Cablegate: "Next Generation" Turkish Economic Reforms

DE RUEHAK #1512/01 1651210
R 141210Z JUN 07






E.O. 12958: N/A
SUBJECT: "Next Generation" Turkish Economic Reforms

1. (SBU) Summary: Turkey is enjoying strong economic performance,
with real GDP growth averaging over 7% per year for the past five
years, government debt down, and inflation nearing single digits.
Medium-sized "Anatolian Tigers" are thriving alongside traditional
business conglomerates and Istanbul-based industries. Jobs are
being created and income disparities are slowly getting smaller.
Yet Turkey remains poor and underdeveloped. Prime Minister Erdogan
has set a target of doubling per capita GDP from the current $5000
over the next five years. This laudable goal would allow Turkey to
approach average EU income levels, but would require sustained high
real GDP growth rates at or above recent levels.

2. (SBU) There is a consensus among local economists and
international institutions (i.e. World Bank, OECD, IMF) that if
Turkey is to sustain its economic boom at the same time as the
population and workforce continue to expand, Turkey's next
government will have to move to a "next generation" of economic
reforms. In contrast to the macro reforms that have so far driven
growth -- budget reform and independent monetary policy -- the next
set of reforms is needed at the micro, grassroots level. To keep
investment and growth going and accommodate an economic
transformation from an economy based on agriculture, basic industry,
and government spending to one based on high-tech, innovation, and
services, a new government will have to remove impediments in the
labor market, the educational system, and the judicial system that
now suppress potential growth. The next government will also need
to move forward with the stalled social security reform.
Implementing these reforms touches on some of the "sacred cows" of
the Turkish system and will be difficult for any government, and
even more so for one that does not enjoy broad-based support. End

Labor market

3. (SBU) The ruling Justice and Development Party (AKP) is working
on a package of labor market reforms that it intends to introduce if
it returns to power. Despite job creation, Turkey's recent growth
has failed to have a significant positive impact on the unemployment
rate because of the flood of new entrants to the labor market, the
low rate of labor force participation, and declining employment in
stagnant niches (i.e. traditional farming and corner grocery
stores). Female employment in the 25-54 age group is far below the
EU average, 27 percent versus 70 percent.

4. (SBU) To stimulate further job creation and to shift employment
from the informal sector (which makes up roughly half of total
employment) to the formal sector, the World Bank and other observers
have identified a package of reforms that would ease restrictions on
Turkey's labor market:

-- a decrease in payroll and other employment taxes so as to reduce
the tax wedge (the difference between employees' net wages and
employers' total payments) and the cost of labor to employers,

-- a decrease in severance pay for workers - Turkey is tied with
Portugal for the highest in the OECD at one month's pay for each
year worked,

-- and a reduction in constraints on part time and temporary hires
to boost employment among women and youth.


5. (SBU) According to World Bank and OECD reports, Turkey will
need to improve its rigid, antiquated education system to provide
workers with skill sets that companies need to compete in a global
market. Turkey will also need to converge toward EU standards on
education if its integration into the EU is not to be an avenue for
a mass emigration of low-skilled workers. Turkey has achieved near
universal enrollment in primary education, modernized its
curriculum, and nurtured top students that perform at the highest
international standards.

(SBU) However, reforms to the Turkish education system are needed

-- make secondary education compulsory and improve student/teacher
ratios to raise secondary school enrollment capacity,

-- provide incentives for girls and the poor to stay in school,

ANKARA 00001512 002 OF 003

-- restructure university entrance exams to reflect competencies
acquired in school rather than test taking skills,

-- align teacher training with the new curriculum,

-- and establish standards to assess student learning and address

Judicial reform

6. (SBU) An entrenched judiciary has been a key institutional
opponent of the AKP Government, striking down privatizations and
social security reform and interpreting the constitution to require
a super-majority quorum to elect a president. Until the judiciary
is modernized and better-trained on commercial and economic issues,
it will continue to hold back economic reform, render politicized
judgments that are biased against privatization and foreign
investment and slow Turkey's transformation to a modern,
well-regulated, market economy. Judicial inefficiency and the lack
of assurance of judicial impartiality in the case of dispute also
undermines the investment climate.

7. (SBU) Judicial reforms for Turkey that the EU has recommended

-- more training for the judiciary, especially on issues relevant to
the convergence of Turkish law with EU standards,

-- and increased interaction among structures in place to combat

Social Security Reform

8. (SBU) Social security reform was supposed to be the centerpiece
structural reform under the AKP's program with the IMF, but
President Sezer and the Constitutional Court derailed it as
"unconstitutional," leaving it to the next government to tackle.
The longer Turkey waits the harder it will be to staunch the red ink
(a deficit of 4.8% of GDP in 2006, expected to rise to 10% by 2050)
of the social security system. The share of the elderly in the
Turkish population is expected to rise from 5.7 percent today to 14
percent by 2035. This significant portion of the electorate will
likely resist change to the benefits it receives from generous

9. (SBU) The AKP's 2006 reforms sought to address the social
security deficit by requiring:

-- a longer period of work to receive full benefits,

-- phasing-in a retirement age of 65 years,

-- valuing past wages on an equal weighting of wage growth and

-- indexing pension benefits to the CPI rate of inflation rather
than wage growth,

-- and basing the size of pension benefits on lifetime average
salary rather than final salary.


10. (SBU) Enacting these next generation reforms will make the
macro reform process up to now look easy. The next government will
have to overcome the populist tendencies of the 1990s that produced
labor market regulations protecting life-long jobs and generous
social security benefits as well as a statist, government-driven
approach to economic management that is still widespread. If the
next government is AKP-led, it will also have to overcome a
perception that it is implementing a "hidden agenda" to Islamicize
Turkish society and institutions with their "reforms" of
long-established educational policies and the judiciary. The
current political situation has pushed structural reforms to the
back-burner, but the desire of the powerful Turkish business
community to maintain growth and pressure from the EU and the IFIs
means that these issues should be at the top of the next

ANKARA 00001512 003 OF 003

government's agenda. However, how quickly reforms will be enacted
will depend largely on whether a new government enjoys broad-based
public and parliamentary support.

© Scoop Media

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