Economic Research Forum (ERF)

New firms and economic geography in Turkey

2022
The Turkish economy is characterised by considerable regional disparities, including big differences in the willingness of new firms to locate in different parts of the country. This column reports research evidence that there is also spatial variation in the factors that can boost local economic activity and contribute to a smoothing of economic geography across Turkey’s western and eastern regions.

In a nutshell

The location decisions of new firms are geographically unequal in Turkey, typically mirroring regional disparities in economic activity.

New firms’ choices of location are affected by the potential of regional demand, local education levels and quality, accessibility to markets, the composition of regional production, economic stability and the availability of financial capital.

There is a significant amount of spatial variability in the determinants of new firms’ location decisions, which should be a reminder that ‘one size fits all’ is not the right approach to economic policy-making across regions.

There is a long lasting duality in the economic geography of Turkey between the developed regions of the western part of the country and the underdeveloped regions of the east. Various reasons have been used to explain this regional disparity, including different capacities to accumulate human capital, a lack of infrastructural capability to link remote and central regions, conflict between macroeconomic priorities (such as growth and rapid industrialisation) and development-based local necessities.

Regional inequality is a big problem for developing economies like Turkey. Regions that lag behind in education, physical infrastructure, healthy local institutions and other socio-economic conditions block the development of a sound economic ecology.

This is particularly well demonstrated in the location choices of new firms. An evolving body of research argues that the presence of new firms in a location is central for sustainable development. Job creation, innovation capacity and the ability of new firms to transform technology into commercial uses are also important. Therefore, identifying factors that influence the formation of new firms is vital for economic policy.

There are two kinds of factors that affect the location decisions of firms. On the one hand, there are ‘centrifugal’ forces that discourage new firms from establishing themselves in a region. Distortions that reduce accessibility within and between regions, mismatch between the structure of production and the quality of labour force, and a lack of internal demand coming from low population density and income levels are the most important factors that push new firms away from certain locations.

On the other hand, there are ‘centripetal’ forces that attract new firms towards regions. Good market access, the suitability of the local labour market and the level of domestic demand influence the formation of new firms positively. A notable feature of this process is the agglomeration of economic activity and the formation of production clusters.

In these discussions, the Turkish case is interesting and in a way peculiar. Economic activity spreads mostly over the western regions, which are historically more prosperous compared with the rest of the country. Meanwhile, isolated and land-locked eastern regions suffer from various socio-economic problems.

This duality between developed western regions and less developed eastern regions transforms into structural polarisation. Among the consequences of this polarisation, the location choice of new firms is spatially biased towards the developed western regions. In almost all lines of production – from manufacturing to service-based activities – the western geography of the country attracts more new firms.

An important challenge for policy-makers is to understand the degree of irreversibility of this pattern. An explanation is required to understand the lack of economic convergence between western and eastern regions.

A key question is why new firms continue to choose already developed western regions that are highly competitive, highly congested in terms of economic activity and likely to be suffering from falling returns. Even though it could be argued that these factors will drive down the formation of new firms in developed regions, western regions are still creating more new firms compared with the rest of the country.

A careful examination of Turkey reveals the factors that shape the geographical concentration of economic activity. First, regional demand potential and accessibility to internal as well as external markets matter. Both supply- and demand-based potential are important factors for new firms’ location decisions. Industrial backward and forward linkages for the supply side, and purchasing power for the demand side all enter into the location decision functions of new firms.

Related to this, the condition of local labour markets is also crucial. Both the level and quality of education shape the local labour market dynamics in Turkey. Firms prefer to locate in regions that have more flexible, diverse and highly qualified labour markets.

In terms of economic conditions, our research shows that people are less reluctant to form new businesses during unstable and cyclical periods. Although there are some region-invariant issues (such as the country-level impact of a macroeconomic crisis), it is still crucial to understand regional variation, as differing spatial production structure can influence the sensitivity of regions to different business cycles.

Another vital aspect of firms’ location decisions is the availability of financial capital. Local relations that will stimulate financial accessibility motivate newcomers. Even though there is a centralised financial system, which does not require a spatial match between the sources and uses of funds, the new firm formation process is still heavily influenced by the local accumulation of financial capital.

It is important to keep in mind that the dual pattern also contains spatial spillovers and heterogeneity. On the side of spatial spillovers, the location decision of new firms and factors influencing their location decisions are also spatially related. This reminds us that policy to facilitate more new firms through different industrial and social policies in a region will have inevitable local spillover effects beyond the administrative local borders.

But spillovers do not impede the overall spatial dichotomy. This spatial heterogeneity pattern creates different spatial regimes across the country. Therefore, mechanisms that are observed in general (for example, the positive impact of financial accessibility on new firms) do not necessarily work in all parts of the country.

Indeed, in the case of financial capital, impact seems to be visible only among the already developed western regions. Therefore, there are possibly other socio-economic determinants that influence the formation of new firms in the less developed eastern regions. Naturally, these factors can be less important for firms locating in the developed western regions.

All these discussions highlight that spatial heterogeneity as well as spatial spillovers shape the economic geography of Turkey. This means that policy recommendations to facilitate new firms’ local formation cannot be common for all regions. Rather, local instability creates the need for more effort to harmonise national and regional economic policies.

 

Further reading

Karahasan, Burhan Can (2015) ‘Dynamics of Regional New Firm Formation in Turkey’, Review of Urban and Regional Development Studies 27(1): 18-39.

Karahasan, Burhan Can (2018) ‘Spatial Varying Relationship between Financial Development and New Firm Formation: Evidence from a Developing Country’, Panoeconomicus 65(5): 633-75.

 

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