This is a chapter from the e-book 'The Future of the Middle East' co-produced by Global Policy and Arab Digest, and edited by Hugh Miles and Alastair Newton. Freely available chapters will be serialised here and collected into a final downloadable publication in the spring
Turkey is often portrayed as a country on the “edge” of somewhere: edge of Europe, edge of the Slavic world, edge of the Arab World. But the one place it has incontestable physical and geographical presence and historical belonging is the Mediterranean. Yet, except for a few years prior to the Arab Spring, Turkish governments have tended to focus on relations elsewhere: the EU, Central Asia, Russia, GCC, or Africa. Nor is Turkey alone in neglecting the Mediterranean. In contrast to its central historic position, the Mediterranean mainly functions as a transport route between Europe and Asia – as underlined with China’s purchase of Piraeus port as the end-point of its One Belt-One Road project. This article will briefly examine the current state of economic relations around the Mediterranean; trace the regional footprint and outlook for the Turkish economy and suggest that for conditions to improve regional growth engines are needed in line with the “flying geese” metaphor of the Asian model.
The neglected Mediterranean…
The wave of global integration in the 2000s mostly passed by the Mediterranean rim with the national economies on its shores looking elsewhere for growth. This was the case with the southern EU members which turned away from the Med as the centre of gravity of the EU single market shifted north. This process began with the southern enlargement of the EEC in the 1980s, followed by the EU eastern enlargement in the 2000s. More recently, the Eurozone crisis followed by lingering slow growth, high unemployment and debt in the southern EU economies have reinforced this negative dynamic.
Since the mid-1990s the Barcelona process, the EU-Med Association Agreements and the Union for the Med recognised these issues but the “Enlargement lite” model offered by the EU failed to reverse the centrifugal dynamic away from the Mediterranean. The agglomeration effects of the EU single market have continued to operate to widen the gap with the EU periphery. Outside of full membership, the EU has been unable to cohere constructive economic policies towards its periphery. In its place, there has been increased “securitisation” of EU policies towards the Mediterranean that has become its core feature since the 2015 migration crisis.
While the EU turned inwards and Turkey struggled to keep its foot in the single market with the EU/Turkey Customs Union, the Mediterranean Arab economic growth trends mostly tracked oil prices and looked to the rapidly growing Gulf Cooperation Council (GCC) economies. However, only a narrow section of the population benefited from the decade of growth in the 2000s due to the oligopolistic structure of the economies. The regime changes in 2011 in Egypt and Tunisia, have begun to chip away (more in the latter than the former) at this structure that limits competition in the domestic market, fosters corruption and keeps unemployment and social conflict high.
The many free-trade agreements (FTA) with the EU did succeed in increasing trade: exports to the EU from the non-EU economies around the Mediterranean rose to 30-60% of total goods exports. However, trade between the non-EU economies remain paltry at around 6-7% of total. This lack of integration between the smaller markets in the Mediterranean as well as weak rule of law and poor transport infrastructure and logistics have held back vital investments. Adding to the problems and blocking transport routes are the well-known long running regional conflicts and the more recent post-Arab Spring instability. Interference by powers external to the Mediterranean seeking spheres of influence have tended to further reinforce existing divisions. These conditions combined have thus created many sub-regional clusters that persist in fragmenting the region and undermining its economic potential.
…Looking for flying geese
The Mediterranean rim contains 20 countries, a population of around half a billion people or 7% of global population, and accounts for 10% of global GDP. The gap between per-capita income across the shores of the Mediterranean remains wide (France the highest has 5-times the per-capita income of Morocco the lowest). This region has had some of the fastest growing Emerging markets in the 2000s. But, the EU has lost market share to others, including the BRICS. The Mediterranean rim is an important market for the Southern EU-4 (SEU4) France, Italy, Spain, Greece. It accounts for 25-30% of total trade of SEU4; 10-15% of total trade is with each other and another 15% with the non-EU Mediterranean. The three biggest economies in southern Europe – Spain, France and Italy, would be expected to be engines of regional trade, investment and growth. This could follow the “flying geese” metaphor, where Japan, Korea and China’s investments have rippled across neighbouring countries boosting economic development in South East Asia.
