How Can Turkey be Part of the EMU?: Turkey's Economic and Monetary Integration into the EMU and the Analyses of Macroeconomic and Institutional Factors by Export-Led Growth

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(1)Title. Author(s). Citation. Issue Date. URL. How Can Turkey be Part of the EMU?: Turkey's Economic and Monetary Integration into the EMU and the Analyses of Macroeconomic and Institutional Factors by Export-Led Growth Ünal, Emre. The Kyoto Economic Review (2016), 85(1-2): 2-41. 2016. https://doi.org/10.11179/ker.85.2. Right. Type. Textversion. Journal Article. publisher. Kyoto University.

(2) KER 85(1-2) pp. 2–41. REFEREED ARTICLE. How Can Turkey be Part of the EMU?: Turkey’s Economic and Monetary Integration into the EMU and the Analyses of Macroeconomic and Institutional Factors by Export-Led Growth Emre Ünal East Asia Sustainable Economic Development Studies, Graduate School of Economics, Kyoto University Received July 16, 2015; accepted December 19, 2015. ABSTRACT Turkey became an EU member candidate in 1999, and its economy achieved greater stability in the 2000s, compared to that observed before the 2000–2001 economic crisis. Nevertheless, it remains unclear whether this performance could help Turkey become a member of the economic and monetary union (EMU), following EU membership. Between 1995 and 2002, Turkey experienced severe inflation, at rates highest among the countries analyzed in this study. It also experienced macroeconomic instability as per the Maastricht Criteria. After 2002, Turkey successfully met the criteria regarding ratios of government deficit to gross domestic product (GDP) and gross government debt to GDP. However, certain persistent problems could create economic instability if Turkey were to join the EMU. Turkey’s inflation rate is higher than the limit established by the criteria; therefore, Turkey should follow a stronger anti-inflationary policy. In doing so, wage growth should decrease and keep pace with the productivity growth of export goods; this would ameliorate the disparity between wage growth and productivity growth of non-tradable goods, and the over-valued Turkish lira should come to balance with purchasing power parity (PPP). Keywords: Productivity growth of export goods, Non-tradable goods, Export-led growth, EMU, Purchasing power parity JEL Classification: E2, F5, N1. Corresponding author: Graduate School of Economics, Kyoto University, Yoshida-honmachi, Sakyo-ku, Kyoto 606-8501, Japan. E-mail: unal.emre.52x@st.kyoto-u.ac.jp. The author would like to thank Prof. Dr. Hiroyuki Uni for his valuable comments and suggestions.. 2. KER 85(1-2)_Book.indb 2. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:51 PM.

(3) How Can Turkey be Part of the EMU?…. 1. Introduction. Since 1999, Turkey has been a candidate for European Union (EU) membership. However, even if Turkey were to become an EU member, it is unclear whether it could also join the Economic and Monetary Union (EMU). Similarly, it is unknown whether the euro will be compatible with Turkey’s growth regime, in terms of the country’s wage growth, inflation rate, nominal exchange rate, and purchasing power parity (PPP).1 Turkey’s relations with the EU have largely focused, either directly or indirectly, on political issues (e.g., human rights, Cyprus, migration, and cultural issues), and on others related to the Copenhagen Criteria.2 This study will focus on Turkey’s economic performance; it seeks to determine whether Turkey is capable of joining the EMU, while considering the Maastricht Criteria. Using tables drawn from the World Input–Output Database (WIOD) for the 1995–2002 and 2002–2011 periods,3 we will analyze the Turkish economy in terms of its productivity growth of non-tradable goods and export goods. Previous research has largely assumed that manufacturing industries comprise the export goods sector, and that non-manufacturing industries comprise the non-tradable goods sector. However, in our study, we distinguish them in terms of commodity base, rather than industry base (McKinnon, 1963). Thus, using the method of vertically integration, we divide final demand into two categories: domestic demand and exports (Uni, 2007, 2012). In addition, this study considers several macroeconomic factors that relate to the Turkish economy— the productivity growth rates of non-tradable goods and export goods, wage growth rates,4 inflation rates, and change rates in nominal exchange rates and. 1 PPP reflects the hypothetical exchange rate and has been considered in terms of export price. PPP × export price of Turkey = export price of Germany. PPP, which is defined in Section 2, is the law of one price under the assumption that this law holds for all commodities. PPP relates to the export price because it is defined in ways that allows for a comparison of the price of export (tradable) goods of different countries. We described export price by implementing the mark-up rate, ULC, and imported material cost (see equation (2)), by using the unit labor cost parity (ULCP) approach (Uni, 2012). For additional information about PPP, see Cassel (1918) and Dornbusch (1985). This definition of “PPP” allows us to determine over-valued or under-valued currencies. 2. Although political issues have been based on the Copenhagen Criteria, Turkey was also criticized by the EU regarding other political factors. From an economic perspective, the Copenhagen Criteria demand a functioning market economy and the capacity to cope with competition and market forces from other EU candidate countries. In addition, the Copenhagen Criteria expect candidate countries to have the capability to be part of the EMU. 3. For Turkey, we consider the 1995–2002 period; this is because, in late 2002, the Justice and Development Party (AKP) was elected in Turkey, and political stability was achieved along with economic stability. In addition, reforms to eliminate the effects of the 2000–2001 economic crisis became apparent, and the productivity growth of export goods increased significantly. We considered peak-to-peak years for the countries; in this way, we could use them in the same tables, between the same years. 4. In this definition, wage growth is nominal.. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 3. 3. 2/23/2017 2:00:51 PM.

(4) Emre Ünal. PPP. By taking wage growth into account, we can ascertain the differences among the models (see Table 1) and better understand the relationship between wage growth and the productivity growth of non-tradable goods and export goods. Wage growth plays a substantial role in the emergence of a growth regime: if wages increase at the same pace as the productivity of either export goods or non-tradable goods, this can create a stable exchange rate or contribute to low inflation under specific assumptions, as we note in Section 2. Wages influence the reproduction of capitalism by affecting the production process, income distribution, and how demand is generated (Boyer, 1990, pp. 38–39; Boyer and Saillard, 2002, p. 44). We choose Germany as the central country for a comparative analysis in this study, as it has the strongest economy in the EMU, and investigate how other countries under analysis perform relative to Germany’s performance. To do so, we must analyze wage growth in comparison to productivity growth rates, and consider the exchange rate systems of the countries involved. Although Turkey has a floating exchange rate, it may face the choice of either joining the EMU or maintaining its floating exchange rate system. In this study, the EU countries that are not included in the EMU comprise Hungary, the Czech Republic, Sweden, and the United Kingdom. These countries will also be analyzed in comparison to Germany. We choose these countries because they continue to use their own currencies and can thus be used to facilitate comparison with Turkey. First, the productivity growth of non-tradable goods and export goods will be calculated for the 1995–2002 and 2002–2011 periods, by using input– output tables. Second, PPP will be estimated by utilizing the productivity growth of export goods and wage growth, and its comparison relative to the nominal exchange rate will be examined. The core of this work will consist of an analysis of two types of factors. The first type comprises the macroeconomic factors for monetary integration—productivity growth rates of nontradable goods and export goods, wage growth, inflation, and the change rates in the nominal exchange rate and PPP—which we analyzed using the Balassa–Samuelson, Pasinetti, and EMU models. The second type comprises institutional factors that stabilized the Turkish economy in the 2000s. The institutional changes reduced wage growth and inflation, and allowed Turkey to conform to some rules inherent in the Maastricht Criteria, in terms of government debt (see Table 6). These factors are important, as they are critical elements of the régulation that helps countries maintain stable economies through institutional arrangements (Boyer and Hollingsworth, 1997, pp. 49–54). Finally, we conclude that Turkey is closer to being a part of the EMU, relative to before 2002. However, the country still has some problems that could destabilize its economy. The first problem relates to the link between wage growth and productivity growth, which causes high inflation; the second problem is that wage growth can reduce PPP and give way to an over-valued exchange rate.. 4. KER 85(1-2)_Book.indb 4. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:51 PM.

