Cyclopedia Of Economics

Question: What approach has been most useful in best serving the needs of small businesses: through private business support firms, business associations, or by government agencies?

It depends where. In Israel (until the beginning of the 90s), South Korea and Japan (until 1997) – the state provided the necessary direction and support. In the USA – the private sector invented its own enormously successful support structures (such as venture capital funds). The right approach depends on the characteristics of the country in question: how entrepreneurial are its citizens, how accessible are credits and microcredits to SMEs, how benign are the bankruptcy laws (which always reflect a social ethos), how good is its physical infrastructure, how educated are its citizens and so on.

Question: How might collective action problems among numerous and dispersed small and medium entrepreneurs best be dealt with?

It is a strange question to ask in the age of cross-Atlantic transportation, telecommunication and computer networks (such as the Internet). Geographical dispersion is absolutely irrelevant. The problem is in the diverging self-interests of the various players. The more numerous they are, the more niche-orientated, the smaller – the lesser the common denominator. A proof of this fragmentation is the declining power of cartels – trade unions, on the one hand and business trusts, monopolies and cartels, on the other hand. The question is not whether this can be overcome but whether it SHOULD be overcome. Such diversity of interests is the lifeblood of the modern market economy which is based on conflicts and disagreements as much as it is based on the ability to ultimately compromise and reach a consensus.

What needs to be done centrally is public relations and education. People, politicians, big corporations need to be taught the value and advantages of small business, of entrepreneurship and intrapreneurship. And new ways to support this sector need to be constantly devised.

Question: How might access of small business to start-up capital and other resources best be facilitated?

The traditional banks all over the world failed at maintaining the balancing act between risk and reward. The result was a mega shift to the capital markets. Stock exchanges for trading the shares of small and technology companies sprang all over the world (NASDAQ in the USA, the former USM in London, the Neuemarkt in Germany and so on). Investment and venture capital funds became the second most important source quantitatively. They not only funded budding entrepreneurs but also coached them and saw them through the excruciating and dangerous research and development phases.

But these are rich world solutions.

An important development is the invention of "third world solutions" such as microcredits granted to the agrarian or textile sectors, mainly to women and which involve the whole community.

Question: Women start one-third of new businesses in the region: now can this contribution to economic growth be further stimulated?

By providing them with the conditions to work and exercise their entrepreneurial skills. By establishing day care centres for their children. By providing microcredits (women have proven to be inordinately reliable borrowers). By giving them tax credits. By allowing or encouraging flexitime or part time work or work from home. By recognizing the home as the domicile of business (especially through the appropriate tax laws). By equalizing their legal rights and their pay. By protecting them from sexual or gender harassment.

Transport Projects, Financing of

The role of government in facilitating transport projects is inevitable. But governments are monopolists and largely cannot be trusted with the efficient allocation of resources, not to mention the problem of corruption. So, the less the state is involved the better off everyone is.

Transport has gone a full circle. Until the beginning of the 17th century it was largely privately financed. The state took over until the last two decades of the twentieth century. And now there is a revival of the involvement of the private sector in financing infrastructure. Additionally, transport has become a commodity and is securitized, as we shall see.

All social (or public) goods carry social costs and bring on negative externalities (such as environmental damage). Embedded in every public good there is a moral hazard - others bear a disproportionate part of the costs while the perpetrators go "free". This is why accurate statistics, forecasting and cost benefit analysis systems are a must. I am not talking only about cost coverage calculations but also about finding ways to impose on the users of transport infrastructure the real costs of their actions. This is known today as "user pays" charging schemes. But to do so, the state needs to know what ARE these costs. This is one way of forcing the private sector to participate in the financing of infrastructure.

But we are digressing. Allow me to return to more conventional methods.

Transport infrastructure is financed today mostly by the state. Governments usually assume bilateral or multilateral debt from commercial banks, through the international bond markets - but, most often, from institutions such as the World Bank and regional development banks through the EBRD. I have already indicated my aversion to this method of financing. The money is sure to be spent either inefficiently or corruptly or both. Yet hitherto both the financial scope of most of these projects, their regional and international repercussions and the need to adhere to statal planning - inhibited most forms of alternative financing.

