Foreign affairs 2014 01-02

january/february 2014 • volume 93 • number 1 • where to bet now America's Social Democratic Future january/f ebruary 2014 Where to Bet Now Six Markets to Watch How China Is Ruled Running the Pentagon Right Talks With Enrique Peña Nieto and Ólafur Ragnar Grímsson NAFTA at 20 f o r e i g naf fai r s .c o m



january/february 2014 • volume 93 • number 1 • where to bet now America's Social Democratic Future january/f ebruary 2014 Where to Bet Now Six Markets to Watch How China Is Ruled Running the Pentagon Right Talks With Enrique Peña Nieto and Ólafur Ragnar Grímsson NAFTA at 20 f o r e i g naf fai r s .c o m



cover photo: getty images / steven puetzer Volume 93, Number 1 Where To Bet Now The Shape of Things to Come 2 Hot Markets to Watch Gideon Rose and Jonathan Tepperman Pact for Progress 4 A Conversation With Enrique Peña Nieto Mexico 11 Viva las Reformas Shannon K. O’Neil South Korea 17 The Backwater That Boomed Marcus Noland January/February 2014

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Poland 23 From Tragedy to Triumph Mitchell A. Orenstein Turkey 29 How Erdogan Did It—and Could Blow It Daniel Dombey Indonesia and the Philippines 37 A Tale of Two Archipelagoes Karen Brooks The Mekong Region 45 A River Runs Through It Thitinan Pongsudhirak The Ever-Emerging Markets 52 Why Economic Forecasts Fail Ruchir Sharma Essays The Unruled World 58 The Case for Good Enough Global Governance Stewart Patrick How China Is Ruled 74 Why It’s Getting Harder for Beijing to Govern David M. Lampton America’s Social Democratic Future 86 The Arc of Policy Is Long But Bends Toward Justice Lane Kenworthy January/February 2014

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Running the Pentagon Right 101 How to Get the Troops What They Need Ashton B. Carter The Rise and Fall of the Failed-State Paradigm 113 Requiem for a Decade of Distraction Michael J. Mazarr NAFTA’s Economic Upsides 122 The View From the United States Carla A. Hills NAFTA’s Unfinished Business 128 The View From Canada Michael Wilson NAFTA’s Mixed Record 134 The View From Mexico Jorge G. Castañeda Iceland’s Saga 142 A Conversation With Ólafur Ragnar Grímsson on foreignaffairs.com Adam Minter on the Anna-Katarina Ira Trivedi on the billion-dollar trade in Gravgaard on Green- romantic revolution scrap metal. land’s rare earths. sweeping India. January/February 2014

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Return to Table of Contents REVIEWS & RESPONSES Let the People Go 152 The Problem With Strict Migration Limits Michael Clemens and Justin Sandefur From Shah to Supreme Leader 160 What the Iranian Revolution Revealed Laura Secor Command and Combust 167 America’s Secret History of Atomic Accidents Gregory D. Koblentz Art in the Time of Authoritarianism 173 Spain’s Cultural Success Under Franco Victor Pérez-Díaz Blind Oracle 179 A Response to “Never Saw It Coming” Richard Katz Reverse the Curse 182 How Can Oil Help the Poor? Karol Boudreaux and Tiernan Mennen; Larry Diamond and Jack Mosbacher Recent Books 186 “Foreign Affairs . . . will tolerate wide differences of opinion. Its articles will not represent any consensus of beliefs. What is demanded of them is that they shall be competent and well informed, representing honest opinions seriously held and convincingly expressed. . . . It does not accept responsibility for the views in any articles, signed or unsigned, which appear in its pages. What it does accept is the responsibility for giving them a chance to appear.” Archibald Cary Coolidge, Founding Editor Volume 1, Number 1 • September 1922 January/February 2014

Return to Table of Contents January/February 2014 · Volume 93, Number 1 published by the council on Foreign relations GIDEON ROSE editor, peter g. peterson chair JONATHAN TEPPERMAN managing editor KATHRYN ALLAWALA Web editor STUART REID, JUSTIN VOGT senior editors CAMERON ABADI deputy Web Editor BENJAMIN ALTER associate editor FREDERICK DEKNATEL staff editor HARRISON MONSKY assistant editor ANN TAPPERT Copy Editor LORENZ SKEETER production manager IB OHLSSON contributing artist SARAH FOSTER Business administrator CHRISTINE CLARK editorial assistant Book Reviewers RICHARD N. COOPER, RICHARD FEINBERG, LAWRENCE D. FREEDMAN, G. JOHN IKENBERRY, ROBERT LEGVOLD, WALTER RUSSELL MEAD, ANDREW MORAVCSIK, ANDREW J. NATHAN, NICOLAS VAN DE WALLE, JOHN WATERBURY LYNDA HAMMES publisher EMILIE HARKIN marketing Director STACY HAN senior product manager CHRISTINE LEONARD marketing manager JONATHAN CHUNG Business operations Manager EDWARD WALSH advertising Director MICHAEL PASUIT senior account manager CAROLINA AGUILAR Manager, Business development RENÉ R. PÉREZ account executive HANNAH CASSIUS publishing associate TOM DAVEY director, Web Management and development ANIQUE HALLIDAY Digital producer CREE FRAPPIER Website and Mobile operations RICHARD WANDERER, KIRK BROWN regional advertising managers BERNADETTE PACE, PROCIRC LLC circulation services LISA SHIELDS, IVA ZORIC, DAVID MIKHAIL media relations Board of Advisers MARTIN S. FELDSTEIN chairman JESSE H. AUSUBEL, TOM BROKAW, SUSAN CHIRA, JESSICA P. EINHORN, MICHÈLE FLOURNOY, FRANCIS FUKUYAMA, THOMAS H. GLOCER, ADI IGNATIUS, CHARLES R. KAYE, MICHAEL J. MEESE, LOUIS PERLMUTTER, RICHARD PLEPLER, COLIN POWELL, DAVID M. RUBENSTEIN, KEVIN P. RYAN, FREDERICK W. SMITH, MAURICE SONNENBERG, MARGARET G. WARNER SUBSCRIPTION SERVICES: Foreign Affairs Foreignaffairs.com/services 58 e. 68th street, new york, ny 10065 TELEPHONE: ADVERTISING: call carolina aguilar at 212-434-9526 or visit 800-829-5539 u.s./canada www.foreignaffairs.com/about-us/advertising 813-910-3608 all other countries WEB SITE: Foreignaffairs.com EMAIL: [email protected] NEWSLETTER: Foreignaffairs.com/newsletters MAIL: p.o. Box 60001, Tampa, FL, 33662-0001 VIDEO: Foreignaffairs.com/video FACEBOOK: Facebook.com/Foreignaffairs R EPRODUCTION: the contents of Foreign Affairs are copyrighted. No part of the magazine may be reproduced, hosted or distributed in any form or by any means without prior written permission from Foreign Affairs. To obtain permission, visit Foreignaffairs.com/about-us Foreign Affairs is a member of the alliance for audited media and the association of magazine media. gst number 127686483rt canada post customer #4015177 publication #40035310

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sec o r ph o t o : american academ y in berlin / annette h o rnischer Return to Table of Contents contributors THITINAN PONGSUDHIRAK grew up in Bangkok and spent his university years in California, Washington, and London. Since then, he has studied the Thai economy as a scholar and participated in it as a consultant. He now teaches political science at Chulalongkorn University, where he is director of the Institute of Security and International Studies, and writes a column for the Bangkok Post. In his forecast of the Mekong region’s prospects (page 45), he explains what is behind mainland Southeast Asia’s economic boom. Until December, ASHTON CARTER was the number two official at the Pentagon. A Rhodes scholar with a doctorate in theoretical physics, Carter has long been a faculty member at the John F. Kennedy School of Government at Harvard University and has served on the Defense Science Board, the Defense Policy Board Advisory Committee, the secretary of state’s International Security Advisory Board, and innumerable other official panels and commissions. In “Running the Pentagon Right” (page 101), he lays out the lessons he has learned about how to get U.S. forces the support and equipment they need, when they need it. CARLA HILLS, an attorney by training, became the third woman to serve in a U.S. cabinet post when she was sworn in as secretary of housing and urban development by President Gerald Ford in 1975. From 1989 to 1993, she served as the U.S. trade representative, negotiating the North American Free Trade Agreement on behalf of the United States. In “NAFTA’s Economic Upsides” (page 122), Hills looks at the fruits of NAFTA 20 years on and sug- gests how to build on the treaty in future decades. A veteran journalist and editor, LAURA SECOR has worked at The New Yorker, The New York Times, The Boston Globe, and The American Prospect, among other publications. Her reporting on Iran has covered everything from the fall of the Green Movement to the rise of the price of chicken. She is currently writing an intellectual history of reformist thinking in Iran—a subject she explores in “From Shah to Supreme Leader” (page 160), a review of two new books on Iranian politics since the Islamic Revolution.

