August 8, 2005

Document of the World Bank

Report No. 29619-TU

TurkeyPoverty Policy Recommendations(In Two Volumes) Volume II

Human Development Sector UnitEurope and Central Asia Region

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Table of Contents

ACKNOWLEDGEMENT EXECUTIVE SUMMARY OF VOLUME TWO 1 . A . B . c . 11 . 111 . A . Macroeconomic .................................................................................................................................................. v B . Health .................................................................................................................................................................. v C . Education ............................................................................................................................................................ v D . Labor .................................................................................................................................................................. v i E . Social Protection ................................................................................................................................................ v i PART I: VOLUME ONE SUMMARIZED ................................................................................................ 1 A . Data Comparability ............................................................................................................................................. 1 B . Recent Economic Developments ........................................................................................................................ 2 c . Poverty Profile .................................................................................................................................................... 3 PART 11: KEY F I N D I N G S ........................................................................................................................ 13 A . Turkey i s a Medium- to High-Inequality Country ............................................................................................ 14 B . Extreme Poverty in Turkey i s L o w 14 c . 14 D . Regional Differences are substantial ................................................................................................................ 15 E . Inequality acts as a “Brake” o n Poverty Reduction .......................................................................................... 15 F . G . Macroeconomic Indicators and Poverty ........................................................................................................... 17 PART 1II:POLICY RECOMMENDATIONS ............................................................................................ 20 A . Macroeconomic Policy Recommendations and Government Reform Program ............................................... 20 B . Health Policy Recommendations ...................................................................................................................... 23 C . Education Policy Recommendations ................................................................................................................ 26 D . Labor Market Policy Recommendations ........................................................................................................... 27 E . Social Protection Policy Recommendations ..................................................................................................... 28 References ................................................................................................................................................................... 32

Brief Summary o f Volume One ........................................................................................................................... 1

Recent Economic Developments ........................................................................................................................ ii Poverty Profile .................................................................................................................................................... ii Key Findings ...................................................................................................................................................... iv Policy Recommendations ................................................................................................................................... v

Data Comparability .............................................................................................................................................. i

................................................................................................................... ................................................................................ Poverty i s H igh Compared to European Union Countries

Poverty Projections in 2004 .............................................................................................................................. 16

List of Tables

Table 1 . Projected Incidence o f Poverty wi th Different GrowtWInequality Scenarios .............................................. 15 Table 2 . Projected Poverty Gap with Different GrowtWInequality Scenarios ............................................................ 16 Table 3 . Turkey: Poverty Projections ........................................................................................................................ 17

Box 1 . Tax Policy ....................................................................................................................................................... 22

List of Annex Tables

......................................................................... Table 1 . Inequal i ty as Measured by the Gini Coeff icient; 33 Table 2 Per Capita GDP and Poverty 34 . .......................................................................................................

This volume is a product o f the staff o f the International Bank for Reconstruction and DevelopmenVThe Wor ld Bank . The findings. interpretations. and conclusions expressed in this paper do not necessarily reflect the views o f the Executive Directors o f the Wor ld Bank. or the governments they represent .

The Wor ld Bank does not guarantee the accuracy o f the data included in this work . The boundaries. colors. denominations. and other information shown o n any map in this paper do not imply any judgment o n the part o f the State Institute o f Statistics and the Wor ld Bank concerning the legal status o f any territory o r the endorsement o r acceptance o f such boundaries .

ACKNOWLEDGEMENTS

The first volume i s ajoint report o f the World Bank and State Institute o f Statistics (DIE). This second volume i s a Wor ld Bank report. Volume One o f the Joint Poverty Assessment Report (JPAR) represents the basic findings in common between the State Institute o f Statistics and the Wor ld Bank, drawing mostly from the 2002 Household Budget Survey (HBS). Volume T w o is of Wor ld Bank authorship only, and represents the views o f the World Bank in considering Volume One and findings from previous World Bank and Turkish literature. DIE does not endorse or have any responsibility for the pol icy recommendations herein Volume Two.

Volume Two: Managed by Jeanine Braithwaite (ECSHD) with contributions o f the World Bank team members from Volume One and the ECSPE team working in Turkey. Edited by Diane Stamm (Consultant). Processed by Carmen Laurente, Jennifer Manghinang, and Gizella Dim (ECSHD).

The team benefited from comments of peer reviewers Jeni Klugman (AFTP2), Peter Lanjouw (DECRG), and Edmundo Murmgarra (ECSHD).

EXECUTIVE SUMMARY OF VOLUME TWO

The Turkey Joint Poverty Assessment Report (JPAR) consists o f two volumes. The f i rs t volume, titled Turkey Joint Poverty Assessment Report, i s a joint publication o f the State Institute o f Statistics (DIE) and the World Bank. The State Institute o f Statistics (DIE) o f Turkey and the World Bank have issued ajoint report on poverty in Turkey for the f i rs t time. The findings o f Volume One have been subject to thorough technical review by both institutions, and are considered to be joint findings.

This second volume i s entitled “Turkey: Poverty Policy Recommendations,” and i s a World Bank report. DIE does not endorse or have any responsibility for the policy recommendations in Volume Two. Additionally, the conclusions in Volume Two that are based on Volume One are attributed only to the World Bank. Volume Two consists o f three sections: (i) an Executive summary o f Volume One; (ii) key findings o f Volume One (World Bank conclusions from the analysis o f Volume One); and (iii) World Bank policy recommendations in the sectors considered in Volume One (macroeconomy, education, health, labor and social protection).

I. BRIEF SUMMARY OF VOLUME ONE

Volume One sets out a new poverty line’ methodology for Turkey as the basic measure o f poverty in the country. However, several poverty lines are calculated for the purpose o f international comparability, and comparability to the World Bank’s poverty measures using the 1987 and 1994 data. In 2002, 27 percent o f the Turkish population was poor, based on the new poverty l ine methodology detailed in Annex One o f Volume One (food and non-food consumption). However, very few (nearly zero) consumed under the food l ine or under the $1 per person per day l ine used in international comparisons (Table A.I.8 found in Vol. 1).

A. DATA COMPARABILITY

An in-depth analysis o f the 2002 Household Budget Survey (HBS) compared to that from 1994 shows that living standards in Turkey remained almost unchanged. Poverty based on the previous methodology declined gradually from 1987 to 2002, from 38.5 percent to 34.5 percent. Poverty based on the updated methodolog9 declined from 28.3 percent to 27 percent between 1994 and 2002. On the other hand, inequality marginally increased. Extreme poverty, already low, further declined from 1994 to 2002. Food poverty declined from 2.9 to 1.4 percent, while $1 per person per day poverty, depending on purchasing power parity (PPP) used, was 2-3 percent or even negligible (0.2 percent).

‘ The poverty l ine i s the minimum amount o f consumption needed for an individual or household to cover i t s basic needs for food and non-food goods. This i s the updated poverty line for 1994, but the consumption aggregate for 1994 i s the old version. For 2002,

both the consumption aggregate and the poverty l ine were the new methodology. Additional details are found in Chapter One (Data Comparisons) and Annex One (Methodology) o f Volume One.

B. RECENT ECONOMIC DEVELOPMENTS

Despite many advantages ranging fi-om its strategic location to i ts dynamic population, Turkey has not achieved the stable high growth o f leading emerging market economies. On average, the Turkish economy grew slightly under 3 percent per year over the past decade, we l l below the best performing emerging economies. Macroeconomic instability, rooted in fiscal imbalances, has played an important role in Turkey’s inability to grow as fast as other countries.

In response to the crisis fol lowing the collapse o f the crawling peg and subsequent devaluation, the Government announced a strengthened economic program in M a y 200 1. Economic activity rebounded strongly in 2002, and the recovery continued into 2003, with real GNP growth reaching 7.9 percent in 2002 and 5.9 percent in 2003. While the inventory build-up led the recovery in 2002, private consumption and investment was behind the strong growth performance in 2003. Fiscal gains were significant in 2003, as the primary surplus rose from 4 percent o f GNP in 2002 to over 6 percent o f GNP in 2003.

C. POVERTYPROFILE

Poverty in Turkey i s strongly associated with age and household composition; children and families with children are poorer than average. Poverty rates are higher for unemployed heads, and female heads, and sharply higher for illiterate heads. There i s a sharp difference in the poverty rates between rural and urban households, with rural poverty substantially greater. Poverty restricts the poor from accessing many goods and services. The poor are less able to afford discretionary expenditures. Turkey i s a middle-income country, and i ts inequality is high. Both consumption and income indexes indicate that inequality i s higher in urban areas than in rural areas, but not much. Other data confirm overwhelmingly that there is a sharp East-West divide in Turkey where Southeastern and Eastern Anatolia regions are much poorer and have sharply lower human development indicators than Western Turkey.

Education

In the 1997-1998 school year, Turkey shifted f rom f ive years o f compulsory schooling to eight. Enrollment rates increased soon after this reform, not only for the 8-year basic education cycle but also for secondary education. As a result, poor households receive a larger share o f public expenditures on basic and secondary education. The level o f public spending o n education also increased significantly after 1998, both in real terms and as a percentage o f gross domestic product (GDP). While rapid progress in recent years is encouraging, analyses o f household survey data reveal that there is significant room for further pro-poor improvements when it comes to: (i) quality o f schooling-the parents o f poor children are more l ikely to report problems with schools, and they are less likely to be satisfied with the quality o f education their children receive; and (ii) enrollments in secondary education-the poor, females, and children who do not have a secondary school in their residential area are al l substantially disadvantaged.

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Turkey’s health care delivery and financing system is fragmented and despite significant efforts, the service delivery network remains highly uneven, with major concentrations in urban areas. Bo th Household Consumption and Income Survey (HCIS) and Household Budget Survey (HBS) data suggest that over one-third (36 to 37 percent) o f the population in Turkey does not have access to health insurance, and almost half the population in rural areas remains without any coverage. Despite considerable progress achieved in the recent past, Turkey continues to rank far behind most middle-income and European Un ion (EU) accession countries o n key health indicators. Health outcomes vary significantly across regions, reflecting the uneven supply o f and access to health care in various parts. Low-income groups suffer from significant access problems. The prime reason for not seeking care when sick, or not seeking hospital admission when required, was lack o f affordability. Public expenditure o n health care grew at an average annual rate o f 7.3 percent between 1999 and 2003. Public sector spending o n health care i s skewed in favor o f the upper-income groups, particularly spending on outpatient care. The poor continue to face significant access barriers to health.

Labor

In Turkey, as in most countries, poverty is closely related to employment status and the type o f job, whereby informally employed and casual workers have a higher rate o f poverty. Education plays a key role in explaining employment and poverty outcomes. Unemployment in Turkey was 10.3 percent in 2002. There are very sharp differences in labor market participation rates between men and women, with extremely l o w rates o f female labor market participation in Turkey. Reasons for not seeking a j o b varied f rom factors relating to age or family structure (student, housewife, elderly) to disability or seasonal employment. Poverty rates o f those who had permanent employment were lower compared to those with casual or temporary jobs. Poverty was found to be sharply associated with the lack o f registration at a social security institution. The largest sector o f employment in Turkey is agriculture, which is also the sector with the highest poverty rate o f those employed in it.

Social Protection

Social protection in Turkey consists primarily o f l imited formal systems in pensions and social assistance, supplemented greatly by informal mechanisms. Formal elements o f social protection are the pension (social security) system, and the Social Assistance and Solidarity Encouragement Fund (SYDTF) and its 93 1 affiliated Social Solidarity Foundations (SYDVs). Institutional, care i s provided by Social Services and Chi ld Protection Organization (SHCEK). Turkey’s social security system is highly fragmented. The three pension programs are SSK (Social Insurance Organization), Bag-Kur (BK), and Emekl i Sandigi (ES), covering workers, the self-employed, and c iv i l servants respectively. Turkey also provides a small noncontributory benefit to those over age 65 who eam below the level o f the benefit. The pension system i s showing large fiscal losses each year and is in need o f transfers from the government to cover those losses expected to be around 4 percent o f GDP in 2004.