Recent developments in private sector financing allow for reasonable solutions to this age-old dilemma. These solutions are widely experimented with in dozens of countries, many of them poorer and less stable than Macedonia.

The most widespread and accepted private sector financing method is the Build-Operate-Transfer (BOT) system. The state grants a 15-35 years concession to a private construction and engineering consortium of firms backed by ample financial resources (the contractors). The private firms build the infrastructure project, operate it for the concession period at the end of which they transfer it to the state without compensation. All the income during the operating period goes to the contractors. If the period of concession is sufficiently long - the contractors have an interest to observe high standards of quality in order to minimize maintenance costs. The state (sometimes through "golden shares") maintains a say in certain operational aspects (such as tariffs of usage).

The BOT approach has spawned off a host of variants. There is BOO - the Build, Own and Operate (classic) version. Then there is Build, sell to a financial institution or an investor, Lease it back from the new owner and Operate (BLO). There is also BLOT - like BLO but with a transfer of the asset to the state at the end of a long, pre-determined period. The Sopang Airport in Malaysia was constructed on a Build-Sell (to a group of banks)-Lease-Operate basis.

Lately, private entrepreneurs have begun to tap the international equity and debt markets to raise financing for transport projects. A case in point is the financing of the M2 Motorway in Australia. Both shares representing ownership in the assets and bonds representing an interest in its future stream of income are sold to investors through investment banks, portfolio managers and then through the international stock and bond markets.

This approach is a remote off-shoot of MUNIS. These are municipal bonds issued by local authorities to finances specific transport infrastructure, such as a toll-way. The income from the project goes to cover the interest and principal payments of the bonds. Such bonds are issued either directly to investors and portfolio managers or through the stock exchange were they are freely traded. The interests of the investors are (supposed to be) protected by custodian banks and trustees. Most of these bonds are backed by long term letters of credit and the interest income is tax free. State Route 91, the Riverside Freeway in California, was fully financed by municipal bonds. Munis have caught on with many countries, including countries in transition.

Last but not least, private enterprises are allowed to own their own infrastructure. Firms can own a railway section and even trains ("Own Your Wagons" schemes) providing they finance them. In many countries, construction licences are conditioned on participation in infrastructure costs.

Macedonia's infrastructure is decrepit. Maintenance is bad. Planning is absent. Corruption is rampant. The only hope is to remove as much as we can from the process of planning and constructing transport infrastructure from the hands of the state. Maybe this will even attract the billion dollars under our mattresses and carpets.

Trust

Economics acquired its dismal reputation by pretending to be an exact science rather than a branch of mass psychology. In truth it is a narrative struggling to describe the aggregate behavior of humans. It seeks to cloak its uncertainties and shifting fashions with mathematical formulae and elaborate econometric computerized models.

So much is certain, though - that people operate within markets, free or regulated, patchy or organized. They attach numerical (and emotional) values to their inputs (work, capital) and to their possessions (assets, natural endowments). They communicate these values to each other by sending out signals known as prices.

Yet, this entire edifice - the market and its price mechanism - critically depends on trust. If people do not trust each other, or the economic "envelope" within which they interact - economic activity gradually grinds to a halt. There is a strong correlation between the general level of trust and the extent and intensity of economic activity.

Trust is not a monolithic quantity. There are a few categories of economic trust. Some forms of trust are akin to a public good and are closely related to governmental action or inaction, the reputation of the state and its institutions, and its pronounced agenda. Other types of trust are the outcomes of kinship, ethnic origin, personal standing and goodwill, corporate brands and other data generated by individuals, households, and firms.

I. Trust in the playing field

To transact, people have to maintain faith in a relevant economic horizon and in the immutability of the economic playing field or "envelope". Put less obscurely, a few hidden assumptions underlie the continued economic activity of market players.

They assume, for instance, that the market will continue to exist for the foreseeable future in its current form. That it will remain inert - unhindered by externalities like government intervention, geopolitical upheavals, crises, abrupt changes in accounting policies and tax laws, hyperinflation, institutional and structural reform and other market-deflecting events and processes.

