Report No. 85830-TR Evaluation of the EU - TURKEY Customs Union March 28, 2014 Document of the World Bank Evaluation of the EU-Turkey Customs Union CURRENCY AND EQUIVALENT UNITS CURRENCY EQUIVALENTS (Exchange Rate Effective February 28, 2014) Currency Unit: Turkish Lira (TL) US$ 1 = 2.2129 TL ABBREVIATIONS AND ACRONYMS ARIP Agricultural Reform Implementation Project IAF International Accreditation Forum BSEC Black Sea Economic Cooperation ICC International Chamber of Commerce BTI Binding Tariff Information ILAC International Laboratory Accreditation Cooperation CAP Common Agricultural Policy IMMIB Istanbul Minerals and Metals Exporters Association CE Conformité Européene IPR Intellectual property rights CEN European Committee for Standardization ISO International Organization for Standardization CENELEC European Committee for Electrotechnical Standardization ITF International Transport Forum CET Common external tariff MENA Middle East and North Africa CGE Computable General Equilibrium MFN Most favored nation CIPM International Committee on Weights and Measures MQS Multilateral Quota System CTC Common Transit Convention NCTS New Computerised Transit System CU Customs Union NFRS National Farmers’ Registry System CUJC Customs Union Joint Committee NSBs National Standards Bodies DCFTA Deep and Comprehensive Free Trade Agreement NTMs Non-tariff measures DSM Dispute Settlement Mechanism PPA Public Procurement Authority EA European Cooperation for Accreditation PPL Public Procurement Law ECHA European Chemicals Agency PTA Preferential trade agreement ECMT European Conference of Ministers of Transport ROOs Rules of origin ECSC European Coal and Steel Community SOEs State-Owned Enterprises ECTS European Common Transit System SQIT Strengthening the Quality Infrastructure of Turkey (SQIT) EEA European Economic Area STRI Services Trade Restrictiveness Index EEC European Economic Community SUPQUIT Support to the Quality Infrastructure in Turkey EFTA European Free Trade Association TAREKS Risk-Based Trade Control System EMA European Medicines Agency TBTs Technical Barriers to Trade EPA Economic Partnership Agreement TCA Turkish Customs Administration ETSI European Telecommunications Standards Institute TDIs Trade Defense Instruments EU European Union TIR Transports Internationaux Routiers EURAMET European Association of National Metrology Institutes TPC Trade Policy Committee FDI Foreign direct investment TSE Turkish Standards Institute FTA Free trade agreement TTIP Transatlantic Trade and Investment Partnership GDP Gross Domestic Product TÜBİTAK Scientific and Technological Research Council GMP Good manufacturing practices TÜRKAK Turkish Accreditation Agency GPA WTO plurilateral Government Procurement Agreement UNECE United Nations Economic Commission for Europe GSP Generalised System of Preferences WTO World Trade Organization GTAP Global Trade Analysis Project Country Director: Martin Raiser Sector Director: Yvonne Tsikata Sector Manager: Ivailo V. Izvorski Task Team Leaders: Ian Gillson Francis Rowe Kamer Karakurum-Ozdemir World Bank Table of Contents Executive Summary ..................................................................................................................................... i I. Introduction ..........................................................................................................................................1 II. Developments in Trade and Investment.............................................................................................5 Trends in Foreign Direct Investment .....................................................................................................5 Trends in Trade ......................................................................................................................................7 Firm-Level Analysis.............................................................................................................................10 III. The Customs Union in a Changing Global Environment ..............................................................19 Import Tariffs and Rules of Origin.......................................................................................................19 Asymmetries in the FTA process .........................................................................................................24 IV. A More Effective Customs Union .....................................................................................................31 Technical Regulation and Technical Barriers to Trade ........................................................................31 Trade Defense Instruments ..................................................................................................................40 Trade Facilitation, Customs Modernization and Customs Controls ....................................................46 Road Quotas .........................................................................................................................................50 V. Opportunities for Widening Turkey’s Trade Relationship with the EU: Potential Impacts and Possible Modalities ......................................................................................57 Agriculture ...........................................................................................................................................57 Services Trade ......................................................................................................................................68 Visa Restrictions ..................................................................................................................................77 Public Procurement ..............................................................................................................................82 VI. Conclusions and Recommendations .................................................................................................85 Key Recommendations ........................................................................................................................85 VII. Bibliography .......................................................................................................................................87 Annex I: Progress and Process in Turkey’s Accession to the EU...........................................................91 Annex 2: A Gravity Model for Measuring Trade Creation and Trade Diversion in the EU-Turkey Customs Union .......................................................................................................93 Annex 3: Number of Turkish Firms by Type of Ownership Across Industries ....................................97 Annex 4: A Short Description of the CGE Framework ..........................................................................98 Annex 5: Simulations of Changes in Turkish Exports for Tariff Removals from EU-FTA Partners with Unresolved FTAs, by Sector ............................................................101 Annex 6: Simulations of Changes in Turkish Exports Resulting Under Levels of Turkish Involvement in the TTIP, by Sector .........................................................................102 Annex 7: Number of Turkish Exporting Firms by the Majority Ownership to Each Destination Market ..................................................................................................................103 Annex 8: Average Export Value of Turkish Exporting Firms by Majority Ownership to Each Market .............................................................................................................................104 Annex 9: Implementing Complex Pieces of EU Regulation: The Examples of Chemicals and Pharmaceuticals................................................................................................................105 Evaluation of the EU-Turkey Customs Union Annex 10: Assistance to Capacity Building in Turkish Quality Infrastructure .................................107 Annex 11: Determinants of Turkey and EU Use of TDIs .....................................................................108 Annex 12: EU’s and Turkey’s TDIs in Effect and Ongoing Investigations that Potentially Affect Bilateral Trade, 2012-13.......................................................................... 