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Report No.

54123-TR

TURKEY
Investment Climate Assessment
From Crisis to Private Sector Led Growth

May 2010

Europe and Central Asia Region


CURRENCY EQUIVALENTS
Currency Unit – New Turkish Lira (TL)

EXCHANGE RATE
May 12, 2010 TL 1.53= USD 1.00

WEIGHTS AND MEASURES


Metric System

FISCAL YEAR
January 1 – December 31

Vice President : Philippe H. Le Houerou


Country Director : Ulrich Zachau
Sector Director : Fernando Montes-Negret
Gerardo Corrochano
Sector Manager : Lalit Raina
Task Manager : Donato De Rosa
ACRONYMS AND ABBREVIATIONS

ABGS Secretariat General for EU Affairs


ABİGEM EU Turkish Business Centers
ACTAL Dutch Advisory Board on Administrative Burden
BILGE Computerized Customs Activity
BRSA Banking Regulation and Supervision Agency
CBRT Central Bank of Turkey
CC Commercial Code
CEDPL2 Second Competitiveness and Employment Development Policy Loan
CGF Credit Guarantee Fund
CIF Cost, Insurance & Freight
CMB Capital Markets Board
CPRR Japanese Council for the Promotion of Regulatory Reform
DA Development Agency
D&Q Design and Quality
DB Doing Business
ECA Europe and Central Asia
EFCAS Enterprise Financial Crisis Assessment Survey
EIF European Investment Fund
ES Enterprise Survey
EU European Union
EURADA European Association of Regional Development Agencies
FDI Foreign Direct Investment
FOB Free on Board
FX Foreign Exchange
GDP Gross Domestic Product
GERD Gross Expenditures on R&D
GoT Government of Turkey
GOV Governance
GVA Gross Value Added
GVC Global Value Chains
IAC Investment Advisory Council of Turkey
ICA Investment Climate Assessment
ICS Investment Climate Survey
ICT Information and Communication Technologies
IFRS International Financial Reporting Standards
IIPR Intellectual and Industrial Property Rights
ISE Istanbul Stock Exchange
ISO International Organization for Standardization
ISPAT Investment Support and Promotion Agency of Turkey
JASME Japan Finance Corporation for Small and Medium Enterprises
KADIM Struggle against Unregistered Employment Project
KKB Credit Bureau of Turkey
KOSGEB Small and Medium Enterprises Development Organization
KSS Small Industrial Estates
MAS Manufacturing Advisory Services
MEKSA Training and Small Industry Support Foundation of Turkey
MEP Manufacturing Extension Partnership
MLT Medium- and long-term
MNC Multinational Corporation
MPM National Productivity Center
MTP Medium Term Program
NIS Networks and Innovation Survey
NPAA National Plan for Adoption of the Acquis
NPL Non-Performing Loans
NSC National Steering Committee
OECD Organization for Economic and Cooperation Development
OLS Ordinary Least Squares
OSB Organized Industrial Zones
PMR Product Market Regulation
R&D Research and Development
RIA Regulatory Impact Analysis
SBA Small Business Administration
SCM Standard Cost Model
SIC Standard Industrial Classification
SME Small and Medium Enterprise
SPO State Planning Organization
TASB Turkish Accounting Standards Board
TESK Merchants and Artisans Confederation of Turkey
TFP Total Factor Productivity
TFRS Turkish Financial Reporting Standards
TOBB Union of Chambers and Commodity Exchanges of Turkey
TOSYOV Small and Medium Industry Owners and Managers Foundation of Turkey
TPI Turkish Patent Institute
TSI Turkish Studies Institute
TUBITAK Scientific and Technological Research Council of Turkey
TÜRKAK Turkish Accreditation Agency
TURKSTAT Turkish Statistical Institute
USPTO United States Patent and Trademark Office
VEDOP Tax Offices Automation Project
WDI World Development Indicators
WFE World Federation of Exchanges
WIPO World Intellectual Property Organization
YOİKK Coordination Council for the Improvement of the Investment Environment
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ACKNOWLEDGMENTS

This report was prepared in close cooperation with the YOİKK Secretariat. Preliminary and intermediate findings
of the report were presented to YOİKK Steering Committee meetings on June 11 and November 13 2009.
Intermediate findings were presented to various stakeholders in a series of roundtables held in November 2009.
The World Bank team also performed field visits to Izmir and Adana, where it greatly benefited from discussions
with local stakeholders.

