“THE PEOPLE HAVE voted for stability,” proclaimed President Erdogan after his party’s electoral landslide in November. The markets applauded, too. Istanbul’s stock index jumped and the Turkish lira rose against the dollar, both reversing long slides. Year-end indicators showed an upward trend in GDP growth, from a rate of around 3% to nearer 4%. But business euphoria quickly faded. Stability certainly beats chaos or months of coalition haggling, the markets seemed to say, but if stability means “more of the same”, we are not so sure.

That may seem a churlish reaction. Turkey has made great economic strides in the past 15 years. It has become a trusted supplier of high-quality consumer goods and is now Europe’s biggest manufacturer of television sets and light commercial vehicles. Its capital goods pass muster in Germany for their precision. Turkey is also the world’s eighth-biggest food producer and sixth-most-popular tourist destination. Forty-three of the top 250 international construction firms are Turkish.

Moreover, Turkish business has often proved nimble. Ten years ago the country’s textile industry was foundering, priced out by East Asia, but it has since discovered a lucrative niche supplying higher-quality goods to Europe on shorter time scales. As prospects in the Middle East have dimmed, Turkish contractors have switched to markets such as Russia and Africa.

The AK party is justly proud of having presided over plunging inflation, shrinking sovereign debt and a jump in exports (by a whopping 325% in the ten years to 2012). However, most of those things were achieved a while back. Between 2002 and 2007 Turkey’s economy expanded by an average of 6.8% a year, but since then it has been more volatile. Over the past decade, annual average growth has been a modest 3.5%. Income per person has barely been rising for the past four years. The same is true for exports. Average inflation has been above the central bank’s target in all but one of the past ten years.

Much of the slowdown is due to the vagaries of the global business cycle. Around 60% of Turkey’s trade is with Europe, which also accounts for three-quarters of foreign direct investment in the country. The continent’s recent economic troubles are not Turkey’s fault. Nor is the mayhem in the Middle East, which a decade ago was Turkey’s fastest-growing export market. A deep recession in Russia, a big supplier of energy and tourists and a market for farm exports, has also hit growth prospects. Turkey’s recent political spat with Russia has made things worse.

Other external events have been more helpful. Thanks to a sharp fall in the oil price, Turkey’s current-account deficit narrowed to around $35 billion in the 12 months to November, the lowest in over five years. Even so, the loans piled up to fund the big external deficits of the past have left the economy vulnerable. Much of Turkey’s foreign debt, notably to its companies, is in dollars, which have become more expensive to service as the lira has steadily weakened.

From know-who to know-how

The economy also suffers from a range of home-grown troubles. Onerous regulations make it hard for small businesses to grow bigger and more efficient. The World Economic Forum, a think-tank, ranks Turkey 131st out of 144 countries by labour-market efficiency. Most economists agree that without substantial structural reform, weak growth is here to stay. “Our new normal seems to be 3-3.5%,” says Emre Deliveli, a columnist on economic affairs. “For America or the EU that would be fine, but with our demographics we need 3.5% as a minimum just to keep unemployment flat.”

Turkey is a classic case of what economists call the “middle-income trap”: the difficulty encountered when countries that have recently emerged from poverty try to move up into the club of rich countries. They may, like Turkey, have learned how to assemble cars or washing machines, boost agricultural productivity or mobilise capital and labour, but they find it harder to add value through research, design, branding and marketing. According to World Bank data, the share of high-tech goods in Turkish manufactured exports has been stuck at 2% since 2002.

Martin Raiser, until recently Turkey director for the World Bank, has described the kind of shift required as a move from the “know-who” to the “know-how” economy. The key, he believes, is to develop institutions that are resilient to changing regimes and can sustain long-term growth. This is where Turkey has fallen short. Connections all too often still outweigh competence. Big privately held holding companies dominate many sectors, squeezing out smaller, more innovative firms.

“We are not in a middle-income trap, we are in a reform trap,” says Zumrut Imamoglu, chief economist of TUSIAD, a think-tank funded by Turkey’s biggest private firms. She sees the AK government drifting away from a pro-growth agenda towards a programme that more narrowly serves the party’s own interests. Consumer and business confidence have taken a knock.

When the Turkish economy crashed in 2001, an IMF-enforced remedial programme provided useful discipline, reinforced by hopes of EU membership. Turkey’s subsequent boom owed much to stringent controls on state spending, increased budget transparency, more independence for the central bank and moves towards more open and better-regulated markets. But once the IMF’s cure had worked and the EU became cooler about Turkish accession, the impetus for reform waned.

In a recent paper two Turkish economists, Daron Acemoglu of MIT and Murat Ucer of Koc University in Istanbul, point out that although AK governments have maintained laudable fiscal discipline, in other respects their economic management has been less impressive. “The AK government that had supported the economic opening made an about-face once it became sufficiently powerful,” they write. “Gradually, the de jure and de facto control of the ruling cadre intensified, amplifying corruption and arbitrary, unpredictable decision-making.”

A forthcoming book by Esra Gurakar of Okan University, "Politics of Favouritism in Public Procurement in Turkey", illustrates the point. The adoption of a law in 2001 to regulate government procurement at first improved transparency, it says. With time, however, the number of exceptions to the law grew and the share of public contracts awarded via open auction shrank. By 2011 some 44% of government contracts were being awarded by unaccountable bureaucrats.

