The Turkish Economy

Including contributions from noted international scholars, this collection of papers provides a strong theoretical and empirical underpinning for the discussion of major public policy issues facing Turkey today. Matters addressed include:

determinants of growth and productivity education and human capital accumulation income inequality corporate control and government performance of the government sector impact of major public policy issues on the future growth prospects of the Turkish economy.

This volume relates the impact of major public policy issues on the future growth prospects of the Turkish economy. At a time when Turkey is currently attempting to gain membership to the European Union, this pertinent reference questions whether the countrys economy is in fact ready for EU accession and membership. Sumru Altux is professor at the College of Administrative Sciences and Economics at Ko university in Istanbul. Her fields of interest include business cycles, investment, productivity and growth, intertemporal models of consumption and labour supply, and financial markets. Her previous publications include Dynamic Choice and Asset Markets (Academic Press, 1994) with Pamela Labadie, and Dynamic Macroeconomic Analysis: Theory and Policy in General Equilibrium (Cambridge University Press, 2003) with Jagjit Chadha and Charles Nolan. Alpay Filiztekin is an Associate professor in the Faculty of Arts and Social Sciences at Sabanci University in Istanbul. His fields of research include growth theory, regional economics, productivity dynamics and real costs of inflation.

Routledge Studies in Middle Eastern Economies

The Egyptian Economy Performance policies and issues Khalid Ikram The Turkish Economy The real economy, corporate governance and reform Edited by Sumru Altux and Alpay Filiztekin

The Turkish EconomyThe real economy, corporate governance and reform

Edited by Sumru Altux and Alpay Filiztekin

First published 2006 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Ave, New York, NY 10016 This edition published in the Taylor & Francis e-Library, 2006.

To purchase your own copy of this or any of Taylor & Francis or Routledges collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.Routledge is an imprint of the Taylor & Francis Group 2006 Sumru Altux and Alpay Filiztekin, selection and editorial matter; the contributors, their own chapters All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0415365929 (Print Edition)

To my grandfathers Sumru Altux To my father Alpay Filiztekin

Contents

List of figures List of tables List of contributors Preface 1 IntroductionSU MRU ALT U X

ix xi xiv xvi 1

PART 1

The real economy2 Productivity and growth, 19232003SU MRU ALT U X A ND A L PAY F I L I Z TE K I N

1315

3 Income and consumption inequality in Turkey: what role does education play?BURC U DU YGAN A ND NE Z I H G NE R

63

4 Female labor supply in TurkeyWN SAN T UNAL I A ND CE M BA V L E VE NT

92

5 A disaggregated analysis of price dynamicsMUSTAFA AX L AYA N A ND A L PAY F I L I Z T E K I N

128

PART 2

The corporate sector6 Capital structure decisions of Turkish firmsYIL MAZ G N E Y, AY D I N Z K A N, A ND K R VAT YA LIN E R

147149

viii

Contents 172B. BU R IN YU RTOX LU

7 Firm-level profitability, liquidity, and investment 8 Ownership concentration and corporate performance of Turkish companiesHAL IT GN E N

199

PART 3

The government sector and reform9 Privatization in Turkey: what has been achieved? AXL A KT E N

225227

10 Political economy of pension reform in TurkeySE R DAR SAYA N

252

11 The Turkish banking sector: a rough ride from crisis to maturationAL I T KEL , M U RAT E R, A ND CA RO L I NE VAN R IJCKE G HE M

276

Index

305

Figures

2.1 2.2 2.3 2.4 3.1 3.2 3.3 4.1 4.2 4.3 4.4 4.5 5.1 5.2 5.3 5.4 5.5 7.1 7.2 8.1 8.2 8.3 9.1 9.2 9.3 10.1 10.2 11.1

Aggregate labor productivity Relative sectoral labor productivity Capital deepening Labor productivity and capital productivity Marital sorting and skill premium Malefemale literacy rate difference, ages 15 Public expenditure on education as a percentage of GDP Labor force participation rates by location and sex Hours of work per week by employment status, females residing in urban areas Distribution of wifes annual hours of work Distribution of wifes wages Distribution of husbands wages Cost of living index inflation The distribution of price durations Monthly percentage of stores with no price changes The distribution of real prices The distribution of heterogeneity controlled real prices An example of a pyramidal ownership structure An example of dual class shares Market capitalization to GDP ratios for several selected countries Association between both earnings and dividends and concentrated ownership Association between market-to-book ratio and concentrated ownership Revenues from privatization Share of public and private sector in total manufacturing value-added Market concentration measured by Herfindahl Index SSKs pension balances under different policy scenarios SSKs pension balances under reform scenario 2 Banking sector total assets and credit

17 18 39 39 80 82 84 99 102 109 109 110 132 138 142 143 144 182 182 200 210 211 233 242 246 267 272 278

x

Figures Saving-investment (non-financial) balances Real interest rate Net trading gains Inflation: the long view Consumer credit growth 278 286 286 288 292

11.2 11.3 11.4 11.5 11.6

Tables

2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13 2.14 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 3.11

Accounting for growth, private manufacturing industries, 19702000 Accounting for growth, private manufacturing industries, 19812000 Sectoral allocation effects, private manufacturing industries, 19702000 Public manufacturing industries Small- and medium-sized firms Value added and employment by region Sectoral shares by region Regional convergence Regional convergence by sector Regional cycles and specialization Productivity and employment growth Decomposition of labor productivity Technical efficiency in selected years Decomposition: average annual changes Distribution of annual total household income: income shares of quintiles and Gini coefficients Distribution of annual total household income: average income by quintiles Distribution of annual total household income per capita, 2002 Distribution of household per capita income, 1990s International comparisons Distribution of consumption expenditures per person Distribution of consumption under alternative equivalence scales Household characteristics of rich and poor (income) Household characteristics of rich and poor (consumption) Relationship between education and earnings Sources of annual household income by per capita income quintiles and geographic area (percentage shares)

29 30 32 35 42 45 45 47 47 48 49 50 52 53 65 65 66 67 68 69 71 72 73 75 76

xii

Tables 3.12 Education expenditure per child by per capita income quintile, 2002, households with children 3.13 Share of education in total government expenditure 3.14 Private education expenditure as a percentage of total education expenditure 4.1 Total employment (age 15 and over) by sector and sex 4.2 Participation by marital status, females aged 15 and over residing in urban Turkey 4.3 LFPR for persons aged 1564 by sex and age group, Turkey and other OECD countries 4.4 Sample means (std. devs.) of variables by labor force participation status 4.5 Maximum likelihood estimates of reduced form participation equations 4.6 Least squares estimates of the wage equation 4.7 Least squares estimates of the annual hours equation 4.8 Maximum likelihood estimates of structural participation equations 5.1 Distribution of products across vendor types and categories 5.2 The duration of price quotations and the size of adjustments 5.3 Within group duration of prices 5.4 The duration of prices across vendors 5.5 Heterogeneity controlled real price distribution: food items 5.6 Heterogeneity controlled real price distribution: all goods 6.1 Selected indicators 6.2 Ownership structure of firms in Turkey 6.3 Descriptive statistics 6.4 Alternative estimates of dynamic capital structure model 6.5 Alternative GMM estimates of dynamic capital structure model 6.6 Long-run multipliers 6.7 Static capital structure 7.1 Share of gross investment in GDP and the growth rate of total gross fixed capital formation 7.2 Evidence from World Business Environment Survey: Measuring Conditions for Business Operation and Growth private enterprise questionnaire 7.3 Ownership and control structure of Turkish listed companies 7.4 Summary statistics 7.5 OLS estimates of the impact of group membership on the investment-cash flow sensitivity of Turkish firms 7.6 GMM estimates of the impact of group membership on the investment-cash flow sensitivity of Turkish firms 7.7 Investment of group firms 81 83 85 95 100 101 111 113 116 118 120 132 134 139 140 143 144 152 153 157 160 162 166 167 174

176 181 186 187 188 190

Tables 7.8 8.1 8.2 8.3 9.1 9.2 9.3 9.4 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 11.1 11.2 11.3 11.4 11A.1 Further tests of the impact of ownership structure as a determinant of investment Sample descriptive statistics on ISE listed firms Changes in concentrated ownership and its categories Empirical results on the relationship between ownership and firm performance Privatization through block sales Public share offering privatizations International public offering privatizations Privatizations through block sales and public offerings Statutory entitlement ages in Turkey before 1999 Pension coverage by status and agency Pre-1999 growth of social security deficit in Turkey Minimum entitlement ages for female workers Transfers to publicly managed social security agencies funded by the treasury Pension deficits of SSK under different policy scenarios Results under scenario 1 with the Genetic Algorithm Results under scenario 2 with the Genetic Algorithm The cost of the banking sector crisis NPL ratio and provisions in the Turkish banking sector Selected items from the balance sheet of the banking sector Performance of ISE-listed banks Efficiency indicators

xiii 192 205 214 218 234 236 237 238 254 256 257 261 262 268 270 271 281 283 284 285 296

