Cablegate: Labor Market Reforms Could Help Turkish

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RR RUEHWEB

DE RUEHAK #6513/01 3311628
ZNR UUUUU ZZH
R 271628Z NOV 06
FM AMEMBASSY ANKARA
TO RUEHC/SECSTATE WASHDC 0083
INFO RUEHFR/AMEMBASSY PARIS 5328
RUEHIT/AMCONSUL ISTANBUL 1698
RUEATRS/DEPT OF TREASURY WASHDC
RUEHBS/USEU BRUSSELS

UNCLAS ANKARA 006513

SIPDIS

SENSITIVE
SIPDIS

TREASURY FOR INTERNATIONAL AFFAIRS - JROSE, MNUGENT
PARIS FOR USOECD

E.O. 12958: N/A
TAGS: EFIN TU
SUBJECT: LABOR MARKET REFORMS COULD HELP TURKISH
UNEMPLOYMENT PROBLEM

REF: ANKARA 6410

1. (SBU) Summary: Turkey has relatively low wage levels in
relation to comparator countries yet strong growth has not
made much of a dent in high unemployment. Rapid growth in
the working-age population contributes to low employment
rates, but so do labor market problems including high
severance payments, rigid rules impeding temporary
employment, and high employment taxes. The IMF, World Bank
and OECD have all called for reforms in these areas although
the IMF has been hesitant to reduce payroll taxes to avoid
worsening the Social Security deficit. New data suggests
the fiscal cost may be worth paying because lower payroll
taxes would bring more employment into the formal sector.
The Government is reportedly considering these reforms but
may not take them on until after next year's elections.
Labor reforms are just one of several areas of structural
reform the Government will need to tackle if wants to deepen
and sustain its economic success. If the next Government is
a coalition, it will be much harder. End Summary.

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Turkey's Persistent Unemployment Problem
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2. (SBU) Despite four years (2002 through 2005) of 7.5% real
GDP growth, Turkey's unemployment rate remains stubbornly
high. Recently released data for August 2006 show an
unemployment rate of 9.1%, slightly better than the 9.4%
recorded in August 2005, but still high. Most economists
agree that the unemployment rate is not that meaningful in
Turkey and understates the extent of the problem, since such
a large share of the working-age population is either
underemployed or has given up looking for work. A more
meaningful indicator is the employment rate, which has crept
up slightly, from 43.7% of the working-age population in 2004
to 45% in August, 2006. It is still, however, far below that
of comparator countries: the EU-15, for example have an
average employment rate of 65%.

3. (SBU) Turkish Government officials point to the large
number of jobs created by Turkey's growth: roughly one
million last year, but this job growth fails to make a dent
in the unemployment rate because of the demographics:
Turkey's high birth rates in the 1980's have meant a
continued flooding of the work force with new entrants. In
addition, substantial rural-urban migration has meant people
formerly counted as employed in the agricultural sector --
even though most of them worked on inefficient small-scale
farms -- are now in the urban work force. The latter
phenomenon helps explain why employment rates for women in
Turkey are less than half of employment rates for women in
western Europe (EU-15). The women were considered employed
when they were on the farm, but tend to stay home more than
men when Turkish families move to the city.

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Despite Low Wage Costs
----------------------

4. (SBU) The price of labor is not the problem. Despite the
strength of the lira in recent years, Turkish wage costs
continue to be low in relation to comparator countries. The
World Bank has analyzed Turkish wage costs in terms of cost
per value-added and found Turkish wages compare quite
favorably to other OECD countries. By this measure, for
example, Turkish wages were only two-thirds of Mexico's,
suggesting substantial room for both wage and employment
growth. Our sense from talking to Turkish subsidiaries of
multinational companies is that the Turkish labor force is
attractive to employers: reasonably priced, educated and with
relatively low absentee rates. This also helps to explain
the continued growth of Turkish manufacturing exports despite
the strong lira: i.e. Turkish labor costs in manufacturing
remain competitive.

5. (SBU) Although average wages are relatively low by
international standards, the legal minimum wage is relatively
high. According to the OECD, the minimum wage in Turkey is
substantially higher than in Poland, Slovakia, Estonia,
Bulgaria or Romania. The ratio of the minimum wage to the
average wage in the formal sector was higher in Turkey (48%)
than in any other OECD country. The OECD report points out
that the relatively high minimum wage magnifies the negative
impact of the labor tax wedge on employment in the formal

sector, as the wage costs of low-skilled workers often exceed
their productivity levels.

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Rigid Labor Markets
-------------------

6. (SBU) The IMF and World Bank have been pointing out for
some time that some features of Turkey's labor market are
exacerbating the unemployment problem and should be reformed.
The OECD, in its recent review of the Turkish economy, made
similar points. Turkey is tied with Portugal as having the
highest severance payments -- one month pay for each year
worked -- in the OECD. This prohibitive cost is one
deterrent to firms hiring, in case they ever have to cut
staff. Turkey's rules on temporary employment also hindr
labor market flexibility: according to the ECD report,
Turkey's temporary employment ruls are the most rigid in the
OECD by a signifiant margin. Firms employing more than 50
workers are also required to hire 6% of their workforce from
"socially assisted" groups (ex-convicts, handicapped people,
victims of terrorist attacks).

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High Payroll Taxes
------------------

7. (SBU) Turkey's high payroll taxes also discourage hiring.
Many analysts and local pundits have picked up on Turkey
having the highest tax "wedge" -- i.e. the difference between
what an employee receives and an employer's total payment
(including taxes) -- in the OECD. In fact, State Planning
Organization officials have explained to us that the truth is
a bit more nuanced: calculations of the tax wedge depend on
family size and what is included in the calculation. By one
calculation, for an employee with a family of four, Turkey
has the highest tax wedge in the OECD. But this nuance
doesn't change the main point: that payroll taxes are
relatively high in Turkey and act as a deterrent to hiring.

8. (SBU) The OECD and the World Bank have been recommending
some reduction in the tax wedge to spur employment. The IMF,
on the other hand, fears that a reduction in payroll taxes
will exacerbate the outsized deficit in the social security
system, since most payroll taxes are really social security
taxes. World Bank officials told us that with Economy
Minister Babacan's support, they have been able to access
company-level data at the Turkish National Statistics Agency
that suggests a high elasticity of labor demand in Turkey.
In other words, the Bank officials believe the data suggest
that reductions in payroll taxes will have a big impact in
terms of employers leaving the informal economy and beginning
to pay their social security taxes. This, in turn means that
the fiscal cost of a payroll tax cut will be partially
recouped from higher participation rates.

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Comment
-------

9. (SBU) The Government seems to be catching on to the
importance of attacking these labor market problems: the
World Bank officials told us the Government is considering a
package of labor reforms but might opt to wait until after
next year's elections. Labor market reforms are one of
several areas of reforms that the Government will need to
address if it wants to sustain and deepen its four-year track
record of economic success. It will need to tackle a "second
generation" of structural reforms if it wants to sustain high
per capita growth rates and permanently end the Turkish
economy's vulnerability to boom-and-bust cycles. Labor
market reforms -- if they produce more jobs -- will also help
provide the political support to sustain economic reform.
These kinds of reforms will be politically difficult for the
current government but if the November 2007 elections produce
a coalition government, it will be much harder, if not
impossible.

Visit Ankara's Classified Web Site at
http://www.state.sgov.gov/p/eur/ankara/

WILSON

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