34422 T U R K E Y Economic Reform & accession to the European Union Editors Bernard M. Hoekman · Sübidey Togan N°24 N°04 AZER- OF. BAIJAN AZER. TION ISLAMIC REP IRAN E° 44 ARMENIA Hakkari IRAQ FEDERA Igdir Van Kars Agri GEORGIA aruK Lake anV nak Sir Ardahan Bitlis t E° tvin sarA Siir 42 RUSSIAN Ar Mus Tigr si Erzurum Batman huroÇ lö taruM Mardin Rize t BingölBing Diyarbakir Baybur rabzonT Erzincan fa ARAB GümüshaneüGshaneüm unceliT Sanliur tariF Elazig REPUBLIC Giresun ¸ Adiyaman setarhpuE E°8 Ordu SYRIAN Malatya Kelkit Sivas Gaziantep Kilis okatT Samsun E3°6 kerekeC Kahraman liziK MarasnahyeC Osmaniye Amasya Sinop Kayseri nahyeS (Antakya) Adana liziK ozgatY Hatay ÇorumorumÇ Icel (Mersin) E3°4 Sea Nevsehir Nigde Kirsehir E°4 Kastamonou zerveD ÇankiriankiriÇ Kirikkale Aksaray Karaman Black kü zTu Gölü Göksu Konya E3°2 KarabükKarab tin Bar ANKARA Bolu E3°2 Zonguldak Sakarya Aksehir Gölü Baysehir Gölü ya Hoyran Gölü ta of Sea E3°0 Sakar (Adapazari) Eskisehir Ispar Gulf Antalya Afyon suropsoB Kocaeli (Izmit) Bilecik Antalya Burdur E° Istanbul avol tahyaüKKütahya 30 Usak Ya Bursa Denizli E3°8 of mara Sea Mediterranean Mar Kirklareli ne ekirdagT sellenadraD Balikesir nidydinAAy Mugla E3° Manisa 28 Edir E2° 26 BULGARIA 42°N ECEERG anakkaleÇÇanakkale Izmir GREECE °N °N 40 38 36°N Turkey: Economic Reform and Accession to the European Union Turkey: Economic Reform and Accession to the European Union Editors Bernard Hoekman and Sübidey Togan A copublication of the World Bank and the Centre for Economic Policy Research © 2005 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, NW Washington, DC 20433 Telephone 202-473-1000 Internet www.worldbank.org E-mail feedback@worldbank.org All rights reserved. A copublication of the World Bank and the Centre for Economic Policy Research 1 2 3 4 08 07 06 05 The findings, interpretations, and conclusions expressed herein are those of the author(s) and do not necessarily reflect the views of the Board of Executive Directors of the World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The World Bank encourages dissemination of its work and will normally grant permission promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA, telephone 978-750-8400, fax 978-750-4470, www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, e-mail pubrights@worldbank.org. Cover: Design by Tomoko Hirata. Photographs courtesy of the Ministry of Culture and Tourism of Turkey. Library of Congress Cataloging-in-Publication Data Turkey: economic reform and accession to the European Union / edited by Sübidey Togan, Bernard Hoekman. p. cm.--(Trade and development series) Includes bibliographical references and index. ISBN 0-8213-5932-0 (pbk.) 1. Turkey--Economic policy. 2. Turkey--Economic conditions. 3. European Union--Membership. 4. International economic integration. I. Togan, Sübidey. II. Hoekman, Bernard M., 1959- . III. Series. HC492.T8576 2005 330.9561'04--dc22 2004063747 ISBN 0-8213-5932-0 E-ISBN 0-8213-6084-1 DOI 10.1596/978-0-8213-5932-0 Contents Acknowledgments xi List of Contributors xiii Acronyms and Abbreviations xv Overview xvii PART I: MACROECONOMIC POLICIES FOR EU ACCESSION 1 1 MACROECONOMIC POLICIES FOR TURKEY'S ACCESSION TO THE EU 3 Sübidey Togan and Hasan Ersel PART II: AGRICULTURE, MANUFACTURING, SERVICES, AND NETWORK INDUSTRIES 37 2 ANALYSIS OF THE IMPACT OF EU ENLARGEMENT ON THE AGRICULTURAL MARKETS AND INCOMES OF TURKEY 39 Sübidey Togan, Ahmet Bayener, and John Nash 3 INTEGRATION AND THE MANUFACTURING INDUSTRY 87 Sübidey Togan, Hüsamettin Nebiog lu, and Saadettin Dogan 4 ACCESSION OF TURKEY TO THE EUROPEAN UNION: MARKET ACCESS AND REGULATORY ISSUES 123 Joseph Francois 5 THE TURKISH TELECOMMUNICATIONS SECTOR: A COMPARATIVE ANALYSIS 147 Erkan Akdemir, Erdem Bas¸çi, and Gareth Locksley 6 ACCESSION TO THE EUROPEAN UNION: POTENTIAL IMPACTS ON THE TURKISH BANKING SECTOR 161 Ceyla Pazarbas¸ioglu 7 COMPETITION AND REGULATORY REFORM IN TURKEY'S ELECTRICITY INDUSTRY 187 . Izak Atiyas and Mark Dutz 8 INSTITUTIONAL ENDOWMENT AND REGULATORY REFORM IN TURKEY'S NATURAL GAS SECTOR 209 Maria Rita Mazzanti and Alberto Biancardi v vi Contents PART III: ECONOMIC CHALLENGES 221 9 LABOR MARKET POLICIES AND EU ACCESSION: PROBLEMS AND PROSPECTS FOR TURKEY 223 Erol Taymaz and S¸ule Özler 10 TURKEY'S FOREIGN DIRECT INVESTMENT CHALLENGES: COMPETITION, THE RULE OF LAW, AND EU ACCESSION 261 Mark Dutz, Melek Us, and Kamil Yilmaz 11 TURKEY ON THE PATH TO EU ACCESSION: THE ENVIRONMENTAL ACQUIS 295 Anil Markandya PART IV: IMPLICATIONS OF EU ACCESSION FOR TURKEY AND THE EU 309 12 ECONOMIC IMPLICATIONS OF EU ACCESSION FOR TURKEY 311 Sübidey Togan 13 THE IMPACT OF TURKEY'S MEMBERSHIP ON EU VOTING 331 Richard Baldwin and Mika Widgrén 14 ECONOMIC EFFECTS OF TURKEY'S MEMBERSHIP ON THE EUROPEAN UNION 341 Harry Flam INDEX 353 LIST OF BOXES, FIGURES, AND TABLES BOXES 7.1 California's Electricity Crisis 205 11.1 The Experience of the World Bank with Water Utilities in the Baltic States 299 FIGURES 1.1 Inflation and the Growth Rate of Reserve Money: January 1987­September 2004 4 1.2 Inflation and the Rate of Depreciation of Turkish Lira: January 1987­September 2004 4 1.3 Current-Account-to-GDP Ratio, 1975­2004 7 1.4 Real Exchange Rate, 1980­2004 7 1.5 Real Interest Rate, January 1990­October 2003 9 3.1 Average Value of Manufacturing Industry Markup, 1980­2000 116 4.1 Comparison of Regulatory Regimes 138 4.2 Decomposition of Overall Transport Regulation Index 139 4.3 Armington Aggregation Nest 142 4.4 Trading Costs in the Services Sector 143 4.5 Basic Features of the Simulation Model 143 5.1 Telecommunications Revenue in GDP 148 5.2 Households with Fixed-Line Telephone Service 149 5.3 Fixed-Line Penetration Rates 149 5.4 Largest City/Overall Country Teledensity Ratio 149 5.5 Investment in Telecommunications 149 5.6 Mobile Penetration Rates 150 5.7 Households with Internet Access 150 Contents vii 5.8 Regular Users of Internet in Population 150 5.9 Internet Access Costs 150 5.10 Regular Use versus Dial-up Access Costs of Internet 151 5.11 Penetration versus Dial-up Access Costs of Internet 151 5.12 Personal Computer Use 151 5.13 Residential Monthly Access Fee (Including Value Added Tax) for Fixed-Line Telephone Service 152 5.14 Cost (Including Value Added Tax) of a Three-Minute Economy Local Call 152 5.15 Quality of Service 152 5.16 International Telephone Traffic 152 5.17 Basket of National Calls 157 5.18 Basket of International Calls 157 6.1 Turkish Bank Restructuring Strategy 163 6.2 Concentration Ratios of Five Largest Banks, 2003 165 6.3 Share of Assets of State-Owned Banks, 2003 165 6.4 Capital Adequacy Ratios, 2003 165 6.5 Size of Deposits Subject to Insurance, 2003 166 6.6 Average Bank Size, 2003 166 6.7 Number of Branches per Bank, 2003 167 6.8 Number of Personnel per Branch, 2003 167 6.9 Selected Indicators, 2003 167 6.10 Return on Equity of EU Banks by Asset Size, 2003 168 6.11 Return on Equity: Turkey and EU Banking Sectors, 2003 168 6.12 Personnel Expenses to Total Assets, 2003 168 6.13 Personnel Expenses to Total Expenditures, 2003 168 6.14 Total Loans to Total Assets, 2003 169 6.15 Nonperforming Loans (Gross) to Total Loans, 2003 169 6.16 Debt Securities to Total Assets, 2003 169 6.17 Financial Strength Rating of the Sector (Moody's), 2003 170 7.1 Structure of the Electricity Market, Turkey 194 7.2 Electricity Losses of Turkey versus OECD, 1984­2000 198 9.1 Employment Protection Legislation, Selected OECD Countries 245 9.2 Flow into Unemployment and Employment Protection: Selected Countries, 1985­94 246 9.3 Unemployment Duration and Employment Protection: Selected Countries, 1985­94 247 9.4 Unemployment Rate and Employment Protection: Selected Countries, 1985­94 247 9.5a Interindustry Wage Differentials: Selected Countries, 1980­2000 248 9.5b Interindustry Wage Differentials: Selected Countries, 1980­2000 248 9.6 Labor Demand Adjustment Speed and Wage Elasticity: Selected Countries, 1980­97 250 9.7 Sectoral Distribution of Employment, Value Added, and Output: Private Manufacturing Industry, Turkey, 2000 254 9.8 Structure of Value Added in Private Manufacturing: Turkey, 2000 255 10.1 FDI Inflows: Turkey versus Comparator CEE Countries, 1990­2001 264 10.2 M&A-Related Inflows: Turkey versus Comparator CEE Countries, 1990­2001 267 10.3 Privatization Revenues: Turkey versus Comparator CEE Countries, 1990­2000 267 10.4 Case Studies 277 10.5 Areas for Investment Climate Reform 285 12.1 OECD Composite Telecommunications Business Basket, November 2001 323 12.2 OECD Composite Telecommunications Residential Basket, November 2001 323 13.1 Passage Probabilities: European Council, 1957­2004, and after Entry of Bulgaria, Romania, Croatia, and Turkey 332 13.2 Change in Power for EU25, Nice Treaty to Constitutional Treaty Rules 334 viii Contents 13.3 Power Difference between Nice Treaty and Constitutional Treaty Rules for EU29 335 13.4 NBI Values under Nice Treaty and Constitutional Treaty Voting Rules for EU29 336 13.5 Impact of Enlargement on EU25 Power, Nice Treaty Rules 337 13.6 Impact of Enlargement on EU25 Power, Constitutional Treaty Rules 338 14.1 Effects of Migration 342 14.2 Forecast of Turkish Immigrant Population in Germany, 2000­30 345 TABLES 1.1 Estimated Inflation (Monthly) 5 1.2 Structure of Revenues, Expenditures, and Public Sector Borrowing Requirements (PSBR), 1998­2002 8 1.3 Debt and Fiscal Sustainability, 1994­2002 10 1.4 Ratios of Public Sector Borrowing Requirements (PSBR) and Debt to GNP and GDP, 2000­03 11 1.5 Total Tax Revenue as Percentage of GDP, 1998­2000 11 1.6 Revenue from Major Taxes as a Percentage of Total Tax Revenue, 1998 12 1.7 Personal Tax, Corporate Tax, and VAT System: Turkey and EU Countries, 2002 13 1.8 Labor Market Indicators: Turkey, 2001­03 13 1.9 European Monetary Union Convergence Criteria 20 1.10 Estimates of the Sacrifice Ratio 21 1.11 Current Account Sustainability Measures, 1984­2003 25 1.12 Results for Quarterly Instrumental Variable Regression of Ratio of Noninerest Current Account (NICA) to GDP 26 2.1 Land Use in Turkey, 1995 and 2000 40 2.2 Value of Agricultural Production: Turkey, 2000 40 2.3 Agricultural Holdings and Land Engaged in Crop Production, Turkey 41 2.4 Exports and Imports of Agricultural Commodities: Turkey, 1999­2001 42 2.5 Most-Favored-Nation Tariff Rates of EU and Turkey, 2002 46 2.6 Agricultural Supports: Turkey, 1998­2002 49 2.7 Base Period Results of Model for Major Activities 57 2.8a Simulation Results for Adoption of Agenda 2000 without Direct Payments 60 2.8b Simulation Results for Adoption of Agenda 2000 with Direct Payments 60 2.9a Simulation Results for Adoption of Agenda 2000 with Direct Payments at 35 Percent 61 2.9b Simulation Results for Adoption of Free Trade with Direct Payments 61 2.10 Selected Positions of Agricultural Negotiation between Slovak Republic and European Commission (EC) 62 2.11 Simulation Results for Alignment to Agenda 2000 under Positive Supply Response 64 2.12 Structure of Household Expenditures 65 2.13 Simulation of Scenario Effects on Real Income, Selected Household Types 66 2.14 Trade-Related Budget Effects and Direct Payments under Agenda 2000 68 2.15 Contributions to and Revenues from EU Budget 69 2.16 Impact of Changes in Agricultural Policies on Agricultural Incomes 70 2.17 Arrangements Applicable to European Community Importation of Agricultural Products, Other than Fruits and Vegetables Originating in Turkey 76 2.18 Arrangements Applicable to European Community Importation of Fruits and Vegetables Originating in Turkey 78 2.19 Agricultural Products for Which EU Entry Price System Applies 80 2.20 Structure of Household Expenditures 81 Contents ix 3.1 Exports and Imports, Turkey 88 3.2 Exports and Imports, EU 91 3.3 Trade with EU, 1990­2003 93 3.4 Effects of Customs Union between Turkey and EU, 1995­2001 95 3.5 Nominal and Effective Protection Rates, 2002 100 3.6 Frequency Distribution of Protection Rates, 2002 102 3.7 Nominal and Effective Protection Rates, 2002 102 3.8 Products Subject to Antidumping Investigations, 1996­2002 104 3.9 EC Technical Regulation Directives and European Community (EC) Imports, 1995 108 3.10 Trade Coverage of Technical Regulations and of Different Approaches to Their Removal 111 3.11 Sectors with Highest RCA Values in Each Category 113 3.12 Characteristics of Turkish Manufacturing Industries, 2000 115 3.13 Average Profit Margins, Turkey and Belgium 117 3.14 Concentration of Domestic Activity 118 4.1 Structure of EU Free Trade Agreements with Selected Developing Countries 125 4.2 Processed Food Concessions under the EU-Turkey Customs Union 128 4.3 Customs Union Scenario 129 4.4 Summary of Macroeconomic Effects of Customs Union for Turkey 130 4.5 Change in Output by Sector in Turkey 131 4.6 Variables Used from OECD International Regulation Database 133 4.7 Regulation Indexes, Air Transport 135 4.8 Regulation Indexes, Road Transport 136 4.9 Regulation Indexes, Rail Transport 137 4.10 Regulation Indexes, All Transport 138 4.11 Regression Results for Gravity Equation on Cross-Border Trade 140 4.12 Sectoring Scheme of Model 141 5.1 Monthly Residential Access Fee and Local Call Tariffs: 15 EU Member States and Washington, DC, July 1, 2002 158 5.2 Monthly Residential Access Fee and Local Call Charges: 13 EU Preaccession Countries (PAC), March 31, 2002 158 6.1 Initial Fiscal Costs of Turkish Banking Crisis, 2000­01 163 6.2 Results, Quantitative Impact Study 2003 171 6.3 Statistics on Banking Sectors of EU15 and Turkey, 2003 174 6.4 Statistics on Banking Sectors of EU15 and Turkey, 2001 175 6.5 Statistics on Banking Sectors of Enlargement (Candidate) Countries and Turkey, 2003 176 6.6 Statistics on Banking Sectors of Enlargement (Candidate) Countries and Turkey, 2001 177 6.7 Income, Costs, and Profits of EU Banks in Different Size Groups, 2003 178 6.8 Indicators of 50 Major EU Banks, 2002 and 2003 179 6.9 Nonperforming Assets and Provisioning of EU Banks, 2003 179 6.10 Regulatory Capital Ratios and Risk-Adjusted Items of EU15 Banks, 2003 180 6.11 EU Balance Sheet Structure of EU Banks, 2003 180 7.1 Turkey's Electricity Generating Capacity: 2002, 2005, 2010 196 7.2 Retail Prices for Electricity 199 8.1 Existing Gas Agreements, Turkey 212 9.1 Employment Indicators: EU and Selected Group of Candidate Countries, 2000 227 9.2a Income Tax Plus Employees' and Employers' Social Security Contributions, 2002 228 x Contents 9.2b Income Tax Plus Employees' and Employers' Contributions Less Cash Benefits, by Family Type and Wage Level, 2002 229 9.3 EU Directives and Turkish Labor Law 232 9.4 Employment Protection Legislation Index: OECD Countries, Late 1990s 241 9.5 Employment Protection Legislation for Regular Employment, Selected OECD Countries 242 9.6 Employment Protection Legislation for Temporary Employment, Selected OECD Countries 244 9.7 Job Turnover, Selected Countries 249 9.8 Job Turnover in Turkish Manufacturing Industries 249 9.9 Composition of Output in Private Manufacturing: Turkey, 2000 254 9.10 Simulation Results 256 10.1 FDI Summary Data: Turkey versus Comparator CEE Countries 265 10.2 FDI Definition in OECD Countries 266 10.3 FDI Stocks by Industrial Sector, 2000 268 10.4 Largest Affiliates of Foreign Transnational Corporations 269 10.5 FDI Stocks by Country of Origin, 2000 271 10.6 Macroeconomic Indicators, 1995­2001 272 10.7a Infrastructure-Related Factors--Strengths: Turkey versus Comparator CEE Countries 273 10.7b Infrastructure-Related Factors--Weaknesses: Turkey versus Comparator CEE Countries 274 11.1 Comparison of Environmental Costs of EU Accession for Turkey and Other Candidate Countries 297 11.2 Scenarios for Implementation of Environmental Investments for the Acquis 301 11.3 Environmental Accesson Costs for Turkey 302 11.4 Types of Benefits of Compliance with Directives Estimated for Candidate Countries 302 11.5 Estimated Benefits for Turkey from Compliance with Environmental Directives 303 11.6 Costs of Accession for Turkey in First Six Years 304 11.7 Environmental Expenditures in Turkey, 1997­99 305 11. 8 Estimated Annual Spending on Monitoring and Enforcement, Turkey 305 12.1 Impact of Agenda 2000 Policies 312 12.2 Restrictiveness Index Scores and Price Effects for Banking Services, EU and Turkey 313 12.3 Restrictiveness Index Scores for Telecommunications Services 315 12.4 Country Data on European and Turkish Electricity Sectors, 1998 318 12.5 Price Impact of Regulation in Electricity Supply, EU and Turkey 319 12.6 EU Country Data on European Natural Gas Sectors 320 12.7 Retail Prices of Natural Gas and Electricity, 2000 322 12.8 OECD Basket of International Telephone Charges, November 2001 324 12.9 Estimated Tariff Equivalents in Traded Services and Network Industries 324 12.10 Gravity Estimates for Intra-EU15 Trade 329 13.1 Power Indices under Constitutional Treaty Rules 339 13.2 Power Indices under Nice Treaty Rules 339 14.1 EU Budget, 2002 346 14.2 Estimates of EU Budget Contributions/Receipts Equations 348 14.3 Estimated EU Budget Contributions and Receipts 348 14.4 Pooled Panel Gravity Estimates for Intra-EU15 Trade 350 14.5 Forecast of Trade with EU15 350 Acknowledgments The essays in this volume, with the exception of the EuropeanCommissiontoTurkey,andAliDogramaci last three, were discussed at the conference "Turkey: of Bilkent University. Towards EU Accession," held May 10­11, 2003, in As editors of the volume, we would like to express Ankara, Turkey. Among the participants were eco- our gratitude to all the participants in the 2003 con- nomists from Turkey, Britain, Italy, the Netherlands, ference, including the contributors to this volume Central and Eastern European countries, the World and their discussants, for their valuable contribu- Bank, and the Organisation for Economic Co- tions. We also are grateful to the three referees who operation and Development (OECD). The mixed provided constructive suggestions for revision of the composition of the participants--drawn from vari- chapters, to Ines Garcia-Thoumi for helping to find ous Turkish universities; official agencies in Turkey, the resources to allow this book to be published, to including the Ministry of ForeignAffairs,Ministry of Rebecca Martin for her assistance in preparing the Agriculture, Ministry of Environment, Ministry of manuscript, to Thierry Verdier, Riccardo Faini, and Labor, General Secretariat for EU Affairs, Undersec- Stephen Yeo for their support in co-publishing this retariat of Treasury, Undersecretariat of Foreign volume with CEPR, and to Mary Fisk, Santiago Trade, State Planning Organization, Central Bank, Pombo-Bejarano, and Stephen McGroarty in the Banking Regulatory and Supervisory Agency, Office of the Publisher for their management of the Telecommunications Board, and Energy Board; publication process. This volume provides readers European University Institute; Erasmus University; with insights into selected aspects of Turkish acces- the World Bank; and the OECD--allowed a wide- sion to the European Union, and we hope it will ranging discussion of the issues. inspire similar studies. The project was supported by the World Bank, European Commission, Robert Schuman Centre for Advanced Studies at the European University Disclaimer Institute, and Bilkent University. We would like to express our appreciation to the sponsors of All opinions expressed in this volume are strictly the project. We are particularly grateful to Ajay personal and should not be attributed to any gov- Chhibber and James Parks of the World Bank, ernment, official agency, or institution with which Giacomo Luciani and Helen Wallace of the Robert authors are or have been affiliated. Schuman Centre, Hansjörg Kretschmer and Vincent Rey at the European Union Representation of the Bernard Hoekman and Sübidey Togan xi List of Contributors Erkan Akdemir Telecommunications Authority of Turkey Izak Atiyas Sabanci University, Istanbul Richard Baldwin Graduate Institute of International Studies, Geneva, and Centre for Economic Policy and Research (CEPR), London Erdem Bas¸çi Central Bank of Turkey Ahmet Bayener Ministry of Agriculture and Rural Affairs, Ankara Alberto Biancardi Acquirente Unico Spa, Italy Saadettin Dogan Undersecreteriat of Foreign Trade, Ankara Mark Dutz World Bank Hasan Ersel Sabanci University, Istanbul Harry Flam Institute for International Economic Studies, Stockholm Joseph Francois Erasmus University, Rotterdam, and CEPR Bernard Hoekman Groupe d'Economie Mondiale, Institut d'Etudes Politiques, Paris; World Bank; and CEPR Gareth Locksley World Bank Anil Markandya World Bank Maria Rita Mazzanti Italian Electricity and Gas Regulatory Authority John Nash World Bank Hüsamettin Nebioglu Undersecretariat of Foreign Trade, Ankara S¸ule Özler University of California at Los Angeles Ceyla Pazarbas¸ioglu International Monetary Fund Erol Taymaz Middle East Technical University, Ankara Sübidey Togan Bilkent University, Ankara Melek Us Association of Dairy Beef and Food Manufacturers and Producers in Turkey Mika Widgrén Turku School of Economics, Turku, Finland, and CEPR Kamil Yilmaz Koç University, Istanbul xiii Acronyms and Abbreviations ACC agricultural credit cooperatives IACS Integrated Administration and BEPG Broad Economic Policy Guidelines Control System BIPS border inspection posts IMF International Monetary Fund CAP Common Agricultural Policy JAP joint assessment paper CCT Common Customs Tariffs MARA Ministry of Agriculture and Rural CEE Central and Eastern European Affairs (Countries) M&A merger and acquisition CEEP European Centre of Enterprises MFN most-favored nation with Public Participation MRA Mutual Recognition Agreement CEN Comité Européen de Normalisation MRP Mutual Recognition Principle CENELEC Comité Européen de Normalisation MTR mid-term review Electrotechnique NBI normalized Banzhaf index COM Common Organization of the Market ncb national central bank CPI consumer price index OECD Organisation for Economic CUD Customs Union Decision Co-operation and Development EAGGF European Agricultural Guidance PEP Preaccession Economic Programme and Guarantee Fund PPP purchasing power parity ECSC European Coal and Steel PSBR public sector borrowing Community requirements EEA European Economic Area RER real exchange rate EFTA European Free Trade Association SDR special drawing rights EMRA Energy Market Regulatory Authority SEE state economic enterprise EMU Economic and Monetary Union SITC Standard Identification Trade ESA European System of Accounts Classification ECB European Central Bank SPO state Planning Organization ECOFIN Council for Economic and Financial (Turkey) Affairs SSI Shapley-Shubik index EONIA European Over-Night Index Average TBT technical barriers to trade EPL employment-protection legislation TEKEL Tobacco and Tobacco Products, Salt, ESCB European System of Central Banks and Alcohol Industry ETUC European Trade Union TFP total factor productivity Confederation TL Turkish lira EU European Union TSE Turkish Standards Institute FDI foreign direct investment TUBITAK Turkish Scientific and Technical FTA free trade agreement Research Institute FX foreign exchange TT Türk Telecom GATT General Agreement on Tariffs and UME National Metrology Institute Trade UNCTAD United Nations Conference on Trade GDP gross domestic product and Development GFCF gross fixed capital formation UNICE Union of Industrial and Employers' GNP gross national product Confederations of Europe HICP Harmonised Index of Consumer VAT value-added system Prices WTO World Trade Organization xv Overview Turkey first applied for associate membership in which have produced a high degree of protection in the European Union (EU)--then the European both the EU and Turkey. Thus, in terms of further Economic Community (EEC)--in 1959. The appli- liberalization of merchandise trade, accession will cation resulted in an association agreement in primarily have an effect on agriculture. 1963, whereby Turkey and the EU would, in princi- A major development under the customs union ple, gradually create a customs union by 1995 at the was that Turkey implemented the European latest. The customs union was seen as a step toward Union's Common Customs Tariff on imports of full EU membership at an unspecified future date. industrial goods from third countries. It has also The EU unilaterally granted Turkey preferential adopted most of the preferential trade agreements tariffs and financial assistance, but the process of concluded by the EU, as well as other measures staged, mutual reductions in tariffs and nontariff covered by the EU's commercial policy (such as barriers was delayed because of the economic and antidumping). Turkey has adopted EU competition political conditions in Turkey. After pursuing policies, established a Competition Board, adopted inward-oriented development strategies through- EU rules on protection of intellectual and indus- out the 1960s and 1970s, Turkey switched over to a trial property rights, set up a Patent Office, and ini- more outward-oriented policy stance in 1980. The tiated a process of harmonizing technical standards opening up of the economy was pursued in part for industrial products and strengthening internal with the aim of integrating the country into the EU. conformity assessment and market surveillance Turkey applied for full membership in the EU in structures. 1987. The response in 1990 was that accession On December 10­11, 1999, the European Coun- negotiations could not be undertaken at the time cil meeting held in Helsinki produced a break- because the EU was engaged in major internal through in Turkey-EU relations. At Helsinki, changes, and that matters were further complicated Turkey was officially recognized as a candidate state by developments in Eastern Europe and the Soviet for accession, on an equal footing with other candi- Union. However, the EU was prepared to extend date states. The result was the creation of a so-called and deepen economic relations without explicitly Accession Partnership with the EU, which means rejecting the possibility of full membership at a that the EU is working together with Turkey to future date. Thus the plans for a customs union enable it to adopt the acquis communautaire, the were revived. legal framework of the EU. But, in contrast to other On March 6, 1995, it was agreed at an Associa- candidate countries, Turkey did not receive a tion Council meeting in Brussels that a customs timetable for accession. After the approval of the union would be created between Turkey and the EU Accession Partnership by the Council and the adop- as of January 1, 1996, to be fully phased in by 2001.1 tion of the Framework Regulation on February 26, As a result, Turkey currently imposes no quotas or 2001, the Turkish government announced on tariffs on imports of industrial goods from the EU. March 19, 2001, its own National Program for the The associated liberalization for Turkey has been adoption of the acquis communautaire. Progress estimated as implying a 7 percent average reduction toward accession continues along the path set by in tariffs (Harrison, Rutherford, and Tarr 1997). the National Program. The major exception to free trade is agriculture-- In late 2004 another milestone was reached with neither party liberalized completely. The average the recommendation of the European Commission tariff rate on imports of agricultural commodities that the European Council endorse the launching from the EU is 21.4 percent. Agricultural trade is of formal accession negotiations with Turkey also subject to tariff quotas and price regulation, and establish a timetable for accession (European xvii xviii Overview Commission 2004b). In December 2002, the ous regulations, decrees, and circulars detailing Copenhagen European Council had concluded that how these reforms should be implemented. A "if the European Council in December 2004, on the Reform Monitoring Group, under the chairman- basis of a report and a recommendation from ship of the deputy prime minister responsible the Commission, decides that Turkey fulfills the for human rights, was established to supervise Copenhagen political criteria, the European Union the reforms across the board and to solve practi- will open accession negotiations with Turkey with- cal problems, including bureaucratic inertia and out delay." At a December 2004 Council meeting, it bottlenecks at both the central government and was decided to launch negotiations. state government levels (European Commission Although the process has now been launched, 2004c). great uncertainties continue to prevail about However, clearly much remains to be done on whether Turkey will be able to achieve its goal of both the macro- and the microeconomic fronts. accession to the EU.2 Some of these uncertainties Accession entails going beyond the customs union are economic, and they are the subject of this book. for manufactures and integrating the markets for Other uncertainties are more political in nature. agriculture, services, and factors (labor, investment, Some of these are in the hands of the Turkish and capital flows). Until now, liberalization of trade government--for example, realization of the EU has been restricted to industrial goods. Because agri- political and human rights criteria formalized by culture accounts for about 14 percent of Turkey's the European Council in Copenhagen in 1993, and gross domestic product (GDP) and services 60 per- acceptance of restrictions on immigration post- cent, the liberalization of trade to date has thus had accession.3 Others are not. Arguably, the greatest limited implications for three-quarters of eco- uncertainty is whether EU governments and soci- nomic activity. Although this statement is an exag- eties are willing to accept a large secular but geration because autonomous reforms have been nonetheless Muslim state as part of the EU. Time implemented in these sectors of the economy, join- will reveal the ultimate outcome. What matters in ing the EU will require Turkey to adopt and imple- the short to medium term is the impact that con- ment the whole body of EU legislation--the acquis tinued progress toward achieving the conditions communautaire--in all areas. for membership will have on Turkey. The EU is the The purpose of this volume is to highlight cer- focal point for reforms in a large number of policy tain aspects of Turkish accession, with an emphasis areas, and the preaccession process, which has on the implications of integrating fully into the sin- been ongoing for several years, is a unique experi- gle market, adopting the acquis, and meeting the ment in using international harmonization as a Maastricht Treaty criteria for fiscal and monetary tool in implementing a comprehensive reform policy.4 The contributors to this volume focus pri- strategy. marily on the impact of accession on Turkey--only Much has been achieved by Turkey in recent two chapters consider the possible impacts on the years, including progress in implementing the EU. One reason for this emphasis is that in size customs union--which covers many policy areas, Turkey is small relative to the EU as a whole. not just trade but also nontariff barriers and com- Turkey's GDP in 2004 was 240 billion compared petition policies--despite severe macroeconomic with the combined GDP of the EU25 of 10.2 tril- shocks and instability. The 1999 European Coun- lion.5 Thus Turkey would account for only 2.3 per- cil decision affirming that Turkey is a candidate cent of the EU's total output. Most of the adjust- for membership was followed by far-reaching ment burden and potential benefits therefore constitutional and legislative reforms, ranging pertain to Turkey. One major exception, however, is from improved civil liberties and human rights to related to Turkey's large population: the free move- enhanced civilian control of the military. A ment of workers could have a substantial impact on Department for EU Affairs was set up in 2000 to the EU in both economic and political terms, and coordinate all of Turkey's policies related to the the large population of Turkey may also have impli- preaccession process. A series of constitutional cations for decision making in a larger EU. The out- and legislative changes were adopted during come of accession talks on the movement of people 2001­04, some of them major, as well as numer- is very important not only for the EU but also for Overview xix Turkey, because the net benefits of accession will concludes with a discussion of lessons for other depend on the conditions under which Turkey may developing countries that can be drawn from accede to the EU. Turkey's efforts to date to bring its policies into Although the primary interest in this volume is alignment with the acquis. to assess what accession may mean for Turkey and to gauge how far along Turkey is toward meeting Macroeconomic Developments the acquis, the Turkish case is also relevant for and Prospects other countries that may seek to use a strategy of "deep integration" with a large, developed country From 1990 to 2000, economic crises began to affect or common market as a focal point and mecha- the Turkish economy with growing frequency. Peri- nism for undertaking both trade-related and regu- ods of rapid economic expansion alternated with latory reforms. Increasingly, developing countries periods of equally rapid decline. Inflation during are negotiating deeper forms of regional integra- 1990­2000 fluctuated between 55 and 106 percent, tion agreements with high-income trading part- for an average rate of 75 percent. Currently, Turkey ners. Even though most of these agreements do not is in the midst of a determined campaign to turn come close to the depth of cooperation entailed by around decades of weak performance stemming accession to the EU--and in some sectors such as from pervasive structural rigidities and weak pub- agriculture the accession process is unique in that lic finances. The past few years have witnessed it implies integration into a common policy three major attempts at addressing underlying involving direct subsidies and managed trade-- weaknesses. The first, during 