The Turkish economy has had a good run since the AKP came to power in 2002. Following the currency crisis in 2001, the AKP faithfully implemented and successfully completed two successive IMF programs between 2002 and 2008. Economic growth averaged more than 7% during this time. Over the past two decades, economic growth averaged more than 5% annually, putting Turkey in the category of high-growth emerging economies, comparable to Asia’s top performers. In the past few years, however, continued strong growth was accompanied by high and increasing inflation and a deterioration of Turkey’s international financial position. This coincided with the increasing centralization of Turkey’s political system following the 2017 constitutional reform. In the context of weakening of support for the AKP and President Erdogan and in view of the high-stakes post-reform presidential and general elections in 2023, short-term political calculus dominated economic policymaking at the expense of monetary stability and economic fundamentals.
Monetary policy was not exactly very orthodox before the constitutional reform, but it deteriorated decisively after 2017-18. Turkey’s central bank had started shifting towards a more unorthodox monetary policy as early as 2010, mainly in an attempt to cope with strong financial inflows and exchange rate appreciation. This policy led the CBRT to miss its inflation target near-continuously, but it also made Turkey stand out compared to its top-tier emerging economy peers where inflation was significantly lower (e.g. Brazil, Mexico, South Africa). Starting around 2018, policy turned decisively inflationary. While inflation was high during 2009-16, it typically averaged 10% or so. In 2018-19, inflation reached the mid-teens, before exceeding 70% in 2022, post-COVID-19.
Macroeconomic policy absent significant checks and balances
Increasing political centralization and a shifting political-electoral calculus helps explain worsening economic policies. When the AKP first came to power more than two decades ago, the AKP gained an absolute majority in the grand national assembly. Economic conditions were improving following the 2001 financial crisis. The AKP won absolute majorities in 2002, 2007, 2011, and following a surprise loss and a repeat parliamentary election, in 2015. In 2018, it failed to win an absolute majority by a narrow margin (295 out of 600). At this point, however, constitutional reform had already weakened the parliament and policy-making had become strongly centralized in the president’s office. The centralization of power, however, was going to make the 2023 presidential a high-stakes election. The centralization of political power provided President Erdogan with both the ability and the incentive to opt for a policy aimed at increasing short-term economic growth.
Although then Prime Minister Erdogan undoubtedly dominated Turkish politics and the AKP, until the mid-2010s, other senior AKP figures retained a degree of influence, at least over economic policy. The AKP expanded its influence by gaining control over institutions (e.g. presidency) and by weakening institutional opponents (e.g. military, judiciary), the 2017 constitutional reform led to a very significant centralization of power in the hands of the president. At the same time, Erdogan successfully sidelined remaining senior AKP officials, giving him unprecedented sway over his party. The constitutional shift and the sidelining of potential AKP internal opposition gave the president free rein after 2018 with the constitutional changes likely weighing more heavily. The strengthened presidency made it imperative to be re-elected in 2023, even after the AKP lost some popularity and the prospect of an opposition winning increased. In this sense, the constitutional reform created the ability and increased the incentives to pursue less orthodox, pro-growth economic policies.
The evolution toward a more centralized political regime tracks the deterioration of macroeconomic policy fairly well. Recep Tayyip Erdogan (2003-14) has undoubtedly been the single most dominant political leader in Turkey since Mustafa Kemal. When he first became prime minister (2003-14), however, other senior AKP figures were on the scene and were influential in economic policy making. After resigning the premiership to make way for Erdogan, AKP founding member Abdullah Gul became president (2007-14). Ali Babacan (2002-07) as Minister in Charge of the Economy and later as Deputy Prime Minister (2009-15) was in charge of economic policy and enjoyed the confidence of Turkish industrialists and international investors alike. Later, Mehmet Simsek, much less of an AKP heavyweight than Gul and Babacan, as minister in charge of the economy (2007-09) and then as deputy prime minister (2015-18) managed to hold more or less and increasing difficulty the line on economic policy. With the departure from office of Gul (2014), Babacan (2015) and Simsek (2018), AKP-internal opposition to less disciplined policies crumbled, while the president’s ability to influence central bank policy increased as a consequence of the constitutional reform and the abolition of the office of the prime minister.
