C. POVERTY IS HIGH COMPARED to EUROPEAN

eotN.269T Turkey Poverty Policy Recommendations Report No. 29619-TU Report No. 29619-TU Turkey Poverty Policy Recommendations

Public Disclosure Authorized Disclosure Public (In Two Volumes) Volume II

August 8, 2005

Human Development Sector Unit Europe and Central Asia Region Public Disclosure Authorized Disclosure Public Public Disclosure Authorized Disclosure Public Volume II

Document of the World Bank Public Disclosure Authorized Disclosure Public

Table of Contents

ACKNOWLEDGEMENT EXECUTIVE SUMMARY OF VOLUME TWO 1. Brief Summary ofVolume One ...... 1 A . Data Comparability...... i B. Recent Economic Developments ...... ii c . Poverty Profile ...... ii 11 . Key Findings ...... iv 111 . Policy Recommendations ...... v A . Macroeconomic ...... v B. Health...... v C . Education ...... v D. Labor ...... vi E. Social Protection ...... vi PART I: VOLUME ONE SUMMARIZED ...... 1 A . Data Comparability ...... 1 B. Recent Economic Developments ...... 2 c . Poverty Profile ...... 3 PART 11: KEY FINDINGS...... 13 A . Turkey is a Medium- to High-Inequality Country ...... 14 B. Extreme Poverty in Turkey is Low...... 14 c . Poverty is High Compared to European Union Countries ...... 14 D. Regional Differences are substantial ...... 15 E. Inequality acts as a “Brake” on Poverty Reduction ...... 15 F. Poverty Projections in 2004 ...... 16 G. Macroeconomic Indicators and Poverty ...... 17 PART 1II:POLICY RECOMMENDATIONS...... 20 A . Macroeconomic Policy Recommendations and Government Reform Program ...... 20 B. Health Policy Recommendations ...... 23 C . Education Policy Recommendations ...... 26 D. Labor Market Policy Recommendations ...... 27 E. Social Protection Policy Recommendations ...... 28 References ...... 32

List of Tables

Table 1. Projected Incidence ofPoverty with Different GrowtWInequality Scenarios ...... 15 Table 2 . Projected Poverty Gap with Different GrowtWInequality Scenarios ...... 16 Table 3 . Turkey: Poverty Projections ...... 17

Box 1. Tax Policy ...... 22

List of Annex Tables

Table 1. Inequality as Measured by the Gini Coefficient; ...... 33 Table 2 . Per Capita GDP and Poverty ...... 34

This volume is a product ofthe staff of the International Bank for Reconstruction and DevelopmenVThe World Bank . The findings. interpretations. and conclusions expressed in this paper do not necessarily reflect the views ofthe Executive Directors ofthe World Bank. or the governments they represent.

The World Bank does not guarantee the accuracy of the data included in this work . The boundaries. colors. denominations. and other information shown on any map in this paper do not imply any judgment on the part ofthe State Institute of Statistics and the World Bank concerning the legal status of any territory or the endorsement or acceptance ofsuch boundaries. ACKNOWLEDGEMENTS

The first volume is ajoint report ofthe World Bank and State Institute of Statistics (DIE). This second volume is a World Bank report. Volume One of the Joint Poverty Assessment Report (JPAR) represents the basic findings in common between the State Institute of Statistics and the World Bank, drawing mostly from the 2002 Household Budget Survey (HBS). Volume Two is of World Bank authorship only, and represents the views of the World Bank in considering Volume One and findings from previous World Bank and Turkish literature. DIE does not endorse or have any responsibility for the policy recommendations herein Volume Two.

Volume Two: Managed by Jeanine Braithwaite (ECSHD) with contributions ofthe World Bank team members from Volume One and the ECSPE team working in Turkey. Edited by Diane Stamm (Consultant). Processed by Carmen Laurente, Jennifer Manghinang, and Gizella Dim (ECSHD).

The team benefited from comments of peer reviewers Jeni Klugman (AFTP2), Peter Lanjouw (DECRG), and Edmundo Murmgarra (ECSHD). EXECUTIVE SUMMARY OF VOLUME TWO

The Turkey Joint Poverty Assessment Report (JPAR) consists of two volumes. The first volume, titled Turkey Joint Poverty Assessment Report, is a joint publication of the State Institute of Statistics (DIE) and the World Bank. The State Institute of Statistics (DIE) of Turkey and the World Bank have issued ajoint report on poverty in Turkey for the first time. The findings of Volume One have been subject to thorough technical review by both institutions, and are considered to be joint findings.

This second volume is entitled “Turkey: Poverty Policy Recommendations,” and is a World Bank report. DIE does not endorse or have any responsibility for the policy recommendations in Volume Two. Additionally, the conclusions in Volume Two that are based on Volume One are attributed only to the World Bank. Volume Two consists of three sections: (i)an Executive summary of Volume One; (ii)key findings of Volume One (World Bank conclusions from the analysis of Volume One); and (iii)World Bank policy recommendations in the sectors considered in Volume One (macroeconomy, education, health, labor and social protection).

I. BRIEF SUMMARY OF VOLUME ONE

Volume One sets out a new poverty line’ methodology for Turkey as the basic measure of poverty in the country. However, several poverty lines are calculated for the purpose of international comparability, and comparability to the World Bank’s poverty measures using the 1987 and 1994 data. In 2002, 27 percent of the Turkish population was poor, based on the new poverty line methodology detailed in Annex One of Volume One (food and non-food consumption). However, very few (nearly zero) consumed under the food line or under the $1 per person per day line used in international comparisons (Table A.I.8 found in Vol. 1).

A. DATACOMPARABILITY

An in-depth analysis of the 2002 Household Budget Survey (HBS) compared to that from 1994 shows that living standards in Turkey remained almost unchanged. Poverty based on the previous methodology declined gradually from 1987 to 2002, from 38.5 percent to 34.5 percent. Poverty based on the updated methodolog9 declined from 28.3 percent to 27 percent between 1994 and 2002. On the other hand, inequality marginally increased. Extreme poverty, already low, further declined from 1994 to 2002. Food poverty declined from 2.9 to 1.4 percent, while $1 per person per day poverty, depending on purchasing power parity (PPP) used, was 2-3 percent or even negligible (0.2 percent).

‘ The poverty line is the minimum amount ofconsumption needed for an individual or household to cover its basic needs for food and non-food goods. This is the updated poverty line for 1994, but the consumption aggregate for 1994 is the old version. For 2002, both the consumption aggregate and the poverty line were the new methodology. Additional details are found in Chapter One (Data Comparisons) and Annex One (Methodology) ofVolume One. B. RECENTECONOMIC DEVELOPMENTS

Despite many advantages ranging fi-om its strategic location to its dynamic population, Turkey has not achieved the stable high growth of leading emerging market economies. On average, the Turkish economy grew slightly under 3 percent per year over the past decade, well below the best performing emerging economies. Macroeconomic instability, rooted in fiscal imbalances, has played an important role in Turkey’s inability to grow as fast as other countries.

In response to the crisis following the collapse of the crawling peg and subsequent devaluation, the Government announced a strengthened economic program in May 200 1. Economic activity rebounded strongly in 2002, and the recovery continued into 2003, with real GNP growth reaching 7.9 percent in 2002 and 5.9 percent in 2003. While the inventory build-up led the recovery in 2002, private consumption and investment was behind the strong growth performance in 2003. Fiscal gains were significant in 2003, as the primary surplus rose from 4 percent ofGNP in 2002 to over 6 percent ofGNP in 2003.

C. POVERTYPROFILE

Poverty in Turkey is strongly associated with age and household composition; children and families with children are poorer than average. Poverty rates are higher for unemployed heads, and female heads, and sharply higher for illiterate heads. There is a sharp difference in the poverty rates between rural and urban households, with rural poverty substantially greater. Poverty restricts the poor from accessing many goods and services. The poor are less able to afford discretionary expenditures. Turkey is a middle-income country, and its inequality is high. Both consumption and income indexes indicate that inequality is higher in urban areas than in rural areas, but not much. Other data confirm overwhelmingly that there is a sharp East-West divide in Turkey where Southeastern and Eastern Anatolia regions are much poorer and have sharply lower human development indicators than Western Turkey.

Education

In the 1997-1998 school year, Turkey shifted from five years of compulsory schooling to eight. Enrollment rates increased soon after this reform, not only for the 8-year basic education cycle but also for secondary education. As a result, poor households receive a larger share of public expenditures on basic and secondary education. The level of public spending on education also increased significantly after 1998, both in real terms and as a percentage of gross domestic product (GDP). While rapid progress in recent years is encouraging, analyses of household survey data reveal that there is significant room for further pro-poor improvements when it comes to: (i)quality of schooling-the parents of poor children are more likely to report problems with schools, and they are less likely to be satisfied with the quality of education their children receive; and (ii)enrollments in secondary education-the poor, females, and children who do not have a secondary school in their residential area are all substantially disadvantaged.

*. 11 Health

Turkey’s health care delivery and financing system is fragmented and despite significant efforts, the service delivery network remains highly uneven, with major concentrations in urban areas. Both Household Consumption and Income Survey (HCIS) and Household Budget Survey (HBS) data suggest that over one-third (36 to 37 percent) of the population in Turkey does not have access to health insurance, and almost half the population in rural areas remains without any coverage. Despite considerable progress achieved in the recent past, Turkey continues to rank far behind most middle-income and European Union (EU) accession countries on key health indicators. Health outcomes vary significantly across regions, reflecting the uneven supply of and access to health care in various parts. Low-income groups suffer from significant access problems. The prime reason for not seeking care when sick, or not seeking hospital admission when required, was lack of affordability. Public expenditure on health care grew at an average annual rate of 7.3 percent between 1999 and 2003. Public sector spending on health care is skewed in favor ofthe upper-income groups, particularly spending on outpatient care. The poor continue to face significant access barriers to health.

Labor

In Turkey, as in most countries, poverty is closely related to employment status and the type of job, whereby informally employed and casual workers have a higher rate ofpoverty. Education plays a key role in explaining employment and poverty outcomes. Unemployment in Turkey was 10.3 percent in 2002. There are very sharp differences in labor market participation rates between men and women, with extremely low rates of female labor market participation in Turkey. Reasons for not seeking a job varied from factors relating to age or family structure (student, housewife, elderly) to disability or seasonal employment. Poverty rates of those who had permanent employment were lower compared to those with casual or temporary jobs. Poverty was found to be sharply associated with the lack of registration at a social security institution. The largest sector of employment in Turkey is agriculture, which is also the sector with the highest poverty rate of those employed in it.

Social Protection

Social protection in Turkey consists primarily of limited formal systems in pensions and social assistance, supplemented greatly by informal mechanisms. Formal elements of social protection are the pension (social security) system, and the Social Assistance and Solidarity Encouragement Fund (SYDTF) and its 93 1 affiliated Social Solidarity Foundations (SYDVs). Institutional, care is provided by Social Services and Child Protection Organization (SHCEK). Turkey’s social security system is highly fragmented. The three pension programs are SSK (Social Insurance Organization), Bag-Kur (BK), and Emekli Sandigi (ES), covering workers, the self-employed, and civil servants respectively. Turkey also provides a small noncontributory benefit to those over age 65 who eam below the level ofthe benefit. The pension system is showing large fiscal losses each year and is in need of transfers from the government to cover those losses expected to be around 4 percent ofGDP in 2004.