2000, was under the close study of the implications of seeking to emu- three-year stand-by agreement with the Interna- late the acquis should be of interest to other coun- tional Monetary Fund (IMF), initiated in Decem- tries contemplating the design of integration ber 1999 after a significant drop in output mostly efforts. caused by external factors, including the 1999 The volume is divided into four parts: earthquake. Despite some notable achievements, a worsening current account and a weak banking · the macroeconomic dimensions of EU accession system led to a liquidity crisis in late 2000. This for Turkey crisis turned into a full-blown banking crisis · sectoral analyses of the effects of integration in February 2001, in which the government into the EU (adoption of the acquis) for the agri- responded by abandoning the crawling peg regime culture, manufacturing, services, and network and floating the currency. In May 2001, the IMF sectors increased its assistance under a new stand-by · the economic challenges of accession for arrangement. Just as the revised program was Turkey's labor market, investment framework, beginning to show results, the terrorist attacks of and environmental policy September 11 in the United States triggered the · an assessment of the net impact for the Turkish reemergence of serious financing problems. In Feb- economy as a whole of the various changes ruary 2002, the IMF approved a new three-year implied by adoption of the acquis in the areas stand-by credit agreement for Turkey to support covered by the other parts of the volume, com- the government's economic program. With the plemented by analyses of the likely implications implementation of the stabilization program, for the EU in three central areas: European deci- Turkey envisaged a gradual but steady improve- sion making and voting after Turkish accession; ment in its economic conditions. In August 2004, international transactions, both trade with and Turkey approached the IMF for what it hoped inward migration from Turkey; and the EU would be a final three-year stand-by agreement budget. that will serve as an exit program from instability and excessive debt. This introduction begins by summarizing the The economic stabilization programs proved themes and key findings emerging from the chap- successful at combating inflation, which fell from ters that follow. It then briefly discusses the likely 54.7 percent during 2000­01 to 10.6 percent in 2004 impacts of Turkey's accession on the EU, and it because of efforts to maintain fiscal and monetary xx Overview discipline. According to the Turkish State Planning required for safety. Third, the labor force participa- Organization (SPO), the fiscal deficit during 2001 tion rate declined from about 57 percent at the amounted to 16.4 percent of the gross national beginning of the 1990s to 48.7 percent in 2004, product (GNP)--and 20.9 percent of GNP, accord- mainly because of the discouragement of job seek- ing to the IMF definition. During 2004, the fiscal ers. The policy of keeping the primary fiscal surplus deficit was brought back down to 6.2 percent and at 6.5 percent of GDP over the coming years will the government ran a primary surplus of 6.9 per- constrain the use of fiscal policy to drive down the cent of GNP. After contracting by 9.5 percent in unemployment rate in the economy. But unless 2001, real GNP expanded by 7.9 percent in 2002, employment growth picks up, continually high 5.9 percent in 2003, and 9.9 percent in 2004. The unemployment and low participation rates could growth was driven by strong productivity gains undermine the social and political support for and by robust private consumption, investment, reforms. and exports, and it has not been hindered by cuts As discussed in greater depth by Sübidey Togan in government consumption and investment. The and Hasan Ersel in chapter 1, the macroeconomic unemployment rate fell from 11.5 percent in the challenges for Turkey remain substantial. Besides first quarter of 2002 to 10.3 percent in 2004, and solving the problems summarized in this introduc- the average interest rate on government debt tion, during the preaccession period Turkey needs declined from 63.8 percent in 2001 to 25.7 percent to reduce its annual inflation rate to about 3 per- during 2004. Ratios of debt to GNP are still high, cent, keep the debt-to-GDP ratio below 60 percent, but they have been falling. The net public debt-to- and achieve stable growth in real income over time. GNP ratio has decreased from 90.5 percent in 2001 Unless Turkey's growth performance does improve, to 63.5 percent in 2004. This decline reflects signif- its real per capita GDP will never converge with the icant income growth during 2002­04, attainment EU average and the accession of Turkey might cre- of sizable primary surpluses over the last three ate unmanageable stresses. In addition, the authors years, and appreciation of the real exchange rate note that to avoid the risk of speculative attacks on (RER). its currency over the coming years, Turkey should Although these are positive developments, it is continue to follow policies aimed at establishing a too early to determine to what extent the rebound sound fiscal framework, a robust banking sector, reflects a transition to sustainable growth. Substan- and sustained price stability. Turkey also must take tial risks remain. First, during 2002­04 the RER measures to increase the national savings rate from appreciated to what is arguably an unsustainable its rather low level of 22 percent in 2004 (China's level. Although the appreciation of the RER helped savings rate is 44 percent) and reverse the apprecia- to reduce the inflation rate and the debt-to-GDP tion of the real exchange rate. To attain sustainabil- ratio, it led to a widening current account deficit. ity of the current account, the real exchange rate The annual deficit in 2004 reached US$15.4 bil- has to depreciate gradually over time to its long- lion,6 and the current account-deficit-to-GDP ratio run equilibrium level. After accession, Turkey will increased to 5.1 percent. Because foreign direct be expected to join the Exchange Rate Mechanism investment (FDI) inflows remain weak, the deficit (ERM II) for at least two years and to meet the is funded by additional foreign debt, raising con- Maastricht conditions for monetary and fiscal con- cerns about the sustainability of the current vergence before a bid for membership in the Euro- account. Second, the public sector debt remains far pean Economic and Monetary Union (EMU) is too high for comfort. Assuming trend economic considered. Once admitted to the EMU, Turkey growth of 5 percent and a primary fiscal surplus of would replace its domestic currency with the euro 6.5 percent of GDP, the debt ratio will fall over time at an irrevocably fixed exchange rate, confer the as long as real interest rates remain below 15 per- bulk of its reserves to the European Central Bank, cent. Currently, the real rates on domestic debt are and be bound by the Stability and Growth Pact. about 11 percent. But shocks to credibility could Togan and Ersel argue that for Turkey the problem easily push them higher and lead to concerns about is not how to stay out of the EMU but, to the con- the sustainability of fiscal policy.7 A primary fiscal trary, how to reap the net benefits expected of surplus of 6.5 percent remains the minimum monetary integration by fulfilling the Maastricht Overview xxi criteria as soon as possible. Finally, the authors tected. Turkish exports of vegetables and fruits note that the benefits of integration can only be receive export subsidies. The EU, by contrast, has derived at some cost, and the costs of fulfilling the granted imports from Turkey preferential treat- Maastricht criteria, including the conditions for ment. Import barriers exist mostly in the form of sustainability of the current account when esti- tariff-quota schemes, in which imports within the mated by expected output losses, could turn out to quota benefit from preferential treatment. Togan be quite substantial. and his colleagues estimate that about 70 percent of imports from Turkey enter the EU duty-free and are not subject to any other import barriers. Sectoral Reform Challenges As a result, most of the adjustment after integra- Achieving and sustaining macroeconomic stability tion of Turkish agriculture into the CAP will fall will depend importantly on structural reforms, on Turkey. especially removal and reduction of subsidies and Agricultural support has been important in price controls, and the imposition of hard budget Turkey, imposing a large burden on taxpayers. In constraints on enterprises owned by the public 2003 the total support of agriculture, including the sector. Agriculture has been a heavily distorted higher prices paid by consumers, was equivalent to sector of the economy, accounting for a significant 4.4 percent of GDP (OECD 2004a). This figure is share of the public sector deficit. The banking much higher than the comparable one for agricul- sector was at the heart of the 2001 crisis--better ture in the EU--1.3 percent of GDP. These num- regulation and noninterference in lending deci- bers suggest that Turkey's accession to the EU is sions are needed to reduce the probability of likely to have important social, distributional, another crisis requiring bailouts or recapitaliza- and political effects, unless these transfers are tion of the system. Privatization of state-owned maintained under a common agricultural policy, firms is the most direct means of imposing hard which is unlikely. Indeed, adoption of CAP-type budget constraints. These and many other issues policies--something Turkey is already in the are addressed in the sectoral chapters that explore process of doing--will reduce the overall level of the effects of integration into the EU on agricul- support, even if Turkey becomes eligible for the ture and on the manufacturing, services, and net- current CAP levels of financial support. work industries. Since 1993, the CAP has been gradually shifting away from price support to income support, with the result that prices in the EU are now closer (but Agricultural Markets and Incomes still above) world market­clearing prices and farm- In chapter 2, Sübidey Togan, Ahmet Bayener, and ers are compensated by direct income payments. John Nash study the impact of EU accession on The structure of the CAP is such that it favors the Turkey's agricultural markets and incomes. In main agricultural products (and farmers) of the Turkey, agriculture accounts for a large share original six EU members: Belgium, Germany, of total output (14 percent) and employment France, Italy, Luxembourg, and the Netherlands. (33 percent). The corresponding figures for the Those products are grains, sugar beets, dairy prod- EU15 are 1.7 percent and 4.3 percent. In absolute ucts, and beef. Fruits, vegetables, poultry, and numbers, Turkey employs about the same number pork--important products of the newer, southern of people in agriculture as the EU15, or more than members--receive less or no support. In prepar- 7 million. Trade in agricultural products between ing for the accession of the Central and Eastern the EU and Turkey is a relatively small part of European (CEE) countries, the EU decided that their total trade, because it is not part of the cus- farmers from the CEE countries would not be toms union and so is subject to duties, quotas, and excluded from direct income support payments, price regulations. Turkey applies high specific but that such payments would be lower: equivalent duties to the commodities supported by the EU's to 25, 30, and 35 percent of the system prevailing in Common Agricultural Policy (CAP): cereals and 2004­06. After 2006, direct payments will be processed cereals, sugar and sugar products, dairy increased gradually in order to achieve parity with products, and meat. Olive oil is also highly pro- the original EU15 in 2013. xxii Overview Turkish agriculture will confront major reforms generate substantial changes in the agricultural in the preaccession period. In Turkey, the most incomes of producers, the welfare levels of con- important part of agricultural policy has been price sumers, and the budget revenues of the govern- support. State economic enterprises and agricultural ment. The authors estimate that, in the medium to sales cooperatives have been commissioned to buy long term, EU-like policies will lead to a 1.9 per- cereals, tobacco, tea, and sugar beet from farmers at cent increase in real household incomes in Turkey. prices determined by the government. These prices, Lower-income households (rural households) will which are higher than world market prices, have experience an even larger increase in real income. been protected by import tariffs. The second most But adoption of the CAP will require substantial important component of Turkey's agricultural pol- adjustments on the part of Turkish farmers. The icy is the various subsidies, grants, and exemptions effect on farmers' incomes will be driven mainly by lowering the cost of inputs, including capital, fertil- the amount of CAP-like compensation payments izer, seed, pesticides, and water. The output of they obtain. Their income will decrease consider- tobacco,hazelnut,tea,and sugar beet production has ably under Agenda 2000 policies without direct been controlled in various ways. Services to farmers, payments, but will increase under Agenda 2000 such as research, training, and extension and inspec- policies with direct payments. The budgetary costs tion services, have been provided free or at low cost. to Turkey of adopting EU-like agricultural policies Turkey is implementing significant reforms to will depend on whether Turkey receives compen- move it toward more decoupled and targeted forms sation from the EU budget for introducing these of support. Under the government's reform pro- policies. Without compensation, the cost will gram, output price supports, import tariffs and amount to 3 billion under Agenda 2000 policies input subsidies and grants are gradually being with direct payments similar to those applied in replaced by direct payments to farmers based on the EU and to 1.2 billion if the payments equal their holdings of land and animals. Income support only 35 percent of what is granted in the EU mem- has been capped. Privatization of state enterprises ber countries. in the agricultural sector is also part of the pro- gram. The end goal is that Turkey will have an agri- Manufacturing cultural policy similar to what is now being pur- sued by the EU in its reforms of the CAP: high In chapter 3, Sübidey Togan, Hüsamettin Nebioglu, intervention prices and protection from the world and Saadettin Dogan study the effects of EU inte- market will have been replaced by direct income gration on the Turkish manufacturing sector. support, lower protection, and prices approaching After reviewing developments in the trade in those on the world market. In chapter 4, Joseph manufactures and in particular the effects of the Francois uses a global general equilibrium model to customs union with the EU, they analyze tariffs assess the quantitative effects of completion of the and nontariff barriers in trade with the EU and customs union by extending its coverage to agri- third countries. Because tariffs are now largely a culture. He concludes that despite the importance nonissue, they focus more on nontariff barriers, of the agricultural sector for Turkey, the overall especially technical barriers to trade (product aggregate welfare gain associated with completion standards). They conclude that challenges lie of the customs union is limited, although resources ahead for both Turkish firms and the govern- will be pulled into agriculture. Commodity-specific ment. Both must apply a large number of EU impacts are small, with the largest adjustment norms. For example, Turkey has adopted all of effects in the more protected sectors, such as grains the 23 new approach directives that require affix- and meat, and expansion in the sectors that are ing the CE conformity marking, but only 18 of highly subsidized in the EU, such as sugar. these directives entered into force up to the present The Turkish reforms have emerged from the time. As a result of these directives, the number of prospect of accession, as well as the need to reduce mandatory EU standards decreased from 1,150 in public expenditure. In the short run they will lead 1999 to less than 500 in 2004 (European Commis- to considerable gains in efficiency. According to sion 2004c). The Turkish Standards Institute Togan and his colleagues, adoption of the CAP will (TSE) is presently concentrating its activities on Overview xxiii the transposition of the European and interna- on advanced technologies that contribute to envi- tional standards and on achieving full membership ronmental and safety objectives; to improve the in the European Committee for Standardization functioning of the single market in order to promote (CEN) and the European Committee for Elec- efficiency and choice; and to improve transport links trotechnical Standardization (CENELEC).8 between the European Union and third countries. Many of the requirements of the acquis in this The common transport policy places a major area revolve around accreditation and conformity emphasis on the strict application of competition assessment, in which a large number of government rules and state aid disciplines.Challenges range from bodies establish criteria as part of regulatory over- physical integration to harmonization of infrastruc- sight activities and the Turkish Accreditation ture, vehicle, environmental, and other standards; Agency (TÜRKAK) accredits the inspection service development of logistics networks; and improve- providers. Here a major challenge is for TÜRKAK ment of border crossings and trade facilitation poli- itself to become accredited and recognized in the cies (such as modernization of customs facilities). EU. Currently, its certifications are not recognized, The EU is concentrating on greater liberalization requiring double accreditation for providers or of rail transport, landing rights/access to airports redundant inspection on entry of goods into the (allocation of slots), gradual abolition of the queu- EU. Progress is also needed on the introduction of ing system for certain inland waterway markets, and mutual recognition clauses in national legislation improved application of the rules on work practices and the acceptance and adoption of simplified pro- in the road haulage sector (European Commission cedures for the import of products bearing the 2004c). An overall goal is a more level playing field CE (Conformité Européene) marking. In 2003 toys, through the application of competition principles, medical devices, and other products bearing the CE including the use of state aid and cross-subsidies.9 marking were entitled to enter the Turkish market Railways are a major fiscal burden for the freely with no further check on the technical Turkish state. Turkish State Railways (TCDD), dossiers (European Commission 2004c). Such manages Turkey's seven largest ports and its rail- measures will facilitate trade and reduce costs for ways, locomotive and carriage manufacturers, and traders. Indeed, it has been reported that during the repair workshops. During the 1980s and 1990s, rail period after the decision was made to accept the CE operation cost the Turkish government more than label, customs authorities sent numerous consign- $10.5 billion in constant 2002 U.S. dollars. As noted ments to the TSE for inspection, arguing that they by the World Bank's Trade and Transport Facilita- were not able to assess the risks related to the mini- tion Web page on Turkey,10 TCDD needs to be mum safety requirements. Numerous studies of the restructured, the railway network scaled down, impacts of a customs union have argued that the service improved, and prices increased. The acquis abolition of such real trade costs is likely to generate in this sector requires that TCDD separate out and significant gains for Turkey. Full implementation of report on the results of each of its activities (to the EU acquis on technical barriers to trade, with identify cross-subsidies), and that it end cross- the accompanying institutional strengthening, will subsidies from ports to rail and from freight to constitute the major change from the status quo in passenger traffic by shifting to a system of direct the nonagricultural merchandise trade with the EU. subsidies for passenger services (motivated by social objectives such as universal service). The much more stringent fiscal discipline associated Market Access and Regulatory Issues with implementing the acquis will have a beneficial In chapter 4, Joseph Francois complements the effect on resource allocation and the use of trans- analysis of the impacts of extending the customs port services. Existing cross-subsidization of the union to include agriculture by a discussion of the railways by the ports suggests that port authorities implications of EU accession for regulatory reform should be subjected to greater scrutiny by regula- in Turkey, focusing in particular on the transporta- tors and the competition authorities, because in tion sector. For this sector, the acquis revolves other countries (the threat of) competition by around the EU's common transport policy, which other (new) terminal operators has been shown to seeks to develop integrated transport systems based be an effective source of market discipline. xxiv Overview Francois explores both the quantitative and the main Turkish legislation and its implementation qualitative implications of Turkish accession to and compare them to those in the EU member and the EU for the transport sector. He adopts an candidate countries.They argue that the main prob- innovative methodology using data provided by the lems facing Turkey are related to the implementa- Organisation for Economic Co-operation and tion of the new legislation,especially in areas such as Development (OECD) to determine how far access to the network. Turkey is from "best practice" as defined by the EU Their conclusion was confirmed by the Euro- standards for this sector--not just in the regulatory pean Commission's 2004 assessment, which found domain but also in terms of "performance." In part, that only limited progress has been achieved in this involves applying numerical estimates of the acquis alignment to date, despite the fact that the economy-wide and sector-specific impacts of acces- remaining monopoly rights of the state-owned sion (given the preexistence of the customs union incumbent operator, Türk Telekom, were legally for goods) on the transport sector. This process is abolished at the end of 2003, including those related complemented by an assessment of the prevailing to national and international voice telephony and regulatory regime, using factor analysis (principal the establishment and operation of telecommuni- components) to identify commonalities across cations infrastructure. Thus the market has been countries and regulations. Francois concludes that open to new entrants since January 2004. However, there is little support for the claim that accession is the authors argue that the (regulatory) measures exerting significant pressure on Turkey to restruc- needed to facilitate market entry are not yet fully in ture in view of either general market access condi- place, including on matters such as numbering, tions or regulatory convergence requirements. interconnection, conditions of access to the net- Notwithstanding this conclusion, as noted above, work, and facility sharing, implying that there are Turkey confronts numerous policy changes in still de facto barriers to new entry. adopting the acquis in the transport area. Banking Telecommunications Sector In chapter 6, Ceyla Pazarbas¸ioglu describes the Chapter 5 by Erkan Akdemir, Erdem Bas¸çi, and impact of EU accession on the Turkish banking sec- Gareth Locksley examines the Turkish telecommu- tor. One of the primary causes of the 2001 currency nications services from the perspective of EU acces- crisis was the unhealthy structure of the sector, sion. Turkey is the last OECD country to liberalize stemming from several factors.11 its fixed-telephone services. Likewise, its privatiza- tion of the public monopoly in fixed lines has been · First, there were problems with state banks. delayed significantly. Yet Turkey, in the medium Governments have used these banks for noncom- term, will need to adopt the new set of directives mercial objectives such as agricultural support; approved and published by the European Parliament income redistribution; and industrial, urban, and and the European Council in 2002. In chapter 5 the physical infrastructure development. As a result, authors consider the framework directive, access the banks faced unrecovered costs from mandates directive, authorization directive, and universal carried out on behalf of the government called service directive. "dutylosses."Thestatebankscoveredtheirfinanc- In June 2001, Turkey and the other EU candidate ing needs by borrowing at very high interest rates countries signed the eEurope+ Action Plan, by and at short maturities from the capital markets. which Turkey committed itself to achieving certain · Second, the banking sector faced problems cre- measurable goals in the electronic communications ated by high public sector deficits. As private sector. Akdemir and his colleagues provide a banks found the financing of public deficits detailed comparison of the current Turkish and increasingly profitable, government domestic European statistics and practices in the telecommu- securities as a share of total assets of domestic nications industry. They discuss licensing, price reg- banks increased considerably, making the banks ulation, access regulation, and universal service vulnerable to changes in interest rates. Further- dimensions. For each dimension, they also describe more, during the 1990s banks began to borrow Overview xxv funds from abroad and use the funds to buy of government funds, and measures were taken to government bonds.12 Thus banks also became facilitate bank mergers and prepare the state banks vulnerable to exchange rate risk. for privatization. · Third, in 1994 as part of an effort to prevent an In addition, the regulation of existing banks was economic collapse following a fear of a bank run, greatly strengthened. Currently, banks are required the government introduced full (100 percent) to maintain an 8 percent capital adequacy standard state guarantees for deposits. Before 2001, fear of ratio, on both a consolidated and unconsolidated a renewed banking crisis prevented the authori- basis. The maximum open foreign exchange posi- ties from replacing this supposedly temporary tion was reduced from 30 percent to 20 percent. measure with a more reasonable deposit insur- Steps have also been taken to correct flaws such as ance scheme. weak loan loss provisioning and the lenient large · Fourth, Turkey lacked competent supervisory exposure and related lending limits. Tighter limits authorities, a good regulatory framework, and an were imposed on both on- and off-balance sheet effective legal and institutional infrastructure. commitments to related parties, and especially to companies belonging to the same group as a bank. Since 1999, Turkey has taken measures to reform Bank shareholders and managers are now personally the regulatory and institutional framework of its liable for the mismanagement and abuse of bank banking sector and restructure the state and private resources. The BRSA requires that banks introduce banks. The acquis in this area requires, among other internationally recognized accounting and auditing things, an independent central bank that, as a pri- standards. All in all, as of 2004 Turkish prudential mary task, maintains price stability. It also prohibits requirements were in general in conformance direct central bank (or public sector bank) financ- with those in the EU for capital adequacy standards, ing of the government deficit. Accession entails loan classification and provisioning requirements, acceptance of the objectives of the EMU, although limits on large exposures, limits on lending to compliance with the convergence criteria is not related parties, and requirements for liquidity and necessarily a precondition. However, because those market risk management. criteria are indicative of a macroeconomic policy The objective of the legislative and regulatory geared to achieving stability, all member states reform has been to bring the regulatory and super- must in due course comply with them on a perma- visory regime for the Turkish financial sector up to nent basis. the level of international practice in line with EU In 1999 the Turkish Parliament passed a new standards. This objective has been achieved to a banking law, which mandated the creation of an large extent. Pazarbas¸ioglu argues that Turkey has independent Banking Regulation and Supervision fulfilled most of the conditions necessary for Agency (BRSA). The BRSA took over the bank reg- attaining compliance in the banking sector with ulatory and supervisory responsibilities previously the EU integration process. She stresses that the fulfilled by the Treasury and the Central Bank. For Turkish banking sector will be exposed to certain state banks, the Treasury provided floating rate costs during and after accession in the form of notes to those banks securitizing their "duty losses," competitive pressures from EU banks that have a and it strengthened their capital base. A law was strong capital base and risk management skills. also introduced prohibiting state banks from run- However, the Turkish banking system has become ning more duty losses--that is, any support pro- more resilient and sounder since the extensive vided to the state banks will henceforth have to be restructuring program and implementation of budgeted. The state banks were also required to international standards. This restructuring process comply fully with all banking regulations. Private came at a large implied fiscal cost estimated to banks that had incurred significant losses in the have reached close to one-third of GDP in the aftermath of the currency crises were either taken initial stages. over by the Savings Deposit Insurance Fund (SDIF) A major remaining issue that needs to be solved is or asked to strengthen their net worth and balance the privatization of state banks. In 2003 Turkey sheet structure. The capital base of banks under decidedtoprivatizethetwolargeststatebankswithin SDIF management was enhanced by the injection three years, to withdraw the banking license of xxvi Overview another state bank, and to resume the privatization efficiency, and nuclear energy (European Commis- process of another large state bank as soon as market sion 2004c). conditions allowed.13 The data on the Turkish bank- In chapter 7, Izak Atiyas and Mark Dutz describe ing sector reveal that in 2004 private domestic competition and regulatory reform in the Turkish banks held about 57.6 percent of the total assets of electricity industry. After reviewing the physical the banking sector, with the five largest banks peculiarities of the electricity industry and dis- accounting for 60 percent of total assets. The share cussing how those characteristics have shaped the of state banks was 34.6 percent, while that of banks evolution of its industrial organization, Atiyas and managed by the SDIF was 0.6 percent. Foreign Dutz present an overview of regulatory reform in banks' share of total banking assets amounted to the EU, the key directives, and the recent proposals 3.5 percent. Thus foreign banks, in terms of their for amendment advanced by the European Com- shares of total credits and deposits, remain insignif- mission. They also identify five main challenges icant in Turkey. associated with adoption of EU norms in this area: With Turkish accession to the EU, competition in market opening, unbundling, third-party access, the financial sector will increase as Turkey recognizes public service obligations, and regulation. the competence of the supervisory authorities of the Historically, the Turkish electricity sector has EU member states and incorporates the principle of been dominated by state-owned enterprises that home country control in its legislation. According provide distribution, generation, trading, and to Claessens, Demirgüç-Kunt, and Huizinga (1998), transmission services. However, privatization has foreign bank assets as a share of total bank assets over been widespread for some time. Privately owned 1988­95 averaged 77 percent in Greece,31 percent in firms have entered the industry through build- Spain, 61 percent in Hungary, and 51 percent in the operate-transfer (BOT) or auto-generator schemes. Czech Republic. Thus, with the liberalization of They account for about 21 percent of electricity gen- financial markets, the penetration rates of foreign eration. In addition, firms have been bidding com- banks in Turkey will increase substantially, causing petitively on build-operate-own (BOO) contracts adjustment costs in the sector. Increased competi- for electricity generation. Transfer of operating tion will improve the quality and availability of rights contracts (TOORs) have been awarded for financial services in the domestic market, enable eight thermal plants and 14 distribution regions. the application of modern banking skills and tech- Privatization of generation assets is envisaged to nology, enhance the country's access to interna- start in 2006 and to be completed in 2011. All assets tional capital, lower prices for consumers, and lead in the distribution sector will be divested by mid- to a larger variety of financial instruments. Some of 2006 (European Commission 2004c). the Turkish banks will benefit from larger