The country's macroeconomic weaknesses are largely due to a competitiveness gap: Foreign investment, which supplies a lot of foreign exchange, disguises the reality that the Turkish lira is overvalued. That makes Turkey especially vulnerable to the increased volatility of global trade and capital movements. And it has led domestic producers to adapt by using capital-intensive technologies that undermine prospects for creating employment.
The flipside of dependence on foreign capital is low domestic savings. In theory, countries can grow indefinitely on the strength of foreign investment. But it's rarely worked this way: The growth miracle in Asia was largely funded by domestic savings, and many analysts attribute Latin America's spotty record to dependence on volatile global capital markets.
Industrial Structure. The technological and managerial sophistication of Turkey's large industrial conglomerates -- notably, the family-controlled Koc Holdings and Sabanci Holdings -- goes a long way in explaining Turkey's success on the global-economic stage in the last decade. However, operating cheek by jowl with these globally competitive businesses are traditional companies with low productivity. This is a legacy of a dysfunctional political system in which rich insiders got preferential treatment from the government. But it is also a symptom of serious under-investment in education.
Moreover, although Turkey has been a star performer in the last decade, global competition from low-cost producers is growing. The only way to finesse this competition is to move upscale products and services that require highly skilled labor and R&D. The government is encouraging collaboration between universities and business, but private-sector R&D still lags.
Human Capital. Turkey's less-than-impressive commitment in the past to higher education and training in part explains low-labor productivity. But other factors ranging from health to income inequality also affect the fitness of the labor force. Perhaps most significant here is discrimination against women in both higher education and the workplace, which are especially problematic in a country attempting to reconcile Islam with modernity.
Regulation. Trade protectionism is minimal; foreign direct investment has been welcomed since the early 1980s. By contrast, entrepreneurship is hindered by erratic and often corrupt enforcement of other regulation. This means monumental headaches for business owners -- unless they are insiders. It takes an average of 70 days to plow through the red tape to obtain an electricity hookup and more than three years to distribute assets in a bankruptcy.
Foreign Trade. The share of Turkish exports going to Europe fell from 55 percent in 2001 to 48 percent in 2008 -- a consequence of global supply and demand, as trade between emerging-market countries grows disproportionately to traditional north-south trade. Turkey's efforts to maintain a cultural distance with the West could prove an asset here, especially if it gives the economy an advantage in the Middle East. But this is a tricky line to walk: Turkey needs close economic ties with the West as a source of technology and as a spur to innovation.
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