They further assume that their price signals will not be distorted or thwarted on a consistent basis thus skewing the efficient and rational allocation of risks and rewards. Insider trading, stock manipulation, monopolies, hoarding - all tend to consistently but unpredictably distort price signals and, thus, deter market participation.

Market players take for granted the existence and continuous operation of institutions - financial intermediaries, law enforcement agencies, courts. It is important to note that market players prefer continuity and certainty to evolution, however gradual and ultimately beneficial. A venal bureaucrat is a known quantity and can be tackled effectively. A period of transition to good and equitable governance can be more stifling than any level of corruption and malfeasance. This is why economic activity drops sharply whenever institutions are reformed.

II. Trust in other players

Market players assume that other players are (generally) rational, that they have intentions, that they intend to maximize their benefits and that they are likely to act on their intentions in a legal (or rule-based), rational manner.

III. Trust in market liquidity

Market players assume that other players possess or have access to the liquid means they need in order to act on their intentions and obligations. They know, from personal experience, that idle capital tends to dwindle and that the only way to, perhaps, maintain or increase it is to transact with others, directly or through intermediaries, such as banks.

IV. Trust in others' knowledge and ability

Market players assume that other players possess or have access to the intellectual property, technology, and knowledge they need in order to realize their intentions and obligations. This implicitly presupposes that all other market players are physically, mentally, legally and financially able and willing to act their parts as stipulated, for instance, in contracts they sign.

The emotional dimensions of contracting are often neglected in economics. Players assume that their counterparts maintain a realistic and stable sense of self-worth based on intimate knowledge of their own strengths and weaknesses. Market participants are presumed to harbor realistic expectations, commensurate with their skills and accomplishments. Allowance is made for exaggeration, disinformation, even outright deception - but these are supposed to be marginal phenomena.

When trust breaks down - often the result of an external or internal systemic shock - people react expectedly. The number of voluntary interactions and transactions decreases sharply. With a collapsed investment horizon, individuals and firms become corrupt in an effort to shortcut their way into economic benefits, not knowing how long will the system survive. Criminal activity increases.

People compensate with fantasies and grandiose delusions for their growing sense of uncertainty, helplessness, and fears.  This is a self-reinforcing mechanism, a vicious cycle which results in under-confidence and a fluctuating self esteem. They develop psychological defence mechanisms.

Cognitive dissonance ("I really choose to be poor rather than heartless"), pathological envy (seeks to deprive others and thus gain emotional reward), rigidity ("I am like that, my family or ethnic group has been like that for generations, there is nothing I can do"), passive-aggressive behavior (obstructing the work flow, absenteeism, stealing from the employer, adhering strictly to arcane regulations) - are all reactions to a breakdown in one or more of the four aforementioned types of trust. Furthermore, people in a trust crisis are unable to postpone gratification. They often become frustrated, aggressive, and deceitful if denied. They resort to reckless behavior and stopgap economic activities.

In economic environments with compromised and impaired trust, loyalty decreases and mobility increases. People switch jobs, renege on obligations, fail to repay debts, relocate often. Concepts like exclusivity, the sanctity of contracts, workplace loyalty, or a career path - all get eroded. As a result, little is invested in the future, in the acquisition of skills, in long term savings. Short-termism and bottom line mentality rule.

The outcomes of a crisis of trust are, usually, catastrophic:

Economic activity is much reduced, human capital is corroded and wasted, brain drain increases, illegal and extra-legal activities rise, society is polarized between haves and haves-not, interethnic and inter-racial tensions increase. To rebuild trust in such circumstances is a daunting task. The loss of trust is contagious and, finally, it infects every institution and profession in the land. It is the stuff revolutions are made of.

Turkey, Economy of

On November 15, 2002 Horst Kohler, the Managing Director of the IMF, acknowledged that, despite a "strong implementation" of the IMF program, Turkey's financing gap may have increased by up to an additional $10 billion. He tenuously and untenably attributed this massive failure of the IMF to the September 11 events. He intended to recommend to the Fund a new (the fourth since 1998) stand-by arrangement to be negotiated in Ankara in December. Many regarded this as an American-inspired prize in recognition of Turkey's pivotal role in the anti-terror global coalition.

