Does a miracle trade deal now spell trouble for Turkey?

ISTANBUL — Turkey's manufacturing sector has come a long way in the past two decades – transitioning from being a supplier of basic knitted garments and vegetables to becoming a regional powerhouse that exports high-tech electronic appliances and automobiles.

This transformation of a country that was once known primarily for its architecture, palaces, and Ottoman history, coincided with the deepening of ties with the European Union.

And the most important aspect of that relationship has been the agreement known as the Customs Union (CU), which governs the trade of manufactured goods between Turkey and the EU.

"The customs union with the European Union is Turkey's biggest achievement in the last 30 years," says Professor Emre Gonen of Bilgi University. "I don't want to exaggerate but it's a matter of life and death for us."

The agreement was the culmination of a long wait for Turkey to be part of the single European market.

It basically eliminated tariffs on the trade of goods. That means cars, precision instruments, yachts, jeans and refrigerators, could move freely across the border with the EU.

Since the early 2000s, when the effects of the CU started to trickle in, Turkey's global exports have more than quadrupled, increasing from $31 billion in 2001 to $142 billion last year.

European companies have invested billions of dollars in manufacturing hubs in Bursa and Istanbul, bringing with them not just the technology but also world-class manufacturing standards.

But now the landmark deal faces problems. The EU has been signing Free Trade Agreements (FTA) with other countries, including Japan, without having any input from Turkey whatsoever.

What does that mean?

That makes it easier for Japanese cars and appliances to be imported without any duties not just into the EU but also Turkey – because of the CU.

While the European firms will in turn get similar preferential access to Japan, Turkish goods won't get the same benefits, since Ankara is not part of the 28-country grouping.

The answer as to how the Turkey-EU deal reached this point lies in its history.

The Ankara Agreement

In 1963, Turkey and the former European Economic Community negotiated the terms of what came to be known as the Ankara Agreement. It marked the start of talks to integrate the Turkish economy into its European neighbours.

"At that time the European project was an economic one," says Dr Erdal Yalcin, an economist for Ifo Institute, a Germany-based think-tank, who has studies the CU extensively.

"But Turkey wasn't a priority for them. So it took many years for the customs union to actually materialise."

The agreement was finally signed and became operational in the mid-90s. But by then, Turkey was going through economic turmoil with runaway inflation and failing banks.

"Having the agreement alone wasn't enough. The benefits actually started to kick-in after a single party government was formed in 2002."

What happened next was remarkable, he says.

The bilateral trade between Turkey and the EU rose substantially, jumping from $37 billion in 1996 to over $156 billion by 2014.

At first, European and Turkish manufacturers mostly focused on tapping each other's market. Gradually, the multinationals from Germany and other countries started to invest in setting up manufacturing plants in Turkey.

Besides lowering trade tariffs, the CU integrated Turkish companies into the EU, making sure both regions had the same quality of goods and employment regulations.

"The Customs Union is the backbone of the integration with the European Union regarding the economy, the competition policy, [and the] requirement of production standards," says Gonen of Bilgi University.

As Ankara adopted the stringent European standards, it opened the doors for European firms to manufacture goods in Turkey, where the labour cost was comparatively low, and then export them back to the EU.

The German industrial giant Bosch is an example.

"Bosch makes intermediate goods like components for automotive engines. Then, it exports them to Mercedes and BMW plants in Germany from Bursa where it has invested heavily," says Ifo Institute's Yalcin.

Another example of how the deal has benefited local firms is the appliance maker Arcelik, one of the leading regional brands. It expanded rapidly in Europe after the CU came into effect.

The company, which is part of the family-run Turkish conglomerate Koc Holdings, also signed an agreement worth 100 million euros with the European Investment Bank to finance its research and development activity.

What went wrong?

The CU was a stepping stone for Turkey's eventual inclusion into the EU. Those talks progressed slowly and have almost come to a standstill since Ankara was granted candidate status in 2005.

Without being a member, Turkey has no say in what Brussels negotiates with other countries. When that involves business and trade, the implications for Turkey can be severe.

The CU allows duty-free trade between EU and Turkish goods. But in case the EU signs a free trade pact with another country outside of the EU, like it did with Algeria, for instance, then the Algerian goods can enter the Turkish market as well.

This same preference is not accorded to Turkish goods.

"This is unfair because products from these [third] countries can enter Turkey via Europe without paying any duties, while Turkish exporters do not get the same terms," says Mehmet Buyukeksi, the Chairman of Turkish Exporters Assembly.

The EU has more than 30 active FTAs with various countries — all of which can send goods to Turkey without bothering about taxes.

Buyukeksi says problems for Turkish manufacturers extend beyond tariffs at the border, "We face transport quotas. Our freight trucks are not allowed to move freely. For instance, Austria doesn't allow our trucks on the highway.

The repercussions of EU's new FTAs could be far-reaching. Turkey leads Japan in car exports to the EU market, according to Turkey's Association of Automotive Parts and Components Manufacturers.

Tokyo's main thrust is to increase car exports to the EU, which in turn sees in the Asian country a market for its cheese, meat and agricultural products.

The two sides account for 40 percent of global trade.

The only way Ankara has to bypass the problem is to sign a parallel FTA with those countries.

"That is where the problem lies. When a country already has access to Turkish market why would it reduce tariffs for Turkish goods?" says Yalcin of the Ifo Institute.

The Turkish government is pushing for an amended CU deal, which also covers services, e-commerce and public procurement.

While there are no taxes on Turkish agricultural products, exporters face non-tariff barriers such as transit fee for trucks.

"The customs union is the foundation of Turkey's economic relationship with Europe, but the current arrangement is broken," wrote Turkish economy minister Nihat Zeybekci for Bloomberg in April.

He also said Turkey is exploring other options.

"If the EU will not renegotiate the customs union, as it should, Turkey will find the means to offset trade diversion, whereby Turkish goods are rendered less competitive by EU free trade agreements."