Turkish Trade Gap Widens

From Bloomberg:

Turkish June Foreign Trade Gap Widens for 2nd Month

By Steve Bryant

July 31 (Bloomberg) -- Turkey's trade deficit widened 18 percent in June from a year earlier, the second consecutive increase, as industry drew in raw materials for manufacture of products to export.

The trade gap grew to $5.5 billion from a revised $4.7 billion in the year-earlier period, the statistics agency in Ankara said on its Web site today. The deficit was forecast to be $4.8 billion, according to the median estimate of 13 economists surveyed by Bloomberg.

Today's figures follow a widening in the trade gap in May for the first time since November and suggest Turkey's current-account deficit, the widest measure of trade in goods and services, may be rising again after six months of stabilization.

``Turkey is addicted to intermediate goods,'' said Sengul Dagdeviren, an economist for Oyak Bank AS in Istanbul. ``It's clear that if the economy picks up, we'll start seeing even larger problems in the trade deficit.''

Exports increased 14.2 percent to $8.9 billion in June, after hitting a record $9.1 billion the previous month, the statistics agency said today. Imports increased 15.6 percent to $14.4 billion in June from the year-earlier period, the agency said.

Imports of raw and unfinished goods, which include oil, steel and machinery, rose 15.8 percent over the period to $10.4 billion. Consumer imports were little changed from the previous year at $1.5 billion, the agency said.

European Goods

Growth in Europe is boosting Turkish exports of goods such as washing machines as cars. The country needs to import raw materials to fuel its export industries.

``The high import dependence of Turkish exports implies that any export strength is accompanied by higher imports,'' Yarkin Cebeci, economist for JPMorgan Chase & Co. in Istanbul, wrote in a note to investors.

Crude oil prices rose to more than $70 a barrel at the end of June from $64.50 at the start of the month.

Turkey imports most of its energy, and higher oil prices mean the current-account deficit may widen this year as a percentage of gross domestic product, Moody's Investors Services Inc. analyst Kristen Lindow said in an interview on July 23. Last year's deficit was 7.9 percent of GDP.

The lira gained as much as two percent against the dollar in June and stood 8 percent higher than its Jan. 1 value at the end of June.

Current-Account Gap

Rising energy costs and a possible increase in demand for imported consumer goods means an increase in the current-account deficit in the second half of 2007 would ``not be surprising,'' the central bank said on July 27.

The gap reached a record $31.6 billion in 2006, 37 percent up on the previous year. It narrowed in May for the third consecutive month and stood at $31 billion in the 12 months to May.

Concern for the country's ability to finance the deficit led to a slump in the value of the lira in May last year. The central bank responded by increasing its benchmark lending rate by 4.25 percentage points to 17.5 percent in three moves in June and July last year.

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Turkey's Balancing Act

Well, the financial markets are happy at any rate. The Turkish stock market jumped 5% on Monday while the lira closed at a two-year high against the US dollar. Tayyip Erdogan (leader of the victorious Justice and Development party, the AKP) was also a happy man: “The new government will bring peace and stability" he informed us. I guess we had all better hope he is right.

Indeed there are plenty of reasons for satisfaction with the outcome of Sunday's elections in Turkey, and despite the very large number of outstanding problems still to be addressed, things could, at the end of the day, have turned out far, far worse. However, given the complex and tangled web of relations which surround Turkey's political life right now, there are also reasons, and plenty of them, for being at least a little nervous.

Before getting down to the nitty gritty, it is worth noting that in general general press and internet coverage of the Turkish election has been quite systematic and fairly informative. Manuel Alvarez of Election Resources has a summary of the results here, and a background briefing here. Among the many articles that caught my eye M K Bhadrakumar had a very insightful piece in the Asia Times over the weekend, with the rather provocative title of Turkey's Election has no losers (I will return to this below) , Bloomberg in the days before the election was full of information about how Tayyip Erdogan was busy flooding rural Anatolia - the AKP's heartland - with water and public money. Back in June the Financial Times had a useful background article on the city of Sivas, onetime stronghold of the main opposition Republican People’s party (CHP).

So now for the "nitty gritty". Well, basically, as we emerge from the initial bout of post-election fever there would seem to be three important issues facing the new government:

i) The Turkish Presidency
ii) Negotiations with the EU
iii) The Kurdish issue, and the tense relations which exist with the North of Iraq

The most immediate challenge facing Prime Minister Recep Tayyip Erdogan is clearly the need to settle the choice of a new state president. After all, it was the Turkish Parliament's earlier rejection of Erdogan's candidate, Foreign Minister Abdullah Gul, which precipitated the elections in the first place. Supporters of the secularist opposition party CHP distrusts Gul, a practicing Muslim whose wife attracts a lot of attention due to the fact that she wears a head scarf in public. For supporters of the CHP - and in increased measure for supporters of the right wing Nationalist Action Party (MHP) - this is seen as a symbol of Islamic militancy. If Erdogan were simply to resubmit Gul's name this could well lead to a new deadlock, as the AKP lacks the two-thirds majority needed to push the nomination through, and even if they did have the necessary majority, any move to impose a president without some sort of consensus with the CHP would be pretty divisive.

However, there have been signs that the AKP leadership, fresh from the electoral triumph is eager to avoid yet another confrontation. "God willing, we will end the presidential election process without giving rise to any tensions,'' Prime Minister Recep Tayyip Erdogan was reported as saying after leaving his meeting on Monday with Turkey's current president, Ahmet Necdet Sezer.


Which brings us more or less directly to the second challenge facing the new Turkish governmernt, the need to continue the process of legal and administrative reform which will equip Turkey for European Union membership. Noises coming out of Brussels this week have already signaled the desire there that Ankara regain the lost momentum associated with Turkey's accession process. EU Enlargement Commissioner Olli Rehn is widely quoted as saying that he expects a new Turkish government to be formed quickly and that "It is essential that the new government will relaunch the legal and economic reforms with full determination and concrete results". In fact the EU froze talks with Turkey last December on eight of the 35 policy chapters which form the basis of the accession process, largely because of Ankara's reluctance to open ports and airspace to Cypriot ships and planes. It is to be hoped that the Cyprus situation is one which the new government in Turkey will now feel freer to address more directly and more constructively.

In fact both Brussels and Ankara have been busy trying to keep talks going on a largely formal and technical level in the meantime (by negotiating on the four chapters which have already been opened). One point of interest in the statements being made by Commissioner Rehn is the way they reveal the complex web of issues we are all involved in here, since he explicitly expressed the hope that Turkey will make "concrete progress" on freedom of expression and religion. Now this may be seen as being a reference to a whole battery of questions (to the Pamuk case for example, or to the case of politicians in Western Turkey who face legal threats for the mere fact that they argue for a new federal structure) but it could be read as saying that the EU, in a country where the majority of the population are of the muslim faith, would find nothing strange about the wife of a President wearing a headscarfe, indeed this could be thought to be only normal and proper in the same way as the pretender to becoming British head of state might be at one and the same time divorced and nominal head of the Church of England. In other words religious freedom can mean a lot of things, although this reality is likely to do little to mollify many of the supporters of the CHP.

So what we would seem to have here are the seeds of what essentially is quite a fragile dialogue, where in fact the two parties at the end of the day actually need each other. On the one hand the EU needs Turkey, in the sense that our idea of religious tolerance should expand to include the idea that there is nothing wrong, or out of order, with the wife of the President of a member state wearing a muslim headscarfe, and the AKP need support from within the EU in order to "anchor expectations" among those who come from the secular tradition that the reform process as it is evolving in Turkey is not set straight down the road towards the creation of an Islamic Republic.


