Political Economy of Economic Growth: A Cross Comparison of Egypt and Turkey

Table of Contents

Introduction

Literature Review
Overview on Turkish and Egyptian Economies (1918-1945)
Overview on Turkey (1918-1945)
Overview on Egypt (1918-1945)
Overview on Turkish and Egyptian Economy (1946-1990)
Overview on Turkey (1946-1990)
Overview on Egypt (1946-1990)
Overview on Modern Turkey and Egypt
Overview on Modern Egypt
Overview on Modern Turkey
Factors Affecting Modern Turkish Economy
Factors affecting Economic Growth
IMF and Economic Growth
Corruption and Economic Development
Religion and Economy
Economic System and Economic Growth

Conclusion

References

Introduction

Growth economics is the branch of economics answering questions related to what are determinants of economic growth; whether is it possible to reach a maintainable growth rate on the long run, if it is preferable to let governments interfere in market performance in order to fasten rates of economic growth. Harrod and Domar attempted to answer these questions through applying Keynes economics for economic analysis. They found that savings and investments stable rates are the key for rapid long term growth especially in developing countries. Therefore, government intervention was needed to help stimulate savings and investments. Years later, Solow and Swan attempted to answer same questions through their neoclassical growth model. In this model, it was assumed that a maintained rising saving rates leads to transition from slow growth into fast growth path. This meant a focus on technological progress. However, part of the growth was not explained by growth in production factors which are capital and labor. Solow stated that this unexplained factor was the residual or total factor productivity. Therefore, government policies were assumed to be effective on aggregate output not on growth rates (Gutema & Fayissa, 2004).

When economic growth is mentioned, foreign trade and foreign direct investment are mentioned; due to the link between trade and foreign direct investment which are believed to be keys for economic growth. Tian (2007) mentioned that FDI has been considered by many firms to be an effective means to realize economic growth like the four Asian tigers ‘Hong Kong, Taiwan, Singapore, and Korea’ which had set some policies to attract FDI into their countries through tax reductions and rebate (Tian, 2007). Moreover, Musila and Sigue´ (2006) stated that African countries adopted FDI as a means to face the financial constraints which hinder their development. FDI refers to the process of purchasing or creating a firm in a country by foreigners (Musila and Sigue´, 2006).

Through history, economic liberalization and free trade had its proponents who call for self-regulating markets and long run equilibrium through efficient allocation of resources. They believed that on political side, trade liberalization will lead to democratization and liberalized political system especially in developing countries. However, this transition process for developing countries into free market system was not achieved in the linear smooth mode; rates of successful transition differed from country to country. Therefore, according to proponents of liberalized markets, economic and political liberalization go parallel together. For example: Turkey as developing country implemented a new economic paradigm in terms of economic neo-liberalization. However, political system was characterized by social, ethnic, and ideological conflicts. The political and institutional environment affected the outcome of economic reform (Demir, 2005).

Trade theories of David Ricardo and Adam Smith explain the phenomena of international trade. The free trade theory assumed that mutual benefits result for trading partners in voluntary trade due to the focus on comparative advantage. However, this theory did not explain the motivation for foreign investments and it was not applied by most policy makers whether in developing or developed countries (Dumludag, 2002). International trade and international investment flows has been a main feature of globalization era. However, international flows of goods, services, labor and knowledge among national borders is not a recent phenomenon. Since World War II, most countries attempted to increase the rates of their international trade flows due to the increased impact of foreign firms investing on their economic performance (Tian, 2007).

Therefore, the focus on FDI was related more to development economics. The focus was on less developed countries attempting to achieve higher economic growth through industrialization and FDI inflows to their economies. Those developing countries were helped by IMF and other developed countries which were living flourishing economic policies due to Keynes’ economics focusing on government interfering and welfare nation. In order for developed countries and international institutions to help these less developed countries, a global framework was necessary. Therefore, international institutions such as IMF, WB and WTO were established. GATT was signed in 1947 in order to maintain sustainable free trade. Later on, the United Nations Conference on Trade and Development (UNCTAD) was built to focus on trade in terms of development. These institutions increased levels of international trade through regulated global currency and FDI and trade relations (Dumludag, 2002).

