Economic Research Forum (ERF)

Modernising the EU-Turkey customs union

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Turkey has benefited from a customs union with the European Union since the mid-1990s, but now is the time for it to be modernised. This column argues that current arrangements should be strengthened by signing a free trade agreement covering agriculture, services, public procurement, investment protection, dispute settlement and sustainable development.

In a nutshell

Turkey is aware of the potential impact on growth of concluding a deep and comprehensive free trade agreement with the EU.

The challenge for Turkey is to achieve liberalisation of agriculture, services, government procurement and investment, and to observe EU rules on dispute settlement and on trade in relation to sustainable development, labour and the environment.

For the EU, this is an opportunity to harness the economic and political potential of deeper integration with Turkey.

The customs union established between the European Union (EU) and Turkey in 1995 required the latter to eliminate all customs duties and quantitative restrictions in the trade of industrial goods with the EU as of 1 January 1996. Turkey was also required to adopt the EU’s common customs tariff on third-country imports and all preferential agreements that the EU had or would conclude with third countries.

In addition to tariffs and related issues, the customs union requirements extend to rules on various regulatory border and behind-the-border policies, such as customs modernisation, eliminating technical barriers to trade, competition policies, intellectual property rights and trade policy instruments.

For Turkey, the customs union has been a major instrument of integration into EU and global markets, offering the country powerful tools for reforming its economy. It has credibly locked Turkey into a liberal foreign trade regime for industrial goods and holds the promise of participation in the EU internal market for industrial products.

What have been the effects of the customs union? A quantitative assessment by Aytuğ et al (2017) finds substantial effects on Turkey’s exports to EU countries and GDP per capita. The authors estimate that as a result of the customs union, Turkey’s exports to the EU have increased by 38% and Turkish GDP per capita by 13%.

Modernisation of the EU-Turkey customs union

During the period when Turkey was implementing the requirements of the customs union, major changes were taking place in the world economy. For example, with the revolution in information technology, some stages of manufacturing production that were previously performed in close proximity were dispersed geographically.

As a result, manufacturing today is increasingly managed through global value chains (GVCs). Since multilateral trade negotiations conducted within the context of the World Trade Organization (WTO) have not dealt with the issues raised by the GVC trade, the EU, Japan and the United States have decided to sign free trade agreements (FTAs) with deep provisions that promote GVC trade. They have also signed bilateral investment treaties.

Since the comprehensive FTAs and investment treaties address issues not covered by the EU-Turkey customs union – such as agriculture, services, government procurement, ‘food safety, animal and plant health’ (SPS) measures, regulatory coherence, sustainable development, small and medium-sized enterprises, investment protection and dispute settlement – both the EU and Turkey realise that the customs union is outmoded and that their trade and investment relations need to be reformed.

The World Bank (2014) and the European Commission (2016a, 2016b) have prepared comprehensive studies of the effects of modernisation of the customs union. While the former emphasises that opportunities for widening Turkey’s trade relationship with the EU should concentrate on liberalisation of agriculture, services trade and public procurement, the latter compares three options: ‘no policy change’, ‘CU modernization and FTA in additional areas’ and ‘Deep and Comprehensive Free Trade Agreement’.

The Commission concludes that the preferred option is modernisation of the customs union plus an FTA covering services, public procurement and further liberalisation in agriculture.

Dawar and Togan (2016) maintain that economic integration between the EU and Turkey should be strengthened further. They advocate signing an FTA that is complementary to the customs union, covering agriculture and SPS measures, services, public procurement, investment protection, dispute settlement and sustainable development.

Agriculture

In agriculture, the challenge for Turkey is to achieve free movement of agricultural products between the EU and Turkey, which requires full compliance with the agricultural acquis. This will require Turkey to adjusts its agricultural policy in such a way as to adopt common agricultural policy measures, and to adopt and implement EU rules on SPS matters.

Services

Services cover a broad range of markets, encompassing network industries, such as electricity, natural gas and communications; other intermediate services, such as transport, financial intermediation, distribution, construction and business services; and services destined for final consumption, such as tourism and travel, recreation, education, health and environmental services. In the EU, services are classified under three headings:

• Services where EU-wide regulations apply, such as financial services, telecommunication services, energy services and transport services.

• Services regulated by Services Directive 2006/123/EC, such as legal services, accounting services, business-related services and construction services.

• Services regulated by national regulations, such as public services.