The World Bank team was led by Donato De Rosa and included Dragana Pajovic, Paulo Correa, Murat Şeker,
Federica Saliola, Delia Rodrigo, Carlos Piñerúa, Jorge Peña, Alvaro Escribano, Manuel de Orte, Barış Dinçer, İrem
Güçeri, Selma Karaman, Ayşe Seda Aroymak, Zeynep Lalik, Erkan Erdil, Murat Uçer. The report was undertaken
under the guidance of Ulrich Zachau, Fernando Montes-Negret, Gerardo Corrochano, Lalit Raina and Keiko Sato.
Indispensable contribution and insight came from İbrahim H. Çanakcı, Undersecretary of Treasury, Cavit Dağdaş,
Deputy Undersecretary of Treasury, Berrin Bingöl, Murat Alıcı, Mehmet Dündar, Özge Dumlupınar, Serenay
Usta, Gamze Özdurgutlu, Gönül Bakır Kartal, Bahar Konak, Başak Ünal and Can Gürlek (Undersecretariat of
Treasury team). In addition to the Treasury team, recognition is extended to all YOİKK member institutions. Willem
van Eeghen and Stefka Slavova (World Bank) and Rauf Gönenç (OECD) were peer reviewers for the report. In
addition, the team received helpful comments and suggestions from Mark Roland Thomas, Cihan Yalcin, Kamer
Karakurum-Özdemir, Mediha Ağar, Muammer Kömürcüoğlu, Jesko Hentschel, Cristobal Ridao-Cano, Raif Can,
Steen Byskov, Jean-Louis Racine, Cemile Hacıbeyoğlu, Andres Federico Martinez, Mahesh Uttamchandani and
Anthony Ody.
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Investment Climate Assessment

TABLE OF CONTENTS
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EXECUTIVE SUMMARY

This Investment Climate Assessment draws on the analysis of firm-level survey data collected during April
2008-January 2009, supplemented by other sources, to provide a comprehensive and up-to-date description of
the investment climate facing Turkish firms of all size classes, including the impact of government regulations
and recent reforms. An important feature of the analysis is extensive use of data from comparable countries
to benchmark Turkey’s performance. Beyond description, the report seeks to identify key priority areas where
further policy reform and institutional development could help strengthen Turkish firms’ performance in such
areas as productivity, export competitiveness and employment creation. A special aspect of the report is its focus
on Turkey’s small and medium scale enterprise (SME) sector.

Since late-2007, global conditions have taken their toll on the Turkish business sector. Turkey’s economy
contracted by 4.7 percent, with unemployment reaching 14 percent in 2009. Sustainable growth in the post-crisis
environment will require continuation of reforms aimed at promoting healthy business sector development.

Continued commitment to business environment reforms will help support a sustainable recovery. Building
on recent reforms, actions to improve the regulatory framework need to be sustained to reduce incentives for
firms to remain informal. Business registration has been simplified, but administrative procedures still impose a
high “time tax” on firms. Improved availability of skilled labor will be crucial for improving productivity. Sustained
encouragement of firm-level innovation would also have positive effects on enterprise performance. The
availability of credit to the corporate sector, especially SMEs, has been negatively affected by the crisis. With a
competitive global environment expected in the post-crisis period, the report identifies three priority areas to help
the economy achieve sustainable, broad-based growth that incorporates SMEs and is more evenly distributed
across the country.

A first key priority is to alleviate the, mainly financial, obstacles that constrain SMEs’ growth, thus preventing
the largest portion of the enterprise sector from reaping scale economies. A healthy SME sector could improve
employment opportunities and promote regional development. SMEs grow more slowly than micro or large firms
in Turkey, unlike SMEs in comparator countries. Existing policies and regulations may impact SMEs more than
either micro or large firms. Access to finance appears to be the single most important constraint to SME growth.
Enhancing banks’ ability to assess borrowers’ creditworthiness, plus a more active Credit Guarantee Fund, should
help ease lending to SMEs.

A second priority is to increase Turkish SMEs’ competitiveness by enhancing their ability to adopt and use
knowledge. Diffusion of the sources of growth beyond firms that are already sufficiently competitive to be direct
exporters (and beyond already-successful manufacturing poles) will increase Turkey’s resilience to future
external shocks in global demand and ensure that the productive base of Turkish manufacturing is more evenly
distributed geographically. The local business and institutional environment combines with country-wide features
to determine firms’ incentives to adopt innovative modes of production and organization. Analysis of Turkish
production networks indicates that the absorptive capacity of local suppliers is key for successful participation in
global markets. Existing government programs aimed at increasing the operational capabilities and absorptive
capacity of SMEs could be improved at the local level in line with international best practice.

