Turkey is awaiting its first-best reforms

Faruk Çelik, minister of labor and social security, announced on Thursday that a final meeting would be held with workers' and employers' unions on Monday aimed at reaching a compromise on the controversial issue of severance pay reform.
Rauf Gönenç, head of Turkey department in OECD Minister Çelik added that if the parties still cannot agree, the reform envisaged by the government will be postponed until a compromise is reached. I bet that there will be no compromise, thus no reform. That outcome is easily predictable. In September, I wrote in this column that “Prime Minister [Recep Tayyip] Erdoğan, by stating that he is waiting for the elusive compromise, has in fact washed his hands of the issue and given up on his political responsibility.” So, another “first-best reform” seems to have been lost. This reform would not only make severance pay effective for millions of workers who are de facto unable to take severance pay, but also enhance productivity, make the labor market more flexible and rapidly expand financial literacy thanks to individual severance pay accounts. Too bad for Turkey, but not surprising! The Justice and Development Party (AK Party) government, despite its high electoral support, is politically incapable of implementing “first-best reforms,” and it tries to plug the gaps with “second-best remedies.” I am borrowing this terminology from Rauf Gönenç, head of the Turkey department of the Organization for Economic Cooperation and Development (OECD). Gönenç made a remarkable presentation at the last İzmir Economic Congress on the issue of economic reform. I would like to summarize the main points he raised. He started with five “simple statements”: 1) Turkey is an entrepreneurial economy of exceptional proportions. 2) Turkey's entrepreneurial engine operates with very limited human capital, at a small scale and with low-productivity business units. 3) Nonetheless, a remarkable “entrepreneurial flourishing” took place in the 2000s. 4) However, this dynamism has not been supported by the existing regulatory framework inherited from earlier times. The mismatch principally concerns labor market rules. 5) Policymakers have made important efforts to offset regulatory obstacles to the growth of enterprises with second-best remedies. These efforts have paid off and helped growth. But first-best structural reforms now seem necessary to support entrepreneurship across the full spectrum of the business sector. Indeed, Turkey is an entrepreneurial economy of exceptional proportions, since employers and the self-employed represent 40 percent of total employment, compared with less than 20 percent in similar countries. This composition of the labor force implies a daily confrontation of participants in the economic process with the disciplines of market competition. This nurtures a very responsive, vibrant and flexible economy. However, Turkey's human capital is quite limited: The share of people of working age with an education below high school level is 70 percent in Turkey, compared with 30 percent in Chile and 10 percent in Poland. The divides are deeper in the “entrepreneurial” sphere of the economy: Turkish employers work with an average of five workers per business, and they themselves have very modest human capital: 40 percent of employers have only a primary education or less. Nevertheless, despite its educational handicaps, Turkey succeeded in reaching the group of “upper-middle income” countries in the 2000s. It now has a GDP per capita level comparable with Poland and Chile. This was largely due to a development of entrepreneurship. From 2003 to 2010, employment in firms of between 20 to 49 workers increased from 500,000 to over 1.2 million. Employment in firms employing between 50 and 249 workers grew from 900,000 to more than 1.7 million. Yet, these developments have taken place in an almost hostile regulatory environment. Labor market regulations in Turkey are typical of a trade-sheltered economy with few dominant firms. Policymakers have tried to reduce the negative effects of these regulations by tolerating informality on a selective basis, notably in certain regions and certain categories of enterprises, and secondly, by cultivating a growing and increasingly sophisticated industrial incentive system to help offset the excess costs of operating under regulations. In conclusion, first-best structural reforms appear highly desirable for the alignment of Turkey's labor, production and capital market regulations and social security with international best practices. This would be preferable to the second-best alternatives of selectively tolerating informality and selectively subsidizing specific types of business.