Exit from the middle-income trap may take years

Almost one year ago I wrote an article about the difficulties that were facing the Turkish economy with regard to increasing per capita income for two years.

In my article titled “Turkey on the brink of middle-income trap," I argued that the high per capita income growth that was led by robust labor productivity growth during the first years of Justice and Development Party (AKP) rule, slowed down first and then totally stopped in 2012, based on a research published by Bahçeşehir University's Center for Economic and Social Research (BETAM) in August 2013.

BETAM published an updated version of this research last Wednesday titled  "Turkey's exit from the middle-income trap may take years" aiming to scrutinize changes in the per capita growth, employment rate and labor productivity that has occurred over one year.

Indeed, from 2002 to 2011, per capita income rose roughly from $3,000 to 10,500. Since then, it has stagnated. This astonishing performance is due to two basic factors: the appreciation of the Turkish lira in real terms against the United States dollar and an average gross domestic product (GDP) growth rate close to 6 percent, which provided a per capita income increase over 4 percent per year, given the population growth rate. This means an overall per capita income increase of over 40 percent in real terms in nine years.

Furthermore, we know this improvement has profited all segments of society almost equally, with the low-income segments being slightly more favored. For more information, see my recent piece “The growth of the middle class." The strong per capita income increase has allowed a modest decrease in income inequality and a rather remarkable decrease in poverty, which, however, continues to be quite high. The BETAM research focuses on the evolution of the main factors that contributed to this striking per capita income increase at the beginning and its abrupt stop at the end of the research period.

As one of the authors of the report, let me briefly explain the methodology used. It is possible to break down the per capita income increase into three contributors: the ratio of the working age population to the total population; the employment ratio (employment by working-age population); and labor productivity, defined as GDP per employed individual.

The contribution of the working-age population ratio is marginal. Though the working-age population is still growing more rapidly than the total population, this factor shall be extending in the 2020s because of an aging population. As for the two other factors -- namely employment ratios and labor productivity -- three different sub periods have been observed. Until the second quarter of 2008, the entry date of the economy into recession, high per capita income growth was driven largely by increases in labor productivity. During this period, total employment almost stagnated; non-farming employment rose significantly, while agricultural employment declined.

In the aftermath of the global crisis, the nature of per capita income growth changed dramatically. From the last quarter of 2009 to the last quarter of 2011, the economy had very high per capita income growth rates -- over 7 percent. Both increases in the employment ratio and in labor productivity contributed more or less equally to this performance.

However, starting at the beginning of 2012, The increase of per capita income decelerated dramatically along with the slowing GDP growth. BETAM's analysis shows that until the second quarter of 2013, the per capita income increases declined under 1 percent; however, the most striking future of this decline was that the decrease in labor productivity turned out to be negative.
In other words, the weak growth -- GDP growth was limited to 2 percent in 2012 -- was supported only by the increase of employment ratio. During the following three quarters one observes slight improvement in the growth performance; labor productivity resumed to contribute to the per capita income increase that rose to some extent and reached 2 percent. Nevertheless, in the first quarter of this year, the contribution of labor productivity had become negative again.

At the end of the day, we can assert that more than two years of labor productivity has not contributed to the per capita income growth, which continues to be quite low. Strong employment increases certainly have prevented the increase of unemployment, but this low level of per capita income growth will not allow Turkey to escape from the middle-income trap quickly.  

  (this article is published in Todays' Zaman, July 26, 2014)

Turkey on the brink of middle income trap

Turkey has had an astonishing performance with regards to income per capita in the last decade. Indeed, the per capita income has risen from $3,000 to $11,000 under the rule of the Justice and Development Party (AK Party). Encouraged by this performance, the AK Party set very ambitious goals for the next decade, feeling confident that it would be possible to repeat this great performance in the future. Indeed, the AK Party is aiming for per capita income of $25,000 by 2023. I tried to explain several times before in this column that there is little chance of doing so. This time I would like to share with readers further evidence to back my claim.
The Bahçeşehir University Center for Economic and Social Research (BETAM) last week published a research paper titled "Türkiye orta gelir tuzağının eşiğinde" (Turkey on the brink of the middle income trap). As one of the authors of this research, let me explain briefly how the idea for this subject came about. At BETAM we have for years now been closely scrutinizing the Turkish labor market, publishing a monthly “Labor Market Outlook” and a number of occasional research briefs on various labor issues. It was surprising to observe continued high job creation despite the huge decline in the growth rate in the last two years. The factors behind this “happy” event are still not clear. Based on the findings of some preliminary research we suspected that the incentives intending to lower labor costs (such as subsidies for social security premiums) would have contributed to this nice surprise regarding unemployment. But considering the quality of growth as well as the per capita income performance, it was not difficult to predict the existence of some problems, particularly regarding the evolution of labor productivity. Thus, we decided to look more closely at this aspect using a simple decomposition methodology that allows us to break down the per capita income increase into its three contributors: the ratio of the working age population to the total population; the employment ratio (employment /working age population); and labor productivity, defined as the gross domestic product (GDP) per employed individual. The contribution of the working age population ratio is marginal. Though the working age population is still growing more rapidly than the total population, this factor will be extending into the 2020s because of an aging population. As for the two other factors, namely the employment ratio and labor productivity, three different periods are observed. Before the Great Recession in 2009, from 2005 to 2008 high growth was driven almost by labor productivity increases, with the index of labor productivity rising from 100 to 109.6. During this period, total employment almost stagnated, though non-farming employment rose remarkably. Indeed, agricultural employment declined strongly, thus contributing -- via the composition effect -- to the increase of overall labor productivity while labor productivity was also increasing in non-agricultural sectors. In the aftermath of the Great Recession, the nature of growth changed dramatically. From 2009 to 2011, though the Turkish economy had high growth rates, both the increase in the employment ratio and the increase of labor productivity contributed more or less equally to the increase of per capita income. However, since 2012, not only did the growth rate decrease dramatically but the increase in labor productivity first stopped and later started to decrease, as BETAM's research shows. Indeed, the index of labor productivity decreased from 105.8 to 104.8 from the second quarter of 2011 to the first quarter of 2013. Thus, for two years now, under the combined effect of low growth and declining labor productivity, the increase of income per capita is almost stagnating. Obviously, if this poor growth performance continues to prevail, the per capita income of $25,000 targeted for 2023 will never be reached. Moreover, the Turkish economy risks being trapped in the middle-income group of countries since increases in the per capita income will be very slow, if not stagnating. High job creation is certainly good for keeping unemployment in check. Nevertheless, labor productivity must start to increase again in order to continue to increase social welfare. The Turkish economy needs growth rates higher than the current one hovering around 3.5 percent actually. Moreover, this additional growth should come from labor productivity gains.