ISSN 1608-7143 OECD Journal on Budgeting Volume 7 – No. 2 © OECD 2007 Budgeting in Turkey by Dirk-Jan Kraan, Daniel Bergvall and Ian Hawkesworth* The Turkish budget process has three features which set it apart from other OECD countries: a centralised yet fragmented decision-making process; the IMF standby agreement as a de facto fiscal rule; and a very detailed line-item classification. This article analyses these features and makes suggestions for policy adjustment to improve effectiveness and efficiency. The article examines all stages of the budget process (preparation, parliamentary approval, execution, and accounting and auditing) and assesses Turkey’s recent rapid progress with reform. The article offers suggestions for next steps and new priorities for Turkey in the light of other OECD country experience. * Dirk-Jan Kraan and Daniel Bergvall are Project Managers in the Budgeting and Public Expenditures Division of the Public Governance and Territorial Development Directorate, OECD. Ian Hawkesworth is an Administrator in the same division. 7 BUDGETING IN TURKEY 1. Introduction 1.1. General characteristics Turkey is a member of the OECD which joined the organisation at its creation in 1960. Since then there has been remarkable economic progress in the country, but this development has been accompanied by many shocks and upheavals. These convulsions originated sometimes in external economic circumstances, such as the oil crises of the 1970s and the Russian default of 1998, but more often in internal economic and political circumstances. Since the 1960s, Turkey has gone through many political and economic crises with severe repercussions on the management of public finance. The latest crisis occurred in 2001 and resulted in a very difficult economic situation. Since then a positive development has begun which has led to rapid economic growth and enormous improvements in public finance management. This article takes stock of these improvements and makes some suggestions about next steps in the light of experiences with budgetary reform in other OECD countries. Turkey is a large country with a population of 72.1 million, situated partly on European and partly on Asian soil. The population is relatively young compared to western Europe. The average annual rate of change of the population has in recent decades been comparatively high (1.6% in the period 1995-2005; OECD, 2006a), but has declined rapidly since 2000 (from 1.41% in 2000 to 1.26% in 2005). By 2010, the number of inhabitants is expected to be around 76 million, somewhat smaller than the population of the most populous EU country, Germany (84 million in 2010). Most of the Turkish people are Muslim. Since the foundation of the Republic in 1923 by Mustafa Kemal Ataturk, Turkey has been a secular republic. At the time of its foundation, the system of governance of the Turkish Republic was inspired by that of the French Republic. Some features of this system are still present and are considered as important or even essential parts of the constitutional or legal structure of the Turkish state. Apart from a strong emphasis on the secularity of the state, these features include: the strong centralisation of service provision with uniform countrywide quality standards; the limited role of private initiative in health care, education and social services; the absence of sub-national tax autonomy; and the special position of the civil service. In the area of public finance management, typical French republican features include the judicial role of the Court of Accounts, 8 OECD JOURNAL ON BUDGETING – VOLUME 7 – No. 2 – ISSN 1608-7143 – © OECD 2007 BUDGETING IN TURKEY the centralisation of the accounting function for the entire central government in the Ministry of Finance and, until very recently, the “Napoleonic” system of preventive spending control by the Ministry of Finance. According to the Constitution, Turkey has a unicameral parliament, the Grand National Assembly, with 550 seats. It is directly elected by universal suffrage on the basis of proportional representation with an electoral threshold of 10% of the total poll. The Assembly is elected for a period of five years. As a consequence of the relatively high threshold, it is difficult for small parties to enter parliament. Since the elections of 2002, there are two main parties in parliament, namely the Justice and Development Party led by Mr. Erdogan, the present Prime Minister, with 352 seats on the basis of 34% of the electoral vote, and the Republican Peoples Party led by Mr. Baykal, with 151 seats on the basis of 19% of the vote. In addition to the two main parties, five smaller parties (28 seats) and independent deputies (11 seats) are represented in parliament, mainly as a consequence of resignations and realignments.1 Of the working population of 22.3 million (civilian employment), about 27.3% (6.1 million) is employed in agriculture (as opposed to 6% on average in the OECD area). The sectors of industry and construction employ 