Turkey: ready to compete?
Turkey’s economic future depends in large part on whether it will be able to compete globally. Only a competitive export sector will help Turkey reduce its external imbalance and move to a sustainable growth path. For Turkey, increasing competitiveness means increasing labour productivity, while reducing the costs of labour. This report specifically considers Turkey’s labour market. It looks at the opportunities created by a large and growing labour force, while also taking account of the many obstacles that currently prevent Turkey from reaping the fruits of this demographic advantage.
Growing labour force
Turkey’s future economic performance stands to benefit from a large young population. While Europe is coping with the effects of an ageing population, Turkey’s population is projected to grow by 0.8% annually, while the working-age population is projected to growth by an even higher 1% annually. Even though population growth will slow somewhat after 2020, growth is still expected to average 0.6% per year until 2030. As a result, by 2030, Turkey will accommodate the second-largest population in Europe (behind Russia). Furthermore, Turkey will also boost the youngest population in Europe. For example, in 2012, the median age in Turkey stood at 28 years, as compared to 45 years in Germany.
Until 2020, Turkey’s working-age population is expected to grow faster than the overall population (by 0.2pp), resulting in a falling dependency ratio. After 2020, when the population starts growing faster, this effect will be reversed. Nonetheless, compared with the European Union, Turkey’s dependency ratios will remain low. Turkish elderly-dependency ratio is expected to reach 17% in 2030, as compared to 48% in Germany (UN Data).
As the population continues to grow, the Turkish labour force increased as well. Nonetheless, over the last decade, the overall participation rate remained roughly stable at 50%. This is below the OECD average. Especially the participation rate of women is considered low at 31%.
Naturally, the only way to benefit from a growing labour force is by creating sufficient jobs to employ the new labour market entrants. Unfortunately, as shown by figure 4, even though employment has risen over the past decade, Turkey’s unemployment rate is still relatively high. And, as the labour force continues to grow, it will become harder to sustain the reduction in unemployment seen over the last years.
Partly explaining the persistently high unemployment rate are Turkey’s elevated wages relative to labour productivity. As shown in figure 2, labour productivity growth slowed since 2007, while unit labour costs continued to increase markedly, driven by a high minimum wage, high social benefits (paid by the employer), high cost of firing employees
with fixed contracts and stringent rules for hiring temporary workers. In fact, in all these areas, Turkey performs worse than the OECD average, while minimum wage as a percentage of median income is actually the highest of all OECD countries (OECD, 2012). Consequently, job creation in the formal sector is limited and the economic progress recorded over the past decade has largely benefitted job creation in the informal sector.
It is hardly surprising therefore that the informal and semi-informal sectors together employ roughly half of the labour force (excluding the public sector). This is especially true for the low-skilled jobs created in the Anatolian industries. The reason being that, in order to be able to compete with similar industries in low-wage countries like China and Taiwan, companies are often forced to hire informally.
The stringent labour laws and high wage levels not only impede job creation in the formal sector, they also undermine the competitiveness of Turkey’s producers vis-à-vis their international counterparts. An argument could be made that as long as Turkish companies are able to hire labour in the informal economy, labour laws become irrelevant. However, as labour productivity in the informal and semi-formal economy lies far below that in the formal economy (see figure 5), a large informal economy is not an optimal outcome and obstructs labour productivity growth. Given this enormous discrepancy between the formal and informal economies, we argue that formalization, through the creation of a more flexible labour market, would immediately result in higher labour productivity and, consequently, a more competitive labour force.
Another reason why labour productivity growth slowed over the past few years is the fact that Turkey’s labour force is poorly educated. While enrolment rates have improved over the past decade, quality is lacking. According to the Global Competitive Index created by the World Economic Forum, the quality of Turkey’s education system falls below that of other emerging markets, such as China, India and Brazil. In addition, there is a mismatch between skills learned in vocational schools and universities and those demanded by employers. As a result, students are poorly prepared to enter the work force.
Moreover, given that the share of high-tech exports in total exports increased from 30% in 2002 to 60% in 2008, a highly educated labour force is vital for Turkey’s future economic growth. Therefore, in order to converge towards advanced economies and prevent falling in a middle-income trap, the education system should be reformed.
