VZCZCXRO5142
RR RUEHDA
DE RUEHAK #1512/01 1651210
ZNR UUUUU ZZH
R 141210Z JUN 07
FM AMEMBASSY ANKARA
TO RUEHC/SECSTATE WASHDC 2577
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUEHIT/AMCONSUL ISTANBUL 2869
RUEHDA/AMCONSUL ADANA 2033
RUCPDOC/USDOC WASHDC

UNCLAS SECTION 01 OF 03 ANKARA 001512 
 
SIPDIS 
 
TREASURY FOR INTERNATIONAL AFFAIRS - JROSE 
USDOC FOR ITA/CRUSNAK 
 
SENSITIVE 
SIPDIS 
 
REF: ANKARA 1015 
 
E.O. 12958: N/A 
TAGS: ECON EFIN TU
SUBJECT: "Next Generation" Turkish Economic Reforms 
 
 
¶1.  (SBU)  Summary: Turkey is enjoying strong economic performance, 
with real GDP growth averaging over 7% per year for the past five 
years, government debt down, and inflation nearing single digits. 
Medium-sized "Anatolian Tigers" are thriving alongside traditional 
business conglomerates and Istanbul-based industries.  Jobs are 
being created and income disparities are slowly getting smaller. 
Yet Turkey remains poor and underdeveloped.  Prime Minister Erdogan 
has set a target of doubling per capita GDP from the current $5000 
over the next five years.  This laudable goal would allow Turkey to 
approach average EU income levels, but would require sustained high 
real GDP growth rates at or above recent levels. 
 
¶2.  (SBU)  There is a consensus among local economists and 
international institutions (i.e. World Bank, OECD, IMF) that if 
Turkey is to sustain its economic boom at the same time as the 
population and workforce continue to expand, Turkey's next 
government will have to move to a "next generation" of economic 
reforms.  In contrast to the macro reforms that have so far driven 
growth -- budget reform and independent monetary policy -- the next 
set of reforms is needed at the micro, grassroots level.  To keep 
investment and growth going and accommodate an economic 
transformation from an economy based on agriculture, basic industry, 
and government spending to one based on high-tech, innovation, and 
services, a new government will have to remove impediments in the 
labor market, the educational system, and the judicial system that 
now suppress potential growth.  The next government will also need 
to move forward with the stalled social security reform. 
Implementing these reforms touches on some of the "sacred cows" of 
the Turkish system and will be difficult for any government, and 
even more so for one that does not enjoy broad-based support. End 
Summary. 
 
------------ 
Labor market 
------------ 
 
¶3.  (SBU)  The ruling Justice and Development Party (AKP) is working 
on a package of labor market reforms that it intends to introduce if 
it returns to power.  Despite job creation, Turkey's recent growth 
has failed to have a significant positive impact on the unemployment 
rate because of the flood of new entrants to the labor market, the 
low rate of labor force participation, and declining employment in 
stagnant niches (i.e. traditional farming and corner grocery 
stores).  Female employment in the 25-54 age group is far below the 
EU average, 27 percent versus 70 percent. 
 
¶4.  (SBU)  To stimulate further job creation and to shift employment 
from the informal sector (which makes up roughly half of total 
employment) to the formal sector, the World Bank and other observers 
have identified a package of reforms that would ease restrictions on 
Turkey's labor market: 
 
-- a decrease in payroll and other employment taxes so as to reduce 
the tax wedge (the difference between employees' net wages and 
employers' total payments) and the cost of labor to employers, 
 
-- a decrease in severance pay for workers - Turkey is tied with 
Portugal for the highest in the OECD at one month's pay for each 
year worked, 
 
-- and a reduction in constraints on part time and temporary hires 
to boost employment among women and youth. 
 
