Turkey, the European Bank for Reconstruction and Development and the European Union

Geographically and symbolically, Turkey is “on the edge” between the more or less liberal democratic and more or less open market capitalist countries of Europe and the much less democratic and much less market-oriented countries that stretch to the south and east. In 1999, the European Union accepted Turkey as a candidate to join the European Union – but has yet to grant admission. A decade later, whether the EU should accept its Turkish suitor remains one of the divisive topics of European diplomacy.

An interesting aspect of this courtship is Turkey’s role in the European Bank for Reconstruction and Development (EBRD). The Bank uses the tools of investment banking to help former Communist countries, in eastern Europe and what had been the Soviet Union, make the transition – remember this word – from planned to market economies. It started to operate in 1991 on the basis of subscribed capital of €20 billion invested by shareholder countries.1 Canada and Turkey were both among the initial countries to subscribe capital.

In the fall of 2008, the Bank admitted Turkey as a “country of operations” – a country whose businesses are eligible to receive EBRD loans or investments. This decision was the culmination of a process set in motion by a request from Turkey in April of that year. Already a shareholder in the Bank, Turkey wanted to become a country of operations as well. In May, after intense negotiations, both in London where the Bank has its headquarters and in other capitals, the Governors of the Bank (representatives of all the member countries; Finance Minister Jim Flaherty is the Canadian Governor) had asked the Board of Directors (a smaller group responsible for the ongoing operations of the Bank) to undertake a review of the issue.

In the initial Board debate on the request, most countries, but not all, were supportive. As a result, the United States proposed that a strategic review be undertaken to determine whether admitting Turkey would be consistent with the Bank’s mandate. Was Turkey’s stage of development comparable to that of existing countries of operations? And were the tools and competencies of the Bank relevant to its transition needs? The strategic review concluded that the principles and mandate of the Bank could be respected while investing in admissible private-sector projects in Turkey.

I was the Canadian Director on the Board of the EBRD while this process was going on. Incidentally, the Canadian Director also represents Morocco, another moderate Islamic country with a possible interest in obtaining the same country of operations status as Turkey. This put me in an interesting position as I tried very hard to keep our options open. In addition, having been elected as Chair of the Board Steering Group, a kind of elected dean, I was quite active in looking for common ground between the United States, other key directors and management.

In the end, the decision to admit Turkey was nearly unanimous. Armenia was originally opposed, but ultimately it too agreed. Unanimity was not legally required but I argued in favour of a very strong majority. All shareholder countries that are also members of the European Union were supportive.

Turkey makes its case

Turkey as a country of operations of a “European” bank? How did this apparently surprising result come about? Does the decision offer insights into the relationship between Turkey and Europe? How could a country that is not a former Communist country be admitted as a country of operations of a multilateral bank specifically set up to support the development of a private sector in precisely those countries? These are important policy and political questions, aside from legal questions in interpretation of the Bank’s founding treaty. The EBRD’s Turkey debate and its resolution also provide insights on the role and future of international financial institutions, especially those with a regional mandate, and of course on the role and future of the EBRD itself.

In much the same manner as some of our Crown corporations here in Canada, the Bank operates on a commercial basis to serve its intended public purpose. It loans money to or invests in private companies or state-owned companies more or less on their way to privatization. Projects must be based on “sound banking” (there is money to be made) and “additionality” (the project would not go ahead without the Bank). They must also have a strong positive transition impact. The Bank’s Office of the Chief Economist has developed an elaborate transition measurement scheme; its composite index looks at privatization, restructuring, price liberalization, trade and foreign exchange regimes, competition policy, banking and nonbanking regulation.

The main sectors in which the EBRD lends are financial institutions, infrastructure, energy and small business. It performs all the normal features of a bank – credit evaluation, risk management, treasury, etc. It also has a compliance department largely concerned with the integrity of its partners, and a department of environmental and social standards. Canada, with 3.4 per cent of the subscribed capital, is the Bank’s eighth largest investor.

The Bank operates in 29 countries. Excluding Turkey, this covers all the countries of the former Soviet Union and all formerly Communist countries of Europe. In 2006, Mongolia was added, as a former Communist country. Because it is obviously not in Europe, its admission required an amendment to the original treaty creating the Bank. This point is relevant to the admission of Turkey.

In requesting admission as a country of operations, Turkey argued that its state of development was comparable to that of several existing EBRD countries of operations, such as Romania and Bulgaria. Table 1 compares Turkey to several other EBRD countries of operations. Turkey’s 2008 per capita GDP was US$10,504, close to the average of the other countries in the table (US$10,720). Similarly, its transition score of 3.26 (the composite EBRD index scores countries from 1 to 4.33) places it right in the middle of those countries.

From a transition and economic point of view, Turkey is not in a class by itself. It is comparable to other countries that were recently admitted to the EU. From the perspective of the EBRD’s mandate, Turkey, while not a former Communist country, is transitioning from a history of significant state control of the economy.

The EBRD’s main areas of investment, noted above, are a close match for Turkey’s areas of interest. In addition, Turkey considered the tools of the Bank, loans or equity investment, as appropriate. Another consideration was the fact the Bank already worked with about 30 Turkish companies doing business throughout the other Bank “countries of operations” – in Central Asia of course, but also in Russia.

