TURKEY’S HUMAN AND SOCIAL CAPITAL PROBLEMS

The tapering remarks by the former FED Chairman Ben Bernanke in May 2013 and the ensuing shift of capital flows have indicated the vulnerability of a set of countries which later came to be known as the “fragile five”. Namely, the fragile five countries are India, Indonesia, South Africa, Brazil, and Turkey whose shared characteristics include large current account deficits, weakening growth prospects, and stubbornly high inflation rates. Hence, it was no surprise to see that these economies were shaken badly at the beginning of this year when FED finally began the long-awaited tapering. Their currencies depreciated considerably and, to lure the international investors, many of them increased the interest rates since January. Compared to last September, interest rates are higher in all of them.

Although Turkey was put into the same group with the other four economies, it was probably more fragile because of two reasons. Turkey has the highest current account deficit to GDP ratio. Plus, at the end of March Turkey held municipal elections before which the political tension escalated seriously.

However, every dark cloud has a silver lining. Bad days for the fragile five lately came to a halt. Of course only temporarily. Bank of Japan recently decided to increase the monetary base in Japan annually by up to 70 trillion yen and the European Central Bank is signaling a prospective quantitative easing period. Hence, thanks to Japan and Europe, global liquidity is unlikely to dry soon even though the interest rates in the US are expected to rise. In return, investors’ risk appetite soared and international capital began to flow into the emerging markets again. Currencies of the fragile countries, and specifically the Turkish Lira, appreciated. International capital is once again demanding Turkish assets. So, is this a relief for Turkey?

Attracting international capital is surely positive since Turkey would otherwise suffer from serious financing gap problem due to the chronic disparity between its low rates of domestic savings and high rates of investments. But I would hardly say international capital is the single most important problem of Turkey. It is just one of the problems of the Turkish economy regarding capital.

To start with, Turkey’s human capital quality is alarmingly low. Every three years, OECD sorts countries with respect to the mathematical, reading and scientific skills of 15-year old students. Among the 34 members of OECD, Turkey currently stands 32nd. 2013 UNDP Human Development Index ranks Turkey 90th out of 187 countries in education sub-index. In addition, the 2013-2014 Global Competitiveness Report of the World Economic Forum says Turkey is 62nd in terms of health and primary education, 65th in terms of higher education and training and 130th in terms of labor market efficiency out of 148 countries. Low educational quality results in low labor market efficiency. In a 2011 report for Turkish Industry and Business Association, İzak Atiyas and Ozan Bakış point at the low quality of human capital as a major constraint on growth and innovation in Turkey.

Still, noteworthy advancements happen as well. For instance, education budget of Turkey tripled between 2002 and 2011 and continues to rise. Moreover, Turkish education system uses the expanding budget wisely. Targeted policies are implemented to improve the performance of

low-achieving schools or students like distributing resources to those schools or students who need them most. In return, from 2003 to 2012, according to OECD, mathematics performance and levels of equity in education simultaneously increased. That is something not every country is able to achieve. However, it should not be forgotten that the initial education level of Turkey is low and that is why the marginal return of each dollar spent on education is high. After some time the marginal returns from budget expansions should diminish. Then Turkey would face a major problem: lack of sufficient teachers. According to the 2010 Monitoring report of the Education Reform Initiative at Sabancı University, a grave problem of the Turkish education system is to find sufficient teachers. “Teachers need to be provided with more extensive and improved training and need to be supported regularly” says the report. Unfortunately, this major problem is not properly addressed yet. Therefore, the success Turkey can achieve seems eventually bounded.

Secondly, the social capital of Turkey too is in miserable situation. Social capital refers mainly to the qualities of relationships in a community and interpersonal trust is an indispensable part of it. Trust is economically important because it might facilitate contract-making, encourage entrepreneurship, and decrease the negative impacts of some information asymmetry problems. It might also decrease the counterparty risk for businesses and make cooperation and idea-sharing easy which might help boost innovation. According to the World Values Survey, Turkey has one of the lowest levels of interpersonal trust in the world. Consequently, in the 2013 Innovation Union Scoreboard of the European Commission, Turkey is the second least innovative country in Europe passing only Bulgaria. A 2010 OECD survey reports Turkey’s levels of interpersonal trust considerably lower than the OECD averages. Interestingly, Turkey stands out among the 20 countries in this survey as the only one where higher educational attainment correlates with lower feelings of trust. Many economists believe trust-building is a bottom-up process which starts in the family and then moves up to the school and etc. The buildup of trust might be a bottom-up process but its destruction should be a top-down issue. In that respect, I would like to note that the current political polarization in Turkey should be far from helping the country in overcoming its problem of low interpersonal trust. Turkey’s low social capital is anyhow not encouraging for the promotion of innovation and wealth creation.

All in all, Turkey is a capital-deficient country and that means more than meets the eye. Turkey should carefully review its capital structure if it is truly aiming to become a developed country one day.