111 Annex 13: Potential Impacts on Turkish Exporters of EU TDIs Against Third Countries ..............113 Annex 14: Selected EU Countries with Which Turkey has Bilateral Agreements and Number of Permits Exchanged between 2009 and 2012 ....................................................115 Annex 15: Turkey Applied MFN Tariffs for Agriculture, 2011............................................................117 Annex 16: EU Applied MFN Tariffs for Agriculture, 2011 ..................................................................117 Annex 17: Agricultural Export Effects for Turkey from a Trade Agreement with the EU in Primary Agriculture....................................................................................................118 Annex 18: Agricultural Import Effects for Turkey from a Trade Agreement with the EU in Primary Agriculture....................................................................................................119 Annex 19: Total Factor Productivity Growth in Agriculture...............................................................120 Annex 20: Calculating the Sophistication of Services Exports ............................................................121 Annex 21: Gravity Model of Trade in Services .....................................................................................122 Annex 22: Economic Impacts of Services and Agricultural Trade Liberalization for Turkey .........125 Annex 23: Measuring the Tariff Equivalent of Protection on Services Trade....................................127 Annex 24: Survey on Visa Restrictions Faced by Turkish Businesses ................................................128 List of Figures Figure 1: Turkey’s trade ...............................................................................................................................8 Figure 2: Turkey’s trade share of the EU .....................................................................................................8 Figure 3: Composition of Turkey’s trade with the EU.................................................................................9 Figure 4: Product sophistication of Turkey’s exports ................................................................................10 Figure 5: Firm size and propensity to participate in export markets by type of ownership ......................13 )LJXUH1XPEHURI7XUNLVK¿UPVH[SRUWLQJE\GHVWLQDWLRQDQGRZQHUVKLS ............................................15 )LJXUH*URZWKLQ7XUNLVKH[SRUWVE\GHVWLQDWLRQDQG¿UPRZQHUVKLS ..................................................16 Figure 8: Changes in Turkey’s MFN tariffs, 1993-2009............................................................................19 Figure 9: Impact of the Customs Union on Turkey’s tax revenues............................................................20 )LJXUH(IIHFWVRI¿QDOL]LQJQRQFRPSOLDQW)7$VLQLQGXVWULDOSURGXFWVIRU7XUNH\ .............................26 Figure 11: Simulated welfare effects for Turkey from an EU FTA with the US with and without unilateral removal of Turkish tariffs and with and without inclusion of Turkey/the EU in the FTA.........27 Figure 12: Turkish imports of PVC from EU member states affected by antidumping duties ....................43 Figure 13: EU’s annual imports subject to TDIs..........................................................................................45 Figure 14: Possible road transport routes from Turkey to Portugal .............................................................54 Figure 15: Structure of agricultural labor and incomes, 1980-2010 ............................................................58 Figure 16: Turkey’s agricultural trade..........................................................................................................59 World Bank Figure 17: Composition of Turkey’s agricultural trade................................................................................60 Figure 18: Producer Support Estimates for selected OECD countries ........................................................63 Figure 19: Average applied MFN tariffs for Turkey and the EU, 2011 .......................................................64 Figure 20: Simulated effects of deepening the EU-Turkey trade agreement in primary agriculture ...........65 Figure 21: Simulated changes in Turkish trade by destination under a deepened EU-Turkey trade agreement in primary agriculture ...................................................................67 Figure 22: Services value added as share of GDP .......................................................................................68 Figure 23: Trade in services as share of GDP ..............................................................................................69 Figure 24: Growth of Turkey’s services exports ..........................................................................................70 Figure 25: Turkey’s services export sophistication......................................................................................71 Figure 26: Services Trade Restrictiveness Index vs. GDP, 2008 .................................................................72 Figure 27: Growth of services imports, 2000-12 .........................................................................................72 Figure 28: Turkey’s services trade with the EU ...........................................................................................73 Figure 29: Gravity model of Turkey’s trade with the EU, 2009-11 .............................................................74 Figure 30: Services Trade Restrictiveness Index .........................................................................................75 Figure 31: Sources of main complaints in the visa process .........................................................................79 Figure 32: The impact of visa regulations on business activities ................................................................80 Figure 33: Overall structure of the GTAP model .........................................................................................98 Figure 34: TDI responsiveness to macroeconomic shocks ........................................................................110 )LJXUH(8LPSRUWVRI¿QLVKHGSRO\HVWHU¿ODPHQWDSSDUHOIDEULFVIURPVHOHFWHGVRXUFHFRXQWULHV .....113 Figure 36: EU imports of refrigerators from selected source countries.....................................................114 )LJXUH5HVLGXDOVYHUVXV¿WWHGYDOXHVHVWLPDWHGZLWK*'3DQG¿[HGHIIHFWV VSHFL¿FDWLRQPRGHOV  ................................................................................................123 )LJXUH3UHGLFWHGWUDGHHVWLPDWHGZLWK*'3YHUVXV¿[HGHIIHFWVVSHFL¿FDWLRQPRGHOV .......................124 Figure 39: Real Turkish GDP in 2018 with respect to 2013: in the baseline and under four bilateral agricultural trade liberalization scenarios with the EU, including services trade liberalization ..126 )LJXUH'LVWULEXWLRQRISDUWLFLSDWLQJ¿UPVDFURVVSURYLQFHVE\KHDGTXDUWHUV ......................................129 )LJXUH'LVWULEXWLRQRISDUWLFLSDWLQJ¿UPVE\HPSOR\PHQW ..................................................................130 List of Tables 7DEOH)',LQÀRZVWR7XUNH\E\VRXUFHFRXQWU\ ........................................................................................6 7DEOH)',LQÀRZVWR7XUNH\E\VHFWRU ......................................................................................................7 Table 3: Market reach of Turkish exporters versus comparator countries ...................................................11 Table 4: Geographical destination of new market entries, 2003-10 ............................................................11 7DEOH7XUNLVK¿UPPDUNHWH[SDQVLRQWUHQGV............................................................................................12 7DEOH3URSHQVLW\WRH[SRUWWRGHVWLQDWLRQPDUNHWVE\¿UPRZQHUVKLS ....................................................14 7DEOH3HUIRUPDQFHRI(8PDMRULW\RZQHG¿UPVH[SRUWLQJWRGLIIHUHQWPDUNHWV ....................................17 Table 8: Simulated change in EU imports from replacing the CU with an EU-Turkey FTA ......................23 Evaluation of the EU-Turkey Customs Union Table 9: Simulated change in Turkish imports from replacing the CU with an EU-Turkey FTA .............24 Table 10: Overlap between Turkey and EU TDI investigations, 1995-2011 ...............................................41 Table 11: Turkey and EU TDI investigations of one another, 1995-2011 ...................................................42 Table 12: Turkey’s applied safeguards and differences in import prices across foreign sources ................44 Table 13: TIR Carnets issued to selected countries (thousands) ..................................................................50 Table 14: Crop yields in Turkey relative to Northern and Southern Europe ...............................................66 Table 15: Status of Turkey’s negotiations on adopting the acquis communuataire.....................................92 Table 16: Gravity estimation of bilateral trade and the impact of the EU-Turkey CU (2005-10) ...............95 Table 17: Gravity estimation of bilateral trade and the impact of the EU-Turkey CU (Second Stage, Cross-Sections) ....................................................................................................96 7DEOH1XPEHURI7XUNLVK¿UPVE\RZQHUVKLSDFURVVLQGXVWULHV ...........................................................97 