Health Warning! I like Turkey – it is hard not to, especially Istanbul! – and as such I may be inclined to give it the benefit of the doubt. That said, if, on rare occasion, my comments seem overly critical, it is probably because I am trying to overcompensate in the other direction so as to try and present a balanced report!!
Compared to my reports on Hungary and the Czech Republic, I have spent more time on my Turkey Report because it reminds me in some key respects of South Africa. Even though at heart Turkey is a passenger car whilst at heart South Africa is a coal truck, I sense their current fortunes are closely related. This is largely because they both run similar macroeconomic policies based on a model that, in today’s world, simply is not sustainable. For small open economies prone to running current account deficits, they are always competing for capital against especially the over-consuming Anglo-Saxons and the Club Mediterraneans (Portugal, France, Italy, Greece and Spain). The latter hoover up the bulk of those mobile savings by consuming them today and leaving behind the detritus of own currency sovereign bond debt; in this dog-eat-dog environment, the likes of South Africa and Turkey find themselves in a monetary tug-of-war which occasionally pulls them completely off their feet.
By running current account deficits and so competing for the world’s mobile savings, Turkey and South Africa are hostages to the macro and especially the monetary cycles of the savings-deficient West. (Other Emerging Market passenger cars caught in this similarly tortuous and volatile dynamic include Egypt, Poland, the Czech Republic, Mexico and Pakistan.)
Current account surplus runners – principally in Asia – largely insulate themselves from the actions of these Western Hoovers having learned the hard way during the 1997 Asian Crisis (for China, the early 1990s); their principal lesson was that the best way to influence the direction of their own economies was to do so via the medium of a hypercompetitive currency. For added protection, the Asians learned the advantages flowing from having high foreign exchange reserves: they act as buffers against rapid outflows of shorter term, more fickle Foreign Portfolio Investment flows such as occurred in Q4 08 and Q1 09.
Such countries have succeeded in creating their own more regulated atmosphere for capital (often including their own lower cost of capital), a process that has allowed them to be in far more control of their demand and credit cycles and so their economic destinies. By contrast, current account deficit runners like Turkey and South Africa, by being overly dependent on the ebb and flow of globally mobile capital to make their external accounts balance, have their demand and credit cycles and so their economic destinies largely determined by foreigners.
Recognizing this uncomfortable economic ‘truth’, it is appropriate to note that it is the season for handing out Nobel Prizes – peace be upon you, President Obama! Unusually in the field of economics, both awards were well deserved and refreshingly real world. With much of the theory of financial economics in tatters, some have even gone so far as to suggest that – given all the damage some of these award-winning theories have caused – some of the prizes of recent decades should be “unrewarded”. Sadly, it is too retrospective for that. Has then the Bank of Norway’s prize selection committee made amends by at last awarding a woman, Elinor Ostrom, the prize (having surely overlooked Joan Robinson)? Ostrom’s contribution on self-management of common resources may seem esoteric but in a world of climate change, overfishing and looming water shortages, her optimistic voice demands attention. She shared her prize with another fine economist, Oliver Williamson, who took Coase’s Theory of the Firm insights to a much higher level.
Alternatively, as if to make amends for past mistakes, perhaps the prize committee should instead award Ignoble Awards for bad, bad ideas in economics. Were they to do this, I would like to suggest the first winner: whichever nincompoop suggested that a small open economy on the periphery of world trade could grow sustainably to the point of economic take off by putting consumption ahead of production. I know of no country that has ever achieved such demand-led growth and eventual take-off. The only sure-fire route to take-off we have in the modern era is production-led – and specifically production for export – growth. Yet someone has fooled (too often aided and abetted by some of the “what works for the developed world surely must work for the developing world” drivel that too often still flows from the IMF and World Bank) countries like Turkey into believing that herein lies the route to economic Nirvana. (Other countries labouring under this illusion? Poland, Pakistan, Mexico and (guess!) our very own South Africa! India too is dangerously close to adopting this model and, I fear, will also have its 1997 Asian Crisis-emulating ‘come-downance’ before it realises the error of its ways. (For the record, China learned this lesson the hard way too, in the early 1990s).
So how does Turkey fit into my playschool New Economic World of locomotives, passenger cars and coal trucks? The answer is “Not easily” marking it out as one of the very few countries that do not fit neatly into one of the three categories. South Africa – born a coal truck but trying so hard to be a passenger car – is one. Turkey – unavoidably a passenger car in structure but trying somewhat vainly to be a mini-locomotive – is another.
So why don’t I stop just there and say Turkey is destined to trundle along behind the EU with the latter travelling at a new normal speed of barely 2% GDP growth per annum? Because to do this would capture only part of the Turkish story, the known part, the “better” part (at least “better” according to conventional wisdom; I am not so sure), the part that secular Turkey has been struggling to turn into the whole for almost thirty years if only some of those vacillating (and deep down one has to suspect racist) Europeans would let them.
But Turkey is not as simple as this, not nearly so. Turkey’s rich and colourful history and extraordinary transcontinental geography (the wags remind you that Istanbul is the only city in the world where you can get drunk in one continent and wake up with a hangover in another!) give it a status that is almost impossible to compare to another country. Which other country? My first thought was not South Africa but Mexico, the maquiladora and supplier of cheap migrant labour to the next door US just as Turkey performs the same function for the EU.
But before I go into Turkey in greater depth, let me tell an economic parable.
Imagine an island that did not trade with anyone – an autarky as we jargon-loving economists would call it. Perhaps taking its cue from the seasons, it would have to rely upon its own credit cycle to try and get its monetary economy moving ahead. But when its borrowers overborrowed and its lenders overlent (as would surely eventually happen), a credit crisis would result. Over the longer term, progress then would occur through fits and starts with occasional trip ups as ‘animal spirits’ ran to far ahead of economic reality and a monetary ‘reset’ became necessary .
In the real world where economies are open to trade, the process is more complicated, though also open to creating greater prosperity. Growth in such worlds reminds me of a race where the shoelaces of one shoe are tied to those of the other. If the distance between the two shoes is short, progress is slow and trip ups are more frequent: the longer the distance between the two shoes, the greater the likelihood of progress.
If you run a current account surplus, you do not need to rely on foreign capital inflows to balance your external account. The result is that you have greater independence in prosecuting your monetary policy – the shoe laces are longer – and so greater chance of running faster. Not so if you run a current account deficit; you are far more heavily dependent on foreign liquidity to keep you moving. Lots of liquidity equals long shoe laces equals faster growth; lack of liquidity (and in particular its fast withdrawal as happened in Q4 08) equals short shoe laces equals more frequent growth trips up.
Turkey and South Africa have the length of their shoe laces largely determined by foreigners, whereas the Asian current account surplus runners largely set their own limits. And if the surplus was still not enough to override a very sharp liquidity withdrawal, then the Asians typically had high ‘national savings’ – foreign exchange reserves – to tide them over.
In today’s world, small open economies with long shoe-laces – current account surpluses and decent FX reserves – not only tend to run faster but fall over less often. Those with shorter shoe-laces – like South Africa and Turkey – not only grow more slowly but tend to fall over more often.
The moral of this tale is thus: small open emerging economies should run current account surpluses (i.e. pursue export-led growth putting production before consumption) and use those surpluses to build an FX reserve buffer as an antidote to sudden liquidity withdrawals by foreigners. This will allow them to grow faster and with lower levels of volatility.
More to come in Part ll, focussing on the specific challenges faced by Turkey.