*.. 111 The SYDTF is an extra budgetary fund financed by earmarked taxes and administered by a Cabinet Minister. The SYDTF, together with its local affiliates, is the largest program of social assistance in Turkey in terms of number ofbeneficiaries. Additional social protection programs are supported by a World Bank loan: conditional cash transfers and local initiatives. Conditional Cash Transfers (CCTs) are a national program recently introduced in Turkey with World Bank support. CCTs are payments made to the mothers of poor children, provided they attend school or visit health clinics. Supported under the Social Risk Mitigation Project (SRMP), the Government of Turkey has undertaken a significant expansion of the microprojects traditionally carried out by the SYDVs with approval from the SYDTF, along with a tightening of procedures. Additionally, institutional development activities to strengthen the SYDTF, SHCEK, and DIE (especially on poverty monitoring and measurement) have been undertaken in the institutional development component ofthe SRMP.

11. KEY FINDINGS

The following key findings emerged from the 2002 HBS data:

0 Turkey is a medium- to high-inequality country. 0 The rate ofextreme poverty in Turkey is quite low. 0 However, the overall rate of poverty is high when compared to the EU, and this reflects the first fact on inequality. 0 Regional differences are the major driver of country inequality, and poverty is highly concentrated in Eastem and Southeastem Anatolia. 0 High and persistent inequality has constrained Turkey’s ability to benefit from growth years, while macroeconomic instability has hindered Turkey from escaping from its medium- to -high-inequality, relatively high overall, poverty situation.

Inequality. Turkey’s Gini for income for 2002 was 44, which is noticeably lower than the very high Ginis in many extremely low- income countries. However, Turkey does not measure up well against Western Europe which is substantially less unequal.

Extreme poverty. Turkey compares very favorably with low- and medium-income countries in terms of its rate of extreme poverty. Turkey has essentially a zero poverty rate for the PPP US$l per person per day poverty line.

Overall poverty. Turkey’s poverty rate of 27 percent is in the midrange for most medium- income countries but is much higher than those in the European Union countries.

Regional differences. Regional differences are the major driver of inequality in Turkey, and by every source of information, quantitative and qualitative, Eastem and Southeastem Anatolia are markedly poorer than Western Turkey.

Inequality/growth. As demonstrated by the growth-inequality decomposition for 1994 to 2002, inequality has held back improvements in poverty that growth would have led to in the absence of inequality. Projections for this in the future demonstrate that growth without redistribution

iv would not “solve” Turkey’s poverty problem. While sustained growth is essential for poverty reduction, if inequality is not held back, gains from growth can fail to significantly reduce poverty. And if inequality worsens, then gains from growth can be partly or even totally erased. Several scenarios for poverty in 2004 were calculated, depending on inequality not worsening from 2002-2004, and these demonstrate that gains from growth could be considerable in the short run ifhousehold consumption responds quickly or fully to GDP growth.

111. POLICY RECOMMENDATIONS

A. MACROECONOMIC

The JPAR and the previous poverty assessment emphasize that the creation of well-paying formal sector jobs is the main lever for poverty reduction in Turkey, and that macroeconomic instability has severely limited Turkey’s attempts to reduce poverty since 1987. The Turkish Government has undertaken a variety of policy reforms that are intended to promote stable economic growth which are being supported by the World Bank. These reforms will create the conditions necessary for sustained economic growth. Additionally, the Government’s reform program includes measures on strengthening the tax system, including the elimination of loopholes and increased transparency, equity, and progressivity oftaxes. The tax strategy should assist in addressing Turkey’s persistent income inequality, which has been a brake on poverty reduction. The Government has adopted a strategy for tax policy reform that would bring Turkey’s tax regime in line with best practice in the European Union. Implementation of the Government’s tax reform strategy is crucial for many reasons, not the least ofwhich would be to address Turkey’s high level ofincome inequality. Decomposition and simulations demonstrated that by addressing inequality, the poverty reduction effects of growth could be substantial. A transparent and progressive tax regime would enable Turkey to achieve other economic reform goals, such as expenditure targets for the social sectors, which in turn would help address the access issues documented in the health and education chapters ofthe joint volume.

B. HEALTH

Reforms in four areas could substantially help improve lower-income group access to health care, while contributing to an improvement ofthe country’s health outcomes. These include: (a) expansion of health insurance to assure better coverage of low-income households; (b) undertaking steps to assure that disadvantaged areas with poor health outcomes have access to professional health care services; (c) strengthening the quality of primary health care services, particularly in underserved areas; and (d) strengthening quality and outreach of maternal and child health services and essential preventive care. c. EDUCATION

In order to ensure long-term economic growth and equity, there is a need to maintain public education spending levels of at least 4.25 percent of GDP (which is in fact a target stipulated in various Ministry ofNational Education publications). The gross enrollment ratio for compulsory 8-year basic schooling is 97 percent. Enrollment rates could increase even further if children of parents with little or no schooling (the demographic group most likely to be out of school) were

V encouraged to enroll in school. If compulsory schooling were further increased to 12 years, as mentioned in some Government planning documents, the beneficiaries would be almost exclusively from the most vulnerable groups. Nonetheless, the prerequisites to such a move include raising the efficiency in the utilization of existing secondary schools and perhaps, establishing new secondary schools. The quality of education also needs improvement especially for the poor: parents ofpoor children are more likely to report problems with schools, and less likely to be satisfied with the quality ofeducation their children receive.

D. LABOR

Implementing the reforms of the education system and the conditional cash transfers of the Social Risk Mitigation Project (SRMP) should help more educated women to participate in the labor market in the future. Also, the literacy training and micro-project endeavors under the Local Initiatives component of the SRMP should assist in this long-term goal. On the linkage among informal and agricultural employment and poverty, here the best policy recommendation is for Turkey to stay the course on macroeconomic reforms that have already led to significant real economic growth. As the economy grows and develops, more formal and better-paying jobs will emerge from that growth, and these will provide the avenue for Turkey’s 27 percent poor to find better jobs that will enable them to escape poverty.

E. SOCIAL PROTECTION

Recommendations for reform ofpensions include: a rise in the retirement age, both in the short and long run; a rise in the number of years of contribution required before receiving a benefit; a reduction in the benefit accrual rate is also required to bring Turkey in line with other countries; a move to wage indexing the pensionable salary in lieu of the current valorization by nominal GDP growth; maintaining price indexation of pensions as dictated by the 1999 Social Security Law, in order to help contain costs; eliminating and avoiding supplementary payments to pensioners; maintaining or reducing the contribution rate; unification of the pension schemes, both in terms of benefit structure and in terms of administration to improve equity and administrative efficiency; and integration ofsocial pensions with other social assistance benefits.

Recommendations for reform of social assistance include: restructuring the system in one single agency/ministry responsible for determining eligibility and payment ofcash benefits (namely the SYDTF) and decentralizing service provisions to make them more responsive to local demands; financing the system adequately; improving the targeting of social assistance; and expanding CCTs.

vi PART I: VOLUME ONE SUMMARIZED

The basic data used in Volume One are from the official 2002 Household Budget Survey (HBS), conducted by DIE. Comparisons over time are made to the 1987 and 1994 official DIE HBS surveys. Additional qualitative information was gathered from a variety of primary and secondary sources. Limited quantitative data from an unofficial survey of 2001 are used as secondary sources in some ofthe chapters. Administrative data from other Turkish Government agencies are also used.

The 2002 HBS sample was designed to be representative of the population of Turkey, and to provide reliable information needed for an urban-rural breakdown of data. It was not designed to be regionally representative. Thus, only qualitative data and secondary source data are used herein to discuss the regional dimensions of poverty in Turkey. The World Bank and DIE anticipate a further joint report on regional aspects of poverty in Turkey, based on data from the 2003 HBS, which has a larger and regionally representative sample.

This report sets out a new poverty line3 methodology for Turkey as the basic measure ofpoverty in the country. However, several poverty lines are calculated for the purpose of international comparability, and comparability to the World Bank’s poverty measures using the 1987 and 1994 data. The basic findings for Turkey for 2002 were published in a press release by DIE (April 13, 2004), and this report provides the underlying analysis and methodology for these figures.

In 2002, 27 percent of the Turkish population was poor, based on the new poverty line methodology detailed in Annex One (food and non-food consumption). However, very few (nearly zero) consumed under the food line or under the $1 per person per day line used in international comparisons (Table A.I.8 found in Volume One). The analysis in this report refers generally to the new poverty line methodology that results in 27 percent poor. This line is called “complete” poverty line, and is referred to as “Total poverty” in statistical tables. Additional poverty lines and rates can be found in Annex One ofVolume One.

A. DATACOMPARABILITY

An in-depth analysis of the 2002 Household Budget Survey (HBS) compared to that from 1994 shows that living standards in Turkey remained almost unchanged. Poverty based on the previous methodology declined gradually from 1987 to 2002, from 38.5 percent to 34.5 percent. Poverty based on the updated methodology“ declined from 28.3 percent to 27 percent from 1994 to 2002. On the other hand, inequality marginally increased. Extreme poverty, already low, further declined from 1994 to 2002. Food poverty declined from 2.9 to 1.4 percent, while $1 per

The poverty line is the minimum amount of consumption needed for an individual or household to cover its basic needs for food and non-food goods. This is the updated poverty line for 1994, but the consumption aggregate for 1994 is the old version. For 2002, both the consumption aggregate and the poverty line were the new methodology. Additional details are found in Chapter One (Data Comparisons) and Annex One (Methodology) of Volume One.

1 person per day poverty, depending on purchasing power parity (PPP) used, was 2-3 percent or even negligible (0.2 percent).

A poverty-growth decomposition demonstrated that while economic growth was a main driving force in poverty reduction, much of the gains from growth were offset by inequality, which slightly worsened from 1994 to 2002. These conclusions should be treated with caution in that both 1994 and 2002 were either crisis years, or immediately following crises, and so there was no measurement ofthe effect of sustained growth on poverty. DIE is now conducting surveys to measure poverty annually, so the measurement problem should abate in the future.

B. RECENT ECONOMIC DEVELOPMENTS

Despite many advantages ranging from its strategic location to its dynamic population, Turkey has not achieved the high growth of leading emerging market economies. On average, the Turkish economy grew slightly under 3 percent per year over the past decade, well below the best performing emerging economies.

Turkey has suffered from an exceptional degree of macroeconomic instability characterized by high inflation and sharp swings in business cycles. Inflation was higher and growth lower in the 1990s than in the 1980s. In this period, unsustainable fiscal policy has repeatedly put pressure on the Turkish Lira (TL), fueled inflation, and undermined financial stability. Open capital accounts and a poorly regulated banking system have magnified the impact of unsustainable fiscal policy on macroeconomic stability. Short-term capital flows have fluctuated widely as investors responded to the boom-bust cycle driven by unstable conditions.

In 2000, a crawling peg exchange rate regime was launched to rid the economy of inflation. Key structural reforms in social security, infrastructure, agriculture, privatization, and banking were introduced. However, these achievements were insufficient to avoid a crisis, given the extent of Turkey’s underlying fiscal and financial sector weaknesses built up over decades of instability and delayed reform.

By 2001, persistent doubts about the peg, and underlying fiscal instability, led to a full-blown speculative attack against the currency. Interest rates shot up to several thousand percent, forcing the Government to abandon the crawling peg and float the TL. The TL immediately lost 40 percent of its value in a single day.

In response to the crisis, following the collapse ofthe crawling peg and subsequent devaluation, the Government announced a strengthened economic program in May 200 1. The key structural and social elements of the program were: (a) a macroeconomic framework designed to restore financial stability and ensure public debt sustainability; (b) a rapid restructuring of the banking sector; (c) a public sector reform program; (d) renewed privatization; and (e) enhanced social assistance.

