Democracy Lab

Turkey's Fragile Success

Turkey has undeniable economic potential, but there is still a lot of work to do.

With equity markets in advanced economies treading water and low-risk bonds offering piddling interest, it's not surprising that investors have rushed back to emerging markets. And where better to go than to Turkey, whose economy briskly rebounded from a nasty recession in 2009 to clock Asian-style growth exceeding 8 percent in both 2010 and 2011? 

Where, indeed. The transition economies in central Europe have not grown even half as fast as Turkey in recent years. And while a handful of economies in the Middle East and North Africa managed to get their acts together in the last decade or two, geopolitical risk in the wake of the Arab Spring has left investors in pause mode.

But with 2012 isn't looking much like 2010 or 2011there's good reason to believe that Turkey is losing its Midas touch. The economy grew at an annual rate 2.9 percent in the second quarter of this year. And while that figure is respectable in light of the sagging European economy -- the European Union is Turkey's largest foreign market -- it was well below consensus expectations.

Those looking on the bright side point to the 20 percent rise in exports in the quarter. But it was driven by soaring gold sales to Iran, which is scrambling to acquire untraceable liquid assets in order to survive the Western economic embargo -- and is therefore not sustainable. Indeed, without the gold windfall, Turkey might well have slipped into recession.

This decidedly mixed economic news is forcing analysts to take a closer look at Turkey's economic fundamentals. And what they're seeing are weaknesses that have long lurked behind the curtain. Turkey's oversized current account deficit -- 10 percent of GDP in the boom years -- makes the economy dangerously dependent on the mood of foreign investors. Meanwhile, inflation remains stubbornly high, threatening to climb into double-digit territory again.

To better understand the Turkish growth story, go back to the banking crisis in 2001, which proved to be an effective wake-up call. With the help of a massive loan from the IMF, Economic Affairs Minister Kemal Dervis -- an outsider finishing a two-decade career at the World Bank -- pushed through a host of reforms ranging from commercial bank restructuring and central bank autonomy to the elimination of restrictions on foreign direct investment (FDI). And when the currently-ruling Justice and Development Party (AKP) came to power a year later, it continued along the lines laid out by Dervis and the IMF. Thus while AKP (and its leader Recep Tayyip Erdogan) would like to take credit for the economy's success in the last decade, its real achievement was to have the sense not to rock the boat built by Dervis.

Actually, there is less credit to spread around than is generally assumed, since the Turkish economy faces some serious problems. Consider the aforementioned large and chronic current account deficit. In theory, there's nothing wrong with a rapidly growing economy covering a big deficit in foreign trade with inflows of foreign capital. But in Turkey's case, two facts give pause. First, Turks save far less of their incomes than their counterparts in high-growth Asian economies, making them uncomfortably dependent on foreign investment to cover the costs of the expansion of productive capacity. Second, much of the capital inflows consist of "hot money" - short-term loans that can exit as fast as they entered - putting the economy at considerable risk in the event of, say, a crisis in which Turkey is sucked into Syria's civil war.

By the same token, Turkey has yet to put in place an education system capable of sustaining an advanced modern economy. The country ranked 32nd out of 34 OECD countries on that organization's 2009 International Student Assessment,  with 40 percent of 15-year-olds lacking the most basic math skills. (Numbers 33 and 34 were Mexico and Chile.)  The government has proposed extending compulsory education from eight grades to twelve. But there's a catch: After just four years of schooling, children could be shunted into vocational or religious training.

Then there's the question of economic justice. The post-2001 high-growth years, in which average real incomes nearly doubled, still left millions of Turks in poverty. The bottom tenth of households take home just two percent of total income, and Turkey ranks among the bottom-three members of the OECD in terms of overall income inequality. (Last place goes to -- you guessed it -- Mexico and Chile).

The most pressing economic problems, though, are related to macro stability rather than long-term fundamentals. With growth sluggish, unemployment at 8 percent and inflation low by Turkish standards, the government is pressing for stimulus. It is lobbying the central bank to lower interest rates and it is allowing the budget deficit to balloon past the 1.5 percent of GDP target.