Contributors

Sumru Altux, Professor of Economics, College of Administrative Sciences and Economics, Ko University, Istanbul, Turkey and Research Fellow, Centre for Economic Policy Research, London, UK Cem Bavlevent, Assistant Professor, Department Economics, Bilgi University, Istanbul, Turkey Mustafa axlayan, Reader, Department of Economics, University of Leicester, Leicester, UK Burcu Duygan, Research Fellow, Department of Economics, Finance and Consumption Programme, European University Institute, Florence, Italy Alpay Filiztekin, Associate Professor, Faculty of Arts and Sciences, Sabanci University, Istanbul, Turkey Halit Gnen, Associate Professor, Department of Business Administration, Hacettepe University, Ankara, Turkey Nezih Gner, Assistant Professor, Department of Economics, Pennsylvania State University, University Park, Pennsylvania, USA Ylmaz Gney, Senior Lecturer, School of Management, University of Surrey, Surrey, UK axla kten, Assistant Professor, Department of Economics, Bilkent University, Ankara, Turkey Aydn zkan, Senior Lecturer, Department of Economics and Related Studies, University of York, York, UK Serdar Sayan, Associate Professor, Department of Economics, Bilkent University, Ankara, Turkey and the Department of Agricultural, Environmental and Development Economics, Ohio State University, Columbus, Ohio, USA Ali Tkel, Boxazii University, Istanbul, Turkey Wnsan Tunal, Associate Professor of Economics, College of Administrative Sciences and Economics, Ko University, Istanbul, Turkey

Contributors xv Murat er, EuroSource Economist and Adjunct Faculty, Ko University, Istanbul, Turkey Caroline Van Rijckeghem, Faculty of Arts and Sciences, Sabanci University, Istanbul, Turkey Krvat Yalner, Assistant Professor, Faculty of Economics and Administrative Sciences, Gazi University, Ankara, Turkey B. Burin Yurtoxlu, Professor, Department of Economics, University of Vienna, Vienna, Austria

Preface

This volume arose from the idea of creating a fresh approach to policy discussions in Turkey. In contrast to much other work on Turkey, we wished to take the real economy as the basis for our discussions. Second, we wanted to present a detailed examination of the behavior of two of its main actors, namely, the corporate sector and the government sector. Third, we wished to phrase the discussion in the language of modern economic analysis. As a reading of the various chapters will show, there exists a significant body of existing scholarship regarding the behavior of the Turkish economy, be it from the pen of economic historians or through the efforts of statisticians, national planners, and economists active in policy circles. Yet the analysis of the Turkish economy from a comparative context and employing the techniques of general equilibrium or dynamic economic analysis is still relatively rare. In this volume, we have sought to collect the work of individuals who are creating precisely this form of pioneering scholarship. Another distinguishing aspect of our volume is that it contains the viewpoint of corporate governance and corporate finance. The future is always created on the legacies of the past, and it is our pleasure to acknowledge the inspiration of Professor Tuncer Bulutay of the Faculty of Political Science at Ankara University. Professor Bulutay and his students have laid the foundations of the modern analysis of the Turkish economy. This tradition also informs the work of Dr Wnsan Tunal, a leading expert in Turkish labor economics. We would also like to acknowledge the influence of Dr Hasan Ersel, formerly of Boxazii University and currently at Sabanci University, especially for his role as founder and co-editor of the Yapi Kredi Economic Review, where many of the recent studies on the Turkish economy have appeared. Another influence on some of the analysis in this volume stems from the outstanding scholarship of Professor Halil Inalck, Bilkent University, and Professor Vevket Pamuk, Boxazii University, who have written extensively on the economic history of Turkey and the Ottoman Empire. We would like to end this brief preface by acknowledging the helpful comments and refereeing advice from various colleagues, especially Dr Hasan Ersel, Kemal Saatioxlu, Aysit Tansel, Ercan Uygur, Murat Usman, and Atakan Yalin. The editors would like to extend their special thanks to Nezih Gner and Wnsan Tunal for reading and reviewing some of the chapters. Finally, we are indebted to Ms Nadia Seemungal for her editorial assistance.

1

IntroductionSumru Altux

The Turkish economy is known for its inflation in the 1990s and, more recently, its successful stabilization. However, relatively few studies have attempted to understand its real economy the factors that kept the Turkish economy functioning in the face of high and chronic inflation and that have underwritten its dramatic recovery of recent months. The present volume seeks to remedy this oversight through a series of in-depth studies on the real side of the economy, along with some on the organization and structure of the corporate sector. This volume will also consider some government sector reform issues. Further distinguishing the volume is its use of state-of-the-art analytic techniques. In sum, the present work seeks to understand the state of the Turkish economy by examining the behavior of its main actors, the real or productive sector, the corporate sector, and the government. In Turkey and elsewhere, considerable popular debate revolves around the link between policy choices and economic outcomes. Several prominent US economists have written extensively on the Turkish economic experience from this perspective. The early study by Krueger (1974) on trade regimes and economic performance is among the most widely known. Turkeys trade liberalization in the 1980s also attracted several studies (e.g. Aricanli and Rodrik, 1990a,b or Krueger and Aktan, 1992). Numerous other studies examine Turkeys economic experience in the context of such issues as debt, exchange rate regimes, and stabilization policies (e.g. Rodrik, 1990, or the studies in Sachs and Collins, 1990).1 Although these studies have provided much insight into Turkeys growth prospects, one cannot help thinking that some important outstanding issues lie in the real economy. A brief enumeration of the salient facts indicates that major challenges are present. The OECD (2004) reports that Turkeys labor productivity is just 30 percent of the level of United States. Further, Turkeys recent growth has lagged behind peer countries. The 20002001 crisis brought a GDP decline of 7.5 percent one of the largest in Turkish Republican history even in the midst of an IMF-sponsored stabilization plan. Whereas many OECD countries witnessed robust sectoral productivity growth during the 1990s, the productivity growth for Turkey in the same period came primarily from sectoral reallocation, with labor moving out of relatively less productive sectors such as agriculture (see table 2.12, Altux and Filiztekin, 2005). The share of the

2 Sumru Altux labor force working in agriculture is 34 percent, but these workers contribute just 12 percent of GDP (OECD, 2004, p. 154). Turkey also suffers from high levels of income inequality: the Gini index for total income was about 0.42 in 1994 (World Bank, 2002). Although extreme examples are higher Brazil or South Africa Turkey is nevertheless close to some very unequal countries, such as the Russian Federation (table 3.5, Duygan and Gner, 2005). Education statistics for Turkey are also alarming. In 2001, education expenditures were only 2.2 percent of gross national income, less than half that of many developing countries with similar per capita income (World Bank, 2003). Illiteracy remains shockingly high, especially among women. In the 2001 data, illiteracy was 15 percent of the general population aged 15 years or more and 25 percent among women aged 15 years or more. By comparison, illiteracy in Brazil was 12 percent, despite the fact that this country has a much higher percentage of its population below the one-dollar-a-day poverty line (World Bank, 2003). Even more troubling is the trend. Between 1990 and 2000 the share of education expenditures in total public expenditure declined by half, plummeting from about 18 to 9 percent (SIS, 2002). Recent Turkish labor market trends are also disconcerting. The analysis in Tunali and Bavlevent (2005) reveals that employment growth has been weak. This is true even before the crisis of 20002001 hit the economy. Employment growth from 1988 to 1998 was 1.4 percent, despite 3 percent growth in working-age population (2054 years). When the period 19982003 was brought under scrutiny, average aggregate employment growth is negative at 0.6 percent per annum. The Labor Force Participation Rate (LFPR) is also very low in Turkey: whereas the LFPR is near 70 percent for OECD countries, this figure is 51 percent for Turkey. The corresponding figure for women in Turkey is even worse, only 28 percent compared to nearly 60 percent as the OECD average. (See table 3.3, Tunali and Bavlevent, 2005.) Perhaps the most surprising aspect of these findings is that they occurred at a time when policy changes were meant to unleash the growth potential of the economy. The purpose of this volume is to account for these observations and to examine their implications for the future. We examine the determinants of productivity and growth, the role of educational attainment in income and consumption inequality, female labor supply and participation decisions, and relative price variability. The second topic considered in this volume pertains to the impact of corporate governance and corporate structure on firms investment decisions and performance. As the chapters on this topic make abundantly clear, Turkish listed firms often have very weak corporate governance, exhibiting problems such as highly concentrated family ownership, divergence of cash-flow and voting rights, pyramidal structures, and business groups. Linking these factors to investment behavior can help answer questions regarding the determinants of Turkeys overall economic performance. This research can also have potential implications for the impact of corporate governance on real outcomes more generally. Our third topic is the government sector, considering three main areas that usually inform structural adjustment programs: privatization, social security