Table 19: CGE model regions ....................................................................................................................100 Table 20: Percent change in volume of Turkish exports to the world........................................................101 Table 21: Change in Turkish exports to the world .....................................................................................102 7DEOH1XPEHURI7XUNLVKH[SRUWLQJ¿UPVE\WKHPDMRULW\RZQHUVKLSWRHDFKGHVWLQDWLRQPDUNHW .....103 7DEOH$YHUDJHH[SRUWYDOXHRI7XUNLVKH[SRUWLQJ¿UPVE\PDMRULW\RZQHUVKLSWRHDFKPDUNHW .........104 7DEOH0DFURHFRQRPLFÀXFWXDWLRQVDQGQHZLPSRUWSURWHFWLRQIRU7XUNH\DQGWKH(8......................109 Table 25: Turkey’s TDI in effect and ongoing investigations in 2012-13 that potentially affect EU exports ........................................................................................................................111 Table 26: EU’s TDIs in 2012-13 that could potentially affect Turkish exports .........................................112 Table 27: Selected EU countries with which Turkey has bilateral agreements and number of permits exchanged between 2009 and 2012 ............................................................................................115 Table 28: Turkey applied MFN tariffs for agriculture, 2011 .....................................................................117 Table 29: EU applied MFN tariffs for agriculture, 2011............................................................................117 Table 30: Agricultural export effects for Turkey from a trade agreement with the EU in primary agriculture...........................................................................................................118 Table 31: Agricultural import effects for Turkey from a trade agreement with the EU in primary agriculture...........................................................................................................119 Table 32: Total factor productivity growth in agriculture .........................................................................120 Table 33: Gravity model of services trade .................................................................................................122 Table 34: Agricultural and services trade simulation results: effects on Turley’s economic welfare and GDP ........................................................................................................................125 7DEOH7DULIIHTXLYDOHQWRIEDUULHUVWRVHUYLFHVWUDGH .............................................................................128 7DEOH6HFWRUDOGLVWULEXWLRQRISDUWLFLSDWLQJ¿UPV ................................................................................130 List of Boxes Box 1: Decision 1/95 .....................................................................................................................................2 Box 2: The impact of the CU on Turkey’s trade tax revenues .....................................................................20 Box 3: The structure of EU ROOs ...............................................................................................................21 World Bank Box 4: EU and Turkey FTAs with third countries .....................................................................................25 Box 5: Implications of the TTIP for Turkey ..............................................................................................27 Box 6: Example of revised Turkey Clause (Joint Declaration Concerning Turkey) .................................30 %R[7XUNH\¶VTXDOLW\LQIUDVWUXFWXUHEHIRUHWKH&8 ...............................................................................32 %R[.H\FRPSRQHQWVRIQDWLRQDOTXDOLW\LQIUDVWUXFWXUH ........................................................................33 Box 9: The EU’s Agreements with EFTA countries and Switzerland .......................................................34 Box 10: Technical regulations in the EU .....................................................................................................36 Box 11: Turkey’s system of product safety ..................................................................................................38 %R[5LVNVIURPGHOD\LQJDOLJQPHQWDQGGHYHORSLQJDPHFKDQLVPWRDSSRLQW1RWL¿HG%RGLHV ...........40 Box 13: Article 28 of decision 1/95 .............................................................................................................47 Box 14: EU transit permits for Turkish road transport operators raise trade costs ......................................54 Box 15: Romania’s road transit agreement with the EU..............................................................................55 Box 16: Tariff preferences for trade in primary agriculture between Turkey and the EU ...........................61 Box 17: Turkish support to agricultural producers ......................................................................................62 Box 18: EU-Turkey agreements on bilateral services trade ........................................................................76 Box 19: Services in the EEA Agreement .....................................................................................................76 This evaluation was prepared by a World Bank team led by Ian Gillson (Senior Economist), Francis Rowe (Senior Economist) and Kamer Karakurum-Ozdemir (Senior Economist) and consisting of Chad Bown (Senior Economist), José-Daniel Reyes (Economist), Sebnem Sahin (Senior Economist), Ana Fernandes (Senior Economist), Marinos Tsigas (International Economist, US International Trade Commission), Tolga Cebeci (Consultant), Amir Fouad (Consultant), Ramon Torrent (University of Barcelona), Caglar Ozden (Senior Economist), Michael Friis Jensen (Consultant), Clayton Kerswell (Senior Trade Facilitation Specialist), Virginia Tanase (Senior Transport Specialist), Will Martin (Research Manager), Don Larson (Senior Economist), Sebastian Saez (Senior Economist), Cevdet Cagdas Unal (Resarch Analyst), Martin Molinuevo (Consultant), Christina Busch (Consultant), Claire +RQRUH+ROOZHJ &RQVXOWDQW $\EHUN<ÕOPD] &RQVXOWDQW 7XQ\D&HODVLQ 6HQLRU([WHUQDO$IIDLUV 2I¿FHU %LOJHQ.DKUDPDQ &RPPXQLFDWLRQV$VVLVWDQW -XOLD2OLYHU &RPPXQLFDWLRQV2I¿FHU DQG Miles McKenna (Consultant). Martin Raiser (Country Director), Yvonne Tsikata (Sector Director), Mona Haddad (Sector Manager), Ivailo Izvorski (Sector Manager), Marina Wes (Lead Economist) and Daniel Lederman (Lead Economist) provided guidance to the team. Salih Bugra Erdurmus (Procurement Specialist) and Salih Kemal Kalyoncu (Senior Procurement Specialist) provided valuable inputs to the section on public procurement. Jean-Pierre Chauffour (Lead Economist), Elena Ianchovichina (Lead Economist) and Professor Sübidey Togan (Bilkent University) were the peer reviewers. Pinar Baydar prepared the report for publication. The report was funded by the European Commission in the framework of the Programmatic Trust Fund for World Bank Knowledge and Advisory Services in the Pursuit of the Objectives of the EUROPE2020 Agenda. This document does not represent the point of view of the European Commission. The interpretations and opinions contained in it are solely those of the authors. Evaluation of the EU-Turkey Customs Union Executive Summary 1. The customs union between Turkey and the EU was a pioneering effort and has remained unique. The implementation of the customs union (CU) in 1995 marked a key moment in the trade relationship between WKH(8DQG7XUNH\7KH&8ZLWK7XUNH\ZDVWKH(8¶V¿UVWVXEVWDQWLDOIXQFWLRQLQJ&8ZLWKDQRQPHPEHU state and was one of the earliest attempts by the EU to share some of its legal system with another country. Turkey is also one of just three countries that have entered into a CU with the EU prior to becoming a candidate country. Under the CU, Turkey adopted the EU’s common external tariff (CET) for most industrial products, as well as for the industrial components of agricultural products, and both the EU and Turkey agreed to eliminate DOOFXVWRPVGXWLHVTXDQWLWDWLYHUHVWULFWLRQVDQGFKDUJHVZLWKHTXLYDOHQWHIIHFWRQWKHLUELODWHUDOWUDGH 2. Trade integration between the EU and Turkey has increased dramatically over the last two decades. The value of bilateral trade between the two has increased more than fourfold since 1996. The ULVHLQ)',WR7XUNH\IURPWKH(8KDVEHHQVLPLODUO\VLJQL¿FDQWDVKDVEHHQWKHGHHSHULQWHJUDWLRQEHWZHHQ 7XUNLVKDQG(XURSHDQ¿UPVDORQJSURGXFWLRQQHWZRUNV7KH&8KDVVXSSRUWHGWKHVHGHYHORSPHQWVDQGKDV directly contributed to Turkey’s productivity gains over the period through the reduction in its import tariffs on most industrial products. The CU has also helped the alignment process with the EU’s acquis, improving WKHTXDOLW\LQIUDVWUXFWXUHDQGIDFLOLWDWLQJUHIRUPRIWHFKQLFDOUHJXODWLRQVLQ7XUNH\WRWKHEHQH¿WRI7XUNLVK FRQVXPHUV7KH&8KDVDOVRSURYLGHGDVLJQL¿FDQWLPSHWXVIRUWUDGHIDFLOLWDWLRQDQGFXVWRPVUHIRUPLQ7XUNH\ including through modernization of the Turkish Customs Administration (TCA). These improvements are of JUHDWHFRQRPLFVLJQL¿FDQFHIRU7XUNH\DQGOLHDWWKHKHDUWRI7XUNH\¶VVWURQJH[SRUWSHUIRUPDQFHRYHUWKHSDVW decade. 