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Trading Freedom for Stability, Turkey Strengthens EU Ties

9 MINS READJun 29, 2017 | 10:58 GMT
Under the current deal, Turkey is a member of the European Union Customs Union but has no say over the bloc's trade deals. Both sides have found the agreement lopsided and dysfunctional.
(Sharrocks/iSTOCK/Getty Images)

The country is drifting further from the European Union on ideological and political matters. But as Ankara prioritizes the short-term goal of avoiding financial crisis, it will make the decision to upgrade its trade deal with the bloc.

Forecast Highlights

  • As the status quo becomes untenable, Turkey and the European Union will renegotiate outdated trade arrangements.   
  • Despite the fact that Turkey's economic opportunities lie increasingly in Asia and the Middle East, the country will try to establish closer trade ties to Europe.
  • But this decision is based largely on short-term economic needs, and any new Turkey-EU customs union agreement may not last long.

Not for the first time, Turkey is facing a dilemma about how to best protect its interests. Toward the end of June, the country is expected to begin negotiations with the European Union about a possible upgrade to their existing trade arrangement. Under the current deal, Turkey is a member of the European Union Customs Union but has no say over the bloc's trade deals. Both sides have found the agreement lopsided and dysfunctional. But Turkey's decision to upgrade the deal, rather than limit it, may come as a surprise to some. Turkey's future opportunities largely lie away from Europe, in Asia and the Middle East. But instead of breaking free from a restrictive EU trade deal to explore them, Turkey will satisfy short-term needs by tying itself closer to its rich western neighbors, though perhaps not for long.

Balancing a Lopsided Agreement

The current EU-Turkey trade arrangements are fairly uneven. Turkey is a member of the bloc's customs union when it comes to most goods, which means that it sits behind the union's common external tariff barrier. That barrier allows tariff-free trade for those — like Turkey — who are inside the customs union bubble, whereas there is a common trade barrier for any countries outside it. This has been largely beneficial for Turkey. But unfortunately for the country, the customs union is not the only feature in the European Union's larger trade picture, and Turkey is excluded from many other trade benefits. Most importantly, free trade agreements negotiated by the European Union do not automatically apply equally to Turkey. When EU negotiators strike a bilateral trade deal with another country, allowing it to pierce the customs union bubble in exchange for opening up aspects of its own market, Turkey's economy becomes open to the third country, but it doesn't get the same access to that new market in return.

This situation is unusual, and is a result of the equally unusual history between Turkey and the bloc. When the European Union-Turkey Customs Union agreement was first created in 1995, it was meant to be a temporary step toward Turkey gaining full membership in the European Union. Accession negotiations later stalled, but the customs union nevertheless benefitted Turkey in the years following. As part of its terms of membership, Turkey had to agree to sections of the European Union's Acquis Communautaire, or, accumulated laws and obligations, which meant that the country had to improve some of its industrial standards. The resulting reforms, along with the access to wealthy European markets that the deal afforded Turkish businesses and citizens, were partly responsible for the economic boom that Turkey experienced in the next two decades. (This boom was helped along by later reforms and other steps to bring Turkey and Europe closer, as well.)

The lopsided trade negotiation aspect also wasn't a major issue until recently. For much of the last 20 years, the European Union was only negotiating free trade agreements with smaller nations. Turkey's solution to the problem of potential trade imbalances was simply to negotiate its own free trade agreements with the same countries immediately after the bloc did, securing its access. If these comparative economic minnows didn't want to talk to Turkey, as happened with South Africa, Algeria and Mexico, the financial impact on the country was minimal.

In Need of Upgrades

But now, this peculiar but workable status quo is unsustainable. The prolonged stagnation of multilateral trade negotiations around the world has led to a general trend of more ambitious bilateral trade deals. And the European Union has followed suit. The bloc started trying to negotiate trade deals with countries of greater economic heft, like the United States and Japan, and an agreement with the latter looks like it may be finalized by the end of 2017. But Turkey has struggled to start talks with the bloc's new free trade partners; those countries recognize that the unbalanced trade situation that comes from resisting a deal with Turkey would work in their favor. Ankara has responded by creating barriers within the customs union bubble to protect its own market and by implementing new regulatory standards, surveillance measures and safeguards that inhibit the flow of goods — all of which essentially defeat the purpose of the customs union.

Meanwhile, other aspects of the original EU-Turkey deal have begun to look outdated. For instance, the agreement only covers the trade of industrial goods and some agricultural items, leaving out crucial elements such as services, which are becoming ever more important to the global economy. The agreement also does not contain a dispute settlement mechanism, making it hard to resolve issues that have arisen between the two parties. The European Union and Turkey thus began to discuss the idea of an upgrade to the deal in 2015, with both sides motivated to create a more equitable and functional system. The pair proposed an expanded deal that would include services and previously excluded agricultural items, as well as a dispute settlement system. In addition, Turkey would become a part of any new EU trade deals that might emerge, solving its problem with uneven trade relationships.

