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On the trade integration effects of the customs union between Turkey and the EU

Masterarbeit 2007 106 Seiten


Table of contents

List of abbreviations

List of figures

Appendices Index

1. Introduction

2. Historical overview about the relations between Turkey and the EU
2.1 General overview
2.2 From the association agreement until today – The history of the CU
2.3 From protectionism to more trade liberalisation
2.4 The abolition of barriers to trade
2.4.1 Tariff barriers
2.4.2 Non-tariff barriers

3. The customs union as a form of trade integration – implications for Turkey and the EU
3.1 General analysis
3.2 The static effects of the customs union
3.3 Dynamic effects
3.3.1 The specialization effect Inter-industry trade Theoretical background - Neoclassic Turkey’s comparative advantage Intra-industry trade
3.3.2 Economies of scale
3.3.3 Competitiveness
3.3.4 Technological transfer
3.3.5 Direct foreign investment Theoretic implementation Direct foreign investment inflows by countries Direct foreign investment volume Direct foreign investment by sectors Prospects
3.4 Exchange rates – Excursus: free floating or pegging to the Euro
3.4.1 Gains and losses from pegging to the euro
3.4.2 Recommendation

4. Conclusions


Internet Sources


List of abbreviations

illustration not visible in this excerpt

List of figures

Figure 1: Milestones in the Turkey –EU relations

Figure 2: Removal of non-tariff barriers

Figure 3: Development of foreign trade in Turkey 1963-2005

Figure 4: Main economic indicators of Turkey, GDP by sectors, 1999-2005

Figure 5: GDP at current prices in $, 1980-2006

Figure 6: EU 27 share of Turkish trade

Figure 7: Customs Union: static effects for Turkey

Figure 8: Customs Union: static effects for the EU

Figure 9: Revealed comparative advantage 1996-2007, factor intensity

Figure 10: Development of the share of intra-industry trade

Figure 11: R&D personnel, 1990-2004

Figure 12: Percentage of innovative firms in Turkey, 1995 – 2000; 2002 - 2004

Figure 13: DFI inflows from special regions

Figure 14: Foreign direct investment in Turkey, 1996-2006

Figure 15: Inflation in the euro area 2002-2006

Figure 16: GG-LL schedule

Appendices Index

Appendix A: Ankara Agreement, chosen articles

Appendix B: Additional Protocol, chosen articles

Appendix C: Decision No 1/95 of the EC-Turkey Association Council of 22 December 1995 on implementing the final phase of the Customs Union, chosen articles

Appendix D: Treaty establishing the European Community, chosen articles

Appendix E: Turkey´s foreign trade by years, 1963-2005

Appendix F: Turkey-EU trade

Appendix G: SITC Classification in factors of production

Appendix H: RCA 1996 – 2007

Appendix I: Revealed comparative advantage 1996-2007, SITC main groups

Appendix J: RCA by factor intensity

Appendix K: Grubel-Lloyd Index 1999-2006

Appendix L: World competitiveness Yearbook - Overall Ranking and competitiveness factors

Appendix M: R&D personnel, 1990-2004

Appendix N: Share of education expenditures in % of GDP, a comparison of Turkey, OECD and other countries in 2002

Appendix O: Share of education expenditures in % of GDP in 2002, graphic

Appendix P: Percentage of innovative enterprises in industry by economic activity

Appendix Q: Direct Foreign Investment in Turkey, main investing countries in 2005, percentage

Appendix R: DFI inflows by country

Appendix S: DFI inflows by country, graphic

Appendix T: DFI inflow by country 2002-2006 cumulative

Appendix U: Sectoral breakdown of investment incentive certificates given for a fixed investment 2000-2006

Appendix V: Sectoral breakdown of investment incentive certificates for fixed investment in 2000, 2006, graphics

Appendix W: International Direct Investment Inflow by Sector

Appendix X: International Direct Investment Inflow in manufacturing

1. Introduction

This Master Thesis shall investigate the trade integration between Turkey and the EU. The plan of this Master Thesis is as follows. At first the historical background of the development concerning the trade relations between the two parties is conveyed. This includes the period from first association to implementing a customs union (CU) between Turkey and the European Union (EU) and to deeper integration abolishing barriers of trade until today.

Subsequently an evaluation of the influence of the customs union follows in chapter 3 which constitutes the main part of the paper. Hereby the analysis is divided into the short-term static and long-term dynamic effects of the CU with the EU that Turkey entered on 1st January 1996. To analyze the static effects this paper adopts Viner’s traditional approach, by comparing the trade creation effects with the trade diversion effects resulting from the removal of trade restrictions for Turkey and the EU as a whole. Thus, the predominant economical theory applied in this paper is the neoclassical customs union theory. This theory was chosen because it still is the predominant and widely recognized theory in analyzing trade data providing a variety of tools. Within the neoclassical theory Ricardo as well as Heckscher-Ohlin play an important role as a tool of analysis. In the relevant passages in the text the most important theoretical principles will be explained with the help of the Turkish example. At the limits of the neoclassical theories the new trade theory is supposed to help out especially where the assumptions of the neoclassical theory limit further analysis.