3. The CU has brought greater bene¿ts than a free trade agreement FTA between the EU and Turkey would have because it has provided an anchor on Turkey’s applied tariffs for industrial products and negated the need for rules of origin ROOs on bilateral trade. 8VLQJ D SDUWLDO HTXLOLEULXP PRGHO (SMART) and assuming the costs associated with ROOs are between 2-6 percent ad valorem, Turkey’s exports to the EU would have been 3.0-7.2 percent lower under an FTA. EU exports to Turkey would have been 4.2 percent lower if ROOs were more restrictive and Turkey maintained its MFN tariffs for industrial products at current levels or 0.7 percent higher if Turkey changed its import tariffs on industrial products to 1993 levels and ROOs were less restrictive. 4. +owever, the changing global economy is exposing design Àaws in the CU. The CU’s implementation LQWKHSRVWSHULRGFRLQFLGHGZLWKVLJQL¿FDQWFKDQJHVLQ7XUNH\¶VHFRQRPLFJURZWKPRGHODQGWHFWRQLF shifts in the global economy. The period was marked by an unprecedented increase in global trade, which was in large measure driven by the rising fortunes of emerging market economies and EU membership expansion eastward. It was an important mechanism for both parties to take mutual advantage of these changing dynamics. 1HYHUWKHOHVVWKH&8LVLQFUHDVLQJO\EHFRPLQJOHVVZHOOHTXLSSHGWRKDQGOHWKHFKDQJLQJG\QDPLFVRIJOREDO trade integration. Design elements of the CU that were once minor irritants are starting to become more binding. &RQVHTXHQWO\FKDQJHVDUHQHHGHGWRPDNHWKH&8ZRUNWREHWWHUHIIHFWIRUERWKSDUWLHVDQGIRUWKHPWRIXOO\ EHQH¿WIURPWKHFKDQJLQJJOREDOWUDGLQJHQYLURQPHQW 5. EU expansion into Eastern and Central Europe during the 2000s is another fundamental development that underscores the urgency to re-think the framework governing the Turkey-EU trade relationship. This development presents opportunities and challenges for Turkey and beyond. For Turkey, an enlarged EU represents an expanded market to tap under the CU. It also represents a source of competition to the more developed, larger markets of the EU membership. A continued commitment to deeper integration ZLWKLQ WKH (8 ZLOO EH UHTXLUHG RWKHUZLVH7XUNH\ ULVNV ¿QGLQJ LWVHOI JLYLQJ XS LQWHJUDWLRQ EHQH¿WV WR QHZ EU members. Evidence presented in this evaluation indicates that Turkey is already falling behind newer EU members (e.g. Hungary) in terms of high technology exports to the EU. In terms of lessons for neighborhood countries wishing to join the EU, not only has EU membership remained a key objective for Turkey but it i Evaluation of the EU-Turkey Customs Union has also been by-passed by a dozen Eastern and Central European countries on the way to accession and may now be even by-passed by other countries in the Eastern and Southern neighborhoods in terms of economic integration. Nevertheless our analysis shows that, for the case of Turkey, there have been very positive impacts of the alignment process itself through, for example, increased competitiveness of key export sectors and increased FDI. 6. Responding in part to slow progress in the WTO Doha Round of multilateral trade negotiations, both Turkey and the EU have made concluding more bilateral FTAs a policy priority. This policy change has exposed a key asymmetry in the CU’s design in that the EU is permitted to negotiate FTAs with third countries, but Turkey is not permitted a seat at the negotiations because it is not an EU member. This situation is not particularly problematic if both parties are able to obtain the same agreement from trading partners. In SUDFWLFHKRZHYHULWKDVSURYHGGLI¿FXOWIRU7XUNH\EHFDXVHSDUDOOHOQHJRWLDWLRQVZLWKWKLUGFRXQWULHVKDYHQRW always been concluded, e.g. EU-Mexico agreement. This asymmetry is potentially very costly for both parties DVLWULVNVWKHLQWURGXFWLRQRIRULJLQFRQWUROVWKHDEVHQFHRIZKLFKKDYHEHHQDNH\VRXUFHRIWKHEHQH¿WVIURP the CU. 7. Widening the CU to cover agriculture and services would bring important bene¿ts to both parties. Agriculture accounts for 10 percent of Turkey’s GDP and services for 60 percent but these sectors are excluded from the CU. Turkey’s average agricultural most-favored nation (MFN) tariff is high (41.7 percent). $JULFXOWXUDOWUDGHLVDOVRVXEMHFWWRWDULIITXRWDVDQGSULFHUHJXODWLRQZKLFKKDYHSURGXFHGDKLJKGHJUHHRI protection in both the EU and Turkey. Liberalizing bilateral agricultural trade and adopting the EU’s common H[WHUQDOWDULIIIRUDJULFXOWXUHZRXOGLPSO\DVLJQL¿FDQWIDOOLQ7XUNH\¶VLPSRUWSURWHFWLRQIRUVRPHSURGXFWV and reductions in farm employment. Mediterranean countries in the EU would face increased competition from Turkish oils and tomatoes whereas animal product exports from other member states to Turkey would increase. However increased movement of agricultural products between Turkey and the EU would depend critically upon how rapidly Turkey could adopt and implement EU rules on food safety, veterinary and phytosanitary issues. For services, Turkey is under-trading with nearly all EU member states suggesting untapped potential to increase trade. On aggregate, the services trade regulatory regimes in Turkey and the EU share similar levels of openness that could facilitate trade integration between the two parties. Nevertheless, there are important sectoral differences. The EU has higher restrictiveness indices than Turkey for retail services and some transportation services. Turkey is measured as being more restrictive than the EU for professional services and rail services. 8. Further reforms are also needed to ensure continued growth in Turkish trade with the EU. Increased trade necessitates the movement of increasing volumes and values of goods. Road transport permits, especially for transit, that limit the free circulation of those goods covered by the CU are therefore a key source of concern as are the use of Trade Defense Instruments (TDIs) by both parties that limit bilateral trade. So too is the perceived restrictiveness of EU visas for business travelers. All three areas are in need of policy actions. :LWKLQ WKH FRQWH[W RI WKH &8 URDG WUDQVSRUW TXRWDV DQG WUDQVLW SHUPLWV VKRXOG EH OLEHUDOL]HG ± DW OHDVW RQ consignments of those products covered by the CU - as they hinder the free circulation of goods. The current YLVDUHJLPHDSSOLHGE\(8PHPEHUVWDWHVWRZDUGV7XUNLVKSURIHVVLRQDOVUHTXLULQJH[WHQVLYHSDSHUZRUNDQG high fees, also has important repercussions on EU-Turkey trade and business relationships. Turkish executives, PDQDJHUVDQGRWKHUEXVLQHVVSHRSOHQHHGWRWUDYHOH[WHQVLYHO\WRWUDGHZLWKWKH(87KHFUHDWLRQRIDVSHFL¿F YLVDFDWHJRU\ZKLFKLVORQJWHUPDQGPXOWLSOHHQWU\IRUEXVLQHVVSHRSOHZKRDUHSUHTXDOL¿HGZLWKVLPSOL¿HG GRFXPHQWDU\UHTXLUHPHQWVZRXOGKDYHDSRVLWLYHLPSDFWRQELODWHUDOWUDGH)LQDOO\UHFHQWDQGHFRQRPLFDOO\ VLJQL¿FDQWFDVHVRI7XUNH\DQGWKH(8XVLQJ7',VRQLPSRUWVIURPRQHDQRWKHUFRXOGWKUHDWHQWUDGH7XUNH\ and the EU have TDIs in effect or currently being proposed that affect more than US$1 billion in merchandise WUDGH7RUHGXFHWKHSRWHQWLDOO\VLJQL¿FDQWLPSDFWJUHDWHUFRQVXOWDWLRQEHWZHHQWKHSDUWLHVRQWKHXVHRIWKHVH measures is needed before investigations are launched. 9. To maximize the bene¿ts of the existing or a widened CU, asymmetries in decision making and participation should be corrected. Asymmetries in Turkish participation and consultation on decisions relating to the CU stem from the original design of the agreement with the initial expectation that it would be a transitional arrangement while Turkey moved towards full EU membership. For example while Turkey has the obligation to align with the policy and legislation of the EU, the formal provisions in the CU agreement were designed to allow Turkey to participate in decision shaping, not decision making. Furthermore those ii World Bank provisions on institutional cooperation and decision shaping have not been properly implemented and used which increases the risk of non-compliance. There is, therefore, a need to make the arrangement work in a PRUHEDODQFHGZD\WRPD[LPL]HWKHEHQH¿WVRIWKH&8IRUERWKSDUWLHVDQGWRSUHYHQWVLPLODULVVXHVDULVLQJ if the CU were to be widened to cover new areas in the context of Turkey’s transition to full EU membership. $¿UVWEHVWVROXWLRQZRXOGEHWRPRYHIRUZDUGZLWKDFFHVVLRQQHJRWLDWLRQV(8PHPEHUVKLSZRXOGUHVROYH these asymmetries through providing Turkey direct input and a vote in the development of the acquis. In the meantime, however, there are also a number of practical steps that can be taken by both parties to reduce the impacts of these asymmetries such as the development of improved consultation and information sharing mechanisms that do not currently exist. 10. A formal mechanism to ensure transparency in Turkey’s transposition of the EU acquis is needed. 