In Turkey, average income per head is 70% lower than in the EU. One-third of the country's labour force still works the land, mostly on small farms, supported by generous agricultural subsidies. Over 50% of the country's economic activity takes place in the informal sector. Unemployment stands at 10%, and some economists estimate that only 25% of the working age population has a regular job.
Now, a deep rift is emerging in Europe over whether such facts mean that full EU membership should be withheld from Turkey.
On October 3, Turkey and the EU are set to begin accession negotiations. Successive Turkish governments have been waiting for this moment for over 30 years. Until recently, all sides were confident that the talks would only end with full admittance to the Union.
But in late August, a small but significant number of European politicians began arguing in earnest that Turkey should be denied full EU membership and, in the words of Angela Merkel, the leader of Germany's Christian Democrats, the country should instead remain a "privileged partner" of the EU. Inserting this phrase into the negotiation documents – the aim of those against full membership – would present a huge shift in the EU position and change in the negotiation climate.
Path of reform
Since Turkey's last financial crisis in 2001, which wiped out 7% of GDP and sent inflation soaring to 70%, the country has experienced a small economic miracle. Two successive governments have stuck with broad structural reforms, halving the budget deficit, bringing inflation to single digits and making Turkey one of the fastest growing countries in Europe. In 2004, economic growth stood at 9%, this year at an expected 5–6%.
"The most important step was the independence of the central bank," says Ahmet Akarli, chief economist at HSBC in Istanbul. Together with tighter regulation in the financial sector, says Akarli, such developments have created the right conditions for attracting foreign investment, which is expected to surge to over $10 billion this year, up from $2.2 billion in 2002–04.
The main driving force for reform has been Turkey's determination to break with the boom-bust cycles of the past and to use the IMF as an insurance against economic turmoil. The EU, on the other hand, has been mainly seen as the anchor for political reform. Many economists now hope that the EU will take over the IMF's role in guiding Turkey's economic development after the current stand-by agreement expires in 2008. "The IMF initiated the overall transformation," says Hayri Culhaci, executive vice-president at Akbank. "But EU integration will be the ultimate seal, creating the positive long-term situation."
The prospect of EU accession, however, might prove a much weaker justification for continuing economic reforms than the IMF. If tangible economic benefits are not forthcoming, or if hostile EU members insist on Turkey's fulfilment of ever more conditions, sentiment towards accession could sour.
For now, market players remain highly confident that diplomatic jitters cannot derail economic progress. "The greatest achievement of the reforms is that politics don't have a direct impact on the economy anymore," says Tolga Egemen, executive vice-president of Garanti Bank. "Low inflation, growth and profitability will be sustained regardless of the EU and political developments."
Steps Ahead
The most pressing changes still on the cards for the government are tax reform, social security reform and improving the efficiency of the bureaucracy. These transformations are necessary to tackle the serious risks underlying the buoyant economy. Turkey's public debt, which has been gradually reduced since 2001, still stands at 70% of GDP. The government's overall fiscal balance, this year at around –4% of GNP, is expected to stay in deficit in the years ahead.
"Eighty per cent of the budget deficit comes from social security payments," says Gazi Ercel, chairman of Ercel Advisory, a consulting firm, and a former central bank governor. "We have three different systems for government, private and self-employed workers. Reform is a must." Changing the retirement and health system is proving a tough challenge, and passing the necessary law through parliament was delayed past the IMF deadline this spring. Now the law is in place and the difficulties lie in the law's application. How swiftly the government will handle implementation is crucial.
The country's imports have risen dramatically, resulting in a current account deficit of $20 billion. Competitiveness of Turkish exports is too low to offset the increased consumption. "We need a major leap forward in our manufacturing industry," says Akarli, who expects to see interplay of foreign investment (FDI) and domestic development to pick up the slack.
Unemployment is the only indicator that has worsened in the past years, and hovers at a persistent 10%. Turkey has the highest population growth rate in Europe, which means that 800,000 additional jobs have to be created every year just to maintain that figure. The high number of unemployed is a central stumbling block on the way to EU accession. Existing members fear a high number of job seekers streaming onto already strained labour markets. Only sustained, high growth over several years can reduce unemployment in the long run.
"Europe is getting older, pension systems are under pressure," says Egemen, who believes that Turkey's young population would improve this situation. Many agree that Turkey's youth is an asset the EU cannot afford to lose. "By 2020, many west European countries may well be wooing Turkish workers to help them compensate for the ageing of their own workforces," argues Katinka Barysch, chief economist at the Centre for European Reform, a London-based think tank.
The Future
Market players and analysts agree that only an external shock could derail Turkey's economic stability and expect that, even then, a crisis would be short lived. The growing controversy surrounding EU accession is not creating much excitement yet. "Ten years down the line we can start worrying about membership," says Nick Eisinger, a director at Fitch rating agency. Eisinger expects talks to begin on time in October, followed by a long and difficult negotiation process.
In Turkey, the growing hostility towards full membership by France, Austria and Denmark is also mainly viewed as political rhetoric aimed at domestic voters. But there are signs that patience is running out. Turkish foreign minister Abdullah Gul expressed anger and frustration in August, when he called the German opposition leader Angela Merkel's initiative to prevent full membership immoral and illegitimate. More recently, he has said, "Should they [the EU] propose anything short of full membership, or any new conditions, we will walk away. And this time it will be for good." Prime minister Recep Tayyip Erdogan followed suit, emphasizing that Turkey had no more concessions to make to the EU.
In the end, it is Turkey itself that has benefited most from the economic stability of recent years, whether the reforms are due to the IMF or the EU. "For us, the very successful growth figures and low inflation are important. Whether or not the EU appreciates this is the EU's problem," says Egemen.