Introduction

3

reform, and banking sector reform. The purpose of these studies is to describe the nature of decision making at the governmental level and to understand the political economy considerations that have helped to shape real outcomes in Turkey. Different facets of the recent policy experience in Turkey have been studied already, for example, Kibritioxlu, A. et al., 2002, discusses inflation and alternative disinflation programs. Whereas such studies consider various endogenous outcomes as a source of macroeconomic risk, the approach in this volume is to identify the underlying factors lead to macroeconomic instability and risk. In our view, the importance of the present volume stems from its potential to illuminate upcoming policy decisions regarding a key set of issues now facing the Turkish economy. The December 17, 2004 summit in Brussels where Turkey obtained a date to begin membership negotiations with the European Union marks a turning point. The question of European Union (EU) accession and European Union membership is becoming the focal point of policy discussions in Turkey.2 It is also beginning to receive attention in the mainstream Economics literature. (See, for example, Flam, 2003.) The question of whether the Turkish economy can converge to the levels of per capita income observed in European Union countries is a key part of the recent discussion (see Derviv et al., 2004; see also Altux and Filiztekin, 2005). The entry of the Republic of Cyprus into the European Union on May 1, 2004 is leading to new debate regarding the reunification of Cyprus. The issue of economic convergence between the formally separated parts of Cyprus figures in this debate. (See the report by Eichengreen et al., 2004 on the economic aspect of the Annan Plan.) Our analysis contributes to this discussion by examining broad characteristics of the Turkish economy. Turning to the individual chapters in more detail, the topic of the first chapter is a new study on productivity and growth for the Turkish economy since the inception of the Republic in 1923. The chapter describes the impact of policies such as import-substituting industrialization practiced throughout the 1970s versus the program of trade and financial liberalization instituted in the 1980s on productivity growth. It includes an analysis of regional convergence and growth as well as an international productivity comparison. Altux and Filiztekin, Chapter 2, use both long time series and sectoral data to conduct a growth accounting exercise, and analyze the behavior of the broad sectors of the economy using production frontier methods. They argue that productivity growth is a key indicator of an economys long-run growth prospects, and it also has ramifications for cyclical fluctuations. In the Turkish context, they note that productivity growth is crucial for the sustainability of economic reform programs and that the rate of productivity growth will also be an important determinant of the ability of the Turkish economy to converge to per capital income levels in developed countries. The chapter utilizes the modern approach to productivity measurement to analyze the determinants of productivity growth for the Turkish economy. The study begins by providing existing theoretical definitions of productivity. It also seeks to incorporate new decompositions and approaches. Total factor productivity (TFP) is measured as the difference between the growth rate of output and the share-weighted growth rates of inputs. An alternative approach to the

4

Sumru Altux

growth-accounting framework for productivity measurement is based on production frontier methods, which allow for differences between technological catch-up (efficiency improvements) and technological change (shifts in the production frontier). Various authors have also suggested that productivity movements may be accounted for by the sectoral re-allocation of inputs to more productive uses rather than an increase in productivity in individual sectors. The chapter discusses the implications for exogenous versus endogenous models of growth for the purpose of explaining the Turkish experience. It also discusses the recent literature that seeks to incorporate the effects of greater openness and trade on productivity growth and convergence. The chapter presents an analysis of other determinants of productivity such as firm size, capital accumulation, and the role of macroeconomic/political instability observed in the 1990s. One of the main findings of the chapter has to do with the relatively weak record of capital accumulation in the Turkish experience. The chapter also highlights the role of macroeconomic instability in Turkeys recent productivity performance and argues that these factors have been influential in determining the nature of productivity and growth as well as the process of structural transformation for the Turkish economy. Duygan and Gner, Chapter 3, provide evidence about Turkeys future growth prospects from a different perspective. Specifically, they examine income and consumption inequality in Turkey and the role of education in determining changes in the distribution of income. Using primarily the 1994 and 2002 Household Income and Consumption Expenditures Surveys, they begin by documenting the extent of income and consumption inequality and then present the results within a broader international context. Moving behind these aggregate statistics, they also provide a detailed characterization of the countrys poor and the rich. Education is found to be an important determinant of inequality both because it is distributed very unequally and because it has a large effect on earnings. They argue that unequal distribution of education is often viewed as a major obstacle to the inequalities in labor markets as well as a key factor in the intergenerational transmission of inequality. Duygan and Gner move beyond the current, shortterm discussions on inequality by highlighting some key determinants of its intergenerational transmission household formation, private and public spending on education, and womens education. The goal is to understand what todays distribution of resources and institutions might imply for tomorrows inequality. Tunali and Bavlevent, Chapter 4, provide an analysis of labor market trends and female labor supply and participation in Turkey over the period 19882003. They relate the trends in employment growth to the structural and demographic changes that have been taking place in the Turkish economy during the same period. Among the structural changes they discuss are the shift to a more open trade regime, the declining share of public enterprises, and the modifications of the social security system. They then provide a micro-econometric analysis of married womens labor supply and participation choices for a given year. They employ a multi-category model of labor force participation. Their results imply that the distinction between self-employment and labor income is an important

Introduction

5

one. They also find that small changes in real wages elicit a large supply response from women. Their analysis brings to bear different pieces of evidence on a complex issue that is likely to have important effects on Turkeys productivity and growth experience in the coming decades. aglayan and Filiztekin, Chapter 5, investigate the duration and the size of relative price changes in Istanbul over the period 19942000. The underlying motivation for their study lies in the recent theoretical literature and the empirical results that inflation induces higher relative price variability. Considering that the average inflation rate was about 60 percent per annum during the sample period in Turkey, their results contribute to an understanding of the effects of inflation on the pricing behavior in Turkey. Their analysis is carried out using a unique set of data collected from 15 neighborhoods in Istanbul. These data allow for a study of the micro-level data price adjustments by providing monthly price observations, which is mainly for foodstuffs, from three distinct store types: bakkals (convenience stores), pazars (open-air markets), and Western-style supermarkets over the period 19942000. These store types are expected to differ in obvious ways in terms of market power, transaction costs, and other characteristics such as fixed costs. Thus, their analysis helps to contribute to an understanding of the microfoundations of the transaction costs of inflation, as well as effects of market structure on price dynamics. Their data also provides prices of several other products from all 15 neighborhoods. These data help to provide a broader perspective of the underlying price dynamics. The findings reveal that on average price duration is 3.1 months, leading to an average reduction of 14.5 percent in real prices in between price changes should prices remain fixed for so long. They also find that price changes are not synchronized, which implies that vendors do not act simultaneously in response to changes in the economy. This behavior implies that the price of a good in relative terms could be substantially different across vendors. Indeed, the chapter finds that the average price dispersion across vendors for food items is around 10 percent and that for clothing is around 25 percent. The average price dispersion is 15 percent when all goods are considered. The findings also raise some questions about the effectiveness of monetary policies pursued by the government. Particularly, nominal price stickiness suggests that it will take a longer time for the monetary policies to have the desired effect on the economy. The chapters on corporate governance analyze the interaction of real and financial decisions for the Turkish economy. Gney, zkan, and Yaliner, Chapter 6, examine the capital structure of firms in Turkey, which has a significantly different legal and regulatory framework and a relatively young stock market. The approach taken in the chapter attempts to provide insights into the following questions. First, do the factors that influence the financing decisions of firms in industrialized countries exert similar impact on the capital structure decisions of firms operating in a different environment? Second, if similar factors exert a different impact, can we determine why this is so? The analysis in the chapter focuses on the dynamics of the capital structure decision. In so doing, the analysis captures important aspects of borrowing behavior of firms arising from market imperfections such as adjustment costs