7KLV PHFKDQLVP ZRXOG KHOS UHGXFH WKH µQRWL¿FDWLRQ GH¿FLW¶ DQG SURPRWH WKH FRQWLQXHG KDUPRQL]DWLRQ RI technical regulations covered by the CU. It would also assist EU stakeholders (e.g. customs, market surveillance, exporters) in knowing the status of Turkish alignment and thus enforce Article 9 of the Decision  LHUHTXLUH7XUNLVKSURGXFWVLQQRQDOLJQHGVHFWRUVWRREWDLQ(8FHUWL¿FDWLRQ :LWKVRPHH[FHSWLRQV Turkey has aligned its technical regulation with the EU acquis in the areas covered by the CU. But the lack of harmonization in selected areas, notably for some Old Approach directives, and the lack of continued harmonization, especially as the acquis evolves, could create barriers to trade. The process of transposition suffers from outdated procedures. The EU and Turkey last issued a list of legislation to be transposed into Turkish law in 1997. A formal mechanism that keeps track of the existing stock of relevant EU legislation and QRWHVWKHVWDWXVRILWVWUDQVSRVLWLRQZRXOGKHOSUHGXFHWKH¶QRWL¿FDWLRQGH¿FLW¶SURPRWHKDUPRQL]DWLRQDQG provide clarity to business about the prevailing rules. 11. The development of formalized structures for parallel track negotiations between the various parties would help resolve imbalances in formulating the common commercial policy. Third countries with ZKLFKWKH(8KDVFRQFOXGHG)7$VVRPHWLPHVUHIXVHWRFRQFOXGH)7$VZLWK7XUNH\&RQVHTXHQWO\7XUNLVK ¿UPVKDYHQRWUHFHLYHGDXWRPDWLFUHFLSURFDODFFHVVWRWKRVHPDUNHWVZKLOHLPSRUWVIURPWKHVHFRXQWULHVFDQ HQWHU7XUNH\GXW\IUHHE\ZD\RIWUDGHGHÀHFWLRQYLDWKH(82QHRIWKHNH\EHQH¿WVRIWKH&8KDVEHHQWKDW it negates the need for ROOs on bilateral trade between the EU and Turkey. But the asymmetries in how the (8 QHJRWLDWHV DQG FRQFOXGHV WUDGH DJUHHPHQWV ZLWK WKLUG FRXQWULHV ZLWKRXW DGHTXDWH7XUNLVK SDUWLFLSDWLRQ ULVN WKH LQWURGXFWLRQ RI RULJLQ FRQWUROV WR SUHYHQW WUDGH GHÀHFWLRQ7KH SUROLIHUDWLRQ RI )7$V ZLWK WKH (8 especially with larger countries such as the US and Canada, risks larger potential losses for Turkey. Well- managed parallel track negotiations to enhance bilateral dialogue between the parties in the formation of the common commercial policy would help resolve the problem. Parallel track negotiations mirroring the main EU negotiations with third countries which aim to have the EU and Turkey start and conclude FTA negotiations at about the same time would be the most plausible solution. As part of this process, the Turkey Clause could be strengthened to have third countries conclude an FTA with Turkey in a set time period. In the meantime, both sides should also consider the goods originating in Turkey and in free circulation in the CU being recognized as goods originating in the EU for the purpose of bilateral cumulation provisions of EU FTAs. 12. Implementing a functioning Dispute Settlement Mechanism DSM would also help to rebalance the trade concessions and market access obligations of the CU and resolve the various ‘trade irritants’ that inevitably arise in any meaningful trade agreement. The existing DSM in the CU is not effective because it is limited to disagreements on the duration of safeguards measures only.1 Shifting to a DSM where one party can bring a case for a broader range of possible disputes would be more effective in resolving trade irritants. For example, Mexico’s recent use of the NAFTA DSM to resolve its lack of export access IRU URDG WUDQVSRUW VHUYLFHV LQ WKH 86 PDUNHW LGHQWL¿HV D IUDPHZRUN WKDW PD\ EH DSSURSULDWH IRU WKH &8 +RZHYHUDQHZ(87XUNH\ELODWHUDO'60ZRXOGEHGLI¿FXOWWRLPSOHPHQWXQOHVVWKHH[LVWLQJDV\PPHWULHV relating to formulating the common commercial policy and technical regulations in the areas covered by the CU are resolved simultaneously. This would prevent, for example, the possibility of the EU changing the law XQLODWHUDOO\ZLWKRXW7XUNH\EHLQJDGHTXDWHO\FRQVXOWHGDERXWWKHFKDQJHDQGWKHQFKDOOHQJLQJ7XUNH\LQWKH DSM of not complying. 1 In contrast, the mechanism established in the Ankara Agreement is not limited to such measures but can only be triggered by the consent of both parties. iii Evaluation of the EU-Turkey Customs Union iv I- Introduction 13. The implementation of the customs union CU in 1995 was the culmination of thirty-two years of association between the EU and Turkey and was expected by Turkey to be the ¿rst step in the EU accession process. Turkey applied for associate membership of the then European Economic Community (EEC) on 31 July, 1959. The application resulted in an Association Agreement between the EEC and Turkey on 12 September, 1963 (the Ankara Agreement) whereby the parties agreed to create a CU. An Additional 3URWRFROZDVVLJQHGRQ1RYHPEHUZKLFKVHWRXWDWLPHWDEOHIRUWKHDEROLWLRQRIWDULIIVDQGTXRWDVRQ goods circulating between Turkey and the EEC and the free movement of workers.2 The EU-Turkey CU was established on 31 December, 1995 by the EU-Turkey Association Council Decision 1/95 (Box 1). Turkey was RI¿FLDOO\UHFRJQL]HGDVDQ(8FDQGLGDWHFRXQWU\LQ'HFHPEHUDQGDFFHVVLRQQHJRWLDWLRQVEHJDQRQ October, 2005 (see Annex 1). 14. The CU has been a major instrument of integration for the Turkish economy into both European and global markets. Trade and investment linkages between the EU and Turkey have deepened with bilateral trade between the EU and Turkey reaching US$147 billion in 2012 making Turkey the EU’s sixth largest trading partner and the EU Turkey’s biggest. The EU is the largest foreign investor in Turkey, accounting for WKUHHTXDUWHUVRIWRWDOIRUHLJQGLUHFWLQYHVWPHQW )', LQÀRZVGXULQJWKHODVW¿YH\HDUV7KH&8KDVFORVHO\ integrated Turkish companies in European production networks for automobiles and clothing. It has helped UDLVHWKHTXDOLW\DQGVRSKLVWLFDWLRQRI7XUNH\¶VH[SRUWV 15. The CU covers trade in just industrial goods including the industrial components of processed agricultural products and excludes primary agriculture, services and public procurement but has proved to be a powerful force of regulatory convergence. The CU was an early attempt at the EU sharing some of its law with a third country whereby it committed Turkey to align its legislation with the EU acquis in the areas covered by it. For example, the free movement of goods between the parties as regulated by the CU is ensured through harmonization of Turkish legislation with a wide range of EU legislation with a view to eliminating technical barriers to trade. It has also been a strong stimulus for customs reform and modernization ZLWK WKH UHTXLUHPHQW WR DGRSW (8 OHJLVODWLRQ RQ WKH DGPLQLVWUDWLRQ RI ERUGHU SURFHGXUHV LQFOXGLQJ 522V Therefore, while Turkey is not yet an EU member state, it has the obligation to adopt the EU acquis in areas related to the CU. It should also be noted that Turkey is not currently extending the CU to Cyprus which has hampered its accession progress, particularly on those eight chapters covered by the Council conclusions of December 2006.3+RZHYHUGHVSLWHWKHLPSRUWDQWSROLWLFDOVLJQL¿FDQFHRIWKH&\SUXVLVVXHWKLVDQRPDO\LQ the implementation of the CU does not have sizeable economic or commercial implications on the overall functioning of the CU. 7KHIUHHPRYHPHQWRIZRUNHUVZDVQRWVXEVHTXHQWO\UHDOL]HGE\WKH&8 3 In its conclusions, the Council of Ministers on 18 December 2013 noted that “Recalling its conclusions of 11 December, 2006 and the declaration RI6HSWHPEHUWKH&RXQFLOQRWHVZLWKGHHSUHJUHWWKDW7XUNH\GHVSLWHUHSHDWHGFDOOVFRQWLQXHVUHIXVLQJWRIXO¿OOLWVREOLJDWLRQVRIIXOOQRQ GLVFULPLQDWRU\LPSOHPHQWDWLRQRIWKH$GGLWLRQDO3URWRFROWRWKH$VVRFLDWLRQ$JUHHPHQWWRZDUGVDOOPHPEHUVWDWHV7KLVFRXOGSURYLGHDVLJQL¿FDQW boost to the negotiation process. In the absence of progress on this issue, the Council will maintain its measures from 2006, which will have a continu- ous effect on the overall progress of the [accession] negotiations.” 1 Evaluation of the EU-Turkey Customs Union Box 1: Decision 1/95 As part of Decision 1/95, Turkey committed to incorporate EU harmonized technical legislation into its domestic legal order. The EU agreed to accept without additional conformity assessment checks Turkish goods for which relevant EU legislation had been incorporated, provided that these goods ZHUHGXO\FHUWL¿HG $UWLFOH 'XO\FHUWL¿HG(8SURGXFWVZHUHWRHQWHU7XUNH\ZLWKRXWDGGLWLRQDO conformity assessment checks irrespective of whether Turkey had incorporated applicable EU legislation (Article 10.1). A central feature of Decision 1/95 was Turkey’s obligation to enact legislation mirroring EU disciplines in the areas covered by the CU. To ensure the free movement of goods both parties agreed to provisions on discriminatory taxation, intellectual property and identical customs legislation. They agreed to common competition and state aid rules and the mechanisms to operate these, based on alignment with EU rules. Finally, to avoid problems resulting from divergent interpretation of legislation, an institutional structure to monitor legal integration and for dispute settlement was developed although this is not functioning well. 7XUNH\ZDVDOVRUHTXLUHGWRDSSO\LGHQWLFDOWUDGHGHIHQVHOHJLVODWLRQWRWKDWRIWKH(8EXWERWKSDUWLHV are not compelled to use the same TDIs and are even permitted to impose these on each other’s imports.4 