markets Many of the benefits of privatization come with by concentrating on activities in which they have a the transfer of risk. When private companies comparative advantage. Other Turkish banks may bear risk, privatization can be expected to lead to be forced to merge with foreign banks or leave the efficiency gains. Under the current regulations in market altogether. Turkey, the private owners in the electricity sector bear construction and operating cost risks. The pri- vate operator signs a long-term power purchase Energy agreement with the state-owned generation enter- Chapters 7 and 8 examine Turkey's energy sector. prise in which the latter commits itself to buy the The objectives of the EU's energy policy include output of the plant for a period of, say, 20 years at a improving competitiveness, securing energy sup- fixed price in foreign currency. In BOT projects, the plies, and protecting the environment. The energy price has ranged on average from between $.08 and acquis consists of rules and policies, notably on $.09 per kilowatt-hour for the first five to 10 years competition and state aid (including in the coal of operation. The BOO projects tend to have lower sector), the internal energy market (for example, prices. The BOO contract, guaranteed by the Trea- opening up of the electricity and gas markets, pro- sury, assures the investor that the project will be motion of renewable energy sources, crisis manage- profitable irrespective of the future demand for ment, and oil stock security obligations), energy power. As a result, the government retains the Overview xxvii commercial risks. Significant problems have arisen They focus on Turkey's natural gas market and the with these arrangements. The high-cost electricity measures adopted to liberalize the sector and to purchase agreements have exposed the state comply with EU requirements for accession. As in providers to significant losses and contingent liabil- the electricity industry, the main challenge con- ities. The financial position of these firms is poor fronting Turkey is to increase competition in the partly because of high-cost BOT contracts that market while dealing with the legacy of past deci- involve purchase costs to the Turkish Electricity sions, in this case the long-term take-or-pay con- and Transmission Company (TEAS¸) in excess of the tracts signed by Turkey's Petroleum Pipeline Corpo- subsequent sales prices to the Turkish Electricity ration (BOTAS¸). This government-owned company Distribution Company (TEDAS¸) set by the govern- dominates the natural gas sector in Turkey, control- ment. The associated subsidies and cross-subsidies ling the pipeline infrastructure for oil and gas trans- will have to be removed as a result of accession. mission, liquefied natural gas (LNG) terminals, and A new electricity law passed in 2001 provides for gas distribution. BOTAS¸ has monopoly rights on the establishment of an independent Energy Mar- gas imports and exports and on wholesale trading, ket Regulatory Authority (EMRA) to take over reg- transmission, and storage activities. ulatory functions from the Ministry of Natural The 2001 natural gas market law (No. 4646) calls Resources. Standard regulatory functions include for liberalization of the gas market and the creation tariff setting, market monitoring, and settlement of of a financially sound, stable, and transparent mar- disputes concerning access. With this law, the gov- ket (Article 1), including the removal of the import ernment is introducing a market model along EU monopoly. As noted in World Bank (2004:1), lines that will transfer most of the task of supplying progress in the three years following adoption of and distributing electricity and the associated the law was slow: "Industry structure remains market risks to the private sector, eliminate the monolithic, with no separation of functions other need for additional state-guaranteed power pur- than some distribution. Cost transparency, largely chase agreements, and minimize costs through due to the existing industry structure, remains defi- competitive pressures on producers and distribu- cient. Competition has not developed in the whole- tors, again along the EU model (see chapter 7). The sale sector. International investors remain con- government, then, will largely withdraw from the cerned by the delays." The 2001 law requires electricity generation and distribution businesses. BOTAS¸ to conduct tenders to transfer to other Electricity generation companies will sign contracts market players its existing contractual obligations for power directly with distribution companies on natural gas purchases and sales until its imports without government guarantees. The government's fall to 20 percent of annual consumption (the so- future role will be largely confined to determining called gas release program). Little progress has been sector policy, owning the transmission system, and made to date on implementing this requirement, ensuring that the rules are respected and that prices and Mazzanti and Biancardi argue that enforcement are determined competitively. The implication is of measures to limit the market power of the that, once the law is fully implemented, the regula- incumbent will be an important determinant of tory and supervisory regime for the electricity gains to Turkey from reform as well as a require- sector will have been brought up to the level of ment for satisfying the acquis in this area. Competi- international practice in line with EU standards. tion in the natural gas industry is impeded by long- Although the various BOT and BOO contracts term investments and contracts in the upstream signed in the past imply that the establishment of a activities (gas contracts and infrastructures). Gas competitive environment may take quite a long tends to be purchased on the basis of long-term time, once the system begins to operate Turkey can contracts with take-or-pay clauses that require the expect to derive efficiency gains in the sector result- gas purchaser to pay 70­90 percent of the con- ing in price reductions and improvements in the tracted capacity whether it receives the natural gas quality of the service. or not; the reason is that extractors must invest In chapter 8, Maria Rita Mazzanti and Alberto huge amounts mining and transporting the gas and Biancardi analyze the institutional endowment and thus confront very high up-front fixed (sunk) costs regulatory reform in Turkey's natural gas sector. and almost zero marginal costs. xxviii Overview Breaking up the upstream and downstream inclusion of handicapped people in the workforce. (wholesale) monopoly of BOTAS¸ is a precondition In all of these areas, EU social legislation lays down for the emergence of competition in the sector. minimum requirements that must be met by mem- Mazzanti and Biancardi note that the targets set by ber states. the law for BOTAS¸ shares (no more than 20 percent Adoption of the EU acquis will bring radical of imports and the wholesale market) are very changes in the functioning of the labor market in ambitious, and much more so than the targets set Turkey, with vital consequences for firms, workers, by EU member states. They also argue that the gas and the long-term performance of the economy. release provisions of the law--which have also been The main impact will fall on the informal sector. used by EU states in introducing competition-- Taymaz and Özler note that the Turkish labor mar- could have a beneficial impact, as long as they are ket is currently quite flexible, because the formal designed appropriately.14 and informal sectors have very different wage- setting mechanisms. The informal sector is largely free from labor regulation and avoids most of the The Complementary Implications taxes and related charges. Job insecurity is perva- and Challenges of Reform sive, and workers receive very few benefits from Although much has been achieved in sector- their employers. By contrast, in the formal sector specific regulation and reform, much remains to be labor regulations are observed, and taxes and done in some areas, especially energy and trans- related charges such as social security contributions port. Other economic reform challenges are associ- and payments to various funds are paid. Because ated as well with accession and realizing gains from the informal sector accounts for some 40 percent of the process. Chapters 9­11 consider three impor- manufacturing jobs, applying EU regulations to tant "horizontal" areas: the labor market, (foreign) this part of the labor market will have major effects. investment policy, and EU regulations pertaining to Taymaz and Özler estimate that when all infor- the environment. The first two complement the mal sector firms in the manufacturing sector begin financial (banking) sector as critical determinants to pay taxes and social security contributions at the of the effects of accession. Labor market regulations same rates applied in the formal sector, the firms will affect the incentives to invest, the costs to work- affected will lose half of their market shares as their ers of layoffs, as well as the overall cost structure of costs rise. As a result, employment in the manufac- doing business in Turkey. FDI is an important turing sector will decline by 9 percent, or some source of knowledge, employment, and competitive 300,000 jobs. As noted by Togan in chapter 12, the pressure on incumbent firms. Finally, environmen- effect of this policy change on employment will be tal regulation has the potential to enhance social even more drastic when one considers its effects on welfare by ensuring that firms and consumers con- employment in agricultural and services sectors as front the appropriate (social) prices of their eco- well. The policy implication is that if a massive nomic activities, but it also raises the danger of increase in unemployment is to be avoided, com- excessively costly regulation that may not be appro- prehensive labor market reform will be required priate to Turkey's circumstances and preferences. that includes both substantial decreases in tax rates In chapter 9, Erol Taymaz and S¸ule Özler look at on wage income, tax-related charges, and payments the labor market. They argue that one of the most to various funds, and reductions in layoff costs. important issues for Turkey in adopting and imple- Such measures will also increase the flexibility of menting the EU acquis is related to the labor mar- the formal market. Such flexibility will benefit the ket regulations and employment policies that pre- economy overall, because it will remove a disincen- vail in the EU. The acquis in this area includes EU tive for firms to grow and become part of the for- legislation covering health and safety at work, labor mal sector--a step that requires access to the capital law and working conditions (working hours, part- markets and banking system, which, in turn, time work, collective redundancies, worker protec- implies becoming subject to taxation. An impor- tion in case of bankruptcy and closure of plants, tant corollary not discussed by any of the contribu- child labor--minimum working age), gender tions in this volume is that other policies in the area equality (equal pay and opportunities), and social of taxation and support for the private sector are Overview xxix rendered neutral with respect to the size of firms-- will probably have major repercussions for Turkey. in Turkey, as in many other countries, tax and Joining the EU will require implementing the entire related policies tend to discriminate de facto if not body of EU legislation and standards on environ- de jure against small firms (Hoekman and Javorcik mental protection. This step, in turn, implies sub- 2004). stantial investments by the public and private Chapter 10 by Mark Dutz, Melek Us, and Kamil sectors, as well as changes in regulations and Yilmaz turns to Turkey's FDI challenges. The supporting institutions. EU policy in this area is authors conclude that Turkey would benefit signifi- based on integration of environmental policy with cantly from EU accession, largely because the acces- the sectoral policies of the EU, prevention meas- sion process would help Turkey to overcome its ures, implementation of the "polluter pays" princi- rule-of-law and competition-related constraints to ple, and measures to address environmental exter- FDI inflows. More rapid and consistent implemen- nalities at their source. The acquis comprises some tation of the rules and regulations that ensure a 200 legal instruments covering a wide range of level playing field for all companies would be areas, including water and air pollution, manage- assisted by the EU accession process; this process, in ment of waste and chemical products, biotechnol- turn, would enable Turkey to take full advantage of ogy, radiation protection, and nature conservation. investment-related benefits. Markandya breaks down the potential costs of During the 1980s, Turkey made frequent use of adopting the acquis based on three scenarios: a investment and export incentives and also relied "base case" in which no special reforms are made heavily on state-owned enterprises. The Turkish and the public sector remains much as it is today; a public enterprise sector has been and still is very "medium reform" case in which the private sector's large. The state-owned enterprises have shown, in share is increased modestly and reforms in pricing general, poor economic performance because of the proceed to reduce the demand for some of the envi- soft-budget constraints they have faced. They are ronmental cleanup services; and a "high reform" not confronted with the threat of bankruptcy and case in which the private sector's role is somewhat have benefited from government subsidies in the greater and environmental reforms are imple- form of direct transfers, equity injections, and debt mented with more rigor. consolidation. In recent years, Turkey has elimi- Consider just one representative area subject to nated most investment and export incentives, but environmental regulation in the EU: wastewater similar progress could not be achieved for the pub- collection and treatment. According to the EU lic enterprises. Although privatization has become urban wastewater directive (91/271/EEC), all urban a prominent part of the Turkish reforms, it gained areas with a total wastewater discharge of 2,000 momentum only after the 2001 crisis and the asso- population equivalent must be connected to the ciated reforms, because it was recognized that state- sewer system, and discharges must receive at owned firms and the related structure of subsidies least secondary treatment except for towns with and soft-budget constraints were a part of the populations of less than 10,000 and in cases in problem underlying the large nonperforming assets which such treatment would produce no environ- of the banks. Turkey recognizes that it will have mental benefit or would involve excessive cost. to stop subsidizing the public enterprises at the Because the majority of the Turkish population prevailing rates, align its state aid policies with lives in municipalities that are not connected to those of the EU, apply the same competition poli- sewer treatment, and because only a very small cies to all firms whether private or public, and pri- number of municipalities have wastewater treat- vatize the public enterprises. Greater FDI can play ment facilities, the implementation costs associated an important role in this transition, as it has in the with meeting this EU regulation will be very large CEE countries. indeed. How large will depend in part on negotia- In chapter 11, the final major cross-cutting or tions with the EU to determine its interpretation of horizontal issue chapter, Anil Markandya looks at what is allowed in view of the flexibility provisions the costs, especially in the public sector, Turkey is embodied in the regulation. But rough estimates of likely to incur in meeting the environmental acquis. the investment costs of compliance run up to more In this area, as in the labor market, the EU acquis than $10 billion. Adding the additional operating, xxx Overview maintenance, and replacement costs would further an analysis is needed to determine where the case increase this amount. for investment is strongest and where it would be Wastewater collection and treatment is just one better to delay making investments (and negotiate of the relevant directives; others include EU regula- extensions or agree on different sequencing with tions on drinking water, industrial pollution, dan- the European Commission). gerous chemicals, fuel standards, air quality, and waste management. Markandya estimates that the total investment will run between 28 billion and Toward an Assessment: Net Effects on Turkey 49 billion. Although this estimate is very high, he also notes that the costs will be spread over many What will be the net impact on Turkey of all the vari- years--he assumes 17 years. Annual investments ous policy reforms involved in EU accession? In would amount to about 2 billion to 3 billion in chapter 12,Sübidey Togan attempts to go beyond the the high reform (i.e., low-cost) case and 3 billion merchandisetradeliberalizationanalysisundertaken to 5 billion in the medium reform (i.e., high-cost) by Francois in chapter 4 and quantify the impacts on case. In the initial years, this investment would those areas identified by the chapter authors as amount to 1­1.5 percent of GDP in the low-cost requiring the implementation of concrete policy case and 1.5­2.5 percent in the high-cost case. To changes. Specifically, Togan considers the welfare this one would have to add the extra annual operat- effects of integration with the EU associated with ing costs that will be incurred, which would be in policy changes in the agriculture, banking, telecom- the range of 5 billion to 8 billion. Because munications, transportation, electricity, and natural Turkey's capital investment spending on environ- gas sectors.He concludes that a conservative estimate mental areas is about 0.5 percent of GDP, accession of the resulting net increase in the real income of will imply an increase of anywhere from a factor of Turkish households is some 3.6 percent of GDP.15 two to four or more. However, many of these invest- Integration with the EU will remove numerous dis- ments would probably be made in any event by tortions in the price system and improve the business Turkey, although perhaps not as fast insofar as the climate for private sector development, which, in EU directives do not correspond to Turkey's priori- turn, will increase the allocative efficiency of the ties at its current stage of development. Important Turkish economy. Because these achievements will here is the extent to which there is "wiggle room" in make Turkey a better place to invest, investment, the various directives, as well as flexibility on the including foreign direct investment, can be expected part of the European Commission in assessing to increase, bringing with it associated employment whether achievement of the acquis in all of the vari- opportunities. The allocative efficiency gains from ous areas is a necessary condition for accession. integrationwillbeboostedbyinducedcapitalforma- Also important will be the extent to which fund- tion. But these welfare gains will have a price: the ing for some of these investments will be provided adjustment costs associated with attaining macro- by EU member states--although it must be recog- economic stability, adopting EU labor market rules nized that the money is fungible and that the Turk- and regulations, and complying with EU environ- ish government must determine for itself where mental directives. grants and loans should be allocated for the highest No assessment of costs and benefits should social rate of return. Indeed, determining this allo- ignore the opportunity costs associated with the cation and deciding what trade-offs to make will accession strategy. Indeed, one can and should ask perhaps be one of the greatest challenges con- what the counterfactual is to accession. Any process fronting successive Turkish governments as the of regional integration by definition excludes other accession process proceeds. In making this determi- options--going it alone or relying more intensively nation, the government must compare cost esti- on multilateral approaches as the focal points and mates with benefit estimates that evaluate the gains anchors for reform. Clearly, the political decision from the implementation of the directives. Under- has already been made to pursue the accession taking such a cost-benefit analysis is critical. One path, but that decision does not take away the strong conclusion that emanates from Markandya's importance of determining whether alternative chapter, as well as others in this volume, is that such strategies might not be superior in economic terms. Overview xxxi It is very difficult, however, to address this question. gradual convergence in areas where this is likely to Virtually everything that is being done and will be be appropriate in view of Turkey's initial conditions. done by Turkey could be done unilaterally. Many of In part, the cost-benefit ratio will depend on the the benefits from the reforms undertaken to date extent to which additional grants are made available were gained autonomously--for example, the steps to Turkey that otherwise would not be forthcom- to exert greater macroeconomic discipline, the ing. Accession implies access to the CAP and Struc- measures to strengthen the banking system, and the tural Funds, and, as a poor country, Turkey will be a introduction of greater fiscal discipline for agricul- net recipient of such transfers. It is not possible at ture and state-owned firms. How much the tem- this point to determine how large this net flow will plates provided by the EU model have helped is not be. The structure of the present system of EU rev- possible to determine. Clearly, however, the prospect enue and expenditure is such that rich member of accession played a role in the pursuit of some of states transfer resources to poorer members. these reforms. The key dimensions of accession Because Turkey is poor relative to the EU25 (even as an anchor and focal point for reforms are as though the difference will be smaller than it was follows: before the accession of the 10 new members), acces- sion will clearly have budgetary effects for the EU if · the availability of the EU "model" to follow and the current criteria are maintained for transfers implement among EU members. Allocations are determined in · the prospect of eventual free access to the EU for part by voting power (in turn, a function of popula- Turkish workers tion and size of the economy) as well as relative · the assistance granted to Turkey by the EU. poverty, and so there is a possibility that the rules of the game will be changed before Turkey accedes in Does the EU model (the acquis) make sense for order to manage the fiscal and redistributive reper- Turkey? When it comes to disciplines associated cussions of its accession. In addition, it is projected with the single market, we would argue the answer that by 2020 Turkey's population will be larger than is yes. The agenda here revolves around introducing that of any other EU25 member. This projection market disciplines, controlling state aids, and may raise concerns about the decision-making pro- encouraging competition in markets for goods and cedures of the EU, as well as worries about possible services. Integrating transport and energy markets immigration effects. also makes good economic sense, as do measures aimed at increasing the contestability of these mar- Effects of Turkey's Accession kets and removing competition-distorting cross- on the EU subsidies. This is not to say that the EU model in these areas is perfect--EU trade policy, for exam- The effects of Turkey's accession on the EU will ple, and the CAP most obviously are not very good depend importantly on what accession will entail examples of efficiency-maximizing policies. But the for EU transfers to Turkey, EU governance (deci- point is that they are better than the status quo ante sion making), and trade and factor flows, espe- prevailing in Turkey, and their adoption therefore cially migration.16 Because the trade in goods, improves the expected policy stance in these areas. services, and capital has already been either cov- Other dimensions of the acquis leave room for ered by the customs union or addressed unilater- doubt. Although much of what is being pursued ally by both parties in terms of bilateral flows, the through the EU directives in the social and envi- effects on the EU in these dimensions are likely to ronmental areas is justifiable and will bring bene- be limited in the sense that they will have already fits, the costs of implementing regulation in these occurred at the time of any accession decision. In areas can be high. It is not clear that benefits will any event, the aggregate impacts on intra-EU trade always outweigh costs, suggesting that these are will be small. Production and trade in agricultural areas in which greater care and attention are goods will be affected by accession, but the major required to sequence implementation appropriately. effects will be in Turkey, not in the EU, because As emphasized before, however, the accession import barriers are relatively low for Turkish agri- process will take a long time, allowing for a more cultural exports. xxxii Overview Decision Making $7,000--and income disparities within the country are great. The population in the southeast has less In chapter 13, Richard Baldwin and Mika Widgrén than half the average national income, and the large evaluate the impact of Turkey's membership on EU rural population is generally much poorer than the voting. They analyze the EU's decision-making effi- urban population. As discussed by Harry Flam in ciency (its capacity to act, as measured by the prob- chapter 14, these facts have implications for both ability of proposals passing a vote) and the distribu- the EU budget and for emigration from Turkey. tion of power in the EU's leading decision-making If the existing rules for contributions to and body, the Council of Ministers. They also compare receipts from the EU budget remain unchanged-- two alternative Council voting rules: those accepted including the Common Agricultural Policy--Flam in the Treaty of Nice and implemented by the estimates that Turkey would receive a net transfer accession treaty of the 10 new entrants in 2004 and of 12 billion from the EU, corresponding to about the rules laid down in the draft Constitutional 14 percent of the present EU budget. The overall Treaty (CT). The latter are conditional on the ongo- net contribution to the 10 new entrants in 2004 and ing ratification process. Turkey is projected to correspond to about 60 per- Baldwin and Widgrén conclude that, in terms of cent of the present budget. Flam concludes from capacity to act, the enlargement will likely have rel- this that it is unlikely that current rules will remain atively little impact, as long as the CT voting rules unchanged in the face of such large increases in net come into effect. In particular, Turkey's member- transfers from richer to poorer countries. ship will have only a negligible effect on the EU's As noted earlier, the major trade impacts of capacity to act--in large part because moving from Turkish accession on the EU are likely to be in the 27 members (the EU25 plus Bulgaria and Romania) movement of labor. The decision to emigrate to 29 (Turkey and Croatia) does not change much. depends on a variety of factors, but real wage differ- The answer, however, is quite different if the CT is entials are clearly important, as are social networks, rejected and the Nice Treaty rules remain in place. culture, language, and geographic distance.17 It will Under the Nice Treaty voting rules, the enlargement take decades for Turkey to attain an income level would substantially lower the EU's ability to act. comparable with that of the EU15, implying that These findings confirm earlier conclusions by the income differentials will be a strong incentive for authors that an enlarged EU cannot function well migration from Turkey to the EU. The prospect of under the Nice Treaty rules. They also suggest that if large-scale immigration from Turkey (as well as the CT is rejected, the Nice Treaty voting rules must from new members and other candidate countries) be reformed before further enlargement takes place. is a source of considerable concern among the As for the distribution of power, they find that EU15. This was a major factor in the French deci- Turkish accession will have a big impact. Under both sion to subject approval of Turkish accession to a the Nice Treaty and CT rules, Turkey would be the referendum. Fears that immigrants will depress second most powerful member of an EU29. Under wages, boost unemployment, and cause social fric- the CT rules, Turkey would be substantially more tion and political upheavals prevail in many EU powerful than countries such as Britain and Italy; member states. Clearly, free migration will not be under the Nice Treaty rules the power differences allowed immediately upon full membership. For among the countries with a population of more the 2004 new EU members, the length of the transi- than 50 million would be small. This situation sug- tion period was seven years, as it was for Greece, gests that the acceptability of the Constitutional Portugal, and Spain. For Turkey, the period may be Treaty and the probability of Turkey's membership longer, and it may be subject to longer-term con- may well be negatively affected. trols. However, because accession is unlikely to occur before 2012, this is an issue that would only Migration and the EU Budget come into play in 2020. By that time, Turkey should Turkey is likely to have a population larger than have converged more toward the average income Germany's 82 million by 2020, if not earlier. Turkey levels of the EU25, reducing migratory pressures. is poor by European standards--PPP (purchasing As noted by Flam, the strength of the incentive to power parity)-adjusted per capita income is roughly move and the total number of people who might Overview xxxiii move are also a function of how rapidly wages rise in ment about the impact of greater trade on labor mar- Turkey. As workers leave and the supply of workers ket outcomes), there is agreement that immigration declines in Turkey, wages will go up. Conversely, will have much greater impacts than expanded trade immigration will have a depressing effect on wages between poor and rich countries. One reason is that in the EU--albeit much smaller because the EU migrants will seek employment in all sectors,not just labor market is much bigger. The net impact on the tradables.19 Turkish economy will be determined by the extent to which capital owners are affected in Turkey, the Implications for Other Developing impact of the loss of (qualified) workers on Turkish Countries GDP, the extent to which earnings in the EU are remitted, and the magnitude and impact of reverse The requirements for accession to the EU provide a movements as people of Turkish origin relocate ready-made template, if a constantly evolving and upon retirement and repatriate capital. Much also expanding one, for countries seeking to implement will depend on the skill levels of the people who far-reaching structural reform programs. What is move. Unskilled migrants are more likely to be com- the relevance of the Turkish experience? What les- plementary to more skilled nationals in the host sons can be drawn for other countries with a start- economy because they will allow the latter to increase ing point similar to that of Turkey that will not be their productivity and thus their real wages. able to accede because they are not part of Europe? Whatever the specific impacts,overall welfare will A first lesson is that the prospect of accession is increase as a result of migration, but there will be a not a panacea. What matters are the autonomous redistribution of income. Turkish GDP will decline, decisions on economic policy made by govern- andtheEU'sGDPwillrise.EUfirms(capitalowners) ments. Although Turkey's accession to the EU was and more highly skilled workers are likely to benefit already under discussion in the 1960s, very little from the increased supply of less-skilled workers. progress was made in converging toward EU norms Turkish migrants will gain from the move, and less- until the early 1990s. A related lesson is that much of skilled EU workers will lose. The overall welfare what is associated with accession can be pursued by increase will stem from a more efficient allocation of countries that will not be able, or may not desire, to labor; Turkish laborers become more efficient when accede. The EU acquis is a public good in the sense they move to European countries, and the optimal that any country can avail itself of that body of leg- allocation is achieved when the marginal productiv- islation and regulation. What matters is implemen- ity of labor is equalized across EU members. tation, which, in turn, requires commitment and the Flam concludes that the Turkish immigrant pop- relevant institutions to apply the standards. The reg- ulation in Germany may rise by some 60 percent by ular monitoring and interaction between the Euro- 2030. About 3 million people of Turkish origin are pean Commission and the partner government, presently in the EU, the overwhelming majority in facilitated by the provision of technical and finan- Germany, which implies a total movement of some cial assistance, can help to maintain progress. How- 1.8 million Turks.18 Although this is a highly specu- ever, accession does not have to be part of the equa- lative exercise--as stressed by Flam, much depends