6 Sumru Altux and financial constraints, which may prevent firms from adapting to new circumstances and immediately offsetting the effects of random shocks. The chapter provides some interesting findings regarding capital structure. First, in contrast to previous studies, there is strong evidence that size exerts a negative impact on borrowing decisions of firms, whereas there is a positive relation between growth opportunities and leverage. Second, firms do not adjust to their desired leverage ratios immediately, which might suggest that the costs of adjustment are significant. Finally, in line with the prediction of theory, profitability and asset structure of firms appear to influence leverage decision. The authors argue that the distinct features of the Turkish corporate sector, such as a high degree of ownership concentration and the absence of an institutional framework to facilitate sufficient protection for investors, may provide some explanation for these findings. The chapter by Yurtoxlu, Chapter 7, tackles the problem of the allocation of economy-wide investment more directly. Yurtoxlu argues that investment in capital equipment and R&D are important determinants of long-run economic performance. Since investment must be financed at the firm level, the efficiency of financial markets, corporate finance, and corporate governance arise as critical determinants of investment behavior of firms. Despite a strong theoretical case established by Modigliani-Miller for the independence of investment and financing decision, there is a large literature that has found a consistent and often strong relationship between investment spending and liquidity at the firm level. Yurtoxlu argues that two quite different explanations for this relationship have been given: one, the existence of asymmetric information (AI); and two, managerial discretion or empire building (EB) These two explanations have dramatically different predictions concerning the deviation of observed investment from levels that would maximize firm value. While the AI explanation points to financing constraints and the resulting under-investment, EB results in over-investment. A large number of studies have shown the importance of these two factors by exploiting different characteristics of firms, such as the dividend pay-out ratios, size, or ownership structure. Most of these studies, however, analyze firms from Anglo-Saxon countries, with relatively efficient capital markets and corporate governance regimes. Yurtoxlu studies the determinants of capital expenditures and R&D expenditures for a sample of publicly listed Turkish firms over the 19902002 period. He focuses on the specificities of a variety of corporate governance structures of firms that are likely to influence the degree of AI and the likelihood of pursuing goals other than shareholder wealth maximization. The chapter starts with a short review of the existing theoretical models of firm-level investment. After giving a detailed account of the corporate governance structures, it formulates and tests several hypotheses concerning the relationship between different corporate governance structures and the sensitivity of investment to the availability of internally generated funds. The final section is devoted to the implications of the findings on the growth process of Turkeys corporate sector. Among Yurtoxlus important findings is the fact that the structure of corporate ownership for Turkey is characterized by the presence of Business Groups (BGs). To control this

Introduction

7

phenomenon, Yurtoxlu examines the response of investment decisions by group versus non-group firms to measures such as Tobins q versus cash flow. He finds that the impact of cash flow is weak to insignificant for group firms, suggesting that part of the role of BGs is to function as internal capital markets. However, further tests reject the notion that BGs function efficiently in terms of allocating capital to group companies with better investment opportunities. Gnen, Chapter 8, also considers the impact of ownership structures on firm-level behavior, but his focus is on the impact of ownership concentration on firm market performance. He argues that one of the key elements for the development of financial markets is better protection of outside investors. Corporate governance is a set of mechanisms that allows outside investors to protect themselves against expropriation by the insiders (both managers and controlling shareholders). Investors would want to make sure that their funds would not be expropriated and would prefer to not only be repaid but also compensated for the time and risk of their investments. One view argues that better legal protection of outside investors leads to the expansion of financial markets with a higher number of listed firms and more valuable stock markets. Since laws protect outside investors, they are willing to invest financial assets such as equity and debt (La Porta et al., 1997). Another view suggests that if legal protection is poor, investors could get more effective control rights by being large (Schleifer and Vishny, 1997.) Thus, ownership concentration is accepted as an alternative of the legal protection for a corporate governance mechanism in the economies that are legally inadequate for the protection of the investors. However, there may be some costs associated with ownership concentration besides benefits of it. Gnen investigates whether concentrated equity ownership creates an agency problem or better monitoring on expropriation of minority shareholders by using Turkish industrial firms as a laboratory. His analysis depends on the period from 1992 to 1998. Most of Turkish corporations listed in stock exchange have highly concentrated equity ownership and are affiliated with each other within a business group. Thus, pyramidal equity ownership structure and cross-shareholdings are dominant. The effect of the concentrated ownership on the firm performance in this context depends on the divergence between control and cash flow rights. Most previous studies assume that equity ownership of the controlling shareholder is exogenously determined and depends on the history and life cycle of the firm. By contrast, the analysis in the chapter employs a simultaneous equation system in which concentrated ownership measured by the total percentage of shares owned by the three largest shareholders is assumed to be endogenous. To support this assumption, Gnen provides evidence for the changing percentage of controlling shareholders, showing that the largest shareholders vary their holdings of stock based on future performance expectations. The evidence shows that concentrated ownership in about 75 percent of sample firms changes on average from the lowest 0.6 percent to the highest 13 percent for the entire sample period. His results also show that holding companies, family members, the Turkish State, foreign investors, non-financial firms, and managers are seen as one of the three largest shareholders and their ownership changes during the sample period.

8

Sumru Altux

The main findings of this study are as follows: Ownership structure of Turkish firms is highly concentrated. The average percentage of shares owned by the three largest shareholders is above 50 percent for 162 out of 185 Turkish industrial firms. He also finds that variation in the firm performance has a positive effect on the variation in the percentage of shares owned by the three largest shareholders. Controlling for the endogeneity of ownership structure, he finds some evidence that ownership concentration is affected by the firm accounting performance rather than it affecting the performance. Taken together, the results in Chapters 6, 7, and 8 emphasize the role that corporate governance and corporate ownership can have on the economy-wide allocation of capital. In the last part of the volume, there are three chapters that examine issues that are relevant for reforming the government sector and implementing long-lasting policy measures to ensure macroeconomic stability. The first is a study of the privatization process in Turkey. The second is a study of pension reform in Turkey and the political economy considerations that underlie it. The third is a study of the behavior of the banking sector during the crises of 20012002 with an eye towards measures that will help prevent similar future events. kten, Chapter 9, provides an evaluation of the privatization process for Turkey. kten shows that while the privatization process in Turkey started earlier than other developing countries, its progress measured by the size of divestiture has been slower compared with the principal Latin American and Eastern European cases. From its start in 1985 up to 2005, the total proceeds from privatization efforts have amounted to $9.4 billion, with more than half of this sum being realized in the 20002005 period after the 1999 IMF Stand By agreement that placed a particular emphasis on privatization. As kten argues, the economic theory of privatization is a subset of the vast body of literature on the economics of ownership and the role for government ownership of productive resources. Within this literature, there are two main views: The Social View and the Agency View. According to the Social View, stateowned enterprises (SOEs) are capable of curing market failures by implementing pricing policies that take into account of social marginal costs and benefits of production. By contrast, the Agency View of firm ownership presents a strong critique of this theory. According to one stand of the Agency View, managers of SOEs may lack high-powered incentives or proper monitoring. According to another stand, political interference in the firm may result in excessive employment, poor choices of product and location, lack of investments, and ill-defined incentives for managers. kten reviews privatization experiences in light of this theory and discusses the results of empirical studies on privatization. She identifies common findings as well as conflicting results in the literature. She examines the impact of privatization in terms of its impact on productive and allocative efficiency, on investment and employment, market structure, and revenue generation. Her analysis is interesting in its own right as it describes the historical record of privatization in Turkey. However, it also complements the analysis by Altux and Filiztekin, Chapter 2, in examining the impact of privatization on productivity. The conclusions that

Introduction

9

emerge from ktens analysis are that Turkey faces a mixed record in terms of its privatization experience. Sayan, Chapter 9, considers the process of pension reform for Turkey. As Sayan notes, insuring workers against future loss of income due to aging is a primary task for any social security system. For this reason, many countries legally require workers to have some old-age insurance coverage provided through publicly managed pension schemes that are typically run on a Pay-As-You-Go (PAYG) basis. However, the financial health of public PAYG pension schemes is sensitive to reductions in the relative sizes of retirees collecting benefits and active workers continuing to pay contributions. If such reductions are not matched with increases in contributions and/or reductions in old-age benefits over extended periods of time, the resulting deterioration in revenueexpenditure balances of public pension schemes eventually turns into contingent liabilities for the fiscal authority. Sayan notes that different political economy issues shape up policy makers attitude towards growing pension deficits and the timing of policy responses. First, incumbent governments tend to delay taking action to curb the growth in pension deficits as long as possible in response to the gradual decline in the number of workers as increasing contributions and/or lowering pension benefits are not likely to prove popular among voters. A second and more extreme form of myopic policy action involves interventions that change the incentive structure driving individuals work/retirement decisions or the eligibility criteria for retirement in such a way as to speed up the deterioration in pension balances for political rent-seeking purposes. The chapter by Sayan discusses some of these political economy issues in the context of recent efforts to rehabilitate the Turkish pension system, and investigates alternative parametric reform scenarios that could be adopted for that purpose. Similar to the chapter by kten, this chapter provides a closer look at the processes that determine governmental decision-making on some important public policy issues. As Sayan notes, the Turkish experience with pension crisis and reform is interesting to study because it differs from the experience of other countries where similar pension systems have faced financial difficulties largely due to population aging. By contrast, the crisis of the Turkish system prior to 1999 was due primarily to the entitlement ages that were exceptionally low by international standards and to other populist interventions of governments that wanted to improve their chances of re-election. Sayans analysis thus makes abundantly clear the short-term political motivations that transformed what was originally a system with ample surpluses into one of the biggest holes in Turkish public finances in recent years. While his proposals for parametric pension reform are also worth reading, perhaps the more interesting part of his analysis derives from obtaining a better understanding of the potential roadblocks to a sounder social security system in Turkey. Tkel, er, and Van Rijckeghem, Chapter 11, discuss the state of the Turkish Banking Sector (TBS) in the period prior to and following the banking and financial crisis of 20002001. Their analysis emphasizes the fact that the TBS has been in a state of transition, with consolidation and the prospects of future growth

