When designing the new incentive system, it is crucial to devise a framework that improves productivity and technological advancement and promotes innovativeness.

The incentive system issue can be addressed with a different perspective: Assume that you are to make an investment. The maximum cost of the product you will produce in your new facility should be no higher than the cost of rival products, under the assumption that there is no incentive mechanism in place. Otherwise, your new facility can survive only with artificial ventilation. The incentive system must not turn into an artificial ventilation device. It is evident that there is no economic benefit in artificially trying to create a competitive production process out of one that is originally uncompetitive. 

Useful in two aspects
Within this perspective, the incentive system must be useful in two aspects. First, it can be used to direct production towards certain regions. The new package puts a special emphasis on selective regional incentives, which is good. Second, the system can encourage R&D activities, and productivity-boosting and innovative investments.

When introducing the new incentive system, it was underscore that there will be a special focus on investments that will heal the current account deficit. The questions that how the current account deficit will be eased and whether the steps that will be taken to this end would bring about any trouble in the future are yet to be answered. If incentives will solely aim to discourage imports and encourage domestic production of certain goods, the mechanism is likely to turn into an artificial ventilation device. We must not fall into this trap.

In this context, I highly recommend you to read Mr. Emrah Aydınonat’s smart commentary on TEPAV’s website (Kidney Bean, Space Administration and the New Incentive System, 14 April 2012, http://www.tepav.org.tr/tr/kose-yazisi-tepav/s/3169). The commentary takes departure from a declaration by the Department of the Non-Wood Products and Services newly opened under the Ministry of Environment and Forestry. Summer snowflake (Leucojum aestivum) is used for medicine production. Turkey exports the plant for $35 per kilogram. After processed in alkaloid facilities, it is sold to international pharmaceutical companies to be used in medicines. So, he asks: 

Structural reforms needed
“Let’s say we founded alkaloid facilities and extracted the alkaloids. Do we have the capacity to produce medicine for Alzheimer, infantile paralysis and neurological diseases using these alkaloids? Will we provide incentives to those who invest in such facilities? If so, will those to invest in this sector be able to find trained labor force capable of handling the production process? If they do, can we run such facilities without importing intermediate production goods? Even if we somehow start the production, can we produce the medicine at a cost lower than that of foreign substitutes? If we cannot, will we limit the importation of the substitute medicine? Let’s assume we limited imports and met the domestic demand with domestic production. What if the “alert” foreign companies develop better medicine for Alzheimer and infantile paralysis using kidney beans instead of summer snowflake, will we abolish the incentives for snowflake investments and incentivize investments on facilities for producing medicine using kidney beans? Will we introduce new import barriers and seek new technical staff? In short, will we always be one or two steps behind the developed countries and the state-of-art technologies?”

These all are critical questions, the last one in particular. When designing the new incentive system, it is crucial to avoid the import-substitution trap and devise a framework that improves productivity and technological advancement and promotes innovativeness. Any incentive scheme encourages investments. What is important is to make sure that investments will enhance the potential output growth rate. In this context, it is important to think through the incentive system together with structural reforms, particularly with education reform to be tailored to improve the skills level of the labor force.

This commentary was published in Radikal daily on 21.04.2012