7XUNH\KDVDOVREHHQUHTXLUHGWRDGRSWDOO37$VZLWKWKH(8¶VSUHIHUUHGSDUWQHUVDVZHOODV the EU’s Generalised System of Preferences (GSP). According to Decision 1/95, a formal mechanism is established through which Turkey’s views for the common commercial policy and draft legislation that affect the CU are taken into account. However these provisions on institutional cooperation and decision making have not been fully used. The processes regarding the consultation and decision making mechanisms envisaged in the CU are outlined in Articles 54-60 of Decision 1/95. In terms of institutional structure, the agreement establishes the Customs Union Joint Committee (CUJC) as the main body responsible for the functioning of the CU. Its roles are outlined in Article 52.3 of Decision 1/95. Section 1 of Chapter 5 explains that the CUJC is to carry out an exchange of views, formulate recommendations and to deliver opinions on the proper functioning of the CU to the Association Council (the main decision making body of the CU). Article 54 sets the coverage of areas for which harmonization is set and of direct relevance to the CU: commercial policy and agreements with third countries (e.g. FTAs) for industrial products; TBTs on industrial products; customs legislation; intellectual property law and competition policy. However as also laid out in Article 54, if the Association Council considers necessary, the coverage of harmonization may be extended to other areas related to the proper functioning of the CU. Articles 59 and 60 provide details on the consultation procedures that are supposed to be used. Article 59 states that in areas related to the CU, the Commission should ensure Turkish experts are involved as far as possible in the preparation of draft measures and on the same basis as experts from EU member states. A similar article (Article 100) is also present in the Agreement on the European Economic Area and constitutes the legal basis for the participation of EEA countries in certain decision making bodies of the EU (e.g. committees, working groups etc.) in areas related to the agreement. Article 60 states that Turkish experts be involved in the work of technical committees in areas covered by the CU. Some of the committees covered are listed in an annex to Decision 1/95 of which there are ones related to the internal market while others are advisory in nature. However this is not an exhaustive list and the committees in which Turkey may participate have been extended as the need has arisen. 4 Article 44 of Decision 1/95 allows the Association Council to review trade defense actions against Turkey ‘provided that Turkey has implemented FRPSHWLWLRQVWDWHDLGVFRQWURODQGRWKHUUHOHYDQWSDUWVRIWKHDFTXLVFRPPXQDXWDLUHZKLFKDUHUHODWHGWRWKHLQWHUQDOPDUNHWDQGHQVXUHGWKHLUHI- fective enforcement, so providing a guarantee against unfair competition comparable to that existing inside the internal market.’ 2 World Bank 16. Much has changed in the global economy since the CU entered into force and the CU is becoming less well equipped to deal with the modern day challenges of trade integration. First, Turkey has become DKLJKJURZWKGLYHUVL¿HGHPHUJLQJHFRQRP\WKDWLVLQFUHDVLQJO\ORRNLQJWRH[SORLWQHZPDUNHWV6HFRQGO\ DYHUDJHWDULIIVJOREDOO\DUHWRGD\PXFKORZHUWKDQLQWKHVDQGTXDQWLWDWLYHLPSRUWUHVWULFWLRQVKDYHODUJHO\ disappeared. Thirdly, there have also been tectonic shifts in the world economy with sustained high economic growth rates in emerging markets making these countries much more important as markets and as sources of competition. Fourthly, countries have fewer incentives to close their markets as the world has become more LQWHUGHSHQGHQWZLWKJOREDOVXSSO\FKDLQV:KHUHVXSSRUWLVEHLQJSURYLGHGWRGRPHVWLF¿UPVWKLVLVWDNLQJ new forms as countries are relying less on raising tariffs to insulate their national markets and using non-tariff measures (NTMs) and trade defense instruments (TDIs) instead. Fifthly, over the past decade there has been a proliferation of FTAs globally which are increasingly covering areas of ‘deep’ integration such as services, government procurement, and provisions on minimum environmental and labor standards. 17. Reforming the CU to meet these challenges is complicated by the fact that both parties do not consider the trade agreement in the same way. The CU was originally conceived as a way of foreshadowing 7XUNLVK PHPEHUVKLS LQ WKH (8 DW DQ XQVSHFL¿HG EXW UHODWLYHO\ QHDU GDWH$IWHU7XUNH\ DSSOLHG IRU IRUPDO PHPEHUVKLS LQ  WKH (XURSHDQ &RPPLVVLRQ  ZKLOH FRQ¿UPLQJ 7XUNH\¶V HOLJLELOLW\ LQ SULQFLSOH WR become a full member - recommended that no accession should be envisaged until a later date. The European Commission recommended, instead, that the parties reinforce cooperation within the framework of association and therefore launch negotiations to conclude a CU by 1995. Indeed, it has prompted Turkey to align its domestic legislation to some areas of the acquisZKLOHDFFHVVLRQZLOOUHTXLUHDOLJQPHQWWRDOORILW 18. The CU, as negotiated, was also imperfect. The EU’s common customs area comprises the 28 EU member states plus Turkey, Andorra and San Marino. However while Turkey has the obligation to align with the policy and legislation of the EU, it cannot participate in the EU’s decision making mechanisms in areas related to the CU. The asymmetric structure of the agreement stems from the original perception on the Turkish side, both at the time of Decision 1/95 and afterwards, that it was meant to be temporary in the OHDGXSWRDFFHVVLRQ0D[LPL]LQJWKHEHQH¿WVRIWKH&8LVGLI¿FXOWZLWKVXFKDV\PPHWULHV)RUH[DPSOHDQG unusually for a customs union, the EU is permitted to negotiate FTAs with third countries. This presents no problem if both the EU and Turkey are able to obtain the same agreement from trading partners. However WKLVKDVSURYHGDGLI¿FXOW\IRU7XUNH\LQFDVHVVXFKDV(80H[LFRZKHUH7XUNH\KDVQRWEHHQDEOHWRVHFXUH a comparable arrangement. Turkey loses from increased competition for its exports and may lose trade tax revenues. Trade costs are incurred for both Turkey and the EU if ROOs are set up and implemented as a result to limit exports from the partner seeking to enter Turkey duty-free via the EU. There is, therefore, a need to make the arrangement work in a more balanced way. 19. There are a number of ‘trade irritants’, or complaints regarding the implementation of the CU, many of which have been unresolved for years. Examples include: x NTMs that are preventing the free circulation of products such as pharmaceuticals, chemicals, second-hand goods, sugar confectionary, scrap metal and retreaded tires. x The semi-effective use of the bilateral process (e.g. due to delays in submission by Turkey; delays in UHVSRQGLQJE\WKH(XURSHDQ&RPPLVVLRQQRWQRWLI\LQJ WRHQVXUHWKDWFKDQJHVWRWKH(8DFTXLVLQ areas covered by the CU are transposed in Turkish law in a timely manner. x Road transport permits, particularly for transit, faced by transport operators and visa restrictions. x Goods categorization issues regarding industrial food products (covered by the CU) versus primary agriculture (not covered by the CU). For example, Turkey charges import tariffs on EU imports of feta cheese, certain beverages, spirits and vinegar as it considers these as primary agricultural products.5  7KHUHDUHDOVRFRQFHUQVRYHUJHRJUDSKLFDOLQGLFDWLRQV *,V IRUVRPHSURGXFWVSURGXFHGE\7XUNLVK¿UPV HJIHWDFKHHVH.DODPDWDROLYHV DOWKRXJK GIs are not addressed by Decision 1/95. 3 Evaluation of the EU-Turkey Customs Union 20. Against this background the European Commission has asked the World Bank to conduct an external evaluation of the CU. The evaluation’s objectives are to assess the impacts of the CU and to make forward looking, solution-orientated recommendations for its improvement with an emphasis on the economics behind the various trade irritants and options for dealing with problems related to asymmetries as well as examining the case for widening. 21. The evaluation provides quantitative and qualitative estimates of the effects of the CU and demonstrates that the trade agreement has been highly bene¿cial for both Turkey and the EU.6SHFL¿FDOO\ the evaluation consists of two main parts: i) an evaluation of the impact of the CU on trade, FDI and, more broadly, welfare in Turkey through the effects it has had on trade policy, eliminating the need for ROOs on preferential trade with the EU and implementing the acquis in areas covered by the CU; and ii) a review of current limitations of the existing trade arrangement, potential gains in dealing with these as well as proposed modalities for reform. 22. The evaluation has six sections. Section 2 reviews trade and investment outcomes between the EU DQG 7XUNH\ 7KH VHFWLRQ DOVR LQYHVWLJDWHV WKH UROH RI (8 ¿UPV LQ 7XUNH\ DQG KRZ WKHLU 7XUNLVK DI¿OLDWHV DUHEHQH¿WLQJIURPLQFUHDVHGLQWHJUDWLRQ6HFWLRQH[DPLQHVWKHHIIHFWVWKH&8KDVKDGRQWKHWUDGHSROLF\ HQYLURQPHQW IRU 7XUNH\ ,W HPSKDVL]HV RQ WKH RQH KDQG WKH VLJQL¿FDQW JDLQV LQ FRPSHWLWLYHQHVV EURXJKW about through Turkey’s adoption of the common external tariff which has greatly lowered its import tariffs for industrial goods and eliminated the need for ROOs while, on the other hand, the costs for Turkey arising from DV\PPHWULHVLQGH¿QLQJWKHFRPPRQFRPPHUFLDOSROLF\6HFWLRQSURYLGHVDQRYHUYLHZRI(87XUNH\WUDGH relations in terms of Turkey’s harmonization with EU regulations and the use of Trade Defense Instruments. 