Past, present and future of Turkey’s fight against inflation

  • 10 Ekim 2018 Çarşamba

This week, the Ministry of Treasury and Finance announced a set of measures declaring a full mobilization against inflation, which has gained speed with rapid hikes in exchange rates and interest rates.

Through the measures that have already been taken and will be taken, Turkey will have completely removed the problem of inflation from its agenda. Before anything else, we should acknowledge that inflation in Turkey is a structural and supply problem rather than a demand one.

Since 2002, Turkey has been successfully implementing market-focused and anti-inflationary programs that strengthen the public finances.

The Justice and Development Party (AK Party) governments did not bring up populist-inflationist policies to the agenda even during the election periods – which is the fundamental success throughout President Recep Tayyip Erdoğan’s tenure as a politician. Even in a period when the EU subverted the euro convergence criteria (aka the Maastricht criteria) due to high public debt, Turkey was the only country which reached these criteria outside the eurozone.

This attentiveness and diligence of Turkey are also related to it being a country that suffered greatly from inflation in previous years and learned lessons from it.

It goes without saying that the inflation problem, which has gained momentum based on consumer prices in recent months, contains very different dynamics from the inflation Turkey experienced in the 1970s. The current rapid inflation rise is triggered by cyclical rapid exchange rate increases. As such, it is a problem to be solved by using the advantages of floating exchange rate regime and open economy.

In other words, Turkey will deal with this issue by further fulfilling the requirements of an open economy and the floating exchange rate regime within the market mechanism. I believe that we will rapidly return to normal with the measures taken by the Ministry of Treasury and Finance.

At this very point, it will be good to look at the inflationary process in Turkey in the 1970s, which has many important historical lessons that will shed light on the present situation. This process, which was the political choice of Turkey in those years, was maintained with the International Monetary Fund’s (IMF) stand-by programs on the economic side of the spectrum and with coups and the tutelary “parliamentary” system on the political side. In this sense, inflation was a revenue transfer mechanism in those years.

When you look at the times when Turkey had an inflation economy and the country’s secession from this economy, you will encounter surprising results. For instance, there is an often told story that Turkey did not join World War II and landed on both feet. This is false information in that Turkey – somehow – joined World War II and lost.

In the process that led to the war, the one-party government at the time issued a decree, authorizing the central bank to issue and release money in circulation in exchange for treasury-secured public bonds. The public sector’s borrowing from the country’s central bank soared to TL 605 million ($98 million) at the end of 1942 from TL 84 million at the end of 1938, while the circulating banknote value rose to TL 734 million from TL 282 million in the same period.

Coupled with the people’s rising demand for all the goods in panic and traders’ stocking up as a result; the ensuing monetary expansion and the shortage in imported goods led to a rapid rise in prices.

What do you think the government of that time did in light of this? It enacted the National Protection Law and started to control stocks and set officially fixed prices. However, the stockpiling increased further and prices rose further. So much so that, in 1941, the government banned pastry production in the face of flour and sugar shortages.

During this period, the state failed to collect taxes and covered expenditures with central bank advance loans, in other words by printing money. So, domestic prices were on the rise, however, the bureaucracy controlled by stocker-traders and sham importer industrialists pegged exchange rates to ensure that imports were cheap.

After a while, the economy bureaucracy introduced authorization for imports and foreign exchange allocation. However, it did nothing but increase the corruption, the black market and the new fraudulent rich.

If you are to write the history of inflation in Turkey, you will face a systemic and global exploitation mechanism. This process and the public sector borrowing ended in the Erdoğan era. Also, the state ceased to produce inflation with an inflationary finance and to transfer it to the private sector. This was also the end of exploitation.

Throughout this entire period, the central bank, state banks and the treasury fell into their right places. Stability and extravagancy in public finances have been a state policy during the Erdoğan period and financial stability has been permanently ensured for the first time in this period. This has enabled Turkey to borrow from global markets in reasonable conditions and foreign investors to benefit from this stable environment.

The main axes of Turkey’s fight against inflation should be to build a new economy based on technological productivity. For this, we should follow the main path of building a competitive small and medium-sized enterprise (SME) economy that competes on a global scale through technology, observes the technological efficiency and reaches the appropriate scale in accordance with the scope economy.

In this sense, the core of fight against inflation must be to combat monopolistic and inefficient structures, and this struggle should place small and medium-sized enterprises on the basis of the functioning of the free market. In the financing of this economy, monopolistic-oligopolistic banking system should not be in the foreground and a new network of financing where capital markets are prominent should be developed. In other words, deep financing, which has a healthy second market, is the sine qua non of the production-oriented economy and the first remedy to inflation.

The basic solution to deal with inflation in Turkey is not to tighten demand rapidly and to make it hard and expensive for small and medium-sized enterprises to access financing. This will lead to stagnation and push up inflation in the medium and long run – which means a permanent vicious cycle of inflation and stagnation, i.e., an ossified stagflation process.

As I stated above, non-market measures, such as price limits, fixed prices or detective stock controls, will no longer apply. They were already not unacceptable in the past, either. However, it is important to take steps to highlight competition in the market, render the Competition Authority more efficient and invalidate monopolistic pricing under the market rules. Let us note that speculative pricing – from food to advanced technological products – is not the task of competitive minors. This requires a top-down monopolistic organization. And, in an open market economy, these organizations are criminal structures that are considered to be Ponzi-style financial structures. Here, we need a new competition law to unearth these structures and an independent-regulatory competition institution that will properly enforce this law from agriculture to industry.

To conclude, Turkey’s fight against inflation will be within market conditions and aims for financial stability. Let me note that, through these measures, we have left behind the worst times regarding inflation. This is also an important step toward permanent financial stability.