The current account deficit to gross domestic product (GDP) ratio reached around 5- 6 percent in the last three years. This is one of the most dramatic deficits among large countries. Even worse, parallel to the soaring food and energy prices, the same process continued in the first five months of 2008, despite a relatively slowing economy. Details of this year's current account deficit received an in-depth analysis by Murat Yülek in his column yesterday.
Today I want to underline the reality behind this tragic situation. Most experts are inclined to explain the current account deficit by referring to the real exchange rates (RER). In a country like Turkey where RER has a significant asymmetric effect on various industries, it is not possible to forecast the net result -- that is, whether it will increase or decrease the competitive strength of the overall economy.
In my view its impact on declining or traditional industries -- such as textiles, leather and shoes -- and on a number of other industries would be positive, whereas the effect on rising and modern industries would be negative due to the fact that this would artificially hinder the import of most cheap and high-quality inputs in a globally integrated production network. This, in turn, would create a negative structure in the competitiveness of locally producing companies. The fact is that the transformation of Turkey's industry and export process is being driven largely by foreign-affiliated companies, and they have global outsourcing and utilize the value chain. If their procurement process is hindered by certain artificial policies before they create a domestic environment providing the same inputs at lower prices and quality, this would deter these companies.
Moreover, having considered Turkey's low import elasticity, especially in the energy sector, a significant devaluation of the Turkish lira would fuel further current account deficit, cause the loss of competitive strength of final goods, harm debt ratios of the private sector and create further pressure on inflation.
Rather than using RER, I prefer Turkey's saving-investment gap, which is around 6-7 percent of GDP, in explaining Turkey's current account deficit. However, the most dramatic explanation can be found in the graph below, in which the real competitive strength of a country is shown. In the graph, a cross-country comparison of innovation performance is given in which Sweden is the best and Turkey the worst. On the horizontal axis, average growth of the summary innovation index (SII) is displayed, with the vertical axis showing the level of SII.
Subcategories of SII are composed of innovation drivers, knowledge creation, application, innovation and entrepreneurship, and finally, intellectual property. Turkey ranks at the bottom of virtually all of these categories, in some cases with a score of zero.
This finding has major implications for Turkey's rising current account deficit. Among other factors, global competition is driven by price and quality. Turkey has been pursuing mainly price competition strategies in its traditional industries, whereas it has been dramatically isolated from the innovation economy in modern sectors since the late 1980s. However, after the China and India syndromes, in which labor and certain inputs are cheaper and the quality of human rights and welfare are the worst, the opportunity for Turkey to continue in price competition has disappeared. In terms of quality competition, however, Turkey is still at the beginning of the race after losing almost a decade in the 1990s.
Obviously, the solution is neither reverting to isolation nor implementing artificial policies, but to cope with this overwhelming challenge by implementing tough policies and reforms. In this regard, in the longer term Turkey should implement policies to increase national savings, increase the R&D expenditures of the private sector, implement radical reform measures in technical education, attract more foreign direct investment in green field sectors, improve infrastructure even further and keep the reform process on track.