The Turkish economy started to grow at a fast pace in 2002. Economic growth reached 5.9 percent in 2003, following 7.9 percent growth in 2002. While the inventory build-up led the recovery in 2002, private consumption and investment was behind the strong growth

2 performance in 2003. The current account deficit widened to almost 3 percent of GNP in 2003, but was easily financed by short-term capital inflows, public sector borrowing abroad and reverse currency substitution. Inflation fell to 18.4 percent in 2003, and the latest data suggest that in mid-2004, inflation declined to the important single digit level for the first time since the 1970s. Aggregate unemployment remained stable at around 10 percent but this was helped by a temporary shrinkage in the labor force. Fiscal gains were significant in 2003, and the primary surplus rose from 4 percent ofgross national product (GNP) in 2002 to over 6 percent ofGNP in 2003, close to the programmed 6.5 percent target. Monetary policy followed a policy ofimplicit inflation targeting, with the Central Bank of Turkey (CBT) occasionally intervening in the foreign exchange market to dampen what was deemed to be excessive fluctuation in the exchange rate. The decline in inflation, which was aided by the strength of the TL, led to a commensurate decline in interest rates from a nominal 60 percent in the first quarter of 2003, to about 25 percent early in 2004.

However, deterioration in the global financial indicators in early May 2004 combined with the higher than expected current account deficit figures have led to a sharp weakening in domestic financial indicators. The excess volatility in the foreign exchange market was curbed to some extent by the Central Bank’s intervention. It appears that some relative stability has been achieved in domestic financial markets. These recent deteriorations have underlined Turkey’s exposure to shocks from the external environment. While depreciation ofthe TL is an adjusting factor to the deteriorating current account balance, it is also likely to affect inflationary expectations and domestic interest rates. Higher domestic interest rates, in turn, together with the impact of the TL’s depreciation, would influence the overall fiscal deficit and economic activity. The spillover from global liquidity tightening and rising spreads are likely to increase the cost ofexternal borrowing. Such developments, if persistent, could disrupt the virtuous cycle that the economy has experienced over the last year and a half.

C. POVERTYPROFILE

Household Size and Composition. Poverty in Turkey is strongly associated with age and household composition; children and families with children are poorer than average. Poverty increases monotonically with additional household members, starting at three members. Larger households are poorer than smaller households, and this is primarily due to the fact that the additional household members are more likely to be children, who have a higher poverty rate. Households with no children or only one child had poverty rates below the average. There is also a correlation between having elderly members and household poverty, though this correlation is not as marked as with having additional children. Having one more elderly member did not appreciably increase the risk of poverty, and having two or more slightly elevated the risk. With respect to correlation with age, younger children are poorer, active-aged adults are not as poor on average, and the elderly are poorer than adults, but not as poor as children.

Household Head Characteristics. The household head has a substantial impact on the poverty status of his or her household, through the employmenthactivity nexus and the amount of income she or he can contribute to the household. The poverty rate for households with

3 unemployed heads is 35.4 percent, compared to 27 percent overall poverty rate. Besides this, other demographic features that are associated with poverty include whether the household head is a female or not (32 percent poor versus 26.6 percent poor for female and male heads respectively), and the education of the household head. Illiterate heads and those who had not completed primary school heads had poverty rates nearly twice the average, while those few with masters or other advanced degrees had a poverty rate ofzero.

Spatial Characteristics. There is a sharp difference in the poverty rates between rural and urban households; the poverty rate is nearly 35 percent for the rural population, but only 22 percent for the urban population. The factors for high rural poverty are the same as for poverty overall.

Rural areas are characterized by limited employment opportunities, and rural households where the head is unemployed face a substantial risk of poverty. Other kinds of inactivity have different implications on rural and urban areas. The major driver for rural and urban employment findings appears to be sector of employment, where rural location is dominated by agriculture, which offers less lucrative options compared to formal employment found in urban areas.

Education has identical effects on both rural and urban areas, whereby those who are illiterate or whose education is limited to primary school have higher poverty rates than average, and graduates of higher education are much less likely to be poor. In both areas, poverty rates steadily decrease as years ofeducation increase.

Non-Income Aspects of Poverty. Poverty restricts the poor from accessing many goods and services. Non-income here refers to material items, assets, or services that are ultimately obtained through income. In Turkey, there is a marked difference in the kind of dwelling. About half the sample population lives in a house, and another 27 percent lives in apartments. While individual houses are primarily in rural areas, apartments are almost exclusively an urban phenomenon. Only 6.5 percent of the apartment dwellers are poor, while 36 percent of those who live in houses are poor.

In terms of landownership, 27 percent of the sample population reported they had a field, but these households were poorer than average. The mean size of the fields for poor households was 75 percent of the non-poor fields. More than one-fifth of the population possessed a car, but only 6 percent ofthese were poor.

The poor are less able to afford discretionary expenditures. The poverty rate of those who smoke, drink, take computer courses, and have access to public transportation to school, for example, is lower for all than the overall poverty rate of27 percent poor. Shopping pattems also vary between poor and non-poor; the latter are more likely to shop at markets or bazaars.

Inequality and Regional Dfferences. Turkey is a middle-income country, and its inequality is high. Both consumption and income indexes indicate that inequality is higher in urban areas than in rural areas, but not much. Other data confirm overwhelmingly that there is a sharp East- West divide in Turkey where Southeastem and Eastern Anatolia regions are much poorer and have sharply lower human development indicators than Western Turkey.

4 Education

In 1923, the year in which the Republic of Turkey was founded, the adult literacy rate was approximately 10 percent. Such a low starting point (not uncommon for that era) gave the Republic a major cause to introduce a series of ambitious reforms that included a move toward secular education and the adaptation of the Latin alphabet. While the schooling environment in Turkey gradually improved over time, the 1997-1998 school year marked another major leap forward, in that, compulsory schooling increased from 5 years to 8 years for children aged 6 to 14. Enrollment rates increased soon after this reform, not only for the 8-year basic education cycle but also for secondary education.

Public Spending on Education

Turkey’s public spending on education increased significantly after 1998, both in real terms and as a percentage of gross domestic product (GDP). Consequently, as of 2000, Turkey’s public spending on education as a percentage of GDP has become comparable to the spending pattems observed in countries of similar levels of economic development. The expansion of compulsory schooling to 8 years had an extremely positive impact on the distribution of public spending on education across rich and poor households. In 2001, 21.7 percent of public spending on basic education reached the poorest 20 percent of households (as opposed to 15.8 percent in 1994). But there is significant room for improvement when it comes to secondary education, since only 13 percent of public spending reached the poorest 20 percent of the population in 2001. Household expenditures on education strongly reinforce the disadvantageous situation of poor children: in 2002, the wealthiest 20 percent of households spent 6.4 times more on education than did the poorest 20 percent of households. The current situation represents a significant improvement compared to 1994, when the wealthiest households spent 28.8 times more on education than did the poorest households.

InefJicient Resource Allocation in the Education Sector

After the expansion of compulsory schooling, the number of primary school students and students enrolled in general secondary schools has significantly increased. The number of students enrolled in vocational secondary schools has remained roughly the same.

Classroom construction at the basic education level has been impressive: students per classroom at this level declined between the 1997-1998 school year and 2002-2003 school year despite increasing enrollments. At the secondary level, however, a curious trend is present in that: (i)the number of vocational school classrooms increased significantly in 2002-2003 even though enrollment in vocational schools did not increase in recent years; and (ii)the number of general secondary classrooms remained stagnant, even though general secondary school enrollment increased visibly in recent years. As a result, as of the 2002-2003 school year, average classroom size was 18 in vocational secondary schools and 45 in general secondary schools.

5 Enrollment in Early Levels of Schooling

According to the 2002 HBS data, 97 percent ofchildren aged 6 to 14 are either enrolled in school or have completed the basic education cycle. Parental schooling is a very good predictor of children’s enrollment level: about 70 percent of the children who are not attending school (but who are ofschool age) have at least one parent who has not completed primary school.

An econometric model of enrollment in secondary schools reveals that males are 7 to 8 percentage points more likely to continue their education beyond compulsory schooling. Secondary school availability in the residential area has a strong predictive power, boosting the probability of enrollment by 10 percentage points-only 64 percent ofhouseholds reported that a secondary school is available in their residential area. Other important correlates of secondary school enrollment are household wealth and presence ofa mother in the household.

Universities and The Poor

In Turkey, entrance to universities is primarily based on a student’s performance in a centrally administered examination. Grades in secondary school (and a specialized field in secondary school) are other factors that influence the overall score. An analysis of the 1997 University Student Survey found that students fiom high-income families are much more likely to be enrolled in private universities and well-established institutions. Thus, (the few) students from poor households who are enrolled in universities do not enroll in universities ofthe same quality as those ofwealthier students.

Some ofthe other findings were that private tutoring plays a key role in determining who attends what type of university. As the main reason for not receiving private tutoring, 57 percent of surveyed undergraduate students mentioned lack ofeconomic resources.

Parental Views About Quality of Education

Analysis of 2001 household survey data reveals that household members are more likely to report problems with public schools (36.7 percent) compared to private schools (25.8 percent). The lack of books and supplies emerges as the leading problem-reported as a problem for 15 percent of children enrolled in public schools and 10 percent of children enrolled in private schools. The next major problem is poor teaching (in both public and private schools), reported in roughly 10 percent of cases. The urbadrural differences are pronounced-only 45 percent of rural responses indicated “no problem with school” as opposed to 68 percent in urban areas.

The wealthier are much less likely to report problems with school. Complaints about lack of books and supplies decline rapidly with increases in household wealth. Complaints about the condition of facilities also decline with wealth. While complaints about poor teaching remain constant across all wealth groups, complaints about lack ofteachers decline with wealth.

6 Schooling Attainment and Selected Labor Market Outcomes

Private returns to schooling are very high in Turkey. The gender gap in earnings is visible, on average, males earn 45 percent more per hour than females with similar characteristics. Schooling has a robust, positive, and large impact on earnings for both genders. If one estimates separate earning regressions for males and females, the impact of schooling on earnings is found to be more pronounced for females. In other words, while females earn less on average, the variation in earnings by schooling attainment is more significant for females when compared with males. These findings, jointly with the finding that only 15 percent of those who report non-zero wages are females, suggest that by under-investing in girls’ schooling and by operating with extremely low female labor force participation rates, Turkey foregoes a vast potential human capital resource that can fuel the economy. Finally, contrary to common perceptions, the unemployment rate among vocational secondary graduates tends to be at about the same level as the unemployment rate among general secondary school graduates.

Health

The Health Care System

Turkey’s health care delivery and financing system is fragmented. Both public and private providers supply health services. The Ministry of Health (MOH), the Social Insurance Organization (SSK), and university hospitals are the main providers. While the public health care sector primarily predominates, private sector provisions are gaining importance in western and urban parts ofthe country.

Despite significant efforts, the service delivery network remains highly uneven, with major concentrations in urban areas, particularly in the western part of the country. This skewed distribution has led to significant regional differences in access to and use of health care and, concomitantly, health outcomes.

Health Insurance

Several public health insurance schemes currently provide financial protection to various target groups. SSK’s health insurance is the most important one, catering to those employed in the formal sector. The green card system, introduced in 1992, is intended to provide coverage to low-income groups who are not covered otherwise. The Government soon plans to shift to universal health insurance, which would operate on the principles of solidarity and risk pooling, and provide coverage to the entire population.