FDI inflows occur as a result of less government intervention, FDI benefits were explained by some researchers (Seyoum and Manyak, 2009; Tian, 2007; Musila and Sigue´, 2006) who believed that developing countries can mostly benefit from FDI; FDI for developing countries is more than just an economic tool helping them realize economic growth. FDI is a means to reduce poverty, enhance their international trade; helping them access advanced technological knowledge. Moreover, FDI is a major financing source for domestic investments in these developing countries. In addition, FDI is an accompanying feature of privatization processes occurring in developing countries (Seyoum and Manyak, 2009). Kosack and Tobin (2006) mentioned that FDI in low and middle income countries had an annual growth rate of 17% in the period between 1995 and 2000. These developing countries consider FDI as the most stable external funding source (Kosack and Tobin, 2006).

Many researchers (Jensen, 2003; Helpman, 2006; Rajan, 2004; Camilla, 2006) stated benefits of FDI on the host country level; FDI is considered by Helpman (2006) as a feature of productive and larger companies. Jensen (2003) stated that countries especially developing ones cannot achieve economic development without being engaged in FDI; as technology, physical capital, employment, global networks, and marketing policies are all provided by FDI. Therefore, it is a helping factor for countries to realize economic growth by enhancing domestic productivity due to global competition, providing work opportunities for domestic work force, enhancing technological knowledge whether by technology transfer from developed to less developed host countries, or through transferring knowledgeable workers, internationalizing the system of research and development, or through vertical relations with local suppliers and buyers, or horizontal relations to other complementary industries within the host country (Rajan, 2004). These investing firms affect the economic growth in host countries due to their contributions to the economic performance and competition within the host country (Camilla, 2006). Jensen (2003) stated that these benefits are related to foreign currency generated for the host country, increasing employment within the host country; this increase can be direct through employing host country nationals in the firm, or indirectly through establishing local firms operating in industries complementary to the main industry of the firm (Jensen, 2003).

Membership in international institutions is another factor effecting economic performance in developing countries. Turkey and Egypt are both members in many international institutions such as: International Monetary Fund, World Bank and World Trade Organization. These international institutions were believed to assist economic growth in developing countries post Second World War. They were all created as institutions of the Bretton Woods agreement. According to Gilpin (2001), international trade was a critical means for countries to develop. Therefore, it was highly needed to have minimal set of laws to regulate these economic relations among countries who are concerned with relative gains from trade. Gilpin believed that rules were created by political rather than economic motives, even if they were created in the most liberal countries; they are needed to confirm the supremacy of property rights and contracts. The same reason holds at international level of complex economic relations among countries. These international institutions are defined by Gilpin (2001) as ‘‘the procedures for decision making through implicit or explicit rules and norms (Gilpin, 2001).

The same point was highlighted by Jensen (2004) who mentioned how the World Bank and IMF were critical to world’s development post Second World War. He mentioned that the World Bank is serving as a helping hand to developing countries which to develop and accelerate their economic growth. This occurs through providing these countries by required funds and capital. On the other hand, the IMF was created to oversee the arrangements of fixed exchange rates among countries. This had the aim of providing these countries with short-term capital for balance of payments (Jensen, 2004).

Corruption is another factor affecting economic development in developing countries. Both countries are assumed to be having high rates of corruption. Therefore, they have both suffered from low growth levels due to the link between corruption and economic growth. This corruption affected foreign investment inflows, international trade and political stability. Low rates of foreign direct investment in both countries were due to high risk levels which mean less return on investments, illegal business practices such as bribe given whether to public officers or private business owners. Moreover, corruption means unnecessary protectionist policies which negatively affect international trade. This in turn affects public finance through rent seeking behavior of decision makers (Hessami, 2014). Another important factor to consider when considering economic growth is corruption. Hayakawa et al (2013) mentioned that low level of corruption is related to higher inflows of foreign investments. This is due to the negative relation between political risk and FDI inflows. Corruption, internal conflicts and bureaucracy are negatively related to FDI inflows. Therefore, it means political stability, low availability of information, red tape and higher sunk costs for foreign investors. Other factors related to corruption include external conflict, lack law and rule, low levels of governmental accountability and low performing institutions. (Hayakawa et al, 2013).

The aim of the following paper is to provide an overview of the political economy of economic growth in both Egypt and Turkey. The paper presents an overview of major three periods in history of both countries; First World War, Second World War and era of 1990s till nowadays. Then the papers presents some factors related to economic growth in both countries. More specifically, factors which affected Turkish economy were listed in details. Then the conclusion is made.