Yet, in southern EU, historically Spain has tended mostly to invest in Latin America and France to limit its focus on the Maghreb with finance and energy the main sectors. On the other hand, Italy has a wide regional and sectoral economic footprint spanning from North Africa, to Eastern Med and Turkey, to the Balkans. The Italian economy could be central to a revival of fortunes of the Mediterranean rim. Such a role for Italy could be strengthened if the identified structural reforms -- similar to those needed in many Mediterranean economies, are implemented. These include measures to loosen the hold of patronage relations, reduce corruption and barriers to competition, strengthen rule of law, and increase transparency.
Increased inter-industry linkages with southern-Med could help to restart a new cycle of investment and growth and to overcome SEU4 competitiveness problems. These links had begun in the 1980s/early 1990s, but the direction shifted as investment flowed into Eastern Europe. Since then, in its place, the EU has imported labour from the Med. But this option has become increasingly difficult to sustain politically. Given the negative demographics and rising labour costs in East Central Europe, this may be a time to revisit the southern-Med as an investment destination. The opportunities also include investment in this region as a base from which to reach the rapidly growing Sub-Saharan African markets, as China has discovered with its investment initiatives in Morocco.
For the economies on the southern and eastern shores, participating in global value chains (GVC) can increase productivity, help overcome middle-income trap barriers, and counter trends towards de-industrialisation. EU supply chain linkages are most developed with Turkey, Morocco, and Tunisia. For example, Italian FDI in Tunisia in chemicals, electrical, and footwear industries employ 55,000. Indeed, among the southern and eastern-Med economies, Tunisia has the widest and most diversified trade relations with half its exports going to SEU4 and Turkey and Italy its main trading partners. In Morocco, the automotive sector has recently seen significant French FDI (Renault). Other sectors with more regional investment links include telecoms where France Telecom, Egypt’s Orascom, Turkey’s Turkcell, and Gulf telecoms are active. In Turkey, there is a broader range of inter-industry linkages. But even there, a recent OECD report highlighted the low level of GVC participation relative to its East European neighbours.
A major factor holding back GVC links is infrastructure. Although this is most developed in the energy sector which dominates north-south trade, there is still major untapped potential. Starting with the gas pipeline connecting Algeria via Tunisia to Italy in the 1970s, some 7,000 km of gas pipelines cross the region. The new gas field discoveries in the eastern Med could increase this connectivity possibly reaching the Turkish and Balkan markets. However, the lack of a pan-Mediterranean electricity grid was one of the causes of the failure of two ambitious EU backed multilateral projects -- the Desertec and the Med. It is still not complete: a project to link North Africa and EU electrical grids via Italy is ongoing, but the Syrian crisis is holding up connecting the Eastern Mediterranean grid to Turkey that would then link-up to the EU grid.
Turkish economy in the Mediterranean…
Of the non-EU Mediterranean economies, Turkey has the widest reach in the region. It is the one non-EU economy that trades, transports and invests the most in the Mediterranean rim and developments just prior to the Arab Spring showed that it could be the second growth node for the region. Around half of Turkey’s total trade is with the EU; 10% with SEU4; 15% with Mediterranean rim as a whole. Uniquely, Turkish services exports are high including media and entertainment to construction and logistics, education, health, and tourism. For Turkey, this region is a natural economic hinterland. It offers opportunities to offset its energy imports deficit – the main component of the large current account deficit (excluding energy imports the current account is mostly balanced). It also helps offset loss of market share in EU markets to East/Central European new members and to Asian low cost producers.
Turkish governments took seriously the plan to establish a EUROMED free trade area by 2010. FTAs were agreed with every country (except Algeria) in addition to the 1995 Customs Union with the EU. In June 2010, a high level Strategic Council with representatives from Turkey, Iraq, Syria, Jordan, and Lebanon had met to move from bi-lateral FTAs into EU-style multilateral mechanisms. Yet the regional instability since the Arab spring protests in 2011, and the collapse of Syria and Libya has put these plans on hold blocking trade routes through Syria and Egypt. In addition, rising domestic political pressures since 2013 in Turkey translated into mis-steps on the foreign policy front, negatively affecting regional initiatives.
