The Kapali Carsi

Civil war in Turkish economic policymaking

The government announced tax hikes last Saturday in response to the deterioration in the budget, or maybe to fill the coffers for pork barrel spending before the upcoming elections.

Here’s the intro. to my latest Hurriyet Daily News (HDN) column, where I discuss how the recent tax hikes surfaced the strife among Turkish econ. policymakers on the direction of policy. Before you go on with this addendum, you can (or rather “should”) read the whole thing at the HDN website. I have quite a few additional points, but before that, I have an announcement. I am running a small contest: If you know the name of the song I am paying homage to in the column, send me an email. One randomly-chosen reader will win the album. Also, apologies for the many Turkish hyperlinks if you don’t speak our beautiful language. But I have put many English hyperlinks as well, and the Turkish ones are clearly marked- if I am not saying anything, the link is in English…

Anyway, on to business: Let’s start with the small details: The editors at HDN forgot to put in the link for the HDN article for Babacan’s Istanbul Finance Summit speech (yep, it has to be put in manually, the fonts get f—ed up otherwise) so here it is.

My unofficial editor (let me know if you need one, as I’m very happy with her edits), who is an American expat living in Istanbul, asked me the following question: “Can’t they find something besides booze to tax?? :)” Well, there are two very good reasons why the government goes to alcohol first to patch up the budget: First, alcohol demand is rather inelastic in Turkey, to either price and income. In plainspeak, a Turk’s gotta have his raki- the same goes for cigarettes I guess. In fact, news portal NTV analyzed the budget realizations recently and found out that alcohol taxes had come out as planned despite the economic slowdown (in Turkish). But the second, and maybe the more important reason is the AKP’s dislike for alcohol. Bulent Arinc, one of the AKP’s bigwigs, said a couple of years ago, after another alcohol tax hike: “Of course, we won’t ban alcohol, so that’s how we’ll discourage people from drinking” Obviously, he doesn’t know about elasticity:)….

Moving on, a reader alerted me that fellow HDN columnist Guven Sak has made the reference to Orwell in his Radikal column on Friday (Turkish). I usually read his columns, but I missed that one. He is my former boss, so maybe we chatted about that some time ago and it stuck in our unconscious. But it seems it isn’t a bad analogy. Another reader emailed me that he likes to call the Ministry of Environment “the Orwellian Ministry of Environment”, especially after the Minister, the former head of Housing Development Administration, noted that he loves to build dams. Damn, I should say, but his Ministry’s full name is Ministry of Environment and Urbanization, so I guess he likes the latter part much more. BTW, even the name sounds Orwellian:)… This is way off-topic, if you’d like to read something a bit more scientific on this, here it is.

Speaking of Orwell, you could actually call the fuel tax hike a price update, as that tax is a fixed amount per liter. Similarly, alcohol taxes are indexed to past inflation, so you could call those updates as well, although I would argue that creates a vicious cycle in fighting inflation.  However, the same would not hold for passenger cars. BTW, this is not the first time the term “price update” was used: Mehmet Simsek used the same terminology last year, to much criticism.

As for the fight between Caglayan and the troika, there are several points to make: For one thing, I am under the impression that Babacan is thinking Simsek is not being too tough against the spending ministers. A newspaper article was actually arguing the two are not in best terms, but they did not provide any evidence regarding that. But all I’m saying is that “the troika” is not in full agreement, either.

The second important point is to note that the Central Bank’s unorthodox/experimental (or whatever you want to call it) monetary policy has been designed to bend the “impossible trinity” to please Caglayan & co. It is also important to realize that, contrary what Caglayan is claiming, monetary policy is not tight at all- refer to my column from a couple of weeks ago, or its blog extension, for more on that. Finally, Basci wants growth as well, as he recently noted, and as I will discuss below. So he is not your typical German central banker who hates inflation above anything else.

Speaking of the Central Bank, Fatih Ozatay of Radikal made a very good point in his Radikal column last week, which he repeated in his column this week (both Turkish): The Central Bank cut is lending rate despite the tax hikes coming a few days later, which led some to speculate the Bank had not known about the hikes. As a former Deputy Governor of the Central Bank, he notes that this is impossible. In fact, the Bank admitted this week they knew of the hikes before their rate-setting decision. And speaking of Radikal, they did a pretty good job covering the fight, with news articles as well as columns from Ugur Gurses and Seyfettin Gursel (all Turkish), who was one of the first to notice the strife in economic policymaking, mentioning it in his columns during the summer- but I doubt even he would expect it would escalate so much.

Since we are discussing the Central Bank, it is important to note the importance of Caglayan’s remarks on changing Central Bank Law, which was completely missed by Turkish media. It seems the admiral made the comment (in Turkish) to pro-Caglayan (I guess I should not use pro-government for them anymore) daily Sabah. The paper ran an article on this issue (in Turkish), and it seems Caglayan was saying he agreed with them. I cannot overemphasize what a dangerous notion this is. One of Turkey’s biggest problems in the 80s and 90s was government deficits financed with printing money. Even the thought of returning to those days of Dark Age Economics scares the shit out of me, if you’d pardon my French!

