards high convergence, European economies need to remain income using the US$12,746 per capita threshold disciplined. beyond which the World Bank classifies countries as high income (which is also the metric used by Gill and Kharas, 2007 and Felipe, Abdon and Kumar, Figure 8.1: Benchmarking Turkey’s high income potential Macro Risks Structural Potenti al Openness Governance Demographic Potential Business Regulati on Innova tion Inclusion BRICS Average New EU Members Average EU Candidate Average MENA Average Growth Markets Average Turkey Source: WB staff calculations based on data from World Development Indicators, Doing Business, Worldwide Governance Indicators (WGI), Transparency International, Open Budget Initiative, Fraser Institute and TurkStat. Note: Macro risks = inflation rate, net international investment position (percent of Gross Domestic Product (GDP)), general government debt (percent of GDP); Openness = export + imports (percent of GDP), FDI inflows (percent of GDP), Logistics Performance Index; Demographic potential = old age dependency, labor force participation rate; Innovation potential = average years of schooling of the workforce, R&D investment (percent of GDP); Inclusion = Gini coefficient of consumption; Business regulation = Doing Business distance to frontier, Fraser Institute index of light regulation; Governance = Fraser Institute index of legal structure, Transparency International Corruption Perceptions Index, Open Budget Index WGI on rule of law, government effectiveness, voice and accountability; structural potential = employment in agriculture (percent of total employment). 1 The figure follows (Bulman, Eden and Nguyen, 2012) in defining thresholds to middle and high income as 10 percent and 50 percent of US income levels respectively. 2 GDP per capita at chained PPPs (2005 US$) (PWT 8.0) 3 Global Economic Prospect Reports Developing Country Growth Rates as follows: 2003-2007 7.7 percent; 2007-2010 5.5 percent. See http://www. worldbank.org/en/publication/global-economic-prospects 248 Chapter 8: Crossing the threshold to high income Figure 8.2: Turkey’s convergence to high income has slowed since 2007 14,500 GNI per capita, Atlas method (current US$) 12,500 10,500 8,500 6,500 4,500 2,500 500 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Mexico Brazil Thailand Malaysia Russian Federation Turkey Poland High Income Threshold (WB Defi nition) Source: World Development Indicators (WDI), TurkStat 2012). In the course of the 2000s, Brazil, Malaysia, apparent slowdown of economic momentum in a Mexico, Poland, Russian Federation and Turkey all number of prominent emerging market economies converged rapidly towards this threshold. But af- have motivated a growing literature on the possible ter 2008, the process of convergence slowed and, existence of a “middle income trap”. Eichengreen, among these peers only Poland and Russian Fed- Park and Shin (2011; 2013) demonstrate that most eration made it across to high income. One reason developing countries tend to experience marked for the interruption of convergence is the impact slowdowns in their growth rates once per capita in- of the crisis on emerging market exchange rates, comes exceed US$10,000 in Purchasing Power Par- accentuated by concerns over the winding down ity (PPP) terms.5 Aiyar et al. (2013) similarly show of extraordinary monetary policy in the advanced that middle income countries have a higher prob- economies during the course of 2013. Another rea- ability of experiencing a growth slowdown than ei- son is that growth rates slumped during 2008-2009, ther low or high income countries. Bulman, Eden although they recovered rapidly afterwards. But if and Nguyen (2012), by contrast, argue that growth we abstract from the crisis period, and compare slowdowns are not at all inevitable. Rather, they projected average growth in 2013-2016 to the pre- show countries that have successfully escaped from crisis average between 2003-2007, we still get a middle income have grown fast both before and notable slow-down in average growth in emerging after crossing the threshold, while countries that markets from 7.7 percent to 5.1 percent.3 For Tur- have remained stuck in middle income have per- key, growth rates in 2013-2016 are forecast to aver- formed consistently worse. Felipe, Abdon and Ku- age 3.7 percent, compared to 6.9 percent in 2003- mar (2012) focus on countries that have remained 2007.4 Eventually, of course, Turkey as well as its “stuck” in middle income for several decades and peers will cross the threshold to high income, but confirm that their policies and structural charac- the rate of progress may not be fast enough to sig- teristics differ from those countries that showed nificantly close the gap to the advanced countries. sustained high growth. Berg, Ostry and Zettelmey- In a similar vein, EBRD (2013) argues that after two er (2008) study the length of growth spells, while decades of rapid economic catch-up, many Eastern Hausmann, Rodriguez and Wagner (2006) inves- European countries are “stuck in transition” and tigate growth collapses. Again, both studies show are unlikely to see continued rapid economic con- that similar policies and structural factors matter vergence without deep structural reform. in ensuring that growth spells last and growth col- lapses are avoided. The Growth Commission (Com- The persistence of relative income levels and the mission on Growth and Development, 2008) also 4 See http://www.worldbank.org/content/dam/Worldbank/document/eca/turkey/tr-tren-jun-2014-eng.pdf 5 Eichengreen, Park and Shin’s first results suggested a single point beyond which growth is likely to slow at US$17,000 PPP. In revised estimates, the same authors find a stepwise deceleration of growth at levels of US$10,000 and again beyond US$15,000. Turkey’s per capita income is between these two levels at US$14,000 in 2011. 249 Turkey’s Transitions Figure 8.3: Only a handful of countries have escaped the middle income trap 6 2008 per capita income rela tive to U.S 5 Portuga l Irel and Korea , Republic of Ja pa n Greece Spa in 4 Turkey (log of %) 3 Bra zi l Chi na 2 1 0 0 1 2 3 4 5 6 1960 per capita income rela tive to U.S (log of %) Source: World Bank (WB) staff calculations using Penn World Tables version 8 identified common characteristics of countries that to experience growth slowdowns. We do not dis- experienced sustained, high growth. cuss this obvious result any further. While the methodologies used to identify growth How does Turkey fare across these categories? To spells and growth slowdowns differ, the conclusions answer this question, we return to the “best in on the factors that matter for sustained economic class” methodology employed in Chapter 1. This success are remarkably similar (Table 8.1). These ranks all the emerging market peers used in this factors may be grouped into the following broad Report in the eight main dimensions listed above. categories: (i) structural characteristics that de- Some of the dimensions are captured by several termine the remaining scope for productive labor variables, others by just one variable. The country reallocations,6 (ii) macroeconomic stability such as ranked best receives a score of 1 and all others are low inflation rates, limited external imbalances and listed as ratios of this top score in each category. sound public finances, (iii) the degree of openness When several variables enter the ranking in one of the economy to trade and FDI (iv) demographic category, the unweighted average score is used. factors such as low (and declining) dependency The resulting diamonds of structural and policy rates and high participation in the labor force, (v) the innovation potential of an economy as reflect- characteristics have a more larger and rounder ed in its skill base and the level of investment in shape the fewer weaknesses and vulnerabilities a Research and Development (R&D), (vi) the degree country has. Our approach is related to the concept of social inclusion as measured by moderate and/ of “risk maps” introduced by Aiyar et al. (2013).8 or declining inequality, (vii) the quality of govern- It is also related to the World Economic Forum’s ment regulation and the business climate, and (viii) (WEF) categorization of a country’s competitive- the quality of economic governance, as reflected in ness using a large number of dimensions. However, measures of the rule of law and of government ac- WEF employs a combination of subjective ratings countability.7 Finally, countries experiencing wars, and statistical data, whereas we stick to data and natural disasters or financial crises are more likely indices available from official sources. 6 The evidence is not unambiguous. Some studies find a large industrial sector helps sustain growth, others find when industrialization has reached its peak, a subsequent slowdown is more likely. McMillan and Rodrik (2011) also show that declines in agricultural employment are not always as- sociated with increasing productivity, although they are if they lead to increases in industrial rather than service sector employment. Given the role of labor reallocation from agriculture in Turkey’s growth story to date, we interpret large remaining agricultural employment as positive “structural potential”. 7 There is an ongoing debate on whether political institutions are important determinants of sustained growth and the quality of economic govern- ance. Eichengreen, Park and Shin (2013) and Hausmann, Rodriguez and Wagner (2006) find a negative effect of regime changes, including democratic openings, on subsequent growth performance. EBRD (2013) argues that greater democracy supports stronger economic institutions, even when controlling for the effect of income on democracy. Acemoğlu et al., 2014 argue that democracy causes growth; Treisman (2013) conversely finds democracy dependent on the level of economic development. We restrict attention on economic institutions as reflected in the World Bank Institute Worldwide Governance Indicators (WGI) and measures of the quality of regulation and the business climate. 8 An application of the methodology of Aiyar et al. (2013) to the case of Turkey places the country in the moderate to high risk category, with high macro-economic risks, moderate risks related to institutional performance and lower risks related to economic structure. Turkey’s still high depend- ency rate also represents a risk in this methodology, but this is declining fast. Results are available upon request. 250 Chapter 8: Crossing the threshold to high income Table 8.1: Growth spells, growth slowdowns: Determinants of sustained growth in middle income countries, selected findings from the literature Source Methodology Key Findings Hausmann, Rodriguez Probability of growth collapses Growth collapses are associated with negative ex- and Wagner (2006) (growth falls below zero; dura- port shocks; sudden stops of capital flows; higher tion, peak to trough change in rates of inflation; weaker rule of law; lower human GDP, cumulative lost output) capital stock (education and health); lower levels of urbanization; poorer connectivity; less diverse prod- uct space; periods of political transition; natural di- sasters; and wars. Berg, Ostry and Length of growth spell above 2 Growth spells are associated with openness to trade Zettelmeyer (2008) percent per annum; probability and trade liberalization in previous period; higher that growth spell lasts levels of FDI inflows; lower current account defi- cits; lower exchange rate overvaluation and lower inflation; recent positive change in manufacturing exports and more diversified product space; better rule of law and investor protection; less inequality; recent reforms towards more democracy. Growth Commission Growth above 7 percent for at Sustained growth is associated with greater open- (2008) least 25 years – 13 cases9 ness; modest inflation and sustainable public financ- es; high investment and savings rates; limited regula- tory and price distortions; high government capacity, good governance and commitment to inclusion. Bulman, Eden and Countries that “escaped” to Escapees have higher Total Factor Productivity (TFP) Nguyen (2012) high income vs. countries that growth; are more open; have a higher stock of educa- remained middle income during tion; greater innovation potential measured by num- past five decades ber of patents; positive changes in share of industry and negative changes in share of agriculture in GDP; no increases in inequality; and declines in depen- dency ratios. Lower inflation and less overvaluation also contribute to sustaining rates of convergence in middle income countries. Political variables do not differ significantly between escapees and others. Felipe, Abdon and Kumar Time needed to cross income Countries that crossed income thresholds in less (2012) thresholds (more than 28 years than the given timeframe had more diversified and for low middle to high middle in- sophisticated exports; experienced more rapid struc- come, more than 14 years from tural transformation from agriculture to industry. high middle to high income) Turkey took more than 28 years to get to high middle income, but is likely to cross from high middle in- come to high income in less than 14 years. Aiyar et al. (2013) Large downside deviations of Middle income countries are more likely to experi- growth from predicted condi- ence growth slowdowns (12-14 percent vs. 9-10 per- tional convergence path in any cent in low income and 6-8 percent in high income one 5-year period countries). Slowdowns less likely in countries with increases in openness; less exposure to foreign capital inflows; smaller increases in investment rates; increases in public debt;10 larger shares of agriculture and ser- vices in GDP or recent increases in these shares; more diversified exports, greater proximity to large markets and greater regional integration; lower de- pendency ratios and more equal sex ratios (male/ female); better rule of law and recent improvements in business regulations; improved connectivity in- 9 The cases are: Botswana (1906-2005); Brazil (1950-1980); China frastructure. Slowdowns are more likely in coun- (1961-2005); Hong Kong (1960-1997); Indonesia (1966-1997); Japan tries with sharp increases in the size of government (1953-1983); Republic of Korea (1960-2001); Malaysia (1967-1997); spending; in countries in the tropics and in countries Malta (1963-1994); Oman (1960-1999); Singapore (1967-2002); Tai- wan, Province of China (1965-2002); Thailand (1960-1997). suffering from war. 10 Result is driven by HIPC countries, where debt relief happened dur- ing periods of growth slowdowns. 