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Friday, September 05, 2003

Where the Growing is Good

Back to my demography thesis for a minute. By now it should be common knowledge that I am treating Italy as the big downside test. In other words if Italy in the next few years should mysteriously, and apparently inexplicably, find itself in a pretty tough economic corner, then I guess I'll know I'm more or less on the right lines. But since I don't want everyone to think I'm an inveterate pessimist, maybe I need one or two positive examples to help things along. Now it's is also common knowledge that I'm pretty strong on China and India. But so too are the World Bank, Brad, and a lot more who shall remain nameless. And none of these necessarily subscribe to the demographic thesis. In addition many could identify this with an Asian cultural phenomenon. So I've been thrashing around trying to come up with something better and, as I indicated last week, Turkey and Brazil to me look like two obvious candidates. Culturally very different, recent hyper inflation history, not the obvious candates. So let's keep watching, and see if my judgement is any good.

The Turkish economy is staging a remarkable recovery with no sign of overheating. The turnaround in economic activity and financial markets appears to be a startling contrast to the gloomy expectations just a few months ago. Real gross domestic product posted a seasonally adjusted annualised growth rate of 12.2% in the first quarter of this year, up from 7.9% in the last quarter of 2002, according to our computations. We believe Turkey is on an upward curve to develop into one of the fastest-growing economies in the world. However, the current economic recovery has a perplexing nature. First, increases in the rate of real GDP growth are largely driven by an extraordinary inventory accumulation. Second, the quasi-recovery has hitherto failed to improve conditions in the labour market. Nevertheless, a debate on the risk of overheating of the economy may soon emerge. In our view, such a judgement is based on a set of flawed assumptions and a misreading of underlying macroeconomic trends and structural changes.

Despite the good news on the inflation front, overheating arguments may be unavoidable. We believe markets may soon start to fear that the rate of economic growth would produce an increase in inflation by lowering the unemployment rate to a point where upward wage pressures become overwhelming. Such a line of reasoning, in our view, contains questionable presumptions. First, it is widely assumed that the sustainable level of economic growth in Turkey is just 4.5%. The dissection of this potential growth rate, which seems to be based on the average real GDP growth rate in the 1990s, shows (probably) a growth rate of 2% in the supply of labour and 2.5% productivity improvement. Second, the argument is based on the assumption that the Turkish labour market is rigid with real wage growth outpacing productivity gains.

We believe productivity growth is not only much greater than 2.5%, but will remain so for a long time. Before dissecting the country’s estimated potential growth rate, we should point out that productivity is virtually impossible to measure in the service sector and the diffusion of new technologies — Turkey is still in the midst of technological convergence — makes measurement errors worse. Nonetheless, we believe measurable productivity is growing much faster than the 2.5% “consensus” figure. Labour productivity in the manufacturing sector grew at an annual rate of 3.7% in the 1988–2001 period, and increased by 16% in the last two years. Although labour productivity is reliable in the short run, we believe total factor productivity, which is also on an improving trend, is a more dependable concept over the long run in determining the potential growth rate...........

The sustainable rate of output growth is close to 7.5%, according to our calculations. The contribution of total factor productivity to real GDP growth was 1.4% in the 1970–2002 period, and we expect it to rise to around 3% in the next 10 years. In fact, the rate of change in total factor productivity can be even much higher than our projection, if the authorities accelerate the process of economic liberalisation through increased openness of external trade and eliminating inefficiencies in the public sector that have actually become a burden on the whole economy. In particular, institutional reforms required for the EU accession would bring foreign capital, technology and know-how and thus increase the country’s total factor productivity. For the time being, our computations show that Turkey’s potential growth rate is close to 7.5% — 2.0% labour-force growth and 5.5% productivity growth...............

We also need to focus on indicators of current labour market weakness. The unemployment rate soared to the all-time high of 12.3% of the civilian labour force in the first quarter of 2003, from 5.6% in 2000. In the last two-and-a-half years, economic troubles destroyed over 2.5 million jobs, and the recent improvement was due predominantly to a drop in the participation rate. If truth be told based on official statistics, which, in our view, underestimate the depth of worsening in the labour market, the non-farming jobless rate increased from 8.2% before the crisis to 15.1% last year, and improved slightly to 14.6% this year (see our recent report, Young, Educated and Jobless, August 28, 2003). There appears to be no shortage of the supply of labour in Turkey. The country’s labour force increased at an average rate of 1.6% in the last decade, and, more recently, expanded by 4.7%, thanks partly to increasing female participation.
Source: Morgan Stanley Global Economic Forum

BTW: Don't lose the point about labour market problems. Turkey, like the US, has a lot of young people entering the market, and is also experience a cultural change with the rise of female employment. This is going to make low unemployment difficult to achieve short term, but with growth rates in the 7% range this should not be unduly preoccupying short term.

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