tion for countries to obtain such assistance--a very on the parameters assumed in the model--these similar structure is available in the form of the numbers are manageable in view of the current association and economic partnership agreements overall EU25 population of 450 million. However, that many countries have signed with the EU. Flam's projections assume no restrictions are placed Such agreements can have major potential on migration--a strong assumption. downsides if they involve asymmetric liberaliza- What such immigration will imply for wages and tion of trade in favor of the EU, while keeping bar- employment in the receiving countries is even more riers to imports from the rest of the world at high speculative. While those who have investigated the levels. For this reason, the standard policy advice to impacts of immigration suggest that it is likely to be governments implementing such discriminatory limited, it should be noted that in contrast to the trade agreements is to pursue a parallel strategy of debates between the proponents and opponents of lowering most-favored-nation protection rates as trade integration (where there is significant disagree- well (Schiff and Winters 2003). Turkey, because it xxxiv Overview formed a customs union with the EU, has adopted factors.A long history of macroeconomic instability the common external tariff, which tends to imply a and high-cost services will lower the interest of an low average level of protection, at least for manu- investor, especially in light of the fact that the Cen- factures.20 Assuming the problem of trade diver- tral and Eastern European countries offer an alter- sion is addressed through the adoption of low, and native location. Administrative barriers to FDI ideally uniform, levels of external protection, the (including red tape) have also been high in the past. EU model of regulatory principles has much to Finally, slow progress on privatization helps to offer countries that are similar to Turkey--that is, explain low FDI. emerging markets that have extensive state involve- A similar situation prevails in neighboring ment in the economy, limited competition in serv- countries, although with one major difference: ice markets, and weak banking systems. A process most Arab countries have experienced macroeco- of "conversion à la carte" is, by definition, not feasi- nomic stability. Administrative barriers to FDI, ble when it comes to accession, but it is possible in monopoly provision of services, state-owned enter- the context of partnership agreements. Indeed, this prises, and slow privatization all reflect political option was made explicit by the EU in its 2004 decisions. It is an open question to what extent European Neighborhood Policy, which offers part- trade agreements that do not involve the prospect ner countries that do not have the prospect of of accession could assist countries that want to pur- accession the opportunity to adopt parts of the sue an investment and services liberalization acquis and through this harmonization share the agenda, although the Turkish experience suggests benefits associated with the relevant elements of that even in a context of possible accession, the EU's Internal Market. The challenge for part- progress on this overall agenda can be slow. How- ner countries is to determine where such approxi- ever, the deepening of accession efforts in the future mation-cum-harmonization will be beneficial and will, by necessity, imply that much of the "behind where not. The Turkish case and its experience the border" reform agenda must be implemented offer valuable guidance on what part of the "EU for accession to become feasible. This may or may package" would be beneficial to adopt and emulate not be true for association agreements that include (with assistance from the EU in the context of such services and investment policies. Much tends to be agreements) and which parts are best left on the made of the fact that bilateral and regional trade shelf for the future. agreements are increasingly covering these areas, The Turkish experience--as well as those of the but there is little experience with actual implemen- CEE countries that acceded to the EU--reveals tation. In principle, again, reforms in this area can clearly that trade policy is important, in that the lib- and should be implemented unilaterally. Trade eralization of trade with the EU led to significant agreements may help by allowing gradual commit- improvements in productivity and trade perform- ments to be made in a more credible manner, but ance, but that in itself is not sufficient. In an envi- much depends on the substance of the reforms. A ronment characterized by limited, if any, competi- key requirement (precondition) for the network tion in the key network services industries--energy, services industries and the financial sector is appro- telecom, transport--a weak financial sector, and priate regulation to ensure efficiency, to guard limited fiscal discipline (and thus extensive cross- against systemic risks, and to achieve social or subsidization and transfers), trade liberalization equity objectives (e.g., universal service obliga- needs to be complemented by measures to harden tions). These are complex areas. Much can be budget constraints and to enact pro-competitive learned from the experience of other countries-- regulation. The limited stock of inward FDI--a such as in the natural gas sector (see chapter 8 phenomenon that also characterizes neighboring by Mazzanti and Biancardi)--but what matters countries in the Middle East and is in striking first and foremost is clear objectives. Also impor- contrast to the situation in CEE countries--is tant is the establishment of an effective, general indicative: foreign investors either perceive the competition authority and mechanisms to assess attractiveness of locating in Turkey to be limited or the impacts and effects of reforms.21 Indeed, an perceive the barriers to FDI to be prohibitive. In important policy decision is to what extent a coun- practice, the answer is likely to be a mix of these two try should rely on general competition law to Overview xxxv discipline the behavior of enterprises, including Eurasia, and the Middle East, Turkey has the poten- dominant firms in the network services industries, tial to act as a major link between these markets. as opposed to sector-specific regulatory bodies. With harmonization of commercial legislation, EU companies will be able to use Turkey as a joint investment and export base for the Middle East and Conclusion Eurasia. Istanbul is already emerging as a base for To join the EU, Turkey will have to attain macro- transnational corporations operating in the Cauca- economic stability, adopt the EU's Common Agri- sus and Central Asia. Finally, Turkish membership cultural Policy, and liberalize its services and could help to secure stability and security in the network services industries. Integration will be Balkans and Caucasus, thereby increasing EU beneficial for Turkey, because it will remove many energy security. distortions in the price system, boosting the alloca- Although the potential net gains for Turkey and tive efficiency in the economy and, in turn, making the EU members are significant, Turkey faces major the country a more attractive place to invest. With challenges in implementing the acquis. Major chal- accession, Turkey will also be eligible for EU Struc- lenges also must be overcome in realizing the poten- tural Funds, with the resulting increase in infra- tial gains associated with increased labor flows from structural investments further contributing to Turkey--even if they will probably be relatively prospects for economic growth. In addition, Turkey small compared with the size of the EU labor force. will reap benefits from monetary integration, as The same is true of decision making and manage- well as from migration of Turkish labor to the EU. ment of the net annual budgetary cost of Turkish However, the welfare gains derived by Turkey from membership to the EU. The Baldwin-Widgrén integration will have a price: the adjustment costs analysis in chapter 13 points to the importance of associated with attaining macroeconomic stability, passage of the EU Constitutional Treaty and the adopting the CAP, liberalizing services and the net- acceptance by existing members of a significant role work industries, and complying with EU environ- for Turkey in decision making. Estimates reported mental directives. by Flam in chapter 14 and in Togan (2004) suggest According to the European Commission (2004a), that budgetary costs will be quite high unless the 71 percent of the Turkish population supports EU rules on the CAP and Structural Funds are membership. This high percentage of support can changed--constituting yet another challenge that be explained in part by the economic benefits that will have to be negotiated successfully before Turkey expects to derive from membership. Equally accession. important is the recognition in Turkey that the sys- tem of governance of a rule-based society, as in the Notes EU with its many institutions, may provide better 1. Decision No. 1/95 of the EC-Turkey Association Council prospects for meeting the demands of various of December 22, 1995, on implementing the final phase of the groups in society.22 Support for EU membership customs union (96/142/EC). also stems from the process of Westernization and 2. "By [their] very nature, [accession negotiations are] an from geostrategic considerations.23 open-ended process whose outcome cannot be guaranteed beforehand" (European Commission 2004b: 10). Turkish accession will also affect the welfare of 3. The Copenhagen criteria for membership were established current members of the EU. Welfare will increase in preparation for the eastern enlargement and cover political because of the further specialization, reflected in and human rights as well as economic criteria. Membership cri- teria include "stability of institutions guaranteeing democracy, trade, capital, and labor flows, as well as the likely the rule of law, human rights and respect for and protection of growth effects of integration. The empirical minorities." As noted by many observers, such as Flam (2003), research on the economic effects of immigration Turkey confronts serious problems in meeting the political and human rights criteria: they imply placing the military under indicates fairly small and on the whole positive political control and ridding it of its power in the judicial effects.24 There will also be political gains for the system, and they have direct implications for recognizing indi- EU. Turkey is a large and fast-expanding market. It vidual and collective cultural rights for minorities (i.e., the is, in fact, the largest market in its neighborhood Kurds). In its recommendation to launch accession negotiations, the Commission argued that in "order to guarantee the sustain- and has a GDP that amounts to 55 percent of that ability and irreversibility of the political reform process, the EU of Russia. Located at the crossroads of Europe, should continue to monitor progress of the political reforms xxxvi Overview closely, on the basis of an Accession Partnership setting out pri- 15. This is equivalent to about a 2.8 percent increase in real orities for the reform process. The Commission will, following GDP. the analysis in the Regular Report, propose to revise the Acces- 16. The 2004 European Commission recommendation sion Partnership in spring 2005. On this basis, a general review states: "The negotiations will be complex and reflect . . . the need of the way in which political reforms are consolidated and for provisions facilitating the harmonious integration of Turkey broadened will take place on a yearly basis starting from the end into the EU. The application in Turkey of the common agricul- of 2005. The pace of the reforms will determine the progress in tural policy and the cohesion policy are two examples. The rules negotiations. In line with the Treaty on European Union and the regarding the free movement of persons are a third. It is likely Constitution for Europe the Commission will recommend the that there will be, as in previous enlargement rounds, a need for suspension of negotiations in the case of a serious and persistent substantial and specific arrangements and in some areas long breach of the principles of liberty, democracy, respect for human transition periods. In the case of free movement of persons per- rights and fundamental freedoms and the rule of law on which manent safeguards can be considered. . . . The EU will need to the Union is founded. The Council should be able to decide on prepare itself because . . . the Union's capacity to absorb new such recommendation by a qualified majority." See European members, while maintaining the momentum of European Commission (2004c, 6). integration, is also an important consideration in the general 4. The European Commission reports on Turkey provide an interest of both the Union and the candidate countries. . . . In extensive list of actions taken by the government (European any event, the EU will need to define its financial perspective for Commission 2004b, 2004c). the period from 2014 before the financial implications of certain 5. In this volume, EU15 refers to the 15 members of the EU negotiating chapters can be tackled" (European Commission prior to the 2004 enlargement in which 10 more countries 2004b: 7­8). became members, creating the EU25. The 15 original member 17. For a survey, see Ghatak, Levine, and Wheatley Price countries were Austria, Belgium, Denmark, Finland, France, (1996). Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, 18. Flam obtains a number of 1.3 million for Germany, based Portugal, Spain, Sweden, and the United Kingdom. Those added on an initial Turkish-origin population there of 2.2 million. The during the enlargement were Cyprus, Czech Republic, Estonia, number in the text takes into account the additional 800,000 Hungary, Latvia, Lithuania, Malta, Poland, Slovak Republic, and Turks in the rest of the EU as of 2002. Slovenia. 19. Borjas, Freeman, and Katz (1992, 1997) found that 6. All dollar amounts are U.S. dollars unless otherwise unskilled immigrants, particularly from Mexico, increased the indicated. ratio of unskilled to skilled workers in the United States by some 7. The short maturity of debt stock and the large share of 20 percent, whereas trade flows were found to have increased the foreign currency­linked securities imply particularly high rates (implicit) ratio by only 4 percent. Freeman (2004) notes that of rollover on domestic and international markets, increasing industries that export still hire a sizable number of unskilled the vulnerability to interest rate and currency rate shocks. workers, while import-competing industries have large numbers 8. The major standards-setting bodies in the EU are CEN, of skilled workers. He also observes that the evidence that immi- CENELEC, and the European Telecommunication Standards gration has a larger impact on the ratio of skilled to unskilled Institute (ETSI). workers does not necessarily mean that large wage impacts are 9. The competition authorities have an important role to associated with immigration. Even large-scale inflows of work- play. The Turkish Competition Authority has taken action in the ers into specific locations are not found to have big effects on transport sector, such as investigating a price-fixing cartel in wages (Borjas, Freeman, and Katz, 1996). Black Sea maritime shipping (see OECD 2004b). 20. In principle, any country can choose to adopt the com- 10. See http://inweb18.worldbank.org/ECA/Transport.NSF/ mon external tariff of the EU, so that even if a customs union is Countries/Turkey? Opendocument. not on the table any country with a free trade agreement with 11. The ratio of nonperforming loans to gross loans of the the EU could emulate the Turkish solution in this dimension. banking system in Turkey reached about 22 percent in 2001. But better than adopting the idiosyncrasies of the EU political The situation improved during 2002 due to acceleration of economy of protection would be to move toward a system of low out-of-court settlements and voluntary debt restructuring and uniform tariffs. arrangements. 21. The Turkish experience, like that elsewhere in the world, 12. The average excess return on Turkish government bonds illustrates the need for a competition authority. The Black Sea over the London Interbank Offered Rate, or LIBOR (both meas- maritime case of restrictive business practices (see note 10) is a ured in U.S. dollars), amounted to only 4 percent over the period case in point. 1990­93, but was 22.9 percent over the period 1995­November 22. This may explain the support provided to EU member- 2000. In chapter 6, Pazarbas¸ioglu argues that the fiscal cost of the ship by followers of the Islamist political parties as well as by 2001 financial crisis has initially amounted to 50 billion (some representatives of different minority groups. 34 percent of GDP). If Turkey had adopted the legislative, regu- 23. During the Tanzimat period (1839­77), Westernizing latory, and institutional framework of the EU banking system at reforms were responsible for the adoption of a series of Western the beginning of the 1990s and had enforced these rules, then law codes, creation of a judicial organization with secular law the cost of the crisis would have been much smaller. courts, introduction of French-style provincial administration 13. The state banks to be privatized within three years are (1864), and use of the so-called millet system, which made it Ziraat Bank and Halk Bank. The government has withdrawn the possible for the Christian minorities to have their own religious banking license of Emlakbank, and it will resume the privatiza- autonomous administration with representative councils. These tion process of Vakifbank as soon as market conditions allow. liberal reforms culminated in the declaration of a constitution 14. See World Bank (2004) for an in-depth discussion of the and the convocation of a parliament in 1876­77. The process of challenges in and policy options for introducing greater compe- reforms continued after the national War of Independence tition into the Turkish natural gas market, including an analysis of 1919­23. Under Mustafa Kemal Atatürk's leadership, the of the sector's strengths and weaknesses. newly founded Republic of Turkey carried out an extensive and Overview xxxvii comprehensive program of modernization and secularization. European Commission. 2004a. "Euro Barometer 2004," Public Atatürk believed that total Westernization of the country was an Opinion in the Candidate Countries, Brussels. absolute precondition for Turkey's becoming a member of the --------. 2004b. "Recommendation of the European Commis- Western family of nations. He succeeded in forging a modern sion on Turkey's Progress towards Accession." COM(2004) nation out of a failing empire and a traditional community, 656 final, Brussels. based on the model of the Western countries. Turkey's --------. 2004c. "Regular Report on Turkey's Progress towards aspiration to membership in the EU stems from the process of Accession--2004." COM(2004) 656 final, Brussels. modernization and Westernization, the roots of which may be Flam, Harry. 2003. "Turkey and the EU: Politics and traced to Atatürk's reforms designed to establish a secular order Economics of Accession." CESifo Working Paper 893, March. in a country with a predominantly Muslim population. The http://www.cesifo.de. Turkish elite consider membership in the EU a natural, desir- Freeman, Richard. 2004. "Trade Wars: The Exaggerated Impact able, and inevitable step in this process. Furthermore, Turkey of Trade in Economic Debate." World Economy. realizes that it sits strategically at the edge of three regions of Ghatak, S., P. Levine, and S. Wheatley Price. 1996. "Migration conflict--the Balkans, the Middle East, and the Caucasus. Theories and Evidence: An Assessment." Journal of Economic Because of the complexity of its security, Turkey seeks to culti- Surveys 159­98. vate stability in order to minimize the potential for conflict. For Haisken-De New, J., and K. F. Zimmerman. 1996. "Wage and Turkey, EU membership can help to secure this stability and Mobility Effects of Trade and Migration." CEPR Discussion contain conflict, particularly in the Balkans. Furthermore, the Paper No. 1318, Centre for Economic Policy Research, EU and Turkey have a mutual interest in preventing and con- London. taining any instability that could arise in the Commonwealth of Harrison, G. W., T. F. Rutherford, and D. G. Tarr. 1997. "Eco- Independent States (CIS) region. nomic Implications for Turkey of a Customs Union with the 24. In addition to chapter 14 by Flam, see the studies by European Union." European Economic Review 41: 861­70. Zimmerman (1995), Haisken-De New and Zimmerman (1996), Hoekman, B., and Beata Smarzynska Javorcik. 2004. "Policies Winter-Ebmer and Zimmerman (1998), and Storesletten (2000). Facilitating Firm Adjustment to Globalization." Oxford Review of Economic Policy 20 (3): 457­73. OECD (Organisation for Economic Co-operation and Develop- References ment). 2001. Market Effects of Crop Support Policies. Paris: OECD. Boeri,T.,and H.Brucker.2000.The Impact of Eastern Enlargement --------. 2004a. OECD Agricultural Policies 2004. Paris: OECD. on Employment and Labour Markets in the EU Member States: --------. 2004b. "Anticompetitive Practices in the Maritime Final Report. Berlin: European Integration Consortium. Transport Industry in Turkey." COM/DAFFE/TD(2004)63, Borjas, G. 1995. "The Economic Benefits from Immigration." September. Journal of Economic Perspectives 9: 3­22. Schiff, Maurice, and L. Alan Winters. 2003. Regional Integration Borjas, George, Richard B. Freeman, and Lawrence F. Katz. 1992. and Development. Washington, DC: World Bank and Oxford "On the Labor Market Effects of Immigration and Trade." In University Press. Immigration and the Work Force: Economic Consequences Storesletten, K. 2000. "Sustaining Fiscal Policy through Immi- for the United States and Source Areas, ed. G. Borjas and gration." Journal of Political Economy 108: 300­23. R. Freeman. Chicago: University of Chicago Press for Togan, S. 2004. "Turkey: Toward EU Accession." World Economy National Bureau of Economic Research. 27: 1013­45. --------. 1996."Searching for the Effect of Immigration on the Winter-Ebmer, R., and K. F. Zimmerman. 1998. "East-West Labor Market." American Economic Review 86: 246­51. Trade and Migration: The Austro-German Case." IZA Dis- --------. 1997. "How Much Do Immigration and Trade Affect cussion Paper No. 2. http://www.iza.org. Labor Market Outcomes?" Brookings Papers on Economic World Bank. 2004. "Turkey: Gas Sector Strategy Note," Report Activity, 1­90. No. 30030-TR. Washington, DC, September. Claessens, S., A. Demirgüç-Kunt, and H. Huizinga. 1998. "How Zimmerman, K. F. 1995. "Tackling the European Migration Does Foreign Entry Affect the Domestic Banking Market?" Problem." Journal of Economic Perspectives 9: 45­62. Working Paper, World Bank, Washington, DC. Part I Macroeconomic Policies for EU Accession 1 1 Macroeconomic Policies for Turkey's Accession to the EU Sübidey Togan and Hasan Ersel This chapter investigates the macroeconomic poli- Despite some notable achievements, a worsening cies appropriate for Turkey both before and after its current account and a fragile banking system led in accession to the European Union (EU).1 The first late 2000 to a liquidity crisis that turned into a full- section of the chapter considers the recent macro- blown banking crisis in February 2001. In response, economic developments in Turkey, and the second the government decided to abandon the crawling examines the macroeconomic policy framework for peg regime and floated the currency. In May 2001, EU membership. The third section analyzes the the International Monetary Fund (IMF) increased macroeconomic challenges faced by Turkey,empha- its assistance to Turkey under a new standby sizing the issues related to inflation, fiscal policy, arrangement. But just as the revised program was public debt, sustainability of current account, and beginning to show results, the terrorist events of exchange rate regimes. The final section offers September 11, 2001, in the United States triggered conclusions. the reemergence of serious financing problems. In February 2002, the IMF approved a new three-year standby credit for Turkey to support the govern- Macroeconomic Developments ment's economic program. With the implementa- in Turkey tion of the stabilization program, Turkey envisages Over the past decade, economic crises began to a gradual but steady improvement in its economic affect the Turkish economy with increasing fre- conditions. In August 2004 Turkey approached the quency. Periods of economic expansion alternated IMF for a final three-year standby agreement--an with periods of equally rapid decline. Although exit program from instability and excessive debt. inflation during the period 1990­2000 fluctuated between 54.9 percent and 106.3 percent, the average Monetary Developments and Inflation inflation rate amounted to 75.2 percent. Currently, Turkey is in the midst of a determined campaign to During the past two decades,Turkey has experienced turn around decades of weak performance stem- high and variable inflation. There is strong evidence ming from pervasive structural rigidities and weak that, in the medium and long term, a close correla- public finances. The past few years have witnessed tion exists between the rate of growth of monetary three major attempts at addressing underlying aggregates and inflation. This correlation appears in weaknesses. The first was during 2000 under the figure 1.1 between the monthly series of annual con- three-year standby agreement initiated in Decem- sumer price index (CPI) inflation and the monthly ber 1999 after a significant drop in output caused by series of the annual growth rate of base money mostly external factors, including the earthquake. over the period January 1987­September 2004. 3 4 Turkey: Economic Reform and Accession to the European Union FIGURE 1.1 Inflation and the Growth Rate of Reserve Money: January 1987­September 2004 Growth rate 140 Price level 120 Reserve money 100 80 60 40 20 0 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Source: Central Bank of Turkey. FIGURE 1.2 Inflation and the Rate of Depreciation of the Turkish Lira: January 1987­September 2004 Growth rate 300 Price level 250 Exchange rate 200 150 100 50 0 50 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Source: Central Bank of Turkey. A close relation also exists between the annual infla- In equation 1.1, the relation between total tion rate and the annual rate of change in the demand and supply is proxied by the output gap. exchange rate on a monthly basis over the same Almost all researchers agree that, besides the output period (see figure 1.2).2 gap, public sector deficits play a significant role in Recent empirical studies of Turkish inflation explaining inflation in Turkey. We model the effect have drawn attention to a set of factors that affect of public sector deficits on inflation through two inflation in Turkey.3 Besides the obvious relation variables. The first variable is the noninterest between the aggregate demand and supply, public expenditures. In contrast to interest expenditures, sector deficits and exchange rate developments this portion of the public expenditures is deter- seem to be the major factors affecting the rate of mined by the government and is the major factor inflation. behind the changes in public sector deficits. The Macroeconomic Policies for Turkey's Accession to the EU 5 TABLE 1.1 Estimated Inflation (Monthly) Coefficient t-Statistic Constant 0.01 1.872 Public price (d log(ppublic)) 0.31 14.35 Exchange rate (d log(E) + d log(E(-1)) 0.04 2.753 Output gap (OG) 0.033 2.567 Noninterest expenditures (NIEXP) 0.012 1.822 Base money (d log (M(-1)) + d log(M(-2)) 0.025 1.963 CPI inflation (d log(CPI(-12))) 0.192 4.282 Dummy -0.016 -6.072 AR(1) 0.463 6.364 R-squared: 0.802 Adjusted R-squared: 0.792 Durbin Watson statistic: 1.884 Note: The dependent variable was d log(CPI), and the estimation period was January 1990­November 2003. The diagnostic tests for this regression indicate that there is no evidence of deviation from normality, autocorrelation, and heteroscedasticity. Source: The authors. second variable is the public sector component of the monthly industrial production index from its the wholesale price index. The movement of this trend, NIEXP the moving average of the consoli- variable is almost totally determined by administra- dated budget noninterest expenditures over the past tive decisions. Adjustments in these prices, regard- 12 months, M the base money supply, and Dummy less of their relation with public sector deficits, have the dummy variable taking the value of 1 during an impact on inflation. Because most of the goods the summer months of June, July, and August of and services produced by the public sector are used each year and 0 otherwise. When we checked all the as inputs, changes in these prices have an impact on variables used in the estimation for unit roots, we private sector costs.Yet as these changes are publicly learned that the series as used in the equation are all announced, they have a signaling effect. In this stationary. The results of the estimation are pre- sense, the role of public sector prices is very similar sented in table 1.1. to that of the exchange rate. The third variable To deal with the problem of identifying the influencing inflation in the equation is the exchange long-run determinants of inflation, we carried out rate, which affects the prices of imported commodi- the Johansen cointegration test with the variables ties. Fourth, in this equation the effect of monetary that were significant in the short-term inflation expansion on inflation is captured by movements in equation and that were found to be I(1)--that is, the base money. Thus one can now estimate Turkish CPI, NIEXP, M, ppublic, and E.4 The significant coin- inflation by using monthly data to solve tegration equation found among four of these vari- (1.1) d log(CPI) = ables can be expressed as 0 + 1dlog(ppublic) + 2(dlog(E) (1.2) CPI = -2.234 + 0.000357 M + dlog(E(-1))) + 3OG(-1) + 0.279695 ppublic + 0.000315 E + 4NIEXP + 5(dlog(M(-1)) As one would expect from economic theory, base + dlog(M(-2))) + 6dlog(CPI(-12)) money and exchange rate play an important role in + 6 Dummy explaining inflation in the long run. By contrast, the where CPI denotes the consumer price index, ppublic presence of the public sector component of the the public sector component of the wholesale price wholesale price index reflects an invariant charac- index, E the Turkish lira/U.S. dollar exchange rate, teristic of policymaking in Turkey. The rather popu- OG the output gap measured by the difference of lar political instrument used to achieve short-term 6 Turkey: Economic Reform and Accession to the European Union objectives seems to have had a strong inflationary deteriorated considerably. The large public sector impact in the long run. deficits were financed by borrowing from the mar- ket at very high real interest rates. Significant capital flowed into the country because it was offering not Real Exchange Rate and Current Account only high real interest rates but also the prospect of Until the end of the 1970s, Turkey followed a fixed steady real appreciation of the exchange rate. Thus and multiple exchange rate policy while experienc- the government's implicit commitment to the RER ing relatively high inflation rates. The policy led to appreciation insured the private sector, domestic a loss of competitiveness and eventually to the and foreign, against currency risk. It encouraged foreign exchange crisis of the late 1970s. The gross capital inflows from abroad and lending to the national product (GNP) shrank by 0.5 percent in public sector, giving rise to the phenomenon of 1979 and by 2.8 percent in 1980. With the stabiliza- large, arbitrage-related, short-term capital inflows. tion measures of 1980, Turkey devalued its lira by The policy pursued during the first half of the 100 percent and eliminated the multiple exchange 1990s was not sustainable. By 1993 the current- rate system, except for imports of fertilizers and fer- account-deficit-to-GDP (gross domestic product) tilizer inputs. After May 1981, the exchange rate was ratio had reached 3.6 percent. In 1994 the country adjusted daily against major currencies to maintain faced balance of payments crises from which the the competitiveness of Turkish exports. Multiple GDP shrank by 5.5 percent. But with the introduc- currency practices were phased out during the first tion of stabilization measures, the trend in the RER two years of the 1980 stabilization program, and reversed. The RER depreciated by 64 percent dur- the government pursued a policy of depreciating ing January 1994 and April 1994. The country had the real exchange rate (RER)--on average by about to reverse its economic policies, however, because 6 percent annually over the period 1980­88.5 of the relatively weak coalition governments. The In January 1984, domestic commercial banks RER began to appreciate again after April 1994, and were allowed to engage in foreign exchange opera- by September 1995 it had appreciated by about tions within certain limits, and restrictions on for- 23.5 percent. eign travel and investment from abroad were eased Between 1995 and 1997, the economy went and simplified. Determination of the exchange rate through a boom period of above-trend growth, was further liberalized by permitting banks to set only to find itself badly hit in 1998 by the Russian their own rates within a specified band around the crisis. In August 1999, a severe earthquake hit the central bank rate. In August 1988, major reform Marmara area of Turkey, and another large shock was introduced, and a system in which the market hit the Bolu area in November 1999. Because of set foreign exchange rates was adopted. In 1989 for- these shocks, real GDP shrank by 4.7 percent in eign exchange operations and international capital 1999. At the end of that year, Turkey embarked on movements were liberalized entirely.6 an ambitious stabilization program. Central to the A drawback of the RER depreciation policy pur- program has been the policy of using a predeter- sued during the 1980s was the decline in real wages, mined exchange rate path as a nominal anchor for measured in terms of foreign currency.7 By the sec- reducing inflationary expectations. ond half of the 1980s, popular support for the gov- During 2000, the RER appreciated considerably, ernment had begun to fall off. In the local elections which aggravated further the current account of March 1989, the governing political party suf- deficits, leading to concerns about the sustainability fered heavy losses. To increase political support, the of the exchange rate regime. The current-account- government conceded substantial pay increases deficit-to-GDP ratio reached 4.9 percent in 2000. during collective bargaining in the public sector. This episode ended with a severe currency crisis in Pressure then built up in the private sector to arrive February 2001. There was a serious run on the at similarly high wage settlements, real wages began Turkish lira (TL), interest rates skyrocketed, and to increase, and the RER started to appreciate. foreign exchange reserves began to decline rapidly. According to the government, the appreciation The government decided to abandon the crawling of the RER after 1989 stemmed from market peg regime and to float the currency. The exchange forces. During the 1990s, Turkey's public finances rate then depreciated sharply. Macroeconomic Policies for Turkey's Accession to the EU 7 On May 15, 2001, the IMF increased its assistance FIGURE 1.4 Real Exchange Rate, 1980­2004 under a new standby arrangement. This program RER aimed to strengthen the balance of public finances in 160 a way that would prevent deterioration in the future. 