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Return to Table of Contents where to bet now A whole new group of economies is heating up, and all are well positioned to thrive as China slows and the commodity boom cools. — Gideon Rose and Jonathan Tepperman The Shape of Things to Come Turkey Gideon Rose and Jonathan Tepperman 2 Daniel Dombey 29 37 A Conversation With Indonesia and the Philippines 45 Enrique Peña Nieto 4 Karen Brooks 52 Mexico The Mekong Region Shannon K. O’Neil 11 Thitinan Pongsudhirak istock / skyman8 South Korea The Ever-Emerging Markets Marcus Noland 17 Ruchir Sharma Poland 23 Mitchell A. Orenstein

Return to Table of Contents The Shape of middle class exploded, and forecasters Things to Come began talking of a great convergence, in which broad swaths of the developing Hot Markets to Watch world would catch up to the developed one. Then, the global financial crisis hit Gideon Rose and like a tidal wave, dousing almost every- Jonathan Tepperman one and redrawing the landscape. In its wake, many of the once-hot emerging The idea that we live in an markets have cooled. The brics are increasingly interconnected and crumbling. China’s three-decade run of turbulent world is something of phenomenal growth seems to be ending, a cliché—yet true and important never- with the big question now being whether theless. Decisions made by the U.S. its landing will be hard or soft. And half Federal Reserve affect the purchasing a decade after the crisis began, Europe power of villagers in southern Thailand; is still floundering. But not all the news consumer demand in Europe and North is bad. The United States has surprised America affects the output of factory skeptics by making a slow but steady workers in eastern China, which affects recovery, led by energy and manufac- the jobs of oil workers in Brazil, Russia, turing. And a whole new crop of green and elsewhere. Elite investors now shoots is springing up. routinely send their capital abroad in a ceaseless quest for new opportunities Given the tumult, we decided that and high returns; whether they realize now would be a good time to survey it or not, hundreds of millions of less these up-and-comers: countries and highflying people do the same indirectly, regions whose combination of size, recent through their mutual or pension funds. performance, and economic potential So global economic forecasting—trying will make them particularly interesting to look past current events to glimpse to watch and attractive to investors over what’s coming over the horizon—has the next half decade. All our choices— become an exercise of general, not Mexico, South Korea, Poland, Turkey, specialized, concern. Indonesia and the Philippines, and the Mekong region—are well positioned to A decade ago, the big story in the thrive as China slows and the commodity international economy was the so-called boom cools. All have crucial strengths rise of the rest: the impressive growth to draw on and will play increasingly of dozens of emerging markets around important roles in the future of the the globe. Poverty rates plummeted, the global economy. And yet, as our expert authors show, each faces a distinctive Gideon Rose is Editor of Foreign Affairs. set of challenges. Jonathan tepperman is Managing Editor After years of stagnation, violence, of Foreign Affairs. and political drift, Mexico is now enjoy- ing energetic new management, and recent reforms, plus the country’s vast oil wealth and proximity to the world’s largest market, should spur it forward 2 foreign affairs

Return to Table of Contents The Shape of Things to Come in the years to come. (In an exclusive the head of emerging markets and global accompanying interview, Mexican macro at Morgan Stanley Investment President Enrique Peña Nieto explains Management. how he did it and what he plans next.) Even the best crystal ball gets cloudy South Korea and Poland have also at times, of course, and there are many profited from smart leadership and factors such a package cannot cover, from proximity to bigger players; indeed, unexpected technological developments both have grown so rapidly in recent to currency fluctuations to natural disas- decades that they no longer fully qualify ters (such as Typhoon Haiyan, which as “emerging.” But both remain more struck the Philippines just before the volatile than established, fully developed package went to press). We have not states, making their manufacturing- tried to make short-term predictions, driven economies especially appealing nor have we focused on the extent to for investors. which global markets may have already priced in the various issues our authors Turkey’s story is somewhat similar, discuss. What we have tried to do is although its economy remains less offer a compelling look at the funda- advanced and its leadership less enlight- mental issues likely to drive success or ened. With an impressive decade behind failure in some of the global economy’s it and an important election ahead, Turkey newest and brightest stars in the years faces its biggest challenge today in the to come.∂ realm of domestic politics. As Prime Minister Recep Tayyip Erdogan flirts with authoritarian populism, the country teeters between continued growth and a reversion to the Middle Eastern mean. Giant Indonesia also confronts politi- cal challenges, and a crucial election in 2014 will determine whether it delivers on its promise or returns to the more familiar path of stagnation. Meanwhile, the nearby Philippines, now an outsourc- ing powerhouse, has been racing ahead under the clean and committed steward- ship of President Benigno Aquino III. Finally, mainland Southeast Asia— the region around the Mekong River and its tributaries—is rediscovering the benefits of interconnectedness, as its diverse economies take advantage of their ancient cultural ties and new transportation links to grow together. We round out the package with a look at the pitfalls and promise of economic forecasting in general by Ruchir Sharma, January/February 2014 3

Return to Table of Contents Pact for Progress started to look a lot gloomier. What R euters / henr y romero A Conversation With concrete improvements can you point Enrique Peña Nieto to from your first year in office? When Enrique Peña Nieto, 47, became Mexico’s president, This government has come not to on December 1, 2012, expec- manage but to transform. Part of what tations were hardly sky-high. A one-term has allowed this is the Pact for Mexico state governor, Peña Nieto was relatively [a deal to push through reform signed untested. His election also represented by all three of Mexico’s major parties at a return to power for Mexico’s Institu- the start of Peña Nieto’s term]. The tional Revolutionary Party (pri), which pact gave us space to debate and agree had run the country for 70 years before on the changes Mexico needs, and that being ousted in 2000 in the country’s is exactly what has been happening first freely contested elections. Many throughout this year. We’ve made feared that Peña Nieto’s ascendance would adjustments in labor, in education, in mean a resumption of the bad old days finance, on fiscal issues, and I hope also of crony capitalism, economic stagnation, in energy. All these adjustments have— and tacit cooperation with the country’s and this is natural—faced resistance brutal drug cartels. Instead, the new from the people who are being affected. president immediately set about enacting But we’ve been building the found­ ations far-reaching economic reforms, taking for a country that will be more promis- on fiscal policy, unions, oligarchs, and a ing in the near future. cosseted energy sector in rapid succes- sion. He even got a fat tax on junk food But for ordinary Mexicans, these changes passed last October. But as Peña Nieto’s first year in office has drawn to a close, must seem abstract. Can you reassure results from the new approach have yet to materialize. Mexico’s economy has them that growth will improve soon or slumped, crime remains a serious threat, and polls show voter confidence in the give them other targets to look for? president sagging. In mid-November, Peña Nieto met with Foreign Affairs manag- Undoubtedly, the changes that have ing editor Jonathan Tepperman at Los already taken place will allow our Pinos, Mexico’s presidential residence, economy to perform better next year, to discuss his term to date and his plans for many reasons. First, the international for the future. environment will improve. We see signs right now that other economies seem Your administration has gotten off to have hit bottom and are starting to recover. This will be good for the to one of the best starts of any in recent economic dynamics of Mexico, which is an open country. history, but recently, the picture has Second, it was natural that with the change of administration, there was a change in the pace of government, and this will be felt next year. There will also be a higher budget, which is the consequence of the fiscal reform. Obviously, this new budget will test the capacity of the government to spend 4 foreign affairs

Return to Table of Contents The president in Mexico City, September 2012

Return to Table of Contents Pact for Progress with transparency and efficiency, but I can you get the kind of participation think this first year has set the basis for us to be able to [do that]. This has Mexico needs? been a year of planning, of undertaking indispensable projects. Some of the I think the model we have presented to results are already materializing. But next Congress is very similar to models that year, we will have a budget that will be have proved successful in other parts of the highest in the history of Mexico. the world. It promotes greater partici­ pation by the private sector in oil, gas, So are you promising specific new kinds and all our energy resources. This issue is very sensitive in Mexican culture. It’s of spending for next year? practically a religious issue. But we’ve seen other countries implement reforms We have to expand higher education and inviting in the foreign private sector, health care. We’re going to be spending and they were able to boost production more. We also have a very ambitious in Colombia, and in Brazil . . . plan for infrastructure. It has to do with roads, highways, modernizing ports, and But Brazil just held its first big foreign also with expanding and modernizing part of our railroad network. auction for the development of its I also hope that in this [current] pre-salt offshore oil field, and they legislative period, the financial reform package (which is different from the got only one bidder. Doesn’t that fiscal reform) will be passed. It seeks to find a lever of growth and to make make you nervous? growth more accessible to the popula- tion. Mexico has very solid financial No. Mexico is a country that has a lot of institutions, with good levels of capital- energy potential. We not only have oil; ization, but they’re not lending much, we also have shale gas. But we cannot perhaps because the current legal frame- expect that a Mexican state company is work doesn’t really favor higher credit. the only one that can exploit the resources. The financial reform seeks to facilitate Resources will continue belonging to the offering of more loans by financial Mexicans. They are the patrimony of institutions and to make loans cheaper the nation. But the Mexican state must for Mexicans. find more efficient ways to exploit those resources. If we don’t make sure that You’ve taken some initial steps on Mexico can offer potential investors more input, they’ll stop coming to Mexico. energy reform, but oil output is falling, They’ll go to the United States or other places where it is more economically and many people argue that more viable to carry out their projects. I think that the debate taking place in Congress needs to be done. You’ve promised to will lead to majority support for the necessary reforms before this legislative allow foreign investment and joint period concludes in December. ventures in the Mexican oil sector as And when can we hope to see output a way of boosting production. But actually start to grow? what exactly are the next steps? And If the energy reform succeeds, its implementation should be gradual but if you offer foreign companies only profit sharing, not production sharing, 6 foreign affairs

Return to Table of Contents A Conversation With Enrique Peña Nieto also immediate, because the major implementing. I think that the issues to challenge Mexico faces is economic improve were there in the past: making growth rates that, unfortunately, have professional policemen more reliable and been lower than expected. Our growth making more investments in instruments has been well below what we originally such as intelligence systems. We’re going thought it would be. But this happened to create five regional centers that will to most other economies, and we believe allow us to reinforce the capacity of that next year will be better. I think local authorities. Mexico can grow, should be growing, by over four percent, five percent. As for extortion and kidnapping, a lot of it comes from the jails them- In your campaign, you promised a selves. We now have a project to put better equipment in jails to inhibit fundamental change in security strategy. telephone calls, so that the people in prison cannot be making phone calls But in some ways, you have followed [to plan and commit crimes]. the same strategy as your predecessor— It seems like the underlying problem, by continuing to target cartel kingpins, though, is really about the lack of the for example. Meanwhile, some sorts of rule of law. Mexico suffers from terrible crime, such as kidnapping and extortion, corruption: the World Bank estimates are on the rise. How is your strategy that it eats up as much as ten percent of different from the last president’s? your annual GDP, and recent high-profile The constant element is the role of cases have involved everyone from the the Mexican state in fighting criminal gangs. This is a task that the Mexican top to the bottom in Mexican society. state cannot renounce. What does your government plan to do But reducing the level of violence is what I [emphasized in the campaign], about that? because the way [crime fighting] was being done in the past resulted in an Corruption is an endemic evil—a increase in homicides. Our strategy cultural problem, not only for Mexico but emphasizes prevention, coordination, and for [all] Latin America. Fighting it has the reconstruction of the social fabric. to do with [improving] the environment And we have seen a reduction in violence, for individual development. And this in homicides. Unfortunately, the reaction involves improving the economy, which of different groups has been to resort to we’re doing. And wherever there’s other types of illegal acts, like kidnapping corruption, people have to denounce it and extortion, and this is something so that there’s no impunity and we can we’re fighting. penalize or sanction corrupt practices. Here, I would highlight a major I [also] think the state should make difference compared with the strategy additional efforts. I have proposed a of the past. Today, we have effective bill in Congress, which is about to be coordination between the federal and passed, to create an anticorruption state governments. There is a permanent commission that will be given autonomy review of the different actions that each to look into claims filed by citizens. level of government is committed to This, along with the effort to give more autonomy to the Federal Institute for January/February 2014 7

