Turkey & the EU: Let’s Make a Deal?

As we have written before, economic relations between the European Union and Turkey make a lot of sense on paper. With a rapidly expanding manufacturing sector, Turkey has the potential to be a cost-efficient producer of goods exported to the broader EU. Meanwhile, a rapidly expanding domestic economy in Turkey creates demand for higher-end European goods, as well as, opportunities for dynamic partnerships with European producers and entrepreneurs.  Between 2003 and 2008, Turkish exports to the EU increased over 300 percent, and the spiking trade with the EU was a key ingredient of the Erdogan boom years.

This period of heady trade growth coincided with Turkish efforts to meet requirements to officially join the European Union. Since 1995, Turkey and the EU have shared a Customs Union that removes restrictions on non-essential goods, while also harmonizing external tariffs. But, while the agreement allowed for the creation of supply chains that spurred trade growth between the two, the pact does not offer Turkey the full benefits of accession to the EU.

As an EU-outsider, Turkey is negatively impacted by a global tendency towards mega-trade agreements, as Turkey is excluded from negotiations between the EU and third-party countries, or blocs of countries. As we argue here, this hurts Turkey both in the EU (Turkey’s most important trade partner), and in the third country. In both cases, Turkish manufacturers cannot receive the benefits of the new agreements, leaving them less competitive in those markets.

For example, consider TTIP, the potential free trade agreement between the US and the EU. Our model suggests that such a pact—which would not feature Turkey as a participant —would lead to steep declines in Turkish exports of transport equipment, electronic equipment, machinery, chemicals, and more (see chart below).

Figure 1: Modeled Changes in Turkish Industrial Exports to EU

Given this looming threat to the Turkish economy, Ankara has long sought to join the European Union directly, thus eliminating these potential consequences. To this end, Turkey took steps such as eliminating capital punishment in hopes of meeting European Commission requirements. However, accession progress has been perpetually delayed, much to the chagrin of Turks who felt the EU was simply stalling because it did not want Turkey to join.

In my interviews for The Crossroads Turkey (new episode coming soon!) multiple experts cited the EU’s stalling tactics as an element in President Recep Tayyip Erdogan shifts towards more authoritarian governance (see video clip below). If the EU was never going to permit Turkish accession, the argument goes, then Erdogan saw no need to meet EU standards.

Since 2008, Turkey and the EU have increasingly drifted apart, and EU-Turkish trade has only increased seven percent in that period. With relations increasingly frosty, we wonder what policy options exist that would allow both partners to take advantage of a mutually beneficial trade relationship.

Policy Options

• Turkish Accession to the European Union

For a series of reasons, Turkish accession to the EU remains extremely unlikely in the near term. In the aftermath of a failed coup attempt on July 15, 2016, President Erdogan has implemented far reaching purges that extend beyond the military and government and into the private sector and academia.  An apparent crack-down on civil liberties puts the country at odds with European Commission requirements—something Bundestag member, Niels Annan (SPD) made clear in our recent interview. Meanwhile, a persistent economic slump—not to mention a burgeoning EU backlash to Islamic migration—makes it both politically and logistically difficult for the EU to incorporate a relatively poor, majority-Muslim country with nearly 80 million people. On November 24, the European Parliament took a non-binding vote to suspend EU membership negotiations with Turkey, provoking a stinging rebuke from President Erdogan. We live in a crazy world and anything can happen, but if you are waiting for Turkey to join the EU, I would recommend not holding your breath.

• Pursuing a Turkish – EU Free Trade Agreement

Another policy option would be to roll back the Customs Union to a free trade agreement. “This would result in greater flexibility for Turkey when determining external tariffs. The existing tariff asymmetry would also be eliminated for Turkey, if the EU were to conclude a new free trade agreement.” (See our study Turkey’s EU integration at a crossroads, pg. 60). However, our model indicates that such a roll-back would cost Turkey 0.8 percent of GDP, as trade with the EU would fall sharply. This stems from the finding that under a free-trade scenario, intermediate goods produced in Turkey would require onerous paperwork proving rules of origin; in other words the creation of red tape that would make Turkey a less attractive location for production.

• Deepening the Existing Customs Union

If the first two policy options seem discouraging, do not panic! We believe this third option could be a winner, despite the currently complicated political environment. A deepening of the existing customs union could generate welfare gains for Turkey and the EU. Specifically, the agreement could be expanded to include the agricultural and service sectors. Moreover, it could implement mechanisms to smooth the third-party asymmetries that arise from the current agreement. In Turkey, this could generate GDP increases of US$ 13.3 billion, which corresponds to a per capita rise of 171.1 US$. Average wages in Turkey would also increase by 2.4 percent as a result of complete deepening.” (See EU integration at a crossroads, Pg. 49) Our study also finds benefits in the scenario for the EU and Germany. Currently, the EU and Turkey are scheduled to meet in January 2017 to open negotiations on updates of the Customs Union.

That is, of course, unless politics get in the way again.