Predicting the Potential of EU-Turkish Trade Flows
Abstract
The gravity model is applied to the bilateral trade flows (in imports) of the EU(15), CEECs(10) and Turkey over 1968-1989 and 1993-2003. This to verify the effects of EU membership on the trade flows, with a focus on the recent enlargement of the EU with the CEECs (2004) and possibly Turkey. First, the history of the EU and the European trade relations are examined, followed by the role of Turkey in this context. The 2004 enlargement and the potential accession of Turkey are considered in the light of a possible shift in trade intensity from the historical core of the EU (EU-15) to the new periphery (CEECs). The trade potentials within the countries in the sample for 2003 are estimated by the coefficients from the 1993-2003 sample, starting with the CEECs and Turkey in their position as non-EU member states, and finally in their fictional situation of being EU members (in 2003). The main findings are: i) a shift in the trade intensity to the Eastern European periphery does not occur; ii) Turkey’s trade with the CEECs demonstrates some room for growth; iii) contrarily, evidence of additional trade with the EU(15) does not come to the light.
Keywords: Gravity model, Turkey, European Union, bilateral trade, core, periphery
F.J.T. Berghuis
Albert Cuypstraat 140d 1073 BJ Amsterdam Student number: s1074393
E-mail: f.j.t.berghuis@student.rug.nl
International Economics& Business (IE&B) Rijksuniversiteit Groningen
Landleven 5
Zernikecomplex Paddepoel 9747 AD Groningen
1st Supervisor: Dr. E.H. van Leeuwen 2nd Supervisor: Prof. dr. S. Brakman
November 2005
Acknowledgements
Before you lies what I gave birth to, and which I therefore call my child. My child and I have moved to Amsterdam lately, where I have made the final stretch to completion in order for it to reach maturity. In hindsight to say that it was an intense experience, is an understatement:
Looking back, I must admit that was an intense experience. It gave me sleepless nights and RSI on the one hand, yet on the other, it transformed me from an econometrical and statistical nitwit into ‘an expert’. A former nitwit who most surprising to myself, gave other students advice concerning econometrical and statistical pitfalls throughout their projects.
The completion of my thesis could not have been adequately taken place without my supervisor, dr. E.H. van Leeuwen. Despite the horror-stories that appear every now and again about clashes between students and their mentors, this was not applicable in my case at all.
On the contrary, I was positively surprised to notice the time dr. van Leeuwen reserved in order to discuss my progress and assist me in overcoming the obstacles I experienced underway. Therefore, I would most sincerely like to thank him for his versatile and kind help and involvement during my project.
One of the goals I set myself before the SID program of International Economics and Business started, was to improve my English significantly. Despite the fact that I find myself reasonably satisfied with my current knowledge in that field, it still needs brushing-up.
Throughout the completion of the thesis, Merel van der Lei supported and corrected me wherever necessary on a linguistic level, being an English graduate, for which I owe her many thanks.
Last, but certainly not least, I would like to express my gratitude towards my parents for their infinite benefaction: the moment I told them I would like to enrol in the SID program of IE&B (as a fifth year student already), they supported me for 100%. They gave me the chance to gain more in-depth knowledge in the economic field and to develop myself as a person.
Accordingly, I would hereby say that I am extremely grateful to them for giving me this opportunity.
Friso Berghuis Amsterdam, 30 November 2005
INTRODUCTION
Generally, the core of the European Union (EU) is considered to consist of its six founding member states1. However, the successive enlargements added a relatively large periphery to the union; first with the addition(s) of the Cohesion Countries2 and followed by that of the CEECs3. Egger and Pfaffermayr (2002), conducted a research into the intra-EU bilateral trade effects of both the formation of the Union and enlargements with new member states over the period from 1960-1998. The changes of bilateral trade flows of the core members and
peripheral (inhomogeneous and developing) countries belonging to the EU were evaluated over this period. The main questions addressed in the study were: whether enlargement brings intra-core, core-periphery and intra-periphery trade and how these trade flows respond to EU enlargements.
”If there is to be a world of regional trading blocs, it seems likely at this point that it will at the very least involve some distinction between the advanced-country cores and developing- country peripheries within each bloc. ...; a crucial question would then be the division of gains measured in increased trade within each bloc between the core and periphery (Egger and Pfaffermayr, 2002).”
The authors concluded that EU integration leads to a stronger growth in core-periphery and intra-periphery trade, than within the core itself. According to Sachwald (2004), trade between the EU(15) and the accession countries has increased rapidly from the early 1990s on. The enlargement of the European Union with the CEECs in 2004 was the most encompassing so far, both in terms of the number of countries as well as the population number. Eight former communist countries as well as Malta and the Greek part of Cyprus joined the European Union. In 2007, if all goes well, Rumania and Bulgaria will also join.
There is one country which has been a candidate-member for many years but with whom negotiations have only recently started, namely Turkey. According to Yazganarikan (2003), the European Union is an important market for Turkey. The EU(15) has a 50 percent share in Turkish exports. The trade between the CEECs and Turkey has increased significantly over the past ten years, but the volume of trade is still low.
The rapid tying in the EU via trade liberalization agreements (Europe Agreements) led to a quick altering of the CEECs trade from the former partners (primarily the former Soviet Union) towards the EU and hence improved East-West trade considerably. The CEECs have shifted their trade flows towards the EU, but the peripheral CEECs have more historical trade ties with each other than with the Western European countries, implying that a shift in the trade centres within the EU could therefore take place. The recent free trade agreements between Turkey and the CEECs, signed in 2005, will probably have positive effects on their bilateral trade flow. Therefore, these removed trade barriers might give an extra boost in the
1 The core of the European Union consists of: France, Germany, Italy, the Netherlands, Belgium and Luxembourg.
2 The Cohesion Countries are Greece, Ireland, Portugal and Spain. They are collectively termed ‘the EU cohesion countries’ because of their low levels of income per head (relative to the EU(15) average) over most of the post-war period (Barry, 2003)
3 This group of countries is better known as the Central and Eastern European Countries (CEECs), and they have low incomes per head similar to the Cohesion Countries: The Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia. The other two new member states are Cyprus and Malta. In the light of accession in 2004, countries like Romania, Bulgaria and Croatia are not incorporated in this group, although they are part of the CEECs geographically.
shift from the core-periphery trade to peripheral-periphery trade. As a result, the ‘direction of trade-map’ in the Union, which demonstrates the direction as well as the intensity of trade, might get a different appearance in the near future.
