Turkey Country Economic Memorandum: Promoting Sustained Growth and Convergence with the European Union

Speakers: Andrew Vorkink, Country Director for Turkey, World Bank
                Aristomene Varoudakis, Lead Economist, World Bank
 
Discussants: Ibrahim Canakci, Undersecretary of Treasury of the Turkish Government
                    Luis Riera, Director, DG Regio European Commission
                    Christophe Pavret de la Rochefordière, Official, DG ECFIN European Commission
                    Christian Danielsson, Head of Unit, DG Relex, European Commission
                    Willem Buiter, Professor, European Institute of LSE
                    Jorge Braga de Macedo, President, Tropical Research Institute
 
Chair: Daniel Gros, Director, CEPS
 
Date: 9 March 2006
 
On 9 March CEPS hosted the launch of a World Bank report entitled ‘Turkey Country Economic Memorandum: Promoting Sustained Growth and Convergence with the European Union’. High unemployment and the current account deficit appeared to be the most important shortcomings of Turkish economy, hindering convergence with the EU.
 
Andrew Vorkink, World Bank Country Director for Turkey, opened the discussion by stating that the report is the start of a series of planned commitments between the World Bank and Turkey in the context of the EU accession process. He said that the report focused on two important questions: the appropriate sequencing of reforms and smooth alignment with the EU acquis and the management of the broader development agenda that lies outside the EU acquis. He stressed that the accession negotiations and eventual membership of the EU have significant economic and social benefits for Turkey.
 
However, he also drew attention to the two main challenges that are slowing down convergence with the European Union. The first one is the poor labour market performance, with employment increasing by less than 1% per year against the fast-growing labour force. He said that creating enough job opportunities at home would be a key factor in alleviating concerns about potentially large labour flows out of Turkey and would greatly support Turkey’s bid for EU membership. Improvement of the quality of fiscal consolidation is the second challenge. Although fiscal consolidation has been the cornerstone of policies in Turkey and has been quite successful in reducing both the level of public debt and interest rates, the size of the current account deficit continues to be unchallenged. He therefore underlined that a robust fiscal framework should be maintained. He concluded by congratulating Turkey for the efforts it had undertaken to provide the stability that had not been forthcoming for some forty years.
 
Aristomene Varoudakis, the team leader for the report, restated the latest achievements in Turkey in terms of both economic growth and stability of macro-economic environment. Presenting the main findings of the report, he explained that the growth is due to three factors;

• Rising private sector productivity
• Increasing exports
• Recently booming foreign direct investment (FDI)

Just as the precedent speaker did, he pointed to the shortcomings of the Turkish economy, namely a widening current account deficit and continuously high unemployment. He stated that, to complete convergence with the EU, Turkey has to fulfill some preconditions. It has to carry out structural reforms in order to promote stronger total factor productivity growth, more job creation, improved efficiency and productivity growth in services and better educational attainment. He also presented the best and worst case scenarios for convergence, emphasising that the outcome will depend on the scope and pace of these structural reforms.
 
As for management of the public finances, he said that structural fiscal reforms are needed to make room for growth-promoting expenditure and lower taxes. He also welcomed the rationalisation of the investment programme, achieved through cuts in the investment expenditures.
 
Regarding the convergence of labour markets Turkey’s employment ratio remains below the average of EU member states and of accession countries. To address this problem, Turkey needs more flexible job security rules and has to undertake ambitious social security reforms.
 
He finished his speech by underlining the significance of a strategy for social inclusion, for rural development and for a sound health care system.
 
The first discussant was the Turkish government official Ibrahim Canakci, who identified two central macroeconomic difficulties facing Turkey; fiscal sustainability and the current account deficit. Concerning the fiscal problems, he specified that they have emerged on the revenue side and that the government is making a huge effort to cut expenditure. He drew attention to the fact that this year no additional measures have been needed for the budget and that the number of civil servants has remained the same. Nonetheless, he acknowledged that the composition of budget should be diversified and a new public procurement system is required. He also announced that they had initiated a public expenditure review programme together with the World Bank to set out the priorities and efficiency gains.
 
As for the current account deficit, he argued that it is driven by high energy prices, productivity growth and the strength of the currency. He stressed that analysing the real interest rates could be misleading in assessing competitiveness and that the profit margins in the export sector should be examined instead. In this context, he pointed out that Turkish exports have more than doubled in three years. Furthermore, he made it clear that Turkey’s response to the deficit has been very much in line with World Bank thinking, which is to further tighten fiscal policy. Finally, he presented a list of priorities to improve the stability of the financial sector, which includes strengthening the institutional aspects of banking laws, the supervision of the non-banking system and speeding up the privatisation of state banks.
 
Luis Riera said that future interventions in Turkey within the framework of the DG Regional Policy will take place under the new accession instrument, IPA, which is made up of five components: institution- building, cross-border cooperation, rural development, human development and regional cooperation. He explained that due to this major conceptual change underlying the notion of structural funds the focus will be mainly on economic restructuring and modernisation.
 
Christophe Pavret began by pointing out that, in its progress report, the Commission acknowledged that Turkey has a functioning market economy. He mentioned, nonetheless, that there are some aspects where progress is slow. Reiterating the preceding speakers, he said that the very low participation rate in the labour market is not sustainable in the long-term.
 
His assessment was that the Lisbon Agenda will become more and more important for candidate countries. Moreover, he said that Turkey would be hard pressed to catch up with the EU acquis as the latter evolves not only through regulations but also through case-law requiring implementation. The third problem he expressed was Turkey’s capacity to compete in the Internal Market. He said that the Turkish economy, which is currently based on the comparative advantage of cheap labour, will have to adapt to the sophisticated knowledge economy of EU.
 
Christian Danielsson said that he found the report extremely interesting and helpful particularly due to its clear message that the reforms are anchored and supported by integration with the EU. He went on to argue that the negotiations as such and the outcomes set out a roadmap for the reforms. He also welcomed the fact that the report addressed the problems beyond EU acquis, such as the labour market and education.
 
Willem Buiter contributed to the discussion with a different point of view stating that the account deficit is eminently sustainable as long as it driven by investment and not consumption. However, in the case of Turkey, not only is investment low but so are savings. Thus, he says that society plays an important role in what happens in Turkey. Another point he raised was the economic significance of meeting the political criteria. As an example he gave the influence of press freedom in the fight against corruption.
 
He also suggested Turkey should have a ‘plan B’ in case of non-membership, which he argued should not be taken for granted even if Turkey fulfils all the criteria. Thus he urged Turkey to concentrate on measures that matter for its development instead of EU accession priorities. Mr Buiter also said that financial aid may be important but it is not essential to improve the state of the Turkish economy and that, instead, the EU should offer unconditional market access. This last argument was controversial as far as the audience were concerned.
 
As the last discussant of the panel Jorge Braga de Macedo stressed that complementarity is key for convergence and that it should have been given a higher profile in the report. He also warned the Turkish government to keep going with the necessary reforms and not to allow the allure of negotiations to distract them.

See the slides of the presentation by Aristomene Varoudakis.
Text of the speech by Undersecretary Canakci.
Text of the Comment by Jorge Braga de Macedo