1. Where Does Turkey Stand in the Competition for FDI Rodrigo A. Chaves February 21, 2007

2. 2 The Investment Climate and Investment The investment climate supports or hinders opportunities and incentives for firms to invest productively, create jobs, and expand output affecting economic growth and welfare. Turkey is in a race with other countries to attract investment, including FDI, to bring new technologies, skills and organizational methods that will promote growth, jobs and living standards.

3. Turkey has received limited FDI FDI-Income correlation (2005) FDI as % of GDP Log per capita GDP, PPP. Gross FDI as percentage of GDP

4. 4 Attracting FDI could become increasingly difficult for Turkey Going forward, global FDI inflows as a share of world GDP in 2005-10 expected to average about 2.2%. Business environments across the world have continued to improve and be more competitive. FDI to emerging markets is likely to be highly concentrated in commodity rich countries. Privatization and M&As in the financial sector will drop - Greenfield investment is needed.

5. 5 FDI is Vital for Turkey

6. 6 There has been progress Privatization, competition, administrative, and regulatory policies. Areas for further improvement include (a) the commercial code, (b) reducing registration fees and licenses, (c) corporate governance, (d) accounting standards, and (e) facilitating access to land for foreigners. Major challenges remain to investment and growth.

7. 7 The “cancer” of informality Turkey’s informal sector is large. Less than half of the active labor force pays social security contributions. The tax burden is unfairly distributed, discouraging investors Unfair competition of the informal sector restricts new investors. Overall productivity and therefore growth are stunted.

8. 8 Percentage of firms identifying the issue as a major obstacle to operation Tax rates remain a key constraint

9. Not enough jobs are created Only 23 percent of the increase in working age population

10. 10 The fiscal adjustment Revenue increases are not the answer unless they come from those now in the informal sector. Largest part of public expenditures are non- discretionary and produce low development returns. This produces a situation where the state has limited ability to invest in growth and job producing activities.

11. 11 A comprehensive and strategic vision is required “To sustain high growth in the economy by attracting more investment and financing while at the same time generating more and better jobs.”

12. 12 From vision to action: Coordinated package of reforms & Areas of Reform Expected Outcomes Productive Public Investment Create fiscal space Attraction of FDI Steady Economic Growth with Employment Generation Investment climate Labor Markets Financial Markets Technology, quality, innovation and labor skills

13. 13 Possible elements in the comprehensive program

14. 14 Fiscal space policies Fiscal space to meet expenditure pressures should be created by a combination of structural public expenditure reforms, expenditure reallocations, and continuing tax reform efforts. Sector-specific reforms Shift resources to programs for growth and social development. Horizontal reforms that improve the efficiency of expenditure programs across sectors. Initiatives to further rationalize the tax system to broaden the tax bases.

15. 15 Improve corporate governance. Strengthen protection of creditor rights. Strenghten competition policy Monitor state aid, phase out distortions and create a state aid monitoring agency Investment Climate

16. 16 Adopting the revised Commercial Code in line with EU requirements Reduce registration fees and licenses by replacing them with better reporting and stronger enforcement Transfer social security collection to the MIFIN to complement reforms in social security institutions Further simplify tax system and conclude functional restructuring of tax administration Investment climate

17. 17 Labor Market Reform Reduce the labor tax wedge as much as fiscally responsible to create new jobs Measures to improve the incentives to hire include: –Lower severance requirements –Lower unemployment insurance requirements –Allow temporary work for economic reasons and functioning of temporary work agencies. Protecting workers (rather than jobs) –Ease eligibility criteria for unemployment insurance –Extend collective bargaining –Improve ISKUR’s capacity for active labor market policy and license private employment agencies. –Improve dispute resolution mechanisms

18. Increase Efficiency and Competitiveness in Financial Sector Continue with privatization of the state banks Enact a framework law for the insurance industry in line with EU requirements Enact law in support of the primary residential mortgage market and establish regulation for secondary market Develop legal and regulatory framework for credit bureau for consumers and corporate business Create legal framework and effective filing system for security interests on movable collateral

19. Increase Technology Absorption and Innovation capacity Develop a national innovation strategy Align Innovation policy and regulatory framework with EU requirements Evaluate results and fiscal impact of Technoparks; R&D fiscal incentive schemes, matching grants and loans Recognize tests and standards from countries with which the EU has mutual recognition agreements

20. Improve Education System Raise graduation rates from secondary school and improving educational opportunities at the tertiary level Modify curricula with a view that all secondary school graduates are taught academic as well as applied competencies Eliminate rigid separation of vocational and general secondary students Restructure OSS to challenge students to demonstrate learning across all academic disciplines and at high standards