GLOBAL DYNAMICS, DOMESTIC COALITIONS AND A REACTIVE STATE: MAJOR POLICY SHIFTS IN POST-WAR TURKISH ECONOMIC DEVELOPMENT 1

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1 GLOBAL DYNAMICS, DOMESTIC COALITIONS AND A REACTIVE STATE: MAJOR POLICY SHIFTS IN POST-WAR TURKISH ECONOMIC DEVELOPMENT 1 Ziya Öniş Koç University, Department of International Relations, 34450, Sarıyer/ İstanbul, Turkey Fikret Şenses Middle East Technical University, Department of Economics, 06531, Ankara, Turkey Abstract The main objective of this study is to propose an analytical framework to explain the major policy shifts that has characterized post-war Turkish economic development; divided into four phases, starting respectively in 1950, 1960, 1980, and Its main contribution is to incorporate external and internal factors into this framework within a broadly political economy perspective, attaching particular significance to the role of economic crises in moving from one phase to the other. While the role of external agents is identified as the main factor behind policy shifts, the role of domestic coalitions in support of policy regime in each phase is also recognized. Drawing attention to the role of state in the impressive recent growth of countries such as China, India, and Ireland, the paper argues that there is still room for the state taking on a developmental role. The paper recommends that Turkey follows a similar path by improving state capacity not only with respect to its regulatory role but also in more developmental spheres, encompassing its redistributive and transformative role on the basis of a domestically-determined industrialization strategy. Keywords: State capacity, policy transformations, crises, multilateral institutions, distributional conflicts, regulation 1 This study is a forerunner of work in progress on a book by the authors on the post-war economic development of the Turkish economy. The authors wish that this essay and its Turkish version, which will be produced in due course, will generate constructive debate among students of the Turkish economy. 1

2 1. Introduction Turkish economic development in the post-war period has been characterized by significant structural transformation. At the same time, however, one can identify significant continuities such as cycles of populist expansionism, periodic crises and encounters with the IMF as one moves from one major policy phase to the other. The objective of the present study is to propose a conceptual framework for understanding the major policy shifts which have occurred in post-war Turkish economic development, notably in the context of multi-party democracy which represents a major departure from the single party government of the interwar period. The proposed framework aims to account for this simultaneous mix of structural transformation and underlying continuities. Our central thesis is that Turkey, in the economic realm, represents a case of reactive state behavior. From a comparative perspective, reactive state behavior, which also appears to have characterized the policy stance of major Latin American countries such as Brazil, Mexico and Argentina, differs sharply from the more proactive state strategies aimed at industrial transformation, which seems to characterize the development experiences of key East Asian hyper-growth cases such as Japan, South Korea and Taiwan, and more recently the case of China. Parallel to the notion of the reactive state, our central contention is that the main impetus for policy transformation in Turkey has originated from external dynamics, with key external actors playing a central role in accomplishing the transition from one policy phase to another. There is no doubt that there exist certain limits concerning the ability of external actors or external forces to engineer policy transformation. External dynamics need to be integrated with domestic factors to provide a coherent explanation of major policy shifts. To be more precise, there must be a supporting domestic coalition of actors to render a major policy regime, such as importsubstituting model of industrialization (ISI) in the 1960s and the 1970s or the neo-liberalism and market-based development during the 1980s and beyond, the hegemonic policy regime during a specific period. Periodic macroeconomic or financial crises have a particular role to play in our analytical schema in the sense that they signify that a particular policy regime is no longer sustainable and needs to be replaced by a new policy regime. Crises also strengthen the hand of external actors and break down the resistance of key elements of the previous domestic coalition. They also facilitate the emergence of a new domestic coalition favoring the implementation of the new policy regime in line with the overriding impetus provided by the major external actors. Crises also serve the function of breaking-down the distributional 2

3 stalemate which emerges towards the end of each policy phase, thereby facilitating the transition to a new dominant policy regime. There is a vast literature on the post-war economic development of Turkey which has greatly enhanced our understanding of its pattern, main phases, as well as the main problems and issues involved. 2 We build on this stock of knowledge and attempt to cover the whole of the post-war period, by integrating the post-2001 crisis developments into our analysis. By bringing the internal and external factors that have affected economic development and incorporating political developments and the role of economic crises into our proposed analytical framework, we make a modest effort to provide a more comprehensive treatment of the major structural transformations involved in the context of the shifting development discourse. The analytical framework proposed is discussed in detail in sections 2 and 3. Then, the framework proposed is employed as a basis for explaining the four basic policy regimes that seem to characterize post-war Turkish experience in the era of multi-party democracy from 1950s to the present era in Section 4. Section 4, in effect, represents the substantive empirical component of the paper where the specific linkages between external actors and influences and supporting domestic coalitions are given precise meaning in the context of individual policy epochs. Although our analysis effectively ends with the transition to the latest policy regime in the post-2001 period, we briefly speculate about this period and consider the question of whether a real rupture has taken place, which differentiates this particular phase from earlier phases in the history of Turkish economic policy. In sections 5 and 6, we extend our discussion beyond the specific Turkish experience to the general realm of comparative development performance. Our central message in the present context is that the nature and quality of state intervention continues to be a critical variable in accounting for differences in development performance in the age of neo-liberal globalization, and notably, in terms of differentiating between cases of hyper-growth and moderate growth cases among lateindustrializing economies. Section 7 concludes. 2 See, for instance Hershlag (1968), Tezel (1994), Boratav ( 2003), Keyder (1987), Kepenek and Yentürk (2005), Kazgan (2001), Yentürk (2003) and Yeldan (2001). 3

4 2. Explaining Major Policy Shifts in the Context of Reactive State Behavior: An Analytical Framework Late development is a characteristic which is not unique to developing countries in the postwar context. Many countries currently classified in the advanced industrialized country category were confronted with similar problems of catching up with the leading countries of their time. 3 France and Germany in the 19th century and Japan in the immediate post-war period are typical cases of currently advanced industrialized countries which have been confronted with the challenge of late industrialization. Recent research reveals that none of the successful cases of late-industrialization, especially during the critical take-off phase of development, were integrated to the world market under free trade conditions. Active statebacked industrialization and the nurturing of a private entrepreneurial class under state protection constituted a critical element of their successful catching up process. 4 Clearly, the balance between state actors and private business shifts over time and the pendulum swings in favor of powerful private actors as these countries reach a certain level of maturity in their industrialization process. Hence, the fact that states play an exceptionally important role in the process of late industrialization given the fundamental initial weaknesses of a late developing country in terms of its technological, educational and entrepreneurial capacities is a commonly accepted proposition. What is important in the present context, however, is that states themselves can exhibit considerable variation in the process of late industrialization. The very differences in the nature of such states, the mode of their interactions with key elements of their societies can result in significant differences in the nature and quality of state intervention. The natural corollary of this is that such differences tend to produce significant contrast in development performance among individual countries over time. Our focus in this study is on a specific sub-set of state behavior or mode of intervention in the context of late industrialization. The sub-set of states that we have in mind are the kind of reactive states, which tend to be more representative of late development in the context of Turkey or the key countries of Latin America representing a sharp contrast with the pro-active or the developmental states that seem to be a key feature of the East Asian region. At a certain 3 See Gerschenkron ( 1962) for a detailed exposition of the concept of late development. For a more recent application of the concept in the East Asian context as well as other national settings see Amsden ( 1989, 2001). 4 See Chang (2002) and Shafaeddin (2005) for details on the industrialization experience of some of these countries and in particular the role of the state in this process. 4

5 level of abstraction, there is a certain similarity between the experiences of the so-called reactive states and the more strategically-oriented, pro-active developmental states of the East Asian region. In the case of reactive states, one can also discern significant element of interventionism in the direction of correcting market failures both directly through an extensive public enterprise sector, especially in the early stages of development, as well as through indirect intervention in the operation of the market mechanism using a large range of instruments. Perhaps, the central difference between the reactive states and their more proactive counterparts in East Asia, for example, is that the former are characterized by a much lower degree of state autonomy. In other words, reactive states tend to be more fragmented and enjoy a much lower degree of relative autonomy from key domestic constituencies such as the emerging industrialists. Hence, their ability to overcome sectional conflicts and concentrate their attention on longer-term strategic goals such as developing internationally competitive export industries tend to be more limited. Moreover, reactive states tend to move closely with the dominant norms in policy behavior accepted in major centers of international decision making. Reactive state behavior by definition means going along with the acceptable line of policy thinking as opposed to deviating from such norms in certain critical respects. Our explanations of major policy shifts in late industrializing countries, which display the common characteristic of reactive state behavior are based on the following integrated set of propositions. Proposition One: External actors or influences play a disproportionately important role in accounting for major policy shifts. There is no doubt that the role of external actors or influences needs to be disaggregated for proper analysis. Take the case of key external actors. This naturally includes the case of the leading or hegemonic power in the international system which in the post-war context has been the United States. There is no doubt that the United States as the global hegemon has played and continues to play a critical role in the case of late developing countries, although its power nowadays is increasingly challenged by a group of countries such as China which are in the process of moving from the semi-periphery to the center of the international economic system. The United States has exerted its economic influence both directly through economic and military assistance, and also indirectly through key international organizations such as the IMF, the World Bank, the OECD, the WTO and so on-institutions over which it 5

6 can exercise a disproportionate degree of influence. Moreover, the global hegemon can influence the development trajectories of individual countries not only through its manipulation of material incentives but also through the development of ideas. Dominant thinking on development typically originate from the center, in which the academic and policy making elite in the United States occupy a central position. Powerful ideas on development then tend to be institutionalized and transmitted to the periphery at particular moments of time through key international organizations. In the context of neo-liberalism, for example, strict conditionality of IMF stabilization policies and structural adjustment loans of the World Bank have been the most effective mechanisms transmitting these ideas to the developing country context. Proposition Two: External influences do not refer exclusively to the global hegemon or to key multilateral organizations. Key regional organizations as well as powerful private actors also play a critical role. This proposition assumes particular validity in the European context where the European Community or more recently the European Union has performed and continues to perform a central role in transforming the economic and political structures of countries in the European periphery, notably those countries which enjoy the concrete prospect of EU membership. Regional dynamics are also operative in other parts of the world, although they are not as institutionalized and powerful as in the EU context. Regional factors tend to interact with global forces. Given that Trans-Atlantic interdependence has been the norm in the post-war period, global and regional forces have tended to move in the same direction and have generally tended to strengthen the impact of one another. At the same time, the relative strength of global pressures and regional dynamics have tended to vary over time for individual countries as well as displaying significant variations across the spectrum of developing countries. Moving beyond the regional realm, powerful private actors also constitute a significant external force. The force of private actors has become increasingly striking over time reaching a peak of its influence in the era of financial globalization. The set of private actors which has now a major role in the policy process includes not only powerful transnational corporations (TNCs) investing directly in developing countries but also a large number of other private foreign investors, often small investors, actively participating in the capital markets of developing countries. The transnational financial alliance also includes, last but not the least, international banks and private rating agencies, which regularly monitor the 6

7 policy process in individual countries. Through their analysis of the credit-worthiness of individual countries, such agencies are able to exert a disproportionate impact over the policy process of individual countries. Aggregating all these elements together, we may be able to refer to a transnational power bloc, which forms the driving force or the central element in explaining the dominance of particular policies as well as policy shifts over time. The danger here is that we may exaggerate the degree of unity and coherence of this transnational power bloc and, in the process, fail to pay sufficient attention to the possible conflicts of interest between the different segments constituting this power bloc. Proposition Three: External Dynamics per se are insufficient to explain major policy shifts. The development of a supportive domestic policy coalition is crucial in this context. In spite of the fact that global or regional forces have become increasingly important in accounting for policy shifts over time, the effectiveness of such forces in terms of accomplishing a major shift in policy requires the parallel development of a supportive domestic coalition. In this context we need to make a distinction between the narrowly-based policy-coalition of interests which directly benefit from the shift of policy regime and the benefits associated with the newly-instituted policy regime. 5 To give an example, in the case of import-substituting industrialization, the policy coalition included the key bureaucratic agencies such as the planning bureaus which assumed a central importance during the course of implementing the strategy, state enterprise managers, domestically oriented industrialists benefiting from protectionism and other subsidies as well as organized labor employed in key import-substituting sectors. In some cases, for example in the case of Brazil and Mexico, inward-oriented TNCs have become a central element of the ruling ISI policy coalition. Hence, we may talk of a domestic power bloc in line with a transnational power bloc with the qualification once again that there may be significant tensions or conflicts of interests between the different elements constituting this power bloc. The important point to emphasize is that the emergence of a dominant policy coalition may not be enough in sustaining the policy especially in the context of more open and democratic regimes. Unlike the case of authoritarian regimes, the narrow policy coalitions needs to be extended and enlarged to build successful electoral coalitions to render the policy regime sustainable. To provide a specific 5 For an insightful examination of the role of domestic coalition building in Turkish economic development in the 1980s, see Waterbury (1992). 7

8 example, the narrow ISI policy coalition in a broadly democratic environment (for example, Turkey in the 1960s and the 1970s) had to be enlarged to include agricultural interests and to some extent small and medium sized enterprises, which were not formally part of the ISI coalition. Clearly, the enlargement of the policy coalition creates additional complications which we shall consider in the following section. Proposition Four: Transnational actors or policy entrepreneurs may play an important conduit role in terms of linking the interests of the transnational and domestic policy coalitions or power blocs. The importance of these actors becomes particularly significant in the context of institutionalizing neo-liberal globalization during the more recent era. In explaining major policy shifts and the institutionalization of the new policy regime, there is a need for an intermediating set of actors, which play a central role in tying the interests of the external and domestic components of the broad transnational coalition and helping to build mutual trust among the key actors involved in the process. Typically, individuals who have been educated in dominant academic establishments and/or have worked in major multilateral financial institutions are typically brought in to leadership positions in their home countries. Striking examples of this phenomenon in the Turkish context include Turgut Özal in the first wave of neo-liberal restructuring in Turkey during the 1980s and Özal s princes, the key American-educated bureaucrats who occupied major positions in the new layers of neo-liberal bureaucracy such as the Privatization Administration, public sector banks and the Central Bank during the same period ( Öniş, 2004). The case of Kemal Derviş, at the time serving as a vice president at the World Bank, who was called in to serve as the economic overlord and to head of the strong economy program in the aftermath of the 2001 crisis is equally striking. Latin American experiences with neoliberal restructuring are full of examples of critical individuals who have played a similar role between the transnational and domestic policy elites. Perhaps the best-known examples include Domingho Cavallo, the key technocrat who played a central role in instituting the Argentine neo-liberal program, and notably the convertibility plan, of the 1990s; Pedro Aspe who was a central figure in Mexican neo-liberal restructuring, and finally the Chicago Boys, the Chicago University educated group of technocrats who played a central role in the first wave of neo-liberal restructuring in the highly authoritarian setting of Pinochet s Chile during the 1970s. 8

9 3. Crises, Policy Choices and Path Dependence Periodic macroeconomic crises play an integral role in our explanation of major policy shifts over time for a number of important reasons: (a) Crises often constitute a clear signal that the underlying policy regime is unsustainable. Macroeconomic or financial crises in Turkey, Latin America and elsewhere often manifest themselves as balance of payments or external debt crises with the natural implication that the existing policy regime is unable to generate the foreign exchange resources needed to sustain the economy at a steady growth path. Typically, however, deeper forces are at work forming the background to such crises. Major economic crises, as the Turkish experience in the late 1970s, in 1994 and in clearly illustrates, are also fiscal and distributional crises. An unsustainable fiscal deficit in itself is a sign that there are major distributional pressures on governments originating from various segments of society such as business, labor, and farmers and so on which governments increasingly fail to handle. Attempts by major interest groups in society to claim a larger share of the pie naturally lead to a situation where government expenditures increase more rapidly than government revenues. Large fiscal deficits become a major driving force in the emergence of a chronic inflationary process which undermines the competitiveness of the economy vis-à-vis the external competitors. In such an environment, the balance of payments situation becomes increasingly vulnerable with stagnant exports, rising imports and falling foreign exchange reserves. For example, Turkey s growing fiscal deficits in the face of growing distributional claims from different segments of society together with attempt to push import-substituting industrialization into intermediate and capital goods in the 1970s increased the import dependence of the economy. Heavy import-dependence in the face of stagnant exports brought about a severe balance of payments crisis and the subsequent collapse of this model of industrialization by the end of the decade. In the more recent era of financial globalization, the problems have been compounded by the fact that such economies have become heavily dependent on fragile flows of short-term capital. Hence, it is not surprising that countries, which find themselves in a vicious circle of fiscal and distributional crises, tend to be even more vulnerable to a balance of payments crisis in an environment of heavy capital mobility and dependence on short-term capital flows. No wonder, therefore, that the frequency of crises has increased in the age of financial globalization as the post-1980 experience of Turkey clearly testifies. 9

10 (b) Frequent crises highlight the institutional weaknesses of countries in terms of their ability to manage underlying distributional conflicts or pressures. We may hypothesize that countries, which are in the middle of the spectrum between the two extremes of established authoritarian regimes and established democracies find themselves in a particularly vulnerable situation in this context. One of the deficiencies of countries, which are in the process of moving from democratic transition to democratic consolidation is the absence of sufficiently strong institutional checks and balances. The presence of such checks and balances would allow governments to manage the underlying distributional conflicts within the parameters of parliamentary democracy, a process which would also help them to contain fiscal deficits within permissible levels. It is also important to bring into the picture the distinction that we have already introduced between narrow policy coalitions and the broad electoral coalitions in this context. Established authoritarian regimes such as South Korea in the 1960s enjoyed a natural advantage in the sense that strategic policy choices could be made through the consent of the narrow policy coalition (namely state and business elites) without the need to engineer a broad electoral coalition. In the Turkish case, in contrast, the narrow policy coalition during the same-period was not sufficient to sustain the strategy. The narrow policy coalition had to be supported by the build-up of a broader electoral coalition. Within the parameters of an emerging parliamentary democracy, Turkey faced the dilemma that the build-up of such a broad electoral coalition raised acute problems of distributional management and fiscal disequilibrium which, in turn, helped to undermine the sustainability of the basic strategy adopted. (c) Crises play a transformative role by ending the existing distributional stalemate and by allowing the emergence of a new policy coalition to emerge especially by empowering external actors relative to domestic actors. Major crises have significant distributional repercussions. For example, the crisis of the late 1970s was resolved in the early 1980s by the collapse of the ISI coalition. The major distributional burden of the shift from an ISI based model to an export-based strategy in Turkey fell on wage and salary-earners and the agricultural sector. The crisis has enabled key external actors such as the IMF, the World Bank and the OECD to play a major transformative role as a new export coalition gradually replaced the previous ISI coalition and the most dramatic policy shifts in this process involved the exclusion of organized labor. In the absence of crises, the existing coalition supporting a particular policy regime tends to display considerable resistance to change in spite of the fact 10

11 that there might be clear signs indicating that the existing policy regime might no longer be viable or sustainable. This was clearly the case in Turkey towards the late 1970s. A major shift to an export-oriented strategy failed to materialize until the country actually experienced a major economic breakdown. (d) Crises also imply that countries postpone major policy choices with the result that action is delayed and the policy choice becomes more limited once the crisis actually occurs. The experience of East Asian economies is quite instructive here in the sense that such countries have been able to accomplish major policy choices voluntarily without actually experiencing major economic crises. A good example is South Korea s voluntary transition to exportoriented growth strategy in the early 1960s at a time when most late industrializing countries opted for a prolonged import-substituting strategy. This relatively early shift enabled South Korea to engineer a major breakthrough in terms of export performance, which proved to be the foundation of its hyper-growth experience allowing it to prosper much more rapidly than the vast majority of late developing countries. By similar logic, one can conjecture that if Turkey had been able to accomplish a voluntary transition to an export-oriented growth strategy in a planned fashion during the early 1970s, as opposed to a forced transition in the form of a reactive response to a major crisis, Turkey s development performance would have reached a higher plateau as a result. Delayed policy response which takes place after a crisis actually occurs means that the range of policy options tends to be much more limited especially in an environment where key external actors like the IMF assume disproportionate power and importance. To provide a concrete example in this context, in the absence of crises countries such as Malaysia and Chile were able to experiment successfully with heterodox policy instruments such as controls on short term inflows or outflows of capital. In contrast, such an instrument was not a realistic choice for Turkey in the aftermath of the 2001 crisis when an IMF-backed stabilization program took central stage. (e) Crises are inherently costly in social, political and humanitarian terms. Even though we recognize the transformative impact of crises, we should also underline the fact that crises tend to be extremely costly in terms of their human and socio-political consequences. In many Latin American countries and Turkey, major macroeconomic crises have been associated with the breakdown of democratic regimes and their replacement by highly repressive military regimes. The interruption of the democratic process in this manner has no doubt represented a major setback for the efforts of these countries to make the transition to becoming a full 11

12 democracy. Even in the more recent cases of crises, where the democratic regimes have tended to be more robust than in the past, the main burden of adjustment has tended to fall disproportionately on weaker segments of society. What is quite striking from this discussion is that the emergence of major policy shifts and the rise of the associated policy coalitions do not involve simply a technical, but also an intensely political process. 4. Major Policy Shifts in Turkey during the Multi-Party Era: Towards an Integrated Explanation The objective of the present section is to construct an empirical counterpart to the analytical framework developed in the previous sections. Our aim is not to provide a comprehensive overview of each policy phase. Instead, what we aim to do is to paint a stylized picture of the four main policy phases that we identify (Table 1) in order to illustrate the relevance or the applicability of our explanatory framework, particularly means of explaining the transition from one particular phase to another. We consider each policy phase in turn. (A) Transition from the Etatism of the Inter-war period to Agriculture-Led Integration to the World Economy: The Democrat Party Era of the 1950s 1950s mark a new era in the political and economic development of contemporary Turkey. This is a period which effectively constitutes the beginning of representative democracy in Turkey. In other words, it represented the end of the monopoly of single party government that characterized the inter-war period. The significance of the period also originates from the fact that etatism, the state-led industrialization strategy, as the hegemonic strategy of the inter-war era is replaced by a new economic strategy which placed primary emphasis on liberalization and a strategy of integration into the world market on the basis of agricultural exports. The emphasis of the new economic model of the 1950s was on agricultural development with a parallel focus on the development of transport and communication networks. The industrialization objective, confined to some progress in light consumption goods such as food and textiles, was relegated very much to the background. The aim of the new strategy was clearly to facilitate a process of integration both in domestic markets and to the global economy. In accounting for this major change of direction during our first policy 12

13 phase, both external and domestic factors were at work. During the post-war period, the United States emerged as the new hegemonic power and in the new Cold War context, with the Soviet Union posing a major security threat, Turkey found itself firmly located in the Western camp. In retrospect, the shift to the new strategy highlighted Turkey s very first encounter with the notion of aid conditionality meaning external resources will be available on the condition that policy changes required by the donor are made. Turkey in the 1950s became an important recipient of Marshall Aid provided by the US to important allies in the emerging Cold War context. Yet, access to aid necessitated a major shift of direction in terms of economic strategy. The key international institution that played an intermediating role in this context was the IBRD (namely the World Bank). The Thornburg Report (Thornburg et al. 1949) and the subsequent country report produced under the auspices of the IBRD ( IBRD, 1951) represented major critiques of the etatist strategy and outlined the key elements of reform. The strategy that the newly elected Menderes government adopted in 1950 was very much in line with the recommendations of the Thornburg Report. Although a major impetus for change originated from the drastically transformed international context of the post-war period, it would nevertheless be unfair to place all the emphasis on external actors and influences. Important changes have also been taking place domestically which also helped to undermine the etatist strategy towards the end of the 1940s. The newly elected Democrat Party under the leadership of Adnan Menderes represented a broad coalition of interests involving major landowners and commercial interests on the one hand and the broad spectrum of peasants and farmers, on the other. Rapid expansion of the cultivated land area accompanied by rapid mechanization and generous price support policies by the government were key instruments of this strategy. This broad domestic coalition also welcomed the new strategy proposed by the key external actors. Even though there was an element of conditionality imposed by the external actors involved, important domestic constituencies also provided significant support to this policy. The changing political environment in the early years of parliamentary democracy enabled the new political elite to implement this strategy quite effectively. Indeed, the early years of the 1950s represented one of the most favorable growth episodes in the history of the Turkish economy. The period, however, also marked the beginning of a pattern which was to be repeated frequently during the course of successive decades. After a promising beginning, aided by some aspects of a generally favorable external environment such as the buoyant demand in world markets for Turkish agricultural exports during the Korean War as well as favorable weather conditions, 13

14 the strategy encountered increasing problems during the course of the decade. Growing fiscal disequilibrium and rising inflation helped to undermine the balance of payments equilibrium with the result that a major economic crisis became inevitable by the late 1950s. Turkey experienced its very first encounter with the IMF in 1958, a decade or so later than its encounter with the World Bank. The collapse in the economic realm was not the only consequence for Turkey; the nascent democratic regime was interrupted by the military coup of 1960, too. Table 1: Key Turning Points in Turkish Economic Development and the Principal Driving Forces Phases Phase I: Transition from Etatism to Agriculture-based Integration to the World Economy: The Agrarian Populism of the 1950s Phase II: Transition from a broadly liberal policy regime to a protectionist import-substituting industrialization strategy in the 1960s and the 1970s Phase III: Collapse of ISI and the rise of Global Context and the Key External Actors US as the new hegemonic power; World Bank/IBRD is the key actor; Direct US aid under the Marshall Plan based on policy guidelines provided by the IBRD OECD/World Bank; EEC becoming important but still in the background in the Transatlantic alliance dominated by the US World Bank, the IMF and the OECD; geo- Dominant Development Discourse Benefit of integration and participation in the capitalist world economy; advantage of market-based development as opposed to the inefficiency of Soviet style central planning hand in hand with the emergence of structuralist development economics recognizing the role of state in development National developmentalism in a mixed economy context; the existence of pervasive market failures and the need for systematic state intervention and planning for rapid industrialization became the occupied mode of thinking The emergence of Washington Domestic Coalitions Policy A coalition of major land owners and peasants favoring an agriculture based strategy; as well as the emerging industrial bourgeoisie; the ruling party representing this new coalition of interests Emerging industrialists, the big bureaucratic agencies responsible for implementing the national developmentalist model as well as organized labor form the backbone of the new ISI coalition 14

15 the Neo-liberal Model with emphasis on Liberalization and De-regulation: The post-1980 era until the outbreak of the crisis Phase IV: Neoliberalism with a Regulatory State Component:The Post-2001 period strategic importance of Turkey in the ongoing Cold War context in the 1980s; EU became more important in the 1990s, but still a weak anchor IMF and the EU as the dominant actors with the World Bank somewhat in background; continued strategic importance of Turkey for the US in the post- Cold War and the post 9/11 global context Consensus; emphasis shifts from market to government failures in development with the logical corollary that correct policy involves extensive liberalization and privatization The emergence of the post-washington Consensus; shift of emphasis to the need for an effective regulatory state as the basic ingredient of market based reforms Export-oriented industrialists, including small and medium sized enterprises in the socalled Anatolian Tigers, financial interests as well as elements of the new neo-liberal bureaucracy Export-oriented big business becoming increasingly transnational in its operations; forming an alliance with a growing group of transnational investors; export oriented small and medium sized businessmen with financial interests; growing segments of the new regulatory bureaucratic agencies, institutions like the Competition Board, Central Bank, and the Bank Regulations and Supervisory Board occupying the prestigious positions on the bureaucratic arm of the neo-liberal state apparatus. (B) The Transition to Protectionism and Domestic Market-Based Industrialization Strategy of the 1960s and the 1970s: the ISI Era In retrospect, Turkey s shift of direction in the 1960s after only a decade seems rather surprising and requires an explanation. Clearly, several influences were operative which collectively explain this dramatic U-turn in a neo-etatist direction. Again starting with the external context, we may conceptualize the Turkish experience in the 1960s as Turkey s delayed encounter with the Keynesian Revolution in the West. The new Constitution of 15

