Are We There Yet ? (2)

The Republic of Turkey has been a "developing" country from the day it established in 1923. Are getting closer to be a "developed" one?

Let's have a closer look at 1980-2006 period. The first graph compares the growth performance of the Turkish economy with the rest of the world:

Figure 1: Average Growth Rate


It is clear that after a brief period of "above-average" performance following the free market reforms in the early 80s, the Turkish economy fell into a "growth recession" through the 90s. Following the 2001 crisis, the economy has recovered considerably and experienced a 7.2% growth rate.

What is remarkable is that the acceleration in groth rate has been achieved despite the negative shocks in the terms of trade. In the early 80s, the export prices increased, on the average, 2.1% (per year) faster than import prices - which mean that by 1988, the export prices were, in cumulative terms, almost 20% higher as compared to import prices.

In the 2000s, on the other hand, due to rise in energy and commodity prices, the terms of trade have deteriorated (on the average) 1.3% per year. The cumulative change was 8% by 2006.

Asia and East Europe have suffered too, albeit less severe than Turkey. All other developing countries in Africa, Middle East, and South America have experienced a positive shock.

Figure 2: Average Change in Terms of Trade (negative numbers indicate a deterioration)


Figure 3: Average Change in Terms of Trade (negative numbers indicate a deterioration)


Therefore, it is not surprising to observe the deterioration in the current account balances of Turkey. Note that East Europe has also relied on foreign capital flows to finance its growth rate. Asia, on the other hand, has continued to increase its current account surplus thanks to rise in national savings:

Figure 4: Average Current Account Balances (negative numbers indicate current account deficits)


Figure 5: Average Savings Rate (percent of GDP)


What is important is that the Investment-growth ratio, which was peaked at the end of 90s, has declined recently and in par with other developing countries.

Figure 6: The ratio of Investment/GDP to Growth Rate (ten year moving average)

It's the oil, stupid!

Turkey has been experiencing a significant trade deficit since 2003. Is it because the country imports too much and/or exports too little due to appreciation of the local currency?

Two tables below explain the problem. The main culpit is the high energy prices. The ratio of manufacturing exports to intermediate goods has never been higher. Ditto for the export/import ratio -- IF ONE EXCLUDES ENERGY BILL.




If there we no change in the energy prices, the ratio of exports to imports would be much better:

Figure: The ratio of exports to imports under 2000 prices

Current Account Deficit in Turkey

In his weekly briefing at Global Economic Forum, Serhan Cevik of Morgan Stanley wrote that:

If the decline in commodity prices is a trend shift, Turkey stands to benefit a lot. The shock of soaring commodity prices has been a major contributor to Turkey’s inflation and current account troubles. This is of course not surprising, given its growing dependence on imported sources of energy.... [N]et energy imports surged from 4.4% of GDP in 2003 to 5.2% in 2005 and 6.5% this year, accounting for more than 70% of the worsening in the current account deficit from 4.4% of GDP in 2003 to 7.4% this year. This is why we have always been careful about passing judgment on external imbalances of the Turkish economy.

It is good to see that somebody is paying attention to the reasons behind Turkey's high CAD in recent years. To clarify the point further I put a small table below that gives you the breakdown of the CAD. If the energy prices were at their 1996-98 rate, the CAD would be 2.6%. The net contribution of trade deficit to the CAD is in fact negative , once energy imports are excluded. In the second table, we can see that although the CAD has increased by 29 billion dollars, rise in energy imports explains 21 billion dollars of that.

Is Foreign Capital Harmful For Economic Growth?

Raghuram Rajan, who is the head of research department at IMF caused quite a debate in Turkey with his recent speech at a conference in Wyoming (bad boy!). In sevral op-eds prominent Turkish economists cited that speech to prove the virtues of (semi) closed economy over an open one that allows free movement of capital.

What did Dr. Rajan said in Wyoming (home of the VP Cheney. Hmmm?)

Our conclusion is therefore that in the long run, capital account opening is unlikely to help poor countries grow by providing resources in excess of what is available in the domestic economy.

Countries that use less foreign finance, or export more savings, grow faster.

Countries that invest more grow more than countries that invest less; but it is countries that invest more and save more (that is rely less on foreign capital) that do the best of all. In fact, within countries that invest more, those that save more (and thus run lower current account deficits) grow at a rate of about 1 percent a year more than countries that save less.

We find ... that controlling for domestic savings in our baseline regression eliminates the effect of the current account on growth but controlling for investment does not.

All this suggests that domestic savings rather than foreign savings are critical for growth.

In other words, it is good to save more and invest it. (You go Robinson Cruiso!). On the other hand, if for a variety of reasons you are not able to increase your savings (which is the case in Turkey), then what is your best course of action? I say let's borrow the savings of other countries and invest it to increase production capacity (but use that money wisely because you are going to pay it back with interest). This is the second-best option and in fact only option that we face in Turkey given that we are living in a democratic society and our elected leaders are likely to be reluctant to commit suicide by forcing their constituencies to adopt a China like savings rate.

Let me give a few numbers:

1. Between 1960 and 2005, 1 percent increase in growth, on the average, has required an investment of 4.7 percent (of gdp) investment.
2. That meansto achieve a 6 percent growth rate, we need 27 percent investment
3. Average savings rate in Turkey in the same period was 20 percent.
4. If we assume that the savings rate will be the same in the future, we need 7 percent foreign capital to make up the difference.

If you do not like this scenario, you only have two alternatives:

1. Increase savings rate through high tax rates, low government spendings, or both (and commit political suicide)
2. Increase the productivity of the economy.

How can we raise productivity? With more competition, new technologies, new business practices. In other words establish the rule of law in the country, cut the red tape, reduce corruption, invest on the infrastructure of the country, prevent oligopolistic business practices, create a competitive business environment, and of course attract more foreign direct investment.

Until then, the country needs foreign capital to grow.