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The SYDTF is an extra budgetary fund financed by earmarked taxes and administered by a Cabinet Minister. The SYDTF, together with i ts local affiliates, i s the largest program o f social assistance in Turkey in terms o f number o f beneficiaries. Additional social protection programs are supported by a World Bank loan: conditional cash transfers and local initiatives. Conditional Cash Transfers (CCTs) are a national program recently introduced in Turkey with World Bank support. CCTs are payments made to the mothers o f poor children, provided they attend school or visit health clinics. Supported under the Social Risk Mitigation Project (SRMP), the Government o f Turkey has undertaken a significant expansion o f the microprojects traditionally carried out by the SYDVs with approval from the SYDTF, along with a tightening of procedures. Additionally, institutional development activities to strengthen the SYDTF , SHCEK, and DIE (especially on poverty monitoring and measurement) have been undertaken in the institutional development component o f the SRMP.

11. KEY FINDINGS

The following key findings emerged from the 2002 HBS data:

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Turkey i s a medium- to high-inequality country. The rate o f extreme poverty in Turkey i s quite low. However, the overall rate o f poverty i s high when compared to the EU, and this reflects the f irst fact on inequality. Regional differences are the major driver o f country inequality, and poverty i s highly concentrated in Eastem and Southeastem Anatolia. High and persistent inequality has constrained Turkey’s ability to benefit from growth years, while macroeconomic instability has hindered Turkey from escaping from i ts medium- to -high-inequality, relatively high overall, poverty situation.

Inequality. Turkey’s Gini for income for 2002 was 44, which i s noticeably lower than the very high Ginis in many extremely low- income countries. However, Turkey does not measure up well against Western Europe which i s substantially less unequal.

Extreme poverty. Turkey compares very favorably with low- and medium-income countries in terms o f i t s rate o f extreme poverty. Turkey has essentially a zero poverty rate for the PPP US$ l per person per day poverty line.

Overall poverty. Turkey’s poverty rate o f 27 percent i s in the midrange for most medium- income countries but i s much higher than those in the European Union countries.

Regional differences. Regional differences are the major driver o f inequality in Turkey, and by every source o f information, quantitative and qualitative, Eastem and Southeastem Anatolia are markedly poorer than Western Turkey.

Inequality/growth. As demonstrated by the growth-inequality decomposition for 1994 to 2002, inequality has held back improvements in poverty that growth would have led to in the absence of inequality. Projections for this in the future demonstrate that growth without redistribution

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would not “solve” Turkey’s poverty problem. While sustained growth i s essential for poverty reduction, if inequality i s not held back, gains from growth can fai l to significantly reduce poverty. And if inequality worsens, then gains from growth can be partly or even totally erased. Several scenarios for poverty in 2004 were calculated, depending o n inequality not worsening from 2002-2004, and these demonstrate that gains from growth could be considerable in the short run if household consumption responds quickly or fully to GDP growth.

111. POLICY RECOMMENDATIONS

A. MACROECONOMIC

The JPAR and the previous poverty assessment emphasize that the creation o f well-paying formal sector jobs is the main lever for poverty reduction in Turkey, and that macroeconomic instability has severely l imited Turkey’s attempts to reduce poverty since 1987. The Turkish Government has undertaken a variety o f pol icy reforms that are intended to promote stable economic growth which are being supported by the World Bank. These reforms will create the conditions necessary for sustained economic growth. Additionally, the Government’s reform program includes measures on strengthening the tax system, including the elimination of loopholes and increased transparency, equity, and progressivity o f taxes. The tax strategy should assist in addressing Turkey’s persistent income inequality, which has been a brake o n poverty reduction. The Government has adopted a strategy for tax pol icy reform that would bring Turkey’s tax regime in l ine with best practice in the European Union. Implementation o f the Government’s tax reform strategy is crucial for many reasons, not the least o f which would be to address Turkey’s high level o f income inequality. Decomposition and simulations demonstrated that by addressing inequality, the poverty reduction effects o f growth could be substantial. A transparent and progressive tax regime would enable Turkey to achieve other economic reform goals, such as expenditure targets for the social sectors, which in turn would help address the access issues documented in the health and education chapters o f the jo int volume.

B. HEALTH

Reforms in four areas could substantially help improve lower-income group access to health care, while contributing to an improvement o f the country’s health outcomes. These include: (a) expansion o f health insurance to assure better coverage o f low-income households; (b) undertaking steps to assure that disadvantaged areas with poor health outcomes have access to professional health care services; (c) strengthening the quality o f primary health care services, particularly in underserved areas; and (d) strengthening quality and outreach o f maternal and chi ld health services and essential preventive care.

c. EDUCATION

In order to ensure long-term economic growth and equity, there i s a need to maintain public education spending levels o f at least 4.25 percent o f GDP (which i s in fact a target stipulated in various Ministry o f National Education publications). The gross enrollment ratio for compulsory 8-year basic schooling i s 97 percent. Enrollment rates could increase even further if children of parents with little or no schooling (the demographic group most likely to be out o f school) were

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encouraged to enrol l in school. If compulsory schooling were further increased to 12 years, as mentioned in some Government planning documents, the beneficiaries would be almost exclusively f rom the most vulnerable groups. Nonetheless, the prerequisites to such a move include raising the efficiency in the utilization o f existing secondary schools and perhaps, establishing new secondary schools. The quality o f education also needs improvement especially for the poor: parents o f poor children are more l ikely to report problems with schools, and less l ikely to be satisfied with the quality o f education their children receive.

D. LABOR

Implementing the reforms o f the education system and the conditional cash transfers o f the Social Risk Mit igat ion Project (SRMP) should help more educated women to participate in the labor market in the future. Also, the literacy training and micro-project endeavors under the Local Initiatives component o f the SRMP should assist in this long-term goal. On the linkage among informal and agricultural employment and poverty, here the best pol icy recommendation is for Turkey to stay the course on macroeconomic reforms that have already led to significant real economic growth. A s the economy grows and develops, more formal and better-paying jobs will emerge f rom that growth, and these will provide the avenue for Turkey’s 27 percent poor to find better jobs that wil l enable them to escape poverty.

E. SOCIAL PROTECTION

Recommendations for reform o f pensions include: a rise in the retirement age, both in the short and long run; a rise in the number o f years o f contribution required before receiving a benefit; a reduction in the benefit accrual rate i s also required to bring Turkey in l ine with other countries; a move to wage indexing the pensionable salary in l ieu o f the current valorization by nominal GDP growth; maintaining price indexation o f pensions as dictated by the 1999 Social Security Law, in order to help contain costs; eliminating and avoiding supplementary payments to pensioners; maintaining or reducing the contribution rate; unification o f the pension schemes, both in terms o f benefit structure and in terms o f administration to improve equity and administrative efficiency; and integration o f social pensions with other social assistance benefits.

Recommendations for reform o f social assistance include: restructuring the system in one single agency/ministry responsible for determining eligibility and payment o f cash benefits (namely the SYDTF) and decentralizing service provisions to make them more responsive to local demands; financing the system adequately; improving the targeting o f social assistance; and expanding CCTs.

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PART I: VOLUME ONE SUMMARIZED

The basic data used in Volume One are from the official 2002 Household Budget Survey (HBS), conducted by DIE. Comparisons over time are made to the 1987 and 1994 off icial DIE HBS surveys. Additional qualitative information was gathered from a variety o f primary and secondary sources. Limited quantitative data from an unofficial survey o f 2001 are used as secondary sources in some o f the chapters. Administrative data from other Turkish Government agencies are also used.

The 2002 H B S sample was designed to be representative o f the population o f Turkey, and to provide reliable information needed for an urban-rural breakdown o f data. I t was not designed to be regionally representative. Thus, only qualitative data and secondary source data are used herein to discuss the regional dimensions o f poverty in Turkey. The Wor ld Bank and DIE anticipate a further jo int report on regional aspects o f poverty in Turkey, based on data from the 2003 HBS, which has a larger and regionally representative sample.

This report sets out a new poverty line3 methodology for Turkey as the basic measure o f poverty in the country. However, several poverty lines are calculated for the purpose o f international comparability, and comparability to the Wor ld Bank’s poverty measures using the 1987 and 1994 data. The basic findings for Turkey for 2002 were published in a press release by DIE (April 13, 2004), and this report provides the underlying analysis and methodology for these figures.

In 2002, 27 percent of the Turkish population was poor, based on the new poverty line methodology detailed in Annex One (food and non-food consumption). However, very few (nearly zero) consumed under the food l ine or under the $1 per person per day line used in international comparisons (Table A.I.8 found in Volume One). The analysis in this report refers generally to the new poverty l ine methodology that results in 27 percent poor. This l ine is called “complete” poverty line, and is referred to as “Total poverty” in statistical tables. Additional poverty lines and rates can be found in Annex One o f Volume One.

A. DATA COMPARABILITY

An in-depth analysis of the 2002 Household Budget Survey (HBS) compared to that from 1994 shows that living standards in Turkey remained almost unchanged. Poverty based on the previous methodology declined gradually f rom 1987 to 2002, from 38.5 percent to 34.5 percent. Poverty based on the updated methodology“ declined from 28.3 percent to 27 percent f rom 1994 to 2002. On the other hand, inequality marginally increased. Extreme poverty, already low, further declined from 1994 to 2002. Food poverty declined from 2.9 to 1.4 percent, while $1 per

The poverty l ine i s the minimum amount o f consumption needed for an individual or household to cover i t s basic needs for food and non-food goods.

This i s the updated poverty l ine for 1994, but the consumption aggregate for 1994 i s the old version. For 2002, both the consumption aggregate and the poverty l ine were the new methodology. Additional details are found in Chapter One (Data Comparisons) and Annex One (Methodology) o f Volume One.

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person per day poverty, depending o n purchasing power parity (PPP) used, was 2-3 percent or even negligible (0.2 percent).

A poverty-growth decomposition demonstrated that whi le economic growth was a ma in driving force in poverty reduction, much o f the gains from growth were offset by inequality, wh ich slightly worsened from 1994 to 2002. These conclusions should b e treated with caution in that both 1994 and 2002 were either crisis years, o r immediately fo l lowing crises, and so there was no measurement o f the effect o f sustained growth on poverty. DIE i s now conducting surveys to measure poverty annually, so the measurement problem should abate in the future.

B. RECENT ECONOMIC DEVELOPMENTS

Despite many advantages ranging from i t s strategic location to i ts dynamic population, Turkey has not achieved the high growth o f leading emerging market economies. On average, the Turkish economy grew sl ightly under 3 percent per year over the past decade, w e l l below the best performing emerging economies.

Turkey has suffered f rom an exceptional degree o f macroeconomic instabil ity characterized by high inflat ion and sharp swings in business cycles. Inf lat ion was higher and growth lower in the 1990s than in the 1980s. In this period, unsustainable fiscal po l i cy has repeatedly put pressure o n the Turkish L i r a (TL), fueled inflation, and undermined financial stability. Open capital accounts and a poorly regulated banking system have magnif ied the impact o f unsustainable fiscal po l i cy o n macroeconomic stability. Short-term capital flows have fluctuated widely as investors responded to the boom-bust cycle driven by unstable conditions.

In 2000, a crawling peg exchange rate regime was launched to rid the economy o f inflation. K e y structural reforms in social security, infrastructure, agriculture, privatization, and banking were introduced. However, these achievements were insufficient to avoid a crisis, given the extent of Turkey’s underlying fiscal and financial sector weaknesses built up over decades o f instabil ity and delayed reform.

By 2001, persistent doubts about the peg, and underlying fiscal instability, l ed to a ful l-blown speculative attack against the currency. Interest rates shot up to several thousand percent, forcing the Government to abandon the crawling peg and float the TL. The TL immediately lost 40 percent of i ts value in a single day.

In response to the crisis, fo l lowing the collapse o f the crawl ing peg and subsequent devaluation, the Government announced a strengthened economic program in M a y 200 1. The k e y structural and social elements o f the program were: (a) a macroeconomic framework designed to restore financial stability and ensure publ ic debt sustainability; (b) a rapid restructuring o f the banking sector; (c) a public sector reform program; (d) renewed privatization; and (e) enhanced social assistance.