The use of fiscal and monetary policy to counter swings in the business cycle is widely accepted. But there risks to stimulus, in large part because Turkey is so dependent on foreign capital. An uptick in inflation could trigger an exodus of hot money and attendant instability in the exchange rate.

More generally, in the atmosphere of uncertainty created by turmoil in the region, any sign that the government has set aside price stability as its highest economic priority could undermine investment driving modernization. Indeed, even if the government chooses to err on the side of conservative fiscal and monetary policy (my preference), Turkey's prospects in the near term may be determined by events beyond its control -- that is, by anything from the euro crisis to the civil war in neighboring Syria to the anti-western dynamic of the Arab Spring revolutions.

Turkey's economic potential is undeniable. However, the country cannot hope to sustain its drive to join the select club of high-income countries if it fails to tackle the structural challenges elaborated above. To be sure, Prime Minister Erdogan and his party have presided over a remarkably successful run for the Turkish economy. But the real test -- successfully managing the reforms needed to approach the productivity of the European Union and the advanced economies of East Asia -- is still ahead. 

Photo by LOUISA GOULIAMAKI/Stringer/AFP/Getty Images


What Happens When the Lights Go Out in Karachi?

Three scary questions that keep Pakistanis up at night.

Since 2001, U.S. dealings with Pakistan have been guided primarily by security concerns -- and with Hina Rabbani Khar traveling to Washington for the first time as Pakistan's foreign minister this week, the buzz about Afghanistan, terrorism, and security is unlikely to abate. Indeed, the last time a Pakistani foreign minister visited Washington, Richard Holbrooke, then the special representative for Afghanistan and Pakistan, felt compelled to remind Americans that "We don't work with Pakistan because of Afghanistan. We work with Pakistan because of Pakistan itself." It was hardly true in 2010 and it's even less true now. The possibility of working with Pakistan for its own sake remains overshadowed by the war in Afghanistan -- and will likely remain so even after NATO withdraws in 2014 given the negative security outlook.

The preoccupation with security persists because the stakes are so high: the security of the U.S. homeland, stability on the Afghanistan-Pakistan border, and the future of U.S.-Pakistan relations -- the latter, of course, being an important determinant of the first two. Because of this, the dialogue on security should continue, but it has distracted us from other circumstances that are potentially more devastating for long-term stability in Pakistan and which also have broader implications for U.S. national security. For those of you planning to attend one of the events featuring Foreign Minister Khar in Washington or New York, consider asking her about something other than the Haqqani network, al Qaeda, or the Taliban. Below are three non-Afghanistan questions to ask the foreign minister; they keep real Pakistanis up at night, and they all affect U.S. interests.

1. Why is Pakistan a hotbed of religious extremism?

Pakistan, like many other Muslim countries, is experiencing a growing trend towards more conservative religious practice. This alone is not cause for concern, but it does mean the political space for secular and progressive interpretation of law, culture, and social behavior is shrinking. Just in the past month, gunmen pulled several Shiites off a bus in Quetta and shot them; Hindus fled Pakistan for India claiming persecution; and a fourteen-year-old Christian girl was jailed on false blasphemy claims. In an incident earlier this month at a McDonald's in Karachi, an employee objected to a married couple sitting side-by-side because it broke the rules. (The manager confirmed that such behavior was against the restaurant's policy on Islamic family atmosphere.) Maybe the owner of McDonald's Pakistan is an über fundamentalist trying to convert wayward Pakistanis one Big Mac at a time or maybe the franchise simply wants to avoid being targeted by violent extremists who deem such behavior inappropriate. Either way, it's a distressing sign of the times.

We can't blame the Pakistani Taliban alone for the rise of extremism throughout the country. Others responsible for fanning the flames include the militant outfit Lashkar-e-Taiba, the pan-Islamist organization Hizb-ut-Tahrir, and religious political parties like Jamaat-e-Islami. But the real question is not who, but why? Some say it's because moderate Muslims are unwilling to speak out against militancy. Others believe jihadist ideology justifies violence. A more controversial view holds Pakistan's legal system responsible for empowering extremists. The trend is a dangerous one where violence is regularly used as retribution for being on the wrong side of politics or religion. The United States could sit back and ignore much of this -- conservative social mores and attacks on religious minorities don't immediately impact its priorities in Pakistan. But the further the pendulum swings to the right, the more challenged U.S.-Pakistan relations will be since railing against the United States is a favorite pastime of violent extremists. Furthermore, the weak civilian government in Pakistan will be in no position to challenge ascendant extremists -- either out of fear of retribution or because of election-year political pressures.