251 Turkey’s Transitions EBRD (2013) Estimates of future potential TFP TFP growth is positively related to increased FDI; growth in model where FDI, Sav- greater human capital stock; less distance to ad- ings, TFP and Investment Rates vanced markets; and greater constraints on ex- are jointly determined ecutive power. FDI is positively related to greater openness; better rule of law; higher share of manu- facturing and services in GDP. Eichengreen, Park and Slowdown in growth from above Probability of slowdown increases significantly be- Shin (2013) 3.5 percent by at least 2 percent- yond US$11,000 and US$15,000 PPP. age points in any 7 year period Probability of slowdown is high in countries with higher rates of investment to GDP; greater degree of previous exchange rate undervaluation; lower rates of openness; lower levels of tertiary education achievement; fewer high tech exports; higher old age dependency ratios; recent financial crises; re- cent political regime changes (a change from autoc- racy to democracy increases the risk of a slowdown) Source: WB staff based on sources quoted in the table. Turkey’s strengths lie in its structural characteris- and North Africa (MENA), albeit below the Growth tics as a young country which has not yet fully ex- Markets and the New EU Member States. Turkey’s hausted the benefits of structural change (Figure rank in the area of social inclusion is relatively poor 8.3). Compared to emerging market peers, particu- compared with other European countries, but rela- larly in Europe, Turkey still has quite a large share tive to emerging market peers in Latin America and of employment in agriculture and its population is Asia, Turkey does better. As discussed throughout young. This provides for significant structural and this Report, Turkey’s growth over the past decade demographic potential, although the realization of has been inclusive. These gains should be sustained and extended. the latter is dependent on continued fast job cre- ation and rising participation rates. Turkey also has Turkey’s weaknesses are in the low degree of open- relative strengths in the area of business regula- ness, relatively greater macroeconomic vulnerabil- tion where it scores better than Brazil, Russia, In- ity and weaker innovation potential.11 The ratio of dia, China and South Africa (BRICS), the European Turkey’s exports and imports to GDP and the in- Union (EU) Accession Candidates and Middle East flow of FDI as a share of GDP are below most other Figure 8.4: The correlation between the quality of economic institutions and per capita income increases as countries get richer 100,000 GDP per capita, PPP (current interna tional $) 90,000 80,000 70,000 60,000 R² = 0.513 50,000 40,000 30,000 Turkey 20,000 Uruguay 10,000 R² = 0.3104 0 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 Average WGI Score Source: WDI, WGI 11 This is consistent with Turkey’s WEF Competitiveness Index rankings, which identify Turkey’s macro environment, labor market efficiency and in- novation as areas of relatively weaker performance. Turkey does well relative to emerging market peers in the following areas according to WEF: institutions, infrastructure, goods market efficiency, financial market development, health and primary education, and business sophistication. 252 Chapter 8: Crossing the threshold to high income emerging market peers analyzed in this Report and at around 0.5 percent of GDP and corporate gover- this is despite the significant improvements re- nance and management quality need to improve to corded in both dimensions over the past decade. make Turkish firms fit for global competition.12 Turkey’s inflation rate is still relatively high (in our sample, only India, Serbia, Egypt and Syrian Arab The quality of Turkey’s economic institutions is not Republic had higher inflation in 2013) and its reli- out of line with the performance of other emerging ance on external financing is a key vulnerability. market peers. The New EU Member States score While Turkey’s public finances are solid, the poor highest in the dimension of governance, the Growth performance in the other two dimensions drags its Markets are on top in the quality of the business ranking down. The rebalancing of Turkey’s economy climate. Turkey does better than the BRICs, the Ac- over the past two years is necessary and needs to cession Candidates and MENA in both dimensions. continue to permanently reduce risks to sustained Yet, on closer inspections, this result is less comfort- growth stemming from Turkey’s macroeconomic ing than it may appear. While institutional arrange- vulnerabilities. Turkey’s innovation potential is be- ments in middle income countries tend to vary low that of many emerging market peers on ac- considerably, all advanced, high income countries count of the legacy of low investment in education. have similar economic institutions; notably strong This is changing, as we document in Chapter 7, but and independent regulation, effective government, the low stock of human capital may, nonetheless, the rule of law, and established mechanisms for affect the incentives for and returns to greater in- government accountability. Moreover, while at low vestment in innovation (Goni and Maloney, 2014). and middle income levels the correlation between Turkey’s public sector investment in R&D is rela- the quality of economic institutions and per capita tively high, comparable with the new EU Member income is relatively flat, at higher middle income States, and the fast increase in tertiary enrolment and high income levels, it is both stronger and is encouraging. Yet, private sector R&D remains low steeper (Figure 8.4).13 Figure 8.5: Turkey remains mid-field on most comparative indices of institutional performance 200 189 177 177 180 152 Total Number of Countries 160 148 Turkey`s Rank out of 140 120 98 112 100 80 69 60 56 55 53 40 42 20 0 Open Budget WEF - Fraser - Light Heritage Corruption WB - Ease of Index Institutions Regulation Foundation - Perceptions Doing Business Index of Index Economic Freedom Total Number of Countries Turkey`s Rank Source: World Bank, World Economic Forum (WEF), Fraser Institute, Heritage Foundation, Transparency International, International Budget Project. 12 Preliminary results of a recent management quality survey for Turkey, following the methodology of Bloom et al. (2012), show that Turkey has a fat “left tail” of poorly managed companies. Its average management quality is comparable to other middle income countries in Latin America and to Greece, Spain and Portugal in Southern Europe. 13 This finding is related to the argument of Aghion and Howitt (2005) among others that appropriate growth policies differ in middle and high income countries. Relating GDP per capita to the average WGI score linearly and testing for a structural break, we find this occurs at a WGI score of 0.7, corresponding to Uruguay with a PPP income of $23,340. Beyond this level, the slope of a linear relationship is significantly steeper. Turkey’s per capita income is significantly higher than predicted by the quality of its institutions ($18,551 compared with predicted $10,211). This makes it more likely that further improvements in institutional performance are necessary for Turkey to continue to increase its income level (see also Chapter 1). 253 Turkey’s Transitions It seems that to get to high income, emerging mar- EU Member States on Government Effectiveness kets need to create the necessary institutional pre- and Control of Corruption, but considerably worse requisites. Measured against the standards of high on Voice and Accountability and the Rule of Law income countries, Turkey does not fare particularly (where Turkey’s score remains well below the mid- well (Figure 8.5). Turkey’s performance is solidly point of the global distribution). In Voice and Ac- middle income whatever indicator of the quality of countability, it is even below the score of the other institutions is used. Turkey’s rank is relatively the EU Accession Candidates and barely better than the strongest in the WEF’s index of institutional qual- BRICS. This composite indicator covers issues such ity (56 out of 148) and Transparency International’s as political rights and civil liberties, freedom of the Corruption Perception Index (53 out of 177). But it media, access to information, and the degree of does not make it into the top 40 on any indicator of institutional quality. parliamentary oversight over the executive. Strong checks and balances become more important as Institutional reforms are complex and often interde- the complexity of policy decisions increases in high pendent. Nonetheless, a closer look at the various income countries. dimensions of institutional performance can help identify priorities. To do so, we take a closer look There is nothing inevitable about being trapped in at the large WGI dataset. These indicators draw on middle income. Japan and the East Asian Tigers and a total of 31 sources, some reporting expert rat- more recently, several new EU Member States have ings, some based on surveys and aggregated into demonstrated persistently high growth rates that 6 broad themes using principle component analysis have taken them quickly through middle income (Kaufmann, Kraay and Mastruzzi, 2010).¹⁴ In Figure to advanced economy status. Benchmarked against 8.6, Turkey is benchmarked against the OECD av- these examples and other middle income peers, erage, the Republic of Korea (the most advanced Turkey’s prospects are mixed. They would brighten among all the peers used in this book), and the oth- considerably as a result of a new boost of struc- er peer group averages. The gap between Turkey tural and institutional reforms. The analysis in the and the high income countries can clearly be seen. preceding Chapters lays out a well-defined reform Turkey’s scores are comparable to those of the new agenda to which we now turn. Figure 8.6: Worldwide Governance Indicators (WGI), 2013 Control of Corruption 1.5 1.0 0.5 0.0 Government Voice and Accountability Effectiveness -0.5 -1.0 Rule of Law Regulatory Quality BRICS Average New EU Members Average EU Candidate Average MENA Average Growth Markets Average (excluding Korea, Republic of) Korea, Rep. Turkey OECD Average Source: WGI Note: The “EU Members” refers to Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia. “EU Candidate Average” refers to unweighted average of Albania, Croatia and Serbia. “MENA Average” refers to unweighted average of Egypt, Jordan, Morocco, Syrian Arab Republic and Tunisia. “Growth Markets Average” refers to unweighted average of Indonesia, Malaysia, Mexico and Philippines. “OECD Average” refers to unweighted average of 34 OECD countries. 14 The index of political stability and violence is not reported, as it is less directly related to issues of economic policy which are the focus of this Report. Turkey scores poorly on this indicator, largely because of the legacy of the long conflict in the country’s Southeast. 