16 1961 had a major emphasis on the extension of social rights and the idea of planned economic development. This new outlook clearly endorsed the key role of the state as a major agent of economic and social transformation and highlighted the impact of the Keynesian Revolution which had a deep impact in the United States and Western Europe in the 1950s and the 1960s. Furthermore, the major international institutions such as the World Bank increasingly found itself more receptive to the ideas of infant industry protectionism, at least on a temporary basis, as well as the idea of planned development as a means of fostering rapid industrialization and development. For the United States, the need to increase the pace of development in the periphery of the capitalist world economy was firmly rooted in the logic of Cold War rivalry, with the threat of the spread of communism creating an important impetus for the tolerance of more interventionist strategies in the emerging states of the developing world. The growing power of TNCs originating in the US, finding a lucrative base for investment in the large and protected home markets of the newly industrializing countries such as Brazil and Mexico also explain in part the growing receptivity on the part of the United States to the adoption of ISI-style development strategies. Hence, turning to the Turkish experience, the changing external context produced a favorable environment for the adoption of a new strategy and the fact that the old strategy had been discredited by a major financial crisis also helped to produce the necessary space within which the new strategy could be institutionalized. The key external actor which was directly involved in the policy process and the development of the new planning bureaucracy was this time the OECD, with Jan Tinbergen, the Nobel Prize winning economist, initially playing a central role in the design of Turkish five year plans. Again, however, we need to turn our attention to the domestic context to provide the necessary balance. In the domestic sphere, we observe the emergence of an ISI or a national developmentalist coalition which favored the new strategy. This new coalition embodied the rising industrialists of the 1960s, who were making the transition from landownership or commercial entrepreneurship to industrial entrepreneurship, a process which, indeed had started earlier, under the creeping protectionism of the late 1950s. The coalition also embodied key elements of the bureaucratic elite which had been marginalized during the Menderes era, but has managed to regain its status following the military intervention of Last but not least, organized labor, which received significant benefits in terms of expansion of social rights under the new Constitution of 1961, became another member of this nascent coalition. In contrast, farmers and peasants, for example, were excluded from the 16

17 basic ISI policy coalition, but given the numbers involved, governments in power under the constraints of parliamentary democracy had to resort to policies to bring the agricultural population into their broad electoral coalitions, particularly in the periods leading to general elections. The approach involving planned industrialization or planned development was often portrayed as a reaction to the uncoordinated expansionism of the Menderes era. The basic logic was to industrialize, moving stage by stage to higher levels of industrialization without undermining balance of payments equilibrium. The strategy was quite effective over the period in terms of accomplishing relatively high rates of economic growth and substantial structural change. Industrial entrepreneurship in Turkey was clearly the product of this particular phase of national development, during which both the private enterprises and state economic enterprises played a significant and complementary role. Again, the problem as in the previous era was that governments were not able to achieve sustainable growth. Rather reminiscent of the pattern of the late 1950s, the Turkish economy experienced another wave of fiscal disequilibrium and rising inflation. The outcome was a much deeper balance of payments and debt crisis in the late 1970s, judged by the standards of the previous crisis. This crisis may also be explained by the fact that Turkey encountered deep external shocks in the form of successive oil price hikes in the 1970s. The crisis pinpointed once again the deficiencies of Turkish democracy and the inability of governments in power to manage distributional conflicts within the institutional boundaries of parliamentary democracy in such a way that the management of these conflicts would be compatible with the goals of fiscal equilibrium and sustained economic growth. In line with our discussion, Turkish state s policy during the 1960s and the 1970s was very much in line with our notion of the reactive state. Turkey followed the route of the majority of late industrializing countries during this period in terms of pursuing a prolonged importsubstituting industrialization strategy. In this respect, Turkish development experience was much more in conformity with Latin America than East Asia. Arguably, we can classify the Turkish state as a fragmented developmental state enjoying a much lower degree of autonomy relative to the key societal actors such as the big business as compared with its East Asian counterparts in South Korea and Taiwan. Unlike the case of the East Asian states, the bureaucratic arm of the domestic policy coalition never had the upper hand. Indeed, the East Asian states were able to display a much more pro-active behavior in terms of their ability to 17

18 engineer major shifts in the direction of export oriented industrialization without actually experiencing the types of crises that Turkey or the major Latin American countries have experienced. (C) The Collapse of the ISI Model and Turkey s Encounters with Neo-liberalism and the Washington Consensus: the 1980s and the 1990s The third policy phase in our analytical schema corresponds roughly to the first two decades of neo-liberalism. Our general framework involving the combination of external dynamics and domestic coalitions is once again relevant in this context. Starting again with the external realm, the late 1970s are marked with disillusionment with the Keynesian Consensus in the North and the parallel process of formidable difficulties with the application of ISI strategies in the South. The late 1970s mark the rise of neo-liberalism as the hegemonic development discourse. The major Washington institutions increasingly embrace the basic message of neoliberalism and incorporate the key neo-liberal principles of market-liberalization and privatization into their conditional policy packages. Indeed, Turkey is one of the countries which become a testing ground for neo-liberal principles in the early 1980s. Key international institutions like the IMF, the World Bank, and the OECD have been collectively involved in Turkey s neo-liberal restructuring process. The collective power of these actors to instigate policy change became even more striking once the previous model had been discredited through a major crisis in the late 1970s and the country became heavily dependent on external financial inflows. The collective interests of major international institutions in Turkish restructuring process were compounded by the country s geo-strategic significance for the United States and its Western allies in a period marked by the Soviet invasion of Afghanistan signaling the continuation of the Cold War contest. On the domestic front, we also observe the collapse of the ISI coalition and its gradual replacement by a new export-oriented policy coalition. A distinctive characteristic of the domestic coalition during this phase was that it was basically built during and under the spurt of the policy transformation itself whereas in the previous phases the domestic coalition was developing before the policy change. 6 The twin forces of heavy external involvement under 6 Two prior short-lived attempts at export orientation in the early 1950s and early 1970s notwithstanding, it can safely be argued that a pro-export orientation constituency was notable for its absence when the ISI model collapsed at the end of the 1970s. As Ebiri (1980) has documented in detail, the most influential segments of 18

19 severe crisis conditions and the subsequent military intervention were instrumental in preparing the ideal ground for the flourishing of the neo-liberal model. The key members of the ensuing coalition were the components of the business community, especially parts of big business, which were able to make the transition from domestic markets to exports as well as elements of the new bureaucracy which became central to the implementation of the neoliberal program. Turgut Özal was the leading transnational policy entrepreneur, occupying central stage in this particular coalition during the first decade of neo-liberal reforms in the 1980s. Sidelined from this coalition were components of big business, which were unable to adjust to the new environment as well as elements of the classical or the etatist components of the economic bureaucracy such as the State Planning Organization (SPO). Perhaps the biggest loser in the new era was organized labor whose fortunes experienced major setbacks, especially during the early years of export-oriented growth when it was faced with severe repression and a sharp fall in real wages. In the early years, there was a considerable rift within the business community with respect to export versus domestic market coalition. This rift became less pronounced over time as the neo-liberal policy coalition expanded to include a larger segment of both big and small businesses which became increasingly export-oriented in their operations. The new policy coalition also included financial interests or the so called rentiers who clearly benefited from financial liberalization and high and rising domestic real interest rates. The fortunes of these groups improved further with opportunities to lend to the state at high interest rates as the government felt growing pressure to finance its rising fiscal deficits. In terms of economic performance, the period again was characterized by a boom-bust cycle rather reminiscent of the previous decades. Following a major recovery process in the early 1980s, a process in which external assistance played an instrumental role, the process became increasingly unsustainable and prone to crises in the context of the 1990s. Once again, this highlighted the weaknesses in the regulatory capacities of the Turkish state and its inability to manage distributional conflicts within a broadly democratic environment. The Turkish state again displayed reactive behavior in conforming to the norms of the Washington Consensus rather wholeheartedly by opening up the capital account regime in 1989, without achieving the necessary degree of macroeconomic stability and the tight regulation of the financial Turkish society just before the transition to the neo-liberal model in 1980 were in favor of the previous model. If anything, there were only isolated voices favoring an alternative path. See Krueger (1974) and Tekin ( 2006 ) on Turkey s attempts at liberalization and export orientation before

20 system. This constituted a sharp contrast with the experience of some other late-comers such as India and China which were much more gradual and selective in their approach to capital account liberalization. Particularly the second decade of neo-liberalism for Turkey represented the unhappy face of the Washington Consensus. The combination of fiscal instability and premature capital account liberalization in the absence of an adequate regulatory framework were largely responsible for the eruption of successive economic crises in 1994, 2000 and These crises have severely undermined Turkey s overall economic performance, especially judged by the performance of some of the key emerging markets, notably those in Asia and the post-communist Eastern Europe. (D) Neo-liberalism with a Regulatory State Component: The Post-2001 Era The crisis of 2001 in Turkey was perhaps instrumental in ending the years of the Washington Consensus and marking the beginning of a new encounter with some of the key principles embodied in Post-Washington Consensus. A mix of changing global dynamics and a parallel shift in domestic policy coalitions are at the heart of this transition to the new phase of the Turkish neo-liberal experiment. In terms of global dynamics, there is no doubt that there has been a broad disillusionment with Washington Consensus in action. Apart from its poor record in dealing with widespread poverty on a world scale, the frequency of crises in emerging markets during the 1990s, in particular, has raised very serious question marks against one of the core principles of the Washington consensus, namely wholesale financial and capital account liberalization. Especially, in the aftermath of the major Asian financial crisis of 1997, the IMF has faced a serious identity crisis. This identity crisis, in turn, has been associated with a shift of emphasis in the direction of strengthening institutions and the regulatory arm of the state. This shift of emphasis is also clearly reflected in the post-2001 restructuring process of Turkey with major attention paid to creating powerful regulatory institutions in the realm of banking and finance as well as enhancing the power and autonomy of existing key institutions such as the Central Bank. In discussing the post-2001 restructuring process a useful formulation might be the IMF-US- EU nexus. The active involvement of the IMF in Turkey s post-2001 process was once again shaped by the security concerns of the US which became all the more important in the post- 9/11 global environment. Furthermore, a distinct feature of the period was that the EU itself, for the first time, became a major source of economic and political change in Turkey, 20

21 following the critical turning point in December 1999 involving the transition of Turkey to full candidate country status for full-membership. Becoming effective at the beginning of 1996, the Customs union agreement represented an important landmark in Turkish economic history. Despite this fact, it is fair to say the real impact of the EU, in terms of both its conditions and incentives, is effectively felt in Turkey during phase IV, once the prospect of membership became a concrete possibility. The combination of IMF and EU conditionality has tended to reinforce one another. At the same time, the EU conditions have helped to generate a major wave of democratization reforms in Turkey. These are also important in terms of their economic repercussions in the direction of improving institutional quality and the rule of law, which probably would not have been possible if the IMF alone was involved in the restructuring process. Turning to the domestic plane, the new policy phase of policy regime had significant backing from key elements of big business as well as small and medium sized interests. Both elements favored a properly regulated macroeconomic environment as a necessary condition for achieving stability and sustainable growth, even if they were not equally enthusiastic about the prospects of tight regulation of the banking system. The business component of the coalition was extended to include much stronger foreign investor presence compared to the previous policy phases as Turkey has started to attract both significant long-term foreign investment as well as short-term investment during the recent era. Furthermore, a new element of the reorganized or reconstituted domestic policy coalition is the group of important autonomous regulatory institutions pointing to a significant shift of power within the internal organization of the state itself to these new forms of bureaucratic institutions. An interesting question to consider which is somewhat beyond the scope of the present essay is whether the current policy phase in Turkey represents a major rupture or a real break with the past, putting an end to the cycle of periodic crises and breakdowns resulting in a new policy phase in line with the changing global context. This is a somewhat speculative question considering that we are still in the process of living through this particular policy phase. An optimistic assessment would suggest that Turkey s economic performance has significantly improved in recent years judged by its ability to achieve high growth in a low inflation environment, which renders the achievement of sustained growth over time a stronger possibility than has been the case in the previous eras. What may also make one more optimistic about the future is that Turkey has been able to attract significant flows of long- 21

22 term investment for the first time in its post-war development trajectory. Furthermore, the EU anchor, in spite of its problems, constitutes a long-term external anchor. This again presents a certain contrast with the experience of the previous decades in the context of which key international institutions have acted as temporary rather than long-term anchors, with their transformative impact often being restricted to the immediate or, at most as in the context of the 1980s to medium-term post-crisis restructuring process. On a less optimistic note, one could also draw attention to elements of fragility that continue to exist in the Turkish economy such as a large current account deficit and a heavy domestic and external debt burden. One should also take into account the fact that Turkey has benefited enormously, like all other emerging markets, from the unusually favorable global liquidity conditions in the post-2001 era. Clearly, a possible reversal of these conditions could undermine the optimistic scenario concerning the future path of the Turkish economy. Likewise, the inability of the economy to generate sufficient productive employment despite rapid rates of growth, in the face of strong supply-side pressures in the labor market, leaves unemployment as a major problem for the foreseeable future. Finally, the persistence of severe inequalities at all levels and deep-seated poverty may present a formidable obstacle for the sustainability of the recent favorable picture. The foregoing analytical framework, while by and large embracing the main structural transformations in post-war Turkish economic development, still suffers from a number of shortcomings, warranting several caveats. First, there are the well-known difficulties of dividing a long period into distinct phases. Individual phases may not always show a uniform pattern over time. For example, although there is sufficient ground to describe Phase 1 as market based, one should not overlook the fact that there was a great deal of intervention by the government in industrial policy through the import and exchange rate regimes and also in the free functioning of the market mechanism through extensive price controls. Likewise, external factors, which were on the whole favorable in the first decade of Phase 2, present an altogether different picture in the second decade as relations with the United States turned sour following the Turkish intervention in Cyprus, adversely affecting Turkey s relations with the IMF and the international financial community. Second, the factors to which we have attached primary importance in explaining the movement of the economy from one phase to another are accompanied and augmented by powerful exogenous events, having differential impact on the course of the economy. For example, the Korean War facilitating buoyant demand for Turkish agricultural exports in Phase 1, labor migration from Turkey to Western 22

23 Europe and the concomitant inflow of sizable workers remittances as well as successive oil shocks in Phase 2, Iran-Iraq war providing an impetus for Turkish exports, the hostilities in the Eastern and Southeastern regions of Turkey over the Kurdish question, and the devastating earthquake in the industrial heartland of the country in Phase 3, and finally 9/11 in Phase 4 constitute some of these factors that in different ways have had a bearing on the nature and duration of each phase. Likewise, the interruption of Turkey s transient democracy on several occasions by military intervention, most notably in 1960, 1971 and 1980, although not altogether independent of developments in the real economy should also be included among such exogenous events shaping development. Third, the broad coalitions that have characterized each phase were not altogether free of inner tensions. For example, in Phase 2, the deep conflicts that bedeviled the First-five year plan even at the preparation stage 7 escalated in later years to stormy tensions between business interests and an increasingly vociferous organized labor. Upon closer examination, several additional characteristics of post-war Turkish economic development based on the four-phase analytical framework presented above emerge. First, Turkey has moved very much with the tide of the dominant development discourse and acted in a similar fashion with the bulk of countries at a similar level of development. In contrast, countries, which have moved against the tide in some important respects, have been the most successful, as the experiences of South Korea and Taiwan in Phase 2 and India and China in Phases 3 and 4 have amply demonstrated. Such observations call for the need to examine Turkish economic performance in different phases within a comparative framework with other countries at a similar stage of development. Although it is beyond the scope of this paper to indulge into such comparisons, 8 efforts in that direction may shed some light, for example, on the reasons behind Turkey s laggard record with respect to its production and labor market structure and key human development indicators. Second, Phase 2 stands out from the other three phases in some important respects. It is, especially in the first decade of this phase that Turkey comes nearest to showing some of the characteristics of a developmental and proactive state. Although external agents are at work they are very much in the background. External assistance is provided to support domestically determined development objectives as stated in five year plans. Moreover, the political regime 7 See Milor (1990) on this issue. 8 See Pamuk (2007) for a general account in this respect. 23

24 is more open than in the other phases. The domestic coalition is also distinctive in the sense that it includes broad segments of society, including labor. Third, although each phase has sufficient distinct characteristics facilitating the delineation of one from the other, one should not overlook the fact that, notwithstanding certain discontinuities they together represent a continuum, explaining a country s development over more than half a century. In this process, there has, however, been a remarkably sharp change in the attitude of domestic policy makers towards external influence in economic policy making. While the agriculture-based development strategy recommended by the World Bank was generally accepted in Phase 1, the relations between the World Bank and the Turkish government were not altogether amicable with the Turkish government showing a great deal of sensitivity to interference by the World Bank in domestic economic policy-making. 9 Likewise, the relations between the IMF and the Turkish government were far from being harmonious. The Turkish government was notorious in its failure not to stick to the initial agreements with the IMF for long in both Phase 1 and Phase 2. The relations between the IMF and the Turkish government reached their nadir at the end of Phase 2, at the height of the crisis in the late 1970s when the Turkish government showed considerable resistance to come to an agreement with the IMF. There was a sharp turnaround in the attitude of the Turkish government towards both of these institutions in Phase 3 so much so that these two institutions took central stage in the design of economic policies in Turkey s transition to the neo-liberal framework and increased their conditionality beyond the economic sphere in Phase 4, amidst charges in some quarters that Turkish economic policy-making is now altogether in their domain. 5. The Turkish Experience in a Broader Setting. The Continued Importance of State Capacity Turning from the Turkish experience to the general realm, the central diagnosis underlying the neo-liberal resurgence in development theory, which subsequently gave rise to the Washington Consensus, was that state failure was the root cause of weak economic performance. The natural corollary of this line of thinking which dominated the practice of key multilateral institutions such as the IMF and the World Bank was to reduce the weight of the state in economic affairs and expand the domain of the market. In a way, the state and 9 This sensitivity at times took a sharp turn with the Turkish government asking the World Bank office in Turkey to be closed and on a different occasion ordering a World Bank policy document to be actually destroyed. 24

25 the market were juxtaposed in dichotomistic terms: the retreat of the state was a necessary state in the enlargement of the realm of the free market. 10 What is interesting is that the accumulating evidence on economic performance in the era of global neo-liberalism during the past two decades reveals a paradox. State capacity, in one way or another, has been quite central in the experience of the more successful set of countries in the new era, managing to capitalize on the potential benefits and minimizing the risks associated with the novel environment of neo-liberal globalization. Similarly, it was weak state capacity which accounted for the relatively less impressive economic performance of countries like Argentina and Turkey. The latter have failed to convert early surges in growth to a process of sustained economic growth which would enable them to converge steadily towards the living standards of advanced economies. A similar dichotomy can be observed in the literature on globalization versus the nation state. Early and simplistic accounts suggested that the process of globalization would necessarily undermine the power and influence of the nation state in a way as to render the nation state obsolete over time. There is no doubt that the forces of globalization have placed major constraints on national economies and have, indeed, rendered certain specific instruments of economic policy quite redundant. 11 In the current international context, individual states find it increasingly difficult to implement old-style protectionism, industrial policies based on direct targeting of specific sectors, tight exchange controls over capital controls, extensive redistribution through large welfare states and the like. The fact that certain specific instruments are no longer implementable does not imply that the state, by definition, has lost all its relevance. In fact, the evidence increasingly suggests that state intervention, but through novel mechanisms and institutions, is the key to economic success in the experience of the emerging outliers ranging from China to India and Ireland in the new global context. Another key element that needs to be firmly integrated to the discussions of state capacity is the impact of the process of regionalization taking place concurrently with the process of globalization. There is a tendency in simplistic accounts to assume that the process of regionalization is likely to undermine state autonomy and render the nation state quite obsolete. Again, there is no doubt that the process of regionalization, particularly in the 10 See Öniş and Şenses (2005) for details. 11 For an early study drawing attention to the limitations on the policy space of developing countries see Öniş (1998). For more recent attempts in the same direction concentrating mostly on the limitations imposed by the WTO on the policy autonomy of developing countries, see Wade (2003) and Akyüz (2007). 25

26 context of formal arrangements like the European Union, results in a transfer of sovereignty in important ways from the nation state to supra-national institutions. But at the same time, active participation in regional experiments, such as membership of the EU, may help in improving state capacity, which also enables individual states to cope more effectively with the pressures and challenges of globalization. Hence, the issue of state capacity, in the current international context, should be approached in a triangular fashion in which the complex interactions between states, regional entities and the global context need to be taken into account and investigated explicitly. 6. Pro-active versus Reactive States: Interpreting the Experiences of Hyper- Growth Cases in the Age of Neo-liberal Globalization Our central contention is that state capacity matters in the age of neo-liberal globalization and following Linda Weiss (1998) state capacity needs to be disaggregated into three distinct components: (a) the developmental or transformative capacity (b) the regulatory capacity and (c) the redistributive capacity or more broadly the ability to build social cohesion. What Weiss refers to as the transformative capacity of the state, namely the ability to coordinate industrial change to meet the changing international competition, is in fact the development functions and capacities of the state (Weiss, 1998, p.7). According to Weiss, whose account is clearly influenced by the experience of Asian developmental states, state capacity in this context refers to the ability of policy-making authorities to pursue domestic adjustment strategies in co-operation with organized economic groups, upgrade or transform the industrial economy (Weiss, p.5). What is interesting in this definition is that there is no reference to specific instruments. The nature of the instruments may change both in line with the depth of development in the domestic industrialization process as well as the changing nature of the global economy and the constraints imposed by multilateral institutions. The focus on the transformative or the developmental capacity is important. But at the same time, it is incomplete in so far as it fails to take into account the other two dimensions of state capacity. These are also quite crucial in terms of the ability to generate sustained economic growth with social cohesion and to avoid costly financial crises in the process in the current international context and the distributional conflicts that often accompany them. 26

27 A cursory examination of comparative evidence suggests that the more successful states in the neo-liberal era have been pro-active states which have deviated from neo-liberal norms in certain crucial respects. There is no doubt that success is not associated with a process of selfenclosure and inward-orientation. Economies that have managed to generate high growth have been generally open, outward-oriented economies, which have tried to capitalize on export opportunities in the world market and long term foreign investment. At the same time, the opening up of this process has been based on a gradual and controlled liberalization process. The early success of South Korea and Taiwan was based on selective industrial policy designed to create successful export industries. The more recent examples of China, India and Vietnam also point towards the importance of industrial strategies. Whilst all of these are outward-oriented models, with external competitiveness as their points of reference, none of these could be described as typical examples of free market models. The Irish case, recently described as the Celtic Tiger, is a striking case of a country which has helped to develop the innovative capacities of domestic firms whilst trying to derive maximum opportunities from foreign investment opportunities at the same time. The Irish state has been quite successful in terms of integrating local firms into international networks. The pro-active policies of the Irish state, through new institutions such as the Irish Development Agency, has also been instrumental in attracting high-tech foreign investment to Ireland with a significant spin-off into the country s long-term industrial performance. (O Donnell, 2004). In addition to providing developmental and transformational capacities for both national firms and transnational corporations in terms of a high quality labor force and physical and legal infrastructure, the Irish state has also displayed strengths in the other key spheres of state capacity. It has been active in terms of developing a competitive and regulatory environment conducive for investment. In addition, the social partnership model, in the context of which the Irish state was an important actor once again, was quite conducive for the achievement of social and political stability needed for long-term productive investment. There is no doubt that the regional context was also important in Ireland s ability to benefit disproportionately from the globalization process. Many European and American firms have taken up the opportunity to serve the European market from a low-cost and nearby location and have consequently taken the decision to restructure production in Ireland. The key lesson here, which is certainly not unique to Ireland but constitutes a common denominator in other successful European cases such as the recent revival of the Swedish 27

28 model to successful Asian cases, is that the real economy matters. In line with this view, states try to adopt pro-active policies through various direct and indirect mechanisms to upgrade the performance of national firms as well as attracting in competition with other states the right kinds of FDI needed for long-term transformation. As the experience of Ireland clearly testifies the approach towards FDI is not a passive policy of creating the right environment, but a strategy that goes beyond this and tries to actively encourage the desired types of FDI through a variety of promotion and inducement mechanisms. Yet another important feature of the more successful pro-active states is that they are able to experiment with heterodox instruments such as controls over short-term capital flows. The evidence suggests that a number of important hyper-growth cases such as Malaysia and more recently other Asian economies which have actually experienced the crisis in 1997, such as South Korea, have successfully experimented with controls over short-term capital flows (Weiss, 2004). What is interesting here is that the more successful economies are the ones which are able to move beyond the confines of orthodox international financial institutions such as the IMF and experiment with heterodox policies of their own, a process that is associated with a virtuous cycle of crisis-free growth. Whilst the traditional developmental state has been undergoing a drastic transformation in recent years, there is no evidence that it has been totally dismantled. In fact, it is argued that it was the strength of the real economy, itself, a by-product of the developmental capacities of the Korean state, which has been quite instrumental in the strong post-crisis recovery process of the Korean economy (Weiss, 2004). In contrast, the relative under-performers or moderate performers, meaning those countries that have failed to realize their true economic potential considering the post-war era as a whole, such as Argentina and Turkey have been characterized by reactive states and weak state capacities in comparative terms. For the past quarter century, these states have been reactive in the sense that they have tried single-mindedly to follow the precepts of orthodox, neo-liberal recipes without in any way attempting to go beyond these recipes and experimenting with alternative forms of openness and degrees of integration into the global economy. All out openness rather than controlled openness have characterized their strategies. In retrospect, state capacity has been weak in all three spheres. First, there was insufficient emphasis in developing the strength of the real economy. Second, key regulatory reforms which would have helped to prevent major economic crises have been delayed. Third, the states concerned were not able to engineer social cohesion over long periods of time. 28

29 Consequently, their development trajectories, in a liberalized capital account environment, depended heavily on inflows of short-term capital and a process of fragile, debt-led growth with costly repercussions. Having made these points, we need to qualify our arguments on reactive states in three important respects. Firstly, a reactive state does not necessarily mean a mild or a benign state. It is a well-known fact that both Argentina and Turkey during critical phases of their post-war development have experienced breakdowns of democracy and highly repressive state behavior involving forced exclusion of popular groups from the political process. Secondly, countries with reactive states have enjoyed boom periods of rapid growth and during those periods they have managed to accomplish the kind of growth rates comparable to star performers. The problem, however, was that these boom periods were short-lived and often ended with a crises, which, in turn, helped to reduce the overall rate of growth by a considerable margin over time. Thirdly, countries like Turkey and Argentina have been performing unusually well in the recent era. Again, it is too soon to say whether this growth will be the kind of robust or durable growth which has characterized the experiences of the hyper growth cases. There is also an interesting problem of interpretation regarding the rather favorable recent macroeconomic performance of these two countries. Is it due to the improvement in the regulatory capacities of these states or have they been benefiting disproportionately from the unusual boom conditions in the international economy in recent years? Finally, an interesting question to pose in this context is whether there exists a link between state capacity and regime type in the current global context. Our basic conjecture here is that countries at the two polar ends of the spectrum namely established authoritarian regimes and established democracies appear to display superior state capacities. They are able to generate the kind of focus needed in terms of the development of longer-term supply-side policies as well as providing a more stable environment for long-term productive investment. In contrast, interim democratic regimes, with Argentina and Turkey clearly falling into this category, find it particularly difficult to develop the kind of state capacities needed to benefit from the globalization process on a substantial scale. The encounters of interim democratic regimes with financial globalization are typically associated with costly consequences. This observation immediately highlights the importance of a favorable regional context in terms of helping to break this deadlock. The incentives provided by potential EU membership are quite 29

30 critical in terms of facilitating the transition from an interim democracy to an established democracy and helping the process of institution building and the implementation of the rule of law which are likely to have a dramatic impact on the process of building state capacity and long-term economic performance in countries located in this category. The new Eastern European members of the EU such as Poland have clearly benefited from this process and have found themselves placed on a crisis-free growth trajectory through a parallel process of democratization and institutional economic reforms from the mid-1990s onwards. A similar process is currently occurring in the Turkish context and arguably places Turkey on a more favorable path compared to Argentina, where regional pressures for reform under MERCOSUR are weaker compared with the mix of conditions and incentives provided by the EU. 7. Concluding Observations The present study has attempted to accomplish two separate but interrelated objectives. The first objective was to propose a general framework based on global-domestic interactions to account for the four major policy shifts in post-war Turkish development experience. The second objective was to highlight the importance of the distinction involving reactive versus pro-active states in accounting not only for major policy shifts over time but also for the differences in the development performances of individual late industrializing countries. Furthermore, we have argued that the reactive versus pro-active state distinction is not only valuable for comparative-historical analysis but also continues to be relevant in the current era of neo-liberal globalization. The recent experience of countries like Turkey suggests that even reactive states can experience significant state transformation and a parallel improvement in state capacity with the primary impetus for change originating from external forces. There is no doubt that the regulatory arm of the Turkish state has improved considerably in the aftermath of the major financial crisis of The crisis itself was instrumental in terms of building a broad domestic coalition in favor of stronger macroeconomic and financial regulation. Perhaps even more significant was the fact that the crisis empowered key external actors such as the IMF and the EU to push strongly in the direction of regulatory reforms and the development of the 30