Both Household Consumption and Income Survey (HCIS) and HBS data suggest that over one- third (36 to 37 percent) ofthe population in Turkey does not have access to health insurance, and almost half the population in rural areas remains without any coverage. The green card program fails to provide broad coverage to all those living in poverty. Thus an important share of the lowest-income households remains without access to health insurance coverage even if they may

7 be eligible for it, and makes significant out-of-pocket payments when seeking health care. The lack of insurance coverage leads many low-income households to forego health care, which in tum negatively affects their health outcomes.

Health Outcomes

Despite considerable progress achieved in the recent past, Turkey continues to rank far behind most middle-income and European Union (EU) accession countries on key health indicators. Health outcomes vary significantly across regions, reflecting the uneven supply of and access to health care in various parts.

The Turkish health system faces a dual challenge. Significant parts ofthe population continue to be afflicted with a high burden of disease from preventable infectious diseases, and high matemal and infant mortality rates, typical of developing countries. At the same time, non- communicable diseases prevalent in developed countries affect a growing share of the population.

Access To and Use of Health Care

People with health insurance, including a green card, are more likely to seek health care when ill than those without insurance. The likelihood of seeking care when ill is lower between the bottom two quintiles than among the upper quintiles, with the difference being particularly marked in rural areas. Low-income groups suffer from significant access problems.

Determinants of Care Seeking

The prime reason for not seeking care when sick, or not seeking hospital admission when required, was lack of affordability. One out of five people from the lowest income quintile who sought outpatient care reported that the main problem with the care was that it was too expensive. Lack ofa facility nearby did not appear to be a prime determinant ofnot seeking care when ill.

The share ofthe population that had to pay for outpatient treatment, drugs, and hospitalization is higher among the lowest income quintile than among the upper-income groups. Furthermore, a multivariate analysis of the determinants of health care-seeking behavior confirms that income, insurance coverage, household size, gender of household head, and severity of illness are the most important determinants ofan individual seeking health care.

Health Care Expenditure

Out-ofpocket Payments. Households in Turkey allocate a modest share of their total expenditure to health care in the form of out-of-pocket payments. Income is a major deciding factor on the amount spent. The top quintile spends about twice as high a share of total household expenditure on health care as the lowest quintile. The largest share of out-of-pocket expenditure on health is allocated to the purchase of drugs, with payments for outpatient consultation ranking second across all income levels.

8 Public Expenditure on Health Care

Public expenditure on health care grew at an average annual rate of 7.3 percent between 1999 and 2003. The main public financiers are the Central Government and the social security institutions. According to the recent National Health Accounts study estimates in Turkey, Central Government funding accounts for over one-third of Turkey’s health care expenditure, employer contributions account for less than one-fifth, and households pay over two-fifths through out-of-pocket payments and social security contributions.

Public sector spending on health care is skewed in favor ofthe upper income groups, particularly spending on outpatient care. Budgetary hnds are not well targeted toward assuring equitable access by the entire population. Thus, overall, the relatively important public subsidies to health care are benefiting the middle- and upper-income households, while the poor continue to face significant access barriers to health.

Labor Market in Turkey

In Turkey, as in most countries, poverty is closely related to employment status and the type of job, whether formal or informal. Informally employed and casual workers have a higher rate of poverty. Education plays a key role in explaining employment and poverty outcomes.

Unemployment and Labor Force Participation

Unemployment in Turkey was 10.3 percent in 2002. Labor market outcomes are mostly driven by low levels of labor force participation. Those who do not work drop out of the labor force, and are thus not captured in the unemployment rate figures. The poverty rate of the non- participants in the labor force reflects strongly the situation of children: inactive household members younger than 15 years of age had a poverty rate of 35 percent, but older inactive household members had a poverty rate ofonly 22 percent, under the total poverty rate. There are very sharp differences in labor market participation rates between men and women, with extremely low rates offemale labor market participation in Turkey and even decreases in the rate for females since the 1999 level of 30 percent, down to 27.9 percent in 2002. The male labor force participation rate was 72 percent in 2002, or more than twice that of women’s. Female unemployment rates have typically been slightly lower than the male unemployment rate. This is primarily because so few women are in the labor force

Unemployment and Inactivity

In 2002,35 percent ofthose aged 12 and above reported that they had worked in a paidjob in the month of the survey. The poverty rate of these 35 percent was 25 percent. Another 43 percent ofthose aged 12 and above who reported that they did not work had almost the same poverty rate (24 percent poor) as the employed.

9 In terms ofunemployment, only 7.2 percent ofthose aged 12 and above reported that they were looking for a job. Households with employed heads had a poverty rate of 26 percent compared to 35 percent where the household head was unemployed.

Reasons for not seeking a job varied from factors relating to age or family structure (student, housewife, elderly) to disability or seasonal employment.

Quality of Employment

In Turkey, there exists a strong association between the type of employment and the poverty status of the individual or household. Poverty rates of those who had permanent employment were lower compared to those with casual or temporary jobs. The relative risk of poverty for casual workers was 3.7 times greater than for the permanently employed. Poverty rates for self- employed and unpaid family workers were higher.

Poverty was also found to be sharply associated with a lack of registration at a social security institution. Of the 35 percent who reported being employed, 32 percent were enrolled in social security. The poverty risk for people with formal jobs was the lowest for those employed by the government and in state-owned enterprises.

Poverty is associated with the size of the enterprise. People employed in larger firms were less likely to be poor compared to people from firms with 1 to 9 people. Almost 70 percent of the respondents (aged 12 and over) reported that they worked in a firm of 1 to 9 people, and thus had a higher poverty rate. In Turkey, poverty is associated more with lack ofwork than with work. The mean number ofhours worked by the poor was 43.4 per week, whereas by the non-poor, it was 46.3 hours. Also, the mean duration of employment ofthe poor in the same low-paying job was longer than ofthe non-poor.

Sector of Employment

The largest sector of employment in Turkey is agriculture. Agriculture is also the sector with the highest poverty rate of those employed in it. Of the 35 percent aged 12 and above, 40 percent are engaged in agriculture. The next-highest poverty rate is that of construction. The poverty rate is lowest for mining and quarrying. After agriculture, the only other significant sectors in terms ofemployment are manufacturing, and wholesale and retail trade.

Social Protection in Turkey

10 Turkish Pension System

Turkey’s social security system is highly fragmented. Benefits and contributions depend on one’s occupation. Sosyal Sigortalar Kurumu (SSK) covers the bulk of the labor force, especially private sector employees and those public sector employees who do not qualify as civil servants. Civil servants are covered by Emekli Sandigi (ES), and the self-employed and farmers are covered by Bag-Kur (BK). Also, there are separate occupational schemes that cover various other groups.

Overall, 42 percent (11 million people) of the labor force is contributing to one or the other scheme. On the beneficiary side, only 29 percent (1.2 million people) of the population over age 65 is receiving an old-age pension. However, almost 3 million individuals below the age of 65 are receiving pensions, primarily old age pensions, with many of the recipients considerably younger than 65. As a result, the pension system is showing large fiscal losses each year and is in need of transfers from the government to cover those losses expected to be around 4 percent of GDP in 2004.

SSK is by far the largest system, and covers mostly private sector employees. Employers contribute 11 percent of wages for pension, and employees contribute 9 percent of wages. In 1999, the Social Security Law changed most of the SSK benefit parameters. Pre-reform and post-reform benefits are discussed in detail in the social protection chapter.

Bug-Kur primarily covers the self-employed and some farmers. Contribution rates are 20 percent for pensions and 20 percent for health coverage. To combat the perennial problem of evaluating income earned, Turkey uses the system of minimum earnings steps, which are attributed to individuals regardless ofwhat they actually earn.

Bag-Kur has a very low collection rate for its contribution revenue. Workers pay very little during their working years, and just prior to retirement, they pay Bag-Kur a lump-sum equivalent to the past-due contributions with interest, and then receive their retirement.

Emekli Sandigi covers civil servants, including military personnel. Financing ofEmekli Sandigi is somewhat different from the other plans in that health insurance during working years is not covered by the pension fund. Instead, it is covered directly by the line ministries in which the civil servants are employed.

Another difference between Emekli Sandigi and other schemes is that the basis for contributions and the basis for benefits are different. Contributions are paid on the basis of basic salary. On the other hand, when pension benefits are paid, they are paid on full remuneration. Thus, there is both a financing gap and an equity issue, where lower-grade workers pay contributions on a larger share of their salary than higher-grade workers.

Noncontributory Pension Benefits. Turkey also provides a small noncontributory benefit to those over age 65 who earn below the level ofthe benefit.

11 Social Assistance and Solidarity Encouragement Fund

The Social Assistance and Solidarity Encouragement Fund (SYDTF) is an extra budgetary fund financed by earmarked taxes and administered by a Cabinet Minister. The SYDTF, together with its local affiliates, is the largest program of social assistance in Turkey in terms of number ofbeneficiaries.

Conditional Cash Transfers

Conditional Cash Transfers (CCTs) are a national program recently introduced in Turkey, supported by a loan from the World Bank, the Social Risk Mitigation Project (SRMP). CCTs are payments made to the mothers of poor children, provided they attend school or visit health clinics. CCTs are important tools that are targeted to the poorest of the poor, many of whom are not able to afford the out-of-pocket expenses of sending their children to school. When the CCT program was fully operational across Turkey in late 2004, and 1.6 million children and 7,000 pregnant women benefited from the program.

Local Initiatives

Supported under the SRMP, the Government of Turkey has undertaken a significant expansion of the microprojects traditionally handled by the SYDVs with approval from the SYDTF, along with a tightening of procedures. In 2004, 250,000 people will benefit from income generation, employment, and social service opportunities under the SRMP Local Initiatives component, which seeks to provide these people with sustainable livelihoods, thereby lifting them permanently out ofpoverty.

Institutional Development

Institutional development activities to strengthen the SYDTF, SHCEK, and DIE (especially on poverty monitoring and measurement) have been undertaken in the institutional development component of the SRMP. These activities have been to computerize and set up an internet data base for the management information system (MIS) of the SYDTF and SYDVs, a MIS for SHCEK, and additional computers for DIE. All three institutions also received staff training programs.

12 PART 11: KEY FINDINGS

The following key findings emerged from the 2002 HBS data:

0 Turkey is a medium- to high-inequality country. 0 The rate ofextreme poverty in Turkey is quite low. 0 However, the overall rate of poverty is high when compared to the EU, and this reflects the first fact on inequality. e Regional differences are the major driver of country inequality, and poverty is highly concentrated in Eastern and Southeastem Anatolia. e High and persistent inequality has constrained Turkey’s ability to benefit from growth years, while macroeconomic instability has hindered Turkey from escaping from its medium- to -high-inequality, relatively high overall, poverty situation.

Additionally, it is striking how similar the situation in Turkey in 2002 was to that in 1994, when the previous HBS data were collected, and to the situation documented in the World Bank’s previous Poverty Assessment (World Bank, 2000). Indeed, virtually all of the policy recommendations emerging out of the 2002 data analysis are echoes of previous findings from the previous Poverty Assessment (World Bank, 2000). This reflects the fact that Turkey’s poverty and inequality situation was virtually unchanged from 1994 to 2002.

Key findings from the previous Poverty Assessment (PA) which are confirmed in the JPAR include:

0 Turkey faces a serious challenge in generating employment (labor force participation rates have further declined since the 1997 data presented in the previous poverty assessment, and there is a very low rate of female labor force participation). 0 Productivity growth is key (agriculture continues to be a poor performer). 0 Income inequality in Turkey is high. 0 Distribution of income is fairly stable (the JPAR finds it has worsened, but only slightly). 0 Absolute poverty is low, but economic vulnerability is widespread. e Poverty in Turkey is linked mainly to education and employment status. 0 Government spending needs to be better targeted to the vulnerable.