10

Sumru Altux

remaining as future challenges. The chapter describes in detail the state of affairs that prevailed in the Turkish banking sector the prevalence of duty losses, open positions, a lax and weak supervisory environment, the existence of outright fraud that eventually led to a bank structuring plan costing over a third of 2001 Turkish GNP. The chapter also describes the various banking sector operations undertaken to re-capitalize the banking system, as well as regulatory changes introduced since the disinflation program of late 1999. The chapter continues by exploring the growth prospects for the TBS. The discussion is based, in part, on the results of a questionnaire conducted by Steinherr et al. (2004) with a number of Turkish bankers. The chapter argues that long-standing impediments to growth of banking in Turkey, notably under-capitalization of the sector and chronic macroeconomic instability, have lost in importance. Another major impediment, the high taxation of the sector, also appears to have become less acute in recent years due to the decline in interest rates and plans to harmonize taxes across financial instruments beginning from 2006. The absence of a clear strategy on state banks, which still make up about (one-third) of the sectors assets, appears to be a key problem. However, the chapter argues that the greatest challenge for the sector is achieving further consolidation and growth, in a way that does not undermine financial stability. In this regard, the chapter concludes by noting that sustaining the single digit inflation-high growth environment through structural reform that lies at the root of the current governments economic policies provides the only way out of the conundrums that face the TBS. Several important topics not covered in this volume deserve serious discussion, especially agriculture. In Turkeys future deliberations with the European Union, it is doubtless that this issue will acquire major importance. The analysis of productivity and convergence for the agricultural sector would constitute another book, but we would like to offer some comments before concluding. Many recent structural reform programs for Turkey aim to increase efficiency and the primacy of market-based institutions. There is a transformation underway in agriculture, as is already being documented by various academic studies. This transformation involves changes in the patterns of production, ownership, trade, and organization of agricultural activity.3 Nevertheless, the state of agriculture remains critical. As we argued earlier, over one-third of the workforce is still employed in agriculture.4 Productivity growth in agriculture is typically low and relative productivity is among the lowest in Europe (table 4.18, OECD, 2004, p. 154). An important topic for future analysis is whether the current changes and reforms will be sufficient to move the level of agricultural productivity closer to those in Europe, and whether they will effect the reallocation labor out of agriculture. A second issue warranting further study is the recent jobless growth phenomenon in Turkey. Whereas there has been a rapid decline in inflation and strong output growth since 2002, the increase in employment has been disappointing. Turkeys demographic pressures make this an issue important for the fortunes of politicians both at home and abroad.5 One of the salient characteristics of Turkeys past economic performance is its relatively weak record in factor accumulation and factor use.6 The recent stabilization effort led many to expect

Introduction

11

that this trend would be reversed. Some preliminary evidence shows that this is not the case (see Grsel and Tunali, 2005). The large informal sector doubtless makes rapid employment expansion in the formal sector problematic for Turkey. As privatization continues and the share of public employment shrinks, a source of jobs is eliminated, at least in the short-run. Changes in firms employment policies, whether in response to changes in the international competitive environment or to technological progress, also suggest that growth in jobs will not necessarily follow on the heels of growth in output. Many of these factors are poorly understood. Yet their ramifications for Turkeys future growth prospects appear crucial. We highlight these issues as important areas for further research. The future of the Turkish economy is also predicated on political developments. Recently, Turkey has witnessed some major political changes. The Justice and Welfare Party came to power on the back of such changes. niv (2005) provides a careful look at these new political players and the transformation of Turkish politics. As the different studies in the volume suggest, this is not the first major shift in Turkish politics, nor is it likely to be the last. How the various political players and their agendas evolve is likely to have important effects in determining the path of the Turkish economy. In this volume, we have not provided a detailed examination of the period since the Justice and Welfare Party took power. The implications of this change for Turkeys democratization, the maturation of its institutions, and for its overall transformation also remain as key issues that will receive much future attention.

Notes1 More recently, see the NBER Project on Exchange Rate Crises in Emerging Market Countries Turkey, July 18, 2001, Jeffrey Frankel and Dani Rodrik. 2 See the Conference on Macroeconomic Policies for EU Accession May 67, 2005, organized jointly by the Central Bank of the Republic of Turkey, Bonn University, and Bilkent University, Ankara. 3 See, for example, the studies in the Turkish Economic Association publication Trade and Agriculture in the Southeast Anatolian Project Area (2004). Earlier studies on the state of Turkish agriculture include Kazgan (1992). 4 In some areas such as the Black Sea region and the eastern Anatolian region, the share of employment in agriculture is over 60 percent. 5 Turkeys potential entry into the European Union is already emerging as one of the several critical issues that is dividing electorates in Europe. 6 On this point, see the report by McKinsey Global Institute (2003) as well as the studies in this volume.

ReferencesAltux, S. and A. Filiztekin (2005). Productivity and Growth, 19232003, Chapter 2, this volume. Arcanl, T. and D. Rodrik (eds) (1990a). The Political Economy of Turkey: Debt, Adjustment and Sustainability, New York: St. Martins Press. Arcanl, T. and D. Rodrik (1990b). An Overview of Turkeys Experience with Economic Liberalization and Structural Adjustment, World Development 18: 13431350.

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Derviv, K., D. Gros, F. ztrak, F. Bayar, and Y. Ivik (2004). Relative Income Growth and Convergence, CEPS-EDP Final Report. Duygan, B. and N. Gner (2005). Income and Consumption Inequality in Turkey: What Role Does Education Play?, Chapter 3, this volume. Eichengreen, B., R. Faini, J. von Hagen, and C. Wyplosz (2004). Economic Aspects of the Annan Plan for the Solution of the Cyprus Problem, Report to the Government of the Republic of Cyprus. Flam, H. (2003). Turkey and the EU: Politics and Economics of Accession, Institute for International Economic Studies, Stockholm University. Grsel, S. and W. Tunali (2005). Ivlendirme Sorunu, Politikalan, ve alivma Ekonomisi Yazsndan karlacak Dersler (Employment Creation Problem, Policies, and Lessons from the Labor Economics Literature), Report for the Turkish Academy of Sciences. Kazgan, G. (1992). Currents Trends and Prospects in Turkish Agriculture, Middle East Technical University Studies in Development 19: 3760. Kibritioxlu, A., L. Rittenberg, and F. Seluk (2002). Inflation and Disinflation in Turkey, Aldershot, UK and Burlington, VT: Ashgate Publishing. Krueger, A. (1974). Foreign Trade Regimes and Economic Development: Turkey. New York: Columbia University Press. Krueger, A. and O. Aktan (1992). Swimming Against the Tide: Turkish Trade Reforms in the 1980s, San Francisco, CA: International Center for Economic Growth. La Porta, R. Lopez-De-Silanes, F., Shleifer, A. and Vishny, R. (1997). Legal Determinants of External Finance, Journal of Finance 52: 11311150. McKinsey Global Institute (2003). Turkey: Making the Productivity and Growth Breakthrough. OECD (2004). Economic Surveys: Turkey, October. niv, Z. (2005). The Political Economy of Turkeys Justice and Development Party, in Hakan Yavuz (ed.) The Transformation of Turkish Politics: The Justice and Development Party of Turkey. Salt Lake City: University of Utah Press (2006, forthcoming). Rodrik, D.(1990). Premature Liberalization, Incomplete Stabilization: The zal Decade in Turkey, in M. Bruno, S. Fischer, E. Helpman, and N. Liviatan (eds) Lessons of Economic Stabilization and Its Aftermath, 323353, Cambridge: MIT Press. Sachs, J. and S.M. Collins (1990). Developing Country Debt and Economic Performance: Country Studies Indonesia, Korea, Philippines, Turkey, National Bureau of Economic Research Project. Schleifer, A. and Vishny, R. (1997). A Survey of Corporate Governance, Journal of Finance, 52: 737783. State Institute of Statistics (SIS) (2002). Demography and Development Indicators, available at http:/ /nkg.die.gov.tr (June 1, 2004). Steinherr, A., A. Tukel, and M. er (2004). The Turkish Banking Sector: Challenges and Outlook in Transition to EU Membership, CEPS EU-Turkey Working Papers No. 4 (August). Tunal, W. and C. Bavlevent (2005). Female Labor Supply in Turkey, Chapter 4, this volume. Uygur, E. and I. Civcir (2004). GAP Blgesinde Ticaret ve Tarim (Trade and Agriculture in the Southeast Anatolian Project Region), Turkish Economic Association Publication, Ankara. World Bank (2002). World Development Report. World Bank (2003). World Development Report.

