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Immigrant Entrepreneurship in the United States

Yoshiko Oka
January 10, 2019

On May 25, 2018, the U.S. Department of Homeland Security (DHS) announced a proposal to end the International Entrepreneur Rule, which was published at the end of the Obama Administration. Unlike many other countries, the United States has no visa for immigrant entrepreneurs, and many had thought the rule would encourage promising business owners, thereby promoting job growth and innovation. This article explores current entrepreneurship trends in the United States and analyzes how the elimination of the International Entrepreneur Rule would affect the labor market. Current trends suggest a decrease in native-born entrepreneurs, and an analysis of the labor market indicates that elimination of the Rule will exacerbate the declining startup rate.

What is the International Entrepreneur Rule?

The International Entrepreneur Rule is a regulation by the U.S. Citizenship and Immigration Services (USCIS) that encourages promising foreign entrepreneurs to start businesses in the United States. Under the rule, these entrepreneurs are granted a stay of 2.5 years to run their business in the U.S., which can be extended another 2.5 years if the company’s performance meets certain requirements.

Immigrants play a pivotal role in entrepreneurship in the U.S. The proportion of immigrant entrepreneurs has been growing, and the National Foundation of American Policy reports that more than 50% of America’s unicorn companies (startups valued with one billion dollars or more) were founded by immigrants. Currently, the United States does not have a particular visa category targeting foreign entrepreneurs.

Although the International Entrepreneur Rule was published three days before the end of Obama Administration and was originally scheduled to go into effect in July 2017, its implementation was delayed twice, finally going into effect in December 2017. Now, DHS is trying to eliminate the rule entirely.

Declining start-up rate and aging firms

The figure below shows the proportion of newly created employer firms (private firms in the nonagricultural sector with one or more employees) to the total number of employer firms. The startup rate is declining; in 2016, the latest data point, the startup rate of 8.39 % is nearly as half what it was in 1977, 16.53%.

The rate stays relatively flat during the 1990s and early 2000s, around 10–11%; the subsequent dramatic plunge occurred during the Great Recession. Although the startup rate has made a slight recovery from its lowest point of 7.78% in 2010, the pace is slow, and it is far from the pre-Recession level.

While job growth and the unemployment rate have returned to their pre-Recession levels, something may be discouraging people from starting their own businesses. Has it become harder for new businesses to survive? We compare the five-year survival rates for companies created before and after the recession.

The figure above shows the survival rate for firms created in 2000 and firms created in 2010. The percentage of those that went out of business within a year increased by 15%, from 22.3% in 2000 to 25.7% in 2010. The higher failure rate persists in the second year; reaches nearly the same level in the third year; and then remains slightly higher for firms started in 2010. After a new business survives its first three years, those created in 2010 have a somewhat greater chance of survival than those created in 2000. However, fewer new businesses are being created.

The next step is to examine current business formation by firm age. The figure below shows the percentage of firms by age in 2016.

Approximately one-third of employer firms in the United States are young firms, in business for five years or less, while 20% have been in business for more than 25 years. Half the firms are 10 years old or younger. It appears the United States is full of young and middle-aged firms. However, comparing the number of establishments reveals a different picture, where an establishment is defined as a stand-alone operation that may or may not be part of a firm.

The figure above, illustrating the share of establishments by firm age, shows 36% of establishments belong to firms that have existed for more than 25 years. Although one-third of firms are young firms, only one-quarter of establishments in the United States are less than six years old.

Meanwhile, the graph below, depicting the share of employment by firm age in 2016, indicates 62% of employment comes from old firms, but only 10% from young firms. Old firms are creating new establishments and expanding their size.

Immigrant Entrepreneurship Trend

Startups not only create employment and increase innovation; they also exert competitive pressure on old and large firms. Yet fewer startups are being generated, and the U.S. government has been seeking a way to encourage the launching of a new business. While native-born Americans are less likely to become entrepreneurs, immigrants play a key role in entrepreneurship.

In the United States, the percentage of immigrant entrepreneurs has been growing since 2000. The figure above shows the proportion of foreign-born business owners (including both incorporated and unincorporated business owners) to all business owners. In 2000, approximately 11.5% of entrepreneurs were foreign-born, but by the beginning of 2018, that share had reached 20% (although it then trailed off slightly).