It is the purpose of this paper to analyze the question how the trade liberalization in form of the CU between Turkey and the EU influences the development of Turkish welfare, specialization in different sectors, economies of scale, competitiveness, technological transfer and direct foreign investment. In some parts of the paper the analysis also refers to some effects for the EU, but main emphasis shall clearly be laid upon the effects on the Turkish economy. For the analysis foreign trade data is used which was compiled by the Turkish Undersecretariat of the Prime Ministry for Foreign Trade, the Prime Ministry Undersecretariat of Treasury, the Turkish Statistical Institute and Eurostat. Finding the adequate data created difficulties because of different time spans available and data from different sources being not comparable. This is why the time spans observed are sometimes not optimal. Therefore the analysis concentrates on the development within the last years, because not many studies were written in the 21st century or using data from this period. Thus, where long time spans were not available, the findings from old studies are compared with the new findings based on data from the last years. Especially within chapter 3.3 dealing with the dynamic effects this approach is reasonable since it shows the long term effects of the CU.

The last subitem within chapter 3 allows a glance at the possibility of further integration taking monetary integration as an example. Last but not least chapter 4 will summarize the findings of the previous sections which will lead to a final estimation of the effects of the CU on Turkey and the EU.

2. Historical overview about the relations between Turkey and the EU

The EU and Turkey constitute the Community's longest ongoing association. It is also the EU's first substantial functioning CU with a third state.[1] The following parts will give an overview about the development of relations between Turkey and the EU.

2.1 General overview

Turkey applied for membership to the EU for the first time in 1959 and in 1987 it started another try. It was only in 1999 that Turkey was granted the status of a candidate country by the European Council.[2] Based on the recommendation of the EU Commission the EU heads of state decided upon the start of accession negotiations with Turkey on December 17th, 2004. This decision by the European Council to open negotiations with Turkey on October 3rd in 2005 was conditional on the enlargement of the CU to include Cyprus.[3]

To start with, the following graphic gives an overview about the most important dates in the development of EU- Turkey relations.

Figure 1: Milestones in the Turkey –EU relations

Source: own creation, grey boxes have special importance for the creation of the CU.

2.2 From the association agreement until today – The history of the CU

This section reviews in particular the background of the CU. Relations between Turkey and the EU are observed focusing on trade.

Turkey’s relations with the EU can be described as an ongoing integration process. In the context of international economic relations the term integration stands for the affiliation between national economies to an economic area or the inclusion of national economies into an existing economic area. Economic integration is achieved by the mutual reduction of barriers to trade of the involved countries.[4]

With the Ankara Agreement of September 12th, 1963 which came into effect on January 1st in 1964 Turkey was associated with the EC. Turkey’s intention was to be closer connected with the west and to find new markets for their industrial and agricultural goods.[5] Art. 2 of the Ankara agreement states:

“The aim of this Agreement is to promote the continuous and balanced strengthening of trade and economic relations between the Parties, while taking full account of the need to ensure an accelerated development of the Turkish economy and to improve the level of employment and the living conditions of the Turkish people.”[6]

In order to attain these objectives the association agreement included the aim to establish a CU between Turkey and the EU. Purpose of the CU is to secure the free movement of goods between the EU and Turkey. Turkey and the EU were required to eliminate all customs duties on imports and exports, and charges having equivalent effect between Member States. Turkey had to adopt the Common Customs Tariff of the Community in its trade with third countries.[7] Article 10 of the CU treaty between Turkey and the EC shows accordance of the content of the ECT (e.g. articles 28, 29).[8] The agreement requires the elimination of all quantitative restrictions on imports and exports and measures having an equivalent effect.[9]

In accordance with the Additional Protocol, in 1971, which set out details of implementation of the CU, the EC abolished all the customs duties and quantitative restrictions on industrial products from Turkey with the exception of certain sensitive products. Turkey was granted a transitional period based on two separate lists with different time spans, the 12 years list and the 22 years list with products classified according to their need of protection.[10] Within that time tariffs, quotas and charges of equivalent effect were to be removed. The Ankara Agreement provided for three phases for the integration of Turkey: the preparatory stage, the transitional stage and the final stage.[11] During the preparatory stage from 1964 until 1973 the European Economic Community (EEC) would give some direct financial aid to Turkey and establish preferential trade conditions with Turkey. During the transitional stage all tariffs and trade barriers were to be abolished while at the final stage, if sufficient progress was observed, the possibility of Turkey becoming a full member of the EU had to be reviewed.[12]

Turkey couldn’t follow the schedule for tariff reduction due to some severe economic problems in the late 70´s. In the 90´s Turkey made big effort to complete the CU on time and in the end it went into effect with just one year delay.[13] With the entry into the final phases of the CU on December 31st, 1995, industrial goods and agricultural goods were added to the free movement of goods between the EU and Turkey.[14]