The aim of this study is to examine the influence of EU membership on the bilateral trade flows within European countries, and offering a prediction for EU-Turkish trade flows.
The observed trade flows, measured by means of the imports of entrants preceding and following their accession to the EU will serve as a benchmark. For the analysis the gravity model, a successful empirical model, will be applied to assess the pattern of trade among the countries in the sample. The gravity model incorporates the variables that are perceived as being the main causes of the imports (and exports) of country pairs. The observed imports will be compared to the predicted imports for the year 2003, which is the last and most representative year of the time-series in the study. The error ( ), in the gravity model, is the difference between the observation (actual) and the estimated imports4. If the observed imports are larger than the estimated ones, the country pair trades more than the model predicts and there is no growth expected in their trade volumes. This is indicated as that there is no trade potential (actual minus estimated imports is positive). If the imports are lower than estimated, the particular country pair is expected to have room for growth left in its imports (and exports for the other). Logically, this indicates a trade potential (actual minus estimated imports is negative).
According to Flam (2003), Lejour et al (2004), and Antonucci and Manzocchi (2004), the EU membership as a preferential trade agreement must be included as a variable in the model to take account of the special intensity of trade relations between EU members. Their trade flows generally exceed the predictions of the gravity model, when there is not given account of the membership as a trade facilitating factor. For the estimations of the EU-Turkey bilateral trade relations, Lejour et al (2004) subsequently used the estimated coefficients to compute the potential EU-Turkey bilateral trade. The present study will measure Turkish trade with (future) EU member states by taking the level of trade that could reasonably be expected among the member states, by assuming that both Turkey and its partners would be EU member states in 20035.
The influence of accession on the intra-EU bilateral trade flows between the member states covers two time spans. The first period is from 1968 until 1989 and includes the set of countries that accessed the EU since the foundation of the Union and within this period. The second period is from 1993 until 2003, and adds the wave of enlargement that took place in 1995, plus the set of countries that joined the EU in 2004. The break in these two periods is a result of East and West Germany’s unification in 1989, and the division of Czechoslovakia into the Czech Republic and Slovakia in 1993. The motivation for incorporation of the 2004 countries is to investigate the effects of their forthcoming membership with respect to the consequences for Turkey as a relatively similar country to the CEECs.
Throughout the study, the findings and results will be discussed from the core-periphery point of view: Turkey’s prospective membership of the Union might be accompanied by a growth in its trade relations with the EU(15) and the CEECs. These trade perspectives will be determined by the results of the gravity model’s estimations, both with Turkey (and the CEECs) as non-member and member states in 2003. The influence of both the CEECs and Turkey as member states will then lead to a different trade map, and core-peripheral distribution, within Europe. The trade intensity in Europe is calculated by a comparative analysis, by taking into account the differences in the size of the populations of the countries.
4 The differences can either be conceived as trade potentials, errors or due to omitted variables of the model
5 Including the Central and Eastern European Countries
The structure of the study is as follows: Chapter one describes the history of the EU and the motivations for countries to become members. The foundation of the European Union after WWII and its appeal to new member states due to the Union’s will be discussed. Thereafter, the enlargement of the EU in 2004 with predominantly Central and Eastern European
countries6 is used to apply their individual ‘roads to accession’ to predict one for Turkey. The EU-Turkey, EU-CEECs and CEECs-Turkey ties are examined in order to make a distinction between the similarities and differences between the earlier accessions and the Turkish case.
Chapter two gives an overview of the trade patterns within Europe, more specifically the EU and future EU member states. The internal market and the trade amongst member states are considered in light of the 2004 wave of enlargement. The accessions of the CEECs will be examined based upon the core-periphery approach by Egger and Pfaffermayr (2002). Finally the possibility of a shift from the former Western European member states as the epicentre of trade to the Central and Eastern European member states is discussed with respect to Turkey.
The EU-Turkey trade agreements might have consequences for Turkey, not only as being a prospective member state, but also in view of the changing trade pattern.
Chapter three deals with the application of the gravity model as the prime tool to assess the trade pattern. It is one of the most popular empirical tools for modelling bilateral trade flows.
The model provides the estimation method for the existence of a trade potential of Turkey, taking into account the data of former accessions. The variables of the model are discussed, and will be determined upon their explanatory power of trade flows between countries within the sample.
Chapter four describes the necessary statistical tests that need to be fulfilled. The legitimacy of the choice for the statistical procedure depends on whether the data fulfil the assumptions.
The implementation and exclusion of the right variables in the gravity equation is crucial. It is of the utmost importance that the variables are either included or omitted on the basis of their relevance in predicting the bilateral trade
Chapter five, finally, discusses the results of the output. The tests of the trade data yield the estimators of the independent variables in. The coefficients that belong to each variable define their influence on the predicted trade flows between the EU member states. The difference between the predicted and actual trade flows give a set of residuals that represent the possibility of room for growth in trade. The estimations are followed by a re-estimation for the case where both the CEECs and Turkey are EU member states and they would be able to benefit from the eventual positive influence of EU membership on trade. Hence, the actual and estimated trade (imports) apply to all EU member states, but with a special interest for the latest CEECs and Turkey, both in the case of their EU membership and non-membership. The outcomes will then provide the necessary information whether EU membership would
enhance trade significantly and if it would induce a shift from the trade intensity from the core to the periphery and between the core and the periphery.
