Download VULNERABILITY TO EXTERNAL SHOCKS:THE CASE OF TURKEY

VULNERABILITY TO EXTERNAL
SHOCKS:THE CASE OF TURKEY
Hasan Ersel
8 June 2011
HSE-Moscow
THE CONCEPT OF “VULNERABILITY”
• Vulnerability is defined from an economic point of view
as the exposure of an economy to exogenous shocks,
arising out of economic openness.
• A shock, by definition, is a change in external
environment that affects the functioning of the economy
in question.
• If it temporarily or permanently disables the workings of
the economy significantly; then the economy is said to
be vulnerable to such a shock.
• On the other hand, if an economy has the policy induced
to withstand or recover from a shock it is said to be
resilient to it.
FUNDAMENTAL CONCEPTS
• The system: f{y, [x,z]}=0: The system
y=Endogenous variables
[x,z]: Exogenous Variables
x= Data (variables exogenous to the system)
z= Policy variables
• Initial State: {y0, [x0,z0]}
• The external shock: є
• The New State of the Economy (After the Shock):
{y*, [(x0+є),z0]}
CRITERIA FOR VULNERABILITY
i) Effect on the productive capability of the economy
y0≤y*
The shock led to a decline in the productive capacity of
some sectors. This is particularly important if the shock
affects a sector with strong linkages. (e.g. financial
sector)
ii) Social evaluation of the outcome
{y0, [x0,z0]} P {y*, [(x0+є),z0]}
Society prefers (P) the initial state. (say, due to increase
in poverty, unemployment etc.)
CURING POLICY
Consider an economy at the initial state, {x0,y0, [x0,z0]},
which was subjected to a shock є. Let the new state be
denoted by {y*, [(x0+є),z0]}.
Suppose the policy makers responded this shock, by
changing the instrument vector from z0 to z1. If that
enables the economy to go to a new state,
{y1,[(x0+є),z1]}, at which the society is indifferent (I)
between this new state and the initial one, i.e.
{y1, [(x0+є),z1]} I {y0, [x0,z0]}
then this policy intervention is a curing policy.
TURKEY WAS BADLY HIT BY THE 2008+
GLOBAL ECONOMIC CRISIS
• Turkey was severely affected by the 2008+ crisis. Turkey
was the tenth worst hit country in the world in terms of
decline in GDP
• The government initially tried to undermine the severity
of the crisis on Turkey. It was mostly a loss of time..
• But even after recognizing the significance of the crisis
the Turkish government did not launch a “fiscal stimulus
program” like many other countries did...
• The measures taken were scattered in time and
piecemeal.
SOME CHARACTERISTICS OF THE
TURKISH ECONOMY
• The Turkish economy became much more integrated to
the global economy since 2001.
• The structural reform program of 2001 was still not
completed in 2008. Therefore some major structural
weaknesses of pre-2001 era remained.
• Since 2006 the economy’s performance was already
weakening (growth, productivity increase, and fiscal
stance).
WHAT MAKES 2008 DIFFERENT FROM
2001
• In 2001 Turkey was in the crisis, the world was not. The
2008 shock, on the other hand, was due to a global
crisis.
• The 2001 crisis was fresh in the memories of all
economic agents and they acted upon the lessons they
drawn from it.
• The 2008 shock is qualitatively different from the one
that Turkey experienced in 2001. (Recognized rather late
by the government)
CHANNELS THAT TRANSMIT AN
EXTERNAL SHOCK
1.
Finance Channel
2.
Trade Channel
3.
Expectations Channel
1-FINANCE CHANNEL
•
Capital Inflow Through Bank Borrowing:
i) Banking system was strong
ii) Capital outflow considerably reversed itself within 6 months.
•
Corporate Sector’s Foreign Debt
i) The actual decline is less than seen in the statistics, but still
considerable
ii) The credit demand of the corporate sector declined due to
decrease in production.
•
Public Sector Borrowing
No visible change from the trends
2-TRADE CHANNEL
• Exports sharply declined. It led to a decline in total
demand and therefore in the GDP
• The decline in export revenues were partly due to
decrease in prices and partly because of the decrease in
the export volume.
• The decline in GDP led to a decrease in total imports.