31 associated institutional capacity needed to implement such reforms. This brings us to a major element which differentiates the fourth and the most recent policy phase in Turkey from the earlier policy phases, namely the existence of a long-term external anchor in the form of the concrete prospect of EU membership. The transformative impact of the EU, which was clearly evident in other national contexts in Europe s Southern and Eastern periphery during the 1980s and the 1990s, was also very much in evidence in the recent Turkish context in the interrelated and mutually reinforcing realms of regulatory and democratization reforms. On the assumption that Turkey will continue to make further progress on the path to an established or a fully consolidated democracy, we are likely to be much more optimistic about its ability to make a radical break away from the boom-bust cycles which have been such a striking feature of its post-war development experience. Despite the existence of powerful external anchors, there is still need for decisive action on the domestic front, which would in the first place lead domestic actors to have a much bigger say in their interaction with the anchors. Although there has been increased transparency in the relations of Turkey with the international organizations such as the IMF, there is still little knowledge available about what goes on behind the scenes during negotiations, in particular on the effectiveness of domestic negotiators in putting forward an alternative case. A similar situation applies with respect to relations with the EU, the other powerful anchor. Turkey s attempts to become a full member going back to nearly half a century during which Turkey has been the passive and docile partner forcing the doors to enter at all cost without many scruples about the terms of entry, are again facing some reluctance on the part of established member states. Based on the accumulated wisdom of the rich development experience at home and abroad and recognizing the limitations imposed by the international environment, Turkey should develop a more balanced development strategy, a strategy in which domestic agents occupy a more central and pivotal role and are engaged in a complementary relationship with external agents as opposed to a strategy which is primarily driven by external agents themselves. The fact that there is still a variety of approaches in terms of foreign trade, foreign investment, R&D as well as macroeconomic and exchange rate policies 12, despite the more or less uniform application of neo-liberal economic polices through much of the developing world 12 See Akyüz (2007) on this point. 31

32 for more than a quarter century, should encourage domestic policy makers in this endeavor. In line with its determination to become an established democracy, the main objectives and instruments of the strategy should be developed with the full participation of major stakeholders. There is sufficient domestic expertise to give Turkey s integration with the international economy a more developmentalist focus. Rather than accepting the continuous retreat of the state from economic life, it should seek ways and means to develop state capacity in all of its three forms. Although some important steps have been taken in recent years to develop regulatory capacity, it is, yet, early to see the effectiveness of the new regulatory institutions in action. Simply transferring institutions from one context to another does not guarantee their effectiveness in the new environment. 13 The establishment of independent regulatory institutions in the post-2001 crisis era was by no means a harmonious process free of political interference. While a lot of the effort for regulation in financial markets requires concerted international action, countries like Turkey which are particularly vulnerable to the speculative whims of financial investors should not be reticent in imposing defensive mechanisms. It is the other two aspects of state capacity that require even more urgent action. In terms of transformative capacity there is need for effective industrial policy to broaden the industrial base towards skill and technology intensive branches. This should in due course help Turkey s current export structure, based on a handful of commodities headed by textiles and clothing to change to incorporate higher value added products with better prospects in world markets. The limitations imposed on nation states to implement independent macroeconomic and industrial polices through multilateral rules and obligations, especially in the post-wto international environment notwithstanding, there is room for maneuver for individual developing countries 14, especially in the sphere of incentives directed to research and development and regional development. The redistributive capacity remains the weakest link in this respect with inequality at virtually all levels but especially in terms of gender based and regional inequalities placing Turkey among high inequality countries in terms of distribution of income and human development. 13 Competition Board, for example, established in 1995 long before the new independent institutions, established after the 2001 crisis has not yet received wide acclaim in terms of its effectiveness. 14 See Akyüz (2007) in this context. 32

33 Although there has been much talk about poverty alleviation, efforts in this direction have remained miniscule in the face of the scale and gravity of the problem. The biggest obstacle here remains in the redistributive component requiring in the final analysis the more active organization and participation of the lower income sections of the population in the political process. Turkey s success in developing state capacity simultaneously in these three spheres no doubt depends on its ability to create the supportive institutional framework and the emergence of a domestic coalition favoring such a transformation. 33

34 References Akyüz, Y. (2007), Global Rules and Markets: Constraints over Policy Autonomy in Developing Countries, paper prepared for the International Institute for Labor Studies of the ILO, Geneva. Amsden, A. (1989), Asia s Next Giant: South Korea and Late Industrialization, New York: Oxford University Press. Amsden, A. (2001), The Rise of the Rest : Challenges to the West from Late-industrializing Economies, New York: Oxford University Press. Boratav, K. (2003), Türkiye İktisat Tarihi, , Istanbul: Imge Kitabevi Yayınları. Chang, H. (2002), Kicking away the Ladder: Development Strategy in Historical Perspective, London: Anthern. Ebiri, K. (1980), Turkish Apertura, Part I, METU Studies in Development, 7 Gershenkron, A. (1962), Economic Backwardness in Historical Perspective: A Book of Essays, Cambridge MA.: Harvard University Press. Hershlag, Z. Y. (1968), Turkey: The Challenge of Growth, Second Edition, Leiden: Brill. IBRD (1951), The Economy of Turkey: An Analysis and Recommendations for a Development Program, Washington DC: International Bank for Reconstruction and Development. Kazgan, G. (2001), Tanzimattan 21 inci Yüzyıla Türkiye Ekonomisi: Birinci Küreselleşmeden İkinci Küreselleşmeye, Istanbul: Istanbul Bilgi Üniversitesi Yayınları. Kepenek, Y. and N. Yentürk (2005), Türkiye Ekonomisi, 11.inci Baskı, Istanbul: Remzi Kitabevi Yayınları. 34

35 Keyder, Ç. (1987), State and Class in Turkey: A Study in Capitalist Development, London: Verso. Krueger,A. O. (1974), Foreign Trade Regimes and Economic Development-Turkey, New York: Columbia University Press for NBER. O Donnell, R. (2004), Ireland: Social Partnership and the Celtic Tiger Economy, in J. Perraton, and B. Clift,eds., Where are National Capitalisms Now? Basingstone Hampshire: Macmillan, Milor, V. (1990), The Genesis of Planning in Turkey, New Perspectives on Turkey, 4: Öniş, Z. (1998), Globalization and the Nation State: The Possibilities and Limits of State Intervention in Late Industrialization in Z. Öniş, State and Market: The Political Economy of Turkey in Comparative Perspective, Istanbul: Boğaziçi University Press, Öniş, Z. (2004), Turgut Özal and His Economic Legacy: Turkish Neo-liberalism in Critical Perspective, Middle Eastern Studies, 40(4): Öniş, Z. and F. Şenses (2005), Rethinking the Emerging Post-Washington Consensus, Development and Change, 36 (2): Pamuk, Ş. (2007), Economic Change in Twentieth Century Turkey: Is the Glass more than Half Full?, in R. Kasaba, ed., Cambridge History of Modern Turkey, forthcoming. Shafaeddin, M. (2005), Towards an Alternative Perspective on Trade and Industrialization Policies, Development and Change, 36(6): Tekin., A. (2006), Turkey s Aborted Attempt at Export-led Growth Strategy: Anatomy of the 1970 Reform, Middle Eastern Studies, 42(1): Tezel, Y. S. (1994), Cumhuriyet Dönemi İktisat Tarihi, Istanbul: Türkiye Ekonomik ve Toplumsal Tarih Vakfı. 35

36 Thornburg, M., G. Spry and G. Soule (1949), Turkey: An Economic Appraisal, New York: Twentieth Century Fund. Wade, R. (2003), What Strategies are Viable for Developing Countries Today? The WTO and the Shrinking of the Development Space, Review of International Political Economy, 10(4): Waterbury, J. (1992), Export-led Growth and the Center-Right Coalition in Turkey, Comparative Politics, 24(2): Weiss, L. (1998), The Myth of the Powerless State. Ithaca, New York: Cornell University Press. Weiss, L. (2004), Developmental States Before and After the Asian Crisis In Perraton, J. and B. Clift,eds., Where are National Capitalisms Now? Basingstone Hampshire: Macmillan, Yeldan, E. (2001), Küreselleşme Sürecinde Türkiye Ekonomisi: Bölüşüm, Birikim ve Büyüme, Istanbul. İletişim Yayınları. Yentürk, N. (2003), Körlerin Yürüyüşü: 1990 Sonrası Türkiye Ekonomisi ve Krizler, Istanbul: Istanbul Bilgi Üniversitesi Yayınları. 36

37 Turgut Özal and his Economic Legacy: Turkish Neo-Liberalism in Critical Perspective ZIYA ÖNIŞ Turgut Özal was a critical figure in Turkey s transition to a neo-liberal development model in the 1980s. Arguably, he was also the most influential political leader in Turkey since the time of Kemal Atatürk. An adequate account of Özal s legacy, therefore, has to encompass a number of different dimensions of his influence not only in the economic field but also the transformations that Turkey has gone through in the spheres of politics, culture and foreign policy initiatives in the post-1980 era. 1 The present article will focus explicitly on one particular dimension of his legacy, namely the impact that he had, both positive and negative, on the course of Turkey s neoliberal economic transformation during the 1980s and 1990s. In assessing his economic legacy, however, we shall also aim to tackle the thorny question of Özal s vision of democracy and democratic institutions particularly in the context of Turkey s ability to accomplish economic transformation in a neoliberal direction within the framework of democratic institutions. From a comparative perspective, certain parallels may be drawn between Özal and neo-populist political leaders, such as the Argentine President, Carlos Menem, who have also played a key role in terms of implementing radical market-oriented economic reforms and justifying the implementation of such reforms to wide segments of the electorate. Yet, even judged by his Latin counterparts, Özal was unique in the sense that within the course of a single decade he managed to combine two rather different attributes, namely the role of a technocrat in a largely authoritarian setting as well as the role of a reformist politician in a broadly democratic environment. In retrospect, Özal s influence embodied a strong positive dimension. The continuity of leadership throughout the 1980s was instrumental in Turkey s swift recovery from the deep economic crisis that the country had found itself in during the late 1970s. It played an important role in enhancing the credibility of the stabilization-cum-structural adjustment programme sup- Middle Eastern Studies, Vol.40, No.4, July 2004, pp ISSN print/ online DOI: / # 2004 Taylor & Francis Ltd.

38 114 MIDDLE EASTERN STUDIES ported by key international institutions such as the Organization for Economic Co-operation and Development (OECD), the International Monetary Fund (IMF) and the World Bank, in both domestic and international circles. His unusually diverse background in economic bureaucracy, private business and international organizations helped to inspire confidence and build a broad base of support for the programme. His bold initiatives helped to accelerate the momentum of the liberalization process in the Turkish economy, notably in the realms of trade and capital account liberalization. Moreover, his bold leadership style injected a considerable degree of optimism concerning the future of the Turkish economy in the mid- 1980s, a state of affairs which was largely absent in the subsequent phase of Turkish neo-liberalism during the 1990s. A balanced interpretation, however, needs to highlight the negative aspects of Özal s economic legacy as well. In retrospect, the weakest link in Özal s economic thinking was the tendency to underestimate the importance of the rule of law and the need to develop a strong legal infrastructure for a wellfunctioning market economy. His preference was for ruling by decrees, hence bypassing normal parliamentary procedures and constraints. His vision was rather typical of the kind of practice associated with the Latin American style presidential systems characterized by the absence of checks and balances providing enormous powers for the key individual in charge. Whilst, this style of decision-making was useful in terms of the ability to undertake decisions rapidly and overcome powerful interest group pressures, nevertheless, it tended to undermine the longer-term viability of the programme. Indeed, the origins of the significant increase in corruption in the Turkish economy during the course of the 1990s might be considered a direct legacy of the Özal era of the 1980s, notably the failure to penalize the misuse of export subsidies during the mid-1980s. The principle involving economic punishments for economic crimes nicely illustrates the rather relaxed attitude that Özal entertained with respect to the proper implementation of the rule of law in the economic sphere with rather devastating consequences. Özal also tended to neglect the need to develop a strong institutional infrastructure for the effective operation of a market-oriented economy. His approach involved direct confrontation with the classical bureaucracy. He tried to implement the reform process in a concentrated and top-down fashion. His approach also involved the creation of totally new layers of bureaucracy (such as the Privatization Administration) which often resulted in serious intra-bureaucratic conflicts. These new institutions often lacked a proper bureaucratic tradition or culture. Hence, one could argue that the implementation of the reform process in Turkey was associated with a weakening of the bureaucratic or the state apparatus, arguably with costly consequences. Yet, to be fair, one clearly needs to highlight the dilemma that

39 ECONOMIC LEGACY OF TURGUT ÖZAL 115 a reformer such as Turgut Özal faced: namely, could radical reforms be implemented in co-operation with existing layers of bureaucracy, given the étatiste mindset prevailing in those key institutions. Finally, the decision to open up the capital account fully in August 1989 was primarily Özal s own initiative. Most commentators would agree that this was a premature decision in the presence of pervasive macroeconomic instability and a severely under-regulated financial system. What is striking for our purposes is that the successive crises that Turkey experienced over a short interval in 1994, 2000 and 2001 had their origins in key decisions implemented during the Özal era. In that sense, one can argue that there is an essential line of continuity between the apparently more successful 1980s and the less successful and unstable era of the 1990s and beyond. Turgut Özal s unusually diverse background equipped him with a unique set of advantages to play an effective leadership role during the course of Turkey s neo-liberal transition. Özal was born in Malatya, a town in the eastern part of Anatolia in He came from a conservative and religious family of humble means. He rose from the periphery of Turkish society to key echelons of public and private power during the course of the 1960s and the 1970s. As a graduate in electrical engineering from the prestigious Istanbul Technical University (ITÜ), he became a public sector employee at the Agency for the Study of Electrical Energy. 3 His renewed association with Süleyman Demirel, who was a few years his senior at ITÜ has played a decisive role in Özal s subsequent career. During the early 1960s, Özal was among a group of conservative politicians and bureaucrats who joined the Justice Party (Adalet Partisi, AP). During this period, Özal acted as a technical adviser to Demirel, who subsequently became the Prime Minister following the electoral victory of the AP in 1965.The special relationship between Demirel and Özal was instrumental in the appointment of Özal as the Under-Secretary of the State Planning Organization (the SPO), the most prestigious institution in economic bureaucracy during the import-substitution era, in 1967 and he remained in that position until Having been exposed to the high echelons of economic bureaucracy, the next stage in Özal s rise to the top was the two-year period that he spent at the World Bank during the early part of the 1970s. Following his return from Washington, Özal returned to Istanbul to work for the private sector. During the period from 1973 to 1979 Özal held a number of top-level managerial positions in the private sector. Particularly important in this context was the key position that he occupied at the Sabancı Corporation, one of the leading conglomerates in Turkey. This unique background involving exposure to public, private and transnational organizations, at successive phases of his career, clearly proved to be a major asset for Özal during his subsequent rise to political power. The fact that he worked for the World Bank during the

40 116 MIDDLE EASTERN STUDIES early 1970s was useful in generating confidence on the part of the key external actors as well as the international financial community at large. Yet, given his strong roots in Turkey s key state institutions and major private sector conglomerates, he was much more than a mere representative of transnational capital. His strong domestic roots provided him with a strong base within the elite structures of Turkish society. Yet, Özal was much more than a technocrat who could only appeal to narrowly-based elite structures within the state establishment as well as the dominant centres of national and transnational capital. His unusual background, once again, provided him with a decisive edge in this respect. Özal s Islamist roots which were evident during his tenure as the Under- Secretary at the SPO, came increasingly to the surface in the late 1970s, when he tried to enter national politics as a candidate of the National Salvation Party (the MSP) led by Necmettin Erbakan. Although Özal failed to win a seat in Parliament at the time, his Islamist leanings have subsequently proved to be a major advantage in his quest to generate broad-based public support. Through his unique background, Özal was able to override the traditional secular-islamist or the centre/periphery divide in Turkish society. His moderate Islamist leanings enabled him to appeal to the conservative masses on the periphery of the Turkish society, whilst he could also appeal to the secular elites through his attractive projects aimed at modernization and economic reform through closer integration with the western world. 4 Considering Özal s extra-ordinary attributes as a technocrat respected both in national and transnational circles, it was perhaps not surprising when he was appointed by Demirel as the key figure to implement the reform programme instigated on 24 January 1980 in his capacity as the Acting Head of the SPO and the Deputy Under-Secretary of the Prime Minister. What is fascinating was the continuity in Özal s role as the key technocrat responsible for the stabilization and reform programme following the collapse of the civilian government in September Özal s strengths in economic matters as well as his skill in negotiation with international organizations rendered him an attractive choice for the military elites, in spite of the fact that they were not receptive to his Islamist leanings. During the interim government that followed the military intervention, Özal occupied the post of the Deputy Prime Minister in charge of Economic Affairs. Özal stayed in this position for almost two years until the time of the bankers crisis in the summer of The fact that his Finance Minister, Kaya Erdem, was implicated during the crisis put pressure on him to resign. 5 From this point onwards, Özal found himself in a new phase of his political career. During the period, Özal was actively involved in the formation of a new political party, namely the Motherland Party (the ANAP). The ANAP gained a major victory in the elections of November 1983 that

41 ECONOMIC LEGACY OF TURGUT ÖZAL 117 marked Turkey s return to parliamentary democracy, contrary to the wishes of the military elite. 6 Özal, as the leader of ANAP, became the Prime Minister and reached the peak of his influence in that position for the next six years, with the ANAP repeating its electoral success during the elections of November Özal became the president of the Republic in November 1989, a position that he occupied until his unexpected death in April Thus, for a period of a decade, from January 1980 to November 1989, albeit with the interruption of a brief period, Turkey experienced extraordinary continuity in economic leadership. This made a sharp contrast with the highly fragmented political order and lack of effective leadership throughout the next phase of economic reforms during the 1990s. Özal had the rare ability to make an effective transition as a leading technocrat in an authoritarian interim regime to a civilian politician with mass political appeal over a short space of time. The political party that he helped to create was based on a hybrid ideology combining elements of liberalism, conservatism with strong Islamist connotations, nationalism and welfarism. By effectively exploiting this hybrid ideology, ANAP under Özal s leadership could appeal to both the centre and the periphery, transcending the elite versus non-elite divide in Turkish society. 7 In retrospect, Özal s unusual credentials become even more apparent when they are placed in comparative perspective. A useful comparison in this context would be with Kemal Derviş. Derviş was appointed as the key technocrat in charge of the economic reform programme by the Prime Minister Bülent Ecevit, following the major economic crisis that Turkey experienced in February Derviş had an impressive career at the World Bank reaching top positions in that institution. Hence, he clearly possessed the credentials that would generate the trust of the transnational financial community as well as key elements of the pro-reform coalition at home. Derviş has undoubtedly played an important role in instigating Turkey s recovery process in the aftermath of the 2001 crisis. Yet, contrary to Özal, Derviş was unable to transform his strong technocratic credentials into political success. 8 Derviş clearly lacked the kind of domestic political base or the kind of political background that Özal possessed that would appeal to broad sections of the electorate. What is interesting, from a comparative perspective, is that support from the transnational financial community per se is not sufficient for domestic political success. Indeed, close affinity with transnational capital and its key institutions might have worked against Derviş, in the sense that key segments of the electorate have identified him as an agent of the IMF, transplanted to Turkish politics by external forces. Derviş, as a representative of the transnational capital and narrowly-based Istanbul elites, lacked the necessary political infrastructure necessary to enable him to appeal successfully to wider segments of Turkish society. What

42 118 MIDDLE EASTERN STUDIES the Özal experience highlights in contrast is that strong, organic links with transnational financial networks may constitute an important source of political advantage in the era of neo-liberal globalization provided that a strong base of domestic political support exists at the same time. Successful transition to a neo-liberal model of development requires strong and effective leadership for a number of different reasons. First, countries like Turkey shift to a neo-liberal model not from voluntary choice but as an inevitable and forced outcome of a major balance of payments crisis associated with the exhaustion of the import-substitution model of industrialization. In this context, the support of the transnational community is crucial for accomplishing a smooth process of recovery and a basis for sustained economic growth. Clearly, support will not be forthcoming from the international financial community, at least not on an adequate scale, if key institutions of the international financial order lack trust in the leadership and its commitment to the reform process. Second, leadership is important in terms of generating trust on the part of both domestic and external capital. This is also a crucial element in the sense that long-term success of a reform programme depends crucially on the investment performance of domestic and external capital. Third, the ability to sustain the reform process, in a predominantly democratic environment, depends on its acceptability to broad segments of the public. Hence, leadership becomes critical in terms of incorporating broad strata of the population as stake-holders in the reform programme. In all these three respects, Turgut Özal s was crucial in the context of the 1980s. The 1980 programme which was one of the earliest of its kind involved close co-operation between the IMF and the World Bank as the providers of massive financial support for Turkey. 9 The scale of financial support was, in part, due to Turkey s geo-strategic importance. Yet, Özal s leadership, with his unique background and credentials as well as his negotiating skills was also important in securing a fine deal with the international financial community from a Turkish point of view. Özal s leadership also injected a considerable sense of optimism into the domestic business community which had been accustomed to operate within closed walls and high protective barriers. Clearly, the changing nature of incentives made the environment much more attractive in the early 1980s. Nevertheless, Özal s influence was important in creating a mood of optimism whereby Turkish businessmen felt confident in their ability to penetrate distant markets. What is important is that this element of optimism was not only injected into the business community but into the Turkish public at large. Özal s project of popular capitalism through such measures as mass housing projects, sale of revenue sharing certificates and high interests for the savings

43 ECONOMIC LEGACY OF TURGUT ÖZAL 119 of small investors managed to incorporate with considerable success middle strata of the Turkish public as key stake-holders in a Thatcher-style project of popular capitalism. Clearly, his aim here was much more than simply generating a broad-based political coalition to secure ANAP s electoral success. It was part of a broader project implemented with missionary zeal to transform the Turkish economy and Turkish society at large in the mould of what he believed to be a genuinely capitalistic economy and society, overcoming its strong étatiste reflexes in the process. On a broader level, Özal s vision and influence was important in helping to transform a selfenclosed society, with a mediocre image of itself, to an outward and forwardlooking society that aimed to participate and play an active role in the key regions surrounding Turkey. The optimism that Özal inspired concerning the future of the Turkish economy also helped to reverse the brain drain. Özal actively encouraged this process through the appointment of highly-educated figures who had been trained in the United States for top positions in the bureaucracy. But, clearly, the process was not confined to bureaucracy. It also constituted a more general phenomenon with a number of highly educated people, who would normally have preferred to stay abroad, returning home and taking up key positions in the private sector. In spite of his moderate Islamist leanings, Özal placed major emphasis on developing close relations with the European Community. Right from the beginning, he believed in the importance of a strong external anchor, such as membership of the EC, for the consolidation of the reform process in Turkey. 10 Indeed, his thinking in this respect may be traced back to the period at the SPO during the late 1960s. Even in the heyday of import-substitution and heavy protectionism he believed in the importance of trade liberalization as a means of disciplining domestic industry by exposure to external competition. Hence, step by step integration into the EC constituted a crucial step in creating a genuinely competitive industry on the domestic front. 11 Özal played an active part in pushing for Turkey s application for EC membership in The move was, in part, tactical in the sense that the primary aim was to accelerate the process of trade liberalization given that there was no likelihood at that point that Turkey s membership application would receive a favourable response from the Community. Indeed, Turkey s application was rejected, but Özal s initiatives paved the way for the Customs Union that became a crucial element in the full-scale liberalization of the Turkish economy in the context of the 1990s. In retrospect, the trade liberalization process in Turkey could have been a much more gradual process in Özal s absence. Important segments of the Turkish business community, notably those that were primarily oriented towards the lucrative internal market, resisted trade liberalization. Were it not for Özal s bold initiatives in this respect, which he often tied in with the goal of EC

44 120 MIDDLE EASTERN STUDIES membership, the exposure of domestic industry to genuine external competition would have been a far more protracted process. Özal was undoubtedly a staunch believer in and supporter of economic liberalism. Yet, his brand of liberalism contained a number of unorthodox elements judged by the standards of liberalism that dominate economic and political discourse in advanced democracies. In contrast, he displayed apparent similarity with his neo-populist counterparts in Latin America, such as Carlos Menem. His style of governance was characterized by weak commitment to democracy, institutions and the rule of law. 12 There is no doubt that Özal displayed a certain vague commitment to representative democracy as a natural counterpart of a market-oriented economy. Yet, he failed to display a kind of deep commitment and respect for the institutions and norms of a democratic polity. In retrospect, his vision of democracy was quite representative of the kind of constitutional economics associated with the writings of Buchanan and Hayek, the kind of neo-conservative, new right thinking that exercised a key influence over the minds of such conservative leaders as Ronald Reagan in the USA and Margaret Thatcher in Britain. A central idea in this respect was to limit the powers of representative institutions such that the natural workings of the free market could be protected and insulated from the detrimental effects of powerful interest group pressures that can be exercised through representative institutions. Hence, the notion of limiting the domain of representative democracy for the benefit of the market was an idea that Özal clearly favoured. 13 Ultimately, what Özal desired foremost was the speedy implementation of market-oriented reforms. It was important in this respect that decisions be taken quickly and not be obstructed by key interest groups that had a stake in opposing reform. Hence, for the sake of the economic process, it was imperative to by-pass democratic processes such as the constraints imposed by bureaucratic and parliamentary norms. Not surprisingly, Özal preferred a decision-making style based on Cabinet Decrees as opposed to Acts of Parliament. For example, key decisions on privatization of state economic enterprises from 1986 onwards were achieved by government decrees. The absence of an explicit Privatization Law, however, has been amply exploited by the opponents of the privatization programme who managed to block key privatization deals via recourse to the Constitutional Court. Hence, the absence of a strong legal infrastructure has clearly jeopardized the success of the privatization programme. 14 Similarly, Özal preferred flexibility in government spending decisions. Indeed, one of the striking landmarks of the 1980s involved the proliferation of extra-budgetary funds (EBFs) which became an important medium of government spending. In retrospect, however, the proliferation of the EBFs during the Özal era helped to introduce a number of important distortions in

45 ECONOMIC LEGACY OF TURGUT ÖZAL 121 the system resulting in arbitrary spending decisions based on political patronage. Furthermore, the widespread use of EBFs progressively undermined financial discipline which constituted one of the central pillars on which the success of the neo-liberal programme depended. 15 Thus, Özal s understanding of democracy appeared to pay scant respect for the principles of transparency and accountability, with the parliament as the key institution at the centre of the system. A similar distrust of bureaucratic institutions was also evident in Özal s approach to the reform process. 16 Although Özal himself was a product of the classical bureaucracy, having occupied top positions in the SPO, he was also heavily critical of the étatiste mindset and the excessive powers enjoyed by the bureaucratic elites. An interesting dichotomy could be identified in his thinking process in this respect. At one level, he was critical of representative institutions such as the parliament and wished to by-pass such institutions for the sake of speedy implementation of the reform process. Yet, at same time, he was critical of classical bureaucracy and what he wanted to accomplish was to reduce the excessive autonomy enjoyed by the predominantly étatiste bureaucratic elites and render them truly accountable to elected politicians, as the true representative of the public. 17 Clearly, these contradictory positions make it rather difficult to assess Özal s true democratic credentials. The common denominator, in this respect, however, is a focus on the primacy of economic reforms and by-passing key institutions and norms, if such institutions and norms appeared to block the path of reforms in the short-run. Given his natural confrontation with the étatiste mind-set of classical bureaucracy, Özal tried to implement the reform process in a top-down fashion. His approach also involved creating totally new layers of bureaucracy such as the Privatization administration, the Under-Secreteriat of Treasury and Foreign Trade and so on rather than trying to implement such key elements of reform such as privatization and trade liberalization through the existing set of bureaucratic organizations such as the SPO or the Ministry of Finance. One major benefit associated with Özal s bureaucratic restructuring involved the inflow of a select group of young, highly trained and internationally oriented bureaucrats to the high echelons of economic bureaucracy. Often referred as Özal s princes in popular discourse, this new elite possessed the kind of expertise needed in the age of financial globalization and injected a considerable degree of dynamism into the bureaucratic decision-making process. 18 The drawback of these new bureaucratic institutions, however, was that they lacked a proper bureaucratic tradition and culture. Hence, one could argue that the implementation of the reform process in Turkey was associated with a weakening of the bureaucratic apparatus with costly consequences that became evident with recurring episodes of corruption, notably in the ensuing