The only finding from the previous poverty assessment that requires nuance is the finding that meeting the employment challenge requires faster GDP growth. While this is certainly true, the persistence of inequality in Turkey suggests that faster growth will fail to resolve the question of how that growth is distributed, and that inequality acts as a brake on raising living standards generally, even when growth is high, as has been the case for most of the non-crises years since 1994. Several scenarios for poverty in 2004 were calculated, depending on inequality not worsening from 2002-2004, and these demonstrate that gains from growth could be considerable in the short run if household consumption responds quickly or fully to GDP growth.

13 A. TURKEYISA MEDIUM- TO HIGH-INEQUALITY COUNTRY

Turkey’s inequality as measured by the Gini coefficient for income to be comparable to other countries (which are predominately income-based measures) puts Turkey in the middle range of countries, as inequality is so high in Afica and Asia. Milanovic and Yitzhaki (2001) estimated that Gini coefficients for these were 52.1 and 61.5, respectively, while Turkey’s Gini for income for 2002 was 44, which is noticeably lower. However, Turkey does not measure up well against Westem Europe. Including the United States leads Milanovic and Yitzhaki (2001) to estimate the combined Gini at 39.4. The Gini for this geographical grouping would be much lower if the United States and Turkey were not included. Comparing Turkey’s inequality to individual Westem European countries (Annex Table l),it is clear that Turkey has markedly higher inequality than the European Union countries. Furthermore, inequality in Turkey has not decreased since 1987.

Decomposing the change in poverty (in comparable measure) for Turkey between 1994 and 2002 reveals that increased inequality over the time period led to less reduction in poverty than could have been achieved with equal growth.

B. EXTREMEPOVERTYIN TURKEYIS LOW

Turkey compares very favorably with low- and medium-income countries in terms of its rate of extreme poverty, measured either as purchasing power parity (PPP) ofUS$l per person or by the food component of the national line. Turkey has essentially a zero poverty rate for the PPP US$1 per person per day poverty line, and the share ofthe population that is below the food-only component of the national poverty line is 1.36 percent (adult equivalent consumption). These rates are extremely low in international comparisons.

As documented in World Bank (2003), there is a very high degree of interhousehold transfers and “social solidarity” that keeps the extremely poor from starvation poverty, and these transfers (often of food but also of housing and clothing) have resulted in a very low rate of extreme poverty in Turkey. c. POVERTY IS HIGHCOMPARED TO EUROPEANUNION COUNTRIES

Turkey’s poverty rate of27 percent is in the midrange for most medium-income countries (Table 2), but this reflects the significant dispersion of poverty rates in those countries. Turkey’s poverty rate is much lower than the poverty rates in many Latin American countries, but significantly higher than the poverty rate in China, which dominates the medium-income class by reason of population size. In particular, Turkey’s poverty rate is much higher than that in European Union countries, and in many ofthe accession candidate countries.

14 D. REGIONALDIFFERENCES ARE SUBSTANTIAL

Regional differences are the major driver of inequality in Turkey, and by every source of information, quantitative and qualitative, Eastem and Southeastern Anatolia are markedly poorer than Western Turkey. In this, Turkey is not unique-many countries grapple with the problem of underdeveloped regions, including Appalachia in the United States, and Southern Italy. There has been tremendous and rapid rural-to-urban migration in Turkey in recent years, and the share of the rural population has fallen from 49 percent in 1990 to 40 percent in 2000, with much of the rural to urban migration occumng from Eastern and Southeastem Anatolia. However, family size remains very large in those regions, so that migration has not “solved” the problem of persistent poverty.

E. INEQUALITYACTS AS A ‘LBRAKE”ON POVERTYREDUCTION

As demonstrated by the growth-inequality decomposition for 1994 to 2002, inequality has held back improvements in poverty that growth would have led to in the absence of inequality. Projections for this in the future demonstrate that growth without redistribution would not “solve” Turkey’s poverty problem (Table 1). While sustained growth is essential for poverty reduction, if inequality is not held back, gains from growth can fail to significantly reduce poverty. And if inequality worsens, then gains from growth can be partly or even totally erased.

Table 1. Projected Incidence of Poverty with Different GrowtMnequality Scenarios

Poverty Rate in 5 Years Poverty Rate in IO Years With Growth and Inequality With Growth and Inequality

4 Inequality (Annual change) 1 J Inequality (Annual change) 1

ISource: Turkey 2002 HBS data. 1

To see these results, it is easiest to first orient on the columns and rows labeled “O%,” meaning no change, in the first half of Table 3 (5 years). If there is no growth in consumption and no change in inequality in five years, then poverty remains unchanged at 27 percent. However, reading along the row labeled 0 percent, even if there is no growth at all, if inequality declined 1

15 percent per year, poverty would fall from 27 to 24.7 percent. This is almost equal to the effect that keeping inequality equal but experiencing a growth improvement of 1 percent per year would have on poverty-24.1 percent.

Still looking at the 5-year results, notice the bottom right entry. If inequality increases at the same 3 percent rate as growth, then poverty will be almost unchanged, declining only slightly to 26 percent. This illustrates that even the beneficial effects of growth can be almost completely offset by inequality. Additionally, it is clear that if inequality can be decreased even slightly, as long as there is growth, there will be significant strides in poverty reduction. For example, a 1 percent growth in consumption coupled with a 1 percent decline in inequality would reduce poverty substantially, from 27 percent to 22.1 percent.

The impact of inequality on the poverty gap (the distance between average consumption and the poverty line) is even greater than on the poverty headcount (Table 2). Here, even when growth is positive, as long as inequality increases, then the gap is greater.

Table 2. Projected Poverty Gap with Different GrowtMnequality Scenarios

Poverty.- Gap in 5 Years Poverty Gap in 10 Years With Growth and Inequality With Growth and Inequality

Source: Turkey 2002 HBS data.

F. POVERTYPROJECTIONS IN 2004

Inequality, while high in Turkey, has been quite stable since 1994, increasing very slightly from 1994 to 2002. Thus, assuming that inequality will not change from 2002 to 2004 is a reasonable assumption, and allows the projection ofpoverty rates from 2002 to 2004. This is simply using a shorter time period, but the same assumption as the center column in the upper left hand quadrant of Table 1 (0 percent change in equality). The more pressing question for the projection is not what to assume about inequality, since an assumption of no change is

16 empirically validated for Turkey, but rather what would the growth rate of household consumption be, given the actual GDP growth from 2002 to 2004 to date.

Here, GDP growth rates are a good guide, but are indicatory only, since typically household consumption increases with growth, but with a lag as it takes time for the positive effects of growth to come to households, particularly those at the lower end of the distribution. Accordingly, five different scenarios about growth and poverty reduction in 2004 are presented in Table 3. All the scenarios depend on inequality not worsening, and demonstrate that gains from growth could be considerable in the short run if household consumption responds quickly or fully to GDP growth.

Table 3. Turkey: Poverty Projections

Percent Poverty Change of Rate Reduction Poverty rate in 2002 (annual, percent ofpopulation) 27.0 Poverty rate in 2004 Scenarios Conservative: Household consumption (HH cons) grows only 3 percent in two years 25.3 6.3 Medium: HH cons grows at 3 and 2.5 percent respectively in two years 23.9 11.5 High: HH cons grows at same rates as GDP, 5.9 and 5.0 respectively 21.3 21.1 Higher: HH cons grows at 5.9 in 2003 and 6.0 in 2004 respectively 20.9 22.6 Lagged model: If growth in HH cons follows one-year lagged GDP growth-- HH cons grows at 7.9 in 2003 and 5.9 in 2004. 20.2 25.2

G. MACROECONOMICINDICATORS AND POKERTY

The Turkish Government has undertaken a variety ofpolicy reforms that are intended to promote stable economic growth which are being supported by the World Bank in the Programmatic Financial and Public Sector Adjustment Loan I11 (PFPSAL 111). These reforms will create the conditions necessary for sustained economic growth. However, achieving high growth rates is not a sufficient condition for reducing p~verty.~Understanding the relationship between poverty and macroeconomic indicators and the transmission mechanisms involved is key in designing effective poverty reduction policies.

Growth-Unemployment-Poverty Relationship

Under certain conditions, high growth rates can be influential in reducing poverty rates. Understanding growth dynamics plays a vital role in assessing the poverty reducing impact of any growth process. While the Turkish economy recorded high growth rates in 2002 and 2003, the unemployment rate increased from 8.4 percent in 2001 to 10.3 percent in 2002 and hrther to 10.5 percent in 2003, mainly due to lack of adequate job creation. Firms had generally low

Neither is it a necessary condition, since an improvement in the income inequality-a redistribution of income toward the poor-will result in a reduction ofpoverty even in the absence ofeconomic growth (see Table 3).

17 capacity utilization ratios in Turkey and during the recession in 2001, the annual capacity utilization ratio fell to 70.9 percent, which was the lowest ratio in the last 15 years. In 2002 and 2003, firms used their idle capacity. The capacity utilization ratio increased to 75.4 percent in 2002 and to 78.4 percent in 2003. More recently, in the first quarter of 2004, the capacity utilization ratio reached a historical high of 78.5 percent. Given this high level and the strong demand in the economy, there is a clear need for firms to expand their capacities, which is likely to entail creation ofnew jobs.

Although production increases that end up in increased gross fixed capital formation or increased inventories both imply positive growth rates, given that firms are likely to use their existing capacity in increasing their inventories, job creation is possible only through new investments. The strength of the link between new investments and job creation depends crucially on the nature of technology employed in the new production process. In an attempt to minimize the labor cost, firms might prefer more capital-intensive technologies, in which case, labor productivity will increase and job creation will not follow the increases in production. Consequently, without new job opportunities, unemployment will continue, especially if there is also a structural component of unemployment. Empirically, in Turkey, unemployment of the household head is particularly associated with poverty.

In 2001, during the recession, Turkey’s GNP contracted by 9.5 percent. The major factor behind the contraction was the plunge in private fixed investments by 35 percent. However, in the recovery year 2002, the main source of growth was the increase in inventory levels. Real GNP in Turkey grew by 7.9 percent in 2002 and 92 percent of the growth was due to an increase in inventory levels. This is the main factor behind the lack of a commensurate increase in employment; while production increased, the firms stocked up inventories rather than increasing sales in an environment of sluggish private consumption. With limited job opportunities, the poor and the vulnerable did not have any opportunity to move out ofpoverty. In 2003, while an increase in inventories continued to be a key contributor to growth, gross fixed capital formation recovered by 10 percent and private consumption by 6.6 percent, promising a more positive impact on the availability ofnew jobs compared to 2002.

Another factor that is important in understanding the unemployment-poverty relationship is the large informal sector in Turkey, given that the informally employed or casual workers have a noticeably higher rate of poverty. After the 2001 crisis, many employees lost their jobs and some of those unemployed shifted to the informal sector with lower wages. In addition, some firms prefer to employ workers informally in order to avoid paying high social security premiums. Increasing unemployment ratios and slightly decreasing poverty rates, despite the high growth rates observed in 2002 and 2003, may be explained partially by the existence of a large informal sector.

A pre-condition for growth to have a poverty-reducing impact is equal distribution of the gains from high growth rates among the different income groups in society. If only income ofthe non- poor people increases with positive growth, income inequality will increase. In Turkey, on average, a 3 percent growth rate was sustained between the years 1994 and 2002, but the poverty-growth decomposition demonstrated that real growth between 1994 and 2002 was significantly offset by a slight increase in inequality, so that there was only a slight reduction in

18 poverty. During this period, non-poor people benefited from the advantages of the positive growth more than the poor people. Additionally, projections demonstrated that future growth could be similarly offset by inequality.

