A Brief History of Monetary Orthodoxy in Turkey

Since late 2010, the Central Bank of Turkey has been employing unconventional monetary policy tools primarily for price stability, and creating an environment conducive for economic development. It is hard to tell the reserve bank has succeeded in the former, and Turkey’s track record of economic growth is disputable.

Now with the CPI growth standing at the highest levels since the inflation targeting implied and fiscal policy being eased to spur the growth which has been rarely observed during the AK governments that are known for the determination to keep the public debt/GDP ratio at the low levels, it is time to look back and see how we ended up here. Please take a moment to look at the chart below.

Also note that the CBT’s average cost of funding hit its highest point at 11.96% last Friday (5/5/2017) since the the global financial crisis period.

Service Jobs: Structural Headwind?

One of the key issues the world economy faces today is declining productivity. At this juncture, Turkey seems to be obliged to deal with a structural headwind stemming from its weakness labor market of which dynamics have changed radically. As this is the case in advanced economies, particularly in the U.S., services jobs now have a larger share in employment while manufacturing has had a percentage shrinking over the past decade (see June Jobs Report: Not Encouraging).

As of the end of September, industry (manufacturing) jobs accounted for only 24% of total employment which meant a 5 percentage points lost in eleven years, with services and construction continued to boost recruiting. Below is the chart for average shares of each industry on annual basis.

The following also visualizes the relationship between the employment and the economic output in services. It is simply not nice at all.

Keeping the labor market at this dependence on services job is no recommendation for policy makers.

Is Productivity in Decline?

In the years since the global financial crisis many economies have face slower expansions in some key components of potential output growth, and following that, lower potential growth has emerging as a new reality for the global economy. In advanced economies it has been driven by slower capital accumulation and labor growth which has been primarily due to adverse demographic. In developing economies slower productivity growth has been the underlying cause.

Encouraging innovation, improving education quality, higher infrastructure spending, enhancing business conditions, and promoting labor force participation -particularly among female workers- are some policy actions to take for positively changing the future trajectory of potential output. These actions, better known as the structural reforms, are needed for strengthening prosperity and stability in developing economies as well as in Turkey. Reforms that address the structural problem of the Turkish economy is expected to be on the agenda following the general elections which resulted in an AK Party coming to power without the support of a coalition partner. It is widely believed that in Turkey a single party government would act in the decision making process without causing a political turmoil. But for now it is also hard to make sure about AK’s readiness to return to reform agenda.

The September jobs report provided an important hint about how Turkish economy is doing in terms of its level of productivity. With broad strokes, Turkey’s unemployment rate increased to 10.3% in September from 10.1% in August as the labor participation rate was up to 52.1%. On a positive note, Turkey added 207K non-agricultural job in seasonally adjusted terms, the highest figure since February 2014, and the third highest over the past ten years.

In a recent post, we highlighted that monthly average of 65K new non-agricultural jobs (in seasonally adjusted terms) would be an explicative threshold for the economic outlook as the economy averagely grew by 6% once it was reached. With the strong September data, we saw the economy averagely generated 75K new jobs per month in 3Q 2015. Not surprisingly, GDP growth was 4% during the same time frame surprising to the upside. However, historically, Turkish economy was proved to be stronger with such an ability to create jobs, put it differently, newly created jobs had helped the economy much more in the past than it did in the last quarter. What this means is simply a decrease in marginal product of labor, which can be defined as the change in output that results from employing an added unit of labor.

Turkey’s Ministry of Science, Industry and Technology releases Index of Production per Person Employed quarter which gauges the level of productivity across the board. As visualized below, productivity in Turkey apparently lost it momentum after 2009, peaked in Q4 2011, then again sharply rose in the second quarter this year. In 3Q 2015 the index stood below where it was in 2009. Overall, 2005-2009 performance was a shining light for the future of economy, however, since then, we have seen an unnerving trend.

Turkey - Productivity

The following is from McKinsey’s report on Turkey in 2003:

Turkey has a watershed decision to make. Policymakers can remove the fundamental roadblocks to faster productivity growth. Or they can maintain the status quo, allowing productivity to limp along at 40 percent of best practice levels, holding Turkey back from a breakthrough to sustained rapid growth.

In order to proceed to the next step of its development story, singing the same tune after twelve years, Turkey now has a watershed decision to make, again.