46 122 MIDDLE EASTERN STUDIES decade of the 1990s. To be fair to Özal, however, we need to re-emphasize the fact that he was faced with a serious dilemma. Considering that his prime motive was the rapid and uninterrupted implementation of reforms, to what extent would he be able to achieve this within the parameters of the existing bureaucratic institutions, given the dominance of the étatiste mind-set in such institutions? Finally, Özal s weak commitment to legal norms was amply highlighted by his frequently cited statement that envisaged economic punishment for economic crimes. 19 Perhaps, the most serious manifestation of this notorious principle in practice occurred in the context of the fictitious exports episode during the mid-1980s. In the early 1980s, a major instrument utilized by the government to promote exports was export subsidies in the form of export tax rebates. Yet, in the presence of weak government discipline, rent-seeking enterprises tried to take advantage of these subsidies through a variety of mechanisms, notably over-invoicing. In short, a large numbers of firms violated the law and claimed large amounts of export subsidies without actually undertaking the required level of exports. Yet, the administration was quite lenient on these activities and no serious attempt was made to punish the crimes involved. Indeed, the kind of thinking embodied in Özal s notion of economic punishment for economic crimes represented a rather light-hearted treatment of the kinds of crime involved. 20 Perhaps, what Özal had in mind, was to avoid repression of entrepreneurial activities through excessive penalties. Yet, most commentators would concede that this proved to be a major mistake. In retrospect, the fictitious exports episode and the lenient response by the state marked the beginning of serious corruption in Turkey, hence representing a necessary line of continuity between the Özal era and the subsequent phase of neo-liberalism during the 1990s. The year 1989 is typically considered to be a natural turning point or dividing line in Turkey s encounter with neo-liberalism in the post-1980 era is considered to be important for a number of signficant reasons. First of all, it effectively marked the end of the Özal era. ANAP, under Özal s leadership experienced a major setback in the municipal elections of March 1989 which marked the beginnings of serious political fragmentation that was to characterize the Turkish party system throughout the 1990s. Furthermore, Özal s resignation as Prime Minister in favour of a new political role as President in November 1989 also constituted a critical turning point. Özal clearly favoured a Latin-American style of presidential system that would allow disproportionate executive powers to the president himself in an environment of weak checks and balances. 21 Yet, in spite of the strengthening of power of the Presidency by the Constitution of 1982, Turkey s strong parliamentary traditions constrained Özal in his quest to play a strong presidential role. 22 Furthermore, during the period of his presidency, with the

47 ECONOMIC LEGACY OF TURGUT ÖZAL 123 Gulf War and its aftermath, Özal s attention increasingly shifted from economic to key political and foreign policy issues such as the Kurdish question and Turkey s role as an active regional power. 23 Finally, 1989 was the year when the critical decision was taken involving the full-scale opening up of the capital account, a decision that created a radically different economic environment in the context of the 1990s. The year 1989 is also used as a typical reference point in comparing economic performance during different phases of neo-liberalism in Turkey. Indeed, a superficial comparison reveals that the Özal decade has been much more successful judged on the basis of a number of key macroeconomic indicators. Average growth has been higher and average inflation has been lower in the context of the 1980s. Furthermore, Turkey has been exposed to successive economic crises in the second phase, in 1994, 2000 and 2001 respectively, in sharp contrast to the crisis-free environment of the 1980s. 24 There is no doubt that political instability and full exposure to the forces of financial globalization constitute two elements that render the 1990s radically different from the earlier decade. Similarly, Turkey has been exposed to serious external or exogenous shocks in the 1990s that again renders the decade radically different from the earlier era. 25 Added to this, one should also take into account that Turkey did not face a fully competitive political environment well until late 1987, in spite of the fact that transition to parliamentary democracy was achieved in November In spite of these obvious differences, however, it is our contention that significant continuities may be identified with respect to these two decades and these continuities, in turn, are a product of Özal s legacy. The argument may be substantiated as follows. Özal himself played an instrumental role in the radical decision to liberalize the capital account fully in August Indeed, this proved to be one of his final acts as Prime Minister. There is evidence that the decision was pushed through contrary to the advice of the Central Bank. 26 The decision was motivated by a mixture of economic and political considerations. Özal hoped that an open capital account regime would help to attract large amounts of external capital. This, in turn, would be instrumental in accelerating the pace of economic growth. He also hoped that this would provide an appropriate context for accelerating the momentum of trade liberalization, which would help to lower inflation through the pressure of low cost consumer goods imports. These forces combined would also help ANAP to recover its political support in subsequent general elections. Yet, this proved to be a serious miscalculation. The decision to liberalize the capital account in an environment of high degree of macroeconomic instability and the absence of an adequate institutional framework to regulate the financial sector rendered the Turkish economy highly dependent on short-

48 124 MIDDLE EASTERN STUDIES term and highly speculative capital flows. Short-term capital inflows magnified the degree of instability in the Turkish economy as political actors used these funds to finance rising budget deficits thereby postponing costly adjustment decisions to the future. It was not surprising in this context that Turkish economy experienced successive financial crises with serious real economy consequences. 27 It is also well worth emphasizing that economic instability in Turkey had already started to build up in the Turkish economy from the late 1980s onwards. Clearly, it was difficult to contain severe distributional pressures in a newly opened political environment as the initial losers of the liberalization process, notably wage earners and agricultural producers, used their newly acquired political power to offset the economic losses that they had encountered during the early part of the decade. In part, Özal as the key economic figure of the period should also share part of the blame for the steady loss of fiscal discipline that progressively undermined the very foundations on which the neo-liberal reform programme rested. His background as an engineer and planner resulted in a certain tendency to underestimate the costs of financial imbalances and inflation from the perspective of sustained economic growth. The strong emphasis that he tended to place on the real economy was coupled with a tendency to underestimate, if not to ignore, the negative consequences of inflation on the quantity and quality of investment and, hence, on the longer-term economic potential of the economy. Somehow, he tended to believe that rapid growth in the real economy would help to relieve inflationary pressures over time, ignoring the arrow that ran from high and variable inflation to low growth in the process. 28 The proliferation of the Extra Budgetary Funds (EBFs) during his period of office facilitated a certain degree of flexibility in spending decisions. Yet, on the whole, they have proved to be rather costly in terms of fiscal indiscipline, not only in the 1980s but for most of the 1990s. Perhaps, the problem was of a more general and deeper nature than simply the absence of financial discipline in the public sector. The whole atmosphere of the Özal era with its emphasis on consumerism and a parallel lack of emphasis on the virtues of thrift in the society as a whole and not simply in the public sector have carried over into the subsequent decade and were clearly in evidence in the highly fragile, debt-led growth that Turkey experienced during the second phase of its neo-liberal experiment. Yet another striking element of the 1990s involved pervasive corruption in the Turkish economy. Arguably, the political instability associated with short-lived coalition governments and the resultant myopic bias on the part of the key political actors made the economy rather vulnerable to widespread corruption. 29 Yet, the seeds of this process were already evident in the previous era of the 1980s. Arguably, the negative consequences of Özal s

49 ECONOMIC LEGACY OF TURGUT ÖZAL 125 influence, namely the failure to pay adequate attention to the problem of accountability and the rule of law, exercised a far deeper negative impact in the context of the post-1989 era, reaching a climax in the context of the February crisis of On a more positive note, important steps have been taken in the context of the 1990s designed to build the kind of strong regulatory institutions needed for effective implementation of key aspects of the neo-liberal programme in such areas as privatization and banking sector reform. Yet, these transformations have occurred in a rather protracted manner with the main initiative coming from external as opposed to domestic actors. For example, the Customs Union agreement which became effective by the beginning of 1996 was instrumental in creating a wave of important regulatory reforms in the Turkish economy in the mid-1990s, resulting in the establishment of key regulatory institutions such as the Competition Board for the first time in the history of the Turkish economy. Similarly, the IMF which once again became heavily involved in the Turkish economy from the late 1990s onwards was the principal actor responsible for the introduction of a key regulatory institution in the banking sector, namely the Banking Regulatory and Supervisory Authority (the BRSA). The Turkish economy in the post-1999 era has, in fact, been confronted with a double external anchor, namely simultaneous IMF and EU discipline, which has clearly been pushing Turkey rapidly in the direction of institutionalizing reforms and greater fiscal discipline. 31 The crisis of 2001, the deepest crisis that Turkey has experienced in its post-war history, has clearly been instrumental in accelerating this process of regulatory reform, although the process, as yet, is far from being completed. Looking back, the outcome would have been far more favourable for Turkey if such reforms had been instigated at an earlier phase. Finally, the Customs Union agreement was clearly in line with Özal s thinking, although arguably the terms of the agreement could have been better negotiated. 32 In retrospect, in spite of its shortcomings, the Customs Union represented the positive side of the 1990s. By accelerating the process of trade liberalization, a process that had already gathered momentum during the Özal era, it marked an important step forward in terms of rendering the Turkish industry more competitive in international markets. Not only for Özal but also for other Turkish political leaders, the Customs Union was not an end in itself but an intermediate step on the path to EU membership. In this respect, the Helsinki Decision of 1999 proved to be a crucial turning point for Turkey s fortunes. The clear improvement of the mix of conditions and incentives facing Turkey following its announcement as a candidate country has undoubtedly been instrumental in accelerating the process of economic and political reforms in Turkey during the recent era. 33

50 126 MIDDLE EASTERN STUDIES A proper understanding of Özal and his economic legacy requires a comparative perspective. A number of scholars of political economy have drawn attention to the emergence of a new phenomenon in the developing world described as neo-liberal populism. 34 Neo-liberal populism differs from traditional populism in the sense that it co-exists with neo-liberal policies aimed at improving economic efficiency and eliminating rentseeking behaviour associated with heavy protectionism and excessive state intervention of the import-substitution period. 35 Hence, rather paradoxically neo-liberalism which is supposed to be the antithesis of populism, replaced the populist political culture with a new kind of populism. Some of the most striking examples of this new breed of neo-liberal populism can be found in Latin America. The best-known examples of neo-populist reformers include Carlos Menem in Argentina ( ), Carlos Salinas in Mexico ( ) and Fernando Collor in Brazil ( ). Alberto Fujimoro of Peru ( ) is also often included in this group. The common denominator of neo-liberal populism is that reforms tend to be initiated in a top-down fashion, often launched by surprise and without the participation of organized political forces. Perhaps this is not surprising given that reforms involve significant social costs and a disproportionate number of losers are associated with this process. The style of policy implementation tends to be autocratic and this autocratic style of policy implementation tends to undermine representative institutions and to personalize politics. Active dialogue and consultation with the key interest groups is by definition excluded from this process. An all-powerful and charismatic leader plays a crucial role in this scenario in terms of implementing the reform package and legitimizing it in the eyes of broad segments of the electorate. Hence, neoliberal populism entails the co-existence of liberal economics with illiberal politics or a kind of shallow democracy. 36 The main features of Turgut Özal s style of economic governance clearly fits into the broad framework identified above. Without attempting a fullblown comparative analysis, a number of interesting parallels may be identified between Özal and Menem with respect to the implementation of neo-liberal reforms in their respective countries that clearly highlight the general nature of this phenomenon classified as neo-liberal populism. Similarities between the two leaders begin with their respective backgrounds. Both were charismatic leaders with a traditional background who were on the periphery of their respective societies. Menem rose to national prominence from a rural province, basing his successful campaign on folkloric symbols, social justice themes and promises to revitalize the economy. 37 Like Özal, he managed to transcend the traditional and the modern and by recourse to wealth and anti-elitist themes, at the same time, could manage to appeal to strikingly different segments of Argentine

51 ECONOMIC LEGACY OF TURGUT ÖZAL 127 society. The unusual backgrounds of both leaders coupled with their flamboyant life styles allowed them to project an image of being reformist, modern and progressive as well as being loyal to tradition and cultural roots of their respective societies. Both enjoyed strong links to the economic and state elites in their countries whilst at the same managing to convey a strongly anti-elitist discourse that clearly appealed to the middle and lower strata of their societies. Özal depended on his conservative, Islamist roots, and Menem effectively exploited his Peronist roots in order to capitalize on anti-elitist sentiments and to appeal to wide segments of their respective societies. 38 As neo-populist leaders, both were in office for roughly a decade. During this period they had considerable success in transforming their societies by implementing economic policies representing a move from protectionism and étatism to an open and outward-oriented culture. Argentina, under Menem s presidency, enjoyed its most successful phase of economic growth during the early and the mid-1990s. 39 Similarly, Turkey, under Özal s premiership, enjoyed the best phase of its neo-liberal restructuring. Indeed, both countries were portrayed by key international organizations as model cases for the rest of the developing world during the periods in question. Admittedly, the strong presidential powers that Menem enjoyed as well as the depth of the crisis and hyperinflation that Argentina had experienced in the previous era allowed Menem to implement neo-liberal restructuring in a far more radical and drastic fashion. A massive privatization programme and the ability to bring inflation to single digit levels through rigid adherence to the convertibility plan based on a rigid relationship between the Argentine peso and the dollar constituted the landmarks of the Argentine neo-liberalism under Menem. Özal s neo-liberalism in contrast, was less radical and more of a gradualist programme. Significant steps were taken in the direction of liberalizing the trade and capital account regime and transforming the Turkish economy from an inward-oriented to an export-oriented direction. Yet, privatization remained limited and chronic inflation continued to be a serious source of disequilibrium, though never reaching the kind of hyperinflationary proportions experienced in the 1980s. Arguably, unlike Menem, Özal did not pay sufficient attention to the problem of inflation per se. His engineering mind-set led him to conceive of inflation as a cost of economic growth an approach that fails to see price stability as a necessary condition for achieving sustained economic growth. Both Özal and Menem saw laws and bureaucracy as impediments to swift decision-making. Indeed, Özal very much wanted the kind of presidential regime that Menem enjoyed which was characterized by the pervasive absence of institutional checks and balances. However, Özal could not achieve this due to the strong parliamentary traditions embedded in the Turkish political system. Indeed, the circumvention of legal rules helped to

52 128 MIDDLE EASTERN STUDIES undermine his reputation just as it did for Menem. 40 Both leaders were heavily criticized for the increase in corruption during the periods that they held office. Menem found himself under house arrest for six months on charges of organizing illegal sales of arms to Ecuador and Croatia. Özal did not face a similar fate during his periods of office. Nevertheless, the second half of the 1980s in Turkey was characterized by widespread allegations of corruption which also included members of Özal s own family. 41 Given the weak commitment to the rule of law evident in the case of both leaders, it was perhaps not surprising that both Argentina and Turkey experienced a substantial increase in corruption during the neo-liberal era. 42 Finally, both leaders experienced a dramatic fall in their electoral fortunes. This was perhaps not surprising in the sense that sustained improvement in economic performance could not be achieved in either of the two cases. In spite of the early success of the neo-liberal experiment, Argentina found itself once again in the midst of a deep economic crisis in In the Turkish case, crises were temporarily postponed to the 1990s and Turkey found itself confronted with successive and increasingly more costly financial crises during the later phase of its neo-liberal experiment. ANAP, as indicated earlier, started to lose its early popularity from the municipal elections of March 1989 onwards. Inability to contain inflation, with its costly consequences for low and middle income groups in society, as well as growing allegations of corruption had a deep negative impact on ANAP s electoral fortunes by the end of the 1980s. During the course of the 1990s, the party was increasingly marginalized losing the kind of broad-based appeal that it had enjoyed during the peak of its popularity in the mid-1980s. Under the leadership of Mesut Yılmaz, ANAP was a pale shadow of its image in the 1980s. Following the departure of Özal the party increasingly lost its broad political support and could only appeal to a narrow group of urban bourgeoisie which was hardly sufficient for electoral success. The ANAP s decline reached a dip in the elections of November The party failed to pass the national electoral threshold of ten per cent and, for the first time since 1983, failed to send any representatives to the Parliament. Similarly, Carlos Menem tried to make a comeback during the recent presidential elections of Argentina in But he decided to withdraw from the presidential race realizing that he had lost his previous popularity among the Argentine public by a drastic margin. These comparative observations suggest that neo-liberal populism inspired by charismatic leaders constitutes an asset in the process of implementing difficult and divisive reforms in its early stages. There is no doubt that both Argentina and Turkey have made significant strides in transforming their economies, having experienced deep crises in their importsubstitution phase of development. Nevertheless, our brief comparison also

53 ECONOMIC LEGACY OF TURGUT ÖZAL 129 highlights that the kind of neo-liberal reform experiment that essentially bypasses and undermines democratic institutions and norms can generate devastatingly unfavourable consequences from a longer-term perspective. The experiences of both Argentina and Turkey illustrate in a rather dramatic fashion the negative repercussions of trying to engineer reforms in a topdown fashion, circumventing democratic norms and the rule of law in the process. Turkey and Argentina are societies characterized by a high degree of income inequality. Both Özal and Menem hoped to deal with the problem of pervasive inequality through sustained economic growth. They tended to reject the notion of extensive direct re-distribution as being inherently inconsistent with the neo-liberal logic. 43 Yet, the kind of growth path that they helped to instigate was a highly fragile pattern of debt-led growth which was highly vulnerable to speculative attacks and financial crises. Turgut Özal s leadership had a decisive impact on the neo-liberal transformation of the Turkish economy. The early 1980s constituted the heyday of the Washington Consensus. Turkey, having lived through a major crisis in the late 1970s, was one of the first countries to encounter the new liberalization message from Washington. Özal s unique qualities as an engineer and economic technocrat as well as his unique background that helped him to cross boundaries involving the traditional and modern, elites and non-elites as well as national and trans-national, destined him to play a key leadership role first as a technocrat and then as the key political figure in the implementation of the reform process. Leadership per se cannot explain economic success. Nevertheless, there is no doubt that Özal s leadership helped to ensure considerable continuity in the reform process. His vision and bold initiatives generated considerable optimism concerning the future direction of the Turkish economy. Indeed, by the mid-1980s, Turkey was frequently singled out by the IMF and the World Bank as an example of successful adjustment that others in line ought to emulate, although danger signs clearly existed notably on the fiscal front. The optimism that characterized the early Özal era has to a large extent been reversed in the subsequent decade and only very recently, with a substantial time-lag, following the electoral victory of the Justice and Development Party (AKP) can we see the beginnings of a new era of confidence in the future of the Turkish economy. A balanced consideration of Özal s legacy, however, reveals a number of fundamental deficiencies that clearly left their mark on the subsequent underperformance of the Turkish economy. To a certain extent, the negative aspects of Özal s legacy were synonymous with the weak spots in the Washington Consensus. For example, Turkey was not alone in being exposed to the vagaries of financial globalization through premature capital account

54 130 MIDDLE EASTERN STUDIES liberalization. Yet, clearly the process could have been delayed in the Turkish case if Özal had not pushed so decisively for the move to full convertibility in August It is also fair to say that the significance of the institutions had been underestimated in the early days of the Washington Consensus. The prevailing intellectual mood in the dominant academic and financial circles that Özal was confronted with in the early 1980s projected a rather optimistic image concerning the ability to create free markets simply by reducing the weight of the state in the economy and releasing entrepreneurial energy in line with correct incentives. The importance of institutions and the rule of law as the necessary ingredients of an effectively functioning market economy were somehow underplayed or pushed aside in this context. Ultimately, the failure to pay sufficient attention to democracy, institutions and the rule of law, in spite of the advantages that it offered in the early stages, has been costly for the Turkish economy in the course of the subsequent decades of Turkish neo-liberalism. In this respect, one can diagnose an essential line of continuity between what appear to be quite separate phases of the Turkish neo-liberal experiment. Finally, a comparative approach is useful in placing Özal s economic legacy in context. Özal enjoyed certain unique attributes derived from the specific, contextual features of the Turkish experience. Yet, at the same time, his style of charismatic leadership was rather typical of the new wave of neoliberal populism that was also evident in other parts of the developing world and notably in Latin America. A cursory comparison with the Argentine President Menem revealed a number of striking points in common with the Özal case, clearly pointing towards the presence of certain general tendencies in the implementation of market-oriented reform with far-reaching social consequences in the tough political environments of emerging democracies. Neo-populist reformers like Özal and Menem placed their priority on rapid implementation of reforms, leaving the issue of democratic deepening into the distant future. What was ironic, however, was that the decision to by-pass democratic institutions and legal norms for the sake of successful implementation of economic reforms ultimately failed to bring about a sustained improvement in economic performance that such leaders had desired in the first place. NOTES The author would like to thank İhsan Dağı for encouragement in writing this article, and Mehmet Uğur and Hakan Tunç for their extremely valuable comments on an earlier draft. He also wishes to thank Evren Tok and Gamze Sezer for their able assistance. 1. Özal s decisive influence in a number of key areas ranging from the economic sphere to issues like the Kurdish question has already generated a large literature, much of it in the

55 ECONOMIC LEGACY OF TURGUT ÖZAL 131 Turkish language. For a sample of such studies, see İhsan Sezal and İhsan Dağı (eds.), Kim Bu Özal? Siyaset, İktisat, Zihniyet (Istanbul: Boyut Yayıncılık, 2001); Feride Acar, Turgut Özal: Pious Agent of Liberal Transformation, in Metin Heper and Sabri Sayarı (eds.), Political Leaders and Democracy in Turkey (Lanham, MD: Lexington Books, 2002), pp Journalistic accounts: Osman Ulagay, Özal ı Aşmak İçin (Ankara: Afa Yayıncılık, 1989), and Özal Ekonomisinde Paramız Pul Olurken Kim Kazandı Kim Kaybetti (Ankara: Bilgi Yayınevi, 1987); Emin Çölaşan, Turgut Nereden Koşuyor? (Istanbul: Tekin, 1989). Autobiographical Studies: Turgut Özal, Turgut Özal ın Anıları, compiled by Mehmet Barlas (Istanbul: Sabah Yayınları, 1994) etc. See, Rıfat N. Bali, Tarz-ı Hayat tan Life Style a (Istanbul: İletişim Yayıncılık, 2002) on the impact of the Özal era in terms of transforming cultural values and elite behaviour and life styles. 2. For useful background information on Özal, see Acar, Turgut Özal: Pious Agent of Liberal Transformation. 3. It is important to note that a number of key political leaders in Turkey including Süleyman Demirel and Necmettin Erbakan were graduates of this key institution of higher learning. Indeed, in all three cases, the individuals concerned have managed to rise from modest roots to key positions of political power and influence. 4. See Acar, Turgut Özal: Pious Agent of Liberal Transformation, for a valuable discussion of this particular aspect of Özal s political personality. 5. On the Bankers Crisis, see Emin Çölaşan, Banker Skandalı nın Perde Arkası: Bankerler Batıyor Kastelli Kaçıyor (Istanbul: Milliyet Yayınları, 1984). 6. There is evidence that influential members of the military elite supported the National Democracy Party (the MDP) led by a retired general, Turgut Sunalp during the period leading to the general elections of November Özal was naturally quite apprehensive about this development. See note 1,Turgut Özal, Turgut Özal ın Anıları, 33 pp.yet, the MDP, in spite of implicit military backing could not match the popularity of the ANAP in the general elections. 7. For a valuable retrospective analysis of the ANAP, see Ersin Kalaycıoğlu, The Motherland Party: The Challenge of Institutionalization in a Charismatic Leader Party, Turkish Studies, Vol.3, No.1 (Spring 2002), pp The short but hectic period from March 2001 to September 2002 during which Kemal Derviş assumed a critical leadership role in running the economy, contributing towards the postcrisis recovery process, has already attracted significant journalistic attention. See, Sefa Kaplan, Derviş in Siyaseti Siyasetin Dervişi (Istanbul: Metis Yayınları, 2002). 9. On the 1980 programme and the scale of financial support see Ziya Öniş, State and Market: The Political Economy of Turkey in Comparative Perspective (Istanbul: Boğaziçi University Press, 1998), pp See, Turgut Özal, Turkey in Europe and Europe in Turkey (Nicosia: K.Rustem Brother, 1991). 11. On Özal s views concerning the primacy of trade liberalization in creating a genuinely competitive economy and the importance of the EC/EU anchor in this respect, see Turgut Özal, Turgut Özal ın Anıları, pp See Atilla Yayla, Liberal Siyaset / Liberal İktisat: Özal Çizgisi in Sezal and Daği (eds.), Kim Bu Özal? Siyaset, İktisat, Zihniyet. On the concept of unorthodox liberalism, see Ziya Öniş, The Political Economy of Turkey in the 1980s: The Anatomy of Unorthodox Liberalism, in Metin Heper (ed.), The Strong State and Economic Interest Groups. The Post Turkish Experience (New York and London: Walter de Gruyter, 1991). See also John Waterbury, Export-Led Growth and the Centre-Right Coalition in Turkey, Comparative Politics, Vol. 24, No.2, Jan. (1992), pp For an elaboration of this point and supporting evidence, see the various articles by Coşkun Can Aktan, Turgut Özal ın Değişim Modeli ve Değişime Karşı Direnen Güçlerin Tahlili, Türkiye Günlüğü Dergisi, Vol.40, May June (1996), pp.15 32; Turgut Özal: Liberal Reformist mi, Yoksa Deformist miydi?, Yeni Türkiye Dergisi, Vol.25, Jan. Feb. (1999), pp ; Turgut Özal ın Anayasal Demokrasi ve Anayasal İktisat Üzerine Düşünceleri, Yeni Türkiye Dergisi, Vol.29, Sept. Oct. (1999), pp

56 132 MIDDLE EASTERN STUDIES 14. For a detailed elaboration of this point, see Metin R. Ercan and Ziya Öniş, Turkish Privatization: Institutions and Dilemmas, Turkish Studies, Vol.2, No.1, Spring (2001), pp On EBFs and their weight in Turkish budetary process, see Oğuz Oyan and Ali Rıza Aydın, İstikrar Programından Fon Ekonomisine (Ankara: Verso, 1997). 16. On Özal s criticisms involving the inherently conservative, anti-reformist bias of classical bureaucracy, see Turgut Özal, Turgut Özal ın Anıları, pp Also see, Aytekin Yılmaz, Türk Bürokrasi Geleneği ve Özal, in Sezal and Daği (eds.), Kim Bu Özal? Siyaset, İktisat, Zihniyet, pp It is also interesting that Özal s thinking in this respect also extended to military elites. Whilst Özal was always careful not to distance himself excessively from the military establishment, he subsequently expressed his unease in terms of working with the military elite during the early 1980s. See, Turgut Özal, Turgut Özal ın Anıları, p.14. He was also a pioneering politician in terms of the attention that he paid to the civilian control of the military in Turkey. For example, he directly intervened to secure the appointment of General Necip Torumtay as the Chief of Staff of the Turkish Armed Forces in The intervention by a civilian politician in military affairs constituted an extraordinary move that was unique in the history of Turkish politics. In this context, see, Paşalar Operasyonu, Milliyet, 18 June On Özal s princes, see Mehmet Ali Birand and Soner Yalçın, The Özal: Bir Davanın Öyküsü (Istanbul: Doğan kitapçılık, 2001), pp Prominent examples of such princes included Rüşdü Saraçoğlu, as the Governor of the Central Bank, Bülent Gültekin and Cengiz İsrafil, as the Chairman and Vice-Chairman of the Privatization Administration, respectively, among others. Parallels may be drawn with the Chicago Boys in Chile and the appointment of Domingho Cavallo in Argentina. 19. For a vivid discussion of Özal s failure to take widespread allegations concerning fictitious exports seriously, see Osman Ulagay, Özal ı Aşmak İçin, pp For detailed documentation of the fictituous exports episode, see Uğur Mumcu, Serbest Piyasa ve Kemalism (Ankara: Umag, 1997). 21. On Özal s case for the desirability of a presidential democracy, see Turgut Özal, Turgut Özal ın Anıları, pp On the Constitution of 1982, see Ergun Özbudun, Contemporary Turkish Politics: Challenges to Democratic Consolidation (Boulder, CO: Lynne Rienner Publishers, 1999). 23. On what appeared to be Özal s radical views on the Kurdish Question and his activist approach to foreign policy, see Sezal and Daği (eds.), Kim Bu Özal? Siyaset, İktisat, Zihniyet. 24. On the economic performance of the Özal era, see, Tosun Arıcanlı and Dani Rodrik (eds.), The Political Economy of Turkey: Debt, Adjustment and Sustainability (London: Macmillan, 1990); Öniş, State and Market; On the economic performance of the 1990s, see, Mine Eder, The Challenge of Globalization and Turkey s Changing Political Economy, in Barry Rubin and Kemal Kirişçi (eds.), Turkey in World Politics: An Emerging Multiregional Power (Boulder and London: Lynne Rienner, 2001), pp ; Ziya Öniş, Domestic Politics versus Global Dynamics: Towards a Political Economy of the 2000 and 2001 Financial Crises in Turkey, Turkish Studies, Vol.4, No.2, Summer (2003), pp Examples of such external or exogenous shocks included the Gulf War of 1991, the Asian Crisis of 1997, the Russian Crisis of 1998, the earthquake of 1999, all of which had a profound negative impact on the fortunes of the Turkish economy. Furthermore, the prolonged armed struggle against the Kurdish separatist organization, the PKK, also constituted a significant drain on the country s resources. 26. See, Hasan Ersel, The Timing of the Capital Account Liberalization: the Turkish Experience, New Perspectives on Turkey, Vol.15 (1996), pp For an elaboration of these points see Dani Rodrik, Premature Liberalization, Incomplete Stabilization: The Özal Decade in Turkey, in Michael Bruno et al. (eds.), Lessons of Economic Stabilization and its Aftermath (Cambridge, MA: MIT Press, 1991); Ercan Kumcu, The Unfinished Struggle for Economic Stability, in Morton Abramowitz (ed.), The United States and Turkey: Allies in Need (New York: The Century Foundation Press, 2003), pp.31 60; Emre Alper and Ziya Öniş, Financial Globalization, the Democratic Deficit and