A third priority is to further reform and strengthen the regulatory capacity of the government. Turkey’s recent
important steps in establishing institutions and mechanisms for regulatory reform could be made more effective
by refining their strategic vision, improving horizontal and vertical coordination, and enhancing consultation with
the private sector. The establishment of Development Agencies (DAs) offers an opportunity to ease investment
climate constraints through actions at the local level.
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OVERVIEW AND POLICY OPTIONS

1. Since late-2007, adverse changes in global conditions have taken their toll on Turkey’s previously booming
economy and business sector. Prior to the global economic crisis, Turkey’s economy had been thriving. Following
the 2001 banking crisis associated with a sharp recession and a restructuring of the financial sector, Turkish
GDP growth averaged nearly 7 percent per annum between 2002 and 2007. An important engine of growth was
private investment, in part driven by large capital inflows, which contributed to a trebling of private sector Gross
Fixed Capital Formation between 2002 and 2008. Since 2008, though, the external economic environment has
deteriorated markedly, with falls in external demand and international capital flows – and associated declines in
domestic demand and credit availability. Turkey’s economy is expected to contract by 6 percent, with unemployment
estimated to have increased to 14 percent in 2009. The corporate sector, in particular, has been hard hit by the
slowdown in global demand. A survey carried out by the World Bank in the summer of 2009 shows that most
enterprises experienced a sharp contraction in sales, with reported declines between 2008 and 2009 in the region
of 40 percent. Almost half of the firms surveyed (46 percent) reported restructuring their liabilities, while one-
third delayed payments to tax authorities and suppliers.

Tough global conditions heighten the need to attack constraints to firms’ productivity and growth.

2. Turkish firms cite a number of external constraints to their own performance. According to a survey
conducted between April 2008 and January 2009, a majority of Turkish firms see themselves as held back by
problems with access to finance (some 26 percent of firms cited this as their single most important constraint).
Tax rates (18 percent) and political instability (18 percent) rank second and third, while other important factors
are competition from the informal sector and an inadequately educated workforce (15 and 9 percent respectively).
Analysis of survey data confirms a significant association between the quality of the investment climate and
performance in areas like productivity, job creation, export competitiveness and attractiveness for foreign
investment. Productivity analysis shows that almost one-third of variation in the performance of the business
sector in Turkey is explained by investment climate factors.

Figure 1: Top Five Investment Climate Obstacles

Source: Turkey ES 2008

3. The regulatory environment is the area of the investment climate with the largest relative contribution to
productivity. Other relevant investment climate areas include infrastructure bottlenecks, access to finance and
corporate governance, the availability of skilled labor and innovation. Aggregate productivity in Turkey appears to
have increased since 2005, driven by improved allocation of resources towards firms with higher productivity. This
has widened the gap between low and high productivity establishments, with larger firms appearing to benefit
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from the more positive aspects of the investment climate and smaller and less productive firms bearing the costs
of its less positive features.

4. Analysis of survey data indicates that firm-level productivity in Turkey is negatively associated with a
number of features of the regulatory environment. Some of these include formal bureaucratic requirements,
such as the number of inspections to which businesses are subjected, the number of compulsory certificates
required and the time necessary to obtain them, as well as time consuming customs procedures for imports.
Burdensome regulatory requirements constitute fertile breeding ground for the negative consequences of cor-
ruption, as it is exemplified by the negative association between productivity and informal payments to obtain
power supply or a contract with the government. Inefficient regulations also provide incentives for firms to remain
partially informal. Firms that are subject to competition from informal establishments are, in turn, associated
with lower levels of productivity.

5. Problems for Turkish firms posed by tax rates and tax administration seem to have declined in importance
since 2005, at least partly reflecting the impact of recent reforms. When examining firms’ perceptions, the
relative importance of tax rates in a ranking of obstacles has dropped, from being the largest obstacle in 2005, to
where a relatively low 18 percent of firms in 2008 perceived tax rates as the single most relevant impediment to
business operations. The share of enterprises identifying tax rates as a major or very severe constraint decreased
from 81 percent in 2005 to 50 percent in 2008. Tax administration, viewed as a major constraint by 59 percent of
manufacturing firms in 2005, had dropped to 19 percent by 2008. These improvements between 2005 and 2008
can, at least in part, be ascribed to tax reforms introduced since 2006. Notable among the reforms are the intro-
duction of a new corporate tax code, the reduction of corporate income tax from 30 to 20 percent, and lower taxa-
tion on interest. On another front, despite the lower tax rates introduced with recent reforms and the fall in the
headline measure of informality – from 53 percent to 44 percent between 2004 and 2008 – the share of surveyed
firms complaining about informal competition increased from 44 percent in 2005 to 52 percent in 2008.

