Can Erdoğan turn Turkey's ailing economy around?

Turkey – a regional industrial giant

Two decades ago, I remember how surprised I was when an Iraqi official started talking about Turkey as the industrial giant of the region. We Turks tend to compare our country with European countries. We seldom have an idea about the performance of our neighbours.

But it's true – Turkey has become the region's industrial giant. That is thanks to the process of opening the economy up, led in the early 1980s by President Turgut Özal.

When it started, the proportion of output that was exported by the manufacturing sector was under 10%. It is now around 80%. Half of those exports go to Europe. If you add G7 countries too, that accounts for 60% of Turkey's exports.

When I was born in the early 1960s, Turkey was an agrarian country. Now it is a dynamic hub of the manufacturing industry. In the early 1980s, the industry was all located around the major cities: İstanbul, İzmir, and Adana.

Then industry moved eastward, and a group of secondary cities emerged: Kayseri, Gaziantep, Kahramanmaraş and Denizli. The skills base for industrial production spread from the first to the second tier.

The graph below is about the economic sophistication levels – or skill sets  – of different countries, and it shows how well-placed they are to meet opportunities.

Move to the right on the horizontal axis, and the country has a workforce with more qualifications, so a better chance to produce more complex products. When you move up on the vertical axis, it means the country has more potential to do well, helped by relevant national policies.

Generally. the more skills you have, the richer you get.

In 1962, Turkey was in the lower left quadrant, together with Saudi Arabia and Yemen. Those are the countries with limited production and opportunity sets.

However, Turgut Özal's reforms helped transform Turkey's place on the chart. By 2000, Turkey had moved to the upper right quadrant, together with most EU countries. It was now a country with a wide opportunity set and looking for the right policies to make the next jump. As of 2020, Turkey is there, looking for the right policy mix to help it get richer.

Economy's rising competitiveness

The move into the manufacturing industry reveals something about the rising competitiveness of the Turkish economy. Its jump in global competitiveness is highly visible in the economic complexity index calculated by MIT's Observation of Economic Complexity.

This index is based on an analysis of the products exported by a country. You either converge with the product set of richer countries or diverge from them.

The MIT index shows the global competitiveness of the Turkish economy jumped up in the 1980s and then in the 2000s.

Both of these periods came on the heels of deep economic crises, showing how times of trouble create opportunities for reform. First, it was the oil crisis; then it was the public debt pile-up which destroyed bank balance sheets.

Both caused a fiscal crisis for the government, but each time, Turkey reacted by taking the opportunity to boost its competitiveness. It shows how taking the right set of measures can pay off.

This graph shows where Turkey is regarding the potential of its manufacturing sector exports.

Here, it is compared with the potential of other countries, like Russia in the north and Gulf nations in the south. The horizontal axis shows the share of manufacturing industry exports in the total exports of the country.

Turkey and Israel are industrial countries with around 80 percent of their total exports from manufacturing. Russia is not in the same league, as only around 30 percent of Russian exports are from manufacturing industries.

The vertical axis shows the country's share of the manufacturing industry in the country's total exports. Turkey has been an industrial giant since 1993. This became more visible when Turkey entered a customs union arrangement with the European Union covering industrial products.

The chart shows both Saudi Arabia and the UAE have increased their manufacturing industry export potential while Russia's industrial base deteriorated relative to the rest of its economy. Russia has effectively become a Gulf country.

The 'Argentinisation' of the Turkish economy is over-stated

The Turkish economy now finds itself back in deep trouble, just like it was in the 1970s and the 1990s.

The country is once again on the verge of a balance of payments crisis. It was the late Süleyman Demirel who said that Turkey needed every cent in 1977. We are fast approaching that stage. Why?

Turkey is a country with a structural savings deficit. It means there is a chronic current account deficit which needs to be financed. That's why Turkey was one of the first countries to implement financial liberalisation measures in the early 1980s.

It needed to do so back then because the nature of international fund flows was changing – moving from being based on government-to-government movements to an open market mechanism.

Turkey, with its chronic financing problem, had to adjust. It needed money markets and capital markets to allow orderly inflows into the country.

The current account deficit and the nature of capital flows left Turkey strongly linked to US dollar markets and the financial pull of the West.

That means problems in international financial markets can affect the tides within capital flows, which in turn can mean a balance of payments crisis in Turkey.

In this regard, indirect comparisons can be drawn with Argentina, but direct parallels with the troubled South American economy are misleading. As Tolstoy put it in Anna Karenina's famous opening line, "All happy families are alike; each unhappy family is unhappy in its own way".

Every balance of payments crisis is alike, but they are also crises in their own ways.

Another look at graphs 3 and 4 will show you the manufacturing industry export base of Argentina and Turkey. If Argentina was here in the Middle East, it would be somewhere below Saudi Arabia.

Any full rationing of foreign exchange in Turkey could lead to a rapid reduction in the hard currency earning capacity of the country and high unemployment, as companies would need to close down factories, at least temporarily.

This is because Turkey's status as a bigger exporter of manufactured goods has implications for the impact of any interruption of the flow of foreign currency into the country. Turkey has to import intermediate inputs in order to produce finished manufactured goods.

High current account deficits have become a structural characteristic of the Turkish economy. In 2023, this will be above 6% of GDP, which measures the size of Turkey's economy.

One structural characteristic of the Turkish economy is its high current account deficits. In 2023, Turkey's current account deficit is going to be above 6 percent of GDP. 

This stems from Erdoğan's policy to lower interest rates even at a time of high inflation. It has been exacerbated by the cost of the recent earthquake and the expense of his recent election pledges.

And last month's election victory is Erdoğan's most costly yet.

It means the country has a twin deficit problem once again – one defined by falling income in real terms as its currency weakens, and higher spending. It looks set to send the budget deficit to a 20-year high, reaching around 10 percent of GDP. 

That would be higher than the 10-year average of Turkey's current account deficits. No matter how you look at it, it's an explosive situation.

Nonetheless, some things stay the same: when push comes to shove, Turkey has always done the right thing.

That's why I always feel optimistic about the country. We have always come back stronger from the brink of economic disaster. The situation is more complex now, but I see no reason why this time should be different.