In addition, Voluntary Restraint Agreements (VRA) concerning trade in textiles were abolished.[15] The CU brought radical economic framework changes through the adaptation of various economic laws and regulations implemented in the European Union, such as an antitrust policy, subsidies to the enterprises, competition and industrial policy laws.[16] Furthermore Turkey is obliged to adopt the EC's secondary competition and state aid legislation including the EC's competition block exemptions and the case law developed by EC authorities as well as the principles of the secondary legislation.[17] There were provisions for the approximation of laws and legislation, with respect to the elimination of technical barriers to trade, and the administration of border procedures including rules of origin. Turkey was also required to adopt the Community’s commercial policy towards third countries, including the multitude of preference agreements the EU has concluded implementing various sectoral provisions such as measures covering textiles and apparel and ensuring compatibility with international agreements for the protection of intellectual property rights.[18]

The 1995 agreement allows a number of exemptions and exclusions in the commercial relations of the two parties. The first and obvious area is agriculture.[19] Agricultural products are not directly affected by the CU. The liberalisation of trade in this sector is realised by tariff preferences which have been extended several times since 1963.[20]

Besides that one should mention the trade defence measures. Under the agreement both parties can initiate, investigate and impose anti-dumping and countervailing duties in cases where trade practices do not conform to the correct functioning of the CU. Finally there exist safeguards.[21] If serious disturbances occur in a sector of either of the two parties, then that party may take necessary protective measures.[22]

It is interesting to notice that by Turkey’s integration into the CU it has given up its national sovereignty concerning foreign trade policy without gaining any form of active participation in the decision making process in Brussels.[23]

2.3 From protectionism to more trade liberalisation

The following section reviews Turkey’s development from protectionist policy making to trade liberalization strategies.

It can be said that the protectionist and interventionist economic policy predominated from the 1930s until the end of the 1970s. A lot of economic fields were under state control.[24] Accordingly, policies were mainly designed to protect the domestic industry from foreign competition. Particularly the infant industries were protected using a varying mix of trade restrictions such as tariffs, tariff-like taxes and surcharges, import bans, quotas and foreign exchange controls.[25] During this period fiscal deficits were financed by monetary expansion. State economic enterprises were created in sectors like steel production and mining. The state took control over the quantity and price of credit to influence the sectoral composition of investment within the private sector. Moreover fixed exchange rates and exchange controls were maintained which resulted in an overvalued domestic currency.[26]

The import substitution policy supported the import of capital goods, technology and intermediate goods. The domestic production had to be ensured by imports and the resulting industrial domestic production should not be exposed to foreign competition. This policy hindered the success of Turkish products abroad, opening up new markets and the diversification of the Turkish exports. Public and private companies were protected significantly from foreign competition which led to an import increase. Industrialization of the country was given priority, and for that imports were needed.[27]

Dervis et al. (1981) and Chenery et al. (1986) suggest that import substitution policies have had remarkable contribution to the growth rate of Gross Domestic Product (GDP) especially during the 1960s. In that sense, they support the view that early import-substitution in Turkey especially in the 1960s may exploit natural advantages and be highly efficient, but sooner or later these advantages were exhausted. It is suggested that Turkey had reached this stage in the 1970s.[28]

A turning point in Turkish economic policy came in January, 1980. The Demirel government was removed by a military regime. The EC froze all relations to Turkey with the justification that Turkey’s government was not democratic.[29] Nevertheless the Turkish government announced an economic reform program. The economic structure of the country changed from an inward-looking import-substitutionalist industrialisation strategy to an outward-oriented growth strategy marked by export promotion.[30]

Consequently liberalization increased after 1980 which can be seen when looking at Turkey's impressive export performance.[31] This could be reached by the influence of a substantial real depreciation of the Turkish lira, the introduction of new export promotion schemes and the improvement of existing ones, and a significant reduction in domestic demand and the resulting shift of production from domestic to foreign markets.[32]

The first step in trade liberalization came with the elimination of quantitative restrictions on imports culminating in a major policy reforms initiative in January 1984. Trade liberalization continued in subsequent steps through a series of reductions in import tariff rates in 1986, 1988 and 1990.[33] Nevertheless the Turkish government was inventive concerning the compensation of cuts in tariff rates with retaining a high level of protection at the same time as for example the introduction of fund levies shows.[34]

Until today the strategy of export orientation is the recommended strategy for developing nations. Free trade, based on the neoclassical theory of factor proportions, has been said to be the best way to avoid misallocation of resources.[35]

2.4 The abolition of barriers to trade

The removal of barriers to trade in general is connected with gains for the economy. It leads to a transfer of factors of production to the more productive areas, to more efficiency, to economies of scale, increased competition, enhanced transfer of technology and knowledge and to advantages for the customers due to improved variety and lower prices.

2.4.1 Tariff barriers

The application of the common external tariff (CET) for most products involves a substantial reduction of tariffs against imports from third countries. Turkey’s weighted average rates of protection through customs duties including the Mass Housing Fund Levy on industrial imports from the EU and EFTA countries dropped from approximately 10% to 0. For products imported from the third countries, these rates declined from approximately 16% to 4.2% in 2004.[36] With the implementation of the Uruguay Round reductions, Turkey’s average rates for third countries will be lowered to 3.5%.[37] This means Turkey is by now a relatively open economy in non-agricultural sectors.