…could do with less political volatility…
For the Turkish economy to function as a driver of investment and growth in the region, there is need for domestic and regional political stability that allows for economic policy stability. Economic policy has turned reactive focused on fire-fighting domestic shocks and frequent crises with important regional trading partners such as Russia affecting the tourism sector (that contributes 13% of export receipts). Since 2015, the economy has had to cope with a repeat general election, the 2016 attempted coup and its aftermath, and multiple terrorist threats. Policy has had to sustain growth with consumer, credit, and investment incentives frequently handed out in the lead up to elections. Despite these props to domestic demand, GDP growth contracted in the aftermath of the July 2016 coup attempt. A rebound in consumption (in response to the consumer incentives packages) in the final months boosted GDP for 2016 as a whole to 2.9% although this was still half the average of 5-6% per year growth in the past decade (new series).
According to government economic spokesmen, short term prospects are positive. The economy bottomed out in the 4Q16; Syria solution is in sight; US President Trump is not a threat to Turkey; and relations with Russia are patched up. The economic policy team also believe that EU economic relations are set to deepen with the renegotiation of the Turkey-EU custom Union. Moreover, business have mostly welcomed the depreciation of the lira for reversing its real appreciation during 2003-2010. Supporting an economic recovery is the stronger growth in the EU, still low international oil prices, and a cautious pace of increase in US interest rates. This should help manage foreign payments pressures -- especially the onerous debt repayments on foreign currency debt of corporates. Thus, as long as a major global financial crisis can be avoided, the short to medium term outlook looks positive.
This is plausible. However, as we have seen in the past few years, there are significant downside risks to this benign outlook including possible further political shocks. Looking forward, there are also new risks that deteriorating political relations with the EU or the US could have negative economic impact on the Turkish economy. Downgrades of Turkey’s hard-won investment grade sovereign ratings by international rating agencies in 2016 also cited weakened institutions as continued risks. Supporters of the AKP project for a presidential system argue it will help overcome the instability of the party/parliamentary institutions in Turkey. However, political volatility seems to have become an entrenched feature of AKP electoral strategy and it looks set to persist whether President Erdogan wins or loses the coming referendum.
Meanwhile, despite a tighter monetary policy, inflation topped 10% for the second month running in March – almost double the Central bank target, due to the pass through from lira depreciation. Given its large foreign currency payments burden (averaging around 25% of GDP), Turkish lira remains under pressure from the vagaries of international capital flows and US dollar gyrations. Central Bank policy -- caught between international markets looking for more decisive action versus domestic political pressures to maintain growth, seems to have opted to try to reduce speculative volatility but not resist depreciation of the TL arising from global forces. Meanwhile it is hoped that the firm fiscal stance and muted domestic demand will act to contain the pass-through inflation.
Since the global financial crisis, the domestic demand driven growth– as export growth slowed due to an appreciating lira and the Eurozone crisis, has also built up potential domestic imbalances. Although it was relatively subdued in 2016, credit relative to GDP has almost doubled in the past decade to around 80%. There is more scope for credit growth for an economy the size of Turkey. But, the rapid pace of growth holds risks in cyclical sectors such as construction and property. Indeed, recent reports of over-supply has led the government to step in late 2016 with tax discounts to boost house purchases. Although the public debt is low, the increasing state investment guarantees also suggest contingent liabilities need monitoring.
More broadly, economic policy is likely to follow the new global trends: more statist, more crony capitalism. Although Turkish economy has done well out of the international liberalisation of trade, policy could also turn selectively protectionist. The ongoing centralisation of political power seems to have also brought a shift towards an Asian-style developmental state. As the state steps in, business circles which are close associates of the AKP follow – bringing with it the usual governance problems and corruption.