Its much criticized obstruction of a settlement in Cyprus and its oft-derided sabotage of the creation of the European ex-NATO Rapid Deployment Force were all but forgotten. Issues like its poor human rights record (bombastic sounding constitutional amendments notwithstanding), the suppression of the Kurdish minority, the pernicious role in state affairs (and in criminal affairs) of its military, police, and bloated bureaucracy, and its rising Islamist sentiment were relegated to the backburner. The Copenhagen criteria for the commencement of membership talks with Turkey have been effectively suspended.

Emboldened by new stature, Bulent Ecevit, the Turkish prime minister, threatened the EU with annexation of the Turkish Republic of Northern Cyprus (TRNC) should the Greek populated south become a full member. Turks overwhelmingly long to belong to the EU but such grandstanding does their cause no good. Ecevit's diatribe was intended for internal consumption by the virulently nationalist allies in his shaky left-right coalition.

A widening financing gap was only the latest in a series of bad news. That same week, Balfour Beatty of the UK and Impregilo of Italy pulled out of the controversial $1.6 billion Ilisu hydro-electric dam - together with the export credit guarantees their governments were supposed to offer. They cited human rights and environmental considerations. The Turkish government vowed to press ahead with this flagship project, but its strained finances cast it in doubt. Turkey was forced to internationally issue the equivalent of almost a billion US dollars (partly in Euros) in 5 year bonds (with a yield of over 11%) in the last 30 days alone.

It all started at the end of last year. A banking meltdown in November was narrowly averted with $7.5 billion in IMF funds. The government, unable to repay its monstrous domestic debt, resorted to eroding it (to 80% of GDP) and to preventing a run on the fast dilapidating lira through a debilitating devaluation in February. Foreign investors fled its collapsing capital markets and drew $5 billion, c. 25% of Turkey's foreign exchange reserves, on February 19th alone. Important privatizations failed to attract a single bidder. The stock exchange rose by a dizzying 650% until March 2000 and then crushed by 63% in a few days and the current account worsened by 3% of GDP. Yields on one month treasury bills shot up to 144%, overnight inter-bank rates touched 9000% briefly.

Structural reform stalled and the Prime Minister and the President publicly fell out over suspiciously under-investigated corruption charges. Industrial production crumbled by 9.2% in the year to September and GDP shrank by more than 9% (though it is expected to recover next year). At least 600,000 workers lost their jobs (adding 3% to the official 6% unemployment rate and to an equal number of unemployed). The Turkish lira halved against the US dollar. Turbulence-prone Turkey experiences now its worst recession in 60 years.

The inevitable IMF cum World Bank rescue package signed in May (initially at $15.7 billion) was coupled with (partly successful) pressure to reform the banks, phase out farm subsidies, and introduce market based regulation and competition through accelerated privatization. Turkey's central bank has adopted inflation targeting. Political appointments to Turk Telekom have been reversed. Over-generous wage settlements have been checked. State as well as private banks have been recapitalized, merged, or closed and a dragnet scheme of deposit insurance has been introduced. More than $7 billion of short term state obligations were swapped in June for much longer maturities (though some of the new bonds were linked to the exchange rate of the US dollar). Still, the IMF's projection of a mere 5.5% decline in GDP looks inane. And government bond auctions continue to end with crippling yields (a real interest rate of 18% - or more than 90% nominally in October).

But this externally imposed ambulatory regime failed to gain the support of opportunistic, populist, and venal Turkish politicians, or of the Turkish people. The private sector oriented technocrat (formerly with the World Bank) in charge of implementing the reforms, the Minister of Economy, Kemal Dervis, was continually sniped at and scapegoated. And though one of the IMF's most vocal critics was sacked in July (an event followed by the release of a delayed IMF loan tranche) - many call for early elections of which the likes of Tansu Ciller and Suleyman Demirel (two discredited politicians) or the thinly veiled Islamist Justice and Development Party may yet benefit. The distrust of the current government translates to a mistrust of its economic policies and to the exacerbation and prolongation of the economic crisis.