254 Chapter 8: Crossing the threshold to high income From achievements to challenges: • Third, Turkey’s institutions need to be upgraded to the requirements of an advanced economy. Sustaining Turkey’s transformation Based on the above benchmarking exercise, this Based on the analysis in the seven preceding chap- is the case particularly in the area of strength- ters and the benchmarking exercise in the previous ening channels for voice and accountability. section, we can now begin to outline the contours There is also scope for significant further prog- of a strategy that would help Turkey get to high in- ress in the quality of the business environment come. In short, Turkey will need to address three and public financial management, as well as the interrelated challenges: strength and independence of regulatory insti- tutions (Atiyas, 2012). Ultimately, Turkey’s prog- • First, the country will need to find new sources ress towards high income is more likely if it is of growth as the benefits of structural change based to a greater extent on “open-access insti- start to peter out. This is all the more impor- tutions” (North, Wallis and Weingast, 2009) that tant because it appears that in recent years, in provide a true level playing field and encourage particular, growth has been increasingly driven the free flow of ideas. by domestic demand, a credit fuelled construc- tion boom, and the rise of the service economy The three pillars of a new growth strategy that to support Turkey’s growing cities. Productivity would take Turkey to high income and beyond are growth has slowed markedly since 2007 and presented in Figure 8.7. Three challenges – sustain- growth has been associated with rising external ing productivity, boosting participation, and deep- imbalances. What is needed is a new growth en- ening institutional reforms – are matched with gine, based on private investment and increases three growth drivers: innovation-based growth, in firm-level productivity. The solution lies in a inclusive growth and open-access growth. Turkey’s move towards “innovation based growth”. Tenth National Development Plan lays out a reform agenda that is closely related to the priorities iden- • Second, Turkey needs to ensure that the great tified in this Book (Annex 1). The first pillar – Quali- structural advantage of a young population is fied Individuals, Strong Society – matches the chal- turned into a driver of economic progress. This lenge of boosting participation (particularly among means boosting participation in the labor force, women) and getting the most out of Turkey’s hu- and ensuring that the skills of new entrants as man capital. The second pillar – Innovative Produc- well as existing workers are continuously up- tion, Sustainable High Growth – summarizes the graded and kept relevant to the demands of a policies to sustain productivity growth. The third changing labor market. At the same time, Tur- pillar of the National Development Plan – Livable key needs to address socio-economic inequali- Spaces, Sustainable Environment – addresses Tur- ties in access to high quality education to en- key’s second generation urbanization and environ- sure that growth remains socially inclusive. mental challenges. While the angle in this third pil- Figure 8.7: Crossing the threshold to high income: Challenges and policy priorities Sustaining Productivity Boosting Participation Deepening Institutional Reforms Challenges Innovation based growth Inclusive growth Open-access growth FDI Education and skills Rule of Law Financial Deepening Childcare and family support Independent and arms Priorities R&D Flexible labor markets length regulation Corporate Governance Public finance management Business Climate Macroeconomic Discipline Source: World Bank Staff 255 Turkey’s Transitions lar is different than that chosen in this concluding • From improved access to services to equal eco- chapter, the policy agenda is overlapping: Turkey nomic opportunities: Chapters 5, 6 and 7 illus- needs stronger rules, reliable arm’s length regula- trated how urbanization, the rise of the service tion and improved mechanisms for government ac- economy, and increased public spending on countability to its citizens. This will help to maintain social and municipal services have vastly im- Turkey’s attraction for private investors to develop proved the livelihoods particularly of the poorer its cities and infrastructure in ways compatible with segments of Turkey’s population. Job creation long-term financial, environmental and social sus- has kept pace with population growth and rising tainability. female labor force participation in recent years, ensuring that prosperity has been shared. But To get fit for high income, Turkey can build on its sustaining this positive momentum will be many achievements as documented in this Report. challenging, particularly if economic growth The analysis in the preceding seven Chapters identi- fies both the mechanisms that have allowed Turkey slows. Remaining socio-economic inequalities to progress to this point, and the remaining short- are significant, both regionally and across in- comings that, if addressed, would allow it to move come quintiles. To achieve sustained, inclusive further (Table 8.2). Crossing the threshold to high growth, government policies may need to be- income will involve three important transitions: come even better targeted. Labor markets need to become more flexible, while offering better • From structural change to innovation: Chapters income security to those negatively affected by 2, 3 and 4 documented the mechanisms that structural shifts in the demand for skills. Wom- have allowed Turkey to create a private sector en need more childcare opportunities and fami- driven growth model, harnessing the benefits lies need improved parental leave to encourage of structural change. International and Euro- more women to continue to work beyond mar- pean integration, including Turkey’s integration riage. Education policies need to evolve from into global value chains with the help of increas- providing access to ensuring quality and reduc- ing FDI, have boosted Turkey’s competitiveness. ing inequality in education outcomes by socio- A sound banking system and vastly improved economic groups. Social security arrangements connective infrastructure have reduced the cost need to be mindful of the fiscal risk of growing of trade and doing business, and regulatory re- entitlements and adjust before such costs mul- forms in the early 2000s have helped, too. But tiply with an aging population. Turkey’s young the momentum created by this combination population is a huge asset as the country looks has weakened. Going forward, Turkey’s firms at the road towards high income. Policies that need to shift their strategy from providing hous- boost participation and ensure equal economic ing and consumption goods to a rapidly growing opportunities will have high returns for many urban population to producing more sophisti- years to come. cated products for the global market and the domestic middle class. For this, they need ac- • From regulatory reforms to open-access insti- cess to better technologies (including through tutions: Chapter 1 reviewed the origins of Tur- attracting more FDI), to better skilled labor, and key’s rise and emphasized the importance of to a national eco-system that encourages inno- the shift of the model of economic governance vation. Turkey’s financiers need to move into from state-led to private sector led growth, par- equity and other forms of risk capital. Turkey’s ticularly in the context of the regulatory reforms managers need to accept modern corporate of the late 1990s and early 2000s. In essence, governance and modern management prac- the difference after 2001 was that Turkish policy tices. Turkey’s scientists need to connect better makers understood that the benefits of market with commercial reality. Government policy can oriented reforms accrue sustainably only to do much to facilitate this shift through deregu- countries that make parallel efforts to improve lation of professional services, the reforms of the rule of law, introduce arm’s length regula- capital markets, setting the framework for the tion and rely on independent institutions to ex- protection of intellectual property rights, and ercise control and accountability. Yet, the analy- better targeted (not necessarily larger) govern- sis also showed to what extent these reforms ment support. A widened trade agreement with have remained incomplete and contested, from the EU, possibly in the context of Turkey joining the Trans-Atlantic Trade and Investment Part- the regulation of financial markets and public nership (TTIP) could provide an important boost private partnerships in infrastructure to the in- to many of these reforms. stitutions of corporate governance and public fi- nance management. Turkey needs to complete the shift towards economic institutions that are 256 Chapter 8: Crossing the threshold to high income politically blind and treat every enterprise and port for women and youth, complemented with every citizen equally. The transition to open-ac- new measures to increase labor market flexibility. cess institutions is a key complement to innova- Finally, Turkey’s achievements in improving health tion-based growth and central to ensuring that and education outcomes ought to caution against growth remains inclusive. calls for a radical rethinking of health and educa- tion policies. Persistence is the theme here as well. Two more general conclusions can be drawn from Policy reversals, on the other hand, could be costly. a review of Turkey’s economic and social progress over the past three decades. New reform momentum is needed: In some ar- eas, Turkey’s reform efforts have slowed down in Persistence pays: In the majority of areas covered the past five years or even been partially reversed by this Report, addressing Turkey’s challenges will in ways that now pose risks to future growth. One require persistence in reforms already under way. area is the business climate where Turkey moved For instance, Chapter 2 and Spotlight 2 argue that fast towards the best practice frontier between the Turkey’s investment in upgrading its logistics ca- late 1990s and the mid-2000s, but has seen other pacity is an asset that should facilitate the deeper countries catch-up as its own pace of reform has integration with global value chains. As Chapter 3 slowed. A second area, as illustrated in Spotlight 3, illustrates, Turkey has already adopted a series of is the reform of public financial management insti- measures to develop its capital markets and de- tutions, where multiple exemptions, for instance, velop the financial market infrastructure needed have weakened the integrity of the public procure- to support technical upgrading and innovation by ment framework and where implementation diffi- Turkish companies. Turkey has recently created an culties have overshadowed positive achievements institutional framework to provide further autono- in the reform of external and internal audit. Figure my to municipal governments to help them man- 8.8 shows that across three indicators of institu- age the next stage of urban development (Chap- tional reforms tracked over time – the Global Gov- ter 5). This new framework now needs to be filled ernance Indicators of the World Bank Institute, the with life (and temptations for centrally directed Doing Business ratings of the World Bank Group, initiatives resisted) and the capacity of municipal and the OECD’s Product Market Regulation indica- governments needs to be strengthened to make tors – progress essentially stopped after 2007. Just good use of their increased responsibilities. Tur- as Turkey’s progress towards high income slowed key’s impressive labor market performance after with the global economic and financial crisis and as 2009, chronicled in Chapter 6, underlines the im- the anchor of EU Accession negotiations weakened, portance of continuing targeted employment sup- institutional reforms also went into slow motion. Figure 8.8: Institutional reforms have slowed since the mid-2000s 20 15 Improvements in Indicators 10 5 0 -5 -10 Accountability Regulatory Rule of Law Distance to Frontier of Corruption E ffec tiveness Government OECD PMR Quality Voice and Doing Business Control Pre-Crisis Post-Crisis Source: WGI, Doing Business, OECD Note: Pre-crisis refers to 2001-2007 for WGI, 2004-2007 for Doing Business, and 2003-2008 for Product Market Regulation (PMR); post crisis refers to 2008-2012 for WGI and Doing Business, and 2008-2013 for PMR. Doing Business indicators are calculated based on the 2014 release. From the 2015 release onwards, a change has been introduced in the methodology and “distance to the frontier” measures for 2015 are not comparable across time. 257 Turkey’s Transitions This is not to deny progress in other areas, includ- riers, particularly in services and in labor markets, ing a series of important judicial reform packages, had become increasingly binding obstacles to fur- but economic institutions have not been given suf- ther gains from economic integration. And Europe’s ficient attention. This will need to change if Turkey welfare model, whilst continuing to deliver strong is to fulfill its aspirations. social protection and higher levels of equality than in any other region in the world, had become unfit Outlook: European integration, the to serve an aging population. demographic dividend and Turkey’s Writing Europe off would be a big mistake, how- convergence to high income ever, both because so many aspects of Europe’s economic and social model remain strong, and In reviewing the pattern of economic convergence because Europe has started to reform the weaker in Europe, Gill and Raiser (2012) concluded: “Of the aspects in the past five years. Reforms to labor mar- countries that have grown quickly from middle in- kets and improvements in the business environ- come to high income, half—Croatia, Cyprus, Czech ment are leading to gains in the competitiveness Republic, Estonia, Greece, Hungary, Latvia, Malta, of Europe’s periphery and the economic imbal- Poland, Portugal, Slovakia, and Slovenia—are in Eu- ances inside the Eurozone are gradually reducing. rope. If you can be a part of the formidable Euro- Europe as a whole still lags the US on innovation, pean Convergence Machine, you do not need to be but Europe’s leading innovators, in Scandinavia, in extraordinarily fortunate [like the Gulf States that Switzerland, or in Germany are showing the way to grew rich after discovering vast oil reserves] to be- others on how to catch-up. And five years of tough come prosperous nor—like the East Asian Tigers— fiscal measures have reduced the burden of over- do you have to be ferocious. You just have to be bloated public sectors in many