(5) How Can Turkey be Part of the EMU?…. 2 2.1. Assumptions and Methods Export-led growth and contexts. In the 1980s, export-led growth became a distinctive characteristic of many countries. Although there are many definitions for “export-led growth,” we can describe it simply as follows: Export-led growth occurs when the production sector of export goods grows faster than that of non-tradable goods, at which point the former’s influence on an economy becomes distinctive and apparent. Exportled growth emerges by virtue of rising growth in the demand for export goods. However, it can be influenced strategically by both an under-valued exchange rate and low labor costs, which can in turn be affected by wage growth, investment, technology, and economy structure. High demand for export goods can affect the productivity of these goods due to dynamic increasing returns. The Turkish economy has been driven by an over-valued currency and high labor costs.5 In the 1980s, Turkey discontinued import substitution industrialization and began to focus on export growth strategies; this became a distinctive characteristic of the Turkish economy, because the production sector of export goods grew more quickly than that of non-tradable goods. To clarify the structure of export-led growth, this study will make use of three different models: Balassa– Samuelson, Pasinetti, and the EMU (Mundell–McKinnon). We use these models to examine Turkey’s capabilities under its current growth regime, with regard to integrating into the EMU. In a previous study, Uni (2012) describes the exchange rate systems of countries in East Asia, based on export-led growth between 1990 and 2000; this study notes that China gained an advantage by virtue of its under-valued currency and low wages, both of which decreased its export price and increased its competitiveness.6 Therefore, countries in East Asia should create a new institutional form of exchange rate system that can stabilize their trade. Mihaljek and Klau (2004) note the case where the Balassa–Samuelson effect on productivity growth of tradable (export) goods is greater than that of non-tradable goods,. 5 In addition, the trade deficit has been a serious problem. Although the Turkish economy gained more stability after the 2000–2001 economic crisis, its trade deficit grew significantly. In 2013, Turkey had a current account deficit of approximately USD 65 billion, ranking it highly among all countries. Source: World Bank, “Current Account Balance” http://data.worldbank.org/indicator/ BN.CAB.XOKA.CD/countries. Furthermore, according to TurkStat, Turkey had an approximately USD 100 billion trade deficit in 2013. These data were derived from TurkStat, foreign trade statistics (http://www.turkstat.gov.tr/). Links were accessed on July 3, 2015. 6 In the 1990s, China’s labor costs increased a slower pace than productivity growth, and the exchange rate also remained at a low rate (approximately CNY 8.28 = USD 1). Consequently, China’s competitiveness increased, and China obtained a greater trade surplus. However, in the late 2000s, China’s labor cost increased rapidly, which reduced its competitiveness. For additional information, see Yi (2008, 2013).. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 5. 5. 2/23/2017 2:00:51 PM.

(6) Emre Ünal. which is a major determinant of inflation in Central European countries. Ito, Isard, and Symansky (1997) used the Balassa–Samuelson effect to examine Asian countries, and realized that rapid economic growth brought about an appreciation there in the real exchange rate. Whereas many studies have discussed Turkey’s integration into the EU from a political perspective,7 the economic perspective has remained unaddressed. Turkey is typically neglected in analyses that use the economic models we identify in the following sections, because the Turkish economy lacks some of the assumptions inherent in those models. However, in our study, we implemented PPP based on mark-up rates, unit labor cost (ULC), and imported material costs, because Turkey does not have the constant mark-up rates that the models assume; we used these factors to explain Turkey’s economic and monetary integration into the EMU.. 2.2. Assumptions and methods for calculating Turkey’s PPP and ULC. We assume that the prices of export goods and non-tradable goods depend on their vertically integrated labor input coefficients (v; see appendix for the calculation), nominal wage rate (w), mark-up rate (m), and imported material cost (cim), as follows: p = (1 + m) (wv + cim) = (1 + m) (w/q + cim). (1). In this study, the product of the vertically integrated labor input coefficient and wage rate is called the ULC, and the inverse of the vertically integrated labor input coefficient is considered labor productivity (q). If the growth rates of productivity and wages are equal, the mark-up rate is constant, and the imported material cost is negligible, the price level will not change. We denote countries A and B with superscripts A and B, respectively, export goods with subscript e, and non-tradable goods with subscript n. We can show the export price as follows: pe = (1 + me) (wve + cim) = (1 + me) (w/qe + cim). (2). where pe indicates export price and ve indicates the vertically integrated labor input coefficient of export goods. The non-tradable price is calculated as follows:. 7. EU integration does involve the political perspective: nevertheless, a political discussion cannot be undertaken in the absence of economic views. Since 2002, Turkey’s political stability has helped contribute to its economic stability (Bac, 2005). However, the analysis of this stability cannot go beyond political discussions, which relate to the Copenhagen Criteria between the EU and Turkey.. 6. KER 85(1-2)_Book.indb 6. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:51 PM.

(7) How Can Turkey be Part of the EMU?…. pn = (1 + mn) (wvn + cim) = (1 + mn) (w/qn + cim). (3). where pn indicates the non-tradable price and vn indicates the vertically integrated labor input coefficient of non-tradable goods. The circumflex (^) indicates the growth rate. From this perspective, PPP is calculated as follows:. PPP A (peA ) = (. B e. ). (4). PPP is defined as follows:. PPP A ( +. A e ). (. A A e. +. A im ). B e ). =( +. (. B B e. +. B im ). (5). If imported material costs are negligible in both the countries,. (. (. )+. ˆ A=⎡ + PPP ⎣. ⎤ ⎡ + ⎦ ⎣. )+. ⎤ ⎦. (6). Moreover, if mark-up rates are constant in both the countries,. (. ) (. ). A ˆ A = wˆ B − qˆ B − wˆ A − qˆ A = ULCP ˆ PPP e e. (7). Here, ULCP refers to unit labor cost parity. The Balassa–Samuelson model usually assumes that productivity growth in tradable (export) goods is higher than that in non-tradable goods (i.e., exportbiased productivity growth), and that the wage increases proportionally to the productivity growth of export goods, as follows: qêA = wˆ A > qˆnA. (8). Hereafter, we assume that qêB = qˆnB = wˆ B. In the case of equation (7), PPP and ULCP are constant; additionally, the export price is constant in country A. However, according to equation (1), under the assumption that wages grow proportionally in both the export goods and non-tradable goods sectors, these assumptions create inflationary pressure in non-tradable goods (Balassa, 1964; Samuelson, 1964). Under the Pasinetti model,8 export-biased productivity. 8. For additional information, see Uni (2012) and Pasinetti (1993, pp. 151–168).. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 7. 7. 2/23/2017 2:00:51 PM.