Return to Table of Contents Pact for Progress Access to Public Information [which more competitive vis-à-vis the world. administers Mexico’s freedom-of- I think that if we are able to attract the information law], will reinforce the attention of the United States, all of capacity of the state to fight corruption North America might be a more com- in a more efficient manner. petitive and productive region. We have to design an infrastructure to But this cannot be the only thing we [unlock] the potential of our nations. do. The effort should also be linked to education and, of course, the conditions So better infrastructure across the of development in Mexico. Whenever there are some who have more opportu- borders. What else? nities than others, this feeds corruption. When you have more [equitable] devel- I would emphasize financing infra­ opment, it helps to curb corruption. So structure projects and the development it’s a dual effort: on the one hand, you of integrated value chains between have to improve the environment and, on Mexico and the U.S. the other, to grant the state the necessary instruments to allow it to fight corrup- Would that require regulatory or tion more efficiently. legislative changes? This year is the 20th anniversary of No. We need political will, so that we NAFTA. You’ve said that you’d like to can build together. The relationship is there, with the governments and widen relations with the United States. without the governments. We’re very integrated. If we look at trade between Would you like to see more integration Mexico and the U.S., for instance, before nafta and after nafta, the and, if so, in what areas? volume has grown. But Mexico and the U.S. were natural destinations As we’ve told the U.S. government, for each other even before nafta. first of all, we need to recognize the We’re neighbors. harmonious and historic relationship between the two countries, breaking We can develop more efficient from the exclusive emphasis in recent borders that will allow the trade of years on fighting insecurity and collab­ goods and the crossing of people to oration for that purpose. The space of become more agile, secure, and safe. the relationship should be broadened. Not many people know this, but the Mexico-U.S. border is the busiest in What do we want? We have to recog- the world. Every day, legally, we have nize that the U.S. is the first destination a million people crossing. We have of our exports. Mexico is also a top good cooperation with the U.S. admin- destination for the U.S. and Canada: istration, but I do think we have a lot there are no other countries the U.S. sells more to do. more to than Mexico and Canada. And we are geographically united. We govern- Is the rising power of Latino voters in ments have to recognize the gaps that still exist, and we have to improve the relation- the United States changing ties? And ship for the benefit of all the populations. has the stalling of immigration reform What have we proposed? Let’s create conditions to help North America be or the Snowden revelations about U.S. 8 foreign affairs

Return to Table of Contents wiretapping of your communications Righting the Balance hurt relations with Washington? How You Can Help proteCt ameriCa Daniel Serwer U.S. politicians are increasingly rec- ognizing the relevance of the Hispanic 978-1-61234-666-3 Cloth, $26.95 vote in U.S. politics. This motivated “Serwer brings a smart, fresh viewpoint [to America’s the immigration reform bill presented foreign policy and civilian involvement within it], and by President Obama. Mexico views that he does it in an accessible and stylish way.” issue with enormous sympathy, although — Tom DaSchle, former U.S. Senator from South it is of course a domestic issue for the Dakota and former U.S. Senate Majority Leader United States. Immigration reform would be a fair recognition of those Available February 2014 [Mexicans] who live in the United States and are part of the dynamic The Rise of Turkey U.S. economy. tHe twentY-First CenturY’s In terms of the espionage, this is First muslim power something I have talked to President Soner cagapTay Obama about. We don’t want it to mar the relationship between Mexico and 978-1-61234-650-2 Cloth, $25.95 the United States. But it is unacceptable Turkey is positioned to become the twenty-first for a country to practice such espionage, century’s first Muslim power. Based on a dynamic especially if there is a good relationship economy and energetic foreign policy, Turkey’s with the other country. This revelation growing engagement with other countries has made is [an issue] not only for Mexico but for it a key player in the newly emerging multidirectional many other world leaders. The espionage world order. is illegal, and I think that it breaks from the climate of harmony and cordiality For more information we should have among our nations and and to order visit us online peoples. Given everything that is now known, and the position of other heads at potomacbooksinc.com of state on this issue, we hope that the or call 800-775-2518 United States, with humbleness, will recognize [the error of] what it did and 9 avoid such actions from now on. And if there have been violations of international law, penalties should take place. We have pointed this out, and we are expecting to get a categorical and convincing explana- tion. But I insist that this will not be an obstacle in our relationship. What are you planning to do to increase Mexico’s global profile? The Pacific Alliance—an Asia-oriented trade pact including Mexico, Colombia, Peru,

Return to Table of Contents Pact for Progress and Chile—seems promising. Will compete, to gain the support of society. I think the pri has really taken in these Mexico join the alliance’s integrated new lessons. stock market, making it the largest And the challenge and the opportu- nity for the pri now is to show that exchange in Latin America? And what we—not just me but also governors and congressmen—have learned these other international initiatives do lessons, have learned to compete, and are here to produce results for society. you have planned? I know there are great expectations. I think there are two initiatives that will But I would conclude by saying, first, help demonstrate Mexico’s openness to that this government understands where the world. One is the Pacific Alliance. we want to go and how we’re going to We’re practically ready to reach the accomplish it, and we haven’t deviated accord. And the other one is the Trans- from our path. And second, things are Pacific Partnership. There are 12 countries happening in Mexico. We have a politi- participating in the tpp: Mexico, the cal climate in which there are differences, United States, Canada, and countries in controversy, polemics, and everything Asia. Asia is a region with great potential, else. And we have our challenges. But and the tpp would create a new rela­ unlike in other countries, where politics tionship with great potential for trade is a lid that doesn’t allow them to develop, among the countries signing the agree­ here in Mexico, things are happening— ment. These two instruments, if they we’re reaching agreements. As we move materialize, will create great oppor­ from passing to implementing the energy tunities for Mexico. Mexico hasn’t and political reforms, that will be a good been the obstacle to finalizing the tpp. closing for this first year of my adminis- On the contrary, Mexico has always tration and will have created a sound been in favor of the tpp. foundation for more development in the coming years. I hope such efforts will project [the image of] another Mexico, a different I’m very optimistic. The three main Mexico, a Mexico [not associated] with parties are at the table. Every time I a climate of insecurity or narco-violence, speak to someone else from another as in the past. Internal success will allow country—from Denmark, Italy, Spain, Mexico to project a different face to, the United States, wherever—they tell and have a better position in, the world. me, “What we need is a pact like in Mexico.” The most important changes In the past, the PRI was hardly known are about to come, but they will come.∂ as the party of reform; in fact, it often blocked such changes. How and why did the PRI change so quickly and become so enthusiastic about reform? I can tell you immediately. The answer is that Mexico changed, and the pri has simply adapted itself to the new democratic conditions of our country. [In 2000,] the pri stopped being the hegemonic party, and it got to be in the opposition. So it had to learn to 10 foreign affairs

Return to Table of Contents Mexico (tpp) and the Pacific Alliance, two of the most Viva las Reformas dynamic free-trade negotiations of this century. Shannon K. O’Neil If Mexico is able to make its legislative changes stick and Just over a year ago, as President harness its geostrategic potential, the Enrique Peña Nieto started his country will excel over the next five administration, the domestic and years, benefiting its people and making international press were touting “Mexico’s it a good bet for investors. moment” and the rise of “the Aztec tiger.” Now, the naysayers have returned. Once Upon a Time in Mexico Their pessimism stems in part from disappointing economic results: Mexico’s As the North American Free Trade gdp growth has fallen, from nearly four Agreement (nafta) celebrates its 20th percent in 2012 to around an estimated anniversary, many forget just how much one percent in 2013. The negativity Mexico has changed in the last two also reflects the impatience of pundits decades. Once hidden behind high and markets, as the economic dividends tariffs, quotas, subsidies, and hundreds from Peña Nieto’s ambitious economic of state-owned enterprises, Mexico’s reform agenda have yet to appear. economy is now one of the most open in the world. Mexico boasts free-trade Today’s vocal disappointment dis- agreements with over 40 countries and counts the positive changes Mexico has a trade-to-gdp ratio—a common measure undergone and continues to make. of economic openness—above 60 per- Over the last three decades, Mexico has cent, surpassing the United States, made the transition from a commodity- Brazil, and even China. And whereas and agricultural-based economy to one oil once represented over 75 percent dominated by manufacturing and ser- of Mexico’s exports, today it is manu- vices. It is also finally moving forward factured goods that produce three out on a host of overdue domestic reforms. of every four export dollars. Internationally, the country is firmly situated within North American supply This transition has not been easy. chains, augmenting its global competi- In fact, Mexico’s openness was for many tiveness. And these advantages should years seen as a weakness. Relentless only grow with Mexico’s involvement international competition threatened in both the Trans-Pacific Partnership new companies and otherwise promising industries, giving them little time to Shannon K. O’neil is Senior Fellow for climb the learning curve. Particularly Latin America Studies at the Council on after China’s 2001 entrance into the Foreign Relations. She is the author of Two World Trade Organization, the search by Nations Indivisible: Mexico, the United States, ceos and their boards for lower-cost and more flexible producers led many east, and the Road Ahead. Follow her on Twitter decimating several of Mexico’s manu- @shannonkoneil. facturing sectors, including textiles and apparel. January/February 2014 11