Businesses without friends in government have suffered. One of Turkey’s most successful construction conglomerates, with a fat international order book and an annual turnover of close to $6 billion, has not won a big Turkish government contract since the AK party took power. Some say this is because it is seen as too close to Western governments that have been critical of the party. Similarly, companies that own media outlets have been cut out of business in other fields if they fail to toe the line. The share price of Dogan Holding, which owns some of the few remaining independent newspapers and TV channels, fell by 16% on news of November’s election results. Firms with the right contacts, say critics of the government, have done well, winning not just direct state contracts but privileged access to deals involving state-owned land and getting early warning of regulatory and zoning changes. One example is TOKI, the state agency for affordable housing, which the AK has turned into a partner for private developers. “There is a cycle,” says Mustafa Sonmez, an economist: “I give you public land, you build, we share—it’s a great way to reward friends.” Slippage is also in evidence over the independence of Turkey’s central bank, or TCMB. The bank is generally held in high regard, but in recent years it has failed either to rein back inflation, currently around 9%, or to prevent a steady decline in the value of the Turkish lira, which has fallen by half against the dollar since 2010. Many economists and businessmen pin the blame on Mr Erdogan, who has publicly badgered the bank to keep interest rates down. On one occasion he accused its governor, Erdem Basci, of being a traitor to the nation for championing a higher rate. A recent analysis of TCMB policies by economists at the Centre for Financial Studies at the Goethe University in Frankfurt reckons that between 2010 and 2014 Turkey’s central bank on average set the official interest rate about 7 percentage points too low, judging by its own policy responses in the previous decade. It is not clear why Mr Erdogan is so concerned about interest rates. Speculation about possible motives ranges from trying to woo voters with cheaper money to religious concerns about usury. His economic advisers have often hinted at a shadowy global “interest-rate lobby” seeking to damage Turkey’s economy.

Mr Basci is due to leave his job in April, perhaps with some relief. Turkish businessmen want his successor to be given more leeway to set credible policies. They reckon that the country’s politically determined loose monetary policy has been partly responsible for a surge in consumer debt, which grew from an average of about 5% of household income in 2002 to 55% in 2013. The credit binge made Turkish consumers feel rich: nominal household wealth has tripled in the past decade. But the cheap money has also steadily eroded Turkey’s savings rate. At just 12.6% of GDP in 2014, it was the lowest in any big emerging market.

Artificially low interest rates have also directed investment away from industry into sectors with quicker returns, such as consumer imports and property speculation. According to the IMF, between mid-2012 and mid-2014 the proportion of bank credit earmarked for construction rose from less than 50% to over 70% of all loans. Across the country, fancy new housing estates, office complexes and shopping malls are far more in evidence than new factories. Since 2012 property prices have risen smartly, helped in part by looser rules on foreign ownership. In July 2015 the average price of a house in booming Istanbul was 20% up in real terms on a year earlier.

The fall in domestic saving has also made Turkey even more dependent on foreign finance. Its foreign debt is approaching $400 billion, or about 50% of GDP. Much of this is short-term, and the vast bulk of it is private. Last July Fitch, a ratings agency, singled out Turkey as the large emerging market most vulnerable to the effects of a long-expected rise in American interest rates. The Fed’s initial move, in December, was smaller than expected, but Turkey still gets poor marks from ratings agencies. Moody’s and Fitch both put its sovereign debt at the lowest investment grade, and Standard & Poor’s rates it as junk.

Foreign direct investment, which reached a peak of about $22 billion in 2007, has been on a downward trend ever since, sliding to around $12.5 billion in 2014 and probably staying at the same level last year. Foreign firms have made no major acquisitions in Turkey in recent years and have launched no big greenfield projects, notes Mr Sonmez, the economist. This is due partly to a general wariness of emerging markets, but partly also to Turkey’s perceived political volatility, a weak currency, relatively high inflation, proximity to a turbulent Middle East and questions about the rule of law. “This is a government that has a habit of changing rules after the match has started,” says a prominent economic columnist. “If a foreign company fears it cannot defend itself in court, why should it invest?”

Since the AK party’s success at the polls, the signs from the new government have been only partly reassuring. It is already committed to costly election promises such as a higher minimum wage, bigger pensions and more social spending, and ministers have also spoken of boosting infrastructure investment to promote growth. A senior adviser to Mr Erdogan hints that in future the party might be less fiscally prudent than in the past, aiming to create more jobs and increase competitiveness.

Outsiders such as the EU, the IMF, the World Bank and the OECD, along with Turkish economists and businesses, suggest different priorities. A tighter monetary policy would strengthen savings and reduce inflation, which would have a useful knock-on effect across the economy. Labour markets need to become more flexible and education must be geared more closely to their needs. Most importantly, sustained growth will require a change of attitude, beginning at the top. A sophisticated market economy cannot be run by offering favours for loyalty. “They used to be giving, sacrificing for the public good,” says an Istanbul news editor. “Now they are taking, using all the redistributive power of the state.”