The third major challenge facing the new Erdogan government is, of course, the Kurdish question, and the delicate relations with the new autonomous region in the North of Iraq. Even here there are some promising signs. For the first time in many years, the new parliament will include deputies with explicitly Kurdish affiliations. These politicians will have the rather onerous task of persuading the rest of Turkey that the Kurdish conflict can be settled by dialogue and negotiation.Obviously the whole situation is complicated by the emergence of the autonomous Kurdish region in northern Iraq, which many Turks fear may spur increasing Turkish Kurdish demands for eventual independence. Turkish troops are currently massed along the Iraqi border, in preparation for a possible incursion in pursuit of guerrillas based there. But Tayyip Erdogan is unlikely to bend to the military here - in particular since he takes the view that that the Turkish military has already made 29 incursions into Iraqi territory since the 1990s, without dislodging the guerrillas - and is far more likely to use his sweeping election victory to open a dialogue with the Kurdish insurgents. Part of the reasoning behind this assessment lies in the little detail that the AKP scored a remarkable victory in the Kurdish south-east itself, doubling their support in these largely Kurdish areas, and obtaining an absolute majority of the vote there (52%). The main Kurdish party inside Turkey, the DTP, took 23 seats, putting it in the new parliament for the first time since 1994. The first indications are not discouraging. According to the Toronto Star, a "jubilant" Aysel Tugluk, one of the 23 Kurdish politicians who won parliamentary seats, declared from the Kurdish city of Diyarbakir that "We want to turn a new page...We want to start a process of dialogue and reconciliation in parliament to resolve the (Kurdish) problem......We will not be a source of tension ... We will act in a spirit of tolerance and understanding."

Problems and possibilities abound. On the one hand, given the fact the AKP lacks the desired two thirds majority, the DTP deputies could offer an interesting point of support (shades of the Spanish PSOE, and its recent alliance with the "separaratist" Esquerra Republicana de Catalunya - ERC - here). But any such "alliance" would be fraught with danger, since the DTP is not the Catalan pacifist ERC, but far more akin to the outlawed Basque Batasuna, insofar as the DTP is widely considered to be the political wing of the PKK. However, the long term stability and prosperity of the Turkish state passes down the road of resolving once and for all the "Kurdish issue", and Erdogan well knows this. So we should expect to see some sort of tightrope balancing act emerging, and again the EU can well play an active and constructive role here.

Of course the other part of the picture here is the regional government of Kurdistan, which is situated just to the south of Turkey's border. Officially, Turkey does not recognise the government led by Massoud Barzani. But there have been continuing rumours of attempts to set up a secret meeting between the Turkish foreign minister, Abdullah Gul, and Barzani, who it might be useful to remember, when he was leading the Kurdish insurgency against Saddam Hussein, was in the habit of travelling on a Turkish diplomatic passport. There are already signs that this kind of meeting may now officially take place. Clearly the Turkish army has emerged from the elections rather bruised and battered, and they are unlikely to be in the mood for a highly risky gamble, and in particular one which would meet with virtually universal condemnation and disapproval. Indeed as M K Bhadrakumar argues, in the above cited article, there may be reasons for doubting that the invasion threat was ever more than politically oriented sabre rattling:

This is where outsiders run into a problem in appreciating the range of the Turkish military's political agenda. It is very simplistic to view the military's opposition to the AKP as the manifestation of a straightforward struggle between the forces of secularism and Islamism. The military's political agenda is multi-layered. It is so apparent that "terror" replaced "secularism" as the hot-button issue for the Turkish military, even as the election campaign got under way in recent weeks.

That's because the military saw that the only way the AKP could be stopped in its tracks, despite its impressive record of reform and economic growth, would be by making Erdogan appear to be "weak on terror". The Jerusalem Post commented, "Threatening to attack the PKK [Kurdish Workers' Party] in northern Iraq has [proved] a powerful propaganda tool for the Turkish military ... the military has pushed security concerns to the forefront in order to reinforce an image of the AKP as indecisive and soft on terrorism and to benefit the nationalist and secular parties with which they have close ties." The military's muscular intervention in the political scene in the past few weeks actually generated electoral support for the ultra-conservative MHP.

The interest of the Turkish military in the outcome of these elections are also wider than simply political ones. As Vincent Boland noted in the Financial Times, there are also economic interests at stake:

There is no question that the military has a huge stake in the outcome of this election, for political, ideological, and even commercial reasons. Its huge economic interests, from automotive to insurance, held through the armed forces pension funds, are a pillar of the secular business establishment.

All of this lead Manuel Alvarez (in e-mail comment) to point out to me that, rather than a simple mapping of the Spanish transition process, events in Turkey have an additional Mexican "feel" about them:

In many ways, it seems to me that Turkey is more like Mexico, which underwent a revolution around the same time as Turkey, featuring - like Turkey's - a strong secularist (or if you will, anti-religious) component, although in both countries there is a large underclass that has remained fairly religious, official policies notwithstanding. In that regard, Erdogan's AKP is not entirely unlike Mexico's National Action Party (PAN) - which regards itself as a Christian Democratic party.

To be certain, there are major differences: Mexico's PRI remained in office for half a century after CHP was voted out of power in Turkey, the Mexican armed forces have played no role in the political process for a long time, there's no major far-right party, and the Mexican government came to terms with the Roman Catholic Church in the last years of PRI rule (an event made possible by the transformation of the Church in the years following the Second Vatican Council, which contributed to defuse the old Church-state conflict in Spain as well).

So, in conclusion, are there grounds for optimism? I think so, and many of these are economic ones. The Turkish economy has been booming in recent years. In the past five years, growth in gross domestic product has exceeded 7% annually, and exports more than tripled to over $95 billion for the year ended June 30. Despite the recent "correction blip" last summer, Turkey would appear to have remained on course, and Morgan Stanley's Sehan Cevik is even arguing that Turkey has the potential to become a trillion dollar economy in the next ten years. Against this background the AKP would seem to have the cards well stacked in their favour, and the old corporatist elements in the Military and the CHP would appear to lack any significant external support, either strategically or financially.

Stronger growth hasn't however substantially reduced Turkey's unemployment rate. Unemployment has remained stubbornly high, and is currently running at about 10% according to the Turkish Statistical Institute. And in the cities, where hundreds of thousands of rural workers flock each year in search of jobs, unemployment was at 12.6% in 2006. So far the voters have stayed with the AKP, but this patience will reach a limit, and in this sense doing something to substantially raise the living standards of its electoral base will become an important priority of the AKP in the coming years, and it is this need which can constitute a powerful leverage instrument for those who know how to use it.

Among these we are unlikely, it seems, to find M. Nicholas Sarkozy, who interestingly enough would seem to share far more with the thinking of the trounced CHP than ever he does with the so-called neo-liberal AKP. Sarkozy has put the whole Turkish entry process into question, and has most notably been widely quoted as saying that Turkey has "no place" in Europe. So was the defeat for the CHP also the first substantial defeat for Sarkozy as French President? Well lets certainly hope so. Clearly there are indications from the statements of people like Rehn that calmer heads will prevail, and it is not without interest that Portugal, who holds the current EU presidency has been a staunch supporter of Turkey's EU ambitions, and has expressly stated the aim of moving ahead with negotiations during their coming six-month term. Could we be seeing more than one party onto a sound thrashing here? Definitely one to watch.

In the Turkish Heartland

From Bloomberg:

Erdogan Floods Turkish Heartland With Development Aid

July 19 (Bloomberg) -- In the Turkish town of Afsar, a new pipeline brings water from a nearby mountain. Farmer Suleyman Er says it has transformed his life.

The seven-kilometer (4.3-mile) pipe, finished two months ago, symbolizes the way Prime Minister Recep Tayyip Erdogan is putting development at the center of his strategy to keep power in July 22 elections.

While Erdogan's rivals court secular, more affluent, urban Turks by stressing suspicions about his Islamic background, the prime minister is pinning his hopes on the conservative, religious voters in Turkey's rural areas and shanty towns. Many of these voters say they've never had it so good.