The Turkish economy started to grow at a fast pace in 2002. Economic growth reached 5.9 percent in 2003, fo l lowing 7.9 percent growth in 2002. Whi le the inventory build-up led the recovery in 2002, private consumption and investment was behind the strong growth

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performance in 2003. The current account deficit widened to almost 3 percent o f GNP in 2003, but was easily financed by short-term capital inflows, public sector borrowing abroad and reverse currency substitution. Inflation fel l to 18.4 percent in 2003, and the latest data suggest that in mid-2004, inflation declined to the important single digit level for the f i rst t ime since the 1970s. Aggregate unemployment remained stable at around 10 percent but this was helped by a temporary shrinkage in the labor force. Fiscal gains were significant in 2003, and the primary surplus rose f rom 4 percent o f gross national product (GNP) in 2002 to over 6 percent o f GNP in 2003, close to the programmed 6.5 percent target. Monetary pol icy followed a pol icy o f implici t inflation targeting, with the Central Bank o f Turkey (CBT) occasionally intervening in the foreign exchange market to dampen what was deemed to be excessive fluctuation in the exchange rate. The decline in inflation, which was aided by the strength o f the TL, led to a commensurate decline in interest rates from a nominal 60 percent in the first quarter o f 2003, to about 25 percent early in 2004.

However, deterioration in the global financial indicators in early M a y 2004 combined with the higher than expected current account deficit figures have led to a sharp weakening in domestic financial indicators. The excess volatility in the foreign exchange market was curbed to some extent by the Central Bank’s intervention. I t appears that some relative stability has been achieved in domestic financial markets. These recent deteriorations have underlined Turkey’s exposure to shocks from the external environment. Whi le depreciation o f the TL i s an adjusting factor to the deteriorating current account balance, i t i s also l ikely to affect inflationary expectations and domestic interest rates. Higher domestic interest rates, in turn, together with the impact o f the TL’s depreciation, would influence the overall fiscal deficit and economic activity. The spillover f rom global liquidity tightening and rising spreads are likely to increase the cost o f external borrowing. Such developments, if persistent, could disrupt the virtuous cycle that the economy has experienced over the last year and a half.

C. POVERTY PROFILE

Household Size and Composition. Poverty in Turkey i s strongly associated with age and household composition; children and families with children are poorer than average. Poverty increases monotonically with additional household members, starting at three members. Larger households are poorer than smaller households, and this i s primarily due to the fact that the additional household members are more l ikely to be children, who have a higher poverty rate. Households with n o children or only one chi ld had poverty rates below the average. There i s also a correlation between having elderly members and household poverty, though this correlation i s not as marked as with having additional children. Having one more elderly member did not appreciably increase the r isk o f poverty, and having two or more slightly elevated the risk. With respect to correlation with age, younger children are poorer, active-aged adults are not as poor o n average, and the elderly are poorer than adults, but not as poor as children.

Household Head Characteristics. The household head has a substantial impact on the poverty status of h is or her household, through the employmenthact iv i ty nexus and the amount of income she or he can contribute to the household. The poverty rate for households with

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unemployed heads i s 35.4 percent, compared to 27 percent overall poverty rate. Besides this, other demographic features that are associated with poverty include whether the household head i s a female or not (32 percent poor versus 26.6 percent poor for female and male heads respectively), and the education o f the household head. Illiterate heads and those who had not completed primary school heads had poverty rates nearly twice the average, while those few with masters or other advanced degrees had a poverty rate o f zero.

Spatial Characteristics. There is a sharp difference in the poverty rates between rural and urban households; the poverty rate is nearly 35 percent for the rural population, but only 22 percent for the urban population. The factors for high rural poverty are the same as for poverty overall.

Rural areas are characterized by l imited employment opportunities, and rural households where the head i s unemployed face a substantial risk o f poverty. Other kinds o f inactivity have different implications on rural and urban areas. The major driver for rural and urban employment findings appears to be sector o f employment, where rural location i s dominated by agriculture, which offers less lucrative options compared to formal employment found in urban areas.

Education has identical effects on both rural and urban areas, whereby those who are illiterate or whose education is l imited to primary school have higher poverty rates than average, and graduates o f higher education are much less l ikely to be poor. In both areas, poverty rates steadily decrease as years o f education increase.

Non-Income Aspects of Poverty. Poverty restricts the poor from accessing many goods and services. Non-income here refers to material items, assets, or services that are ultimately obtained through income. In Turkey, there is a marked difference in the kind o f dwelling. About ha l f the sample population l ives in a house, and another 27 percent lives in apartments. Whi le individual houses are primari ly in rural areas, apartments are almost exclusively an urban phenomenon. Only 6.5 percent o f the apartment dwellers are poor, while 36 percent of those who l ive in houses are poor.

In terms o f landownership, 27 percent o f the sample population reported they had a field, but these households were poorer than average. The mean size o f the fields for poor households was 75 percent o f the non-poor fields. More than one-fifth o f the population possessed a car, but only 6 percent o f these were poor.

The poor are less able to afford discretionary expenditures. The poverty rate o f those who smoke, drink, take computer courses, and have access to public transportation to school, for example, is lower for a l l than the overall poverty rate o f 27 percent poor. Shopping pattems also vary between poor and non-poor; the latter are more l ikely to shop at markets or bazaars.

Inequality and Regional Dfferences. Turkey i s a middle-income country, and i ts inequality i s high. Both consumption and income indexes indicate that inequality i s higher in urban areas than in rural areas, but not much. Other data confirm overwhelmingly that there i s a sharp East- West divide in Turkey where Southeastem and Eastern Anatolia regions are much poorer and have sharply lower human development indicators than Western Turkey.

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Education

In 1923, the year in which the Republic o f Turkey was founded, the adult literacy rate was approximately 10 percent. Such a low starting point (not uncommon for that era) gave the Republic a major cause to introduce a series o f ambitious reforms that included a move toward secular education and the adaptation o f the Latin alphabet. While the schooling environment in Turkey gradually improved over time, the 1997-1998 school year marked another major leap forward, in that, compulsory schooling increased from 5 years to 8 years for children aged 6 to 14. Enrollment rates increased soon after this reform, not only for the 8-year basic education cycle but also for secondary education.

Public Spending on Education

Turkey’s public spending on education increased significantly after 1998, both in real terms and as a percentage o f gross domestic product (GDP). Consequently, as o f 2000, Turkey’s public spending on education as a percentage o f GDP has become comparable to the spending pattems observed in countries o f similar levels o f economic development. The expansion o f compulsory schooling to 8 years had an extremely positive impact on the distribution o f public spending on education across rich and poor households. In 2001, 21.7 percent o f public spending on basic education reached the poorest 20 percent o f households (as opposed to 15.8 percent in 1994). But there i s significant room for improvement when it comes to secondary education, since only 13 percent o f public spending reached the poorest 20 percent o f the population in 2001. Household expenditures on education strongly reinforce the disadvantageous situation o f poor children: in 2002, the wealthiest 20 percent o f households spent 6.4 times more on education than did the poorest 20 percent o f households. The current situation represents a significant improvement compared to 1994, when the wealthiest households spent 28.8 times more on education than did the poorest households.

InefJicient Resource Allocation in the Education Sector

After the expansion o f compulsory schooling, the number o f primary school students and students enrolled in general secondary schools has significantly increased. The number of students enrolled in vocational secondary schools has remained roughly the same.

Classroom construction at the basic education level has been impressive: students per classroom at this level declined between the 1997-1998 school year and 2002-2003 school year despite increasing enrollments. At the secondary level, however, a curious trend i s present in that: (i) the number o f vocational school classrooms increased significantly in 2002-2003 even though enrollment in vocational schools did not increase in recent years; and (ii) the number o f general secondary classrooms remained stagnant, even though general secondary school enrollment increased visibly in recent years. As a result, as o f the 2002-2003 school year, average classroom size was 18 in vocational secondary schools and 45 in general secondary schools.

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Enrollment in Early Levels of Schooling

According to the 2002 HBS data, 97 percent o f children aged 6 to 14 are either enrolled in school or have completed the basic education cycle. Parental schooling i s a very good predictor o f children’s enrollment level: about 70 percent o f the children who are not attending school (but who are o f school age) have at least one parent who has not completed primary school.

An econometric model o f enrollment in secondary schools reveals that males are 7 to 8 percentage points more l ikely to continue their education beyond compulsory schooling. Secondary school availability in the residential area has a strong predictive power, boosting the probability o f enrollment by 10 percentage po in ts -on ly 64 percent o f households reported that a secondary school i s available in their residential area. Other important correlates o f secondary school enrollment are household wealth and presence o f a mother in the household.

Universities and The Poor

In Turkey, entrance to universities is primarily based o n a student’s performance in a centrally administered examination. Grades in secondary school (and a specialized field in secondary school) are other factors that influence the overall score. An analysis o f the 1997 University Student Survey found that students f i om high-income families are much more l ikely to be enrolled in private universities and well-established institutions. Thus, (the few) students f rom poor households who are enrolled in universities do not enroll in universities o f the same quality as those o f wealthier students.

Some o f the other findings were that private tutoring plays a key role in determining who attends what type o f university. A s the main reason for not receiving private tutoring, 57 percent of surveyed undergraduate students mentioned lack o f economic resources.

Parental Views About Quality of Education

Analysis o f 2001 household survey data reveals that household members are more l ikely to report problems with public schools (36.7 percent) compared to private schools (25.8 percent). The lack o f books and supplies emerges as the leading problem-reported as a problem for 15 percent o f children enrolled in public schools and 10 percent o f children enrolled in private schools. The next major problem is poor teaching (in both public and private schools), reported in roughly 10 percent o f cases. The urbadrural differences are pronounced-only 45 percent of rural responses indicated “no problem with school” as opposed to 68 percent in urban areas.

The wealthier are much less l ikely to report problems with school. Complaints about lack of books and supplies decline rapidly with increases in household wealth. Complaints about the condition o f facilities also decline with wealth. Whi le complaints about poor teaching remain constant across al l wealth groups, complaints about lack o f teachers decline with wealth.

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Schooling Attainment and Selected Labor Market Outcomes

Private returns to schooling are very high in Turkey. The gender gap in earnings i s visible, o n average, males earn 45 percent more per hour than females with similar characteristics. Schooling has a robust, positive, and large impact on earnings for both genders. If one estimates separate earning regressions for males and females, the impact o f schooling o n earnings i s found to be more pronounced for females. In other words, while females earn less o n average, the variation in earnings by schooling attainment is more significant for females when compared with males. These findings, jo int ly with the finding that only 15 percent o f those who report non-zero wages are females, suggest that by under-investing in girls’ schooling and by operating with extremely l o w female labor force participation rates, Turkey foregoes a vast potential human capital resource that can fuel the economy. Finally, contrary to common perceptions, the unemployment rate among vocational secondary graduates tends to be at about the same level as the unemployment rate among general secondary school graduates.

Health

The Health Care System

Turkey’s health care delivery and financing system i s fragmented. Bo th public and private providers supply health services. The Ministry o f Health (MOH), the Social Insurance Organization (SSK), and university hospitals are the main providers. Whi le the public health care sector primarily predominates, private sector provisions are gaining importance in western and urban parts o f the country.

Despite significant efforts, the service delivery network remains highly uneven, with major concentrations in urban areas, particularly in the western part o f the country. This skewed distribution has led to significant regional differences in access to and use o f health care and, concomitantly, health outcomes.

Health Insurance

Several public health insurance schemes currently provide financial protection to various target groups. SSK’s health insurance i s the most important one, catering to those employed in the formal sector. The green card system, introduced in 1992, i s intended to provide coverage to low-income groups who are not covered otherwise. The Government soon plans to shift to universal health insurance, which would operate o n the principles o f solidarity and risk pooling, and provide coverage to the entire population.

Both Household Consumption and Income Survey (HCIS) and HBS data suggest that over one- third (36 to 37 percent) o f the population in Turkey does not have access to health insurance, and almost ha l f the population in rural areas remains without any coverage. The green card program fails to provide broad coverage to al l those living in poverty. Thus an important share o f the lowest-income households remains without access to health insurance coverage even if they may

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be eligible for it, and makes significant out-of-pocket payments when seeking health care. The lack o f insurance coverage leads many low-income households to forego health care, which in tum negatively affects their health outcomes.

Health Outcomes

Despite considerable progress achieved in the recent past, Turkey continues to rank far behind most middle-income and European Union (EU) accession countries on key health indicators. Health outcomes vary significantly across regions, reflecting the uneven supply o f and access to health care in various parts.