The rising percentage of immigrant entrepreneurs in the United States is not only due to the increase in the proportion of foreign-born individuals in the labor force, but also because fewer native-born persons become entrepreneurs. The figure below compares entrepreneurship rates for native- and foreign-born workers.

The orange line represents the proportion of foreign-born entrepreneurs in the foreign-born labor force, and the blue the proportion of native-born entrepreneurs in the native-born labor force. While the foreign-born entrepreneurship rate increased through 2007 and has remained relatively flat since then, the native-born entrepreneurship rate has been declining since 2006. The entrepreneurship rate has been higher for foreign-born individuals since 2006.

Many countries, including Canada, Singapore, and the United Kingdom, seek to increase employment and innovation by attracting high-skilled foreign entrepreneurs through the use of a “startup visa.” The United States is one of the few leading economies that do not have such a visa category. As a result, foreign entrepreneurs seeking to start their business in the country enter on another type of visa, such as the H1-B, and endure a complicated process to start their own business.

The International Entrepreneur Rule was considered a huge step toward implementing a startup visa. Its stringent initial requirements, such as requiring the immigrant receives “significant investment of capital (at least $250,000) from certain qualified U.S. investors with established records of successful investments in the 18 months before applying,” indicate a temporary stay would only be granted to business owners with exceptional promise who are likely to bring employment to the United States in the future. However, the U.S. government is moving to eliminate the International Entrepreneurship Rule. As fewer startups are being born and native-born people are less willing to become entrepreneurs, the United States will need to devise another solution if it wishes to compete on the global stage.

Immigrant Entrepreneurship in the United States2019-01-11T23:46:09+00:00

The Credit Crunch and the Great Recession

Paul Krugman
December 08, 2018

Ben Bernanke wrote a paper arguing that the financial crisis and the resulting credit crunch were central to the Great Recession. His summary measures of financial conditions fall into two categories: Panic Factors (related to the financial panic) and Balance Sheet Factors (related to borrower and lender balance sheets). Using time series analysis, he estimates their impact on output and concludes that Panic Factors simulate the fluctuations in economic growth substantially better than the Balance Sheet Factors.

I wrote a piece raising questions about that verdict. I have trouble seeing the “transmission mechanism” — the way in which the financial shock is supposed to have affected actual spending to the extent necessary to justify a finance-first account of the slump. Dean Baker, who has long argued that the burst housing bubble was the main factor in both the slump and the slow recovery, with financial disruption a minor and transitory factor — a view I mostly agree with— has weighed in.

What Bernanke does in his paper, as I see it, is a kind of reduced-form analysis, identifying factors in the credit markets and using time series to estimate their impact on output. What Baker does, and I largely follow, is more of an accounting-based structural analysis: look at the components of aggregate demand, and ask what their behavior seems to imply about causes. In principle, these approaches should be consistent.

Here I summarize these views because it still seems to me that we’re somewhat talking past each other. The starting point for both of us thinking about the Great Recession and aftermath is that we clearly had a very large housing bubble. Here’s the ratio of housing prices to owner’s equivalent rent, the sort of housing equivalent of the P/E ratio for stocks:

Figure 1: S&P/Case-Shiller 20-City Composite Home Price Index
Source: Federal Reserve Bank of St Louis

Housing prices went extremely high relative to rental rates in 2006 (and consumer prices more generally), then suffered a long and protracted fall. This decline started well before the period of severe financial distress, which was a fairly short episode from September 2008 to around June 2009. And prices were still way down years later, which suggests that while the credit crisis surely accelerated the pace of decline, prices were going to come down and stay down regardless of what happened to the financial system.

Given a housing price slump of this magnitude, you had to expect large macroeconomic impacts. Consider investment, which is what you’d expect a credit crunch to depress. The bust led to a huge decline in residential investment, directly subtracting around 4 percentage points from GDP.

Figure 2 Fixed Residential Investment as a Share of Gross Domestic Product
Source: Federal Reserve Bank of St Louis

So, can we attribute this decline to credit conditions? If so, why did residential investment remain depressed five years after credit markets normalized?

The bust was also linked to a fall in consumer spending because of the wealth effect, and a decline in nonresidential, i.e., business investment, because of the slump in demand brought on by the first two effects.

