Turkey’s Economy Is at a Crossroads Ahead of Key Elections
A robust economy, in combination with a stable democratic system, would make Turkey a pillar of stability in an uncertain region.
On February 6, a magnitude 7.8 earthquake shook the southern cities of Turkey. Thousands of buildings, vital highways, and airports collapsed. According to the latest figures, more than 30,000 Turkish citizens were killed, while millions of people are directly impacted.
Although Turkey is highly prone to earthquakes, Erdogan’s government is facing severe criticism because of the insufficiency of the government’s response. Centralized bureaucracy has hampered the mobility of many NGOs and volunteer associations, indirectly increasing losses.
The earthquake could not come at a worse time. The Turkish economy is already in a bad shape, and the current disaster further complicates the economic and political situation in the country. We cannot know at this time the expected costs of reconstruction efforts, but the Izmit Earthquake (1999), which was less destructive, cost approximately $17 billion, or approximately 1 percent of the GDP at that time.
When Turkish voters head to the polls in June—presuming elections are not postponed due to the earthquake—for the first national elections since 2018, they will be tasked with affirming or correcting President Recep Tayyip Erdogan’s sweeping economic policies over the last ten years.
Turkey’s economy is an anomaly, even against the backdrop of global economic turmoil. Since the country lifted its COVID-19 lockdowns in June 2020, the ruling Justice and Development Party (AKP) has instituted sweeping economic reforms to stimulate growth at all costs.
This has led to strong economic indicators, including 11 percent economic growth in 2021, growth for nine quarters during a global recession, surpassing many G-20 and OECD countries, and an expected 5 percent growth last year, making it one of the world’s fastest-growing economies.
Over that time, Turkey has also proven that economic growth does not necessarily lead to prosperity. Millions of Turkish citizens have been hurt by these policies, leading to a severely weakened Lira and runaway inflation, an impoverished middle class, and a steep decline in consumer confidence. These circumstances have bankrupted many small businesses and led to Turkish bonds reaching “junk” status among foreign investors.
Just two years ago, $1 was equal to approximately seven Turkish Liras. Today, with a strengthening dollar and a weakening Lira, that conversion rate is approaching 1:19, adversely affecting purchasing power.
Turkey’s economic “rising tide” has left the vast majority of the population underwater. These people will now decide if the current policies stick, or if a new path forward is needed.
Despite the recent economic hurdles, Turkey still possesses the potential to become a regional and global economic force. With a population of 84 million people and a strong manufacturing industry, Turkey is a global leader in consumer products, transportation equipment, electronics, and agricultural products.
To realize its full potential, Erdogan’s administration—or his successor’s—must embrace a broader definition of economic success.
Cooling Off the Overheated Economy
As of October 2022, Turkey’s runaway inflation reached 85.5 percent year-over-year, which ranked seventh-highest among any nation in the world, alongside low-income, underdeveloped countries like Zimbabwe, Lebanon, and Venezuela, and sanctioned economies such as Iran.
Though it fell to 64 percent in December, Turkey’s inflation rate is still nearly ten times that of leading Western economies.
Increasing interest rates is a commonly used tactic by central banks to cool down hot economies. However, Erdogan holds the unorthodox economic belief that high-interest rates generate high inflation, pushing for lower interest rates to keep economic activity high in exchange for popular support. To maintain his control over monetary policy, he has replaced the governor of the Turkish Central Bank four times over the last seven years.
Last fall, Erdogan called on the central bank to take interest rates into the single digits to close out 2022. This fourth-straight rate cut pushed Turkey into what Bloomberg described as “extreme outlier status” at a time when most central banks have been hawkish on interest.
In addition to driving inflation, Erdogan’s interventionist monetary policies jeopardize the independence of the Turkish Central Bank and lead to a dramatic decrease in confidence from domestic consumers and foreign investors.
Combine this with widespread industry strikes and civil unrest, a gutting of the country’s middle class, and a 55 percent raise in the minimum wage—which is expected to fuel inflation further and crush small businesses—and Turkey is nearing a hyperinflation spiral, despite its economic growth.
Turkey’s CDS premiums, the putative indicators of country risk, exceeded 900 in July 2022, the highest since 2003. This means the country is at high risk of default.