The Turkish health system faces a dual challenge. Significant parts o f the population continue to be afflicted with a high burden o f disease from preventable infectious diseases, and high matemal and infant mortality rates, typical o f developing countries. At the same time, non- communicable diseases prevalent in developed countries affect a growing share o f the population.

Access To and Use of Health Care

People with health insurance, including a green card, are more l ikely to seek health care when ill than those without insurance. The likelihood o f seeking care when ill i s lower between the bottom two quintiles than among the upper quintiles, with the difference being particularly marked in rural areas. Low-income groups suffer from significant access problems.

Determinants of Care Seeking

The prime reason for not seeking care when sick, or not seeking hospital admission when required, was lack o f affordability. One out o f five people from the lowest income quintile who sought outpatient care reported that the main problem with the care was that it was too expensive. Lack o f a facility nearby did not appear to be a prime determinant o f not seeking care when ill.

The share o f the population that had to pay for outpatient treatment, drugs, and hospitalization is higher among the lowest income quintile than among the upper-income groups. Furthermore, a multivariate analysis o f the determinants o f health care-seeking behavior confirms that income, insurance coverage, household size, gender o f household head, and severity o f illness are the most important determinants o f an individual seeking health care.

Health Care Expenditure

Out-ofpocket Payments. Households in Turkey allocate a modest share o f their total expenditure to health care in the form o f out-of-pocket payments. Income i s a major deciding factor on the amount spent. The top quintile spends about twice as high a share o f total household expenditure o n health care as the lowest quintile. The largest share o f out-of-pocket expenditure on health i s allocated to the purchase o f drugs, with payments for outpatient consultation ranking second across a l l income levels.

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Public Expenditure on Health Care

Public expenditure o n health care grew at an average annual rate o f 7.3 percent between 1999 and 2003. The main public financiers are the Central Government and the social security institutions. According to the recent National Health Accounts study estimates in Turkey, Central Government funding accounts for over one-third o f Turkey’s health care expenditure, employer contributions account for less than one-fifth, and households pay over two-fifths through out-of-pocket payments and social security contributions.

Public sector spending o n health care is skewed in favor o f the upper income groups, particularly spending o n outpatient care. Budgetary h n d s are not well targeted toward assuring equitable access by the entire population. Thus, overall, the relatively important public subsidies to health care are benefiting the middle- and upper-income households, while the poor continue to face significant access barriers to health.

Labor M a r k e t in Turkey

In Turkey, as in most countries, poverty i s closely related to employment status and the type o f job, whether formal or informal. Informally employed and casual workers have a higher rate o f poverty. Education plays a key role in explaining employment and poverty outcomes.

Unemployment and Labor Force Participation

Unemployment in Turkey was 10.3 percent in 2002. Labor market outcomes are mostly driven by low levels o f labor force participation. Those who do not work drop out o f the labor force, and are thus not captured in the unemployment rate figures. The poverty rate o f the non- participants in the labor force reflects strongly the situation o f children: inactive household members younger than 15 years o f age had a poverty rate o f 35 percent, but older inactive household members had a poverty rate o f only 22 percent, under the total poverty rate. There are very sharp differences in labor market participation rates between men and women, with extremely l o w rates o f female labor market participation in Turkey and even decreases in the rate for females since the 1999 level o f 30 percent, down to 27.9 percent in 2002. The male labor force participation rate was 72 percent in 2002, or more than twice that o f women’s. Female unemployment rates have typically been slightly lower than the male unemployment rate. This i s primarily because so few women are in the labor force

Unemployment and Inactivity

In 2002,35 percent o f those aged 12 and above reported that they had worked in a paid j o b in the month o f the survey. The poverty rate o f these 35 percent was 25 percent. Another 43 percent o f those aged 12 and above who reported that they did not work had almost the same poverty rate (24 percent poor) as the employed.

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In terms o f unemployment, only 7.2 percent o f those aged 12 and above reported that they were looking for a job. Households with employed heads had a poverty rate o f 26 percent compared to 35 percent where the household head was unemployed.

Reasons for not seeking a j ob varied from factors relating to age or family structure (student, housewife, elderly) to disability or seasonal employment.

Quality of Employment

In Turkey, there exists a strong association between the type o f employment and the poverty status o f the individual or household. Poverty rates o f those who had permanent employment were lower compared to those with casual or temporary jobs. The relative r isk o f poverty for casual workers was 3.7 times greater than for the permanently employed. Poverty rates for self- employed and unpaid family workers were higher.

Poverty was also found to be sharply associated with a lack o f registration at a social security institution. O f the 35 percent who reported being employed, 32 percent were enrolled in social security. The poverty r isk for people with formal jobs was the lowest for those employed by the government and in state-owned enterprises.

Poverty i s associated with the size o f the enterprise. People employed in larger firms were less l ikely to be poor compared to people from firms with 1 to 9 people. Almost 70 percent o f the respondents (aged 12 and over) reported that they worked in a firm o f 1 to 9 people, and thus had a higher poverty rate. In Turkey, poverty i s associated more with lack o f work than with work. The mean number o f hours worked by the poor was 43.4 per week, whereas by the non-poor, i t was 46.3 hours. Also, the mean duration o f employment o f the poor in the same low-paying j o b was longer than o f the non-poor.

Sector of Employment

The largest sector of employment in Turkey i s agriculture. Agriculture is also the sector with the highest poverty rate o f those employed in it. Of the 35 percent aged 12 and above, 40 percent are engaged in agriculture. The next-highest poverty rate is that o f construction. The poverty rate i s lowest for mining and quarrying. After agriculture, the only other significant sectors in terms o f employment are manufacturing, and wholesale and retail trade.

Social Protection in Turkey

Social protection in Turkey consists primarily o f limited formal systems in pensions and social assistance, supplemented greatly by informal mechanisms. Formal elements o f social protection are the pension (social security) system, and the Social Assistance and Solidarity Encouragement Fund (SYDTF) and its 93 1 affiliated Social Solidarity Foundations (SYDVs).

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Turkish Pension System

Turkey’s social security system i s highly fragmented. Benefits and contributions depend on one’s occupation. Sosyal Sigortalar Kurumu (SSK) covers the bulk o f the labor force, especially private sector employees and those public sector employees who do no t qualify as c i v i l servants. Civil servants are covered by Emekli Sandigi (ES), and the self-employed and farmers are covered by Bag-Kur (BK). Also, there are separate occupational schemes that cover various other groups.

Overall, 42 percent (1 1 million people) o f the labor force i s contributing to one o r the other scheme. On the beneficiary side, on l y 29 percent (1.2 million people) o f the population over age 65 i s receiving an old-age pension. However, almost 3 m i l l i on individuals be low the age o f 65 are receiving pensions, primarily old age pensions, with many o f the recipients considerably younger than 65. A s a result, the pension system i s showing large fiscal losses each year and i s in need of transfers from the government to cover those losses expected to be around 4 percent o f GDP in 2004.

SSK i s by far the largest system, and covers most ly private sector employees. Employers contribute 11 percent o f wages for pension, and employees contribute 9 percent o f wages. In 1999, the Social Security Law changed most o f the SSK benefit parameters. Pre-reform and post-reform benefits are discussed in detail in the social protection chapter.

Bug-Kur pr imari ly covers the self-employed and some farmers. Contr ibution rates are 20 percent for pensions and 20 percent for health coverage. To combat the perennial problem of evaluating income earned, Turkey uses the system o f minimum earnings steps, wh ich are attributed to individuals regardless o f what they actually earn.

Bag-Kur has a very low collection rate for i t s contribution revenue. Workers pay very l i t t le during their working years, and just pr ior to retirement, they pay Bag-Kur a lump-sum equivalent to the past-due contributions with interest, and then receive their retirement.

Emekli Sandigi covers c i v i l servants, including mi l i ta ry personnel. Financing o f Emek l i Sandigi i s somewhat different f rom the other plans in that health insurance during working years i s not covered by the pension fund. Instead, i t i s covered directly by the l ine ministries in wh ich the c i v i l servants are employed.

Another difference between Emek l i Sandigi and other schemes i s that the basis for contributions and the basis for benefits are different. Contributions are pa id on the basis o f basic salary. On the other hand, when pension benefits are paid, they are pa id on full remuneration. Thus, there i s bo th a financing gap and an equity issue, where lower-grade workers p a y contributions on a larger share o f their salary than higher-grade workers.

Noncontributory Pension Benefits. Turkey also provides a small noncontributory benefit to those over age 65 who earn below the level o f the benefit.

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Social Assistance and Solidarity Encouragement Fund

The Social Assistance and Solidarity Encouragement Fund (SYDTF) i s an extra budgetary fund financed by earmarked taxes and administered by a Cabinet Minister. The SYDTF, together with i ts local affiliates, i s the largest program o f social assistance in Turkey in terms o f number o f beneficiaries.

Conditional Cash Transfers

Conditional Cash Transfers (CCTs) are a national program recently introduced in Turkey, supported by a loan from the World Bank, the Social Risk Mitigation Project (SRMP). CCTs are payments made to the mothers o f poor children, provided they attend school or visit health clinics. CCTs are important tools that are targeted to the poorest o f the poor, many o f whom are not able to afford the out-of-pocket expenses o f sending their children to school. When the CCT program was fully operational across Turkey in late 2004, and 1.6 mill ion children and 7,000 pregnant women benefited from the program.

Local Initiatives

Supported under the SRMP, the Government o f Turkey has undertaken a significant expansion o f the microprojects traditionally handled by the SYDVs with approval from the SYDTF, along with a tightening o f procedures. In 2004, 250,000 people will benefit from income generation, employment, and social service opportunities under the SRMP Local Initiatives component, which seeks to provide these people with sustainable livelihoods, thereby lifting them permanently out o f poverty.

Institutional Development

Institutional development activities to strengthen the SYDTF, SHCEK, and DIE (especially on poverty monitoring and measurement) have been undertaken in the institutional development component o f the SRMP. These activities have been to computerize and set up an internet data base for the management information system (MIS) o f the SYDTF and SYDVs, a MIS for SHCEK, and additional computers for DIE. All three institutions also received staff training programs.

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PART 11: KEY FINDINGS

The following k e y findings emerged from the 2002 H B S data:

0 Turkey i s a medium- to high-inequality country. 0 The rate o f extreme poverty in Turkey i s quite low. 0 However, the overall rate of poverty i s high when compared to the EU, and this reflects

the f irst fact on inequality. e Regional differences are the major driver o f country inequality, and poverty i s highly

concentrated in Eastern and Southeastem Anatolia. e High and persistent inequality has constrained Turkey’s ability to benefit from growth

years, wh i l e macroeconomic instabil ity has hindered Turkey from escaping from its medium- to -high-inequality, relatively high overall, poverty situation.

Additionally, it i s str iking how similar the situation in Turkey in 2002 was to that in 1994, when the previous H B S data were collected, and to the situation documented in the World Bank’s previous Poverty Assessment (World Bank, 2000). Indeed, virtual ly a l l o f the policy recommendations emerging out of the 2002 data analysis are echoes o f previous findings from the previous Poverty Assessment (World Bank, 2000). This reflects the fact that Turkey’s poverty and inequali ty situation was virtual ly unchanged from 1994 to 2002.

K e y findings from the previous Poverty Assessment (PA) wh ich are confirmed in the JPAR include:

0 Turkey faces a serious challenge in generating employment (labor force participation rates have further declined since the 1997 data presented in the previous poverty assessment, and there is a very low rate o f female labor force participation).

0 Productivi ty growth i s key (agriculture continues to b e a poor performer). 0 Income inequality in Turkey i s high. 0 Distr ibution o f income i s fairly stable (the JPAR finds it has worsened, but only slightly). 0 Absolute poverty i s low, but economic vulnerabi l i ty i s widespread. e Poverty in Turkey i s l inked mainly to education and employment status. 0 Government spending needs to b e better targeted to the vulnerable.