Part 1

The real economy

2

Productivity and growth, 19232003Sumru Altux and Alpay Filiztekin

IntroductionProductivity growth is a key determinant of an economys long-run growth prospects. In Solows neoclassical growth model, the source of long-run growth is given by the rate of exogenous technological progress. Endogenous growth theories attribute long-run growth to increasing returns that arise within the model. These may derive from a broad measure of capital as in Romer (1986) or from human capital as in Lucas (1988). Productivity shocks may also have ramifications for cyclical fluctuations. Following Kydland and Prescott (1982), the Real Business Cycle approach attributes a significant contribution of productivity changes to business cycles. According to this approach, procyclical productivity movements are due to exogenous technological shocks. This approach has generated a large literature on testing for the sources of cyclical fluctuations.1 In the Turkish context, productivity growth is a key indicator for the sustainability of economic reform programs. The rate of productivity growth will also be an important determinant of the ability of the Turkish economy to converge to per capita income levels in the European Union and other developed countries and to eliminate regional income disparities. Labor productivity provides the basis for discussions involving convergence of per capita incomes and the standard of living. Total factor productivity (TFP) growth allows a decomposition of a countrys (or sectors) growth rate in terms of a component involving the growth rate of the inputs and the growth rate of technology. It is often used in discussions involving the determinants of a countrys growth rate, as in recent discussions involving the so-called Asian miracle.2 There is a wide literature surrounding productivity measurement. The measurement of TFP typically follows Robert Solows seminal (1958) contribution. According to this approach, TFP growth is measured as the difference between the growth rate of output and the share-weighted growth rates of inputs. The Solowian model assumes that firms maximize profits subject to a constant returns to scale production function and that product and factor markets are perfectly competitive. The simple growth-accounting framework has acquired widespread use in studies of growth, convergence, and the determinants of productivity change.

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Sumru Altux and Alpay Filiztekin

Measures of TFP growth provide a comparison with a countrys (or industrys) past performance. An alternative approach to productivity measurement constructs a best-practice frontier, and measures how far each country (or industry) is away from this frontier. This approach is based on the Malmquist index introduced by Caves et al. (1982). This approach does not require cost or revenue shares to aggregate inputs or outputs, and allows measurement of total factor productivity change in multiple output settings. In this chapter, we examine the sources of productivity and growth in the Turkish economy. We employ the modern theory of productivity measurement to examine the determinants of productivity changes. The Turkish experience is interesting, because it includes an extensive period of import-substitution policies followed by a period of trade and financial liberalization. There is also a period beginning with the 1990s that is characterized by volatility and macroeconomic instability. Another reason for examining the Turkish experience resides in issues of European Union integration and enlargement. In this chapter, we also examine the evidence regarding convergence for the Turkish economy. The predictions from the Solow growth model for long-run convergence have been tested extensively. (See, for example, Barro and Sala-iMartin, 1992.) One outgrowth of this literature is that economies may converge to their own unique steady state equilibrium that is characterized by differences in population growth rates, differences in government policy, societal preferences, and technology. This approach has become known as conditional convergence. Another outgrowth of this approach is that there may exist convergence clubs, that is, countries that are similar in their structural characteristics and initial conditions will converge to each other. However, there is no presumption that there will be convergence among the different clubs. (See Quah, 1996.) We take as our starting point the establishment of the Turkish Republic in 1923 for our productivity analysis. The growth experience of the economies in the Mediterranean and the Middle East has become the subject of increasing study by economic historians.3 At various points, we seek to provide a comparative perspective based on historical experience. The remainder of this chapter is organized as follows. In the section on Historical experience of the Turkish economy, we provide a brief description of historical patterns in labor productivity. In the section on Productivity and growth, we provide some definitions of productivity, and in the section on Growth accounting for Turkey, we discuss the application of growth accounting to Turkish manufacturing industries. The section on Determinants of productivity provides a further analysis of the determinants of productivity while the section on Regional convergence and growth is devoted to a discussion of regional growth and convergence. The section on EU and Turkey: ready or not? contains an international comparison of productivity. The final section concludes.

Historical experience of the Turkish economyOne of the most comprehensive sets of data on the Turkish national accounts is due to Bulutay et al. (1974) for the period 19231948. These data were

Productivity and growth, 192320037 6 5 4 3 2 1

17

0 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003

Figure 2.1 Aggregate labor productivity, 19232003.

subsequently updated and linked to form data on sectoral accounts by Temel (1998) for the period 19231967. Using these data, Figure 2.1 displays aggregate labor productivity or real GDP per employee for the Turkish economy for the period 19232003. This measure of labor productivity is defined as the ratio of aggregate GDP in 1987 prices to aggregate employment.4 The historical data show that aggregate labor productivity increased nearly sixfold between 1923 and 2003. There are various episodes that characterize productivity growth. Figure 2.1 shows that there are significant productivity increases for the early Republican years defined loosely as the period from 19281929 to 19381939. It is well documented that prior to 1929, the Turkish economy was one that mainly produced and exported agricultural products under a liberal trade regime. However, in 1929, Republican policy-makers began undertaking new policies in the face of the drastic fall in commodity prices. These include more protectionist measures in foreign trade, and the adoption of a new system of state-led import-substituting industrialization known as etatism. In Figure 2.2, we report relative sectoral productivity, or the ratio of labor productivity in each sector to aggregate labor productivity, for the main sectors of the economy. From this figure, we observe relative productivity increases in such key sectors as manufacturing, services, and utilities.5 These relative productivity increases are no doubt due to the new measures to stimulate output in manufacturing and utilities, and the ensuing activity in services. However, the large increases in relative sectoral productivity for manufacturing, utilities, and services are also due to the low levels of employment in these sectors in the early Republican years. Thus, we observe declines in relative productivity as these sectors develop at the expense of agriculture. The early Republican years are characterized by both impressive increases in labor productivity and GDP growth. Using the data underlying our productivity

18 Sumru Altux and Alpay Filiztekin(a) 7 6 5 4 3 2 1 0 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 Agriculture (b) 30 25 20 15 10 5 0 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 Mining Utilities Transportation Manufacturing Services

Figure 2.2 Relative sectoral labor productivity, 19232003 (Aggregate

1).

calculations, it is possible to show that output growth was 6.5 percent on average for the period from 19281929 to 19381939. It has generally been assumed that the interventionist policies followed by the new regime were responsible for stimulating output during the period from 19281929 to 19381939. Using data that is similar to ours in construction, Pamuk (2000) disputes this claim. Pamuk (2000) argues instead that the expansion in agriculture, which accounted for 50 percent of the economy, was at least as important for Turkeys strong growth performance during this time.6,7 Boratav (1997) also attributes a significant role to agriculture

Productivity and growth, 19232003

19

to the development of a national economy. His analysis refers to the pre-Republican period 19081922 when the Ottoman Empire was being wracked by uprisings, rebellions, and the First World War itself. The war years 19401945 are generally viewed as constituting a break in this set of favorable developments. Despite Turkeys neutrality during the Second World War this period is characterized by widespread mobilization of the male working age population and high military expenditures. Due to these developments, it is documented that wheat production fell by 50 percent during this period, and national income itself declined on average by 5 percent per year. It is often claimed that the deprivations experienced by various classes during this period laid the foundations for many of the political and economic developments in the years that followed. The postwar era is distinguished by several new phenomena. One of these is the shift to a multiparty system in 1950. Part of the reasons for this shift can be found in a combination of external and internal factors. The Democrat Party (DP), founded by large landowners and merchants, initially followed a program favoring agriculture and private enterprise. Indeed, from Figure 2.2a, we see some evidence of the relative decline in manufacturing productivity and the relative increase in agricultural productivity in the post Second World War era. Aggregate labor productivity also shows a strong increase up until 1953, corresponding to the end of Second World War and the commodity boom associated with the Korean War. However, with the end of favorable world conditions after 1953 and the decline in exports, the DP government soon began implementing more restrictive economic and political measures, including policies to restrict foreign trade. The worsening economic situation culminated in 1958 with the government agreeing to a major devaluation and other measures under the auspices of an IMF-sponsored program.8 Once the negative effects of the military coup staged to oust the BayarMenderes Democratic Party regime in 1960 had been overcome, the Turkish economy started growing rapidly around 1963. The post-1963 period also witnessed the pursuit of importing-substituting industrialization (ISI) policies in a more comprehensive manner, which reputedly obtained the backing of even some international agencies such as the OECD. The State Planning Organization (SPO) was established and five-year plans were drawn up to coordinate investment decisions. In contrast to the etatism of the 1930s, the ISI regime of this period featured State Economic Enterprises (SEEs) investing in large-scale intermediate goods production while the large private conglomerates took as their base the more lucrative consumer goods industries. For much of the 1960s, labor productivity shows a steady increase, and Turkey is typically mentioned among the group of more rapidly growing developing economies. By the early 1970s, however, most commentators agree that the continued pursuit of ISI policies was beginning to take its toll of the Turkish economy.9 In 1970, a balance-of-payments crisis erupted and was overcome as in the earlier case with IMF support. This date is also coincident with the second time that the military assumed power since 1960. After 1970, a favorable foreign exchange situation based on large foreign