57 ECONOMIC LEGACY OF TURGUT ÖZAL 133 Recurrent Crises in Emerging Markets: The Turkish Experience in the Aftermath of Capital Account Liberalization, Emerging Markets Finance and Trade, Vol.39, No.3, May June (2003), pp A typical statement by Özal in this context was Leave inflation alone and concentrate on rapid growth. See Osman Ulagay, Özal Ekonomisinde Paramız Pul Olurken, pp Data reported by Transparency International puts Turkey among high corruption cases. Furthermore, the corruption perception index (which ranges between 10 meaning highly clean and 0 meaning highly corrupt) has dropped over time from 4.05 during to 3.2 in 2002 suggesting an increase of corruption over time. See, Transparency International, Transparency International Corruption Perceptions Index available at Failure to regulate the banking sector and the absence of transparency and accountability in the public banking system were at the heart of the 2001 crisis. On the crises, see Yılmaz Akyüz and Korkut Boratav, The Making of the Turkish Financial Crisis, paper presented at the conference on Financialization of the Global Economy, PERI, University of Massachusetts, 7 9 Dec., (Amherst, MA. 2002), available at ; and Alper and Öniş, Financial Globalization, the Democratic Deficit and Recurrent Crises in Emerging Markets. 31. With full membership becoming a serious possibility rather than a vague hope in the post- Helsinki era, the economic components of the Copenhagen criteria also constituted a critical source of external discipline for the Turkish economy in line with the IMF reforms. In this respect, Turkey found itself in a more favourable position than Argentina in the post-2001 context. 32. Arguably a free trade agreement with the EU would have been a better alternative to a more restrictive arrangement such as a customs union. But, Turkish policy-makers saw the customs union as a necessary concession on the way to EU membership rather than an end in itself. Hence, the details of the arrangement have not been seriously negotiated. 33. See in this context, Ziya Öniş, Domestic Politics, International Norms and Challenges to the State: Turkey EU Relations in the post-helsinki Era, Turkish Studies, Vol.4, No.1 (Spring, 2003), pp See Kenneth M. Roberts, Neoliberalism and the Transformation of Populism in Latin America: The Peruvian Case, World Politics, Vol.48, No.1 (Oct.1995), pp ; Kurt Weyland, Neo-populism and Neo-liberalism in Latin America: Unexpected Affinities, Studies in Comparative International Development, Vol.31, No.3, Fall (1996), pp.3 31; Kurt Weyland, Neoliberal Populism in Latin America and Eastern Europe, Comparative Politics, Vol.31, No.4, July (1999), pp For a good general discussion of the concept of populism both old and new, and its application to the Turkish development experience, see Mine Eder, Populism as a Barrier to Integration with the EU: Rethinking the Copenhagen Criteria, in Mehmet Uğur and Nergis Canefe (eds.), Turkey and European Integration: Prospects and Issues in the Post-Helsinki Era (London: Routledge, 2004), pp See in this context Luiz Carlos Bresser-Pereria et al., Economic Reforms in New Democracies: A Social Democratic Approach (Cambridge: Cambridge University Press, 1993). Specifically on the notion of illiberal democracy that seems to be at the heart of neoliberal populism, see Fareed Zakaria, The Rise of Illiberal Democracy, Foreign Affairs, Vol.76, No.6, Nov./Dec. (1997), pp.22 43; as well as Guiellermo O Donnell, Delegative Democracy, Journal of Democracy, Vol.5, No.1 (April, 1994), pp See, Nancy R. Powers, Re-electing Neo-liberals: Competing Explanations for the Electoral Success of Fujimori and Menem (or Why Menem is not a Neo-populist), 1997 Meeting of the Latin American Studies Association, Mexico, (April 17 19, 1997) online paper at the Latin American Studies Association at University of Pittsburgh, available at 5 lasa.international.pitt.edu/lasa97/powers.pdf 4, last retrieved on September 4, For a more detailed comparison of the respective upbringing of the two leaders, see, Ş. Savaş Karataşlı, Rise and Fall of Neo-populists: A Comparative Analysis of Argentine and Turkish Neo-populist Experience, undergraduate term paper, mimeographed, Department of International Relations, Koç University, Istanbul, 2003.

58 134 MIDDLE EASTERN STUDIES 39. On Argentia s economic performance during the 1990s and comparisons with Turkey, see Barry Eichengreen, Crisis Prevention and Management: Any New Lessons from Argentina and Turkey?, mimeographed, Department of Economics, University of California Berkeley, 2001; and Ziya Öniş, Argentine Crisis, IMF and the Limits of Neoliberal Globalization: A Comparative View from Turkey, mimeographed, Department of International Relations, Koç University, Istanbul, 2002, available at 5 SOFNEO.PDF 4. Specifically on the Argentine privatization experiment, see Luigi Manzetti, Privatization in South American Style (Oxford; New York: Oxford University Press, 1999). 40. See Heath W. Lowry, Betwixt and Between: Turkey s Political Structure on the Cusp of the Twenty-First Century, in Morton Abramowitz (ed.), Turkey s Transformation and American Policy (New York: The Century Foundation Press, 2000), pp in this context. Although, illegal arms sales charges against Menem are dropped, investigations on other corruption allegations like illegal enrichment while in office and the Swiss bank accounts are continuing. See, Arms trafficking case dropped against Menem, but corruption case still on, Agence France-Presse, 28 Aug. 2003, available at 5 Qargentina menem.rzd6_das.html 4, last retrieved on 5 September, See Emin Çölaşan, Turgut Nereden Koşuyor?, in this context. 42. Argentina occupies a similar position to Turkey in the international league table in terms of the degree of corruption experienced. Moreover, data generated by Transparency International highlight a worsening of corruption practices in Argentina over the course of the 1990s. The corruption perception index for Argentina has dropped from 5.91 during to 2.8 in 2002, suggesting a dramatic increase in the degree of perceived corruption observed over a relatively short period of time. See, Transparency International, Transparency International Corruption Perceptions Index available at Özal, for example, argued that increasing economic growth was the only way to deal with the problem of income inequality. See, Turgut Özal, Turgut Özal ın Anıları, p.135.

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116 World Development Vol. 31, No. 9, pp , 2003 Ó 2003 Elsevier Ltd. All rights reserved Printed in Great Britain X/$ - see front matter doi: /s x(03) The Making of the Turkish Financial Crisis YILMAZ AKY UZ United Nations Conference on Trade and Development, Geneva, Switzerland and KORKUT BORATAV * University of Ankara, Turkey Summary. At the turn of the century the Turkish economy was in need of an urgent stabilization in order to halt a treacherous process of inflation, unsustainable public debt accumulation, and increasing financial fragility, resulting from irresponsible policies and lack of fiscal discipline that had been endemic since the early 1980s. The stabilization program launched with support from the IMF has, however, failed to deliver its promises, plunging the economy into an unprecedented recession, largely because of serious shortcomings in its design as well as in crisis intervention which appears to have drawn no useful lessons from recent crises in emerging markets. Ó 2003 Elsevier Ltd. All rights reserved. Key words financial crisis, emerging markets, Turkey The absolutists of contract... are the real parents of revolution (Keynes, 1971). Party tied to Islam wins big in Turkey (Washington Post, November 4, 2002). 1. INTRODUCTION In December 1999 the Turkish government launched an exchange rate-based stabilization program with the support of the Bretton Woods Institutions (BWIs) in order to bring down inflation and check what looked like an unsustainable process of public debt accumulation. The program appeared to be on course in the subsequent nine months, enjoying wide public confidence and support as well as gaining praise from International Monetary Fund (IMF) officials. But, it started running into problems in Autumn 2000, necessitating a relatively large IMF bailout to keep it on course. After a few months of muddling through it became clear that the program was not viable, and in the face of massive attacks on the currency and rapid exit of capital, the currency peg had to be abandoned in February 2001 and replaced by a regime of free floating, again on advice from the IMF. As in most other episodes 1549 of financial crisis the currency overshot, interest rates rose sharply and the economy contracted at an unprecedented rate. But the bust in the financial cycle came much earlier in Turkey than in most other episodes of financial crisis, before inflation could be brought under control. What went wrong? The Turkish crisis has a number of features common to crises in emerging markets that implemented exchange rate-based stabilization programs. Such programs typically use the exchange rate as a credible anchor for holding down inflationary expectations, often leading to currency appreciations and relying on capital inflows attracted by arbitrage opportunities to finance growing * The authors are Director, Division on Globalization and Development Strategies, UNCTAD, and Professor of Economics, University of Ankara, respectively. The opinions expressed in this paper and the designations and terminology employed are those of the authors and do not necessarily reflect the views of UNCTAD. The authors are grateful to Andrew Cornford, Richard Kozul-Wright and an anonymous referee for comments and suggestions. Final revision accepted: 25 February 2003.

117 1550 WORLD DEVELOPMENT external deficits. The consequent build-up of external financial vulnerability eventually gives rise to self-fulfilling expectations of sharp currency depreciations and a rapid exit of capital, resulting in overshooting of the exchange rate in the opposite direction and hikes in interest rates. Through such a boom-bust financial cycle, some countries (e.g., Mexico, Brazil and Russia) have succeeded in overcoming their chronic price instability and avoiding a return of rapid inflation, despite the collapse of their currencies and the external adjustment necessitated by the crisis. The Turkish program initially followed a similar path, but ran into difficulties at a much earlier stage of the disinflation process. The difficulties arose largely because the program was launched in the face of structural problems and fragilities on many fronts, notably in public finances and the banking sector. In particular, the banking system was heavily dependent for their earnings on high interest spreads between deposits and T-bills associated with rapid inflation, and thus highly vulnerable to disinflation. Consequently, there was a basic policy dilemma at the core of the program, since much of the fiscal adjustment was predicated on declines in the very nominal and real interest rates on which many banks depended for their viability. Furthermore, while the program incorporated a preannounced exit from the crawling peg after 18 months, it failed to meet its inflation targets despite full implementation of its monetary and fiscal policy targets. Thus, what initially looked like a strength of the program backfired, as persistently high inflation, together with widening current account deficits, fed into expectations of a sharp depreciation of the currency. These shortcomings in the design of the program, rather than a failure to implement it, are the main reason why the boom in capital inflows was much shorter in Turkey than in most other experiments with exchange rate-based stabilization, and why the crisis broke out before inflation was brought under control. That the Turkish crisis has proved much deeper than most crises in emerging markets is not only due to problems in the design of the stabilization program. Equally important is mismanagement in crisis intervention, which had been premised, as in most other emerging markets, on restoring confidence, maintaining capital-account convertibility, and meeting the demands of creditors through fiscal and monetary tightening. While the implementation of the program had created a tradeoff between public and private finances, abandoning the peg and moving to free floating under full capital account convertibility and extensive dollarization aggravated the difficulties of both public and private sectors. The collapse of the currency hit hard those sectors with high exposure to exchange rate risks which the earlier peg had encouraged. Public finances were squeezed from rising external and domestic debt servicing obligations due to the collapse of the currency and the hike in interest rates. Fiscal austerity and monetary tightening served to deepen recession, and even the response of exports to the sharp depreciation of the currency was delayed because of disruptions in the credit and supply systems, in very much the same way as in the earlier phase of the crisis in East Asia. Various packages of legislation passed in order to initiate structural reforms in the public and private sectors failed to restore confidence, while their initial impact was to add to stagflationary pressures. Furthermore, the external economic environment deteriorated further with the downturn in the major industrial countries and the events of September 11. These events have, however, helped Turkey in mobilizing unprecedented amounts of external support from the IMF due to the strategic position that the country occupies in the United StatesÕ war against terrorism. Despite four IMF bailout packages in two years, however, the economy shrunk at an unprecedented rate of some 9.5% in 2001, and prospects for sustaining the recovery underway are highly uncertain as the problem of debt and fiscal sustainability remains unresolved. 2. THE BUILD UP OF IMBALANCES: INFLATION, DEBT AND CAPITAL FLOWS Many of the imbalances and fragilities that characterized the Turkish economy at the turn of the century had their origin in the policies pursued in the previous two decades. Turkey started the 1980s with a stabilization-cum-liberalization experiment under a military rule in response to a debt and balance-of-payments crisis beginning in late 1970s. The program enjoyed some initial success and was widely praised as an example of successful transition from an inward to an outward development strategy and generously supported by multi-

118 THE TURKISH FINANCIAL CRISIS 1551 lateral institutions. 1 Inflation was brought down from three digit levels in 1980 to some 30% in the subsequent two years. The current account deficit was halved from a level of 5% of GDP while the public sector borrowing requirement (PSBR) fell from around 10% of GNP to less than 4%. After an initial contraction the economy enjoyed an export-led growth averaging above 6% per annum during , supported by favorable exchange rates and tax incentives. Macroeconomic imbalances reappeared, however, after The PSBR reached almost 10% of GNP and inflation accelerated rapidly. Two factors played a significant role. First, the return to parliamentary democracy in 1987 led to the reversal of regressive incomes policies pursued during the military regime of and the subsequent civilian government (Boratav & Yeldan, 2001). Second, domestic financial markets were liberalized before fiscal discipline had been secured and inflation brought under control. Deregulation of interest rates and the shift from central bank financing to direct security issues raised the cost of financing of public sector deficits, pushing up domestic debt and interest payments as a proportion of GDP. The policy response was to liberalize the capital account in 1989 in order to facilitate the financing of public deficits without crowdingout private investment. But, the outcome was to aggravate the fiscal problem, forcing the government to pay interest rates incorporating a higher spread compared to the safer dollar assets which had become easily accessible. During the 1990s interest rates on government debt exceeded the inflation rate, on average, by more than 30 percentage points (Table 1). This led to a rapid build up of public debt, acceleration of currency substitution and the emergence of a banking system which came to depend on arbitrage margins offered by high rates on government debt in comparison with international borrowing and domestic deposits, including forex deposits, at the cost of large currency risks. Government was increasingly engaged in Ponzi financing whereby rising interest payments could only be met by issuing new debt. Thus, while interest payments on domestic debt absorbed less than 20% of tax revenues at the end of the 1980s, this Table 1. Turkey: macroeconomic indicators, GDP growth rate ) ) CPI (per cent change) Interest rates a Exchange rate b Public sector balance c )7.6 )11.3 )12.4 )13.1 )10.2 )6.4 )13.2 )13.1 )15. 9 )24.5 )19.3 Of which primary )3.6 )6.2 )7.0 )5.6 ) )1.2 ) ) balance Net debt of the public sector c Of which net domestic debt Current account ) )0.6 ) )1.5 )1.3 ) )0.9 )4.9 deficit c Gross external debt c Foreign deposits Billions of dollars Per cent of total deposits Source: IMF (2000a, 2001c); OECD (2001); Central Bank of Turkey (various issues), Quarterly Bulletin; and T urkiyeõnin G ucßl u Ekonomiye Gecßis Programi, 2001, Undersecretary of Treasury. a During : overnight interest rates, annual simple basis. During : Treasury bills, three-month or close to maturity realized at Treasury auctions, compounded and weighted by net sales. From 1998 onward: Treasury bills, up to three months traded in the secondary market, compounded and weighted by the volumes. b Percentage change in the lira/$ exchange rate. c Percentage of GDP.

119 1552 WORLD DEVELOPMENT proportion rose steadily throughout the 1990s exceeding 75% at the end of the decade. As a result, the PSBR rose rapidly during the same period reaching, on IMF definition, 24% of GDP. 2 Like many other emerging markets with open capital accounts, Turkish financial markets, interest rates and exchange rates went through large swings during the 1990s, associated with boom-bust cycles in international capital flows. The increased financial instability was almost fully mirrored by unprecedented instability in economic activity. The initial boom coincided with the surge in capital inflows to Latin America in the early 1990s: during , cumulative net capital inflows by nonresidents reached $25 billion while the current account deficit remained below $10 billion. The boom was associated with an appreciation of the currency, a strong recovery and widening public sector and current account deficits (Table 1). It was followed by a bust in early 1994, about a year before the Mexican crisis, with a sharp reversal of nonresident capital flows by 12% of GDP. The economy went into a deep recession as the lira collapsed, and inflation and interest rates reached three-digit levels. As in Mexico the downturn was short-lived and the recovery rapid. Capital flows returned and the cumulative sum of nonresident flows reached $26 billion over The economy enjoyed three successive years of growth in excess of 7%. Currency appreciation was generally avoided as the Central Bank of Turkey (CBT) effectively pursued a policy of stabilizing the real exchange rate. This together with the initial real depreciation of the lira meant a sharp recovery in exports, which helped to keep the current account at sustainable levels despite rapid growth. Capital inflows were attracted in large part by short-term arbitrage opportunities as interest rates on public debt remained well above the rate of depreciation of the nominal exchange rate. But, they slowed sharply after the East Asian crisis, falling from 5.8% of GNP in 1997 to 1.8% in Growth was halved and the current account went into surplus. The fallout from the Russian crisis and a devastating earthquake in 1999 pushed the economy into a deep recession. While a currency crisis was averted over the turbulent years of , the banking sector felt the squeeze from tightened external financial conditions and contraction in economic activity. Eight insolvent banks had to be taken over by the public Saving Deposit Insurance Fund (SDIF), in accordance with the full insurance granted to deposits after the 1994 crisis, thereby adding to public debt and deficits. Thus, on the eve of the launching of the 1999 stabilization program, the Turkish economy was undergoing a sharp contraction and there were serious difficulties in the banking system. By contrast the external sector looked relatively healthy. The balance of payments position was sustainable and the currency did not seem to be out of line with the underlying fundamentals thanks to the 1994 devaluation and the exchange rate policy pursued by the CBT. 3 Domestic imbalances were serious, however. Government debt had grown rapidly over the preceding decade exceeding 60% of GDP at the end of 1999, and two-thirds of this was domestic debt. Interest payments from the budget had reached 22% of GDP while primary deficits were around 2%. With interest rates exceeding inflation by some 30 percentage points, fiscal sustainability could not be secured without lowering inflation and hence interest rates; at the end of the decade the operational deficit of the consolidated public sector, allowing for the inflation component of interest payments, was at an unsustainable level of 12.4% of GDP (Table 2). The banking system was extremely fragile, as it had been deregulated and granted deposit insurance without effective supervision. It had come to depend on high inflation and high interest rates by lending to the government which had become the single most important borrower in the domestic market. BanksÕ open foreign exchange positions had increased rapidly, from $3.6 billion at the end of 1997 to $12.6 billion at the end of 1999 as they increasingly relied on borrowing abroad and resident forex deposits for investment in government paper (Kaplan, 2002, p. 22). 3. STABILIZATION AND CRISIS (a) The stabilization program The government launched a stabilization program in December 1999 after extensive consultations with the BWIs, supported by an IMF stand-by credit. 4 Its target was to bring down the CPI and WPI to 25% and 20%, respectively by the end of 2000, and to the singledigit level by the end of 2002 from over 60% in 1999 (Table 2). The inflation target was anchored to a preannounced crawling peg set in

120 THE TURKISH FINANCIAL CRISIS 1553 Table 2. Turkish stabilization and crisis: macroeconomic targets and performance Target Performance Target a Performance Real sector GNP growth rate )6.1 5 to )3.0 (5 6) )9.4 WPI inflation b (10 to 12) 88.6 CPI inflation b (10 to 12) 68.5 Average T-bill interest rate Nominal Real (backward looking) 25.2 ) Real (forward looking) 32.0 ) Consolidated public sector c Primary balance ) (5.0) 5.5 Net interest payments PSBR (inc. CB profits) Operational balance )12.4 )7.4 )6.6 )3.2 Net debt (561/2) 93.5 Net domestic debt External sector c Current account balance )0.7 )1.5 to )2 )4.8 )0.6 ()1.5 to )2) 1.5 Net external debt 34.0 < Source: IMF (1999a, 2001c, 2002); IMF Press Release No. 01/23, 15 May 2001; real sector performance figures for 2001 are from the Central Bank of Turkey. a Figures in brackets give the targets set in the original stabilization program of December b 12-month, end-of-period. c In percentage of GNP. terms of a basket made up of the dollar and the euro, with a greater weight accorded to the former. The value of the basket in lira was set to increase by 20% for the year 2000 as a whole (i.e. at the target rate for WPI), at declining monthly rates starting with 2.1% for the first quarter and going down to 1% for the last three months of the year. A gradual shift toward a more flexible exchange rate regime would begin in July 2001 with the introduction of a symmetric, progressively widening band about the central exchange rate. This preannounced exit from the peg was considered a major strength of the Turkish program (Fischer, 2001, p. 9; IMF, 2000b, p. 48; IMF, 2001a, p. 137). Earlier experiments with exchange rate-based stabilization, particularly in Latin America, had often been criticized on the grounds that they were launched without adequate attention to the potential problem of currency appreciation and without a clear exit strategy as to when and how to alter the currency peg or the regime and realign the exchange rate (Eichengreen et al., 1998; Fischer, 2001). While appreciation is unavoidable, governments are often unwilling to abandon the peg and devalue as they are afraid of triggering a sharp reversal of capital flows. But delaying exit only aggravates currency misalignments and external imbalances, eventually making it difficult to engineer an orderly realignment of the exchange rate. The Turkish exit strategy was designed to avoid these problems. It was also a gamble on the pace of disinflation: a failure to meet inflation targets could reinforce expectations of a sharp depreciation at the time of the preannounced exit date, risking an earlier attack on the currency. This was, in the event, what happened in Turkey. The program also provided for a quasicurrency board whereby money printing against domestic assets was precluded. As the CBT was committed not to engage in sterilization, macroeconomic equilibrium was to be attained mainly through changes in interest rates: if capital inflows fell short of the currentaccount deficit, liquidity would be withdrawn from the economy and interest rates would rise, thus restoring external equilibrium by

121 1554 WORLD DEVELOPMENT attracting more capital, on the one hand, and by restraining domestic demand and imports, on the other. Fiscal goals included an improvement in the primary balance of the consolidated public sector, to yield a surplus in 2000 to be attained with additional taxation, cuts in current public primary spending, and pension reform. This was seen to be sufficient to stabilize the public debt-to-gdp ratio over the medium term although disinflation was expected to result in a temporary rise in the burden of interest payments on previously issued fix-rate securities. All these were to be supported by incomes policy designed to end backward indexation of wages and salaries, and by upfront structural reforms. Rationalization of agricultural policies and the pension system, improvement in fiscal management and tax administration, privatization of state-owned enterprises, including in particular Turk Telekom, and strengthening of the banking regulations were among the structural reforms agreed with the IMF. (b) The outbreak and deepening of the crisis In the event, during the course of 2000 the targets for the nominal exchange rate, net domestic assets and primary deficits were all attained, but prices proved to be stickier than expected, resulting in a significant appreciation of the currency in real terms. The CPI inflation on a year-to-year basis started to fall steadily after February 2000, but the pace was slow and the end-year target was overshot by some 15 percentage points. A number of factors contributed to price inertia. First, the large increase in international energy prices added to domestic costs and inflation. Second, a tradeoff emerged between fiscal adjustment and inflation since reducing losses of state-owned enterprises required increases in their prices. Third, wage increases in the public sector often exceeded the inflation target as a result of implementation of collective agreements reached in previous years while in the private sector wage settlements continued to be based on backward indexation. Finally, certain components of CPI, notably rents, rose much faster than the inflation target. Interest rates fell significantly faster than the rate of inflation, and indeed much faster than expected, resulting in negative real rates (Table 2). This was greeted with enthusiasm since earlier attempts at stabilization had failed to lower interest rates despite some success in disinflation (IMF, 2000b, p. 46). It brought considerable relief to the budget and played an important role in restraining debt accumulation. The improvement in the budget was very impressive, with the primary surplus reaching 2.8% of GDP against a target of 2.2%. This, together with the decline in interest rates, was sufficient to cut the operational deficit as a proportion of GDP by a large margin and stabilize, and in fact reduce, the public debt ratio. There was a fine balance between interest rates and capital inflows throughout the first three quarters of While capital inflows helped to lower interest rates, the latter were nevertheless high enough to create large international arbitrage opportunities, since the nominal depreciation of the currency fell far short of the differentials with foreign interest rates: the average interest rate in dollar terms on government paper was close to 15%. Consequently, private capital inflows and largescale foreign borrowing by the Treasury were more than sufficient to meet the growing current-account deficit, resulting in an increase in international reserves which reached some $24 billion, exceeding the year-end target of the program. Under the policy rule of nonsterilization, this meant a considerable expansion of domestic liquidity. This, together with the shift in government borrowing from domestic to international markets and the decline in risk premiums brought about by tight fiscal policy and the exchange rate anchor, helped to lower interest rates. The economy enjoyed a net capital inflow of $12.5 billion during the first 10 months of 2000 on account of a large inflow by nonresidents which financed not only the mounting current account deficits, but also net outflows by residents and increases in reserves (Table 3). Over 90% of these were debt-creating with international sovereign bond issues and bank credits constituting more than 80% of the total. Since investment and lending in domestic currency by nonresidents were a small proportion of net capital inflows, currency risk was borne largely by borrowers. An important part of these risks were concentrated in commercial banks. Just before launching the stabilization program, the government had lowered the upper limit on banksõ open forex positions to 20% of their equity. Banks could exceed this limit subject to a reserve requirement of 8% in the form of a deposit at the CBT. The reserve requirement was raised to 100% in June 2000 in order to

122 THE TURKISH FINANCIAL CRISIS 1555 Table 3. Boom and bust in capital flows in the turkish crisis (millions of dollars) January October 2000 November 2000 September 2001 Net nonresident flows 15,179 )12,416 Net resident flows )2,707 )1,247 Total net capital flows 12,474 )13,663 Changes in reserves a )2,324 16,585 Errors and omissions )2,550 )3,215 Current account balance )7, Source: Central Bank of Turkey. a Includes IMF credits and changes in official reserves. Minus sign indicates increase. eliminate open positions. But as banks were allowed to engage in forward forex transactions outside their balance sheets, these limits were exceeded. BanksÕ open positions are estimated to have exceeded $22 billion in October 2000, to fall to some $12 billion at the end of 2001 (Kaplan, 2002, p. 19, 23). Disinflation, currency appreciation and exceptionally low real interest rates combined to generate a strong domestic demand-led recovery in much the same way as in most episodes of exchange rate-based stabilization programs. Together with the appreciation of the currency and a rising oil bill, this led to a surge in imports which increased by 35% in 2000, while export growth remained at 7%. The trade deficit doubled to more than $20 billion, pushing the current-account deficit to an unprecedented 5% of GDP, about three times the level targeted in the program. Clearly, the rise in international reserves, strong as it was, would not have been sufficient to sustain external payments in the event of an interruption of capital inflows. While at the beginning of the year reserves were just enough to cover short-term external debt, at the end of the year short-term debt exceeded reserves by 50%, similar to the figure in Thailand on the eve of the 1997 crisis. Again, the ratio of the current-account deficit to reserves rose from 10% to 50% during the same period. Thus, the Turkish exchange rate-based stabilization program followed a familiar path: a surge in capital inflows, an upturn in economic activity, a significant appreciation of the currency, mounting trade deficits, worsening balance sheets and rising exchange rate risks. But the program ran into trouble before a significant progress could be made in disinflation. As in most emerging-market crises, it is difficult to identify a single event behind the sudden collapse of confidence and capital flight. The events that led to a rapid exit of capital in November included disappointing inflation results for October, unexpectedly high monthly trade deficits, political difficulties encountered in privatization, worsening relations with the EU, the economic situation in Argentina, and disclosure of irregularities in the banking system and a criminal investigation into several banks taken over by the SDIF. There may also have been a rush to liquidity due to competitive maneuvering among some private banks. 5 Quite apart from all this, however, the program had clearly run into the familiar problems of exchange rate-based stabilization that relies on arbitrage flows. As confidence eroded, foreign creditors refused to roll over their contracts with local banks or sold assets to exit while domestic banks sold liras in an effort to reduce their end-of-year open positions. The exit from the lira resulted in a liquidity crunch and a hike in interest rates by draining international reserves. Banks carrying large T-bill portfolios with funds borrowed in overnight markets suffered significant losses and started to bid for funds in the interbank market, at the same time unloading large amounts of government paper. Within a few days stock prices plummeted, rates on benchmark T-bill rose from 35% to 50% and overnight rates reached three-digit levels. The CBT faced the dilemma posed by loss of confidence under currencyboard regimes: either to defend the monetary rule and, ultimately, the currency peg at the expense of a financial crisis, or to act as a lender of last resort and rescue the financial system by injecting liquidity at the risk of deepening the currency crisis (Chang & Velasco, 2000). After some hesitation it started supplying liquidity to troubled banks. But this only served to accelerate the erosion of international reserves as the sale of liras on the foreign exchange market accelerated. Thus, the injection of liquidity did not prevent a contraction in the monetary base.

