Turkish economy: between hard and soft landing

Yet, study after study indicates that it is not politics but living standards and “bread and butter” issues that determine election results. In many ways, the axiom “it's the economy, stupid” holds true if you really want to understand which direction the electorate will go.

Focusing on the economy is also the best way of analyzing the Justice and Development Party's (AKP) electoral success since November 2002. No political party in Turkish politics won three consecutive elections by raising its share of the vote after each election. The fact that the Turkish economy managed to grow by an average of 7 percent during the last decade is arguably the most important factor behind such electoral success.

Given this strong correlation, bordering on causality, between economics and electoral performance, the future of the AKP and the fate of Prime Minister Recep Tayyip Erdoğan greatly depend on whether the Turkish economy will maintain its stellar performance. There are diverging views on this issue.

In one camp you find the pessimists who argue that Turkey's recent performance is essentially a bubble that is bound to burst, as all bubble eventually do. Their views often clash with those who point out that Turkey's competitiveness is on the rise and that growth is not just fueled by short-term capital flows.

As mentioned in The Economist: “A recent research paper by Dani Rodrik of Harvard University showed that Turkey's productivity record improved markedly in the decade after 2000, with average growth rates of 3-3.5% in GDP per person, GDP per worker and industrial output per worker. Income per head (in current dollar prices) has tripled in less than a decade to around $10,000 and there is still plenty of scope for Turkey to converge on the higher living standards of the rich world.”

But despite Rodrik's point, The Economist, usually a reliable and balanced source of analysis, is now leaning towards the pessimistic camp. Central to the argument of the pessimists about the Turkish economic “miracle” is the growing current account deficit (CAD). As Turkey grew at 9 percent in 2010 and 8.5 percent in 2011, so did its CAD, which ballooned to 10 percent of gross domestic product (GDP). This indicates the propensity of Turkish consumers to spend more than they save. It is also a clear indicator of the growing gap between imports and exports. Inflation, which recently reached 10.2 percent, is another indicator of such spending-related macroeconomic imbalances.

The optimists have been arguing that Turkey's imports are mainly energy related, given the absence of oil and gas in Turkey, and that the CAD will go down as the economy slows down in the next couple of years. Most figures already indicate that annual GDP growth slowed to 5.2 percent in the last six months and that the economy will continue to decelerate further during 2012.

Under normal circumstances such a slowdown would also diminish spending and improve the CAD. Yet, as The Economist argues, we are not going through normal times in the global economy: “The European Central Bank's huge provision of cash to euro-zone banks has led to a revival in risk appetite, which has kept capital flowing to Turkey and elsewhere. That has lessened the pressure for prudence. The danger now is that a few more years of big current-account deficits, and the debt-creating capital flows that finance them, will leave Turkey less resilient when trouble strikes. Few countries that run big external deficits have avoided subsequent stresses.”

The obvious cure to the problem is to improve Turkey's public finances to compensate for the weakness in private sector saving. This would require cutting public spending to improve the primary surplus. Yet anyone who follows Turkish politics knows that Turkey is always in election season. The temptation for more spending and populism will be with us until 2014, when Prime Minister Erdoğan is likely to run for the presidency. It looks like we will be discussing whether Turkey will have a soft or hard landing for a couple of years to come.