Getting out of the ‘middle-income trap’

KEMAL KİRİŞCİ

Today, Turkey’s economy is no longer growing at the 2010-11 levels of 9.2 and 8.8 percent and instead faces a number of structural problems, appearing to be stuck in the infamous “middle-income trap.”

According to a World Bank report, “Turkey’s Transitions,” Turkey is “some 20 percent shy of the high income threshold.” The report recommends a range of economic, institutional and political reforms to overcome this gap. However, considering the chaos reigning throughout Turkey’s neighborhood and the accompanying loss of markets for Turkish goods and services, it also critical that Turkey deepens its economic integration with the transatlantic community.

The EU recently increased Turkey’s growth rate predictions for 2015 from 3.3 to 3.7 percent as the drop in oil prices precipitated a fall in one of Turkey’s perennial structural problems: its large current accounts deficit. Turkey’s growth performance for 2014 was 3 percent, far ahead of the European Union’s average of 1.3 percent. Nevertheless, this growth rate is considered by many to be short of what Turkey should be achieving to break out of the middle-income trap and ensure the successful integration of newcomers into the labor market.

There are many causes for this. A setback in democratic governance and the rule of law in Turkey in recent years has been cited extensively. A drop in the flow of foreign direct investment (FDI) into Turkey, especially from developed Western economies, is at least partly attributed to the Turkish government’s growing authoritarianism and erosion of the rule of law. The chaos in Turkey’s neighborhood is inevitability contributing to this fall as well, as investors worry about long-term stability and the security of their investments.

This instability is also taking a toll on Turkey’s foreign trade. Turkey’s dynamic growth performance was closely linked to the expansion of trade with countries in its immediate neighborhood. Between 1992 and 2012, trade with neighboring countries increased 23-fold from $4 billion to $93 billion, in contrast to a nine-fold increase in EU-Turkish trade during the same period. This was also a period during which the EU’s place in Turkey’s foreign trade dropped from a peak of 55 percent to 38 percent.

As violence in the Middle East persisted and Russia became embroiled in the Ukrainian crisis, however, this picture quickly changed. Turkey’s exports to the Middle East, with the exception of Israel, have dropped dramatically. In the case of Iran, for example, exports plummeted 61 percent between 2012 and 2014. Similarly, Turkey’s exports to Russia and Ukraine between 2013 and 2014 fell by 15 and 21 percent, respectively, while expanding to the recession-stricken EU and the United States by 9 and 13 percent. These trends are likely to continue in the near future. As long as the instability in Turkey’s neighborhood continues to erode its exports markets and capital inflows, it will need the transatlantic community’s business.

Although Turkish membership in the EU is not likely to happen anytime soon, maintaining a credible process is crucial. The Turkish government should adopt the reforms and policies necessary to ensure the EU opens new chapters for negotiations. This will also help boost confidence in the Turkish economy. Additionally, it is crucial for Turkey to adopt the World Bank’s April 2014 recommendation to upgrade its Customs Union with the EU. Many experts as well as Turkish officials recognize that the Customs Union has been beneficial to Turkey’s economic development and expansion of its exports.

Thus, a stronger political will should be shown by the Turkish government in support for upgrading the Customs Union. Words must be translated into actions. The EU should reciprocate as well, especially at a time when they are still struggling to come out of recession and sanctions on Russia are hurting exports, they need Turkey economically. Turkey is a major importer of the EU’s goods and services and was the EU’s sixth largest trading partner in 2013, just behind Norway and Switzerland. Even if at a modest level, Turkey contributes to the economic growth and employment in the EU. These economic realities suggest it is in the EU’s interest to engage Turkey, particularly by upgrading the Customs Union, a move that would benefit everyone. 

This also applies to the Transatlantic Trade and Investment Partnership (TTIP) that the EU and the U.S. are in the process of negotiating. Once an agreement is reached, the TTIP will cover a geographic area generating nearly half of the world’s GDP and close to a third of world trade. The Turkish government has been following these negotiations closely and has repeatedly called for its inclusion in the TTIP given that its Customs Union with the EU would be negatively impacted by the TTIP. While the issue of the TTIP’s enlargement has not yet been resolved, it is important for Turkey in the meantime to start adopting the necessary economic and trade-related reforms. As the chaos in Turkey’s neighborhood persists, closer and deeper economic relations with its traditional transatlantic community partners would help Turkey overcome the structural problems that keep it in the “middle-income trap.”

Kemal Kirişci is the TÜSIAD senior fellow in the Foreign Policy Program at Brookings in Washington.