Turkish lessons for the Eurozone crisis
Below is my Hurriyet Daily News column for this week, which you can also read at the Daily News website. I decided to give cheesy titles a short break, so this week’s title is right to the point.
I have quite a few interesting additional comments, so there will be an an addendum, later today or at the latest tomorrow. So here we go:
The world does not need another op-ed on the Eurozone crisis, definitely not one from a Turkey economist. However, there may be some room for lessons from a country that went through a major crisis a decade ago.
As depressing as this may sound, Italy’s problems are worse than they seem. Markets concentrate on the country’s debt, and rightly so. At the current interest rates and assuming around zero growth, simple fiscal sustainability algebra reveals that it would have to run a primary surplus of around 8 percent just to keep debt at a constant share of GDP.
However, as my blog host Nouriel Roubini argues in a recent column, Italy, and the whole Eurozone periphery for that matter, suffers more importantly from flow problems: Lack of growth and competitiveness as well as large current account and fiscal deficits. Unless these more important challenges are addressed, any fix is bound to be temporary.
The September Italian rescue plan was not successful because it did nothing to address these flow issues. On the other hand, the reforms after the 2001 Turkish crisis tackled the budget deficit, whereas the currency depreciation, which Italy and Greece cannot do, helped with competitiveness.
Moreover, the fiscal and current account deficits have led to yet another deficit in the periphery countries: A democracy deficit. As you are reading these lines, Italy will have probably followed Greece in putting a technocrat at the helm. This story would sound familiar to any Turk- no wonder Lucas Papademos was heralded by Turkish papers as the Greek Kemal Derviş.
Only a technocrat, supported by a national unity government as in Greece, may take the necessary but painful steps. But such a government is likely to be short-lived, if the Turkish case is any guide. Turkey was lucky that the Justice and Development Party was wise enough to stick with the economic program.
And it is also unlikely that Italy and Greece can save themselves by lowering their interest rates with more austerity. For one thing, Paul Krugman argues that “the big determining factor for interest rates isn’t the level of government debt but whether a government borrows in its own currency.”
Even if debt mattered, Krugman is right that austerity has not worked during the current crisis for any country. Turkey in the aftermath of the 2001 crisis is one of the few cases of a successful “expansionary fiscal contraction”, although it was starting with debt levels much lower than those found in Italy today.
Recent research on fiscal consolidation sheds light on the Turkish miracle. In OECD countries with large government sectors, only fiscal adjustments based on structural reductions in spending (as opposed to temporary cuts) have a lasting impact on debt-to-GDP ratios. Moreover, spending cuts have smaller recessionary effects than tax increases, and the negative impact on growth can be offset by structural growth-enhancing measures. This is exactly how Turkey did it.
Perhaps most importantly, the IMF acted as a lender of last resort for Turkey at the time. With the ECB legally banned from taking on this role, Italy is set for a debt restructuring and exit from the Eurozone.
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