Return to Table of Contents Shannon K. O’Neil This trend is now reversing. The the president’s plan low-skilled, low-paid jobs are likely gone from Mexico for good. But rising wages The current government under Peña in China, combined with higher Mexican Nieto has kicked off its six-year term productivity; increasing energy costs, with an ambitious reform agenda. which make shipping more expensive; the Working with Congress even before proximity of Mexican factories to the he donned the presidential sash, Peña United States, reducing delivery times; Nieto helped pass a labor reform to and worries about intellectual property reduce the size of the informal sector by rights, have led a number of manufac- making it easier for businesses to hire turers to choose Mexico over China. and fire employees (among many other Others have brought back production changes). Once in office, his adminis- once sent across the Pacific. In advanced tration, working with all three major manufacturing industries such as aero- political parties, passed an educational space and automotive, Bombardier, reform to make the system more trans- Embraer, Honda, Nissan, and Volks­ parent and merit-based, introducing wagen have invested billions of dollars in evaluations and performance tests. Mexico and made the country a vital leg Next came telecommunications and of their global supply chains. the media, with new legislation creating a more powerful regulator and opening As Mexico’s economy has changed, up the broadcast spectrum in an attempt so, too, has its society. Alongside a few to break up the current monopolies. of the world’s wealthiest individuals Recent fiscal reforms should increase and tens of millions who are still poor, government revenue while also redis- a growing middle class has arisen. tributing the tax burden, raising rates Depending on how one measures this on the wealthiest, taxing capital gains group, it now comprises anywhere from and dividends, and creating universal 40 million to over 60 million Mexicans— pensions and unemployment insurance either way, a large percentage of a popu- for those in the formal sector. lation of 116 million. These individuals and their families own cars, houses, and Peña Nieto’s administration has every modern appliance, as well as new focused on major political and energy cell phones. A growing number use reforms, which are intended to take on their newfound disposable incomes to two of Mexico’s most sacred political send their children to private schools. cows: the reelection of politicians and foreign investment in energy, both of Such increased consumption shows which have long been banned. The up in aggregate gdp numbers and on government has also pursued financial companies’ balance sheets. Providers reforms that would encourage lenders of electronics (Elektra), air travel to extend credit beyond just a fortunate (Interjet, Volaris), basic goods (OfficeMax, few. Although all the reforms entail Walmart), cars (Ford, gm), credit cards compromises, many represent real (American Express), and high-end changes. If fully implemented, they coffee (Starbucks) are just some of the have the potential to chip away at firms that have seen their sales and Mexico’s many barriers to broader, profits rise. more inclusive growth. 12 foreign affairs

Return to Table of Contents Mexico Homemade: a “Made in Mexico” marking, July 2007 flickr / ruben balderas With a stronger domestic economic found that on average, 40 percent of the base and a richer society, Mexico can content of the products imported by take advantage of its greatest potential, the United States from Mexico actually which lies in its deepened ties to two comes from the United States, reflecting developing economic blocs: North the degree to which Mexico and the America and the Pacific Alliance. The United States now make things together. most important region for Mexico is and will be North America. The continent The recent boom in North American is a global economic powerhouse, with energy could further deepen regional Canada, the United States, and Mexico ties. Ten years ago, North American together boasting around 470 million analysts worried about a growing energy citizens and an economy totaling some deficit as demand rose and supply dimin- $19 trillion—nearly equaling the eu in ished. Today, with the rise of shale oil population and outpacing it in production. and gas production in the United States, oil sands in Canada, and the potential A large part of North America’s opening of Mexico’s energy sector, many economic dynamism stems from its experts are talking about the possibility interdependence. Since nafta entered of the continent’s becoming self-sufficient. into force, intraregional trade has multi- For Mexico, greater access to stable and plied, from around $290 billion in 1993 affordable gas from the United States also to over $1.1 trillion in 2012. Roughly half stands to boost the country’s competitive of this trade crosses the U.S.-Mexican edge in manufacturing. border each year. The nature of this back-and-forth has also changed, as Still, challenges remain. Limited new supply chains have taken root infrastructure investments, higher security throughout the region. A study by the hurdles, and duplicate regulations and National Bureau of Economic Research bureaucratic procedures have increased border delays, raising costs for many January/February 2014 13

Return to Table of Contents Shannon K. O’Neil North American operations. Studies side Chile, Colombia, and Peru (Costa show that the added time costs billions Rica and Panama are expected to join of dollars—eating away at profit margins soon, too). These like-minded globaliz- and hurting companies and workers on ing countries are working to eliminate both sides of the U.S.-Mexican border. tariffs, allow the free movement of people, share diplomatic embassies overseas, After a decade of stagnation, the and combine their stock markets into a United States is finally taking steps to joint trading platform. Although trade improve and facilitate economic ties and investment flows among the members between itself and Mexico. In Septem- of the Pacific Alliance remain modest, ber 2013, the two governments began the bloc offers a space for rapid growth. the U.S.-Mexico High Level Economic Dialogue, led by U.S. Vice President By laying the groundwork for deeper Joseph Biden and Mexican Finance regional supply chains, these blocs Secretary Luis Videgaray and Mexican could represent a boon to manufacturers, Foreign Secretary José Antonio Meade. distribution and logistics companies, From customs forms to border cross- construction businesses, and service ings, product testing to standardized providers. Taken together, they could regulations, teams in both countries are help Mexico compete with, and benefit beginning to work to reduce the current from, a rising Asia. obstacles to freer trade, to the benefit of regional manufacturing and production. no country for old ways Not just nafta For all of Mexico’s strong positioning, the country still faces many daunting Mexico also now forms part of the United hurdles, which, if unaddressed, will hold States’ most ambitious international it back. The biggest one is security. trade effort, the tpp. Bringing the nafta Crime remains stubbornly high—not only partners together with Chile and Peru in homicides but also extortion, kidnapping, the Western Hemisphere and Australia, and petty crime. Corruption and impunity Brunei, Japan, Malaysia, New Zealand, only compound the problem. Mexico’s Singapore, and Vietnam across the Pacific, police have often proved unwilling or the bloc would represent one-third of the unable to stem the bloodshed of the world’s trade and 40 percent of global gdp. country’s violent drug wars. The judicial The tpp is intended to transcend tradi- system has also failed, with just two tional free-trade agreements and address percent of all crimes leading to convic- such issues as regulatory coherence, tions. Without the basic rule of law, e-commerce, and how to encourage small citizens and investors cannot hope to and medium-size businesses to trade thrive over time. internationally, all of which would increase competition and deepen The most immediate bellwether production chains. for investors is whether Peña Nieto’s government will use the political will But even as Mexico is reaching out and influence so ably wielded in the to the north, it is also actively looking economic realm during its first year to south. In 2012, it became a founding reform security policies in its second. member of the Pacific Alliance, along- Perhaps the first important step will 14 f o r e i g n af fai r s

Return to Table of Contents be fully implementing Mexico’s justice Asian reforms. Passed in 2008 under President Economic Felipe Calderón, they aim to fundamen- Papers tally transform Mexico’s judicial system, moving it from one of written evidence Jeffrey Sachs, Wing Thye Woo, Sung-Chun Jung to one of oral trials; redefining the roles Naoyuki Yoshino, Editors of judges, prosecutors, and defense attorneys; and even altering the de facto Asian Economic assumption of guilt. Although the Papers promotes changes are not a panacea for all of high-quality analyses Mexico’s criminal ills, they would move of the economic the country toward a more transparent issues central to and accountable system of justice. Asian countries and offers creative solutions to Mexico’s political reforms are just as the region’s current problems important for its future. If the country by drawing on the work of actually allowed reelections, elected economists worldwide. officials would have incentives to keep their promises to voters rather than AEP strives to anticipate their promises to their party bosses, developments that will affect whom they currently rely on for their Asian economies, encourage next posts. This shift would not only discussions of these trends, and empower citizens but also encourage explore individual country or politicians to invest in public goods that regional responses that minimize take more than one term to be fully negative repercussions on realized, such as professionalized police neighboring economies. forces and reformed court systems. http://mitpressjournals.org/aep Economically, weak infrastructure holds the nation back. According to the World Bank, less than 40 percent of Mexico’s roads are paved, and much of its railways were laid over a century ago. Investments in ports, airports, and highways have not kept pace with the growing economy or its increasing north- ward orientation. In the energy sector, underinvestment in pipelines has left half the country unconnected and caused gas shortages that reduce its competitive advantage as part of North America. Finally, Mexico still struggles with uneven playing fields in business and in its citizen’s daily lives more generally. For companies and entrepreneurs, the monopolies and oligopolies across various ASEP FA nov13.indd 1 1511/19/2013 1:39:34 PM

Return to Table of Contents Shannon K. O’Neil sectors both box out healthy competition financial reforms are adopted, expanding and new ideas and raise the basic costs credit in the country, which currently lags of doing business. As a result, according behind that in not just the United States to estimates from the Organization for but also Mexico’s emerging-market peers, Economic Cooperation and Development, such as Brazil, China, and India. Hotels, the average Mexican pays 40 percent retail outlets, clothing lines, restaurants, more than necessary for everyday basics. cinemas, pharmacies, and thousands of Mexicans also have unequal access to other businesses stand to gain. health care and basic household services and face huge disparities in educational Although Peña Nieto recently made a opportunities. These obstacles make it show of going to China and promoting difficult for poorer Mexicans to climb bilateral economic ties, Mexico competes up the economic ladder and, in the with, rather than complements, China’s process, keep the country stuck in the rise. It provides few natural resources “middle-income trap,” with not enough to the Asian behemoth, and its own highly skilled, educated workers or factories have faced the threat of low- innovative jobs to boost productivity cost Chinese production. But with its and grow its burgeoning middle class. growing trade links to the United States, Mexico now looks increasingly attractive; made in mexico investing in Mexico remains, in essence, an anti-China play. Despite these barriers, many companies have found a way to thrive. The auto- For the moment, the idea that the motive, aerospace, electronics, and next iPhone or iPad will be built in the appliance industries have all seen both Western Hemisphere from beginning to investment and returns grow quickly end seems far-fetched. Few believe that over the last decade. In other sectors, the continent has the capacity, the skill, Mexico’s obstacles could turn into the supply chains, or the competitive economic opportunities. The unevenness pricing to compete with China or the of public education opens up space for rest of Asia. But the tpp and the Pacific for-profit schools and universities. The Alliance represent the best and most infrastructure deficits, combined with promising paths to making this a reality— the current government’s ambitious and Mexico stands at the heart of both. five-year investment plan and advanta- geous public-private partnership laws, What Mexico already has is a stable create possibilities for profitable private economy, a strong banking system, a investment in ports, railroads, airports, democratic government, favorable roads, and border crossings. Recent demographics, globally competitive reforms have also opened up at least manufacturing sectors, and preferential the possibility of competition in long- access not just to the world’s largest closed sectors and markets; for instance, market (the United States) but also to Virgin Mobile has already announced many others through its growing trade new investments in telecommunications. alliances. If Mexico is able to get beyond its current limitations and capitalize on Consumer sectors more broadly remain these benefits, investors and Mexican promising, especially if the proposed citizens alike will come out far ahead.∂ 16 f o r e i g n af fai r s