140 During 2001, Turkey introduced a set of structural reforms. But the terrorist attacks of September 11, 120 2001, threatened the progress of the reforms. Turkey 100 responded with a strengthened medium-term pro- gram intended to clean up the banking sector, con- 80 solidate fiscal adjustments, and achieve disinflation, 60 and in February 2002 the IMF approved a three-year 40 standby credit for Turkey to support the govern- ment's economic program. During 2001, the GNP 20 contracted by 9.5 percent, and the loss in employ- 0 ment was put at more than 1 million.8 Toward the end of 2001, the RER began to appreciate again. 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 With the appreciation of the RER, considerable eco- Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. nomic recovery was observed during 2002­04. Note: An increase in the real exchange rate indicates Figure 1.3 shows developments in the current its depreciation. account-to-GDP ratio over the period 1975­2003. Source: The authors. Currency crises arose in the late 1970s, 1994, and 2001. The figure indicates that the probability of a Figure 1.4 shows the time path of the RER over balance of payments crisis increases in Turkey as the past two decades, and it reveals four episodes of the current-account-deficit-to-GDP ratio increases RER developments. After the foreign exchange cri- above the critical level of 5 percent.9 By October sis of the late 1970s, the RER began to depreciate 2004, the annual current account deficit had sharply in response to the stabilization measures of reached $14.17 billion, and the current-account- 1980. It continued to depreciate until 1988, when it deficit-to-GDP ratio had increased to about 5 per- began to appreciate--that is, until 1994, when the cent by the third quarter of 2004. country was faced with another currency crisis. In 1994 the RER depreciated sharply, but it appreci- ated again from April 1994 to February 2001, when the country was faced with yet another currency FIGURE 1.3 Current-Account-to- crisis. After the sharp depreciation of the RER from GDP Ratio, 1975­2004 February 2001 to April 2001, it began to appreciate, Ratio especially after October 2001. It appreciated until 3 March 2004 by about 36.3 percent. During March 2004 and May 2004, the RER depreciated by about 2 11 percent, and thereafter it stayed relatively con- 1 stant until October 2004. 0 1 Fiscal Developments 2 Table 1.2 shows the structure of the revenues and 3 expenditures of the public sector from 1998 to 4 2002. The public sector consists of the central gov- 5 ernment, revolving funds, social security institu- 6 tions, extrabudgetary funds, local governments, and state economic enterprises (SEEs). The table reveals 1970 1975 1980 1985 1990 1995 2000 2005 that, on average, during 1998­2002 revenues made Source: Central Bank of Turkey. up 29.24 percent of GNP, expenditures 42.4 percent 8 TABLE 1.2 Structure of Revenues, Expenditures, and Public Sector Borrowing Requirements (PSBR), 1998­2002 Share of Total Revenue Share of Total Expenditure Nontax Factor Social Privatization Current Investment Interest Other Stock Taxes Income Income Funds Revenues Expenditures Expenditures Payments Transfers Changes Fund Revenue/GNP Expenditure/GNP PSBR/GNP 1998 80.62 4.94 19.93 -9.27 3.78 31.63 19.43 35.88 9.89 3.16 25.56 34.99 9.42 1999 87.01 5.93 18.60 -11.84 0.31 32.45 16.17 37.21 10.82 3.35 25.57 41.09 15.52 2000 82.51 7.37 11.41 -6.30 5.00 29.19 16.34 41.30 11.07 2.10 30.45 42.23 11.78 2001 81.64 6.63 16.31 -7.34 2.76 26.41 11.21 49.31 9.80 3.27 33.26 49.65 16.39 2002 76.60 9.74 23.38 -10.24 0.53 28.74 14.21 44.66 10.82 1.57 31.38 44.06 12.68 Average 81.67 6.92 17.93 -9.00 2.48 29.68 15.47 41.67 10.48 2.69 29.24 42.40 13.16 Source: Turkish State Planning Organization. Macroeconomic Policies for Turkey's Accession to the EU 9 of GNP, and public sector borrowing requirements external and foreign exchange (FX) indexed debt had (PSBR) 13.16 percent of GNP. Taxes are the main reached 59.4 percent of total debt. source of revenues, forming about 81.67 percent of The evolution of public debt is best explained by the total; indirect taxes make up about 70 percent of decomposing the annual change in debt into vari- tax revenue. Although factor incomes generated by ous components as shown in table 1.3. Concentrat- the profits of SEEs have constituted, on average, ing on developments during the past two years, the 17.93 percent of total revenues, the social funds World Bank (2003) notes that the debt-to-GNP have not generated revenue; they have been subsi- ratio in 2001 alone rose by 37.6 percent. Although dized from the budget. On the expenditures side, the country ran a primary surplus of 5.5 percent of current expenditures and investments constitute, its GNP with the introduction of the IMF stabiliza- on average, 29.68 percent and 15.47 percent of total tion program, three factors mainly contributed to expenditures, respectively. The most important the increase in the debt-to-GNP ratio: (1) the high expenditure item during the period 1998­2002 was interest rates prevailing in the country; (2) depreci- the interest payments--on average, they were ation of the real exchange rate, leading to increases 41.67 percent of total expenditures. in the ratio of FX-denominated debt to GNP; and (3) the costs of the banking crisis. In response to Public Sector Borrowing Requirements and Public the banking crisis, the government issued new Debt During the 1990s, the PSBR amounted on bonds in order to recapitalize failing banks. The average to 12 percent of GNP. The high deficit bonds issued for this purpose amounted to 20 per- incurred during the period was financed by borrow- cent of GNP (table 1.3). In 2002 the debt picture ing from the market at very high real interest rates,as improved, but this time it stemmed mainly from shown in figure 1.5.10 Table 1.3 reveals that between the real appreciation of the real exchange rate. the end of 1995 and the end of 2001 Turkey's debt The PSBR-to-GNP and debt-to-GNP ratios stock more than doubled in terms of the debt-to- given earlier are based on data from Turkey's State GDP ratio and reached 95 percent at the end of 2001. Planning Organization (SPO). Two other sets of In 2002 the debt stock shrank somewhat, but it data on the PSBR-to-GNP ratio, and thus on the remained at almost twice its level in 1995. By 2002 debt-to-GNP ratio in Turkey, are also available-- the first from the IMF and the second from the EU, consistent with the European System of Accounts FIGURE 1.5 Real Interest Rate, 1995 (ESA 95) codes. The differences among the January 1990­October 2003 three sets of data are mainly attributable to the Real interest rate large duty losses. During the 1990s, the state banks 160 faced unrecovered costs from duties carried out on 140 behalf of the government, and they covered their 120 financing needs from markets by borrowing at very 100 high interest rates and at short maturities. The 80 direct subsidies given through the state banks to 60 farmers and small business were not shown in the government budget figures of the SPO; instead, 40 they were shown on state banks' balance sheets as 20 performing assets accruing interest income. The 0 PSBR-to-GNP ratios of the SPO do not reflect the 20 subsidy components given through the state banks, 40 whereas the figures estimated by the IMF and EU do. A close look at the data in table 1.4 will reveal 19901991199219931994199519961997199819992000200120022003 Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. that the public sector, according to the IMF defini- tion, ran a deficit equal to 18.9 percent in 2000, Note: Some data are missing in this figure because 21.1 percent in 2001, 12.1 percent in 2002, and auctions could not be held during the indicated months. 10 percent in 2003. As a result, the net debt-to-GNP Source: The authors. ratio, according to the IMF definition, increased 10 TABLE 1.3 Debt and Fiscal Sustainability, 1994­2002 1994 1995 1996 1997 1998 1999 2000 2001 2002 Stock of public debt (% of GNP) Domestic debt 14.0 12.2 20.5 20.4 24.4 40.9 39.1 57.2 47.7 FX-denominated/indexed 2.7 20.4 15.3 Floating rate 28.6 20.5 External debt 30.7 29.1 26.0 22.5 19.3 20.1 18.3 37.7 32.1 External + FX-denominated/indexed 30.7 29.1 26.0 22.5 19.3 20.1 21.0 58.1 47.4 Total debt 44.7 41.3 46.5 42.9 43.7 61.0 57.4 95.0 79.8 Public debt dynamics (% of GNP) Change in debt -3.4 5.2 -3.6 0.8 17.3 -3.6 37.6 -15.2 Debt-creating items Interest payments 7.3 10.0 11.0 16.2 22.1 21.9 23.5 16.3 Debt-reducing items Primary balance 2.7 -1.2 -2.1 0.9 -2.0 2.7 5.5 3.9 Growth effect 1.7 1.5 2.0 0.9 -1.8 2.4 -3.9 4.8 Inflation effect 6.5 5.3 9.2 8.8 8.7 13.8 13.0 11.2 Revaluation effect 4.4 1.9 1.6 2.5 -1.2 3.8 -13.2 10.1 Seigniorage 3.0 2.4 2.9 2.4 3.2 1.8 1.4 1.5 Other 0.0 0.0 0.1 0.5 0.1 1.6 -18.1 -1.8 Privatization 0.0 0.0 0.1 0.5 0.1 1.6 1.9 0.1 Cost of financial sector bailout 0.0 0.0 0.0 0.0 0.0 0.0 -20.0 -1.9 Source: World Bank 2003. Macroeconomic Policies for Turkey's Accession to the EU 11 TABLE 1.4 Ratios of Public Sector Borrowing Requirements (PSBR) and of Debt to GNP and GDP, 2000­03 PSBR/GNP PSBR/GDP Debt/GNP Debt/GDP SPO IMF EU SPO IMF EU 2000 11.8 18.9 9.8 57.5 57.4 65.4 2001 16.4 21.1 15.9 91.0 93.9 102.6 2002 12.8 12.1 13.6 78.7 79.2 89.5 2003 9.4 10.0 10.1 70.5 70.9 80.2 Note: The debt/GNP figures of the IMF refer to the net debt of the public sector as a ratio of centered GNP, where centered GNP is defined as the sum of quarterly GNP in the last two quarters of the year and in the first two quarters of the next year. The debt/GDP figures of the EU refer to the ratio of the gross debt of the public sector to GDP. Sources: IMF 2004; Turkish State Planning Organization (SPO) 2004; http://www.treasury.gov.tr. from 57.4 percent in 2000 to 93.9 percent in 2001, TABLE 1.5 Total Tax Revenue as Percentage and then decreased to 79.2 percent in 2002 and to of GDP, 1998­2000 70.9 percent in 2003. Public debt, according to the IMF definition, is a net debt that is measured in 1998 1999 2000 percent of centered GNP, defined as the sum of Austria 44.3 44.1 43.7 quarterly GNP in the last two quarters of the year Belgium 45.8 45.4 45.6 and in the first two quarters of the following year.11 Denmark 50.1 51.2 48.8 By contrast, the EU measures the debt in gross Finland 46.1 46.8 46.9 terms. Thus total gross public debt, according to France 45.1 45.7 45.3 the EU definition, decreased from 102.6 percent of Germany 37.1 37.8 37.9 GDP in 2001 to 89.5 percent in 2002 and 80.2 per- Greece 35.6 36.9 37.8 cent in 2003. Ireland 31.7 31.3 31.1 Italy 42.5 43.3 42.0 Luxembourg 39.8 40.9 41.7 Structure of Taxes Because taxes constituted Netherlands 40.0 41.2 41.4 about 80.25 percent of total revenues during Portugal 33.3 34.1 34.5 2000­02, this section will consider the tax burden Spain 34.0 35.0 35.2 in Turkey, compare the composition of tax rev- Sweden 51.6 52.0 54.2 enues in Turkey with that of tax revenues in the EU, United Kingdom 36.9 36.4 37.4 and compare the main features of personal, corpo- Turkey 28.4 31.3 33.4 rate, and value added tax (VAT) systems in Turkey and the EU. Source: OECD 2003. Turkey is an upper-middle-income country, whose per capita income falls at the lower end of it is comparable with that of Ireland (see table 1.5), those of this group of countries. A comparison of but it is still below the tax/GDP figures in the mem- the central government tax revenues of Turkey with ber countries of the EU.12 those of other countries reveals that Turkey has a Table 1.6, which shows the composition of tax relatively high tax burden in its per capita income revenues in Turkey and the EU, reveals that EU group (see World Bank 2003). When compared countries obtain a significantly larger percentage of with those of lower-middle-income countries, tax revenues from social security and payroll taxes Turkey's tax burden is markedly above the revenue (32.7 percent) compared with Turkey (14.3 per- average of 13.6 percent of the lower-income group. cent). In Turkey, the share of taxes on goods and It is also significantly above the average of 21.3 per- services (35.7 percent) is higher than the similar cent for all upper-middle-income countries. In fact, share in the EU (28.8 percent). 12 Turkey: Economic Reform and Accession to the European Union TABLE 1.6 Revenue from Major Taxes as a Percentage of Total Tax Revenue, 1998 Personal Corporate Social Security Goods and General Income Income and Other Payroll Property Services Consumption Taxes Austria 22.5 4.8 40.3 1.3 27.9 18.7 Belgium 30.7 8.5 31.5 3.2 24.9 15.3 Denmark 51.6 5.6 3.9 3.6 33.2 19.6 Finland 32.3 9.0 25.2 2.4 30.7 18.5 France 17.4 5.9 39.5 7.3 26.6 17.5 Germany 25.0 4.4 40.4 2.4 27.4 17.9 Greece (1997) 13.2 6.4 32.3 3.8 41.0 22.6 Ireland 30.9 10.7 13.8 5.2 38.7 22.2 Italy 25.0 7.0 29.5 4.8 27.4 14.2 Luxembourg 18.8 19.7 25.6 8.4 26.1 13.7 Netherlands 15.2 10.6 39.9 4.9 27.7 16.9 Portugal 17.1 11.6 25.5 2.9 41.3 23.3 Spain 20.8 7.3 35.2 6.0 29.4 16.6 Sweden 35.0 5.7 33.5 3.7 21.6 13.6 United Kingdom 27.5 11.0 17.6 10.7 32.6 18.1 EU 23.9 7.1 32.7 5.4 28.8 17.2 Turkey 27.0 5.8 14.3 2.8 35.7 30.0 Source: Noord and Heady 2001. Table 1.7 compares for 2002 the personal tax, population of 70.7 million and a labor force partici- corporate tax, and VAT systems of Turkey and the pation rate of 48.3 percent in 2003, has created jobs EU countries. The table reveals that the average for about 21 million people. During 2003, 33.9 per- income tax and social security contribution rate on cent of the labor force was employed in agriculture, gross labor income in Turkey amounts to 43.2 per- 18.2 percent in industry, and 47.9 percent in serv- cent, whereas the same tax rate is 25.8 percent in ices. The unemployment rate was 10.5 percent. The Ireland and 29.7 percent in the United Kingdom. average unemployment rate during 1990­2000 was The corporate income tax in Turkey is 44.1 percent, 7.6 percent, but it increased considerably with the whereas it is 16 percent in Ireland and 30 percent financial crisis of 2001. in United Kingdom. By contrast, the VAT rate in These figures indicate that Turkey must create Turkey is 18 percent, whereas it is 15 percent in jobs for its unemployed workers, as well as for those Luxembourg and 16 percent in Germany and entering the labor force for the first time at the Spain. According to the table, tax rates are in gen- average rate of 900,000 persons a year. In addition, eral very high in Turkey. With such high tax rates, Turkey has to increase the labor force participation Turkey should have achieved a much higher total- rate from its current low level of 48.3 percent to the tax-to-GNP ratio than the 31.8 percent achieved levels that prevailed at the beginning of the 1990s. in 1999. Currently, the country has a large share At that time, the labor force participation rate was of employment declared to be at the minimum 56.5 percent. By contrast, the comparable level in wage because of attempts by both employees and the EU was about 63 percent. Job creation, then, is a employers to reduce their tax burden, and it has rel- major challenge that Turkey must meet over time. atively large employment in the informal sector. As The Turkish labor market is extremely flexible a result, Turkey's tax base is rather narrow. because of the country's formidable informal sector, whose wage-setting mechanism is quite different from that of the formal sector. The informal sector Employment and Growth is largely free from most types of labor regulation, Table 1.8, which shows developments in the labor and it does not pay most taxes and related charges. market for 2001­03, reveals that Turkey, with a Activities in this sector rely largely on the provision Macroeconomic Policies for Turkey's Accession to the EU 13 TABLE 1.7 Personal Tax, Corporate Tax, and VAT System: Turkey and EU Countries, 2002 Marginal Income Average Income Tax and Social Tax and Social Security Contribution Security Contribution Corporate Standard Rate on Gross Rate on Gross Income Tax VAT Labor Income Labor Income Rate Rate Austria 55.3 44.7 34.0 20.0 Belgium 66.7 55.6 40.2 21.0 Denmark 50.4 44.2 30.0 25.0 Finland 57.4 45.9 29.0 22.0 France 53.0 48.3 -- 19.6 Germany 63.9 50.7 38.9 16.0 Greece 44.1 36.0 -- 18.0 Ireland 33.9 25.8 16.0 21.0 Italy 54.5 46.2 -- 20.0 Luxembourg 47.9 34.2 30.4 15.0 Netherlands 51.0 42.3 34.5 19.0 Portugal 39.4 32.5 33.0 19.0 Spain 45.5 37.9 35.0 16.0 Sweden 50.4 48.6 28.0 25.0 United Kingdom 39.2 29.7 30.0 17.5 Turkey 45.6 43.2 44.1 18.0 -- Not available. Note: The first two columns report marginal and average personal income tax and social security contribution rates for a single person without dependents at 100 percent of the average production wage. The corporate income tax rate for Turkey refers to the total effective tax burden of a nonpublicly owned company. In the case of a publicly owned company, the tax burden goes down to 36.7 percent. Source: OECD tax database (http://www.oecd.org). TABLE 1.8 Labor Market Indicators: Turkey, 2001­03 2001 2002 2003 Population (thousands) 68,610 69,626 70,712 Population 15 and over (thousands) 47,158 48,041 48,912 Labor force (thousands) 23,491 23,818 23,640 Participation ratio (%) 49.8 49.6 48.3 Civilian employment (thousands) 21,524 21,354 21,147 Unemployment (thousands) 1,967 2,464 2,493 Unemployment rate (%) 8.4 10.3 10.5 Employment by sector (thousands) Agriculture 8,089 7,458 7,165 Industry 3,774 3,954 3,847 Services 9,661 9,942 10,135 Sectoral distribution of employment (%) Agriculture 37.6 34.9 33.9 Industry 17.5 18.5 18.2 Services 44.9 46.6 47.9 Source: Treasury statistics, 1980­2003. 14 Turkey: Economic Reform and Accession to the European Union of labor without formal employment contracts. Job interest rate convergence, budget deficits, govern- insecurity is pervasive, and workers receive very few ment debt, and exchange rate stability.17 benefits from their employers. Because wages in the informal sector are determined by demand and sup- Macroeconomic Policy Framework ply conditions, the informal sector itself is flexible. for EMU Members By contrast, the formal sector observes labor regula- tions, and it pays all taxes and related charges such On January 1, 1999, 11 of the 15 member countries as social security contributions and payments to of the EU entered the third and final stage of the various funds. Thus, this sector is not as flexible as process leading to the formation of the EMU. At the informal sector. Until now, Turkey has success- that time, the exchange rates among the currencies fully solved the unemployment problem by means of the participating countries were irrevocably of its large informal sector.13 Indeed, over time this fixed in relation to the new single currency, the sector has grown considerably through the lax euro, and the newly formed European Central Bank enforcement of tax, social security, and labor laws. (ECB) had taken over responsibility for monetary But the current system of formal and informal sec- policy in the Euro Area. Individual member coun- tors, with the informal sector accounting for about tries of the EMU therefore no longer have control 60 percent of total employment, does not seem to be over either monetary policy or exchange rate sustainable in the long run.14 policy; they have surrendered their sovereignty in As for the growth of GDP, over the period monetary and exchange rate policy to the suprana- 1950­2002, GDP increased at an average annual tional authority, the ECB. rate of 4.9 percent.15 However, over the same period the average growth rate declined. The growth rate Monetary Policy The European System of Cen- of GDP was 7.1 percent during 1950­59, 5.4 per- tral Banks (ESCB) is composed of the European cent during 1960­69, 4.7 percent during 1970­79, Central Bank and the national central banks 4.1 percent during 1980­89, and 3.6 percent over the (NCBs) of all 15 EU member states.18 Because not period 1990­2002. Besides experiencing decreasing all members joined the monetary union from the average growth rates of real income, Turkey has outset, the term Eurosystem was adopted to recently faced greater economic volatility, because describe the ECB and the NCBs of the 11 member economic crises have begun to affect the Turkish states that have adopted the euro. All decisions economy with increasing frequency. As noted ear- related to the Eurosystem are made by the decision- lier, during the last decade periods of economic making bodies of the ECB, the Executive Board, expansion have alternated with periods of equally and the Governing Council. The Executive Board rapid decline. comprises the president and the vice president of the ECB and four other members. It implements monetary policy in accordance with the guidelines Macroeconomic Policy Framework and decisions laid down by the Governing Council. for EU Membership The Governing Council comprises the members of Upon accession, Turkey, according to Article 122 of the Executive Board and the governors of the NCBs the treaty establishing the European Community participating in the Euro Area. It is the primary (hereafter known as the "Treaty"), will be treated as decision-making body of the ECB. a "Member State with a derogation" until it fulfills The Treaty specifies that the main task of the the convergence criteria.16 The Central and Eastern Eurosystem is to deliver price stability (Article 105). European (CEE) countries, when signing the acces- According to Article 107 of the Treaty, the Eurosys- sion treaty, have accepted the goal of monetary tem is solely responsible for the Euro Area's single union as part of the acquis communautaire, the monetary policy, and it is to pursue the goal of entire body of legislation of the European Commu- price stability free from political pressure by EU nities and Union. To become members of the institutions, interest groups, or individuals. The European Economic and Monetary Union (EMU), Treaty does not precisely define price stability. The the CEE countries must fulfill the convergence cri- Eurosystem interprets it as a year-to-year increase in teria, which involve conditions on price stability, the Harmonised Index of Consumer Prices (HICP) Macroeconomic Policies for Turkey's Accession to the EU 15 for the Euro Area of below 2 percent (European The second way in which control is exercised over Central Bank 2003b), which is to be maintained EONIA is ECB auctions, usually weekly, with a over the medium term. The phrase "below 2 per- maturity of two weeks at a rate the ECB chooses. cent'' delineates the upper bound for the rate of These auctions, called refinancing operations, pro- measured inflation in the HICP. vide the liquidity needed by the banking system, and To achieve price stability, the Eurosystem uses the chosen interest rate serves as a guide for EONIA. two pillars. The first pillar is what the Eurosystem Transactions related to weekly tenders are conducted calls "economic analysis." It consists of a broadly by the NCBs in the form of standard (fixed-rate or based assessment of the outlook for price develop- variable-rate) tenders. The NCBs are responsible for ments and the risks to price stability in the Euro collecting the tender offers and transmitting them to Area as a whole. The assessment concentrates on the ECB. They also inform credit institutions about the medium impact of the current conditions of the results of the tenders and arrange the settlement inflation. The second pillar is an assessment of the aspects--that is, receiving the collateral and provid- evolution of monetary aggregates (M3) and credit. ing the liquidity. Both the ECB and the NCBs con- It analyzes the longer-run impact of monetary duct longer-term refinancing operations monthly, aggregates on inflation. The two perspectives offer with a maturity of three months. These operations complementary analytical frameworks to support provide the financial sector with additional longer- the Governing Council's overall assessment of risks term liquidity. In addition, the NCBs may carry out to price stability. The inflation forecast is published structural open-market operations. The Governing twice a year. If the forecast exceeds the target (i.e., Council can authorize fine-tuning, outright transac- the 2 percent definition of price stability), the pre- tions of securities, foreign exchange swaps, and the sumption under an inflation targeting strategy is collection of deposits to be conducted, in excep- that monetary policy will be tightened. Although tional circumstances, by the ECB itself. the Eurosystem's strategy resembles inflation tar- Although in conducting monetary policy the geting, the Eurosystem does not want to give the Eurosystem uses mainly short-term interest rates, it appearance that it acts mechanically. is the long-term interest rate that affects the econ- In conducting monetary policy, the Eurosystem omy. Indeed, households and firms borrow for rel- uses mainly short-term interest rates and focuses on atively long periods. Thus central banks control the the overnight rate EONIA (European Over-Night short maturity, while it is the long maturity that Index Average, a weighted average of overnight really matters. Yet these banks do influence the lending transactions in the Euro Area's interbank long-term rates by being clear about their longer- market). Control over EONIA is achieved in two run aims and intentions. ways. First, the Eurosystem has two facilities at its Overall, the Eurosystem constitutionally enjoys disposal: a marginal lending facility and a deposit considerable independence, both in defining its facility. These facilities operate under overnight objectives and in deciding how to conduct mone- maturity and are available to counterparties at their tary policy. The ECB is accountable to the European own initiative. They are administered on a decen- Parliament. tralized basis, with their features harmonized across the Eurosystem. Overnight liquidity is provided at a Fiscal Policy The Euro Area does not have a cen- prespecified interest rate against eligible collateral. tral fiscal authority.19 There is a budget for the EU In normal circumstances, the interest rate on the as a whole, but it is relatively small. Spending marginal lending facility defines the ceiling for amounts to only a little over 1 percent of GDP, EONIA in the market. Similarly, the deposit facility devoted mostly to common agricultural policy and defines the floor for overnight market rates. All the structural funds, and deficit financing is pro- financial institutions fulfilling the general eligibility hibited. Thus, budgetary decisions in the Euro Area criteria may access this facility. Access is granted will remain almost exclusively the province of through the NCB in the country in which the finan- member states, albeit subject to surveillance by the cial institution is established and on all days that the EU as a whole in the context of the requirements set national payment and securities settlement systems out in the Maastricht Treaty and subsequently the are operational. Stability and Growth Pact. 16 Turkey: Economic Reform and Accession to the European Union For countries seeking to qualify for EMU mem- tions and of the main economic policy measures bership and those already members, the Maastricht the country intends to take to achieve the targets; Treaty and the SGP established certain targets on and, second, that the European Council, on a rec- the size of debt and deficits and other obligations. ommendation from the Commission, must deliver For countries already in the EMU, the targets were an opinion on each program and its yearly updates intended to achieve and maintain "sound" budget- and, if deemed necessary, a recommendation. ary positions and to avoid harsh penalties. Article Three types of recommendations are possible. First, 104 of the Treaty establishes that "member states the Council could issue a recommendation that the shall avoid excessive government deficits" and that program be adjusted if deemed deficient in some compliance with budgetary discipline will be respect. Second, if after approving the program judged on the basis of two criteria: the Council identifies a "significant divergence of the budgetary position from the medium- (a) whether the ratio of the planned or actual term budgetary objective, or the adjustment path government deficit to gross domestic product towards it," the Commission can issue a recom- exceeds a reference value, unless either the ratio mendation (early warning) in accordance with has declined substantially and continuously and Article 103(4). Third, if the divergence persists, the reached a level that comes close to the reference Council can issue a recommendation to take cor- value, or, alternatively, the excess over the refer- rective action, and can make the recommendation ence value is only exceptional and temporary and public. the ratio remains close to the reference value Regulation No. 1467/97 first tries to make more (b) whether the ratio of government debt to precise the notion of "exceptional and temporary" gross domestic product exceeds a reference excess of the deficit over the 3 percent of GDP value, unless the ratio is sufficiently diminishing threshold, as introduced by Article 104 of the and approaching the reference value at a satis- Treaty. Article 2(1) of the regulation specifies that factory pace. an "exceptional and temporary" excess of the deficit As is well known, these two reference values were is allowed "when resulting from an unusual event set at 3 percent and 60 percent, respectively. outside the control of the Member State concerned The SGP was designed to provide concreteness and which has a major impact on the financial to several provisions of the Treaty on economic position of the general government or when result- policies in the EU. It consists of a resolution of ing from a severe economic downturn." Arti- the European Council and of two regulations cles 2(2) and 2(3) further specify that a deficit will (No. 1466/97 and No. 1467/97) of the Council for be considered exceptional "if there is an annual fall Economic and Financial Affairs (ECOFIN).20 The of real GDP of at least 2 percent" or if a member resolution reaffirms the commitment to fiscal disci- state can argue successfully that the circumstances pline and introduces the notion that the "medium- are "exceptional," based on "the abruptness of the term budgetary objective of positions close to downturn or on the accumulated loss of output balance or in surplus" should be respected by mem- relative to past trends." The regulation then clarifies ber states in order to "allow all Member States to the "excessive deficit procedure" set out in Arti- deal with normal cyclical fluctuations while keep- cle 104 of the Treaty, including the imposition of ing the government deficit within the reference fines. value of 3 percent of GDP." The medium term is Countries found exceeding the 3 percent of understood to represent about three years. GDP limit must take corrective action"as quickly as Regulation No. 1466/97 clarifies the procedures possible after [its] emergence." The timing of the to be followed in implementing the surveillance of policy decisions and the rhythm at which the Com- the Stability and Growth Pact, as envisioned in gen- mission, which monitors the process, prepares its eral terms in Article 99 of the Treaty. In particular, reports imply that a country can run deficits in it establishes, first, that member states must every excess of 3 percent of GDP for two years in a row year submit an update to the stability program that without incurring sanctions. If a country fails contains