Figure 3 Fixed Nonresidential Investment as a Share of Gross Domestic Product (left)
and Real Gross Domestic Product (right)
Source: Federal Reserve Bank of St Louis

But this decline was only about the same size as the decline in the early 2000s slump — which, admittedly, was partly because of the collapse in telecom spending, but still. And it seems pretty easy to explain simply by the accelerator effect: business investment always plunges when the economy is shrinking, which it was doing mainly because of the housing bust.

So, when I look at these two key drivers of the Great Recession and subsequent depressed period, I don’t see an obvious role for financial disruption. Bernanke’s VARs tell a different story; but I generally don’t trust VARs unless I can relate them to phenomena we see from other perspectives. Something very much like the Great Recession seems like an inevitable consequence of the bursting of the housing bubble. And the magnitude of the shocks — around 4 percent of GDP for housing investment, perhaps around 2 percent for the wealth effects of the decline in home equity — looks well within the range needed to explain the whole thing.

My problem with Bernanke’s paper is that I have trouble seeing the “transmission mechanism” — the way in which the financial shock is supposed to have affected actual spending to the extent necessary to justify a finance-first account of the slump. The paper is mainly focused on the first year or so after Lehman, while both Baker and I are more focused on the multiyear depressed economy that lasted long after the financial disruption ended. (Bernanke’s measures show the same spike and fast recovery as other stress indexes.) But there’s still a clear difference.

Bernanke has replied to those questions: Looking at the GDP components he says that despite the deterioration in residential investment real output growth was positive until 2008q1 and declined little early 2008. The panic accelerated the downturn in the fall of 2008 while residential investment continued to fall. The recovery began once the panic subsided in the spring of 2009. What Bernanke offers is, as I read it, mainly evidence that the pace of decline accelerated a lot during 2008-2009. Indeed, it did — and no reasonable person would deny that the combination of financial disruption and sheer fear that gripped the world after September 2008 brought the slump forward and made the decline steeper than it would otherwise have been.

But did it make the decline deeper as well as steeper? The unemployment rate averaged 9.6 percent in 2010 and 8.9 percent in 2011. How much did the financial crisis contribute to these extremely high levels of economic slack, long after the disruption had ended? I still don’t see how to make it the main story.

Now, does this mean that rescuing the financial system was pointless? Here Dean Baker and I disagree, I think. Dean says yes, because finance didn’t cause the slump. I think that the slump we had didn’t have much to do with finance — but the slump we would have had if the financial system had been allowed to implode might have been much worse. On precautionary grounds, bailouts were in my view the right thing to do, although the terms were too sweet for the bankers.

On the other hand, the fact that we suffered such a deep, prolonged slump despite rescuing banks shows the limits of a finance-centered view.

The Credit Crunch and the Great Recession2018-12-08T20:16:48+00:00

November 27: New York Sees Strong Job Gains in October

The New York State Department of Labor reported a gain of 22,000 jobs statewide in October.  Employment in the state is up 1.3% over a year ago, moderately below the nationwide gain of 1.7%.  The BLS reported a gain of 18,000 jobs in New York City in October, and employment in the city is up 1.4% over a year ago.

November 27: New York Sees Strong Job Gains in October2018-11-28T01:55:48+00:00

Argentina’s Latest Crisis

Meng-Ting Chen and Joseph van der Naald
November 16, 2018

Following a stunning fall in the value of its peso, a total loss of nearly 50% for 2018, and interest rates hitting 60%, Argentina’s economy appeared to be facing the strong likelihood of a crisis. While the government responded by taking a number of measures to calm the markets for the time being, the roots of Argentina’s crisis are complex. In this article, we outline the economic precursors to the Argentinian financial crisis and examine the steps being taken to address the situation. The country recently accepted a $57.1 billion bailout from the International Monetary Fund (IMF), temporarily stabilizing the situation. The administration of President Mauricio Macri has agreed to economic reforms, including spending cuts of 1.4% and revenue increases of 1.2% of GDP. The Central Bank is also keeping the nominal money supply constant with the objective of slowing inflation.

Though Argentina’s adjustments have partially restored investor confidence, the future remains uncertain. Emergency funds from the IMF signal confidence in Argentina, and yet both the Fund and Moody’s is predicting a considerable contraction in the economy in the coming year. Further, rising interest rates in the United States threaten Argentina’s situation as dollar-denominated debt becomes harder to repay. This crisis has been characterized as the potential beginnings of a “textbook” emerging-market crisis, caused by considerable short-term external debt in tandem with a budget deficit, and a current-account deficit.