``Water means life, and thanks to the prime minister, ours is getting better,'' Er, 60, said in an interview at a coffee house in Afsar, which nestles on the arid plains of Turkey's Anatolian heartland, 550 kilometers southeast of Istanbul. ``Arguments over Islam and ideology just won't get us anywhere.''

Erdogan's Justice and Development Party, which is rooted in a movement outlawed in 1998 for mixing religion with politics, called early elections after the army, which regards itself as the guardian of the modern, secular Turkish state, objected to his Islamist-leaning candidate for president. Erdogan, 53, says that while Justice is conservative and Muslim, it bases its policies on democracy and economic development rather than ideology.

A Road and a School

Afsar, a town of 5,000 farmers and laborers who typically earn less than half the national yearly average wage of $5,500, has received about 2.7 million liras ($2 million) over the past two years to build the water pipeline, a 20-kilometer road to a nearby highway and the town's first-ever high school.

The aid to Afsar is part of a wider government strategy to modernize the Anatolian heartland, where Erdogan's secular rivals have traditionally held sway. The government has spent $3.5 billion on the program in the past three years.

``Villages are now using washing machines for the very first time because of these projects,'' Nihat Ergun, the deputy chief of Justice responsible for local government, said in a telephone interview. ``We are giving people a better standard of living in places where water systems and roads have never existed.''

Turkey's economy expanded for 21 straight quarters, the longest period of uninterrupted growth in the nation's history, allowing the government to increase spending on such projects. Income per person has more than doubled since Justice took power in November 2002, while unemployment has remained at about 10 percent even as 1 million teenagers have joined the workforce each year.

A Lead in the Polls

A Genar poll carried out July 9-17 gave Justice 40 percent support, more than the 34 percent it won in 2002 and enough to secure between 297 and 310 of the 550 seats in parliament. The Republican People's Party, Justice's nearest rival, had about 21 percent. A Konda poll conducted July 14-15 found 48 percent support for Justice and 19.5 percent for the Republicans.

``Turkish voters seem to think that no other party can deal with issues such as unemployment, agricultural dislocation and inequality between the haves and have-nots,'' Mark Parris, U.S. ambassador to Turkey from 1997 to 2000, said in an interview in Washington.

Erdogan's efforts aren't limited to the countryside: His party is also targeting less affluent city-dwellers. In the capital of Ankara, the Justice-controlled municipality provides more than 500,000 of the city's 4 million inhabitants with 60 kilograms (132 pounds) of food and household supplies each a year at a cost of 200 million liras. Most of the city's budget comes from national-government transfers to local administrations, which more than doubled last year to 6 billion liras.

Backtracking

The Republicans accuse Erdogan of using the free handouts to buy support for an Islamist agenda. Over the past five years, Justice, under pressure from the Republicans and President Ahmet Necdet Sezer, backtracked from plans to outlaw adultery and to move bars from city centers.

``Don't sell your votes for free wheat and rice,'' Republican leader Deniz Baykal told voters at a rally in the southern city of Igdir on July 17. ``Turkey is at an important crossroads.'' Erdogan, a graduate of a school that trains Islamic clergy, pledges allegiance to Turkey's secular principles.

Justice is focusing on Ankara's poorest neighborhood, Mamak, where three-quarters of the 600,000 inhabitants live in illegal squatter settlements. Such dwellings have ballooned in the past two decades as millions of people moved to cities from the countryside to seek better standards of living.

Apartment Blocks

Since Justice came to power, Mamak has been the focus of a 300 million-lira project to tear down the illegal houses and replace them with modern apartment blocks with daycare facilities and children's playgrounds.

``Some people in Ankara are surviving purely because of the aid we provide,'' Avni Kavlak, an aide to Mayor Melih Gokcek, said in a telephone interview. ``Otherwise, there would be a social explosion.''

Selva Gur, 37, wears the Islamic headscarf banned in government buildings, hand-sews cotton and silk garments at home to help put her two children through school. She is one of hundreds of Mamak residents who queue up each morning for free bread delivered by Gokcek's trucks.

``Justice is giving priority to economic development so my family's vote is with them,'' Gur said. ``Living standards are most important, not ideology.''

Turkey and the EU

From the Gulf Economist:

Is EU membership in Turkey's best interest?

As images of massive Turkish pro-secularism protests aired around the globe, a hitherto less publicized, parallel struggle in Turkey is increasing in intensity. A struggle which is perhaps less overt, but nonetheless equally significant, perhaps even more. What’s at stake is nothing short of the Turkish economic miracle, a miracle which has transformed Turkey from an unattractive investment destination with uncontrolled inflation, to an investor-friendly, politically stable and competitive economy.

At this point, cracks are becoming increasingly visible in Turkey’s hitherto broadly supported application for the coveted EU membership. Turkey is torn apart by two opposite forces, those who desperately crave for EU membership and those who object in the strongest sense of the word. Traditionally, the former dominated the public discourse and the latter was little more than a vocal minority. Today, the scales have tipped in the opposite direction as a 2006 poll in Milliyet newspaper showed that only 1/3 of the Turks are still supportive of their nation’s bid for EU membership. This dramatic drop is explainable by four prime reasons:

# Too many compromises at the expense of national interest. The most prominent of these compromises being the status of EU member Cyprus and the alleged Armenian genocide.
# Too many cultural tradeoffs. Europe may fear Turk’s inherent Muslim culture, by analogy Turks fear a spill-over of certain elements of European culture. Among others, there is growing opposition to Christian missionaries by Turkish nationalists. This opposition is largely peaceful and not much different from Western conservatives’ opposition to Islam, but has the potential to erupt on a micro-level. Last April’s widely publicized murder of several Muslim converts to Christianity proved the exact potential of this undercurrent. In Turkey’s defence, the attack was widely condemned.
# Rise of nationalism in the EU. With all the anti-Turkish rhetoric in European media and public discourse (a recent Dutch poll showed that roughly 70% of the Dutch oppose Turkish membership of the EU), an increasing number of Turks are coming to the realization that they will be uninvited guests at a hostile party.
# Diminishing sovereignty. It will take years before Brussels will wield the needed power to outweigh national governments on major issues, but the day will come. Even though Turkey, as the most populous nation, would form the biggest bloc in the European Parliament, the question is whether the Turks are ready to delegate power to Bulgarians, Romanians, French, Greeks, Cypriotes and Brits over issues affecting them. Careful readers may notice that the reference to these specific EU members is not unintentional.


Europe in its turn, is equally divided on the issue. The economic significance of Turkey is rarely disputed. Even those who are vehemently opposed to Turkey’s inclusion, admit its economic significance as a major market. Also, there is wide consensus on the merits of its ‘bridge function’ between the Islamic and Western world, a ‘bridge function’ which is far from a luxury in the so-called ‘global war on terror.’ But, many European governments fear that the inclusion of 70 million –mostly Muslim- Turks would further strain the overheated social welfare system and would further complicate Europe’s integration of its 20 million Muslims.

In the midst of these tensions, the question is: Who would gain the most in the case of EU membership, Turkey or the EU? We spoke to Dr. Ahmet Arinc, a Brussels-based economist of Turkish descent. As part of a new generation of Turkish intelligentsia, he remarked: “The problem we are facing is that we are so obsessed by Europe, so blinded by the imaginary pot of gold, that we forget EU’s ocean of rules, the burden of implementing the costly ‘acquis communautaire,’* the high taxes and sluggish welfare states. Worst of all, we forget that Asia is where the action has been going on for the last decade.” In defence of Europe, the sluggishness has been a target for reform of virtually all European cabinets for the past years. Nonetheless Dr. Arinc is absolutely right about Asia as a future economic powerhouse and European overregulation.