European countries, disciplined.” although the structural reforms needed to confront the challenges of aging are still largely outstanding. Turkey’s growth story over the past three decades Europe’s economic recovery is no longer a fantasy is intricately linked with the story of European in- as the Region is expected to turn the corner to posi- tegration and convergence. The Customs Union tive growth in 2014. between Turkey and the EU, which entered into force in 1996, has been a catalyst of technologi- Turkey’s exporters have been among the first to no- cal upgrading as well as improvements in product tice. Exports to the EU, which experienced negative regulations and quality control in Turkish manu- growth between December 2011 and September facturing. This has helped Turkey expand both its 2012, have recently started to pick up again (Fig- regional and global presence. The prospect and, ure 8.9). The accession negotiations received a (at after 2005, the start of accession negotiations with least temporary) fillip when the European Council the EU has deeply influenced the focus of structural agreed to open a new Chapter (22) on regional pol- and institutional reforms, from regulatory changes icy. Leading Turkish politicians have declared 2014 in the transport and energy markets, the tighten- to be the “year of Europe”. If history and the experi- ing of environmental safeguards, and the develop- ence of Turkey’s Eastern European neighbors is any ment of a new capital markets infrastructure, to guide, this orientation is well advised. Turkey has the reform of public finance management in areas shown in the aftermath of the 2001 crisis that it is such as external audit or public procurement. Even disciplined. Turkey’s location allows it to partake in Turkey’s labor market institutions and the aspira- the benefits of Europe’s Convergence Machine. As tions of its population for a relatively extensive wel- the Machine starts turning again, Turkey once more fare state point towards an economic model more could benefit. similar to Europe’s social market economy than Asia’s developmental capitalism. In short, Turkey’s Besides its location and integration with the Euro- achievements are part of a pattern of economic pean Convergence Machine, Turkey’s second big- convergence and institutional harmonization that gest asset is its young and dynamic people. As em- is unique to Europe, and quite possibly the Region’s phasized in this Report, Turkey can look forward to biggest asset. a double demographic dividend as its dependency ratio is falling and as more women enter the labor Yet, many Turks have lost faith in the ability of Eu- force. In a downbeat assessment of US growth rope to help them catch-up. The strength of Eu- prospects, the American economist Robert Gordon rope’s Convergence Machine has faltered not just (2012) predicts US growth will slow down signifi- as a result of the global economic and financial cri- cantly in part because of a decline in the contribu- sis. Long before, Europe had stopped catching up tion of human capital. This is intimately linked with with the US in productivity and was facing increas- America’s own demographic transformation, as ing competition from Asia. Remaining market bar- the convergence of female with male employment 258 Chapter 8: Crossing the threshold to high income rates has been largely completed and the benefits Turkey’s path to high income, thus, lies visibly of earlier extensions in access to education have ahead. Progress will not be automatic, but as this become exhausted with the first cohort of baby Report has shown, Turkey has much strength on boomers starting to exit the labor market. What which to build. At a time when many observers appears as a drag on American growth prospects have raised doubts over the future of Turkey’s eco- could be a boon for Turkey: if female employment nomic and social development model, it is useful to rates continue to grow and as the investments in remember these strengths, examine Turkey’s policy increased schooling over the past decade work lessons and refocus attention on the tasks remain- their way into the labor market, Turkey’s growth ing ahead. These tasks will require diligent reform prospects would brighten. They would brighten efforts over a number of years. But if Turkey is able even more if the efforts to make Turkey’s develop- to meet this challenge, as it celebrates the cente- ment model more socially inclusive that have been nary in 2023 of the founding of the modern Turkish chronicled in this Report translate into genuinely Republic, it will do so as a more competitive, inclu- higher rates of social mobility. sive and, ultimately, prosperous country. Figure 8.9: The Convergence Machine starting up again? Change in exports to EU 50% 40% 30% 20% Percent Change 10% 0% -10% -20% -30% -40% -50% Jan.09 Apr.09 Jul.09 Oct.09 Jan.10 Apr.10 Jul.10 Oct.10 Jan.11 Apr.11 Jul.11 Oct.11 Jan.12 Apr.12 Jul.12 Oct.12 Jan.13 Apr.13 Jul.13 Oct.13 Jan.14 Apr.14 Source: TurkStat Note: EU market includes Croatia, an EU member since July 2013. 259 Turkey’s Transitions Table 8.2: Turkey’s Transitions: Achievements, Lessons and Challenges Lessons Learnt from Turkey’s Challenges to reaching Turkey’s achievements development experience high-income status INTEGRATION Turkey‘s integration into the European The liberalization of economic activity in Further increases in Turkey’s per capita and global economy has brought the the 1980s has created a powerful con- income will need to rely on investment in country to the threshold to high income. stituency for market-based solutions, and support of an expansion of Turkey’s asset unleashed Turkey’s entrepreneurial spirit. base. This will require further improve- The positive attitude towards the private ments in the investment climate and the sector is a distinguishing characteristic of rule of law, as well as continued invest- Turkey’s development reminiscent of the ments to upgrade Turkey’s skill base. It transition process in Central and Eastern will also require steps to boost domestic Europe. savings and manage the volatility associ- ated with dependence on foreign financ- ing. Trade: Turkey’s openness (the ratio of The initial liberalization efforts of the While Turkey has dramatically increased trade in goods and services to GDP) has early 1980s and their culmination in the its medium-technology exports, it has risen from 11 percent in 1970 to 58 per- 1995 Customs Union agreement with stagnated in high-tech exports. Higher cent in 2012. Over the past decade, ex- the EU have laid the basis for Turkey’s value added exports will require technol- ports of goods and services in US$ terms integration into the world economy. The ogy upgrading, innovation, and experi- grew by 15 percent annually. Medium- process of integration with the EU has mentation by large and medium-sized technology exports have increased as increased Turkey’s participation in global firms. Attracting more FDI would help Turkey has become more integrated in value chains and has resulted in higher move up the value chain which would European production chains. Diversifi- technology content and sophistication of also allow Turkey to more successfully cation of exports has allowed Turkey to exports. Investments in logistics and dip- compete in high growth markets in Asia. mitigate the slump in EU demand. lomatic outreach have supported the di- versification of Turkey’s trading partners. Finance: Turkey’s banking system is re- Governance reforms rooted in greater Turkey’s capital markets remain thin silient and was the only one in the OECD transparency and accountability, coupled compared to other countries at the same that withstood the headwinds of the with strong regulatory and legal steps level of development and further deep- global economic and financial crisis with- to limit moral hazard, have enabled the ening of financial markets would support out an injection of public funds. It boasts turn-around of Turkey’s banking sector. Turkey’s transition to high income. By strong capital buffers and the sector’s However, despite an unorthodox policy contributing to raise domestic savings, loan to deposit ratio, while increasing, is framework and the use of a large arsenal this would also make Turkey more resil- only around 110 percent. of macro-prudential tools, Turkey has had ient in the face of its dependence on ex- limited success to insulate itself against ternal flows. volatile international capital markets. Enterprise: Productivity growth has been Improvements in the business environ- For Turkey to move to high income, pro- strong, driven by a re-allocation of the la- ment, policies to support urbanization, ductivity gains will need to come increas- bor force out of agriculture and into ser- and the flexibility of labor markets due ingly from within each sector and within vices and manufacturing. Patterns of pro- to the informal sector have facilitated the firm. Regulatory red tape, legal ductivity growth are supporting regional structural change to date. Regional con- uncertainty, and segmented labor mar- convergence within Turkey, although pro- vergence can be linked to fiscal policy, kets may become greater constraints on ductivity levels in the Western part of the including per capita public expenditures productive labor reallocation within sec- country remain the highest. on transport and communications, as tors going forward. Despite rising R&D well as per capita expenditures on social spending, Turkey needs to strengthen the infrastructure. links between research and business ap- plications, improve patent and Intellec- tual property rights (IPR) protection, and boost the quality of its universities. Infrastructure: Turkey has improved the More than half of Turkey’s infrastructure Despite an ambitious PPP pipeline, deal quality of its infrastructure in transport, investments in transport, energy and closures have been slow, and financing telecoms and energy and ranks in the telecoms have come from the private needs exceed domestic capacity. Turkey top 30 worldwide for its logistics perfor- sector. Sector unbundling, privatization should use PPPs to attract greater long- mance. of assets and strong independent regu- term foreign financing given domestic lation have led to significant efficiency constraints. This will require improve- improvements and better, cost-effective ments in the regulatory framework, and services for Turkey’s citizens and busi- also in project selection and appraisal nesses. and risk and contract management prac- tices. 260 Chapter 8: Crossing the threshold to high income Lessons Learnt from Turkey’s Challenges to reaching Turkey’s achievements development experience high-income status INCLUSION Turkey’s development model in the 2000s Turkey’s poverty reduction and social Sustaining improvements in social in- has become socially inclusive, as reflected inclusion story have primarily resulted clusion will require continued rapid job in a sharp decline in poverty, significant from sustained economic growth and job creation (including for women), further improvements in the welfare of the bot- creation. Turkey’s sustained fiscal con- reduction of the gap in access to and tom of the income distribution, and large solidation after 2001 has opened space quality of basic services, and a widening reductions in the inequality of access to for spending increases in health, educa- of targeted policies to assist the most vul- basic social services. tion and municipal services which have nerable. Over the medium-term, Turkey supported improved access and greater should prepare for an aging society even economic opportunities for rural-urban if the demographic window will remain migrants. open for some time. Urbanization: Turkey is one of the world’s Rural-urban migration was not restricted In fast growing secondary cities, lack of fastest urbanizers and has created a sys- but facilitated by public policy, with great planning capacity risks growing urban tem of cities that is economically efficient, economic benefits. City planning was sprawl. Turkey’s advanced cities are ef- whilst widening access to municipal ser- consolidated at the municipal level early ficient but could become more livable if vices to the whole population. on in the 1980s. Turkey’s privately-pro- second generation issues of public trans- vided social housing model avoided the port, green and recreational areas, and creation of urban slums. greater public consultation in city plan- ning are addressed. Labor markets: Employment growth since In addition to the strong cyclical upswing, Sustaining job creation at least at histori- the 1980s has roughly kept pace with in- reductions in the tax wedge on labor and cal rates is critical to ensure that Turkey creases in the labor force. Most of the new an expansion of active labor market pro- fully utilizes its demographic window jobs created have been of higher produc- grams contributed to Turkey’s labor mar- of opportunity. With growth likely to tivity, boosting overall growth and social ket performance post-2008. Structural moderate in the medium term, this may progress. The pace of job creation has change, improvements in education, and require targeted measures to boost em- accelerated after 2008, when Turkey cre- the pace of urbanization have ensured ployment, particularly among women, ated more than 4 million new jobs, many that the majority of new jobs created whose labor force participation remains of which at higher skill