Presidential elections will be held in Turkey on Sunday 14 May and whoever wins them will find themselves managing a country with a disastrous economy, with very high inflation, with a currency at historic lows, unsustainable public finances and considerable social tensions. Current Turkish President Recep Tayyip Erdogan and Kemal Kilicdaroglu, the leader of the Republican People’s Party and unity candidate of almost all opposition forces, are very close according to polls.
Erdogan has ruled the country for about 20 years and has been carrying out extremely controversial economic policies for some time and contrary to the orthodoxy recognized by most economists on issues such as inflation and public spending: these policies have managed to considerably the economy, but have led to social costs that risk becoming unbearable, and impoverish the population in the long run.
In the last two years, the Turkish economy, which has emerged rather compromised by the coronavirus pandemic, has managed to grow at a good pace thanks to huge subsidies and very expansive economic policies by the government. GDP grew by 11 percent in 2021 and by 5 percent in 2022, according to estimates by the International Monetary Fund. This result was achieved at the cost of allowing inflation to rise considerably, ie the general increase in the level of prices which in recent months almost doubled compared to the previous year.
Due to the fact that prices rise at a much faster rate than wage increases, the Turkish population is increasingly impoverished and the government over time has responded with some popular but economically inexpedient measures in order to regain their favour, such as the raising wages and minimum pensions and reducing the retirement age. These measures, although they are able to give relief to the population, have temporary effects and in the long run only make the situation worse, according to most economists.
Behind a double-digit GDP growth like that of Turkey hides an “overheated” economy: the bottlenecks in the production chains, the shortage of raw materials, an offer that cannot keep up with the demand and the energy crisis have led even Turkey to deal with high inflation. Prices have risen and the purchasing power of households and businesses has decreased. These are the same problems the rest of the world has been dealing with, but in Turkey the situation is much more serious: inflation in November was 85 per cent, which means that within a year prices are almost doubled. In April, it fell to 50.5 per cent, an exceptionally high level nonetheless.
The reason is linked to the difference in the monetary policy response that has been given compared to other countries: the classic response to such high inflation is the increase in the reference interest rates, i.e. the cost of money at which central banks lend to other banks. The goal is to “cool down” an economy that is growing too much, in which we want to consume more than the system is able to produce, with a consequent increase in prices.
Turkey, on the contrary, is pursuing a sort of economic experiment: Erdogan is keeping interest rates forcibly low because he wants to preserve economic growth in any way, even at the cost of doubling prices. Low interest rates make you want to borrow money to buy things or invest. For example, people buy more houses, so they hire more workers to build or renovate them, they in turn will spend and the economy grows. Furthermore, the fact that the Turkish lira is so weak represents an incentive for exports: for those who buy in foreign currency it is relatively cheaper to buy Turkish goods because they can take advantage of a favorable exchange rate.
When the economy gets “overheated” prices start to rise a lot: this is usually the time when central banks raise interest rates to slow down the economy. In Turkey, the central bank is not independent, as it should be, but responds to the political logic dictated by President Erdogan, who is effectively “doping” the Turkish economy to maintain consensus: the Turkish central bank has lowered rates month after month , going exactly in the opposite direction of all central banks in the West. But in Turkey central bankers have no choice but to do as they are told by the president or else they will be fired.
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The reduction in interest rates overall by ten percentage points from 2021 has done devalue a lot the Turkish lira, which in any case came from a rather difficult period: within 5 years it lost about 80 percent of its value against the dollar.
It is true that the weak currency has helped exports, which have reached an all-time high of $254 billion. At the same time imports also increased significantly, due to the increase in energy prices, which the Turks also had to pay more because they bought it with a weak currency (it took more lire to buy gas and oil in euros or dollars). Banks then started rationing loans, because it’s no longer cheap to lend at interest rates that low relative to inflation. This is putting companies that rely on credit on a lot of difficulty.
The Turkish economy has proved to be very resilient in the face of this very particular economic challenge: the population and companies have learned to live with ever higher prices and above all with growing uncertainty about the future. The Turkish manufacturing industry is solid and used to managing situations of financial instability, but for the development of companies it is one thing to survive adversity and one thing to be able to invest to grow. The population has basically stopped saving because they don’t know how much money will be worth in the future: therefore today consumption is substantially good, but sooner or later the system runs the risk of jamming and the consequences will be social rather than economic.
To aggravate the problem is the fact that in the meantime Erdogan has tried to buffer the social cost of keeping inflation so high with measures that are never decisive and often even counterproductive: in the past year he has increased minimum wages several times, increased minimum pensions and lowered the retirement age. Lately he has also promised to increase the salaries of civil servants. In a tweet he wrote: “We will increase the wages of our civil servants by 45 per cent, including the welfare quota, as part of the collective labor agreement. Good luck to our workers and our institutions».
We are going to increase the wages of our public workers by 45%, including the welfare share, within the framework of the collective bargaining agreement. Good luck to our workers and institutions. pic.twitter.com/pRXYFQkrk7
— Recep Tayyip Erdogan (@RTErdogan) May 9, 2023
In such an inflationary context, and in which monetary policy responses are totally counterproductive, the beneficial effect of an increase in workers’ wages will only last a few months: companies will have to bear higher costs, which they will then have to compensate with new increases in prices. In this way what is known in economics as the “price-wage-price spiral” is fueled: if wages are increased to compensate for inflation, it will in fact only increase and therefore one enters an endless inflationary cycle.
According to various analysts, after the elections there is a serious risk that the situation will worsen further: foreign investors have essentially abandoned the Turkish financial markets and the central bank has run out of foreign currency reserves it needs to artificially support the lira Turkey on the foreign exchange market. Emre Akcakmak, an economist heard from Financial Timessaid that the Turkish economy is now close to “breaking point”.
If Erdogan were to win, not much should change from the point of view of economic policies: it is probable that there will be a relaxation of the more populist measures, but there are no signs of a substantial change of course.
The opposition, on the contrary, argues that a reversal of the economic measures introduced so far is necessary and has made it clear that it intends to return to more conventional policies to stop the rise in prices. According to some economists heard from Politicoif Kilicdaroglu wins, however, it will not be easy to propose more appropriate measures after the years of Erdogan: interest rates should increase by at least 30 percentage points and the government should immediately have the credibility to convince the economic system that it is really intending to lower inflation.
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