6 Malta and Cyprus can, geographically seen, not be counted to the Central and Eastern European countries.
They are, however, mentioned in the same breath since they joined the EU at the same time and their importance is relatively small in the study.
1. ACCESSIONS TO THE EUROPEAN UNION
For centuries, Europe was the scene of internal wars: the period from 1870 to 1945, for example, was characterized by France and Germany’s threefold hostile interaction. The European post-war period in the late 1940s and thereafter was characterised not only by rebuilding the continent, but also by a reunification of Western-European countries. At the locations where the allied forces and Soviet troops ‘encountered’ each other, while invading Europe at the end of WWII, frontiers were newly erected. The so-called iron curtain divided Europe into east and west. Germany itself was separated by the Berlin Wall, transforming the former nation into two separate ones. In the post-war years, East-Germany remained strictly Soviet-controlled for a long period, while West-Germany gradually recovered autonomy. The contrast, with the central planning by the communist Soviet regime on one side, and the capitalist Western regimes on the other, was striking.
This chapter will review the history of the European Union, its successive enlargements and their implications to the functioning of the EU. The overview of the Union is followed by discussion of the eventual enlargement with Turkey.
The background of the Union will be discussed in section 1.1, followed by an overview of its successive enlargements in 1.2. Section 1.3 will deal with the negative effects resulting from the enlargements. Accession negotiations with Turkey would imply the largest in EU history.
Turkey already applied for association with the European Economic Community in 1957.
From this point of view, it might be strange that the official negotiations for accession started only in October 2005. The prospective enlargement with Turkey and its historical ties and characteristics with the EU, are discussed in section 1.4.
1.1 Background of the European Union
The Marshall Plan, called into existence by the United States (US) in 1947, provided the necessary economic support for rebuilding Western Europe. The US reasons for the financial aid were twofold. Firstly, US trade with Europe had always been important for both
economies. The Marshall-plan contained restrictions that forced the Western European
countries to buy American, and the US thus stimulated their domestic economy. Secondly, the support had an anti-communist character due to the tense situation between the US and the Soviet Union. The Eastern European countries were therefore not in the position to obtain the financial means to recover at an equal pace with the Western European countries. As a result, the external financial aid facilitated rapid recovery for the Western European countries, whereas the CEECs significantly dropped behind in terms of economic development and accompanying levels of welfare.
In the years following WWII, the focus was not merely on economic recovery in Western Europe. A number of European leaders became convinced that the only way to secure a lasting peace between their countries was to unite them economically and politically. In 1957, six countries7 confirmed their lasting peace and supported their recovery and economic prosperity by signing the Treaty of Rome, establishing the European Economic Community (EEC), the precursor of the European Union. Over more than half a century of European integration, the Union has shown that a whole is greater than the sum of its parts8. The EU as a unity aims at creating more economic, social, technological, commercial and political power than its member states could achieve individually (25 members in 2004). The European Union has added value: Acting as one, speaking with a single voice, and trade liberalization in its
7 Germany, France, Belgium, Italy, Luxembourg and The Netherlands
8 http://www.delkor.cec.eu.int/en/highlight/why_the_european.htm
market (the internal market). The succeeding enlargements and the growing pains by which they were accompanied will be discussed in the following paragraph.
1.2 Waves of Enlargement
From an economic point of view, accession to the EU means accession to the ultimate form of free trade. One has free access to the large internal market, and the trade flows are facilitated with a ‘guaranteed’ level of reliability, ratified by the acquis communautaire9. With the accession of the CEECs in 2004, the member states have created the largest single market for trade and investment in the world. The market currently consists of around 500 million consumers, which is larger than those of the USA and Japan combined.
Until 2004, 19 countries successively joined the European Union. The latest wave of
enlargement, in 2004, added ten new member states. Eight of the new members were Central and Eastern European countries (CEECs). At the moment, there are 25 member states, and new enlargements are on the way (see figure 1.1). Bulgaria and Romania expect to join the EU in 2007, while Turkey and Croatia started their membership negotiations in October 2005.
9 http://en.wikipedia.org/wiki/Acquis: The French term acquis (or sometimes acquis communautaire) is used in European Union law to refer to the total body of EU law accumulated so far. The term is also used to describe laws adopted under the Schengen treaty, prior to its integration into the European Union legal order by the Treaty of Amsterdam, in which case one speaks of the Schengen acquis.
Figure 1.1 Accession Dates
1973: Denmark, United Kingdom and Ireland 1981: Greece
1986: Spain and Portugal 1995: Austria, Sweden, Finland
2004: Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia
After the founding of the EEC in 1957, the six core members saw their efforts leading to great benefits. Their main objective was to re-establish political stability and economic growth, in which they succeeded rapidly. The success of the Union attracted the attention of other countries on the continent. The willingness to become a member state increased over time.
The United Kingdom, for example, initially retracted its application to become a member, This proved the doubts of the President of the French Republic, General de Gaulle, about the political will of the United Kingdom to join the Community. The economic prosperity created by the EEC members in the 1950s and 1960s, however, made the UK review their opinion. In 1967, the United Kingdom re-applied to join the Community. General de Gaulle, however, remained reluctant to accept British accession. In 1961, Britain, Denmark and Ireland formally applied to become EEC members and in 1973, they joined the EU and they have benefited from their membership ever since (Delhey, 2001).
By joining the EU in 1981, Greece was able to benefit from the system of international
economic and political relations. Much of the geographic and economic distance, separating it from the rest of the European Union, has been reduced. To put it in other words, according to Egger and Pfaffermayr (2002), Greece moved from the periphery or the semi-periphery to the centre of the Union. The manner, in which the Greek economy operates nowadays, in a competitive environment and in a regulatory framework, has radically changed since 1981.