levels. have been productive ones. far below the other higher middle in- come countries. Creating high produc- tivity jobs going forward also requires steps to reduce the segmentation of labor markets between the formal and informal sectors, whilst increasing over- all labor market flexibility. Welfare: Health and education outcomes Rising spending as well as sector specific Turkey will not enjoy the fiscal divi- have improved significantly addressing eq- reforms have boosted social outcomes. dend of debt consolidation forever and uity as well as access, benefitting also the Extension of the mandatory school age needs to prioritize spending. In looking less well-off. and changes in the curriculum in the late for spending efficiencies, Turkey should 1990s and early 2000s has helped Tur- revisit its social security model, which key catch up on education. In the health is generous particularly thanks to a low sector, a large scale reform effort has age of retirement. Sustaining progress created performance linked incentives, in education will require more spend- supported a shift towards prevention and ing, and also reforms to boost quality in primary care, and vastly improved access the classroom and at the school level. In for the poorer parts of the population. health care, dealing with rising entitle- ments and technology driven cost in- creases present challenges for efficiency. Public finance: Comprehensive structural Conservative budget policies and com- Continued fiscal prudence would sup- reforms in the public sector have support- mitments to primary surpluses were port Turkey’s transition to high-income. ed a sharp and continuing decline in Tur- combined with a wholesale reform of Reforms on both the revenue and expen- key’s public debt to GDP ratio and created public financial management to escape diture side of the budget remain incom- fiscal space for improved public services. from the fiscal politics of patronage and plete, with a highly cyclical revenue base, create a rule-based system for spending growing social entitlements, and pockets allocations, as well as expanding the rev- of spending (particularly in infrastruc- enue base. ture) outside the scope of rule based fiscal governance representing the main challenges. INSTITUTIONS Turkey has recorded significant improve- The pace of institutional reforms has Turkey has yet to establish the institu- ments in institutional performance and slowed since 2007, with only marginal tional foundations for the transition to public sector governance, particularly af- improvements in overall governance, and high income. Improvements across the ter the 2001 crisis and anchored by the EU some concerns over reversals in selected board are needed, including in the busi- Accession negotiations process. areas such as voice and accountability or ness climate, the rule of law, regulatory independent regulators in finance and in- policies, the guarantee of civil and po- frastructure. litical rights, public sector accountability, and decentralized decision making. 261 Turkey’s Transitions Annex 1: Turkey’s Tenth National childhood (ECE) and tertiary education. Securing flexible work arrangements and broadening access Development Plan (NDP) and provision of childcare facilities with the aim to The Tenth NDP stretches from 2014 to 2018 and increase female labor force participation to around 35 percent by 2018 is an additional target. The plan diagnoses the key challenges that Turkey needs to aims to build on İŞKUR’s success and raise the share address to overcome the “Middle Income Trap”. of the unemployed who are hired via İŞKUR to 50 The focus of the NDP is on building Turkey’s human percent in 2018 with active labor market policies and social capital (Pillar 1: Qualified Individuals, based especially on consultancy and orientation. Strong Society), enhancing its competitiveness and The Plan also provides a new approach linking boosting productivity (Pillar 2: Innovative Produc- social assistance policies with employment, thus, tion, Sustainable High Growth), and ensuring Tur- aiming to increase employment among the poorest key’s development progress is in harmony with the segment of the population. environment (Pillar 3: Livable Spaces, Sustainable Environment). There is also a fourth pillar on Inter- The second pillar (Innovative Production and Sus- national Cooperation and Development (see below tainable High Growth) envisages a growth strategy figure). Under these four pillars, the NDP identifies focused on improved competitiveness via increas- 25 priority national spending programs, many of ing the overall TFP of the economy by improving them of a largely cross-sectoral nature reflecting the quality of the regulatory framework in both the complexity of the challenges that Turkey faces the financial and private sectors. There are four as it moves towards high-income. Relative to pre- transformation programs that support this pillar, vious development plans, an increased focus has namely, (i) Improvement of the Doing Business and been placed on monitoring and evaluation (M&E) Investment Environment, (ii) Competition Frame- with specific targets for each program and one en- work, (iii) Increasing R&D and Innovation; and (iv) tire program calling for strengthening Turkey’s sta- Reducing Informality. The Plan’s target of moving tistical and information infrastructure. Turkey’s Doing Business ranking into the top 50 countries requires improvement of the overall qual- Tenth Development Plan (2014 - 2018) Innovative Qualified Liveable Space, International Production, Individuals, Sustainable Cooperation for Sustainable High Strong Society Environment Development Growth 25 Priority Transformation Programs Implementation, Monitoring, Evaluation The first pillar (Qualified Individuals, Strong Soci- ity of the regulatory framework (including competi- ety) emphasizes enhancing the capacity of human tion policy) along with increasing institutional ca- capital through education, health, justice, employ- pacity. The Plan recognizes that a comprehensive ment and social security and public administration framework covering incentives, Small and Medium policies. The first 18 transformation programs fall Enterprises (SMEs), intellectual property rights, In- under this pillar, all emphasizing equal opportuni- formation and Communication Technologies (ICT) ties and shared prosperity, with a specific focus policies is needed to allow an innovation friendly on gender, youth and children. The plan contains system. The Plan also adopts some new approaches ambitious targets for raising enrollment in early and concepts for SME development and entrepre- 262 Chapter 8: Crossing the threshold to high income neurship policies. Female and young entrepreneurs second pillar of improving competitiveness. Com- are targeted in enterprise support policies. petitive cities are emphasized as centers for the knowledge based economy, financial and special- As part of the second pillar, the Plan acknowledges ized services, qualified labor force and R&D. Simi- the achievements in the financial sector - especial- larly, regional development is addressed from the ly the performance of the banking sector - during perspective of national competitiveness. the last decade and highlights some priority areas for future growth. Priority areas for the develop- Turkey’s newly emerging donor role forms the ment of financial sector envisaged in the Plan can core of the fourth pillar. Turkey aims to assume be summarized under three headings; (i) deepen- an active role in international collaboration and ing and diversification of the financial sector, (ii) im- development assistance as an upper middle in- proving financial inclusion; and (iii) strengthening come country. The pillar emphasizes this new role legal and physical infrastructure. through providing financial support to Least De- veloping Countries (LDC), taking an active role in The third pillar (Livable Spaces, Sustainable Envi- international structures/organization such as G20, ronment) introduces the concept of sustainabil- COMCEC, UN, and ECO. The Plan not only makes ity into urbanization and infrastructure policies. reference to the EU Accession process and values It also emphasizes minimizing regional disparities its role as an anchor, but also emphasizes the con- and improving the social and economic benefits of tribution of Turkey to solving the EU’s economic environmental measures. Additionally, this pillar challenges particularly by providing a large pool of analytically links sustainable urbanization with the young and dynamic workers. 263 Turkey’s Transitions References Acemoğlu, D., & Robinson, J. (2012). Why Nations Gill, I., & Kharas, H. (2007). 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Basic Indicators GDP GNI, per Real, per capita Per capita, PPP, PPP, capita, US$ 2012 growth, international $, international $, bil- percent, 2012 lions, 2012 2000-2010 Turkey 10,830 18,348 1358 2.9 BRICS Brazil 11,630 11,716 2327 2.5 Russian Federation 12,700 23,501 3373 5.7 India 1,580 3,813 4716 5.7 China 5,720 9,083 12269 9.6 South Africa 7,610 11,255 576 2.2 EU Members Romania 8,820 17,004 363 4.5 Poland 12,660 22,162 854 4.1 Hungary 12,380 21,959 218 2.4 Bulgaria 6,840 16,044 117 5.1 Czech Republic 18,120 26,698 281 3.3 Slovakia 17,180 25,175 136 4.5 EU Accession Albania 4,030 9,403 30 5.9 Croatia 13,490 20,964 89 3.0 Serbia 5,280 11,801 85 4.2 MENA Morocco 2,960 5,220 173 3.5 Tunisia 4,150 9,636 104 3.5 Egypt 2,980 6,614 534 3.2 Jordan 4,670 6,037 38 3.7 Syrian Arab Republic - 5,347 120 1.9 Growth Markets Mexico 9,640 16,734 2022 0.8 Korea, Republic of 22,670 30,801 1540 4.0 Indonesia 3,420 4,876 1204 3.7 Malaysia 9,820 16,919 495 3.0 Philippines 2,500 4,339 420 2.8 266 Annex Tables Population Old age, Total, Old age, TFP level at Total, Working age, Working age, current PPPs percent, thousands, percent, thousands, 2012 percent, 2012 percent 2050 2012 2050 2050 73,997 66.7 7.3 100,955 63.9 19.3 1.01 198,656 68.1 7.3 232,304 63.1 21.1 0.43 143,533 71.6 13.0 129,908 60 25.7 0.63 1,236,687 65.4 5.2 1,656,554 65.5 14.7 0.46 1,350,695 73.3 8.7 1,303,723 59.5 26.8 0.37 51,189 65.0 5.4 49,401 66.8 11.4 0.58 21,327 70.0 15.0 18,060 56.1 31.3 0.55 38,543 71.0 14.0 32,085 55.4 31.7 0.80 9,944 68.3 17.0 8,490 56.7 29.9 0.56 7,305 67.5 18.9 4,651 53.9 33.8 0.56 10,515 69.2 16.2 10,210 57.1 29 0.59 5,410 72.3 12.7 4,944 56.7 30 0.73 3,162 68.1 10.6 2,824 62.8 24 - 4,267 67.0 18.0 3,864 57 29.6 0.71 7,224 69.5 14.0 5,869 58 29 0.51 32,521 67.2 5.0 42,026 62.3 18.6 0.38 10,778 69.7 7.1 12,180 59.3 24.3 0.45 80,722 63.1 5.6 137,873 64.3 13.1 0.64 6,318 62.4 3.5 11,243 61.8 12.5 0.36 22,399 60.7 3.9 33,658 65.9 13.9 - 120,847 64.7 6.3 150,568 63.9 18 0.72 50,004 72.9 11.8 43,369 53.9 35.9 0.68 246,864 65.6 5.1 300,183 63.8 19 0.38 29,240 68.2 5.2 42,929 63.3 16 0.50 96,707 61.6 3.8 171,964 64.8 11.7 0.33 267 Turkey’s Transitions Table A2. Trade Exports of goods and services Imports of goods and services Exports, US$ Exports, US$ Goods Services (% of GDP) (% of GDP) (in billions) (in billions) 1980 2011 - 2012a 1980 2011 - 2012a 2012 2012 Turkey 5.2 26.4 11.9 31.6 163 44 BRICS Brazil 9.1 12.6 11.3 14.0 243 40 Russian Federation - 29.4 - 22.1 528 62 India 6.0 23.8 9.1 31.5 298 146 China 10.6 27.3 11.0 24.5 1,971 196 South Africa 35.4 28.3 27.3 31.3 93 15 EU Members Romania - 34.2 - 41.4 51 12 Poland - 46.2 - 45.8 191 38 Hungary 39.1 94.0 41.3 86.5 90 22 Bulgaria 35.7 66.6 30.7 70.3 27 7 Czech Republic - 78.0 - 72.4 125 23 Slovakia - 89.2 - 86.6 81 7 EU Accession Albania 23.1 31.3 22.7 49.1 1 2 Croatia - 43.4 - 42.7 12 12 Serbia - 38.2 - 54.2 11 4 MENA Morocco 17.4 36.2 26.7 50.4 17 15 Tunisia 40.2 48.0 45.6 58.6 17 5 Egypt 30.5 17.4 42.9 25.8 27 22 Jordan 40.4 43.9 85.3 74.3 8 6 Syrian Arab Republic 18.6 - 36.1 - - - Growth Markets Mexico 10.7 32.9 13.0 34.5 371 16 Korea, Republic of 32.1 56.5 40.0 53.4 553 111 Indonesia 34.2 24.3 20.2 25.8 187 24 Malaysia 56.7 87.1 54.3 75.3 228 38 Philippines 23.6 30.8 28.5 34.0 46 19 a. Data for the most recent available year 268 Annex Tables Imports of High Export Market Export goods and Global Export Market Share Technology Exports Destination Product services (in billions, % of Manufactured Concentration Concentration % of World Trade current US$) Exports Index Index 2012 2011 1970 1990 2012 2008 -2009 a 2006 - 2009 a 249 1.8 0.21% 0.40% 0.85% 12.3 9.8 304 9.7 0.97% 0.93% 1.36% 17.6 10.7 445 8.0 - - - 15.1 36.3 580 6.9 0.72% 0.53% 1.67% 16.2 14.2 1935 25.8 0.91% 4.35% 13.97% 20.7 9.6 120 5.1 - - - 17.1 15.4 72 10.2 0.66% 0.17% 0.32% 21.4 9.7 229 5.9 1.26% 0.40% 1.01% 24.3 7.9 103 22.7 0.61% 0.28% 0.56% 25.4 13.9 36 7.5 - - - 16.6 13.2 139 16.0 - - - 30.0 9.6 83 7.1 - - - 23.7 18.0 6 0.5 - 0.01% 0.01% 55.8 26.7 24 7.6 - - 0.07% 24.1 12.1 22 - - - 0.06% - 10.6 47 - 0.17% 0.14% 0.11% 23.0 15.9 26 5.6 0.07% 0.11% 0.09% 31.7 17.3 69 0.7 0.27% 0.08% 0.16% 13.6 21.5 23 2.5 0.01% 0.03% 0.04% 20.1 24.6 - - 0.07% 0.12% 0.06% 30.0 34.0 402 16.5 0.47% 0.80% 2.07% 71.4 16.4 622 25.7 0.30% 2.01% 3.07% 24.7 15.7 213 8.3 0.39% 0.76% 1.06% 23.0 12.9 229 43.4 0.60% 0.87% 1.27% 22.4 18.6 76 46.4 0.37% 0.24% 0.29% 29.3 34.6 269 Turkey’s Transitions Table A3. Finance Bank Bank Current Bank credit to Stock market regulatory capital nonperforming account bank capitalization to to risk-weighted loans to gross balance deposits (%) GDP (%) assets (%) loans (%) (% of GDP) 2010-2011a 2011 2011 2011 2012 Turkey 16.5 99.6 2.7 31.0 -6.0 BRICS Brazil 17.3 115.7 3.5 58.3 -2.4 Russian