high restrictions on firm operations, there are not sufficient selection mechanisms or up‐or‐out dynamics. Regulations on the operations of the firm are in effect barriers to up‐scaling after firm entry.

**In Turkey, services firms are relatively small, and there is little evidence of post‐entry firm growth in both goods and services.** The recent Turkey enterprise survey (World Bank, 2017) shows that services firms are overwhelmingly small on average, with a few stand‐out large firms. This reflects the general patterns in Turkey that both goods and services firms tend to be smaller than in comparator countries. More importantly, the vast majority of firms in Turkey start with very few employees and show no significant pattern of growth. No matter the age group, about three‐quarters of firms in Turkey that start small remains small. Only a handful of Turkish firms see a substantial growth pattern. Moreover, medium‐ sized firms (20‐99 employees) do not show signs of scaling‐up over time. Reducing conduct regulation could therefore help young firms to grow or exit (i.e. “up‐or‐out”).

# **5. Policy Implications**

**Productivity gaps appear in the same areas where services are more restricted.** Section 3 found that manufacturing firms with an establishment, post‐manufacturing, or post‐sales affiliate are less productive than their non‐servicified peers (Figure 3.9). This is true for both exporters and non‐exporters. Exporters with a back‐office service affiliate were also found to be less productive than non‐servicified exporters. Section 4 presented evidence that FDI restrictions, domestic regulatory restrictions, and services trade barriers are most prevalent in the establishment (e.g. FDI in real estate), post‐manufacturing (maritime, road, rail, and air transport) and back‐office (accounting, legal) stages. These include barriers to firm entry and, to a greater extent, firm operations (which affect the ability of firms to grow).

**These findings suggest that restrictions on competition in services, particularly from foreign firms, may lead Turkish manufacturing firms to provide more services in‐house than would be optimal from a productivity perspective.** In other words, while it may be more efficient to outsource certain services (e.g. logistics, transport, accounting), Turkish firms may instead perform them in‐house due to lack of high quality, reasonably priced external service providers. This could help explain the high shares of revenue associated with post‐manufacturing and establishment services activities within manufacturing firms (Figure 3.8), which could divert these companies from their core manufacturing activities and dampen productivity. Similarly, manufacturing industries use and export levels of transport and real estate services value‐added that well‐exceed OECD averages. The high revenue and exported value‐added shares of these services also suggest that regulatory restrictions may be inflating prices, creating market inefficiencies.

**Given the negative relationship between services restrictions and firm performance, removing restrictions could boost the productivity of Turkish manufacturing firms.** Increased competition could improve the quality and reduce prices of services inputs, boosting Turkey’s performance in GVCs and the economy more broadly. Yet, increased competition is not a given. As the recent literature has shown (e.g. World Bank, 2016 and Van der Marel et al., 2016), regulatory reform processes work best when institutions are strong and promote effective competition in services. Some types of services can lag due to market failures, requiring special attention from competition agencies and domestic regulators. OECD competition policy indicators show that Turkey performs well vis‐à‐vis peer countries (left panel of Figure 5.1), suggesting that future service reforms could be effectively enforced. Another institutional factor that has proven to have a strong impact on the effectiveness of services reform is rule of law. Turkey shows room for improvement in this area, as seen in the right‐hand panel of Figure 5.1.

30