Protection and incentives in Turkish manufacturing : an evaluation of policies and their impact in 1981

SWP-660 Protedion and Incentives in Turkish Manufaduring An Evaluation of Policies and Their Impact in 1981 Fahrettin Yagci WORLD BANK STAFF WORKING PAPERS Number 660 FILE GUM V   WORLD BANK STAFF WORKING PAPERS Number 660 Protection and Incentives in Turkish Manufacturing An Evaluation of Policies and Their Impact in 1981 Fahrettin Yagci The World Bank Washington, D.C., U.S.A.  Copyright ('0 1984 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing July 1984 This is a working document published informally by the World Bank. To present the results of research with the least possible delay, the typescript has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. The publication is supplied at a token charge to defray part of the cost of manufacture and distribution. The views and interpretations in this document are those of the author(s) and should not be attributed to the World Bank, to its affiliated organizations, or to any individual acting on their behalf. Any maps used have been prepared solely for the convenience of the readers; the denominations used and the boundaries shown do not imply, on the part of the World Bank and its affiliates, any judgment on the legal status of any territory or any endorsement or acceptance of such boundaries. The full range of World Bank publications, both free and for sale, is described in the Catalog of Publications; the continuing research program is outlined in Abstracts of Current Studies. Both booklets are updated annually; the most recent edition of each is available without charge from the Publications Sales Unit, Department T, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from the European Office of the Bank, 66 avenue d'Iena, 75116 Paris, France. Fahrettin 'Yagci is an economist with the Economic Analysis and Projections Department of the World Bank. Library of Congress Cataloging in Publication Data Yagci, Fahrettin, 1944- Protection and incentives in Turkish manufacturing. (World Bank staff working paper ; no. 660) Bibliography: p. 1. Turkey--Manufactures--Government policy. 2. Industry and state--Turkey. 3. Turkey--Commercial policy. 4. Tariff--Turkey. 5. Export premiums--Turkey. I. Title. II. Series. HD9736 .'92Y33 1984 338.9561 84-13182 ISBN 0-8213-0391-0  A B S T R A C T Turkey has made an ad hoc and piecemeal use of protective and incentive measures. Sufficient attention has not been given to the interdependence of these various instruments and to their net effect on different market destinations and sectors. By estimating and evaluating the quantitative indicators of incentives and comparative advantage, this study attempts to quantify the incidence of the system of protection and incentives in Turkish manufacturing in 1981. The findings are as follows: (a) Both nominal and effective protection are high and differ substantially among sectors, between public and private firms, and between domestic and export markets. (b) Tariff redundancy exists in a number of sectors. (c) There is a substantial bias against the private sector, due to a lower input protection in the public sector and to the substantial interest subsidy granted to public firms. (d) There is a heavy bias against exports in spite of generous export subsidies. (e) The domestic resource cost in a large number of sectors is high and differs substantially among sectors. (f) The domestic resource cost is substantially higher in the public sector, indicating a higher inefficiency in that sector. (g) Social profitability, on average, is higher in the private sector. Mi) Wide differences exist between social and private profitability among sectors and between public and private firms, indicating the presence of price distortions both in the product and factor markets. To rationalize resource allocation in Turkey, the wide variations in protection and subsidies among manufacturing sectors, between public and private firms, and between domestic and export markets need to be gradually narrowed. This requires substantial restructuring not only in import protection but also in the whole incentive system. The needed measures include: (1) the elimination of quantitative restrictions; (2) a reduction in the average tariff rate and a narrowing of the variation around it; (3) the elimination of preferential credit to the state economic enterprises; (4) a granting of duty-free access to all imported inputs for export production; and (5) the continuation of a realistic exchange rate policy with a gradual elimination of export subsidies following the reduction in import protection. The policy measures introduced in December 1983 and January 1984 are steps in the right direction. However, the new tariff and export rebate rates were set in an ad hoc manner without an analytical back-up to work out their impact on effective rates.  EXTRACTO Turquia ha venido usando las medidas de protecci6n y los incentivos de producci6n en forma'ad hoc y fragmentaria. No se ha prestado suficiente atenci6n a la interdependencia de estos diversos instrumentos y a su efecto neto en los diferentes destinatarios y sectores del mercado. En el presente estudio se procura cuantificar la incidencia del sistema de protecci6n e incentivos en el sector industrial turco en 1981 mediante la estimaci6n y evaluaci6n de los indicadores cuantitativos de los incentivos y de la ventaja comparativa del pais. Las conclusiones son las siguientes: a) la protecci6n, tanto nominal como efectiva, es elevada y difiere notablemente entre los distintos sectores, entre las empresas publicas y las privadas y entre el mercado interno y el de exportaci6n; b) existe redundancia arancelaria en varios sectores; c) hay un fuerte sesgo contra el sector privado, debido a la menor proteccion de los insumos en el sector publico y a los elevados subsidios a los intereses sobre los prestamos que se conceden a las empresas estatales; d) existe un importante sesgo contra las exportaciones, a pesar de los generosos subsidios a la exportaci6n; e) el costo de los recursos internos es elevado en numerosos sectores y difiere considerablemente de un sector a otro; f) el costo de los recursos internos es mucho mas alto en el sector publico, lo que indica la mayor ineficiencia existente en ese sector; g) la rentabilidad social media es mas elevada en el sector privado; i) la rentabilidad social y la privada difieren ampliamente entre los sectores y entre las empresas pdblicas y las privadas, lo que indica la existencia de distorsiones de precios tanto en el mercado de productos como en el de factores. Para racionalizar la asignaci6n de los recursos en Turquia sera necesario reducir gradualmente las grandes diferencias en materia de protecci6n y subsidios entre los subsectores industriales, entre las empresas puiblicas y las privadas y entre los mercados interno y de exportaci6n. Para ello se requerirA una considerable reestructuraci6n, no s6lo del sistema de protecci6n frente a las importaciones, sino tambien de todo el sistema de incentivos. Entre las medidas necesarias cabe citar las siguientes: 1) la eliminaci6n de restricciones cuantitativas; 2) la reducci6n del arancel medio y de las variaciones en torno al mismo; 3) la eliminaci6n de las preferencias otorgadas a las empresas econ6micas estatales en materia de cr6dito; 4) la concesi6n de acceso exento de impuestos a todos los insumos importados para la producci6n de articulos de exportaci6n, y 5) la continuaci6n de una politica cambiaria realista, con la paulatina eliminaci6n de los subsidios a la exportaci6n despues de que se reduzca la protecci6n frente a las importaciones. Las medidas adoptadas en diciembre de 1983 y enero de 1984 son un avance por el buen camino. Sin embargo, los nuevos aranceles y las tasas de desgravaci6n de las exportaciones se han fijado de una manera ad hoc, sin estar respaldadas por un analisis de sus repercusiones en las tasas efectivas.  La Turquie a un systeme de protection et d'incitations fait de mesures circonstancielles et fragmentaires. L'interdependance des divers instruments qul le composent et leur efi-et net sur les differents marches destinataires et les differents secteurs n'ont pas requ une attention suffisante. Les auteurs de cette etude s'efforcent, en estimant et en eva- luant les indicateurs quantitatifs des nnesures d'incitations et des avan- tages comparatifs, de chiffrer l'incidence du systeme sur le secteur manu- facturier turc en 1981. Leurs conclusions sont les suivantes : a) La protection, tant nominale qu'effective, est elevee mais varie sensiblement selon les secteurs, selon qu'il s'agit d'entreprises publiques ou d'entre- prises privees et selon que la production est destinee au marche int6rieur ou a 1'exportation. b) Le tarif comprend des droits qui font double emploi dans un certain nombre de secteurs. c) Le secteur prive est nette- ment defavorise, le secteur public beneficiant de droits reduits sur les importations d'intrants et de bonifications d'int6rets importantes. d) La production pour l'exportation est tres defavorisee, malgre l'existence de subventions genereuses. e) Le cofit en ressources interieures est nette- ment plus eleve dans le secteur public, ce qui prouve que celui-ci est moins efficace. g) La rentabilite sociale est, en moyenne, plus elev6e dans le secteur prive. h) I1 existe des differences considerables entre rentabilite sociale et rentabilite financiere selon les secteurs et entre les entreprises publiques et privees, ce qui indique 1'existence de dis- torsions des prix sur les marches des produits et des facteurs. Pour rationaliser la repartition des ressources, il faut reduire progressivement les differences consid6rables de protection et d'aide sous forme de subventions entre les divers secteurs manufacturiers, les entre- prises publiques et privees et les march]s int6rieurs et d'exportation. Cela exige une reorganisation substantielle non seulement de la protection contre les importations mais egalement de l'ensemble du systeme d'incita- tions. Parmi les mesures necessaires, citons : 1) l1'limination des res- trictions quantitatives; 2) une reduction du taux de droit moyen et un retrecissement des ecarts par rapport a celui-ci; 3) la suppression du credit pr6ferentiel accorde aux entreprises d'Etat; 4) l'admission en franchise de tous les intrants importes pour la production de biens d'exportation; et 5) la poursuite d'une politique de change realiste et l1'limination progressive des subventions aux exportations lorsque la protection contre les importations aura diminue. Les mesures adoptees par les pouvoirs publics en decembre 1983 et janvier 1984 constituent autant de pas dans la bonne voie. Toutefois, les d6cisions concernant le nouveau tarif et les ristournes au profit des exportateurs ont ete prises de facon ponctuelle sans qu'il ait ete proced6 a une analyse permettant d'en determiner les effets sur les taux effectifs.  ACKNOWLEDGEMENTS This study was done under the guidance of Bela Balassa. He has provided his guidance at every stage of the study. He also read the draft final report and made invaluable comments and suggestions. Jayanta Roy supervised the work. Professor Mukerrem Hic of Istanbul University (now a member of Parliament) directed the study. His efficient administration and coordination contributed in an important way to the completion of the work. Mehmet Genceli assisted him in the collection of the data. Ilker Birdal went through the files and checked the consistency of the firm- level data. I greatly benefitted from discussions with Garry Pursell on issues related to the methodology and the computer program. He also commented upon early drafts. Michel Noel estimated some of the country coefficients. Jong Lee transferred the INCA program to Bogazici University's computer. Yoon Joo Lee made several modifications in the program at my request. Neil Roger read some parts of the report and made useful comments. Branko Milanovic prepared the correlation coefficients matrix. I am indebted to Kemal Dervis and Demetrios Papageorgiou who read and commented upon the final draft. Metin Cosgel and Altug Karamenderes provided valuable assistance in processing the data.  The members of the Turkey Division of the World Bank gave their invaluable support throughout the study and hosted me in their Division when I was writing this report. Mildred Weiss helped me in editing the text. Mary MaGinley and Vicky Sugui skillfully typed the report. I would like to express my heartfelt appreciation to all of them.  