Moving from Inward-Looking and State-led Development Strategy to World market - Oriented Strategy

1923-2014A Case Study for Turkey

Bahri Yilmaz

EU Jean Monnet Professor and Professor in Economics, Sabanci University, Istanbul

Paper prepared 9.Economic Freedom of the Arab World Conference, Amman, November 18-19, 2014

ECONOMIC DEVELOPMENT OF TURKEY

Reconstruction of the economy and inward- looking strategy (import-substitution policy) between 1923- 1980.

Outward- looking (export-oriented) development strategy starting 1980- 2014.

The young Turkish Republic inherited from the Ottoman Empire: After the establishment of the Turkish Republic, there was no foundation on which to build an ambitious economic policy.

The decline of the Ottoman Empire had left the Turkish economy in very bad conditions.

From the breakdown of the Ottoman Empire the economic life of Turkey was based on agriculture. The country had approximately 13 million inhibitions. Per capita income was 30 US Dollars (in current $ prices).

The share of industrial sector in total GDP was only 12% and the limited amount of labour was employed in the industrial sector. 50 percent of GDP and 80 percent of population are estimated to have been in agriculture in the early 1920s.

So the country was exporting agricultural products. (Tobacco, Cotton, Hazelnuts, olive oil and wheat).

The only part of the infrastructure, which had received attention, was the railways, and they were foreign-owned, as were most banks and manufacturing enterprises.

What made matters worse was that a large portion of the non- Muslim ethnic minorities had left the country during the war of liberation, greatly diminishing Turkey’s already small contingent of technicians and entrepreneurs.

Because, educated Muslim Turks had tended to regard commerce and industry as beneath them, preferring a more prestigious career in the civil service or armed forces.

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Although the republic was exempted from payment of war reparations and most of its war debt was written off, it was nonetheless held responsible for the large commercial debt the Ottoman Empire had accumulated in the 19th and early 20th centuries. Turkey was also obligated by terms of the treaty to continue to allow concessions granted to foreign companies before 1914, which included rights to impose taxes and collect tariffs.

Perhaps most important of all, Turkey was forced to maintain the Ottoman tariff schedule until 1929.

1923-1930: Construction and Searching for its Development Strategy

Turkey’s development strategy built upon three broad objectives:

Rapid economic growth;

Self-reliance (or self sufficiency) and job creation;

Equitable income distribution and social justice.

The government was no in position to pursue that objective in the 1920s. Because the leadership had neither the clear concept nor the necessary experience for the economic development of the country.

Given the liberal economic way the industrialization should have been carried out by “the Turkish businessmen and national industry”.

At the same time, it is assumed that the capital accumulation had to be forced by the state.

Additionally, the state should have taken the economic responsibility and should have attended to the production process actively in a way, in which the private sector was not in a position to do its own resources. The government’s policy initiatives were mainly directed at promoting private investment through the establishment of several investment banks and the creation of certain tax concessions and direct subsidies (for example, in the sugar industry).

Two main reasons, which hindered the success of this attempt at liberal policies:

One of them was again the burden of foreign debts taken over from the Ottoman Empire, which made it difficult to finance the planned productive investments.

The second complication came from the lack of entrepreneur and capitalist spirit of individuals.

1930- 1950: The Etatist Period (State-led economic Development)

Beginning in about 1930, the government’s approach to the economy began to change.

The “First Industrial Plan”, which was prepared with the help of the planning experts of the Soviet Union, was introduced.

There are three mains for changing economic policies from market-oriented to state-oriented:

After an initial period of relatively free trade policies in 1920s and very low overall growth, the government decided to introduce a policy of "Etatism" in the 1930s.

Within the framework of the new development philosophy and policy, the government then in power started heavily to intervene into the economy.

It helped launch and sustain an inward-looking strategy, taking into consideration the initial conditions in structure and industrial organization.

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Import substitution is a policy replacing imports by domestic production under the protection of high tariffs and quotas.

This approach ignores the benefits of specialization and comparative advantage.

The reasons why import substitution or inward-looking development strategy rather than export-oriented development strategy has usually been chosen as an industrialization strategy are:

1. Until, 1970s many developing countries were sceptical about the possibility of exporting manufactured goods.

They believed that industrialization was necessarily based on a substitution of a domestic industry for imports rather than on a growth of manufactured exports.

2. The infant industry argument: According to the infant industry argument, potentially developing countries have a comparative advantage in manufacturing.

But manufacturing industries in developing countries cannot initially compete with well-established manufacturing sector in developed countries.

In order to make manufacturing more competitive government should temporarily support new industries until they have grown strong enough to meet international competition.

Therefore, it makes sense, according this argument, to use trade restrictions and to protect domestic young industries from outside competition.