123 1556 WORLD DEVELOPMENT Within a few days the CBT reversed its policy and, evidently after the insistence of, and securing commitments from, the IMF, reinstated the currency-board rule with a new ceiling on domestic assets. As liquidity injection was discontinued and reserves were still sufficient to meet short-term external liabilities, capital outflows stopped, but interest rates shot up with overnight rates reaching four-digit levels. Persuaded that the program was on track, at the beginning of December the IMF agreed to a new financial package of some $10.5 billion, including $7.5 billion, or 600% of TurkeyÕs quota, from the Supplemental Reserve Facility. 6 The government undertook fresh commitments, including further spending cuts and tax increases, the dismantling of agricultural support policies, liberalization of key goods and services markets, financial sector restructuring and privatization. It also extended guarantees for foreign creditors as well as for all depositors of local banks in order to help restore confidence in the banking system. 7 By mid-january international reserves had been replenished, exceeding their pre-crisis level, and interest rates had stabilized. Imports slowed with the weakening of aggregate demand, and inflation continued to fall even though it remained at twice the rate of the crawl. Because of the underlying weaknesses, however, stability proved short-lived and it became increasingly clear that the program was not viable. While external funds remained invested at extremely short maturity, maturities in T-bill auctions started to shorten drastically already in late-january and interest rates started to shoot up, reaching 70% in mid-february. These cast serious doubts on the sustainability of public debt, and exposed banks with large portfolios of government bonds with maturities of months purchased at low interest rates during Rising public debt, high inflation and the continued real appreciation of the currency created considerable uncertainty over the sustainability of the peg. It took a political skirmish between the Prime Minister and the President to break the peg in the second half of February Massive flight from the Turkish lira could not be checked despite rising interest rates, with overnight rates reaching 5,000% and liquidity drying up. As the attack on the currency threatened complete loss of control over monetary policy as well as a rapid depletion of international reserves, the government was forced to abandon the peg and to float the currency, again with the support of the IMF. Within a single day the currency lost about one-third of its value against the dollar. As the financial turmoil deepened, the economic team was changed and an agreement was reached with the IMF in May 2001 on a new program supported by an additional stand-by credit of $8 billion, bringing the total IMF credit extended since December 1999 to $19 billion (IMF, 2001b). New macroeconomic targets were set for the rest of the year as well as for Growth and current account deficit targets for 2001 were significantly lowered while inflation and public debt targets were raised (Table 2). It was expected that the economy would stabilize and growth would resume in the second half of 2001 as inflation declined and exports rebounded (IMF, 2001c, pp ). All these were predicated on a strong fiscal adjustment to generate a primary surplus 5.5% of GNP for 2001, primarily through cuts in public employment and investment (IMF, 2001c, p. 18). But while the government was on the one hand trying to stabilize its debt by creating large primary surpluses and converting domestic debt to external debt, it was on the other hand adding to its liabilities by capitalizing the banks taken over by the SDIF and meeting the losses of state banks exposed to mounting interest rates (IMF, 2001c, pp. 7 8, Box 1, p. 10, & Table 5, p. 78). Even though fiscal and monetary performance criteria were generally met throughout 2001, stabilization and growth proved elusive. Despite a sharp turnaround in the currentaccount balance brought about by the collapse in economic activity and the freeing of the central bank from its obligation to defend the currency peg, reserves fell drastically as a result of continued exit of capital (Table 3). Thus, for the entire period from the launching of the stabilization program until September 2001, the swing in net capital flows reached $28 billion, or 14% of GDP, compared to some 10% during the Mexican boom-bust cycle. Inflation and interest rates remained well above projections, and the exchange rate continued to overshoot under speculative pressures in a rather thin market as the CBT stood-by and watched, to recover only on the news that the Fund would provide some additional finance. The government and the Fund only gradually came to grasp the gravity of the situation. All targets set for the real sector for 2001 were missed by a large margin (Table 2), leading to repeated downward revisions in GDP and upward revi-

124 THE TURKISH FINANCIAL CRISIS 1557 sions in inflation projections (IMF, 2001d, pp. 1 2; IMF, 2001e, p. 2). The move to floating under distress effectively removed any control policy may have had over exchange rates, interest rates and inflation. Although the currency was left to markets in order to free monetary policy from defending a particular exchange rate, the erosion of confidence in the lira and capital outflows tended to reduce liquidity and push up the interest rates which in turn aggravated the fiscal problem and resulted in further loss of confidence. The collapse of the currency and hikes in interest rates, a combination often observed in emerging markets applying orthodox recipes in response to capital flight, have appeared with greater force in Turkey because of the accompaniment of high inflation and fiscal imbalances. There has been little scope for monetary policy to bring down interest rates so as to stimulate the economy and facilitate fiscal adjustment. Not only have there been restraints on monetary expansion owing to a ceiling on net domestic assets and a floor to international reserves, but a move in the direction of monetary relaxation would also raise fears of monetization of budget deficits. Hopes were thus pinned on the return of arbitrage capital to stabilize the exchange rate and to bring down interest rates by restoring confidence through greater political commitment to structural change, but the reform program created difficulties in the fragile coalition. Again, the IMF became the key player, not only by providing the funds needed to support the fiscal and financial systems, but also the much-needed positive signals to financial markets. Persuaded that implementation of the program was very strong but that the external shock of September 11 had raised the financing gap, the Fund stood ready at the end of 2001 to establish a new stand-by agreement and to provide the country with an additional $10 billion. This was the fourth bailout package in two years, bringing the total of IMF financing to almost $30 billion. 8 While the Fund bailout package helped stabilize the currency market, much of the impetus came through the familiar deflationary process. On the one hand, as debt deflation and recession deepened, many debtors became insolvent and unable to raise funds to purchase foreign exchange to service their debt, thus reducing the sales of domestic currency for foreign exchange. On the other hand, the collapse of economic activity brought a massive turnaround in the balance of payments mainly as a result of a sharp decline in imports: these fell by 26% in 2001 after growing by 35% in the previous year, while export growth remained at a modest 11%. The acceleration of exports in 2002 provided a major stimulus to recovery, with current growth projections for the year ranging between 5% and 6%. As in most other emerging market crises, the lira started appreciating against the dollar both in nominal and real terms. Three years after the initiation of the stabilization program, inflation stood at around 30% on a year-to-year basis, unprecedented since the mid-1980s but not a very impressive performance compared to most exchange rate-based stabilization programs (Table 4; see also IMF, 2001a, p. 136, Table 4.4). More important, fiscal sustainability has not been secured. With the shift to floating, interest rates have lagged considerably behind the decline in inflation with benchmark rates staying around 60%, in large part because of increased exchange rate and credit risks attached to lira assets. In dollar terms public domestic debt increased by some 10% over , and its average maturity has remained short compared to despite some improvement over the previous year. 4. ACCOUNTING FOR THE CRISIS: OMISSION OR COMMISSION? As in other recent crises in emerging markets, the IMF has come up with a number of ex post facto explanations for why the crisis broke out and why it has proved so deep, putting the blame on policy slippages and external shocks rather than on the design of the stabilization program or misguided intervention in the crisis: The speculative attack on the Turkish lira took place against the background of increased political uncertainty, policy slippages and a weakening of economic fundamentals (IMF, 2001c, p. 2); The Turkish authorities were initially very effective in implementing the IMFsupported program, but they were less successful in coping with unexpected events such as the tripling of oil prices, the strong dollar, rising international interest rates, and an overheating economy (Cottarelli, 2001); The recent difficulties in Turkey relate more to banking sector problems, and the failure to undertake corrective fiscal actions when the current account widened, than to the design of the exchange rate arrangement (Fischer, 2001,

125 1558 WORLD DEVELOPMENT Table 4. Disinflation and initial conditions in selected exchange rate-based stabilization programs a Current account balance External debt Fiscal balance (% of GDP) GDP growth rate (%) Inflation, consumer prices (%) year over year Country Start of program (% of exports) Annual (% of GDP) Annual (% of exports) Quarterly Annual Annual (% of GDP) Annual Third year of program After one year At start of program Mexico December ) Argentina April )2.4 ) ) (convertibility) Brazil (Cardoso) July b ) Russia July )12.6 ) Turkey December c )5.1 )13.0 )0.7 ) Source: Thomson Financial Datastream, IMF Balance of Payments Statistics and International Financial Statistics. a Annual figures refer to the same year as the start of program for Mexico and Turkey and the preceding year for other countries. b Calculated on the basis of quarterly data (year over year). c Estimated. p. 9). Indeed, as it became clear that the program was no longer viable, the Fund started to harden its position in an effort to shift a greater share of the responsibility onto the government, interfering in such matters as appointments in public bodies, an action which created conflicts within the coalition government. 9 As in Indonesia, this proved to be counterproductive, eroding further the confidence that the Fund and the government were desperately seeking to reestablish. The explanations given by the IMF for the crisis have been challenged by many Turkish economists, including some former senior economists of the BWIs, on grounds that the policies advocated were based on a poor diagnosis of economic conditions in the country and the Fund was experimenting with programs that lacked sound theoretical underpinnings (e.g., Kumcu, 2001; Yenal, 2001). There is no denying that many other exchange ratebased programs supported by the Fund had also ended in financial crisis. Again, the policy response was broadly the same as in Turkey: namely, to provide funds in order to guarantee repayment of foreign creditors and to ensure the maintenance of convertibility of the lira and free capital movements, while also promoting tight macroeconomic policies and structural reforms to restore confidence in financial markets. In Turkey, however, capital flows were reversed in less than one year, the currency peg had to be abandoned before a significant progress could be made in disinflation, and output and employment losses were greater than in most other countries facing similar crises. 10 Compared to most other exchange rate-based stabilization programs, the Turkish inflation target did not look overambitious. For instance, in nine such programs implemented over , at the end of the first year the inflation rate was reduced, on average, to onequarter of its initial level (IMF, 2001a, p. 137) while the target in Turkey was to reduce inflation from some 60% to 20 25%. Disinflation was also very rapid in the Latin American and Russian programs implemented during the 1990s although in most of these cases there was considerable inertia as high inflation had lasted for several years (Table 4). In Turkey the program overlooked a number of factors which introduced additional impediments to rapid disinflation in its initial stages including, as already noted, the tradeoff between disinflation and fiscal adjustment and built-in backward indexation in salary and wage settlements.

126 THE TURKISH FINANCIAL CRISIS 1559 In terms of initial macroeconomic conditions, the Turkish economy was not particularly handicapped compared to various countries that succeeded in overcoming inflation under similar programs (Table 4). As in Argentina and Russia, the Turkish stabilization program was launched under recessionary conditions. There was thus considerable idle capacity in the economy that could provide a buffer against a rapid surge in demand associated with capital inflows, alleviating potential pressures on costs and prices. The initial Turkish current account position was sustainable while, according to FundÕs own judgment noted above, the lira was estimated to have been undervalued by some 10%. The subsequent appreciation was in the same order of magnitude and somewhat less than the average rate of appreciation in the nine exchange ratebased stabilization programs mentioned above. While Turkish external debt as a proportion of GDP was somewhat higher than in Argentina and Brazil (but lower than in Mexico), Turkey had a much lower debt-exports ratio than the Latin American countries because of its wider export base. Again, debt service in Turkey as a proportion of export earnings was similar to or lower than the ratios observed in the other countries in Table 4. Finally, Turkey, like Brazil, Mexico and Russia, launched its stabilization plan in the presence of large and unsustainable fiscal deficits. 11 A better diagnosis of the conditions in the Turkish banking system together with a proper understanding of the dynamics of the exchange rate-based stabilization programs could have alerted policymakers to the risks entailed by a rapid decline in interest rates as well as to the vulnerability of the economy to boom-bust cycles in capital flows. Both theory and empirical evidence show that the involvement of the banking sector adds considerably to the severity of a currency crisis in large part because of destabilizing feedbacks between bank balance sheets and currency markets, and in most emerging markets banking crises precede currency crises (Eichengreen & Arteta, 2000; Kaminsky & Reinhart, 1999; and Pesenti & Tille, 2000). In Turkey, overhauling the banking system before launching the stabilization program would have helped to avoid many of the subsequent difficulties noted above. 12 Restructuring was attempted however only after the outbreak of the November turmoil, ignoring one of the most valuable lessons from the East Asian crisis that the worst time to reform a financial system is in the middle of a crisis (UNCTAD, 1998, p. iii). Recent bouts of financial instability in emerging markets have given rise to a debate over whether currency crises can best be explained by inconsistent monetary and fiscal policies and fundamental macroeconomic imbalances, as emphasized in the first-generation models (e.g., Krugman, 1979), or by sudden spontaneous shifts in market sentiments and self-fulfilling prophecies, as in the second generation models (e.g., Obstfeld, 1986). 13 While sudden shifts in expectations are often triggered by macroeconomic imbalances, evidence suggests that crises have occurred under varying macroeconomic conditions including in countries with strong fundamentals (Aky uz, 2000b). Moreover, a careful examination of recent experiences with soft-pegs and exchange ratebased stabilization programs shows that many of the weaknesses in economic fundamentals including currency appreciation, deterioration of the current account, and increased exposure of the banking sector to exchange rate risks often result from the effects of capital inflows themselves rather than from policy slippages (UNCTAD, 1998, Chapter III). The Turkish program overlooked such potential weaknesses despite mounting evidence from recent history. Indeed, as noted above, both monetary and fiscal targets of the stabilization program were fully met, but external payments became increasingly unsustainable and the banking sector highly vulnerable. But while both the Fund and the government were quick to take credit for a strong economic upturn in 2000 after a deep recession in 1999, they were unwilling to discourage the capital inflows underlying this unstable process. Reserve requirements introduced to discourage open positions were not implemented effectively. More generally, although after the recent bouts of financial crises the Fund has admitted that some such marketbased restrictions over arbitrage flows (including the Chilean-type reserve requirements) could be useful, it has rarely encouraged developing countries to check such flows even when it was clear that they could not be sustained over the longer term. Again, experience shows that even countries with fiscal discipline have not always been able to pursue countercyclical policies at times of massive capital inflows to prevent overheating and currency appreciation. 14 The room for such policies was more limited in Turkey owing to the size of initial fiscal imbalances and the

127 1560 WORLD DEVELOPMENT extent of retrenchment already incorporated in the stabilization program. More fundamentally, the program was so designed that there was little policy space left for corrective macroeconomic action in the face of widening current-account deficits. By the time the difficulties became apparent, the 2000 budget had already been finalized according to the targets set in the program, and there was effectively little room either on the spending side or on the revenue side to act rapidly to slow demand expansion. This role could have been achieved by monetary policy, but this was excluded by the quasi-currency board and nonsterilization rules stipulated in the stabilization program. While poor diagnosis of economic conditions and shortcomings in the design of the program played a key role in the quick reversal of capital flows in Turkey, it should also be recognized that recent bouts of liquidity crises in emerging markets have significantly eroded the confidence of international investors in the sustainability of soft pegs, so that rapid exits tend to be triggered at the first signs of trouble. In this sense the Turkish experience also suggests that the chances of successful disinflation by means of an exchange rate anchor may now be lower. Indeed, the behavior of private capital flows to emerging markets in the current global downturn shows that, unlike in the first half of the 1990s, international investors have become much more nervous in raising their exposure to emerging markets despite falling investment opportunities in the major industrial countries (UNCTAD, 2002, pp ). 5. STANDING STILL AND MOVING FORWARD The Turkish debt problem is predominantly an internal one. With high and volatile inflation, real interest rates tend to hover at double digit rates, necessitating large primary fiscal surpluses in order to check a rapid build up of domestic debt, but this in turn depresses growth, thereby making it more difficult to sustain government debt without recourse to Ponzi financing. By contrast, as noted above, the stock of external debt is low relative to export capacity, and the current account remains at sustainable levels even at times of rapid economic growth as long as the currency is properly aligned. The Turkish stabilization program, designed to halt the unsustainable process of public debt accumulation by reducing inflation and interest rates, has led to an unprecedented financial crisis with massive costs in terms of output and employment. After November 2000, the economy faced a liquidity crisis in meeting its external debt obligations, necessitating large IMF bailouts. But, the orthodox policy response to the crisis failed to prevent the collapse of the lira and hikes in interest rates which, in turn, aggravated the domestic debt problem. Although inflation has now come down to levels not seen for almost two decades, real interest rates remain high and the problem of sustainability of public domestic debt unresolved. Much has been written on possible solutions to the problem of internal debt, but no one has done so more forcefully and with greater persuasiveness than did Keynes in his analysis of what he called progressive and catastrophic inflations in Central and Eastern Europe during the early 1920s: The active and working elements in no community, ancient or modern, will consent to hand over to the rentier or bond-holding class more than a certain proportion of the fruits of their work. When the piled-up debt demands more than a tolerable proportion, relief has usually been sought in one or other of two out of the three possible methods. The first is repudiation. But except as the accompaniment of revolution, this method is too crude, too deliberate, and too obvious in its incidence... The second method is currency depreciation... The owners of small savings suffer quietly, as experience shows, these enormous depredations, when they would have thrown down a Government which had taken from them a fraction of the amount by more deliberate but juster instruments. The remaining, the scientific, expedient, the capital levy,... is the rational, the deliberate method. But it is difficult to explain, and it provokes violent prejudice by coming into conflict with the deep instincts by which the love of money protects itself... But if it has become clear that the claims of the bond-holder are more than the taxpayer can support, and if there is still time to choose between the policies of a levy and of further depreciation, the levy must surely be preferred on grounds both of expediency and of justice (Keynes, 1971, pp ). 15 The Turkish government has been demanding sacrifices from the active and working elements of the society in order to be able to hand over the rentier or bond-holding class a large portion of the fruits of their work (the entire tax revenues in the past two years), refusing to seek remedies in some other ways including in one or the other two out of the three possible methods favored by Keynes.

128 THE TURKISH FINANCIAL CRISIS 1561 For obvious reasons neither monetization and accelerated inflation nor a capital levy nor any other measure that would place a sizeable burden on the rentier class can be successfully applied when the capital account is open and the currency is fully convertible. In other words, the conditions that make it difficult to manage the external value of the currency also aggravate the difficulties in managing domestic debt. Consequently, temporary suspension of convertibility and standstills on external debt payments are a practical policy option for stabilizing the exchange rate in countries facing international liquidity problems as well as for addressing the problem of domestic debt. These measures have long been advocated by the UNCTAD secretariat drawing on the rationale for an orderly debt workout as found in domestic bankruptcy procedures, most notably Chapter 11 of the United States Bankruptcy Code, in order to overcome the difficulties associated with official bailouts and crisis intervention. 16 These procedures involve three principles: (a) provisions for an automatic standstill on debt servicing that prevents a grab race for assets among the creditors; (b) maintaining the debtorõs access to working capital required for the continuation of its operations; and (c) an arrangement for the reorganization of the debtorõs assets and liabilities, including debt rollover, extension of existing loans, and debt write offs and conversions. The main objective of these procedures is to maintain the firm as a going concern through financial restructuring rather than liquidation. The need for such bankruptcy procedures arises because contracting parties cannot always make provisions for all possible contingencies or redraw contracts in situations for which provisions had not been made due to certain imperfections such as incomplete information, imperfect enforceability of contracts and high negotiating costs (Cornelli & Felli, 1995). Naturally, the application of these principles to crossborder debt involves a number of complex issues. But, fully-fledged international bankruptcy procedures would not be needed to ensure orderly debt workout of international debt, particularly for liquidity crises. The key element is internationally sanctioned mandatory standstills. Under certain circumstances, it might be possible to reach agreement on voluntary standstills and rollovers with creditors but as recognized by the IMF, in the face of a broad-based outflow of capital, it may be difficult to reach agreement with the relevant resident and non-resident investors (IMF, 2000c, p. 10). Standstills on sovereign debt involve suspension of payments by governments themselves, while on private external debt they require the imposition of temporary exchange controls which restrict payments abroad on specified transactions, including interest payments. Further restrictions may also be needed on the capital-account transactions of both residents and nonresidents. The rationale for the application of such principles to crisis management is based on selffulfilling prophecies and the collective action problem (Eichengreen & Portes, 1995, pp. 8 9). As noted above, a loss of confidence by creditors and investors can be self-justifying, leading to a collapse of the currency and hikes in interest rates, and plunging the economy into recession. Whether or not it is justified by imbalances in economic fundamentals, the outcome is often overshooting of exchange rates and interest rates which can, in turn, exert serious damages on balance sheets. Such behavior can easily turn a liquidity problem into widespread insolvencies and defaults, hurting creditors as well as debtors. Even though the creditors as a group are better off if they continue to roll over their maturing claims on a debtor, an individual investor has an incentive to rush for the exits. Such debt runs reflect the failure of markets to coordinate individual decisions so as to generate a superior outcome for the creditors as well as the debtors. In the absence of immediate access to adequate amounts of international liquidity, a possible way out is to rule out bad equilibrium by force majeure, imposing capital controls as a temporary emergency measure during a crisis (Krugman, 1999, p. 4). Provision of international liquidity under crisis conditions in the form of IMF bailouts is neither immediate, nor unlimited. In almost all recent emerging market crises, assistance coordinated by the IMF usually came after the collapse of the currency, and was combined with policies which often failed to restore confidence, but served to deepen economic contraction. Provision of large amounts of liquidity to countries as needed would require turning the Fund into an international lender of last resort and eligibility of countries to automatic access to Fund resources, but such proposals face political opposition as well as practical difficulties (Aky uz, 2000a, pp ; Aky uz & Cornford, 2000, pp ). Furthermore, it is generally agreed that bailouts

129 1562 WORLD DEVELOPMENT create moral hazard for lenders and shift the burden onto debtor countries. In fact they are difficult to reconcile with the rationale of free markets since it is generally agreed that market discipline will work only if creditors bear the consequences of the risks they take. Recognizing these difficulties UNCTAD economists have proposed that a credible strategy for involving the private sector in crisis resolution should combine temporary standstills with strict limits on access to Fund resources (UNCTAD, 2001, p. 140). The IMF Board has also recognized that it may be necessary to impose a unilateral standstill: Directors underscored that the approach to crisis resolution must not undermine the obligation of countries to meet their debt in full and on time. Nevertheless, they noted that, in extreme circumstances, if it is not possible to reach agreement on a voluntary standstill, members may find it necessary, as a last resort, to impose one unilaterally. Directors noted that... there could be a risk that this action would trigger capital outflows. They recognize that if a tightening of financial policies and appropriate exchange rate flexibility were not successful in stanching such outflows, a member would need to consider whether it might be necessary to resort to the introduction of more comprehensive exchange or capital controls...most Directors considered that the appropriate mechanism for signalling the FundÕs acceptance of a standstill imposed by a member was through a decision for the Fund to lend into arrears to private creditors. 17 Until recently, however, the Fund Board was unwilling to provide statutory protection to debtors in the form of a stay on litigation because of strong opposition from some of the major economic powers and market participants. Governments in some debtor countries, notably in Latin America as well as in Turkey, have also been reluctant to back this proposal for fear of impairing their access to international capital markets. But, in view of the difficulties encountered in implementing voluntary workouts for the Argentinian debt and the failure of IMF interventions to stabilize Argentina and Turkey, together with the economic difficulties faced in industrial countries themselves, international bankruptcy codes and standstills have been getting a fuller hearing. The IMF now appears to be moving in the direction of establishing some international debt workout procedures. Its First Deputy Managing Director has described the new approach in the following terms: A formal mechanism for sovereign debt restructuring would allow a country to come to the Fund and request a temporary standstill on the repayment of its debts, during which time it would negotiate a rescheduling with its creditors, given the FundÕs consent to that line of attack. During this limited period, probably some months in duration, the country would have to provide assurances to its creditors that money was not fleeing the country, which would presumably mean the imposition of exchange controls for a temporary period of time... Sovereign debt owed to domestic residents may well need to be included in any restructuring for three reasons. First, in the absence of capital controls, balance of payments problems are as likely to arise from the flight of domestic investors and lenders as from withdrawal of foreign ones. Second, domestic debt may impose an unsustainable fiscal burden, especially as the crisis will already be weakening the countryõs budgetary position by depressing economic activity. Third, external creditors are less likely to agree to a reduction in the value of their own claims if they know that domestic investors are simultaneously being repaid in full or in much greater proportion (Krueger, 2001, pp. 7 9). 18 While this initiative has recently encountered difficulties due to the opposition of international bankers and investors (Blustein, 2003), it certainly reflects a growing recognition that the approach so far adopted in official intervention in emerging market crises, built on the principle of maintenance of open capital accounts and convertibility and guaranteed repayment to creditors, and combined with restrictive monetary and fiscal policies may not always be successful in stabilizing the markets and avoiding costly crises. Despite this recognition, most countries facing currency crises have been unwilling to resort to unilateral standstills and capital controls, and even oppose to the introduction of a statutory basis for such actions. A notable exception is Malaysia. Unlike other East Asian countries that followed orthodox programs designed and supported by the IMF in response to the crisis, Malaysia chose to impose comprehensive but temporary controls over capital account transactions and to fix the exchange rate after failing to restore confidence and stabilize the currency through orthodox policies. Despite initial prognostications by credit-rating agencies and the IMF that such controls would only serve to deepen the crisis, they proved to be highly effective in accelerating recovery by allowing expansionary macroeconomic policies (UNCTAD, 2000, pp ; Kaplan & Rodrik, 2001). Furthermore, there was only a limited outflow of capital when the