(8) Emre Ünal. growth exists, but the wage rate grows proportionally to the productivity of non-tradable goods, as follows: qêA > qˆnA = wˆ A. (9). In the case of equation (7), PPP and ULCP increase, and the export price decreases in country A. However, inflation does not occur. Under the Mundell–McKinnon model—the origin of the rules for joining the EMU—the wage growth and the productivity growth rates in both non-tradable and export goods are identical. qêA = qˆnA = wˆ A. (10). Then, export prices do not change, and PPP and ULCP remain constant; moreover, there is no inflation. Under this model, balance of payments problems do not emerge with monetary integration (Mundell, 1960). In his previous work, Mundell (1961) mentions that when a country’s price of goods is kept lower than that of another country, unemployment can ensue, as well as a trade deficit under the conditions of a rigid wage and a fixed exchange rate. In addition, McKinnon (2005) mentions that if wage growth is linked to productivity growth, this situation can create stability in a region that features a fixed exchange rate system, and the countries involved can create balance in international competitiveness. Thus, the Mundell–McKinnon definitions also reflect the Maastricht Criteria for economic and monetary integration (Mundell, 1997, 1998) regarding the conditions for creating mobility of labor and capital among countries. Therefore, if wages were to increase in excess of productivity growth, inflation will occur and the export price will increase. For perfect monetary integration, wages should increase proportional to productivity growth (in non-tradable goods and export goods), in all member countries. The aforementioned characteristics of the three models are summarized in Table 1. There are some crucial assumptions that are important to the application of equation (7); these are stable mark-up rates and negligible imported material costs. Therefore, we must analyze the mark-up rates of the countries involved by considering 1 + mˆ e , to decide whether it is constant. As shown in Table 2, the Czech Republic has a constant 1 m̂ˆ e only between 1995 and 2002, thus satisfying the assumption of equation (7). However, each of Turkey, Hungary, Sweden, Germany, and the United Kingdom does not have a constant 1 m̂ˆ e during both the periods (i.e., 1995–2002 and 2002–2011). In addition, the Czech Republic does not have a constant 1 + mˆ e between 2002 and 2011. Regarding the assumption of negligible imported material costs, we compared the change rates of the mark-up rates by including imported material costs, pe = (1 + me) (wve + cim), and by not including them pe = (1 + me) (wve). The. 8. KER 85(1-2)_Book.indb 8. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(9) How Can Turkey be Part of the EMU?…. Table 1.. Growth Regimes by Three Models.. Category. Balassa– Samuelson. Pasinetti. EMU (Mundell–McKinnon). Nominal wage growth linked. Productivity growth of export goods. Productivity growth of non-tradable goods. Proportional growth of productivity of both goods. Export price. Constant. Decrease. Constant. Inflation rate. High. Zero. Zero. Exchange rate. Fixed. Managed. Fixed. PPP. Constant. Appreciates. Constant. Note: In country B, the prices of export goods and non-tradable goods are constant.. Table 2.. Growth Rate of (1+me) in the Countries (Average Annual Rate, Unit: %). Turkey. Hungary. Czech Republic. Sweden. United Kingdom. Germany. 1995–2002. 0.3. 4.1. 0.0. −0.6. −0.5. 0.5. 2002–2011. 1.6. 2.2. 1.7. 1.9. 0.5. 0.5. Years. 9. Source: Author’s calculations.. mark-up rates did not change in either equation, in any country. This means that imported material costs were negligible in all countries. Therefore, we used equation (6) for all countries. Regarding the assumptions of proportional wage growth in the two sectors, as shown in Table 3, we concluded that approximately proportional wage growth exists in these countries.9. 9. pe = (1 + me) (wve + cim) and pe = (1 + me) (wve) were used to calculate the growth in the mark-up rate as seen in Table 2, between 1995 and 2011. In both equations, the mark-up rates were the same, thus indicating that the imported material cost was negligible. pe shows the export price (see Figure 1), which was calculated from the United Nations data “National Accounts Estimates of Main Aggregates,” which can be found in the database of the United Nations Development Statistics Divisions (http://data.un.org/Explorer.aspx?d=SNA). To calculate wage rate growth, wages and number of persons engaged in production were derived from the WIOD, using the database “Socioeconomic Accounts” (http://www.wiod.org/new_site/database/seas.htm). Imported material costs were derived from the WIOD, from the database “National Input–Output Tables” (http:// www.wiod.org/new_site/database/niots.htm). See appendix for more on the calculation of ve. All links in the footnotes were accessed on July 3, 2015.. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 9. 9. 2/23/2017 2:00:52 PM.

(10) 10. KER 85(1-2)_Book.indb 10. 12.4. 12.0 5.5. 4.9. 15.5. 14.3. Hungary. 4.3. 3.9. 11.1. 10.7. Czech Republic. 2.6. 2.4. 4.3. 4.2. Sweden. 3.1. 3.1. 3.9. 4.2. United Kingdom. 1.1. 2.1. 1.2. 2.1. Germany. By considering the data and information cited in footnote 9, we used pe = (1 + me) (weve) for wage rate growth in the export goods and pn = (1 + mn) (wnvn) for wage rate growth in the non-tradable goods, for all countries studied.. 10. 10. Source: Author’s calculations.. 10. Non-Tradable. Export. 65.0. Non-Tradable. 2002–2011. 64.1. Export. 1995–2002. Turkey. Category. Wage Rate’s Growth in the Countries (Average Annual Rate, Unit: %).. Years. Table 3.. Emre Ünal. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(11) How Can Turkey be Part of the EMU?…. 3. Macroeconomic Factors for Monetary Integration. The euro was introduced in the EMU to establish a single market among member countries. As a result, the EMU member countries lost the opportunity to devalue their own currencies in an effort to gain competitive power in international trade. Before the EU member countries became part of the EMU, trade deficits could be eliminated by depreciating national currencies; clearly, EMU member countries cannot do this. Thus, these countries’ trade deficits may increase in cases where there is disproportional productivity growth between export goods and non-tradable goods.11 If the ratio of export prices to non-tradable prices is constant and approximately 1, it means the productivity growth of export goods and productivity growth of non-tradable goods increase proportionally under proportional wage growth, as described by the EMU model in Table 1. Figure 1 shows the ratio of export price to non-tradable price in the Turkish economy and in the current EU member countries, between 1990 and 2013. As one can see, Turkey’s ratio changed significantly: in 1995, it was approximately 1.2556. However, subsequently, the ratio decreased, as the Turkish economy experienced disproportional productivity growth with proportional wage growth. To understand the importance of these macroeconomic factors in the Turkish economy discussed in Section 2, we will extend this research to the analysis of the following factors: productivity growth rates of export goods and non-tradable goods, wage growth, inflation, and the rates of change in nominal exchange rate and PPP.. 3.1. Export-led growth and macroeconomic factors between 1995 and 2002. Before 2000, it was predicted that the euro would become the main currency among some EU member countries, and that these countries would peg their national currencies to the euro to completely qualify for EMU membership. Thus, the euro replaced the German mark as Europe’s principal foreign currency, and this new currency was adopted by a number of countries (Kenen, 2002). Therefore, we combined the euro and the mark to measure the change rates of the member countries’ currency, against that of Germany. As observed in Table 4, although the productivity growth of export goods was distinctive in each country, between 1995 and 2002, the Czech Republic, Sweden, and the United Kingdom had similar macroeconomic factors with. 11. This occurred in Greece and Spain within the most recent decade, for example.. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 11. 11. 2/23/2017 2:00:52 PM.

(12) Emre Ünal. Figure 1. Ratios of Export Price to Non-Tradable Price in the Countries.. Turkey. Hungary. Czech Republic. Germany. Sweden. United Kingdom. 2013. 2012. 2011. 2009. 2010. 2008. 2007. 2005. 2006. 2004. 2002. 2003. 2001. 2000. 1998. 1999. 1996. 1997. 1995. 1994. 1993. 1991. 1992. 1990. 1.800 1.700 1.600 1.500 1.400 1.300 1.200 1.100 1.000 900 800. Source: Author’s calculations.12. 12. respect to the models.13 Export-led growth was not a characteristic of the countries; additionally, Hungary and the Czech Republic, as developing countries, experienced a significant increase in the productivity growth of export goods, by approximately 10.4% and 8.9%, respectively. Turkey’s productivity growth of export goods, which was approximately 4.7%, was relatively low but closer to that of Sweden and the United Kingdom, which experienced productivity growth rates of 4.3% and 4.7%, respectively. The disparity between Turkey and the current EU countries was stimulated by wage growth. Turkey’s wage growth rate of 69.5% far surpassed that of other countries: the wage growth rates of Hungary and the Czech Republic were 17.6% and 11.4%, respectively, while those of Sweden, the United Kingdom, and Germany were approximately 4.0%, 4.2%, and 2.4%, respectively. Turkey’s high wage growth caused a large depreciation in PPP, of approximately 66.6%, a figure much higher than that observed in other countries.. 12. The ratios were calculated by deriving data from the United Nations, using the database of the United Nations Development Statistics Divisions for export price (2005=100), which was derived from “the national accounts estimates of main aggregates” and “GDP by type of expenditure” categories (http://data.un.org/Explorer.aspx?d=SNA), accessed on July 3, 2015. Export price can be calculated from exports at current prices (national currency) divided by exports at constant prices (national currency). pn shows the non-tradable goods price. pn was calculated from domestic demand at current prices (national currency) divided by domestic demand at constant prices (national currency) as follows: Domestic Demand = GDP – Export + Import. 13 No country had an under-valued currency, which indicates they cannot be easily categorized under export-led growth; however, it can be said that Sweden and the United Kingdom had the characteristics of the Balassa–Samuelson model.. 12. KER 85(1-2)_Book.indb 12. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(13) KER 85(1-2)_Book.indb 13. The Kyoto Economic Review ❖ 85(1-2). 1.0. Germany. 2.5. 4.7. 4.3. 8.9. 10.4. 2.4. 4.2. 4.0. 11.4. 17.6. 69.5. Nominal Wage Growth. 1.4. 1.6. 1.2. 7.2. 14.8. 69.7. Inflation. −11.1. −6.9 0.0 3.7. −0.6. −0.3. −5.6. −66.6. −55.8 0.9. Change Rate in PPP15 against Germany. Change Rate in the Nominal Exchange Rates against the Mark14. In equation (7), if mark-up rates are constant between two countries, changes in PPP can reflect in changes in ULCP. Therefore, we used PPP in the tables.. 15. For Turkey’s exchange rates, we found information pertaining to the mark and the euro by using the CBRT in the database Electronic Data Delivery System (http://evds.tcmb.gov.tr/fame/webfactory/evdpw/yeni/cbt-uk.html). For other countries, we first found the country’s currency value against the US dollar from the OECD Monthly Monetary and Financial Statistics (http://stats.oecd.org/index.aspx?queryid=169); and then found the value of the mark and euro against the US dollar. From there, we converted national currencies from the US dollar base to the mark and the euro bases. The exchange rate of the euro against the US dollar was derived from the Board of Governors of the Federal Reserve System: statistics are the foreign exchange rates (http:// www.federalreserve.gov/datadownload/Choose.aspx?rel=h10). The exchange rate of the German mark against the US dollar was derived from the Federal Reserve Bank of St. Louis (http://research.stlouisfed.org/fred2/release?rid=87) in the category of the Transitional Euro Country Exchange Rates. The links in the footnotes were accessed on July 3, 2015.. 16. In Table 4, the mark also includes the value of the euro, as the euro was shaped under Germany’s influence.. 14. Source: Author’s calculations. The productivity growth rates of non-tradable goods and export goods were calculated from WIOD data using the method shown in the appendix. For the exchange rates, see the footnote below.16 The nominal wage growth was derived from the OECD, using database Main Economic Indicator (hourly wages), and inflation rates were derived from the World Bank, using its database World Development 141516 Indicator (inflation, consumer prices).. 2.0. 2.5. United Kingdom. 3.1. Czech Republic. Sweden. 3.4. Hungary. 4.7. Export Goods. Non-Tradable Goods. 2.2. Growth of. Productivity. Macroeconomic Factors in Turkey and the Current EU Member Countries (Average Annual Rate, 1995–2002, Unit: %).. Turkey. Countries. Table 4.. How Can Turkey be Part of the EMU?…. 13. 2/23/2017 2:00:52 PM.

