Revisiting the Trade Effects of the EU-Turkey Customs Union
In 2015, the Turkish government and the European Commission officially started a process for the modernization and expansion of the Customs Union between the European Union (EU) and Turkey (hereafter called “CU-EUT”). The CU-EUT entered into force 25 years ago on December 31st, 1995. While it provides a far-reaching trade integration for industrial goods, lately both the EU and Turkey have stressed deficiencies in the implementation of the agreement and have discussed extending trade liberalization to new areas like services, agriculture and public procurement. In December 2016, the European Commission asked the European Council for a mandate to launch negotiations with Turkey. However, so far, the European Council has refused to approve the mandate and has suspended any preparatory work for the reform of the CU-EUT over concerns about the democratic development and human rights situation in Turkey. Consultations about the opening of negotiation talks are still ongoing.
Amidst the recent political tensions between the EU and Turkey, we look back and analyze how successful the CU-EUT has been in spurring trade flows between Turkey and the EU.
Reassessing the CU-EUT trade effects
Previous studies have mostly drawn an underwhelming picture of trade creation within the CU-EUT. Many academic papers do not find evidence for a significant and relevant trade-enhancing effect. For the preparation of the opening of negotiation talks the European Commission also requested two external studies which reach sobering conclusions regarding the effect of the CU-EUT on bilateral trade flows: while the World Bank finds no statistically significant effect, BKP, Panteia, and AESA identify an overall negative impact of the CU-EUT on two-way goods trade. In order to provide a thorough reassessment of the CU-EUT effects on trade between the EU and Turkey, we apply the latest developments in the quantification of regional trade agreements and rely on a database of international and internal trade flows in the manufacturing sector between 1988 and 2006. In contrast to previous research, we find a statistically significant and strongly positive impact of the CU-EUT. Compared to trade flows under the Ankara Agreement which had been in place before, the CU-EUT has increased manufacturing trade between the EU and Turkey by 60%. We also show that deviations from the best practices in evaluating trade policies can explain why previous studies were often unable to find a significant and economically large effect.
The effects on trade between Turkey and non-EU countries
The implementation of the CU-EUT committed Turkey to align to the EU’s customs tariffs and rules, to its commercial policy vis-à-vis third countries, as well as to the EU’s acquis in the areas covered by the CU-EUT. This alignment resulted in a decrease of Turkey´s import tariffs and provided an impetus for reforming Turkey´s customs procedures and internal technical legislation. Besides the immediate effects on Turkish trade flows with the EU, these improvements may also foster Turkey´s trade with other partner countries. Based on recent contributions in the empirical trade literature, we are able to estimate these third-country trade effects. Our results indicate that the reductions in bilateral trade frictions between Turkey and non-EU countries after the entry into force of the CU-EUT have increased trade flows by 28%. Thus, the CU-EUT has significantly fostered Turkish trade not only with EU member countries but also with all other trading partners.
One heavily debated feature of the CU-EUT is its asymmetric structure as to the external commercial policy. The CU-EUT requires Turkey to recognize all trade policies taken by the EU vis-à-vis third countries, such as the signing of a free trade agreement or a change in the EU´s common external tariff. At the same time, as Turkey is not a member of the EU, it neither receives automatic reciprocal access to these outside markets nor is it permitted to participate in the negotiations of trade liberalizations with them. Under this set up the CU-EUT may have asymmetric third-country effects on Turkish im- and exports. Indeed, we find that Turkish imports from non-EU countries increase more strongly than its exports as a consequence of the CU-EUT. Nevertheless, the results also indicate that Turkish exporters benefit from the CU-EUT by gaining market access to non-EU countries.
Do some member countries and sectors benefit more from the CU-EUT?
Policymakers are often interested in the specific trade effects for a single member country or sector. Although economic theory suggests that generally countries gain from trade liberalization, recently many political debates about free trade agreements have raised concerns about “one-way trade deals” and challenged that they bring prosperity to the individual nations. Therefore, we also examine heterogeneous impacts of the CU-EUT for each pair of member countries within the customs union as well as for various manufacturing sectors. Estimating country- and sector-specific effects reveals substantial heterogeneity in both dimensions. The largest effects are found for trade between Turkey and Ireland, Portugal, Belgium as well as Finland, while the positive impact of the CU-EUT is lowest for Italy, Austria, and Germany as Turkey´s trading partners. As regards sectoral differences, trade has increased the most in Machinery and Wood, whereas the smallest coefficients are estimated for Minerals, Chemicals and Food.
At the same time, the heterogeneity analysis also demonstrates that the positive CU-EUT trade effects are far-reaching. We find that for almost all country pairs and sectors the CU-EUT has significantly promoted trade flows. Exceptions are Turkish imports from Italy, Denmark, and Austria as well as trade in the Metals sector. We also combine the two dimensions of heterogeneity, allowing for different ex- and import effects in each sector and country, and estimate in total almost 1001 different coefficients for the CU-EUT. Two thirds of these coefficients are significantly positive which demonstrates the widespread benefits from the customs union at a highly disaggregated level. Overall, our results highlight that both the EU and Turkey gained considerably from the CU-EUT in terms of trade creation.
Renegotiating the CU-EUT
The small trade effects in some sectors indicate a potential for additional liberalization of manufacturing trade in an upcoming renegotiation of the CU-EUT. Furthermore, the CU-EUT cannot be considered an exceedingly deep agreement in terms of covered provisions since it misses, inter alia, liberalization in primary agriculture, services, public procurement, and investment. There is still room for more far-reaching commitments which may stimulate trade flows between the EU and Turkey even more. Our analysis reveals that deep trade liberalization beyond a mere free trade agreement is a worthwhile endeavour. In that sense, an upcoming modernization of bilateral trade relations should not easily jeopardize the benefits arising from a customs union.
This blog is based on our article ”A Tale of (almost) 1001 Coefficients: The Deep and Heterogeneous Effects of the EU‐Turkey Customs Union”.
Mario Larch is professor of empirical economics at the University of Bayreuth. He is also a scientific advisor at CEPII, research professor of the ifo institute, external fellow of GEP, and CESifo research network fellow. His research focusses on theoretical and empirical international trade and econometrics.
Aiko Schmeißer is a PhD student at the Berlin School of Economics. He has worked on research projects in labor economics, international trade, and political economy.
Joschka Wanner is an assistant professor of quantitative economics at the University of Potsdam and external researcher at the Kiel Institute for the World Economy. He works on econometric challenges in the estimation of trade flow determinants, as well as on international environmental agreements and environmental policy in a global context.