International competitiveness

IN 2004-2005 when the Lira had begun to appreciate – not only on an inflation-adjusted basis but even in nominal terms – exporters were busy complaining about the exchange rate. They made it clear that they couldn’t compete with an over-appreciated currency in international markets. There was talk about China. Wasn’t it true that the Chinese Renminbi was an invaluable currency and cheap Chinese products had invaded global markets? In Turkey, whether over-appreciation was in the eye of the beholder or not was a hot topic for debate back then. Today the Lira is undervalued by any historical metric. This is so even though the depreciation of the least few months doesn’t even match the inflation differential between the U.S. and Turkey. However, at around 16.5 – it was 8.30 on September 1, 2021 – the steep Lira (nominal) depreciation against the USD doesn’t suffice to trigger Turkey’s exports. In fact the trade deficit continues to widen. So, maybe it isn’t the exchange rate that matters.

WHAT ABOUT TRADE ELASTICITY?

The trade-weighted real effective exchange rate stood at 126.5 in October 2010. That was the peak. The Lira was overvalued in real terms. Today it stands at 60.6, i.e. patently undervalued. Undervaluation is a trend that lasted almost an entire decade. The Lira has been weakening since 2013. Did any of this help in promoting exports? It didn’t help at all as a casual inspection would reveal. Why is that so? First, exports fluctuate according as domestic demand falters or soars, and export markets are favourable or not. Also their value added depends on unit costs and innovation. In the old, ‘Old School’ New Keynesian arguments, dating back to 1980s, and which I was still using some 20-odd years ago, the real exchange rate was a significant argument in export regressions. Mostly the elasticity of imports was about .60 and that of exports .35, but still the real exchange rate was “significant” – whatever that means.

Yes, back in 2005, when the TL was obviously over-valued, exporters could complain about it and criticize the exchange rate policy. Now all of this talk may have lost its meaning. Not only did the import content of exports increase significantly – so exporters are also importers in a sense – but international pricing rules may also have changed. Also, the deviation from trend is a good statistic. The Lira has not only been undervalued but also volatile relative to other EM countries. Could that kind of high real exchange rate volatility help boost exports? Of course it couldn’t.

WHAT ABOUT OTHER EXPLANATIONS?

That the exchange rate elasticity of exports is almost half of import elasticity has been documented in the past. Yet, the reasons were not explained based on a global matrix. There are new models. The DCP (dominant currency paradigm) is one, and an encompassing one at that. Gita Gopinath and others have been busy documenting the validity of that paradigm. Accordingly, even if we continue to embrace the old school PCP (producer currency pricing), currency depreciations would fail to promote exports. They fail because exports are produced out of imports. Now with the new DCP, there are other reasons as well. First, invoicing is in dollars, and terms of trade becomes independent from bilateral currency pairs in trade. The dollar index sets them all. Second, there are complementarities in exports. We knew LCP (local currency pricing) worked and even if the Lira depreciated, export destinations would cut the dollar export price anyway. Even this is not enough qua explanation. The dominant currency (USD) determines trade flows, terms of trade, and inflationary pass-through. Fully independent monetary policy is but an illusion. In Turkey, there is no way TL depreciation helps exports beyond a very limited scope. The Lira decoupled from EM currencies so fast that this could not have worked. There is no way such a massive deviation from the weighted average could work as an export-promoting device. Because corporates are so indebted in FX, and because the world trade does not function that way, it can’t. Expecting an export boom predicated upon a weak currency is an urban legend.

MISSED OPPORTUNITIES

Developing countries shouldn’t miss opportunities. A wide variety of opportunities are sometimes available: favourable demographic windows, productivity spill-overs, ample cross-border investment waves and suchlike. However, they may not last long. After the 2001 IMF programme, which for better or worse changed the Turkish economy’s structure, there were many opportunities. First, there was a global savings glut and money poured in until 2008. Indeed, in the first three quarters of 2008 Turkish banks continued to lend at breakneck speed as if nothing had happened. Then, the Lehman shock set in and lasted 13 months. Thanks to

correct regulatory measures and to a successful monetary policy, Turkish banks emerged out of the recession with 15% above trend equity growth and high profitability –and 50% nominal earnings increase in 2009. They could thus finance the capital and intermediate goods import wave and the domestic demand-driven 9.8% average GDP growth for two consecutive years. Things looked good for a while after the global crisis of 2008-09. Second, even though cross-border investments fell drastically after Lehman, the two-speed recovery worked. EMs attracted a higher share of global inflows. Hence, even the all-time high 9% current account deficit-to-GDP ratio of 2011 could be financed. However, at around 2011 things have begun to change. The private sector FX debt increased rapidly. The whole movement of the shortterm private sector debt closely followed that of syndications, securitizations, subloans and all that. Banks were able to fund all FX debt for a while but that couldn’t last forever. After the “taper tantrum”, that occurred between 2013 and 2021, the Lira continually depreciated above inflation. In the end, the real effective exchange rate fell so drastically that it could finally add some impetus to exports. Nevertheless, in the end that too has ended because exports’ exchange rate elasticity isn’t as high as some bureaucrats may think.

I see an enormous amount of missed opportunities. In fact maybe a whole decade has been lost. After years of investment in property development and construction, which accounted for almost all of fixed capital contributions to GDP at some point, this is where we are.

POLITICAL SURVIVAL

“The Logic of Political Survival” is the title of an interesting book by four distinguished authors, among them Bruce Bruno de Mesquita of NYU and the Hoover Institution. The logic of political survival requires many things, some going against the inner beliefs of most leaders. However, this kind of logic can provide useful insights whenever privately held core beliefs would lead many leaders astray. Instead, they should let themselves be conquered by canons of time-honoured international power politics. Then, and only then, they can stand firmer on political soil. What we have witnessed last week in Madrid is conform to power politics, and it is understandable because it is an instance of rational behaviour. On the other hand, not all conflicts can be readily resolved through a rational prism. I expect more of this in the coming months because an acceptance of international power balances is a key to political success domestically. After all, even economics can become a vehicle for gathering more power, and when political survival is all that matters the long-run can easily be sacrificed. The problem here is that the long-run never comes. Politics is always in a rush, and short-run considerations always block long-run structural reforms. It is high time to accept that interest rates, exchange rates, inflation and all that can’t pass in lieu of productivity gains and technological innovations. Even if you cut the policy rate to zero, nothing will be obtained in terms of growth, but a high price will be paid in terms of inflation and market distortion. In the same vein, currency depreciation won’t help a thing in the long-run.