A Tragedy for Turkey and the US
After years of unsustainable growth driven by loose fiscal and monetary policies and foreign borrowing, Turkey is finally facing an economic reckoning. But with the Trump administration doubling tariffs on Turkish steel and aluminum, the prospects for reform have shrunk substantially.
WASHINGTON, DC – Among the many casualties of US President Donald Trump’s trade-policy misadventures, Turkey may be the saddest case to date. Until a few years ago, Turkey was an economic and geopolitical success story – one in which the United States could proudly claim to have played a key role. Though there were occasional bilateral disputes, Turkey remained a reliable ally for many decades.
But all that began to change in recent years. This summer, the Turkish economy started imploding under the weight of overly loose monetary and fiscal policies. Then, the US responded to the Turkish government’s failure to release an imprisoned American pastor by “punishing” the country with trade barriers and targeted sanctions. Trump announced that he was doubling US import tariffs on Turkish aluminum and steel, to 20% and 50%, respectively.
Turkey’s currency crisis could have been a wakeup call for the Turkish government to reverse its unsustainable economic policies. But owing to the Trump administration’s actions, President Recep Tayyip Erdoğan can instead pin the problem on the “bullets, cannonballs, and missiles of the economic war being waged against our country.”
To be sure, Erdoğan is hardly blameless. But it is worth remembering that Turkey’s integration into the West has long conferred significant strategic benefits on Europe and the US. After World War I and the disintegration of the Ottoman Empire, Turkey, under the secular modernizer Mustafa Kemal Atatürk, emerged as an independent country with national ambitions to join the West. After World War II, Turkey pursued this project in earnest, by joining NATO, the International Monetary Fund, the World Bank, and the General Agreement on Tariffs and Trade (the predecessor of the World Trade Organization). Between 1950 and 1953, Turkish troops fought under the United Nations Command in the Korean War.
Then, in 1963, Turkey entered into an Association Agreement with the European Economic Community; in 1995, it entered into a customs union for manufactured goods with the EU. Most recently, Turkey has provided vital support in the European Union’s effort to curb migration. As such, the EU is unlikely to support Trump’s current policy toward Turkey, despite European concerns about the Erdoğan government’s track record on human rights and the rule of law.
Erdoğan’s Justice and Development Party (AKP) came to power in 2002, following a severe foreign-exchange crisis in 2001, which itself was preceded by a half-century of volatile growth. With the support of an IMF program, the new government continued the reforms initiated by its predecessor, and the program’s success surpassed all expectations. In Turkey’s 2007 election, support for the AKP grew further; and by 2010, the country’s per capita income had tripled since the start of the century. Turkey was a functioning democracy that had achieved middle-income status.
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But in recent years, as the Turkish economy continued to grow, Erdoğan’s government became more authoritarian. And this June, Erdoğan was reelected to the presidency under a new constitution that grants him unprecedented executive powers. In the run-up to the election, government spending increased sharply, and Erdoğan pressured the Turkish central bank to keep interest rates low.
Owing to these policies, Turkey’s economy boomed in 2017, with the growth rate reaching 7.5%. But this unsustainable expansion was financed by foreign borrowing, and the inflation rate has since skyrocketed to over 15%, with the current-account deficit exceeding 5% of GDP.
With monetary conditions in the US tightening, and with Erdogan doubling down on his loose fiscal and monetary policies, the Turkish lira depreciated rapidly in the first half of this year, losing some 20% of its value. Suddenly, many Turkish corporations found it increasingly difficult to service their dollar-denominated debts with liras.
The signs of Turkey’s emerging crisis were clearly visible before the souring of US-Turkish relations this month. But with the doubling of US import tariffs on Turkish steel and aluminum, the lira plummeted by another 12% in a single day. It has now depreciated by more than 40% against the dollar this year. Unsurprisingly, Erdoğan has responded by imposing tariffs on some imports from the US; and Trump has suggested that he will retaliate further.
In the past, tariffs have not been countries’ chosen instrument for pressuring others. While the US should of course act to secure the pastor’s release, imposing additional tariffs is overkill. Other countries have been subjected to far milder penalties for more egregious offenses. The international community has long agreed that trade wars pose a direct threat to the global trading system, and thus should be used only as a measure of last resort (and usually through multilateral institutions).
Had Trump not blundered into the Turkish crisis, Erdoğan’s popularity would surely have fallen, and his government’s economic policies would have had to change. To the Turkish public, it would have been obvious that the country’s economic problems were homemade, and that the good times were unsustainable. But now Erdoğan has plausible deniability. By standing up to the foreigners who are “waging economic war” on the Turkish economy, he has actually garnered more public support.
In most foreign-exchange crises, the afflicted country’s government can turn to the IMF and other countries for financial support as it pursues necessary reforms. But in Turkey’s case, the outlook is dire. Given that Erdoğan has already accused the West of waging economic warfare, it is hard to see how he could ever change course and seek its support now.
Yet, barring some change, the standoff will end in a double tragedy. The US will have lost a key ally; and the Turks will have lost their chance at prosperity and ever-higher living standards.