Indeed, in the 1930s, Turkey had to cope with huge amount of

structural and institutional problems.

There was a shortage of entrepreneurs and managers to undertake activities in private sectors.

The private sector had little of both domestic and foreign markets.

As a matter of this fact, it assigned a leading and dominant role for the state in economic development with key industries such as manufactured goods, textiles, railways, and telecommunications and energy sector.

Under the new state-led and inward-looking development strategy, a number of State Economic Enterprises (SEEs) were established in Turkey.

They mainly produced and marketed a variety of agricultural, mineral and manufactured commodities.

Many of these SEEs produced manufactured goods that had previously been imported.

Excessive protectionist measures were put in force to protect the infant industries from international competition.

Throughout the years the importance of the SEEs and its share, either in total production or in total employment, grew steadily.

At the same time, the state owned enterprises were the main school of up-and coming industrialist and top managers in the private sector.

The Inward looking development strategy led to

• Heavy involvement of the state

•State owned enterprises in industry, mining (critical sectors)

•Large public banks directing credit to targeted sectors and groups •Some sort of planning, setting of national targets

•Widespread price controls (eg on critical inputs to industry)

•Smaller reliance on “market forces”, greater reliance on government action

•Most sectors oligopolistic; very little domestic competition

•Because industry was inefficient, it could not compete internationally, countries could not earn foreign exchange that they needed to import the necessary industrial inputs, or pay back foreign debt

III. 1950-1960: The Return back to Private Sector Friendly Liberal Economic Policies.

The unexpected defeat in 1950 of the Republican People’s party, which had ruled since the founding of the republic in 1923, raised hope that the failures of etatism would be put right.

Then new government wanted to give large role for private enterprise. Also promised was greater attention to the problems of agriculture, which had largely ignored. In a short time, the newly elected government headed by Menderes, whose new economic program to take gradual steps towards the integration of the Turkish economy into world markets, initiated the economic policy reform.

The New Economic Program included the following measures:

Quantitative restrictions on foreign trade were removed to large extent, the distortions of import tariffs was reduced, export was promoted, mainly agriculture, rules on foreign direct investment became quite liberal.

The government had intended to privatise and to regulate state economic enterprises.

The success of policy reforms, on which Turkey embarked during the 1950s, remained very limited. Here three main reasons could be mentioned:

First of all, the fundamental conditions for import-substitution were maintained and the government did not totally disengage itself from control of the economy.

Secondly, the economic liberalisation program during 1950s was not accompanied by the full liberalization of the foreign trade and foreign exchange regulations.

Thirdly, export revenues could not be so rapidly increased, as industrialisation required

Consequently, the economic of the Menderes government reached a deadlock at the beginning of August 1958, when a new stabilization plan of the IMF was enforced.

This stabilisation package covered not only the standard measures, but also the establishment of restricted import regime based on annual import programs fixing quotes by users and producers.

The 1958 and 1959 measures succeeded in stabilising the economy but not the political system. So military leaders took power in May 1960.

1960-1973: Planned Industrialisation

At the beginning of 1960, the inward looking strategy was greatly reinforced with a new image.

Turkey turned towards indicative development planning, which had first been instituted in the 1930s in a very simple way:

In the early 1960s a newly formed State Planning Organisation (SPO) was given responsibility for designing development policy.

The SPO articulated the policy of encouraging industrialisation through import substitution.

By the mid- 1960s the Turkish economy had already completed the first stage of its import substitution in replacing imports non-durable consumer goods (food processing, textiles etc).

Now the government and planning authorities had to come to a final decision and make up its mind between:

Either switching of the development strategy partly from inward- looking to outward-looking ones and embarking on exportation of homemade manufactured goods or moving on the second stage of import substitution

They decided to go over the second stage of import substitution. This meant that the imports of intermediate goods (steel) and consumer durables were to be replaced by domestic production.

In contrast to the first stage, the economy needed the transfer higher capital-intensive technologies and the qualified labour force was in evitable to achieve the planning targets.

By 1970 the government once again entered a stabilisation program with the IMF, devaluing the currency against US Dollar and attempting to stabilise the economy.

As in the 1958-1960 devaluation episode, the intention was to rationalise the trade and payments regime, but the fundamental philosophy of import-substitution underlying the regime was not questioned.

Political antagonism, on the other hand, remained very close to the surface and hampered the government’s ability with the growing economic problem. As a consequence, the military again intervened, this time 1971.

1973-1980: Boom and Bust:

The outlook for the Turkish economy in the early 1970s was optimistic.

The foreign exchange constraint seemed to have been overcome, and foreign capital was available thanks to the expansion in world liquidity generated by OPEC surpluses after 1973.