Literature Review

In late nineteenth century, foreign direct investments received attention from political economists. For example: Lenin considered foreign investment as the last stage in capitalism. However, the ultimate focus was on capitalism and historical analysis. For Lenin, capital was scarce in developing peripheral countries while labor wages, raw materials and land were cheap. Moreover, he considered that monopoly was transition from capitalism to exporting system. However, major models for FDI were not formulated till 1960s. For example: Heckscher-Ohlin trade theory considers that international trade occurs due to differences in production factor endowment. This theory assumed that constant returns to scale, same technology and perfect competition existed in all countries’ international and national markets. Therefore, two countries which are endowed by production factors in different ratios are likely to engage in international trade; production can be either capital intensive or labor intensive. Although these efforts existed, after Second World War, international trade levels increased (Dumludag, 2002).

According to some theorists, similar structural and institutional problems in developing countries led to failing efforts to liberalize their economies; these problems created maintained inequalities and imbalanced economic systems. In Turkish case, it had the military, economic and legislative powerful institutions. However, it lacked the transparency and accountability which led to its democratic gap. Moreover, its uncontrolled financial liberalization, lack of funds, differences between lending and borrowing interest rates and strict rationing of credit deferred long-run investments. Turkish asset market was unstable because of capital rough flows. Moreover, the public sector debt records went to highest levels. Therefore, Turkish economy faced many crises in years 1994, 1999 and 2001. The IMF provided its help through rescuing packages to stabilize the collapsing economy. This deregulated financial markets and goods market which were globally integrated through international trade did not lead to increased investments or enhanced macroeconomic performance; inflation rates kept increasing and economic growth rates were unstable. The widening social conflict between Turkish and Kurdish, Secularism and Islamism, urban and rural groups was also a factor in deteriorating economic performance. Moreover, military and political social classes were isolated from other classes. This led to granting them special power in terms of unquestionable conduct (Demir, 2005).

In 19th century, a duality existed in economic development rates in world regions; in developed countries such as UK, USA, France and Germany the rates of economic growth were highest while in many other areas stagnated economies exited. This gap between rich and poor countries widened in the 20th century. In developing countries, the term economic growth never had existence; economic growth means that economic quantities are increasing, while economic development means structural changes. Therefore, economic development occurs in developing countries such as Turkey and Egypt (El-Kammash, 1968).

Developing countries have high rates of population growth. This means a low per capita income and low investments due to little amounts of savings. This is referred to vicious poverty circle. This circle explains how poor countries are trapped in continuous poverty due to less income, less demand, less production which means less profit and less employment which means fewer investments and savings. The supply approach to economic development rests of premise that lack of capital and knowledge in less developed countries are reasons for less development opportunities. On the other hand, demand based view of development viewed it as a result of less demand which leads to less production. All developing countries have low economic rates of growth. However, the nature of problem differs among countries due to political, economic, social and legal systems (El-Kammash, 1968).

Overview on Turkish and Egyptian Economies (1918-1945)

According to Pamuk and Owen (1998), The Middle East referred to Egypt, Turkey, Israel, Iraq, Syria, Lebanon and Jordan. However, they narrow down Middle East to three countries: Egypt, Turkey and Israel. This is due to the fact that those three countries had a growth path different from other countries and other than Gulf countries which always depended on oil as the main source of wealth (Owen & Pamuk, 1998).

If nation’s growth was to be understood, it must be considered within three contexts: political, historical and global. Political context refers to role of state in harmonizing conflicting socio-economic needs of social groups and the allocation of nation’s resources. Historical context refers to history of landownership, how populations were relocated and transportation systems changed. And finally global context refers to the impact of external forces on national markets and economic performance in terms of investments (Owen & Pamuk, 1998).

After Second World War, Middle East population was 40 million with the majority residing in Egypt and Turkey. Agriculture in Egypt was concentrated around Nile Delta and main crops were wheat, cotton and Barley. Land ownership was mainly a privilege for wealthy individuals who let tenants to work in these large states (Owen & Pamuk, 1998).

International trade grew much in the 19th century in both Ottoman Empire and Egypt which had its major trade relations with Britain which imported Egyptian cotton. Consequently, the Middle East was a part in the first globalization wave which took place from 1872 till 1914. However, in 1870, both Ottoman and Egyptian governments went into bankruptcy due to the misallocation of European debts they borrowed. For example: Egyptian per capita income did not witness any growth in the period between 1913 and 1940 (Owen & Pamuk, 1998).