The Genesis of the Crisis

Argentina’s current crisis has its roots in economic policies of crises past. During the four-year Argentine Great Depression of 1998 to 2002, the peso was pegged to the US dollar and the Argentine government imposed a set of capital controls known as “el corralito,” restricting bank account activity and prohibiting withdrawals from U.S. dollar-denominated accounts. With the official rate fixed and currency exchange restricted, these controls contributed to the emergence of twin exchange rates: one official and the other a much lower black market rate.

Economic growth in the decade that followed was weak, averaging a little less than 1.0 percent annually, although with sharp declines in the 2008 global financial crisis and again in 2012. Since 2012, annual growth rates have generally been less than 0.5%., with a sharp decline in the first quarter of 2018.

Source: Global Economic Monitor, World Bank

During the administrations of Presidents Néstor and Cristina Fernández de Kirchner (2003 – 2015), the slowing GDP growth rates coincided with a dramatic increase in public expenditure, reaching over 41% of GDP in late 2015. Government budget deficits exceeded 1.5% of GDP in eight of the past ten years. In 2002, Argentina had a trade surplus of $8.6 billion, which accounted for 16% of GDP, yet after a decade of protectionism, which threw key sectors into disarray with high tariffs suffocating agricultural exports and import restrictions putting the country at odds with global trading partners, this surplus had eroded into a deficit by 2015. Further, the Fernández de Kirchner administration imposed additional capital controls to prevent the flight of “hot money,” exacerbating the gap between the black market exchange rate, “dólar blue,” and the official exchange rate.

Efforts to Address the Crisis

As the Macri administration assumed power in 2015, Argentina faced a number of challenges. The issue of the dual exchange rates was addressed by the imposing of a flexible exchange rate. While official exchange rate initially depreciated to meet the black market rate, depreciation soon accelerated thereafter.

Source: Bank for International Settlements

Rather than engaging in money creation, the Macri administration sought deficit financing in international capital markets. This increased Argentina’s vulnerability to both currency devaluation and further external financing opportunities, and in 2017 a variety of factors from rising US Federal Reserve interest rates to a terrible drought, set the currency into a downward spiral. While a depreciated peso could help the economy through increased exports, it also has important implications for debt financing and inflation. Most of Argentina’s debts are issued in US dollars, the so-called “original sin.” As the government engages in external deficit financing with foreign currency debt, and as the value of the peso drops, these debts become harder to pay off increasing investors’ fears of default. Investors then began selling these debts fostering a further drop in the value of the peso.

Source: International Monetary Fund, World Economic Outlook Database, April 2018

Inflation, after holding steady through 2012, has been in excess of 20% in each of the past four years, in part the result of the declining peso and rising import prices. Upon taking office, Marci returned monetary independence back to the Central Bank, which began tightening monetary policy in an attempt to lower inflation. One of the ways by which the Central Bank has sought to decrease inflation is through the sale of Central Bank bonds (LEBACS). Yet, as the peso depreciates, bonds issued previously are more difficult to repay. In turn, the Central Bank increased its interest rates to attract more lenders, raising its rates to an unprecedented high of 60% in August 2018, which effectively increasing existing debts to pay old ones, creating a snowball of central bank bonds.

Source: Bank for International Settlements

The $57.1 billion credit line from the IMF is intended to reassure investor confidence; however, the credit line demands a budget deficit reduction through fiscal austerity and a narrowing of the capital-account deficit. Argentine authorities have committed to accelerating the process of fiscal convergence and plan to meet these goals in two ways. First, it is slashing operating expenses, subsidies, and infrastructure. Second, it will introduce temporary export taxes on goods and services to increase revenue. In addition to these tough fiscal steps, the Central Bank is overhauling its monetary policy, as it switches to targeting monetary aggregates as its new nominal anchor. This strong monetary contraction is likely to be effective in slowing down inflation; however, if it is too effective, it is likely to deepen the recession. The exchange rate will be allowed to float within a target zone of 33 to 44 pesos to the dollar and the Central Bank will intervene in foreign exchange markets only if the exchange rate crosses this predetermined mark.