Figure 2: Share of firms facing informal competition

Source: Turkey ES 2008

6. Turkey has made significant reforms in some areas of the regulatory climate, including easing business
registration, but red tape still imposes significant costs on businesses. The Government has made progress to-
wards facilitating the process of business registration. According to Doing Business 2010, recent Turkish reforms
have reduced the time it takes to register a business from 13 required steps in 2004, down to six steps in 2009.
The Government has initiated e-Judicial Registrations and Online Company Registration procedures, with a draft
act currently being evaluated by the Prime Minister’s Office and expected to be adopted in the National Assembly
in early 2010. Manufacturing firms interviewed in the 2008 enterprise survey reported that the time it takes to
acquire an operating license had decreased from 66 days in 2005 to 62 days in 2008. Even after the improvement,
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though, this is still higher than in comparator countries. More broadly, compliance with administrative proce-
dures remains problematic for business operation. There is no clear framework for streamlining administrative
procedures for businesses, and operating licenses are issued by various Ministries, each responsible for different
business areas. Additionally, in overall terms the perceived ‘time tax’ – the share of management time spent deal-
ing with government regulation – appears to have increased sharply since 2005, from 9 to 27 percent. The time tax
is largest for medium and large enterprises (32 percent and 34 percent respectively), whereas managers in small
firms report spending 23 percent of their time dealing with red tape.

Figure 3: The ‘time tax’

Source: Turkey ES 2008

7. A specific area of improvement has been in the cost and time invested in construction of business premis-
es. According to the Doing Business’ measure of the time involved in building a warehouse, Turkish firms were
able to shorten their average site development time by 44 days between 2005 and 2009. This said, the time to
obtain building permits varies significantly between Turkish cities, with firms in Istanbul seeming to struggle with
construction permits more than firms located elsewhere. Additionally, a variation is notable by firm size, with
SMEs spending nearly twice the time as large firms dealing with construction permits (60 versus 32 days).

8. Business inspections appear to be somewhat less burdensome in Turkey than in comparator countries. The
average time all employees in a company spend with inspections per year is 6.6 days, which puts Turkey ahead of
several comparator economies. The survey results are similar when firms are asked about the number of inspec-
tions taking place in their organization: the average annual frequency of inspectors’ visits has diminished from 4
in 2005 to 2 in 2008. When examining the time that each firm spends on inspections, medium size firms seem to
be more affected. Additionally, regional comparisons show significant variations in inspection times and duration.
In general, the large regional variations observed for licenses, permits and inspections are a consequence of the
fact that municipalities, often lacking adequate capacity, are frequently responsible for implementing regulations
that are established at the central level. This institutional setup tends to create a burden for businesses and indi-
viduals, when having to comply with procedures established locally without prior agreement at the central level.

Better availability of skilled labor would help improve Turkish firms’ productivity.

9. Firms with a higher share of staff with university education tend to show higher productivity, according to
econometric analysis. Survey results show that larger firms are in a better position to afford skilled staff with
university education.

10. Education levels in Turkey lag behind other OECD countries. OECD data show that 26 percent of the Turkish
adult population holds secondary education diplomas. This is well below the OECD average of 69 percent and
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the EU19 average of 70 percent. Graduates with tertiary education in Turkey are also scarce, and the entry rate to
higher education programs (tertiary education) is low by international standards. Only 29 percent enroll in higher
education in Turkey, compared to a 56 percent average in the OECD countries. Nearly a quarter of Turkish firms
rate the education and skills levels of the workforce as a “major” or “very severe” constraint on operations and
growth (See Figure). Although this is an improvement from the 33 percent in 2005, the high rate still requires the
attention of policymakers and shows that measures need to be taken to better coordinate labor supply with the
demands in the business sector.

Figure 4: Education of workforce as an obstacle

Source: Enterprise Surveys 2008

11. The share of Turkish firms offering formal training to their employees has increased slightly. Some 24
percent of manufacturing businesses reported offering training to their employees in 2005, and this number had
risen to 29 percent three years later. The share of large firms offering training is three times higher than that
among small businesses. Enterprises with exporting activities are also more active in offering training to work-
ers.