Since the third countries tariff is relatively low compared with the situation before the entry to the CU the trade diversion costs[38] are not that high in Turkey’s case and result in additional gains from trade.[39]

Although the CU has been existing only since 1996 the EU had abolished import tariffs on Turkish industrial goods already in 1971. Turkey on the other hand completely removed its tariffs and quantitative restrictions on EU-imports only after the establishment of the CU in 1996 and at the same time adopted the CET.[40] From 2001 also the sensitive manufactures from third countries are subject to the CET. Before that time Turkey could keep special protective tariffs for imports from third countries in areas of sensitive goods like shoes or motor vehicles.[41]

Additionally, Turkish exporters are supposed to obtain improved access to the markets of those countries with preferential trade agreements with the EU, since the tariffs of these countries will be reduced against Turkish exports. The improved access for Turkish exports to third markets should equal the improved access that Turkey will offer third country imports.[42]

The application of the CET towards third countries obviously led to a reduction of the import duties which resulted in lower revenue for the public purse. Öymen (2001) estimated the loss for Turkey due to lower import taxes to be around 2.5 billion dollars.[43]

2.4.2 Non-tariff barriers

The Commission’s White Paper on the Single Market operates with three types of non tariff barriers: physical, technical and fiscal. A typical physical barrier is a customs control at ports and frontier crossings required because of international differences in indirect taxation, veterinary regulations, road transport licensing etc. They impose administrative costs on governments and firms as well as causing extra transport costs and at times warehousing costs at a border crossing. Technical barriers to trade include product regulations and standards, discriminatory public purchasing, restrictions on foreign employment, ownership and business activity, restrictions on trade in services and restrictions on the mobility of capital. Technical regulations are legally binding, which distinguishes them from standards, which have been voluntarily agreed upon. Anyhow, the latter are also barriers to trade since they are often the basis of court rulings on matters of insurance, product liability and public purchasing. Fiscal barriers to the free mobility of commodities result from the fact that individual member countries have different rates of value added tax and excise duties. Physical, technical and fiscal trade barriers impose direct costs on producers, exporters and importers, and indirectly they lead to a failure to exploit comparative advantage, scale economies and the benefits of competition.[44]

Although the CU calls for the removal of non-tariff barriers some are still persisting or even have been re-introduced. The EU developed within its integration process special measures to protect their sectors in need efficiently. A new protectionism developed including for example subventions to domestic companies, national norm systems and voluntary restraint agreements (VRAs).[45] In the area of technical barriers to trade, Turkish exports produced under European specifications continue to be restricted because of the EU’s lack of recognition of certain Turkish certification procedures.[46] Practically it makes the CET towards third countries irrelevant.[47] Article 60 of the association agreement[48] allows for safeguards for the own industry. In virtue of this article the EU wanted to restrict the import of Turkish textiles to the European market. Turkey strongly objected and as a consequence the EU agreed on VRAs with private companies.[49] VRAs also have a negative effect on consumers. As a result prices of the goods in question rise and the customers have less choice in the EU. The gains from the higher prices benefit the companies who sign such agreements while the consumers’ surplus in the importing country declines. Importers from the EU can protect their market from abroad and the exporters from Turkey can secure their market share with a relatively high price in the EU.[50] A VRA is always more costly to the EU than a tariff that limits imports by the same amount. The difference is that what would have been the tariff revenue become rents earned by Turkish companies under the VRA, so that it clearly produces a loss for the EU.[51] Actually these voluntary quotas are in clear contradiction to articles 7 and 9 of the additional protocol[52] and the GATT (General Agreement on Tariffs and Trade) rules.[53]

Safeguards can be imposed when 'serious disturbances occur' in a sector of the EC or the Turkish economy, or where the 'external financial stability' of a party is prejudiced. Where 'discrepancies' between EC and Turkish legislation or 'differences in implementation cause or threaten to cause impairment of the free movement of goods or deflection of trade' and a party believes that immediate action is necessary, it may take the ´necessary protective measures´.[54] They must be proportionate and are subject to consultations before and after adoption with a view to avoiding them or ending them as soon as possible. When one party invokes a safeguard, the other may take a proportionate balancing measure, subject to consultations with the Council of Association.[55] In 1976, Turkey invoked the safeguard clause to delay any further opening of its market. For its own part, the Community imposed safeguards on Turkish textile and clothing exports in 1977, followed by voluntary restraint agreements that continued until Decision 1/95[56] of the EC-Turkey Association Council of on implementing the final phase of the Customs Union entered into force.[57] These restrictions had protectionist effects on the Turkish economy since this sector has a special importance for the whole economic development of the country.[58]

Contingent protection continues to represent a serious barrier in bilateral market access like the continuation of EU antidumping and anti-subsidy tools which have led to considerable welfare losses for Turkey.[59] Preventing an increase in Turkish textile and clothing exports to the EU is in marked contrast to the European agreements where trade defence measures are eliminated.[60] It is interesting to note that especially those Turkish industrial products are a matter of anti-dumping and anti-subvention measures which are competitive. It is an important evidence for the EU-protectionism and the foreclosure of its markets towards Turkish export goods.[61]

The removal of a non-tariff barrier is a real cost reduction. Therefore it is more likely to lead to a welfare gain than an equivalent reduction in tariffs.[62] This is made clear in figure 2. P stands for Turkey, the partner country of the EU with its export supply curve Xp. If R is a tariff that is reduced to zero the formation of the CU costs Turkey a loss of tariff revenue corresponding to the area a + d. There is no equivalent loss when R is a non-tariff barrier. The variable profit per unit of export rises as the cost reduction of R exceeds the price fall of P0 to P1. The gain in export producer’s surplus corresponds to the areas d and e which represent respectively gains from pre-existing and new exports.[63]

illustration not visible in this excerpt

Figure 2: Removal of non-tariff barriers

Source: Adam/Moutos (2005), p.8.