In summary, growth, although being a very important tool, is neither sufficient nor a necessary condition for poverty reduction. Policymakers must examine the reasons behind growth. In addition, growth could be offset, partly or completely, by inequality. Thus, a major policy concern would be for Turkey to address the persistence of inequality while at the same time pursuing policies for high and sustainable growth. Turkey’s continued commitment to structural reforms is not only key for maintaining the hard won macroeconomic stability but also to create an environment conducive for new domestic and foreign investments.

Inflation-Poverty Relationship

High inflation acts a direct source of poverty by increasing income inequality in society, Poor people generally have fixed incomes and under an inflationary environment, their real incomes are eroded through the mechanism of inflation tax. However, for the non-poor, there is a hedging option. High inflation rates increase uncertainty in an economy and returns from investment tools tend to be higher than inflation reflecting the implied risk premium. People using these hedging options can compensate the effects of the inflation tax and earn over and above the inflation rate through these high returns. On the contrary, poor people do not have savings to invest in these hedging options and they bear the burden of the inflation tax.

In Turkey, between 1994 and 2002, there was high inflation and, on average, positive growth. In this period, the Gini coefficient increased by 1 percent, which indicates an increase in income inequality. Poor segments of the population were faced with the inflation tax, whereas non-poor people benefited from the effects of inflation by investing heavily in government bonds with extremely high interest rates. This worsening in income equality counteracted any positive impact due from positive growth during this period. However, in 2003 and early 2004, inflation and interest rates declined sharply due to the Central Bank’s successful disinflation program and the government’s strong fiscal stabilization policies supported by structural reform. Reduced inflation rates are likely to have had a decreasing effect on poverty rates in this period.

In an environment of low inflation rates, the effects of the inflation tax can be minimized. Due to low inflation and reduced uncertainty, extra gains from investment tools, like government bonds with high profit margins, can be decreased. Thus, distortions in income distribution and the negative impact on poverty can be mitigated. To promote poverty reduction, the disinflation program should continue to be implemented, while fiscal prudence is maintained. Continued commitment to the structural reform agenda is a key factor that will strengthen macroeconomic stability and enhance gains from the disinflation process.

19 PART 111: POLICY RECOMMENDATIONS

A. MACROECONOMIC POLICYRECOMMENDATIONS AND GOVERNMENTREFORM PROGRAM

The main objective of PFPSAL I11 is to support implementation during 2004 of the Government’s financial and public sector reform priorities while ensuring that social programs are adequately hnded and increasingly better targeted. Key reform priorities in the financial sector include: (a) strengthening the regulatory framework for banking; (b) building institutional capacity at the Banking Regulation and Supervision Agency (BRSA) and the Savings Deposit Insurance Fund (SDIF); (c) restructuring and privatizing state banks; and (d) improving the corporate insolvency regime. Key reform priorities in the public sector include: (a) deepening of structural fiscal policies in support of sustainable fiscal adjustment; (b) implementing public expenditure management (PEM) reforms covering budget planning and execution, financial accountability, and public liability management; and (c) strengthening public sector governance including implementation of the national anticorruption strategy and preparation of the civil service reform strategy. Priorities for social spending include: (a) adequate expenditure for health, education, and social protection in the 2004 budget; and (b) better targeting of social protection.

Medium-term projections suggest that sustained implementation ofeconomic reform is necessary for Turkey to attain macroeconomic stability and growth. Under these projections, the economy is expected to grow by about 5 percent during 2005-2006. Specific factors underlying stability and sustained growth include: (a) greater confidence in the policy framework; (b) improved macroeconomic stability and declining real interest rates-which would stimulate private investment and consumption demand; (c) stronger export performance-which would permit faster import and output growth; and (d) higher extemal inflows, including greater foreign direct investment. Under this scenario, fiscal adjustment would yield a permanent reduction in the public sector borrowing requirement from about 10 percent of GNP in 2003 to 5 percent of GNP in 2006. This would underpin the projected stabilization of the net public debt stock-to-GNP ratio below 60 percent of GNP by 2006. The programmed fiscal adjustment would also support the projected decline in inflation to single digits by 2005.

On the creation of macroeconomic stability and growth, the Government’s program emphasizes the critical role of structural reforms. Policy continuity is essential to maintain the stability achieved after the 2001 crisis, and to preserve the growth and macroeconomic perfonnance of the last three years. The first reform priority is to accelerate banking reform to consolidate the renewed trust in the sector and to preclude the possibility of a systemic crisis. The program

20 emphasis has now moved from crisis management to broad-based financial sector development. The second priority area is the comprehensive reform of the public sector to address the underlying structural causes of Turkey’s macroeconomic instability, ensure medium-term fiscal sustainability, and increase the transparency and efficiency of public expenditure management. The third priority area is continuation of vital reforms in the agriculture, energy, and telecommunications sectors to improve the climate for private investment in an effort to raise productivity, growth, and incomes. Many of the latter reforms also have a structural fiscal dimension.

Turkey needs comprehensive financial and public sector reforms to definitively break with its history of inadequate transparency, public deficits, inflation, and financial instability. A quick retrospective highlights the structural weaknesses in both the public and financial sectors that contributed to macroeconomic instability and created the preconditions for the 200 1 crisis.

Chronic public sector deficits led to the build-up of debt and the rapid expansion of the banking sector, which greatly outpaced the capacity of the regulatory framework. Macroeconomic distortions arising from fiscal imbalance created incentives for the banks to take on excessive risk, which was not curtailed by adequate regulation and enforcement. The absence of ample, accurate, and timely fiscal information-particularly the reliance on off-budget funds and quasi- fiscal obligations, including the so-called “duty losses” of the state banks-reinforced political and institutional obstacles to structural change and sustainable fiscal adjustment.

Unhealthy interactions between inadequate fiscal and financial transparency compounded the risks to the economy, and helped ensure the build-up of a major systemic crisis following earlier cycles of crisis and aborted stabilization efforts throughout the 1990s. After undertaking urgent financial restructuring to address the impact on the banks of the November 2000 and February 2001 crises, the authorities are making progress in correcting the underlying weaknesses in the financial sector. In parallel, institutional and policy reforms are being deepened to address systemic problems in the public sector, together with further structural measures to gradually underpin the fiscal adjustment. These reforms complement ongoing actions to improve the climate for private investment and promote growth. Rebuilding investor confidence and sustaining economic growth depend critically on the Government’s ability to maintain the momentum of reforms to address the structural roots ofTurkey’s chronic financial instability.

Strong fiscal performance has been the cornerstone of the economic program in the last few years. Fiscal gains were significant in 2003, and the primary surplus rose from 4 percent of GNP in 2002 to over 6 percent of GNP in 2003, close to the programmed 6.5 percent target. Although the 2004 budget passed in December 2003 was consistent with the 6.5 percent primary surplus target, a sizable gap quickly emerged. The Government announced an above-inflation increase in minimum wages, and it also cut contribution rates for social security to reduce the additional costs to employers. In addition, the Government increased pensions by 21 percent, well above the inflation target. These initiatives, together with revenue shortfalls relative to the budget, created a financing gap of close to 1.7 percent of GNP. The Government introduced a fiscal package in March 2004 to close the fiscal gap. The Government is implementing additional measures to meet the primary surplus target of 6.5 percent of GNP for the consolidated public

21 sector-af which 5 percent of GNP is for the Central Government-set in the revised budget for 2004.

The 2004 fiscal package has two main components: original budget measures and supplementary budget measures. To meet the 2004 primary surplus target, the authorities undertook a set of measures in December 2003 within the context of the original 2004 budget. The special communication and transaction taxes became permanent, and the surcharge on income taxes, was extended for one more year. Motor vehicle taxes were adjusted upward to compensate the reimbursement of 2003 payments for an additional car tax (ruled unconstitutional). In addition, savings also came from cuts in investment programs, lower value-added tax (VAT) rebates for pensioners, and by eliminating vacancies when public sector workers leave their positions. The special appropriation6 has been eliminated. The second set of measures was introduced with the supplementary budget in March. The supplementary budget law cuts discretionary spending by 13 percent across all ministries. The Government also introduced measures to increase tax revenues by adjusting excises of petroleum products, alcohol, and tobacco.

The Government has adopted a strategy for tax policy reform that would bring Turkey’s tax regime in line with best practice in the European Union (Box 1).

Box 1. Tax Policy

Simplify and consolidate the indirect tax structure with a VAT with a standard rate and two low rates (1 percent for agriculture and 8 percent for other basic consumption goods). Introduce a unified special consumption tax (SCT) that will consolidate the current range ofexcise and specific taxes into a single tax charged on a limited range of luxury goods. A threshold will be established for obligatory filing of VAT returns. Earmarking of revenues will be abolished and all revenues from earmarked taxes will be brought into the budget. Simplify and consolidate the direct tax regime in line with OECD standards and international best practice. Convert tax rebate for wage earners into a tax credit to simplify administration and reduce tax burden on low- income wage earners. Minimize tax exemptions and exceptions. Harmonize real effective tax rates across all types of financial instruments and maturities. Phase in the full indexation of the corporate and business income taxes (real interest deduction to replace nominal interest deduction). Reduce the scope of investment incentives, consolidate into a single investment allowance rate across sectors and geographic regions, and gradually eliminate withholding tax on these allowances. Make the incentive system more transparent and automatic. Overhaul the tax regime for Free Trade Zones. Terminate the corporate tax and payroll tax exemptions, Provide reduced corporate tax rate only on condition that separate subsidiaries are established and inward trading is below 15 percent of sales. Adjust taxation offinancial leasing in line with internationally generally accepted accounting practices.

Implementation of the tax strategy is progressing reasonably well. On the tax policy side, a unified special consumption tax (SCT) to consolidate a range of excise and specific taxes into a single tax charged on a limited range ofluxury goods was enacted in June 2002. Implementing circulars for the SCT law were published in July 2002 and the tax went into effect in August 2002. Earmarking ofSCT revenues was eliminated, with retroactive effect for the 2003 budget, through a government decree issued in January 2003. Ln April 2003, Parliament enacted the first legislative package under the direct tax reform designed to simplify and consolidate the direct tax regime in line with OECD standards and international best practice. This legislation: (a)

Special appropriation is a mechanism of converting earmarked revenues into appropriation during the year.

22 harmonizes tax rates on income from financial investments at the declaration stage; (b) simplifies and harmonizes the system of investment incentives; (c) reforms the system of income tax credits; and (d) simplifies taxation of corporate earnings and dividends. Key provisions of the legislation became effective immediately, and the remaining articles became effective in January 2004. Subsequently, a second package of direct tax reform legislation was enacted in January 2004 to minimize geographic, sectoral, and other investment incentives-including rationalizing the benefits in Free Trade Zones. The Government is strongly committed to addressing the problem of taxation of unrecorded income, and will prepare secondary legislation to require that all large financial transactions take place through the banking system.

Implementation of the Government’s tax reform strategy is crucial for many reasons, not the least of which would be to address Turkey’s high level of income inequality. Decomposition and simulations demonstrated that by addressing inequality, the poverty reduction effects of growth could be substantial. A transparent and progressive tax regime would enable Turkey to achieve other economic reform goals, such as expenditure targets for the social sectors, which in turn would help address the access issues documented in the health and education chapters of the joint volume.