Federation 14.7 110.5 6.6 49.2 3.5 India 14.2 75.8 2.3 68.7 -5.0 China 12.7 251.4 1 58.7 2.3 South Africa 14.9 110.1 4.7 145.2 -6.3 EU Members Romania 13.4 121.1 14.1 15.0 -3.3 Poland 13.1 - 8.2 32.6 -3.7 Hungary 14.2 - 13.3 17.1 1.7 Bulgaria 17.5 - 14.9 14.9 -1.4 Czech Republic 15.3 - 5.5 19.7 -2.4 Slovakia 13.4 90.7 5.6 4.8 2.2 EU Accession Albania 15.6 58.4 18.8 - -10.4 Croatia 19.2 97.3 12.3 38.7 -0.4 Serbia 19.7 118.1 18.8 22.1 -10.7 MENA Morocco 12.3 80.1 4.9 66.4 -10.0 Tunisia - 131.3 - 22.0 -8.3 Egypt 16.4 49.5 11 27.5 -2.7 Jordan 18.2 73.3 8.5 100.1 -18.4 Syrian Arab Republic - - - - - Growth Markets Mexico 15.7 74.4 2.1 37.4 -1.2 Korea, Republic of 14 134.1 1.4 96.2 3.8 Indonesia 16.1 82.5 2.2 45.0 -2.7 Malaysia 17.7 87.0 2.7 144.1 6.1 Philippines 17.4 60.9 3.3 73.9 2.8 a. Data for the most recent available year 270 Annex Tables Domestic Stock market total Foreign credit provided by Cross-border External debt value traded to direct Short-term debt banking sector banking flows stocks GDP (%) investment (% of GDP) net inflows, 2012 2012, 2012 2012 (% of total 2012 2011 (% of GDP) (% of GDP) (% of GNI) external debt) 71.9 50.9 1.6 17.5% 43.1 29.9 110.5 38.8 3.4 8.1% 19.9 7.4 41.5 52.4 2.5 6.5% - - 76.6 46.9 1.3 9.6% 20.8 24.6 155.1 112.4 3.1 4.8% 9.2 67.6 187.2 89.0 1.2 7.5% 36.6 20.3 54.3 1.3 1.1 21.5% 78.9 20.5 63.8 17.1 1.4 13.9% - - 68.7 16.9 7.5 27.2% 173.4 11.2 71.0 0.7 4.1 24.2% 102.9 27.1 68.4 7.1 5.4 12.5% - - - 0.2 1.7 20.0% - - 66.5 - 10.0 5.6% 53.1 21.3 96.3 1.7 2.4 46.9% - - 62.4 0.7 0.9 17.9% 94.8 3.0 115.4 8.8 3.0 9.6% 36.0 12.3 82.3 3.1 3.4 6.4% 58.4 24.5 77.7 12.4 1.1 3.5% 15.7 16.6 114.2 23.4 4.8 15.1% 59.8 56.9 - - - 0.5% 6.7 7.6 47.0 9.5 1.3 7.1% 30.7 20.4 168.7 168.0 0.4 10.2% - - 42.6 16.2 2.2 6.8% 29.9 17.6 134.0 38.9 3.2 11.8% 35.5 45.2 50.9 13.6 1.1 9.2% 24.6 13.8 271 Turkey’s Transitions Table A4. Enterprise GDP Per GDP Per GDP Per GDP Worker Worker Worker     Per Worker Growth Growth Growth Output-side real Annual Average Annual Average Annual Average Average Average GDP at chained Compound Compound Compound TFP Growth TFP Growth PPPs in 2005US$ Growth Rate Growth Rate Growth Rate 2011 1980-1989 1990-1999 2000-2009 1991-2000 2001-2010 Turkey 47,729 3.4% 0.3% 3.8% -0.8% 0.5% BRICS Brazil 16,805 0.3% 4.9% -0.2% -0.3% 0.5% Russian Federation 35,283 - -9.0% 6.7% -4.0% 4.1% India 9,404 0.3% 4.2% 5.6% 1.5% 1.4% China 13,826 3.2% 5.3% 7.7% 4.2% 3.1% South Africa 21,050 -1.2% -2.4% 1.3% -1.9% 0.1% EU Members Romania 30,968 1.0% 3.0% 8.5% -0.6% 2.9% Poland 42,279 5.1% 7.2% 2.2% 3.3% 1.8% Hungary 39,424 2.4% 3.2% 2.6% 0.0% 1.1% Bulgaria 25,695 4.3% 0.9% 2.2% -2.1% 0.5% Czech Republic 42,265 - -0.8% 1.6% -1.6% 1.5% Slovakia 47,644 - 0.5% 3.7% -0.3% 3.0% EU Accession Albania 26,036 -0.6% 1.2% 7.0% - - Croatia 48,180 - -1.1% 3.0% -1.9% 1.2% Serbia 29,204 - -0.1% 4.1% -5.0% 3.9% MENA Morocco 10,047 3.5% -1.1% 0.0% -0.9% 0.8% Tunisia 16,757 2.0% 1.8% -1.2% 1.3% 0.7% Egypt 15,145 5.1% 8.3% 0.8% -0.6% -1.5% Jordan 18,775 0.0% -5.3% 5.6% -1.2% 3.0% Syrian Arab Republic 15,152 -6.7% -2.0% 12.9% - - Growth Markets Mexico 30,473 -3.0% -0.2% 0.5% -0.2% -1.3% Korea, Republic of 58,865 6.9% 5.0% 2.5% 0.7% 0.5% Indonesia 9,329 1.2% 1.1% 2.5% -1.0% 0.9% Malaysia 25,142 -0.2% 1.3% 1.3% 0.0% 0.7% Philippines 9,549 0.2% -0.5% -0.7% -0.7% 1.0% a. Data for the most recent available year 272 Annex Tables Research and Employment Employment Employment Employment Employment Employment development Expenditure Agriculture Agriculture Industry Industry Services Services (% of GDP) 2010 - 2012a, % 2010 - 2012a, % 2010 - 2012a, % 1990, % of Total 1990, % of Total 1990, % of Total of Total Employ- of Total Employ- of Total Employ- 2010 - 2011 a Employment Employment Employment ment ment ment 46.9 23.6 20.7 26.0 32.4 50.4 0.8 22.8 15.3 22.7 21.9 54.5 62.7 1.2 13.9 - 40.2 - 45.6 - 1.1 - 47.2 - 24.7 - 28.1 - 60.1 34.8 21.4 29.5 18.5 35.7 1.8 - 4.6 - 24.3 - 62.7 - 29.1 29.0 43.5 28.6 27.4 42.4 0.5 25.2 12.6 37.0 30.4 35.8 57.0 0.8 18.2 5.2 36.8 29.8 45.0 64.9 1.2 18.5 6.4 44.2 31.3 37.3 62.2 0.6 - 3.1 - 38.1 - 58.8 1.8 - 3.2 - 37.5 - 59.2 0.7 - 41.5 - 20.8 - 37.7 - - 13.7 - 27.4 - 58.7 0.7 - 21.0 - 26.5 - 52.6 0.7 3.9 39.2 36.4 21.4 59.5 39.3 0.7 - 16.2 - 33.5 - 49.6 - 39.0 29.2 20.7 23.5 40.1 47.1 0.4 - 2.0 - 17.5 - 80.5 - - 14.3 - 32.7 - 53.0 - 22.6 13.4 27.8 24.1 46.1 61.9 0.5 17.9 6.6 35.4 17.0 46.7 76.4 3.7 55.9 35.9 13.7 20.6 30.2 43.5 - 26.0 12.6 27.5 28.4 46.5 59.0 1.1 45.2 32.2 15.0 15.4 39.7 52.5 - 273 Turkey’s Transitions Table A5. Urbanization Urban population Improved sanitation Improved sanitation Urban population growth facilities facilities Average of Annual rural, 2011 (% of rural urban 2011 (% of 2012, (% of total) Growth Rates population with ac- urban population with 1960 - 2012 cess) access) Turkey 72.3 3.5 75.5 97.2 BRICS Brazil 84.9 3.1 48.4 86.7 Russian Federation 74.0 1.0 59.3 74.4 India 31.7 3.0 23.9 59.7 China 51.8 3.6 55.8 74.1 South Africa 62.4 2.7 57.1 84.3 EU Members Romania 52.8 1.2 - - Poland 60.8 1.0 - 95.5 Hungary 69.9 0.4 100 100 Bulgaria 73.6 1.2 100 100 Czech Republic 73.4 0.6 100 100 Slovakia 54.7 1.5 99.6 99.9 EU Accession Albania 54.4 2.4 93 94.7 Croatia 58.1 1.4 97.6 98.6 Serbia 56.7 - 95.6 98.5 MENA Morocco 57.4 3.2 52 83.1 Tunisia 66.5 2.9 75 97.3 Egypt 43.7 2.4 93.5 96.9 Jordan 83.0 4.9 98 98.1 Syrian Arab Republic 56.5 3.9 94 96.1 Growth Markets Mexico 78.4 3.1 77.4 86.7 Korea, Republic of 83.5 3.5 100 100 Indonesia 51.4 4.4 43.5 73.4 Malaysia 73.4 4.4 94.6 96.1 Philippines 49.1 3.5 69.3 79.2 274 Annex Tables Combustible Improved water source Improved water source CO2 emissions renewables and waste rural 2011 (% of rural urban 2011(% of urban metric tons per capita, % of total energy, 2011 population with access) population with access) 2010 99.1 100 4.1 3.3 84.5 99.5 2.2 28.9 92.2 98.7 12.2 1.0 89.5 96.3 1.7 24.7 84.9 98.4 6.2 7.9 79.3 99 9.2 10.3 - 98.5 3.7 10.3 - 100 8.3 8.1 100 100 5.1 7.2 99 99.7 5.9 5.1 99.6 99.9 10.6 6.5 100 100 6.6 5.5 93.7 95.5 1.4 9.6 96.8 99.8 4.7 5.6 98.9 99.5 6.3 6.4 60.8 98.2 1.6 2.8 89.2 100 2.5 14.6 98.8 100 2.6 2.1 90.5 97.3 3.4 0.1 86.5 92.6 2.9 0.0 89.3 95.9 3.8 4.4 87.9 99.7 11.5 1.5 75.5 92.8 1.8 25.4 98.5 100 7.7 4.6 92.1 92.7 0.9 17.1 275 Turkey’s Transitions Table A6. Labor Labor Force Labor Force Unemployment Employment Employment Participation Participation Rate Creation Rate 2009 - 2012, Total, %, 2010- Annual Average Total, % , 2012 Female, %, 2012 Total, %, 2012 12 a Compound Growth Rate Turkey 53.5 32.2 9.2 4.9% 44.9 BRICS Brazil 74.9 64.8 6.7 2.0% 65.0 Russian Federation 73.1 68.4 5.5 1.3% 60.0 India 57.9 30.3 3.6 1.5% 53.7 China 77.0 70.0 - 0.6% 68.0 South Africa 55.7 48.5 25.0 0.0% 38.8 EU Members Romania 64.5 56.6 7.0 0.0% 52.3 Poland 66.7 60.0 10.1 0.5% 50.8 Hungary 64.2 58.3 10.9 0.7% 46.2 Bulgaria 67.2 63.3 12.3 -4.1% 46.6 Czech Republic 71.4 63.3 7.0 -0.1% 54.7 Slovakia 69.6 61.9 13.9 -0.3% 51.2 EU Accession Albania 62.8 51.7 14.2 0.7% 47.0 Croatia 63.8 58.2 15.8 -4.5% 43.2 Serbia - - 23.9 -1.9% 42.0 MENA Morocco 58.9 52.0 9.0 1.5% 45.8 Tunisia 51.0 27.2 18.3 1.9% 41.4 Egypt 52.4 25.6 12.7 1.4% 43.2 Jordan 43.3 16.2 12.2 1.9% 36.2 Syrian Arab Republic 45.6 14.2 8.4 2.6% 39.9 Growth Markets Mexico 64.9 48.1 4.9 2.9% 58.6 Korea, Republic of 65.7 55.1 3.2 1.6% 58.8 Indonesia 70.0 53.4 6.6 2.0% 63.3 Malaysia 62.2 46.8 3.0 2.6% 57.5 Philippines 67.0 52.6 7.0 3.1% 60.7 276 Annex Tables Labor force with less Notice period for Severance pay for Female Part Time Employment Rate than secondary redundancy redundancy Employment education dismissal dismissal % of Total 2014, average for 2014, average for Part Time % of total, workers with 1, 5 and workers with 1, 5 and Young (15-24), %, 2012 Employment, 2010 - 2012 a 10 years of tenure, in 10 years of tenure, in 2009-12a salary weeks salary weeks 32.8 60.0 61.4 6.7 23.1 53.3 67.5 46.4 6.6 8.9 33.4 64.5 - 8.7 8.7 34.0 - 54.7 4.3 11.4 50.8 - - 4.3 23.1 12.5 65.4 52.5 4 5.3 23.9 48.6 22.8 4 0 24.9 67.6 7.5 10.1 8.7 18.7 64.6 12.8 6.2 7.2 21.6 53.2 13.3 4.3 3.2 25.2 69.7 5.6 8.7 11.6 20.3 59.4 5.8 11.6 7.2 26.3 - - 10.1 10.7 16.3 54.3 14.9 7.9 7.2 15.5 - 20.3 0 7.7 29.9 - 79.2 7.2 13.5 22.2 - 42.7 4.3 7.8 21.9 - 43.6 10.1 26.7 16.9 - 49.3 4.3 0 24.4 27.4 - 8.7 0 43.3 56.7 31.7 0 22 24.9 61.0 - 4.3 23.1 39.6 - - 0 57.8 35.7 - 19.8 6.7 17.2 40.7 - - 4.3 23.1 277 Turkey’s Transitions Table A7. Welfare Infant Life Total Gross Health Health Mortality expectancy Dependency Enrollment Expenditures Expenditures Rate at birth Ratio Rate Pre-Primary per 1000 live Total, % of Public, % of 0-14 and 65+, (36-72 years, 2011 births, 2012 GDP, 2011 GDP, 2011 2012 months), 2010 - 2012 a Turkey 12.2 74.5 6.7 5.0 0.50 29.2 BRICS Brazil 12.9 73.3 8.9 4.1 0.47 - Russian Federation 8.9 69.0 6.2 3.7 0.40 - India 43.8 66.0 3.9 1.2 0.53 58.1 China 12.1 75.0 5.2 2.9 0.36 62.0 South Africa 33.3 55.3 8.5 4.1 0.54 76.5 EU Members Romania 10.7 74.5 5.8 4.7 0.43 77.9 Poland 4.3 76.7 6.7 4.8 0.41 73.7 Hungary 5.3 74.9 7.7 5.0 0.46 86.9 Bulgaria 10.5 74.2 7.3 4.0 0.48 85.1 Czech Republic 3.1 77.9 7.4 6.2 0.44 103.3 Slovakia 6.3 76.0 8.7 5.5 0.38 90.1 EU Accession Albania 15 77.2 6.3 2.8 0.47 68.8 Croatia 4 76.9 7.8 6.6 0.49 64.1 Serbia 5.7 74.6 10.4 6.5 0.44 55.8 MENA Morocco 26.8 70.4 6.0 2.1 0.49 59.2 Tunisia 13.8 74.8 6.2 3.4 0.43 - Egypt 17.9 70.7 4.9 2.0 0.58 27.4 Jordan 16.4 73.6 8.4 5.7 0.60 33.8 Syrian Arab Republic 12.3 74.8 3.7 1.8 0.65 10.6 Growth Markets Mexico 13.9 76.9 6.2 3.0 0.54 99.4 Korea, Republic of 3.3 80.9 7.2 4.1 0.37 117.7 Indonesia 25.8 70.4 2.7 0.9 0.52 41.5 Malaysia 7.3 74.7 3.6 1.6 0.47 77.7 Philippines 23.5 68.4 4.1 1.4 0.62 - a. Data for the most recent available year b. Shanghai - China 278 Annex Tables Gross Gross Gross Number of Physi- PISA Score PISA Score PISA Score Enrollment Rate Enrollment Rate Enrollment Rate cians Secondary, Secondary, Tertiary, per 1000 people, Math Reading Science Female, 2010 - 2012 a 2010 - 2012 a 2010 - 2011 a Average, 2012 Average, 2012 Average, 2012 2010 - 2012 a 88.9 85.0 60.7 1.7 448 475 463 - - - 1.8 391 410 405 - - - 4.3 482 475 486 68.5 66.3 23.3 0.6 - - - 86.6 87.3 24.3 1.8 613 b 570 b 580 b 101.9 103.5 - 0.8 - - - 96.0 95.1 51.6 2.4 445 438 439 97.4 96.7 73.5 2.1 518 518 526 100.8 99.7 59.5 3.4 477 488 494 93.2 90.8 59.6 3.8 439 436 446 96.0 96.1 64.6 3.7 499 493 508 93.5 93.8 55.1 3.0 482 463 471 - - 54.9 1.1 394 394 397 98.0 99.9 58.8 2.7 471 485 491 91.7 92.6 52.4 2.1 449 446 445 68.9 63.4 16.2 0.6 - - - 91.1 93.3 35.2 1.2 388 404 398 75.9 74.4 28.8 2.8 - - - 89.1 90.6 39.9 2.6 386 399 409 74.4 74.6 25.6 1.5 - - - 84.1 87.2 27.7 2.0 413 424 415 96.7 96.0 100.8 2.0 554 536 538 81.2 81.6 27.2 0.3 375 396 382 66.9 65.9 37.1 1.2 421 398 420 - - - 279 Turkey’s Transitions Table A8. Fiscal General government General General General primary net lending government total government gross debt government revenue borrowing expenditure Percent of GDP, Percent of GDP, Percent of GDP, Percent of GDP, 2012 2009 - 2011 Avr. 2009 - 2011 Avr. 2009 - 2011 Avr. Turkey 36.2 0.4 36.7 33.5 BRICS Brazil 68.0 2.6 39.0 36.3 Russian Federation 12.5 -2.4 38.4 35.7 India 66.7 -4.5 27.6 18.7 China 26.1 - 23.3 21.4 South Africa 42.3 -2.5 32.5 27.6 EU Members Romania 38.2 -4.7 38.0 32.0 Poland 55.6 -4.1 44.5 37.7 Hungary 79.2 2.3 50.3 48.7 Bulgaria 17.6 -2.0 35.8 33.5 Czech Republic 45.9 -3.5 43.9 39.3 Slovakia 52.1 -5.7 40.0 33.0 EU Accession Albania 61.4 -1.8 30.9 25.9 Croatia 53.7 -2.9 43.0 38.1 Serbia 61.8 - 45.8 41.8 MENA Morocco 60.5 -2.0 32.5 28.2 Tunisia 44.0 0.0 32.1 30.3 Egypt 80.6 -4.1 33.3 25.0 Jordan 79.6 -5.0 33.0 25.9 Syrian Arab Republic - - - 22.4 Growth Markets Mexico 43.5 - 26.8 22.6 Korea, Republic of 35.0 0.4 21.8 23.0 Indonesia 24.5 - 18.3 17.1 Malaysia 55.5 -3.4 29.5 24.7 Philippines 41.9 1.1 19.1 17.2 280 Annex Tables WGI Control of WGI Government Ef- WGI Voice and Tax revenue Open Budget Index Corruption fectiveness Accountability Percent of GDP, Percentile Rank 2013 Percentile Rank 2013 Percentile Rank 2013 Country Rank, 2012 2009 - 2011 Avr. 19.9 62 66 41 42 15.1 55 51 59 12 13.7 17 43 19 10 10.0 36 47 61 14 10.5 47 54 5 86 25.8 55 67 65 2 16.8 53 53 57 49 16.7 71 71 78 25 22.8 65 70 70 - 19.7 50 59 58 17 13.4 63 75 77 9 12.5 60 73 76 15 - 26 44 51 52 19.1 61 71 63 22 22.3 51 50 57 61 23.7 46 52 28 64 20.3 54 55 45 85 14.6 33 20 18 82 16.0 61 50 25 30 - 8 8 4 - - 39 63 54 23 15.4 70 82 68 8 11.4 32 45 49 20 14.6 68 82 37 62 12.3 44 57 48 47 281 Turkey’s Transitions Table A9. Infrastructure Fixed broadband Logistics Mobile cellular Road density Internet performance index subscriptions subscribers 2009 - 2010a (km of Overall (1=low to road per 100 sq. km of (per 100 people), 2012 (per 100 people), 2012 5=high), 2012 land area) Turkey 3.5 46.9 10.5 90.8 BRICS Brazil 3.1 18.6 9.2 125.2 Russian Federation 2.6 6.0 14.5 183.5 India 3.1 - 1.1 68.7 China 3.5 41.8 13.0 81.3 South Africa 3.7 - 2.2 134.8 EU Members Romania 3.0 34.3 15.9 106.1 Poland 3.4 129.9 16.6 132.7 Hungary 3.2 214.5 22.9 116.4 Bulgaria 3.2 17.5 17.6 145.7 Czech Republic 3.1 165.7 16.6 122.8 Slovakia 3.0 89.6 14.6 111.2 EU Accession Albania 2.8 - 5.0 108.4 Croatia 3.2 51.8 20.3 113.3 Serbia 2.8 50.1 10.2 92.8 MENA Morocco 3.0 13.1 2.1 119.7 Tunisia 3.2 11.9 4.8 120.0 Egypt 3.0 13.7 2.7 115.3 Jordan 2.6 7.9 3.0 139.1 Syrian Arab Republic 2.6 37.7 1.8 61.2 Growth Markets Mexico 3.1 18.9 10.9 86.8 Korea, Republic of 3.7 105.0 37.6 110.4 Indonesia 2.9 25.0 1.2 115.2 Malaysia 3.5 43.7 8.4 140.9 Philippines 3.0 - 2.2 106.8 a. Data for the most recent available year 282 Annex Tables Quality of Procedures Quality of Cost to get Electricity