Especially in the area of technical barriers to trade there are still some deficits in the abolition progress in Turkey. Namely the Turkish system of standardisation and conformity assessment is quite non-transparent, there needs to be greater effort in strengthening Turkey’s technical capacity and infrastructure to meet the requirements of testing and certification processes. Reputation building of Turkish institutes and organizations should continue in order to promote the recognition of equivalency.[64]

The European Commission states in its progress report on Turkey 2006 that:

“EC-Turkey trade has continued to expand in the context of the CU, reaching € 75 billion in 2005. In all occasions, the EU urged Turkey to remove all restrictions on the free movement of goods, including restrictions on means of transport regarding to Cyprus. Other unfulfilled commitments by the Turkish side persist, relating to technical barriers to trade, import licences, state aids, enforcement of intellectual property rights, and other discriminatory provisions. The partial reduction of mandatory standards is however a positive step. The EU hopes that negotiations to extend the CU to the area of public procurement and services can resume soon. Trade negotiations were completed in September on processed agricultural products. These aimed to improve market access and to adjust CU provisions to the EU's 2004 enlargement. No progress can be reported concerning Turkey's long-standing ban on imports of live bovine animals, beef and other animal products.”[65]

As it can be concluded from the aspects mentioned before the full realisation of the CU’s integration potential is still restricted by a number of policy barriers that remain.[66]

3. The customs union as a form of trade integration Implications for Turkey and the EU

The term economic integration can be described in two different forms. Integration can be regarded as a process which implies the dynamic aspect, or it can be interpreted as a state which is the static aspect. As a process integration considers the pathway, which establishes a special structure of the international economy. It is marked by a development from a low intensity of integration to a higher intensity. The main aim of this process is to enhance welfare of the involved economies.[67] The analysis of the static effects, however, doesn’t include the time factor. It basically regards the situation before and after the integration. Economic interdependencies are not considered.[68] Two regions are integrated when they add up to a whole and when there are close links between them.

The next part deals with these two aspects of integration. Furthermore an excursus of further integration regarding exchange rates follows. The aspects chosen are of special importance although certainly a lot of other influences exist. All aspects somehow influence each other and depend on each other so that references to other chapters can be found all over the section.

3.1 General analysis

Regarding the development of foreign trade in Turkey the following graphic displays Turkey exports and imports as well as the trade balance from the beginning of Turkish EU association until 2005. The figure illustrates the change of strategies and the liberalization process of Turkey. It can be seen that there was an increase after joining the CU in 1996, especially in the amount of goods that Turkey imported from the EU. Also imports from third countries increased after the final stage of the CU went into force. While exports increased consistently during the years the import curve shows quite a volatile development especially from 1993 onwards. Important to note is also the trade balance deficit which arose because of the imports exceeding the exports which is displayed by the yellow line. The current account deficit increased significantly especially after the creation of the CU in 1996.

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Figure 3: Development of foreign trade in Turkey 1963-2005

Source: own creation, data from Turkstat (2006),, view Appendix E.

Since Turkey’s traditional customs tariff was higher than the EU´s common customs tariff, the import of goods from third countries also became more beneficial.[69] When on the one hand the import boom led to a trade balance deficit, on the other hand the increased consumption of foreign goods supported the sensitivity of Turkish consumers in terms of standards, quality and consumer rights.[70] A considerable rise in Turkey's industrial exports to the EU was not expected because already since 1971, there have been no tariffs on the Turkish exports. In addition, the abolition of export incentives, state aids or bringing their level down to the EU standards, affected Turkey's exports negatively.[71]

In the 1990s Turkey’s open economy was more vulnerable to external developments being highly sensitive to external shocks. For this reason the annual growth rate from 1996 to 2001 was lower than in 1990 – 1995. After 2001 the economy recovered due to structural adjustment and an economic reform program and reached 18.3% in 2006.[72]

In the next table it can be seen that the importance of the agricultural sector is declining while the industrial sector was quite stable between 1999 and 2004 and had a boost in 2005. Services are the biggest sector having the highest share of GDP which is due to the great tourism sector in Turkey. Besides that the service sector attracts most direct foreign investment especially in the banking and finance sector.[73]

The Turkish new Lira introduced in 2005 brought stability in exchange rates throughout the year. However, it did not ban the development of Turkish exports but increased the imports revealing higher foreign trade deficit. Nevertheless, this deficit was compensated with the support of the developments in other sectors like tourism.[74]