(14) Emre Ünal. We compared the currency change rates to that of the German mark. As seen in Table 4, the Turkish currency’s change rate was high compared to that of other countries. The change rate in the lira was −55.8%, which had been deepened by the Central Bank of the Republic of Turkey (CBRT) after it triggered sudden devaluations. In addition, the gap between the change rates in PPP and the lira were larger than in other countries. However, the nominal exchange rates of Hungary and the Czech Republic changed by −6.9% and 0.9%, respectively. In addition, the change rate in the nominal exchange rate was 0.0% in Sweden, but 3.7% in the United Kingdom. Moreover, disparity between wage growth and productivity growth caused a disturbing inflation rate in the Turkish economy, which reached 69.7%. Hungary and the Czech Republic experienced high rates of inflation of approximately 14.8% and 7.2%, respectively, whereas developed countries enjoyed low rates of inflation, owing to the macroeconomic stability of their economies. The current members of the EU revealed more stability in their macroeconomic performance, compared to Turkey. We cannot say that Turkey had strong wage indexation with respect to its productivity growth of export goods, although Turkey did attempt to reduce its wage growth in the 2000s. Similarly, in subsequent years, Hungary and the Czech Republic attempted to reduce their wage growth, so that it better approximated the productivity growth of export goods (Table 5). Under its growth regime, Sweden could keep its wage growth close to its productivity growth of export goods.17 A similar condition can be observed in the United Kingdom by considering the change rate in its PPP. The disparity was small between the United Kingdom and Germany regarding change rates in PPP. In conclusion, if we consider the potential membership of Turkey in the EMU by looking at the Maastricht Criteria (see Section 4.1), it becomes difficult to ascertain that Turkey could have been part of the EMU in the 1990s. First, as the best-performing country, Germany’s rate of inflation was approximately 1.4%, whereas that of Turkey was 69.7%. In addition, the change rates in the lira and PPP were the highest compared to those of the other countries, and the lira had been dramatically over-valued. High disparities in macroeconomic factors made it impossible the prospect that Turkey could join the EMU.. 17 The Scandinavian model shows that wage growth is linked to productivity growth. This model usually contains extensive employment in the public sector and workers’ rights under welfare state policies (Becker, 2007). In this model, company bargaining is usually conducted under agreed-upon criteria of productivity (Dolvik, 2008). In another study, it was noted that wages in the tradable (export) goods sector are determined by productivity growth, which also increases wages in the non-tradable goods sector (Thomas, 1998). Thus, wage growth, which is determined by the productivity growth of export goods, is extensive in the economy.. 14. KER 85(1-2)_Book.indb 14. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(15) KER 85(1-2)_Book.indb 15. The Kyoto Economic Review ❖ 85(1-2). 0.4. 0.4. United Kingdom. Germany. Source: Author’s calculations. See Table 4.. 2.4. 1.6. Sweden. 1.2. Hungary. Czech Republic. 3.2. Non-Tradable Goods. Productivity. 2.3. 0.5. 3.6. 6.6. 6.5. 4.7. Export Goods. Growth of. 1.7. 3.5. 3.1. 5.6. 7.9. 13.9. Nominal Wage Growth. 1.5. 2.4. 1.5. 2.6. 5.1. 14.1. Inflation. −2.4. −1.6. −1.7 −3.5. 0.0 −3.8. −0.5. −11.1. −5.9 2.4. Change Rate in PPP against Germany. Change Rate in the Nominal Exchange Rates against the Euro. Macroeconomic Factors in Turkey and the Current EU Member Countries (Average Annual Rate, 2002–2011, Unit: %).. Turkey. Countries. Table 5.. How Can Turkey be Part of the EMU?…. 15. 2/23/2017 2:00:52 PM.

