Putting growth on a more balanced path

What is more striking is that this insufficient growth in 2008 associated with a current account deficit (CAD) of almost 7 percent of the country's gross domestic product (GDP), an unemployment rate of 10 percent and a stubborn consumer inflation rate at around 10 percent, is a figure that was significantly higher than the emerging market average back then.

In that regard, it could be argued that the global crisis has been a chance for Turkey in the sense that the focus shifted from Turkey to the central countries, from inflation to fiscal deficits, from the CAD to the growth and employment creation capabilities of these countries. However, almost the same configuration has returned in 2012.

Based upon this picture, it is suggested in the latest version of the Organization for Economic Cooperation and Development's (OECD) survey on Turkey that by carrying out the necessary reforms and establishing new institutions for good governance, the country should graduate from a position that would condemn it to a middle income trap. Among the most urgent and encompassing structural reforms that could institutionalize Turkey's long-term high and sustainable economic growth are labor market and education system reform.

The latest OECD survey on Turkey for 2012 argues that “if the economy reaches and remains on a more balanced path, it will make fuller use of its resources and will produce higher employment, income and private saving, with a lower external imbalance. Increasing employment and income is crucial to reduce the saving gap and should be supported by tight fiscal policies to increase public savings.”

As we suggested above, the OECD proposes an alternative policy framework in structural policy areas that would shape “the economy's capacity to mobilize labor resources and domestic and international savings in a balanced way in the short term and the pace of convergence with the OECD labor utilization, human capital and productivity standards in the longer term.”

A new, stylized, cross-country long-term growth model is used to estimate the impact of ongoing and recommended structural reforms. Under this model's baseline scenario, Turkey's annual growth rate would average 4.4 percent between this year and 2030, with some decline over time. This baseline scenario incorporates likely structural policy developments in line with, but less far-reaching than, the recommendations in the survey affecting labor participation and productivity, which would imply higher growth:

As it is seen from the given table, in the OECD's baseline scenario with a 55 percent labor participation rate and eight years of schooling, long-term average potential growth would be just around 4.4 percent for the next 18 years. In the base line scenario, the contributions from longer schooling, increased labor market participation and multifactor productivity (MFP) growth to the average annual GDP growth rate amount to 0.5, 0.4 and 1 percentage points, respectively.

However, deeper labor market reforms than in the baseline scenario could raise participation rates further. In this better scenario aggregate labor force participation would increase from 49 percent in 2012 to 60 percent by 2030. The trend growth rate would be increased by 0.6 percentage points compared to the baseline and the level of trend output would be 10 percent higher in 2030. Also, according to the OECD scenario, “lifting the average duration of schooling of the adult population to 10 years between 2012 and 2030 (similar to the improvement observed in South Korea over the past two decades) would increase average annual trend growth by 0.8 percentage points and the level of potential output by 15 percent by 2030 relative to the baseline, assuming major quality improvements in the education system, the key strategic priority of Turkey's education policy.”

A combined effect of these two sets of labor and education reforms would raise GDP growth by 1.3 percentage points annually relative to the baseline over 2012-30, and potential output would increase by 25 percent by 2030. However, as labor market reform is politically costly, the best scenario seems not likely in Turkey. Also contribution from current educational reform would be much lower as the basic strategy behind it is quite weak. Therefore, a more realistic expectation is that average GDP growth would materialize somewhere around 5 percent, implying the continuation of Turkey's average past performance. If this “modest” scenario between the baseline and the best one materializes, Turkey's long-term-oriented targets for 2023, when Turkey will celebrate the anniversary of the republic, would remain quite a romantic chimera.