Return to Table of Contents South Korea presents some serious challenges. So, too, does The Backwater That Boomed its highly concentrated corporate sector, aging Marcus Noland population, and politically dangerous neighborhood. South South Korea’s development over the Korea may well be more dynamic than last half century has been nothing some developed economies, making it short of spectacular. Fifty years attractive to investors, but it is also ago, the country was poorer than much riskier. Bolivia and Mozambique; today, it is richer than New Zealand and Spain, so long, korea discount with a per capita income of almost $23,000. For 50 years, South Korea’s Given South Korea’s extraordinary economy has grown by an average of accomplishments, it is tempting to try seven percent annually, contracting in to distill the secrets of its success, so that only two of those years. In 1996, South they can be bottled and used elsewhere. Korea joined the Organization for But South Korea’s remarkable leap from Economic Cooperation and Develop- poverty to riches owes to a unique set ment, the club of rich industrialized of historical circumstances. countries, and in 2010, it became the first Asian country and the first non- Soon after the division of the Korean G-7 member to host a G-20 summit. Peninsula, in 1945, South Korea already had in place the building blocks for To call South Korea an emerging growth: an educated population, property market, therefore, is a bit of an anachro- rights, land reform that boosted pro- nism. The country is a rich, technologi- ductivity, and the institutions of modern cally advanced, mature democracy with capitalism. But then came the Korean an impressive record of innovation, War, which devastated the country. economic reform, and sound leadership. Investment did not take off until the Yet South Korea is not exactly a developed country began to rebuild in the 1960s, market, either. The value of its exports when the authoritarian president Park plus imports (at $1.25 trillion a year) Chung-hee (father of the current presi- exceeds its national income (at $1.1 dent, Park Geun-hye) embarked on a trillion). That openness, along with set of policy reforms that encouraged the lack of protection provided by a bloc domestic saving and opened the economy such as the eu, subjects South Korea up to international trade. to greater market volatility than other major industrialized countries and South Korea’s initial rapid growth was characterized by both political author- marcus noland is Executive Vice President itarianism and extensive state intervention in the economy. In the 1970s and 1980s, and Director of Studies at the Peterson Institute Seoul channeled massive amounts of capital through subsidies and low-interest- for International Economics and a Nonresident rate loans into trusted family-led chaebol, or conglomerates. These favored firms Senior Fellow at the East-West Center. also enjoyed trade preferences and mo- January/February 2014 17

Return to Table of Contents Marcus Noland nopoly rights, among other indulgences firms; and occasionally corrupt corporate extended by the government. Such governance practices. But the govern- preferential treatment enabled the ment under Kim Dae-jung responded chaebol, which today include Hyundai by undertaking significant reforms: it and Samsung, to grow into massive shut down bad banks, forced the resolu- business empires whose brands are now tion of bankrupt companies, and, most recognized and envied around the world. of all, strengthened previously inept But the story has a dark side: today, financial regulation. the chaebol’s ongoing dominance poses challenges to regulators seeking to make Such changes have paid off hand- South Korea’s markets more competi- somely. According to several international tive. And the conglomerates’ historical barometers, including the World Bank’s ties to the country’s early dictators feed Ease of Doing Business Index and the resentment among many South Koreans, World Economic Forum’s Global Com- who regard the businesses as having petitiveness Index, South Korea’s achieved their dominance unfairly. financial institutions and business prac- tices, which once dragged down income In recent decades, South Korea’s levels, have steadily converged on global politics have gone through an evolution norms. The so-called Korea discount, just as stunning as that of its economy. under which South Korean equities were After 40 years of rule by a succession undervalued due to international of strongmen, in 1987, South Koreans concerns about opaque corporate gover- freely elected Roh Tae-woo as president. nance, has disappeared. Roh, a former general who had been handpicked by his military predecessors, The reforms of the late 1990s also was still linked to the old regime. But helped South Korea weather the global his next two successors—Kim Young-sam financial crisis. Despite a sudden stop (a centrist civilian politician) and Kim in capital inflows and a precipitous fall Dae-jung (a former dissident)—most in its currency in 2008, South Korea was certainly were not. Their elections were a able to avoid a larger crisis or a dramatic testament to South Korea’s rapid liberal- decline in output. And its recovery was ization. As Park’s recent election shows, swift: the International Monetary Fund however, the echoes of the country’s forecasts that the country’s economy authoritarian past linger, and divisions will grow by 3.7 percent in 2014 and by over that past form one of the main 3.0–3.5 percent a year over the long term. fault lines in modern South Korea. Maintaining this economic perfor- Despite all this progress, the country’s mance will not be easy, however. South recent years have not been uniformly Korea faces a range of challenges, from its easy. Still, one of the things that has aging population and the stresses that distinguished South Korea is its ability the swelling ranks of retirees will put to adapt to and learn from setbacks. The on the government budget to its lagging country was badly burned during the productivity in the service sector, domes- 1997–98 Asian financial crisis, for example, tic inequality, and geopolitically unstable which exposed a weak, badly regulated region. South Korean business may have financial system; wildly overleveraged gone global, but the country is still wedged between two political and economic giants, 18 f o r e i g n a f fai r s

Return to Table of Contents South Korea Won love: a poster depicting South Korean currency, Seoul, November 2004 reuters / kim k y ung - hoon China and Japan, which will remain And then, of course, there’s South formidable for years to come—even if Korea’s stunted twin. Even if North the former slows, as expected, and the Korea manages to avoid starting a war recovery of the latter proves short-lived. or collapsing, the threat of instability or the sudden need for South Korea to A downturn in China might give absorb the North’s 25 million citizens some South Korean midtech manufac- will remain a real risk, both for South turers, such as steel-makers and ship- Koreans and for foreigners looking to builders, a little more breathing room. do business in South Korea. But it could also threaten South Korea’s trade surplus with its neighbor. Factories technology vs. demographics in China rely on South Korean machinery for their operation, so a Chinese slow- Economists normally ascribe growth to down would also have an adverse impact the availability of basic inputs—labor on South Korean makers of capital and capital—as well as to increases in equipment and intermediary industrial productivity. From 1963 to 1997, when products. South Koreans complain South Korea was growing at its fastest, bitterly about Japan’s policy of quantitative it benefited not only from the general easing—buying bonds in large amounts openness of the world economy but also to push down long-term interest rates— from a rapid expansion of its labor force which they regard as a form of beggar-thy- and a relatively low number of depen- neighbor currency depreciation. But dents per worker, combined with a any “tapering” of those purchases, in major increase in the education level either Japan or the United States, could of its work force. But those favorable hit indebted South Korean households demographics are now reversing. In and firms hard. 2010, South Korea’s “core productive January/February 2014 19

Return to Table of Contents Marcus Noland population”—citizens aged 25–49—fell more capital available to underwrite for the first time. If current trends innovation and boost investment. continue, its dependency ratio will begin to rise within the next decade, and by South Korea also needs more financial 2030, its population will start to decline, integration between its corporations and falling below current levels by 2050. their foreign counterparts. Seoul has largely lifted long-term barriers to both If those forecasts prove broadly correct, foreign direct investment in and equity they will put significant new burdens ownership of South Korean firms. But on South Korea’s health-care and pen- balancing that integration with South sion systems, forcing the government Korea’s desire to preserve its corporations’ to consider such measures as raising the autonomy will be difficult, especially given retirement age, improving the efficiency that South Korean public opinion is still of the delivery of health-care and retire- sometimes xenophobic and chauvinistic— ment services, and making better use of an expression of the country’s long-held female labor, especially educated women. resentment of being a proverbial South Korea may also have to reconsider “shrimp among whales.” its immigration policies, which are cur- rently among the most restrictive in the However, given South Korea’s track developed world. record as the quintessential open econ- omy and its major trade relations with South Korea also needs to squeeze China, the eu, Japan, and the United the most productivity it can out of its States, Seoul is likely to surmount these labor and capital, especially given the difficulties. South Korea is an enthusias- competition it faces from its neighbors tic negotiator of free-trade agreements, low-wage China and high-technology including with the eu and the United Japan. South Korea may be tempted to States, and it is considering agreements try to accomplish this feat by emphasizing with China and Japan. In 1997, South technology above all else. After all, Korea signed the World Trade Organi- as competitors from Apple to Toyota zation’s Agreement on Government will attest, the country’s progress in Procurement, bringing greater transpar- this field, particularly in information ency to public procurement and creating technology and manufacturing, has new opportunities for foreign firms. been phenomenal. Trade in manufacturing and the service sector in the country is largely open; But increasing productivity requires only agriculture is still protected. The more than just technological innovation; automobile sector remains a source of it also takes encouraging innovation in contention. Many of the policies that emerging sectors while terminating in the past deterred foreign entry into inefficient practices throughout the the market have been removed, but economy. In South Korea’s case, the area foreign car companies still struggle to that needs the most help is the heavily get a foothold against Hyundai and regulated service sector. If the govern- Kia and their well-established sales ment were willing to lower barriers to and distribution networks. entry, the ongoing development of the country’s financial sector could help South Korea still needs to fix a labor restructure the service sector by making market in which some workers have 20 foreign affairs

