The economic costs of political instability

In this column, I want to focus on the long-term economic costs of Turkey’s continuing political upheaval, drawing lessons from Turkey’s history of political instability and from academic research on the economic costs of political instability. Turkey’s lackluster economic performance until very recently -- as compared with many other developing countries -- since the end of World War II, has been caused largely by its lack of sustained political stability based on an uninterrupted democratic form of government. Of course, another powerful cause has been the lack of a government, until the AK Party government came to power, that strongly and consistently believed in the virtues of private enterprise and the open markets. Academic research suggests that political stability is a necessary if not sufficient condition for good economic performance. It also suggests that although political stability can exist under either a democracy or a dictatorship, uninterrupted long-term political stability is more likely under a democracy than under a dictatorship.

Here are two plausible scenarios, one cheerful and the other dismal, to consider. First scenario: The definitive victory of the AK Party in the general elections in July results in a strong majority in parliament and the smooth election of the republic’s next president would diffuse and eventually end the current political instability, provided that the democratic processes are not hindered. There would be no long-term economic costs to worry about.

Second scenario: The emergence of a coalition government, however, whether it includes a demoralized and weakened AK Party or not, would lead to continued political instability. It would make rational economic policymaking increasingly more difficult, and tilt policies toward greater state control of the economy, given the predilections of the political parties other than the AK Party, both on the left and the right, for statism. Structural reforms in the economy would come to a halt. Privatization would be put on hold if not reversed. Government spending would begin once again to get out of control, and the still-tentative independence of the Turkish Central Bank would be totally compromised, leading to the monetization of the bulging fiscal deficits, which would result in accelerating inflation. The economy would become increasingly unstable, as people struggle with short-term decisions and unproductive activities to shield themselves against rising inflation and falling real economic growth. The business environment for foreign direct investment (FDI) would again become unattractive, abruptly ending Turkey’s recent upsurge in inward FDI (see my earlier columns). Turkey’s bid to join the EU would become totally hopeless. The customs union with the EU would become increasingly controversial, leading to calls by statist and protectionist parties for it to be abolished. Turkey would retrogress to its inward-looking statist economic policies of the 1970s, becoming susceptible to recurrent and worsening crises. The situation could be even worse than that during Turkey’s so-called ‘lost decade’ of the 1990s, which was characterized by deepening political instability and economic crises.