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The Customs Union Between Turkey and the European Union and Its THE CUSTOMS UNION BETWEEN TURKEY AND THE EUROPEAN UNION AND ITS EFFECTS ON THE TURKISH ECONOMY A thesis presented by Ali Murat PALA to The Department of Economics In partial fulfillment of the requirements for the degree of Master of Arts In the field of Economics Northeastern University Boston, Massachusetts August, 2011 1 THE CUSTOMS UNION BETWEEN TURKEY AND THE EUROPEAN UNION AND ITS EFFECTS ON THE TURKISH ECONOMY by Ali Murat PALA ABSTRACT OF THESIS Submitted in partial fulfillment of the requirements for the degree of Master of Arts in Economics in the Graduate School of Northeastern University August, 2011 2 ABSTRACT Since the declaration of the Republic in 1923, Turkey has always looked to the West for its modernization and development processes. Following the Second World War, several organizations were created among countries in order to maintain joint power against conflicts, including organizations that had just economic reasons. Being a founding member of the United Nations, a member of the North Atlantic Treaty Organization, the Council of Europe and the Organization of Economic Cooperation and Development, it was only sensible for Turkey, an ally of the West to follow the modernization and development processes by proving a part of the European Economic Community formed by six Western European countries in 1957. Making its first application in 1959, Turkey ended up signing the Ankara Agreement also known as the Association Agreement in 1963 that foresaw how the customs union would be established in order to secure Turkey’s membership to the Community. As stated by Appleyard (2010), customs union is the second stage of economic integration. Economic integration can be defined as the integration of countries in order to remove trade barriers among themselves. Customs union not only removes the customs tariffs among member countries but also holds a common trade policy towards non-member countries. Customs unions have static and dynamic effects on the countries’ economies. This study analyzes why the customs union between Turkey and the EU does not manifest the expected static effects, why the trade share of the EU decreased over 3 time in spite of the customs union agreement and what measures should be taken in order to increase the trade between Turkey and the EU. In order to identify the problems, Turkey’s trade with the EU, OECD, OIC, BSEC, CIS, luggage trade with Russia, and the relations with Germany are observed. In addition, a basic econometric analysis is carried out to forecast the trade between Turkey and the EU. Following the results of the study, some suggestions are tried to be put forward to enhance the likelihood in achieving a more effective customs union between Turkey and the European Union. In this regard, firstly it is argued that Turkey should create policies towards technological developments and innovations in the manufacturing sector in order to produce at a lower cost than other member countries in the customs union. Secondly, Turkey should pursue a policy of including all of its goods, including agricultural goods, in the customs union agreement with the EU. Thirdly, economic policies to increase income should be carried out. Also, considering the Turkish population in the other customs union member countries, trade policies should be adjusted accordingly. Finally, the luggage trade with Russia should be taken under control in order to reduce its volume to increase the trade with the EU. 4 In memory of my beloved Mother, Hayriye Pala 5 ACKNOWLEDGMENTS I would like to express my deepest gratitude to my supervisor Prof. Oscar T. Brookins for his valuable comments, advice, and support throughout my research. Without his encouragement and help, this thesis would be incomplete. I would also like to thank Prof. Kamran Dadkhah for his support and guidance throughout the preparation of this thesis. I am also appreciative to the Department of Economics at Northeastern University for providing an ideal environment for me to pursue my graduate work. I would also like to express my gratitude to the Prime Minister of Turkey, Undersecretariat of Customs for their most generous financial support for my education in the United States. Lastly, I would like to thank my family for their huge support and belief in me throughout my graduate studies at Northeastern University. 6 TABLE OF CONTENTS ABSTRACT………………………………………………………………………............... 3 DEDICATION……………………………………………………………………................ 5 ACKNOWLEDGMENTS…………..……………………………………………............... 6 TABLE OF CONTENTS………………………………………………………….............. 7 LIST OF TABLES…………………………………………………………………............. 9 LIST OF GRAPHS………………………………………………………………............... 11 LIST OF ABBREVIATIONS……………………………………………………................ 