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)

Are We There Yet?

Turkey is a developing country. We all agree on that. In her quest to become a developed country, is she getting closer to her goal? Diagrams below may give you an idea.

Using PPP GDP per capita figures, I normalized the income level of countries with respect to Turkey (i.e. by setting Turkey's income per capita as one). In the first figure, we compare the economic development of Turkey with three of her peers in the early 1900s: Greece, Portugal and Spain.

In 1913, all three were richer: Spain by 120%, Greece by 70% and Portugal by 45%. On the average, income per capita in these countries were 78 percent higher than that of Turkey.

• Fast-forwarding to 1950, the difference is almost the same: 75%.


• In the 50s, Turkey was able to get closer a little bit.


• But in the 60s and 70s, Turkey was not able to keep pace with the three and fell behind.


• In 1980, they were almost 3 times richer.


• In the 80s, the gap shrunk again - to 2.79.


• Following the "lost decade" of 90s (which can be characterized by an ever-lasting political and economic uncertainty in Turkey), Greece, Portugal, and Spain are 2.79 times richer.

Figure 1: Income per capita (PPP) - Turkey vs. Greece, Spain, and Portugal



The other diagrams compare Turkey with Europe, South America, Asia and Pacific.


Figure 2: Income per capita (PPP) - Turkey vs. Europe





Figure 3: Income per capita (PPP) - Turkey vs. South America




Figure 4: Income per capita (PPP) - Turkey vs. Asia




Figure 5: Income per capita (PPP) - Turkey vs. Pacific

In the last graph, we compare income per capita of Turkey with the 38 countries. It seems that we are not there yet...

Figure 5: Income per capita (PPP) - Turkey vs. Pacific

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Data Set:
1. Angus Maddison (‘Monitoring the World Economy 1820-1992’, OECD 1995).
2. Penn World Table
3. World Economic Outlook Database, April 2007

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.