25.4% (5.7 million), and the services sector 47.3% (10.2 million). The population that makes its living from agriculture is mostly scattered over villages in the countryside. There are 34 500 villages in Turkey with their own elementary form of local administration. Industry and service employment is mainly concentrated in the big cities (Istanbul 10 million, Ankara 4 million and Izmir 3.4 million inhabitants) and in a number of fast growing medium-sized cities (“Anatolian tigers” such as Bursa, Denizli, Diyarbakir, Eskisehir, Gaziantep, Kayseri and Konya). In view of the low productivity of labour in agriculture (less than a third of that in industry), this leads to a large dispersion in income and prosperity between the cities and the countryside, which in turn induces a continuous exit from agricultural employment to urban employment (around 10% of agricultural employment between 2002 and 2005). Although Turkey has made considerable progress since the financial crisis of 2001, there is still a long way to go before the Turkish economy can achieve the level of prosperity which characterises the member states of the European Union. GDP per person measured at purchasing value of the currency is a third of the EU average. In view of the large population growth, Turkey would have to achieve a real growth of 4% per year just to make sure that the gap with the EU does not widen. Real growth in the 1990s amounted to 3.1% a year. Only since the beginning of the century has the growth performance improved, albeit at a quite volatile rate (between 5 and 10%). Real growth is now somewhat higher than the average in the new central European OECD JOURNAL ON BUDGETING – VOLUME 7 – No. 2 – ISSN 1608-7143 – © OECD 2007 9 BUDGETING IN TURKEY and Baltic EU member states, but its take-off level has been much lower. Convergence with the European level of prosperity will not occur unless Turkey grows at a rate of at least 8% a year for the next 25-50 years. The macroeconomic performance of Turkey is impaired by a number of structural shortcomings that the government has put at the top of the political agenda only since the financial crisis of 2001. Two of these shortcomings which have a major impact on the budget process are: 1) the large size of the informal and half-formal parts of the Turkish economy; and 2) a lack of institutional barriers against off-budget and back-door public spending. It is estimated that of the 18.9 million persons working in the private business sector, 50.1% are informally employed (88.2% in the agricultural, forestry, hunting and fishing sector; 32% in the manufacturing sector; 64.3% in the construction sector; 43.8% in the wholesale, retail, trade, restaurant and hotel sector; 39% in the transportation, communication and storage sector; and 21.6% in the finance, insurance, real estate and business service sector). Informal firms are mostly micro-enterprises (family enterprises and self employment). Half-formal firms are mostly medium-sized enterprises (between 10 and 249 employees). Informal firms avoid labour regulations and labour taxes, environmental and safety regulations, corporate and other income taxes, and value-added taxes. Half-formal firms, typically run by families and employing both formal and informal personnel, while being registered, comply only partly with regulations and tax obligations. Generally, they use special arrangements to avoid the burdens of formality. A popular avenue is to employ workers under sub-contracting agreements, outside company payrolls (OECD, 2006a). A lax attitude on public spending control has been characteristic for consecutive cabinets in the last decades of the 20th century. The state has played a leading part in the development of the Turkish economy since the foundation of the Republic. The first factories built in the 1930s were owned and operated by the state. The same was true for mines, utilities and railways. Most banks were also state owned. In the second half of the century, consecutive governments promised to reduce the stake of the public sector in the economy but it has not happened. Privatisation never took off, and the public sector remained overmanned. Its efficiency was impaired by political interference. Transfers were made for political reasons to business sectors (agriculture, construction, transport) through credits from state banks, covered by state guarantees (quasi-fiscal activities), off-budget spending (loans, guarantees, off-budget revolving funds) and back-door spending (tax exemptions, entitlements in substantive legislation). Similarly, there was a deeply ingrained culture of electoral spending for regional development through bank credit and for social purposes through extension of entitlements without funding. The resulting losses were often covered by Treasury 10 OECD JOURNAL ON BUDGETING – VOLUME 7 – No. 2 – ISSN 1608-7143 – © OECD 2007 BUDGETING IN TURKEY borrowing from the Central Bank which until 2001 was not independent but under tight political control.