Disregarding the EU, what are Turkey’s chances in Asia?

Turkey’s potential as the centre of all ‘Turkic’ nations increased the day the Soviet Union imploded. Many former Soviet states (many of which are currently awash with oil and gas dollars since the 2003 price hike) have close cultural, ethnical and linguistic ties with either Turkey or Iran and both try to maximize the potential of this potentially lucrative opportunity. In the end, the Caspian Sea is being hinted as a new economic powerhouse and scale does matter in international commerce and politics, the ‘Anglo-Saxon axis’ has proven this. The bigger your (ethnic, linguistic, religious) bloc, the bigger your influence becomes.

Perils of EU membership.

Turkey’s low wages and lax –relative to EU- regulation might be jeopardized in the case of EU membership, destroying its two most valuable investor attractions: cost benefits and flexibility. One of the worst hit sectors will probably be Turkey’s surging tourist sector, of which the success is -to a large extent- explainable by low prices with which traditional European holiday destinations such as Spain and Greece find it hard to compete. It should be noted that the latter two show no signs of giving up and try to carve out new markets. Dr. Arinc stated that: ”We really aren’t sure that the merits of EU membership will outweigh the huge costs of implementing the acquis communutaire. There is serious debate on this issue. It’s a gamble and I don’t know if we should take this gamble when there are so many sure bets out there.”

Poland perfectly illustrates the perils of EU membership. Poland has witnessed a period of continuous influx of manufacturing jobs, primarily due to its abundance of manpower and its –relatively- low wages. This trend is still visible and upward oriented, but shows signs of cooling of. Poland’s relatively lax regulation is slowly being replaced by elaborate and complex EU rules and regulations, diminishing its competitive edge in many ways. One also has to be aware of the spill-over in ‘cost of living’ when entering a relatively rich economic/monetary union. The nineties attracted a lot of investment to Poland, this caused the GDP and wages to increase. Hans Blatter, a Hamburg-based corporate analyst told us in a phone interview: ”Today’s Polish workers are becoming ‘high maintenance,’ they are demanding higher wages and benefits. In a sense, they are ‘Westernizing’ and this scares some of the investors away. And then there are all these new rules sprouting from all corners. Let’s be frank about it, manufacturers, especially those in labour-intensive sectors, hate rules. That’s why so many businesses moved to China when it opened up, businesses can pretty much do whatever they want over there….. We are seeing a definite trend in investment flowing to Ukraine which we didn’t see before. I think Ukraine is going to take from Poland what Poland took from Germany.”

Mr. Blatter brings up interesting points that match our own analysis and observations. During the course of the past two months, we have surveyed a total of 87 Dutch companies and asked them to state their top source of agitation with the Dutch system.

34%-Overregulation
31%-High wages
23%-High Taxes
3%-Infrastructure
2%-Lack of qualified personnel
7%-Other

We did the same in Italy and the results were similar.

32%-Overregulation
26%-High wages
24%-High Taxes
12%-Lack of qualified personnel
2%-Infrastructure
4%Other

The results are revealing. Overregulation and high wages form the two top sources of agitation for Italian and Dutch entrepreneurs. So far, little empirical evidence shows a European-wide dedication at curbing the immense cannon of rules and regulations. Many European entrepreneurs, frustrated by high wages and burdensome rules, eventually vote with their feet and move their companies to nations such as Turkey, where wages are still low and EU rules and regulations are not yet in sight. And curbing this capital flight has been a priority for many a West European government ever since the fall of communism. Part of the strategy is inclusion of competitors. The theory, which we call 'swallowing competition,' has proven to be quite successful at a micro-level. The European Union is now implementing it at a macro-level. By including new members in the EU:

-New markets can be carved out.
-New (cheaper) human resources can be tapped.
-Existing members can impose their rules and regulations on the new members. Passively, the existing members’ living standards will spill over to the newly admitted nations. This process of imposing rules and ‘spill-over effects’ will eventually curb uncontrolled ‘capital flight’ from the richer nations.

The downside of courting Europe.

Courting the EU also included a less prominent role for the powerful Turkish military, the same military that functions as guardian of Mustafa Kamal Ataturk’s secular Turkey. The most drastic effects however, materialized in the nation’s eastern mountainous area, an area dominated by so-called ‘Mountain Turks.’ The ‘Mountain Turks’ are better known in the rest of the world as Kurds. Buoyed by their prosperous and semi-independent brothers in Iraq, some Kurdish factions have blown new life into the waning armed struggle which has claimed some 30.000 lives in recent years. It should be noted that this armed conflict seems to have less legitimacy among average Kurds than it did in the past. There exists a dual explanation for this.

-After the last wave of violence, Ankara refocused on the area and created better schooling, better infrastructure and ample jobs. Ankara was helped by the economic upswing of recent years.
-The scale of the sectarian violence in Iraq has cooled of many Kurdish aspirations of armed struggle and created a more pragmatic approach.

The upside of courting Europe.

Despite all this, the very process of courting Europe by itself, has had a tremendous positive effect on Turkey’s economy. A positive correlation is definitely visible, whether this correlation is a hint to causality is probable, yet hard to prove. In order to appeal to European governments, Turkey pushed through with a series of rigorous economical reforms to further liberalize its economy, and with liberalization came rejuvenation. Also, the prospect of future membership forced the Turkish central bank to bring the uncontrolled inflation back to manageable and acceptable levels.

Inflation: GDP deflator (source: World Bank)

2001: 55%
2002: 44%
2003: 23%
2004: 10%
2005: 5%

In conclusion, our own view is that in the midst of remerging European nationalism and Turkish rationalization, the chances of a Turkish member of the European Parliament have not been so negligible in the past two decades. From a political and economic point of view, this might actually be in Turkey’s best interest.

-M. Tahmasebi & S. Van Zanten

*Aquis Communutaire refers to the vast (roughly 85000 pages) European cannon of rules and regulations thus far. All aspiring EU members must implement these rules and regulations in the case of membership.

Turkey's Elite and Anatolia

From the Financial Times:

Turkey’s elite ponders the revenge of Anatolia

By David L. Edgerly

Published: July 20 2007 19:17 | Last updated: July 20 2007 19:17

The elegant, 40-something woman sits in one of Istanbul’s better restaurants along the Bosphorus, her diamond stud earrings glittering in the candle light. She sips a glass of Sancerre and nervously taps the table as a garishly lit tour boat full of women in shapeless raincoats and head scarves makes its way up the straits.

“I hate them, I hate them, I hate them,” she mutters with increasing vehemence – twice in English and once in French, just for emphasis. “They are ruining my country.”

The target of her ire is not the innocent women on the boat, but the ruling Justice and Development Party (AKP) whose vision of modernity most definitely clashes with her own. Her reaction is perhaps extreme, but illustrates the deep and widening social/political divide in Turkey.

The traditional secular elite, the so-called White Turks, bitterly resents the erosion of the power that it has assumed since the founding of the Turkish Republic in 1923. The elite sees itself as the true embodiment of Ataturk’s secular reforms, and now fears that those hard-won reforms and its traditional leadership position are under threat from the AKP. The fact that AKP draws much of its strength from the so-called Black Turks - that part of the population steeped in traditional social and religious values, less well travelled, less educated, based in Anatolia and the poor sections of the large cities, that tends to spend its holidays with families in small home towns scattered across the country rather than Europe or the US - only intensifies the resentment. Some call AKP’s political success the ‘revenge of Anatolia.’

A prominent businessman reinforced this sense of being besieged by Anatolia at a lunch in Istanbul’s swanky Kanyon shopping centre, complete with Harvey Nichols and Jo Malone when he laughed that Kanyon “is the last fortress of the White Turks.” Indeed, head scarves were far outnumbered by £100 hair constructions.