The question of whether Turkey is a European country was not seen as an issue in the Bank discussions. At the time of the Bank’s founding, the subscribing countries had classified Turkey, one of the original shareholders, as European. Even the European countries that oppose the admission of Turkey into the EU do not question whether the country is geographically in Europe; if they had, it would not be an accession candidate. More later on the complex mixed signals of EU pre-accession programming in Turkey.

Turkey argued explicitly that the Bank should consider its request to become a country of operations in the context of the much bigger issue of EU membership. It pointed out that the eastern European countries that joined the EU in 2004 and 2007 had benefited from EBRD investments in their private sectors and these investments had helped them meet EU requirements.2 Turkey wanted the same support. In the words of the Turkish board member, Turan Oz, in a 2007 interview with the EBRD’s internal magazine:

My government believes that Turkey can benefit from the EBRD’s experience … The EBRD can help particularly in increasing the speed of privatization in Turkey. Strengthening of corporate culture and corporate governance is another area … We would like the EBRD to invest more in the emerging regions of Turkey where there is little contribution from other international financial institutions … Finally the EBRD played an important role in strengthening the economies of countries in central and eastern Europe and preparing them for the EU membership. We hope that Turkey’s partnership with the EBRD will also accelerate my country’s accession to the European Union.3

 

Mandate issues for the EBRD

Two intriguing questions deserve attention. First, why did governments that oppose Turkey’s accession to the EU agree to Turkey’s admission as a country of operations? And why did the finance departments of Bank member countries – these are typically the home departments of Bank directors – agree with this mandate change? Better to answer the second question first.

There are sceptics who believe that the leadership of the EBRD was interested in adding Turkey as a “country of operations” as a way of extending the life of the Bank. By definition, this is an institution that should not go on forever. Eventually the transition from planned to market economies will be, if not complete, at least sufficiently advanced that there is no “additionality” from the Bank. That was, for example, the state of affairs of the Czech economy before the international economic crisis that began in 2008.

Finance ministries instinctively oppose mandate expansions, or mandate “creep.” They are suspicious of open-ended mandates, suspicious that international institutions, once created, are never terminated. This instinct is consistent with their responsibility for maintaining fiscal discipline. If you believe that institutions inevitably strive to survive regardless of their original mandate, then you would not be surprised that the Bank has supported various proposals to expand to other countries and other missions – such as energy efficiency projects, at which the Bank is getting very good. Finance departments in subscribing countries see this “mission creep” as both predictable and unacceptable. Once the mandate has been achieved – whether it has is a major debate in itself – the Bank should go. It is interesting that the Bank has no long-term pension or health plan, in order to avoid liabilities after its closure.

To others, and I am one of them, why not entertain the idea that the Bank’s capital, both financial and human, could be used productively in other regions or for other missions? But a new expanded mandate for the Bank should be decided deliberately, not implicitly by a series of individual decisions. It is not straighforward, of course, to figure out who should make that decision and how.

Even though the international economic crisis slowed their rate of transition, the 2004 EU accession countries will be ready to graduate in a few years. Possibly some time later, Romania, Bulgaria, Croatia and Serbia will be in the same situation. In the meantime the Russian Federation might decide to take itself out. Turkey would also have graduated by then. In such a scenario, the Bank would be left to operate in some very difficult transition countries, in the Caucasus and central Asia. Would the international community want to keep it for that purpose? Maybe, maybe not. But that is another story.

In any case, finance officials don’t always act alone in these matters. The extent to which they consult with other departments in their respective capitals varies quite a bit but, in this case, they had no choice given the stakes. Turkish diplomats posted in shareholder countries made sure foreign affairs ministries were aware of the request. The quality of Turkey’s diplomatic service, which has long historical traditions, was often remarked on during Bank deliberations.

The answer to the first question flows partly from the second. Left unsaid, admitting Turkey into this little-known bankers’ club does not carry the political risks of supporting Turkey’s bid to join the EU or offer politicians the political rewards of opposing it. Second, politicians opposed to Turkey’s EU accession probably viewed this as a compromise decision. It allowed them to demonstrate that they do in fact wish to work closely with Turkey without making the ultimate commitment of supporting accession to the EU.

Business opportunities in Turkey and a potential for firms in EU members working profitably with Turkish companies may be a third reason. Turkey is an attractive market and its businesses are making their mark all over Europe and Asia. They benefit from very old connections, including ethnic and linguistic ones in parts of the Caucasus and Central Asia. Professor Kemal Kirisci, from Bogaziçi University in Istanbul, has written extensively about the economic integration of Turkey into its immediate and broader “neighbourhoods.” He emphasizes the significance of its business world as a primary driver of its foreign policy.

As for its relationship with the EU, Turkey has had “candidate country” status since December 1999; negotiations for admission started in 2005. In the meantime, Turkey has access to pre-accession funds designed to help a country meet membership criteria. These will run at €782 million in 2011. The European Investment Bank, which invests mostly inside the EU, is allowed to invest a portion of its assets outside. Its largest non-EU investments are in Turkey (€2.7 billion in 2008), where they are also aimed at preparing the country for EU membership! At least to an outsider like me, the EU is sending very mixed signals.

Continue reading “Mixed Signals”