Macroprudential Policy

In the short run, Argentine policymakers could proactively enforce capital controls to stem the risks of rapid capital outflows. Accompanied by new monetary policy and a flexible exchange rate regime, both imposing controls on inflows and outflows of capital has been proven an effective prudential policy for most of emerging market economies. Controls on outflow prevent the risk of crises, while controls on inflow can insulate Argentina from external shocks. Moreover, Argentine overborrowing due to the “original sin” exposes the economy to external shocks that can cause a “sudden stop.” Taxation of privately held foreign-currency denominated assets and/or the incomes those assets generate can preventcountries from overborrowing and reduce the probability of financial crisis.

The analysis above provides context to the needed interventions that the government should make in order to mitigate the worst aspects of the crisis’ fallout. Moreover, as the likelihood of a global emerging markets crisis increases the state must prioritize efforts to insulate the economy against further instability.

Argentina’s Latest Crisis2018-11-17T23:02:44+00:00

Why is New York Job Growth Slowing?

Fadime Demiralp and James Orr
October 31, 2018

Employment data through the third quarter of 2018 show job growth in New York City and State continuing to moderate from the relatively high rates reached earlier in the recovery. In this post we examine the sources of this cooling off of job growth by focusing on employment trends in key sectors that make up the city and state economies. In New York City the latest numbers show jobs growing fairly solidly but well off their heady pace in 2014 and 2015. Beginning mid-year, the city’s year-over-year job growth rate fell below the comparable nationwide rate, reversing a pattern that had held for much of the eight years since the recovery of employment got underway. Statewide, job growth had tracked the nation fairly closely but has been moderating as well and has also fallen below the nationwide rate.

Employment Trends in New York City, the State and the Nation

Employment patterns in the current cycle are shown in the figure below. The figure, also presented here, plots a monthly index of the level of total employment in New York City, New York State and the nation from January 2006 through September 2018. The figure shows the decline in employment during the downturn and the subsequent recovery and expansion.

 

In New York City, the recovery of jobs has been relatively strong and the level of employment in the city is well above its previous peak. An index of coincident economic indicators for the city, a summary statistic that measures the monthly change in overall economic activity, shows a similar pattern of recovery and expansion. Statewide, employment was somewhat slower to recover and though job counts have been above their previous peak for about five years.

Both the city and the state plots have become somewhat less steep in recent years, and a comparison of monthly job growth rates highlights this moderating growth. In the figure below, year-over-year job growth rates in the nation were relatively steady in the recovery, roughly in the range of 1.5 – 2.0 %. In New York City, recent job growth rates are down from previous months and for roughly two years have been down from gains in excess of 3.0 % in 2014 and 2015. Growth rates remained above the comparable national rate until recently. Statewide, job growth rates, which had tracked those of the nation during much of the recovery, declined over the past year to about 1.0%.

This uneven pattern of recoveryacross New York State reflects a disparity between the relatively rapid growth of jobs in the city and the slower growth rates in the metropolitan areas in upstate and western New York. This disparity continues to characterize the pattern of employment change in the state.

Sources of Moderating Growth in New York City

We look for the sources of moderating job growth by selecting key sectors and comparing the job growth rate in the third quarter of 2018 over a year ago to the growth rate of employment in the third quarter of 2017 over a year ago. A mixed performance is seen in the figures below. The overall slowing reflects a combination of moderating growth rates in some very large sectors, some outright declines in others, with some sectors gaining, though not by enough to offset the declines.

A first grouping includes two relatively large sectors—Healthcare and Social Assistance and Leisure and Hospitality. Job growth here was quite strong in 2018 but nevertheless modestly below that in 2017.

Healthcare and Social Assistance has the largest share of employment in the city, and also in each of the boroughs other than Manhattan, and has been a steady and robust source of new jobs. Declining growth trends in both sectors were also observed at the state and national levels suggesting a more general pull back from earlier growth rates may be occurring. The size of the two sectors, almost 30 percent of city employment, suggest any slowing will have an outsized impact on overall job growth.

A second group consists of five sectors which had relatively slow growth or declines in employment. The Utilities and Administrative Support and Waste Management sectors increased only modestly, and jobs in the Transportation and Warehousing, and Information sectors declined modestly following their sharp expansion a year ago. A recent report looking into the size of the independent contractor workforce, or the gig economy, noted that the Ground Transportation component of the broader Transportation sector in the Greater New York area had sizeable growth in non-traditional taxiing services which rely on app based systems, such as Uber and Lyft.