and Telephone lines required to connect Transport Infrastructure electricity Telephony to electricity Infrastructure Infrastructure (per 100 people), (% of income per Country Rank, Country Rank, Country Rank, (number), 2012 2012 capita), 2012 2013 - 2014 2013 - 2014 2013 - 2014 18.6 517.9 5 27 87 49 22.3 116.7 6 75 64 71 30.1 1573.7 10 48 44 45 2.5 247.3 7 34 120 85 20.6 547.0 5 26 79 48 7.9 1505.8 5 38 94 66 21.9 584.2 7 122 82 100 16.0 208.3 6 92 60 74 29.8 116.9 5 71 43 51 30.4 340.7 6 97 62 75 19.9 180.0 6 49 40 39 17.8 249.1 5 83 51 67 9.7 573.7 6 108 93 99 37.4 318.7 5 60 37 42 30.2 502.6 4 126 67 90 10.1 2515.2 5 45 71 57 10.3 878.5 4 74 73 77 10.2 396.0 7 79 101 98 6.7 292.3 5 61 59 54 20.9 902.9 5 - - - 17.4 382.8 7 39 92 64 61.9 33.3 4 9 21 11 15.5 1243.8 6 40 90 61 15.7 53.9 5 15 48 29 4.1 833.3 5 84 98 96 283 Turkey’s Transitions 284 Sources and Definitions Sources and Definitions Infrastructure Finance Fiscal Space Trade Welfare Enterprise Cities Labor Turkey’s Transitions: Integration, Inclusion, Institutions 285 Turkey’s Transitions 286 Sources and Definitions Table A1. Basic Indicators     Indicator Sources Definitions GNI per capita (formerly GNP per capita) is the gross national income, converted to U.S. dollars using the World Bank Atlas GNI, per capita, US$ 2012 WB - WDI method, divided by the midyear population. To smooth fluctuations in prices and exchange rates, a special Atlas method of conversion is used by the World Bank. GDP per capita based on purchasing power parity (PPP). PPP GDP is gross domestic product converted to international GDP, Per capita, PPP, international $, WB - WDI dollars using purchasing power parity rates. An international 2012 dollar has the same purchasing power over GDP as the U.S. dollar has in the United States. GDP, PPP, international $, billions, GDP, adjusted by PPP, expressed in billions of current WB - WDI 2012 international dollars. Average growth of real GDP Average Annual percentage growth rate of GDP per capita WB - WDI per capita, percent, 2000-2010 based on constant local currency over 2000-2010 Total population is based on the de facto definition of population, which counts all residents regardless of legal status or citizenship--except for refugees not permanently Population, Total, thousands, 2012 WB - WDI settled in the country of asylum, who are generally considered part of the population of their country of origin. The values shown are midyear estimates. The series is expressed in thousands. The working age population is defined as people ages 15- Population, Working age, percent, 64. Working age population is the percentage of the total WB - WDI 2012 population that is in the age group 15 to 64. Population is based on the de facto definition of population. Old age populations as a percentage of the total population. Population, Old age, percent, 2012 WB - WDI Population is based on the de facto definition of population. The old age population includes people ages 65 and older Total number of people living in a country in 2050, projected Population Total, thousands, 2050 U.S. Census by the U.S. Census. Working age population in 2050, projected by the U.S. Population, Working age, percent, U.S. Census Census. The series is expressed as a percentage of total 2050 population. Old age population in 2050, projected by the U.S. Census, as Population, Old age, percent, 2050 U.S. Census a percentage of total population. 287 Turkey’s Transitions Table A2. Trade     Indicator Sources Definitions Exports of goods and services represent the value of all goods and other market services provided to the rest of the world. They include the value of merchandise, freight, insurance, Exports of goods and services transport, travel, royalties, license fees, and other services, WB - WDI (percent of GDP) such as communication, construction, financial, information, business, personal, and government services. They exclude compensation of employees and investment income (formerly called factor services) and transfer payments Imports of goods and services represent the value of all goods and other market services received from the rest of the world. They include the value of merchandise, freight, insurance, transport, travel, royalties, license fees, and other Imports of goods and services WB - WDI services, such as communication, construction, financial, (percent of GDP) information, business, personal, and government services. They exclude compensation of employees and investment income (formerly called factor services) and transfer payments Goods exports refer to all movable goods (including nonmonetary gold and net exports of goods under Exports of Goods (in billions US$) WB - WDI merchanting) involved in a change of ownership from residents to nonresidents. Data are in current U.S. dollars Services refer to economic output of intangible commodities Exports of Services (in billions US$) WB - WDI that may be produced, transferred, and consumed at the same time. Data are in current U.S. dollars. Imports of goods and services comprise all transactions between residents of a country and the rest of the world Imports of goods and services WB - WDI involving a change of ownership from nonresidents to (in billions current US$) residents of general merchandise, nonmonetary gold, and services. Data are in current U.S. dollars. High-technology exports are products with high R&D High Technology Exports as a percent WB - WDI intensity, such as in aerospace, computers, pharmaceuticals, of Manufactured Exports scientific instruments, and electrical machinery. Global export market share percent IMF - DOTS Share of exports of a specific country in total world trade.  of World Trade Export market destination concentration index - This Export Market Destination WB - WTI indicator reflects the Herfindahl-Hirschmann index measure Concentration Index of the degree of export market concentration of a country. Export product concentration index - this indicator reflects Export Product Concentration Index WB - WTI the Herfindahl-Hirschmann index measure of the degree of export product concentration of a country. 288 Sources and Definitions Table A3. Finance     Indicator Sources Definitions The capital adequacy of deposit takers. It is a ratio of total Bank regulatory capital to WB- GFD regulatory capital to its assets held, weighted according to risk risk-weighted assets (%) Database of those assets. The financial resources provided to the private sector by domestic money banks as a share of total deposits. Domestic WB- GFD money banks comprise commercial banks and other financial Bank credit to bank deposits (%) Database institutions that accept transferable deposits, such as demand deposits. Total deposits include demand, time and saving deposits in deposit money banks. Ratio of defaulting loans (payments of interest and principal past due by 90 days or more) to total gross loans (total value Bank nonperforming loans to gross WB- GFD of loan portfolio). The loan amount recorded as nonperforming loans (%) Database includes the gross value of the loan as recorded on the balance sheet, not just the amount that is overdue Stock market capitalization WB- GFD Total value of all listed shares in a stock market as a percentage to GDP (%) Database of GDP. Current account balance is the sum of net exports of goods and Current account balance (% of GDP) WB - WDI services, net primary income, and net secondary income Domestic credit provided by the banking sector includes all credit to various sectors on a gross basis, with the exception of credit to the central government, which is net. The banking sector includes monetary authorities and deposit money banks, Domestic credit provided by banking WB - WDI as well as other banking institutions where data are available sector (% of GDP) (including institutions that do not accept transferable deposits but do incur such liabilities as time and savings deposits). Examples of other banking institutions are savings and mortgage loan institutions and building and loan associations. Stock market total value traded WB- GFD Total value of all traded shares in a stock market exchange as a to GDP (%) Database percentage of GDP. Foreign direct investment are the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy Foreign direct investment WB - WDI other than that of the investor. It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short- term capital as shown in the balance of payments. Bank for Cross-border banking flows International External loans and deposits of reporting banks vis-à-vis all (% of GDP) Settlements sectors. Vis-à-vis individual countries. (BIS) Total external debt stocks to gross national income. Total external debt is debt owed to nonresidents repayable in currency, goods, or services. Total external debt is the sum of public, publicly guaranteed, and private nonguaranteed long- term debt, use of IMF credit, and short-term debt. Short-term External debt stocks (%of GNI) WB - WDI debt includes all debt having an original maturity of one year or less and interest in arrears on long-term debt. GNI (formerly GNP) is the sum of value added by all resident producers plus any product taxes (less subsidies) not included in the valuation of output plus net receipts of primary income (compensation of employees and property income) from abroad Short-term debt includes all debt having an original maturity of one year or less and interest in arrears on long-term debt. Short-term debt (% of total external Total external debt is debt owed to nonresidents repayable in WB - WDI debt) currency, goods, or services. Total external debt is the sum of public, publicly guaranteed, and private nonguaranteed long- term debt, use of IMF credit, and short-term debt 289 Turkey’s Transitions Table A4. Enterprise     Indicator Sources Definitions Penn World Ratio of Output-side real GDP at chained PPPs in 2005US$ to GDP per Worker Table Version number of persons engaged 8.0 Penn World GDP per Worker Growth Table Version Average annual compound growth rate of GDP per Worker 8.0 Penn World Average annual growth rate of TFP at constant national Average TFP Growth Table Version prices (2005=1) 8.0 Employees are people who work for a public or private employer and receive remuneration in wages, salary, Employment in Agriculture commission, tips, piece rates, or pay in kind. Agriculture WB - WDI (% of Total Employment) corresponds to division 1 (ISIC revision 2) or tabulation categories A and B (ISIC revision 3) and includes hunting, forestry, and fishing. Employees are people who work for a public or private employer and receive remuneration in wages, salary, commission, tips, piece rates, or pay in kind. Industry Employment in Industry WB - WDI corresponds to divisions 2-5 (ISIC revision 2) or tabulation (% of Total Employment) categories C-F (ISIC revision 3) and includes mining and quarrying (including oil production), manufacturing, construction, and public utilities (electricity, gas, and water). Employees are people who work for a public or private employer and receive remuneration in wages, salary, commission, tips, piece rates, or pay in kind. Services correspond to divisions 6-9 (ISIC revision 2) or tabulation Employment in Services WB - WDI categories G-P (ISIC revision 3) and include wholesale and (% of Total Employment) retail trade and restaurants and hotels; transport, storage, and communications; financing, insurance, real estate, and business services; and community, social, and personal services Expenditures for research and development are current and capital expenditures (both public and private) on creative Research and Development work undertaken systematically to increase knowledge, WB - WDI Expenditure (%of GDP) including knowledge of humanity, culture, and society, and the use of knowledge for new applications. R&D covers basic research, applied research, and experimental development 290 Sources and Definitions Table A5. Urbanization     Indicator Sources Definitions Urban population refers to people living in urban areas as defined by national statistical offices. It is calculated using Urban Population (% of Total) WB - WDI World Bank population estimates and urban ratios from the United Nations World Urbanization Prospects Urban Population Growth WB - WDI Average of annual growth rate in urban population Access to improved sanitation facilities refers to the percentage of the population using improved sanitation facilities. The improved sanitation facilities include flush/ Improved Sanitation Facilities WB - WDI pour flush (to piped sewer system, septic tank, pit latrine), ventilated improved pit (VIP) latrine, pit latrine with slab, and composting toilet. Access to an improved water source refers to the percentage of the population using an improved drinking water source. The improved drinking water source includes piped water on premises (piped household water connection located Improved Water Source WB - WDI inside the user’s dwelling, plot or yard), and other improved drinking water sources (public taps or standpipes, tube wells or boreholes, protected dug wells, protected springs, and rainwater collection). Carbon dioxide emissions are those stemming from the CO2 emissions, metrics tons per burning of fossil fuels and the manufacture of cement. They WB - WDI capita include carbon dioxide produced during consumption of solid, liquid, and gas fuels and gas flaring Combustible renewables and waste comprise solid biomass, Combustible renewables and waste WB - WDI