12. Turkey’s rate of labor force participation, at less than 50 percent, is low by international standards and has
decreased somewhat since 2005. This places Turkey around 20 percentage points below OECD and EU-15 aver-
ages. The employment rate for women is particularly low, standing at 26.7 percent in 2007, far below the OECD
and EU-15 averages of 61.3 percent and 65.3 percent respectively. The 2008 Enterprise Survey shows that on
average only 16 percent of production employees and four percent of non-production employees are female.

13. The 2008 survey found firms in Turkey less likely to regard labor regulations as a serious obstacle than
they had been in 2005, probably an effect of the timing of the survey. Turkey’s score on this indicator appears
to have improved substantially vis-à-vis the average for the Europe and Central Asia region. The survey results
require cautious interpretation, however, as the inflexibility of labor regulations is still mentioned by enterprises
in face to face interviews as the overarching constraint facing firm operation and growth. While firms’ perceptions
in the 2008 survey might have been influenced by labor reforms initiated in early-2008, it is also possible that the
timing of the survey (from April 2008 to January 2009) found business more preoccupied with other, more imme-
diate issues – e.g. loss of market share requiring downsizing or problems with access to finance – thus decreas-
ing the perceived relative importance of labor regulations. These concerns may resurface as a major constraint
for sustainable recovery.

Productivity and exports would benefit from policies encouraging innovation.

14. Turkish firms that invest in Research and Development (R&D) tend to show higher productivity levels, ac-
cording to analysis of the 2008 survey of Turkish enterprises. Firms that had re-organized production processes
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to take advantage of outsourcing were also found to be more productive. Employment, exports and FDI are all
positively associated with innovation at the firm level. Econometric analysis also points to a positive association
between employment levels and the use of ICT in communication with customers and suppliers. Firms with qual-
ity certifications are also more likely to have a larger workforce. Finally, there is a significantly positive correlation
between variables reflecting innovation (such as quality certification and the use of ICT) and the probability of
exporting.

15. Turkey’s total investment in R&D has nearly doubled over the past ten years, reaching 0.73 percent of GDP
in 2008. This is also reflected in the relative high number of Turkish firms (23 percent) that perform R&D expen-
ditures (See Figure).Nonetheless, Turkey still lags behind other middle income countries and the OECD, which
presented an average of 2.29 percent in 2007, compared to 0.71 percent for Turkey in the same year.

16. Turkey’s application of international quality standards (ISO 9001) has shown remarkable improvement over
the past decade, with more than 13,200 certificates issued by the end of 2008. This performance compares rela-
tively well to that of other economies. Firm surveys in 2008 found 30 percent of Turkish firms reporting having an
internationally recognized quality certification. This puts Turkey ahead of other middle-income countries, such as
Brazil (26 percent), Bulgaria (20 percent) and Poland (17 percent). Certifications among small firms lag far behind
medium and large companies: about 55 percent of large firms hold a quality certification, which is three times the
share of small firms.

Figure 5: Share of firms with R&D spending

Sources: Enterprise Surveys

17. The Government has taken steps to encourage the use of ICT. With the implementation of the e-Transfor-
mation Turkey Project, the expansion of ICT in public services has received a boost. The Government has also
stepped up initiatives to raise awareness of ICT among citizens and businesses. Further support is planned for
enterprises in their use of ICT, as well as increased competition in the electronic communication sector.

Credit availability to firms, especially SMEs, has suffered during the crisis.

18. Turkish firms with good access to finance tend to show higher productivity. Analysis from 2008 indicates that
higher productivity was related to several variables representing financial soundness (e.g., firms with a higher
share of sales paid for before delivery, and firms with the ability to finance a higher proportion of fixed assets
purchases with internal funds).

19. Turkey’s financial sector is relatively small by comparative standards. According to a recent study by the
Banks Association of Turkey, the ratio of financial assets to GDP in 2007 was 150 percent in Turkey, compared
to 246 percent for emerging market economies and a global average of 421 percent. This said, according to the
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2008 enterprise survey, 57 percent of Turkish firms had access to a loan, which compares fairly well to other mid-
dle income economies (see Figure). Nonetheless, firms of all size categories perceive access to finance as their
single most severe obstacle, with medium-sized firms appearing to be particularly affected (34 percent), followed
by micro (26 percent), small (24 percent) and large firms (19 percent). Turkish firms rely more on bank loans for
investment financing (38 percent) than do firms in other countries. This is especially true for medium-sized firms,
for which bank finance accounts for 47 percent of total investment funding. Collateral requirements appear par-
ticularly onerous for SMEs, compared to both micro and large firms, amounting to 100 percent of loan value for
small firms and 91 percent for medium firms. The share of loan applications that is rejected is also substantially
higher for SMEs (17 percent) compared to large firms (12 percent).