Entrants like Portugal and Spain (1986), and Ireland (1973) have fared pretty well after their accession. Production per capita in Ireland is now one of the highest in the European Union.
Measured in purchasing power terms, Spain has also increased its production per capita from 74% in 1986 to 84% in 2001 of the EU(15) average, and Portugal’s has increased from 62%
to 75% in the same period (Lejour et al., 2005).
Austria, Sweden and Finland used to be members of the European Free Trade Association (EFTA) since 1961. Similar to the UK, Denmark and Portugal in their respective preparatory
stages of accession, theses countries decided to leave the EFTA and join the EU instead in 1995. Their accession to the EU added relatively highly developed industrial and rich countries to the Union, contrary to the previous enlargements with Greece, Portugal and Spain.
To some extent the CEEC accession process began in the early 1990s, shortly after the free market system got under way in these countries. During that period, the countries signed bilateral agreements with the EU (i.e. the Europe Association Agreements), which represented an advance in the path towards integration through making provisions for a progressive
liberalisation of trade. Countries such as Poland, the Czech Republic and Hungary have always felt to be culturally part of the west. In their opinion, it was the cold war that cut them off from the past 50 years of economic and political progress (The Economist, 2001). Their leaders believed that joining the EU would make them part of the stability of the west and would allow them to turn their backs on the threat of chaos, tyranny and poverty coming from the east. Besides economic prosperity, one of the most cited arguments for application by CEECs was the European regulation (often criticized by existing members). The CEECs leaders considered these regulations to be necessary in order to create a stable market
economy. Besides, they feared that without the set of rules and regulations from Brussels, the countries would remain vulnerable to Russian capitalism to some extent.
The CEECs have been granted preferential trade treatment since the Europe Agreements10, signed between 1993 and 1995, came into force around 1995, 1996 and 1997 (Mordonu, 2004). The formal start of negotiations for the EU’s latest enlargement started in the same period (De Benedictis et al, 2005). The CEECs, including Romania and Bulgaria, individually applied for EU membership between 1993 and 1996. The CEECs signed the Treaty of
Accession in April 2003, whereas the Romanian and Bulgarian applications were shelved, merely on the basis of their inability to cope with the level of corruption and the respect for human rights.
1.3 Drawbacks of Accession
As in many circumstances, the benefits for one party bring disadvantages for the other. From the perspectives of the Western European countries, there were threats involved in the
accession of the CEECs as well. These countries expected to face fierce competition from the accession countries with regard to inward investment and some sectors were very likely to suffer from it. Nowadays, the Czech Republic has already become Europe's most popular location for investment in the automotive industry, and the temptation for EU-based suppliers to move eastwards is increasing.
In addition to the benefits of the large internal market caused by the enlargements of the EU, there are also drawbacks: its size makes it harder to keep close control of the various internal processes. The growing size of the EU, for example, is accompanied by substantial
differences in the levels of welfare between the (new) member states. The levels of
development differ per country, especially between the older members and the 2004 member states. The CEECs are significantly lagging behind in terms of their gross domestic products per capita, the level of corruption and budget deficits. In 2001 the income per capita in the ten new member states was about 45% of the EU(15) average (measured in purchasing power terms). The income gap with the EU(15) is larger compared to earlier entrants like Ireland,
10 Europe Agreements, also called Association Agreements, have been signed by Hungary and Poland in 1991, by Bulgaria, Czech Republic, Romania, Slovakia and the Baltic Republics in 1993, and by Slovenia in 1996.
They have come into force for Hungary and Poland in 1994, for Bulgaria, Czech Republic, Romania, Slovakia in 1995, and for the Baltic Republics in 1998 and for Slovenia in 1999. They include trade liberalization clauses.
Portugal and Spain (Lejour et al, 2005). Barro and Levine (1991) conducted their research to the convergence of low-income countries to the EU(15) average, expressed in per capita incomes (see figure 1.2). They used Portugal, Spain and Greece, as previous accession countries, as benchmarks. The calculations of the growth in GDP per capita for the CEECs were on the assumption that the former accession countries grew at a rate of 2 per cent per year.
--- Figure 1.2 in the Appendix ---
The figure demonstrates that, even for a rapid developing economy like in the Czech Republic, it will take 10 to 15 years to attain the average income level of the EU(15). For a large number of countries incorporated in the figure, the path towards equalization is even expected to exceed 20 years. Barro and Levine (1991), however, neglect any effect of
enlargement on growth in the CEECs. The accession is likely to speed-up the convergence of per capita incomes, but even then any convergence on the short term remains uncertain.
According to Boeri and Brücker (2001), estimates based on computable general equilibrium models predict that Eastern Enlargement will rise per capita GNP levels in the candidate countries by 1.5% under conservative assumptions and approximately 19% if the impact of EU membership on risk premiums and capital accumulation would be taken into account (which represents a once-only boost to the national incomes). Moreover, EU membership is also expected to enhance sound economic policies in the CEECs-10, which may speed-up economic convergence.
EU membership also implies that there will be support for its member states in, for instance, the field of agricultural subsidies. Agriculture is the main problem for the CEECs and applicant countries. The problem lies in the sense that a lower welfare level can also be expressed in the share of agriculture, to which it is negatively correlated. Whereas in the EU(15) the farm sector employs around 5% of the population, the proportion in, for example, Poland is over 20% (in 2004), while the other CEECs are in between. The welfare gap
between the existing and applying countries was one of the reasons for the settlement of the Copenhagen criteria11 in 1993, at the Copenhagen European Council.
