Monday, March 23, 2009

Weekly Hurriyet Column: What makes a good economist?

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. BTW, the Higher Education study I mentioned in the column can be downloaded here. The World Bank commissioned other studies on higher education, and they have a relatively short report incorporating all the studies.

We had another full economics agenda last week, with a couple of events worthy of a separate column, but each will get just one paragraph, as I have to recount my newly-found optimism in the Turkish economy.

Surprisingly, the Central Bank did not surprise this time around, delivering the expected 1 percent cut. I am not worried about a real interest rate of 4 percent driving foreigners away from lira assets. It will not, as we are way past that mysterious threshold; and in fact, we have been seeing steady portfolio outflows since August, which have picked up in the last two months. Note that as a corollary, the relative stability of the lira following the rate decision can not be taken to mean that Turkey’s risk perception has decreased, especially as the lira has been supported by locals’ foreign currency selling. But I am worried about shocks from a stronger-than-expected exchange rate pass-through the rapidly deteriorating budget.

The February budget figures illustrated that higher expenditures, along with lower tax revenues on the back of a slowing economy, are working their way fast. Even without new economic packages, the primary surplus, whether you take the IMF-defined central government or consolidated public sector version, is on a fast downward trajectory and is likely to hit negative territory before summer. The deterioration in the budget, in turn, could put pressure on not only the debt stock, taking the rollover ratio to over 100% even with an IMF program, but also on the Fund itself, who might not be lenient on such major a fiscal expansion.

So, how come I am convinced that the Turkish economy is on the road to salvation? While the new crisis package, which looked promising (but has not gone beyond the consumption boosters, as we still do not know how the government will start credit flowing) certainly lifted my spirits, now that I know there is a first-rate economist at the wheel, I am relieved. How do I know? To recount the story of John and Celine, who are lost flying in a balloon and go down to ask a passer-by where they are: “You are in a balloon”, he answers. Celine comments: “His answer is perfectly right and utterly useless. He must be an economist”.

Economy Minister Simsek’s explanation that unemployment was rising because more people were looking for work is worthy of a true economist. While this added worker effect has been well-documented and was prevalent, albeit to a somewhat lesser degree, during the 2001 crisis, correcting for seasonal effects reveals that non-farm employment has contracted 100-130 thousand in the second half of 2008. Moreover, it would not be a surprise to see a contraction three times this amount this year. And even if the economy starts growing again next year at slightly below its potential, the pick-up in employment is likely to be extremely slow, as firms are likely to respond to the recovery with overtime rather than new employees at first.

Equally remarkable was the minister’s observation that much of unemployment was structural in that it reflected lack of vocations, providing the best summary of the World Bank Labor Market & Higher Education studies of a couple of years ago (email me for those reports), akin to Woody Allen’s sum-up of War and Peace as “taking place in Russia” and yet another indicator that we have a first-rate economist at the helm. Unfortunately, the minister’s solution of more education, albeit noble, is unlikely to do all those unemployed this year any good.

Similarly, the onus is on the prime minister to provide incentives rather than threats to employers to keep the workers employed. And to make sure the ones who are not are supported.

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