The Great Depression after First World War started by declining prices and profits. When it moved to developing countries, they were highly affected due to four main reasons:

1. Low demand for exports of developing countries
2. Low price elasticity of demand of primary products led to deterioration in terms of trade.
3. Declining international inflows of funds to developing countries.
4. Increased debt burden of developing countries.

Overview on Turkey (1918-1945)

Republic of Turkey was established in 1923. However, it came after many wars. First Balkan War (1912-1913), First World War (1914-1918) and Independence War (1919-1922). In 1924, Turkish population was around 13 million which was a number reflecting the declined population as a result of wars. The loss in human meant a declined productivity. Till 1st World War, when protectionist policies were undertaken unlike Ottoman Empire which favored foreign companies. Therefore, monopolists importing certain goods existed and lands of killed Armenians were seized by Muslim Bourgeoisie. The focus on domestic industry was maximized during was times. M.K. Atatürk established the Republic of Turkey in 1923 and began the economic framework for the newly established state; some foreign firms were nationalized, 67 percent of Ottoman debt was promised to be paid by Turkish government and free trade agreements were suspended (Owen & Pamuk, 1998).

Till 1929, Turkish economy was an open economy. While during The Great Depression, protective measures were taken. Later on, production declined so policies changed to face shortages and meet demands of its strong army. Turkish government attempted to attract foreign investments and to provide incentives for some industries such as textiles and cement. Moreover, new railroads were built so construction industry flourished. The agricultural sector improved due to increased world demand. However, the decline in agricultural products due to the great depression affected Turkish economy. Therefore, deteriorated terms of trade led to less real income in agricultural sector. The foreign exchange rate crisis which happened in 1929 affected the economy negatively. Therefore, protectionist measures were taken in forms of high import tariffs on food and manufactured items. These closed policies led to decline in imports and exports. The Turkish government resorted to bilateral trade agreements and reciprocal quota systems. Germany was the major trade partner during the period of (1937-1939). The government attempted to take over foreign firms operating in public services, it also attempted to increase capital inflows but efforts were not successful due to the world economic crisis. The role of state as the major economic actor was emphasized when a five-year industrial plan was adopted in 1934 and 1938. State led enterprises became main suppliers of iron, steel, transportation and mining (Owen & Pamuk, 1998)

Therefore, after 1929, Economic growth in Turkey was due to tight interventionist governmental policies which reduced imports and the exchange rate strict regime. These conditions led to increased manufactured output. Unemployment rates declined so that three fourth of labor force was employed (Owen & Pamuk, 1998). Finally, it is clear that inward looking policies adopted by Turkish government led to improved economic performance through tariffs and increased manufacturing. Moreover, the government provided health and education services (Owen & Pamuk, 1998).

A brief historical description of old Turkish economy was presented by Pamuk who mentioned that before First World War, no country in the Middle East had an income official accounting system like Egypt, Turkey and Gulf states. The Ottoman Empire began its agricultural series in 1897 while in Egypt it started in the 1880s. Pamuk believes the national accounting systems were first used in the period between the two world wars. In particular, Turkey had its income national accounts starting from 1923. The GDP per capita in Turkey declined by more than 50 percent during First World War but it lasted till 1929 till Turkish GDP to reach levels similar to 1913’s levels. The high degree of centralization in Ottoman Empire era meant higher percentage of agricultural output. It indicates that growth rates were slow but positive. In this period, many institutional changes ‘Tanzimat’ occurred in Ottoman Empire. These tanzimat included areas such as: property rights, trade policy and law. These changes resulted in created differences in levels in per capita income for Ottoman Empire areas which were divided into two regions. The regions were divided based on how they are linked to world trade. For example: some parts were linked to world trade through Eastern Mediterranean which had high growth rates and larger amounts of FDI, and other areas were linked through Read Sea and Gulf; Turkey in the interwar period implemented state- led industrialization, import substitution and protectionism. Therefore, it had stable growth rate of 2.9 percent in period between 1950- 1973, and 2.4 percent in period 1973-2000. The growth rate was declining after 1973 due to global slowdown economy (Pamuk, September 2006).