12 CHAPTER 1 - INTRODUCTION………………………………………………................ 13 CHAPTER 2 - ECONOMIC INTEGRATION…………………………………................ 18 2.1 Definition………………………………………………………………………............. 18 2.2 Customs Union……………………………………………………………….............. 21 2.3 Economic Effects of the Customs Union…………………………………............... 23 2.3.1 Static Effects………………………………………………………………............... 24 2.3.2 Dynamic Effects…………………………………………………………................. 28 CHAPTER 3 - HISTORY OF THE FORMATION OF THE CUSTOMS UNION BETWEEN TURKEY AND THE EUROPEAN UNION……………….......................... 30 3.1 Establishment of the Customs Union Between Turkey and the EU…….............. 32 3.1.1 Introduction…………………………………………………………………............. 32 3.1.2 Ankara Agreement…………………………………………………………............. 34 3.1.3 Additional Protocol…………………………………………………………............. 35 3.1.4 Turkey’s Application for Full Membership in 1987……………………................ 36 3.1.5 Formation of the Customs Union Between Turkey and the EU……….............. 38 7 CHAPTER 4 - EFFECTS OF THE CUSTOMS UNION ON THE TURKISH ECONOMY…………………………………………………………………………............ 41 4.1 Static Effects of the Customs Union on Turkish Trade…………………............... 43 4.1.1 Trade Creation Effects…………………………………………………….............. 43 4.1.2 Trade Diversion Effects……………………………………………………............. 48 4.1.3 Conclusion………………………………………………………………….............. 63 4.2 Dynamic Effects of the Customs Union on Turkish Trade……………….............. 66 4.2.1 Turkey’s Trade by Broad Economic Categories………………………............... 67 CHAPTER 5 - FORECASTING THE TRADE BETWEEN TURKEY AND THE EU WITH AN ECONOMETRIC ANALYSIS……………………………….......................... 76 5.1 Econometric Model…………………………………………………………............... 76 5.2 Testing for Stationarity……………………………………………………….............. 78 5.3 Linear Regression Analysis…………………………………………………............. 81 5.4 Vector Autoregression Analysis…………………………………………….............. 83 5.5 Granger-Causality Testing…………………………………………….…….............. 85 5.6 Forecasting the Trade……………………………………………………….............. 87 CHAPTER 6 - CONCLUSION…………………….…………………………….............. 91 BIBLIOGRAPHY…………………………………………………………………............... 98 8 LIST OF TABLES Table 4.1 Turkey’s Foreign Trade and EU’s share……………………………………... 45 Table 4.2 Turkey’s Exports by Organizations in Nominal Values…………………….. 50 Table 4.3 Turkey’s Imports by Organizations in Nominal Values…………………….. 51 Table 4.4 Trade by Organizations in Percentages……………………………………... 52 Table 4.5 Luggage Trade with Russia…………………………………………………... 62 Table 4.6 Turkey’s Exports by Broad Economic Categories ……....…………………. 69 Table 4.7 Turkey’s Imports by Broad Economic Categories ……..…………………... 70 Table 4.8 Employment by Agriculture and Manufacturing Sectors…………………… 74 Table 4.9 Educational Status by Agriculture and Manufacturing Sectors…..……….. 74 Table 5.1 Dickey-Fuller General Least Squares Test Values…………………………. 79 Table 5.2 Dickey-Fuller General Least Squares Test Values II………………………. 80 Table 5.3 Linear Regression of the Model………………………………………………. 81 Table 5.4 Vector Autoregression for 10 Optimal Lags of dLex ................................... 84 Table 5.5 Vector Autoregression for All Variables with 10 Lags……………………… 85 Table 5.6 Granger Causality Wald Test Results………………………………………... 86 9 Table 5.7 Pseudo-Out-Of-Sample (POOS) Analysis…………………………………… 88 10 LIST OF GRAPHS Graph 4.1 Growth of Exports and Imports……………………………......................... 47 Graph 4.2 Exports Percentage…………………………………………………………… 53 Graph 4.3 Imports Percentage……………………………………………………………. 53 Graph 5.1 The Growth of Model Variables ……………………………………………... 78 Graph 5.2 Forecast of the Trade Between Turkey and the EU……………………….. 89 11 LIST OF ABBREVIATIONS AIC Akaike Information Criterion Benelux Belgium, the Netherlands and Luxembourg BSEC Black Sea Economic Cooperation CIS Commonwealth of Independent States EC European Community EEC European Economic Community EFTA European Free Trade Association EU European Union GATT General Agreement on Tariffs and Trade GDP Gross Domestic Product IMF International Monetary Fund NATO North Atlantic Treaty Organization OECD Organization for Economic Cooperation and Development OEEC Organization for European Economic Cooperation OIC Organization of the Islamic Conference POOS Pseudo Out-Of-Sample RMSE Root Mean Square Error RMSFE Root Mean Square Forecasting Error UN United Nations USSR Union of Soviet Socialist Republics WTO World Trade Organization 12 CHAPTER 1 INTRODUCTION Following the Second World War, nations started to seek integration with each other in order to maintain strength against other countries in the world. Several organizations such as North Atlantic Treaty Organization, United Nations, the Council of Europe and the Organization for European Economic Cooperation
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