Therefore trade and current account deficits moderated.
3-EXPECTATIONS CHANNEL
• Change in global environment may affect the behavior of
domestic agents, notably banks.
• That may lead banks to curb credits, consumers to
reduce their demands and producers to make downward
revisions in their output, employment and investment
plans.
2008 CRISIS: THREE SHOCK WAVES
1) The initial shock: The direct effects of the recession in
the USA and the EU (the center) on Turkey.
2) The secondary shock: The indirect effect through the
economic relations of Turkey with other countries that
also affected by the crisis at the center (such as Dubai,
Egypt, Russia among others).
3) The tertiary shock: The direct and indirect effects of the
measures taken by other countries on Turkey. (FED and
ECB etc.)
TURKISH GOVERNMENT’S INITIAL
REACTION
• The government did not change its policy stance.
Instead it tried to convince the public that the expected
effect of the crisis on the Turkish economy will not be as
bad as feared. (Using the expectation channel.)
• It was claimed that the government was deliberately
trying to postpone the necessary decisions, including an
agreement with the IMF, to the aftermath of the local
elections (that took place on March 29, 2009).
• This may indeed be the case, but it doesn’t fully explain
the government’s apparent confidence to the economy
as well as to the sustainability of the credibility of its
policies.
SOME FACTORS THAT MAY EXPLAIN
GOVERNMENT’S STANCE (1)
1) Crisis Experience: Turkey’s experience with the 2001
crisis, program design as well as the implementation
issues are fresh in the memory of the policy makers.
Both the government and economic bureaucracy may be
assuming that they are, intellectually, ready to deal with
the new situation.
2) Increased Policy Credibility of the Government:
Although the government did not initiated the 2001
recovery program it successfully implemented it after
2003. That enhanced its credibility considerably in the
eyes of the public. This process may also have
strengthened government’s self confidence.
SOME FACTORS BEHIND
GOVERNMENT’S STANCE (2)
3) Strong Banking System: Restructuring of the
banking sector in 2001 and better supervision/regulation
in the following years made Turkish banking system
much stronger.
 The capital adequacy ratio of almost all banks were
significantly higher than the legal minimum.
 Banks were paying more attention to liquidity and to
hedge themselves against exchange rate risk.
GOVERNMENT’S ATTITUTE-AN
INTERPRETATION (1)
• 2008 shock was something new!
• The global crisis created a completely uncertain
environment.
• It was obvious that Turkey will be affected by such a
crisis
• Under such circumstances, it is practically impossible to
figure out the possible effects of alternative policies on
the economy.
• The government couldn’t have a series of reliable
scenarios to work on. Instead it may at most confine
itself to the “good” and the “bad” cases.
GOVERNMENT’S ATTITUTE-AN
INTERPRETATION (2)
• Good Case: The effect of 2008 shock on the
Turkish economy is comparable with what
Turkey experienced in 2001
• Bad Case: The 2008 shock is different from the
one that the economy experienced in 2001. The
Turkish economy will be badly affected.
GOVERNMENT’S ATTITUTE-AN
INTERPRETATION (3)
• Assumption 1: 2001 and 2008 shocks are similar in
their nature.
• Assumption 2: 2001 reform program increased the
resiliency of the Turkish economy. (Optimism)
• Governmnt’s Conclusion: There is no need to launch a
socially costly fiscal stimulus program to deal with the
shock. Piecemeal policy measures plus managing the
expectations of the private decision makers will be
sufficient
GOVERNMENT’S ATTITUTE-AN
INTERPRETATION (4)
• Was the government irrational? Not necessarily!
• Its behavior can be explained by referring to Leonid
Hurwicz’s decision rule under uncertainty.
Hurwicz, L. : “Optimality Criteria for Decision-making
Under Ignorance”. Cowles Commission Paper. Statistics,
No. 370, December 11, 1951]
WHAT DID THE GOVERNMENT KNOW?
A) Two policy alternatives were available
i) Continue with the existing policy of sustaining fiscal
discipline.
ii) Increase public spending to compensate the fall in
external and domestic private demand.
B) Government was familiar with the first policy option,
and enjoyed the benefits of its implementation.