The only finding from the previous poverty assessment that requires nuance i s the finding that meeting the employment challenge requires faster GDP growth. Whi le this i s certainly true, the persistence o f inequality in Turkey suggests that faster growth will fa i l to resolve the question of how that growth i s distributed, and that inequali ty acts as a brake on raising living standards generally, even when growth i s high, as has been the case for most o f the non-crises years since 1994. Several scenarios for poverty in 2004 were calculated, depending o n inequality not worsening f rom 2002-2004, and these demonstrate that gains from growth could b e considerable in the short run if household consumption responds quickly or fully to GDP growth.

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A. TURKEYIS A MEDIUM- TO HIGH-INEQUALITY COUNTRY

Turkey’s inequality as measured by the Gini coefficient for income to be comparable to other countries (which are predominately income-based measures) puts Turkey in the middle range of countries, as inequality i s so high in A f i c a and Asia. Milanovic and Yitzhaki (2001) estimated that Gini coefficients for these were 52.1 and 61.5, respectively, while Turkey’s Gini for income for 2002 was 44, which is noticeably lower. However, Turkey does not measure up wel l against Westem Europe. Including the United States leads Milanovic and Yitzhaki (2001) to estimate the combined Gini at 39.4. The Gini for this geographical grouping would be much lower if the United States and Turkey were not included. Comparing Turkey’s inequality to individual Westem European countries (Annex Table l), it i s clear that Turkey has markedly higher inequality than the European Union countries. Furthermore, inequality in Turkey has not decreased since 1987.

Decomposing the change in poverty (in comparable measure) for Turkey between 1994 and 2002 reveals that increased inequality over the time period led to less reduction in poverty than could have been achieved with equal growth.

B. EXTREME POVERTYIN TURKEYIS LOW

Turkey compares very favorably with low- and medium-income countries in terms o f its rate of extreme poverty, measured either as purchasing power parity (PPP) o f U S $ l per person or by the food component of the national line. Turkey has essentially a zero poverty rate for the PPP US$1 per person per day poverty line, and the share o f the population that i s below the food-only component o f the national poverty l ine i s 1.36 percent (adult equivalent consumption). These rates are extremely low in international comparisons.

A s documented in World Bank (2003), there i s a very high degree o f interhousehold transfers and “social solidarity” that keeps the extremely poor from starvation poverty, and these transfers (often o f food but also of housing and clothing) have resulted in a very low rate o f extreme poverty in Turkey.

c. POVERTY IS HIGH COMPARED TO EUROPEAN UNION COUNTRIES

Turkey’s poverty rate o f 27 percent i s in the midrange for most medium-income countries (Table 2), but this reflects the significant dispersion o f poverty rates in those countries. Turkey’s poverty rate is much lower than the poverty rates in many Lat in American countries, but significantly higher than the poverty rate in China, which dominates the medium-income class by reason o f population size. In particular, Turkey’s poverty rate is much higher than that in European Union countries, and in many o f the accession candidate countries.

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D. REGIONAL DIFFERENCES ARE SUBSTANTIAL

4 Inequality (Annual change) 1

Regional differences are the major driver o f inequality in Turkey, and by every source o f information, quantitative and qualitative, Eastem and Southeastern Anatol ia are markedly poorer than Western Turkey. In this, Turkey i s not unique-many countries grapple with the problem of underdeveloped regions, including Appalachia in the United States, and Southern Italy. There has been tremendous and rapid rural-to-urban migration in Turkey in recent years, and the share of the rural populat ion has fallen f rom 49 percent in 1990 to 40 percent in 2000, with much o f the rural to urban migration occumng f rom Eastern and Southeastem Anatolia. However, fami ly size remains very large in those regions, so that migration has no t “solved” the problem o f persistent poverty.

J Inequality (Annual change) 1

E. INEQUALITYACTS AS A ‘LBRAKE” ON POVERTY REDUCTION

As demonstrated by the growth-inequality decomposition for 1994 to 2002, inequality has he ld back improvements in poverty that growth would have led to in the absence o f inequality. Projections for this in the future demonstrate that growth without redistribution would not “solve” Turkey’s poverty problem (Table 1). Whi le sustained growth i s essential for poverty reduction, if inequality i s not he ld back, gains f rom growth can fa i l to significantly reduce poverty. And if inequality worsens, then gains f rom growth can b e part ly or even total ly erased.

Table 1. Projected Incidence o f Poverty with Different GrowtMnequa l i ty Scenarios

Poverty Rate in 5 Years

With Growth and Inequality

Poverty Rate in I O Years With Growth and Inequality

ISource: Turkey 2002 HBS data. 1 To see these results, i t i s easiest to f i rs t orient on the columns and rows labeled “O%,” meaning n o change, in the f i rst h a l f o f Table 3 (5 years). If there i s no growth in consumption and no change in inequality in f ive years, then poverty remains unchanged at 27 percent. However, reading along the r o w labeled 0 percent, even if there i s no growth at all, if inequality declined 1

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percent per year, poverty would fal l f rom 27 to 24.7 percent. This i s almost equal to the effect that keeping inequali ty equal but experiencing a growth improvement o f 1 percent per year wou ld have on poverty-24.1 percent.

Poverty Gap in 5 Years

St i l l l ook ing at the 5-year results, notice the bo t tom right entry. If inequality increases at the same 3 percent rate as growth, then poverty wil l b e almost unchanged, declining only sl ightly to 26 percent. Th is illustrates that even the beneficial effects o f growth can be almost completely offset by inequality. Additionally, i t i s clear that if inequali ty can b e decreased even slightly, as long as there i s growth, there will be significant strides in poverty reduction. For example, a 1 percent growth in consumption coupled with a 1 percent decline in inequality would reduce poverty substantially, from 27 percent to 22.1 percent.

Poverty Gap in 10 Years

The impact o f inequali ty o n the poverty gap (the distance between average consumption and the poverty line) i s even greater than o n the poverty headcount (Table 2). Here, even when growth i s positive, as long as inequality increases, then the gap i s greater.

Table 2. Projected Poverty Gap with Different GrowtMnequal i ty Scenarios

. -

With Growth and Inequality With Growth and Inequality

Source: Turkey 2002 HBS data.

F. POVERTYPROJECTIONS IN 2004

Inequality, whi le high in Turkey, has been quite stable since 1994, increasing very slightly from 1994 to 2002. Thus, assuming that inequality wi l l not change from 2002 to 2004 i s a reasonable assumption, and allows the projection o f poverty rates from 2002 to 2004. This i s simply using a shorter t ime period, but the same assumption as the center column in the upper left hand quadrant o f Table 1 (0 percent change in equality). The more pressing question for the projection i s not what to assume about inequality, since an assumption o f no change i s

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empirically validated for Turkey, but rather what would the growth rate o f household consumption be, given the actual GDP growth f rom 2002 to 2004 to date.

Poverty Rate

27.0 Poverty rate in 2002 (annual, percent o f population)

Poverty rate in 2004 Scenarios

Here, GDP growth rates are a good guide, but are indicatory only, since typical ly household consumption increases with growth, but with a lag as i t takes time for the positive effects o f growth to come to households, particularly those at the lower end o f the distribution. Accordingly, f ive different scenarios about growth and poverty reduction in 2004 are presented in Table 3. All the scenarios depend o n inequality not worsening, and demonstrate that gains f rom growth could be considerable in the short run if household consumption responds quickly or fully to GDP growth.

Percent Change of Reduction

Table 3. Turkey: Poverty Projections

Conservative: Household consumption (HH cons) grows only 3 percent in two years Medium: HH cons grows at 3 and 2.5 percent respectively in two years High: HH cons grows at same rates as GDP, 5.9 and 5.0 respectively Higher: HH cons grows at 5.9 in 2003 and 6.0 in 2004 respectively Lagged model: If growth in HH cons follows one-year lagged GDP growth-- HH cons grows at 7.9 in 2003 and 5.9 in 2004.

25.3 6.3 23.9 11.5 21.3 21.1 20.9 22.6

20.2 25.2

G. MACROECONOMIC INDICATORS AND POKERTY

The Turkish Government has undertaken a variety o f pol icy reforms that are intended to promote stable economic growth which are being supported by the World Bank in the Programmatic Financial and Public Sector Adjustment Loan I11 (PFPSAL 111). These reforms will create the conditions necessary for sustained economic growth. However, achieving high growth rates is not a sufficient condition for reducing p ~ v e r t y . ~ Understanding the relationship between poverty and macroeconomic indicators and the transmission mechanisms involved i s key in designing effective poverty reduction policies.

Growth-Unemployment-Poverty Relationship

Under certain conditions, high growth rates can be influential in reducing poverty rates. Understanding growth dynamics plays a vital ro le in assessing the poverty reducing impact o f any growth process. W h i l e the Turkish economy recorded high growth rates in 2002 and 2003, the unemployment rate increased f rom 8.4 percent in 2001 to 10.3 percent in 2002 and h r the r to 10.5 percent in 2003, mainly due to lack o f adequate job creation. F i rms had generally low

Neither i s i t a necessary condition, since an improvement in the income inequality-a redistribution o f income toward the poor-will result in a reduction o f poverty even in the absence o f economic growth (see Table 3).

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capacity ut i l izat ion ratios in Turkey and during the recession in 2001, the annual capacity utilization ratio fe l l to 70.9 percent, which was the lowest ratio in the last 15 years. In 2002 and 2003, firms used their idle capacity. The capacity utilization ratio increased to 75.4 percent in 2002 and to 78.4 percent in 2003. More recently, in the first quarter o f 2004, the capacity utilization ratio reached a historical high of 78.5 percent. Given this high level and the strong demand in the economy, there i s a clear need for firms to expand their capacities, which is l ikely to entail creation o f new jobs.

Although production increases that end up in increased gross f ixed capital formation or increased inventories both imply positive growth rates, given that firms are l ikely to use their existing capacity in increasing their inventories, j o b creation is possible only through new investments. The strength o f the link between new investments and job creation depends crucially o n the nature o f technology employed in the new production process. In an attempt to minimize the labor cost, firms might prefer more capital-intensive technologies, in which case, labor productivity will increase and j o b creation wi l l not fol low the increases in production. Consequently, without new j o b opportunities, unemployment wi l l continue, especially if there i s also a structural component o f unemployment. Empirically, in Turkey, unemployment o f the household head i s particularly associated with poverty.

In 2001, during the recession, Turkey’s GNP contracted by 9.5 percent. The major factor behind the contraction was the plunge in private fixed investments by 35 percent. However, in the recovery year 2002, the main source o f growth was the increase in inventory levels. Real GNP in Turkey grew by 7.9 percent in 2002 and 92 percent o f the growth was due to an increase in inventory levels. This i s the main factor behind the lack o f a commensurate increase in employment; whi le production increased, the firms stocked up inventories rather than increasing sales in an environment o f sluggish private consumption. With limited j o b opportunities, the poor and the vulnerable did not have any opportunity to move out o f poverty. In 2003, while an increase in inventories continued to be a key contributor to growth, gross f ixed capital formation recovered by 10 percent and private consumption by 6.6 percent, promising a more positive impact on the availability o f new jobs compared to 2002.

Another factor that i s important in understanding the unemployment-poverty relationship i s the large informal sector in Turkey, given that the informally employed or casual workers have a noticeably higher rate of poverty. After the 2001 crisis, many employees lost their jobs and some o f those unemployed shifted to the informal sector with lower wages. In addition, some firms prefer to employ workers informally in order to avoid paying high social security premiums. Increasing unemployment ratios and slightly decreasing poverty rates, despite the high growth rates observed in 2002 and 2003, may be explained partially by the existence o f a large informal sector.

A pre-condition for growth to have a poverty-reducing impact i s equal distribution o f the gains from high growth rates among the different income groups in society. If only income o f the non- poor people increases with positive growth, income inequality will increase. In Turkey, on average, a 3 percent growth rate was sustained between the years 1994 and 2002, but the poverty-growth decomposition demonstrated that real growth between 1994 and 2002 was significantly offset by a slight increase in inequality, so that there was only a slight reduction in

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poverty. During this period, non-poor people benefited from the advantages o f the positive growth more than the poor people. Additionally, projections demonstrated that future growth could be similarly offset by inequality.

In summary, growth, although being a very important tool, i s neither sufficient nor a necessary condition for poverty reduction. Policymakers must examine the reasons behind growth. In addition, growth could be offset, partly or completely, by inequality. Thus, a major policy concern would be for Turkey to address the persistence o f inequality while at the same time pursuing policies for high and sustainable growth. Turkey’s continued commitment to structural reforms i s not only key for maintaining the hard won macroeconomic stability but also to create an environment conducive for new domestic and foreign investments.