Return to Table of Contents South Korea extensive benefits and job protection Still, addressing the widening wealth and others do not. It will also have to gap is critical if South Korea hopes to phase out its highly restrictive regulations avoid the kind of political backlash that on hiring and firing. At the same time, could damage its economic growth. it should pass legislation that protects Park, a conservative, won the presi- the interests of nonregular workers and dency in 2012 thanks in part to strong encourages the smooth deployment of support from older voters who have labor to its most productive uses by relatively fond memories of her repres- making wages less dependent on job sive, though effective, father. But few tenure or seniority and making pensions younger South Koreans share such and benefits more portable. sentiments. South Korea has a history of alternating between center-left and Seoul should also implement smaller center-right leaders every decade or reforms to encourage innovation. If South so (presidents serve single five-year Korea can reduce the risk that its firms terms). Given that history, as well as will imitate and reverse-engineer technol- the country’s shifting demographic ogy invented abroad, foreign firms will trends and growing wealth gap, the become less hesitant to transfer technol- center-left—with its greater emphasis ogy to South Korean partners. Meanwhile, on redistribution, or what South Koreans universities and other public institutions term “economic democracy”—could should integrate their research and return to power in 2017. Such a shift development with the private sector, could impede South Korea’s progress if and South Korean researchers should the center-left turns populist, breaking look harder for new partnerships abroad. the budget with politically popular measures such as free university education, A final challenge faced by South higher property taxes on the wealthiest, Korea—although it is hardly alone in and punitive but dubious legal cases this area—is the growing inequality of against prominent firms. income and wealth. Encouraged by the historically symbiotic relationship the hardest part of breaking up between business and the state, the government has concentrated economic, Of course, many countries share such political, and cultural life in Seoul, one political risks. What makes South Korea of the world’s most expensive cities. As unique is the threat that lies just beyond with London in the United Kingdom, the 38th parallel: North Korea. Most the pull of the capital city has stoked South Koreans agree that economic inequality elsewhere in South Korea. engagement with North Korea would To fight this, the government has tried make Pyongyang less repressive domes- to stimulate regional development by tically and less belligerent in its foreign establishing “special economic zones” relations. Even though North Korea’s and relocating many government offices new head of state, Kim Jong Un, is a to provincial areas. But the movement third-generation hereditary leader with of government ministries will only com- a penchant for nuclear provocation, plicate the lives of many South Koreans hope springs eternal that he will turn and foreigners currently used to working out to be a reformer. with the government in Seoul. January/February 2014 21

Return to Table of Contents Marcus Noland In the meantime, South Korea is than with a reversal of South Korea’s own hesitantly planning for reunification. gradual success at regularizing its business- Inter-Korean projects, such as the government relations, which are still Kaesong Industrial Complex (closed far too cozy, opaque, and corrupt. In earlier this year by North Korea but the North, of course, there is no real recently reopened) and the opening of difference between the state and the railroad lines along the east and west economy. Any large-scale economic coasts, linking South Korea to Russia integration between the two countries and China, are broadly popular in the would by its very nature be highly South. Gas pipelines from Russia politicized, and the expansion of the through North Korea to South Korea government’s role in the South Korean (and even onto Japan) could follow. economy could seriously undermine recent reforms. Despite such efforts, there is no guarantee that a North Korean transition From an investor’s perspective, would go smoothly; sudden collapse North Korea represents both a threat remains a distinct possibility. Such a and an opportunity. The dangers are scenario would have one of two conse- obvious. As for the potential benefits, quences, both dire: the massive movement the successful opening of the North of southern money north or of northern would provide South Korean firms people south. Plausible estimates of with a new source of low-cost labor. the money that would be needed to And North Korea has underground raise North Korean incomes to some minerals, including rare-earth metals, significant share of those in the South, possibly worth trillions of dollars. and thereby forestall mass emigration, exceed $1 trillion—equal to South For investors, South Korea has the Korea’s annual national income. deep, well-regulated debt and equity markets of a developed economy such Mass emigration from North Korea as Japan, but in an economy with higher could also provoke a number of political growth and greater dynamism. It is far cleavages within South Korea, especially more transparent than its giant neigh- between capital and labor. Industrialists bor, China, with greater protections for view Northerners as a potential new investors, including the rule of law. The source of cheap labor, while labor regards country’s manufacturers are competitive the North as a potential source of compe- globally; the service sector represents tition. The liberation of North Korea an emerging opportunity. could also exacerbate divisions between high-skilled and low-skilled workers in Sixty years ago, the U.S. government the South and, if foreign capital flows considered making its destitute ally in and drives up the value of the won, South Korea a regular line item in its between the export sectors, which would foreign aid budget; many Americans suffer, and the local construction sector, expected Seoul to remain a ward of which would boom. Washington in perpetuity. South Korea, of course, has proudly proved that In the nearer term, however, the real expectation wrong—and seems likely risks posed by the North have less to do to keep defying skeptics for years to with an abrupt, German-style reunification come.∂ 22 foreign affairs

Return to Table of Contents Poland was reduced to rubble, and mass graves were From Tragedy to Triumph sown across the landscape. Then came four gray and Mitchell A. Orenstein sooty decades of communist domination. Only the Catholic Anyone who knows Polish history Church offered Poles any hope. cannot help but marvel at the country’s emergence from the Since communism collapsed in 1989, ashes of its traumatic past. Over the last however, Poland has experienced a 25 years, Poland, after centuries of war remarkable reversal of fortune. After and subjugation, has enjoyed peace, a leading the protest movement that stable and booming economy, and toppled the old regime, the trade union integration with the rest of Europe. Solidarity won democratic elections and initiated aggressive, market-oriented An independent kingdom for the economic reforms. The communist previous 800 years, in 1795, Poland Polish United Workers’ Party turned was wiped off the map of Europe and into the capitalist Democratic Left absorbed into three great neighboring Alliance, which won elections in 1993 powers—the Prussian, Russian, and and 1995 and led the country into nato Austro-Hungarian empires—a state of in 1999. And in 2004, Poland joined affairs that lasted until 1918. Reborn the European Union as a full member, following World War I, Poland spent a cementing its close alliance with Germany, few short years as a democracy before its erstwhile antagonist. proving ungovernable, succumbing to dictatorship, and then once again being The Polish economy, meanwhile, has conquered and divided, this time by grown rapidly for two decades—at more Nazi Germany and the Soviet Union, than four percent per year, the fastest in 1939. Over the next six years, Poland speed in Europe—and garnered massive found itself at the center of what the investment in its companies and infra- historian Timothy Snyder has called the structure. Poland’s is now the sixth-largest “bloodlands” of Europe; an estimated economy in the eu. Living standards five million Poles died between 1939 more than doubled between 1989 and and 1945, more than half of them Polish 2012, reaching 62 percent of the level Jews. The Nazis and the Soviets also of the prosperous countries at the core wiped out the cream of the crop of of Europe. All of this led the World Bank Poland’s intelligentsia and clergy. Warsaw economist Marcin Piatkowski to conclude in a recent report that Poland “has just mitchell a. orenstein is a Professor and had probably the best 20 years in more than one thousand years of its history.” Chair of the Department of Political Science at How did Poland manage so decisively Northeastern University and an Associate at to move beyond the repeated tragedies of its past? The question is rarely asked by both the Minda de Gunzburg Center for market analysts, whose sense of Poland seems to go no further back than the European Studies and the Davis Center for economic reforms of the 1990s. Those Russian and Eurasian Studies at Harvard University. Follow him on Twitter @m_orenstein. January/February 2014 23

Return to Table of Contents Mitchell A. Orenstein reforms are indeed part of the story— were then driven from the annexed east but only part it, and focusing exclusively into the newly emptied west. on them obscures the deeper causes of the country’s resurgence. Explaining Today, Moscow’s decision to push Poland’s economic boom—and why it Poland to the west must seem a massive is likely to last—requires a deeper look strategic error. That’s because its long- into its troubled history. term effect was to move Poland solidly into the orbit of Germany. Indeed, today’s WESTWARD HO! Poland, to a large extent, is Germany, inhabited by Poles. Since Germany For centuries, Poland’s tragedy was one accepted this situation by signing a of geography. Situated on the flat, open peace treaty with Poland in 1990, it plains of northern Europe, with no natural has sought to draw Poland closer. And boundaries separating it from Germany Warsaw has proved a willing partner. to the west and Russia to the east, Poland was often torn between the two. From Part of what makes Poland such a 1569 to 1795, Poland had an eastward- good place to invest today is the depth looking empire of its own: the Polish- of the bond it has forged with Europe’s Lithuanian Commonwealth, which leading economy. The relationship ben- included large parts of present-day efits both countries. A large part of the Belarus, Estonia, Latvia, Lithuania, German export machine is now based in and Ukraine. Today, however, Poland Poland. Poland gets German investment has decidedly joined the West—so much and markets for its goods, and Germany so that Poles hate when their country profits from the opportunity to use Poland is considered a part of eastern Europe, as a low-cost, high-quality production insisting that they live in central Europe. platform to compete with East Asia. Although some attribute this shift to the Indeed, some German industries are able warm embrace of the eu, the real author to produce goods in Poland for less than of Poland’s Western transformation was what they would cost to make in China. none other than Joseph Stalin. And Poland offers Germany a friendly business climate, plenty of skilled labor, Stalin’s unwitting contribution and, above all, proximity. stemmed from the way the Soviet leader forcibly reshaped the country’s borders Germany owes much of the success after World War II. His top priority was of its automobile industry to its eastern to expand the Soviet Union, and so he neighbor. At its factory in Poznan, Volks­ kept all the parts of eastern Poland that wagen employs 6,900 workers who he had annexed in 1939 and compensated produce intake-pipe modules, cylinder the country with a large chunk of the heads, and steering-gear housings, as eastern German territories of Silesia, well as 155,000 commercial vehicles each Pomerania, and East Prussia. Apart from year. The man Group employs 4,000 increasing the size of his own empire, workers in Poland who build heavy trucks, Stalin was focused on punishing the city buses, and bus chassis at three differ- Germans, and indeed, millions of them ent factories. Cars and automotive compo- were expelled from their homes in the nents are now Poland’s leading export, new Polish territories. Millions of Poles despite the fact that the country has no internationally known brand; a large 24 f o r e i g n a f fa i r s