Finally, it is important to note that it is not that the troika doesn’t want growth; that would be like shooting themselves on the foot, at least for Babacan and Simsek. But they realize the importance of caution. Besides, Turkey needs to get out of its external finance-led growth cycle. My friend Murat Ucer of Turkey Data Monitor has explained this really well in his latest GlobalSource weekly:

Put differently, everyone wants growth — that is not the problem. The problem is, as we’ve been pointing out for some time, Turkey needs to boost growth from the supply-side to make it – sort of — compatible with the inflation target and a manageable CAD-to-GDP ratio. But the likes of PM Erdogan and Minister Caglayan have no patience to wait for that, at a time several elections are lined up ahead and the regional and domestic political pressures are rapidly growing.

I have kept arguably the most important player of the fight, even more than Erdogan himself, for the last. I was wondering what President Abdullah Gul would say on the economy, and whether he’d align himself with the troika or the admiral, in his Parliament opening speech. Radikal ran a story before the speech, arguing the President would support the troika, and they were right (both in Turkish): Nearly one fourth of the President’s speech was on the economy, quite a bit when you think that the country is faced with many problems such as Syria, terrorism and imprisoned MPs- HDN has summarized the political headlines from the speech. Gul noted that “fiscal and monetary loosening would have irreversible consequences”, which is clearly siding with the troika if you ask me. He also underlined that “the results we aim of would be obtained with the right policies, not by orders”. IMHO, that is a direct answer to Erdogan’s arguments for lower rates. Anyway, Ugur Gurses has analyzed the econ. parts of the speech in his Radikal column, and he seems to agree with me (in Turkish). Anther interesting point Gul raises is that we should be aiming for stable growth without a current account deficit, but without endangering price and financial stability. If that sounds familiar, it is indeed deja vu, literally: This is more or less Murat Ucer’s point I quoted above. Finally, it is important to mention that all these points, along with his more vocal political criticisms, has led many political commentators to note that he will not leave the Presidency without a fight, and if he does, he won’t let an Erdogan puppet take over the PM position, similar to the Putin/Medvedev model.

But I don’t want to ignore Erdogan. There are two important points that will help you understand his mentality: First, he said, at the AKP Congress on Sunday, that the government had put on the brakes on purpose in 2012 to slow down the current account deficit. So I think he is thinking “basta!” when siding with Caglayan. Second, while I obviously don’t agree, I argue that you could make a monetarist case for the relationship between high rates and inflation. But I doubt that is on the PM’s mind: I’d think his story goes like this, as a friend speculates: When interest rates are high, firms face higher cost, which they then pass on to prices. But the problem is that just as inflation is “a result”, so are interest rates, although pro-governmentCaglayan Sabah clearly does not get this, as they recently criticized banks for not lowering their credit rates– I don’t blame them, as inflation expectations have jumped after the most recent tax hikes. Anyway, I am glad to see Erdogan is as ingenious as the Central Bank when it comes to challenging standard economic wisdom.

BTW, the fight continued this week. Or rather Caglayan continued to attack the Central Bank, saying that the Central Bank stubbornly did not lower rates and that it did not act responsibly (both in Turkish). So maybe, we should be putting the brakes on Caglayan, as Radikal columnist Ugur Gurses recently tweeted:)… And speaking of the fight, here’s the banking regulator (BDDK/BRSA) report I refer to in the column (I couldn’t link it there, as we are not allowed to post non-English links at HDN), and news channel NTV has caught my point on loosening credit policies in a short piece– I am glad to know the Turkish media at least skims through these documents. BTW, BRSA releases their reports in English as well, with a bit of delay- they haven’t posted the most recent one yet.

Coming back to taxes and other revenue-boosting measures, the government did indeed hike natural gas and electricity prices, both by 10 percent, early this week. Now, we have to wait for October inflation to see the first-round inflationary effects of those, which should be around 0.4 percentage points, but they will probably add to 2012 inflation around 1 percentage point. And since I am talking about taxes, I should definitely commend business association TUSIAD’s criticism of indirect taxes, a few days after Erdogan criticized the big bosses for not paying taxes. BTW, if you speak Turkish and want to be entertained, the pro-governmentCaglayan daily Sabah’s “analytical piece” on how much taxes TUSIAD is paying is a must: I found several mistakes in two paragraphs of “analysis”. BTW, if you haven’t studied econ. at college, fellow Daily News columnist Erdogan Alkin explains, in simple terms, why there are limits to indirect taxes.

Before I conclude another lengthy post, I noticed that the troika never mentioned structural reforms in their debate with Caglayan, which is a pity: As I have argued before, the macro reforms of the early AKP years were not followed by micro ones, which is where Turkey’s binding constraints to growth lie- Radikal’s Seyfettin Gursel has made the same point in his latest column, by noting that reforms were not mentioned in the AKP’s “manifesto”, which was distributed during the party’s congress on Sunday. Similarly, the priority of increasing the country’s low savings rate seems to have been brushed under the carpet. Speaking of reforms, I have heard a few commentators note that a fiscal rule would have let the government fill up the coffers when the economy was growing fast, allowing for some fiscal expansion right now. But the fiscal rule had serious problems in its original form, so I am not lamenting too much…

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