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Dianne Wampler  11/22/2006 06:31:31 PM  From  DB/Inbox:  Dianne Wampler

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UNCLAS        ISTANBUL 02095

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    ACTION: ECON
    INFO:   CONS PA RAO FAS MGT PMA FCS POL DCM AMB

DISSEMINATION: ECON /1
CHARGE: PROG

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TO RUEHC/SECSTATE WASHDC PRIORITY 6362
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUEHSS/OECD POSTS COLLECTIVE PRIORITY
RUEHFR/AMEMBASSY PARIS PRIORITY 0187
RUEHDA/AMCONSUL ADANA PRIORITY 2271
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UNCLAS SECTION 01 OF 03 ISTANBUL 002095 
 
SIPDIS 
 
EB:OIA:W.SCHOLZ 
EUR/SE:P.MALIK 
TREASURY FOR INTERNATIONAL AFFAIRS - J.ROSE 
COMMERCE FOR 4121/ITA/IEP:S.MATHEWS, A.TAYLOR 
PLEASE PASS USTR FOR L.ERRION 
 
E.O. 12958: N/A 
TAGS: EINV BEXP ECON ECIN OECD TU
SUBJECT: STABILITY VS. THE CANCER OF INFORMALITY 
 
REF: PARIS 7395 
 
NOT FOR INTERNET DISTRIBUTION CONTAINS REPORT OF OECD MEETING. 
 
¶1.  Summary:  On November 6, at the Organization of Economic 
Cooperation and Development (OECD) Global Forum on 
Investment, an OECD Country Roundtable examined Turkey's 
recent experience with strategies to enhance the investment 
environment and the dramatic improvement in foreign 
investment in Turkey over the last five years.  The main 
focus was on the impact of regulatory reform on Turkey's 
investment climate.  The session began with a series of 
welcoming remarks, the highlight of which was a speech by 
Economics Minister Ali Babacan which was televised live by 
most major Turkish networks.  The roundtable itself consisted 
of remarks by Karl Sauvant, Columbia School of Law; Andrew 
Vorkink, World Bank Country Director, Cavit Dagdas, Deputy 
Undersecretary of Treasury, and Ferit Sahenk, Chairman of 
Dogus Holding, followed by a short question and answer 
period.  End Summary. 
 
Stability, Stability, Stability 
------------------------------- 
 
¶2.  Economics Minister Ali Babacan repetedly stressed the 
need for both economic and poitical stability as the 
indispensable foundationfor all of the conditions needed for 
a positive nvestment climate.  He attributed mch of 
Turke's progress over the last for year to a ruing pary 
with a strong parliametary majority able to implement stable 
and realistic macroeconomic policies.  Babacan, who is also 
Turkey's chief EU accession negotiator, described the 
long-term future of Turkey as linked to full EU membership. 
This vision has been a primary focus over the past four years 
and will be a defining force for the next five to fifteen 
years, he noted, describing the level of predictability 
provided by Turkey's EU anchor as the primary difference 
between Turkey and other emerging markets. 
 
¶3.  Turkey's economy has improved greatly over the last four 
years with greater than 7.5% annual growth paralleled by 
diminishing inflation for most of the period.  Babacan 
explained that the Government of Turkey (GOT) had focused on 
bringing high, unpredictable inflation under control and on 
de-linking growth and inflation.  Turkey missed its inflation 
target this year, but was focused on meeting its 4% target 
for 2007.  He explained that the GOT recognized that tight 
monetary policy and budgetary discipline were vital to 
macroeconomic stability and noted that Turkey had achieved 
the first of the Maastricht Criteria (budget deficit under 
3.5%.)  Declining interest rates contribute to the reduction 
of the debt burden with debt to GDP ratios of 90% in 2000 
falling to 55% in 2005 and 50% in 2006. 
 
¶4.  Babacan described several areas in which structural 
reforms had contributed to macroeconomic success.  Banking 
sector reform undertaken with the support of the IMF has 
greatly improved the legal framework as well as regulation 
and put Turkey on the path to Basel II.  Social Security 
remains a very serious problem, he acknowledged, with both 
legal reforms as well as a restructuring of the health 
insurance system yet to be completed.  The GOT is working 
with the World Bank on reforms that would reduce 
unemployment.  These reforms must parallel the EU accession 
process and should include both the education system and the 
manpower market.  Tax reform is ongoing with corporate taxes 
recently reduced to 20%.   Privatization has seen more 
reforms in the past 4 years than ever before he claimed. 
Finally the GOT is working to simplify regulations related to 
founding companies, reducing red tape and national treatment 
of joint venture companies that should make Turkey a more 
attractive location for foreign direct investors. 
 