20

Sumru Altux and Alpay Filiztekin

workers remittances allowed the Turkish economy to invest and to grow at a rate of 89 percent until 1975 or 1976. Around 1975 or 1976 the effects of the first oil shock began to make themselves felt in the Turkish economy. Even a cursory look at the data shows that things were not going right for the Turkish economy after 1975 or 1976. From Figure 2.1, we observe aggregate labor productivity falling relative to its level in 1974 or 1975. As Krueger (1995) shows, GDP grew by 15 percent between 1975 and 1980. This is nearly the same as the rate of population growth during the same period. Filiztekin (2000) provides a breakdown of real value-added growth in manufacturing for different periods between 1970 and 1996. According to these data, real value-added grew by 7.13 percent between 1970 and 1976 in manufacturing industries. By contrast, manufacturing value-added had a negative growth rate of 7.64 percent between 1976 and 1980. As various authors have recounted, the Turkish authorities had failed to provide an adequate response to the first oil shock in 1973.10 This created various external and internal imbalances in the Turkish economy. Some have argued that beginning with the 1970s Turkish industry had failed more fundamentally to change its orientation towards exports and to more capital-intensive sectors.11 In any case, the combination of events during this period also spelled the end of the era of ISI. The severe economic and political crisis at the end of 1979 and the beginning of 1980 eventually led to a sweeping set of changes to liberalize the Turkish economy. The initial measures were enacted by the government headed by Sleyman Demirel, with Turgut zal as the deputy prime minister in charge of economic affairs. However, even as initial measures were being put in place to end the balance-of-payments crisis, the military took power for the third time in September 1980, installed a new government, and enacted additional measures to restrict trade union activity and other forms of political organization. Alongside, at times, highly controversial political measures, a major set of economic reforms were passed. From the period beginning with 1980, many of the former quantitative restrictions on imports were almost totally abolished. Deposit interest rates were eliminated and other measures to liberalize financial markets were put in place. The first democratically held elections in 1983 brought to power Turgut zal and the newly formed Motherland Party. The reforms continued under the new zal government. Capital account liberalization soon followed, as did other measures to liberalize capital markets such as the reopening of the Istanbul Stock Exchange, the beginning of Treasury auctions for marketing new government debt, the formation of an inter-bank money market, and other changes.12 Sustained increases in productivity are observed during 19831989 following the program of trade and financial liberalization instituted in the early 1980s. Filiztekin (2000) notes that real value-added in manufacturing grew by 9.77 percent between 1980 and 1988. The pattern of output is mirrored in the behavior of labor productivity. Whereas labor productivity in manufacturing fell by 10.82 percent during the period 19761980, it increased by 4.86 percent during 19801988. Nevertheless, there are various studies that have questioned the basis of the growth and productivity performance during the 1980s. Voyvoda and Yeldan

Productivity and growth, 19232003

21

(2001) note that the orientation of the economy to export-led growth was achieved at the expense of cost savings on wage labor which were then directed to export markets by means of a generous export subsidy program. They argue that the subsequent shortfall in investment rates circumscribed to a large extent the policy of export-led growth in manufacturing.13 Onaran (2002) examines the question of labor market flexibility as part of the adjustment of the Turkish economy from import-substitution to export-led growth. She shows that whereas productivity increases were typically reflected in real wages during the 19631979 period, after 1980 real wages became insensitive to productivity increases. During the latter period, real wages also became more responsive to the unemployment rate. She argues that relying on wage suppression to enhance competitiveness was not only unsustainable but also unsuccessful in overcoming high unemployment rates and generating effective domestic demand. There is a more erratic pattern in aggregate labor productivity after 1989. From Figure 2.2a, we also observe that relative sectoral productivity in manufacturing falls after this date. Commenting on a peculiar feature of the relative productivity displayed in Figure 2.2b, we note the large decline in relative productivity in utilities after 1990. As in Figure 2.2a, this is a relative decline, and it has to do with the large expansion of employment in newly established telecommunications industries. In contrast to the first part of the 1980s, there are some other noteworthy changes in the latter part of the 1980s. One of these has to do with the increased share of government expenditures in current GDP. As Krueger (1995) demonstrates, this share increased from a low of 18 percent in 1982 to 24 percent by 1990. In the early 1980s, the zal government had embarked on an ambitious program of infrastructure investment, financed by domestic and external borrowing. The increasing deficits were due to the costs of these expenditures together with the cost of their financing. After 1983, as the Turgut zal and the Motherland Party began losing popularity at the polls, the deficits also arose from transfer payments made prior to elections. As successive governments followed, the government expenditures begun during the zal years were increasingly financed by monetary expansion. The liberalized capital account regime allowed for unfettered capital movements. Instead of providing funding for long-term investment projects, as zal had hoped, international capital flows turned out to be short-term, volatile hot money. A financial crisis erupted in 1994 with an overvalued exchange rate and rising current account deficits. A speculative attack against the Turkish Lira (TL) was followed by a devaluation of 150 percent, skyrocketing overnight interest rates, and inflation reaching 107 percent. Average inflation in the 1980s had been in the range 50.4 percent whereas it increased to 73.2 percent in the 1990s. Throughout much of this period, real interest rates in Turkey have traversed in the 2025 percent range. Turkish GDP during the 1990s also showed a highly volatile path, declining by 6 percent in 1994 and by 5 percent again in 1999 as a result of the Marmara earthquake. Turkeys GDP registered one of its largest declines in Republican history of 7.5 percent during the banking and financial crisis of

22

Sumru Altux and Alpay Filiztekin

20002001 that erupted in the midst of an IMF-sponsored stabilization plan. As the OECD (2004a) notes, the 1990s represents the lost decade in Turkey. The combination of high real interest rates, high and chronic inflation, and macroeconomic and political instability also make themselves evident in the low growth rate for aggregate labor productivity during the 1990s. The period of the 1990s is witness to another set of developments. These pertain to Turkeys relation with the European Union. In 1996, Turkey entered into the Customs Union Agreement with the European Union and in 1999, Turkeys candidate status was confirmed at the European Union summit in Helsinki. Following the election of the Justice and Welfare Party in 2002, Turkey has witnessed a decline in inflation to single-digit levels in 2004, strong output growth in 2003 and 2004, and a dramatic expansion of trade volume. The recent December 17, 2004 Summit in Brussels in which Turkey obtained a date to begin membership negotiations also marks a turning point.

Productivity and growth: some further definitionsIn this section we discuss issues related to productivity measurement and to convergence and growth of an economy. We briefly outline the implications of exogenous versus endogenous models of growth. We also discuss alternative methods of productivity measurement. Exogenous versus endogenous growth models The neoclassical growth model advocated by Solow (1956) has long constituted one of the primary frameworks for analyzing countries growth experience. Recent models of endogenous growth constitute an alternative approach to modeling growth. To briefly describe the implications of the Solow growth model, consider an aggregate production for output that is of the CobbDouglas variety: Yt K t AtL1 , t 0 1, (2.1)

and L, K, and A denote labor, capital, and the level of technology, respectively. Assume that labor and technology grow exogenously at rates n and g as: Lt At L0ent, A0e gt. (2.2) (2.3)

The model assumes that a constant fraction of output, s, is saved. Defining k as y the stock of capital per effective labor, k K AL, and as the level of output per effective labor, y Y AL, the evolution for k is given by: dkt dkt sy skt

(n (n

g g

)kt, )kt,

(2.4)

Productivity and growth, 19232003

23

where is the rate of depreciation. Equation (2.4) implies that k converges to a steady state defined as k* where k*

[s (n

g

)]1 (1

)

.

