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Tuesday, January 13, 2004

Turkey On The Ramp?

If my demography thesis can really hold water, we should be able to look to trends beyond China and India for additional confirmation. I have already been playing around with Turkey and Brasil as potential beneficiaries of the transition for some time now (and I have been meticulously nay-saying Russia, and the transition economies generally, for similar, but of course diametrically opposite reasons). Now it is heartening that Morgan Stanley's Serhan Cevik seems to be among the converted, at least as far as Turkey goes. Incidentally note his estimate of the 30 - 50% gain in productivity necessary to move workers from the informal to the formal economy, this is coming up in a later post.

The Turkish economy will continue to grow at an above-trend speed, we believe. Turkey’s gross domestic product increased by 5.4% year on year in the first three quarters of last year, after rising by 7.8% in 2002. With far-reaching economic and institutional reforms unlocking the country’s full potential, we are witnessing a paradigm shift in progress, and expect the economy to grow at an above-trend pace in the foreseeable future (see Everything’s Gonna Be All Right, December 12, 2003). Of course, Turkey is still in the early stages of economic and financial convergence, but the latest data show that structural changes in the economy and political consolidation have started to yield promising results. In our opinion, the remarkable growth performance is no longer a story of cyclical recovery, but driven by productivity gains and a significant compression of real interest rates.

A discernible improvement in the rate of productivity growth has been an important factor in the strength and duration of the current economic expansion. Labour productivity in the manufacturing sector rose by 8.0% in the third quarter of 2003, up from an average of 3.9% in the first half. On a seasonally adjusted basis, the underlying growth of labour productivity increased to an annualised rate of 13.5% in the third quarter, from 9.4% in the first half of 2003. Although Turkey’s private sector has the lead in improving productivity, restructuring measures have also increased labour productivity in the public sector by 23.4% in the last two and a half years. As a result, the rate of overall productivity growth accelerated from less than 4% per annum in the 1990s to 8.4% in the aftermath of the 2001 crisis............

Notwithstanding the economy’s modern segments that display exciting productivity growth, traditional segments remain inefficient and continue to drag down overall productivity growth. The country’s large informal economy is a big obstacle for upgrading production technologies, in our view. Since modern production processes require a larger scale, firms that adopt such technologies cannot maintain the low visibility and mobility that allow them to avoid the taxes and other obligations of the formal economy. Therefore, the state’s failure to enforce the tax and regulatory system in a uniform way imposes a very high tax burden on efforts to improve productivity, since moving a worker from the informal to the formal sector requires a productivity gain of 30-50% just to cover the tax wedge. Macroeconomic reforms may have breathed a new life into the country’s development prospects, but speeding its transition into the ranks of developed nations requires (1) microeconomic reforms that would dismantle the rent-based political economy and (2) investments in education and knowledge that would increase value-added.

And if you think deflationary labour market pressures are only a Chinese phenomenon - take a look at this from his post last week:

Labour’s share of national income might be a better measure of the ‘demand’ gap. In our opinion, the share of labour in national income is an important variable in explaining inflation variation in Turkey. With declining real wages and employment, the labour share of GDP declined from 30.7% in 1999 to 26.7% in 2002 and, on our estimates, to 25.6% last year. Meanwhile, the 30.4% rise in labour productivity led to an unprecedented 37% reduction in unit labour costs. Of course, productivity gains take a while to feed through to higher growth of labour compensation. In fact, productivity gains are not raising demand as much as might have been expected and may even have been delaying the recovery of investment by enabling firms to increase output without expanding capacity. As a result, declining employment and labour income have created a ‘demand’ gap and effectively accelerated the pace of disinflation despite rapid economic growth in the last two years............

The death of inflation would mark a historic turning point. Turkey has suffered from high and variable inflation rates for over three decades, and thus achieving a single-digit inflation rate would signal the arrival of economic stability. Of course, the end of the road is still far away, and achieving price stability in a country with structural infirmities and a long history of macroeconomic instability requires policy consistency. Nonetheless, macroeconomic developments have shown that the country has an exciting long-run capacity for economic growth, and a benign global outlook should help to maintain an above-trend job-creating expansion and disinflation in the direction of the year-end inflation target. However, to sustain the growth and disinflation performance of the last two years, the authorities must keep implementing economic and institutional reforms.

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