Ferdi Ilkhan

Viewed from afar, Turkey has huge potential to becoming a target for long-term direct investment. The country has a relatively large, young population, increasing purchasing power, and cost competitive labour force. Moreover, Turkey has a strategic and fertile geographical location and large domestic market. In addition, particularly after introducing the concept of foreign direct investment in the year 2003, the Turkish government established various measures and policies mainly focusing on attracting inward long lasting investments (Edgerly, 2013).

As a result, just two years after this concept was launched, the annual net foreign direct investment (FDI) flowing to Turkey reached $10 billion USD. This amount was above the sum of net FDI that the Turkish economy experienced (slightly more than $8 billion USD) during the previous decade before the concept was implemented. By the end of the year 2006, the annual amount of net FDI in the Turkish economy exceeded the $20 billion USD mark. However, the more recent numbers show that the Turkish economy does not seem to be able to reach the pre global financial crisis level of inward net FDI (The Republic of Turkey Prime Ministry, 2014). Therefore, this report analysis the impact of FDI on the macroeconomic performance of Turkey and explores possible explanations of some reasons for the decreased FDI inflows, in more recent years. Moreover, it provides and briefly evaluates selected measures recently introduced by the Turkish government to overcome these issues.

Impact on Macroeconomic Performance

Foreign direct investment (FDI) is mainly seen as a key element in the international integration of a country, which establishes direct, stable and lasting links between economies. Therefore, the increase of inward FDI represents a crucial dimension for the international integration of the Turkey economy. Moreover, net FDI also contributes to the amount of gross domestic product (GDP), which is commonly used as the main indicator of a country’s macroeconomic performance. In short, GDP is the market value of all final goods and services produced in a country in a year, or over a given period of time. This definition can be found also in Keynes’s theory of aggregated demand. According to this theory, aggregated demand also refers to the total demand for goods and services in an economy, and consists of the consumption demand by households, investment demand by the firms, government expenditures as well as net income from abroad (value of exports adjusted by the value of imports). In this context, FDI initially contributes to the amount of GDP in form of investment demand by firms. After a while, when the investment is concluded and the supply of goods or services has reached a certain level of production, it is also expected that the foreign investors begin to generate exports and contribute in a second component of the aggregate demand – the net income from abroad (Chamberlin and Yueh, 2006).

In the year of 2006, FDI flows to Turkey reached the amount of $20.1 billion USD and had a share of 3.8% of the overall GDP. In 2007, inward FDI increased to the peak of $22 billion USD and took a share of 3.4% of this year’s GDP. In the following year of 2008, when the inward FDI to Turkey reached $19.7 billion USD, this amount was 2.7% of the overall GDP. These achievements clearly exceed the same indices in many comparable emerging markets and developing economies such as Bulgaria, Romania, or Indonesia. For instance, the net FDI in Indonesia reached a GDP share of 1.3% in the year of 2006, 1.6% in 2007 and 1.8% in 2008. However, this situation changed after the worldwide financial crises and especially during 2009 and 2010. During the worldwide financial crises, these numbers dropped drastically as expected until an annual net FDI of $8.6 billion USD by the end of the year 2009 and increased slightly up to $9 billion USD in the following year of 2010. But more important, recent figures show that the share of the inward FDI still remain below the level before the financial crises. The amount of net FDI dropped to $8.4 billion USD by the end of the year 2012 and had a share of 1.7% of the annual GDP. In the same year, net FDI in Indonesia had a share of 2.2% of the GDP. According to the latest figures, Turkey received an annual amount of $12.9 billion dollars as inward FDI by the year of 2013. This was 1.6% of the annual GDP in the year of 2013 (World Bank, 2014; The Republic of Turkey Prime Ministry, 2014).

These numbers illustrate that not only the annual amount of net FDI inflows to Turkey dropped, but also the share of received net FDI on annual GDP decreased significantly. So far, we can notice a decrease in the impact of inward FDI on the macroeconomic performance of Turkey. Furthermore, as already mentioned above s exports counted for a share of 22.3% in the annual GDP. In more recent years, where we can expect the positive effect of FDI on the exports, the share of exports in the GDP increased to 24% by the end of 2011 and rose further to 26.3% in the year 2012. Therefore, we can assume that inward FDI actually had an indirect positive impact on the amount of exported goods and services (World Bank, 2014).

Another main indicator to measure the macroeconomic performance of a country is the employment status. It should be expected that with an increase in inward FDI the unemployment rate in a country also decreases. To be able to measure the employment status we should have a look at the developments of the unemployment rate. The unemployment rate in Turkey is reported by the Turkish Statistical Institute. According to the Turkish Statistical Institute, the unemployment rate averaged 10.71% from 2005, the year when we started to measure the level of net FDI in this report, until the current year of 2014. It is interesting to see that in 2007 when the net FDI reached its record high, the unemployment rate in Turkey still was above the 10% mark and was not able to decrease significantly below the average mentioned above. On the other hand, the unemployment rate reached its record low in June 2012, in the year where the net FDI experienced low levels (Turkish Statistical Institute, 2014). There is clearly a controversial development between the unemployment rate and the level of net FDI. As a result, we can assume that there is no significant relationship between these two indices. The following graphs illustrate the developments of the unemployment rate as the blue line as well as the trend of this unemployment rate as a black linear line:

Figure 1: Turkey Unemployment Rate – Percentage of Labour Force (Turkish Statistical Institute, 2014)

Inflows of FDI obviously would have direct benefits for the host country, such as an increase in tax revenues or increase in competition within the domestic market, or it would also gain certain positive spillover effects such as the opportunity of domestic firms to imitate more efficient production processes, or improve other technology and managerial know-how. However, alongside the recent decrease in the level of net FDI, the analysis above shows that inwards FDI only had a relatively small impact on the macroeconomic performance of Turkey.