ABBREVIATIONS A : actual capacity D . domestic DRC : domestic resource cost DYB : State Investment Bank E : exports EPC : effective protection coefficient ESC : effective subsidy coefficient F : full capacity HIS. C historical capital stock IRRF interest rate rebate fund NPC : nominal protection coefficient PPC : private profitability coefficient Pr private sector Pu : public sector REV. C revalued capital stock SEE : state economic enterprise SIS : State Institute of Statistics SPC social profitability coefficient SPO : State Planning Organisation T : total TSKB Industrial Development Bank of Turkey TUD : Incentives and Implementation Department  TABLE OF CONTENTS Page No. INTRODUCTION ......................................................... 1 CHAPTER I: AN OVERVIEW OF THE TURKISH MANUFACTURING INDUSTRY ...........4 1. INTRODUCTION ................................................... 4 2. TURKISH MANUFACTURING IN FIGURES ............................... 7 Basic Indicators ............................................... 7 Product Mix and Investment .................................... 10 Ownership ..................................................... 13 Foreign Trade ....................................... 14 SOURCES OF GROWTH ....................................... 16 ACHIEVEMENTS AND PROBLEMS ..................................... 18 CHAPTER II: THE SYSTEM OF INCENTIVES AND PROTECTION ................... 20 1. INTRODUCTION ................................................ 20 2. EXCHANGE RATE ................................................ 20 3. IMPORT PROTECTION ............................................. 22 Tariff Protection ............................................. 23 Quantitative Restrictions ..................................... 24 4. EXPORT INCENTIVES ............................................. 27 Export Tax Rebate ....................... 28 Subsidized Export Credit ....................... 29 Foreign Exchange Allocation ....................... 32 Foreign Exchange Retention Scheme ............................. 34 Corporation Tax Allowances .................................... 35 Temporary Import Scheme ....................................... 36 Price Control and Licensing in Exports ........................ 36 5. INVESTMENT INCENTIVES ....................................... 37 6. ADDITIONAL INCENTIVES TO PUBLIC FIRMS ......................... 40 7. ADMINISTRATION OF INCENTIVES .................................. 42 8. INCENTIVE COEFFICIENTS ....................................... 42  TABLE OF CONTENTS (Cont'd) Page No. CHAPTER III: SAMPLE CHARACTERISTICS .............................. 44 1. SAMPLE REPRESENTATION .................................... 44 2. SECTOR CHARACTERISTICS ................................... 46 3. DISTRIBUTION OF SUBSIDIES ................................ 50 CHAPTER IV: THE INCIDENCE OF PROTECTION AND INCENTIVES IN TURKISH MANUFACTURING: AGGREGATE RESULTS ......... 55 1. INTRODUCTION ............................................. 55 2. GENERAL PATTERN OF NOMINAL PROTECTION .................... 57 Output Protection on Total Sales ......................... 58 Output Protection in Public and Private Sectors .......... 62 Output Protection on Domestic and Export Sales ........... 64 Input Protection on Total Sales .......................... 66 Input Protection in Private and Public Sectors ........... 67 Input Protection in Domestic and Export Sales ............ 68 3. THE GENERAL PATTERN OF EFFECTIVE PROTECTION .............. 69 Effective Protection on Total Sales ...................... 70 Effective Protection in Public and Private Sectors ....... 71 Effective Protection on Domestic and Export Sales ........ 73 4. THE GENERAL PATTERN OF EFFECTIVE SUBSIDY ................. 78 Effective Subsidy for Total Sales ........................ 80 Effective Subsidy in Public and Private Sectors .......... 81 Effective Subsidy on Domestic and Export Sales ........... 82 5. NET INCENTIVE COEFFICIENTS ............................... 85 6. DOMESTIC RESOURCE COST ESTIMATES ......................... 85 Domestic Resource Cost in Public and Private Sectors ..... 91 The Relationship Between DRCs and EPCs ................... 93  TABLE OF CONTENTS (Cont'd) Page No. 7. SOCIAL PROFITABILITY COEFFICIENT ESTIMATES ............... 95 Social Profitability in Public and Private Sectors ....... 97 Financial Profitability .................................. 99 Social Profitability and Private Profitability .......... 101 CHAPTER V: THE INCIDENCE OF PROTECTION AND INCENTIVES IN TURKISH MANUFACTURING: SOME 66-SECTOR RESULTS... .104 1. TARIFF AND NON-TARIFF PROTECTION ON OUTPUT .............. 104 2. FREQUENCY DISTRIBUTION OF THE ESTIMATES ................. 110 3. RELATIONS AMONG INDICATORS OF INCENTIVE AND COMPARATIVE ADVANTAGE ................................... 114 CHAPTER VI: CONCLUSIONS AND POLICY GUIDELINES ................ .. 117 1. CONCLUSIONS .......................................... 117 2. POLICY GUIDELINES ....................................... 122 3. POSTSCRIPT .......................................... 125 ANNEX A: METHODOLOGY .......................... 130 ANNEX B: 66-SECTOR RESULTS ........................... 137 ANNEX C: FIRM-LEVEL RESULTS .......................... 146 ANNEX D: FIRM DATA ............................ 156 REFERENCES ....................... 166   INTRODUCTION The growth of Turkey's manufacturing output has been impressive, averaging 10 percent in the First Perspective Plan period (1963-77). This can be ascribed mainly to the generous industrial incentive system created in 1963 and continuously enhanced thereafter. This system includes tax allowances, interest subsidies, export tax rebates, duty-free importation, tariffs, quantitative restrictions, export earnings retention as well as foreign exchange and credit priorities. These incentives, combined with the rapid expansion in domestic demand, increased profitability in the domestic market relative to the export market and created a resource-pull effect in basic import- substituting industries, particularly petroleum refining, transport equipment and vehicles, fertilizers, machinery, and basic metals, with public sector playing an important role. All these favorable developments should be judged, however, against the costs, namely the sub-optimal, high-cost, and inefficient firms created during the industrialization process and the protracted stagnation in employment and exports. These adverse developments could be attributable mainly to the fact that the industrial incentives provided very high, indefinite and indiscriminate import protection and created a heavy bias against employment and exports. The belated adjustment to the oil price increases and the consequent heavy short-term borrowing combined with the adverse effects of the incentive system created a deep and protracted balance of payments crisis in 1977. Due to the shortage of imported intermediates  the growth rate of manufacturing output declined rapidly, becoming negative after 1977. In the early 1980, a far-reaching stabilization program was introduced and the incentive system was partially modified. The manufacturing industry responded favorably to the partial reversal of industrial policies. The rate of growth of manufacturing output has increased to 8.1 percent in 1981 and 6.0 percent in 1982; manufactured exports grew at 131.7 percent in 1981 and 55.0 percent in 1982. All these bring the industrial incentives into focus. A careful evaluation of the system of industrial incentives seems to be a precondition to redressing industrial policies so as to attain growth and stability in the Turkish economy. It is the purpose of this study to provide such an evaluation. By estimating and evaluating the quantitative indicators of incentives and comparative advantage, this study attempts to quantify the incidence of the system of protection and incentives in Turkish manufacturing in 1981. The effects of industrial incentives are reflected in the following two sets of indicators: (a) indicators of incentives: nominal protection coefficient (NPC), effective protection coefficient (EPC) and effective subsidy coefficient (ESC); and (b) indicators of comparative advantage: domestic resource cost (DRC) and social profitability coefficient (SPC). 1/ These coefficients were estimated by using data obtained from a sample survey of 123 public and private 1/ For their description, interpretation, and estimation, see Balassa (1977, 1982).  - 3 - firms in 66 manufacturing sub-sectors. The results are presented at four levels of aggregation: (i) firms; (ii) 66 sectors; (iii) 14 sectors; and (iv) total manufacturing. To compare the differential incidence, the results are also broken down by ownership (public and private) and by market destination (domestic and export). The study was initiated under the Structural Adjustment Loan I to Turkey and financed by the World Bank and the State Planning Organization of Turkey (SPO). It was directed by Prof. M. Hic of Istanbul University under the supervision of Bela Balassa. The survey was organized by Prof. Hic and the data were collected by a team under his leadership. The rest of the work was done by the author. This report is organized as follows. Chapter One provides an overview of the manufacturing industry in Turkey in the last two decades and thus serves as a background for the following chapters. Chapter Two describes the evolution and structure of the system of industrial incentives. Chapter Three discusses the sample characteristics. Chapter Four focuses on the macro results of the study. Chapter Five takes up some more detailed results. Finally, Chapter Six summarizes some of the major findings of the study and attempts to provide general policy guidelines. It also includes a postscript that evaluates Turkey's recent policy changes aimneid at restructuring the incentive systems. The annexes explain the metlhodology and present more detailed tables of the results and survey data.  - 4 - CHAPTER I AN OVERVIEW OF THE TURKISH MANUFACTURING INDUSTRY 1. INTRODUCTION The manufacturing industry in Turkey has been considered the main instrument of rapid growth, structural change and self- sufficiency. As such it has usually been the most favored sector of the economy. Resources have been channelled into it through heavy public sector investment, particularly in import-substituting basic industries, and through generous financial incentives coupled with a high level of protection for private investment. Replacing imports of non-durable consumer goods and their inputs with domestic production did not encounter much difficulty and the first stage of import substitution was completed with success by the early 1960s. The second stage which involves the replacement of imports of intermediate inputs and producer and consumer durables, followed and was intensified in the 1970s. Compared with the products of the first stage, these products are more capital-, skill-, and import-intensive. A successful second stage of import substitition, therefore, depends on the availability of capital, skills, and imports. But the policies pursued in the 1970s were not conducive to generating them. Moreover, the high level of import protection combined with an overvalued exchange rate created an anti-export bias, and export disincentive resulting in stagnating export revenues in the 1960s and 1970s. Rising import requirements had to be financed increasingly by  - 5 - external resources and workers' remittances, the latter equalled to 93 percent of total merchandised exports in 1974. With a constantly rising incremental capital-output ratio, increasing volumes of external resources were needed to supplement insufficient domestic savings. Adjustment to the oil price increases and to the world depression that followed, was considerably delayed. Despite insufficient voluntary savings and stagnating exports, the pace of industrialization was maintained after 1973. But the consequent deficit financing accelerated inflation. Short term external borrowing mounted, and by 1978, external borrowing possibilities were exhausted. Imports declined and production and investment came to a standstill by the end of 1979. Since 1980 a series of policly reforms have been introduced to stabilize the economy. These reforms include: (a) An initial large devaluation in 1980 followed by daily adjustment of the exchange rate. (b) Higher export incentives: subsidized credit, priority and duty-free access to imported inputs for export production, tax rebates, elimination of licensing and relaxation of price controls in exports and simplification of regulations and centralization of administration. (c) Partial import liberalization: elimination of the quota list, shifting some imports to the more liberalized list and reduction in guarantee deposits.  - 6 - (d) Tax reforms to mobilize domestic resources and restructure investment allowances. (e) Reorganization of the capital market: deregulation of interest rates and legislation for strengthening the capital market. (f) Relaxation of direct controls: decontrolling the selling prices of most state economic enterprises (SEE) and simplification of regulations and procedures. The economy as a whole, and the manufacturing industry in particular, responded favorably to the policy reforms. Inflation fell from 100 percent in 1980 to 30 percent in 1982. The growth rate of GNP and manufacturing value added became positive after 1980. Export performance of manufacturing industry has been impressive. In real terins manufactured exports increased by 131.7 percent and 55.0 percent in 1981 and 1982, respectively. International confidence has been restored. These favorable results, however, have been accompanied by rising unemployment, falling real wages, and declining investment. This chapter provides an overview of the manufacturing industry in Turkey in the last two decades. Section 2 presents the basic data on Turkey's manufacturing sector in the 1960s and 1970s. Section 3 discusses the sources of growth. Finally, Section 4 takes up the principal achievements and problems of Turkey's manufacturing sector.  - 7 - 2. TURKISH MANUFACTURING IN FIGIJRES This section draws together the readily available data to provide an overall view of the sector. Basic Indicators Table 1.1 summarizes the basic indicators. The growth rate of value added was substantial in 1963-77: 10.0 percent on average. With the emergence of the balance of payments crisis at the end of 1977, however, it declined sharply and became negative in 1980. Production responded favorably to the policy reforms introduced since 1980 and growth again became positive in 1981 and 1982 (8.1 percent and 6.0 percent, respectively). The share of manufacturing value added in GNP increased from an average of 12.4 percent in 1963-65 to an average of 16.7 percent in 1981-82. This rapid growth is due basically to the creation of new capacity in the manufacturing industry. Indeed, the rate of growth of manufacturing investment has been 11.6 percent on average until 1977, and its share in total investment increased from 20.1 percent in 1963-65 to 31.3 percent in 1978-80. After 1978, however, the growth of manufacturing investment became grossly negative and manufacturing's share in total investment declined from 31.3 percent in 1978-80 to 24.2 percent in 1981-82. While manufactured imports grew at an average rate of 8.3 percent in 1963-77, manufactured exports attained a 6.0 percent average growth and their share in total exports increased from 20.6 percent to 31.2 percent in the same period. The growth rate of manufactured  Table 1.1: TURKISH MANUFACTURING INDUSTRY: BASIC INDICATORS, 1963-82 Growth Rates Average Average Average (1 in constant prices) 1963-65 1978-80 1981-82 1963-73 1973-77 1978 1979 198 1-981 198Z manf. value added (% of GNP) 12.4 17.1 16.7 10.9 8.3 3.6 5.3 -5.4 8.1 6.0 manf. investment (S of total investment) 20.1 31.3 24.2 11.1 12.0 4.3 -11.3 -3.6 -2.8 -10.7 oX manf. exports (S of total exports) 20.6 31.2 54.7 9.0* 2.0 3.0 12.0 9.8 131.7 55.0 manf. imports (S of total imports) 60.0 68.2 57.4 4.7 11.7 -29.6 4.5 9.0 7.3 -11.7 manf. employment (% of total employment) 7.8 10.3 10.4 3.7 2.9 1.1 -2.3 -1.5 3.0 1.6 * The average growth rate of exports was 0.O% in 1963-70 and 36.0S in 1970-73. Source: SPO and SIS.  - 9 - exports, however, has not been steady: for example, it was 0.0 percent in 1963-70, 36.0 percent in 1970-73, and 2.0 percent in 1973-77. The major exchange rate adjustment in 1970 and the resulting increase in the real exchange rate vis-a-vis the US dollar (see Table 2.1 in Chapter 2) were responsible for the rapid growth of exports in 1970-73. The sharp increase in 1979 and 1980 (12.0 percent and 9.8 percent respectively), is due mainly to the special trade relations established with the Middle Eastern countries. Then, substantial policy changes in 1981 and 1982 produced remarkable growth rates of 131.7 percent in 1981 and 55 percent in 1982. Turkey's increasing trade deficit was financed by multilateral foreign assistance in the 1960s, by workers' remittances and short-term commercial borrowing in the 1970s, and by OECD, IMF, and World Bank credits in the 1980s. Manufacturing employment recorded an average growth rate of 3.3 percent between 1963 and 1977 and its share in total employment increased from 7.8 percent in 1963-65 to 10.3 percent in 1978-80. In line with changes in production, mariufacturing employment declined in 1979 and 1980, but started rising afterwards. Turkey tried to maintain the pace of industrialization after 1973. In the face of stagnating exports, it resorted to heavy short- term borrowing which eventually resulted in a rapid accumulation of foreign debt ($16.6 billion in 1977,, about 30 percent of GNP) and a collapse of international confidence. Credits were cut. A severe balance of payments crisis emerged at the end of 1977 which adversely affected investment and production.  - 10 - Product Mix and Investment Table 1.2 sets out the product mix of manufacturing industry. It indicates substantial structural change. In 1981 the six largest industries, in terms of value-added were food and beverages (16.9 percent of total manufacturing value added), textiles and apparel (15.7), chemicals (10.1), basic metals (9.1), nonmetallic mineral products (8.7), and petroleum products (7.9), which collectively accounted for 68.4 percent of total manufacturing value added. In 1960, however, the largest three - food and beverages (34.8), textiles and apparel (20.9), and tobacco processing (9.9) - produced 65.6 percent of the total. The sectors whose growth rates were substantially above average were chemicals, nonmetallic mineral products, petroleum products, machinery, electrical machinery, rubber products, basic metals, and transport equipment. Their collective share in total value added increased from 25.3 percent in 1960 to 55.1 percent in 1981. Sectors markedly below the average growth rate are food and beverages, tobacco processing and textiles and apparel, whose collective share in total value added decreased from 65.6 percent in 1960 to 36.8 percent in 1981. Table 1.3 shows the shares of manufacturing industries in total manufacturing investment in 1973-77 and 1978-81. Six industries (basic metals, textiles and apparel, petroleum products, chemicals, food and beverages, and nonmetallic mineral products) absorbed 75 percent of total investment in both periods. The replacement of imports of basic intermediate inputs and producer and consumer durables by domestic production, continuously  Table 1.2: THE STRUCTURE OF PRODUCTION IN TURKISH MANUFACTURING VALUE ADDED IN 1960, 1970, and 1981 (percent)* 1960 1970 1981 T-r-- Pr Pu T Pr Pu Pr Pu Food and Beverages 34.8 22.8 77.2 15.6 42.2 57.8 16.9 48.2 51.8 Tobacco Processing 9.9 17.8 82.2 19.6 3.8 96.2 4.2 15.3 84.7 Textiles and Apparels 20.9 66.9 33.1 16.2 77.8 22.2 15.7 88.2 11.8 Wood Products 1.1 73.3 26.7 1.0 74.5 25.5 1.2 63.5 36.5 Paper Products 1.9 5.6 94.4 2.8 18.2 81.8 1.7 50.4 49.6 Printing and Publishing 1.5 93.5 6.5 1.2 93.0 7.0 1.2 87.4 12.6 Leather Products 0.3 100.0 0.0 0.3 100.0 0.0 0.7 81.8 18.2 Rubber Products 1.2 100.0 0.0 2.2 100.0 0.0 3.3 99.7 0.3 Chemicals 5.3 88.4 11.6.4 4 80.2 19.8 10.1 70.9 29.1 Petroleum Products 2.5 0.1 99.9 14.7 1.5 98.5 7.9 19.5 80.5 Nonmetallic Mineral Products 3.8 73.3 26.7 5.5 80.6 19.4 8.7 77.4 22.6 Basic Metals 7.1 9.8 90.2 9.9 16.7 83.3 9.1 41.3 58.7 Metal Products 4.3 42.2 57.8 4.4 80.1 20.0 3.3 92.9 7.1 Machinery Production 0.9 47.5 52.5 4.9 81.6 18.4 5.5 79.1 20.9 Electrical Machinery 1.0 96.1 3.9 1.4 98.3 1.7 4.0 97.1 2.9 Transport Equipment 3.5 8.8 91.2 3.1 42.8 57.2 6.5 79.1 20.9 Total 100.0 39.2 60.8 100.0 46.7 53.3 100.0 64.9 35.1 T: total, Pr: private, Pu: public * Data refer to firms with 10 or more workers. Private plus public equal 100%. Source: SIS, Annual Surv-vs of Manufacturing Industry.  - 12 - Table 1.3; ALLOCATION OF MANUFACTURING INVESTMENT, 1973-77 AND 1978-81 (percent) 1973-77 1978-81 Food and Beverages 10.9 9.1 Tobacco Processing 1.5 0.1 Textiles and Apparel 14.4 17.3 Wood Products 1.7 1.7 Paper Products 3.9 2.4 Printing and Publishing 0.6 0.7 Leather Products 0.8 0.3 Rubber Products 1.9 2.7 Chemicals 9.0 11.4 Petroleum Products 14.7 7.1 Nonmetallic Mineral Products 7.4 10.8 Basic Metals 19.9 19.3 Metal Products 2.3 3.6 Machinery 4.2 4.7 Electrical Machinery 2.4 2.4 Transport Equipment 4.0 6.3 Other 0.4 0.1 Total 100.0 100.0 Source: Fourth Five-Year Plan, p. 237, and Annual Surveys of Manufacturing Industry (SIS).  - 13 - increased the capital intensity of mianufacturing production. The new investment brought successively smaller increments of output and created fewer jobs per capital invested. The incremental capital-output ratio in manufacturing rose from 1.6 in 1963-67 to 2.9 in 1968-72 and to 4.7 in 1973-77, while the amount of capital per job created, expressed in 1976 prices, increased from TL 267 thousand to TL 363 thousand and, finally, to TL 572 thousand (Balassa 1981: 302). Ownership The public sector has always had a large share in manufacturing investment and production. However, its share has declined. At present it absorbs 33 percent of total manufacturing investment and contributes 35 percent of total manufacturing value added by manufacturing firms with 10 or more workers. In 1960, its share in total investment had been 48.3 percent and in value added 60.8 percent. The public sector share in value added in individual sectors is shown in Table 1.2. It is apparent that public firms are dominant (over 50 percent) in food and beverages, tobacco processing, petroleum, products, and basic metals, but play, an insignificant role (under 10 percent) in rubber products, metal products and electrical machinery. The public share in wood products and paper products is under 50 percent, but quite high (36.5 percent and 49.6 percent, respectively in 1981). In six sectors out of the 16 sectors in Table 1.2 (tobacco processing, wood products, printing and publishing, leather products, rubber products, and chemicals), the public share has increased since  - 14 - 1960, whereas in the remaining ten it has decreased. The loss of public sector dominance is most pronounced in paper products, metal products, machinery and transport equipment. The public share in these sectors decreased from 94.4 to 49.6, 57.8 to 7.1, 52.5 to 20.9 and 91.2 to 20.9 percent, respectively between 1960 and 1980. There are enormous differences in size between enterprises of public and private ownership. Considering only the large firms, the average public manufacturing enterprise is about nine times the size of the average private manufacturing enterprise (Ebiri 1979: 288). The share of foreign-owned firms in value added and investment is negligible (about 3 percent in both). Foreign Trade The share of manufactured exports in total merchandise exports increased from 19.6 percent in 1963 to 59.7 percent in 1982. The composition of manufactured exports, which is set out in Table 1.4, has changed considerably. The share of food and beverages decreased from 54.7 percent in 1963 to 16.0 percent in 1981. But the share of textiles increased from 3.9 percent to 36.6 percent in the same period. New products added to manufactured exports since 1963 are wood products, cement, leather products, rubber products, basic metals, metal products, machinery, electrical machinery, and transport equipment; together made up 30.9 percent of manufactured exports in 1981. Manufactured imports have represented about 60-70 percent of total merchandise imports. The share of consumption goods has been around 5 percent of the total. Chemicals (22.8 percent of total  Table 1.4: EXPORTS AND IMPORTS OF MANUFACTURED PRODUCTS BY SECTORS, 1963 AND 1981 (USS million and percent) Exports Imports 1963 P 1981 1963 1981 Vale I r Value % Value Value % Food and Beverages 39.4 54.7 367.3 16.0 5.1 0.9 171.0 3.3 Tobacco Processing - - 0.1 0.0 - - - Textiles and Apparel 2.8 3.9 839.1 36.6 43.7 7.8 111.7 2.1 Wood Products - - 27.6 1.2 24.6 4.4 2.3 0.0 Cement - - 198.5 8.7 - - 0.4 0.0 Glass and Ceramics 2.5 3.5 102.1 4.5 - - 39.8 0.8 Leather Products - - 82.1 3.6 - - 0.6 0.0 Rubber Products - - 71.8 3.1 9.8 1.8 239.8 4.6 Chemicals 2.1 2.9 93.8 4.1 80.0 14.3 1198.9 22.8 Petroleum Products 8.9 12.4 107.0 4.7 33.2 5.9 620.8 11.8 Non-Ferrous Products 6.3 8.8 29.8 1.3 10.0 1.8 140.9 2.7 Basic Metals - - 100.2 4.4 60.7 10.9 604.7 11.5 Metal Products - - 20.2 0.9 9.0 1.6 22.8 0.4 Machinery - - 64.8 2.8 130.4 23.3 1222.8 23.2 Electrical Machinery - - 26.1 1.1 60.0 10.7 336.1 6.4 Transport Equipment - - 117.6 5.1 72.6 13.0 355.9 6.8 Others 10.0 13.8 42.0 1.9 19.8 3.6 192.8 3.6 Total 72.0 100.0 2290.1 100.0 558.9 100.0 5261.3 100.0 Source: SIS  - 16 - manufactured imports), petroleum products (11.8), and basic metals (11.5) in the intermediate goods category, and machinery (29.6) and transport equipment (6.8) in the capital goods category were the dominant commodities in 1981. The share of non-competitive intermediate imports in total use of intermediate inputs is shown in Table 1.5. As was to be expected, in the second stage of import substitution, the degree of import dependence increased, with the exception of in the consumption-goods-producing industry. Table 1.5: SHARE OF IMPORTED INTERMEDIATES IN TOTAL INTERMEDIATE INPUTS (percent) 1963 1968 1973 Manufacturing Total 3.86 10.19 14.01 Consumption Goods Industries 3.33 2.50 Intermediate Goods Industries 16.58 23.17 Capital Goods Industries 18.85 28.08 Source: Input-Output Tables, SPO 3. SOURCES OF GROWTH Sources of growth analysis decomposes total demand into domestic demand, export demand, and import substitution, and then estimates the relative contribution of each category in absorbing total supply. As Table 1.6 indicates domestic demand expansion counts for the most important demand category. The contribution of import substitution  - 17 - Table 1.6: DECOMPOSITION OF GROWTH, PERCENTAGE COMPOSITION BY SOURCES Domestic Demand Export Import Changes in Expansion Expansion Substitution Input-Output Coef. 1963-68 83.6 4.9 8.3 3.2 1968-73 81.8 16.