a medium-term objective for the budget- to take corrective action and to bring its deficit ary position, as well as a description of the assump- below 3 percent of GDP by the deadline set by the Macroeconomic Policies for Turkey's Accession to the EU 17 Council, it is sanctioned. The sanction takes the Italianer (2002), the requirements of the legislation form of a nonremunerated deposit. The deposit are starts at 0.2 percent of GDP and rises by 1/10th of · Completion of the orderly liberalization of capi- the excess deficit, up to a maximum of 0.5 percent tal movements (Article 56) of GDP. Deposits are imposed each year until the · Prohibition of any direct public sector financing excessive deficit is corrected. If the excess is not cor- by the central bank (Article 101) rected within two years, the deposit is converted into a fine; otherwise, it is returned.21 · Prohibition of privileged access of the public sector to financial institutions (Article 102) · Alignment of the national central bank statutes Exchange Rate Policy The exchange rate of the with the Treaty, including the independence of euro in relation to other currencies such as the dol- the monetary authorities (Articles 108 and 109). lar and the yen is determined by the market, although market misalignments and excessive The first requirement--that capital movements exchange rate fluctuations are corrected through a be completely liberalized--underpins the efficient combination of economic policy dialogue, the allocation of resources in the internal market.24 The occasional use of interventions, and verbal exchange second and third requirements are related to central rate management. bank economic independence, which rests on the condition that operating procedures not be restricted by government policies. Traditionally, the Macroeconomic Policy Framework greatest threat to central bank economic independ- for Accession Countries ence is pressures to monetize the fiscal deficit. As a Based on the Treaty, three distinct phases for the result of the second and third requirements, the adoption of the EMU acquis by accession countries central bank is prohibited from having primary can be identified: (1) the preaccession period, dealings with the fiscal authorities. Essentially, this (2) the period from accession to the adoption of the prohibition means no automatic overdraft facility euro, and (3) the Euro Area phase, after adopting for treasuries and no central bank purchases of debt the euro.22 directly from the government. The prohibition of privileged access complements the prohibition of Preaccession Phase During the preaccession central bank financing, imposes market discipline phase, accession countries carry out the economic in public sector borrowing, reinforces freedom of reforms and policies needed to fulfill the Copen- capital movements, and gets rid of the distortions in hagen economic criteria, which are the existence of the allocation of financial resources toward the pub- a market economy and the capacity to cope with lic sector. The two requirements force the market to competitive pressure and market forces within the establish the relevant price, thereby making conces- EU.23 In this context, countries have to establish sionary finance more difficult, and they make trans- functioning property rights, competition, free price actions more visible, thereby making the monitor- formation, and a well-developed financial sector. If ing of central bank performance much easier. The a country is to be able to cope with international fourth requirement related to central bank inde- competition and if capital is to be channeled pendence prepares the national central bank for its smoothly within a country, it is of paramount future assignment of seeking price stability, and it importance that the domestic banking and finan- reinforces fiscal discipline. cial sector are efficient. Such efficiency requires a Policy coordination in the preaccession phase high degree of financial intermediation, liquid cap- between the EU and the accession country is ital markets, banks with a sufficient capital base, a achieved through (1) preparation of an annual Pre- functioning system of banking and securities accession Economic Programme (PEP) by the supervision, and a sound payments system. In accession country, (2) annual evaluation of the PEP addition, the accession countries must adopt the by the European Commission, (3) a fiscal notifica- EMU legislation in order to acquire the status of tion system, (4) a report on the macroeconomic and "Member State with a derogation," which they need financial sector stability developments in candidate to adopt the euro (Article 122). According to countries, (5) macroeconomic forecasts by the 18 Turkey: Economic Reform and Accession to the European Union Commission, (6) meetings between the ECB and · Treatment of economic policies as a matter of candidate countries aimed at bringing financial and common concern and coordination of eco- payment systems in line with those in the Eurosys- nomic policies between the member states tem, and (7) the Commission's regular reports on through participation in Community proce- progress toward accession. dures (Articles 98 and 99) The PEP concentrates on the economic reforms · Avoidance of excessive government deficits and needed for EU accession, and the PEP procedure adherence to the relevant provisions of the SGP offers an opportunity to develop the institutional (Article 104) and analytical capacity necessary to participate in · Further adaptation of the national central bank's the EMU upon accession, particularly in the areas of statutes with a view toward integration into the economic analysis and medium-term policy plan- European System of Central Banks (Article 109) ning. The PEP consists of four parts: (1) a review of · Progress toward achieving a high degree of sus- recent economic developments, (2) a detailed tainable convergence (Article 121). macroeconomic framework, (3) a discussion of public finance issues, and (4) an outline of the With accession, the common macroeconomic structural reform agenda. It places special emphasis policy framework becomes more constraining, with on public finance by presenting the medium-term a strong reinforcement of fiscal discipline and the fiscal objectives in terms of the general government integration of other economic policies. Budgetary deficit, the primary balance, and the public indebt- policy and outcomes become subject to the excessive edness. Moreover, the candidate countries specify deficit procedure and the nonpunitive parts of the and explain the factors underpinning their choice of SGP.The Maastricht Treaty specifies that these coun- objectives, and the programs undertaken to achieve tries will have to make progress toward fulfillment of the objectives should demonstrate the feasibility of the Maastricht criteria, and, under the conditions of the government's fiscal objectives by means of a the SGP, they will have to endeavor to avoid excessive projection of the main fiscal aggregates. Shortly deficits. Furthermore, the exchange rate policy after submission of the PEP, the Commission evalu- becomes a matter of common interest.This develop- ates the program. The evaluation does not make an ment means that, to protect the smooth functioning assessment of whether a country has made progress of the single market, competitive devaluations are toward meeting the Copenhagen criteria--this is not allowed. Thus, new member states must avoid provided on an annual basis by the Commission's policies leading to excessive fluctuations of the regular report on progress toward accession. Yet the exchangerate.ParticipationintheERMIIisexpected accession countries report to the Commission sometime after accession. Such participation implies through the fiscal notification system the debt and setting the central rate to the euro and the fluctuation deficit figures calculated in accordance with the bands within ±15 percent by mutual agreement. EU methodology based on the ESA 95 system of Because the economic policies of the accession national accounts. These notifications use the same countries become a matter of common concern, format as the fiscal notifications provided by mem- these policies will be subject to policy coordination ber states in the framework of the excessive deficit and multilateral surveillance procedures. Shortly procedure (see European Commission 2002). after accession, the new member states will be required to submit a full notification of govern- From Accession to Adoption of the Euro Phase ment debt, deficit, and associated data. New mem- Upon accession, the new member state will have ber states also will have to prepare convergence the status of "Member State with a derogation" programs, which will set out their budgetary strate- granted in the accession treaty. It will have to show gies for the coming years, in particular with respect adherence to the aim of economic and monetary to the medium-term objective of reaching a budg- union and compliance with the relevant parts of etary position "close to balance or surplus." The Title VII of the European Commission Treaty and European Council will examine the programs, and, the other EMU acquis. These parts are based on the Commission's recommendation, will · Treatment of exchange rate policy as a matter of adopt an opinion on each of the programs. common interest and, eventually, participation In addition to the convergence programs, in the exchange rate mechanism (Article 124) economic and fiscal policy coordination and Macroeconomic Policies for Turkey's Accession to the EU 19 surveillance in the EU are achieved through the will no longer be permitted. The EU expects each of Broad Economic Policy Guidelines (BEPG). These the acceding countries to join the ERM II--that is, guidelines, which are prepared on an annual basis, to agree to an exchange rate arrangement between present the member states' consensus opinion on the euro and each country's currency. This phase macroeconomic and other structural economic will last at least two years. The test period for the policies in the medium term. Each year, the Euro- exchange rate criterion will probably be from May 1, pean Commission reviews in its annual economic 2004, to April 30, 2006. It is crucial that a country report the implementation of the guidelines by the avoid devaluation within the two-year test period, member states.25 because that country would fail the exchange rate Participation in the Euro Area will be the ulti- criterion. mate goal for each new member state. A favorable During the second half of 2006, the convergence decision is made when the conditions for adoption test will probably be conducted by the ECB and the of the single currency are met, after determining European Commission. The decision on acceptance whether a new member state has achieved a high into the EMU will be made by ECOFIN on the basis degree of sustainable convergence. Prior to acces- of a proposal of the European Commission and sion, there is no requirement that the EU assess after consultation with the European Parliament progress made on convergence criteria, or that can- and after a discussion in the European Council. The didates for accession meet the criteria. As it was for examination of the budget and of government debt the present member states, adoption of the euro will likely be based on the data for 2005 or the latest occurs when a high degree of sustainable conver- available figures. In January 1, 2007, the euro will gence has been demonstrated within the internal probably be adopted as national currency. The cen- market. tral bank governor of each new EMU country then becomes a member of the Governing Council, the Euro Area Phase The adoption of the euro will main decision-making body of the ECB.26 add two key elements to the macroeconomic framework of "Member States with a derogation." The Macroeconomic Challenges One is the single stability-oriented monetary policy Facing Turkey and the ensuing single exchange rate policy. The second is implementation of the sanction provi- Turkey realizes that, in the long run, price stability sions of the SGP, by which member states surpass- and fiscal discipline create the best conditions for ing the 3 percent ceiling in their deficit will be sustained, robust economic growth, but currently subjected to substantial fines. The aim is to allow the situation is problematic. The data in table 1.9 the ECB to conduct an independent monetary show the EMU convergence criteria for Turkey and policy supported by prudent national fiscal poli- the Central and Eastern European countries. The cies, which are subjected to the SGP and policy table reveals that the CEE countries are about to coordination. The Treaty does not specify any satisfy the criteria, but that Turkey is far from satis- mandatory timetable for fulfillment of the condi- fying the conditions. In 2003 the inflation rate in tions for introduction of the euro. In other Turkey was 25.3 percent, compared with a reference words, although the economic policies of the new value of 2.7 percent for the EU; the budget deficit as member states will have to pursue a high degree a percentage of GDP was 8.8 percent, compared of sustainable convergence, the speed at which with a reference value of 3 percent for the EU; the this should happen is left undetermined by EU debt-to-GDP ratio was 80.2 percent, compared legislation. with a reference value of 60 percent for the EU; and interest rates were 28.5 percent, compared with a Prospects for Central and Eastern European reference value of 6.2 percent for the EU.27 Countries The Central and Eastern European The challenge facing Turkey is how to move countries that acceded to the EU on May 1, 2004, from the current state of affairs to one in which the will have to coordinate their economic and fiscal Maastricht criteria will be satisfied. The main issues policies with the Community in the ECOFIN are reducing the inflation rate to about 3 percent Council. They must submit annual convergence over time and reducing the debt-to-GDP ratio to programs, and restrictions on capital movements 60 percent over time, while attaining sustainability 20 TABLE 1.9 European Economic and Monetary Union Convergence Criteria, 2000­03 Interest Exchange Rates, Rate against Inflation Rate (%) Budget Deficit (% of GDP) Government Debt (% of GDP) 10Y Bonds Parity 2000 2001 2002 2003 2000 2001 2002 2003 2000 2001 2002 2003 (last) (max, 2Y) Currency Regime Czech Rep. 3.9 4.7 1.8 0.1 -4.0 -3.2 -4.6 -6.6 29.2 29.0 22.4 37.6 5.1 -5.0 Managed float (EUR) Estonia 4.0 5.8 3.6 1.3 -0.7 1.1 1.2 2.4 6.6 6.2 5.4 5.1 2.3 -0.4 Currency board (EUR) Hungary 9.8 9.2 5.3 4.7 -3.5 -5.0 -9.6 -5.7 56.1 51.5 50.4 58.6 8.4 -9.3 Target zone (EUR) Latvia 2.7 2.5 1.8 2.9 -2.8 -1.9 -2.7 -1.6 10.0 12.2 13.9 16.3 7.4 -9.9 Peg (SDR) Lithuania 1.0 1.3 0.3 -1.2 -2.8 -1.4 -2.8 -1.7 28.3 29.0 25.0 23.6 6.4 0.2 Currency board (EUR) Poland 10.1 5.5 1.9 0.7 -2.7 -6.3 -5.4 -4.5 43.8 38.0 48.0 51.0 7.3 -17.2 Float Slovakia 12.0 7.3 3.3 8.5 -6.8 -7.2 -1.9 -3.6 32.9 42.7 32.0 42.8 5.1 -6.3 Managed float (EUR) Slovenia 8.9 8.5 7.5 5.6 -1.4 -1.3 -1.1 -1.4 25.1 25.4 32.2 26.8 4.0 -4.3 Managed float (EUR) Bulgaria 10.1 7.9 5.8 2.3 -1.1 -1.0 0.2 0.0 83.8 72.5 60.9 53.7 5.4 -0.8 Currency board (EUR) Romania 45.7 34.5 22.5 15.3 -4.1 -3.7 -1.7 -2.3 29.2 31.2 25.7 26.2 17.3 -19.2 Managed float (US$) Turkey 54.9 54.4 45.0 25.3 -6.1 -29.8 -12.6 -8.8 65.4 102.6 89.5 80.2 28.5 16.3 Float Reference value 2.8 3.3 3.0 2.7 -3.0 -3.0 -3.0 -3.0 60.0 60.0 60.0 60.0 6.2 +/- 15% Note: Parity refers to the last three-year average exchange rate against the euro. In the case of Turkey, the interest rate is the annual compound interest rate obtained in the auction of treasury bills and government bonds during November 2004. SDR = special drawing rights. Sources: Deutsche Bank Research, EU Enlargement Monitor, April 2002, and EU Monitor, September 2004; State Planning Organization 2004; Central Bank of Turkey (http://www.tcmb.gov.tr). Macroeconomic Policies for Turkey's Accession to the EU 21 of the current account and decreasing the unem- commonly used measure of the costs of disinflation ployment rate in the economy. is the "sacrifice ratio," which can be defined as the number of percentage points of lost output associ- Inflation ated with a policy-induced 1 percent reduction in As of November 2004, the annual inflation rate in inflation. Following Ball (1994), we identify disin- Turkey was 9.8 percent, and the government was flation episodes as the time range within which aiming to reduce the inflation rate to 8 percent in trend inflation falls substantially and define trend 2005. To satisfy the Maastricht criteria on inflation, inflation as a centered five-quarter moving average Turkey must reduce the inflation rate further, to of the actual inflation rate.29 During the time period 3 percent. The annual inflation rate in Turkey has between the first quarter of 1987 and the third quar- been reduced in recent years through strict imple- ter of 2003, we identify in Turkey two disinflation mentation of the IMF economic program, which episodes. The first episode starts at the fourth quar- calls for controlling the growth of base money. ter of 1994 and ends during the fourth quarter of Another factor leading to a lower inflation rate has 1996. The second episode starts at the first quarter been the decrease in the cost of imported goods, of 1998 and ends during the first quarter of 2001. achieved as a result of real appreciation of the The trend inflation rate decreases by 29.62 percent Turkish lira. But reducing the inflation rate over during the first episode and by 43.05 percent dur- time through real appreciation of the currency is ing the second episode. We assume that output is at not sustainable in the long run, because the real its potential level at the start of the disinflation appreciation of the currency will lead to problems episode. For potential output and output gap pro- of sustainability of the current account. Current jections, we consider the estimates provided by the account sustainability in Turkey as of December Turkish State Planning Organization (SPO).30 They 2004 requires that the real exchange rate be depre- have estimated the potential output using the linear ciated to its long-run equilibrium level.28 Yet reduc- method, the Hodrick-Prescott method, and the ing the inflation rate by reducing the public sector production function method (see State Planning component of the wholesale price level, ppublic, is Organization 2003). The sacrifice ratio is then cal- also not sustainable, because this policy will lead to culated by the formula increases in the ratio of the public sector borrowing Z+4 requirement to GDP, leading, in turn, to problems (1.3) SR = (yt - yt ) (t - t ) related to the sustainability of fiscal policy. Thus -1 t=S ppublic should be increased at least at the same rate as the inflation rate in the economy. The only policy where yt stands for the natural logarithm of real option for reducing the rate of inflation is therefore output, yt for the natural logarithm of potential to control the growth rate of base money. output, t -1 for the trend inflation rate at the To reduce the inflation rate from its current level beginning of the episode, t for the trend inflation of 9.8 percent to around 3 percent, Turkey will rate at the end of the episode, and the disinflation probably go through a disinflation period. But dis- episode starts at period S and ends at period Z. The inflation in general entails costs, and the most calculations are presented in table 1.10. In the table, TABLE 1.10 Estimates of the Sacrifice Ratio Production Linear Episode HP Filter Function Method April 1994­April 1997 0.000 0.000 -0.013 April 1994­April 1996 0.005 0.006 -0.003 January 1998­January 2002 -0.001 -0.001 -0.001 January 1998­January 2001 0.005 0.005 0.007 Source: The authors. 22 Turkey: Economic Reform and Accession to the European Union the first line of each episode denotes the estimate of the real rate of interest by r, the foreign real interest the sacrifice ratio obtained under the assumption rate by r, the real exchange rate by q, the rate of that output returns to its potential level four quar- depreciation of the real exchange rate by , and the ters after the end of an episode, as in Ball (1994). By velocity of money by V, we get the equation deter- contrast, the second line of each episode denotes mining the time path of the total-debt-to-GDP the estimate of the sacrifice ratio obtained under ratio dt = bt + bt : the assumption that output returns to its potential level right at the end of the episode. (1.5) dt = -pst + (1 + g) (1 + r) bt The table reveals that the estimates of the sacri- -1 fice ratio in Turkey are not very much different from zero,31 which indicates, in turn, that disinflation in + (1 + r)(1 + )bt (1 + g) -1 Turkey will entail relatively little output cost. The result probably stems from the extreme flexibility of 1 - g + + g the Turkish labor market.32 But the output costs of V (1 + )(1 + g) disinflation will increase as the Turkish labor mar- -privt + fsbt ket becomes less flexible.33 Thus it would be advis- able for Turkey to follow the disinflationary policies The equation shows that debt-to-GDP ratio as long as the labor market is flexible. decreases with increases in the primary-surplus-to- GDP ratio ps, the growth rate of real GDP g, the privatization-revenues-to-GDP ratio priv, and Public Debt and Fiscal Policy the seigniorage-revenues-to-GDP ratio, defined as To analyze the issues associated with reducing the 1 g++g . By contrast, the debt-to-GDP ratio V (1+)(1+g) debt-to-GDP ratio from 80.2 percent in 2003 to increases with increases in the real domestic inter- 60 percent over time, we consider the government est rate r, the real foreign interest rate r, the rate of budget constraint represented by depreciation of the real exchange rate , and the (1.4) Gt - Tt + it Bt financial-sector-bailout-to-GDP ratio fsb. -1 + iEtBt + FSBt = (Bt - Bt Over 2000­03, seigniorage and privatization -1 ) + Et(Bt - Bt -1 -1 ) + Mt - Mt revenues were running at about 1.3 and 1.7 percent -1 + PRIVt of GDP, respectively. The crucial parameters deter- where G refers to government expenditures exclud- mining the time path of the debt-to-GDP ratio turn ing the interest payments, T government revenues, out to be the primary-surplus-to-GDP ratio, the B the TL-denominated debt stock of the public domestic and foreign real rates of interest, and the sector, B the FX-denominated debt stock of rate of real exchange rate depreciation. Turkey is the public sector, i the nominal interest rate on committed to the primary surplus target of 6.5 per- the TL-denominated government debt, i the cent of GNP over the next few years. In 2004 the interest rate on the FX-denominated government domestic real interest rate was running at about debt, E the exchange rate, FSB the public expen- 12 percent and the foreign real interest rate at about diture for the financial sector bailout, M the 8 percent (see OECD 2002 and IMF 2004). Finally, it monetary base, and PRIV privatization revenues. is noteworthy that Turkey, after appreciating the Let Yt = pt, yt be the nominal GDP, p the GDP real exchange rate by 13 percent in 2002, appreci- deflator, and y real GDP. Denoting the primary- ated the real exchange rate by a further 23.8 percent surplus-to-GDP ratio by pst = (Tt - Gt)/Yt , the in 2003. All these factors have contributed to reduc- TL-denominated debt-to-GDP ratio by bt = ing the debt-to-GDP ratio. But even under these (Bt/Yt), the FX-denominated-debt-to-GDP ratio favorable circumstances, it will take quite a long by bt = (Et Bt )/Yt, the privatization-revenues-to- time to reduce the debt-to-GDP ratio from its level GDP ratio by privt = (PRIVt/Yt), the financial- of 80.2 percent in 2003 to 60 percent and below. sector-bailout-to-GDP ratio by fsbt = (FSBt/Yt), Here three issues deserve careful analysis. the domestic rate of inflation by , the foreign rate First, the real appreciation of the exchange rate of inflation by , the growth rate of real GDP by g, contributed substantially to the reduction in the Macroeconomic Policies for Turkey's Accession to the EU 23 debt-to-GDP ratio during 2002 and 2003. But this the economy, which was 9.5 percent during the policy is not sustainable in the long run, because third quarter of 2004. That constraint may have the real appreciation of the currency will lead to serious political implications, unless the country problems of sustainability in the current account, tries to broaden its tax base, reduce the tax burden as explained later in this chapter in some detail. of economic units in the formal sector, and Second, EU accession will entail costs for Turkey improve tax compliance in the country. that must be identified and financed. These costs will include the social consequences of economic Sustainability of Current Account restructuring, such as those in the agriculture sec- The basic presumption of our approach is that the tor, where restructuring presents particular prob- current account is sustainable. If not, Turkey could lems for small farmers. The process of adopting the face an exchange rate collapse or an external debt acquis communautaire entails, among other things, default, which, in turn, would imply a reduction in comprehensive structural reforms of the public real income and employment, deviating from the administration and the productive sectors, as well long-run growth path. Starting from the notion as extensive investment in human resources and the that under current account sustainability the coun- environment. From a budgetary perspective, the try must satisfy its lifetime budget constraint, we fiscal costs of EU accession in the other accession contend that the current policies are sustainable if countries have been estimated to be over 3 percent continuation of the current government policy of GNP annually. Turkey would also face significant stance and private sector behavior into the future fiscal costs--costs that would have to be financed in the context of continuing fiscal adjustment.34 does not entail a drastic policy shift or lead to a cur- rency or balance of payments crisis. This situation implies either a reduction in the Here we emphasize the points stressed earlier by primary-surplus-to-GDP ratio by the same amount considering the balance of payments relation, or further increases in the revenues of the public which can be written as sector. Third, to reduce the debt-to-GDP ratio from its (1.6) TB$t - iDt -1 + FDIt + Dt - Dt -1 level of 80.2 percent in 2003 to 60 percent over - Rt = 0 time, Turkey, even in the face of the higher costs of where TB$ denotes the noninterest current account EU accession, must stick to the primary surplus tar- (NICA), i the foreign rate of interest, D the stock of get of at least 6.5 percent of GNP over the next few foreign debt, FDI the net foreign direct investment, R years. Any downward deviation from the target will theforeignexchangereservesof thecountry,and Rt postpone achievement of the 60 percent debt-to- the change in reserves. Also, (TBt - iDt $ -1) = GDP ratio. Achievement of the primary surplus Current Accountt and (FDIt + Dt - Dt -1) = Capi- target of at least 6.5 percent of GNP over time tal Accountt. All variables are measured in terms of requires that Turkey increase its tax revenue by foreign currency. If dt = Et Dt is the foreign-debt- broadening its tax base. In this context, Turkey pt yt Et T Bt $ could introduce, like Russia and Ukraine, a flat tax to-GDP ratio, tbt = the noninterest-current- pt yt on income at a relatively low rate. The introduction account-to-GDP ratio, fdit = FDItEt the FDI-to- pt yt of such a flat tax at a low rate would improve tax GDP ratio, and rt = ( Rt)Et the change-in- compliance and efficiency,35 and it would increase pt yt reserves-to-GDP ratio, the equation determining the tax base and thus the tax revenue, as long as the the time path of dt can be written as necessary steps are taken simultaneously to mod- ernize the tax administration and improve tax (1 + r)(1 + ) (1.7) dt = -tbt + dt-1 compliance.36 Such measures also will help to 1 + g decrease the share of the informal sector in the - fdit + rt economy. where r denotes the foreign real rate of interest Finally, the government's desire to achieve a pri- and the rate of depreciation of the RER. The mary surplus target of at least 6.5 percent of GNP equation reveals that the external-debt-to-GDP over the next few years will constrain its use of fis- ratio decreases with increases in the noninterest- cal policy for decreasing the unemployment rate in current-account-to-GDP ratio tb, the FDI-to-GDP 24 Turkey: Economic Reform and Accession to the European Union ratio fdi, and the growth rate of GDP g. By contrast, t + n, we assume that the values of tbt +i and fdit+i the debt-to-GDP ratio increases with increases in for i = 1, ... , n will remain unchanged at their the foreign real interest rate r, rate of depreciation initial values of tbt and fdit. Thus we assume that of the RER , and changes in the reserves-to-GDP the government, private sector, and rest of the ratio r . world will not change the policies they pursue in Following the approach of von Hagen and period t over the time period t + 1 and t + n. Harden (1994), we solve this expression forward for A look at Turkey's annual GDP growth rate over n periods and obtain the period 1980­2003 reveals that the average growth n rate of GDP amounted to 4.1 percent during (1.8) dt = tt dt ,n +n + t t At ,i +i i=1 1980­1989 and to 3.7 percent during 1990­2003. where Thus for the growth rate of GDP over the time period k t to t + n we take the figure of 4 percent. By con- t 1 + gi ,k trast, the foreign real interest rate is to equal 8 per- i=1(1 + ri )(1 + i) cent. Finally, we assume in the following calculations and that r = 0 for each year of the period t to t + n At = tbt + fdit - rr . and that over the same period equals zero. Followingtheapproachof vonHagenandHarden Here, t ,k can be interpreted as the "k-periods (1994),the current account is not sustainable if ahead" discount factor used to calculate the present (1.9) value of assets and liabilities in period t + k for S(n) = dt - t dtt ,n +n n period t. txt+k denotes the period t expectation of = t t At ,i +i < 0. the variable x in period t + k. The equation shows i=1 that current-debt-to-GDP ratio equals the expected This is a rather mild sustainability condition. Here discounted present value of foreign debt outstand- dt denotes the actual debt-to-GDP ratio in period t, ing in period t + n relative to GDP, plus the sum of and At +i = (tbt + fdit) for i = 1, ..., n. The all discounted At's between period t and period result of the calculations for n = 10, n = 20, and t + n. Theoretically, the intertemporal budget n = 25 are shown in table 1.11. constraint requires that lim tt dt ,n +n 0 as n The table reveals that during 1993 the current becomes very large, so that foreign debt remains accountwasunsustainableinthesensethattheactual bounded relative to GDP. If the intertemporal debt-to-GDP ratio in 1993 fell short of the expected budget constraint were violated, private investors discounted present value of foreign debt outstanding would realize that the government's liabilities inperiod2003relativetoGDPby14.03percentwhen would eventually exceed its revenue-raising capa- n = 10 and that the actual debt-to-GDP ratio in bilities. As a result, the price of the debt of the 1993 fell short of the expected discounted present country would fall to zero, and the country would value of foreign debt outstanding in period 2018 rel- see itself barred from international capital markets. ative to GDP by 27.26 percent when n = 25. This To translate the intertemporal budget constraint finding indicates that the current account needed into a practically more relevant requirement, we adjustment in the NICA-to-GDP and FDI-to-GDP consider the above relation for a limited period of ratios. During 1994, Turkey increased the NICA-to- time n and add the condition that the discounted- GDP ratio considerably, but there was not much debt-to-GDP ratio at the end of period t + n change in the FDI-to-GDP ratio. The table indicates should not exceed the debt-to-GDP ratio at time t. that the policy was successful; the sustainability We use actual data on dt, tbt, and fdit for any year measure was positive thereafter. The warning signals during the time period 1984­2003. For each year t for the 2001 currency crisis were evident in the nega- of the time period, we estimate the expected dis- tive figures of the sustainability measure for the year counted present value at time t of foreign debt out- 2000. The situation improved after the crisis, when standing in period t + n relative to GDP, plus the the sustainability measure increased and became sum of all discounted At's between period t and positive at the end of 2001. Although the current period t + n. As for the government policy stance account was sustainable in 2001 and 2002,the system and the private sector behavior over the period t to was not sustainable again in 2003. Macroeconomic Policies for Turkey's Accession to the EU 25 TABLE 1.11 Current Account Sustainability level of 0.03 percent, we next turn to the study of Measures, 1984­2003 the determinants of noninterest-current-account- (values of S (n*), percent) to-GDP ratio.37 Using quarterly data from 1988 (first quarter) to 10 Years 20 Years 25 Years 2003 (second quarter) we note that one of the main 1984 1.55 2.61 3.00 determinants of this ratio is the RER. A second fac- 1985 6.53 11.01 12.69 tor that strongly affects the NICA-to-GDP ratio is 1986 4.85 8.18 9.43 the aggregate demand for domestic goods and serv- 1987 12.30 20.73 23.89 ices, consisting of total consumption plus invest- 1988 39.31 66.27 76.38 ment demand in the home country as well as the 1989 29.16 49.15 56.65 rest of the world. As the aggregate domestic 1990 2.20 3.71 4.28 demand for goods and services in the home coun- 1991 19.12 32.23 37.15 try increases, it triggers imports, and, other things 1992 11.54 19.46 22.43 being equal, the NICA-to-GDP ratio is expected to 1993 -14.03 -23.65 -27.26 1994 36.46 61.45 70.83 decline. Similarly, as aggregate domestic demand 1995 3.00 5.06 5.83 for goods and services increases in the rest of the 1996 1.74 2.93 3.38 world, it triggers imports of the foreign country, 1997 3.06 5.16 5.95 and, other things being equal, the NICA-to-GDP 1998 21.57 36.37 41.91 ratio in the home country is expected to increase. 