Turkey's economy is a hybrid of modern industry (29%), trade, and services (56%) with primitive agriculture (40% of the workforce but only 15% of GDP), of state ownership (mainly of infrastructure and industry) with a thriving and vibrant private sector (mainly textiles). Income inequality is great and GDP per capita is c. $2000 in current exchange rates. Despite the fact that it enjoys a robust investment rate of 25% of GNP and a merchandise trade which amounts to 50% of its GNP - Turkey was rated a poor 86 in the 1999 UNDP Human Development Index. Adult female illiteracy is higher than Albania's (at 25%), and infant mortality (38 per 1000) is almost African. Less than 35% of the roads are paved.

More than a million Turks work abroad and their remittances are of crucial importance to the foreign exchange reserves of the country and to its economy. More than 40% of the government's budget is used to defray the domestic debt. This leads to consistent fiscal deficits of 10% of GDP (though the budget sports a primary surplus). Turkey has consistently been on the verge of hyperinflation, with double digit inflation the norm (though recently it dropped below 40%).

Yet, Turkey's fate is determined not in Ankara or Brussels, but in Washington. Should the coalition attack Iraq, or isolate Syria, or fail to coerce Israel (Turkey's improbable ally in the region) to accommodate Palestinian needs - Turkey will be the first and foremost to suffer the consequences. An oil-rich and trouble stirring Kurdish state in Iraq, a water dispute with Syria, a wave of Islamist anti-Israeli zeal - could all undo a year's worth of economic overhaul. The military is likely to re-assert itself in any such crisis and the EU will keep mum, averse to jeopardizing the US-led grand coalition.

Moreover, the likes of Iraq are Turkey's neighbors and natural trade partners. It has a full time Ambassador in Baghdad, another border crossing is being negotiated, and dozens of Turkish business delegations visit Iraq (Turkey's erstwhile second largest trade partner) regularly. "The Economist" quotes Turkey as saying that "it has forfeited over $40 billion in trade because of the UN's continuing sanctions against Iraq." Naturally, the US is no too thrilled about Turkey's gravitation towards its arch enemy.

IFI's like the IMF and the World Bank are bound to play an inordinate and much resented role in Turkey's affairs in the foreseeable future. The World Bank, for instance, has pledged in excess of $5 billion and disbursed more than $2 billion. But most of this money goes towards disaster relief or support of IMF programs - and not to long term development projects. Ordinary Turks do not benefit from the World Bank's activities and believe, however erroneously, that they directly harmed by the IMF policies. Should Turkey also find itself the victim of US geopolitics, a wave of xenophobia and a backlash against liberalism and market economy might well ensue.

In emphasizing its "special relationship" with Turkey, the United States conveniently overlooked the fact - confirmed yet again by a recent Pew Global Attitudes Project survey - that 84 percent of Turks view America "unfavorably".

According to the Anadolu news agency, the Chairman of the Union of Chambers and Commodity Exchanges in Turkey, Rifat Hisarciklioglu, cajoled his countrymen on Monday to rid themselves of their dependence on "foreign" assistance - common euphemism for handouts from America and, as the Turks firmly believe, its long arm, the International Monetary Fund.

A country's foreign policy stature, he averred, is conferred by its domestic product. Somewhat implausibly, he pegged Turkey's war-related damages this year at $16.2 billion and between $70-150 in the following decade. It will have to resort to more expensive alternative sources of oil. Tourism, its second largest foreign exchange earner, will wither.

If true, Turkish refusal to be used by U.S. troops as a launching pad for a second, northern, Iraqi front - was nothing short of suicidal.

Turkey could have ended up with $30 billion in sorely needed aid and loan guarantees - now reduced, perhaps, to a mere $8.5 billion in commercial debt in return for overflight rights. Moreover, future IMF aid and even disbursements from an existing standby agreement are in jeopardy.

Last year, at the behest of the United States, Turkey received another dollop of $17 billion in multilateral funds to shore up its ailing economy. According to the Washington Post, it already owes the Fund five times the ordinary borrowing limit under the lending agency's rules.