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Figure 4: Main economic indicators of Turkey, GDP by sectors, 1999-2005

Source: Undersecretariat of The Prime Ministry for Foreign Trade (without year), p. 39

The GDP per capita is one of the major indicators of a country’s development level. It is a significant factor in the integration process.[75] It serves as an indicator for the economic development and describes the extent of the value of all productive output. The growth in GDP therefore can be influenced by an increase of domestic demand for domestic goods but also by the foreign demand for domestic goods. The high variations in the growth rates show on the one hand that Turkey is susceptible to negative shocks but on the other hand that it can surmount these shocks relatively fast.[76] This is demonstrated by figure 6. What can be recognised are the demand shocks attributable to financial crisis in the years 1994 and 2001, mainly due to the big gap in the balance of payments and the overvalued Turkish lira. Also the huge earthquake with epicentre in Ismit in 1999 influenced the GDP as the graphic shows.

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Figure 5: GDP at current prices in $, 1980-2006

Source: Central Bank of the Republic of Turkey (2007),

A surprising effect of the CU has been the diversion of Turkey’s trade from EU countries towards non-EU countries. One would expect that the share of the EU in Turkish trade volume would increase due to the closer integration. Just before the CU, the share of the EU in total Turkish exports was 51.2%, while the share of imports from the EU in total Turkish imports was 47.2%. Thus, almost 50% of total foreign trade of Turkey has been realized with the EU countries in 1995.[77] This share increased directly after entering the CU. In 1996 the EU share in imports amounted to 55.7% and share in exports was 54.1%, overall share being 55.2%. The EU-share reached its peak in 1999 (56.4%) and decreased from that time onwards. The EU share of trade with Turkey is falling during the time of the CU to 47.7% in 2006[78] which means that Turkey increased its trade with third countries. One reason might be the better access to third countries´ markets because of preferential trade agreements that also Turkey had to implement. Moreover, the adoption of the CET led to a much lower protection level of Turkey granting cheaper imports from third countries. Figure 6 shows the absolute trade volumes in Turkey-EU trade. As Turkey’s trade volume grows, also the volume of the Turkey-EU trade increased significantly, proving that the EU is still Turkey’s most important trading partner.

illustration not visible in this excerpt

Figure 6: EU 27 share of Turkish trade

Source: Turkstat (2007):,

Turkey’s most important trading partners in terms of exports are Germany, the UK, the USA and Italy. Turkey is importing the most from Russia, Germany, China and Italy.[79]

Even before the CU, the EU countries have always been the main exporting markets for the Turkish products. The reason for this is that most Turkish industrial goods could be exported to the EU with zero tariffs already from 1971. Also geographically, the EU countries are the closest developed markets to Turkey. This closeness also creates a cost advantage in transportation for Turkish exporters. And finally the Turkish population living in the EU has been always a natural buyer for Turkish products exported to the EU countries.[80] Regarded from the EU point of view Turkey was on rank 46 of the EU´s supplier countries in 1980. In 1990 it was already on rank 17. Also Turkey is an important partner regarding EU exports. In the beginning of the 80s Turkey ranked 25th and 10 years later already 9th.[81]

In the relations to third countries it can be seen that Russia could increase its trade with Turkey and it became one of the most important trading partners after the EU and the USA. Russia’s trade with Turkey was positively influenced by the adoption of the CET by Turkey and the dissolution of the Soviet Union in 1991.[82]

The increase in bilateral trade relations has not been at the expense of trade with the rest of the world. For Turkey the intense bilateral trade with the EU has been accompanied by stronger trade growth overall. This combination leads to important welfare gains for Turkey.[83]

3.2 The static effects of the customs union

The term customs union is legally defined in Art. 23 ECT.[84] It is declared to be the foundation of the community which spans the whole exchange of goods. The integration model of a CU adopts essential elements of a free trade area. It can also be described as a free trade area with a common customs tariff.[85] The neoclassic CU theory is based on a number of assumptions which on the one hand make the theoretical foundations easier to explain but on the other hand simplify the reality. The assumptions being very restrictive economic recommendations have to be considered very carefully.[86] The basic assumptions are: perfect competition, homogeneous goods, and constant returns to scale, no market entry barriers, no development of new products and no technological change.[87]

Jovanovic states that a static model considers the impact of the formation of a CU on trade flows and consumption in the united countries. In order to analyse these static effects most of the researchers’ traditional framework is trade creation and trade diversion.[88]

A CU has to be regarded as a double-edged sword. Viner (1950) disproved the assumption of classic foreign trade theory that every reduction of barriers to trade leads to increases in welfare. He stressed that it is not equivalent to a move to free trade since it amounts to free trade between the members and protection against the outside world. This combination of free trade and protectionism results in trade creation and trade diversion.[89] On the positive side, trade creation allows higher-cost domestic production to be replaced by lower cost production from a partner country in the union.[90] This improves the allocation of global resources and represents a step in the direction of free trade.[91]

On the contrary, trade diversion describes the situation when tariff barriers with respect to the rest of the world remain high due to discriminatory trade policies against non-member countries. There is a danger that the resulting additional trade between partners would replace lower-cost imports from the rest of the world.[92] As this worsens the global allocation of resources, it represents a step towards protectionism.[93] The relative weight of these two effects determines the overall impact of the CU.[94]