Studies reveal that barriers to trade in services, which are typically regulatory in nature, lead to high costs and inefficiencies in service sectors. Since the productivity and competitiveness of goods and services firms depend largely on access to low-cost and high-quality producer services such as transport, distribution, telecommunications and finance, and since they have a powerful influence on economic growth, it is of utmost importance for Turkey to increase the efficiency of service industries. This can be achieved mainly through liberalisation of trade in different sectors.

The challenge is to achieve free trade in services between the EU and Turkey. This will require Turkey to adopt and implement the regulatory framework of the EU for each service sector it intends to liberalise (Togan, 2010, 2016). Thus, a future FTA covering liberalisation of services will probably include all services with EU-wide regulations and some of the services subject to the Services Directive 2006/123/EC. But it will exclude all services regulated nationally.

Public procurement

Turkish companies face obstacles in winning public contracts in the EU; and EU companies face obstacles in winning public contracts in Turkey. Both parties would win if they could agree on rules that maximise opportunities and transparency in tendering for public contracts at all government levels. Market opening based on the principles of competition, transparency, non-discrimination and integrity would be good for Turkey.

For public authorities with tight budgets, this can bring better money for value, more choice, greater economic efficiency and good governance. In addition, a comprehensive procurement chapter in a future FTA would require Turkey to accede to the WTO Government Procurement Agreement. Such a step would provide the platform for reform of the Turkish public procurement system, providing major benefits to Turkey and also sheltering Turkish firms from EU instruments such as the proposed International Procurement Instrument (European Commission, 2016c).

Investment protection

Both the EU and Turkey are interested in securing protection for their investors against discrimination in terms of ‘most favoured nation’ treatment and national treatment. Both parties desire protection against expropriation of their investors’ assets, if these expropriations are not for public policy purposes and not fairly compensated. And both parties aim for fair and equitable treatment, and the right to transfer capital.

Thus, a deep integration FTA with an investment chapter could serve Turkey, as well as supporting the EU’s overall investment strategy. There is already an attractive investment model in the EU-Canada Comprehensive Economic and Trade Agreement (CETA).

Dispute settlement

The mechanism for dispute settlement in the current EU-Turkey relationship is dysfunctional (Ülgen, 2017). This is a serious shortcoming that the future FTA has to address. The best approach would be one similar to that in the modified EU-Canada CETA.

Sustainable development

All recent FTAs concluded or under negotiation by the EU have incorporated provisions on trade and sustainable development, trade and labour, and trade and the environment. It is highly likely that the new FTA between the EU and Turkey will also seek to regulate these issues.

Conclusion

Turkey is aware of the growing importance of GVC trade and the potential impact on growth of concluding a deep and comprehensive FTA with the EU.

For Turkey, the challenge is to achieve liberalisation of agriculture, services, government procurement and investment between the EU and Turkey, and to observe the EU rules on dispute settlement and on trade in relation to sustainable development, labour and the environment.

For the EU, this is an opportunity to harness the economic and political potential of deeper integration with Turkey, through further liberalisation of trade in goods, services, agriculture and public procurement, as well as encouraging investment and sustainable development complemented with appropriate dispute settlement mechanisms.

Further reading

Aytuğ, H, MM Kütük, A Oduncu and S Togan (2017) ‘Twenty Years of the EU-Turkey Customs Union: Effects of EU Integration’, Journal of Common Market Studies 55: 419-31.

European Commission (2016a) ‘Study of the EU-Turkey Bilateral Preferential Trade Framework, including the Customs Union, and an Assessment of Its Possible Enhancement’.

European Commission (2016b) ‘Recommendation for a Council Decision Authorising the Opening of Negotiations with Turkey on an Agreement on the Extension of the Scope of the Bilateral Preferential Trade Relationship and on the Modernization of the Customs Union’.

European Commission (2016c) ‘Amended proposal for a Regulation of the European Parliament and of the Council on the access of third-country goods and services to the Union’s internal market in public procurement and procedures supporting negotiations on access of Union goods and services to the public procurement markets of third countries’.

Dawar, K, and S Togan (2016) ‘Bringing EU-Turkey Trade and Investment Relations up to date?’, Directorate General for External Policies, Policy Department, European Parliament.

Togan, S (2010) Economic Liberalization and Turkey, Routledge.

Togan, S (2016) The Liberalization of Transportation Services in the EU and Turkey, Oxford University Press.

Ülgen, S (2017) ‘Trade as Turkey’s EU Anchor’, Carnegie Europe.

World Bank (2014) ‘Evaluation of the EU-Turkey Customs Union’.

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