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June 03, 2012, Sunday

Sluggish growth and AK Party rule

Last week in my article “Pro-poor economic growth and the AK Party” I was explaining how income inequality and poverty have declined in the last decade, coinciding with Justice and Development Party (AK Party) rule.

The basic factor behind this decline has been the high economic growth which benefited the poor more than the rich. This success has been achieved mainly through three channels: high increase of non-agricultural employment due to an average economic growth rate of more than 5 percent despite the crisis of 2008-09; a big push to increase the lowest wages and salaries at the beginning of the AK Party incumbency; and finally, thanks to fiscal discipline, decreasing interest rate expenditures that made the increase of social transfers possible. Needless to say, the noticeable improvement in social cohesion boosted electoral support for the AK Party, whose margin of the vote increased from 35 percent in the November 2002 elections to 50 percent during the June 2011 elections.

Now the Turkish economy has entered a new period. The previous one -- which succeeded the decade characterized by financial crisis and political instabilities -- created a window of opportunity for the AK Party, which did not fail to take advantage of it. But do not forget that the high growth has been led by domestic demand, causing diminishing private savings and an increasing external deficit. The current account deficit is currently 10 percent of the 2011 gross domestic product (GDP), a historic record peak. The availability of abundant international liquidity as well as positive accession negotiations with the European Union helped to sustain this increasing deficit. This growth strategy reached its limit at the end of last year, and a structural correction has become unavoidable.

This correction is now under way. Domestic demand is severely constrained through tight monetary and fiscal policies. The aim is to put the Turkish economy on a more balanced growth path. The government's Medium-term Economic Program (OVP) counts on 4 percent GDP growth for this year and 5 percent for the next, with a much lower current account deficit due to exports growing more than imports.

Now the problem is that the OVP targets seem to be unrealistic. It is true that since the third quarter of 2011, exports have been growing more than imports, making a positive contribution of net exports to growth, which is the sine qua non of the so-called “soft landing scenario.” But the latest leading economic indicators show that this achievement would be realized against a lower growth rate. Bahçeşehir University's Center for Economic and Social Research (BETAM) forecast a 3.5 percent year-on-year growth for the first quarter of 2012. The Organization for Economic Cooperation and Development (OECD) recently forecast 3.3 percent growth for the whole year and 4.3 percent for 2013, assuming that Europe's economy is in better shape than it is today.

Indeed, exports to European markets have been decreasing since the beginning of this year, and no one can confidently assert that a reversal will occur very soon. On the contrary, there are many reasons that lead us to think that the situation might get worse. The increase of Turkish exports is due to the high performance of our exporters in other markets. But let me point out that the European market still accounts for 40 percent of all Turkish exports.

When I started this column in February I was a partisan of the soft landing camp. Based on the latest information on macro indicators, both domestic and foreign, I am now inclined to opt for an intermediate scenario between soft and hard landing -- which I call the “tarnished landing.” I think the current account deficit will be narrowed but not sufficiently enough; it would be possible to curb the inflation rate currently running at more than 10 percent to around 7 percent. But all these half successes would be achieved against lower economic growth -- something between 3 and 4 percent. At this level of growth, we can forget about high job creation, which is capable of tackling unemployment and reducing income inequality as well as poverty, simply because there will not be enough room in the budget to increase social spending without jeopardizing fiscal discipline.

Are we stuck to a too-little growth? I don't think so. There is still a way to escape this, but it requires better political skill. The government's priority should be economic structural reforms. I have tried many times to explain in this column how labor market reforms (severance pay reform, fiscal devaluation, etc., and product market reforms (the New Commercial Code, for example) are necessary and urgent in order to improve the competitiveness of local industries, to continue to have economic growth of around 5 percent and to fight unemployment and poverty. Having said that, look at what the AK Party is currently doing -- it is expending its energy on the Uludere air strike and abortion clashes while at the same time it is getting ready to postpone the implementation of the New Commercial Code in July and trying to remove or amend certain key articles in it. Parliament will go into summer recess within a month, and any economic reforms will be postponed to autumn.

Time is running out. I agree that these structural reforms are painful and politically dangerous, at least for the short term, but trying to escape them might be more costly in the long run.

Previous articles of the columnist