(16) Emre Ünal. 3.2. Export-led growth and macroeconomic factors during the 2000s. In the 2000s, as seen in Table 5, while Turkey’s macroeconomic factors changed significantly and gained greater stability, it did not have favorable macroeconomic factors with respect to export-led growth. Turkey’s over-valued currency and high labor costs were persistent features of its economy. Between 2001 and 2007, the Turkish economy produced a significant increase in the productivity growth of export goods, of approximately 10.9%, on average.18 Although the 2008 economic crisis slowed Turkey’s productivity growth of export goods, it did not show an outstanding difference compared to Table 4, as it remained at 4.7%. In other countries, the productivity growth rates decreased dramatically—particularly in Hungary and the Czech Republic.19 The most significant change to emerge in the Turkish economy was undoubtedly its wage growth. Compared to 1995–2002, in 2002–2011, Turkey’s wage growth decreased to 13.9%. Meanwhile, the wage growth rate of Hungary and the Czech Republic— which were 7.9% and 5.6%, respectively—more closely approached the productivity growth of export goods in their economies. In Turkey, decreasing wage growth slowed the change rate in PPP of approximately −11.1%. Moreover, the change rate in the lira decreased to −5.9%, and Turkey eliminated a relatively large part of its currency’s disparity with the currencies of the current EU member countries. In addition, Turkey rather quickly and successfully reduced its inflation rate to 14.1%, although it was still comparatively higher than that of the best-performing countries, such as Germany. The outstanding difference in Turkey’s macroeconomic factors derives from the institutional changes in the Turkish economy, as discussed in Section 4. As discussed in Table 3, export-biased productivity growth influenced inflation in the countries studied because of proportional wage growth. In Table 5, we see that the Czech Republic became more stable in terms of its PPP than in the previous period, which was around −0.5% against Germany; additionally, its inflation rate was approximately 2.6%, which did not create a large disparity regarding the Maastricht Criteria. In addition, its macroeconomic factors more closely approximated those of Sweden. Sweden had successfully continued to enforce its stable macroeconomic policies, which can be explained under the Balassa–Samuelson model as being an outcome of maintaining the nominal exchange rate and the PPP at approximately 0.0% and −1.7%, respectively. Germany, Sweden, and the Czech Republic kept their wage growth rates. 18 To understand the rapid increase in the productivity growth rate of export goods before the 2008 economic crisis, we considered the average annual rate between 2001 and 2007. The largest trade partners of Turkey are located in Europe; therefore, the economic crisis in 2008 slowed demand for export goods from Turkey. Thus, the productivity growth of export goods decreased in the years that followed. 19. Hungary fell more in line with the Balassa–Samuelson model between 2002 and 2011.. 16. KER 85(1-2)_Book.indb 16. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(17) How Can Turkey be Part of the EMU?…. slightly lower than their respective productivity growth rates of export goods, unlike the cases seen in Turkey, Hungary, and the United Kingdom. Not joining the EU does not relate directly to economic stability, because although Turkey did not become an EU member, its macroeconomic factors gained more stability in the 2000s. In addition, Turkey’s gross domestic product (GDP) greatly increased between 2002 and 2012, and its per-capita GDP rose significantly following the establishment of its new economic policies. Turkey attracted a great amount of foreign direct investment (FDI);20 nonetheless, FDI inflows to Turkey during the 1990s were lower than the corresponding inflows to Hungary and the Czech Republic. In 1995, FDI in Turkey amounted to USD 885 million, whereas those for Hungary and the Czech Republic were estimated at USD 5 billion and USD 2 billion, respectively. However, during the 2000s, FDI inflows to Turkey increased significantly, surpassing those to Hungary and the Czech Republic: in 2007, the amount of FDI to Turkey was USD 22 billion, compared to USD 4 billion to Hungary and USD 10 billion to the Czech Republic. In 2012, Turkey attracted USD 13 billion of FDI; 50% of this amount was invested in its industrial sectors.21 Furthermore, Turkey experienced high productivity growth of export goods. When the 2008 economic crisis emerged worldwide, the productivity growth of export goods decreased dramatically, across all countries (see Tables 4 and 5). In the 2000s, Turkey was able to maintain a more stable economy and ameliorate, within a short period, the effect of the 2008 crisis—even though its largest trade partners were EU members.. 3.3. The relation between PPP and the nominal exchange rate in Turkey. If countries differ in terms of their macroeconomic factors, then institutional changes should play a significant role in bringing them together. Thus, to be a candidate country for EMU membership, there must not be a large disparity between the central rate and nominal exchange rate fluctuations. Exchange rates can be used to provide stability within the framework of the short term fluctuation band limits of the Exchange Rate Mechanism (ERM II);22 moreover, a country must not have devalued its own central rate against the euro in the previous two years. The stability of both PPP and nominal exchange rates. 20. Source: The United Nations Conference on Trade and Development (UNCTAD), foreign direct investment statistics (http://unctad.org/en/Pages/Statistics.aspx). 21 Source: Republic of Turkey Ministry of Economy, “Foreign Direct Investment in Turkey 2012,” retrieved from http://www.yoikk.gov.tr/upload/ydk/FDI2012_Report.pdf. Links in footnotes were accessed on July 3, 2015. 22. The band allows a country to limit fluctuation by up to 15% above or below the central rate.. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 17. 17. 2/23/2017 2:00:52 PM.

(18) Emre Ünal. 96. 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10. 19. −25. 19. 19. −5. 95. Figure 2. Change Rates in PPP and the Nominal Exchange Rate in Turkey against Germany (Annual Rate, 1995–2010, Unit: %).. −45 −65 −85 −105 PPP. Lira. Source: Author’s calculations. See Table 2.. are important factors in the above condition. A large change in PPP makes it difficult for a country to maintain a narrow band in its nominal exchange rate. To examine the potential for Turkey to join the EMU, we must examine its PPP and nominal exchange rate against those of Germany. We concede that Germany is at the center of both the EU and the EMU; therefore, changes in the lira and PPP of Turkey against the currency and PPP of Germany will indicate whether the euro can be compatible with Turkey, and whether Turkey can join the EMU.23 Figure 2 shows the annual change rates in the lira and PPP. Most importantly, this figure clearly indicates the base year of the institutional changes— the year of the 2000–2001 economic crisis. In Figure 2, the lira was over-valued, as observed by the PPP change rate. In addition, the gap between the change rates of the lira and PPP was significantly large until 2001. Decreasing wage growth attenuated PPP volatility, and lira’s depreciation brought these two factors closer together in the following years, compared to the period before the 2000–2001 economic crisis. Figure 3 indicates the base year of the institutional changes—the year of the 2000–2001 economic crisis—which brought the change rate of Turkey’s PPP closer to those of the EU’s current member countries. Although each country has different economic features, the possibility of a single labor market is made possible under the PPP change rates, which work to equalize. 23. See Section 4.1 for details on the Maastricht Criteria.. 18. KER 85(1-2)_Book.indb 18. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(19) How Can Turkey be Part of the EMU?…. Figure 3. Change Rates in PPP of the Countries against Germany (Annual Rate, 1995–2010, Unit: %).. 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10. 97. 19. 19. 96 19. 19. 95. −5. −55. −105 Turkey. Hungary. Czech R.. Sweden. UK. Source: Author’s calculations. See Table 2.. Figure 4. The Fluctuation of the Lira within the Band Limit (01.01.2003–31.12.2010). 2.500 2.000 1.500 1.000 500. 10 1/ /0 01. 20 1/ /0 01. Central Rate. 20. 09. 08 1/ /0 01. 20 1/ /0 01. Upper Rate. 20. 07. 06 1/ /0 01. /0 01 Lira. 20. 05 20 1/. 20 1/ /0 01. 01. /0. 1/. 20. 04. 03. 0. Lower Rate. Source: Author’s calculations.24 Regarding the ±15% limit, the central rate was 1.850, the upper rate was 2.128, and the lower rate was 1.573. Maximum deviation occurred on March 23, 2009 (EUR 1 = TRY 2.311), when the fluctuation rate was 24.9%—a number considerably higher than the 15% band limit.. export prices among the countries. In conclusion, first, Turkey could eliminate the disparity between its change rates in the lira and PPP, by creating greater balance between these factors. Second, Turkey could reduce its disparity with member countries, in terms of PPP’s change rates in the 2000s.24. 24. In Figures 4 and 5, a decline in the value implies an appreciation of the lira. The EMU band limit is defined in the short term; thus, we considered the daily change rate of the lira against the euro. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 19. 19. 2/23/2017 2:00:52 PM.

