Download ECON 401 November 19, 2012 Fragile Economy in the 1990s

ECON 401
November 19, 2012
Fragile Economy in the 1990s
How to deal with corruption and rent-seeking policies?
 The economic policies of the earlier period were criticized
on the basis of creating rent-seeking acitivities.
 Presence of import licenses and investment permits created
rents for private groups (rent-seeking)
 It was more profitable for firms to use their resources in order to
capture the rents
 Was it different under the new liberal period?
 Liberalization of external trade and domestic markets would
remove all opportunities associated with rent-seeking.
 Rent-seeking and corruption through fictitious exports (hayali ihracat)
 Land speculation in urban and touristic areas
 Bailing out of private firms in distress
 The responsibilities about creating these rent-seeking
acitivities were given to the institutions/positions directly
related to the ruling party.
 Annual growth rate was 4.9 between 1980 and 1988
 The same rate was much higher if we just focus on the
years between 1983-1987
 That was achieved as a result of the shift of
production from domestic to external markets
 There was more than five-fold increase in exports
between 1979 and 1988
 Almost eighty percent of this rise came from
manufacturing exports (textile, clothing, iron and steel)
 This period was indeed led by exports in terms of
numbers, but:
 Domestic demand was limited following the lower incomes
for workers and farmers
 Growth in exports was enforced by extensive export
subsidies (tax rebates and subsidized credit) and policies
targeting low exchange rate
Major Problems of the 1980s
 The growth of exports came mostly from using the
excess capacity that was kept idle in the last period
of the 1970s
 The share of investments allocated to industry fell
from 29 % to 16 % in 1988 (almost one-third of these
investments was concentrated in construction sector)
 In a period where outward orientation was supposedly
directed to increased manufacturing exports through
significant price and subsidy incentives, distribution
of investments revealed a declining trend for the
sector.
• The shift of SEEs from productive manufacturing
sector to infrastructural activities such as transport,
communications, and energy.
Major Problems of the 1980s
 The implications of the non-conformity between the
stated foreign trade objectives towards
manufacturing exports and the realized patterns of
accumulation away from manufacturing constituted
one of the main structural problems of the growth
pattern of the period
 Exports became industry’s only solution to gain higher
profits given the lack of domestic demand and high
costs of financing the new investment
 In other words, it was easier for the private sector to
capture high but temporary profits by switching from
domestic to external markets, rather than use its
savings (i.e. profits) for long-term productivityenhancing investments in manufacturing industry.
Major Problems of the 1980s
 However, the same period also witnessed a
significant rise in external debt
 The economy still depended on external sources for
economic growth, therefore imports grew at a high
rate
 External debt rose from 25 % of GDP in 1980 to 60
% of GDP in 1988
 There was a steady support for Turkey’s policies by
international financial markets
 Turkey being one of the primary examples of new
economic policies
Major Problems of the 1980s
 This export-led growth seemed to reach its limits






towards the end of the 1980s
It was not (politically) possible to keep the domestic
demand at the same low levels
The level of real wages in 1988 was below that in 1977
There were significant demonstrations organized by
major trade unions in 1989.
Huge defeat for the ruling party in municipal elections
in early 1989
All these developments led to an increasing trend in
wages (first in the public sector) and agricultural
support prices
How would the government finance these new
expenditures?
1990s
 Capital account Liberalization in 1989
 No restrictions on the movement of foreign exchange
 Starting in 1989 there was a surge in short-term
capital inflows in Turkey
 The inflow of capital helped, at least in the shortrun, to overcome the acute distributional pressures
present in the Turkish economy during the period.
 The economy expanded at a faster rate than would
otherwise have been possible and the rising capital
inflows provided a way of satisfying the
distributional claims of the key groups involved.
 Workers, particularly in the public sector had
huge rises in their wages and salaries
 Real wages in manufacturing industry increased
by 90 percent between 1988 and 1991
 Farmers received higher support prices and
other subsidies
 How did the private sector respond to higher
wages in manufacturing industry?
 Imperfect market structures and high markup
pricing
 Cost x (Markup + 1) = Sale price
 During the 1990s, high markups enabled firms to gain
more profits in the presence of higher wages and other
labor costs
 Declining ratio of intermediate costs to labor costs
 From 12 % in 1988 to 6.5 % in 1991
 Lower prices for domestically produced intermediate goods
through SEEs
 Lower import prices for intermediate goods through real
appreciation of Turkish Lira
 Labor shedding
 One of the major characteristics of the labor market
adjustments throughout the 1990s has been widespread
layoffs and an overall intensification of marginalized labor
employment.
 In 1994, the number of informal workers exceeded the
number of formal employees in private manufacturing
industry
 In 1995, about 95 percent of all firms in manufacturing
industry employ less than 10 workers; they employ only onefourth of all formal workers and pay only one-fourth of the
wage paid by the larger firms
 Following the higher wages and agricultural subsidies in the





public sector, government started to run huge deficits
Government could have financed these expenditures by
raising tax or printing money
The public sector deficit started to be financed through
domestic agents who increasingly borrowed from abroad.
The stock of domestic debt was only about 6% of the GNP in
1989, just when the liberalization of the capital account was
completed. It grew rapidly, and reached 20% by 1997.
In 1993, shortly before the onset of the crisis almost all the
central government’ s budgetary expenditures were being
allocated to current expenditures (mainly wage and salary
payments), interest payments on domestic and external debt
and transfer payments
It was extremely difficult to sustain economic growth in an
environment characterised by over-expansion of public
expenditures and inadequate increases in public revenues.
 Financing of budget deficits relied on new money from




abroad
The rising foreign capital inflow to Turkey created a
pressure in the direction of appreciation of the
exchange rate in real terms
The appreciation of the exchange rate, in turn, helped
to undermine export growth and encouraged a parallel
process of import expansion.
It was clear that the rising current account deficit (i.e.
trade deficit), covered by primarily short-term capital
inflows could not provide a basis for a sustainable
growth process
Crisis broke out in April 1994.
 This, in turn, generated a major outflow of short-term
capital.
 There was also a major depreciation of the exchange rate
Rising power of finance
Share of
Wages in
Value
added
Real Agricultural
wage Terms of
index Trade
Share of
Interest
gains in
GDP
Real Return
int. on hot
money
1988
15.4
100
100
9.8
-2.5 -7.3
1993
20.7
232
130
18.2
17.9 4.5
Rising power finance
 Return on hot money
 It yields the net return to a foreign portfolio
investment, which switches into TL, captures
the interest income offered in the domestic
economy and switches back to the foreign
currency at the end-of-period exchange rate.
 The difference between interest earned and
the loss due to currency depreciation is the
net earnings appropriated by the investor