-3 -1.4 3.3 1973-77 100.4 -1.0 0.6 - 1981-84 64.3 39.5 -3.7 -0.1 Source: Dervis and Robinson (1978: 132, 135), Lewis and Urata (1983: 80). has been negligible (an even negative in some periods). This does not imply, however, that import substitution has not taken place in Turkish manufacturing. On the contrary, there has been substantial import substitution. This apparent contradiction can be resolved by differentiating between gross and net import substitituion. Gross import substitution is related to the industrial structure. Net import substitution represents net foreign exchange savings and is relevent for the balance of payments and grc;th. The contribution of exports to growth has been uneven; insignificant in 1963-68 and negative in 1973-77, but significant in 1968-73 and 1981-84. One should note that in 1973-77, when the contribution of exports was negative, Turkey tried to maintain its growth momentum in the face of oil price increases and the subsequent world recession. The significant contribution of exports during 1968-73 and 1981-84 was due to the exchange rate and other export-promotion policies adopted in 1970 and since 1980.  - 18 - 4. ACHIEVEMENTS AND PROBLEMS The achievements of the Turkish manufacturing industry have been substantial. The growth rate of value added averaged 10 percent between 1963 and 1967. There has been a substantial amount of import substitution, particularly in consumer durables, transport equipment, machinery, petroleum products, chemicals, fertilizers, and iron and steel. This has been accompanied by the introduction of a wide range of new techniques into the economy, yielding a considerable learning effect and inducing the development of new skills. These achievements, however, should not conceal the following serious shortcomings and problems of the industry. 1. Low level and slow growth of manufactured exports. Except in 1970-73 and after 1981 manufacturing exports have stagnated. This is due to the anti-export bias created by the system of incentives and exchange rate polciy. 1/ These policies are reviewed in Chapter II. Owing to the sustained real devaluation and the other export incentives, export growth was spectacular in 1970-73 (36 percent annual average) and after 1981 (131.7 percent in 1981 and 55 percent in 1982). This indicates that manufacturing exports are indeed sensitive to policy changes. On the small country assumption, the following equation was estimated to work out the sensitivity of manufactured exports to trade policies (Yagci 1983): 1/ Krueger (1974: 187) estimates that in the 1950s and 1960s the TL receipts from a dollar's worth of exports averaged half of the TL receipts from a dollar's worth of import substitution.  - 19 - ln EM = -11.09 + 1.53 In YM + 1.79 ln [PMW(1 + S) ER/PM] + 0.75 D (7.91) (5.24) (6.05) R2_ = 0.95, D.W. = 2.75, 1970-81 EM manufactured exports (constant $) YM manufacturing value added (constant TL) PMW: dollar price index of manufactured exports S average combined subsidy rate for manufactured exports ER exchange rate (TL/$) PM price index of manufacturing value added D dummy to represent the special economic relations with the Muslim countries The second term on the ri(ht-hand side, which reflects the effect of export policies, has a significant coefficient with the correct sign. 2. Slow growth of manufacturing employment. The manufacturing industry has created about one million new jobs in two decades which is less than the employment created for Turkey in the European markets in the same period. This state of affairs can be ascribed to the distortions created in factor prices. Imported capital is largely exempt from import duties and taxes, and overvalued exchange rates further decrease its price. That real interest rates were negative until 1981 when interest rates were decontrolled, had provided additional incentive for the use of capiital-intensive techniques. 3. Deterioration of income distribution. High manufacturing growth was associated with a worsening of income distribution (see Ozbudun and Ulusan 1981). The principal causes were the huge and increasing differences in inter-sector productivity (4 to 5 folds between agriculture and industry) and the inability of the manufacturing sector to absorb agricultural surplus labor.  - 20 - CHAPTER II THE SYSTEM OF INCENTIVES AND PROTECTION 1. INTRODUCTION The high emphasis and priority given to the manufacturing industry in Turkey necessitated setting up a system of protection and incentives to direct economic activities in desired directions. In this chapter the main instruments of this system are described and evaluated. 1/ The incentive and comparative advantage coefficients estimated in this study reflect the incidence of these instruments in 1981, the survey year. 2. EXCHANGE RATE Turkey has pursued a fixed exchange rate policy with infrequent, irregular, and unpredictable official exchange rate adjustments. The excess demand for foreign exchange has been curbed by stringent controls on trade and exchange flows. With the exception of brief periods in the early 1960s and the 1970s, the official exchange rate was overvalued until 1980. The overvaluation reached its peak in 1979 (Table 2.1). Overvaluation has aggravated the existing bias in incentives against exporters created by tariffs and the wide use of QRs. Bias is defined as the relative profitability of supplying the domestic as compared with the export market. It depends on the 1/ See also World Bank 1982.  - 21 - Table 2.1: REAL EXCHANGE RATE IN TURKEY, 1963-82 Exchange Rate Wholesale Price Wholesale Price Index of Real TL/$ Index in Turkey Index in USA Exchange Rate 1963 9.00 41.74 70.26 107.07 64 9.00 43.54 70.46 102.97 65 9.00 47.46 71.86 96.32 66 9.00 49.58 74.25 95.27 67 9.00 52.11 74.25 90.60 68 9.00 53.92 76.25 89.96 69 9.00 57.10 79.24 88.27 70 11.50 60.28 82.03 110.60 71 14.92 70.55 84.63 126.50 72 14.15 83.47 88.42 105.94 73 14.15 100.00 100.00 100.00 74 13.93 129.66 118.96 90.32 75 14.44 144.07 129.96 92.01 76 16.05 166.95 135.93 92.37 77 18.00 206.36 144.31 88.98 78 24.28 309.64 154.49 85.58 79 31.08 510.38 175.05 75.34 80 76.04 1059.32 199.60 101.27 81 111.22 1456.57 217.76 117.53 82 162.55 1831.46 222.36 139.51 Source: IMF, International Financial Statistics  - 22 - interaction of several policy instruments, such as tariffs and quotas on imports, tax rebates and financial incentives to exporters, and the exchange rate,. There has always been a political resistance to conventional devaluation in Turkey based on export pessimism and inflationary considerations. The multiple exchange rate system has been used occasionally to varying degrees as an alternative, to compensate for the perverse effects of the overvalued official exchange rate. The general tendency has been to apply a lower rate to agricultural exports and to imports of fertilizers and petroleum products and a higher rate to all other transactions, with still higher rates given to remittances of Turkish workers abroad. More flexibility has been introduced into the exchange rate policy since 1980. There was a 70 percent devaluation in January 1980, and frequent adjustments thereafter. Since May 1981, the exchange rate has been adjusted daily by the Central Bank. As a result the real exchange rate vis-a-vis the US dollar has appreciated since 1980. 3. IMPORT PROTECTION Import controls have been applied in Turkey both to ease the balance of payments imbalance and to protect the import-competing activities, with varying weights in different periods. Under its heavy emphasis on import-substitution industrialization, Turkey has provided extensive protection to domestic producers through tariffs and quantitative import restrictions.  - 23 - Tariff Protection Tariffs protect import-competing industries by increasing their domestic prices and attracting resources into them. This creates a domestic market bias at the expense of exports. For the products included in the sample, the average tariff rate and the other tariff-like charges is 49 percent on non-EEC imports and 42 percent on EEC imports (see Table 5.1). This latter enter at preferential rates in the framework of Turkey's Association Agreement with the EEC. These rates are the averages for the products included in our sample. However, they are very close to the average rates for all manufacturing products, estimated at 53 percent on non-EEC imports and 44 percent on EEC imports (World Bank 1982: 93). The tariff-like charges added to the tariffs include municipal tax, stamp duty, quay charges, and transaction tax, collectively averaging around three quarters of the basic tariff rate. 1/ As indicated in Table 5.1 there is considerable variation in tariff rates 2/ among the sectors included in the sample. They range from zero percent (for chemicals, petrochemicals, fertilizers, pharmaceuticals, sugar, flour, and tea) to 216 percent (for synthetic yarn) on non-EEC imports. In general, the rates are higher (over 100 1/ In principle, the transaction tax should not be added to the tariff because it also applies domestic production. An adjustment is necessary only if the rates cliffer for domestic and imported products. The reported tariff rates, therefore, overestimate the protective effect of the tariff structure. 2/ In this report, "tariff rate" covers all tariff and tariff-like charges when it refers to Turkey.  - 24 - percent) on finished products, such as textiles, leather products, wood products, glassware, plastics, and metal products, and are somewhat lower on semi-finished goods, capital goods, and raw materials. There have been minor modifications in the current tariff structure since 1973 when the last revision was made. There is a "general tariff" applied to non-EEC goods, and a lower tariff applied to imports from the EEC. These lower rates are part of the Annex Protocol which Turkey signed in 1970 with the EEC, setting the conditions of transition to full membership in 1995. Imports from the EEC were divided into two lists. Turkey agreed to eliminate the tariffs on the commodities on list 1 (50 percent of all imports from the EEC in 1973) by 1985 and the tariffs on the commodities on list 2 1/ by 1995. Starting from 1973 the tariffs on the commodities on lists 1 and 2 were reduced by 20 percent and 10 percent, respectively, by 1978. Turkey decided to "freeze" her relations with the EEC in 1978 and has postponed further scheduled tariff reductions. Quantitative Restrictions In addition to tariffs, Turkish manufacturing has received considerable protection through a complex system of quotas, import licensing, and exchange controls. -Imports are regulated by means of Import Programs since 1958. These are prepared by the Ministry of Commerce after negotiations with the Ministry of Finance, the Central Bank, the State Planning 1/ List 2 includes most of the Turkish import-competing goods.  - 25 - Organization (SPO), and the Union of Chambers of Commerce and Industry. Apart from the regulations governing importation, each program enumerates the commodities eligible for importation under each of the two lists: the Liberalized List and the Quota List. Commodities not enumerated on either list are not legally importable. These last commodities are referred to by Krueger (1974) as being on the "Prohibited List"; they include principal durable and non-durable consumer goods. The Quota List imports varied between 15 and 30 percent of total imports in the 1960s and 1970s. Under the 1981 Import Program, the Quota List was abolished. In 1969, the Liberalized List was divided in two: the Liberalized List 1, consisting of intermediate inputs and spare parts not produced domestically, and Liberalized List 2, covering intermediate and final goods manufactured in Turkey. Free importation was allowed for the former and the licensing scheme was retained for the latter. Liberalized List 1 has covered about 15 percent of total imports and Liberalized List 2, about 50 percent. The other important categories of imports not included in the Import Program are the Bilateral Agreement Imports (the goods eligible for importation from countries with which Turkey has bilateral trade agreements) and Self-Financed Imports (mainly capital goods imports under project aid), which together have covered 10 to 15 percent of total imports. There is evidence that the degree of QRs has been intensified in the 1960s. Krueger (1974) shows that there was a definite tendency  - 26 - to shift importable items, once they were domestically produced, from the Liberalized List to the Quota List, and eventually to the "Prohibited List." Foreign transactions in Turkey have always been administered under exchange controls. Commercial banks have been allowed to retain a limited amount of the foreign exchange deposited with them. In addition, foreign exchange allocations have been made following the deposit of a cash guarantee with the Central Bank: these allocations have varied according to the type of imports (industrial or commercial) and according to the list under which the importation was undertaken. The rate of guarantee deposits was set as high as 150 percent of the value of imports in the late 1960s. However, the situation has changed somewhat in the last four years. As part of the stabilization program of January 1980, the Quota List was abolished in January 1981. Some of the items in the Quota List (9 percent of the total value of the Quota List in 1980, 0.8 percent of total imports) were transferred to Liberalized List 1 and the remaining items were moved to Liberalized List 2. In addition, some 253 commodities have been shifted from Liberalized List 2 to Liberalized List 1 in the following three years. The "Prohibited List," however, has been retained. In January 1980 import regulations were also simplified and commercial banks were allowed to retain a higher proportion of foreign exchange deposits with them. In 1981 guarantee deposits were reduced to 10 percent for industrial importers and to 20 percent for commercial importers, for imports under Liberalized Lists 1 and 2.  - 27 - Of course, tariffs and non-tariff levies provide only an impressionistic view of the system ol protection in Turkey. Protection has also been granted through quantitative restrictions. The system of quotas, licensing, and exchange controls has created a complex system of QRs in Turkey. Domestic and world prices have been completely separated and domestic production has enjoyed absolute protection. The import premium created by QRs has been considerable. One study 1/ compares import prices (c.i.f), landed costs (import price + tariff + tariff-like charges), and domestic wholesale prices (landed cost + import premium) of 74 commodities, representing 8.6 percent of Turkey's imports in 1968. It turned out that, for 31 commodities in the sample, the premium exceeded the landed cost; for 27 of these 31, the difference exceeded 100 percent of the landed cost. 4. EXPORT INCENTIVES The second stage of import substitution has substantially increased import requirements in Turkey in the last two decades. To enable the importation of the capital goods and intermediate inputs needed for the growth of the industrial sector, a series of measures has been taken to provide incentives for industrial exports: indirect tax rebates, access to preferential export credit, foreign exchange allocation and retention, and temporary import permits. 2/ However, the impact of these measures had been limited until 1980, because the overvalued exchange rate had negated these positive incentives. 1/ Krueger (1974: 173-178). 2/ For further information see SPO (1982, 1983) and World Bank (1982).  - 28 - Export Tax Rebate The export tax rebate scheme was introduced in 1963 to help compensate industrial exporters for the indirect taxes they paid on their domestic inputs and outputs. In practice, however, the link between the rebates and the indirect taxes has not been strong. The number of products included in the scheme has been increased substantially and rates have been changed frequently to offset the export disincentives inherent in the exchange rate policy and the import protection. Supplementary rates have been granted to those exporters exceeding a predetermined level of total exports. The scheme was extended in 1969 to cover fresh fruits and vegetables, cotton, meat and forest products. The number of products included in the scheme has increased from 98 in 1970 to about 500 in 1983. Individual rates varied between 5 and 45 percent of the f.o.b. price of exports. In general, the rates have been increased during the balance-of-payments stringency and decreased after foreign exchange adjustments. Commodities were also transferred among lists, usually from lists with lower rebate rates to lists with higher rebate rates (World Bank 1982: 61). Initially the rebate rates were set individually. In 1970 the system was simplified by grouping the export commodities into 4 lists and applying a common rate to the f.o.b export value of all commodities on the list. The number of lists was increased to 6 in 1973 and 10 in 1975.  - 29 - After the 1980 devaluation, rebate rates were substantially reduced. But in 1981 all rates were increased by 5 percentage points across the board and commodities were reshuffled among lists. In 1982 and 1983 further increases in the baisic and supplementary rates were granted. The export tax rebate scheme may not provide an export incentive if it merely compensates for the indirect taxes paid on domestic inputs and outputs. To calculate the subsidy element of the scheme, one should adjust the rebate rates for indirect taxes. But the data are not available. Assuming that the rebate rates granted in 1980 exactly compensated for the indirect taxes paid on inputs, 1/ the net subsidy element of the tax rebate scheme in the survey year (1981) is estimated as the difference between the rebate rates in 1981 and 1980. The results are presented in Table 2'.2 for the 18 manufacturing sub- sectors for which data are available. As will be seen in Chapter IV, these net rebate rates are substantially lower than the tariff and non- tariff protection on domestic sales. Therefore, the export tax rebate scheme eliminates only a part of the anti-export bias. Subsidized Export Credit Since 1968 exporters have been granted short-term credit at preferential rates to finance production, purchases, storage, packing, and transportation of goods for export. Since 1980 they have received subsidized medium- and long-term credits to finance export-oriented 1/ In 1980 TL was devalued by 70 percent against the US dollar and the export tax rebate rates were substantially reduced.  - 30 - Table 2.2: SECTORAL EXPORT TAX REBATE RATES IN 1980 AND 1981 (percent of f.o.b. export value) 1980 1981 Difference Food 7.0 13.8 6.8 Beverages 5.3 7.1 1.8 Textiles and Wearing Apparel 10.0 12.8 2.8 Leather and Leather Products 5.5 15.2 9.7 Paper and Paper Products 4.9 10.0 5.1 Chemicals 7.0 10.3 3.3 Glass and Glass Products 6.5 11.8 5.3 Plastics 4.5 11.9 7.4 Rubber Products 5.1 13.6 8.5 Iron and Steel Products 5.8 17.2 11.4 Metal Products 7.0 16.0 9.0 Non-Ferrous Metals 7.8 11.5 3.7 Cement 6.2 16.6 10.4 Machinery 10.9 18.9 8.0 Electrical Machinery 5.5 17.2 11.7 Electrical Appliances 7.9 11.0 3.1 Transport Equipment 13.9 18.9 5.0 Others 7.8 12.7 4.9 Source: SPO  - 31 - investments. Export-oriented investments also enjoy remissions of customs duties on investment goods and income as well as corporation tax allowances of 50 percent, instead of the general rate of 30 percent. (Investment incentives are reviewed later in this Chapter.) Table 2.3 compares the interest subsidy on short-term export credits with that on general non-preferential short-term credits. There are four subsidy elements in short-term export credits; (a) a lower basic rate, (b) exemption from the transaction tax (15 percent of the basic rate on non-preferential credit), (c) a lower contribution to Interest Rate Rebate Fund (IRRF), 1/ and (d) a subsidy from IRRF (35 percent of the basic rate). The total subsidy is estimated in the following way. The 36 percent basic rate is taken to be the norm. 36 - 25 = 11 percent is the subsidy on the basic rate. Ignoring the commission, the net subsidy of 6.3 percent from IRRF (8.8 - 2.5 - 6.3) brings the total subsidy to 17.3 percent of the credit granted. The credit limit, on average, is 80 percent of export receipts with a term of 8 to 12 months. Commercial banks are encouraged to grant export credits through (a) automatic refinancing by the Central Bank of up to 75 percent 2/ of the credit at a lower rediscount rate, (b) a lower reserve ratio, and (c) rebates from IRRF (10 percentage points since August 1981). 1/ 10 percent as against 15 percent; on non-preferential credits in 1981. In January 1983 these rates were reduced to 5 and 10 percent, respectively. 2/ This was reduced to 55 percent in November 1981 and to 45 percent in March 1982.  - 32 - Table 2.3: INTEREST RATE STRUCTURE IN 1981 (percent) Non-Preferential Short-Term Credit Export Credit Basic Rate 36.0 25.0 1/ Transaction Tax 5.4 Contribution to IRRF 5.4 2.5 Commission 2.0 2.0 Effective Rate 48.8 29.5 Rebate from IRRF -- 8.8 Final Cost to Borrower 48.8 20.7 The use of export credits has increased rapidly (Table 2.4) and high subsidies have led to leakages of export credits to domestic operations. The expansion was so rapid after 1980 that the Central Bank was forced to occasionally suspend or delay the rediscounting of export credits to stay within the constraints imposed by the tight monetary policy. As will be seen in Chapter IV the generous interest subsidy provided to exporters has somewhat reduced the bias against exports. Foreign Exchange Allocation The foreign exchange allocation scheme, introduced in 1965, grants industrial exporters priority access to foreign exchange to 1/ Average of 22.5 percent and 27.0 percent, effective throughout the year.  - 33 - Table 2.4: EXPORT CREDITS (million TL) Percentage Total Central Total Export Share in Bank Credit Credit Total Credit 1973 28,780 2,221 7.7 1974 52,592 1,577 3.0 1975 66,198 3,002 4.5 1976 110,621 5,918 5.3 1977 189,699 8,399 4.4 1978 241,886 15,600 6.4 1979 382,138 24,314 6.4 1980 655,183 48,110 7.3 1981 925,980 113,182 12.2 1982 910,513 100,605 11.0 Source: Central Bank import their raw, intermediate, and packing materials used in export production and their machinery and equipment used in export-oriented investment. The amount allocated under this scheme could not exceed 50 percent of the f.o.b value of the export pledge in the case of intermediate inputs and 25 percent in the case of capital goods. In 1970, priority access to foreign exchange was extended also to suppliers of the industrial exporters. Since 1980 exporters have been allowed to use their exchange allocation for the duty-free importation of raw, intermediate, and  - 34 - packing materials in export production, as well as for the duty- inclusive importation of capital goods. The imported goods did not need to be on any of the import lists. The maximum rate of allocation was increased from 50 to 60 percent of the export pledge. In addition, a retrospective foreign exchange allocation was also provided. Since 1981, firms that have obtained subsidized export credits and have fulfilled their export pledge may apply for foreign exchange allocations for the importation of intermediate and capital goods to be used in future export production. This allocation can not exceed 80 percent of the f.o.b value of the pledged exports, half of it may be used for duty- free importation. Allocation under this scheme has not exceeded 5 percent of total non-oil intermediate inputs. The subsidy element of this scheme has been significant only in the high import stringency periods of the late 1960s and 1970s. Duty-free importation is an important export incentive, however, that; reduces the cost of exports in foreign exchange markets despite the fact that the foreign exchange allocation scheme permits only a part of inputs of export production to be obtained duty-free. Foreign Exchange Retention Scheme In the 1960s industrial exporters were allowed to retain up to 50 percent of their export earnings to finance their own import requirement. After the 1970 devaluation, this figure was reduced to 25 percent. It was increased to 50 percent again in 1979, when the difference between the official and the parallel market was very wide.  - 35 - In addition, in 1979, exporters were allowed to transfer these rights to their suppliers at mutually agreed prices. In 1980, foreign contractors and fresh fruit and vegetable exporters were also included in the scheme, with a 10 percent retention rate. Besides, exporters were allowed to transfer their rights not only to their suppliers but also to any industrial user at competitive prices. The average realized retention has varied between 5 and 10 percent of industrial exports. The subsidy element involved in this scheme was significant in the late 1960s and 1970s. These periods were characterized by severe import shortages and a substantial differential between official and parallel market exchange rates. By compensating for the overvaluation of the official exchange rate this scheme has reduced the bias against industrial exports, but at the same time it has discriminated against traditional agricultural exports. Corporation Tax Allowances Amendments were made to the Corporation Tax in 1980 to allow industrial exporters with annual export revenues exceeding $250,000 to deduct 20 percent of their export revenues from taxable income. This incentive has also been extended to exporters of fresh fruit and vegetables and to firms engaged in tourism. Contracting companies abroad are fully exempted from the corporation and income tax. If the exportation is done through a trading company, one fourth of the tax deduction is given to the trading company.  - 36 - This scheme provides significant incentives to exporters. The actual benefit is somewhat reduced, however, as a result of the withholding tax applied to deductions from taxable income. Temporary Import Scheme This scheme was introduced in 1970 to allow industrialists holding a purchase order from a foreign firm to import the required inputs. Initially, industrialists deposited tariffs on the requisite imports, which were then refunded in full upon export. Since 1980, intermediate inputs have been imported duty-free and the foreign exchange allocation under this scheme may go up to 80 percent of the export revenues. The realized foreign exchange allocation under the temporary import regime has been negligible (less than one percent of total non- oil imports on average). Price Control and Licensing in Exports The major instruments of QRs used in connection with exports are export licensing and price registration. Apart from the traditional exports such as cereals, nuts, raisins, figs and metal ores, a variety of industrial commodities (meat, margarine, olive oil, etc.) have also been subject to export licensing. Minimum export prices for various agricultural and industrial exports have also been set, primarily to prevent capital flight. In 1980, price controls on exports were substantially reduced and export licensing was relaxed. The export regime was further  - 37 - liberalized in 1982. The number of items requiring an export license was reduced from 25 to 2: tobacco and opium. In addition, the number of goods subject to price registration was reduced from 40 to 30. 5. INVESTMENT INCENTIVES During the 1960s a seriies of investment incentives were introduced to direct investment toward the desired sub-sectors and regions indicated in the 5-year plans and annual programs. The instruments used to administer these incentives have been the following: (i) income and corporation tax allowances (introduced in 1963), (ii) tariff and duty deferrals (1969) or exemptions (1969) in capital goods importation, and (iii) interest rebates (1970). Investment incentives are administered by the Department of Incentives and Implementation (TUD) at the SPO through the General Incentive Table (GIT), published yearly with the annual program and prepared according to the plan priorities. This table specifies the sub-sectors and regions in which the investment should be made to be eligible for investment incentives as well as the types of incentives to be applied for. Tariff benefits are granted if the imported capital good is new. The amount of the interest rebate varies from one investment project to another and is paid out of IRRF, maintained by the Central Bank and financed by levies on non-preferential credits (IRRF contributions). Currently, firms are allowed to deduct 30 percent of the cost of approved fixed investment from their taxable income if the investment  - 38 - is made in the designated sub-sectors in the manufacturing industry. Deductions are 40 percent for eligible investment projects in agriculture and 60 percent for eligible investments in underdeveloped regions. Investment incentives were extended to export-oriented investment in 1981 at a rate of 50 percent. To be eligible, investment projects in the manufacturing industry should exceed TL 20 million. The cost of the project should be at least TL 4 million in agriculture and TL 10 million in underdeveloped regions. In addition, 40 percent of the cost of projects must be financed from own sources. The share of own equity finance may be 30 percent for projects in the underdeveloped regions and 10 percent for investment in shipbuilding and livestock. The export-oriented investment to be eligible, at least 75 percent of the annual production has to be exported for a period of 5 years, with annual exports not falling below $500,000 ($250,000 in underdeveloped regions). One final restriction, introduced in 1981, was that no carry forward of any excess of the allowance over taxable income would be permitted. Corporation and income tax allowances have provided substantial financial benefits to firms. On average, three-quarters of total private investment has been eligible and has actually benefitted from the tax allowances. The revenue loss for Government has varied between 3 to 5 percent of the budget revenue. Table 2.5 shows the sectoral distribution of tax allowances. In value terms 89.4 percent of total tax allowances were granted to the manufacturing industry in 1968-75. After 1980 sectoral priorities  Table 2.5: SECTORAL DISTRIBUTION OF INVESTMENT PROJECTS BENEFITTING FROM CORPORATION AND INCOME TAX ALLOWANCES. 1968-75 AND 1980-82 1968-75 1980-82 Total Cost of Total Cost o-T Number of Investment Projects Number of Investment Projects Investment Projects Value (m.TL) Share (M Investment Projects Value Wm.TL) ShareTfl Agriculture 53 2413 1.3 786 97947 5.6 Mining 75 4975 2.7 119 47562 2.7 Manufacturing 1885 163037 89.4 2245 877077 50.3 Food and Beverages 378 13234 7.3 385 98993 5.7 Textiles 318 36805 20.2 207 129613 7.4 Wood Products 81 5332 2.9 35 18021 1.0 Paper Products 29 3406 1.9 16 20255 1.2 Leather Products 49 19973 11.0 29 3538 0.2 Rubber and Plastics 30 6510 3.6 4 1667 0.1 Chemicals 114 25889 14.2 89 64375 3.7 Glass Products 18 1439 0.8 9 3620 0.2 Basic Metals 38 2337 1.3 22 39914 2.0 Non-Ferrous Metals 13 1336 0.7 9 5162 0.3 Transport Equipment 175 7936 4.1 696 399942 19.8 Metal Products 164 8763 4.8 70 19148 1.1 Machinery 99 9757 5.4 56 28523 1.6 Electrical Machinery 54 9986 5.2 35 29036 1.7 Cement 38 6936 3.5 22 16491 0.9 Ceramics 17 1148 0.6 9 4828 0.3 Others 270 11454 2.0 552 47888 3.1 Energy 3 422 0.2 14 2064 0.1 Services 286 11458 6.4 2465 719299 41.2 Export-Oriented Projects - - 62 24519 1.4 TOTAL 2302 182305 100.0 5691 1768968 100.0 Source: SPO  - 40- changed somewhat. Following the export boom, investment in international road transportation has been encouraged. As a result, 41.2 percent of tax allowances were given to the services sector in 1980-82. This reduced the share of manufacturing to 50.3 percent in the same period. Within the manufacturing industry sectoral composition has also changed. From 1968-75 to 1980-82 emphasis shifted from chemicals, textiles, leather products, and electrical and non-electrical machinery to transport equipment, particularly to trucks and buses, for which export to the Middle Eastern countries have increased substantially. Despite the higher tax allowances, investment has not been attracted to Turkey's underdeveloped regions. Only 10.6 percent of total tax allowances were given to investment projects made in the Eastern and the South-Eastern Anatolia (the least developed regions in Turkey) in 1968-75 and only 7.3 percent in 1980-82 (Table 2.6). 6. ADDITIONAL INCENTIVES TO PUBLIC FIRMS The incentives we have considered so far are given to all firms, whether they are publicly or privately owned. The following incentives are granted to state economic enterprises (SEE) only. 1. Tariff and duty exemption is granted to some of the SEEs (Petkim, Seka, MKE, etc.) even for production for the domestic market. This firm-specific privilege is given by special government decrees if their production is considered "essential for Turkey's long-term development." 2. A 35 percent corporation tax rate for the SEEs, as compared to a 40 percent tax rate for private firms, provides a 5 percent tax benefit to SEEs.  - 41 - Table 2.6: REGIONAL DISTRIBUTION OF INVESTMENT PROJECTS BENEFITTING FROM CORPORATION AND INCOME TAX AlLOWANCES, 1968-75 AND 1980-82 (cost of projects, in percent) 1968-75 1980-82 Marmara 33.4 51.8 Black Sea 6.5 8.1 Eastern Anatolia 2.8 3.0 South-Eastern Anatolia 7.8 4.3 Mediterranean 16.8 11.3 Central Anatolia 16.7 14.2 Aegean 16.0 7.3 Total 100.0 100.0 Source: SPO 3. SEEs obtain a high proportion of their credits from the Central Bank, the State Investment Bank (DYB), and other publicly owned financial institutions(Sumerbank, Etibank, etc.) at heavily subsidized rates. The interest rate in the survey year ranged from 10 percent for the Central Bank to 21.5 percent for the DYB credits depending on the type of the credit and the nature of use. In addition, these credits are exempted from the transaction tax (15 percent) and the IRRF contribution (15 percent). If the credit is obtained from commercial banks, SEEs pay only the transaction tax (5.7 percentage points), but also receive an interest rebate from IRRF (5 percentage points). In this latter case commercial banks also receive one percentage point rebate from IRRF. Compared with  - 42 - the 48.8 percent effective interest cost 1/ on non-preferential short-term credit available for private firms, these heavily subsidized interest rates provide substantial additional financial benefits to SEEs. 7. ADMINISTRATION OF INCENTIVES Investment incentives are monitored by TUD through GIT, published every year with the annual programs. GIT indicates the sub- sectors and regions in which the investment should be made if it is to be eligible for investment incentives as well as the benefits to be applied. GIT is prepared in the light of 5-year plan priorities. Regulation of export incentives is less formalized. The types of export incentives are set and modified by decrees as necessary. In 1982, the administration of all incentive measures, which had been dispersed among SPO, the Ministry of Finance, the Ministry of Commerce and the Ministry of Industry, was centralized in TUD at the SPO. 8. INCENTIVE COEFFICIENTS The incentive measures described here are reflected in the estimated coefficients. The nominal protection coefficients (NPC) are estimated by comparing the c.i.f. import prices and the ex-factory prices to take account of the effects of QRs. Net export tax rebate rates are reflected in the NPCs on export sales. Tariff rates are used to calculate the NPCs on imported inputs. In the case of duty-free 1/ This excludes the effect of compensatory balances which further increases the cost.  - 43 - importation, the NPCs on imported inputs are taken to be one. All investment incentives and additional incentives to SEEs are included in the calculation of the effective subsidy coefficients (ESC). Foreign exchange allocation and foreign exchange retention are not considered in the calculation of the ESCs on export sales because their subsidy effect was minimal in 1981 due to a more realistic exchange rate policy.  - 44 - CHAPTER III SAMPLE CHARACTERISTICS 1. SAMPLE REPRESENTATION The estimation of the indicators of incentives and comparative advantage is based on data obtained from a sample survey of 123 manufacturing firms, 19 of which are public, in 66 manufacturing sub- sectors. The questionnaire was sent to 353 firms, selected to yield a high representation of both public and private activities; at least two firms were selected for each sub-sector. Only 165 of the 353 firms responded. Their questionnaires were then checked for the completeness and consistency and 42 of them turned out to be unusable. The remaining 123 responding firms constitute the data base of the estimations. Out of the 86 4-digit ISIC industries, 66 are covered. At the 3-digit level, the excluded industries are beverages, tobacco manufactures, printing and publishing, petroleum refining, and pottery, china and earthenware; these excluded industries produced 20.1 percent of Turkey's total manufacturing output in 1981. As Table 3.1 indicates 123 firms cover 22.0 percent of the total manufacturing output of the 66 sectors included in the sample. The rate of representation in the public and private sectors are 46.5 and 14.3 percent, respectively. The average size of the sample's public firms was several times higher than that of the private firms, and the 19 public firms produced almost half of the total output in the public sector. The highest rate of representation is in wood and paper products (52.3 percent), followed by non-ferrous metals (33.5),  Table 3.1: SAMPLE CHARACTERISTICS Percent Million TL Number of Sample Value-Added/ Export/ import/' Capital/ Capital/ Output,7 Firms Representation Output Output Output Output Labor Labor Total Manufacturing Pu 19 46.5 32.4 2.5 7.4 2.11 6.35 3.01 Pr 104 14.3 31.4 10.5 18.9 .70 3.67 5.48 T 123 22.0 31.9 6.5 13.2 1.39 5.41 3.88 Food Pu 4 70.5 27.2 3.2 0.3 .99 2.36 2.91 Pr 10 8.5 27.8 13.1 9.7 .29 2.80 5.43 T 14 30.0 27.3 5.0 1.8 .87 2.38 3.82 Textiles Pu 4 21.5 53.3 1.0 2.5 .43 .74 1.73 Pr 15 8.2 40.2 17.6 8.5 .78 2.02 2.56 T 19 10.0 43.6 13.3 6.7 .69 1.58 2.27 Leather Products Pu 1 99.7 46.1 - - .66 1.23 1.86 Pr 3 2.7 30.8 35.3 1.6 .30 .76 2.55 T 4 15.3 43.7 5.6 0.2 .60 1.17 1.94 Wood and Paper Products Pu 2 82.9 37.0 0.5 1.4 3.33 9.41 2.82 Pr 5 15.1 33.8 12.1 11.4 1.41 6.53 4.62 T 7 52.3 36.6 2.0 2.7 3.08 9.17 2.98 Chemicals Pu 3 55.2 26.4 1.2 17.5 4.22 37.25 8.83 Pr 14 9.0 29.4 8.1 27.3 .51 4.16 8.19 T 17 20.6 27.4 3.5 20.7 3.01 25.89 8.61 Rubber and Plastics Pu - - - - - - - - Pr 10 31.7 30.7 7.0 16.8 .62 5.68 9.11 T 10 31.5 30.7 7.0 16.8 .62 5.68 9.11 Cement and Glass Pu 2 8.8 30.3 14.7 - .42 1.78 4.27 Pr 4 12.4 46.6 29.9 1.4 .35 1.27 3.58 T 6 11.6 43.7 24.0 1.1 .36 1.34 3.74 Iron and Steel Products Pu 1 39.2 37.9 0.7 18.7 1.84 9.60 5.22 Pr 7 16.3 21.3 7.6 35.0 1.84 10.63 5.78 T 8 27.1 32.7 2.9 23.9 1.84 9.90 5.38 Non-Ferrous Metals Pu 2 46.1 37.3 12.9 17.5 3.39 5.09 1.50 Pr 3 27.2 26.8 4.0 16.3 1.10 8.13 7.36 T 5 33.5 31.6 8.1 16.8 2.15 5.67 2.63 Metal Products Pu - - - - - - - Pr 3 2.0 52.7 2.6 0.4 .52 1.14 2.20 T 3 1.9 52.7 2.6 0.4 .52 1.14 2.20 Machinery Pu - - - - - - - - Pr 9 29.6 23.9 6.7 15.6 .30 1.81 5.97 T 9 23.0 23.9 6.7 15.6 .30 1.81 5.97 Electrical Machinery Pu I 100.0 66.3 1.0 2.8 .19 .56 2.93 Pr 5 6.8 50.8 0.1 9.2 .57 2.11 3.70 T 6 11.3 57.3 0.5 6.6 .41 1.38 3.33 Transport Equipment Pu - - - - - - - Pr 13 36.3 31.3 10.3 32.3 .68 3.78 5.57 T 13 31.6 31.3 10.3 32.3 .68 3.78 5.57 Measuring Equipment Pu - - - - - - - Pr 2 27.8 35.4 2.9 6.3 .20 .50 2.51 T 2 27.8 35.4 2.9 6.3 .20 .50 2.51  - 46 - transport equipment (31.6), rubber and plastics (31.5), food (30.0), measuring equipment (27.8), iron and steel products (27.1), machinery (23.0), chemicals (20.6), leather products (15.3), cement and glass (11.6), electrical machinery (11.3), textiles (10.0), and metal products (1.9). In four cases out of nine, the rate of representation in the public sector is above 50 percent. In contrast, in all cases but transport equipment, the rate of representation in the private sector is below 35 percent. 2. SECTOR CHARACTERISTICS Table 3.1 presents some macro ratios for total manufacturing and 14 sectors. There are substantial differences among manufacturing activities and between public and private sectors in output/labor, capital/labor, capital/output, export/output, and import/output ratios. The output/labor ratios for total manufacturing in the public and private sectors are TL 5.48 million and TL 3.01 million, respectively, indicating 82.1 percent higher labor productivity in the private sector. Variation among sectors is very high. The highest output/labor ratio is observed in the case of rubber and plastics (TL 9.11 million), and the lowest is in leather products (1.94). The ratio is higher in the private sector in seven of the nine sectors where both public and private firms are represented; the exceptions are chemicals and cement and glass. For total manufacturing, the average capital/output ratios in the public and private sectors are 2.11 and .70, respectively. This implies that, on average, the productivity of capital in the private sector is three times that of the public sector. The capital/output  - 47 - ratios are higher in the public sector in all cases except in the case of textiles and electrical machinery. In the 14 sectors the capital/output ratios range from 3.08 in wood and paper products to .20 in measuring equipment. The capital/labor ratio in the public sector for total manufacturing (TL 6.35 million) is higher, on average, than that in the private sector (3.67). The situation is reversed, however, in the case of food, textiles, iron and steel products, non-ferrous metals, and electrical machinery. The low value of capital/labor ratio in the public sector in textiles (.74) is due to the revaluation of the capital stock; revaluation did not go back before 1953 although one public textile firm was established in 1851. Very high capital/labor ratios are observed in the public sector in the case of chemicals (37.25), iron and steel (9.60), and wood and paper products (9.41). The highest ratio in the private sector is in iron and steel (10.63). The sectors with relatively low capital/labor ratios (less than 2.00) are leather products (1.17), textiles (1.58), cement and glass (1.34), metal products (1.14), machinery (1.81), electrical machinery (1.38) and measuring equipment (.50). As one might expect, there is a close relationship among capital/labor, output/labor, and capital/output ratios. As indicated in Figure 3.1, the higher the capital/labor ratio, the higher is the productivity of labor but the lower is the productivity of capital. There is not much difference between the public and private sectors in value-added ratios in total manufacturing; 32.4 and 31.4 percent, respectively. Broken down by sector, however, the difference is wide, particularly in textiles, leather products, cement  Figure 3.1: CAPITAL/LABOR, CAPITAL/OUTPUT AND OUTPUT/LABOR RATIOS WoIL0RoD R6E CEIIteT IRot 1oJ-FR F1eTAL ALECTr TrQAJ% f1eASuR FOoo TExc ILE LEATI4Es c U E1d^t+ PA PC. it PLASICS GLASS STEEL METAL PRo1Ur-TS IACRI4E EQL41P EQUIP Z5 ___ K/L ... Y/L --- K/Y tot 10 10~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0 C 4  49 - and glass, iron and steel, non-ferrous metals, and electrical machinery. With the exception of food, chemicals, and cement and glass, value-added ratios are higher in the public sector. This can be explained mainly by the SEEs' privileged access to duty-free imports. A second possible explanation lies in the understatement of value-added in the private sector for purposes of tax evasion, a wide-spread practice in the Turkey. The export/output and import/output ratios for total manufacturing are 2.5 and 7.4 percent for the public sector and 10.5 and 18.9 percent for the private sector. This indicates a 4.9 percent trade deficit for the public sector and an 8.4 percent for the private sector. Although the private sector exported more than the public sector, it also imported more and therefore incurred a higher trade deficit. The import/output ratio in the public sector is underestimated, however, because the SEEs obtain many of their imports duty-free. Broken down by economic activity, the import/output ratios in the public sector are lower than in the private sector except for non- ferrous metals. There are three cases in the public sector in which the import/output ratio exceeds 15.0 percent: chemicals (17.5), iron and steel products (18.7), and non-ferrous metals (17.5). The number of such cases in the private sector is six: chemicals (27.3), rubber and plastics (16.8), iron and steel (35.0), non-ferrous metals (16.3), machinery (15.6) and transport equipment (32.3). Export/output ratios are also lower in the public sector, except for non-ferrous metals and electrical machinery. There are three cases in the private sector in which export/output ratio exceeds 15.0  - 50 - percent; textiles (17.6), leather products (35.3), and cement and glass (29.9). There is no such case in the public sector. Not all manufacturing activities exhibit trade deficit. Food and cement and glass in the public sector have a trade surplus. Those sectors with a trade surplus in the private sector are food, textiles, leather products, wood and paper products, cement and glass, and metal products. 3. DISTRIBUTION OF SUBSIDIES Table 3.2 summarizes the distribution of various subsidies between the public and private sectors and between production for export and production for domestic markets. The value of all subsidies granted to the manufacturing industry in 1981 was TL 50,506.1 million, equal to 8.8 percent of the total manufacturing production. This is equally divided between production for export and domestic markets. The value of all export subsidies is a substantial 67.8 percent of total manufacturing exports. 1/ It was mainly these generous subsidies that generated the 131.7 percent growth rate of manufactured exports in 1981 and the 55.0 percent growth rate in 1982. The interest subsidy granted to production for the domestic market is the most important single subsidy category and constitutes 48.3 percent of the total value of subsidies. It is followed in importance by the export tax rebate (21.0 percent), duty exemptions (17.9), the corporation tax reduction on export sales (7.0), the 1/ Note that this 67.8 percent is not the nominal output protection on export sales. The nominal protection on export sales includes only net export tax rebate and is discussed in the next chapter.  Table 3.2: SUBSIDIES GRANTED TO THE MANUFACTURING INDUSTRY, 1981 Public Sector Private Sector Total Value Structure Percent of Value Structure Percent of Value Structure Percent of (m.TL) (percent) Total Production (m.TL) (percent) Total Production (m.TL) (percent) Total Production Export Subsidies Export Tax Rebate 1062.8 2.7 9555.9 81.2 10618.7 21.0 Export Credit 86.4 0.2 1945.7 16.5 2032.1 4.1 Corporation Tax Reduction 1249.1 3.2 2296.5 19.5 3545.6 7.0 Duty Exemption 7026.2 18.1 2007.9 17.1 9034.1 17.9 Total Export Incentives 9424.5 24.3 3.2 15806.0 134.3 5.5 25230.5 50.0 4.4 Subsidies on Domestic Sales Investment Allowances 2055.7 5.3 730.0 6.2 2785.7 5.5 Corporation Tax Subsidy (SEEs) 3083.5 8.0 - - 3083.5 6.1 1-) Subsidy on Non-Preferential Credit - - -5016.0 -42.6 -5016.0 -9.9 Interest Subsidy 24179.4 62.4 243.0 2.1 24422.4 48.3 Total Incentives on Domestic Sales 29318.6 75.7 10.3 -4043.0 -34.3 -1.4 25275.6 50.0 4.4 Total Subsidies 38743.1 100.0 13.5 11763.0 100.0 4.1 50506.1 100.0 8.8  - 52 - corporation tax subsidy for SEEs (6.1), investment allowances (5.5), and the interest subsidy on export credits (4.1). The tax element on non- preferential credit used in non-export activities is 9.9 percent of the value of all subsidies. These subsidies for export plus domestic production are unequally distributed between public and private sectors. 76.7 percent of all subsidies goes to the public sector, for 13.5 percent of the total production in that sector. Only 23.3 percent of the subsidies are granted to the private sector, for 4.1 percent of that sector's total production. Within the public sector, 75.7 percent of the subsidies are given to domestic production and 24.3 percent to export production. 