Accordingly, to become a member of the EU, it was now necessary to fulfil a set of criteria, the first of which stipulated to achieve a stability of institutions, to guarantee democracy, the rule of law, human rights and respect for and protection of minorities and follow the
democratic principles and human rights established by the Helsinki Act and the Chapter of Paris for a new Europe (Yazganarikan, 2003). The second economic criterion is the
requirement of the existence of a functioning market economy and, consequently the capacity to cope with the competitive pressure and market forces within the European Union. The third criterion is the ability to take on the obligations of membership, including adherence to the aims of a political, economic and monetary union. This criterion refers to the implementation of the Union’s legislation, the acquis communautaire. The acquis communautaire are
important to guarantee that after accession the free movement of labour, capital, goods and services is guaranteed. At the moment the CEECs, however, seem to catch up economically at a faster pace than most studies predicted (see Barro and Levine (1991): figure 1.2), with the
11 The EU’s Copenhagen Criteria stipulate that in order to join the EU, a country must: have a stable democracy that respects the rule of law, and the protection of minorities; and have a functioning market economy; adopt the rules, policies and standards that make up EU law.
Czech Republic and Poland in the lead. The surprisingly high rate of development is due to the fact that they were forced to in order to fulfil the Unions’ requirements, settled in the Copenhagen criteria, as well as the fact that their economies are highly competitive relative to the Western European ones. According to Delhey (2001), EU membership does not guarantee catching up, but it makes catching up easier. Enlargements that preceded the 2004 set of countries, gave rise to more signs of success than of failure. Convergence with respect to development is a long-term goal, and therefore less advanced countries need perseverance.
Even Ireland needed 25 years to catch up economically, and Greece continued to demonstrate growth rates lower than the EU average following their accession in 1981. These facts are very interesting in the light of the current negotiations for accession of Turkey, considering its characteristics and historical ties with the EU. The next section will discuss the Turkish case.
1.4 Turkeys History of Application for EU Membership
In October 2005, the official negotiations for accession for Turkish accession to the European Union started. The entry is heavily debated on several points, which makes it less likely for Turkey to join in the near future. The unprecedented debates concerning accession are largely due to the specific features of Turkey that remain constant subjects of discussion, namely its size, culture, location, welfare level, political convictions, human rights and institutions.
The Turkey-EU relations started very shortly after the creation of the European Economic Community in 1958. In 1959, Turkey made the first application to join the EEC. The EEC suggested the establishment of an association agreement to prepare Turkey for full
membership (Yazganarikan, 2003). 41 years have passed since this so-called Ankara
Agreement12. This arrangement indicated the first step in Turkey’s attempt to join the process that has resulted in the formation of the EU.
The Turkish attempts for EU-membership had the effect of trade being purposely oriented towards Europe. Especially after the 1980s, during which the Turkish economy became more liberated in terms of international economic flows and after the dismantling of the Soviet Block, this tendency increased with the formation of the Customs Union between Turkey and EU(15) in 1996 (Deger, 2003). The EU(15) and Turkey Customs Union heralded the
abolishment of customs duties between both parties. The implementation involved the Common Customs Tariff (CCT) and the adaptation of the EU’s commercial policy and all preferential trade arrangements the EU had concluded with third countries. Moreover, there were preparations for the similar modifications in the field of law and legislation mainly in the areas of protection of intellectual, industrial and commercial property, competition rules, state aids, direct and indirect taxation and government procurement.
In comparison with previous accessions, the Turkish case has turned out to be significantly different (Yazganarikan, 2003). At the beginning of the 1980s, Turkey started its
liberalization efforts. As a result, its economic structure changed by shifting the inward looking policies to export oriented policies. Before the 1990s, in contrast with the CEECs, the economic structure of the Turkish economy was based on market principles. During the 1990s, Turkey had a liberal open economy that was more vulnerable to external
developments. The annual growth performance was affected by these external ‘shocks.’
Between 1996 and 2001 the average growth rate was 3%, which was lower than the 1990-
12The Ankara Agreement is the oldest and long/standing association relationship in which the EU is engaged. It was signed on 12 December 1963 and came into effect on 1 December 1964. The agreement facilitated the settlement of the 1996 Customs Union, financial cooperation and free movement of workers (Yazganarikan, 2003)
1995 period growth level of 4.3%. After the 2001 shock, the economy recovered quickly with a structural adjustment and economic reform program. The growth rate recovered and became positive again (see figure 1.3).
Figure 1.3 Economic Growth Turkey
Source: Erçan, H. (2004)
The figure demonstrates that the Turkish annual growth was on the rise after the 2001 decline.
In 2002 there was a growth rate of 7.8% and it is still increasing. The growth from 2001 onward is higher than the EU average, which implies convergence towards the average GDP in the EU. These figures were confirmed by calculations of VNO-NCW (2004)13, who predicted the Turkish GDP to have a considerable growth potential in the near future, while the GDP in the EU is likely to have a negligible growth.
As mentioned by the Barro (1991) calculations in figure 1.2, however, income convergence of low-income countries towards the EU-average takes 25 years on average. Furthermore, the data in table 1.1 show that the future prospects for Turkey are not as bright as they might seem.
13 See: www.ser.nl/downloadpdf.asp?filename=/ _upload/databank_deeladviezen/b23238_5.pdf Quarterly growth (year-on-year)
-15,0%
-10,0%
-5,0%
0,0%
5,0%
10,0%
15,0%
20,0%
25,0%
19881989199019911992199319941995199619971998199920002001200220032004
Industry
GDP
Table 1.1 Evolution of the GDP per Capita as % of the EU(15)
Source: Dervi et al (2004)
Dervi et al (2004) concluded that the convergence of the GDPs per capita to the EU(15) would be low. They found that it would take Turkey more than half a century to reach income levels comparable with the EU(15), even with sustained GDP-growth differences of 3 percent.
Despite the recently high level of economic growth and the relative low initial level in 2004 compared to the other countries, Turkey was expected to have converged only up to 50% of the EU average in 2019.The predictions in table 1.1 demonstrate that in 2019, Turkey would be at the level of Romania. Romania was rejected to join the EU in 2004, merely as a result of its welfare gap with the EU member states and future economic growth prospects, as
mentioned in figure 1.2 on page 9. Accession of Turkey (and countries like Romania), on the other hand, might give a boost to their per capita income. According to Benedictis et al (2004), forthcoming accession by itself has proven to be of positive influence on the economies of accession countries.