Therefore, the next section explores possible explanations of the decline in FDI and investigates the reasons why Turkey was not able to gain from the effects of increased net FDI at the expected levels.

Difficulties related to inward FDI and its expected impact on the economy

In general, we can assume that FDI inflows reduced as a result of the global financial crisis, because of the increased caution of potential foreign investors. Also the current political climate certainly plays a role in this situation. However, this section focuses on reasons more directly linked to the Turkish economy itself as well as the measures implemented by the government to attract inward FDI.

The analysis above shows that we can assume a positive effect of previously received higher levels of net FDI on the increased level of exported goods and services, during the years 2011 and 2012. However, looking at the achieved increases in net FDI, the increases in the level of exports can also be considered insufficient. During the last decade, the intermediation services and manufacturing sectors have attracted the highest amount of FDI, although the agricultural and food sectors are the most important sectors within Turkey’s economy. Turkey has a large and growing food and agriculture industry that corresponds to 9 percent of the overall gross value-added (GVA) and 25 percent of the employment levels in the country. Although there is significant potential for an increase, agricultural exports currently make up only about 5% of total exports. FDI in this sector would obviously lead to an export boom. Turkey’s beneficial climate and about 21m hectares of arable land provide a potential for export growth. Additionally, the agricultural sector in Turkey could massively benefit from technology and processes implemented by foreign investors (The Republic of Turkey Prime Ministry, 2014).

The lack of interest of foreign investors in Turkey’s agricultural sector also provides a possible explanation of the low impact of inwards FDI on unemployment rate. This sector alone accounts for 25 percent of employment levels in the country. Therefore, we can assume that missing out this sector as a possible target of FDI automatically decreases its impact on the overall employment status in Turkey. Related to the labour force in Turkey, another issue arose when it comes to attracting high-value-added capital intensive technology investment. Here, The World Economic Forum’s Global Competitiveness Report 2012-2013 provides possible answers to the question why high-tech companies may prefer Asia to Turkey. Accordingly, for example, South Korea ranks 22nd, whereas Turkey only reaches the 65th place in the higher education and training category. In the innovation and sophistication category South Korea sits in 20th place and Turkey in 47th (World Economic Forum, 2013).

This lack of technology knowledge and skills in turn may also refer to the relatively insufficient increase of exports affected by foreign direct investment. According to Posner’s Theory of Technological Gap, trade between countries is based on the introduction of new products, new technology, as well as a demand and supply gap. Therefore, it assumes that countries such as the U.S., China and Japan have a competitive advantage over other countries because of their ability to innovate (Salvatore, 2014).

Finally, an explanation about the overall decrease in inflow of FDI can be provided by the FDI figures. Before the year 2010, more than 35% of inwards FDI was via privatisation of government assets. In more recent years, we can assume that there is nothing left to privatise and that this obviously influenced the overall decrease in FDI inflows to Turkey. Obviously, Turkey needs to generate alternative sources to attract inwards FDI (The Republic of Turkey Prime Ministry, 2014).
The next section, therefore, provides selected measures taken by the government to overcome the difficulties mentioned above.

Government’s Response

Turkey’s government is driven to attract further inflows of FDI in order to increase the amount of net FDI, although it obviously has taken into account the loss of a significant source such as privatisation. In order to achieve this goal, Turkey launched a new investment incentive that was also vital for the production and export-oriented strategy and aimed to boost production and employment, increase foreign direct investment and reduce regional development disparities. The government also introduced the so-called “Turkish Exports Strategy for 2023” with the main purpose of reaching $500 billion USD of exports by 2023; this envisaged plans to increase the share of foreign direct investors in the volume of exports. Furthermore, it also implemented sectoral and country based diversification strategies in export composition, and aimed to promote capital intensive technology investments (Republic of Turkey Ministry of Economy, 2014).

Closing Thoughts

In sum, by introducing a new concept of FDI in 2003, Turkey took a step in the right direction and gained an increase in its net FDI. However, the more recent years have shown that there are still difficulties to overcome. The latest response to these issues undertaken in the years of 2012 and 2013 illustrate that the government has noticed certain weaknesses in its FDI concept and the difficulties in macroeconomic performance. Therefore, the measures taken are promising steps in the right direction. However, there are still some measures missing from Turkey’s strategy in order to create a competitive agricultural sector that can both compete globally as well as feed its own population. In terms of foreign investors, focusing on the agricultural sector would massively contribute to Turkey’s 2023 vision – Becoming one of the world’s 10 largest economies and taking a 1.5 percent share in world trade by 2023.

References

Online Sources

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Textbooks

Salvatore, Dominick; International Economics – Trade and Finance, John Wiley & Sons Singapore Pte. Ltd., Asia, 2014, p. 164

Chamberlin, Graeme and Yueh, Linda; Macroeconomics, Thomson Learning, London, 2006, pp. 233-235