Figure 6. Share of firms with loans

Source: Enterprise Surveys

20. The credit crunch following the global financial crisis has affected lending to the SME sector. Starting in late
2007, SMEs’ share in total credit declined by about 5 percentage points to just over 20 percent, while SMEs’ share
in total corporate credit dropped from about 52 percent to some 44 percent. While growth in total banking sector
credit remained relatively high until the escalation of the global crisis in late 2008, SME credit growth started to
decelerate as early as the beginning of 2008. Between December 2006 and November 2009, cumulative growth in
SME credit amounted to some 35 percent, which was only about half the rate of growth in other (non-SME) cor-
porate credit. Non-performing loans SMEs rose from below 4 percent in the middle of 2008 to almost 8 percent.

Actions in three priority areas will support broader-based growth that incorporates SMEs and is better distrib-
uted geographically.

A first key priority is to alleviate the, mainly financial, obstacles that constrain the growth of Turkish SMEs.

21. Difficult access to finance prevents the largest element in the Turkish enterprise sector from reaping scale
economies. SMEs account for 79.4 percent of employment, 44.6 percent of total investments, 25-30 percent of
total exports, 57.3 percent of total value added and 25 percent of bank credit (indeed, given data limitations and
the size of the informal sector, the contribution of SMEs to the economy may well be somewhat underestimated).
Given SMEs’ scale, the development of a more productive and more outward-oriented SME sector is a crucial
development challenge for Turkey. A healthy SME sector can not only provide increased employment opportuni-
ties for a rapidly increasing workforce and promote regional development, but is also crucial to increasing the
resilience of the economy to future external shocks.

22. Turkish SMEs grow more slowly than other firms, the opposite of international experience. Analysis of firm
dynamics indicates that small (11-50 employees ) and, especially, medium firms (51-250 employees) grow more
slowly than all other size categories, with employment growth 16 percent lower than micro firms and 5 percent
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lower than large firms. This is contrary to what is observed in comparator countries, where SMEs grow faster
than large firms. Comparison with other countries also shows that SMEs in Turkey are, on average, older. This
is especially true for medium-sized firms, with 60 percent in Turkey being more than 16 years old, compared to
20 percent in the EU-10. This might indicate that SMEs in Turkey face barriers to their expansion that force them
to remain at a smaller – and suboptimal – scale of operations. By contrast, the demographics of Turkey’s large
firms are in line with values in other countries. The slower growth of Turkish SMEs suggests that existing poli-
cies and regulations may have more distortionary effects for SMEs than for either micro or large firms. It seems
likely that SMEs have neither the capacity of large firms nor the flexibility of micro firms to cope with the effects
of these policies.

Figure 7: Growth rates (percent) of Turkish SMEs relative to SMEs in other countries (2004-2007)

Source: Turkey ES 2008

23. Problems with access to finance seem to be the most important constraint to the growth of SMEs. Accord-
ing to econometric analysis, one percent more usage of external finance for investment is related with 0.3 percent
higher employment growth. The association of a loan or a line of credit with employment growth is even stronger
and is estimated to have an effect on employment growth of 33 percent.

24. Improved ability on the part of banks to assess borrowers’ creditworthiness, plus targeted interventions
to ease collateral requirements, could help ease financial constraints to SME growth. Structural measures to
enhance the ability of banks to assess the creditworthiness of SME borrowers appear necessary to help SMEs to
tap into bank credit. Such measures would include (i) encouraging the expansion of coverage of existing credit
bureaus, the Credit Registry of the Central Bank and the Credit Bureau of Turkey (KKB), and (ii) accelerating the
adoption of the new Commercial Code, in order to enable SMEs to benefit from a simplified set of financial report-
ing standards.

25. Enhancing the role of the Credit Guarantee Fund (CGF) may also help improve SMEs’ credit access. The CGF
has played an important role in facilitating SMEs’ access to credit by easing collateral requirements (especially
since its recapitalization in 2007). The new CGF model, with Treasury involvement for a period of two years, is a
positive initiative that expands the capacity of the CGF to serve the financing needs of SMEs following the credit
crunch in the aftermath of the crisis. Considering ways to make the new CGF scheme more active would, hence,
be a priority. Furthermore its scope could be enhanced to better target the needs of medium-sized firms. In fact,
since 1994, the bulk of credit guarantees provided by the CGF has benefited micro and small enterprises, with
only 11 percent of the guarantee fund being used by medium-sized firms.

