Caught in a trap

The IMF is among bodies that have warned that Turkey could languish in a “middle-income trap” unless it reforms key sectors such as the labour market.

For thousands of years sultans, kings and rulers have descended on Turkey to hunt and trap, its unique geography providing rich habitats for wild boar, ibex, bears and wolves.

Impressive development since 2002, with the country clocking up average annual growth rates of around 7%, has led among other things to the emergence of specialist tour companies catering for the modern hunters who now head for the country’s great outdoors.

But it would appear that it is Turkey itself that is now ensnared, with the IMF warning that low domestic savings and poor competitiveness are putting its ailing economy at risk of being caught in the “middle-income trap”.

A key reason is lack of progress on structural reforms under the ruling AKP Party, and while reforms are seen as a potentially fertile focus of the government after parliamentary polls on June 7, there is a growing sense that something more comprehensive may be needed.

Bruna Skarica, an economist at emerging market research firm Trusted Sources, said: “If you look at the figures since the AKP came to power, the average growth rate per year in their first term [2002–07] was about 7%, and this was really demand-driven because credit was quite cheap.

“So there was very little incentive to do any really serious structural reform that would dent those high-growth figures. But now that the country is growing by about 3%, policymakers are becoming much more aware of the need for structural reform.”

In a gloomy report released late last year, the IMF pointed out that Turkey’s impressive development had been at the expense of a persistently large external deficit and, without policy change, annual growth was likely to be only 3.5% over the next five years

The IMF wants carefully sequenced reforms aimed at increasing aggregate savings, competitiveness and output, and called on the government to accelerate measures promised under its 10th Development Plan published last year. The labour market is seen as a pressing target of reform alongside energy policies and product market regulations.

“Turkey needs to upgrade the quality of its human capital to reignite growth momentum; Turkey also needs to liberalise labour markets and product markets, to increase the level of savings and investment, and to upgrade the quality of institutions, in order to escape the middle-income trap,” said Fadi Hakura, manager of the Turkey project at the Chatham House foreign affairs think-tank in London.

Nonetheless, reform has long been on the agenda in Turkey and a key issue is implementation. The country’s quest for membership of the EU has driven waves of modernisation since the late 1990s, and bold changes to labour and employment laws were made before 2005.

However, cooling sentiment towards Turkey within the EU and the country itself has complicated this dynamic, and little seems to have changed since 2012 when the OECD outlined a wish-list of labour reforms.

The long-term threat posed by Turkey’s sluggish economy to the AKP might now suggest a more powerful incentive operating in favour of reform after June 7, although not everyone is convinced.

Inflexible

“Turkey has an extremely inflexible labour market and nothing really seems to have been done for a long time. There are arguments that after the electoral cycle, when they won’t have another poll for three or four years, they may be able to do something,” said William Jackson, senior emerging markets economist at Capital Economics.

“There is an upside scenario in which they do suddenly embark on reforms, but I find it hard to see why, if they have been in power for so long – and if anything, have moved further away from reforms – they would suddenly change tack.”

Despite rising substantially since 2007, Turkey’s overall employment rate (50%) remains much lower than the OECD average (65.6%) and euro area average (63.8%). The OECD believes this is mostly due to the low labour force participation rate of women, which is around 30%.

“The declining global energy prices give a respite to the Turkish economy, in particular reducing the perennially high current account deficit, and in principle offers the government an opportunity to implement some critical structural reforms, but I think it is highly unlikely to undertake these any time soon. So low energy prices are more like a sticking plaster across Turkey’s endemic economic challenges rather than a viable solution to escaping the middle-income trap”

Another priority would be improving the quality of employment by tackling informality in the labour market. Turkey has some of the most rigid employment protection rules in the OECD, and these fuel informality.

Jackson said: “There’s a point where inflexibility in the labour market tends to create a dichotomy in conditions, whereby you have some parts of the population on high-paying contracts and relatively protected from, say, being fired, by quite strong legislation; but because it is strong, it makes firms reluctant to hire in large numbers, and so what you see then are that a lot of people are locked out of the official labour market and turn to the informal labour market, where they have very little protection.”

The OECD has called for far-reaching changes that includes more flexible contracts for permanent workers, a less costly severance payment regime, the legal availability of temporary and agency work, and lower minimum wages.

Economist Murat Ucer, Turkey adviser for Global Source, believes a return to orthodoxy is required: “We need a comprehensive labour market reform that bites; we need to overhaul the severance pay structure; we need to rethink policies on the minimum wage, which is actually very high compared with the average median wage and does not take into account regional differences in purchasing power; we need a national strategy on where we want to take the education system – all of these issues will have to be revisited to make the Turkish labour market more flexible and more skilled.”

There is no doubt that at a political level the Turkish authorities recognise that reforms are needed. The 10th Development Plan prioritises job creation and the government has sketched out changes to severance pay, unemployment benefits and temporary work contracts.

But political promises aside, significant implementation gaps remain. While falling oil prices took some pressure off Turkey’s current account deficit, Jackson at Capital Economics believes this has not enhanced the circumstances in which reforms become imminent.

Hakura of Chatham House agreed, saying: “The declining global energy prices give a respite to the Turkish economy, in particular reducing the perennially high current account deficit, and in principle offers the government an opportunity to implement some critical structural reforms, but I think it is highly unlikely to undertake these any time soon. So low energy prices are more like a sticking plaster across Turkey’s endemic economic challenges rather than a viable solution to escaping the middle-income trap.”

Reform has also taken a back seat to politics, and in their response to the IMF report last year, Turkey’s policy-makers said they aimed to start implementing key steps only after the polls.

Skarica at Trusted Sources said: “AKP’s popularity is very closely affiliated to the situation in the economy and unemployment, so if they see social unrest potentially developing linked to a weaker economy, they might be very incentivised to do something serious on structural reform, especially since there are no elections in the next four years.”

Some observers, however, believe structural reform in itself may not be the solution to Turkey’s economic woes. Ucer of Global Source said broader steps were needed to create a more predictable investment environment.

He said: “It is probably fair to say that we have regressed in terms of the general institutional environment of Turkey – there are fewer rules, a lot more discretion now. I believe we should just go back to basics, like leave the central bank alone, learn to live within our means, accept low growth for a while and do all we can in the way of very specific, prioritised reforms to raise potential growth or the ‘speed limit’ of our economy – an internally consistent wholesale effort to restore institutional strength, starting with the central bank.”

Marcus Svedberg of East Capital agreed that structural measures have to form part of a more comprehensive package if social tensions are to be avoided in Turkey.

“This is a complex issue, which means that you need a comprehensive plan,” he said. “It has to be a cautious approach and carefully sequenced. What I would like to see after the election is a comprehensive plan with sequencing, financing, that says this is what we want to do to take Turkey to the next level – labour market reform, industrial policy, etc.

“There has been an element of the government presenting white elephants – an airport, a bridge, a canal – what we want now is a comprehensive reform agenda run by credible people.”