Information about Europe Europa
Chapter

1. Trade Policies and Development Strategies Before 19801

Author(s):
International Monetary Fund
Published Date:
November 2005
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From the early 1930s to the early 1980s, the Turkish government took extensive responsibility for selecting and fostering the development of portions of the manufacturing sector of the economy in a pattern similar to that adopted in a number of other developing countries. Early five-year plans specified targets for the growth of textiles, paper, ceramics and glass, chemical products, and iron and steel industries. State-owned investment banks were set up to channel credit, usually at near-zero interest rates, into public firms in selected industries. There was no policy of discouraging private enterprise, which continued to contribute a little more than half of value added in manufacturing even at the height of the state-directed industrialization program in the 1960s and 1970s.

The role of the state fluctuated somewhat with domestic political changes and exogenous events (depression, war-time controls and the reaction to them, and periods of low or high agricultural prices), but changed little until the period of reform in the early 1980s. The party in power in the 1950s favored a reduced role for the state compared to prewar decades, but it took few concrete steps to achieve this objective. In fact, state economic enterprises (SEEs) were given access to central bank credit during this period. While the fiscal accounts of general government were roughly in balance, there were large public sector deficits because of SEE borrowing, especially to finance agricultural price supports. The deficits led to monetary expansion and inflation. With an exchange rate pegged to the U.S. dollar, the inflation led to an increasing overvaluation of the lira and falling exports. Import demand was limited by restrictions and licensing requirements.

Following the adoption of a stabilization program in 1959, including a devaluation, and a change in government,2 the state’s role in the economy was re-asserted in the 1960s with a constitutional amendment requiring a state planning organization and the official adoption of an import-substituting policy.3 Industry expanded by 10 percent per year in real terms from the middle 1960s, a time when per capita income in Turkey was equal to that in Korea,4 and the expansion continued and accelerated through the mid-1970s. Not only was growth strong, but inflation was low. As part of the stabilization program, SEEs were denied unlimited access to central bank credit to cover operating deficits, and limits were placed on commercial bank borrowing from the central bank. The modestly growing money supply was absorbed partly by falling velocity throughout the decade as monetization of the economy proceeded. Credit from banking system went more to finance private sector investment than government deficits. The general government deficit in relation to GDP hovered around 5 percent during this period, substantially financed by inflows of foreign aid.5 Growth in the supply of labor outpaced demand two to one—population growth in Turkey has averaged around two and a half percent per year in recent decades—but the availability of jobs in neighboring countries in western Europe provided an outlet for some of the excess workers.6

Under a policy of import substitution, the economic objective is to replace reliance on imports with an increased supply of goods made at home, especially manufactures. This strategy involves an innovative role for government in establishing new producing units with access to subsidized credit, and requires the erection of high tariff barriers to protect “infant” domestic producers against foreign competition. While higher-cost domestic producers can be effectively sheltered by this strategy, the high tariffs, besides discouraging imports, result in a more appreciated currency than would otherwise be the case, which penalizes exporters. In Turkey, a secondary objective of the inward-looking strategy was to export the manufactures produced in the government-supported sectors of industry. The two goals can in principle be pursued simultaneously (by taxing imports and subsidizing exports, or by fixing the exchange rate at a more depreciated real rate). However, Turkey’s exports grew by only 1½ percent on average in the 1960s and ¾ of 1 percent in the 1970s.

In the early 1960s Turkey was successful in preserving balance in the external sector. The current account retained strength from the large devaluation at the end of the 1950s, and foreign aid flows financed modest deficits for a number of years. In line with import substitution policy, high import tariffs were supplemented by other controls and restrictions: import and export licensing, quotas, numerous surcharges, and advance import deposit requirements. As partial relief, rebates were granted on selected exports, and a structure of multiple exchange rates was used to favor importation of the producer goods needed to equip chosen manufacturing ventures.7 Nevertheless, by the end of the 1960s, pressure on the external sector had mounted as aid flows declined and foreign borrowing increased so that restrictions on imports were increasingly tightened. With growing pressure on the lira, a major devaluation took place in 1970, which strengthened the balance on goods and services temporarily and fostered a large inflow of emigrant workers’savings. Credit from foreign financial centers again became available. However, the devaluation was not accompanied by any other stabilization measures.

Although growth remained strong through the first half of the 1970s, it was a decade of mounting imbalances. The central government budget deteriorated due to large public sector wage increases and higher agricultural price subsidies at the time of the devaluation, subsidies to increase SEE investments plus heavy SEE borrowing from the central bank and from other state banks, and a relaxation of the limits on borrowing by the central government from the central bank. With a resumption of central bank financing and more rapid money growth, the pressures on the exchange rate increased continuously despite the administrative restrictions that were used to limit demand for foreign exchange. Two other external-sector developments accelerated the drift of macroeconomic performance. First, when world oil prices were raised in 1974, and again in 1979-80, Turkey resisted a pass-through of the higher energy costs to the domestic economy. Development of energy-using sectors proceeded according to the numbers in the five-year plans without regard for the need to economize and let demand and supply respond to the new relative price alignment.8 The conspicuously high costs of some public and private enterprises and the bloated petroleum import bill were covered ultimately by foreign borrowing. Second, in the aftermath of the first oil-price crisis, there was a decline in the opportunities for Turkish laborers to find employment in neighboring countries as guest workers; the growth of remittances and transfers from emigrants decelerated in step with the availability of foreign jobs.

One of the techniques devised to cope with the deteriorating external imbalance was a form of foreign borrowing known as the “convertible Turkish Lira deposit” scheme or the Dresdner Bank scheme. The program, dating from the late 1960s, was designed to attract the savings of Turkish nationals working in foreign countries and also the cash deposits that might have been earned in black-market trade, smuggling, or the mis-invoicing of imports and exports. According to the scheme, the Central Bank of Turkey offered interest rates on foreign exchange deposited in Turkish commercial banks 1¾ points above the Euromarket rate while also guaranteeing the foreign exchange value of both principle and interest. Beginning in 1975, the program was broadened to allow nonresidents in general, and not only Turkish nationals working abroad, to hold these deposits. Foreign exchange receipts from this source were transferred from commercial banks to the Turkish central bank and on-lent to government and SEEs, with expansionary effects on the money supply.9 Inflation accelerated markedly (still with a fixed exchange rate), worsening the underlying disequilibrium in the external sector. The Dresdner deposits constituted short term foreign loans, and therefore the maturity of Turkey’s external indebtedness became increasingly short term as the decade progressed, despite earlier reschedulings intended to spread out debt servicing over time.

In 1977 Turkey went into arrears on its commercial debt, and capital inflows stopped. The need for a serious stabilization program was apparent but agreement on such a program could not be reached. There was serious political weakness in Turkey during the 1970s—a succession of five elections and five governments, each of the latter achieving less than a popular majority and being forced to form a fragile coalition with incompatible splinter parties as partners. The governments in this succession took no strong measures. Inflation accelerated markedly after 1977. There was increasing civil unrest. The second oil-price shock occurred in 1979–80, and GDP growth turned negative in both of those years. In the midst of a political vacuum and a deepening economic crisis, a military government took power in 1980 vowing to implement and enforce a stabilization program. The military government elevated the author of the plan, Turgut Özal, to the position of deputy prime minister.10

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