Figure 5: Labour productivity per sector
Source: OECD, 2012
Increasing labour productivity
The above clearly shows that in order for Turkey to increase its labour productivity and thereby its competitiveness, the government needs to formalize the economy by lowering labour costs and making the labour market more flexible.
Since 2010, the government has made some efforts to formalize the economy by making it easier for companies to hire temporary workers and fire permanent workers. The most notable change was a reduction in social benefit contribution, which reduced the minimum wage costs by 35%. In 2012, this policy was expanded by allowing employers in the poorest regions not to pay any social contributions. Another noteworthy policy change is an initiative introduced in 2011 that allows businesses in the most volatile sectors (sectors that endure most competition) to hire temporary workers more easily. Still, even for those companies, the total number of temporary workers cannot exceed 20% of all people employed.
Next to labour market reforms, improvements in education should further enhance labour productivity. Unfortunately, education reforms have become the subject of a fierce debate, which focuses more on the role of religion in education than on the quality of education itself. In March 2012, parliament approved a new law that states that every child should obtain at least 12 years of education, from eight years before. The 12 years will be divided in three blocks of four years. The middle four years, which are now spent in primary school, could be spend in either primary school, or vocational training. The problem with this approach is that it could especially motivate poorer households to enroll their children in vocational schools (including Islamic schools) at a younger age. This would effectively reduce the percentage of the population that receives higher education, rather than increase it. In addition, parents will be allowed to homeschool their children after only four years of primary education. Of course, only time will tell how these policies will come to affect education attainment.
With respect to labour market reforms, the measures taken so far are a good step in the right direction, but more is needed.
Unfortunately, we do not see any major reforms coming about in the immediate future. We fear that the presidential elections, planned for 2014, will have a paralyzing effect on public policy and reduce the likelihood of unpopular reforms being undertaken. We therefore deem it unlikely that the government will further reduce employee protection, or compensation, in the short term. In addition, Turkey’s powerful labour unions further block progress in this area. Nonetheless, the government has shown that is well aware of the consequences of having a large informal economy and does appear willing to address the issues.
Box 1: Inequality
Designing the policies and reforms needed to formalize the economy and reduce unit labour costs is complicated by Turkey’s enormous internal disparities. On the one hand, in the west (and particularly in Istanbul) we find a region whose prosperity and skyline match that of advanced economies. On the other hand, especially in Turkey’s Southeastern regions poverty is still widespread and education levels are low.
Further underscoring this division is the difference in income levels. The last available data on income disparities comes from a study conducted between 2006-8. In this period, South-East Anatolia housed 10% of the population, but these households only accountted for over 4% of total household consumption. In contrast, greater Istanbul accommodates 18% of the population and they consume 25% of total household consumption. Bridging this gap are the five Anatolian tigers, regions where economic progress has speed up over the past decade, aided by a growing industrial sector.
Given the size of the disparity, both labour and education policies should be tailored to each individual region. Especially the South-East needs a greater investment in education. In addition, lower income in this region, but also the Anatolian regions, justifies lower minimum wages. This would also help Turkey’s newly developed industries compete with low-wage countries such as China.
Education reforms will also take time to come about. Moreover, the debate surrounding the new policy mentioned above pulls focus from a much more stringent issue: the quality of the education received. Unfortunately, improving the quality of education will require additional funds. Whereas countries like China, Brazil and India spend over 5% of GDP on education, Turkey spends only about 3% of GDP annually. Unfortunately, it is doubtful that the government can make room for additional education spending. Given the large informal economy, tax revenues are low. In addition, the government cannot afford to run large and persistent twin deficits (with the current account already firmly in deficit). We therefore do not expect any major changes in the short, or medium term.
For the coming fifteen years, a young and growing population places Turkey at an advantage. Nonetheless, in order to benefit from this advantage, Turkey needs to create jobs for new labour market entrants, increase the productivity of its labour force and reduce the costs of labour. Doing so will require the government to bridge the divide between the formal and informal economy and provide high-quality education. Success in this area largely depends on the ability of the government to channel funds to education and implement unpopular labour reforms.
Given the lack of public funds and politically sensitive nature of the reforms required, it is unlikely that change will come about overnight.