1999 9.89 16.67 19.21 To explain the developments in the NICA, the 2000 -25.41 -42.83 -49.36 following equation is estimated: 2001 58.32 98.31 113.31 2002 12.70 21.40 24.67 (1.10) (NICA/GDP) 2003 -8.79 -14.81 -17.07 = 0 + 1 dlog(ADD) + 2 dlog(ADDF) + 3 RER + 4DQ3 Source: The authors. + 5 D1999 + 6 D93ST + 7 D2000 where d log(ADD) denotes the annual growth rate A look at the sustainability measure for 2003 with of real aggregate domestic demand in the home n = 25 reveals that the actual-debt-to-GDP ratio country; d log(ADDF) the annual growth rate of real in 2003 fell short of the expected discounted present aggregate domestic demand in the rest of the world; value of foreign debt outstanding in the period 2028 DQ3 the third-quarter seasonal dummy; D1999 the by 17.07 percent. The system is not sustainable. The recession and earthquake dummy for the year 1999, sustainability of the current account requires that taking the value of 1 for the second, third, and fourth the value of the sustainability measure be increased quarters of 1999 and 0 otherwise; D93ST the struc- so that it becomes positive. This goal can be achieved tural break dummy in 1993, taking the value of 1 either through an increase in the NICA-to-GDP after 1993 and 0 otherwise; and D2000 the exchange ratio tbt or through an increase in the FDI-to-GDP rate­based stabilization measures, taking the value ratio fdit during each year of the period 2004­28 or of 1 for all quarters of 2000 and 0 otherwise. The through a combination of increases in both the D93ST dummy refers to the structural break in NICA-to-GDP and FDI-to-GDP ratios during the Turkey's balance of payments that took place after same time period. During 2003, the actual value of the liberalization of the capital account in 1990. At = (tbt + fdit) was -1.08 percent. For Turkey to Because economic agents respond with lag to such achieve the minimal condition for external sustain- decisions, a series of tests were conducted to identify ability, the value of At during each time period of the the structural break resulting from this decision. All interval 2004­29 would have to be 0 percent. Thus of the variables used in the estimation were checked Turkey has to increase the sum of its noninterest- for unit roots, and it was learned that the series are current-account-to-GDP ratio and its FDI-to-GDP all stationary. Because of the simultaneity problems ratio during each period of the interval 2004­29 by faced in the model, we use instrumental variable at least 1.08 percent. Supposing that fdit during the techniques to estimate the parameters.38 The results time period 2004­28 remains constant at its 2003 of the estimation are presented in table 1.12. 26 Turkey: Economic Reform and Accession to the European Union TABLE 1.12 Results for Quarterly Instrumental Variable Regression of Ratio of Noninerest Current Account (NICA) to GDP Variable Coefficient t-Statistic C -2.56863 -1.41186 d log (aggregate domestic demand, home country) -29.89038 -12.12362 d log (aggregate domestic demand, foreign country) 38.84045 1.95129 Real exchange rate 0.03719 1.97118 DQ3 1.84541 4.52182 D1999 -3.82977 -4.34096 D93ST -0.91545 -2.34142 D2000 -2.72463 -3.18816 R-squared 0.82106 Adjusted R-squared 0.79787 Durbin-Watson statistic 2.14602 Source: The authors. The coefficients of the variables are all statisti- the RER, = d NICA/GDP RER . Then starting cally significant, and all have the expected signs. An d RER NICA/GDP from initial trade balance we derive that increase in the growth rate of aggregate domestic demand in the home country reduces the NICA-to- = (im + exp - 1), GDP ratio; an increase in the growth rate of aggre- where im and exp denote the import and export gate domestic demand in the rest of the world elasticities with respect to the RER. Estimates based increases that ratio. The ratio increases as the RER on estimated Turkish import and export functions depreciates. The coefficient of the structural change range quite widely. Here we consider the estimates dummy is negative, which indicates that liberaliza- of Tansel and Togan (1987) who determine the tion of the capital account had a negative impact on export price elasticity as 0.933 and import price the NICA-to-GDP ratio, as expected. elasticity as 0.472. Thus, = 0.405. Considering the The above considerations reveal that the NICA- ratio of exports to GDP of 19.6 percent, the param- to-GDP ratio can be increased by decreasing aggre- eter values imply that a reduction of the ratio of gate demand for domestic goods and services and/or noninterest-current account-to-GDP of 1 percent by depreciating the RER. Decreasing the aggregate requires a depreciation of the RER by 12.6 percent. demand for goods and services requires that the Thus sustainability of the current account follow- country aims for a more ambitious fiscal objective ing the approach of von Hagen and Harden (1994) than the constant primary surplus of 6.5 percent of requires that the RER at the end of 2003 be depreci- GDP. But this will be very painful after so many ated by 13.6 percent. failed stabilization attempts. The alternative is to An alternative specification of the sustainability depreciate the RER and keep the RER at its "long- condition requires that the ratio of the stock of for- run equilibrium level" over time.39 eign liabilities to GDP stay constant over time at its To determine the extent of depreciation in the initial value in time period 2003. In that case, the RER,we consider the regression equation reported in equation determining the time path of the debt-to- table 1-12.But,this equation yields rather high levels GDP ratio d can be solved for the equilibrium value of required rates of depreciation of the RER for alter- of the sum of tb and fdi, under the assumption that native specifications of the sustainability condition. r = 0, as We therefore consider a different approach in order to determine the extent of the required rate of depre- (g - r - - r) (1.11) (tb + fdi) = - d ciation of the RER for achieving current account sus- (1 + g) tainability. We consider the elasticity of the ratio of Assuming that equals 0 and setting the values of noninterest-current account-to-GDP with respect to g = 0.04, r = 0.08, and d = 0.612 of the year Macroeconomic Policies for Turkey's Accession to the EU 27 2003, the equilibrium value of (tb + fdi) is deter- and expected, that influences the perceived returns mined to be 2.354 percent. Because in 2003 the and risks associated with investment in terms of actual value of (tbt + fdit) equaled -1.08 percent, both quantity and productivity of investment Turkey must increase the sum of its noninterest- flows. Investment climate thus defined depends on current-account-to-GDP and FDI-to-GDP ratios a wide array of factors that can be grouped under over time by 3.4 percent. Suppose again that fdit the headings of (1) macroeconomic and trade poli- over time stays constant at its 2003 level of 0.03 per- cies, (2) infrastructure, and (3) governance and cent. Then the increase in tbt, and thus in At over institutions. time, can be achieved by depreciating the RER by Although Turkey had an open trade regime over about 42.8 percent and maintaining it at about that the past two decades, it was unable to attract large level over time. FDI inflows. One of the main culprits behind this Finally, following the suggestion of Reinhart, failure was the uncertain macroeconomic environ- Rogoff, and Savastano (2003), we consider cases in ment, which, along with the uncertainties stem- which the country tries to decrease its ratio of stock ming from domestic politics and the ensuing high of foreign liabilities to GDP from its initial value of real interest rates, produced a very erratic growth 0.612 to 0.5 and 0.4 over a period of 10 years. In performance. Throughout the past two decades, those cases, Turkey has to increase the sum of its Turkey put on hold many decisions that could help noninterest-current-account-to-GDP ratio and its foreign investors cope with high inflation. One of FDI-to-GDP ratio over time by 4.3 and 5.2 percent, the critical measures that Turkey did not introduce respectively. This change, under the assumption was the inflation accounting framework in the that fdit over time stays constant at its 2003 level, context of the highly inflationary environment. requires that the RER be depreciated by 54.2 per- Infrastructure-related factors were at play as well. cent and 65.5 percent, respectively. Although the quantity and quality of Turkey's Consider now the issue of increasing the FDI- broadly defined infrastructure--including its geo- to-GDP ratio. A striking feature of foreign direct graphic and demographic endowments and its investment flows to Turkey is that the level is too physical and financial infrastructure--help to posi- low compared with that of FDI flows to developing tion Turkey as a potentially powerful magnet for countries with similar levels of GDP per capita. In FDI inflows, these factors were ineffective in particular, the FDI flows to Central and Eastern Turkey's effort to increase those flows. The main European countries are much larger than those to bottlenecks, as emphasized by Dutz, Us, and Yilmaz Turkey. However, in terms of population, Turkey's in chapter 10 of this volume, seem to have been is larger than that of Poland, the Czech Republic, insufficient respect for the rule of law and weak and Hungary combined. In terms of GDP, Turkey's competition in local markets, reinforced by an economy is four times larger than that of the Czech uneven application of bureaucratic red tape. Republic or Hungary, and one-quarter larger than To attract higher levels of FDI flows in the future, that of Poland in 2000. In terms of gross fixed capital Turkey must therefore not only improve its macro- formation, Turkey's investments during 2000 were economic environment, but also increase respect three to four times larger than those of the Czech for the rule of law, increase competition in local Republic and Hungary and roughly a sixth larger markets, and reduce the bureaucratic red tape. than those of Poland. In terms of average annual Once Turkey is able to attract higher levels of inflows of FDI during the 1990s, Turkey attracted FDI into the country, it does not need to depreciate inflows valued at US$800 million, which is roughly its RER by as much as before in order to attain sus- one-fifth of the US$4.1 billion in FDI inflows to tainability in its current account. With increases in Poland and significantly lower than the inflows to the FDI-to-GDP ratios, the calculated required the Czech Republic and Hungary, each of which rates of depreciation of the RER decreases. When attracted about US$2.1 billion per year. the net FDI-to-GDP ratio increases by 1.08 percent An explanation of the factors determining the to 1.11 percent of GDP while the non-interest- FDI flows must begin with a definition of the current-account-to-GDP ratio stays constant at its investment climate in the country. It is the policy, 2003 value of -1.11 percent, then the system institutional, and behavioral environment, present becomes sustainable under the approach of von 28 Turkey: Economic Reform and Accession to the European Union Hagen and Harden (1994) with no change in the increasing the fiscal deficits. The country has to RER. For increases in net FDI-to-GDP ratio below introduce tax reforms that will aim to lower the 1.08 percent, the required rate of depreciation of personal income and social security taxes, while the RER will be positive but less than 13.6 percent. broadening the tax base through, for example, the In the second case when sustainability requires that introduction of a relatively low flat tax and simulta- debt-to-GDP ratio stays constant over time the neously modernizing the tax administration. system becomes sustainable with no change in RER Achieving a relatively high but sustainable when the net FDI-to-GDP ratio increases by 3.4 per- growth rate of GDP is also a challenge for Turkey. cent while the non-interest-current-account-to- According to a recent study by Togan (2003), the GDP ratio stays again at its 2003 value of -1.11 per- problem can be analyzed in terms of the growth of cent. In this case for increases in net FDI-to-GDP productivity and the growth of employment.41 ratio below 3.4 percent, the required rate of depre- Noting that Turkey achieved annual productivity ciation of the RER will again be positive but less growth of 3.12 percent over the period 1950­99, than 42.8 percent. Finally, under the third approach Togan emphasizes that the percentage contribution when sustainability requires that debt-to-GDP of the three sources of growth to productivity ratio decreases over a period of 10 years from its growth were (1) 38.1 percent from growth in the initial value of 0.612 to 0.4, the system becomes amount of capital per worker in the economy (cap- sustainable with no change in RER when the net ital deepening), (2) 25.15 percent from improve- FDI-to-GDP ratio increases by 5.2 percent while the ments in labor quality, and (3) 36.75 percent from non-interest-current-account-to-GDP ratio stays at total factor productivity (TFP) growth.42 Thus if its 2003 value of -1.11 percent. For increases in net Turkey wants to achieve higher growth rates of FDI-to-GDP ratio below 5.2 percent, the required GDP than the 3.6 percent a year achieved over the rate of depreciation of the RER again be positive but period 1990­2002, it has to increase, on the one less than 65.5 percent. hand, the productivity growth rate--through capi- tal deepening, improvements in labor quality, and increases in the growth rate of the TFP--and, on Employment and Growth the other hand, the growth rate of employment.43 As emphasized earlier in this chapter, the unem- Togan (2003) points out that Turkey, to increase ployment rate in 2003 was high in Turkey. The the amount of capital per worker, has to increase employment challenge facing the country is to cre- not only its investment ratio but also its domestic ate jobs for those unemployed, to create new jobs savings rate, because too much reliance on foreign for those entering the labor force for the first time savings over considerably long periods of time may at an average rate of 900 thousand persons per year, lead to problems of solvency and sustainability of and to increase the labor force participation rate the current account. In addition, Turkey has to from its low level of 48.3 percent. increase its investment in human capital formation. To solve the unemployment problem over time, It must increase not only the proportion of the Turkey has to preserve the flexibility of the labor adult population with primary, secondary, and market and achieve a relatively high but sustainable higher education, but also the quality of education growth rate of GDP over the next decades. Turkey at each of these levels. Turkey also must increase can no longer sustain the flexibility of the labor TFP growth. Because the sources of TFP growth are market through the lax enforcement of laws on tax- better technology, better organization, specializa- ation and social security, because such enforcement tion, and innovations on the shop floor, Turkey has tends to create different problems for Turkish soci- to increase the channels of acquiring knowledge, ety.40 Instead, the country has to attack the root of as well as the competitive pressure in the economies the problem, which is the large wedge between under consideration. Besides creating the knowl- labor costs and workers' disposable income because edge itself through strict enforcement of intel- of the high labor taxes. Such a high tax wedge raises lectual property rights, Turkey can adopt the labor costs, discourages work in the formal econ- knowledge created by others, mainly through inter- omy, and contributes to high nonemployment in national trade, FDI, and licensing. Finally, various the working-age population. The challenge facing economists have shown that trade liberalization Turkey is to reduce the high labor taxes without affects productivity change positively.44 TFP Macroeconomic Policies for Turkey's Accession to the EU 29 growth also depends on the macroeconomic poli- of productivity growth, GDP growth depends posi- cies followed. tively on the growth rate of employment, and the To elaborate statistically the relationship between level of employment in the economy is determined the TFP and trade and macroeconomic policies, we largely by the flexibility in labor markets. Increases follow the approach of Burnside and Dollar (2000) in labor market flexibility increase employment in which and reduce the unemployment rate in the econ- omy. Thus, GDP increases until labor is fully (1.12) TFP = 0 + 1 INFLATION employed with increases in labor market flexibility. + 2 OPEN In summary, to increase the growth rate of its + 3 BUDGET SURPLUS GDP, Turkey must (1) increase not only its invest- ment ratio but also its domestic savings rate, where INFLATION refers to the rate of inflation (2) increase its investment in human capital forma- measured by the GDP deflator, OPEN to the trade tion, (3) follow outward-oriented and prudent indicator, and BUDGET SURPLUS to the ratio of macroeconomic policies, and (4) increase the flexi- budget surplus to GDP. In the equation, the second bility in the labor market. The pursuit of these term indicates the effect of instability in macro policies, however, should not jeopardize the sus- policies. It is hypothesized that instability in tainability of fiscal policy or the sustainability of macroeconomic policies negatively influences the the current account. TFP and that its coefficient should therefore be negative. The third term refers to trade policies measured by the ratio of exports and imports to Exchange Rate Policy GDP. The coefficient would be positive if trade lib- As for an appropriate exchange rate regime, the eralization contributes to increases in the TFP. Maastricht criteria do put restrictions on the per- Finally, it is hypothesized that a budget surplus pos- missible exchange rate regime after accession. itively influences the TFP. Insolvent debt paths Floating within a band or target zone measuring no characterized by large budget deficits will require more than 15 percent from a euro central rate, with monetization of debts and thus inflation, leading to intervention at or within margins of the band, is instability in the economy. Uncertainty from insta- permissible. Even without adopting a formal target bility reduces both the willingness and the capabil- zone, the country could manage to maintain its ity of economic units to take a long-term view exchange rate within 15 percent of some euro toward increasing efficiency, which eventually central rate. Definitely permissible under the decreases the TFP. Furthermore, falling budget Maastricht exchange rate criterion are a conven- deficits will lead to greater private use of private tional fixed exchange rate regime and a currency savings, leading to increases in the TFP. board with the euro. Furthermore, any of the previ- Based on annual data for 1951­99, the estima- ous regimes could be combined with the adoption tion yields of the euro as a parallel currency. Under such a (1.13) TFP = 0.593 - 0.0713 INFLATION scheme, the euro would be joint legal tender with (0.477) (­2.741) the domestic currency. However, full, unilateral + 0.2454 OPEN euroization, with the abolition of the domestic cur- (2.693) rency, is not compatible with the Maastricht criteria for joining the EMU. The argument is that, once + 0.6832 BUDGET SURPLUS the domestic currency has been abolished, the (1.996) Council of Ministers can no longer determine n = 49 (1951­99); R2 = 0.311; DW = 2.2686. the conversion rate at which the candidate EMU The variables have the expected signs. Instability in member's currency eventually joins the EMU. macroeconomic policies proxied by the inflation Before we turn to the question of what the rate negatively influences the TFP. Yet trade liberal- exchange rate arrangement for Turkey ought to be ization and budget surplus positively affect the TFP. during the preaccession period, a quick glance The factors just mentioned determine produc- at current practice by the 10 new members and tivity and its growth rate, which, in turn, influence candidate countries is useful. Table 1.9 character- the growth rate of GDP. However, for a given level izes the current exchange rate regime of each of 30 Turkey: Economic Reform and Accession to the European Union these countries. Among the 10 CEE countries, tions, the Eurosystem's monetary policy will not Bulgaria, Estonia and Lithuania have currency change, and real depreciation will call for a lower boards with respect to the euro; Latvia has a fixed price level in the accession country. Thus if prices exchange rate regime with a peg against the special and wages are downward inflexible in the accession drawing rights (SDR); Hungary has a target zone country, higher unemployment or capacity utiliza- with a central rate fixed against the euro and a 15 per- tion may result--a situation that might be avoided cent fluctuation band on either side; the Czech if the accession country conducted its own mone- Republic, Slovakia, Slovenia, and Romania have tary policy and devalued it currency in nominal managed float; Poland has floating currency. terms. Yet as long as the accession country conducts The countries under consideration had opted a large share of its trade with countries in the Euro during the early 1990s for different exchange rate Area, the likelihood of the country being hit hard regimes. Although most of them chose some kind by an external shock originating from a country or of fixed exchange rate arrangements, others such as region outside the EU is rather small. A high degree Slovenia opted for more flexible solutions. Since of real factor mobility can be an effective substitute then, most of these countries have moved toward for nominal exchange rate adjustments in the face more flexible exchange rate arrangments. For of sysmmetric shocks. Real factors, whose mobility example, Poland now has fully flexible exchange matters, are labor and physical capital. Finally, the rates. Meanwhile, in all of these countries except existence of international (and supranational) fis- Romania inflation is under control, and as of 2003 cal tax transfer mechanisms with serious redistrib- five countries satisfied the Maastricht condition on utive powers spanning the member countries of the inflation (the Czech Republic, Estonia, Lithuania, currency area will ensure compensation of the loss Poland, and Bulgaria). All of these countries are of the exchange rate instrument if the accession interested in adopting the euro as early as possible. country were to give up monetary autonomy. According to Nuti (2002), the benefits of early The optimum currency area literature empha- adoption of the euro include greater exchange rate sizes that during the period in which the conditions certainty, greater policy credibility, lower transac- just stated are not satisfied, it is advisable for the tion costs, lower interest rates, greater macroeco- accession country to adopt a flexible exchange rate nomic stability, and greater economic integration regime. Clearly, any individual CEE country should through both trade and investment. The costs of have doubts about the net advantage of giving up euroization are loss of seigniorage, loss of a lender national monetary independence. The migration of of last resort, and, more generally, loss of monetary workers is not free, and all the candidate countries policy. are relatively small compared with the Euro Area, According to the optimum currency area litera- with the exception of Poland and Romania, and then ture of Mundell (1961) and McKinnon (1963), the only in terms of population.The candidate countries costs will exceed the benefits of joining the cur- are all very open to the EU, and the diversification of rency area as long as the country exhibits a high exports to the EU is growing. As for the instruments degree of nominal rigidity in domestic prices and to absorb asymmetric shocks in the absence of inde- costs, a relatively large size in terms of GDP and low pendent monetary and exchange rate policies, the degree of openness to trade in real goods and serv- picture for the CEEs does not look worse than that ices, a high incidence of asymmetric (nation- for the existing EMU members.45 Maurel (2002) specific) shocks as opposed to symmetric shocks, notes that one cannot assess ex ante the optimal cur- a less diversified structure of production and rency area criteria, because the mere fact of entering demand, a low degree of real factor mobility across a monetary union also influences the way in which national boundaries, and an absence of significant those criteria are satisfied. Corricelli (2002) empha- international (and supranational) fiscal tax transfer sizes that the 10 candidate countries would incur rel- mechanisms. Consider the case of asymmetric atively small losses from asymmetric shocks and that shocks and assume that the monetary policy of the the CEE countries do qualify to join the EMU. Eurosystem does not take into account the business Buiter and Grafe (2002) point out that only two cycle in the accession country. Also assume that exchange rate regimes are sustainable in the long a shock calls for depreciation of the accession run. These are the free-floating exchange rate and a country's real exchange rate. Under these assump- symmetric monetary union, which is defined to be Macroeconomic Policies for Turkey's Accession to the EU 31 a monetary union with a monetary authority that primary surplus target of at least 6.5 percent of GNP, satisfies the following conditions: (1) its mandate even in the face of the increased costs of EU acces- spans the entire monetary union, (2) it acts as sion for a considerable period of time. Any down- lender of last resort on the same terms in every ward deviation from the target will postpone union member state, (3) seigniorage is shared fairly achievement of the 60 percent debt-to-GDP ratio. among all union member states, and (4) it is The primary surplus target of at least 6.5 should be accountable to the legitimate political representa- achieved within the context of a fiscal reform that tives of the citizens of the whole union. To join a will broaden the tax base by reducing the tax burden monetary union with a fixed exchange rate, a coun- substantially on both labor and capital. try must resolve its fiscal problems, attain price sta- bility, achieve a sound banking sector, and ensure Notes its current account is sustainable. Until these condi- tions are satisfied, Turkey should avoid adopting 1. The authors thank Juergen von Hagen and seminar partic- a fixed exchange rate regime. Currency board ipants at the Center for European Integration Studies (ZEI) in Bonn for their useful comments. They are particularly in debt to arrangements and euroization should not be alter- anonymous referees, whose comments helped them to correct natives for Turkey.46 Because participation in the several errors in an earlier draft. Sübidey Togan thanks ZEI for EMU is a must for Turkey, it will ultimately be part its hospitality and the Alexander von Humboldt Stiftung for of a symmetric monetary union.47 But during the financial support while this paper was written. 2. The value of the correlation coefficient between the period before accession, Turkey could pursue an monthly series of annual CPI inflation and the monthly series of exchange rate policy with central bank interven- the annual growth rate of base money is 0.7572, and that between the monthly series of annual CPI inflation and the tions aimed at attaining the long-run equilibrium monthly series of the annual rate of change in the exchange rate value of the RER. In the terminology of the IMF's is 0.7698. "Exchange Arrangements and Exchange Restric- 3. See, for example, Metin (1995, 1998), Lim and Papi tions Annual Report," we thus refer to "Crawling (1997), and Kibritçioglu (2002). 4. The output gap, which has been found to be stationary, Band" with a +/- 10 percent width.48 The country and the dummy variable have been included in the Johansen could pursue this policy until it resolves its fiscal cointegration test as exogenous variables. problems, attains price stability, and achieves sound 5. Anyone constructing real exchange rate indices is faced with choosing the price index, the currency basket, weights, and banking sector and sustainability in the current a mathematical formula. In formulating the RER, we use the account. CPI, because these data are available on a monthly basis for a large number of countries. For the currency basket, we consider countries that are major competitors of Turkey in world mar- Conclusion kets, as well as major suppliers of imported commodities to Turkey. These countries are the following: Western Europe: The criteria for accession to the EMU include a ceil- Belgium, France, Germany, Greece, Italy, the Netherlands, ing for the permissable rate of inflation one year Portugal, Spain, Switzerland, and the United Kingdom; America: Brazil, Canada, Mexico, and the United States; Middle East and prior to accession and a constraint on the permit- North Africa: Egypt, Iran, Syria, Tunisia; Central and Eastern ted variations of the nominal exchange rate-- European and Commonwealth of Independent States countries: membership in the ERM for a two-year period prior Czech Republic, Hungary, Poland, Russia; Asia: China, Indonesia, Japan, Republic of Korea, Malaysia, Taiwan (China), to accession while observing the normal fluctuation Thailand. To determine the weights of different countries, we limits of the ERM. This constraint means that use the approach developed by Zanello and Desruelle (1997), in Turkey would be free to choose the exchange rate which overall trade weights are derived by combining the bilateral import weights with the double export weights, using regime until accession. During this period, the risk the relative size of Turkish imports and exports in overall of speculative attacks on the Turkish currency will be Turkish trade to average both sets of weights. In formal terms, unavoidable, unless Turkey establishes a sound fiscal the import weight can be expressed as wi = (Mi /M), the m framework, achieves a sound banking sector, and export weight as ensures that its real exchange rate equals its long-run equilibrium level. In addition, Turkey should pursue wi = x Xi yi i a policy of maintaining the real exchange rate at X yi + Xh h around its long-run equilibrium level. By contrast, a look at fiscal issues reveals that Turkey, to reduce its Xik Xik debt-to-GDP ratio from its 2003 level of 80.2 per- + k=i X yk + Xh k cent to 60 percent over time, must stick to the h 32 Turkey: Economic Reform and Accession to the European Union and the overall weight as 9. In addition to the size of the current account deficits, the quality of the sources of financing the deficit is important. A M X wi = m x high percentage of short-term debt increases the probability that X + M wi + X + M wi sudden capital outflows will lead to a crisis. It is recognized that foreign direct investment (FDI) is by far the surest form of exter- where Mi denotes Turkish imports from country i, M the total nal financing. But FDI flows into Turkey have been rather low. value of Turkish imports, Xi Turkish exports to country i, X the Thus external sustainability is an important issue for Turkey. total value of Turkish exports, yi the value of domestic manufac- 10. Real interest rate is defined as turing production for the home market of country i, and Xi k exports of country k to country i. The formula used to estimate it the RER is + r1 = 1 100 1 + t - 1 100 100 RER = CPIi /Ei wi CPI/E where it denotes the annual rate of interest on government bonds and treasury bills, attained as the weighted average rate in where stands for the product sign, i for the index that runs auctions during the month t weighted by total sales during the over the country's trade partners, Ei for the exchange rate month, and t denotes the expected annual rate of inflation at defined as domestic currency per unit of U.S. dollar of country i, E for the Turkish lira/U.S. dollar exchange rate, and wi for the time t over the period t to t + 12. In the calculations of the real interest rate, we set the expected annual rate of inflation at time competitiveness weight attached by Turkey to country i, calcu- t over the period t to t + 12 equal to the actual annual rate of lated using the method of Zanello and Desruelle (1997). inflation over the period t to t + 12. The average level of real 6. Turkey opened the capital account in 1989 before it had interest rates over the period February 1994 to October 2003 was taken measures to upgrade banking and financial market super- 25.5 percent. vision and regulation, adopt international auditing and 11. Net debt figures are from IMF (2004), measured in per- accounting standards, strengthen corporate governance and cent of centered GNP, defined as the sum of quarterly GNP in shareholder rights, and modernize bankruptcy and insolvency the last two quarters of the year and in the first two quarters of procedures. The 1994 and 2001 crises occurred while the coun- the following year, in line with the IMF definition. try was facing large fiscal deficits, public debts, and high infla- 12. Consideration of total tax revenues, including social tion rates. Problems of competitiveness led to substantial cur- security contributions, reveals that total tax receipts in Turkey rent account deficits. In addition, the currency and maturity amounted in 1999 to 31.3 percent of GDP, compared with gen- mismatches on the balance sheets of the banks had left the eral government receipts of 40.7 percent in EU countries. authorities with little leeway for using either interest rate or According to Noord and Heady (2001), the unweighted average exchange rate adjustments to restore balance without under- of total tax revenue as a percent of GDP in the EU is 42.1 per- mining the stability of the banking sector. Finally, there was an cent, and the GDP weighted average is 40.7 percent. excessive dependence on short-term foreign borrowing to 13. Other factors contributing to the country's relatively finance the current account deficits. These weaknesses con- low unemployment rate are labor migration from the country tributed substantially to the balance of payments crisis of 1994 and the achievement of relatively high growth rates of GDP and 2001. 