Overview on Egypt (1918-1945)

In 1917, Egyptian population was 12.72 million. The majority was clustered in the Nile Delta with highest density records of 700 people per squared kilometer. At that time, 86.4 percent of males and 97.9 of females were illiterate. Moreover, life expectancy rates were thirty one years for males and thirty six for females. Around two-thirds of GNP and one-third of government revenues came from agriculture. Egyptian agriculture was mainly depending on long staple cotton, rice and clover. Cotton was the main export generating revenue for Egyptian government. Cotton as major crop received much attention from British authorities which attempted to expand dams and canals. However, soil fertility was affected by the extra water and many repairs had to be taken on. Another major feature of Egyptian agricultural sector was the what; large estates starting from 50 feddans. They represented owners of 45 percent of agricultural land. They relied on tenants. Another 30 percent of land was held in form of medium properties between 5-50 acres. On the other hand, areas less than 5 acres were left to small farmers. This reflected the unfair distribution of ownership among 1.4 million farmer owning one fourth of land and other 150,000 holding three fourth of land. At same time, between 30- 40 percent of Egyptians in Middle and Lower Egypt had no ownership.

While for manufacturing sector, only 5.9 percent of labor was employed in it. This labor was employed in small firms related to processing of agricultural raw materials such as cotton and leather, or in firms related to bricks or cement. Other workers worked in tobacco small firms. Machine- rolled tobacco was exported while hand rolled one was locally consumed. However, the modern firms at that time were represented by foreign firms such as French Sugar Company which had total of 17,000 employees in 1916. The weak manufactured products were not for exporting. The Egyptian market was minimally protected through 8 percent duty between 1861 and 1930 due to the international Commercial Convention. During the First World War, manufacturers increased output to fulfill increased local demand by both domestic and foreigner troops.

The government gave minimal priority to education and health care. Moreover, no central bank existed to organize money supply or set interest and exchange rates. The National Bank of Egypt in under supervision of Bank of England was responsible for issuing money. Moreover, English, Italian and Greek consultants and expatriates existed in each ministry (Owen and Pamuk, 1998).

In the period between 1929 and 1950, three initial economic shocks helped divide this period into three sub-periods. Between 1913 and 1928, the deteriorating economic economics as consequences of world first war; the recovery following this period witnessed a 1 percent growth in GDP. Between 1929 and 1939, the effects of Great Depression occurred; the growth rate in GDP was 1.5 percent. The third period was between 1939 and 1950; effects of Second World War but GDP grew at 2.5 percent. The explanation for these percentages is as follows: the declining agricultural output due to deteriorating soil fertility prior to First World War, the weak manufacturing sector, the rapidly growing population and the deteriorating terms of trade. These facts reflected the low standards of living in Egypt. Therefore, it was believed that what Egypt witnessed in this period was ‘‘development without growth’’. This is due to the fact that income could not increase despite of structural changes increasing manufacturing sector’s contributions to GDP.

Governments in Egypt

Egyptian governments were always unable to set autonomous economic policy in terms of tariffs or taxes due to British pressures till Second World War. Although cabinets were always changing, the common belief was the need for a more active state which can revive agricultural sector and expand manufacturing sector. The other main belief was the need to prioritize Egyptians’ needs and interests over those of foreigners’ interests. Therefore, nationalism as a concept led to creation of Bank Misr in 1920 to help provide purely domestic capital for local projects. However, there was no clear vision of actual steps to follow. The fact that wealth land owners had much impact on government’s policies through their close ties with political parties and representation at parliament. Therefore, the support of wealthy land owners was vital for any effort to improve whether agriculture or manufacturing sectors (Owen and Pamuk, 1998).

The government in 1920s began to increase budget allocated for education by making primary public education obligatory, it also began considering drainage issue. Moreover, government was pressured to maintain cotton prices so it was buying part of the crop. In response for pressures from commercial interest groups, the government raised rates and tariffs especially on finished manufactured goods. The textile sector was facing fierce competition from Japanese and European textiles. Therefore, as an attempt to encourage domestic industry, the government imposed higher tariffs in 1933 and 1935. However, when Great Depression occurred, prices of cotton dropped. So the government kept restricting cotton acreage. However, these policies had no effect on price due to the small size of Egyptian share in cotton international market. However, the government kept its investments to improve agriculture; building dams, tax reductions, raising prices of agricultural products which sharpened the poverty problem for poor social classes. Social inequality in Egypt was always a social concern due to the ownership of land which was concentrated in hands of few families which seized political and social power. These land owners were always able to make pressure on governments to support agriculture sector and maintain their interests (Owen and Pamuk, 1998).

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