The country's finances are in dire straits. Its foreign debt catapulted from $50 billion in the wake of the first Gulf war - to more than $130 billion in the run-up to the second. The government's economic policies are still founded on the defunct assumption that U.S. aid will be allotted, despite Turkey's denial of service.

Inflation, at more than 25 percent, is rising as are real interest rates - at 30 percent above inflation - and an already unsustainable $95 billion in domestic public debt, a sizable chunk of it extremely short term. Financial markets and the currency are plummeting. The yield on Turkish bonds is a stratospheric 70-80 percent. An incredible three quarters of the budget are earmarked for debt repayments.

The country should service $80 billion in obligations in the remainder of this year. Not surprisingly, Standard and Poor's is contemplating a lowering of Turkey's country rating, currently below investment grade at B1. Fitch went ahead and reduced Turkey's rank to B minus with a negative outlook to boot - akin to destitute and near-default Moldova.

According to Stratfor, the strategic forecasting consultancy, risk premiums on Turkish treasuries leaped 90-122 basis points on March 17 alone - to 9.5 percent above comparable U.S. bonds. This spread narrowed by 0.85 percent the following day when Turkey came up with the offer to allow U.S. planes to make use of its air space.

Closer integration with the European Union, warned EU enlargement commissioner, Günter Verheugen, will be adversely affected by any unilateral Turkish move in north Iraq. The acrimonious breakdown of reunification talks between the Greek and Turkish-sponsored parties in Cyprus did not help either.

Turkey has been allocated $1.1 billion by the EU as pre-accession aid. Unruly behavior on its part may endanger this carrot as well. To complicate matters further, America may drop its staunch political and pecuniary support for the Baku-Ceyhan Main Export oil Pipeline (MEP).

Nor is the domestic situation less ominous.

The new, hitherto popular, prime minister, Recep Tayyip Erdogan, vowed on Sunday to "carefully and diligently" implement the IMF's agonizing austerity program which calls for spending cuts of $2 billion by the end of the month, the privatization of the tobacco and alcohol monopolies and tax reform. The 2003 budget envisages a primary surplus of 6.5 percent of gross national product. It aims to raise revenues by $5 billion and cut expenditure by $3 billion.

Such prescriptions ill-fit with promises to help the poor and fiscally boost growth. But a mid-April loan tranche of $1.6 billion - of the $3.5 billion left to be disbursed - is dependent on strict adherence. Nor is a new agreement with the IMF in the offing without considerable U.S. pressure or its implicit guarantee, both now unlikely.

The threat of dispatching troops to northern Iraq is Turkey's last, desperate, card in a depleted deck. To avoid this cataclysmic scenario, the United States may yet, teeth gnashing, revive the moribund economic aid package it has seethingly withdrawn. The alternative is an Argentina-style default with a shock wave cruising through a volatile and ignitable Middle East - or a military dictatorship in Ankara.

It is ironic that relations between Turkey and Israel have never been better. The former is ruled by yet another Islamic government - though constrained by secular-minded generals. The latter is increasingly nationalistic-Messianic and theocratic - though its newly elected Prime Minister, a former army general, Ariel Sharon, has just put together a largely secular coalition government.

Each year, more than 300,000 Israelis spend their vacation - and more than a quarter of a billion dollars - in scenic and affordable Turkish resorts. A drought-stricken Israel revived a decade-old plan to buy from Turkey up to 400 million cubic meters a year, instead of expensively desalinating sea water.

Israeli land use, hydrological and agricultural experts roam the Texas-sized country. The parties - with a combined gross domestic product of $300 billion - have inked close to thirty agreements and protocols since 1991. Everything, from double taxation to joint development and manufacturing of missiles, has been covered.

Buoyed by a free trade agreement in force since 1997, bilateral trade exceeded $1.5 billion last year, excluding clandestine sales of arms and weapons technologies. According to the Turkish Ambassador to the United States, "Turkish exports to Israel consist mainly of manufactured goods, foodstuffs and grain, while Israel's main export items to Turkey are chemical products, plastics, computers and irrigation and telecommunications systems technologies."