Turkey’s continued commitment to structural reforms is not only key for maintaining the hard- won macroeconomic stability but also to create an environment conducive for new domestic and foreign investments. To promote poverty reduction, the disinflation program should continue to be implemented, while fiscal prudence is maintained. Continued commitment to the structural reform agenda is a key factor that will strengthen macroeconomic stability and enhance gains from the disinflation process.

B. HEALTHPOLICY RECOMMENDATIONS

Turkey’s current health care system is characterized by marked inequalities in access to and use of health services. These are driven by skewed distribution ofhealth care service provisions and medical personnel in favor of the urban areas, particularly in the western parts of the country; public spending on health care, which is skewed toward the upper-income groups; and a health insurance system that leaves an estimated one-third of the population without coverage. Those without insurance coverage are predominantly in the lower-income groups. The need to cover health care expenditures with out-of-pocket payments by all those who do not benefit from insurance coverage in turn leads a significant share of the population to forego health care, even when they are critically ill. Lower-income groups are significantly more likely to forego health care than upper-income groups. Coupled with marked inefficiencies in service provision, the system of unequal access and use has resulted in health outcomes that are not commensurate with Turkey’s income level.

Reforms in four areas could substantially help improve lower-income group access to health care, while contributing to an improvement of the country’s health outcomes. These include: (a) expansion of health insurance to assure better coverage of low-income households; (b) undertaking steps to assure that disadvantaged areas with poor health outcomes have access to professional health care services; (c) strengthening the quality of primary health care services,

23 particularly in underserved areas; and (d) strengthening quality and outreach of maternal and child health services and essential preventive care.

Improve Health Insurance Coverage of Low-income Groups. Almost 60 percent of those living below the poverty line are not covered by health insurance, while HCIS data show that insurance coverage is an important determinant of health-care-seeking behaviors. Therefore, expansion of health insurance to accord better financial protection to low-income groups would be a key step toward improving use ofhealth care by the poor. Introduction of universal health insurance is a core component of the Government’s recently launched health sector reform program. The reform program will consolidate the four existing insurance schemes and expand coverage to those who have no financial coverage. The new universal insurance scheme is to be based on the principle of solidarity and risk pooling, with the State making premium contributions on behalf of those unable to do so. A key implementation challenge will be to assure that government contributions will indeed be targeted to those most in need, while minimizing errors of exclusion. In this context, options oflinking qualification for government- paid health insurance contributions to targeting mechanisms used for other social assistance benefits should be explored. To the extent that the planned universal health insurance fund will have various semiautonomous regional branches, funding equalization to ensure branches in lower-income regions with poor health indicators are adequately resourced should be based on regional demographic, health, and income profiles.

Reduce Regional Disparities in Service Delivery. Supply-side issues are an important contributor to low health care use in rural areas in general, and in Southeastem and Eastern Anatolia, in particular. Posting and keeping physicians and other medical staff in isolated areas where many ofthe poor live has been a long-standing problem. While recently introduced salary supplements for postings in those areas may help somewhat alleviate the problem, it is unlikely that these measures alone will suffice to assure an adequate supply ofmedical personnel in high- poverty areas. In addition to further incentive mechanisms (such as postings in places of choice after postings in shortage areas, and admission to high-demand specialization programs), consideration should also be given to establishment of mobile health teams that visit isolated areas on a regular basis from their base in district capitals.

Improve Quality of Primary Care. The perceived low quality of primary care leads the vast majority of patients to self-refer to specialized, mostly hospital-based, care. This can lead to substantially higher direct and indirect costs for care seekers, and thus increased access barriers, particularly in rural areas. Circumvention ofprimary care is also more likely to result in the lack of continuity of care, which in turn leads to reduced effectiveness and use of care. Therefore, efforts to improve the quality of and the population’s confidence in primary care, by ensuring that a greater range of health needs can be effectively accommodated at the primary care level, could help reduce access barriers to health care. In this respect, planned efforts to introduce a family-medicine-based primary care system can be expected to have a positive impact on lower- income group access to and use of care. In remote areas, efforts to deepen the technical capacity of health care personnel to allow for a broader range of and more effective service provision at the primary care level would need to be complemented by measures that assure local availability of basic diagnostic services and essential drugs.

24 Strengthen Maternal and Child Health and Preventive Care. The continued high levels of maternal and infant mortality in many areas ofTurkey calls for concerted efforts to improve the quality and use of maternal and child health services. The fact that at least one-fifth of all births in the East and Southeast continue to be unattended by any trained medical personnel (Table 2) and that up to one-third of women do not receive any prenatal care,’ point to serious shortcomings in the Turkish medical system in this area, with both supply and demand factors at play. Similarly, the continued marked regional variation in vaccination coverage points to serious shortcomings of basic preventive services, with large externalities. While recent data to ascertain the correlation between poor health outcomes and household income are not yet available,* earlier DHS data point to an expectedly strong correlation between health outcomes and household welfare (World Bank, 2003). Therefore, overall efforts to strengthen the quality and accessibility of primary care should integrate targeted efforts to improve access to and use of maternal and child health services and basic preventive care to reduce marked regional and intrahousehold variations in health outcomes.

The Government’s recent Urgent Action Program and its sectoral spin-off, the Program for Transformation in Health, released in 2003 and supported by the recently approved World Bank Health Transformation Project, target far-reaching sectoral reforms aimed at improving sectoral efficiency and increasing equity in access to health services. This is to be achieved through the separation of financing from service provision, introduction of financial and managerial autonomy ofpublic health care providers, more effective delivery of primary health care through the introduction of family medicine and, with particular importance to lower-income groups, and introduction of universal health insurance. The Program is expected to be fwlly implemented by about 201 1, and will require major structural changes in the sector. Aside from the drafting of legislation to support these fundamental structural reforms, initial steps to eliminate access to health facilities based on insurance affiliation have already been taken.’ Similarly, important initial steps have been taken to encourage medical personnel to accept postings in underserved areas.

While challenging on many accounts, the much-needed reform program, if implemented as envisioned, will indeed provide a technically sound avenue to substantially improve equity in access to health care. This in tum can be expected to effectively improve use of health services by lower-income groups, which currently forego care. Together with planned efforts to improve the quality of care (introduction of family medicine, emphasis on improved matemal and child health services) they have the potential to help bring Turkey’s health outcomes more in line with those of other OECD and European Union accession countries. As reform implementation progresses, it will be important to monitor its impact on access to care, particularly among the low-income groups and in the more disadvantaged regions.

’ Figures on lack of prenatal care date back to the 1998 DHS, and may have improved somewhat since then. Data from the 2003 DHS, expected to become available during the second half of 2004, will shed more light on accessibility and use of prenatal care, delivery, and child health care, including regional variations and variations across income groups. DHS 2003 data are expected to be available during the second half of2004. Since early 2004, the distinction between SSK and MOH hospitals and health centers has been removed and patients are free to visit their facility ofchoice.

25 C. EDUCATION POLICYRECOMMENDATIONS

Spending on Education

The 1997-1 998 education reform has been extremely effective in increasing the schooling attainment of children coming from poor households. In 1994, wealthier households benefited more from public subsidies to basic education. Following the 1997 education reform, the distribution of public spending on education at the basic education level became roughly flat across household income quintiles. The distribution ofpublic funds across schooling levels now favors basic education, which is another positive trend since the poor are more likely to benefit from these funds, and social returns to schooling are higher for early levels. At the secondary school level, too, there has been some improvement in the distribution of public funds, but there is much room for further pro-poor shifts (which would occur if poor children’s secondary school enrollment increases, as was the case with primary school enrollment).

Only after increases in education spending associated with the financing of the 1997 education reform did Turkey’s public spending on education as a percentage of GDP become comparable to the spending patterns observed in countries of similar levels of economic development. In order to ensure long-term economic growth and equity, there is a need to maintain public education spending levels of at least 4.25 percent of GDP (which is in fact a target stipulated in various Ministry ofNational Education publications).

Enrollment in Basic Education

The gross enrollment ratio for compulsory 8-year basic schooling is 97 percent. Parental schooling is identified as a very good predictor of enrollment. Enrollment rates for the basic education cycle could increase even hrther if children of parents with no schooling (the demographic group most likely to be out of school) were encouraged to enroll in school. Turkey’s Conditional Cash Transfer program already provides financial subsidies to extremely poor families enabling these parents to keep their children enrolled in school. While this poverty assessment does not include a formal assessment of the effectiveness of this program, in principle, such targeted incentive schemes have been shown to be essential in ensuring the participation ofchildren from the poorest families to attend school.

Enrollment in Secondary Education

This report demonstrated the importance of the availability of secondary schools to increase enrollment. But it also demonstrated that general secondary schools operate with significantly higher students-per-teacher ratios than vocation schools. Thus, a first priority should be ensuring optimal usage of the physical infrastructure of existing secondary schools. This alone may still not be sufficient, however, and thus there may be a need to proceed with building new secondary schools.

The children who were found to be less likely to enroll in secondary school have similar characteristics to those in other countries: the poor, females, those with uneducated or absent

26 parents, those who reside in rural areas, and those who do not have a secondary school in their residential area. The magnitude of the impact of each of these characteristics on enrollment is striking, as demonstrated by the analysis ofhousehold survey data. The important point is that if compulsory schooling is further increased to 12 years, as mentioned in some Government planning documents, the beneficiaries would be almost exclusively the vulnerable groups listed above. Nonetheless, the prerequisites to such a move include raising efficiency in the utilization of existing secondary schools and perhaps establishing new secondary schools.

Parental Views on the Quality of Schooling

The parents of poor children are more likely to report problems with schools, and less likely to be satisfied with the quality of education their children receive. In 2001, the most commonly expressed problem with education was the lack ofbooks and supplies (29 percent ofthe poorest quintile of households expressed this problem). Since then, the Govemment has acted on this issue by providing textbooks free of charge to all primary school students. As a result, it could be that a major problem has already been resolved. Now attention needs to shift to other main complaints from poor parents that emerge from the survey: namely the condition of school facilities, poor teaching, and even a lack ofteachers (especially in rural areas).

Tertiary Education

The most effective way to ensure better representation of poor children in tertiary education is through investments in their schooling at earlier levels ofeducation. Interventions that come into play later in the education cycle are likely to be less effective. In fact, if high quality (free) primary and secondary schooling were made available to poor children, then perhaps the main intervention needed at the postsecondary education level would be to ensure poor students’ access to credit and scholarships.

Nonetheless, raising the quality of primary and secondary education will not lead to significant increases in the enrollment of the poor in tertiary education, in the short to medium term. Therefore, other interventions should be considered. Assuming that the centrally-run university entrance examination system (which has a number of positive features) is not changed, the Government may wish to design interventions to raise the performance of qualified poor children in these examinations. As discussed in the main chapter, wealthier children are much more likely to receive private courses (often through “dersane ” attendance) specifically designed to improve scores on university entrance examination. In this context, policy makers may consider providing govemment subsidies to poor children to enroll in dersane-type university entrance examination preparation courses.

D. LABORMARKET POLICYRECOMMENDATIONS

The analysis of the labor market demonstrated two key findings: the extraordinarily low rate of female labor force participation in Turkey and the strong link between informal and agricultural employment and poverty. It is difficult for policy makers to do much about the low rate of female labor force participation in the short run, but certainly implementing the reforms of the

27 education system and the conditional cash transfers of the Social Risk Mitigation Project (SRMP) should help in the future for more educated women to participate in the labor market. Also, the literacy training and micro-project endeavors under the Local Initiatives component of the SRMP should assist in this long-term goal.