liquid biomass, biogas, industrial waste, and municipal (% of total energy) waste, measured as a percentage of total energy use 291 Turkey’s Transitions Table A6. Labor     Indicator Sources Definitions Labor force participation rate is the proportion of the population ages 15-64 that is economically active: all people Labor Force Participation Rate WB - WDI who supply labor for the production of goods and services during a specified period Unemployment refers to the share of the labor force that is without work but available for and seeking employment. Unemployment Rate WB - WDI Definitions of labor force and unemployment differ by country. Annual average compound growth rate in total employment Employment Creation WB - WDI between 2009 - 2012. Employment to population ratio is the proportion of a Employment Rate, Total WB - WDI country’s population that is employed. Ages 15 and older are generally considered the working-age population Employment to population ratio is the proportion of a Employment Rate, Young WB - WDI country’s population that is employed. Ages 15-24 are generally considered the young population Part time employment refers to regular employment in which Female Part-Time Employment WB - WDI working time is substantially less than normal. Definitions of (% of total part-time employment) part time employment differ by country. Labor force with less than secondary education is the Labor force with less than WB - WDI proportion of the labor force that has a less than secondary secondary education education, as a percentage of the total labor force. Notice period for redundancy WB - Doing Notice period for redundancy dismissal. Average for workers dismissal Business with 1, 5 and 10 years of tenure, in salary weeks Severance pay for redundancy WB - Doing Severance pay for redundancy dismissal. Average for workers dismissal Business with 1, 5 and 10 years of tenure, in salary weeks 292 Sources and Definitions Table A7. Welfare     Indicator Sources Definitions Infant mortality rate, per Infant mortality rate is the number of infants dying before WB - WDI 1000 live births reaching one year of age, per 1,000 live births in a given year. Life expectancy at birth indicates the number of years a newborn infant would live if prevailing patterns of mortality Life expectancy at birth WB - WDI at the time of its birth were to stay the same throughout its life. Total health expenditure is the sum of public and private health expenditure. It covers the provision of health services Total Health Expenditures % of GDP WB - WDI (preventive and curative), family planning activities, nutrition activities, and emergency aid designated for health but does not include provision of water and sanitation. Public health expenditure consists of recurrent and capital spending from government (central and local) budgets, Public Health Expenditures % of GDP WB - WDI external borrowings and grants (including donations from international agencies and nongovernmental organizations), and social (or compulsory) health insurance funds. Dependency ratio is the ratio of dependents--people younger Total Dependency Ratio WB - WDI than 15 or older than 64--to the working-age population-- those ages 15-64. Gross enrollment ratio is the ratio of total enrollment, regardless of age, to the population of the age group that officially corresponds to the level of education shown. Gross Enrollment Rate, Pre-Primary WB - WDI Preprimary education refers to the initial stage of organized instruction, designed primarily to introduce very young children to a school-type environment Gross enrollment ratio is the ratio of total enrollment, regardless of age, to the population of the age group that officially corresponds to the level of education shown. Secondary education completes the provision of basic Gross Enrollment Rate, Secondary WB - WDI education that began at the primary level, and aims at laying the foundations for lifelong learning and human development, by offering more subject- or skill-oriented instruction using more specialized teachers Gross enrollment ratio is the ratio of total enrollment, regardless of age, to the population of the age group that officially corresponds to the level of education shown. Gross Enrollment Rate, Tertiary WB - WDI Tertiary education, whether or not to an advanced research qualification, normally requires, as a minimum condition of admission, the successful completion of education at the secondary level. Physicians include generalist and specialist medical Number of Physicians WB - WDI practitioners The Programme for International Student Assessment (PISA) is a triennial international survey which aims to evaluate education systems worldwide by testing the skills PISA Scores OECD and knowledge of 15-year-old students. Fifteen-year-old students from randomly selected schools worldwide take tests in the key subjects: reading, mathematics and science, with a focus on one subject in each year of assessment. 293 Turkey’s Transitions Table A8. Fiscal     Indicator Sources Definitions Gross debt consists of all liabilities that require payment or payments of interest and/or principal by the debtor to the creditor at a date or dates in the future. This includes debt liabilities in the form of SDRs, IMF - World currency and deposits, debt securities, loans, insurance, pensions and General government Economic standardized guarantee schemes, and other accounts payable. Thus, gross debt all liabilities in the GFSM 2001 system are debt, except for equity and Outlook investment fund shares and financial derivatives and employee stock options. Debt can be valued at current market, nominal, or face values (GFSM 2001, paragraph 7.110). IMF - World General government primary Primary net lending/borrowing is net lending (+)/borrowing (–) plus net Economic net lending/borrowing interest payable/paid (interest expense minus interest revenue). Outlook Total expenditure consists of total expense and the net acquisition of IMF - World nonfinancial assets. Note: Apart from being on an accrual basis, total General government total Economic expenditure differs from the GFSM 1986 definition of total expenditure expenditure in the sense that it also takes the disposals of nonfinancial assets into Outlook account Revenue consists of taxes, social contributions, grants receivable, and other revenue. Revenue increases government’s net worth, which is IMF - World the difference between its assets and liabilities (GFSM 2001, paragraph General government Economic 4.20). Note: Transactions that merely change the composition of the revenue balance sheet do not change the net worth position, for example, Outlook proceeds from sales of nonfinancial and financial assets or incurrence of liabilities. Tax revenue refers to compulsory transfers to the central government for public purposes. Certain compulsory transfers such as fines, Tax Revenue % of GDP WB-WGI penalties, and most social security contributions are excluded. Refunds and corrections of erroneously collected tax revenue are treated as negative revenue. Control of Corruption captures perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as “capture” of the state by elites and private interests. Percentile rank indicates the country’s rank among WGI Control of Corruption WB-WGI all countries covered by the aggregate indicator, with 0 corresponding to lowest rank, and 100 to highest rank. Percentile ranks have been adjusted to correct for changes over time in the composition of the countries covered by the WGI. Government Effectiveness captures perceptions of the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government’s WGI Government WB-WGI commitment to such policies. Percentile rank indicates the country’s Effectiveness rank among all countries covered by the aggregate indicator, with 0 corresponding to lowest rank, and 100 to highest rank. Percentile ranks have been adjusted to correct for changes over time in the composition of the countries covered by the WGI. Voice and Accountability captures perceptions of the extent to which a country’s citizens are able to participate in selecting their government, as well as freedom of expression, freedom of WGI Voice and association, and a free media. Percentile rank indicates the country’s WB-WGI Accountability rank among all countries covered by the aggregate indicator, with 0 corresponding to lowest rank, and 100 to highest rank. Percentile ranks have been adjusted to correct for changes over time in the composition of the countries covered by the WGI. The Open Budget Survey countries from around the world, International measuring three aspects of how governments are managing public Open Budget Index Budget finances: Budget transparency, budget participation, budget Partnership oversight. 294 Sources and Definitions Table A9. Infrastructure     Indicator Sources Definitions Logistics Performance Index overall score reflects perceptions of a country’s logistics based on efficiency of customs clearance process, quality of trade- and transport-related infrastructure, ease of arranging competitively priced shipments, quality of Logistics performance index WB - WDI logistics services, ability to track and trace consignments, and frequency with which shipments reach the consignee within the scheduled time. The index ranges from 1 to 5, with a higher score representing better performance. Road density is the ratio of the length of the country’s total road network to the country’s land area. The road network includes Road density WB - WDI all roads in the country: motorways, highways, main or national roads, secondary or regional roads, and other urban and rural roads. Fixed broadband Internet subscribers are the number of Fixed broadband internet subcribers WB - WDI broadband subscribers with a digital subscriber line, cable modem, or other high-speed technology. Mobile cellular telephone subscriptions are subscriptions to a public mobile telephone service using cellular technology, which Mobile cellular subscriptions WB - WDI provide access to the public switched telephone network. Post- paid and prepaid subscriptions are included. Telephone lines are fixed telephone lines that connect a subscriber’s terminal equipment to the public switched Telephone lines WB - WDI telephone network and that have a port on a telephone exchange. Integrated services digital network channels ands fixed wireless subscribers are included. The cost is recorded as a percentage of the economy’s income per capita. Costs are recorded exclusive of value added tax. All the fees and costs associated with completing the procedures to connect a warehouse to electricity are recorded, including those Cost to get electricity WB - WDI related to obtaining clearances from government agencies, applying for the connection, receiving inspections of both the site and the internal wiring, purchasing material, getting the actual connection works and paying a security deposit.  This indicator records the number of procedures required for a business to obtain a permanent electricity connection and supply for a warehouse. To ensure that data are comparable across economies, a standard case study in which an entrepreneur Procedures required to connect to WB - WDI seeks to connect a newly built warehouse for cold meat storage electricity to electricity was used. Data are collected from the electricity distribution utility, then completed and verified by independent professionals such as electricians, electrical engineers, electrical contractors, and construction companies. Quality of Transport Infrastructure WEF - GCI WEF GCI 2.A. Transport Infrastructure Quality of Electricity and Telephony WEF - GCI WEF GCI 2.B. Electricity and Telephony Infrastructure Infrastructure Infrastructure WEF - GCI WEF GCI 2nd Pillar Infrastructure 295 Turkey’s Transitions 296 Integration, Inclusion, Institutions Country codes and names The 3-letter country codes used in this report are taken from the international Organization for Standardization (ISO) 3166-1 alpha-3 codes, except for a few countries, as described by the World Bank (data. worldbank.org/node/18). The use of the word countries to refer to economies implies no judgement by the authors and contributors about the legal or other status of a territory. The following are the codes and corresponding country names which can be found in the report: Code Name Code Name ALB Albania KAZ Kazakhstan ARG Argentina KOR Korea, Republic of AUS Australia LIE Liechtenstein AUT Austria LUX Luxembourg AZE Azerbaijan LVA Latvia BEL Belgium MAC Macao BGR Bulgaria MAR Morocco BRA Brazil MDA Moldova, Rebuplic of CAN Canada MEX Mexico CHE Switzerland MKD Macedonia, the former CHL Chile Yugoslav Republic of CHN China MYS Malaysia COL Colombia NLD Netherlands CRI Costa Rica NOR Norway CZE Czech Republic NZL New Zealand DEU Germany PAK Pakistan DNK Denmark PAN Panama ECU Ecuador PER Peru EGY Egypt PHL Philippines ESP Spain POL Poland EST Estonia PRT Portugal FIN Finland PRY Paraguay FRA France ROM Romania GBR United Kingdom RUS Russian Federation GEO Georgia SGP Singapore GRC Greece SRB Serbia HKG Hong Kong SVK Slovakia HRV Croatia SVN Slovenia HUN Hungary SWE Sweden IDN Indonesia SYR Syrian Arab Republic IND India THA Thailand IRL Ireland TUN Tunisia IRN Iran, Islamic Republic of TUR Turkey ISL Iceland TWN Taiwan, Province of China ISR Israel UKR Ukraine ITA Italy URY Uruguay JOR Jordan USA United States JPN Japan VEN Venezuela, Bolivarian Republic of ZAF South Africa 297 Turkey’s Transitions 298