With respect to Turkey’s willingness to join the EU, a lot of obstacles still remain from an EU point of view. The EU can allude to the fact that Turkey fails to meet the Copenhagen criteria in all areas, but there are other factors playing a role as well. One reason can be extracted from the implications for the EU budget. Turkey's size, its large agricultural sector and relatively low income (per capita) would make it the largest net recipient of funds from the EU budget. A second reason may lie in the power Turkey would get in EU decision-making according to the size of its population (70 million inhabitants in 2005). Turkey may well have a population larger than that of Germany by 2020, if the present growth-in-population trend continues. A third reason is that Turkey is seen as the other Europe, with respect to the dominant religion and ties to the Middle-East (Müftüler-Bac, 1998). A fourth obstacle to accession concerns the difference between a customs union in industrial goods, and being part of the Single Market. EU membership adds free trade both in agricultural goods and services, and free mobility of capital and labour after a transitional period. Therefore, it will be
interesting to see whether the statistical findings in chapter five will share the expectation that membership has no effects on the trade pattern (in industrial goods).
The above mentioned barriers to membership seemed to be reduced during the recent EU- Turkey negotiations for accession. One last important issue, however, still stands in the way:
Turkey consistently refuses to acknowledge Cyprus as an independent country, while the latter has been a full-blood member of the Union since 2004. As a result of the 2004 enlargement of the EU, Turkey signed for a Customs Union with the CEECs in July 2005.
This was in accordance with the EU’s pledge to extend its Customs Union with the new member states. Thereby, Turkey indirectly signed for a Customs Union with Cyprus, while its interaction with Cyprus is still tense. The situation is the main obstacle for the progress in the negotiations for Turkey to become an EU member state.
1.5 Conclusion
Since its founding in 1957, the success of the EU has been augmented by countries’
willingness to become member states. The successive enlargements generally resulted in increased levels of welfare for the accession countries as well as opportunities for EU incumbents. The largest enlargement took place in 2004, and new enlargements are forthcoming. The candidate countries are Bulgaria, Romania, Croatia and Turkey. The Turkish case is unique in terms of the size of the country, religion, economic position and geographical location. Compared to previous accessions, Turkey’s accession is relatively more highly debated within the EU.
For the near future of the Union, the EU set itself strategic goals preceding the accession of the ten new member states in 2004. At the European Council in Lisbon in March 2000, the EU decided upon a new set of goals. The strategy was designed to outline the role of the enlarged European Union in a 21st century world, especially with respect to the rapidly changing environment of the Union. According to the strategy that was decided upon, the overall ambition of the EU of a possible 27-member-states' Union must be the effective exploitation of the European diversity in order to create a competitive Europe. The next chapter will discuss the economic consequences by which previous enlargements and
Turkey’s accession are accompanied. The focus will be on the trade pattern within the Union as well as its trade relations with Turkey.
2. THE EUROPEAN TRADE PATTERN
The nature of bilateral trade can be explained by means of cultural familiarity (e.g. common borders, sharing a common language and religion) and similarity (cultural similarities like corporate governance structures and institutional settings). Bilateral differences in
institutional quality are expected to negatively influence trade costs, according to De Groot et al (2003). A firm exporting to a foreign country with an institutional quality level comparable to that of the firm’s home country is likely to operate more effectively in that country. This is because it does not incur large adjustment costs stemming from the unfamiliarity and the insecurity related to transaction contingencies in trade. A large cultural distance, on the other hand, raises the costs of international trade, as large cultural differences make it difficult to understand, control, and predict the behaviour of others, which complicates interactions. De Groot et al (2003) found that countries with comparable governance quality levels generally traded more. This study concluded that the institutional quality of both the importer and exporter has a positive effect on the amount of trade between them. The institutional distance turned out to have a negative effect on bilateral trade flows, while cultural distance had a positive effect.
Besides the cultural and institutional mentioned above, this study will also examine alternative and more straightforward trade enhancing factors that explain the nature of bilateral trade. The size of countries, both population and national income, has proven to be an important determinant of trade. Moreover, the distance and the existence of trade
agreements are trade enhancing, intuitively. In the light of the core-periphery trade and the model that will be determined in chapter 3, these factors will play an important role
throughout the study. Section 2.1 will determine the nature of trade flows within Europe and the European Union. The trade relations of Turkey and the possibility of its forthcoming accession are discussed in section 2.2.
2.1 Trade in the EU
According to Eichengreen and Irwin (1996), cultural familiarity, similarity and history play a role in shaping the direction of international trade. Countries with a history of trading with each other, for reasons of politics policies or other factors, generally continue doing so, because, for instance, market-specific sales, distributing and service networks might have been set up. The founding members formed the EU on the basis of their historical ties and similar institutional and governance structures, which facilitated trade amongst the countries.
With the 1957 settlement of the EEC, the precursor of the EU, the remained trade
impediments between the member states were reduced. The removal of the trade barriers further increased the trade ties between the EU core members14, and it strengthened their position in being the epicentre of trade in Europe. The successive enlargements, however, added an increasingly important periphery to the Union, as described by Egger and Pfaffermayr (2002).
The Southern European economies at their time of entrance into the EU, were specialized in agricultural products and traditional industries like food, textiles, apparel and leather.
Considering the enlargement of the EU with these countries, evidence shows that Portugal rapidly changed its export structure, moving closer to the EU average level of trade intensity in volume and value. Both Spain and Portugal experienced a large increase in trade volumes with the EU after their accession. Spanish imports and exports increased by 58% and 23%
14 Germany, France, Italy, Belgium, Luxembourg and The Netherlands
respectively in real terms, while Portuguese imports and exports increased by 192% and 64%.