62.4 percent of total public sector subsidies are in the form of interest subsidies used in non-export activities. The second largest subsidy instrument in the public sector is the duty exemption (18.1 percent of total public sector subsidies). In the private sector, the negative subsidy on non-preferential credit is 42.6 percent of total private sector subsidies. This, compared with the substantial amount of interest subsidy granted to non- export credits in the public sector, indicates the heavy bias against the private sector in the distribution of non-export credits. Export subsidies, on the other hand, are so high in the private sector that they provide positive incentives to private firms, even after compensating for the negative interest subsidies on non-preferential credits. 81.2 percent of all subsidies in the private sector are in the form of export tax rebates. This is followed by corporation tax  - 53 - reduction on export sales (19.5 percent), duty exemption (17.1), and subsidies on export credits (16.5). Small contributions are made by investment allowances (6.2) and the interest subsidy on non-export credits (2.1). The distribution of subsidies in 1981 among the 14 sectors is presented in Table 3.3. The bulk of the interest subsidy on non-export credit in the public sector is granted to food industry (57.2 percent of total). This subsidy was given to four public firms producing dairy products, sugar, tea, and meat products. The other public sector activities which receive a heavy interest subsidy are wood and paper products, chemicals, and iron and steel products. The last two activities also receive substantial duty exemptions.  Table 3.3: SUBSIDIES GRANTED TO THE MANUFACTURING INDUSTRY BY SECTORS, 1981 (million TL) Export Subsidies Subsidies on Dom,estic Sales Corporation Corporation l-( Subsidy on Export Tax Export Tax Duty Investment Tax Subsidy Non-Preferential Interest Total Rebate Credit Reduction Exemption Total Allowances (SEEs) Credit Subsidy Total Subsidies Total Manufacturing Pu 1062.8 86.4 1249.1 7026.2 9424.5 2055.7 3083.5 - 24179.4 29318.6 38,741. Pr 9555.9 1945.7 2296.5 2007.9 15806.0 730.0 - -5016.0 243.0 -4043.0 11763.0 1 10618.7 2032.1 3545.6 9034.1 25230.5 2785.7 3083.5 -5016.0 24422.4 25275.6 506.1 Fooa Pu 70i.4 - 992.2 22.8 1716.4 - 241.4 - 16532.7 16774.1 18490.5 Pr 94.9 30.0 91.1 7.0 223.0 - - -241.4 89.0 -152.4 70.6 T 796.3 30.0 1083.3 29.8 1939.4 - 241.4 -241.4 16621.7 16621.7 13561.1 Textiles Pu 25.7 - 8.2 1.7 35.6 - 76.3 - 287.4 363.7 399.3 Pr 869.0 358.4 440.1 139.7 1807.2 90.3 - -717.7 0.7 -626.7 1180.5 T 894.7 358.4 448.3 141.4 1842.8 90.3 76.3 -717.7 288.1 -263.0 1579.8 Leather Products Pu - - - - - - 5.7 - 0.6 6.3 6.3 Pr 58.5 - 19.8 3.9 82.2 - - -11.6 - -11.6 70.6 T 58.5 - 19.8 3.9 82.2 - 5.7 -11.6 0.6 -5.3 76.9 Wood and Paper Products Pu 15.6 - 13.8 143.7 173.1 - 142.0 - 3953.0 4095.0 4268.1 Pr 69.5 51.5 52.5 126.7 300.2 49.0 - -53.3 - -4.3 295.9 T 85.1 S1.5 66.3 270.4 473.3 49.0 142.0 -53.3 3953.0 4090.7 4564.0 Chemicals Pu - 86.4 49.3 3128.8 3264.5 - 430.7 - 1643.8 2074.5 5339.0 Pr 357.9 131.4 178.9 147.8 816.0 - - -702.0 48.9 -653.1 162.9 1 357.9 2117. 22M.2 3276.6 4080.5 - 430.7 -702.0 1692.7 1421.4 5501.9 1 Rubber and Plastics Pu - - - - - - - - - - 4 Pr 178.2 135.2 182.9 231.0 727.3 - - -641.0 - -641.0 86.3 1 T 178.2 135.2 182.9 231.0 727.3 - - -641.0 - -641.0 86.3 Cemnt and Glass Pu 76.8 - 40.3 - 117.1 - 12.0 50.7 - 62.7 179.8 Pr 937.8 302.7 382.5 25.0 1648.0 216.0 - -112.9 - 103.1 1751.1 T 1014.6 302.7 422.8 25.0 1765.1 216.0 12.0 -62.2 - 165.8 1930.9 Iran and Steel Products Pu 38.2 - 21.4 2780.6 2840.2 2055.7 34.4 - 1033.3 3123.4 5963.6 Pr 286.9 134.4 118.5 89.0 628.8 - - -307.5 88.1 -219.4 409.4 T 325.1 134.4 139.9 2869.6 3469.0 2055.7 34.4 -307.5 1121.4 2914.0 6373.0 Nn-Ferrous Metals Pu 205.1 - 119.6 974.7 1299.4 - 4.6 - 677.9 682.5 1981.9 Pr 75.9 51.6 57.8 170.6 355.9 121.2 - -306.3 - -185.1 170.8 T 281.0 51.6 177.4 1145.3 1655.3 121.2 4.6 -306.3 677.9 497.4 2152.7 Retal Products Pu - - - - - - - - - - - Pr 22.7 10.0 10.3 0.1 * 43.1 - - -37.0 - -37.0 6.1 T 22.7 10.0 10.3 0.1 43.1 - - -37.0 - -37.0 6.1 Machinery Pu - - - - - - - - - - Pr 75.9 2.2 35.2 5.0 118.3 - - -151.0 - -151.0 -32.7 T 75.9 2.2 35.2 5.0 118.3 - - -151.0 - -151.0 -32.7 Electrical Machinery Pu - - 4.3 0.9 5.2 - 80.3 - - 80.3 85.5 Pr 564.2 103.1 180.0 179.5 1026.8 - - -545.9 - -545.9 480.9 T 564.2 103.1 184.3 180.4 1032.0 - 80.3 -545.9 - -465.6 566.4 Transport Equipment Pu - - - - - - - - - - - Pr 1233.9 635.2 460.5 882.6 3212.2 253.8 - -1188.0 16.3 -917.9 2294.3 T 1233.9 635.2 460.5 882.6 3212.2 253.8 - -1188.0 16.3 -917.9 2294.3 Measuring Equipment Pu - - - - - - - - - - Pr 0.3 - - - 0.3 - - -0.4 - -0.4 -0.1 T 0.3 - - - 0.3 - - -0.4 - -0.4 -0.1  - 55 - CHAPTER IV THE INCIDENCE OF PROTECTION AND INCENTIVES IN TURKISH MANUFACTURING: AGGREGATE RESULTS 1. INTRODUCTION The incentive and comparative advantage cofficients, estimated for 123 firms (19 public and 104 private), were first aggregated into 66 sectors. They were then aggregated into 14 sectors and finally into total manufacturing. For each level of aggregation, the results were broken down by ownership (public and private) and by market destination (domestic and export). The results will be evaluated in two chapters. This chapter aims to provide an overall picture of the protection and comparative advantage in Turkish manufacturing, with particular reference to the relative incidence of the system of incentives on the public and private sectors and on domestic and export sales. Sectoral details will be avoided. The main emphasis of this chapter will be on total manufacturing and on the 14-sector aggregation. Evaluation of the 66- sector results will be taken up in the following chapter. The sensitivity of the estimated coefficients to prices and the difficulty involved in estimating world prices are well known. Although maximum care has been given to obtain the best available data, the possibility of errors, particularly in estimates of world prices, still remains. The conclusions, therefore, should be taken with caution and the reader should be forewarned against drawing facile deductions from the evidence presented.  - 56 - But before these results are presented, two points need mentioning. First, the nominal protection coefficients (NPCs) are estimated through price comparison: they are not adjusted for the quality differentials between domestic and foreign products. Quality differentials should normally be obtained from the users of the products. But deciding the differentials involves a high degree of personal judgment and therefore introduces subjectivity in data. Besides, it is a highly time-consuming work and would have considerably delayed the completion of the project. It was decided, therefore, that the NPCs would be estimated by comparing prices without allowing for quality differences. Given the lower quality of most of the domestic products, the NPCs calculated from price comparisons are underestimated, since the observed price differences do not reflect the lower quality of domestic products. One should keep this underestimation in mind when one evaluates the results and drive policy conclusions. The direction of bias in the EPCs, however, is not clear because the extent of quality differentials for output and inputs are not known. Second, the evaluation of the incentive coefficients (NPCs, EPCs, and ESCs) in this and the following chapters pertains mainly to unadjusted (gross) coefficients obtained under the current exchange rate rather than to the adjusted (net) coefficients that would prevail under the hypothetical free trade conditions. Comparative advantage coefficients (DRCs and SPCs), in contrast, are presented on a net basis. To allow comparison, the incentive coefficients are also adjusted for the overvaluation of the exchange rate and presented  - 57 - separately. Adjustment is made by expressing the world market prices in terms of domestic currency at the exchange rate that would prevail under free trade conditions. This adjustment is necessary, because protection and exchange rates are interrelated. Protection makes it possible to maintain a balance of payments equilibrium at a lower exchange rate than the rate that would have existed under free trade. But the lower the exchange rate, the lower will be the border prices in domestic currency, and hence the NPCs provided by tariffs and QRs. It is necessary, therefore, to eliminate the existing upward bias in the incentive coefficients estimated under the current exchange rate. The net incentive coefficients are presented in Table 4.2 and briefly discussed in the text. One should note that the relative protection of one sector or one market does not change whether the overvaluation is accounted for or not. 2. GENERAL PATTERN OF NOMINAL PROTECTION The NPC expresses the effect of protective measures on the price received by a domestic producer for a particular product. It equals the ratio of the domestic producer price to the world market price. The NPCs on domestic sales and domestically produced inputs are calculated through a direct comparison of the domestic producer prices and the c.i.f import prices of equivalent products. The NPC on export sales is one plus the net export tax rebate. For imported inputs the  - 58 - NPC equals one plus the ad valorem rate of tariff. In the case of duty- free imports the input NPC is one. Output Protection on Total Sales Columns 7, 8, and 9 of Table 4.1 present the NPCs on output for total manufacturing and for the 14-sector aggregation, which are broken down by ownership and market destination. Disregarding the quality differentials, the NPC for total manufacturing is estimated at 1.32. This is an average of both domestic and export sales, and both public and private sectors. This coefficient indicates that manufacturing output as a whole enjoys a positive protection of 32 percent under the official exchange rate. The degree of protection is underestimated, however, because the quality differentials between domestic and foreign products are not considered. The degree of protection varies over sub-sectors, the highest being 1.53 for rubber and plastics and non-ferrous metals. The lowest NPC on output among the 14 sectors is 1.05, for measuring equipment. For rubber and plastics, non-ferrous metals, and transport equipment, the NPCs are higher than 1.50. The NPCs of seven sectors are between 1.25 and 1.49: leather products, wood and paper products, chemicals, iron and steel products, metal products, machinery, and electrical machinery. Only for food, textiles, cement and glass, and measuring equipment are the output NPCs as low as 1.00 to 1.24. Thus, in 10 sectors out of 14 sectors the NPCs exceed 1.24. These are thie basic intermediate ar,d capital goods producing sectors. High output protection ini these sectors is certainly detrimental, particularly to  TaWc 4.1:- loi cai3rs of Iien4ves oac4 Cooiparq4-v Advan~aj-c_ (rurhkc. 1is() --- rwnlfa#urlini 7o+~a aviaf 1i-Scc4or Ajqcjx4ohi I ~~~~~~~~~~~~~~~~~~~~N P C IFWPA,5IAL OUTPUT INPUT EPC EC DR. 1 pC SPC PROFITAGM,~ly 5.ECTOA S ECTOR NIU.or CPCT* CODE Spec~itcATION FIRM5s Ot.IO. Emp. UTIL . DOM4.I EXP-. TOTA L Doll. IEXP. TOTAL D0OM. EXP'. TOTAL DOMl EY-P. TOTAL AtTOAL FULL ACTUAL FULL HIS.C RxV.C. ____Total l.lnufdfacutif5 i9 P. 95-g9: .-78 2 1.2. 107 1.25 1.08 1.08 1.08 2.o2 /.o4 1.97 12.4 1 . 8 2.43 3.76 2,.Z1 .007 .015 .o -.012 _______ ________________ 104lo Pr 542S'`O .'7 1.43 1.07 1.37 1.31 I. 1q 1.30 1.86 .92 I. 1 7? 7 I 2i. ZB 70 I. 42 1.7 1.042. .0"4 .200 .074 ______ 123~~~~~~~~~)S T I419?39 .71. 1.34 .0 .2 1.20 1.17 1.20 1.93 .94- 1. 81 2 19 1357 2.01 2.04 1.82 . Oi5 .033 .100 .014 31 ______4___Pu 4$2 III -So 1.02 1.07 1.08 1.08 1.)08 1.08 1.13 1.04 11.13 1.77 1.94 I.-7 2.01 1.35 .028 .07o . ai4 .00k, 10 P 24' . -S 1.1) 1 .04 1.lS' 1.04 1.0i1 1.04 i.SL 1.13 1 .o I86.3 157 ~ __ ____ ..Z2 ______ I 14 1.10 ~~~~~~~~~~50szi,o.0 11 1.07 1.05 I.06 .2 ____ 2.1 J. 73 Il . {)-4 .7 1.29 .07s ____ .018 .1~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~L 321,322 Te (f I t-s 4 Pu 644k. .83 1.27 .-03 1.24 1.18 I1.04 1I.189 1.38 1.02 1.27 .4-f5 1.17 1.45 .95 .8? .l40 .147 .2314 .148 _________________ is TP 18173 .2 1.28 7 0 1.23 1.23 Io9 1.0 1.29 1.329 5 1.21I 1.23 1.18 i. zz 2. 2 .83 .138 .144 .-204 .090 _________________ II 7 19 - . _ __ ___ _7 12 - 1.03 1.4 12 I0 .1 13 ? 1.2 6 1.31 1.18 1.21 .13 .85 .138 - I 5 .2.11 .101 32s, 3 2 4 Le0 ec+ P(Odcius I P 1 0__ .88 [-Si- I-s I 31.31 ~ l.f - . 1.8- - 1.87 1.17 ).S? -.07o -.0 .033 . O24 _________________ ~~3 Pr j5 .66 1 13 1. o7 1.12. 1.11 1.10 1.11 .-18 1.07 I 1.1 2. . 15' 1.13 .97 .84 .12.2 .l5S4 . 1157 .087 _______ _________________ 4 T I~~~~~~~~.7 .37 01 .?4 1 .22. 1.10 1.21 I. 1 .07 l.1l~ .151_ I l~ .4 .0 01 .077 .042- 2712 1.3 J417- 1.- . 3734'(j +Paper PrO 2 PU I4 .7 )15 1.05 5 I l 1.31 1..__ 1_ _0 __ .4 2.47 3.30 3. 50 __ I5.4 1 3.82.-.olo -.010 .014 .043j 1174 4 1.I 1*5 ,58 .T?1 1.41 1.58 .3 1+ ;.40 I.+4 0o4 .04 .