At the other end of the spectrum a cab driver wondered why I was even bothering to ask a question about the elections. “Tayyip bey (Prime Minister Tayyip Erdogan is the head of AKP) is the only choice.”

In the previous election almost five years ago the AKP crushed all other parties, and emerged with enough votes to form a single party government – a very difficult feat in Turkey where coalitions of small, fractious parties have dominated government in recent decades.

It is unclear whether AKP will win enough members of parliament to form another single-party government after the July 22 elections, but all the polls show them winning the highest percentage of the vote.

AKP’s political success is due in large part to its ability to capitalise on and mobilise a large segment of the population often overlooked by Turkey’s shallow political class. A member of Turkey’s educated and professional class concedes as much when he says, “The serial failures of the traditional politicians to deal successfully with our social and economic problems opened the door wide open for AKP.”

While he won’t be voting for AKP, he is unhappy with the alternatives. “None of the parties deserves to be elected. We’re forced to vote for the least bad of bad alternatives.”

Often overlooked in criticism about AKP’s ‘hidden’ Islamic agenda or its efforts to stuff the bureaucracy with its supporters is the party’s skill at fundamental political organization. It has been preparing for this election ever since coming to power more than four years ago. AKP members have spent a great deal of time on mundane tasks such as updating voter lists and staying in touch with the electorate.

The party has held regular meetings, training sessions, with its officials from all parts of the country. When elections were recently called, AKP was able to hit the ground running and its election meetings around the country have vastly outnumbered those of its opponents.

The AKP says it is working to extend democracy to all corners and segments of the country. Its vocal opponents claim it is abusing democracy to extend its own Islamic agenda at the expense of secularism - one of the main pillars of the modern Turkish Republic laid down by Ataturk.

Regardless of the election outcome, however, the problem of how to resolve Turkey’s growing social/economic divide will dominate the country’s agenda for a long time to come.

The Military and the Elections

From the Financial Times:

Military's strategy to neutralise opponents is big casualty of poll

By Vincent Boland

Published: July 24 2007 03:00 | Last updated: July 24 2007 03:00

When General Yashar Buyukanit, head of Turkey's armed forces, went to his polling station in a wealthy Ankara suburb on Sunday to vote in a general election, other voters gave him a round of applause.

Now his institution is emerging as one of the chief casualties of the election, which has potentially changed the relationship between the military and politics in Turkey decisively in favour of politicians.

Gen Buyukanit initiated a clash with the outgoing government of the Islamist-rooted Justice and Development party (AKP) in April. In a now infamous midnight ultimatum on its website, the general staff issued a not entirely persuasive statement complaining about the creeping Islamisation ofsociety.

Turkey's military has ousted four elected governments since 1960, but its political role was supposed to be diminishing because of changes to the constitution introduced by the AKP as part of reforms aimed at joining the European Union. The April 27 "e-coup" therefore caused uproar and the ensuing constitutional crisis led to last weekend's general election, in which the AKP has emerged as the clear winner, with an enhanced mandate and 340 seats in the 550-seat parliament.

It was hardly the result Gen Buyukanit can have wished for, in spite of the military's scrupulous silence since the April 27 démarche. There is agreement among political analysts that the intervention increased support for the AKP and may have drained it from the army, said to be Turkey's most trusted institution. It also upset, perhaps fatally, the system of checks and balances the military put in place in the 1982 constitution, and may have compromised its ability to shape Turkey's political direction.

"This election result is a slap in the face for the military because it shows that the Turkish people don't want them trying to design the political and social space. It's a determined 'no' to their interference in politics," says Ihsan Dagi, professor at the Middle East Technical University.

The scale of the AKP's win is not the only piece of bad election news for the general staff. The main opposition Republican People's party (CHP), the group traditionally closest to the military top brass, performed dismally. And 27 independent MPs, most of them representing troubled Kurdish south-eastern provinces, won seats, giving Kurds a voice in parliament for the first time since the early 1990s.

Between them, the AKP, which doubled its Kurdish vote in this election, and the independents have the two-thirds parliamentary majority needed to enact constitutional change. While they almost certainly do not want to pursue such reform, the symbolic and practical importance of their domination is inescapable. They represent the two factions the constitution was designed to keep out of parliament - political Islam and Kurdish separatism.

The constitution is a legacy of the military coup of 1980. Turkey at the time was ravaged by political violence. The army stepped in to restore order, but it also decreed the depoliticisation of Turkish life, banning parties and politicians and locking up dissidents. It then used the constitution, written under the general staff's supervision, to engineer a two-bloc system with the CHP on the left, secular parties on the centre-right, and a 10 per cent threshold for party representation inparliament.

The system did not deliver political stability, and Turkey suffered a series of increasingly weak coalition governments. But it has taken the rise of the AKP, representatives of a resurgence of religious belief and social conservatism, to expose its limitations

"It's the end of the 1982 constitutional system," says Cengiz Aktar, an academic in Istanbul. "The checks and balances put in place by the military to avoid the twin threats to the republic - as the military would see them - of separatism and political Islam have failed. The religious guys are in power, and the so-called separatists bypassed the 10 per cent threshold [by standing as independents]. It's a total failure of the system."

That does not mean the military is out of the picture - it is too big and important an institution to be sidelined so easily.

But Prof Dagi says the snub delivered to it "might really be a turning point in the consolidation of Turkish politics".

Investing in Turkey

From the Financial Times:

INVESTING IN TURKEY: Polls unlikely to deter investors

By Vincent Boland, Financial Times
Published: Jul 18, 2007

As it heads into a general election on July 22, Turkey's government might have been forgiven for taking its foot off the privatisation pedal for a few months.

Selling state assets has been a passion of the ruling, centre-right Justice and Development party (AKP), even if the public is either indifferent or hostile to the idea.

Foreigners own two-thirds of the Istanbul stock market, and fewer than 1m of Turkey's 73m people own shares, according to Mehmet Sami, an investment banker in Istanbul.

But election fever did not halt the sale in early July of a 50 per cent stake in Petkim, Turkey's leading chemicals group. It provided confirmation - if any were needed - that one of this government's guiding principles in selling state assets is that he who offers the most money gets the prize. With a current account deficit hovering around 8 per cent of gross domestic product, this might be understandable.

Petkim paid off handsomely. The transaction raised more cash - just over $2bn - than expected, valuing the group at three times its stock market capitalisation.

Such is the apparent demand for Turkish assets that investors are prepared to pay ever-higher multiples for them. The winning consortium comprised Troika Dialog, a Russian investment bank, the Investment Production Group Eurasia, a real estate investment company controlled by Kazakh investors, and Caspi Neft, a Kazakh oil exploration business. They said they would make significant investments in their new asset.

But that has not stopped the transaction being controversial, electoral considerations aside, for two reasons.

A trade union has threatened to go to court to block the sale of the Petkim stake. Previous efforts by Turkey's trades unions to halt privatisation deals have proved disruptive though not conclusive, and this is likely to be no different.

And Fitch Ratings, a credit rating agency, said it would have a negative effect on Petkim's creditworthiness if, as seems possible, the new owners seek to recover their investment by leveraging Petkim. That would have the effect of "turning the transaction into a leveraged buy-out," according to Oguz Bardak, a director in Fitch's industrials team.

The government tried to sell 80 per cent of Petkim in 2003, but nobody wanted to buy it except Cem Uzan, a controversial businessman. The transaction fell through. The group was making heavy losses at the time.

Now it has been restructured and is profitable. The turnround, and the value it created, are evidence of the wider improvement in the Turkish economy, which has grown by an average of 7.4 per cent in each of the past five years, creating a lot of value along the way.

Regardless of the details of any particular transaction, the bigger picture is what matters for investors, and there is no doubt that the investment climate in Turkey is better than it has been for a generation.