The integration process between Turkey and the EU includes partners with very different levels of development. The Heckscher-Ohlin model[95] predicts that similarly developed countries trade with countries of other levels by specializing in different sectors. In the case of homogenous goods the different level of development between Turkey and the EU bears a high potential for trade diversion because of the distortion of prices among third countries and EU countries on the Turkish market.[96] To achieve welfare gain the tariff level must be low enough to allow third countries to retain their share of the market.[97]

Lohrmann (1999) found that in fact the trade diversion effects of the Turkey EU customs union are stronger than the trade creation effects for many sectors in Turkey. She expects that as a consequence inefficient sectors will gain and consumers and some efficient branches will have to pay with higher consumer prices and higher production input costs. This implies the risk for Turkey to fail to develop the efficient and competitive sectors in the world market which it might have achieved under free trade. Trade diversion in favour of the EU leads to a cost increase for Turkish producers especially for intermediate products such as textile yarns and fabrics. This impairs the competitiveness of Turkish clothing exporters in the European market.[98]

illustration not visible in this excerpt

Figure 7: Customs Union: static effects for Turkey

Source: own creation, following Zentrum für Türkeistudien (publisher) (1999), pp. 26ff.

This graphic demonstrates the situation of Turkey in a partial equilibrium diagram for one typical export good of Turkey. St and Dt are the supply and demand schedules of Turkey while Pw is the perfectly elastic world supply curve. As already mentioned in chapter 2.3, before the 1980s Turkey followed a policy of import substitution which can be considered as autarky. In that situation Turkey levied a tariff Tt – Pw. Turkey consumes 0N and no imports occur. After the 1980s Turkey changed its policy and started to liberalize its trade. In the graph this situation is marked by a lowering of the customs tariff to Tt´- Pw. Domestic price therefore is Tt´, which gives domestic production of 0M. The imports from the world are MP. Turkey pays the red area for the imports while the domestic consumer pays the red, pink and yellow area with the difference (pink and yellow) being the tariff revenue which accrues to the Turkish government. This government revenue can be viewed as a transfer from the consumers to the government with the implication that, when the government spends it, the marginal valuation of that expenditure should be exactly equal to its valuation by the private consumers so that no distortions occur.[99]

When entering the CU with the EU in 1996, the lower community tariff CET – Pw is introduced. Consumption in Turkey increases to 0Q, the imports are LQ and are now supplied by the EU. The CU is in a Vinerian sense trade diverting for all imports now come from the higher cost producers in the EU, but at the same time it is also trade creating, for domestic production has been replaced by cheaper imports and there is also an increase in imports because Turkish domestic consumption has risen. The imports cost the light blue area to import from the EU while they originally cost the light blue area plus the light green area to produce domestically. There is therefore a saving of the light green area.

Product variety will increase, Turkish consumers will benefit from a broader choice of goods, and welfare will be enhanced by the resulting consumer surplus corresponding to the grey, yellow and green areas due to the fall in the price combined with the rise of consumption. Part of this (the light green area) is a fall in producers´ surplus due to the decline in domestic production and another part (yellow) is a portion of the tariff revenue now transferred back to the consumer who pays lower prices. Tariff revenue corresponding to the yellow and pink areas is lost. All tariff revenues from the CET besides the administration allowance flow to the EU budget. Areas grey and yellow represent only a domestic redistribution to consumers from producers and the public purse, respectively. The positive welfare effects for Turkey are therefore a saving in production costs corresponding to the light green area, and an increase in consumption corresponding to the dark green area. The light and dark green areas display the trade creating effects of the CU. The initial imports of MP cost the country the red area, but these imports now come from the EU costing the pink and red area. Therefore these imports lead to a loss in government revenue equivalent to the pink area. The welfare loss corresponding to the pink area is the extra cost of imports as cheap supplies from the rest of the world were replaced by more expensive supplies from the EU. This loss is the trade diverting effect of the union. The net welfare gain, consequently, is illustrated by area light green plus area dark green minus area pink. Whether this sum is positive is a matter of empirical investigation for each CU.


[1] See Peers (1996), p. 1.

[2] See Quaisser/ Reppegather (2004), p. 32.

[3] See Danzinger et al. (2005), p. 5.

[4] See Adali (2003), p. 1.

[5] See Sönmez (1994), p. 24.

[6] Ankara Agreement (1963), Art. 2. See Appendix A.

[7] See ibid. (1963), Art. 10.

[8] See Bulut (2002), pp. 5f.

[9] See Zentrum für Türkeistudien (publisher) (1999), p. 47.

[10] See Akkonyunlu-Wigley/ Mihci (2006), p. 6.

[11] See Ankara Agreement (1963), Art. 2. See Appendix A.

[12] See Adam/ Moutos (2005), p. 5.

[13] See Zentrum für Türkeistudien (publisher) (1999), p. 47.

[14] See Quaisser/ Reppegather (2004), p. 32.

[15] See Danzinger et al. (2005), p. 5.

[16] See Yilmaz (2005), p. 75.