Despite the increase in trade of Greece, Spain and Portugal over a decade, they did not fully converge to the EU average in terms of trade structure (in terms of capital and labour
intensity). The correlation between Greece and the EU in terms of exports is still very low and it actually decreased over time (Tajoli, 2003).
The countries in the fourth enlargement (Sweden, Finland and Austria) were at least as prosperous as the average of the 12 EU member states at that time, and quite similar to them in many respects. A striking point in the wave of enlargement in 1995 is that the Austrian, Finish and Swedish ratios of exports did not display a significant increase. In contrast to the estimations by Strada and Tajoli (2003), who predicted an increase in the exports and imports, there seemed to be an unexpected fall for Austrian and Swedish imports and exports after their accession. This could be explained by the fact that these countries were already at a similar welfare and trade level before their accession, so that the EU membership did not have significant effects.
In January 1997, tariffs on most of the industrial goods exports from the CEECs to the EU were dismantled. The removal of tariffs on EU exports to the CEECs was completed in January 2002. The 2004 wave of enlargement added the CEECs, who did not have a history of trade with the incumbents of the Union. According to the findings of De Groot et al (2004), the differences between the parties would impede the realization of business deals. As a result of the tariff removal, however, trade between CEECs and the EU grew rapidly over the last decade and EU exports to CEECs increased fourfold, while the imports from CEECs to the EU more than trebled (Bartsch and Grimaldi, 2003). With a helping hand from foreign investors, the CEECs export mix started to change and began to gravitate towards that of the EU. According to the findings in the EU-CEECs literature, the actual level of EU-CEECs trade due to the effectiveness of pre-accession agreements, the Europe Agreements in
particular, is very high. The effects of further EU enlargement to the East by the accession of Romania and Bulgaria are nevertheless expected to be modest. Nowadays nearly two thirds of the CEECs trade takes place with members of the EU and volumes of trade increased at a fast rate, so that the CEECs are today the second largest trade partner of the EU after the U.S. the evolution of trade patterns being in line with the evolution of other economic indicators.
In sum, the enlargement with the CEECs introduced a new set of trade partners to the EU, who are expected to have room for growth with respect to their intra-trade and with the EU(15). The CEECs accession could therefore be accompanied by a shift in the direction of trade. The former Western European epicentre of trade, where the intensity of the bilateral trade amongst members used to be very high, might shift to the Central- and Eastern European part of the Union. Egger and Pfaffermayr (2002) pointed out the possibility of a shift from a core-core and core-periphery trade, towards a periphery-peripheral trade, and thereby the formation of a new core in the periphery (Central and Eastern Europe). Trade facilitating effects like cultural familiarity and similarity between the CEECs, as discussed by De Groot et al (2004), might hereby play an important role. The following part will highlight the case of Turkey with respect to its trade relations with the EU.
2.2 Turkey – EU Trade
As in the case of the CEECs, the EU is an important market for Turkey. According to De Groot et al, this historical relationship might seem strange because of the lack of cultural
familiarity and similarity between the two. According to European External Trade website15, the EU ranked a solid number one position in both Turkey's imports and exports in 2003. The EU as export partner accounted for 58.1% of Turkish exports in 2003, followed by the US and Russia with only 8.2% and 2.3%, respectively. The EU as import partner accounted for
52.4%, of which textiles compose for about 40% of the total of Turkey’s imports. The other main imports concerned machinery (28.3%), chemical products (16.4%), and transport material (19.1%).
Hence, the EU as a trading partner is very important for Turkey. Until 2000, the Turkish imports and exports with its EU trade partners were rising. After the shock of 2001, figure 2.1 shows that the bilateral trade is on the rise again.
15 http://europa.eu.int/comm/trade/issues/bilateral/countries/turkey/index_en.htm
Figure 2.1 Turkey’s Trade Balance with the EU (in millions of Euros)
Source: Eurostat (2005)
Figure 2.1 displays that the bilateral trade between Turkey and the EU is increasing, after 2000. From that year, however, Turkey’s trade balance is deteriorating. The majority of studies concerning this topic estimate that there is room for development in the bilateral trade, especially if Turkey will join the EU. Besides, research revealed that Turkey benefited from countries’ accession in that its exports to these new member states increased. Turkey’s exports to Austria, Sweden and Finland, for instance, increased after their accession in 1995, even without Turkish membership of the EU. One explanation might lie in the fact that Turkey signed for a Customs Union Agreement with the European Union in 1996. The
agreement had a positive effect on Turkey’s trade pattern, and a great acceleration can be seen since then.
The fact that Turkey’s trade ties with EU member states are strong, indicates that with the 2004 wave of enlargement extra room for trade is created between Turkey and the CEECs.
Similar situations exist, more strikingly, between Turkey and a number of other countries, especially Greece, Latvia, Lithuania and the Slovak Republic.
In general, Turkey is a relatively unimportant importing trade partner for the EU countries and the CEEC-10, with the exception of Greece, Bulgaria and Romania. The proximity to these countries is probably the main reason for the higher-than-average trade flows. The EU, on the other hand, is Turkey’s most important import and export partner (see table 2.1).
Table 2.1 Turkey’s Import & Export Partners in 2004 Import Partners Export Partners 1. Germany (12.9%) Germany (13.9%)
2. Russia (9.3%) UK (8.8%)
3. Italy (7.1%) US (7.7%)
4. France (6.4%) Italy (7.4%)
5. US (4.8%) France (5.8%)
6. China (4.6%) Spain (4.2%)
7. UK (4.4%)
Source: CIA World Factbook, 2004
An important issue for Turkey’s exports is the end of The Multifibre Agreement (the global quota system on textiles and clothing), as a result of which Turkey expects to face fierce competition in international markets. As mentioned earlier in this paragraph, the exports of textiles represent around 40% of Turkey’s total exports to the EU. Therefore, EU imports of Chinese textiles and clothing in particular might replace their imports from Turkey.