The combination of a stable government, structural reforms, the prospect of eventual membership of the European Union (even if it is receding somewhat), a new openness to foreign direct investment, and vast amounts of global liquidity for investment in emerging markets, has transformed Turkey's prospects as a destination for FDI and as a manufacturing and industrial base.

It has also increased the competitiveness of the $400bn economy, although many analysts say there is a need for more thorough microeconomic reforms.

Mustafa Boydak, chairman of Boydak Holding, a cables-to-furniture conglomerate in Kayseri with revenues of $1.8bn last year, says: "We do a lot more business now than we did in 2000, although the environment is more competitive."

According to figures from Garanti Securities, the sale of Petkim will put Turkey on course to attract about $25bn of FDI this year, compared with less than $1bn a year six years ago. Much of this investment has consisted of foreign companies buying mature Turkish assets, especially in the banking, telecommunications, media, and consumer goods sectors.

It seems certain that this will continue: some family-controlled conglomerates, which tend to dominate the corporate landscape, are experiencing generational change or seeking to shift their strategic interests.

At the same time, the small and medium-sized business sector is booming. Although its family-owned multinationals such as Koc and Sabanci are the best known faces of corporate Turkey, its SMEs are the lifeblood of the economy.

They are becoming as numerous in Anatolia as in Istanbul and its hinterland, the traditional hub of the economy. Cities such as Kayseri, Gaziantep and Konya are contributing an ever larger share to GDP. They are also growing in political importance - the AKP is strong in these centres.

One of the most active seekers after returns in the Turkish market is the private equity industry. "It's the busiest after strategic investors," says Michael Schilling, a lawyer at Linklaters who has advised on many Turkish private equity transactions.

"In the past three years, private equity investors have gone from talking about investing in Turkey to actually doing it." It is a one-way street that can get crowded: some private equity firms bid against their rivals for the most prized assets, such as retail and pharmaceuticals companies, sending multiples soaring.

Mr Schilling says an added attraction of the Turkish market for foreign investors, including the private equity industry, is that its capital markets are deep enough to allow financing for deals to be raised and syndicated locally.

Still, Turkey remains an emerging market, with many of the long-term obstacles to investment and to sustained economic growth that such status entails.

Yased, the association of foreign investors that has recently come under new leadership, is drawing up a list of priorities for reform. First is the issue of addressing the enormous unregistered economy - "the mother of all our problems", according to Tahir Uysal, Yased's new chairman. The unregistered sector, by some estimates, accounts for half of economic activity.

The association is also pushing for a review of corporate taxes and incentives for foreign investors, for measures to address the shortage of skilled labour, for more support for research and development, for reform of property rights, for an improvement in the climate for green-field investments, and for Yased itself to play a more active role in the debate surrounding possible EU membership.

Unless steps are taken on all these pressing issues, Yased argues, it will continue to lag behind its competitors in attracting FDI. "In 2006, there was $1,300bn of foreign direct investment seeking a home worldwide, and Turkey got only $20bn of it," Mr Uysal points out. Despite the surge in FDI inflows in the past two years, the country is actually slipping down the league table of FDI destinations, he says.

Whether the political environment changes after the election is also a consideration. Although the AKP is expected to retain power, perhaps with a smaller majority, the constitutional crisis that precipitated the July 22 poll could have long-term reverberations.

One effect of the crisis over the appointment of the next president - which set the army, the opposition, the courts, the parliament, and the government at loggerheads - is that it has severely dented the image of Turkey's governing institutions in the eyes of the public. It may take more than a general election to restore their credibility.

The other issue hovering over the economy is whether it will have a hard or a soft landing if - or perhaps when - global liquidity begins to shift away from emerging markets.

As Kristin Lindow, a senior credit officer in the sovereign risk unit at Moody's Investors Service, observed at a recent conference in Istanbul: "The question is whether the effect of global liquidity has changed the rules of the game [permanently for the better] in Turkey, or whether the party will stop. The answer is that I don't know."

An area of vulnerability is the high value of the lira against a sagging US dollar, which has made imports cheap. Much of the import bill is spent on goods that are used in the manufacture of Turkish goods that are then exported.

The economy is export-dependent and exports are booming, partly because companies have become much more efficient as a result of the economic turnround and are shedding jobs as they become more profitable and technologically sophisticated.

Ms Lindow estimates the import content of exports at above 80 per cent, however. Whether this can continue if the lira retreats at some point is another question dogging the economy.

It seems unlikely that the new government, regardless of its political stripe, will want to interfere excessively with the economy, which is growing at its fastest ever pace.

But for a variety of domestic factors, the past four years of relative stability may be over, at least until Turkey decides on the political direction it wants to take in the next five years.

Turkey's Army

From the Financial Times


Turkish army marches into unknown

By Vincent Boland

Published: July 13 2007 03:00 | Last updated: July 13 2007 03:00

A huge granite monument at the tip of the Gallipoli peninsula in western Turkey commemorates the 86,692 Ottoman soldiers who died fighting the Allies during the first world war.

To many Turks it also represents the moment at which the armed forces stepped forward to shape the country's destiny. They have been doing so ever since, in one guise or another.

The latest manifestation of the military influence on political life is a constitutional crisis largely initiated by the general staff, which has triggered a general election being held on July 22.

On April 27, in what has become known as "the e-coup", the general staff issued an ultimatum on its website about the "growing threat" to Turkey's secular republic.

Since the time of Kemal Ataturk, the soldier who forged Turkey out of the ruins of the Ottoman empire, the military has seen itself as the guardian of the republic and its Kemalist principles, of which secularism - more accurately laicism, involving strict control of religious observance by the state - is probably the most important.

The ultimatum did not name names; nor did it really read like a coherent statement of principle - a fact that may account for its lack of gravitas.

However, it was interpreted to mean that the imminent elevation of Abdullah Gul, the foreign minister with past links to Turkey's Islamist movement - like the governing AKP party of which he is a member - as the next president, was not acceptable to the military high command.

This time, though, the generals may have overestimated their ability to engineer a desirable outcome.

Turks have an admiring but not uncritical relationship with their soldiers. It is said - and not just by generals - that the armed forces are the country's most respected institution. Others say they are the most opaque, the most unaccountable, and the most self-regarding institution.

General Yashar Buyukanit, chief of the general staff - a gruff, bullish man of 67 - seems to embody the institution's contempt for Turkish civil society (such as it is).

Few Europeans can name the head of their armed forces. In Turkey everybody knows who Gen Buyukanit is. This is to be expected: the Turkish armed forces have ousted four elected governments since 1960.

The coups have been rationalised as a necessary development that prevented something worse from happening at times of political crisis, although there is general agreement that the Latin American-style 1980 coup, with its total ban on political activity, did lasting damage to Turkey's political development.

The "e-coup" has arguably had two unexpected - or at least unintended - developments. One is a surge in support for the AKP.

Ihsan Dagi, professor of international relations at Middle East Technical University, says: "The military got what it wanted with the ultimatum, which was to prevent Gul's appointment as president.

"But it stirred the democratic reflex, and that has certainly increased the standing of the AKP."

Second, it damaged the credibility of the opposition CHP, an ostensibly social democratic party that appeared to support the ultimatum. The avowedly secularist CHP is so identified with the military that it can sometimes seem like its political wing.

As Sahin Alpay, an academic in Istanbul, noted in a recent newspaper column, the party "has become a spokesman for the civilian-military bureaucracy, which continues to think that the Turkish people at large are not mature enough for democracy".

There is no question that the military has a huge stake in the outcome of this election, for political, ideological, and even commercial reasons. Its huge economic interests, from automotive to insurance, held through the armed forces pension funds, are a pillar of the secular business establishment.

This entrenched corporate hierarchy is facing competition for capital and resources from the Anatolian entrepreneurial bourgeoisie that forms the core of the AKP's support.

