Where Does Turkey Stand in the Competition for FDI

Rodrigo A. Chaves

February 21, 2007

2

The Investment Climate and Investment

• The investment climate supports or hinders opportunities and incentives for firms to invest productively, create jobs, and expand output affecting economic growth and welfare.

• Turkey is in a race with other countries to attract investment, including FDI, to bring new technologies, skills and organizational methods that will promote growth, jobs and living standards.

Turkey has received limited FDI

FDI-Income correlation (2005)

Turkey

Spain

Slovakia

Singapore

Romania

Poland

Hungary

Estonia

China

Bulgaria

10

20

3.2 3.8 4.60

FDI as % of GDP

Log per capita GDP, PPP.

Gross FDI as percentage of GDP

0

2

4

6

8

10

12

14

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Chile Hungary Poland Romania Turkey

4

Attracting FDI could become increasingly difficult for Turkey

• Going forward, global FDI inflows as a share of world GDP in 2005-10 expected to average about 2.2%.

• Business environments across the world have continued to improve and be more competitive.

• FDI to emerging markets is likely to be highly concentrated in commodity rich countries.

• Privatization and M&As in the financial sector will drop - Greenfield investment is needed.

5

FDI is Vital for Turkey

GDP Per Capita Relative to EU15

Greece

Ireland

Korea, Rep.Portugal

Singapore

Spain

Turkey

15%

25%

35%

45%

55%

65%

75%

85%

95%

105%

115%

125%

135%

145%

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

6

There has been progress

• Privatization, competition, administrative, and regulatory policies.

• Areas for further improvement include (a) the commercial code, (b) reducing registration fees and licenses, (c) corporate governance, (d) accounting standards, and (e) facilitating access to land for foreigners.

• Major challenges remain to investment and growth.

7

The “cancer” of informality

• Turkey’s informal sector is large.

• Less than half of the active labor force pays social security contributions. The tax burden is unfairly distributed, discouraging investors

• Unfair competition of the informal sector restricts new investors.

• Overall productivity and therefore growth are stunted.

8

• Percentage of firms identifying the issue as a major obstacle to operation

Tax rates remain a key constraint

41%

45%

45%

49%

52%

54%

57%

67%

77%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Regulatory policy uncertainty

Labor regulations

Access to finance

Cost of financing

Corruption

Anti-competitive or informal practices

Tax administration

Macroeconomic uncertainty

Tax rates

Not enough jobs are created

Unemployment Rate

6.5

8.4

10.3 10.59.6

10.310.3

456789

1011

2000

2001

2002

2003

2004

2005

2006

(Nov

)

Perce

nt

Demand for Labor(Increase during 2002 - 2006(Nov))

4,842,000

1,565,000 1,117,000

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

Worki

ng age

popu

lation 15+ La

bor

Force

Emplo

ymen

t

Perso

n

Only 23 percent of the increase in

working age population

10

The fiscal adjustment

• Revenue increases are not the answer unless they come from those now in the informal sector.

• Largest part of public expenditures are non-discretionary and produce low development returns.

• This produces a situation where the state has limited ability to invest in growth and job producing activities.

11

A comprehensive and strategic vision is required

“To sustain high growth in the economy by attracting more investment and financing while at the same time generating more and better jobs.”

12

From vision to action:Coordinated package of reforms

&

Areas of Reform Expected Outcomes

Productive Public Investment

Create fiscal space

Attraction of FDI

Steady Economic Growth with

Employment Generation

Investment climate

Labor Markets

Financial Markets

Technology, quality, innovation and labor skills

13

Possible elements in the comprehensive program

14

Fiscal space policies

Fiscal space to meet expenditure pressures should be created by a combination of structural public expenditure reforms, expenditure reallocations, and continuing tax reform efforts.

•Sector-specific reforms

•Shift resources to programs for growth and social development.

• Horizontal reforms that improve the efficiency of expenditure programs across sectors.

•Initiatives to further rationalize the tax system to broaden the tax bases.

15

• Improve corporate governance.

• Strengthen protection of creditor rights.

• Strenghten competition policy

• Monitor state aid, phase out distortions and

create a state aid monitoring agency

Investment Climate

16

• Adopting the revised Commercial Code in line with EU requirements

• Reduce registration fees and licenses by replacing them with better reporting and stronger enforcement

• Transfer social security collection to the MIFIN to complement reforms in social security institutions

• Further simplify tax system and conclude functional restructuring of tax administration

Investment climate

17

Labor Market Reform

• Reduce the labor tax wedge as much as fiscally responsible to create new jobs

• Measures to improve the incentives to hire include:– Lower severance requirements– Lower unemployment insurance requirements– Allow temporary work for economic reasons and functioning

of temporary work agencies.

• Protecting workers (rather than jobs)– Ease eligibility criteria for unemployment insurance– Extend collective bargaining– Improve ISKUR’s capacity for active labor market policy and

license private employment agencies.– Improve dispute resolution mechanisms

Increase Efficiency and Competitiveness in Financial Sector

• Continue with privatization of the state banks

• Enact a framework law for the insurance industry in line

with EU requirements

• Enact law in support of the primary residential

mortgage market and establish regulation for

secondary market

• Develop legal and regulatory framework for credit

bureau for consumers and corporate business

• Create legal framework and effective filing system for

security interests on movable collateral

Increase Technology Absorption and Innovation capacity

• Develop a national innovation strategy

• Align Innovation policy and regulatory framework with

EU requirements

• Evaluate results and fiscal impact of Technoparks;

R&D fiscal incentive schemes, matching grants and

loans

• Recognize tests and standards from countries with

which the EU has mutual recognition agreements

Improve Education System

• Raise graduation rates from secondary school and

improving educational opportunities at the tertiary level

• Modify curricula with a view that all secondary school

graduates are taught academic as well as applied

competencies

• Eliminate rigid separation of vocational and general

secondary students

• Restructure OSS to challenge students to demonstrate

learning across all academic disciplines and at high

standards