An important feature of Turkey, in contrast to the EU member states’ average, is that its population amounts to 70 million (in 2005). Its accession would add a considerable
population to the number of 460 million inhabitants of the EU (in 2005). This means that the Turkish population would represent 15% of the EU. According to Feenstra et al (1999), country size plays a role in demand. If the prices of countries i and a j are the same, the total demand will be higher for the goods produced in the large country, because most of the total demand will be at the low no-transport cost price in the domestic market. This implies a more- than-proportionate entry of firms to restore zero profits. This is the origin of the so-called home market effect. Although the Union aims at one internal market, countries themselves remained important throughout the history of the Union. In that light, the larger countries with the right factor endowments would benefit from the variety of goods produced and the trade it yields. The enlargements with developing countries like the CEECs and eventually Turkey implied for these countries the attraction of Foreign Direct Investment (FDI). According to Tüsiad and Yased (2004), FDI has been increasingly seen as an important stimulus to the industrial growth and development and developing countries can attract it by creating the right circumstances16.
In a study to the home-country bias in the goods market among OECD countries from 1982 to 1994, Wei (1996) found that the transactions in the home-country market were about 2.5 times as large as imports from foreign countries. This home-country bias, however, is found to be slowly but steadily declining in many countries. In particular, the home-country bias of countries in the European Union (EU) declined by 50%. In the light of Turkey’s accession, these findings might contribute to an increased bilateral trade between Turkey and the European member states.
Potential benefits of Turkish entry that are of minor importance throughout this study are the various claims that Turkey could be a bridge to other regions: in the context of a wider
16 The ‘pocket list for investment’ includes: information from political and economic stability to taxes, incentives, investment location, logistic costs, personnel costs, presence of skilled labour, costs and condition of infrastructure for transportation, telecommunication, and energy (Tüsiad and Yased, 2004).
Europe, that Turkey could play the role of a connecting platform between Mediterranean and the CIS17 countries, on the one hand, and the enlarged European Union, on the other hand (Antonucci and Manzocchi, 2004). Member states’ exports to these regions could have a respectable growth. Turkey also has a strategic location with respect to Europe’s future energy supplies from the Middle East. Besides, Turkey as a secular and partly freeIslamic country has also been presented to the European public as a potential bridge to the Islamic world. Turkish membership could in this respect represent a chance for the EU to play a role in the reconciliation of Islam, democracy and the West.
2.3 Conclusion
The former (Western European) core of the EU is expected to shift in an eastward direction as a result of the enlargement with the CEECs. The forthcoming accessions of Bulgaria,
Romania, Croatia and eventually possibly Turkey, might intensify this change in the direction of trade. Turkey might benefit from the trade potential that is created by its forthcoming EU membership. Moreover, as a result of these countries (and the CEECs already in 2004) accession, a shift in the trade intensity towards intra-peripheral and periphery-core might take place in the near future. For Turkey, these developments are highly interesting, since trade liberalisation has been an important aspect of Turkey’s economic policy since the early 1980’s. It has already led to the formation of the Customs Union between Turkey and the EU in 1995, which covered trade in industrial goods and processed agricultural products. Most European countries export only a small part of all their goods and services to Turkey. Similar to the CEECs and Bulgaria and Romania, the majority of all exports from Turkey are
transported to the EU(15). The 1995 Customs Union intensified economic integration between the EU and Turkey, and the enlargement with Turkey would further facilitate the trade relations and the trade ‘centre of gravity’ within the Union. The next chapter will introduce the gravity model, by which these trade epicentres and flows are examined.
17 Commonwealth of Independent States: Armenia, Azerbaijan, Belarus, Kazakhstan, Kyrgyzstan, Republic of Moldova, Russian Federation, Tajikistan, Turkmenistan, Ukraine and Uzbekistan
3. THE GRAVITY MODEL IN THE EU CONTEXT
The “Law of Universal Gravitation” was proposed by Newton in 1687. His gravitation model stated that: the attraction between two heavenly bodies is proportional to the product of their masses and inversely related to the distance between them (Frankel, 1997, ch.4). The earliest form of the gravity model applied to economics was introduced by Tinbergen in 1962.
Tinbergen found that the equation could roughly be applied to international trade flows between countries (Head, 2003, p.2). The major advantage of the model is that the
independent variables can be incorporated depending on their applicability in the specific study. Thereby, its popularity stems from the fact that most gravity equations fitted the data so well that they typically yielded high R-squared (Sohn, 2005)18.
Since the gravity model has demonstrated its applicability in studies towards the trade flows, the model will be used to the estimate the imports of the countries in this study. This chapter is organised as follows: Section 3.1 gives a brief introduction to the origins of the gravity model, followed by its theoretical underpinnings in part 3.2. The application of the model in similar, preceding studies is described in section 3.3. The final version of the model as used in this study will be given in section 3.4. Section 3.5 presents an explicit discussion of the
variables of the model and the difficulties encountered. Finally, section 3.6 and 3.7 present the countries and the data that have been used.
3.1 Origins of the Gravity Model
Gravity models have long been applied to examine bilateral trade flows. The gravity model predicts that the volume of trade between two economies should increase with the economies’
size (measured in real GDP) and decrease with transaction costs (measured in bilateral distance). The “physical entities” are the exporting and importing countries, and their
“masses” are the sizes of their economies. The argument is that the larger the economies of the involved countries, the larger the trade among them. Distance forms a barrier to trade, because of transport costs and delivery lags, among other things. Additional trade hampering factors are import tariffs, border controls and quantitative restrictions, representing indirect or artificial trade costs (Antonucci and Manzocchi, 2004).
The very first and plain form of the general gravity law as proposed by Tinbergen (1962) had the following notation:
18The R-squares generally were in the range of 0.65-0.95