(20) Emre Ünal. Figure 5. The Fluctuation of the Lira within the Band Limit (01.01.2011–29.06.2015). 3.500 3.000 2.500 2.000 1.500 1.000 500 0 01/01/2011. 01/01/2012 Lira. 01/01/2013 Upper Rate. 01/01/2014 Central Rate. 01/01/2015 Lower Rate. Source: Author’s calculations; see Figure 4. The central rate was 2.559, the upper rate was 2.943, and the lower rate was 2.175, regarding the ±15% limit. Maximum deviation occurred on January 28, 2014 (EUR 1 = TRY 3.211), when the fluctuation rate was 25.5%—which is again considerably higher than the 15% band limit.. Figure 4 was generated by considering fluctuations in the lira, which gained stability around 2003. As seen in Figure 4, the lira fluctuated largely within the ERM II band limit. The 2008 economic crisis caused a deviation from the central rate on October 24, 2008, and this instability continued into 2009; however, the lira again decreased within the band limit, in 2010. In Figure 5, although the lira largely adhered to the band limits, its fluctuation increased and exceeded the band limit in early 2014; this condition continued into 2015, owing to increased economic uncertainty and the US interest rate policy, both of which led to deprecations in the lira.. 4. Institutional Changes in Turkey and the EU under the Maastricht Criteria. As shown in Figure 6, the ULC growth rate began to decrease significantly in the 2000s, owing to institutional changes in the Turkish economy. We explained in the previous section that this slowdown in wage growth led to PPP stability in Turkey. In this section, we explain these institutional changes.. to calculate the central, upper, and lower rates regarding the ±15% limit. Source: the CBRT’s Electronic Data Delivery System database (http://evds.tcmb.gov.tr/fame/webfactory/evdpw/yeni/cbt-uk. html), accessed on July 3, 2015, using the category of exchange rates (converted to new Turkish lira) in the market statistics.. 20. KER 85(1-2)_Book.indb 20. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(21) How Can Turkey be Part of the EMU?…. 19. 19. 95. 110 90 70 50 30 10 -10. 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10. Figure 6. Growth Rates of ULC in Turkey (Annual Rate, Unit: %).. ULCe. ULCn. Source: Author’s calculations.25 25. The régulation approach seeks to identify how a capitalist economy can survive and continue its accumulation process (Jessop, 2006a, pp. 123–151), by using institutional forms to explain transformations in economies. According to the régulation theory, there are five institutional forms: bank and credit relations, wage–labor relations, the mode of competition, the mode of international insertion, and the role of government (Boyer, 1990, pp. 38–39; Boyer and Hollingsworth, 1997, pp. 49–54; Boyer and Saillard, 2002, p. 44). In addition, the régulation theory uses small (minor) crises and structural (major) crises (Lipietz, 1987, p. 34). Small crises can emerge because of external or internal factors; however, major crises emerge because of increasing conflict inside an economy, which then leads to the emergence of a new system and remarkable institutional changes. Therefore, the structural crisis is an important concept in the régulation approach. The largest crisis in the beginning of 2000s sustained by the Turkish economy profoundly influenced its economy and radically changed its institutional forms, increasing its macroeconomic stability and pushing it to become more integrated with the EU economies. Although deregulation policies began in the 1980s under Turkey’s liberal and conservative government, it was postponed because of social pressure until the 2000–2001 economic crisis, which presented an opportunity for another liberal and conservative government to introduce new institutional changes in the 2000s.26 These structural. 25. Using vertically integrated labor input coefficients and wage rates, ULC of non-tradable goods and export goods were calculated using the equations ULCe = we ve and ULCn = wn vn.. 26. In the 1980s, the Özal government attempted to implement deregulation policies in tandem with many countries. However, the government’s attempt was sustained because of increasing political and social problems. In the 2000s, the Erdoğan government, which obtained power in parliament, continued deregulation policies.. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 21. 21. 2/23/2017 2:00:52 PM.

(22) Emre Ünal. developments related to technological change, which reflected in Turkey’s productivity growth in the 2000s. Between 2001 and 2007 (i.e., before the 2008 crisis), the Turkish economy experienced high productivity growth of export goods, as discussed in Section 3, and its GDP increased significantly, from USD 196 billion in 2001 to USD 823 billion in 2013. Consequently, the régulation approach provides us with the concepts and ideology needed to describe the transformations in the Turkish economy in the 2000s, by using institutional forms that relate to wage–labor relations. We analyzed these relations by using productivity, wage growth, and an inflation targeting system that sets wages and salaries according to a targeted inflation rate; an exchange rate system, which is a concept under bank and credit relations; and the mode of international insertion, by which to design trade relations between countries. Equally important in implementing the inflation targeting system in wage–labor relations is the role of government, which changed institutional forms, the conditions of that role under market-driven and deregulation policies, and caused the weakening of trade unions. In the early 2000s, Turkey generated new economic reforms to recover from the biggest crisis in its history. The Turkish economy could reduce its chronic economic problems by making key institutional changes; in particular, the government plays an important role in regulating the Turkish economy.27 In the following section, we will explain the institutional rules that Turkey followed. These rules were created by the EU, under the Maastricht Criteria. Previous governments did not implement the institutional changes needed in the Turkish economy to make integration with the EU countries more plausible. In the 2000s, while considering its future policies, the government made major institutional changes that would preclude conflict between the Turkish economy and the EU economies. This action shows that the role of government was decisive, although it also received supports from international organizations. However, it remains controversial, whether these changes are satisfactory and sufficient for the Turkish economy in accessing EMU membership.. 4.1 Institutional rules of maastricht criteria and the monetary policy of the EU The Maastricht Treaty was signed in February 1992. However, it is difficult to say whether the Turkish economy transformed along with the EU countries prior to the 2000–2001 economic crisis. The reactions of, and the institutional changes in the Turkish economy with regards to its process of integration. 27. Jessop (2006b) largely explains the role of the government in terms of the régulation theory. For the role of the state and market, see Boyer (1996).. 22. KER 85(1-2)_Book.indb 22. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(23) How Can Turkey be Part of the EMU?…. with the EMU countries became clear following the 2000–2001 economic crisis. According to the Maastricht Criteria, EMU candidate countries must regulate their economies by making institutional changes to satisfy certain conditions. The goals of the EMU are to provide sustainable economic development and create a strong market economy, with stable monetary integration among its member countries. Embracing the euro is a milestone for EU member countries in becoming full members of the EMU, as the provision of a single currency is the most important factor in the functioning of a single market. Additionally, a single currency requires a single bank (Mundell, 1961). To guarantee success, export price stability is crucial, which depends on the equality of productivity growth of export goods and wage growth. If the productivity of non-tradable goods grows proportionally to the productivity of export goods, the aforementioned equality leads to equality of wage growth and productivity of non-tradable goods, which in turn leads to price stability with respect to non-tradable goods. Therefore, the Maastricht Criteria include the following conditions: first, the inflation rate must not increase beyond 1.5%, compared to that of the three best-performing countries;28 second, the long term interest rate must not increase beyond 2%, compared to the interest rate of government bonds among the three best-performing countries in the EU;29 third ratio of the annual government deficit to GDP must not increase by more than 3%—or must fluctuate around this ratio—relative to the previous year; fourth, the ratio of gross government debt to GDP must not surpass 60% and must fluctuate under or around this ratio, because without reducing public finance problems, it is not feasible to integrate into the region, given the dependence on inflation in financing public industries; finally, to preserve exchange rate stability, EMU candidate countries must not have depreciated their central rates in the short term against the euro for at least the two previous years. During the 1980s, many European countries began to implement deflationary policies. However, the narrow band limit regarding exchange rate fluctuations—implemented until 1992—did not help countries stabilize their economies. Therefore, the band limit was increased from ±2.25% to ±15%.30. 28 Source: European Central Bank, “The Maastricht Convergence Criteria and Optimal Monetary Policy for the EMU Accession Countries” (https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp896. pdf), accessed on July 3, 2015. 29 Source: For additional information, see European Commission, “Summaries of EU Legislation” (http://europa.eu/legislation_summaries/other/l25014_en.htm), accessed on July 3, 2015. In addition, in the Turkish economy, inflation and the interest rate are strongly connected: high inflation causes a high interest rate. Therefore, reducing inflation could also reduce the interest rate. 30. Source: European Commission (http://ec.europa.eu/economy_finance/euro/adoption/erm2/ index_en.htm), accessed on July 3, 2015. The ERM was implemented by EU member countries before 1999. A country that wants to be part of the EMU must keep its national currency within the band limit of the ERM II (i.e., a ±15% limit in the short term).. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 23. 23. 2/23/2017 2:00:52 PM.