7KHVHFWLRQDOVRGLVFXVVHVWKHVLJQL¿FDQWLPSHWXVWKH&8KDVSURYLGHG7XUNH\WRLPSOHPHQWWUDGHIDFLOLWDWLRQ reforms through customs modernization and streamlined customs controls, although restrictive road transport permits, especially for transit, continue to create obstacles to the free movement of goods and hinder the full RSHUDWLRQRIWKH&87KH¿IWKVHFWLRQH[DPLQHVWKHSRWHQWLDOLPSDFWVRIZLGHQLQJWKHWUDGHDUUDQJHPHQWWR cover new areas in agriculture and services and makes proposals for the modalities that could be used to include these as part of an agreement including in the context of full accession. It also analyses the cost of visa restrictions applied by EU member states towards Turkish businessmen and the potential impacts these restrictions have on trade as well as the extent of Turkey’s alignment of its Public Procurement Law with that of the acquis. Section 6 concludes with policy recommendations for improving the effectiveness of the CU. 4 II- Developments in Trade and Investment 23. The CU has brought mutual economic bene¿ts to Turkey and the EU. It has helped to integrate 7XUNLVK¿UPVLQ(XURSHDQSURGXFWLRQQHWZRUNV HJ5HQDXOW)LDW ZLWKWKUHHTXDUWHUVRI7XUNH\¶V)',FRPLQJ IURP(XURSH7UDGHEHWZHHQWKHWZRSDUWLHVKDVTXDGUXSOHGDQGLQFUHDVHGLPSRUWVRIPDFKLQHU\DQGFDSLWDO goods have boosted Turkey’s competitiveness which, combined with regulatory harmonization with the EU, has facilitated Turkey’s exports not just to the EU but also to other markets such as those in the Middle East and North Africa (MENA) including in higher value-added sectors. Trends in Foreign Direct Investment 24. When the CU was ¿nalized in 1995, expectations were that it would boost FDI. (8 ¿UPV ZHUH attracted by the prospect of regulatory harmonization and accessing highly skilled labor with lower wages. Firms based in third countries that wished to export industrial goods to the EU market duty-free saw an opportunity. The CU being considered a stepping stone in Turkey’s accession process towards full EU membership was another positive factor. 25. FDI inÀows to Turkey peaked in 2007 at US19.1 billion but have not yet recovered to that level in the post-crisis period. The EU, led by the Netherlands, Austria, UK, Luxembourg, Germany and Spain, KDVEHHQWKHODUJHVWIRUHLJQLQYHVWRULQ7XUNH\RYHUWKHSDVW¿YH\HDUVDFFRXQWLQJIRUWKUHHTXDUWHUVRIWRWDO )',LQÀRZVGXULQJWKHSHULRG 7DEOH &RXQWULHVLQWKH*XOIDQG0LGGOH(DVWDUHDOVREHFRPLQJVLJQL¿FDQW LQYHVWRUVLQ7XUNH\IRUH[DPSOHLQWKHKHDOWKVHFWRUDFFRXQWLQJIRUSHUFHQWRI)',LQÀRZVLQ 26. Foreign investment into Turkey is mostly for services and manufacturing. Large investors include %RVFK0HUFHGHVDQG7R\RWD+RZHYHULQYHVWPHQWVLQDJURSURFHVVLQJDUHVLJQL¿FDQWDQGJURZLQJDFFRXQWLQJ IRUSHUFHQWRI)',LQÀRZVVLQFH 7DEOH )',LQWR7XUNH\UHPDLQVORZFRPSDUHGWRRWKHUIDVWJURZLQJ HPHUJLQJPDUNHWV7KLVPD\EHGXHWRWKHUHJXODWRU\HQYLURQPHQWFRQFHUQVRYHUWKHHI¿FLHQF\RIWKHMXGLFLDU\ LQDGHTXDWH VNLOOV RI WKH ZRUNIRUFH DQG UHODWLYHO\ KLJK ZDJH OHYHOV DV ZHOO DV D KLVWRU\ RI PDFURHFRQRPLF instability6. At the same time, Turkey’s location is a key attraction, and its young population and improving infrastructure and logistics are assets. 6 The Association of Foreign Investors (YASED) carries regular surveys on the main constraints faced by FDI. 5 Evaluation of the EU-Turkey Customs Union Table 1: FDI inflows to Turkey by source country US millions 2007 2008 2009 2010 2011 2012 2013 Total 2007-  of total Jan-May May 2013 World 19,137 14,747 6,252 6,238 15,855 10,136 3,129 75,494 (100%) (100%) (100%) (100%) (100%) (100%) (100%) (100%) Europe 12,974 11,367 5,234 4,920 12,336 7,795 1,996 56,622 (68%) (77%) (84%) (79%) (78%) (77%) (64%) (75%) Netherlands 5,442 1,343 718 486 1,589 1,182 374 11,134 (28%) (9%) (11%) (8%) (10%) (12%) (12%) (15%) Austria 370 586 1,019 1,584 2,235 1,491 300 7,585 (2%) (4%) (16%) (25%) (14%) (15%) (10%) (10%) UK 703 1,335 350 245 917 2,004 56 5,610 (4%) (9%) (6%) (4%) (6%) (20%) (2%) (7%) Luxembourg 583 3,140 493 292 481 1,261 77 6,327 (3%) (21%) (8%) (5%) (3%) (12%) (2%) (8%) Germany 954 1,237 498 597 605 551 241 4,683 (5%) (8%) (8%) (10%) (4%) (5%) (8%) (6%) Spain 583 838 145 205 2,230 170 443 4,614 (3%) (6%) (2%) (3%) (14%) (2%) (14%) (6%) USA 4,212 868 260 323 1,402 438 158 7,661 (22%) (6%) (4%) (5%) (9%) (4%) (5%) (10%) Azerbaijan 10 18 69 12 1,265 339 39 1,752 (0%) (0%) (1%) (0%) (8%) (3%) (1%) (2%) Saudi Arabia 10 1312 34 39 25 152 16 1,588 (0%) (9%) (1%) (1%) (0%) (1%) (1%) (2%) Russia 108 71 12 2 762 11 147 1,113 (1%) (0%) (0%) (0%) (5%) (0%) (5%) (1%) Kuwait 77 330 73 193 38 245 177 1,113 (0%) (2%) (1%) (3%) (0%) (2%) (6%) (2%) Kazakhstan 613 1 20 2 1 1 1 639 (3%) (0%) (0%) (0%) (0%) (0%) (0%) (1%) Japan 2 11 3 347 227 33 304 927 (0%) (0%) (0%) (6%) (1%) (0%) (10%) (1%) Source: Central Bank of Turkey. 6 World Bank Table 2: FDI inflows to Turkey by sector US millions 2007 2008 2009 2010 2011 2012 Jan- May Total 2007-  of total 2013 May 2013 All 19,137 14,747 6,252 6,238 15,855 10,136 3,129 75,494 (100%) (100%) (100%) (100%) (100%) (100%) (100%) (100%) Services 14,091 9,520 2,315 3,274 7,993 4,568 2,000 43,761 (74%) (65%) (37%) (52%) (50%) (45%) (64%) (58%) Banking 10,103 4,111 473 835 4,849 891 868 22,130 (53%) (28%) (8%) (13%) (31%) (9%) (28%) (29%) Insurance & pensions 1,333 1,895 174 765 907 1,758 1,916 8,748 (7%) (13%) (3%) (12%) (6%) (17%) (61%) (12%) Wholesale & retail 234 2,088 390 435 703 219 198 4,267 (1%) (14%) (6%) (7%) (4%) (2%) (6%) (6%) Construction 287 337 209 314 310 1,453 91 3,001 (1%) (2%) (3%) (5%) (2%) (14%) (3%) (4%) Manufacturing 4,131 3,971 1,642 923 3,413 4,392 540 19,012 (22%) (27%) (26%) (15%) (22%) (43%) (17%) (25%) Electricity & gas 567 1,055 2,153 1,823 4,271 924 394 11,187 (3%) (7%) (34%) (29%) (27%) (9%) (13%) (15%) Agro-processing 691 1,252 221 123 650 2,199 77 5,213 (4%) (8%) (4%) (2%) (4%) (22%) (2%) (7%) Chemicals 1,111 199 337 120 343 518 24 2,652 (6%) (1%) (5%) (2%) (2%) (5%) (1%) (4%) Mining 336 145 89 135 144 214 182 1,245 (2%) (1%) (1%) (2%) (1%) (2%) (6%) (2%) Primary agriculture, 9 41 48 80 32 38 13 261 IRUHVWU\ ¿VKLQJ (0%) (0%) (1%) (1%) (0%) (0%) (0%) (0%) Source: Central Bank of Turkey. Trends in Trade 27. As well as the most signi¿cant foreign investor, the EU has also been a major trading partner for Turkey ever since the EEC was established in 1957. The value of bilateral trade between the two parties has increased considerably (Figure 1a). At the same time, the EU’s share in Turkey’s total trade has declined, particularly after 2007 (see Figure 1b). Between 1996 and 2011, Turkey’s exports to the EU increased almost IRXUIROGZKLOH7XUNH\¶VH[SRUWVWRWKHZRUOGJUHZE\DOPRVW¿YHIROG7XUNH\¶VLPSRUWVIURPWKH(8LQFUHDVHG DOPRVWWKUHHIROGRYHUWKHSHULRGEXWLQFUHDVHGPRUHWKDQ¿YHIROGIURPWKHUHVWRIWKHZRUOGZKLFKIURPWKH SHUVSHFWLYHRIHFRQRPLFZHOIDUHKDVEURXJKWLPSRUWDQWSRVLWLYHEHQH¿WV 28. It is dif¿cult to argue that the CU caused a major shift in relative trade shares for Turkey because the EU had already opened its markets for Turkish exports of industrial goods long before the CU came into effect. Turkish exports of industrial goods to the EU have been mostly duty-free since the 1970s although there were several product exclusions until the CU was established.7 EU MFN tariffs have also been reduced, and the EU has increasingly signed PTAs with third countries, so Turkey has faced preference erosion in the (8PDUNHWORVLQJLPSRUWVKDUHVLQFH )LJXUH (PSLULFDOHYLGHQFHVXSSRUWVWKHQRWLRQWKDWLWLVGLI¿FXOW WRGLUHFWO\LVRODWHWKHTXDQWLWDWLYHLPSDFWVRIWKH&8RQELODWHUDOWUDGHEHWZHHQWKHWZRSDUWLHV VHH$QQH[  7 )RUH[DPSOHWKH(8UHWDLQHGWKHULJKWWRFKDUJHLPSRUWGXWLHVRQFHUWDLQRLOSURGXFWVLQH[FHVVRID¿[HGTXRWDDQGLPSRUWGXWLHVRQFHUWDLQWH[WLOHV products were retained. 7 Evaluation of the EU-Turkey Customs Union Figure 1: Turkey’s trade (a) Nominal trade with the EU (US$ millions) 100.000 90.000 80.000 70.000 60.000 50.000 40.000 30.000 20.000 10.000 0 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 Exports Imports Source: IMF Direction of Trade Statistics. (b) Turkey’s exports by region (% of total) 70% 60% 50% 40% 30% 20% 10% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012* Africa Asia EU27 MENA Rest of Europe USA Source: UN Comtrade *January-September 2012. Figure 2: Turkey’s trade share of the EU 6% 5% 4% 3% 2% 1% 0% Turkey share in total EU exports Turkey share in total EU imports Turkey share in extra-EU exports Turkey share in extra-EU imports Source: IMF Direction of Trade Statistics. 