The period from 1973 to 1977, the third five-year plan, was one of remarkable achievement, particularly in the industrial sector, which experienced real growth of 14.2 percent per annum.

The main stimulus to growth was a rapid rise in the level of investment, especially in the public sector.

Foreign rather than domestic savings financed the rise in investment from about 19 percent of GDP in 1973 to 24 percent of GDP in 1977, therefore. This approach was not sustainable.

The growth boom began to decrease in 1977 as foreign lenders became worried about the size and structure of Turkey’s rapidly growing external debt.

During the mid-1970s’ boom, inflation averaged about 20 percent per annum or four times the average rate in the preceding decade. But inflation accelerated, hitting an all-time high of just over 100 percent in 1980.

Two developments led rising budget deficits in the early 1970s: One large salary increases to civil servants.

The second was a dramatic rise in SEE financial deficits, owing both to increased wage cost and a rise in the rate of investment by SEEs.

Toward the end of the decade, however, foreign exchange difficulties intensified.

Consequences and final results of state-led development strategy

From 1930s until 1980, the inward looking development strategy played a major role and was pursued rigorously by all Turkish governments for almost more than a half of a century.

Nevertheless, Turkey has succeeded in building a well-diversified industrial structure.

It has been producing a far greater variety of industrial goods, including intermediate and capital goods, than most developing countries. The country has also succeeded in eliminating poverty; improved education, health conditions of its population

In the late 1970s and the early 1980s Turkey's policy makers recognized that inward orientation led the economy to the economic and social crises, which regularly repeated itself within every ten-year time period ended in a " Stand by Agreement" with the IMF.

It was immediately followed by a military coup d'etat three times, namely in 1960, 1971 and 1980. The last huge external financing difficulties, which arose from "the first and second oil shocks" in the 1970s, provided an opportunity for reformers to advance their plans for economic liberalization.

Rapidly accumulating foreign debt, inability to repayLarge drops in GDP

IMF, the World Bank said:

The reason for the crisis were “distortions” created by the ISI model

Protection from imports created inefficient industries, there was no competition

It also created a lot of “rent seeking”.

It was very important to have access to cheap inputs, cheap credit or foreign exchange

=> political influence rather than productivity and efficiency was the main determinant of success

Hence IMF ad the World Bank saidHence IMF ad the World Bank said

Put an end to ISIPut an end to ISI liberalize trade (and international finance)liberalize trade (and international finance) end price controlsend price controls eliminate state owned enterpriseseliminate state owned enterprises privatizeprivatize let market forces, not governmentslet market forces, not governments,, determine how resources (eg foreign determine how resources (eg foreign

exchange and domestic credit) will be allocatedexchange and domestic credit) will be allocated All of this was called “All of this was called “structural adjustment”. structural adjustment”. The World Bank and the The World Bank and the

IMF said they would help only if countries IMF said they would help only if countries embark on structural embark on structural adjustment programs (SAP).adjustment programs (SAP).

This meant the end of a model of development (and political This meant the end of a model of development (and political alignments that supported it?)alignments that supported it?)

1980-2014. Outward – Looking Development Strategy:

In January 1980, the government announced, under pressure of the IMF and the World Bank, a series of far-reaching reforms starting with massive devaluation and an announcement that henceforth there would be frequent adjustments in the exchange rate to keep pace with differentials between domestic and foreign inflation. Additionally, prices of outputs in public sector enterprises were increased sufficiently to reduce their deficits and thus sharply cut the size of the public sector deficit.

Also, foreign trade reforms were coordinated with radical shifts of policies away from market intervention, import reliance on market forces and trade liberalisation.

It was also expected that the outward orientation could bring some benefits for the Turkish economy such as:

Improved resource allocation in line with social marginal costs and benefits; access to better technologies, inputs and intermediate goods;

an economy better able to take advantage of economies of scale and scope; better education and training; greater domestic competition; and the increase in employment of highly skilled labour in the production process.

The main objectives of the 1980 reforms were:

to improve the balance of payments and raise international competitiveness;

to contain inflation; to raise the efficiency of SEEs; to shift the economy’s center gravity from the public to the private

sector,

The economic reform policies, which were initiated on 24 January 1980 included the following measures:

The most important steps taken towards reliance on market forces concerned exchange rate management and trade policy.

Further more, the export promotion measures were intensified and import quotes

Unfortunately, on grounds of populist and inconsistent policies pursued the " two steps forward and one step backward" sequence, the outward-looking development strategy put in force in 1980 has been interrupted by significant mistakes made by Turkish policy makers in the 1990s.

Today, inflation, current account deficit and unemployment remain a major concern of the Turkish economy once again.