A second priority is to enhance SMEs’ ability to adopt and use knowledge.

26. Access to the sources of higher efficiency needs to be extended to a wider share of firms. Turkey needs to
open up the sources of growth beyond firms that are already sufficiently competitive to be direct exporters (and
beyond already-successful manufacturing poles). Success in this effort will increase the resilience of the Turkish
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economy to future shocks in global demand. It will also ensure that the productive base of Turkish manufacturing
is more evenly distributed across Turkish regions. Since the 1980s, the liberalization of the Turkish economy has
offered new opportunities related to the general rise in trade in intermediate goods and in international capital
mobility. Integration into global trade and investment flows has been accompanied by a significant spatial trans-
formation of the Turkish economy, characterized by the emergence of a number of new industrial agglomerations
far from the earlier manufacturing regions. These new centers are the so-called “Anatolian Tigers.” Clusters of
industries have formed in various parts of the country, with specialization in both traditional and more technologi-
cally advanced sectors, and have become the core of manufacturing and exporting activities. In response to these
developments, the government has activated a number of instruments to foster the ability of SMEs to participate
in global markets. The rationale of several such interventions has been to remove obstacles to the competitive-
ness of SMEs related to the business environment. For instance, SMEs in the manufacturing sector have been
encouraged to locate in appropriately planned “small industrial estates” (KSS) and “organized industrial zones”
(OSB) that can ease investment climate constraints by providing a number of advantages in terms of infrastruc-
ture services and regulation of business activity.

27. The local business and institutional environment combines with country-wide features to determine firms’
incentives to adopt and use innovative modes of production and organization. The availability of a research
base at the local level can, for example, encourage innovative behavior, if contacts exist between firms and local
research organizations. The availability of a skilled workforce is also highly dependent on the quality of the local
higher education and vocational training. The ease of access to bank finance is, on its part, conditional on the
development of the local banking sector, as well as on personal contacts that may facilitate relational lending
practices. Local conditions also influence the effect that the regulatory environment has on firm operations, since
a large number of operating licenses are awarded at the local level. As a result, the effects in terms of knowledge
transfer of linkages between globally connected firms and local suppliers may vary widely depending on local
conditions. Analysis of Turkish production networks indicates that the absorptive capacity of local suppliers, es-
pecially SMEs – i.e. their ability to adopt and use knowledge – is key for successful participation in global markets.
Specifically, together with a more efficient regulatory environment and easier access to finance for investment,
the availability of technical skills and capacity “to handle technology” is conducive to more knowledge-intensive
value chain arrangements.

28. In addition to wider investment climate reforms, scope exists to improve local-level programs aimed at in-
creasing the operational capabilities and absorptive capacity of SMEs. Several governmental and non-govern-
mental organizations provide support to firms, especially SMEs, with the objective of increasing their operational
capabilities and absorptive capacity. The largest government program is offered by the Small and Medium Scale
Enterprises Development Organization (KOSGEB), while the Union of Chambers and Commodity Exchanges of
Turkey (TOBB) also provides such services to its associates. Following international best practices, the govern-
ment could aim at reforming existing support programs by: (i) advancing the implementation of a flexible and
decentralized management model to better serve the needs of SMEs on a local level; (ii) ensuring that the serv-
ices on offer are not already available on market terms to SMEs, in order not to crowd out private providers; (iii)
rationalizing the services on offer to create a single entry-point which could help SMEs better understand their
business needs and opportunities; (iv) expanding the scope of support schemes beyond micro firms to better
cater to the needs of larger SMEs.

A third priority is to further reform and strengthen the regulatory capacity of the government.

29. Turkey has taken important steps to improve the regulatory environment. The Government has paid par-
ticular attention to establishing institutions and mechanisms for regulatory reform; enacting legal reforms con-
ducive to simplification of the legal framework; and introducing, through pilot projects, a number of regulatory
tools to improve the quality of regulations. In this process, achieving EU harmonization has been a key driver of
reform and Turkey has partially embraced the EU Better Regulation agenda in a number of areas. As a result,
Investment Climate Assessment
xvi

Turkey has established solid pillars of a regulatory system that have the potential to develop into a “whole-of-
government” approach to regulatory management and reform. The Coordination Council for the Improvement of
the Investment Environment (YOİKK) has become a key structure where the private sector makes contributions to
the process of improving the investment climate. The Council conducts its agenda with the help of 12 Technical
Committees working on specific issues with participation of both public and private institutions. However, the dif-
ferent responsibilities allocated to institutions are not always linked towards a single regulatory reform strategy.
This creates difficulties when it comes to establishing priorities and taking the lead for reform, and it often also
results in overlapping responsibilities within and across levels of government that make implementation cumber-
some, thus directly affecting business operation.