(2.5)

Substituting this relation into the production and taking logs yields the expression for the steady state level of per capita income as ln Yt Lt ln A0 gt ln(s) ln(n g ). (2.6)

1

1

Thus, the Solow growth model predicts that countries will converge to a steadystate level of per capita income that depends on the nature of societal preferences, population growth, government policy, and technology. This expression can be used to derive quantitative predictions about the speed of convergence of per capita income. Let y* be the steady-state level of income per effective worker given by equation (2.6) and let yt be the actual value at time t. Approximating around the steady state, the speed of convergence is d ln( yt) dt where ln( yt) (n g (1 (ln( y* ) )(1 ln( yt)), ). This equation can be written as e t ln( y0), (2.8) (2.7)

e t ) ln( y* )

where y0 is income per effective worker at some initial date. Subtracting ln(y0) from both sides and substituting for y* yields ln( yt) ln( y0) (1 (1 e t) ln(s) (1 e t) ln(n g ) (2.9)

1

1

e t )ln( y0)

We can determine the rate of convergence by evaluating the convergence coefficient under some plausible assumptions. Suppose that the share of capital in 0.04, and aggregate income 0.33 and n g 0.06.14 Then the value of the economy moves halfway to the steady state in 17 years. We denote this by the half-life of convergence and refer to it in versions of 2.9 that we estimate for the Turkish economy. The Solow growth model also has predictions for convergence for countries or regions that differ in such characteristics as their saving rates, population growth rates, etc. This is known as conditional convergence and states that countries will converge to their own steady states, irrespective of their initial conditions. Endogenous growth models have widely differing predictions compared to the Solow growth model. One important variant of endogenous growth models

24

Sumru Altux and Alpay Filiztekin

which delivers sustained growth has become known as the AK-model. These models dispense with the assumption of diminishing returns to capital and lead to a representation of output that has the form Y AK, where A denotes the given level of technology and K the aggregate capital stock. We can derive a version of the AK model by assuming that the production function at the level of the firm has the form Yt AtK jt L1 , jt (2.10)

where At denotes the common level of technology. If all firms face the same technology and factor prices, then the aggregate production function can be written as Yt where At A(Kt Lt) , 0 1. (2.12) AtK t L1 , t (2.11)

Thus, the aggregate stock of knowledge At is proportional to the capital per person in the economy. Furthermore, the stock of knowledge is endogenous to 1, then the aggregate the economy but it is taken as given by firms.15 If production function has the form Y AK. Furthermore, assuming a constant saving rate, the evolution of the aggregate capital stock can be written as dKt sAKt Kt. (2.13)

Thus, this model implies that capital grows at the constant rate sA and output also grows at this rate. Unlike the Solow growth model, the simple endogenous growth model presented in this example also shows that the growth rate of output depends on the saving rate. Furthermore, endogenous growth models do not predict conditional convergence: depending on differences in parameters that determine saving rates, the AK model predicts that there will be permanent differences in growth rates of per capita income. Another implication of endogenous growth is that the growth rate of per capita income may depend on the size of the economy. Ignoring the labor input in (2.11) and (2.12) and setting 0, if we take At as equal to the total (rather than average) stock of accumulated capital, then the growth rate of capital and output become equal to g sA(NK ) where N denotes the number of firms in the economy. Thus, the larger the number of firms, the greater the potential for creating potential knowledge externalities and the faster the growth rate of the economy. The relationship between the size of the economy and growth also provides a rationale for trade liberalization, the extent of the market having a positive effect on overall growth.

Productivity and growth, 19232003 The growth accounting approach

25

The literature of productivity measurement has defined productivity in terms of an index.16 The growth-accounting approach decomposes output growth into components arising from the growth of inputs versus changes in total factor productivity. The (primal) measure of TFP gives output per unit of factor inputs whereas the dual TFP measure gives marginal cost per unit of input prices. The output-based primal productivity measure constitutes the basis for much of the growth-accounting literature. However, the price-based dual measure has also featured in many recent debates.17 To derive the standard output-based primal measure of TFP, consider a production function for gross output Yit in sector i at date t as Yit F i(Ait, Kit, Lit, Mit). In this expression, Lit denotes man-hours, Kit denotes services from capital, Mit denotes a vector of materials inputs, and Ait denotes the possibly sector-specific technology shock. The function F i is assumed to be homogeneous of degree i in L, K, and M. Totally differentiating the production function, assuming that technological progress is Hicks neutral, and making use of the first-order conditions for the firms cost-minimization problem yields: d(Yit Kit) Yit Kit sJ itJ L,M

d( Jit Kit) Jit Kit

( (

it

1)J L,M

sitj dKit Kit

d( Jit Kit) Jit Kit dAit , Ait (2.14)

1)

where sitj denote the revenue shares of the inputs, it is the markup of price over marginal cost, and is the returns to scale parameter. Notice that if 1, then we obtain the Solow residual: it (dAit Ait) (dYit Yit)J K,L,M

sJ (dJit Jit), it

(2.15)

which is just the residual growth in output after the contribution of the inputs have been removed.18 Comparing (2.14) with (2.15), the Solow residual overstates technical progress when there is imperfect competition or endogenous changes in efficiency due to increasing returns to scale.19 Decomposing productivity changes: changes in efficiency versus technical change An alternative approach to productivity measurement seeks to differentiate the impact of changes in productivity arising from the impact of technological progress versus changes in efficiency. Deterministic production frontier methods have been used to provide international productivity comparisons. See, for example, Kumar and Russell (2002). In the Turkish context, these techniques have been used to analyzing the sources of productivity growth for public and private Turkish firms. In a

26

Sumru Altux and Alpay Filiztekin

later section, we employ the Malmquist productivity index to examine changes in efficiency versus technical change for Turkey relative to a set of OECD countries. The Malmquist productivity index is based on quantity-based distance functions. Distance functions are function representations of multiple-output, multipleinput production technologies that require data only on outputs and inputs. For each time period t 1, . . . ,T, the production technology S t models the transformation of inputs x t Rn into outputs y t Rm as S t {(x t, y t ): x t can produce y t}, where S t satisfies certain axioms that serve to define meaningful distance function. The output distance function at date t is defined as the reciprocal of the maximum proportionate expansion of the output vector yt, given the inputs xt, that is, as Dt0(xt, yt ) inf{ : (xt, yt/ ) S t}.20 An output-based Malmquist productivity index is defined as M0(xt 1, yt 1,xt, yt ) Dt0(xt 1, yt 1) t D0(xt, yt )t D0 1(xt 1, yt 1) t D0 1(xt, yt ) 1 2 21

.

(2.16)

This index allows a decomposition of productivity change into efficiency change and technical change as M0(xt 1, y t 1,x t, y t ) efficiency change technical change, (2.17)

where efficiency change measures the change in how far is observed production from maximum potential production between years t and t 1 and technical change captures the shift in technology between years t and t 1 evaluated at xt and xt 1, that is, efficiency change and technical changet D0(xt 1, yt 1) t 1 t 1 t 1 D0 (x , y ) t D0(xt,yt ) t 1 t t D0 (x ,y ) 12

D t0(xt 1, yt 1) D t0(xt, yt )

(2.16)

.

(2.16)

Notice that the first term measures relative technical efficiency at t and t 1, that is, whether production is getting closer or further way from the frontier over time. The second term measures the shifts in technology at the vector of inputs x t, x t 1, respectively; thus, technical change is the geometric mean of the two shifts. In terms of the decomposition, changes in relative efficiency are interpreted as evidence of catching up while technical change is interpreted as evidence of innovation.

Growth accounting for TurkeyIn this section, we provide a growth-accounting exercise for Turkish manufacturing industries. We begin our analysis of productivity growth for Turkey with

Productivity and growth, 19232003

27

manufacturing industries because they have been typically identified as an engine of growth. We consider the evidence for productivity growth for the import-substituting and export-led growth eras separately. One of the earliest studies to implement a growth accounting exercise for Turkey is the influential study by Krueger and Tuncer (1982). These authors examine the behavior of productivity using TFP measures for Turkish manufacturing for 19631976, and consider the impact of trade policy on relative TFP growth for both private and public firms. Despite the continuous implementation of import-substitution policies during this period, the authors note that there are sub-periods when, for example, foreign exchange difficulties forced the authorities to follow trade policies that were more restrictive. For this purpose, they divide the entire period into four sub-periods. The first and third sub-periods, 19631967 and 19701973, are ones in which there are plentiful foreign exchange reserves and relatively less restrictions while the second and fourth sub-periods, 19681970 and 19731976, are characterized by more restrictions. Krueger and Tuncer estimate TFP growth for the manufacturing sector over the entire period as 2.10 percent. For the four sub-periods in question, they find TFP growth of 3.2, 1.31, 2.51, and 1.18 percent, respectively. Thus, they conclude that TFP growth for Turkish manufacturing industries was negatively affected during periods that correspond to foreign exchange shortages and greater import restrictions. Krueger and Tuncer also compare the performance of public versus private enterprises. They find that the public enterprises are about 5 percent less efficient than the latter. Somewhat to their surprise, however, they find that TFP growth for public enterprises is 2.65 percent whereas it is 1.84 percent for private enterprises. Yildirim (1989) examines TFP growth in two-digit public and private manufacturing industries. He considers the period 19631983, which he splits according to the duration of the first four Five-Year Plans. His findings corroborate