8 World Bank 29. The CU has also coincided with more deeply integrated production networks between Turkish and European ¿rms. This has occurred in sectors such as automobiles and clothing which are the main H[SRUWHGSURGXFWVIURP7XUNH\WRWKH(8 )LJXUHD &RQVHTXHQWO\LQWUDLQGXVWU\WUDGHEHWZHHQ7XUNH\DQG the EU has increased from 30 percent in 1990 to over 50 percent (Figure 3b). The reduction in trade costs associated with the CU, including the harmonization of standards and elimination of ROOs is likely to have promoted growing intra-industry trade along global value chains, which are known to be particularly sensitive to trade costs (WEF, 2013). Figure 3: Composition of Turkey’s trade with the EU (a) Product composition (% of exports to EU) (b) Intra-industry trade (% of exports to EU) Source: UN Comtrade. 30. Duty-free access to the EU has helped to increase the sophistication and quality of Turkey’s exports, at least to some markets. In terms of sophistication, Turkey has grown its medium technology exports (e.g. automobiles, textiles, iron and steel) dramatically over the past decade from 20-32 percent of total exports (Figure 4a) while high technology exports (e.g. R&D intensive products such as pharmaceuticals and computers) have not yet gained a foothold in its export basket (World Bank, 2012). Newer EU member states such as Hungary have been more successful in this regard (Figure 4b). 9 Evaluation of the EU-Turkey Customs Union Figure 4: Product sophistication of Turkey’s exports (a) Medium-tech exports (% of total exports) 60 40 (sum) sh 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 ROM POL HUN SVK CZE TUR (b) High-tech exports (% of total exports) 40 30 (sum) sh 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 ROM POL HUN CZE SVK TUR Source::RUOG%DQN  7HFKQRORJLFDOFODVVL¿FDWLRQLVEDVHGRQ/DOO   Firm-Level Analysis 31. The analysis of aggregate trade Àows presented in the previous sub-section shows a clear trend in the growth and diversi¿cation of Turkey’s export markets.,QWKLVVXEVHFWLRQZHH[DPLQH¿UPOHYHOGDWD WREHWWHUXQGHUVWDQGWKHGHJUHHWRZKLFKWKLVLVDUHVXOWRIFRUUHVSRQGLQJVWUDWHJLHVSXUVXHGE\¿UPVLQFOXGLQJ WKRVHZLWKPDMRULW\(8RZQHUVKLSDQGWKHLPSDFWVPDUNHWGLYHUVL¿FDWLRQKDVKDGRQH[SRUWVXUYLYDOUDWHV average wages, productivity and employment. 32. Almost half of Turkish ¿rms that export do so to just one market. In contrast, less than 10 percent of LWVH[SRUWLQJ¿UPVUHDFKPRUHWKDQPDUNHWV DOWKRXJKWKHVH¿UPVPDNHXSPRVWH[SRUWVE\YDOXH ±7DEOH &RPSDUHGWRRWKHUFRXQWULHVWKLVSDWWHUQLVTXLWHQRUPDO6LPLODUGDWDDYDLODEOHIRU&KLOH6RXWK$IULFDDQG France shows that in these countries too total exports are dominated by a few top exporters that are relatively large and export to several foreign markets. 10 World Bank Table 3: Market reach of Turkish exporters versus comparator countries # of export Turkey Chile South Africa France destinations  of total Value of  of total Value of  of total Value of  of total Value of exporters exports exporters exports exporters exports exporters exports  of total  of total  of total  of total 1 45% 7% 54% 2% 48% 4% 43% 3% 2 to 5 36% 15% 31% 8% 37% 11% n.a. n.a. 6 to 10 10% 10% 8% 10% 9% 13% n.a. n.a. >10 9% 69% 8% 80% 7% 72% 16% 85% Total 100% 100% 100% 100% 100% 100% 58% 88% Source: World Bank (2012) based on data from TUIK and World Bank Exporter Dynamics Database (Cebeci et al., 2012). 33. Commensurate with changes in aggregate exports, Turkish ¿rms have also increased their attention to non-traditional markets. Forty two percent of new Turkish exporters8 in the period 2002-10 focused exclusively on the EU or European Free Trade Association (EFTA) with an additional 8 percent of them exporting to these groups of countries alongside other destinations. In contrast, just 14 percent of new exporters exported solely to MENA. However, data on new market entries (Table 4) shows that while in 2003 new entries to the EU or EFTA markets were 8,471 by 2010 this had fallen to 5,402. Correspondingly, the number of new exporters to non-traditional markets in MENA and the rest of Europe and Central Asia has increased markedly. In 2010, the number of Turkish exporters entering the MENA market was larger than those entering the EU. Table 4: Geographical destination of new market entries, 2003-10 Number of new 2003 2004 2005 2006 2007 2008 2009 2010 exporters to: EU & EFTA 8,741 8,113 7,350 6,792 8,553 6,727 6,002 5,402 MENA 4,772 4,751 4,589 4,264 4,933 4,799 5,803 5,568 Rest of Europe 5,015 5,005 5,297 5,159 5,986 5,716 5,167 5,333 and Central Asia Rest of world 3,602 3,398 3,376 3,205 3,582 3,138 3,270 3,264 Source: Adapted from World Bank (2012). 34. New market entry tends to be by ¿rms already present in the EU and likely to stay present there, implying the EU is a springboard for ¿rms to reach new markets. Firms exclusively serving the EU and EFTA markets in any given year between 2003 and 2010 either stopped exporting (39 percent), kept exporting to the EU and EFTA (46 percent), or changed their destination markets (14 percent). Of the latter, just 3 percent switched entirely from the EU and EFTA markets to other destinations (Table 5).  ,QWKHFXUUHQWDQDO\VLVDQHZH[SRUWHULVGH¿QHGUHODWLYHWRWKHSUHYLRXV\HDUVRIRUH[DPSOHLVFODVVL¿HGDVQHZLILWH[SRUWHGLQLILWGLGQRW H[SRUWLQ$QDOWHUQDWLYHDSSURDFKZRXOGKDYHEHHQWRGH¿QHDQHZ¿UPLQUHODWLYHWRDQµH[SRUWHUSRUWIROLR¶ZKLFKZRXOGEHPDGHRIDOO ¿UPVWKDWH[SRUWDWOHDVWRQFHEHWZHHQDQG7KHODWWHUGH¿QLWLRQLVPRUHFRQVHUYDWLYHDQGZRXOGKDYHOHGWRORZHUHQWU\UDWHVWKDQLQRXU analysis. 11 Evaluation of the EU-Turkey Customs Union Table 5: Turkish firm market expansion trends Firms serving exclusively the EU market in year t Firms that cease to export in year t+1 39 Firms that keep exporting to the EU/EFTA market only in 46 year t+1 Firms that switch to other markets at year t+1 3 MENA 1% Other Europe and Central Asia 1% Both MENA and other Europe and Central Asia 0% Other destinations 1% Firms that expand their export destinations at year t+1 11 MENA 3% Other Europe and Central Asia 3% Both MENA and other Europe and Central Asia 1% Other destinations 5% Source: World Bank (2012). 35. Turkey’s exports to the EU contribute the most to employment creation in Turkey, increases in average wages and growth in productivity. Cebeci (2013) evaluates the role of export destinations on SURGXFWLYLW\HPSOR\PHQWDQGZDJHVRI7XUNLVK¿UPVE\FRPSDULQJWKHSHUIRUPDQFHRI¿UPVWKDWH[SRUWWR low-income destinations, those exporting to high-income destinations, and those that do not export. Beginning to H[SRUWWRWKH(8PDUNHWHQKDQFHV¿UPSURGXFWLYLW\LQ7XUNH\VLJQL¿FDQWO\LQFUHDVLQJWRWDOIDFWRUSURGXFWLYLW\ E\DQGSHUFHQW FRPSDUHGWRQRQH[SRUWLQJ¿UPV LQWKH¿UVWVHFRQGDQGWKLUG\HDURIH[SRUWLQJ WRWKH(8UHVSHFWLYHO\,QFRQWUDVWEHJLQQLQJWRH[SRUWWR0(1$GRHVQRWEULQJVLJQL¿FDQWEHQH¿WVWR¿UPV¶ total factor productivity. For average wages, the impact of exporting to the EU is estimated to be 1.3, 3.5 and SHUFHQW UHODWLYHWRQRQH[SRUWLQJ¿UPV IRUHDFKWKH¿UVWWKUHH\HDUVRIH[SRUWLQJZKHUHDVWKHLPSDFWRI H[SRUWLQJWR0(1$LVQRWVWDWLVWLFDOO\VLJQL¿FDQW9 36. Since Turkey is an important investment base for EU companies, this has led to an increasing degree of integration of Turkey af¿liates in EU supply and production networks. Using the latest available GDWDPRUHWKDQ(8PDMRULW\RZQHG¿UPVRSHUDWHGLQ7XUNH\¶VPDQXIDFWXULQJVHFWRUGXULQJ7KH\ are substantially larger and exhibit a much higher propensity to participate in export markets than domestic- RZQHG¿UPV )LJXUH 7KHWKUHHPDLQVHFWRUVLQWHUPVRIKLJKHUSUHVHQFHRI(8PDMRULW\RZQHG¿UPVDUH FKHPLFDOV FKHPLFDO SURGXFWV DQG PDQPDGH ¿EHUV PRWRU YHKLFOHV DQG IRRG SURGXFWV DQG EHYHUDJHV VHH $QQH[ $FFRXQWLQJIRUVHFWRUDOGLIIHUHQFHV DWWKHGLJLW,6,&OHYHO (8PDMRULW\RZQHG¿UPVDUHPRUH OLNHO\WKDQGRPHVWLFPDMRULW\RZQHG¿UPVWRH[SRUWWKHLUSURGXFWVWRDOOGHVWLQDWLRQVH[FHSW0(1$ 7DEOH   1RWHWKDWWKHLQFUHDVHLQZDJHVIRU¿UPVLQWKHLU¿UVW\HDUH[SRUWLQJWRWKH(8LVQRWVWDWLVWLFDOO\VLJQL¿FDQW 12 World Bank Figure 5: Firm size and propensity to participate in export markets by type of ownership (a) Average number of employees per firm 400 350 300 250 200 150 100 50 0 2006 2007 2008 2009 Domestic-Owned EU-Majority Owned Other Foreign-Owned (b) Probability of exporting 100% 80% 60% 40% 20% 0% 2006 2007 2008 2009 Domestic-Owned EU-Majority Owned Other Foreign-Owned Source: World Bank staff calculations based on TurkStat’s Structural Business Surveys. 13 Evaluation of the EU-Turkey Customs Union Table 6: Propensity to export to destination markets by firm ownership10 Dependent variable Dummy Dummy Dummy Dummy Dummy Dummy Dummy Dummy for ¿rm for ¿rm for ¿rm for ¿rm for ¿rm for ¿rm for ¿rm for ¿rm exporting exporting exporting exporting exporting exporting exporting exporting to the EU to MENA to Central to Africa to other to Latin to the US Asia & Asia America rest of Europe (1) (2) (3) (4) (5) (6) (7) (8) EU-majority 1.054*** 1.137*** -0.00618 0.130*** 0.356*** 0.556*** 0.553*** 0.290*** owned dummy (0.0380) (0.0647) (0.0347) (0.0340) (0.0373) (0.0339) (0.0374) (0.0372) Other 0.916*** 0.248** -0.0204 -0.0204 0.347*** 0.622*** 0.333*** 0.517*** foreign-majority owned dummy (0.0855) (0.0968) (0.0806) (0.0805) (0.0885) (0.0799) (0.0934) (0.0834)