Patronage is a historic feature of Turkish and other Mediterranean cultures that have traditionally had weak rule of law and a large informal economy. The latter has grown in past decades with increased smuggling activity fostered by international sanctions on Iran and the collapse of Syria. Following a period of increased transparency in its first term when a major privatisation programme was implemented, AKP appears to have reverted to new forms of patronage. There are also echoes of Kremlin tactics, for example in the energy sector where President Erdogan’s son-in law is the minister. However, unlike the resource based economies such as Russia with structures that facilitate oligarchic control, the diversity and by now complexity of the Turkish economy, as well as large holdings in key sectors that predate the AKP regime, could act to limit the reach of the Asian-Kremlin-crony model.
…and a new growth model
Turkish economy’s evident resilience to high levels of volatility is owed to a number of structural strengths which are likely to continue to support economic prospects. These underlying strengths include its large internal market, diversified economy, relatively well regulated banking sector, and low public debt. Growth will also be supported by the large infrastructure investments in energy, transport, and health that are expected to be funded by PPP-type project finance, Islamic finance, and the new Turkish Wealth Fund.
Yet, longer term, for the Turkish economy to be a motor of growth for the Mediterranean region a new growth model that is less reliant on domestic demand is necessary. Drivers of growth need to change, from extensive growth (more resources used in the same way) to higher productivity/ higher technology growth. This requires increased global integration with GVC to overcome the “middle income trap” which in the case of Turkey could be led by strategic sectors identified as the defence industry, automotive, transport, telecoms, engineering and logistics. Policy recommendations to exit the middle-income trap highlight three broad necessary conditions: improved competition, technological upgrading, and macro-economic stability. There is a high risk that continued political instability, deterioration in transparency, weakening rule of law, traditional norms blocking increased participation of women in employment, and decreasing political accountability could undermine this project.
However, despite the fraught political atmosphere, Prime Minister Binali Yildirim’s government and economic policy team do seem to have these developmental tasks in their sights. The past few years have seen difficult structural reforms passed including labour market reforms, pension reform and a national fund to boost the savings rate – although these will take time to have an effect. In December 2016 taking advantage of the powers under emergency rule also saw the passage of the Intellectual Property Rights legislation that had been languishing in parliamentary committees since 2013.
Despite the difficulties of doing business around the Mediterranean, the existential crisis of the EU, and the roller-coaster ride of the Turkish economy, there is no other alternative but for these littoral states to cooperate and engage in increased trade and investment. Given its internal political tensions, the Turkish economy is unlikely to be the poster-child of successful policy and steady growth. But it is likely to continue to be a growth pole of sorts making uneven progress towards a more productive economy. As discussed above and, given its size (some $850bn), along with Italy –the other big economy with a wide regional reach -- an upgrade of the Turkish economy could provide opportunities for a new round of cross-border investments establishing new supply chains across the Mediterranean. Prior to the Syrian crisis, Turkey had visa-free travel with Syria, Lebanon, and Jordan which resulted in a doubling of trade volumes. Between 2004-10, the number of Turkish companies operating in Egypt had more than tripled and were employing 40,000 Egyptians. The conditions are not there yet for a major restart of this dynamic, but small steps are ongoing. Recent news from the Turkish Foreign Economic Relations Board (DEIK) reported several investments in the Balkans and a Turkish solar panel manufacturer investing to produce in Palestine. Today the “geese” leading the flight in South East Asia also include firms from Indonesia, Malaysia, or Thailand investing in Viet Nam or Cambodia. In East Central Europe, firms from Poland, Hungary, and Czech Republic have taken flight to invest further east. It is time for a Mediterranean take on this metaphor.
Dr Mina Toksoz is an Honorary Lecturer at the University of Manchester Business School and an Associate Fellow of International Economics at Chatham House (RIIA). She is a specialist in country risk analysis, and an Independent Director on the Supervisory Board of the EIU Country Risk Service. Her book The Economist Guide to Country Risk was published in November 2014.This essay will be part of a panel at the BRISMES conference in July: “The Mediterranean Rim – looking for a growth engine”.
Photo credit: Foter.com