On the linkage among informal and agricultural employment and poverty, here the best policy recommendation is for Turkey to stay the course on macroeconomic reforms, which have already led to significant real economic growth. As the economy grows and develops, more formal and better-paying jobs will emerge from that growth, and these will provide the avenue for Turkey’s 27 percent poor to find better jobs that will enable them to escape poverty.

E. SOCIALPROTECTION POLICY RECOMMENDATIONS

Recommendations for Reform of Pensions

The immediate issue in the Turkish pension system is the high and completely unsustainable level of deficits requiring financing from the Treasury. The current high deficits and their rapid rise after an initial period of decline following the 1999 reforms highlight the need for deeper parametric changes than had been enacted in 1999. Potential parametric changes include:

0 A rise in the retirement age, both in the short and long run. Currently, women may retire as young as 41 and men as young as 43, but even in the long run, the retirement ages are expected to stabilize at 60 for men and 58 for women. The current retirement ages are the youngest anywhere in the world and even the long run ages will look young relative to life expectancy when they have been finally reached. The system should aim for a life expectancy of 15 years after retirement, with legislated increases in retirement age to match increases in life expectancy and move to this point as quickly as is legally feasible.

0 A rise in the number of years of contribution required before receiving a benefit. Currently, SSK requires only 19.4 years of contribution to receive a full pension with a reduced pension available with only 12.5 years, while the other systems all require 25 years for men and 20 years for women. Internationally, full pensions are usually available after 25 and 40 years of service, although usually the generosity ofthe pension available at 25 years is significantly less than what is available in Turkey. Reduced pensions for those unfortunate enough to have fewer numbers of working years need to be available, but these need to be provided on a prorated basis, unlike the current system which gives the bulk of the pension for the first years of contribution, reducing the incentive for further contribution.

0 A reduction in the benefit accrual rate is also required to bring Turkey in line with other countries. Currently SSK pays 3.5 percent of wages in pension for the first 10 years of contribution and then 2 percent per year for the next 15 years, while Emekli Sandigi pays 3 percent per year. The international averages are between 1 and 1.5 percent per year and even these are not fully affordable in all countries.

28 e A move to wage indexing the pensionable salary in lieu of the current valorization by nominal GDP growth would also be preferable. As Turkey moves, based on the 1999 Social Security Law, toward using career average salary as the basis for the pension, how the early wages are revalorized in creating this average becomes a critical factor in determining the value of the pension and the cost of pension payments. The 1999 law had specified GDP growth, which is historically higher than wage growth as the indexing factor. As a result, individuals who had earned the average salary throughout their career would have a pensionable salary higher than their working wage. This bonus needs to be eliminated by using wage indexation or some close approximation.

e Maintainingprice indexation ofpensions as dictated by the 1999 law is also important to containing costs. Prior to the 1999 law, Turkey had a tradition of ad hoc increases in pensions. The Government disregarded the 1999 law in 2004 and announced arbitrary increases in pensions once again, which were above the level ofinflation and raised costs not just for this year, but also for all future years.

e Eliminating and avoiding supplementary payments to pensioners. Prior to 1996, the Turkish Government had provided supplementary payments to pensioners, which became higher than the earned pensions breaking all links between contributions and benefits. These were frozen in nominal terms in 1996, but resurfaced under a new name in 2003, social support payments. Politically, there seems to be a tradition that instead of reacting to low pensions by contributing for more years or by correctly declaring earnings, pensioners use the political process to exact higher pensions, thereby undermining the pension systems and incentives to contribute.

a Maintaining or reducing the contribution rate. Despite the fiscal issues, raising the contribution rate in Turkey is not an option. As the fiscal situation improves, lowering labor taxes will serve to improve the efficiency ofthe labor market.

Besides the parametric changes discussed above, the Turkish pension system is also plagued by being fragmented into four separate benefit schemes administered by three different agencies. Two of these four schemes retain the older, pre-1999, more generous benefit structure, resulting in large transfers from the state in particular to the civil servant scheme. There is an issue of fairness as to why the state as a whole should favor one group over another as well as the administrative complications involved with workers who contribute to more than one scheme during their working careers and of ensuring that workers are indeed complying with the law and submitting contributions to one ofthe four schemes. Thus, another recommendation is:

a Unification of the pension schemes, both in terms of benefit structure and in terms of administration to improve equity and administrative efficiency.

Finally, there is still a large uncovered group of the elderly in Turkey. While the social pensions administered by ES do provide some safety net for the many elderly without an income, it would be beneficial to integrate this special program for the elderly with the other social assistance efforts in the country to try and reduce administrative costs and increase equity by using the same means testing methodology used by other social assistance programs. However, the social

29 pension administrator needs to also be aware of minimum and average levels of contributory pensions to avoid providing such a generous noncontributory benefit that people choose to not contribute to mandatory schemes.

e Integration of social pensions with other social assistance benefits.

The system for evaluating whether a person is eligible for a social pension is separate from the systems, which determine eligibility for other types of cash benefits. There is no inherent reason that all social assistance benefits not be evaluated together and provided to families as a package, particularly given that the elderly poor may reside within larger poor households.

Recommendations for Reform of Social Assistance

Despite recent improvements, Turkey still has a fragmented, under-funded and inadequate social assistance and social services system. Social assistance, in terms ofcash and in-kind payments to the poor is managed mainly by the Social Assistance and Solidarity Encouragement Fund (SYDTF) and its 931 affiliated Social Solidarity Foundations (SYDVs). However, a variety of other programs are managed by institutions as diverse as ES (non-contributory pension for those over 65 as discussed above), the Ministries of Defense (for the families of conscripts), National Education, General Directorate of Youth and Sports, Prime Ministerial Office for the Disabled, municipalities and the State Social Services and Child Protection Organization (SHCEK, as well as a plethora of minor programs under other agencies). Moreover, the SYDTF itself suffered from the lack of a hlly concretized structure that was not rectified until the passage of Law 5263 on December 9,2004.

Expenditures through the SYDTF, which until 2002 were fully funded through an extra- budgetary fund (EBF) receiving specified percentages of a diverse array of government revenue flows, have fluctuated between 0.19 and 0.32 percent of GNP. This is very low by comparator standards-in many OECD countries, child benefits alone account for over 0.70 percent of GNP, with total social assistance rising sometimes to 2 percent of GNP. Only in recent years have expenditures stabilized closer to 0.30 percent of GNP, with the encouragement of the World Bank and through the allocation of budgetary transfers (in 2004 reaching TL 200 million). By any standards, this is barely adequate. Under the medium to long term, with health expenditures ofthe SYDTF transferred to universal health insurance (UHI), but the old-age social assistance pension transferred to the SYDTF, expenditures should be maintained at least at 0.60 percent} of GNP in order to have any meaningful impact on reducing poverty and establishing a robust social safety-net. In the short to medium term, expenditures should rise to and be maintained at 0.35 percent of GNP pending the necessary restructuring ofexpenditures.

The Government, with the support of the World Bank under the SRMP, has already begun the process of strengthening social assistance programs. This includes a substantial improvement of targeting through the use of a proxy means test, the introduction of new poverty-focused programs to break the inter-generational cycle ofpoverty such as the Conditional Cash Transfers (CCT)-targeted to the poorest on condition that children are kept in school and that pregnant mothers and pre-school children attend well-care medical services, improved programs to lift the poor permanently out of poverty (thereby not becoming long-term social assistance recipients)

30 through Local Initiatives providing support for income generation opportunities, improved robust and regular poverty monitoring and evaluation (M&E) through the State Institute of Statistics, and greater attention to M&E ofsocial assistance programs overall.

Despite these improvements, the overall system could still be much improved. Social services per se are weak and under-developed. SHCEK, whilst providing good services at the provincial level in some provinces, has a spotty record, and fails to exercise an effective strategic policy- making and quality control role at the central level. Service provision is not well coordinated with other service providers (e.g., municipalities) and is frequently supply rather than demand- driven. The draft Public Administration Framework Law moreover appropriately transfers responsibility for service provision to the local level, designating the policy formulation, norms derivation, quality control and M&E functions to a reconstructed central level. Strengthening and reforming the social assistance and services system thus necessarily has the following elements, all ofwhich must be encompassed in framework legislation.

Restructuring the system. This should provide for: (i)policy formulation, norms establishment, quality control and M&E for all population groups (children, youth, working poor, gender- related, elderly, disabled) at the central level in one single agency/ministry which would reduce the number of central agencies; (ii)a single agency for determination of eligibility and payment of cash benefits, namely the SYDTF-streamlining the system and enhancing efficiency, itself strengthened by a formalized legal structure; and (iii)decentralizing service provision to make it more responsive to local demands.

Financing the system through a Government commitment to at least a minimum level of expenditure of 0.35 percent of GNP. The quality ofTurkish fiscal adjustment leaves much to be desired as key expenditures in the social area and public investment have been cut in order to finance recurrent expenditures.

Targeting. The targeting of social assistance can be significantly improved by using the same proxy means-test targeting used for the conditional cash transfers, but with a different cutoff point, depending on the desired number ofbeneficiaries. Improved targeting of social assistance is a reform being supported under the PFPSAL 111. This proxy means-test targeting system could also be used for fee waivers for health insurance.

Expanding CCTs. Targeting of social expenditures can definitely be improved as recommended above, and the fiscal savings from this would be well directed toward expanding CCTs, as well as any savings from future adjustments of the public expenditure program or gains from sustained economic growth. The number of beneficiaries of CCTs was kept to 1.6 million children (and recently expanded to 7,000 pregnant women), or less than 2 percent of the population. However, it is clear that there are many vulnerable, who, while not extremely poor, are still quite poor and who would benefit from keeping their human capital from eroding by an expanded CCT program. Additionally, Turkey could consider external financing for an expanded CCT program. For example, USAID has recently agreed to co-finance the existing CCT program, and a bilateral development bank finances many CCT programs in Latin America.

31 REFERENCES

Milanovic, Branko, and Sholomo Yitzhaki. 2001. “Decomposing World Income Distribution: Does the World Have a Middle Class?” Policy Research Working Paper No. 2562. Washington, D.C.: World Bank.

Ministry of National Education. 2001. “The Turkish Education and Developments in Education. ” Ankara, Turkey.

World Bank. 2000. “Turkey: Economic Reforms, Living Standards, and Social Welfare Study. ” Report No. 20029-TU. Washington, D.C., January 27.

. 2003. “Turkey: Poverty and Coping After Crises. Report No. 24185-TR. Washington, D.C., July 28.

32 ANNEX

Table 1. Inequality as Measured by the Gini Coefficient; All Countries Included in the Sample (Ranked by $PPP Income Level)

I Pooulation Gini I ZncomdExpenditures Estonia 0.383 Lithuania 0.369 I Guyana 0.490

Malaysia 0.463

Ireland 0.284~ Austria 0.472 Israel 0.347 Chile 0.564

Italy 0.306 Belgium 0.246 Taiwan 0.293 Australia 0.345 U. K. 0.354 Sweden 0.249 Netherlands 0.311 South Korea 0.3 10 Finland 0.226 Cyprus 0.297 Germany 0.294 France 0.326

0.246

Between-Country Gini 0.498 Within-Country Gini 0.161 World Gini 0.659 Source: Milanovic and Yitzhaki (2001)

33 Table 2. Per Capita GDP and Poverty

Below National

34 Below National

34 35 n.a.

36 United Kingdom 26,150 17 n.a. United States 35,750 12 n.a.

-- -- n.a. = Not available. Sources: GDP and National Poverty are taken from Global Development Finance; and World Development Indicators; and World Bank Central database (2004). USSl PPP per person per day is taken from the World Bank website: http://www.worldbank.org/research/povmonitor/.

37 38