Inflation-Poverty Relationship

High inflation acts a direct source o f poverty by increasing income inequality in society, Poor people generally have fixed incomes and under an inflationary environment, their real incomes are eroded through the mechanism o f inflation tax. However, for the non-poor, there i s a hedging option. High inflation rates increase uncertainty in an economy and returns from investment tools tend to be higher than inflation reflecting the implied r isk premium. People using these hedging options can compensate the effects o f the inflation tax and earn over and above the inflation rate through these high returns. On the contrary, poor people do not have savings to invest in these hedging options and they bear the burden o f the inflation tax.

In Turkey, between 1994 and 2002, there was high inflation and, on average, positive growth. In this period, the Gini coefficient increased by 1 percent, which indicates an increase in income inequality. Poor segments o f the population were faced with the inflation tax, whereas non-poor people benefited from the effects o f inflation by investing heavily in government bonds with extremely high interest rates. This worsening in income equality counteracted any positive impact due from positive growth during this period. However, in 2003 and early 2004, inflation and interest rates declined sharply due to the Central Bank’s successful disinflation program and the government’s strong fiscal stabilization policies supported by structural reform. Reduced inflation rates are likely to have had a decreasing effect on poverty rates in this period.

In an environment o f low inflation rates, the effects o f the inflation tax can be minimized. Due to low inflation and reduced uncertainty, extra gains from investment tools, l ike government bonds with high profit margins, can be decreased. Thus, distortions in income distribution and the negative impact on poverty can be mitigated. To promote poverty reduction, the disinflation program should continue to be implemented, while fiscal prudence i s maintained. Continued commitment to the structural reform agenda i s a key factor that will strengthen macroeconomic stability and enhance gains from the disinflation process.

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PART 111: POLICY RECOMMENDATIONS

A. MACROECONOMIC POLICY RECOMMENDATIONS AND GOVERNMENT REFORM PROGRAM

The JPAR and the previous poverty assessment emphasize that the creation o f well-paying formal sector jobs i s the main lever for poverty reduction in Turkey, and that macroeconomic instability has severely limited Turkey’s attempts to reduce poverty since 1987. The Government’s reform program begins with implications for reducing income inequality through improved taxation, discussed below. First, though, the Government’s action plan for creating macroeconomic stability and growth, as supported by the Programmatic Financial and Public Sector Adjustment Loan I11 (PFPSAL 111), i s detailed.

The main objective o f PFPSAL I11 i s to support implementation during 2004 o f the Government’s financial and public sector reform priorities while ensuring that social programs are adequately hnded and increasingly better targeted. Key reform priorities in the financial sector include: (a) strengthening the regulatory framework for banking; (b) building institutional capacity at the Banking Regulation and Supervision Agency (BRSA) and the Savings Deposit Insurance Fund (SDIF); (c) restructuring and privatizing state banks; and (d) improving the corporate insolvency regime. Key reform priorities in the public sector include: (a) deepening o f structural fiscal policies in support o f sustainable fiscal adjustment; (b) implementing public expenditure management (PEM) reforms covering budget planning and execution, financial accountability, and public liability management; and (c) strengthening public sector governance including implementation o f the national anticorruption strategy and preparation o f the c iv i l service reform strategy. Priorities for social spending include: (a) adequate expenditure for health, education, and social protection in the 2004 budget; and (b) better targeting o f social protection.

Medium-term projections suggest that sustained implementation o f economic reform is necessary for Turkey to attain macroeconomic stability and growth. Under these projections, the economy is expected to grow by about 5 percent during 2005-2006. Specific factors underlying stability and sustained growth include: (a) greater confidence in the policy framework; (b) improved macroeconomic stability and declining real interest rates-which would stimulate private investment and consumption demand; (c) stronger export performance-which would permit faster import and output growth; and (d) higher extemal inflows, including greater foreign direct investment. Under this scenario, fiscal adjustment would yield a permanent reduction in the public sector borrowing requirement from about 10 percent o f GNP in 2003 to 5 percent o f GNP in 2006. This would underpin the projected stabilization o f the net public debt stock-to-GNP ratio below 60 percent o f GNP by 2006. The programmed fiscal adjustment would also support the projected decline in inflation to single digits by 2005.

On the creation o f macroeconomic stability and growth, the Government’s program emphasizes the critical role o f structural reforms. Policy continuity i s essential to maintain the stability achieved after the 2001 crisis, and to preserve the growth and macroeconomic perfonnance o f the last three years. The f i rs t reform priority i s to accelerate banking reform to consolidate the renewed trust in the sector and to preclude the possibility o f a systemic crisis. The program

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emphasis has now moved from crisis management to broad-based financial sector development. The second priority area i s the comprehensive reform o f the publ ic sector to address the underlying structural causes o f Turkey’s macroeconomic instability, ensure medium-term fiscal sustainability, and increase the transparency and efficiency o f publ ic expenditure management. The third priority area i s continuation o f v i ta l reforms in the agriculture, energy, and telecommunications sectors to improve the climate for private investment in an effort to raise productivity, growth, and incomes. Many o f the latter reforms also have a structural f iscal dimension.

Turkey needs comprehensive financial and public sector reforms to definit ively break with i ts history o f inadequate transparency, publ ic deficits, inflation, and financial instability. A quick retrospective highlights the structural weaknesses in both the publ ic and financial sectors that contributed to macroeconomic instabil ity and created the preconditions for the 200 1 crisis.

Chronic publ ic sector deficits led to the build-up of debt and the rapid expansion o f the banking sector, wh ich greatly outpaced the capacity of the regulatory framework. Macroeconomic distortions arising f rom fiscal imbalance created incentives for the banks to take on excessive risk, wh ich was no t curtailed by adequate regulation and enforcement. The absence o f ample, accurate, and t imely fiscal information-particularly the reliance on off-budget funds and quasi- fiscal obligations, including the so-called “duty losses” of the state banks-reinforced pol i t ical and institutional obstacles to structural change and sustainable fiscal adjustment.

Unhealthy interactions between inadequate fiscal and financial transparency compounded the risks to the economy, and helped ensure the build-up o f a major systemic crisis following earlier cycles o f crisis and aborted stabilization efforts throughout the 1990s. A f te r undertaking urgent f inancial restructuring to address the impact on the banks o f the November 2000 and February 2001 crises, the authorities are mak ing progress in correcting the underlying weaknesses in the financial sector. In parallel, institutional and pol icy reforms are being deepened to address systemic problems in the publ ic sector, together with further structural measures to gradually underpin the fiscal adjustment. These reforms complement ongoing actions to improve the climate for private investment and promote growth. Rebui ld ing investor confidence and sustaining economic growth depend cri t ical ly o n the Government’s abi l i ty to maintain the momentum o f reforms to address the structural roots o f Turkey’s chronic financial instability.

Strong fiscal performance has been the cornerstone o f the economic program in the last few years. Fiscal gains were significant in 2003, and the pr imary surplus rose from 4 percent o f GNP in 2002 to over 6 percent o f GNP in 2003, close t o the programmed 6.5 percent target. Although the 2004 budget passed in December 2003 was consistent with the 6.5 percent p r imary surplus target, a sizable gap quickly emerged. The Government announced an above-inflation increase in minimum wages, and i t also cut contribution rates for social security to reduce the additional costs to employers. In addition, the Government increased pensions by 21 percent, w e l l above the inf lat ion target. These initiatives, together with revenue shortfalls relative to the budget, created a financing gap o f close to 1.7 percent of GNP. The Government introduced a fiscal package in March 2004 to close the fiscal gap. The Government i s implementing additional measures to meet the pr imary surplus target o f 6.5 percent o f GNP for the consolidated public

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s e c t o r - a f wh ich 5 percent o f GNP is for the Central Government-set in the revised budget for 2004.

The 2004 fiscal package has two main components: original budget measures and supplementary budget measures. To meet the 2004 pr imary surplus target, the authorities undertook a set o f measures in December 2003 within the context o f the original 2004 budget. The special communication and transaction taxes became permanent, and the surcharge o n income taxes, was extended for one more year. Motor vehicle taxes were adjusted upward to compensate the reimbursement o f 2003 payments for an additional car tax (ruled unconstitutional). In addition, savings also came f rom cuts in investment programs, lower value-added tax (VAT) rebates for pensioners, and by eliminating vacancies when publ ic sector workers leave their positions. The special appropriation6 has been eliminated. The second set o f measures was introduced with the supplementary budget in March. The supplementary budget l a w cuts discretionary spending by 13 percent across a l l ministries. The Government also introduced measures to increase tax revenues by adjusting excises o f petroleum products, alcohol, and tobacco.

The Government has adopted a strategy for tax po l i cy re fo rm that would bring Turkey’s tax regime in l ine with best practice in the European Union (Box 1).

Box 1. Tax Policy

Simplify and consolidate the indirect tax structure wi th a VAT with a standard rate and two l ow rates (1 percent for agriculture and 8 percent for other basic consumption goods). Introduce a unified special consumption tax (SCT) that will consolidate the current range o f excise and specific taxes into a single tax charged on a limited range o f luxury goods. A threshold w i l l be established for obligatory filing o f VAT returns. Earmarking of revenues wil l be abolished and al l revenues from earmarked taxes w i l l be brought into the budget. Simplify and consolidate the direct tax regime in l ine wi th OECD standards and international best practice. Convert tax rebate for wage earners into a tax credit to simplify administration and reduce tax burden o n low- income wage earners. Minimize tax exemptions and exceptions. Harmonize real effective tax rates across al l types o f financial instruments and maturities. Phase in the full indexation o f the corporate and business income taxes (real interest deduction to replace nominal interest deduction). Reduce the scope o f investment incentives, consolidate into a single investment allowance rate across sectors and geographic regions, and gradually eliminate withholding tax on these allowances. Make the incentive system more transparent and automatic. Overhaul the tax regime for Free Trade Zones. Terminate the corporate tax and payroll tax exemptions, Provide reduced corporate tax rate only on condition that separate subsidiaries are established and inward trading i s below 15 percent o f sales. Adjust taxation o f financial leasing in line wi th internationally generally accepted accounting practices.

Implementation o f the tax strategy i s progressing reasonably well. On the tax po l i cy side, a uni f ied special consumption tax (SCT) to consolidate a range o f excise and specific taxes into a single tax charged on a l im i ted range o f luxury goods was enacted in June 2002. Implementing circulars for the SCT l a w were published in July 2002 and the tax went into effect in August 2002. Earmarking o f SCT revenues was eliminated, with retroactive effect for the 2003 budget, through a government decree issued in January 2003. Ln April 2003, Parliament enacted the first legislative package under the direct tax reform designed to simplify and consolidate the direct tax regime in l ine with OECD standards and international best practice. This legislation: (a)

Special appropriation i s a mechanism o f converting earmarked revenues into appropriation during the year.

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harmonizes tax rates o n income from financial investments at the declaration stage; (b) simplif ies and harmonizes the system o f investment incentives; (c) reforms the system o f income tax credits; and (d) simplif ies taxation o f corporate earnings and dividends. K e y provisions o f the legislation became effective immediately, and the remaining articles became effective in January 2004. Subsequently, a second package o f direct tax reform legislation was enacted in January 2004 to min imize geographic, sectoral, and other investment incentives-including rationalizing the benefits in Free Trade Zones. The Government i s strongly committed to addressing the problem o f taxation o f unrecorded income, and will prepare secondary legislation to require that a l l large financial transactions take place through the banking system.

Implementation o f the Government’s tax reform strategy i s crucial fo r many reasons, not the least of wh ich would b e to address Turkey’s high level o f income inequality. Decomposit ion and simulations demonstrated that by addressing inequality, the poverty reduction effects o f growth could b e substantial. A transparent and progressive tax regime would enable Turkey to achieve other economic reform goals, such as expenditure targets for the social sectors, w h i c h in turn would help address the access issues documented in the health and education chapters o f the joint volume.