(24) Emre Ünal. This gave countries a competitive advantage, by measuring their exchange rates before completing monetary integration. Until 2000, France could reduce the volatility rate of its national currency against that of Germany, which had been using the mark as its national currency (Aglietta and Uctum, 1996, pp. 5–15). Consequently, this policy helped France achieve monetary integration with Germany. Examining the daily fluctuation in the lira against its central rate, it was clear that this fluctuation remained largely within the band limit of the ERM II (see Figure 4), after the effect of institutional changes became apparent in the Turkish economy, but the volatility of the lira increased in times of economic uncertainty. This uncertainty was caused by the economic crises that deepened in the EU; it was also caused by the decision of the United States to increase its interest rate, which led to increased depreciation in the lira against the US dollar and, more directly, the euro (see Figure 5).. 4.2. Institutional changes in Turkey in the 2000s. Although Turkey began to establish deregulation policies in the 2000s, which could better integrate it with the EMU,31 its first step toward a free market economy emerged during the 1980s, following its import substitution industrialization crisis (Pamuk, 2010). The Turkish economy was influenced by neoliberal policies, which mainly began in the 1980s and imposed extensive liberal economic policies by supporting the private sector, increasing privatization, implementing deregulation policies, and improving free trade, which gave way to reduced government spending. Nevertheless, institutional changes in deregulation policies, privatization, and a functioning free-market economy slowed, until the 2000–2001 economic crisis. Therefore, between 1990 and 1999, the ratio of net public debt to gross national product was stimulated and dramatically rose, from 29% to 61%.32 In addition, there was an over-employment problem in the public industries and a disparity between wage growth and productivity growth.33 During the 2000–2001 economic crisis, GDP decreased, the lira depreciated, interest rates significantly increased, inflation remained. 31. Turkey’s integration process into the EU began in the early 1960s. With the establishment of the European Economic Community (EEC), Turkey made its first application for membership. Negotiations between Turkey and the EU opened a page for the Customs Union, which was established to abolish economic barriers and promote free trade. In 1995, Turkey became part of the Customs Union that went on to influence investments and trade volume in the 2000s. Turkey was finally accepted in 1999 as a candidate for EU membership; negotiations began in 2005, and they continue even today. 32. Source: the CBRT, “Strengthening the Turkish Economy: Turkey’s Transition Program” (http:// www.tcmb.gov.tr/), accessed on July 3, 2015. 33. Source: See footnote 32.. 24. KER 85(1-2)_Book.indb 24. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(25) How Can Turkey be Part of the EMU?…. at a very high rate, and many banks went bankrupt. Following its structural economic crisis in 2000–2001, Turkey implemented significant regulations in its economy, and created new policies under the rubric of a “Transition to the Strong Economy.” As seen in Table 6, in 2012, Turkey’s ratio of government deficit to GDP was 1.8%, and the ratio of gross government debt to GDP was 36.2%—one of the lowest among the countries. In this way, Turkey became a model country for successfully reducing gross government debt within a 10-year period. However, in terms of price stability, Turkey still continues to experience high inflation; this implies that after successfully handling other problems, Turkey must reduce its inflation rate to complete the process of economic and monetary integration, and achieve price stability under the Maastricht Criteria. During the 1990s, Turkey experienced unstable economic performance. High inflation, trade deficits, and other related problems emerged in the Turkish economy,34 which led to the conclusion that it was not possible for Turkey to create in the short term an economy conducive to EMU integration. However, following the 2000–2001 economic crisis, Turkey instituted structural changes in its economic system and introduced significant reforms. These reforms were based on neoliberal policies included the privatization of certain enterprises, the enactment of banking system regulations, the adoption of a floating exchange rate system,35 and reduced wage growth. Thus, in Turkey, both inflation and government debt have decreased significantly over the last 10 years. The economic reforms in Turkey were supported by the International Monetary Fund (IMF) and the World Bank. Additionally, these reforms were crafted to accord with the EU, as Turkey had produced its economic policy to access EU membership. Upon joining the EU, Turkey is presupposed to meet the EMU criteria. Monetary and fiscal policies were implemented to reduce inflation; in particular, wage growth was decreased by government policies. These policies have mainly concentrated on trade unions that undertake collective bargaining; privatization that increased the number of unemployed people and whose players demanded low minimum wage growth from the government; and the financing of public industries, which has been reduced by virtue of laws pertaining to CBRT independence.. 34. During the 1990s, although Turkey’s trade deficit was not as large as that in the 2000s, it was very much problematic. In the 1990s, the average trade deficit was USD 13.4 billion. Data were derived from the foreign trade statistics of TurkStat (http://www.turkstat.gov.tr/), accessed on July 3, 2015.. 35 Because of high inflation, there was a loss of confidence in the lira. During the 2000s, institutional changes in the Turkish economy reduced the volatility of the lira under the floating exchange rate system and the inflation targeting system. For additional information, see the report of the CBRT, “Strengthening the Turkish Economy: Turkey’s Transition Program” (http://www.tcmb.gov.tr/), accessed on July 3, 2015.. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 25. 25. 2/23/2017 2:00:52 PM.

(26) 26. KER 85(1-2)_Book.indb 26. −1.8 −2.0 −4.4 −0.7 −8.0 0.0. −14.4. −8.9. −6.5. −1.5. −2.1. −3.9. Turkey. Hungary. Czech Republic. Sweden. United Kingdom. Germany. 60.7. 37.1. 52.5. 27.1. 55.8. 74.0. 2002. 81.0. 88.6. 38.2. 45.7. 80.0. 36.2. 2012. Gross Government Debt to GDP (Should be less than 60 percent). 113.6. 133.2. 94.2. 28.4. 34.5. 14.5. 2002. 98.0. 166.4. 133.8. 53.9. 55.8. 57.9. 2012. Domestic Credits to Private Sectors (Percent of GDP)36. 38 The source is the World Development Indicators, and the private sector (http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS), accessed on July 3, 2015.. 37 The source is the IMF database, with the country category being “emerging and developing Europe” and the statistics category being “government finance” (http://www.imf.org/external/pubs/ft/weo/2014/01/weodata/weoselgr.aspx), accessed on July 3, 2015.. 36 After 2002, because of institutional changes calling for more open and free economic policies, many important parts of the public sector were privatized. Thus, in 2012, the amount of domestic credit to the private sector in terms of GDP increased. Increased privatization also expanded the credit needs of the private sector. This information does not relate to the Maastricht Criteria, but it can be used to understand the increased credits needs within the private sector following Turkey’s institutional changes.. 363738. Source: Government debt and deficit to GDP were derived from the IMF data.37 Domestic credits to the private sectors (percent of GDP) were derived from the World Bank.38 Italic numbers indicate countries below the significance level regarding the Maastricht Criteria.. 2012. 2002. Government Deficit to GDP (Should be less than −3 percent). Government Deficit and Gross Government Debt for the Monetary Integration.. Countries. Table 6.. Emre Ünal. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:52 PM.

(27) How Can Turkey be Part of the EMU?…. Table 7. Change Rate in Employment and Expenditure-Based GDP in Public and Private Sectors (Average Annual Rate, Unit: %). Change Rate in ExpenditureChange Rate in Expenditure- Based GDP in Private Based GDP in Public Sectors Sectors. Change Rate in Employment in Public Sectors. Change Rate in Employment in Private Sectors. 1995–2002. 1.6. 3.6. 5.7. −0.8. 2002–2010. −0.8. 5.3. 4.8. 13.5. Period. Source: Author’s calculations.39 Information regarding employment in the public sector was derived from the International Labor Organization (ILO) (public sector employment), and that in the private sector was calculated by using TurkStat data (employed persons by employment status). Change rates in expenditure-based GDP were derived from TurkStat data (GDP by expenditure approach).. 39. Trade unions were strong in Turkey’s public industries; thus, the small benefit deriving from exports reflected more on wage growth than its expected rate. The trade unions, which were unwelcome institutions, owing to the increased number of strikes and industrial actions,40 combined with radical left-wing parties in the Turkish economy from 1960 to 2000, and lost power during the 2000s. In addition, the productivity growth of non-tradable goods was not linked to the wage growth that had caused severe inflation, and trade unions acted only for the benefit of workers in public industries. Although trade union power has slowly attenuated since the enactment of privatization programs in the mid-1980s, public industries still accounted for a large proportion of the economy until 2000. In the 2000s, increased privatization brought about new legislation under a rule named 4/C, which gave public workers temporary working status in public institutions; this rule was established as part of an effort to minimize the impact of the unemployment that derived from privatization and resulting layoffs.. 39 In Turkey, total employment = regular and casual employees + employers + self-employed + unpaid family workers. Private sector employees = regular and casual employees – public sector employees. For additional information, see the statistical indicators derived from TurkStat for the 1923–2011 period (statistical indicators, pp. 149–150) (http://www.tuik.gov.tr/Kitap. do?metod=KitapDetay&KT_ID=0&KITAP_ID=158). The link in the footnote was accessed on September 14, 2015. 40. In 1990, the numbers of strikes peaked at 458. In 1995,120 strikes occurred, but this number decreased to its lowest point of eight, in 2012. See the Ministry of Labor and Social Security, “Strikes and Lock–outs in Turkish: Grev ve Lokavt uygulamaları” (https://www.csgb.gov.tr/home/ Contents/Istatistikler/GrevLokavtUygulamalari) accessed on July 3, 2015.. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 27. 27. 2/23/2017 2:00:52 PM.