C) The second policy implies an increase in public sector
deficit, which may damage the policy credibility of the
government. The outcome is also not clear.
HURWICZ CRITERION (1)
• The Hurwicz criterion attempts to find a middle ground
between the extremes posed by the optimist and
pessimist criteria by assigning a certain percentage
weight to optimism and the balance to pessimism.
• A weighted average can be computed for every action
alternative with a weight, α, called the coefficient of
optimism, where 0 ≤ α ≤ 1.
• α = 1 denotes absolute optimism (Maximax) while α = 0
indicates absolute pessimism (Maximin).
• The α is selected subjectively by the decision maker.
HURWICZ CRITERION (2)
Hurwicz weighted average, H, can now be computed for
every action alternative Ai as follows:
A) For positive payoffs (profits, revenues)
H (Ai ) = α (row maximum) + ( 1 - α ) (row minimum)
B) For negative payoffs (costs, losses)
H (Ai ) = α (row minimum) + ( 1 - α ) (row maximum)
HURWICZ CRITERION (3)
1. Select a coefficient of optimism value α .
2. For every action compute its Hurwicz weighted average
H.
3. Choose the action with the best H as the chosen
decision ("Best" means Max {H} for positive-flow payoffs,
and Min {H} for negative-flow payoffs).
HURWICZ CRITERION (4)
“PAYOFF TABLE”
GOOD STATE
BAD STATE
STABILIZATION
POLICY
Sg
Sb
FISCAL
STIMULUS
PROGRAM
Fg
Fb
HURWICZ CRITERION (4)
A NUMERICAL EXAMPLE
Suppose the payoff table is as follows and α=0,75,
then the authority will choose the stabilization policy
alternative-which is more or less what the government
did
GOOD STATE
BAD STATE
STABILIZATION
POLICY
3
1
FISCAL STIMULUS
PROGRAM
2
2,5
GOVERNMENT’S CHANGING MOOD
• The Turkish government, apparently, changed its view
on the severity of the shock in summer 2009 and began
undertake a series of measures including a medium term
program that was announced in September.
• But these measures, in terms of their financial cost, were
quite modest when compared by those taken by other
countries, including Russia.
• The increase in budget deficit to 5,5% in 2009 (which
was not dramatic) was mostly due to decline in tax
revenues.
MEASURES TAKEN IN 2009
• The special consumption tax rates on a limited number
of sectors—automotive and durable consumer goods—
were reduced.
• Unemployment benefits were increased and a temporary
short-term employment support scheme was announced.
• It was declared that skill conversion courses for 200,000
unemployed were going to be opened.
• Budget support to credit guarantee mechanisms was
announced.
• To support exporters, the Central Bank increased its
rediscount limit to Eximbank in successive two steps and
the government took some further measures.
GOVERNMENT COMMITMENT TO
STABILITY
• The cautious stance of the government strengthened its
commitment to the economic stability.
• This behavior the government may have contributed to
Turkey’s “deep V type” reaction to global crisis:
-Initially by allowing the economy to fall freely.
- Later on by gaining the confidence of the foreign
investors, notably international banks. This in turn may
be one of the reasons behind the reversal in the direction
of capital flows from outflow to inflow within a reasonably
short time period.
• Turkey was the fourth fastest growing economy in the
world in 2010 at a rate of 8,9%.
REMAINING SERIOUS PROBLEMS
• The economic recovery
1) did not bring down unemployment even to its precrisis level
2) led to a high current account deficit (6,6% of the
GDP in 2010).
• Both developments are threatening for the economic
(social and political, as well) stability.
WAS TURKEY VULNERABLE?
• The short answer is “yes”.
• Measures taken by the government although can not be
said to be misdirected were far from satisfying the
conditions of a curing policy. Unemployment is higher
tha the pre crisis peiod and the current account deficit
more threatening than ever.
• It seems that many policy measures, notably the socially
unpopular ones are postponed to after election.
• The new government (after the election) faces a major
challenge: It has to convince the (over-) cautious
economic agents to the need for structural reforms,
when the EU anchor is no more available.
CONCLUSION IN A NUTSHELL
It seems that the government followed the following
advice:
"If you do not know what to do, continue to do
whatever you have been doing"
THANK YOU