DP402 | Premature Liberalization, Incomplete Stabilization: The Ozal Decade in Turkey

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01/04/1990

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Abstract

In late 1979 Turkey found itself in the throes of a foreign exchange crisis, with widespread shortages, negative growth and three-digit inflation. A decade later, Turkey has a comfortable balance-of-payments situation, and holds considerable foreign exchange reserves. The economy has achieved a remarkable transformation from an inward to an outward orientation. Yet, despite some initial success in the early 1980s, inflation remains high and the public sector budget is out of control.This paper provides an interpretation of the Turkish experience in the 1980s. It argues that foreign capital inflows in the early 1980s cushioned the fiscal squeeze, and allowed a relatively painless reduction in inflation alongside a process ofexport-oriented growth. The outward-oriented reforms should ideally have taken sufficient hold by the mid-1980s to allow the public sector to undertake the delayed retrenchment as the inflows came to an end, at no great cost to output. Instead, policy combined liberalization with patronage politics in a mixture detrimental to monetary discipline. Financial liberalization reduced demand for base money at the same time as fiscal balances came under increasing strain due to the external transfer. Inflation was rekindled under the dual influence of fiscal deficits and a shrinking base for the inflation tax.