The perceived threat to secularism posed by the AKP, however, lies behind the April 27 e-coup. Gen Buyukanit declared before that event that Turkey's next president should be "secular not just in word but in essence".

Clearly, he and his colleagues felt that Mr Gul, whose wife wears the Islamic headscarf, did not meet those criteria. After the election, parliament is expected to try again to elect a new president, and Mr Gul has not ruled out standing.

The question in thatevent is whether the general staff will have anything else to add to its April 27 statement. As Prof Dagi says: "The military may be capable of learning that once they interfere in the political process they damage their own cause."

The City of Sivas

From The Financial Times:

The city where Turkey’s republic lost its way

Published: June 27 2007 01:41 | Last updated: June 27 2007 01:41

If anywhere in Turkey ought to be an opposition stronghold, it is Sivas. This city of 350,000 people on the high Anatolian plateau, 450km east of Ankara, was the base from which Ataturk’s republican revolution spread to the rest of the country nearly 90 years ago. A ­slogan in gold lettering beside a statue of the nation’s founder, just off the main square, says: “The republic began here.”

A month before Turkey’s general election, however, the republic that Ataturk founded seems to be in retreat in this slightly shabby city.

The main opposition Republican People’s party (CHP), which sees itself as the guardian (along with the military) of Ataturk’s republic, was once the strongest political force here. Before 1980, the party won comfortably in Sivas. Now it struggles to be relevant, not only here but also in much of Anatolia.

The gradual shift from the secular left to the religiously conservative right that characterises Turkish politics in recent decades may be more evident in Sivas than anywhere else in Turkey.

Even some of the opposition’s supporters admit that the shift has left the party high and dry. The CHP is a secular, vaguely leftist and overtly statist party in a country of conservative capitalists. That might explain its close links to the military, which has ousted four elected governments in Turkey since 1960.

“The move from left to right is the trend especially in central Anatolia,” says Osman Yildirim, a disillusioned CHP supporter who is president of the Sivas chamber of commerce and industry.

“The left had no solutions for Turkey’s problems and it is seen as distant from religion, and Turkey is a religious country.” Until the party modernises, he says, it will continue its losing streak in former republican bastions such as Sivas.

Malik Ecder Ozdemir, the main CHP candidate in Sivas, sounds equally glum, if a little more defiant. He insists the party will do better in the July 22 election than it did at the last election in 2002, when it captured one of the six seats the city and province of Sivas have in parliament.

The outgoing government of the Justice and Development party (AKP), which has Islamist roots and is the chief beneficiary of the swing to the right, won the other five.

“Sivas is important for the CHP,” Mr Ozdemir says. “If we are weak here we are weak all over Turkey.”

The main factor in shifting the political orientation of Sivas is migration. The city has absorbed migrants from the surrounding provinces, who brought their conservative rural and small-town customs to the city and who tend to be self-employed or to work for their kith and kin. They have gradually outnumbered state employees, who would have voted for the CHP.

“Migration is the problem – it is changing the balances in Turkey,” says Mr Yildirim.

Vahap Sag, a sociologist at Republic University in Sivas, says: “The better-educated and wealthier people are leaving and poorer people are arriving. Sivas is becoming more religious, and that is reflected in voting ­patterns.”

This election has been called four months early to try to resolve a clash between Turkey’s secularists (including the CHP and the military) and the AKP. The AKP wanted to put Abdullah Gul, the foreign minister whose wife wears the Muslim headscarf and who has past links with Turkey’s Islamist movement, into the president’s job.

That sparked a constitutional crisis. The CHP accuses the government of trying to undermine secularism, while the AKP insists it had a democratic mandate to appoint Mr Gul.

The two visions of Turkey – one secular, one democratic – are the central issues in this election.

Whether the CHP can regain prominence in its former stronghold poses an organisational and political challenge. One factor in its favour in Sivas is that Abdullatif Sener, the leading MP for the city who was a senior and respected moderate in the outgoing government, has not sought re-election. This may eat into the AKP’s support.

Mr Ozdemir agrees that Mr Sener’s withdrawal is a bonus. But he paints a much starker picture of what is at stake in this election.

“Turkey is changing,” he says, “but it is not changing for the better. People ask me, ‘Don’t you have any other policies besides secularism and protecting Ataturk’s principles?’

“Now, I think, people accept that those principles are under threat. This is the most important election in Turkey’s history.”

Turkey and the EU

From MS GEF

Turkey: The Real Stake of Turkey-EU Negotiations

Serhan Cevik and Eric Chaney | London

We need to put Turkey’s relations with the European Union into a historical context, before analysing its convergence path. The process of “Europeanisation” started centuries ago during the Ottoman Empire, with the realisation of scientific and institutional progress in the west. But it really accelerated to a revolutionary pace in the early decades of modern republic under the reign of Ataturk, overhauling archaic institutions and bringing economic rejuvenation to the agrarian society. Unfortunately, despite such significant progress, a dreadful sense of inertia descended over the country, and political frictions slowed institutional modernisation. Consequently, although Turkey applied for associate membership status in the European Economic Community in 1959, the EU waited until 1999 to confirm the candidacy status and until 2005 to start accession negotiations. Nevertheless, Turkey’s difficult relations with the EU have always played a fundamental role in its institutional and economic development.

Bringing political and economic institutions into line with European standards will transform Turkey’s economy and social standing, but it would be naïve to expect accession talks to be straightforward, without any challenges. The experience of the last twelve months is an obvious case in point. First, despite the encouraging steps forward in recent years, Turkey still has a long list of political and socio-economic requirements to complete. Second, Europe’s enlargement fatigue and the unresolved Cyprus conflict will keep obstructing Turkey’s accession process, even if Turkey meets all the conditions without any delay. Indeed, Turkey’s membership aspirations have always been an important feature in the “widening versus deepening” debate in Europe, but the prevailing rhetoric suggests a deeper resistance to further integration and enlargement. In our view, these underlying shifts in Europe’s political climate are likely to place new stumbling blocks (such as the argument on the Union’s absorption capacity) in front of Turkey’s accession process.

One of the major concerns is the income inequality between Turkey and the EU and regional income disparities within Turkey. Turkey’s per capita GDP in purchasing power standards was just 29.8% of the EU-25 average in 2005, even below Bulgaria (31.9%) and Romania (32.9%). Furthermore, although the latest figure represents a 16% increase from the country’s relative income level of 25.7% in 2001, it is still below the average of 30.5% in the 1990s. As a result, Europeans perceive Turkey’s young and growing population as a threat that could lead to a wave of immigration. However, we believe that such figures alone are not enough to reach a gloomy conclusion. As a matter of fact, an encouraging process of convergence is already underway and the Turkish economy should continue catching up with the EU over the medium term. Even in the near future, we are likely to see further improvements that would raise Turkey’s per capita income to 34.2% of the EU-25 average (or about 40% if we take into account the conversion of national accounts to the European standard) by the end of 2008.

Many fear Turkey’s growing population with an average age of 26.5, but we see it as a demographic gift that could help the country achieve faster convergence. After all, working-age population is the basis for employment and income growth. Turkey’s problem has always been the low level of employment limiting the speed of convergence. While the share of the working-age population in total population stands at 71.2% (compared to 64% in Europe), the number of employed is just 45% of the working-age population (compared to 63.8% in Europe). The employment rate is partly a function of the level of labour force participation, which unfortunately stands at 49.3% compared to 72% in Europe. However, if Turkey improves the state of the labour market and brings its employment rate to the European level, the number of employed could increase by almost 50%, or by 11.6 million workers. Put differently, Turkey can potentially create new jobs that would be approximately half of the entire employment in the ten new members of the EU. Given the significant difference between per capita GDP and per worker GDP, that would imply a level of per capita income that is already at about 50% of the EU-25 average, even with today’s figures. In other words, Turkey’s demographic characteristics that may look like a threat now are actually an indication of its great potential to accelerate the pace of income convergence.