A sizable portion of Turkey's $3-5 billion in annual spending on the modernization of its armed forces is rumored to end in Israeli pockets. This is part of a 25-year plan launched in 1997 and estimated to be worth a total of $150 billion. Israeli contractors are refurbishing ageing Turkish fighter planes and other weapons systems at a total cost exceeding $2 billion hitherto.

Last May, the Israeli Military Industries and Elbit secured a $688 million contract to upgrade 170 M-60A1 tanks. There are at least another 800 pieces in the pipeline. Small arms, unmanned aerial vehicles and rockets originating in Israel make only part of a long shopping list. Israeli pilots regularly train in Turkey. Joint military exercises and intelligence sharing are frequent. The Israeli backdoor allows friendly American administrations to circumvent a rarely Turkophile Congress.

The American-Israel Public Action Committee (AIPAC), the Jewish Institute for National Security Affairs (JINSA) and, more generally, the almighty Jewish lobby in Washington, often support Turkish causes on the Hill. Three years ago, for example, Jews helped quash a resolution commemorating the Armenian genocide perpetrated by Turkish forces during the first world war.

This exercise in hypocrisy did not endear the Jewish community or Israel to either Armenians or to European Union cardholding Greeks who have long permitted Palestinian terrorists to operate from the Greek part of Cyprus with impunity. The friend of my enemy is my enemy and Israel is clearly Turkey's Jewish friend.

But Israeli hopes that Turkey will reciprocate by serving as a conduit to Arab regimes in the Middle East proved to be ill-founded. Only one tenth of Turkish trade is with its neighbors near and far. Turkey's leverage is further limited by its chronic economic distress and its offensive designs to monopolize waterways shared by adjacent countries.

Though Moslem, like the Iranians, Turkey is not an Arab nation. It counts Syria, Iraq and Iran as potential enemies and competitors for scarce water resources - as does Israel. The recent rebuff by its parliament of America's request to station troops on Turkish soil notwithstanding, the country is defiantly pro-American against a backdrop of anti-Western virulence.

Turkey aspires to join the European Union because it regards itself as an island of civilization in an ocean of backwardness and destitution. This counter-regional orientation is another thing it has in common with the Jewish state. In an effort to differentiate themselves, both polities were early adopters of economic trends such as deregulation, equities, venture capital, entrepreneurship, privatization and hi-tech.

Turkey was the first Moslem state to recognize an ominously isolated Israel in 1949. Both Israel and Turkey are democracies though they are implicated in systemic human rights violations on a massive scale. The political class of both is incestuously enmeshed with the military.

The two countries face terrorism on a daily basis and feel threatened by the rise of militant Islam, by the spread of weapons of mass destruction - though Israel is hitherto the only regional nuclear power - and by global networks like al-Qaida.

In his travelogue, "Eastward to Tartary", published in 2001, Robert Kaplan notes:

"Turkey's more friendly position toward Israel was the result of several factors. (Turkey) became tired of diplomatic initiatives that failed to induce the Arabs to end their support of the Kurdish Workers' party, which was responsible for the insurgency in southeastern Turkey. The Turks felt, too, that the Jews could help them with their Greek problem (via the Jewish lobby) ... (The Turks realized) they might never gain full admittance to the European Union. Thus, they required another alliance."

This confluence of interests and predicaments does not render Israel the darling of the Turkish street, though. Turks, addicted to conspiracy theories, fully believe that the second Iraq war is being instigated by the Israelis. They also decry the way Israel manhandles the Palestinian uprising. Flag-burning demonstrations are common occurrences in Ankara and Istanbul. Suleyman Demirel, Turkey's former president, nearly paid with his life for the entente cordiale when a deranged pharmacist tried to assassinate him in 1996.

Turkey's power behind the throne and future prime minister, Recep Tayyip Erdogan, called Israel's Ariel Sharon a terrorist. The previous prime minister called Israel's behavior in the occupied territories "genocide" - hastening to reverse himself when faced with the possible consequences of his Freudian slip.