--------- 
Education 
--------- 
 
¶5.  (SBU)  According to World Bank and OECD reports, Turkey will 
need to improve its rigid, antiquated education system to provide 
workers with skill sets that companies need to compete in a global 
market.  Turkey will also need to converge toward EU standards on 
education if its integration into the EU is not to be an avenue for 
a mass emigration of low-skilled workers.  Turkey has achieved near 
universal enrollment in primary education, modernized its 
curriculum, and nurtured top students that perform at the highest 
international standards. 
 
(SBU) However, reforms to the Turkish education system are needed 
to: 
 
-- make secondary education compulsory and improve student/teacher 
ratios to raise secondary school enrollment capacity, 
 
-- provide incentives for girls and the poor to stay in school, 
 
ANKARA 00001512  002 OF 003 
 
 
 
-- restructure university entrance exams to reflect competencies 
acquired in school rather than test taking skills, 
 
-- align teacher training with the new curriculum, 
 
-- and establish standards to assess student learning and address 
deficiencies. 
 
--------------- 
Judicial reform 
--------------- 
 
¶6.  (SBU)  An entrenched judiciary has been a key institutional 
opponent of the AKP Government, striking down privatizations and 
social security reform and interpreting the constitution to require 
a super-majority quorum to elect a president.  Until the judiciary 
is modernized and better-trained on commercial and economic issues, 
it will continue to hold back economic reform, render politicized 
judgments that are biased against privatization and foreign 
investment and slow Turkey's transformation to a modern, 
well-regulated, market economy.  Judicial inefficiency and the lack 
of assurance of judicial impartiality in the case of dispute also 
undermines the investment climate. 
 
¶7.  (SBU)  Judicial reforms for Turkey that the EU has recommended 
include: 
 
-- more training for the judiciary, especially on issues relevant to 
the convergence of Turkish law with EU standards, 
 
-- and increased interaction among structures in place to combat 
corruption. 
 
---------------------- 
Social Security Reform 
---------------------- 
 
¶8.  (SBU)  Social security reform was supposed to be the centerpiece 
structural reform under the AKP's program with the IMF, but 
President Sezer and the Constitutional Court derailed it as 
"unconstitutional," leaving it to the next government to tackle. 
The longer Turkey waits the harder it will be to staunch the red ink 
(a deficit of 4.8% of GDP in 2006, expected to rise to 10% by 2050) 
of the social security system.  The share of the elderly in the 
Turkish population is expected to rise from 5.7 percent today to 14 
percent by 2035.  This significant portion of the electorate will 
likely resist change to the benefits it receives from generous 
pensions. 
 
¶9.  (SBU)  The AKP's 2006 reforms sought to address the social 
security deficit by requiring: 
 
-- a longer period of work to receive full benefits, 
 
-- phasing-in a retirement age of 65 years, 
 
-- valuing past wages on an equal weighting of wage growth and 
inflation, 
 
-- indexing pension benefits to the CPI rate of inflation rather 
than wage growth, 
 
-- and basing the size of pension benefits on lifetime average 
salary rather than final salary. 
 
------- 
Comment 
------- 
 
¶10.  (SBU)  Enacting these next generation reforms will make the 
macro reform process up to now look easy.  The next government will 
have to overcome the populist tendencies of the 1990s that produced 
labor market regulations protecting life-long jobs and generous 
social security benefits as well as a statist, government-driven 
approach to economic management that is still widespread.  If the 
next government is AKP-led, it will also have to overcome a 
perception that it is implementing a "hidden agenda" to Islamicize 
Turkish society and institutions with their "reforms" of 
long-established educational policies and the judiciary.  The 
current political situation has pushed structural reforms to the 
back-burner, but the desire of the powerful Turkish business 
community to maintain growth and pressure from the EU and the IFIs 
means that these issues should be at the top of the next 
 
ANKARA 00001512  003 OF 003 
 
 
government's agenda.  However, how quickly reforms will be enacted 
will depend largely on whether a new government enjoys broad-based 
public and parliamentary support. 
Wilson