130 THE TURKISH FINANCIAL CRISIS 1563 controls were lifted, suggesting that controls can be successfully advertised as temporary measures, and removed when the risk of selffulfilling pessimism has abated (Krugman, 1999, p. 5). It was suggested in a Korean government report to G-20 that such a strategy could have also been more effective in dealing with the crisis in Korea (G-20, 1999, p. 13). Like most other developing countries Turkey followed the orthodox route, combining tight macroeconomic policies with IMF bailouts. Two unsuccessful attempts were made to reach agreement with foreign banks on voluntary standstills and rollover of interbank credits. 19 The first one occurred soon after the November 2000 turmoil, organized by the IMF with a few large creditor banks from the G-10 countries in accordance with its catalytic approach designed to involve the private sector in crisis resolution alongside multilateral lending to overcome the immediate liquidity crisis (Eichengreen, 2001, p. 24). No firm commitment could be obtained from these banks to maintain their December 11 level of exposure, in large part because the central banks of the countries concerned were unwilling to exert moral suasion. The second attempt was made in June Even though it was combined with explicit public guarantees for the credits lines used by private Turkish banks, the initiative was again largely unsuccessful: at the end of 2001, the exposure of foreign banks on interbank credit lines stood at half of its December 2000 level. Furthermore, the decline in exposure was associated with sharply rising spreads despite rapidly declining dollar interest rates brought about by the aggressive easing of monetary policy in the United States: interest payments for shortterm borrowing for liquidity needs were about two times higher than the pre-crisis period despite decreasing debt stock (Senel, 2002, p. 25). In view of the failure of the FundÕs catalytic approach in involving the private sector in the resolution of the Turkish crisis, an option would have been to combine a unilateral standstill with lending-into-arrears and exchange restrictions. After all, the conditions in Turkey were broadly consistent with those stipulated by the IMF Board for resort to such an action: the government was committed to meeting its external obligations in full and was pursuing a Fund program, but private creditors were not cooperating. A standstill mechanism could have been introduced during the first months of 2001 when it became clear that the stabilization plan was no longer viable and the foreign banks were not willing to cooperate. Because of high inflation, it would have been necessary to combine it with a crawling peg regime (rather than a fix rate as in Malaysia) in order to stabilize the real exchange rate after a one-off devaluation to correct for the appreciation of the lira. Given the weaknesses in the Turkish economic fundamentals, particularly with respect to inflation, fiscal deficits and the stability of the banking system, exchange restrictions and capital controls may not have been fully effective in preventing capital flight. It is not clear however if more capital would have left the country than that actually did throughout 2001, particularly if the IMF had given its full support by lending-into-arrears. A standstill could have saved the country large sums of additional interest charges on existing credit lines. More important, preventing the overshooting of the exchange rate could have limited the damage exerted on private balance sheets and saved the public sector alone more than one percentage point of GDP in budgetary resources, thereby helping reduce the primary surplus and easing the deflationary pressures in the economy. 20 In Malaysia the main purpose of exchange restrictions was not to check capital outflows or support external payments, but rather to stop speculative pressures against the currency so as to bring down interest rates in support of a rapid recovery. 21 In Turkey, too, there was a need to bring down interest rates in order to check the downturn in economic activity, but the real question was (and still is) how to stop the unsustainable pace of public debt accumulation associated with double-digit real interest rates. During 2000 when real interest rates on government paper issued in the previous year reached 36% because of the decline in inflation, a relatively moderate one-off tax was successfully imposed on interest incomes, resulting in a significant revenue collection and reducing the effective rate on government debt. The acceleration in inflation in 2001 associated with the sharp drop of the currency resulted in negative real interest rates on government papers issued during 2000 when interest rates were falling. But, as interest rates rose rapidly in 2001 and inflation started to decline in 2002, ex post real rates on government papers issued in 2001 rose to almost 30%. Clearly, under crisis conditions it would be difficult to tax financial incomes without suspending convertibility. Indeed, the

131 1564 WORLD DEVELOPMENT government has maintained full convertibility and kept the capital account open while interest payments continued to drain budgetary resources, necessitating larger primary surpluses to check public debt accumulation. Even if the current program based on fiscal austerity were eventually to bring inflation and interest rates under control and resolve the debt problem, its costs in terms of welfare and economic growth are likely to be onerous. Indeed, a study investigating welfare and growth implications of various fiscal policy alternatives in bringing debt sustainability in Turkey, including a capital levy a la Keynes, has concluded that the continued implementation of the current program may resolve the public debt problem, but the productive sphere of the real economy might be severely hampered. By contrast, an alternative program based on a one-off wealth tax is likely to produce the most superior outcome in terms of both growth performance and fiscal accounts (Voyvoda & Yeldan, 2002, p. 26). In any case, with real interest rates still hovering at rates over 20% and fiscal austerity reaching the limits of political acceptability, debt sustainability in Turkey remains unresolved. Moreover, economic prospects are further complicated by political uncertainties in the region. A combination of capital controls with taxes on financial incomes and/or wealth may not only be a superior alternative to the current policy of fiscal austerity in terms of equity and growth, but it may also be the only viable and orderly way to resolve the public debt predicament in Turkey. NOTES 1. For various aspects of this experience see a collection of papers in Aricanli and Rodrik (1990). 2. This definition, adopted by the IMF to measure the true stance of fiscal policy and hence the extent of adjustment needed, includes state-owned enterprises, extra-budgetary funds and social security institutions as well as the central government. 3. This was also the conclusion reached in an IMF staff report issued on the eve of the stabilization program: the results suggest that the lira could appreciate by about 10 per cent from its 1998 average while remaining consistent with a sustainable current account deficit (IMF, 2000a, p. 68). 4. For the details of the program see IMF (1999a) and IMF (2000b, box 2.1, p. 46). 5. On some accounts the crisis was triggered because a number of banks pushed up the interbank rate in a competitive manoeuvring with their rival, Demirbank, forcing it to unload substantial amounts of T-bills and creating a break in market liquidity and putting pressure on interest rates. For a view from financial markets on the possible contribution of various factors to the outbreak of the crisis in Turkey see JP Morgan (various issues). 6. IMFÕs Fischer says Turkey Program on Track, IMF News Brief No. 00/17, November 26, See also the subsequent statement by K ohler just before the February crisis, IMF News Brief No. 10/13, February 5, This move appears to have had the full support of the Managing Director of the IMF: I particularly welcome the governmentõs firm commitment to implement a bold set of measures to strengthen the soundness of the banking sector aimed at tackling the root causes of the current problems. I welcome the firm action already taken in this respect, including the decision to protect depositors and other creditors in Turkish banks, IMF, News Brief No. 00/113, December 6, IMF News Brief, No. 01/116, November 15, During the East Asian crisis there was a widespread criticism of Fund conditionality, including from some mainstream economists (e.g., Feldstein, 1998), on the grounds that it was intrusive, often resulting in unnecessary interference with the proper jurisdiction of a sovereign government. Subsequently, the International Monetary and Financial Committee recognized the need to streamline IMF conditionality, and urged the Executive Board to take forward its review of all aspects of policy conditionality associated with Fund financing in order to ensure that, while not weakening that conditionality, it focuses on the most essential issues in its Communique of September The Fund policies in Turkey however have shown no tendency to depart from past practice. 10. For description and comparison of various boombust cycles and exchange rate-based stabilization programs, see UNCTAD (1995, Chapter II; 1999, Chapter III; & 2000 Chapter IV); Mussa et al. (2000, Appendix III); and IMF (2001a, Chapter IV).

132 THE TURKISH FINANCIAL CRISIS For comparability across countries the definition adopted for fiscal balance in Table 4 is different from the PSBR used in Table 2 (see note 2). 12. Before the stabilization program was launched in December 1999, one of the authors of this paper had urged that priority should be given to legal and institutional arrangements in order to reform the banking system and social security institutions, and in order to bring fiscal discipline before attacking inflation; see S oylesi/yilmaz Aky uz, T urkiyeõnin isi zor!, Power, July See also Milliyet, June For a comparison, contrast and reconciliation between these models see Pesenti and Tille (2000). 14. For the problems faced in countercyclical policies at times of boom in capital flows see Ocampo (2003). 15. The political difficulties of introducing a capital levy, KeynesÕ preferred instrument for dealing with a debt overhang, are exemplified by the eventually abortive attempt to use this approach by another famous twentieth-century economist, Joseph Schumpeter, during his seven-month tenure as Minister of Finance in Austria in 1919 (Stolper, 1994, Part IV). 16. This proposal was first made in the context of the debt crisis in the 1980s (UNCTAD, 1986, Annex to Chapter IV), and more recently in relation to emergingmarket crises (UNCTAD, 1998, pp ). For a detailed description of these principles, the problems with bailouts and IMF intervention in crises and the state of the debate on involving the private sector in crisis resolution see Aky uz (2000a, 2002) and Aky uz and Cornford (2000). 17. See IMF (2000d). For further discussion of the debate in the IMF see Aky uz (2002, pp ). 18. There are some differences between UNCTAD and IMF proposals. In the UNCTAD proposal the decision to impose standstill should rest with the debtor country but would then be subject to an examination and endorsement of an independent panel very much along the lines of the WTO safeguards procedures. UNCTAD proposal also includes strict limits on crisis lending. In the IMF proposal, the standstill would be activated if a request by the debtor country was endorsed by the Fund (Krueger, 2001, p. 9). 19. This account is based on an insider view from a staff member of the CBT, Senel (2002). 20. This estimate is based on a one-off real devaluation to correct for the appreciation that had taken place after the launching of the stabilization program, and an unchanged real exchange rate thereafter. 21. Indeed, the controls were introduced well over a year after the outbreak of the crisis, during which time most of foreign short-term capital had already left and the current account had turned into a surplus because of sharp contraction of economic activity: see UNCTAD (2000), p. 55. REFERENCES Aky uz, Y. (2000a). The debate on the international financial architecture: reforming the reformers. UNCTAD Discussion Paper, No. 148, April. Aky uz, Y. (2000b). On financial stability and control. In J. J. Teunissen (Ed.), Reforming the International Financial System (pp ). The Hague: Fondad. Aky uz, Y. (2002). Crisis management and burden sharing. In Y. Aky uz (Ed.), Reforming the global financial architecture: Issues and proposals (pp ). London: Zed Books. Aky uz, Y., & Cornford, A. (2000). Capital flows to developing countries and the reform of the international financial system. In D. Nayyar (Ed.), Governing globalization (pp ). New York: Oxford University Press. Aricanli, T., & Rodrik, D. (Eds.). (1990). The political economy of Turkey. London: Macmillan. Blustein, P. (2003). IMF cuts disputed clause from debt plan. Washington Post, January 8. Boratav, K., & Yeldan, E. (2001). Turkey, : financial liberalization, macroeconomic instability and patterns of distribution. Mimeo, CEPA, New School, New York. Central Bank of Turkey (various issues). Quarterly Bulletin. Ankara: CBT. Chang, R., & Velasco, A. (2000). Financial fragility and the exchange rate regime. Journal of Economic Theory, 92, Cornelli, F., & Felli, L. (1995). The theory of bankruptcy and mechanism design. In B. Eichengreen, & R. Portes (Eds.), Crisis? What crisis? Orderly workouts for sovereign debtors (pp ). London: Centre for Economic Policy Research. Cottarelli, C. (2001). Turkey always had control of its economy. Financial Times, June 5. Eichengreen, B. (2001). Crisis prevention and management: any new lessons from Argentina and Turkey. Background paper for the World BankÕs Global Development Finance University of California, Berkeley.

133 1566 WORLD DEVELOPMENT Eichengreen, B., & Arteta, C. (2000). Banking crises in emerging markets: presumption and evidence. Mimeo. University of California, Berkeley. Eichengreen, B., & Portes, R. (1995). Crisis? What crisis? Orderly workouts for sovereign debtors. London: Centre for Economic Policy Research. Eichengreen, B., Masson, P., Bredenkamp, H., Johnston, B., Hamann, J., Jadresic, E., & Otker, I. (1998). Exit strategies. Policy options for countries seeking greater exchange rate flexibility. IMF Occasional Paper, No Feldstein, M. (1998). Refocussing the IMF. Foreign Affairs, 77, Fischer, S. (2001). Exchange rate regimes: Is the bipolar view correct? New Orleans: American Economic Association (January). G-20 (1999). The Republic of KoreaÕs crisis resolution and its policy implications (final draft). G-20 Report. Seoul: Ministry of Finance and Economy, December. IMF (1999a). Turkey. Letter of Intent, December 9. IMF (2000a). Turkey: selected issues and statistical appendix. Staff Country Report No. 00/14, November. IMF (2000b). World Economic Outlook, May. IMF (2000c). Involving the private sector in the resolution of financial crises standstills preliminary considerations. Washington, DC: International Monetary Fund, September 5. IMF (2000d). Executive Board discusses involving the private sector in the resolution of financial crisis. IMF Public Information Notice (PIN), no. 00/80. Washington, DC, 19 September. IMF (2001a). World Economic Outlook, May. IMF (2001b). IMF approves augmentation of TurkeyÕs Stand-By Credit to US$19Billion, Press Release No. 01/23, May 15. IMF (2001c). Turkey: sixth and seventh reviews under the Stand-By Arrangement. IMF Country Report No. 01/89, June. IMF (2001d). Turkey. Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding, July 31. IMF (2001e). Turkey. Letter of Intent. November 20. IMF (2002). Turkey: Tenth review under the Stand-By Arrangement. IMF Country Report No. 02/21, February. JP Morgan (various issues). Data watch: Turkey. Global Data Watch. Kaminsky, G., & Reinhart, C. (1999). The twin crises: the causes of banking and balance-of-payments problems. American Economic Review, 89, Kaplan, C. (2002). Open foreign positions of the banking sector. Paper presented to the 6th international conference of economics. Ankara: Middle East Technical University. Kaplan, E., & Rodrik, D. (2001). Did the Malaysian capital controls work? Mimeo. Harvard University, Cambridge, MA. Keynes, J. M. (1971). Public finance and changes in the value of money. In A tract on monetary reform in the collective writings of John Maynard Keynes (Vol. IV). Cambridge: Cambridge University Press. Krueger, A. (2001). International financial architecture for 2002: a new approach to sovereign debt restructuring. Address given at the National EconomistsÕ Club Annual MembersÕ Dinner. Washington, DC: American Enterprise Institute. November 26. Krugman, P. (1979). A model of balance of payments crises. Journal of Money, Credit and Banking, 11, Krugman, P. (1999). Analytical afterthoughts on the Asian crisis. Unpublished paper. MIT, Cambridge, MA. Kumcu, E. (2001). The IMFÕs blunder in Turkey, Financial Times, March 13. Mussa, M., Masson, P., Swoboda, A., Jadresic, E., Mauro, P., & Berg, A. (2000). Exchange rate regime in an increasingly integrated world economy. IMF Occasional Paper No Obstfeld, M. (1986). Rational and self-fulfilling balanceof payments crises. American Economic Review, 76, Ocampo, J. A. (2003). Developing countriesõ anti-cyclical policies in a globalized world. In A. Dutt, & J. Ros (Eds.), Development economics and structuralist macroeconomics: Essays in honor of Lance Taylor. Aldershot: Edward Elgar. OECD (2001). OECD economic outlook, No. 69, June. Pesenti, P., & Tille, C. (2000). The economics of currency crises and contagion: an introduction. In Economic policy review, special issue: Lessons from recent crises in Asian and other emerging markets (Vol. 6, pp. 3 16). New York: Federal Reserve Bank of New York. Senel, A. (2002). Foreign debt rollover during crises: Turkish experience. In Paper presented at the 6th international conference of economics, Middle East Technical University, Ankara. Stolper, W. F. (1994). Joseph Alois Schumpeter: The public life of a private man. Princeton, NJ: Princeton University Press. UNCTAD (various years). Trade and development report, Geneva: UNCTAD. Voyvoda, E., & Yeldan, E. (2002). Beyond crisis adjustment: investigating fiscal policy alternatives in an OLG model of endogenous growth for Turkey. In Paper presented at the 6th international conference of economics. Middle East Technical University, Ankara. Yenal, O. (2001). The irresponsible monetary fund. Financial Times, July 12.

134 Review of International Political Economy 12:3 August 2005: The Turkish encounter with neo-liberalism: economics and politics in the 2000/2001 crises Ümit Cizre Bilkent University, Department of Political Science, Ankara and Erinç Yeldan Bilkent University, Department of Economics, Ankara ABSTRACT Turkey initiated an extensive dis-inflation program in December 1999 backed and supervised by The International Monetary Fund (IMF). The program aimed at decreasing the inflation rate to a single digit by the end of It exclusively relied on a nominally pegged (anchored) exchange rate system for dis-inflation and on fiscal prudence. In February 2001, however, Turkey experienced a very severe financial crisis, which deepened and continued to-date. The official stance is that the crisis was the result of the failure of the public sector to maintain the austerity targets and the failure to implement fully the free market rationale of globalization. We argue in this article that, contrary to the official wisdom, the current economic and political crisis is not the result of a set of technical errors or administrative mismanagement unique to Turkey, but is the result of a series of pressures emanating from the process of integration with the global capital markets. We further provide a discussion on the fundamental parameters of the Turkish politics connected with the crisis. KEYWORDS Economic and political crisis; Turkey; globalization; stabilization; IMF conditionality. 1. INTRODUCTION The last two decades witnessed an extensive shift in the development strategy with the rise to hegemony of the neo-liberal orthodoxy dictating Review of International Political Economy ISSN print/issn online C 2005 Taylor & Francis Group Ltd DOI: /

135 REVIEW OF INTERNATIONAL POLITICAL ECONOMY market rationality over any other form of collective decision-making. In the words of Bourdieu (1998), this infernal machine, termed globalization, has sought to destroy all collective structures that are held as a hindrance to the profitability of private capital. Thus, trumpeted with the rhetoric of TINA (There is no alternative) the neo-liberal orthodoxy introduced new rounds of conditionality as part of its hegemonic agenda: privatization, flexible labor markets, financial de-regulation, flexible exchange rate regimes, central bank independence (with inflation targeting), fiscal austerity, and good governance. This neo-liberal ideology attempted to explain the motives behind financial liberalization arguing that such measures would restore growth and stability by raising savings and improving economic efficiency. Accordingly, as the strangulation of the so-called financial repression is dismantled, loanable funds would expand; the real cost of credit would fall; and the increased pace of capital accumulation would generate sustained growth. A major consequence, however, has been the exposure of those economies that underwent financial deregulation to speculative short-term capital (hot money) attacks, which increased instability and precipitated a series of financial crises. In the last 20 years alone, the world economy experienced about 70 financial crises, with about two-thirds hitting the developing countries (Adelman, 2000). Furthermore, contrary to expectations, post-liberalization episodes were characterized by the diversion of domestic savings away from fixed capital investments towards speculative financial instruments with often erratic and volatile yields. As a result, developing economies with weak financial structures and shallow markets suffered from increased volatility of output growth, shortsighted investment decisions, and financial crises with severe economic and social consequences. Often the economic crises occurred hand in hand with the ensuing political crises. All of which led to a severe contraction of labor incomes and increased unemployment together with marginalization of the work force, and resulted in violation of basic labor rights in trade union activity, deprivation of rights to engage in collective bargaining and participatory democracy. Turkey initiated its neo-liberal reforms in 1980 with the liberalization of commodity trade and flexibilization of its labor markets. The capital account was de-regulated and financial liberalization was completed in After going through a series of short-term cycles of instability-crisis- (unsustained) growth-instability throughout the 1990s, Turkey entered a period of severe economic-cum-political crisis in November, 2000 with a final burst of the financial bubble in February, If the structural market reforms promoted by the then-prime minister Turgut Özal in the 1980s can be termed as Turkey s first-generation economic liberalization, the current stage of neo-liberal economic reform can be termed second-generation marketization reforms. Essentially, both rounds of reforms relied on the 388

136 CIZRE AND YELDAN: THE TURKISH ENCOUNTER same prescriptive orthodoxy, namely, the establishment of unfettered freemarket capitalism. However, the new generation of market policies have been formed and implemented in a context where the transnational mobility of capital and global production networks were far more pronounced than before. 1 Yetasthe Turkish economy moved into a new stage of macroeconomic stabilization program, it has become clear that an ill-timed decision on liberalization of capital movements in 1989 had already generated the structural preconditions of the crisis. In this context, the emergence of the February 2001 crisis is directly related to the implementation of the IMF-led adjustment package unveiled in December Clearly, the operations of a globalized financial system depend on the existence of connections between the global order and domestic politics. As required, designed and imposed by international financial organizations (IFO s), marketization policies aim to reshape the power relations between the government bureaucracy, national and international capital, and the laboring masses. In fact, the post-february 2001 predicament in Turkey painfully illustrates the theoretical debate on how to modify the state market relations in a country to convert it into a reliable and stable partner state in the global capitalist order. The official view is that the February crisis was the result of the failure of the public sector to maintain the austerity targets set by the IMF-led stabilization program initially initiated in December Thus, the crisis in Turkey was the result of the failure of the Turkish government to maintain its austerity targets and to implement the necessary structural adjustment reforms on time, thereby disturbing the market agents and causing foreign capital to leave the country. We argue, however, that the February 2001 political and economic crisis in Turkey was not the product of a few technical errors or mismanagement, but was the result of a set of cumulative processes that were set in motion by the overly premature attempt to liberalize and deregulate the economy. Contrary to the official stance, economic evidence clearly shows that the fiscal targets were reached throughout the implementation of the program in 2000, and the central bank (CB) was successful in maintaining its monetary targets. It is our operating hypothesis in this article, therefore, that because the fragile and shallow domestic asset markets of Turkey s peripheral capitalism were prematurely exposed to foreign competition, and all the underlying conditions for the financial crisis were already in place. Thus, the question is whether the causes of the crisis and the proposed remedial reforms are as simple and mono-causal as the neo-liberal thinking behind the IMF-backed recovery program in Turkey would lead us to believe. This article addresses these issues based on recent economic evidence. The plan of the article is as follows: in the next section, we offer an overview of the orthodox perceptions on the causes of the February crisis in Turkey. Then we investigate the macroeconomic impacts of financial 389

137 REVIEW OF INTERNATIONAL POLITICAL ECONOMY de-regulation in a developing economy in the context of the Turkish experience. We continue with a discussion of the distinguishing characteristics and parameters of the Turkish political apparatus in the aftermath of the crisis. We provide concluding comments in the final section. 2. ORTHODOX PERCEPTIONS OF THE FEBRUARY 2001 CRASH The official interpretation of the causes of the February 2001 crash is based upon what we term the orthodox political and economic mismanagement perspective. That interpretation is further incorporated into the underlying logic of the current structural adjustment program. It argues that the preoccupation with private and political gain in the public bureaucracy and politics compromised the quality of the economic decision-making, which in turn, laid the foundations for the ensuing crisis. The corruption of public bureaucracy Prominently represented by marketization friendly elements of the political elite -the bureaucracy, media pundits, majority of the academia and the IFO officials this discourse attributes the 2001 crisis to policy errors and deviations from or deadlocks in the first-generation market reforms. 3 In a general sense, for this perspective, the blame for the crisis lies in the failure of Turkey to adapt to globalization and seek benefits from it. Accordingly, the failure to implement fully the free-market rationale stems from two clusters of factors that are not mutually exclusive. First, the lack of political will on the part of the government bureaucracy and political actors, second, the fusion of politics with the economics. The combined result, it is argued, was bad governance with wasteful populism and institutional rigidity, which brought about ineffectual and erratic patterns of economic policy-making. 4 According to this position, the appropriate reform strategy is to make administrative changes that provide the needed disassociation of politics from the economic rationale to manage effectively a market economy. If we begin by looking at this so-called lack of political will, we can see that those economy bureaucrats and politicians and their supporters in important economic interest groups, which support them contend that the first-generation reform phase and subsequent IMF structural reform programs did not go far enough simply because the political elite lacked the courage to identify themselves with the reforms. 5 They failed to carry them out and risk the political costs of the kind of austerity measures essential to integrating with global capitalism. The former minister of economy, Kemal Dervis, himself adhered to this point of when he attributed the failure of the past IMF programs to the absence of a group of politicians willing to 390

138 CIZRE AND YELDAN: THE TURKISH ENCOUNTER commit themselves to the strong measures required by the structural logic of neo-liberal orthodoxy. 6 More specifically, for this school of thought, the genesis of the crisis derives from the incompetence of those managing public enterprises: an extensive and expensive series of populist entitlements made possible by the role of the state in the economy. Moreover, it is argued that the character of Turkey s public sector provides the natural habitat for corruption, which in turn precipitated the February 2001 crisis. 7 It is argued that a large and unprofitable network of state-owned banks has encouraged rent-seeking behavior by bureaucrats and politicians. Is corruption only public? However, there is something amiss in explaining corruption as an aberrant behavior by the public servants only. In the 1990s, an enormous and unsustainable network of some 80 private banks with no connection with the real sector emerged to take advantage of quick returns from public sector debt. They relied on the open and un-regulated financial system for making these quick returns. In fact, as argued forcefully in Cizre-Sakallıoglu and Yeldan (2000); Önis and Aysan (2000); and Boratav and Yeldan (2002), throughout 1990s, Turkey s banking and financial institutions became disengaged from financing real production activities to the point where they became the dominant faction within capital and, therefore, able to manipulate the accumulation patterns. Thus, between 1990 and 2000, while the real gross domestic product grew only by 3.4% per annum, the annual real rate of growth of the banking sector assets exceeded 13% (Balkan and Yeldan, 2002). This enormous divergence between the performance of the real economy and the financial bubble was clearly a result of the rapid acceleration of short-term foreign capital inflows that were made possible by the lax supervision of a myopic financial sector. Moreover, as marketization intensified, corruption in the private sector also became more commonplace: media barons were seen to be buying banks and siphoning off their assets. 8 The crucial flaw in orthodox perceptions of public-led corruption and rent seeking is that it tends to view the private sector as a neutral entity, composed of agents and actors obeying only the rationality of the market signals. Yet, as in all peripheral capitalist societies, Turkey s recent economic history shows very clearly how the bourgeoisie itself is a creation of the state; molded, protected and fed by the various rents and positions of advantage that emanate both from distorted production processes and also through state-regulated surplus creation mechanisms. 9 Thus, the so-called rent seeking activities and the associated waste result not from excessive government intervention, but from the very processes of how private industrial and financial capital seek to appropriate resources to sustain its livelihood. The role of the state in that case is to act where necessary, as 391

139 REVIEW OF INTERNATIONAL POLITICAL ECONOMY a non-neutral distributive agent vis-à-vis different segments of the bourgeoisie in order to bring forth the required shifts in the mode of surplus extraction. As Evans (1997, p. 76) argues, perspectives that identify corruption and venality with public bureaucracies and place an emphasis on rent-seeking, do have significant explanatory value, If, however, they crowd out all other interpretations of public behavior, leaving public authority as a synonym for rent-seeking and venality, they run the danger of becoming a self-fulfilling prophecy. When this kind of understanding is combined with the pervasive failure of heavily indebted and politically dependent countries to deliver public goods, the result is a strong antistate and anti-bureaucracy discourse expounded especially by proponents of the neo-liberal consensus. The fusion of economics with politics The second component of the political mismanagement school regards the failure to segregate politics from economics as a primary reason for corruption and lethargy over structural reforms, resulting in the February 2001 crisis. According to Yalman (2002), this anti-state discourse is a form of oppositional hegemonic discourse that has captivated the popular and political mind (Yalman, 2002, pp. 7 9). It portrays the market and civil society as independent realms from the state where freedoms can flourish, while the state is seen as an a historical entity incapable of adjusting itself to global developments, unresponsive to societal changes, and is to blame for bringing about the crisis. This idea of dissociating market and political forces is a deliberate attempt to disconnect the economic stabilization program from any wider democratization discourse and to break the forces of simultaneity between the two. As a typical representative of this anti-political view, for instance, Mr Kemal Dervis maintained that strengthening the economy by market reforms and establishing a strong democracy in Turkey was a problem of sequence, not a problem of the two issues being tackled simultaneously, the stronger the economy of Turkey, the more European investment and production come to Turkey, the more trade there is, the more financial links there are, the stronger will be the European interest in integrating Turkey. I do believe that the economy deserves priority. 10 The problem Kemal Dervis tried to evade by prioritizing economic over democratic reforms is real enough. Genuine democratization is more likely to hinder than facilitate the imposition of this aggressive structural adjustment plan simply because the population seriously hurt by the massive cuts in social spending and layoffs would resist these measures if the process of democratic politics were at work. What is conveniently ignored by this approach is the fact that the separation between market activity and 392