The Election Effect on an Interventionist Economy
Turkey has a strong democratic tradition, yet in recent years, there have been concerns raised regarding the transparency and accountability of the country's democratic institutions.
Turkey’s 2023 election is thus considered a watershed moment by many, a choice between institutionalizing competitive authoritarian rule or moving back to democratization.
Erdogan has signaled that he intends to stay the course on high growth at the expense of taming inflation. Poor management of the economy is the principal source of widespread dissatisfaction with Erdogan and the AKP.
Stagflation can be tolerated by an electorate if other political issues outweigh the economy. In recent elections, voters have valued the AKP’s approach to national security and fighting terrorism over economic weakening. Prior to the recent earthquake, the weakness of the Turkish economy was the most important issue among likely voters. But now it seems that the earthquake will remain the main topic in the political agenda during the next year with irrefutable economic consequences.
Nevertheless, Erdogan cannot be underestimated, thanks to his firm control over the state.
The current presidential system—a shift from the parliamentary system before it—was endorsed in a national referendum in 2017. Since his re-election in 2018, Erdogan has consolidated power over all institutions, including the judiciary, removing democratic checks and balances.
According to many international watchdogs, Erdogan has embraced the telltale signs of authoritarianism, including nepotism, clientelism, and a lack of governmental accountability. Whoever has spoken out against Erdogan internally has been replaced by a loyal yes-man.
A win for the AKP in May, which seems probable, will serve as a ruling mandate for these policies, despite their unsustainable track. This will likely lead to increased interventionism and state management as the situation spins out of control.
Drawing insights from Erdogan’s actions and rhetoric, Turkey could see a deterioration of economic ties with the European Union and the International Monetary fund, leading to decreased Western foreign direct investment (FDI) and borrowing capacity.
However, Erdogan has shown a pragmatic approach to replacing the influence of Western economic support, including by strengthening ties with erstwhile regional rivals Saudi Arabia and the United Arab Emirates.
It’s Not Too Late for a Turkish Turnaround
On the other side of the ballot, the opposition alliance has assembled some of the world’s top economic minds to provide an alternate vision for economic success. These include world-renowned economists like Daron Acemoglu, Wharton professor Bilge Yilmaz, and former AKP economic minister and ex-Erdogan ally Ali Babacan.
If these technocrats can reach a consensus, they could swing the election and help restore the trust of foreign investors and international donors.
It will be challenging for a new government to prioritize Turkey’s long-term economic health with short-term, necessary pain. There is no path forward without institutional revision that attains broad domestic and international support.
Returning to conventional economic policies also means unraveling some of the artificial economic growth over the last few years.
Turkey’s economy would also benefit from a return to its democratization process. A more transparent and accountable government would create a more predictable and stable business environment, thereby encouraging entrepreneurship, investment, and growth in the country.
Embracing Stakeholder Capitalism to Defeat Income Inequality
In Turkey’s new economy, everyone needs to have a seat at the table—a model commonly referred to as stakeholder capitalism. Everyone, including investors, business owners, workers, customers, and the general public, should experience long-term economic gain from growth.
Poor policy-making and governance have led to the current paradigm, taking much of the economy down with it. However, certain sectors are showing resilience against economic headwinds.
Turkish tech startups Getir, Peak Games, and Insider each recently attracted investments from prominent venture capital firms. Technology-driven development is more important for Turkey’s future, providing major employment and wage growth.
If the winner of the next election embraces logical economic governance, Turkey can become a more predictable place for FDI and investment of all kinds. If existing policies change, startups will have greater access to capital, which they can leverage to grow in Turkey. If current trends stay the same, however, then these startups will leave and take the opportunity for economic prosperity with them. It’s really that simple.
The current government bears an enormous responsibility for the recent economic losses, including from the earthquake. After all, earthquake taxes are collected in Turkey and designated for disaster relief. However, in recent years, much of those funds have been redirected to infrastructure projects, such as highways and airports.
Likewise, it would be tough for any government to coordinate relief efforts after such a large disaster like the one that has befallen Turkey. However, the current government took a number of unwise and incorrect steps, including banning social media.