[17] See Peers (1996), p. 23.

[18] See Ülgen/ Zahariadis (2004), p. 1.

[19] See ibid. (2004), p. 2.

[20] See Quaisser/ Reppegather (2004), p. 32. For detailed information about the agricultural sector in Turkey and its trade relations with the EU view e.g. Grethe (2003).

[21] See Additional Protocoll Art. 5 and 60. See Appendix B.

[22] See Ülgen/ Zahariadis (2004), p. 2.

[23] See Yilmaz (2003), p. 4.

[24] See Kalberer (2002), p. 12.

[25] See Akkoyunlu-Wigley/ Mihci (2004), p. 5.

[26] See Utkulu/ Özdemir (2003), pp. 8ff.

[27] See Findikci (1997), p. 211.

[28] See Utkulu/ Özdemir (2003), p. 11.

[29] See Sönmez (1994), p. 27.

[30] See Yazganarikan (2003), p. 7.

[31] View figure 3.

[32] See Utkulu/ Özdemir (2003), p. 13.

[33] See Akkonyunlu-Wigley/ Mihci (2006), p. 2445.

[34] See Zentrum für Türkeistudien (publisher) (1999), p. 23.

[35] See Lohrmann (2000), p. 27.

[36] See Akkonyunlu-Wigley/ Mihci (2006), p. 6.

[37] See Adam/ Moutos (2005), p. 7.

[38] The issue of trade diversion is regarded more deeply in chapter 3.2.

[39] See Harrison et al. (1997), p. 862.

[40] See Adali (2003), p. 45.

[41] See ibid. (2003), p. 28.

[42] See Harrison et al. (1997), pp. 865f.

[43] See Öymen (2001), p. 134.

[44] See Hansen/ Nielsen (1997), pp. 28ff.

[45] See Findikci (1997), pp. 105f.

[46] See Ülgen/ Zahariadis (2004), p. 4.

[47] See Findikci (1997), pp. 105f.

[48] See Appendix B.

[49] See Öymen (2001), p. 131.

[50] See Findikci (1997), pp. 126f.

[51] See Krugman/ Obstfeld (2006), p. 192.

[52] See Appendix B.

[53] See Findikci (1997), p. 125.

[54] See Peers (1996), pp. 25f., Additional Protocol Art. 60.

[55] See Peers (1996), pp. 24f.

[56] Some important paragraphs from this decision can be found in Appendix C.

[57] See Peers (1996), p. 5.

[58] See Findikci (1997), p. 125.

[59] See Zentrum für Türkeistudien (publisher) (1999), p. 75.

[60] See Adam/ Moutos (2005), p. 8.

[61] See Findikci (1997), p. 373.

[62] See Hansen/ Nielsen (1997), p. 31.

[63] See ibid. (1997), p. 31.

[64] See Ülgen/ Zahariadis (2004), p. 17.

[65] Commission of the European Communities (2006), p. 5.

[66] See Ülgen/ Zahariadis (2004), p. 5.

[67] See Adali (2003), p. 1.

[68] See ibid. (2003), p. 13.

[69] See ibid. (2003), p. 52.

[70] See Adali (2003), p. 55.

[71] See Utkulu/ Seymen (2004), p. 6.

[72] See Undersecretariat of Treasury (2007), view Internet Sources.

[73] See Adali (2003), p. 75.

[74] Undersecretariat of The Prime Ministry for Foreign Trade (without year), p. 38.

[75] See Yazganarikan (2003), pp. 7f.

[76] See Adali (2003), p. 46.

[77] See Malkoc (2002), p. 18.

[78] See Appendix F.

[79] See Turkstat (2007), view Internet Sources.

[80] See Malkoc (2002), p. 18.

[81] See Adali (2003), p. 32.

[82] See ibid. (2003), p. 77.

[83] See Ülgen/ Zahariadis (2004), p. 4.

[84] See Appendix D.

[85] See Adali (2003), p. 7.

[86] For a detailed describtion of the assumptions see e.g. Lohrmann (1997), pp. 25f.

[87] See Ohr/ Theurl (publisher) (2001), p. 6.

[88] See Karakaya/ Özgen (2002), p. 2.

[89] See El-Agraa (2004), p. 99.

[90] See Ülgen/ Zahariadis (2004), pp. 3f.

[91] See El-Agraa (2004), p. 118.

[92] See Ülgen/ Zahariadis (2004), pp. 3f.

[93] See El-Agraa (2004), p. 118.

[94] See Ülgen/ Zahariadis (2004), pp. 3f.

[95] More details and analysis of this issue follows in chapter

[96] See Zentrum für Türkeistudien (publisher) (1999), pp. 54f.

[97] See Hansen/ Nielsen (1997), p. 26.

[98] See Zentrum für Türkeistudien (publisher) (1999), p. 56.

[99] El Agraa (2004), p. 100.


ISBN (eBook)
1 MB
Institution / Hochschule
Europa-Universität Viadrina Frankfurt (Oder) – Wirtschaftswissenschaften, European Studies
2008 (März)
turkey european union



Titel: On the trade integration effects of the customs union between Turkey and the EU