140 CIZRE AND YELDAN: THE TURKISH ENCOUNTER political activity is itself a political project. For key economic and social concepts like structural reforms, markets, households, labor, stratification, social networks, poverty, crime and public policies can only be understood through a politics that lends them meaning and stability. Hence, the idea of segregating the political from the economic is subterfuge. Furthermore, the discourse reduces politics to the role of administration and the issuing of technical decrees, and society to a conservative and obedient, and therefore, a malleable mass. Politics is characterized as merely an instrument at the service of markets, efficiency, and profitability. The momentum of the stabilization project is enhanced by subordinating politics to the so-called imperatives of a global agenda. Moreover, by cloaking the IMF-backed stabilization programs in technical and scientific sounding language, the separation discourse smothers the potential for substantive resistance of even a constructive kind. The language of positivistic certitude protects itself because, by definition, it leaves no scope for even the idea of critical thinking. 3. THE ECONOMIC EVIDENCE The Turkish 2000/2001 crises, as in the case of the Argentinean debacle, broke out in the midst of an IMF-directed adjustment program. It became one of the clearest examples of how in a developing economy with shallow and segmented financial markets, the unfettered workings of the myopic markets can serve as the main source of disequilibrium through the speculative attacks of international financial capital flows. In fact, there is now surmountable evidence that with the recent attempts towards full liberalization of the capital account under pressures from the US and the IMF, governments lost their independence in designing a strategic mix of these two instruments for promotion of industrialization/development targets. (See, for example, Adelman and Yeldan, 2000b; Pettifor, 2003; Baker, Epstein and Pollin, 1998.) As open capital markets replaced closed short-term capital markets and regulated flows of foreign investment, governments became unable to employ their traditional policy instruments (interest rates, government expenditures, and exchange rates) unilaterally: Raising interest rates above world markets triggers large inflows of foreign capital, setting the stage for a financial crisis. Fixing them below world markets triggers a large foreign capital outflow, thereby generating a crisis. Similarly, setting exchange rates above equilibrium levels leads to a current account deficit; while fixing them below equilibrium stimulates capital flight and investment abroad, also producing a crisis. Finally, running a budget deficit to stimulate growth or provide social programs more generous than the international norm is also seen to cause capital outflows. Flexible exchange rates amplify the effects of these international capital flows, by allowing speculation on foreign exchange markets that are 393

141 REVIEW OF INTERNATIONAL POLITICAL ECONOMY excessively large; excessively-liquid; excessively volatile; imperfectly informed; and subject to herd psychology. One of the direct impacts of financial de-regulation in Turkey has been the consequent overvaluation of the domestic currency (Turkish Lira-TL). Fueled by excessive inflows of short-term financial capital, the Turkish currency markets became flooded with foreign exchange. As the Lira appreciated and the Turkish tradables lost their competitiveness in the world markets, imports surged and the current account deficit widened, setting the stage for a vicious cycle of growth-instability-crisis. Resonating the pre-crisis conditions of Mexico 1994, South Asia 1997, and Argentina 2001, the overvaluation of the domestic currency has become a concomitant feature of post-financial de-regulation episodes. In Figure 1, we document this evidence clearly. Here the monthly Turkish Lira/US Dollar exchange rate is portrayed in real terms deflated by the wholesale price index (1987 = 100) between January 1982 and September The figure discloses two distinct paths of the real exchange rate: and August 1989, marks the beginning of capital account liberalization and declaration of convertibility of the Lira. The Lira is on a distinctively overvalued plateau after 1989 with two spikes 1994 and 2001 crises when a corrective devaluation became imminent. Thus, after financial de-regulation Turkey was already trapped into the conditionalities of international financial system seeking... a stable exchange rate (to) underpin the confidence needed for large capital inflows (Sachs, 1997). Furthermore, in the 1990 s Turkey entered a period of very high real rates of interest with a significant threat of dollarization and capital flight. The specter of capital flight became the main discourse of monetary policy and, as a newly emerging market, Turkey has offered speculative arbitrage rates reaching at times over 100% during the 1990s. This financial arbitrage can be calculated as the result of an operation that converts initially the foreign exchange into Turkish Liras at the rate ER, and after earning the rate of interest R offered in the domestic asset markets, is re-converted back to the foreign currency at the prevailing foreign exchange rate. Algebraically, this net arbitrage gain is calculated as 1 + R 1 + ε 1 Thus, during the course of the operation, financial speculators would gain domestic rate of R, and lose at the rate of depreciation of the exchange rate. The net difference between the two prices would give us the net financial arbitrage gain. We calculate the evolution of such gains in Figure 2. Here, the main hypothesis is that the financial arbiters would financially invest their foreign monies at the domestic instrument that would bring the highest rate of return in the domestic asset markets (most of the case 394

142 CIZRE AND YELDAN: THE TURKISH ENCOUNTER the government debt instruments GDIs). According to the calculations portrayed in Figure 2, Turkey offered real rates of 100% in January 1996; 60% in December 1998; 80% in March 2001, and became one of the leading emerging markets in the world of financial speculation. It would be unrealistic to expect to find fixed investments connected with industrial activities within an economy offering such rates of return in comparison to such speculative financial transactions. As a matter of fact, throughout the 1990s fixed investments linked to the manufacturing industries virtually stagnated and did not exceed their real 1990 levels as of Consequently, the share of manufacturing investments as a share of total had receded continuously. (The average of 2001 being 22%, in contrast to the 1970s, which averaged 40%.) Finally, in Figure 3 we portray the movement of net financial flows from the balance of payments data, and contrast it with the growth of real gross domestic product. The figure underscores the observation that under the de-regulated financial environment, sources of growth originated not from domestic capital accumulation, but from the ad hoc and often irrational decrees of foreign (speculative) financial capital. In periods of high inflows of financial capital, growth rate of the gross domestic product tended to increase, yet periods of capital flight meant direct recession even outright collapse as in 1994, 1999, and Under these conditions, whatever the growth performance of the economy during the post-capital account liberalization, it had to be based on speculative-led patterns (á lagrabel, 1995). Consequently, finance was elevated over industry and the real sphere of the economy, and the financial sector drifted to the speculation of the short-term capital flows in a process that has been characterized as casino capitalism (Strange, 1986). Thus, we argue that the crisis conditions emerged, mainly because of the increasing fragility in the financial system. This fragility, in turn, was generated by the uncontrolled and excessively volatile capital flows, which were characterized by a high level of speculation. Turkey had been trapped in this cycle with its premature move towards financial deregulation in 1989, and the opening of its domestic asset markets to international capital flows. Given this new environment the Turkish Central Bank lost control over its monetary policy instruments. As in all other developing economies that took similar steps towards external liberalization, Turkey was trapped into a vicious cycle of high real interest rates, appreciated Turkish lira, and inflows of speculative short-term foreign capital. 11 This cycle reached its zenith during the implementation of the 2000 exchange rate-based disinflation program as the currency risk was eliminated and the whole liquidity generation mechanism was based on the short-term, hot money inflows. Increased foreign exchange activity led to the appreciation of the Lira in real terms. Imports surged, exports fell, and the current account deficit widened. This process continued in cycles until the financial 395

143 REVIEW OF INTERNATIONAL POLITICAL ECONOMY speculators interpreted the expanding current account deficits as signifying the fragility of the domestic financial system. At this point, capital inflows came to a sudden halt and turned into outflows, leaving the country illiquid and the central bank with no control over its instruments, and therefore, unable to stabilize the economy. According to Akyüz and Boratav s (2003) calculations, in the last week of November, 2000 alone Turkish financial markets lost $5.3 billion via nonresidents short-term speculative operations. In fact, with this rapid change of direction, net flows of non-residents foreign capital would turn to $8.7 billion after November and the Turkish asset markets loss of foreign exchange reached $23.9 billions. Faced with these numbers, a financially shallow emerging market economy such as Turkey could not endure the disruptive consequences of such financial shocks. Yet, the 2000 dis-inflation program completely ignored the fragile conditions of the Turkish financial and asset markets, and denied both the monetary (the Central Bank) and the fiscal (the Treasury) authorities utilization of their traditional tools of austerity, rendering them powerless against the speculative forces of the markets, all in the name of good governance. 4. THE FINANCIAL AND FISCAL FRAGILITY OF THE TURKISH ECONOMY We tabulate the so-called fragility indicators of the Turkish economy in a longer time span in Table 1. As seen in Table 1, the Turkish economy rested on a quite shallow and unbalanced financial base throughout the whole 1990s. In this context, one of the important elements of the culminating process of external fragility can be measured by the ratio of short-term foreign debt to Central Bank s international reserves. This ratio is interpreted as one of the crucial leading indicators of external fragility and has recently been called as the most robust predictor of a currency crisis in Rodrik and Velasco (1999, pp. 60 1). It is alarming to note that in Turkey this particular ratio has never fallen below the 100% mark since the opening of capital account in Thus, the Turkish financial system has been operating constantly under the danger zone for the past 12 years. What is crucial to note in Table 1 is that the disinflation program actually deepened the fragility as signaled in this indicator. Let alone turning this path to a favorable trend, the 2000 program which aimed at disinflation (and stabilization) caused an increase of external fragility with a rise of this indicator to 112% in June, and to 145% by December 2000 (Yeldan, 2002). This level was the highest score since 1993, just before the 1994 financial crisis. Yet, the authors of the Letter of Intent 12 envisaged that possible increases in central bank reserves would be able to match the increase in outstanding short-term foreign debt, and that Turkey would be able to remain sound externally. However, the external accounts deteriorated in 396

144 CIZRE AND YELDAN: THE TURKISH ENCOUNTER Table 1 Financial and fiscal fragility in the Turkish economy As ratios to the GNP (%) Current account balance Foreign debt stock Domestic debt stock Budget balance a 18.2 a 14.3 Non-interest (primary) budget Public sector borrowing req. Fragility indicators Short-term foreign debt/cb international reserves (%) M2Y/CB international reserves (%) Currency substitution b Interest paym on domestic debt/total tax revenues (%) Interest paym on domestic debt/net new dom. borrowing (%) Net new domestic borrowing/domestic debt stock (%) a Exclusive of transfers from the CB, interest revenues and privatization receipts. b (Rate of Dollarization): Ratio of foreign exchange deposits to total deposits of residents. Sources: SPO Main Economic Indicators; Undersecreteriat of Treasury, Main Economic Indicators. spite of the $4 billions reserve assistance obtained from the IMF in late November The generous external support did not suffice to generate stability in the domestic macro environment, and the Turkish asset markets drifted to the worst economic crisis in its history in February Table 1 underscores one of the most striking indicators of the Ponzifinance attitudes of the Turkish fiscal authorities: the ratio of the net new domestic borrowings to the domestic debt stock. Since 1995 with the exception of 2000 the Turkish Treasury has been engaged in net new borrowing amounting to almost half of its already incurred stock of debt. The net new domestic borrowing of 2001 added to the existing debt stock as much as 70%. The real meaning of the objective of debt turn-over is thus very clear. The central budget is being utilized mainly as an instrument of transferring real income to the rentier classes rather than regulating domestic savings and investment targets. In other words, the budget in Turkey has now turned into an instrument of transferring real resources to the financial sector, rather than financing social infrastructure and economic growth. 397

145 REVIEW OF INTERNATIONAL POLITICAL ECONOMY In terms of the causes of the February 2001 crisis, for the political mismanagement school, the crisis is the result of crony capitalism, which is a deviation from market economy. In contrast, we regard such cronyism as the unavoidable outcome of the changing nature of global networks of finance. In fact, the main source of the contested fragility of the Turkish financial sector can be traced back to the 1989 decision to eliminate all the regulations on the capital account. This decision liberalized all external financial transactions of the Turkish economy vis-à-vis the rest of the world and led the domestic asset markets to be dependent on the short-term, speculative movements of foreign capital flows. 5. POLITICS IN THE POST-CRISIS ERA Three principal features define the ways in which the Turkish political structure and dynamics connect with the structural adjustment processes under post-crisis conditions. First, the economic crisis served to reinforce the political status quo rather than change it. Second, the crisis precipitated a regressive trend in politics. While the political eminence of the civil-military bureaucracy rose, the relevance and weight of representative institutions receded. Third, given heavy loan conditionality, the economic and political decision-making process was delegated out to a level where international financial organizations achieved ultimate veto power. In conclusion, we take each of these issues in turn. The politics of Turkish inertia in comparative perspective Regarding the first point, it is necessary to note that perhaps as significant as the economic crash itself was the lack of an imaginative leap of statecraft that took place after February 2001 when no attempt was made to modify the extant political structure to cope with the public s mounting discontent. The economic slump provided the context for a growing awareness of limitations of the prevailing political system as well as of the need for a radical transformation. However, despite the ongoing clichés of reform and liberalization, politics in Turkey sought refuge, if anything, in the status quo. The three-party coalition government, which oversaw the post-2001 crisis management, epitomized this inertia. It did not owe its longevity to its political ingenuity, or empathy with the hopes and fears of the masses. It stayed put because in order to provide confidence to the markets, government stability was regarded as crucial at a time when the country was going through difficult times. Therefore, it became a government by default, coexisting relatively peacefully with both a highly centralized military and civil bureaucracy and a powerful president. The serious vacuum in political authority was complemented by the absence of any viable opposition. The coalition sustained itself in office more by the 398

146 CIZRE AND YELDAN: THE TURKISH ENCOUNTER absence of serious challenges to its policies than by its own muscle power. This situation was also a result of the policies of dominant domestic and international actors who preferred the status quo to the uncertainties and ambiguities of change for fear that it might upset political balances that may lead to a worsening of economic conditions. The political consequences of such economic crises are played-out through regime characteristics and structures. Since Turkey has a unitary and parliamentary system of state marked by a strong party tradition, erosion of the governing capacity of the institutions was observable on the parliamentary, governmental, and political party levels. In contrast, in countries that have a federal and presidential systems of state like Argentina, which is still reeling from the devastating effects of its financial collapse in December 2001, it was the political power of the president and the federal institutions which disintegrated while that of the Governors and institutions of the provinces rose. That the IMF itself resorted to direct negotiations with the Governors attests to the fragmentation of power both before and after the crisis (Escude, 2002, p. 459). Power wielded in today s Argentina is increasingly province-based with relatively rich provinces having an advantage of their own. The January 1999 financial crisis of Brazil, another federal state, was not only triggered by one of the federal states declaring moratorium on payment of state s debt to the federal government, but as the crisis unfolded, the power of the president and the congress declined and the fiscal and administrative powers of the Governors went up (Flynn, 1999, p. 308). The president and his team also exhibited clear signs of political inertia before and after the crisis, in terms of not giving sufficient political priority to driving through the congress the reforms which were needed, most notably the measures for social reform in a country with one of the worst patterns of wealth distribution in the world. Judging by these similar episodes, it is relatively unsurprising then that an important aspect of the politics of this crisis was the Turkish government s increasing emphasis on conservative policies. As distributional stress mounted, the bureaucracy tried to create some sense of security and certainty by moving to a discourse that made no promises of change although the system had already been rendered obsolete by the emergence of the crisis. 13 In the aftermath of the February 2001 collapse, new political actors did not supplant the existing political parties and their leaders, and the structures that sustained them were not subject to critical reevaluation and revision. That inertia, in terms of the personalities involved and the structural make-up of Turkish politics supported the tendency to see the political realm as merely a conduit for passing stringent marketization reforms. As neo-liberalism has become the unquestioned orthodoxy, the leading segments of the business, intellectual, party political and bureaucratic communities automatically presumed that the socialist, social 399

147 REVIEW OF INTERNATIONAL POLITICAL ECONOMY democratic, and populist alternatives were implausible. Public discussion of the program was framed in the technical language of how the nation would be adjusted to the discipline of monetary and fiscal imperatives. The dominant mode of political imagination became technical know how as technocrats replaced the politicians. This anti-political mindset was particularly apparent with regard to the expansion of the autonomy of civil and military establishment. The political autonomy of the Turkish Armed Forces (TAF) is a historical reality according to which it has maintained a privileged position as the guardian of the foundational ideology of the Republic (Cizre-Sakallioğlu, 1997). The last crisis not only reinforced this trend but also reaffirmed the military s long-held conviction that Turkey s political cadres are incompetent in the sense that they have failed to instill the fundamental priority of secularism over political Islam, economic discipline over populism, and unity over cultural and social pluralism. The rise of bureaucracy and fall of representative politics A further aspect of the post-crisis politics that the structural adjustment plan generated was the ultimate demise of representative politics based on a mandate. In Turkey, one manifestation of this trend came in the 1980s with the former Prime Minister, Turgut Ozal s promotion of the model of the political entrepreneur, who, as an elected politician either appropriates an existing issue or creates a new policy issue and builds her/his career on its promotion (Cizre 2002a, 2002b). This strategy suffered a setback in the 1990s when the issues entrepreneurs could promote tended to converge because of the further erosion of the boundaries between the left and the right. Hence, they all tended to agree on a shift from public to private enterprise, from insulation to integration into the world capitalist market, from import-substitution industrialization to an export-led development. Terms like reform and liberalization were used by nearly all political persuasions to indicate that all economies operate according to the same laws. 14 With or without political entrepreneurs, however, representation in Turkey can no longer be said to correspond to a power generating and distributing process. Policies that define the winners and losers, and the re-construction of the state-economy and state-society relations do not depend on the formation of a public consensus or even the retrospective acquisition of public backing. On the contrary, what matters most is not that politics should deliver the particular policies required and endorsed by the voters at elections, but that they deliver effective policies regardless of the electoral premises. Likewise, leaders believe that they should be able to change their policy plans at a moment s notice, not according to publicly debated and accepted issues, but as determined by their entrepreneurial acumen. 400

148 CIZRE AND YELDAN: THE TURKISH ENCOUNTER That neoliberalism raised the profile of political entrepreneurs is part of a global process of redefinition of politics and collective action in many democracies. Speaking of the future matrix of democracy in Latin America, Garreton diagnoses the central trend in terms very similar to that of Turkey s:... concrete political projects, politics and policies... make sense if they are capable of giving meaning to and improving the quality of personal and social life. That, in present circumstances depends less on their content... than on the capability of the individual (Garreton, 2001, p. 241). In part, this is owing to the fact that as the grip of one single ideology and meaning in a nation-state loosened, and the socioeconomic transformation under structural adjustment policies weakened the material bases and spaces of social action, those political actors that have emerged have lacked the confidence backed by a publicly validated ideology and they have instead adopted defensive/efficiency issues and ideas. The development of these politics highlights the detachment of ideas from the material circumstances in which people live. Although economic liberalization has failed to better the real life situation of workers, peasant families and small-scale independent business, it has remained the unquestioned model. Moreover, the neo-liberal conception of the market conveniently forecloses a full critique of the interests it serves. This is the paradox, not only of the Turkish nation, but also of those other countries and continents where neo-liberal model is implemented. The predominant everyday experience of the great majority of people runs counter to the captivation of the public mind by the laissez faire model. Once the life experience of the citizenry is disconnected from the world of ideas, the potential for political backlash by the losers against the system is undermined. Forrest D. Colburn draws attention to the same phenomenon in Latin America where public dissatisfaction is not directed at the economic model of the day, unfettered markets. Instead, public disenchantment is focused on corruption and ineptitude in governing... election results also do not demonstrate public rejection of the economic model (Colburn, 2002, p. 36). He then connects this development with common fatalism about politics, as if all outcomes are foreordained (Colburn, 2002, p. 38), which, can be interpreted as a product of lack of ideas and conflicting paradigms on how to organize state, politics and society. Politics of loan conditionalities The most important way for the IFOs to prompt economic reform is through stringent loan conditionality. In the past, the populist base of politics and nationalist sensitivities in such states rendered loan conditionality 401

149 REVIEW OF INTERNATIONAL POLITICAL ECONOMY unattractive to the Turkish political class. However, the extreme crisis-situation of the economy and polity paved the way for such conditionalities. 15 Conditionality here refers to international policies and incentives that involve the promotion of some minimum requisites and threshold conditions below which defined forms of international support will purportedly be withheld, and above which they can be supplied (Whitehead, 1996, p. 257). In the literature on conditionality a distinction is made between three types of conditionality (Whitehead, 1996). Whereas the first set of conditionality policies aims at restraining certain undesirable forms of conduct like the violation of human rights, the second set targets to improve measurable types of performance in the administrative and economic realm. The objective of the third group of incentives, on the other hand, is to promote the much more complex and imprecise processes of enhanced participation, increased political competition, and the quality of democratic rule (Whitehead, 1996, p. 262). Unfortunately, conditions designed to promote democratic practices are much more limited than conditions designed to fulfill the other two objectives. The difficulty arises from various factors, for example, democracy promotion is mediated as much through the work of the local players as through transnational players and cleavage patterns and political loyalties. More important however, the eventual prospects of democratic reform in a country transcend the constitutional and legislative changes and include social, cultural, and psychic ambits. There is not, however, a necessary consensus on just how wide and how deep the less invisible changes in the foreground should be. In addition, the growing role of the IFOs in pressing for reform in the democracy-oriented climate of the post-cold War era, can meet entrenched resistance not just from those who gain from partaking in the public sector spoils but also from sectors of bureaucracy, which consider themselves as the ideological guardians of the state. The main objective for this sector is to maintain its strategic position as the chief interlocutor in politics. It is not surprising then that the IMF s political agenda and foreign policy-based concerns are centered on providing international support to Turkey, a country that is a strong ally of the western bloc in a highly sensitive region. The September 11th attacks have only served to reinforce the geopolitical significance of Turkey to the United States. 16 Alternatively, after gaining candidate country status at the December 1999 Helsinki Summit of the European Council, the European Union prescribed a package of political preconditions that must be fulfilled if Turkey is to gain entry into the European fold successfully. This pressure continues even though December 2002 Copenhagen Summit set December 2004 as the date to review Turkey s progress on democratization to decide when to start accession negotiations. In this regard, a comparison of the Turkish and 402

150 CIZRE AND YELDAN: THE TURKISH ENCOUNTER Argentinean cases with regard to their IMF links offers a stark contrast. After years of support for Argentina during the Cold War, as the political importance of the country was deemed to have declined in the post Cold War era, the IMF reversed its course in late 2001 and refused Argentina s request for... a waiver on its fiscal targets to enable the disbursal of $1.2 billion from one last loan in August 2001 (Starr, 2003, p. 70). The country went into default and financial collapse in December In contrast, in Turkey, loan conditionality is used as a tool to promote economic re-structuring without altering the basic power structure in a way that would threaten Ankara s position as a close partner of the Euro- Atlantic Community. What it seeks to do is to set in motion the forces of the free-market by reducing the economic resources flowing through the public sector. As a result, the scope of political patronage available to the power wielders in the Turkish political system is curtailed. This reflects an understanding of politics as an epiphenomenon of the economic dynamics, which can only emerge when Ankara s economic patronage networks are dried up by a severe reduction for money running through the public sector. 6. CONCLUSIONS In this article, we have argued that the February 2001 economic and political crisis was not the result of a set of unfortunate mishaps or administrative errors unique to Turkey, but was the result of a series of pressures emanating from the process of integration with the global capital markets. It is true that in Turkey there is a heightened awareness and perhaps a firm consensus that economic paralysis was a product of political ineptness and corruption. According to this view, the regulatory policies of the state have both led to corrupt public procurement policies and to shady dealings and contracts in the state enterprises and banks. More importantly, the perception that Turkey is passing through a critical juncture of history with the security, well-being, and integrity of the individuals being put at substantial serious risk, has given rise to a fresh willingness for wide-reaching reform. However, the public s enthusiasm for a departure from corruption, cronyism, and unconstrained greed should not be taken as signifying unequivocal support for the shape and scope of the reform policies envisaged by Turkey s ongoing structural adjustment program. This program is incapable of rallying a conscious public demand for substantive change for two basic reasons. First, it lacks democratic legitimacy. Second, it cannot overcome the obstacles posed by the very nature of the program insofar as it fails to address the basic human needs. The absence of a democratic dimension in the structural adjustment program means there is a lack of a meaningful and critical public debate that goes beyond 403

151 REVIEW OF INTERNATIONAL POLITICAL ECONOMY scientific-sounding technicalities and provides genuine alternatives for consideration. As the program depends heavily on disciplined behavior, restrained expectations, and limited demands by the population, a democratic public space would be highly inimical to the achievement of its fundamental objectives. Given these conclusions, it is clear that the ongoing stabilization program officially outlined in the Transition to Strong Economy Program (May 2001) and the series of Letter of Intent given to the IMF, pursue a rather dogmatic development model. This model is built on false assumptions and contradictory policies. Its perspective on international capital flows, for instance, is that in a market economy, international capital mobility helps allocate savings and investments more efficiently and diversifies investment opportunities and risks. 17 The model ignores the fact that currency speculators can supplant political decision makers, and that there are no clear indications that liberalization of international capital flows can deliver sustainable growth and better equity. Furthermore, in this model, what is really meant by the concept of stabilization is to establish an exchange rate system free from the devaluation risk, and to maintain high real returns in the national financial markets to attract foreign capital. Under this structure, the central banks are set to be autonomous and their means of intervention in the economy are restricted, so that they would not undertake any role apart from maintaining price stabilization. Fiscal policies are to be directly focused on the objective of maintaining a budget with a primary surplus. As result of these policies, the boundaries of the public space are restricted and traditional economic and social infrastructural facilities of the public sector are left to the strategic interest of foreign capital at the cost of extraordinary cuts in public spending and investments. In other words, the adjustment program simply opens the way for Turkey s resources to be siphoned-off by international speculators rather than orienting the Turkish economy on a sustainable and equitable growth path. NOTES 1 See Akyüz and Boratav (2003); Boratav, Yeldan and Kose (2002); Yeldan (2002); Ertuğrul and Selcuk (2001, 2002); Metin-Özcan, Voyvoda and Yeldan (2001); Cizre-Sakallıoğlu and Yeldan (2000); Kepenek and Yentürk (2000); Uygur (1996); and Ekinci (1998) for a thorough overview of the post-1990 Turkish macroeconomic history. Bicer and Yeldan (2003); Balkan and Yeldan (2002); Gürkaynak (2000); Öniş and Aysan (2000); and Yentürk (1999) provide similar analyses based on the effects of international speculative financial capital flows on the Turkish economy. Yeldan (1995, 1998), in turn, discusses the characteristics of the post-1990 Turkish macro adjustments in terms of creation and absorption of the economic surplus, and provide a quantitative analysis on the strategic role played by the state apparatus. 404

152 CIZRE AND YELDAN: THE TURKISH ENCOUNTER 2 On the official evaluation of the 2001 crisis, see Transition to Strong Economy Program, Undersecretariat of Treasury, Ankara. ( 3 See, for example, Alper and Yilmaz, 2003; Ertugrul and Selcuk (2001, 2002). 4 This is a long-held conviction prevalent not only among policy-makers but also journalists, politicians of all spectrum, intellectuals and theorists. For a succinct summary of this argument in the 1990s, see Cizre-Sakallioglu and Yeldan (2000). 5 The best evidence comes from the prolific research publications of powerful TUSIAD, the Turkish acronym for Turkish Industrialists and Businessmen s Organization and TESEV, Turkish Foundation for Economic and Social Research, the websites of which can be used to obtain the publications. The respective addresses are and 6 Interview with Kemal Derviş by Leyla Boulton and Martin Wolf, Winning Turkey s Trust, Financial Times, 14May For a succinct overview of the arguments including this particular perspective on the crisis see Ziya Önis, Domestic Politics versus Global Dynamics: Towards a Political Economy of the 2000 and 2001 Financial crisis in Turkey, in Önis and Rubin (2003). 8 A detailed account of corruption in the private sector including the banking and media groups see Seymen (2001), Şener (2001) and Adaman, et al. (2003). 9 See Boratav, Yeldan and Kose (2002); Yeldan (1995, 1998) and Somel (2003) for an overview of the recent Turkish economic history emphasizing the nature of class conflict and the role of the state in creation and extraction of the economic surplus. 10 Lecture by Kemal Derviş, Distinguished Lecture Series, European University Institute, Robert Schuman Centre for Advanced Studies, 1 June 2001, p Elements of this vicious cycle are well known and are studied extensively in the literature. See, for example, Diaz-Alejandro (1985); Velasco (1987); Dornbusch, Goldfajn and Valdés (1995); and Adelman and Yeldan (2000a). 12 Letter of Intent, dated 9 December 1999, signed by Gazi Ercel (the governor of the TR Central Bank and Recep Onal (Minister of State). 13 This mode of managing crises has antecedents in Turkey. When the economy collapsed in January 1994, to cope with the corrosive effects of the distributional crisis which ensued, Tansu Çiller, the then-prime minister took an even more conservative political turn by deploying a rhetorical strategy that focused on nationalism, religion, cultural values and embracing an anti-liberal position with regard to the individual rights, civil society and democratization (Cizre, 2002a). 14 For an historical understanding of the issue of convergence of almost all political platforms on neo-liberal oriented values and policies see my own two works: Cizre-Sakallıoglu (1996) and Cizre (2002a). 15 The IMF s conditions were based on structural reform, first on a pegged, and then on the free floating of the Lira, fiscal tightening in the public sector through spending cuts, privatization, a more autonomous central bank and the overhaul of the banking sector. 16 President Bush called the then Prime Minister Bülent Ecevit only two days after the outbreak of the crisis to give his strongest support to the economic reforms. Again, on 14 December 2001, President Bush expressed his administration s positive backing by personally asking the Turkish ambassador in Washington about the economic situation in Turkey and wishing the country well in its problems. Is it worth pointing out that this runs contrary to the initial policy position of the newly elected Bush administration? The 405

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