Monetary policy became significantly more inflationary and the government began to resort to unorthodox policies in order to limit the negative effects of easy monetary policy on inflation, currency valuation and capital outflows. The CBRT undershot its inflation target in 2002-2005 and 2009-10 (no doubt helped by the global financial recession and recession). While the CBRT failed to meet its five-percent inflation target throughout the 2010s by a smallish margin, policies and inflation took a decisive turn for the worse in 2017-18, as the pressure on the CBRT to pursue expansionary increased substantially. The Turkish central bank has had nine different governors since 2001. It has had six different governors since 2019, several of them sacked or otherwise pushed out of office by the president (Murat Uysal in 2020, Naci Agbal in 2021), as they failed to align with the president’s preference for low interest rates. In 2021, an individual who was aligned with the need to pursue an easy monetary policy was appointed by governor, setting the stage for even more inflationary policies (Sahap Kavcioglu, 2021-23).
With the appointment Berat Albayrak (2018-2020), who happened to be the president’s son-in-law and had no policy-making experience, economic policy became also much more interventionist, if not necessarily significantly more expansionary in fiscal terms. Albayrak failed to regain market confidence by a slightly less unorthodox finance minister, Lutfi Elvan (2020-21), whose tenure proved short-lived, likely a reflection of disagreement over the course of economic policy. Ultimately, sustainable policies aimed at maintaining macroeconomic stability were at odds with the president’s political-electoral calculus focused on pump-priming the economy in view of the important 2023 general and even more so presidential elections against the backdrop of the AKP’s and the president’s weakening popularity.
Exploiting the Phillips curve
In the years following the 2018 elections and the years leading up to 2023 elections, the Turkish government exploited the so-called Phillips curve, which postulates an inverse correlation between unemployment and wage growth (or inflation). Economists are agreed that this inverse relationship only holds in the short term only. If a governments want to continue to exploit this tradeoff in favor of lower employment (and higher economic growth), it needs to raise inflation continuously. This is why political economists recognize the need to establish independent, inflation-righting central banks to limit the ability of elected politicians to exploit the Phillips for short-term electoral benefits at the expense of longer-term economic and financial stability. By replacing several central bank governors, President Erdogan was ultimately able to get his way and force the CBRT into a pro-inflationary, Phillips-curve-exploiting policy shift.
In the run-up to the 2023 elections, inflation reached 85% year-on-year in November 2022. Following his narrow re-election in May 2023, President Erdogan appointed a new economics team led by former minister of finance and deputy prime minister Mehmet Simsek tasked with reducing inflation and stabilizing the economy. Although an inflationary monetary policy had helped maintain high economic growth, high inflation had not only become deeply unpopular, and with no elections, other than the March 2024 municipal elections on the horizon, such a policy shift will have limited financial costs for the president.
Economic policy focused on rolling back some of the interventionist policies, letting the exchange rate adjust and tightening monetary policy. Thus far, the adjustment has been fairly gradual. The CBRT raised its policy rate just after the elections in June with a modest hike to 15% in the context of 40% year-on-year inflation. It took until March 2024 for the policy rate to reach 50%, but in the meantime inflation had reached 70%, leaving real interest rates in deeply negative territory. Moreover, a minimum wage hike in January 2024 was not exactly conducive to rapid disinflation, either. This suggests that political consideration remain as important as economic ones.
It is difficult to say whether lack of more aggressive adjustment is due to political constraints faced by the economics team or by a conscious decision to avoid a potentially destabilizing “shock therapy” in light of potential financial vulnerabilities in the banking sector. The IMF, for one, has highlighted “high and growing” banking sector risks due to rapid credit growth and weakening of supervision. Equally important, however, is the fact that Turkey’s executive presidency makes economic policy subject to the decision of a powerful president who faces very limited checks-and-balances. More so than before, this makes Turkish economic policy subject to the whims of the president, or this political-electoral calculus. The outlook for the Turkish economy depends on what the authorities do today as well as what they can be expected to do in the future. Quite different from countries other large emerging economies, such as Brazil, Mexico, India or Indonesia with far more robust institutions and greater predictability, Turkey’s policies are more difficult to predict because they are less subject to institutional and political checks-and-balances. On June 4, Turkey’s Constitutional Court invalidated a presidential decree issued in 2018 that authorized the president to sack central bank governors and force the central bank into an inflationary monetary policy. The gradual rebuilding of institutional guardrails around Turkish economic policy would boost domestic and foreign investor confidence and help Turkey exploit its significant economic growth potential in the context of greater economic stability.
Turkey is an example where an increasingly centralized political system and limited checks-and-balances increase policy uncertainty. Political leaders in all political systems are weary of market outcomes over which they have little control as well as independent institutions whose mandates and preferences might run counter to their own political-electoral interests. However, in a political system where power is highly concentrated, this makes economic policy substantially more unpredictable. In less centralized political systems, significant shifts in economic policy can occur when for example a different political party comes to power. But typically it is easier to predict what it will do once in power. It is more difficult to predict policy shifts if power is more highly concentrated and individual decision-makers are highly influential.