Turkey’s continued commitment to structural reforms i s not on ly k e y for maintaining the hard- w o n macroeconomic stability but also to create an environment conducive for n e w domestic and foreign investments. To promote poverty reduction, the disinflation program should continue to b e implemented, whi le fiscal prudence i s maintained. Continued commitment to the structural reform agenda i s a k e y factor that will strengthen macroeconomic stabil ity and enhance gains from the disinflation process.

B. HEALTH POLICY RECOMMENDATIONS

Turkey’s current health care system i s characterized by marked inequalities in access to and use of health services. These are driven by skewed distribution o f health care service provisions and medical personnel in favor o f the urban areas, particularly in the western parts o f the country; publ ic spending on health care, wh ich i s skewed toward the upper-income groups; and a health insurance system that leaves an estimated one-third o f the population without coverage. Those without insurance coverage are predominantly in the lower-income groups. The need to cover health care expenditures with out-of-pocket payments by a l l those who do not benefit from insurance coverage in turn leads a significant share o f the population to forego health care, even when they are cri t ical ly ill. Lower-income groups are significantly more l i ke ly to forego health care than upper-income groups. Coupled with marked inefficiencies in service provision, the system o f unequal access and use has resulted in health outcomes that are not commensurate with Turkey’s income level.

Reforms in four areas could substantially help improve lower-income group access to health care, wh i le contributing to an improvement o f the country’s health outcomes. These include: (a) expansion o f health insurance to assure better coverage o f low-income households; (b) undertaking steps to assure that disadvantaged areas with poor health outcomes have access to professional health care services; (c) strengthening the quali ty o f p r imary health care services,

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particularly in underserved areas; and (d) strengthening quali ty and outreach o f maternal and ch i ld health services and essential preventive care.

Improve Health Insurance Coverage of Low-income Groups. Almost 60 percent o f those living be low the poverty l ine are not covered by health insurance, wh i l e H C I S data show that insurance coverage i s an important determinant o f health-care-seeking behaviors. Therefore, expansion o f health insurance to accord better financial protection to low-income groups wou ld be a k e y step toward improving use o f health care by the poor. Introduction o f universal health insurance i s a core component o f the Government’s recently launched health sector reform program. The reform program wil l consolidate the four existing insurance schemes and expand coverage to those who have no financial coverage. The new universal insurance scheme i s to b e based on the principle o f solidarity and r isk pooling, with the State mak ing premium contributions on behal f o f those unable to do so. A k e y implementation challenge wil l b e to assure that government contributions will indeed be targeted to those most in need, wh i le min imiz ing errors o f exclusion. In this context, options o f linking quali f icat ion for government- pa id health insurance contributions to targeting mechanisms used for other social assistance benefits should b e explored. To the extent that the planned universal health insurance fund will have various semiautonomous regional branches, funding equalization to ensure branches in lower-income regions with poor health indicators are adequately resourced should b e based on regional demographic, health, and income profiles.

Reduce Regional Disparities in Service Delivery. Supply-side issues are an important contributor to l o w health care use in rural areas in general, and in Southeastem and Eastern Anatolia, in particular. Posting and keeping physicians and other medical staff in isolated areas where many o f the poor l i ve has been a long-standing problem. Wh i le recently introduced salary supplements for postings in those areas m a y help somewhat alleviate the problem, i t i s unl ikely that these measures alone will suffice to assure an adequate supply o f medical personnel in high- poverty areas. In addition to further incentive mechanisms (such as postings in places o f choice after postings in shortage areas, and admission to high-demand specialization programs), consideration should also b e given to establishment o f mobi le health teams that v is i t isolated areas on a regular basis from their base in district capitals.

Improve Quality of Primary Care. The perceived l o w quali ty o f p r imary care leads the vast major i ty o f patients to self-refer to specialized, mostly hospital-based, care. This can lead to substantially higher direct and indirect costs for care seekers, and thus increased access barriers, particularly in rural areas. Circumvention o f pr imary care i s also more l i ke l y to result in the lack o f continuity o f care, wh ich in turn leads to reduced effectiveness and use o f care. Therefore, efforts to improve the quali ty o f and the population’s confidence in primary care, by ensuring that a greater range o f health needs can be effectively accommodated at the primary care level, could help reduce access barriers to health care. In this respect, planned efforts to introduce a family-medicine-based pr imary care system can be expected to have a posit ive impact o n lower- income group access to and use o f care. In remote areas, efforts to deepen the technical capacity of health care personnel to a l low for a broader range o f and more effective service provision at the primary care level would need to be complemented by measures that assure local availabil ity of basic diagnostic services and essential drugs.

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Strengthen Maternal and Child Health and Preventive Care. The continued high levels o f maternal and infant mortal i ty in many areas o f Turkey calls for concerted efforts to improve the quality and use o f maternal and chi ld health services. The fact that at least one-fifth of a l l births in the East and Southeast continue to be unattended by any trained medical personnel (Table 2) and that up to one-third o f women do not receive any prenatal care,’ point to serious shortcomings in the Turkish medical system in this area, with both supply and demand factors at play. Similarly, the continued marked regional variation in vaccination coverage points to serious shortcomings o f basic preventive services, with large externalities. Whi le recent data to ascertain the correlation between poor health outcomes and household income are not yet available,* earlier DHS data point to an expectedly strong correlation between health outcomes and household welfare (World Bank, 2003). Therefore, overal l efforts to strengthen the quality and accessibility of pr imary care should integrate targeted efforts to improve access to and use o f maternal and ch i l d health services and basic preventive care to reduce marked regional and intrahousehold variations in health outcomes.

The Government’s recent Urgent Ac t ion Program and i ts sectoral spin-off, the Program for Transformation in Health, released in 2003 and supported by the recently approved Wor ld Bank Health Transformation Project, target far-reaching sectoral reforms aimed at improving sectoral efficiency and increasing equity in access to health services. This i s to b e achieved through the separation o f financing from service provision, introduction o f financial and managerial autonomy o f publ ic health care providers, more effective del ivery o f p r imary health care through the introduction o f fami ly medicine and, with particular importance to lower-income groups, and introduction o f universal health insurance. The Program i s expected to b e fwlly implemented by about 201 1, and will require major structural changes in the sector. Aside f rom the drafting of legislation to support these fundamental structural reforms, in i t ia l steps to eliminate access to health facilities based o n insurance aff i l iat ion have already been taken.’ Similarly, important in i t ia l steps have been taken to encourage medical personnel to accept postings in underserved areas.

Whi le challenging on many accounts, the much-needed reform program, i f implemented as envisioned, will indeed provide a technically sound avenue to substantially improve equity in access to health care. This in tum can be expected to effectively improve use o f health services by lower-income groups, wh ich currently forego care. Together with planned efforts to improve the quality o f care (introduction o f fami ly medicine, emphasis on improved matemal and ch i ld health services) they have the potential to help bring Turkey’s health outcomes more in l ine with those o f other OECD and European Union accession countries. As reform implementation progresses, it will be important to monitor i t s impact on access to care, particularly among the low-income groups and in the more disadvantaged regions.

’ Figures on lack o f prenatal care date back to the 1998 DHS, and may have improved somewhat since then. Data from the 2003 DHS, expected to become available during the second ha l f o f 2004, w i l l shed more light on accessibility and use of prenatal care, delivery, and chi ld health care, including regional variations and variations across income groups.

DHS 2003 data are expected to be available during the second ha l f o f 2004. Since early 2004, the distinction between SSK and MOH hospitals and health centers has been removed and

patients are free to visit their facility o f choice.

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C. EDUCA TION POLICY RECOMMENDATIONS

Spending on Education

The 1997-1 998 education reform has been extremely effective in increasing the schooling attainment o f children coming from poor households. In 1994, wealthier households benefited more from public subsidies to basic education. Following the 1997 education reform, the distribution o f public spending on education at the basic education level became roughly flat across household income quintiles. The distribution o f public funds across schooling levels now favors basic education, which i s another positive trend since the poor are more likely to benefit from these funds, and social returns to schooling are higher for early levels. At the secondary school level, too, there has been some improvement in the distribution o f public funds, but there i s much room for further pro-poor shifts (which would occur if poor children’s secondary school enrollment increases, as was the case with primary school enrollment).

Only after increases in education spending associated with the financing o f the 1997 education reform did Turkey’s public spending on education as a percentage o f GDP become comparable to the spending patterns observed in countries o f similar levels o f economic development. In order to ensure long-term economic growth and equity, there i s a need to maintain public education spending levels of at least 4.25 percent o f GDP (which i s in fact a target stipulated in various Ministry o f National Education publications).

Enrollment in Basic Education

The gross enrollment ratio for compulsory 8-year basic schooling i s 97 percent. Parental schooling i s identified as a very good predictor o f enrollment. Enrollment rates for the basic education cycle could increase even hrther if children o f parents with no schooling (the demographic group most likely to be out o f school) were encouraged to enroll in school. Turkey’s Conditional Cash Transfer program already provides financial subsidies to extremely poor families enabling these parents to keep their children enrolled in school. Wh i le this poverty assessment does not include a formal assessment o f the effectiveness o f this program, in principle, such targeted incentive schemes have been shown to be essential in ensuring the participation o f children from the poorest families to attend school.

Enrollment in Secondary Education

This report demonstrated the importance o f the availability o f secondary schools to increase enrollment. But i t also demonstrated that general secondary schools operate with significantly higher students-per-teacher ratios than vocation schools. Thus, a first priority should be ensuring optimal usage o f the physical infrastructure o f existing secondary schools. This alone may s t i l l not be sufficient, however, and thus there may be a need to proceed with building new secondary schools.

The children who were found to be less likely to enroll in secondary school have similar characteristics to those in other countries: the poor, females, those with uneducated or absent

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parents, those who reside in rural areas, and those who do not have a secondary school in their residential area. The magnitude o f the impact o f each o f these characteristics o n enrollment is striking, as demonstrated by the analysis o f household survey data. The important point i s that if compulsory schooling i s further increased to 12 years, as mentioned in some Government planning documents, the beneficiaries would be almost exclusively the vulnerable groups listed above. Nonetheless, the prerequisites to such a move include raising efficiency in the utilization of existing secondary schools and perhaps establishing new secondary schools.

Parental Views on the Quality o f Schooling

The parents o f poor children are more l ikely to report problems with schools, and less l ikely to be satisfied with the quality o f education their children receive. In 2001, the most commonly expressed problem with education was the lack o f books and supplies (29 percent o f the poorest quintile of households expressed this problem). Since then, the Govemment has acted o n this issue by providing textbooks free o f charge to a l l primary school students. A s a result, i t could be that a major problem has already been resolved. N o w attention needs to shift to other main complaints from poor parents that emerge from the survey: namely the condition o f school facilities, poor teaching, and even a lack o f teachers (especially in rural areas).

Tertiary Education

The most effective way to ensure better representation o f poor children in tertiary education i s through investments in their schooling at earlier levels o f education. Interventions that come into play later in the education cycle are l ikely to be less effective. In fact, if high quality (free) primary and secondary schooling were made available to poor children, then perhaps the main intervention needed at the postsecondary education level would be to ensure poor students’ access to credit and scholarships.

Nonetheless, raising the quality o f primary and secondary education will not lead to significant increases in the enrollment o f the poor in tertiary education, in the short to medium term. Therefore, other interventions should be considered. Assuming that the centrally-run university entrance examination system (which has a number o f positive features) i s not changed, the Government may wish to design interventions to raise the performance o f qualified poor children in these examinations. As discussed in the main chapter, wealthier children are much more l ikely to receive private courses (often through “dersane ” attendance) specifically designed to improve scores on university entrance examination. In this context, po l icy makers may consider providing govemment subsidies to poor children to enroll in dersane-type university entrance examination preparation courses.

D. LABOR MARKET POLICYRECOMMENDATIONS

The analysis o f the labor market demonstrated two key findings: the extraordinarily l o w rate of female labor force participation in Turkey and the strong link between informal and agricultural employment and poverty. I t i s dif f icult for pol icy makers to do much about the l o w rate of female labor force participation in the short run, but certainly implementing the reforms o f the

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education system and the conditional cash transfers o f the Social R isk Mit igation Project (SRMP) should help in the future for more educated women to participate in the labor market. Also, the literacy training and micro-project endeavors under the Local Initiatives component of the SRMP should assist in this long-term goal.