Quality, Competition, the Cancer of Informality and Other 
Roundtable Topics 
--------------------------------------------- ------------- 
 
¶5. Sauvant made a general presentation on world FDI noting 
that over the next four years (2006-2010) annual flows should 
stabilize in the region of $1.2 - $1.4 trillion with inflows 
to emerging markets hovering in the range of $410 - $430 
billion during the same period.  This scenario has important 
implications for Turkey and other emerging markets in three 
areas:  regulation and institutions, incentives and the 
nature of FDI.  With FDI flows more or less stable in the 
near term regulatory competition is likely to compete.  As 
FDI regimes become more similar quality will become 
increasingly important, particularly in the area of 
post-investment services and administration.  More 
sub-national entities will offer incentives with the 
attendant possibility of "incentive wars."  Governments must 
rationalize internal competition at the national level and 
focus on incentives that will add value ("quality 
incentives") not just to the foreign direct investor but also 
to local firms in the surrounding area, such as 
infrastructure improvements. Finally Sauvant stressed the 
need for emerging markets to attract quality FDI, in other 
words FDI that contributes to economic development such as 
tech intensive higher-value-added FDI in manufacturing and 
services. 
 
¶6.  Vorkink discussed steps to improve Turkey's investment 
climate, noting even if Turkey sustains FDI at $15 billion 
per year, Turkey will still be receiving less than 3% of GDP 
in FDI, less than key competitors and what is needed to 
sustain growth.  He noted that privatization as well as 
mergers and acquisitions in the financial sector are not a 
sustainable source of FDI in the medium- to long-term and 
that competition for greenfield investment is key.  Turkey 
must grow faster than EU countries to converge with EU income 
levels and will need to invest 8-10% of GDP to sustain that 
level of growth, he argued.  At the same Turkey needs FDI to 
finance its chronic current account deficit.  There is room 
for improvement and the GOT is considering a program that 
would make many of the necessary reforms, he noted. 
 
¶7.  Vorkink described a broad challenge stemming from "the 
cancer of informality." Vorkink described a workforce with 
over half of all participants (53%) in the informal sector. 
This is damaging to both the formal sector, which is taxed to 
provide government services to the informal sector, as well 
as to the informal sector, which is consistently less 
productive because enterprises are small-sized, cannot 
benefit from economies of scale and lack access to financial 
markets.  A large part of public sector expenditures are 
non-discretionary and produce low returns (debt serve, public 
sector wages, social security) making it difficult for the 
government to lower taxes.  Vorkink argued the only way out 
of this vicious cycle is attract more FDI through fiscal 
reforms, improvements to the investment climate, labor market 
reform, increasing financial sector efficiency and 
competitiveness, as well as fostering innovation and 
improving technology absorption.  Vorkink singled out 
educational reform as Turkey's single most important reform 
both for the EU and for attracting FDI. 
 
¶8. Dagdas returned to the themes of stability and 
predictability as enunciated earlier by Minister Babacan. 
Noting that competition would increase within emerging 
markets he stressed the need for both economic and political 
predictability as well as an investor friendly legal 
structure.  He cited the GOT's ongoing economic and 
structural reform program and noted that the GOT worked 
closely with the private sector, mainly industry groups and 
chambers of commerce to vet laws and regulations prior to 
their introduction.  He expressed great interest in the OECD 
Policy Framework for Investment (PFI), the subject of the 
sessions immediately following the Turkey Country Roundtable. 
 He noted that adherence to the PFI would involve a 
restructuring of how the GOT looks at the investment climate 
because the PFI incorporates infrastructure, public 
governance and responsible business conduct while the current 
GOT structural reform program does not. 
 
¶9.  Sahenk stressed the tremendous change in mindset that had 
occurred in Turkey as it chose to embrace globalization and 
"be a part of the world."  Turkey has adopted two very 
challenging reform programs, he explained, linked to the EU 
accession process and a very difficult IMF program.   These 
reforms have established regulatory bodies, made the Central 
Bank independent and implemented changes that affect the 
entire social structure.  Meanwhile, the reduction of 
inflation and interest rates means that investors can focus 
on the real economy in a way that was not possible in the 
90's.  He noted that political and economic stability was 
vital but that Turkey still had a long way to go.  Citing the 
automotive sector as an example, he explained that 
multinational companies now use Turkey as a manufacturing hub 
not just for the region but for the world.  In 1980 Turkey's 
annual vehicle production capacity was approximate 50,000 
vehicles.  Today annual production capacity is 1, 260,000 
vehicles.  Turkey is a young, dynamic country with a 
"demographic gift" but it must educate youth and create jobs. 
 If it succeeds, Turkey will be a regional economic power, 
Sahenk argued.  Turkey is an export-oriented, industrial 
society with a rapidly developing information society, but 
the GOT needs to develop a 5 - 10 year strategic plan that 
focuses on the strengths that come from a young population 
and strong productive capabilities and identify potential 
export markets and attract high quality FDI. 
 
Comment 
----------- 
 
¶10.  Turkey has indeed made remarkable progress since the 
2001 financial crisis.  Attracting enough FDI to sustain 
growth remains a challenge.  Over the next few years the 
massive post-crisis privatization campaign will wind down and 
the rapid pace of mergers and acquisitions in the financial 
sector will cool off.  In order to sustain annual FDI at the 
better than $15 billion figure cited by Vorkink in his 
presentation the GOT must look long and hard at the steps it 
needs to take to become globally competitive for 
high-quality, greenfield FDI.   End Comment. 
 
JONES