Macroeconomic normalisation and structural changes have acted like a “technology shock” raising the rate of productivity growth to a higher plateau. And given the favourable demographic trends, we estimate Turkey’s potential growth rate at around 7.5% — three times the EU-25’s potential. Of course, having a great potential is no guarantee for catching up with the rest of Europe at an accelerated pace. Maintaining the actual growth rate close to the potential growth rate, without triggering inflation pressures, is a challenging task that requires prudent macro policies and, more importantly, a wide-ranging set of structural reforms to remove microeconomic bottlenecks. As discussed above, one of the important building blocks for such a scenario is improving the economy’s labour absorption capacity. Greater flexibility in the labour market, together with the rationalisation of the tax regime and bureaucracy, would certainly help accelerate job creation and reduce inefficiencies in traditional sectors of the economy. For example, gross value added per worker in the agriculture sector is less than one-third of those figures for services and manufacturing sectors. In other words, sectoral productivity differentials (reflecting structural problems) also explain regional income disparities and the low level of per capita income relative to the EU average. Therefore, by improving labour-market conditions, Turkey can enhance its potential growth rate and keep its actual growth rate close to its potential.

Turkey may have the potential to boost employment growth, but that is not an automatic process even with more flexible labour-market regulations. Educational attainments are crucial, especially in today’s global economy. Even though we have seen a steady improvement over the years that will no doubt make the next generation of workers better equipped, Turkey’s human capital endowment remains low compared to other countries. For example, the share of the adult population with upper secondary education is 25% in Turkey, as opposed to the OECD average of 56%. This is partly a result of “gender gap” in educational attainments that also leads to an unusually low female participation in the labour force. Therefore, Turkey needs a comprehensive strategy to improve human capital endowment across the board. That is of course necessary but not sufficient to achieve higher productivity and income growth. After all, labour productivity depends on the capital-to-labour ratio and total factor productivity, not just the quality of human capital.

Even though fiscal consolidation and restructurings in the banking sector have led to a better allocation of capital, domestic savings are inadequate to finance Turkey’s investment requirements. This is why it needs a sustained increase in foreign direct investment, which had remained at an annual average of $720 million (or 0.4% of GDP) and accounted for a mere 2% of capital spending between 1985 and 2003. But that was not surprising, given macroeconomic volatility and structural limitations keeping foreign firms away from the Turkish market. The good news is that macroeconomic normalisation and institutional improvements in the investment climate have already led to a breakthrough in FDI flows — surging to $9.8 billion (or 2.7% of GDP) in 2005 and around $20 billion (or 5.2%) this year. Obviously, the EU accession process plays an important role in attracting FDI and therefore accelerating productivity growth. It has happened in numerous other countries, and Turkey should enjoy a similar injection of low-cost capital with positive externalities. Coupled with higher educational attainments, the FDI-driven accumulation of new technologies and know-how would support the rise in total factor productivity growth, which already increased from 0.5% a year in the 1990s to 4.8% in the last four years.

Estimating the path of income convergence is an empirically challenging task, but our simple model based on growth rates and population dynamics provides useful insights and reasonable accuracy. Full income convergence is not necessary at this stage, or even at the time of accession. Hence, we instead focus on two alternative scenarios — uninterrupted accession process towards full membership or prolonged “Europeanisation” with no membership status. In our “accession” scenario, Turkey’s trend GDP growth would reach 7.5% a year, as opposed to 2.5% in Europe, thanks to the rising share of the qualified workforce and capital inflows. That would bring per capita income from 29.8% of the EU-25 average in 2005 to 48.5% (even excluding the likely revision in national accounts) by 2015. In our “sub-optimal” scenario, negotiations would fail, but “Europeanisation” would continue, albeit slower and with higher political risks. Trend GDP growth would be only 4.5% and leave Turkey lagging behind China and India. All in all, we still believe that the likelihood of an absolute breakdown of Turkey’s relations with Europe is negligible and the accession process, though more challenging than for other candidates, will help accelerate the speed of income convergence.
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Turkey: Looking Beyond the Wall of Noise

Serhan Cevik | London

Turkey is moving into an election cycle, but we should look beyond the wall of noise. It is the time of the year when we update our economic analysis and roll out new projections looking into 2008. However, before we even get there, a challenging period of elections and global fears will greet us next year. Turkey has so far enjoyed an unprecedented era of uninterrupted expansion and become the fastest growing OECD country in the last five years. But as the burst of global volatility earlier this year reminded us, it has a troubling exposure to liquidity-driven capital flows and remains sensitive to noise and global sentiment. One of the main sources of market noise next year will be the country’s political cycle, starting with a presidential election in May and then general elections in November. We will regularly survey the political landscape over the coming months, but for now we believe that political developments (including the EU accession process) are unlikely to unsettle the favourable business cycle. And on the external front, although global imbalances may result in bursts of financial volatility, Turkey is less vulnerable to a US-led global slowdown (see When Atlas Sneezes, October 25, 2006). All in all, Morgan Stanley’s forecasts point to a mild correction in global GDP growth from 5% in 2006 to 4.3% next year and then 4.5% in 2008. Furthermore, the projected strength of Europe should keep the composition of growth favourable to the Turkish economy, given its extensive links to the continent.

Macroeconomic normalisation reflects fundamental improvements, in our view. On our estimates, Turkey will continue growing faster than the global economy in the coming years. We expect real GDP growth to slow from 7.4% in 2005 and 5.8% in 2006 to 5.6% next year, but reaccelerate to 7.2% in 2008. In our view, tighter financial conditions and slow recovery in real disposable income growth will moderate domestic demand growth, as the rate of increase in consumer spending eases from 8.8% in 2005 to 5.3% in 2006 and 4.4% next year. However, we are confident about income generation and financial penetration over the medium term, and thus expect private consumption to grow 6.2% in 2008. On the other hand, investment spending is more sensitive to transitory shocks and exhibits higher volatility. As a result, the annual growth rate of gross fixed investment expenditures is likely to lose pace from 24% in 2005 to 13.2% in 2006 and 7.5% next year. But we see this deceleration as a healthy sign of consolidation after a 104% cumulative increase in the past four years, and we expect a 12.8% increase in 2008. Overall, while domestic demand moderates toward a more balanced growth path, the rise in exports should support the economy and even help bring stabilisation in the current account.

Inflation should remain high in the first half of next year, but then start declining. The Turkish economy, albeit standing on stronger footing, still faces a number of challenges — mainly stemming from exogenous factors (like higher energy prices) and domestic excesses that emerge during the normalisation phase. In our view, the best policy anchor to manage these risks is the correction of fiscal imbalances. And thanks to prudent policies, the budget deficit has already narrowed from 15.2% of GDP in 2001 to about 1.2% this year, making the Treasury a net debt payer for the first time ever. The marked reduction in the public sector’s dis-saving rate not only improves debt dynamics but also supports the disinflation process. This is why we prefer looking beyond short-term volatility and focusing on fundamental drivers of the secular shift toward price stability. With sustained productivity gains that have outpaced wage growth and expanded the country’s supply frontier, we expect inflation to decline from 9.8% in 2006 to 5.8% by the end of next year and 3.6% in 2008.

The extent of monetary easing should be limited next year but accelerate in 2008. In our view, the Central Bank of Turkey will keep interest rates unchanged in the next six months, as it has to bring disinflation — firmly and visibly — back on track. Once inflation starts moving toward the “uncertainty” range, the authorities should be in a position to ease their monetary stance by 150 basis points in the second half of 2007 and 300 bps in 2008. That may not be immediately exciting for financial markets, but we think maintaining stability in a challenging year would be priceless, nonetheless.