(28) Emre Ünal. Table 7 indicates change rates in employment in both the public and private sectors in the 1995–2002 and 2002–2010 periods. As one can see, between 1995 and 2002, the change rate in employment within the public sector was 1.6%; however, this rate decreased to −0.8% between 2002 and 2010, owing to intensified deregulation policies. After 2002, the rate of privatization accelerated in the Turkish economy, and this affected employment in the public sector. The change rate in employment in the public sector was −7.8% in 2003. The employment in the private sector increased significantly from 3.6% to 5.3% between the 1995– 2002 and 2002–2010 periods. Whereas employment in the public sector declined, in the private sector, it increased by 8.5% in 2004, following layoffs and privatization in the public sector in 2003. In addition, in the 2000s, the role of the private sector became more important in terms of its contribution to Turkey’s GDP. Using the expenditure approach, it becomes clear that the growth rate of GDP increased significantly in the private sector, from −0.8% to 13.5%, between the two periods. Regarding the public sector, the growth rate of GDP based on the expenditure approach decreased from 5.7% to 4.8%. In examining changes in the rates of employment and GDP in terms of the public versus private sector between the two periods, one can see the influence of institutional changes on the Turkish economy in the 2000s—changes that had been brought about by deregulation policies. Turkey’s high government deficit and government debt in the 1990s triggered privatization in the 2000s. Privatization income increased significantly compared to pre-2000 levels,41 and widespread privatization occurred in public industries, including large monopolies. The Privatization Board of Turkey, established in 1994, played an effective role in privatization during the 2000s.42 Privatization triggered an increase in the number of unemployed people,43 and in the 2000s, joblessness became another problem under the low-inflation policies, even as deregulation policies significantly reduced government debt and the government deficit.44 In addition, because of the open economic policies. 41 For additional information on the implementation of privatization by year, visit the website of the Privatization Board of Turkey (http://www.oib.gov.tr/program/uygulamalar/1985-2004_years_ table.htm), accessed on July 3, 2015. 42 Between 1985 and 2002, total privatization income was approximately USD 9.053 billion; between 2002 and 2015, however, it was approximately USD 57.993 billion. 43. In Turkey, the number of unemployed people in 2001 nearly reached 700,000; however, it continued to increase gradually, eventually reaching nearly 2.5 million in 2014. Source: OECD (main economic indicators, labor force statistics, registered unemployed and job vacancies) (http://stats. oecd.org/index.aspx#) accessed on July 3, 2015. 44 After 2002, the privatization of public industries accelerated, and this helped reduce government debt. With the new government, export-led growth strategies that featured increased privatization and the attraction of FDI gained importance.. 28. KER 85(1-2)_Book.indb 28. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:53 PM.

(29) How Can Turkey be Part of the EMU?…. established for private industries, special investment zones gained more importance, and a number of techno-parks were introduced to attract more FDI.45 The CBRT became independent from the government, and it started to implement inflation targeting policies; the target has usually been between 3% and 7%. Thus, increased privatization and the independence of the CBRT interrupted the flow of money supply otherwise used to finance government debt, the growth of which had been stimulated by unproductive public industries. New legislations in 2001 abolished the ability to print money to underwrite government debt, at least in the absence of a CBRT counterpart. To regulate banks and credit facilities, the Banking Regulation and Supervision Agency (BRSA) was established in 2000, which played a crucial role in controlling these institutions and protecting them from inflation in the following years. In addition, wage–salary policies were implemented with regard to inflation; therefore, the government followed with more wage repression policies compared to before the 2000–2001 economic crisis. One of the most important institutional changes to emerge has been the exchange rate system,46 regarding which there had been considerable speculation, given the presence of a managed exchange rate system in the Turkish economy prior to the 2000–2001 economic crisis. To enhance the credibility of the lira, the managed exchange rate system was transformed into a floating exchange rate system, reducing the gap between the change rates of PPP and the nominal exchange rate; it also reduced speculative attacks on the lira. Between 1995 and 2002, the lira was over-valued, which caused instability in the Turkish economy (see Figure 2). In developing countries, under-valued currency is expected to contribute to the growth in exports; however, in Turkey, the over-valued currency was associated with a foreign currency shortage, current account deficits, and a balance of payments crisis. The budget deficit, which rose because of the high interest rate, was a serious problem and was financed by the public treasury (Atiyas, 2012). In general, the government created the budget deficit, and it turned into a current account deficit by losing reserves; this also encouraged speculation attacks against the lira. Thus, the domestic currency lost confidence and holders attempted to eliminate it and acquire foreign currency.47 High wage growth combined with the over-valued currency damaged the Turkish economy in terms of its macroeconomic stability. After Turkey changed its exchange rate system, a sharp depreciation in the lira emerged bringing it more in line with the country’s change rate of PPP. Therefore,. 45 The Investment Support and Promotion Agency was established to support the intake of FDI into the Turkish economy. 46. Turkey has sustained several institutional changes in its exchange rate system since 1980. In the 1980s, Turkey discarded the fixed exchange rate system and began to use a managed exchange rate system to increase its export competitiveness. In 2000, Turkey applied a crawling-bands exchange rate system. On February 22, 2001, the floating exchange rate system was adopted by the CBRT. 47. For additional information about increasing demand for foreign currency, see Kenen (1995, 1996).. The Kyoto Economic Review ❖ 85(1-2). KER 85(1-2)_Book.indb 29. 29. 2/23/2017 2:00:53 PM.

(30) Emre Ünal. during the 2000s, institutional changes in the Turkish economy reduced the volatility rate of the lira under both the floating exchange rate system and the inflation targeting policies that increased confidence in the lira.. 4.3. Income policy and possibility of Turkey’s integration into the EMU. Between 1995 and 2002,48 it was self-evident that the Turkish economy had become no better equipped to join the EMU, given the serious problems with its macroeconomic factors.49 As we saw in Table 4, there was a large disparity between the change rates of PPP and the nominal exchange rate, as well as between productivity growth and wage growth. Hence, inflation was extremely high in Turkey, and this fostered an unstable economy in Europe. However, more recent tables and figures suggest that since 2002, Turkey’s economy has become more sustainable, thus making the country better equipped to join the EMU—although unemployment increased significantly and new problems have emerged due to institutional factors imposed by the EU. Both wages and inflation have decreased, and the change rate in Turkey’s PPP has reached that of EMU member countries (see Figure 3). In addition, the disparity between the nominal exchange rate and PPP has contracted (see Figure 2). After 2002, when Turkey implemented institutional changes to its exchange rate system and wage–labor relations through anti-inflationary policies,50 the country’s macroeconomic factors changed in line with the monetary policies set forth by the Maastricht Criteria. Wage growth significantly decreased, which pushed down inflation. The lira largely remained within the short term band limit of the ERM II criteria, except during periods of economic uncertainty. In addition, Turkey successfully managed to reduce the ratios of government deficit to. 48 The Turkish economic transformation to open its economic strategies began after the January 24 1980 Decision, and following the military coup on September 12, 1980. After the coup, trade unions were forbidden for three years, which led to increased strikes in industries that became part of radical left-wing movements in the 1970s. In the 1980s, privatization became one of the main policy efforts in the Turkish economy; however, domestic consumption growth had clearly stagnated in 1985. We calculated productivity growth rates by using TurkStat’s input–output tables, which contain 64 industries. Between 1973 and 1985, domestic consumption growth became the dominant regime, as the growth rate of productivity of the non-tradable goods was 3.8%; of the export goods, it was 2.0%. (Calculations were performed as per the method in the appendix.) After 1985, Turkey’s economic transformation became obvious: between 1985 and 2003, the productivity growth rates of export goods and non-tradable goods were 5.3% and 3.0%, respectively. 49 The trade deficit was a serious problem: in 1997, it peaked at USD 22.2 billion (Source: TurkStat, foreign trade statistics), but Turkey’s GDP was nearly USD 190 billion (Source: World Bank, World Development Indicators, GDP). 50 The CBRT’s inflation targeting policy has usually been based on a band limit of 3–7%. If inflation exceeds this limit, the bank must provide a briefing to the government. Therefore, the CBRT’s main policy is to maintain price stability.. 30. KER 85(1-2)_Book.indb 30. The Kyoto Economic Review ❖ 85(1-2). 2/23/2017 2:00:53 PM.

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