2. Why has Karachi become a killing field? 

While Washington has been obsessing about the Haqqani network, Karachi has become a killing field. The problems of the megalopolis do not seem to worry U.S. policymakers -- but they should. Karachi is one of the world's largest and most dangerous cities. The problems of its population, estimated to be anywhere from 14-20 million strong, are representative of the country's broader struggle to address changing demographic patterns.

Just take Karachi's changing ethnic composition and city politics -- a root cause of rising violence -- as an example. Mohajirs -- migrants from northern India -- have traditionally dominated Karachi's politics and economy through the Muttahida Quami Movement (MQM), a secular political party with liberal positions on many social and political issues. The 1998 census listed Karachi's Mohajir population at roughly 50 percent. In the mid-2000s, the balance of power shifted with the influx of Pashtuns, who now represent an estimated 20-25 percent of the city's total population. This influx enabled the rise of the Pashtun nationalist Awami Nationalist Party, which, along with the Pakistan People's Party, has sought to carve off a greater share of the revenues from Karachi's enormous informal sector, which some unofficial sources estimate at $1 billion.

All parties use violence to some extent in pursuit of their economic interests, which has not insignificant implications for the United States. Opportunist criminal networks often collude with anti-American actors such as the Karachi-based Taliban, outlawed sectarian groups like Sipah-e-Sihaba Pakistan, and Lashkar-e-Jhangvi, and other terrorist outfits that hail from the semiautonomous region in northwest Pakistan. More importantly, the Karachi port manages a large portion of imports for NATO troops in Afghanistan. To date, domestic violence in Pakistan has not impeded the port's operation, but the potential risks create a more hostile operating environment for already strained U.S.-Pakistan cooperation.

3. What happens when the lights go out?

In simple economic terms, Pakistan spends more than it makes. A lot of that spending is devoted to importing oil to meet energy demands at home. Despite the expenditure, the lights can go out for up to 20 hours at a time in some parts of the country. That's not a shortage of electricity -- it is an absence of electricity. Most efforts to improve energy provision are short-lived because the government can't get buy-in from Parliament, even from members of its own coalition. Long-term reforms will be costly to the government and to the average Pakistani, who will likely end up having to pay more for power that is not guaranteed. The initiatives that do make it through the political gridlock are often temporary measures intended to alleviate short-term economic burden for equally immediate political gain. But when the lights go out, people take to the streets -- and this year, several protests turned violent. In July, protesters threw stones at riot police in Rawalpindi and attacked power supply departments in Punjab and Khyber Pakhtunkhwa.

A Pakistani government has never collapsed as a result of such protest, but government neglect and mismanagement of the economy has historically foreshadowed military coups -- of which Pakistan has had many over the years. While this is probably less likely to occur now than ever before -- the military simply faces too many challenges of its own to take on those of the civilian government's -- we should not underestimate the extent to which the Pakistani military views itself as a caretaker of the nation. When civilians fail, it stands ready to fill in the gaps. The United States has an interest in striking a balance in civil-military relations in Pakistan -- but it will never be able to get it right if the generals and politicians can't first figure it out.

Taken individually, the three questions above allow us to think outside of the "Af-Pak" mindset we've been wed to since the phrase was introduced in 2009. But taken as a whole, the questions are a harbinger of deeper instability. The problems of rising extremism, violence in Karachi, and power shortages will be shaped by one of the biggest challenges of all: a population of 180 million people that is expected to grow to 335 million by 2050. Each of these problems compounded by the others creates a snowball effect that could prove to be more than the state -- and its allies and partners -- can handle. It would be worth asking the foreign minister about that, too.