What a difference ten years makes. In 2001, Greece adopted the euro as its national currency. Its borrowing costs, which plummeted in expectation of this momentous event, were almost as low as Germany's. Its growth rate for the year climbed to 4.1 percent and inflation hovered around 4 percent-a sharp decline from the double digits of the '80s and '90s. It was a country on the way up. On the other hand, Turkey, its neighbor and geopolitical arch-rival, was mired in a major financial crisis. Its currency was collapsing, its banking system was broken and unemployment was skyrocketing.
These days, it is the Greeks who are in an economic freefall, while Turkey is one of the fastest-growing economies in the world: In 2011, Turkish GDP jumped by 8.5 percent, almost besting its 9 percent expansion in 2010. In a country with a young workforce (the average age is 28), a large rural underclass, and poor infrastructure aching to be upgraded, the prospects for more banner years look good. Furthermore, as the Turkish Harvard economist Dani Rodrik argues in a recently published paper, the policies put in place after the 2001 crash-inflation-targeting by an independent central bank, fiscal restraint by successive governments, sound banking regulation-have short-circuited many of the potential domestic sources of instability.
In Istanbul last month, in a meeting of the World Economic Forum-from whose stage in Davos he had stormed off in a huff in 2009-Turkey's combative prime minister Recep Tayyip Erdogan had a lot to brag about. In a speech to reporters quoted by the Financial Times, he said: "The experience we have had is an important example, not just for countries in the region, but for countries in Europe affected by the crisis." Writing last year in Newsweek, in the seventh year of stalled negotiations on his country's bid to join the European Union (EU), Erdogan boasted that "Turkey is bursting with the vigor that the EU so badly needs."
For the moment, Turkey indeed seems to stand out as a bright spot amid Europe's economic turmoil. But managing its relationship to the EU will be crucial both in safeguarding its economic achievements and in maintaining its progress towards a more fully democratic polity.
As Rodrik observes in his paper, the crisis of 2008-9 showed that even a soundly managed, open economy like Turkey's can be rocked by outside storms. This is particularly true because it is so dependent on hot money from abroad-capital flows like stock and bond purchases-that can lead to an overabundance of liquidity when times are good, but can also lead to a meltdown if investors see trouble ahead. Foreign direct investment, on the other hand-in factories and offices, the kind that is much less flight-prone-remains low. As the Economist put it a couple of months ago: "Net foreign direct investment (FDI) typically accounts for only a small share of capital flows and precious little FDI is new factories or offices." With a current account deficit hovering around 10 percent of GDP, Turkey's vulnerability to external shocks is the darkest cloud in its economic horizon.
The likeliest source of such an external shock is-what else?-the eurozone. European banks own a significant number of Turkish banks. The EU is also, by a huge margin, the largest buyer of Turkish exports; European countries accounted for 46 percent of total exports by Turkey in 2010. Foreign direct investment is almost exclusively European in origin.
The signs of a European drag on the Turkish economy are already apparent. First quarter growth in 2012 was 3.2 percent. The government expects a rate of 4 percent for the year as a whole, but the International Monetary Fund forecasts a rate of 2.3 percent, and most private-sector economists are also considerably more pessimistic than their official counterparts. Export growth has slowed significantly, as exports to the EU have fallen sharply, to 36 percent of the total on May figures.
For all its growing confidence, then, Turkey looks west with increasing trepidation. A Greek exit from the eurozone, and the flight from risk that it would precipitate, would badly damage the Turkish economy. Growth in Turkey is heavily dependent on domestic consumption, which in turn is dependent on external financing.
The other, more serious concern about Turkey's future, which could have major economic consequences, is its politics. Erdogan, who has led the country since 2003, has achieved a great deal beyond economics in his tenure. Above all, he has gained the upper hand over the armed forces and their allies. In the past, the military tended to get rid of elected politicians they felt did not abide by the principles of modern Turkey, as laid down by its founder Kemal Atatürk and interpreted by them. Today they are under civilian control, and many of their leaders are under arrest for plotting to bring down the democratically elected government of Erdogan's moderately Islamist AKP (Justice & Development) party.
Alas, the generals' fall has not been an unalloyed triumph for democracy and the rule of law. Dominating the political scene, Erdogan has displayed increasingly authoritarian tendencies. He has shown a particular penchant for jailing Kurds, journalists, and student activists, often for minor offenses, and has been accused of using high profile cases of anti-government plots to target political opponents.
Active negotiations for EU membership would place constraints on such developments, given the need for the Turkish government to live up to European standards of press freedom, individual rights, and due process. But the process is essentially frozen because of stalemate on Cyprus and because conservative European politicians are opposed to the entry of a still-poor, populous Muslim nation in the European family.
"Authoritarianism hurts Turkish economic progress both directly, and in more subtle ways," professor Rodrik explains. "The centralization of power in Erdogan's hands means that there are few people around him who can warn him about potential economic risks. More fundamentally, the government's authoritarian style prevents broad-based agreement on the kind of reforms that the economy needs, and leaves the economy hostage to partisan, populist policies financed by short-term capital inflows."
Erdogan is working towards amending the Turkish constitution to bolster the power of the presidency. It is widely expected that he will seek the office himself in 2014. The longer he towers over Turkish politics, the less likely it is that his legacy will be a government of laws, not men; and the more likely it is that his departure will be followed by political instability and the river of hot money going cold.
