To Go Forward, Turkey Must Look Back

The lira crisis has faded from the headlines, but the Turkish government"s stopgap measures to halt the hemorrhaging will not fix what ails the economy. There are other crises around the corner: Foreign capital flows financing the country"s massive current account deficit have dried up following the row between President Donald Trump and President Recep Tayyip Erdogan over the fate of Andrew Brunson, the American pastor jailed by Turkish authorities. The heavily indebted corporate sector, especially real-estate and construction companies, are hanging by a thread.

How does Ankara get out of this mess? There has been no dearth of policy prescriptions. Some, like Paul Krugman, have recommended temporary capital controls and the repudiation of foreign-currency debt. Others are pointing to ways to shore up the corporate or the banking sector, by restructuring private-sector debt, tightening fiscal discipline and perhaps reaching out to the International Monetary Fund again. But what Turkey needs to do is both simpler and more difficult: Start reversing the downward slide of its institutions.

The roots of the crisis lie not in fickle foreign investors or the tweetstorms of a capricious American president, but in structural problems: low productivity in the corporate sector, unsustainable credit growth, and corporate overextension. These problems are themselves grounded in the decline of economic and political institutions over the past decade.

It wasn"t always like this. Not long ago, the strength of those institutions allowed Turkey to enjoy rapid and high-quality economic growth.

Between 2002 and 2006, following the Turkish financial crisis of 2000-2001, the country experienced growth of about 7.5 percent a year. This was accompanied by high investment, about 25 percent of gross domestic product, and by robust productivity growth - which meant that Turkish companies were becoming more efficient and adopting newer, better technologies.

Inflation was tamed because the central bank was given greater autonomy, and budgets were brought under control, reining in politically motivated runaway spending. Some degree of openness was brought to government-business relations, not least in the area of government procurements.

These reforms helped curb corruption and wasteful spending, and, together with the fiscal elbow room created by the lower debt-service obligations (a dividend from reduced inflation), they allowed spending to be directed to more productive outlets, including basic infrastructure and education. There were areas of concern, to be sure: Most importantly, the judiciary remained inefficient and far from autonomous. But the good news drowned out the bad.

The center of gravity of economic activity changed during this period, too. There was vigorous growth away from Istanbul and in smaller, younger companies, which were able to compete against the conglomerates that had dominated the Turkish economy for decades.

All of this was possible not because some economists were designing better policies, but because of political changes favoring greater inclusion. These were directed, first and foremost, at the base of Erdogan"s Justice and Development Party, or AKP, which was among the poor and more conservative segments of the population. They also unshackled the more westernized sections of Turkey"s middle class, and the youth. The military domination of Turkey was crumbling, generating democratic breathing room - this, in turn, allowed economic openings and laid the foundations for high-quality growth.

These economic dividends from political opening were not unique to Turkey. Transitions to democracy are often accompanied with surges in economic growth.

The move toward greater democracy in Turkey came in large part because of the economic and political constraints placed on the governments of the early 2000s. The program implemented by the IMF in the aftermath of the 2000-2001 crisis devised a tighter framework for economic policy and imposed institutional reforms, including in public finances and government procurement. Crucial, too, was Turkey"s bid for accession to the European Union, which created another incentive for political reforms.

Alas, all of this ceased around 2006. If politics was what brought improvements, politics was what took them away.

The framework for policy introduced after the financial crisis began to weaken. The EU accession process had already started unraveling soon after it was initiated in 2005. After the AKP increased its political domination in the 2007 general elections, the limited independence and effectiveness of the judiciary started to disappear, along with media freedom.

Where politics led, economics followed. The government started clawing back the independence that had been granted to the public agencies. The central bank dutifully started doing the government"s bidding. The reforms in the procurement process were rolled back, with corruption and backroom deals increasing. In the private sector, the good graces of the governing party once again became the most valuable asset of any company.

Though Turkey did weather the global recession reasonably well, the growth that followed has been low in quality. Productivity has declined for most of the past decade. Growth during this era relied on a construction boom and rampant credit expansion. It is these unsustainable engines of growth that have also created the persistent current-account deficits and inflationary pressures that have become harder to contain.

Understanding the institutional background to Turkey"s problems is important for at least three reasons. First, any policy response that fails to tackle the root causes of the current crisis is unlikely to restore high-quality growth. Second, the experience of 2002-2006 shows that another path, one of growth based on improving economic and political institutions, is possible. Third, since a major part of the short-term problem is foreign capital flight, a strategy for tackling the structural problems of the Turkish economy could, by reassuring foreign investors, generate a short-term dividend, too.

Rather than hope that capital controls or other forms of financial engineering will miraculously restore to health an economy ailing from institutional ills, it is better to be clear-headed about what the Turkish economy needs: more inclusive economic institutions guaranteed by democratic institutions.

Important steps would include rolling back the sweeping powers of the executive presidency; freeing up the media; freeing political prisoners, such as the businessman and peace activist Osman Kavala; granting independence to public agencies such as the central bank, and to the courts; reactivating the controls over government procurement; and taking simple confidence-building measures for foreign and domestic investors.

But the simplicity of the solution shouldn"t allow false hope.

The conditions that enabled political reform in the early 2000s do not exist now. Turkey changed its constitution in a more authoritarian direction, and the opposition is in no position to force President Erdogan to take a reformist turn. The courts and the media have completely ceased to provide checks against government power. The population has become much more anti-Western in the intervening years, in part because of the collapse of the EU accession process, and also because of the steady barrage of propaganda in the Turkish media. The coup attempt of July 2016, which led to the deaths of over 300 people, has scarred the public psyche and further polarized the country.

Even if the path out of Turkey"s economic troubles seems clear, getting there is no easy thing.