Indeed, the looming conflict in Iraq may well be the watershed of the Turkish-Israeli love fest. Turkey is growing increasingly religious and more pro-Arab by the year. The further the United States - Israel's sponsor and unwavering ally - pushes into the region, the less aligned are its interests with Turkey's.

Consider the Kurdish question. Turkey is committed to preventing, if need be by force of arms, the emergence of independent Kurdish polity in Iraq. It would also wish to secure oil-rich northern Iraq as a Turkish protectorate. But the Kurds - America's long-standing and long-suffering collaborators - are the United States' "Northern Alliance" in Iraq. It cannot abandon them for both military and moral considerations.

But even in the absence of such blatant conflicts of interests, Turkey's shift is inevitable, a matter of geography as destiny.

Turkey continues to ignore the Arab world at its peril. Regional conflicts fail to respect international borders - as the country is discovering, faced with the damaging Iraqi spillover. Until 1998, Syria, another restive neighbor, actively aided and abetted the rebellious Kurds. It may yet resume its meddling if Israel, its bitter enemy, is neutered through a peace accord. The dispute over precious water sources is embedded in Turkish-Syrian topography and is, therefore, permanent.

It may have been in recognition of these facts that Abdullah Gul, Turkey's prime minister, embarked on a tour of Arab capitals in January. Simultaneously, the Turkish Trade Minister, Korsad Touzman, led a delegation of 150 businessmen in a two day visit to Baghdad to discuss trade issues. Turkey claims to have sustained damages in excess of $30 billion in the 1991 Gulf War - a measure of its regional integration.

Turkey has also recently begun considering the sale of water in the framework of the "Manavgat Project for Peace" to Egypt, Jordan and even Libya. Turkey's foreign minister, Bashar Yakis, is a Turkish diplomat who knows Arabic and had served in Damascus, Riyadh and Cairo.

Turkey's Occidental orientation has proven to be counterproductive. As the European Union grows more fractured and indecisive and the United States more overweening and unilaterally belligerent, Turkey will have to give up its fantasies - bred by the country's post-Ottoman founding father, Kemal Ataturk - of becoming an inalienable part of Western civilization.

Both Turkey and Israel will, in due time, be forced to accept - however reluctantly - that they are barely mid-sized, mostly Asiatic, regional powers and that their future - geopolitical and military, if not economic - lies in the Middle East, not in the Midwest. Turkey could then serve as a goodwill mediator between erstwhile enemies and Israel as a regional engine of growth.

Until they do, both countries are major founts of regional instability, often deliberately and gleefully so.

Israeli engineering firms, for instance, are heavily involved in the design and implementation of the regionally controversial Southeast Anatolian Project (GAP), intended to block Turkish water from reaching Syria and Iraq. Additionally, protestations to the contrary aside, the thrust of Israel's burgeoning military cooperation with Turkey is, plausibly, anti-Arab.

Turkish security officials confirmed to the English-language daily, Turkish Daily News, in March last year, that Turkey worked with Israel to counter the Hezbollah in Lebanon. As early as 1998, Turkey threatened war with Syria - and mobilized troops to back up its warnings - explicitly relying on the always-present Israeli "second front". The Egyptian government's mouthpiece, the daily al-Ahram, called this emerging de-facto alliance "the true axis of evil".

Israel's massive army, its nuclear weapons, its policies in the West Bank and Gaza, its influence on right-wing American decision-makers and legislators - provoke the very same threats they are intended to forestall, including terrorism, the coalescence of hostile axes and alliances and the pursuit of weapons of mass destruction by regional thugs.

Turkey's disdain for everything Arab, its diversion of the Tigris, Asi and Euphrates rivers, its arms race, its suppression of the Kurds and its military-tainted democracy have led it, more than once, to the verge of open warfare. Such a conflict may not be containable. In 1995, Syria granted Greece the right to use its air bases and air space, thus explicitly dragging NATO and the European Union into the fray.

It is, therefore, the interest of the West to disabuse Turkey of its grandiosity and to convince Israel to choose peace. As September 11 and its aftermath have painfully demonstrated, no conflict in the Middle East is merely regional.