Turkey Makes a Trade-Off

From a Turkish perspective, the renegotiation might initially seem like a no-brainer. The European Union is Turkey's largest market and trading partner: The bloc receives 48.5 percent of the nation's exports and its members represent six of Turkey's top 10 export destinations (at least until the United Kingdom, which consumes 8.2 percent of Turkey's exports, makes its Brexit). The opportunity to improve Turkish access to the EU market and solve the free trade agreement problem in one fell swoop holds clear advantages for Ankara.

In a recent study, investment bank HSBC concluded that the majority of Turkey's trade growth in the next 15 years will come from Asia and the Middle East. By moving closer to the European Union, Turkey will be sacrificing its ability to access those markets without being subordinate to a bloc that it does not even fully belong to.

But the situation is not quite that simple; as always, there are trade-offs involved. If Turkey is to fully join the customs union and the EU trade negotiation process, it will give up even more of its trade autonomy at a moment when opportunities are emerging elsewhere. In a recent study, investment bank HSBC concluded that the majority of Turkey's trade growth in the next 15 years will come from Asia and the Middle East. By moving closer to the European Union, Turkey will be sacrificing its ability to access those markets without being subordinate to a bloc that it does not even fully belong to.

Turkey moving closer to the European Union also runs counter to the direction the country is going overall. While Turkey has spent much of the last 100 years looking to the West for guidance, inspiration and wealth — as demonstrated by the customs union agreement itself — recent years have seen a shift in momentum away from Europe. Faced with a restive situation across Turkey's southern border and violence in the country, Turkish President Recep Tayyip Erdogan has become increasingly authoritarian. And while such a move may suit a country bordering a war zone, it's not useful for one trying to gain access to a bloc based on shared democratic values. As a result, the EU-Turkey relationship has become fractious. And the subject of Turkey becoming a full member of the European Union, which has seemed unlikely for a long time, is now closer to being dropped altogether than to reaching fruition.

So it might be considered anomalous that while Turkey moves away from Europe politically, it's tying its hands economically by negotiating a new customs union agreement with the European Union. And it's a particularly curious decision given that a strong alternative exists. Instead of upgrading the current deal, Turkey could negotiate a comprehensive free trade agreement. It would take Turkey out of the customs union bubble, free it to manage its own trade negotiations with other countries and solve the imbalance problem. And Turkey could still maintain tariff-free access to the union as part of the new deal, as well as modernize the agreement to include services and more agriculture products and even add a dispute settlement mechanism for good measure. In short, a comprehensive free trade agreement could solve all of Ankara's trade problems with the European Union, while also freeing up its options for the future elsewhere. The question, then, is why not take that chance to step back?

The answer can be found in the country's economic circumstances. Over the last five years, Turkey's economy has become increasingly fragile. Its current account deficit and sizable short-term debt have left it in danger of a crisis. The administration's solution to this financial frailty has been to make more credit available to companies, delaying the problem, but also making it bigger. The reason for this evasive strategy is that critical elections loom in 2019, which Erdogan will have to win if he's to hold onto power. He won an important referendum earlier in 2017, but only by a thin margin, so an economic crisis that could affect his re-election must be avoided at all costs.

Over the last five years, Turkey's economy has become increasingly fragile. Its current account deficit and sizable short-term debt have left it in danger of a crisis. The administration's solution to this financial frailty has been to make more credit available to companies, delaying the problem, but also making it bigger.

Against this political backdrop, stability is paramount. Turkey needs as much capital and trade flowing into the country as possible to achieve it. But a free trade agreement with the European Union, even if it maintains tariff-free trade, would create a hard customs border that would inhibit such inflow. The agreement would also discourage foreign investors who use Turkey as a steppingstone to enter the European market, since under the terms of a free trade agreement, Turkish goods would probably have to prove their points of origin. So while the free trade option might provide more opportunities for future growth in general, for a Turkey that wants to maintain the strongest possible economy and the least disruption in the short term, simply renegotiating the customs union makes more sense.

Not-So Binding Ties

Turkey has always been at the intersection of differing geopolitical spheres. Throughout history, whoever controlled Constantinople had to balance the European with the Arabic, the Russian with the Persian. Today's administration is no different. In contemporary Turkey, the focus toward Europe in the north may seem like the past, while the east and south might feel like the future. But there are always other considerations in play. Since economic stability in the immediate term is key for Turkey, increased trade ties with the European bloc are critical. As circumstances change, of course, this may no longer hold true: Turkey could soon chafe against its EU ties once more, and any new deal may thus prove short-lived.

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