This is the one inevitable discussion for Turkey. There exists a common belief that Turkey has high rate of informality. This belief is common though there are no comprehensive studies on this issue. If Turkey wants to get on a sustainable and steady medium term growth path, it should deal with the informality problem in a comprehensive manner. So, why is that the case and how can informal economy be eliminated? Let us talk about these today.  I personally believe that the shift from informal to formal economy cannot be secured and coordinated solely by the Ministry of Finance.

The first thing to consider is as to why informality is an impediment to sustainable growth. The reason is quite simple: low savings rate threatens the stability of growth. The way to solve this structural problem is to increase national saving rate. It is quite hard, in fact impossible to solve this problem by voluntarily increasing private savings.  Then, the solution locks at forced savings. With a short term perspective, the tool at hand can be expanding the tax base. The state can forcefully convince the citizens to save more. Given the tax rates Turkey applies, the solution seems to be easy at first glance. The thing to do is to secure shifts to formal economy and directly improve tax collections. The government seems to have a large room to maneuver at the first instance.

But, is it only the Ministry of Finance that should implement a series of measures to use this room to maneuver? No it is not. The process of eliminating informal economy is closely related with the modernization of Turkey's economy. First, increasing the share of organized retailing in the delivery channels of the economy is of great importance in terms of shifting the agriculture and food sector, which was pushed into the informal sector upon exceptions and exemptions, to the formal economy. The share of informality in the economy will be reduced as much as the shift to organized retailing market is ensured.  This is the first point to state. Second, shifts to the formal economy will be accelerated as much as the share of the banking system in payments system increases. It should also be noted that what brings banking system to the fore in payments system is the comfort of increasing credit card usage. So, this is not directly related with the Ministry of Finance. Let this be the second point to state. Third, shifts to the formal system will be accelerated as the SMEs access to bank credits is facilitated and as SMEs realize that the path of growth passes through the financial system. Currently, for banks extending credits to SMEs mean abiding with extra costs. It is hard to deal with SMEs instead of purchasing Treasury bills. And this is the third point to state. The fourth issue is that the main driving source of informality is the exceptions and exemptions the tax system defines. When these are eliminated, it will become crystal clear that Turkey's tax system gives way to informality due to a voluntary political choice. And this last issue is closely related with the Ministry of Finance.

Nonetheless, this room to maneuver can be used, i.e. national saving rate can be increased via securing the shift toward the formal sector, only under two assumptions. So, let us underline this issue as the fifth point. First, public savings rather than public expenditures should be improved through the rising public revenues. In this context, politicians should forego spending the resources for political purposes. And as far as I am concerned, this goes against the grain. And it is evident this is a hard thing to accomplish given that the "fiscal rule" regulation needed for remedying this "oxymoron" goes round in circles. In fact, this fiscal rule issue has been lengthened out even more than the IMF deal. Second, improving national savings through improving public savings implies that the public sector has the mechanisms to transfer the savings to the private sector efficiently. And this brings us back to the "entrepreneurial government" issue we discussed earlier. Entrepreneurial government is the government that does not hesitate to make resource allocation decisions or make mistakes. What is important is to mend the mistake quickly. If Turkey's saving rate will be increase through public savings, a channel to transfer efficiently the public resources to private sector must be built.

Some countries used venture capital system was used exactly for this reason. Perhaps the YOZMA experience of Israel can be revised with this lens.

This commentary was published in Referans daily on 16.03.2010