On the linkage among informal and agricultural employment and poverty, here the best pol icy recommendation i s for Turkey to stay the course on macroeconomic reforms, which have already led to significant real economic growth. As the economy grows and develops, more formal and better-paying jobs will emerge from that growth, and these wil l provide the avenue for Turkey’s 27 percent poor to find better jobs that wil l enable them to escape poverty.

E. SOCIAL PROTECTION POLICY RECOMMENDATIONS

Recommendations for Reform of Pensions

The immediate issue in the Turkish pension system i s the high and completely unsustainable level o f deficits requiring financing from the Treasury. The current high deficits and their rapid rise after an init ial period o f decline following the 1999 reforms highlight the need for deeper parametric changes than had been enacted in 1999. Potential parametric changes include:

0 A rise in the retirement age, both in the short and long run. Currently, women may retire as young as 41 and men as young as 43, but even in the long run, the retirement ages are expected to stabilize at 60 for men and 58 for women. The current retirement ages are the youngest anywhere in the world and even the long run ages will look young relative to l i fe expectancy when they have been finally reached. The system should aim for a l i fe expectancy o f 15 years after retirement, with legislated increases in retirement age to match increases in l i fe expectancy and move to this point as quickly as i s legally feasible.

0 A rise in the number of years of contribution required before receiving a benefit. Currently, SSK requires only 19.4 years o f contribution to receive a full pension with a reduced pension available with only 12.5 years, while the other systems al l require 25 years for men and 20 years for women. Internationally, full pensions are usually available after 25 and 40 years o f service, although usually the generosity o f the pension available at 25 years i s significantly less than what is available in Turkey. Reduced pensions for those unfortunate enough to have fewer numbers o f working years need to be available, but these need to be provided o n a prorated basis, unl ike the current system which gives the bulk o f the pension for the first years o f contribution, reducing the incentive for further contribution.

0 A reduction in the benefit accrual rate is also required to bring Turkey in line with other countries. Currently SSK pays 3.5 percent of wages in pension for the first 10 years o f contribution and then 2 percent per year for the next 15 years, whi le Emekl i Sandigi pays 3 percent per year. The international averages are between 1 and 1.5 percent per year and even these are not fully affordable in al l countries.

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e A move to wage indexing the pensionable salary in l ieu o f the current valorization by nominal GDP growth would also b e preferable. As Turkey moves, based o n the 1999 Social Security Law, toward using career average salary as the basis for the pension, how the early wages are revalorized in creating this average becomes a cri t ical factor in determining the value o f the pension and the cost o f pension payments. The 1999 law had specified GDP growth, wh ich i s historically higher than wage growth as the indexing factor. As a result, individuals who had earned the average salary throughout their career would have a pensionable salary higher than their work ing wage. Th is bonus needs to b e eliminated by using wage indexation o r some close approximation.

e Maintainingprice indexation ofpensions as dictated by the 1999 l a w i s also important to containing costs. Prior to the 1999 law, Turkey had a tradition o f ad hoc increases in pensions. The Government disregarded the 1999 l a w in 2004 and announced arbitrary increases in pensions once again, wh ich were above the level o f inf lat ion and raised costs n o t just for this year, but also for a l l future years.

e Eliminating and avoiding supplementary payments to pensioners. Prior to 1996, the Turkish Government had provided supplementary payments to pensioners, wh ich became higher than the earned pensions breaking a l l l inks between contributions and benefits. These were frozen in nominal terms in 1996, but resurfaced under a n e w name in 2003, social support payments. Politically, there seems to b e a tradition that instead o f reacting to l o w pensions by contributing for more years or by correctly declaring earnings, pensioners use the pol i t ical process to exact higher pensions, thereby undermining the pension systems and incentives to contribute.

a Maintaining or reducing the contribution rate. Despite the fiscal issues, raising the contribution rate in Turkey i s no t an option. As the fiscal situation improves, lowering labor taxes wil l serve to improve the efficiency o f the labor market.

Besides the parametric changes discussed above, the Turkish pension system i s also plagued by being fragmented into four separate benefit schemes administered by three different agencies. T w o o f these four schemes retain the older, pre-1999, more generous benefit structure, resulting in large transfers from the state in particular to the c i v i l servant scheme. There i s an issue of fairness as to why the state as a whole should favor one group over another as w e l l as the administrative complications involved with workers who contribute to more than one scheme during their working careers and o f ensuring that workers are indeed complying with the l a w and submitting contributions to one o f the four schemes. Thus, another recommendation is:

a Unification of the pension schemes, bo th in terms o f benefit structure and in terms o f administration to improve equity and administrative efficiency.

Finally, there i s s t i l l a large uncovered group o f the elderly in Turkey. Wh i le the social pensions administered by ES do provide some safety net for the many elderly without an income, i t would be beneficial to integrate this special program for the elderly with the other social assistance efforts in the country to try and reduce administrative costs and increase equity by using the same means testing methodology used by other social assistance programs. However, the social

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pension administrator needs to also b e aware o f minimum and average levels o f contributory pensions to avoid providing such a generous noncontributory benefit that people choose to no t contribute to mandatory schemes.

e Integration of social pensions with other social assistance benefits.

The system for evaluating whether a person i s eligible for a social pension i s separate from the systems, wh ich determine el igibi l i ty for other types o f cash benefits. There i s n o inherent reason that a l l social assistance benefits not be evaluated together and provided to famil ies as a package, particularly given that the elderly poor may reside within larger poor households.

Recommendations for Reform o f Social Assistance

Despite recent improvements, Turkey st i l l has a fragmented, under-funded and inadequate social assistance and social services system. Social assistance, in terms o f cash and in-kind payments to the poor i s managed mainly by the Social Assistance and Solidarity Encouragement Fund (SYDTF) and i ts 931 affiliated Social Solidarity Foundations (SYDVs). However, a variety o f other programs are managed by institutions as diverse as ES (non-contributory pension for those over 65 as discussed above), the Ministr ies o f Defense (for the families o f conscripts), National Education, General Directorate o f Youth and Sports, Prime Minister ia l Of f i ce for the Disabled, municipalit ies and the State Social Services and Child Protection Organization (SHCEK, as we l l as a plethora o f minor programs under other agencies). Moreover, the S Y D T F i tsel f suffered from the lack o f a h l ly concretized structure that was not recti f ied until the passage o f L a w 5263 on December 9,2004.

Expenditures through the SYDTF, which until 2002 were fully funded through an extra- budgetary fund (EBF) receiving specified percentages o f a diverse array o f government revenue flows, have fluctuated between 0.19 and 0.32 percent o f GNP. This i s very low by comparator standards-in many OECD countries, ch i ld benefits alone account for over 0.70 percent of GNP, with total social assistance r ising sometimes to 2 percent o f GNP. Only in recent years have expenditures stabilized closer to 0.30 percent o f GNP, with the encouragement o f the World Bank and through the allocation o f budgetary transfers (in 2004 reaching TL 200 million). By any standards, this i s barely adequate. Under the medium to long term, with health expenditures o f the S Y D T F transferred to universal health insurance (UHI), but the old-age social assistance pension transferred to the SYDTF, expenditures should be maintained at least at 0.60 percent} of GNP in order to have any meaningful impact on reducing poverty and establishing a robust social safety-net. In the short to med ium term, expenditures should r ise to and b e maintained at 0.35 percent o f GNP pending the necessary restructuring o f expenditures.

The Government, with the support o f the World Bank under the SRMP, has already begun the process o f strengthening social assistance programs. This includes a substantial improvement of targeting through the use o f a proxy means test, the introduction o f n e w poverty-focused programs to break the inter-generational cycle o f poverty such as the Condit ional Cash Transfers (CCT)-targeted to the poorest on condition that children are kept in school and that pregnant mothers and pre-school children attend well-care medical services, improved programs to lift the poor permanently out o f poverty (thereby no t becoming long-term social assistance recipients)

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through Local Initiatives providing support for income generation opportunities, improved robust and regular poverty monitoring and evaluation (M&E) through the State Institute o f Statistics, and greater attention to M&E o f social assistance programs overall.

Despite these improvements, the overall system could st i l l be much improved. Social services per se are weak and under-developed. SHCEK, whilst providing good services at the provincial level in some provinces, has a spotty record, and fails to exercise an effective strategic policy- making and quality control role at the central level. Service provision i s not we l l coordinated with other service providers (e.g., municipalities) and i s frequently supply rather than demand- driven. The draft Public Administration Framework L a w moreover appropriately transfers responsibility for service provision to the local level, designating the pol icy formulation, norms derivation, quality control and M&E functions to a reconstructed central level. Strengthening and reforming the social assistance and services system thus necessarily has the fol lowing elements, a l l o f which must be encompassed in framework legislation.

Restructuring the system. This should provide for: (i) policy formulation, norms establishment, quality control and M&E for a l l population groups (children, youth, working poor, gender- related, elderly, disabled) at the central level in one single agency/ministry which would reduce the number o f central agencies; (ii) a single agency for determination o f el igibi l i ty and payment of cash benefits, namely the SYDTF-streamlining the system and enhancing efficiency, itself strengthened by a formalized legal structure; and (iii) decentralizing service provision to make it more responsive to local demands.

Financing the system through a Government commitment to at least a minimum level of expenditure o f 0.35 percent o f GNP. The quality o f Turkish fiscal adjustment leaves much to be desired as key expenditures in the social area and public investment have been cut in order to finance recurrent expenditures.

Targeting. The targeting o f social assistance can be significantly improved by using the same proxy means-test targeting used for the conditional cash transfers, but with a different cutoff point, depending o n the desired number o f beneficiaries. Improved targeting o f social assistance i s a reform being supported under the PFPSAL 111. This proxy means-test targeting system could also be used for fee waivers for health insurance.

Expanding CCTs. Targeting o f social expenditures can definitely be improved as recommended above, and the fiscal savings from this would be wel l directed toward expanding CCTs, as wel l as any savings from future adjustments o f the public expenditure program or gains from sustained economic growth. The number o f beneficiaries o f CCTs was kept to 1.6 mi l l ion children (and recently expanded to 7,000 pregnant women), or less than 2 percent o f the population. However, i t i s clear that there are many vulnerable, who, while not extremely poor, are s t i l l quite poor and who would benefit from keeping their human capital from eroding by an expanded CCT program. Additionally, Turkey could consider external financing for an expanded CCT program. For example, U S A I D has recently agreed to co-finance the existing CCT program, and a bilateral development bank finances many CCT programs in Latin America.

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REFERENCES

Milanovic, Branko, and Sholomo Yitzhaki. 2001. “Decomposing World Income Distribution: Policy Research Working Paper No. 2562. Does the World Have a Middle Class?”

Washington, D.C.: World Bank.

Ministry o f National Education. 2001. “The Turkish Education and Developments in Education. ” Ankara, Turkey.

World Bank. 2000. “Turkey: Economic Reforms, Living Standards, and Social Welfare Study. ” Report No. 20029-TU. Washington, D.C., January 27.

. 2003. “Turkey: Poverty and Coping After Crises. Report No. 24185-TR. Washington, D.C., July 28.

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ANNEX

Table 1. Inequality as Measured by the Gini Coefficient; All Countries Included in the Sample (Ranked by $PPP Income Level)

I Pooulation Gini I ZncomdExpenditures

Estonia 0.383 Lithuania 0.369

I Guyana 0.490

Malaysia 0.463 Ireland 0.284 ~

Austria 0.472 Israel 0.347 Chile 0.564

Italy 0.306 Belgium 0.246 Taiwan 0.293 Australia 0.345 U. K. 0.354 Sweden 0.249 Netherlands 0.311 South Korea 0.3 10 Finland 0.226 Cyprus 0.297 Germany 0.294 France 0.326

0.246

Between-Country Gini 0.498 Within-Country Gini 0.161 World Gini 0.659 Source: Milanovic and Yitzhaki (2001)

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Table 2. Per Capita GDP and Poverty

Below National

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Below National

34

35

n.a.

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United Kingdom United States

--

26,150 17 n.a. 35,750 12 n.a.

n.a. = Not available. Sources: GDP and National Poverty are taken from Global Development Finance; and World Development Indicators; and World Bank Central database (2004).

USSl PPP per person per day i s taken from the World Bank website: http://www.worldbank.org/research/povmonitor/.

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