ABSTRACT
Introduction Investment decisions occupy a central role among the determinants of growth. As empirical studies such as Levine and Renelt (1992) have revealed, fixed investment as a share of gross domestic product is the most robust explanatory variable of a country’s growth. DeLong and Summers (1991) also provide evidence emphasizing the correlation of investment in equipment and machinery with growth. New growth theories have been developed that assign a growthsustaining role to investment. Barro (1990) considers a simple endogenous growth model with infrastructure investment. Rebelo (1991) shows that differences in growth rates across countries may be explained by differences in government policy in an endogenous growth model. In Rebelo’s model, changes in certain policy variables such as an increase in the income tax rate decrease the rate of return to investment activities in the private sector and lead to a permanent decline in the rate of capital accumulation and in the rate of growth. Easterly and Rebelo (1993) study the implications of models that link fiscal policy to growth, and find a positive impact of infrastructure investment on growth. Investment is also the most variable component of GDP, and therefore an understanding of its determinants may shed light on the source of cyclical fluctuations. Policy-makers are typically concerned about the ultimate impact of alternative policy measures on investment. In this chapter, we will examine the record of investment and growth for the Turkish economy over the period 1950-2007 in the light of both the neoclassical growth framework and also new growth theories that assign a growth-sustaining role to investment. Until recently, Turkey’s growth performance has been examined in terms of alternative economic policy regimes such as state-led growth, import-substituting
industrialization, and economic liberalization including trade and financial liberalization.1 More recently, attention has turned toward understanding the fundamental determinants underlying this performance.2 This analysis has revealed that total factor productivity (TFP) growth has been typically low in Turkey, and that Turkey’s growth has been driven primarily by capital accumulation. Yet a detailed study understanding the factors determining investment performance in Turkey is not readily available. This is an important deficiency because most if not all of the policy proposals regarding the future of the Turkish economy – be they proposals regarding macroeconomic stability or those aimed at ensuring greater competitiveness – have to do with improving the investment environment in Turkey. Various factors affect investment including macroeconomic instability, corruption, the existence of the informal economy, regulatory and tax policy, to name just a few. In an early paper, Mauro (1995) examines the relationship between corruption and growth for a cross-section of countries (including Turkey). He takes into account the endogeneity of various corruption indicators, and finds that corruption and lack of bureaucratic efficiency lower investment, thereby also lowering growth. Farrell (2004) argues that the existence of a large informal sector tends to create an uneven playing field for firms, thereby deterring investment. Tax policy can also affect the level and composition of investment expenditures. New studies for the US show that tax changes have a much stronger impact on real GDP than previously found, and they trace the source of this effect to the strong (negative) impact of the tax change on investment. (Romer and Romer 2007). The investment tax credit (ITC) has been a popular fiscal tool to influence the level of investment for reasons of macro-stabilization or to stimulate specific sectors. In Turkey, incentives of various forms have been implemented to spur exports, to promote a more equal distribution of investment, and to aid regional development. As we describe below, the record of such incentive schemes is decidedly mixed. Furthermore, high tax and regulatory burdens on the formal economy co-exist side-by-side with a large informal economy, creating a negative incentive structure and impeding efforts at creating a more efficient tax and regulatory system. In this chapter, we will study the record of Turkey’s past investment performance over the period 1950-2007. We will also study the sectoral decomposition of investment. We will examine in depth the factors that are thought to be important for determining investment behavior in Turkey. Given the central role that investment plays in growth, the results of our study will have implications for Turkey’s future economic performance, for its ability to converge to per capita income levels of developed countries, and for the viability of its current bid for European Union membership.