Return to Table of Contents Poland Kiss and sell: Polish Prime Minister Donald Tusk and Merkel in Berlin, November 2012 reuters / thomas peter share end up as German marques. The for it and the rest of eastern Europe, same holds true for industries as diverse ensuring democratic freedoms and as household appliances and clothing; administrative reforms and helping the the German fashion house Hugo Boss, region liberalize its markets. In the last for example, produces its shoes at a factory decade, the eu has invested nearly 40 in the Polish city of Radom. billion euros in Polish infrastructure, building the autobahns that Poland never Because Poland is now a key part of had; replacing its outmoded, overcrowded, the German supply chain, it has become and often deadly two-lane highways; reno- a great exporting economy—exports now vating its decrepit train stations and train make up 46 percent of its gdp. A recent lines; cleaning up its rivers; and setting up Morgan Stanley report estimated that broadband infrastructure. In the process, 30 to 40 percent of Poland’s exports Poland has become Europe’s biggest to Germany now end up as German construction site. Between 2000 and 2013, exports to the rest of the world. This the aggregate length of Polish highway interdependence explains why Germany and express roads grew fivefold, dramati- is by far Poland’s largest trade partner, cally reducing the cost and the time it buying or selling 25 percent of Poland’s takes to transport goods to the west. And exports and imports, which total about the benefits should keep coming: between 12 percent of the overall Polish economy. 2014 and 2020, the eu is expected to pump 106 billion more euros into the None of this could have happened if country. That infusion of cash will equal the German-Polish relationship were not nearly two percent of Poland’s annual gdp, embedded in the broader eu. Since Poland joined in 2004, the eu has done wonders January/February 2014 25

Return to Table of Contents Mitchell A. Orenstein a level of funding similar to what Wash- relative to its more developed neighbors— ington provided to Europe under the only 0.7 percent of gdp, compared with Marshall Plan. about 2.0 percent in the eu as a whole. But there is reason to believe that Poland MANAGING POLAND’S RISE can change course. The country’s great- est asset is its mass education system. Because of the centrality of foreign One of the very few benefits of commu- investment to Poland’s economy (most nist rule was that it left Poland with of its major banks and enterprises are one of the highest literacy rates in the foreign-owned), its reliance on foreign world. And since 1989, Poles have trade, and the fact that so many Poles continued to invest heavily in their work outside the country, political education, learning English, building economists often characterize Poland new private universities, and participat- as a “dependent market economy.” ing in the Erasmus student-exchange This dependence creates a fundamental program among European universities. dilemma: to attract foreign business and Poland now has the second-highest maintain its competitiveness, Poland rate of college enrollment in the Organ­ must keep down its wages, which today ization for Economic Cooperation and stand at about one-third of those in the Development. Meanwhile, as small, more developed countries of the eu. But innovative Polish technology compa- Polish workers live adjacent to the rest nies boom, the path to a high-tech of Europe, traveling and working there future is presenting itself. in great numbers, and thus aspire to a higher standard of living. This fact will Yet the greatest long-term risk to make it difficult for Poland to maintain Poland is that its consumption and the advantages that come with cheap labor. wages will rise too fast, crowding out domestic investment and deterring Poland should be especially worried foreign business. In managing their about this dilemma given the presence of country’s rise, Polish politicians must other low-wage countries in its neighbor- walk a fine line between satisfying hood that could serve as manufacturing voters’ concerns and maintaining the bases. In 2009, when the computer manu- country’s cheap labor costs. facturer Dell moved its main European factory from Limerick, Ireland, to Lodz, This dilemma of dependence also Poland, the mayor of Limerick predicted, explains why Poland is unlikely to join with deep schadenfreude, that “Dell will the eurozone, at least not anytime soon. probably head for Ukraine in six to eight Although the Polish government and years’ time.” One could say the same about Polish elites initially clamored to adopt the many call centers that have become the common currency, the financial and mainstays of Polish employment. sovereign debt crises changed their minds. Part of the reason Poland weathered the To overcome this challenge, Poland 2008 global financial crisis well was that must rise up the value-added ladder it was able to devalue the zloty, which and begin producing more high-tech helped Warsaw maintain its exports and and knowledge-intensive exports. At keep jobs in the country. And when the the moment, Poland does not invest sovereign debt crisis hit in 2009, Poland much in research and development 26 foreign affairs

Return to Table of Contents Poland relied on devaluation and government Republic or Hungary—means that it stimulus to avoid a recession, making has a large domestic market. Whereas it the only European country to do so. the Czech Republic and Hungary have Warsaw knows that keeping its own richer and more open economies, Poland currency means that investors will pay has much lower labor costs and has transaction costs, but it will also help grown more rapidly. At the same time, the country keep wages down. So don’t its governance structures are more expect to see euro notes on the streets rule-bound than those of its low-wage of Krakow or Gdansk until Poland’s competitors, such as Bulgaria, Romania, and the eurozone’s living standards get or others outside the eu. All these coun- much closer to each other. tries need to continue to move into more technologically sophisticated industries WHY POLAND? over time, in order to enable their citizens to increase their living standards. A final challenge facing Poland, and one potential investors should take note of, is In some ways, Poland is the template the extent to which it, like other countries for the Europe that German Chancellor in its neighborhood, has struggled to build Angela Merkel hopes to create. It has an effective bureaucracy. Poland still carved out a profitable niche in the ranks only 41st and 55th, respectively, on German production machine, and it can Transparency International’s Corruption thrive with an export-oriented economy Perception Index and the World Bank’s based on a strong currency and damp- Ease of Doing Business Index—below ened domestic demand. This German all western European countries with the model has provoked the ire of southern exception of Italy. Although there is Europe, but for Poland, it works. little political risk to doing business in Poland—especially compared with doing Warsaw is sometimes called “the business in Russia—it takes months to phoenix city” because of the way it rose, establish a company there, with as many like the mythical bird, from the ashes as 33 separate stamps needed from of World War II. Today, many ordinary different agencies. Some businesses Poles and investors are wondering just complain that Warsaw favors partially- how high the phoenix can fly. Economic state-owned enterprises, using regulation projections suggest that Poland’s econ- as a tool to pick winners, or that the omy will grow by about 2.5 percent per government has not worked aggressively year through 2030, becoming one of the enough to remove administrative barriers top 20 economies in the world before to growth. Even though opportunities eventually succumbing to demographic for investment abound, the government decline. If the country can create a is unlikely to help. more hospitable business environment, build a knowledge-based economy, Although some other central and and encourage immigration and higher eastern European countries offer similar birthrates, it may keep growing even opportunities, Poland is still an attractive faster. After all, the Poles have a knack choice relative to its neighbors. Its for beating expectations.∂ population of 38 million—approximately four times the population of the Czech January/February 2014 27

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Return to Table of Contents Turkey office, propelling Ankara’s ascent to greater global How Erdogan Did It—and prominence. In the late Could Blow It 1990s, Turkey was running 90 percent inflation and attract- Daniel Dombey ing almost no foreign investment. As recently as 2002, Turkey was using up For much of last year, Turkey’s almost 90 percent of its tax revenues to economy seemed almost on top pay the interest on its debt. Today, these of the world. In May, as huge problems have all but disappeared. construction projects moved ahead, Ankara paid off its remaining debt But the optimism of May has since to the International Monetary Fund, faded. Turkey, like many other developing ending what seemed to many Turks a countries, has found itself facing skittish long history of humiliation. The country markets, volatile exchange rates, political received an encouraging investment- unrest, and an uncertain outlook. The grade rating, and foreign funds poured picture of Turkey today is less flattering in like never before. but more revealing than before, display- ing both the promise and the perils of In a flurry of appearances that month, being an $800 billion emerging economy. Prime Minister Recep Tayyip Erdogan feted record-low interest rates, a slide in Turkey is still on track to grow faster the unemployment rate from 15 percent than much of the industrialized world in to nine percent since 2009, and, above all, the coming years. In October, Jim Yong the growth that Turkey has enjoyed “due Kim, the president of the World Bank, to reforms carried out over the past ten hailed the country as “an inspiration to years.” He underlined his point—and his many developing countries.” But the driving ambition—on an exuberant visit fact remains that Turkey’s success could to Washington. Addressing the U.S. yet unravel. To live up to its economic Chamber of Commerce, he noted that potential, Turkey will have to overcome when his Islamist-rooted Justice and two main challenges: its reliance on fickle Development Party (akp) came to power foreign funds and the intrusion of heavy- in 2002, at least 20 other economies were handed politics into its economic life. bigger than Turkey’s in terms of dollar output. “Now, we are 17th,” he exulted, seeds of success “and in due course, we are going to be among the ten largest economies.” The seeds of Turkey’s success this century lie in the failure of the period The Turkish economy has indeed come that immediately preceded it. After the a long way during Erdogan’s decade in liberalizing reforms of Turgut Ozal, the visionary prime minister of the Daniel dombey is Turkey Correspondent for 1980s, who opened up what had been a perennially closed economy, the 1990s the Financial Times. Follow him on Twitter were a wretched decade, punctuated by economic crisis, brutal episodes in the @danieldombey. country’s Kurdish conflict, a de facto coup, and a devastating earthquake. January/February 2014 29

Return to Table of Contents Daniel Dombey This was a time when the lack of interest rates slowed the overheating foreign funds, often the result of spikes economy to 2.2 percent growth in 2012. in U.S. Treasury yields, could cause economies to seize up, and Turkey was hooked on foreign funds hardly alone in its misery. During these years, macroeconomic shocks also hit Yet for all its strengths, Turkey remains Mexico, Russia, and Southeast Asia. vulnerable. Its first major problem is its dependence on foreign funds. The For Turkey, this sorry period came to country suffers from structural weak- an end just after a 2001 banking crisis, nesses that have been obscured by the when Finance Minister Kemal Dervis, waves of money that have been crashing with the cooperation of the International in because of loose monetary policies Monetary Fund, laid the groundwork for elsewhere. It shares this problem with success. Ankara pruned back its spending, other developing countries, including brought inflation under control, intro- Brazil and Indonesia, whose governments duced a floating exchange rate, restruc- have grown lazy about reforms and let tured the country’s banks, and granted the quantitative-easing-induced good more independence to the central bank times roll. This dependence has become and regulators. When the akp took over particularly worrying since May, when in 2002, it stuck to this template, which the U.S. Federal Reserve floated the paid off as Turkey’s discussions with the possibility of reining in its monetary European Union progressed. The prospect stimulus, a step that would likely reduce of eu membership—negotiations started the funds that have been pouring into in 2005—opened the floodgates for emerging economies. For Turkey, the talk foreign direct investment. of a tighter U.S. monetary policy left a particular mark: amid other troubles, A boom in infrastructure development yields on the country’s benchmark and construction added to the good times. two-year bonds doubled. Since the outset of Erdogan’s tenure, the country’s highway network has been Turkish markets were sensitive for expanded by more than 10,000 miles. The one reason above all: a lack of balance number of airports has doubled, to 50, in the country’s economy. Even though and Turkish Airlines now flies to more Turkey was expected to have grown by than 100 countries, more than any other only 3.5 to 4.0 percent in 2013—below carrier in the world. New, upscale hous- the level needed to create enough jobs ing complexes and shopping malls seem for new entrants into the work force— to flank every major city. the country’s current account deficit stands at about seven percent of gdp. Turkey’s once-fragile banking sector Despite Turkey’s enormous appeal for was strong enough to get through the tourists (36 million arrived in 2012), a 2008 financial crisis with only a brief, manufacturing base well positioned for albeit deep, recession. Then, as the United exports, a $62 billion agricultural sector, States unleashed an unprecedented a tradition of trading, and ambitions to monetary stimulus, Turkey floated on a become an energy hub, the country still sea of money. Growth roared ahead: the relies on domestic consumption to power economy expanded by 9.2 percent in 2010 its economy, and consumption has risen and 8.8 percent in 2011, although higher 30 foreign affairs