Manufacturing is included with this group as it had declining employment both in 2018 and 2017. At the national level, manufacturing employment expanded modestly in 2018, roughly 300,000 jobs, concentrated in the durable goods category. That pickup, however, was not reflected in job counts in either New York City or New York State.

A third group consists of four sectors that saw job growth increase in 2018—Construction, Educational Services, Professional, Scientific and Technical Services, and Retail Trade.

Construction jobs saw a healthy pickup in 2018 which also occurred in New York State and nationwide. Jobs in the Educational Services sector picked up in 2018 over 2017 despite the slowing growth in the sector at the state and national levels; Professional, Scientific and Technical Services sector saw a modest pickup in growth in 2018, and that pickup was also seen in the sector nationally.

Retail Trade improved upon its flat performance in 2017. Recent reports have attributed declines in employment in department stores in the city, a component of the general merchandise store category, to the growth of online shopping, and jobs in the general merchandise category declined more than 3 percent in 2017. However, there was only a modest decline in jobs in general merchandise stores in 2018, offset to some degree by growth in some other categories, such as furniture, food and beverages and health and personal care stores.

The Finance and Insurance sector saw a very modest pickup in jobs. The sector plays a critical role in the overall city economy, less so for its employment growth and more so for the relatively high incomes earned: 30 percent of total city earnings and average earnings of over $400,000 statewide in the securities component of the industry.

Looking Ahead

Two recent reports forecast job growth in New York City to continue slowing over the next several years, though the annual rate of growth is still expected to remain above 1.0 percent through 2020. Several factors can influence the outlook. Among them is the performance of the national economy where a weaker than expected expansion could further weigh down employment growth in the city. A second is more local and relates to the provision in the recent tax bill, the Tax Cuts and Jobs Act of 2017, which caps the size of the individual federal tax deduction for state and local tax payments. It remains to be seen how this provision will impact the state and city economies in the coming years.

 

Why is New York Job Growth Slowing?2018-11-02T05:14:39+00:00

October 22: New York State Jobs Report for September 2018 Shows Continued Gains in Employment

The New York State Department of Labor reported that the state gained 6,300 jobs in September.  Employment in the State is up 1.0% over a year ago, below the nationwide increase of 1.7%.  The U.S. Bureau of Labor Statistics reported that New York City gained 9,000 jobs in September, and employment in the city is up 1.3% over a year ago.

October 22: New York State Jobs Report for September 2018 Shows Continued Gains in Employment2018-10-23T02:06:58+00:00

October 19: China Reports Its Weakest Growth in Nearly a Decade

According to the Wall Street Journal, China’s economic growth slowed to 6.5%—its weakest pace since the financial crisis of 2008-09. As its growth in industrial output and consumption weakened over the past quarter, Chinese regulators have reacted by launching a coordinated effort to calm investors. Read more

October 19: China Reports Its Weakest Growth in Nearly a Decade2018-10-19T14:34:59+00:00

The Turkish Currency and Debt Crises

Merih Uctum and Zhuo Xi
September 22, 2018

On August 9 the Turkish currency, the Lira, hit record lows and rattled emerging markets. The travails of the Argentinian economy subsequently weakened the Lira further. In this analysis article, we examine the economic and financial reasons behind the turmoil the economy is going through and discuss the future path it may take.

Following the sound economic policies adopted in the wake of the twin crises of the early 2000s, the economy experienced solid growth, except during the 2007-8 global financial crisis. Since 2010, the economy has averaged a healthy annual growth rate of 6.85% despite a slowdown since 2017.

Source: Federal Reserve Economic Data

But the recent collapse of the currency was dramatic and does not square with the strong performance of the economy. Since 2008 the Lira depreciated by 82% against the dollar and 76% against the euro:

Source: The Central Bank of the Republic of Turkey

After hitting a historic low on August 13 of 7.0 Lira against the dollar and 7.93 against the euro, belated minor measures by the Central Bank of Turkey and a pledge of $15 billion worth of investment by Qatar in Turkey, the currency stabilized briefly before being hit again on August 18 as contagion from Argentina spread to other fragile currencies.