30. Building on recent progress, regulatory reform could aim at a clearer strategic vision, improved horizontal
and vertical coordination among levels of government, and enhanced consultation with the private sector. In
order for regulatory reform to produce substantial effects on the regulatory burden experienced by the business
sector, a number of steps are necessary. First, there is a need for support at the highest political level that is
translated into a clear, coherent and comprehensive strategy for regulatory reform (country-wide and includ-
ing all components of a regulatory system). Second, coordination among different institutions and of different
initiatives with similar objectives could be improved. Third, there is a need to link regulatory reform to clear and
measurable economic targets and objectives in the medium and long term. Fourth, capacity building across the
administration remains a crucial element for success. Efforts in different directions to train officials in the use
of modern regulatory tools testify to the need to dedicate resources to this goal. Fifth, consultation with private
sector stakeholders should be mandatory and institutionalized, with the existing YOİKK platform offering a good
starting point.

31. Complementing other reforms, the establishment of Development Agencies (DA) could offer an opportu-
nity to ease investment climate constraints by providing an interface for businesses at the local level. The Gov-
ernment, through the State Planning Organization, is currently in the process of making Development Agencies
operational, with the goal of having 26 DAs that will cover the entire country. DAs are potentially well placed to be
an interface between business and government, provided that they can preserve a light organizational structure
and remain at arm’s length from the government, with the objective of minimizing the risk of capture by local
interests. Additionally, an essential condition for DAs to be able to perform their tasks will be the existence of
internal Government regulations recognizing their formal role vis-à-vis central and local government. Looking
ahead, DAs could perform a number of useful functions. First, as already intended by the Government, they could
act as “one-window” shops. Even short of radical reform of responsibilities for the issuance of licenses and per-
mits, DAs could perform a useful facilitator role between issuing agencies and firms. Second, DAs could act as
information points for businesses, in close cooperation with TOBB as well as with Government agencies, such as
KOSGEB and TÜBITAK. The objective would be to rationalize financial and non-financial support initiatives – es-
pecially for SMEs who normally face high information costs – available at the local level. Third, the FDI promotion
function via Investment Support Offices could be carried out in close coordination with ISPAT, the national FDI
promotion agency.
Investment Climate Assessment
xvii

Summary of Policy Objectives and Options

Objectives Options

• Encourage the expansion of coverage of existing credit bureaus.


• Accelerate adoption of the new Commercial Code in order to enable
Ease constraints on the ability of SMEs to benefit from a simplified set of financial reporting standards.
SMEs to grow in size and generate • Consider ways to make the new CGF scheme more active, expand its
employment reach, and allow it to better reach the medium-sized firm segment.

• Advance the implementation of a flexible and decentralized


management model for SME support programs.
• Ensure that the services on offer are not already available on market
terms to SMEs in order not to crowd out private providers of such
Increase the “absorptive capacity” of
services.
SMEs at the local level
• Create a single entry-point for the various SME support programs,
possibly in cooperation with DAs, in order to help SMEs better
understand their business needs and opportunities.
• Expand the reach of support programs beyond micro-enterprises, to
better serve the needs of larger SMEs.

• Map current regulatory reform initiatives in a single strategic document


setting priorities and sequencing of reforms.
• Strengthen the institutionalization of regulatory reform by creating
a single oversight body for regulatory reform in the Prime Minister’s
office.
• Strengthen YOİKK’s role to improve the business environment and
advocate for regulatory reform.
• Design a comprehensive administrative simplification strategy
Improve the regulatory environment with clear objectives, targets and review criteria for lower levels of
for businesses regulation to improve the business environment.
• Improve coordination mechanisms inside the administration when
preparing laws and regulations.
• Strengthen coordination and cooperation among levels of
government.
• Make consultation with stakeholders compulsory for the preparation
of new and amended laws and regulations.
• Continue implementation of Regulatory Impact Analysis (RIA).
• Use existing e-government strategies to support regulatory reform
and simplification efforts.

Development Agencies (DAs) could serve as


• “one-window” shops, without radical reform of competences for the
issuance of licenses and permits.
Improve access to information
• information point for businesses, in close cooperation with business
on regulatory requirements and
associations with a local presence, such as TOBB, as well as with
government support programs
Government agencies, such as KOSGEB and TÜBITAK, etc.
• FDI promotion, with Investment Support Offices acting in close
coordination with ISPAT.