Return to Table of Contents Turkey Ottoman of the people: an Erdogan election poster, Istanbul, June 2011 reuters / osman orsal rapidly as savings have fallen. At present, more traditional U.S. monetary policy Turkey sucks in foreign goods and relies should not be compared with traumas on foreign cash to finance even lackluster on the scale of the collapse of Lehman economic expansion. Brothers. And in fact, with the U.S. economy still troubled, the Federal Making matters worse, the foreign Reserve has so far held off tapering back funds that are financing Turkey’s expan- its $85 billion of monthly asset purchases: sion are overwhelmingly short-term money has returned to Turkey, and the investments and could be swiftly pulled spike in Turkish bond yields has partially out of the country. Net foreign direct subsided. Most analysts predict that investment underwrote just $7.3 billion Turkey will continue to grow moderately, of the country’s $56.7 billion current as the country’s living standards continue account deficit between August 2012 and to converge toward those of the developed August 2013. By contrast, five years ago, world, albeit at a slower pace than before. such investment—which is intrinsically more stable than short-term portfolio But Washington’s loose monetary funds—financed half the deficit. policy can’t last forever, and behind the Turkish economy’s ups and downs, deeper Turkish officials argue that concerns problems lurk. The rebound from the about the country’s prospects are exagger- 1990s is over, the low-hanging fruit of the ated and emphasize that a return to a January/February 2014 31

Return to Table of Contents Daniel Dombey last decade’s reforms has been picked, and reduce its dependence on foreign fuel, the foreign money on which the economy which accounts for almost all its current depends will eventually be in shorter account deficit, by encouraging alterna- supply. If Turkey cannot reduce its depen- tive sources of energy and attempting to dence on short-term foreign capital, it develop Turkey as an energy hub between will not be able to grow enough, or at its oil- and gas-rich neighbors. The govern- least not sustainably. ment has recently imposed measures to limit credit card and consumer lending To a certain extent, the Turkish story to contain private consumption, and it so far has been less than meets the eye. has offered new incentives for pension The government trumpets that during schemes to encourage saving. The World its time in office, income per capita Bank recently commended the “remark- has tripled, partly a result of disparities able improvement” in Turkey’s education between inflation and the exchange system since 2003. And the government’s rate. But that growth happened early finances are in admirable shape. on, mostly due to the lira’s strengthen- ing in real terms, and for the past half But the existing problems translate decade, that figure has largely been into economic facts of life: much of the stuck around $10,500. increase in employment in recent years has come from agriculture, services, and Then there are a whole host of struc- relatively low-technology manufacturing tural issues that Turkey must address. in Anatolia. Outside the greater Istanbul Participation in the labor force remains area and beyond the Aegean coastline, low: only about 50 percent of working-age two areas that export products such as adults were employed in 2012, compared refrigerators, washing machines, televi- with an average of 68 percent across the sions, and vehicles, much of the country mostly developed countries of the Organ­ produces low-value-added goods, which ization for Economic Cooperation and generate less income and can be more Development. Part of the reason for this vulnerable to competition. is the fact that Turkey has overlooked the potential of half its population: accord- the strongman ing to a recent World Economic Forum report, Turkey ranks 120th out of 136 Turkey’s other main challenge is political. countries in terms of gender equality, The concentration of power under and women constitute only 23 percent of Erdogan was once an essential precondi- the nonagricultural work force. Moreover, tion for economic success. Today, however, Turkey still lags behind the developed it could make things worse, not better. world in terms of educational levels. In 2011, two-thirds of Turkey’s working-age Erdogan’s chief accomplishment has population had received only primary been to establish the supremacy of education or less, and according to the eu, Turkey’s elected leaders and hence the fully 30 percent of Turkey’s young people stability of government on which eco- are neither receiving education or training nomic progress often rests. After 40 years nor securing jobs. in which the military ousted four govern- ments, Turkish democracy no longer The government acknowledges all operates at gunpoint. Erdogan has pushed these concerns. Ankara is seeking to aside a host of opponents, some of them 32 f o r e i g n a f fa i r s

Return to Table of Contents Turkey antidemocratic, including the military, big ongoing and could fizzle out in the long business, the country’s old media barons, run, but Turkish executives now privately and the judges who bent laws in a bid complain that such an atmosphere could to weaken the akp government. But the scare away the foreign direct investment consequence is that the prime minister that Turkey so desperately needs. is now master of almost all he surveys, which, combined with his often erratic Indeed, the risks that Erdogan’s erratic behavior of late, has raised important policymaking could wreak economic questions about the Turkish government’s damage is especially great in a country transparency, rationality, and stability. with few natural resources and little capital of its own. If the government The institutions that played a role in continues to punish the media for Turkey’s success over the past decade broadcasting bad news, if big decisions now struggle to appear independent of come to depend on the mood of one the prime minister’s will. Despite the man, and if companies fear predatory prospect of an end to the U.S. stimulus— fines, Turkish growth seems unlikely and inflation of about eight percent—the to continue at the rates to which the central bank has kept the benchmark country has become accustomed. interest rate at 4.5 percent. Instead of increasing that rate—what would seem Little of this seems to have dawned the appropriate response—the central on Erdogan himself, however: the prime bank has tightened the money supply minister has rarely sounded more opti- with unorthodox and often confusing mistic. His government projects that measures. Underlining the constraints Turkey will reach a per capita income under which the bank operates, Erdogan of $25,000 by 2023—the centenary of has long made clear his aversion to high the founding of the republic—and realize interest rates, not least because of their its aim of becoming one of the world’s role in holding back growth, and blamed ten biggest economies. The latter target an “interest-rate lobby” for stoking the would require barely credible rates of Gezi Park protests last summer. growth—15 percent a year, according to Rahmi Koc, the patriarch of Koc Other examples of the centralization Holding—but it is in keeping with the of economic power abound. The Capital prime minister’s monumental approach. Markets Board of Turkey has named Erdogan has also backed and begun three akp officials, including two former such giant projects as a vast new airport ministers, as directors of Turkcell, the for Istanbul, a new bridge across the country’s biggest cell-phone company. Bosporus, and a new canal to run parallel Last summer, Turkey’s broadcasting to the strait. In Turkey’s current politi- watchdog fined television stations that cal climate, any suggestion that such screened footage of the Gezi protests. projects could face financing difficulties Most conspicuous, after Erdogan de- leads to howls of outrage by the pro- nounced the Turkish conglomerate Koc government press. Holding for sheltering protesters in one of its hotels, in July, tax inspectors As all of this implies, Turkey’s eco- accompanied by police raided the offices nomic potential is decidedly mixed. The of several Koc subsidiaries. The case is country remains alluring to consumer goods companies that want to sell to the January/February 2014 33

Return to Table of Contents Daniel Dombey country’s youthful population; it has been he do so, the current president, Abdullah tried and tested as a manufacturer, and it Gul, may well become prime minister. retains a strong tradition of exporting And a country led by Gul could be an apparel. But for other foreign investors, entirely different place. Although Gul it presents more uncertain prospects; and Erdogan are old allies who built the government officials acknowledge that akp together, in recent years, Gul has foreign direct investment is considerably taken pains to establish himself as a more below where they would like it to be. moderate alternative to his old comrade. During his address at the opening of Nevertheless, Turkey still stands out parliament in October, Gul called for amid the troubled economies of southern a “new growth policy” and argued that Europe, not to mention a Middle East Turkey should address its low savings in turmoil. In a November survey, the rate, its educational failings, and the lack European Bank for Reconstruction of women’s participation in political and Development forecast that in 2014, and economic life, as well as find ways Turkey would grow by 3.6 percent—less to make “foreign investors and our own than it had previously expected, but still entrepreneurs feel safe and secure.” a higher rate than those projected for many of its neighbors. The country’s Whoever leads Turkey next will face enviable geographic location and its strong headwinds. Few analysts predict customs union with the eu remain that Turkey will face the sort of crashes important competitive advantages. that have done it so much damage in the past. But in a harsh report in September, ankara’s ambition the International Monetary Fund warned that it would be difficult for Turkey to The current state of affairs may not grow by four or five percent annually—let necessarily endure. Optimists argue that alone by the extraordinary levels of recent the country will return to trend, in politics memory—“while continuing to accumu- as well as economics. They note that late large external liabilities.” It predicted Turkey is incomparably richer and freer that without structural reform, higher than it was 15 years ago. On the economic interest rates, and tighter spending front, if education improves and Turks policies, the country would be left with save more, the country can continue to an unenviable choice between sluggish grow at an accelerated pace. And on growth and bouts of instability. the political front, Erdogan may change course if the drawbacks of his current This is the dilemma that Erdogan approach sink in. faces as he seeks to continue the political and economic advances his country has In fact, Erdogan might not even be at made since 2002. He has often proved the helm of government for much longer. his critics wrong. But Erdogan can achieve Erdogan has sworn not to serve another his outsized ambitions only if the coun- term as premier (akp term limits prohibit try and the government do everything it), and he has shown great interest in right. And the way things currently running for the country’s presidency— look, that might simply be too much currently a largely symbolic post—in to expect.∂ the first direct elections for the position, which will be held later this year. Should 34 f o r e i g n a f fa i r s