Public debt is usually one of the culprits in economic crises. However, in Turkey this is not the case at hand. While public finances in Western economies and in several emerging markets went into large deficits after 2008, and many are still struggling to reduce it, Turkish government debt has declined and been hovering at a modest 30% of GDP.

Source: The Central Bank of the Republic of Turkey

The story of the Turkish currency crisis, however, repeats a familiar scenario of emerging market crises. In an environment with ultra-low interest rates, strong growth in the economy is fueled by borrowed funds by the private sector, mostly from international capital markets.

During the first quarter of 2018, total external debt stock climbed to $466.67 bn, about half of GDP, with private debt making up 70% of it. Both the financial and nonfinancial (mostly corporate) sectors have been borrowing heavily since 2010. After ballooning during the financial crisis, corporate debt declined and steadied around 12% of GDP but rose steeply by 70% for the last three years. Foreign borrowing of financial institutions and banks continued and surpassed that of the corporate sector.

Source: The Central Bank of the Republic of Turkey

Although banks’ external roll over ratios (long-term external borrowing/repayments) are at a five-year low, rising interest rates in the West and a depreciating currency may generate sufficient risk to discourage lending by foreign banks.

Due to “original sin,” a term describing the fact that emerging markets economies cannot borrow in their own currency but only in foreign currency, usually US dollars, any event that triggers a depreciation of the currency and/or a rise in interest rates aggravates the foreign currency-denominated debt burden, when translated into the local currency. While various factors have been contributing to the accelerating depreciation of the Turkish Lira, it is the recent conflict with the United States that triggered the run on the currency.

Depreciation of a currency has several consequences on an economy. One beneficial impact is to stimulate exports over a certain period, but another dire and more immediate effect is to exacerbate inflation, which can undo the benefits of the first impact. In an economy dependent on oil imports and with endemic inflation, as in Turkey, the influence of depreciation on prices has been swift and painful.

August data indicate that consumer price inflation reached 17.9%, more than quadrupling since the end of the financial crisis in 2009.

Source: The Central Bank of the Republic of Turkey

The conventional response of policymakers in such a situation is to raise interest rates, reschedule the external debt and implement austerity measures. However, policymakers in Turkey had been reluctant to change rates aggressively or to start discussions with the IMF. For comparison, Argentina, which is in the throes of a financial crisis, increased rates to more than 60% and is preparing to receive guidance from the IMF. After the long-awaited increase in the one-week repo rate by 625 basis points last week to 24 %, an increase above the expectations of the markets, the currency stabilized but several dark clouds in the horizon suggest further trouble ahead.

Leading indicators point to decreased confidence among households and businesses. The Purchasing Managers’ Index in manufacturing took a plunge since the beginning of the year, falling to 46.4 and creating further jitters in markets.

Source: Istanbul Chamber of Industry and HIS Markit

Total debt service as a percentage of exports is a measure used to assess sustainability of a country’s debt burden. Turkey’s debt service ratio increased continuously since 2013 and surpassed its 2002 crisis level for the first time at the end of 2017. Tightening by the Federal Reserve Bank, which is also likely to be followed by the European Central Bank, will continue to worsen the debt burden of the country.

Source: The Central Bank of the Republic of Turkey

It took two crises (2000 and 2001) followed by serious economic reforms and austerity measures to bring down inflationary expectations in Turkey. These policies earned back the confidence of markets, with an influx of foreign direct investment and access of the country to international financial markets. The recent events might have done damage to the economic progress achieved so far.

Currently, the main concern of market participants is the contagion of the Turkish crisis to similar economies with large foreign debt levels and to international banks that lent to Turkey. During August, the Turkish Lira dragged down the currencies of several emerging economies such as Argentina, South Africa, Brazil, Russia and India against the dollar, which reached their lowest levels since May. The European Central Bank expressed concern about the impact that a plummeting Turkish currency could have on Spanish, French and Italian banks that are holding Turkish assets. Another concern is about borrowers in Turkey who might start defaulting on their debt. Both of these events could hurt European banks.

The problems discussed above necessitate concerted and committed effort by the government to contain the currency and debt crises. International financial markets are bracing for hard times ahead.

The Turkish Currency and Debt Crises2018-09-22T22:44:31+00:00
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