7. Let p E/p be the RER where p denotes the gross domes- over time. 14. Various methods can be used to estimate the size of the tic product (GDP) deflator in the foreign country, E the informal sector in the labor market. exchange rate, and p the GDP deflator in the home country, and let py = wL + rK be the nominal GDP where y stands for real Castells and Portes (1989) define informal employment as GDP, w the nominal wage rate, L total employment, r the return the sum of unpaid family workers, domestic servants, and the self-employed, minus professionals and technicians. on capital, and K the stock of capital. Expressing the capital income in this equation as rK = (wL), where stands for the An alternative approach to determining the size of the infor- mal sector considers the coverage of workers by social security profit margin, the RER can be written as institutions (Assaad 1997). Workers are divided into two groups: E p y E w(1 + ) those who are covered by a social security program and those = L who are not. The covered workers are considered to be part of p y (1 + )w - the formal sector and uncovered workers to be part of the infor- L mal sector. where (y/L) denotes labor productivity in the home country, A third approach to determining the size of the informal sec- (y/L) labor productivity in the foreign country, the profit tor is provided by Bulutay (1999). He considers the data pro- rate in the foreign country, and w the wage rate in the foreign vided by Turkish Household Labour Force Survey Results on country. Thus for given values of productivities and profit rates "employed persons by size of workplace and status in employ- in the two countries, depreciation of the RER leads to a decrease ment." As he defines the informal sector, it consists of (1) the in wages measured in foreign currency (w/E). self-employed, (2) unpaid family workers, (3) employers who 8. The severity of the 2001 crisis when compared with the employ two or three workers, and (4) regular and casual effect of the previous foreign exchange crisis is explained by the employees in private sector work places that employ one to three fact that by 2001 Turkey had a high level of "liability dollarization," workers. with high public and private foreign debt denominated in foreign In his estimation of informal employment, Togan (1997) currencies, and a high share of foreign currency­denominated defines employment in the informal sector as the sum of bank deposits. The sharp depreciation caused a large increase in employment in the agricultural sector and in the private, non- both the gross and the net indebtedness of the economy, which agricultural informal sector. He determines employment in more than offset the positive effect of depreciation on the demand the private, nonagricultural informal sector by deducting from for exports. regular and casual employers in the nonagricultural sector Macroeconomic Policies for Turkey's Accession to the EU 33 (reported by the State Institute of Statistics) the number of reg- achieved stability of institutions guaranteeing democracy, the istered wage earners reported by the Ministry of Labor. rule of law, human rights and respect for and protection of A fifth estimation method used to determine the size of the minorities, the existence of a functioning market economy as informal sector considers the share of subcontracting activity in well as the capacity to cope with competitive pressure and mar- the economy. ket force within the Union. Membership presupposes the candi- Calculations by each of these methods reveals that, on aver- date's ability to take on the obligations of membership including age, informal labor makes up about 60 percent of total employ- adherence to the aims of political, economic and monetary ment in Turkey. union" (European Council 1993). These criteria have from then 15. The growth rate of GDP at time period t is calculated as on been referred to as the Copenhagen criteria. [GDP(t) - GDP(t - 1)]100/GDP(t - 1). The average annual 24. With the entry into force of the Treaty on European growth rate over the time period under consideration is then the Union on November 1, 1993, the principle of full freedom of average of these growth rates over the indicated time period. capital movements was incorporated into the treaty. As of Janu- 16. According to Italianer (2002), there are two formal rea- ary 1, 1994, which corresponds to the start of the second stage of sons a new member state has this status. First, the procedures the economic and monetary union, Articles 73a­73g of the foreseen in Article 121(1) for assessment of the conditions for Treaty on European Union introduced new arrangements for adoption of the euro cannot be applied before accession. Sec- capital movements. Article 73a states that as of January 1, 1994, ond, one of these conditions cannot possibly be met upon acces- Articles 67­73 of the Treaty of Rome no longer apply and are sion, because it requires participation in the Exchange Rate replaced by Articles 73b­73g of the Maastricht Treaty.Article 73b Mechanism (ERM II), which is not open to nonmembers. More introduces the principle of full freedom of capital movements important, the economic rationale for the construction of the and payments, both between member states and between EMU presupposes participation in the internal market before member states and third countries. This article is directly appli- adoption of the euro. The free movement of goods, the freedom cable. Article 73c introduces the possibility of maintaining cer- to provide services, the free movement of persons, and full liber- tain existing restrictions vis-à-vis third countries.Article 73d sets alization of capital movements are expected to be accomplished out the areas in which member states can maintain information, before adoption of the euro, except for negotiated transition prudential supervision, and taxation requirements without capi- periods in a limited number of areas. tal movements being hindered. Article 73e provides for the dero- 17. Price stability requires that, over a period of one year gations adopted prior to the entry into force of the Treaty on before the examination, a country's inflation rate not exceed the European Union to be maintained for a transitional period. Arti- average rate of the three best-performing EU member states in cle 73f provides for the possibility of taking safeguard measures if price stability by more than 1.5 percentage points. Interest rate movements of capital to or from third countries cause serious convergence requires that the average long-term interest rate not difficulties for the operation of the economic and monetary exceed that of the three EU countries with the best inflation per- union. Article 73g allows the European Community or a mem- formance by more than two percentage points. The budget ber state to take measures on movements of capital to or from deficit criterion requires that the ratio of general government third countries for security or foreign policy reasons. deficit to GDP not exceed 3 percent. The government debt crite- 25. In addition, member states participating in the Euro Area rion requires that the ratio of general government debt to GDP have to prepare yearly stability programs that will report on the not exceed 60 percent. Finally, the exchange rate stability crite- medium-term budgetary objectives and on measures the mem- rion requires that the country observe the normal fluctuation ber states intend to take toward fiscal convergence. margins of the ERM II for at least two years without devaluing. 26. On voting modalities in the Governing Council after In the ERM II, the euro is the anchor currency. Although the enlargement, see European Central Bank (2003a). standard fluctuation band for the exchange rates of the partner 27. The figures for the government-deficit-to-GDP ratio and countries is ±15 percent around the central rate, narrower the debt-to-GDP ratio were obtained from State Planning Orga- bands are possible. nization (2004). These figures have been harmonized with the 18. This section is largely based on Mottiar (1999). deficit and debt definitions of the EU. 19. This section is based mainly on the work of Gali and 28. Consideration of current account sustainability in Perotti (2003). Turkey reveals that under perfect capital mobility there will 20. ECOFIN, a formation of the Council of the European always be an unavoidable risk of speculative attacks on the Turk- Union, is made up of the ministers responsible for economic ish currency, unless the country resolves its fiscal problems, affairs and finance in the EU countries. attains price stability, achieves a sound banking sector, and 21. In late 2003, France, Portugal, and Germany faced exces- brings its real exchange rate equal to the RER's long-run equilib- sive deficit proceedings after violating the 3 percent limit for rium level. Currently, Turkey is trying hard to satisfy the first three years in a row. In January 2004, this situation culminated three conditions, but its RER is, as emphasized later in this chap- in the European Commission taking legal action against the ter, overvalued. council of finance ministers over the latter's decision to suspend 29. Ball (1994) defines trend inflation as a centered nine- the SGP. These events have led to substantial public debate on quarter moving average of the actual inflation rate. In our calcu- the effectiveness of the SGP for ensuring fiscal discipline, and lations, we start with the monthly consumer price index series on the wider issue of the optimal institutional structure for fiscal and determine the quarterly CPI series as the average of the three policy within the EU. See, for example, Fatas and others (2003). monthly CPI series. Thereafter, we determine the annual quar- 22. This section draws heavily on European Commission terly inflation rate as (p(t) - p(t - 4))100/p(t - 4), where p(t) (1998), European Parliament (1999), and Italianer (2002). denotes the CPI value during quarter t. The trend inflation is 23. At the Copenhagen summit of June 1993, the EU mem- then defined as the average of inflation rates between (t - 2) and ber states agreed that "accession will take place as soon as an (t + 2). associated country is able to assume the obligations of member- 30. We are grateful to Zafer Mustafaoglu of the SPO for ship by satisfying the economic and political conditions providing the estimates of potential output and output gap required. Membership requires that the candidate country has projections. 34 Turkey: Economic Reform and Accession to the European Union 31. Similar results were obtained by Yavuz and Çetinkaya and (2002). Q = q + L 32. As emphasized earlier, the reason for this flexibility lies in where Q denotes the growth rate of output, q the growth rate of the existence of a formidable informal sector, whose wage- labor productivity, A the growth rate of technical progress, k the setting mechanism is quite different from that of the formal growth rate of the capital-to-labor ratio, H the growth rate of sector. labor quality, L the growth rate of employment, and the out- 33. As Turkey begins to enforce the labor, tax, and social put elasticity with respect to capital. security laws within the economy, labor market flexibility will 44. See, for example, Özler and Yilmaz (2003). Yet many decrease, unless the country decreases the tax and social security economists argue to the contrary. They maintain that if trade contribution rates substantially and changes the labor law liberalization reduces the domestic market shares of domestic accordingly. producers, the incentives of those producers to invest in superior 34. For estimates of the costs of EU accession for Turkey, see technologies might decrease as protection is lifted. Furthermore, in this volume chapter 2 on agriculture, chapter 9 on labor mar- they stress that liberalization of trade under asymmetric infor- kets, and chapter 11 on the environment. mation in markets may prove fragile for developing economies. 35. A flat tax on income of 13 percent was introduced in 45. On the similarity of business cycles of countries in the Russia in 2001. The income tax revenue growth then outstripped Euro Area and the accession countries, see European Forecasting the rates of economic growth and inflation in both 2001 and Network (2003). 2002. The flat tax has also boosted the share of total tax revenue 46. Before the collapse of its currency regime in 2001, Turkey held by the personal income tax. After the adoption and success did have a regime very close to the currency board. But the sys- of the flat tax in Russia, Serbia, Slovakia, and Ukraine adopted it, tem failed, because Turkey had neither a sound fiscal framework and other countries are in the process of adopting it as well. nor a sound banking sector and had not attained price stability. 36. If tax rates are reduced and the tax system is simplified Furthermore, it did not have a graceful exit strategy. but taxes cannot be effectively enforced in the private sector, the 47. The European Monetary Union is such a symmetric country may find itself facing major revenue shortfalls. monetary union that has strict conditions on fiscal policy. The 37. During 2003, inward and outward FDI flows amounted budgetary decisions by member countries are subject to surveil- to 0.23899 percent and 0.20990 percent of GDP, respectively. lance by the EMU as a whole in the context of the requirements Thus the net FDI inflow was 0.0290946 percent of GDP. set out in the Maastricht Treaty and subsequently the Stability 38. To deal with the simultaneity problem in a simple way, a and Growth Pact. four-quarter lagged value of RER is used as the instrumental 48."Crawling pegs" refers to pegs with central parity period- variable. ically adjusted in fixed amounts at a preannounced rate or in 39. The literature basically includes two approaches to deter- response to changes in selected quantitative indicators. "Crawl- mining the long-run equilibrium value of the RER. According to ing band" refers to crawling pegs combined with bands larger Williamson (1994) andWren-Lewis and Driver (1998),the funda- than 1 percent. "Managed Floating with no Preannounced mental equilibrium exchange rate (FEER) is the real exchange rate Path for the Exchange Rate" refers to regimes in which the that would exist when the economy is at full employment (internal monetary authority intervenes in the foreign exchange market balance) and in current account equilibrium (external balance). without precommitment to a preannounced path for the Thus the FEER is the RER that will bring the current account into exchange rate. Finally, "Independent Floating" refers to regimes equality with the "sustainable" capital account, where home and in which the exchange rate is market-determined, with any foreign aggregate outputs are set at their full employment values. foreign exchange intervention aimed only at preventing exces- By contrast, the model of a behavioral equilibrium exchange rate sive volatility in the exchange rate movement. For a system of (BEER) by Clark and MacDonald (1998) analyzes the actual classification of exchange rate regimes different from that of the behavior of the RER using econometric techniques, where the IMF, see Reinhart and Rogoff (2002). reduced form equation is estimated with assumed longer-term fundamentals and short-term variables using cointegration analy- sis. MacDonald and Stein (1999) and Hinkle and Montiel (1999) References consider productivity and net foreign assets as fundamental vari- ables.Other variables identified in the literature include real inter- Assaad, R. 1997. "Explaining Informality: The Determinants of est differentials, measures of openness of trade and the exchange Compliance with Labor Market Regulations in Egypt." Paper system, and size of fiscal balance. Finally, Stein and Allen (1995) presented at the Economic Research Forum Fourth Annual distinguish between medium- and long-term factors influencing Conference, Beirut, Lebanon, September 7­9. the RER. The approach developed in this chapter can be consid- Ball, L. 1994."What Determines the Sacrifice Ratio?"In Monetary ered an extension of the FEER approach. The latter approach Policy, ed. N. G. Mankiw. Chicago: University of Chicago. requires that the NICA-to-GDP ratio be sustainable. Buiter,W. H., and C. Grafe. 2002."Anchor, Float or Abandon Ship: 40. The economic units may begin to assume they can avoid Exchange Rate Regimes for Accession Countries." Discussion the rule of law. Paper No.3184,Centre for Economic Policy Research,London. 41. Productivity is defined as GDP measured at constant Bulutay, T. 1999. "Giri¸s: Türkiye'de Azörgütlü Kesim." State prices, Q, divided by employment, L--that is, Q/L. Institute of Statistics, Ankara. 42. Letting Q stand for GDP, K for capital, L for labor, and Burnside, C., and D. Dollar. 2000. "Aid, Policies and Growth." H for the index of labor quality, total factor productivity, American Economic Review 90: 847­68. using the Cobb-Douglas production function, is defined as Castells, M., and A. Portes. 1989. "World Underneath: The Q/[K (H L)(1 -) ], where denotes the output elasticity with Origins, Dynamics, and Effects of the Informal Economy. In respect to capital. The Informal Economy, ed. A. Portes, M. Castells, and L. A. 43. Symbolically, the relations can be expressed by the Benton. 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Part II Agriculture, Manufacturing, Services, and Network Industries 37 2 Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey Sübidey Togan, Ahmet Bayener, and John Nash Integration into the European Union (EU) is one of gross domestic product (GDP), while the corre- Turkey's central foreign policy priorities.1 As a part sponding figure for the EU15 is 1.7 percent.2 of this integration, Turkey will have to adopt an Although the Turkish GDP grew at 4 percent per agricultural policy and institutional framework year over the period 1980­2003, the growth rate of compatible with the EU's Common Agricultural agriculture was only 1.1 percent per year, and it Policy (CAP) and accept the full body of the legisla- fluctuated widely over the period. As a result, the tion and policies on agriculture in the EU as it exists sector shrank as a share of the economy, from on the date of accession. For Turkey, the adoption of 25 percent in 1980 to 12 percent in 2003. The sector EU-like agricultural policies will constitute a signif- still accounts for a very large share of employment, icant modification of current policies, and such although this share has also fallen considerably. policies will have enormous implications for the Between 1980 and 2003, the number of people incomes of both farmers and the wider population. employed in agriculture fluctuated between 7.2 mil- The purpose of this chapter is to explore these lion and 9.2 million, but because of a steady increase issues of EU enlargement to Turkey. The chapter is in employment in other sectors,agriculture's share in organized as follows. The first section reviews the civilian employment dropped from 54.2 percent agricultural situation in Turkey. The second and in 1980 to 33.9 percent in 2003. third sections consider the agricultural policies in Turkey has a total land area of 78 million Turkey and in the EU, respectively, as they are now hectares (see table 2.1 for land use in Turkey). The and as they may evolve in line with changes recently total agricultural area of 39 million hectares con- proposed formally by the European Commission sists of arable land (24 million hectares), the area (the administrative arm of the EU government). used for permanent crops (2.5 million hectares), The impact of introducing the CAP is analyzed in and permanent meadows and pastures (12.7 mil- the fourth section using a partial equilibrium model lion hectares). Fallow land makes up more than of the agricultural sector. The fifth section discusses 20 percent of total arable cropland. In addition, issues related to institutional development. Conclu- Turkey has slightly more than 20 million hectares sions are presented in the final section. of forested land. The total irrigated area is about 4.5 million hectares, or 19 percent of total arable area. It is estimated that the country can potentially Agricultural Situation irrigate about 8.5 million hectares. Agriculture is an important part of the Turkish Turkey's agricultural land, exposed to both mar- economy; it contributes about 12 percent to the itime and continental weather conditions, tolerates 39 40 Turkey: Economic Reform and Accession to the European Union TABLE 2.1 Land Use in Turkey, 1995 and 2000 1995 2000 (thousand Percentage (thousand Percentage hectares) Distribution hectares) Distribution Arable land 24,373 31.5 23,826 30.8 Area sown 18,464 23.8 18,207 23.5 Vegetable gardens 785 1.0 793 1.0 Fallow land 5,124 6.6 4,826 6.2 Permanent crops 2,461 3.2 2,553 3.3 Vineyards 565 0.7 535 0.7 Orchards 1,340 1.7 1,418 1.8 Olive groves 556 0.7 600 0.8 Permanent meadows and pastures 12,659 16.3 12,671 16.4 Total agricultural land 39,493 51.0 39,050 50.4 Forests and woodland 20,199 26.1 20,703 26.7 Other land 17,271 22.3 17,210 22.2 Total land area 76,963 99.3 76,963 99.3 Total area 77,482 100 77,482 100 Source: Food and Agriculture Organization Statistical Database. TABLE 2.2 Value of Agricultural number of small farms. The 2001 census revealed Production: Turkey, 2000 that 83.4 percent of farms had less than 10 hectares of land. The average size of farm holdings was Value Percentage 6.1 hectares (see table 2.3).3 Product (US$ millions) Distribution An examination of Turkey's foreign trade in the Crops 28,163 68.48 agricultural commodities HS (Harmonized Sys- Livestock 10,600 25.77 tem) 01­24, HS 41.01­41.03, HS 51.01­51.03, and Forestry 1,101 2.68 HS 52.01­52.03 reveals that over the period Fishing 1,246 3.03 1999­2001 the average annual agricultural exports Total 41,129 100.00 amounted to US$4.06 billion, or about 14.2 percent of total exports.4 Turkey's agricultural exports to Source: Turkish State Planning Organization. the EU of $1.8 billion made up about 12 percent of its total exports to the EU. By contrast, Turkey's a wide range of crops. Climate and geography also total agricultural imports amounted on average to have an important bearing on the location and type $2.7 billion, or about 6.2 percent of total imports. of animal husbandry carried out in Turkey. Accord- Agricultural imports from the EU, valued at ing to table 2.2, which shows the value of agricul- $0.7 billion, made up about 3.2 percent of Turkey's tural production during 2000, crops account for total imports from the EU. 69 percent of production value, livestock products Table 2.4 shows that the three agricultural com- for 26 percent, forestry for 3 percent, and fishing modities with the highest shares of total agricul- products for 3 percent. tural exports were edible fruits and citrus fruits, In Turkey, the family-owned farm is the basic 28.5 percent; foods made of vegetables, fruits, and unit of agricultural production, and family mem- other plants, 13.0 percent; and processed tobacco bers provide most of the farm labor. The number and substitutes, 12.2 percent. The three agricultural and size of holdings are inferred from agricultural commodities with the highest shares of exports to censuses, which are conducted every 10 years on the EU, of total agricultural exports to the EU, were the basis of small sample surveys. The picture edible fruits and citrus fruits; foods made of vegeta- that emerges from these censuses is that of a large bles, fruits, and other plants; and processed tobacco Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 41 TABLE 2.3 Agricultural Holdings and Land Engaged in Crop Production, Turkey Average Size Holdings Total Area of Farm Size of Holdings Holdings (decares) Number Percent Decares Percent (decares) Less than 5 177,893 5.89 481,605 0.26 3 5­9 290,327 9.61 1,951,672 1.06 7 10­19 539,507 17.86 7,374,515 4.00 14 20­49 950,539 31.46 29,523,341 16.02 31 50­99 559,999 18.54 38,123,216 20.68 68 100­199 327,330 10.83 43,881,626 23.81 134 200­499 153,688 5.09 42,076,313 22.83 274 500­999 17,431 0.58 11,218,554 6.09 644 1,000­2,499 4,198 0.14 5,476,930 2.97 1,305 2,500­4,999 222 0.01 695,541 0.38 3,133 5,000 + 56 0.00 3,526,174 1.91 62,967 Total 3,021,190 100 184,329,487 100 61 Note: The figures on the number of holdings and area are from the 2001 census. Source: Turkish State Institute of Statistics. and substitutes. Yet the three agricultural com- importer of commodities such as cotton and modities with the highest shares of exports to the oilseeds, various seeds and fruits, and industrial EU, of total sectoral exports, were other animal plants. By contrast, in its trade with the EU, Turkey products, 95.3 percent; products made from meat, is a net exporter of edible fruits and citrus fruits; fish, and crustacea, 83.9; and plants and floriculture foods made of vegetables, fruits, and other plants; products, 76.1. Overall, exports of agricultural and processed tobacco and substitutes. It is a net commodities to the EU formed 44.3 percent of all importer of hides and skin, cotton, and various of Turkey's agricultural exports. foods. As for imports of agricultural commodities, the three commodities with the highest shares of total Agricultural Policies in Turkey agricultural imports were cotton, 19.0 percent; ani- mal or vegetable oils and fats,13.6 percent; and cere- The main objectives of agricultural policies in als, 12.0 percent. The three agricultural commodi- Turkey are set out in the government's five-year de- ties with the highest shares of imports from the EU, velopment plans. These objectives are to (1) ensure of total agricultural imports from the EU, were adequate levels of nutrition, (2) increase yield and cotton, hides and skin, and animal or vegetable oils output, (3) reduce the vulnerability of production and fats. Finally, the three agricultural commodities to adverse weather conditions, (4) raise levels with the highest shares of imports from the EU, of of self-sufficiency, (5) provide adequate, stable total sectoral imports, were plants and floriculture incomes for those working in the agricultural products, 89.4 percent; cereal products, wheat flour, sector, (6) increase exports, and (7) develop rural and pastries, 89.3 percent; and vegetable lacquers, areas. In pursuit of these objectives, the government resins, and balsams, 86.4 percent. Overall, imports has implemented various measures. In the crops of agricultural commodities from the EU made up sector, government interventions have primarily 25.7 percent of all agricultural imports. taken the form of price supports, augmented by Table 2.4 further reveals that Turkey is a net high tariffs. In the livestock sector, quantitative exporter of commodities such as edible fruits and restrictions and tariffs have been the main mecha- citrus fruits; foods made of vegetables, fruits, and nism used to support prices. In addition, farmers other plants; and sugar and sweets. It is a net were given input subsidies and credits to improve 42 TABLE 2.4 Exports and Imports of Agricultural Commodities: Turkey, 1999­2001 Net Exports Exports Exports Exports Imports Imports Net in Trade to EU, from from EU, Imports from Exports, with EU, Average, Average EU as a Average, Average EU as a Average Average Harmonized 1999­2001 1999­2001 Share of 1999­2001 1999­2001 Share of 1999­2001 1999­2001 System (HS) (US$ Percentage (US$ Total (US$ Percentage (US$ Total (US$ (US$ Code Description thousands) Distribution thousands) Exports thousands) Distribution thousands) Imports thousands) thousands) Live animals and animal products 01 Live animals 19,159 0.47 1,471 7.68 26,326 0.98 15,467 58.75 7,168 13,996 02 Meat and edible offal 13,916 0.34 708 5.09 418 0.02 64 15.41 13,498 643 03 Fish and sea products 54,154 1.33 38,532 71.15 22,508 0.83 12,378 54.99 31,647 26,154 04 Milk and dairy products; eggs; 35,301 0.87 6,316 17.89 30,824 1.14 20,828 67.57 4,477 14,512 honey 05 Other animal products 36,423 0.90 34,701 95.27 18,860 0.70 2,516 13.34 17,563 32,185 Vegetable products 06 Plants and floriculture products 15,262 0.38 11,613 76.09 16,203 0.60 14,490 89.43 941 2,877 07 Vegetables, plants, roots, tubers 304,529 7.50 100,117 32.88 75,451 2.80 6,605 8.75 229,079 93,512 08 Edible fruits; citrus fruits 1,159,461 28.54 743,676 64.14 57,082 2.12 6,103 10.69 1,102,379 737,573 09 Coffee, tea, spices 58,123 1.43 22,574 38.84 27,450 1.02 3,135 11.42 30,673 19,439 10 Cereals 203,561 5.01 33,582 16.50 323,726 12.00 57,506 17.76 120,165 23,923 11 Products of the milling industry 82,013 2.02 26,202 31.95 5,175 0.19 4,431 85.61 76,838 21,772 12 Oilseeds, various seeds/fruits; 52,430 1.29 28,351 54.07 233,454 8.66 31,223 13.37 181,024 2,872 industrial plants 13 Vegetable lacquers, resins, 1,341 0.03 145 10.84 14,110 0.52 12,194 86.42 12,770 12,049 balsams 14 Vegetable plaiting materials 16,471 0.41 10,819 65.68 2,695 0.10 62 2.28 13,776 10,757 Animal or vegetable oils and fats 15 Animal or vegetable oils and 241,189 5.94 81,999 34.00 366,550 13.59 74,579 20.35 125,361 7,419 fats Foodstuffs, beverages, tobacco 16 Products made from meat, 34,964 0.86 29,342 83.92 830 0.03 369 44.43 34,134 28,973 fish, crustacea 17 Sugar and sweets 258,178 6.36 25,237 9.77 14,019 0.52 9,125 65.09 244,158 16,112 18 Cocoa and cocoa products 81,023 1.99 12,256 15.13 68,351 2.53 22,007 32.20 12,672 9,751 19 Cereal products, wheat flour, 116,732 2.87 13,538 11.60 30,841 1.14 27,544 89.31 85,891 14,006 pastries 20 Foods made of vegetables, 528,298 13.00 352,375 66.70 17,542 0.65 12,057 68.73 510,757 340,319 fruits, and other plants 21 Various foods 93,845 2.31 11,226 11.96 101,011 3.75 81,416 80.60 7,165 70,190 22 Alcoholic and nonalcoholic 38,877 0.96 18,984 48.83 14,331 0.53 12,365 86.28 24,546 6,619 beverages 23 Residues of food industry; 13,271 0.33 357 2.69 167,152 6.20 17,820 10.66 153,881 17,463 fodders 24 Processed tobacco and 496,247 12.22 145,360 29.29 308,653 11.45 11,652 3.77 187,594 133,708 substitutes Hides, wool, and cotton 4101­4103 Hides and skin 21,519 0.53 209 0.97 199,473 7.40 106,243 53.26 177,954 106,035 5101­5103 Wool and animal hair 6,553 0.16 3,255 49.67 42,362 1.57 1,905 4.50 35,809 1,350 5201­5203 Cotton 79,630 1.96 46,330 58.18 511,392 18.96 129,916 25.40 431,762 83,586 Total 4,062,470 100.00 1,799,277 44.29 2,696,790 100.00 694,001 25.73 1,365,680 1,105,276 Source: The authors. 43 44 Turkey: Economic Reform and Accession to the European Union yields and income and to counterbalance the loans from the Turkish Bank of Agriculture have implicit protection given to domestic input indus- been significantly negative in real terms. In addi- tries through border measures. Finally, administra- tion, the unpaid loans of the ASCUs have been rou- tive controls have been applied to the production of tinely covered as "duty losses" of the Treasury. a few important crops. The domestic manufacturers and consumers of fertilizers have received subsidies since 1961. The subsidy was set until recently as a percentage of Output Price Supports, Input Subsidies, and Supply market price, with the percentage varying consider- Control Measures ably over the years. In 1996 and 1997, the subsidy Output price supports, input subsidies, and supply was about 40­50 percent of the market price, control measures are three important components depending on the type of fertilizer. In November of agricultural support policies. Government price 1997, the government decided to fix the fertilizer supports for most major crops (such as grains, subsidy at a nominal amount of Turkish lira (TL) oilseeds, cotton, sugar beet, tobacco, hazelnut, and per kilogram. This shift in policy has reduced the tea) have in the past been announced by decree fertilizer subsidy substantially in real terms, and each year, but this practice is changing because of inflation has eroded its value. the reform program discussed later in this section Agriculture has also received substantial subsi- on agricultural policies. Related state-owned enter- dies through irrigation projects. The Turkish gov- prises (SOEs) and agricultural sales cooperative ernment has been investing heavily in irrigation, unions (ASCUs) were commissioned to buy at the financing the associated capital investments largely announced floor prices. Crops could also be sold to through the budget. Farmers have paid no fee for independent buyers. For some crops, a system of the resource value of water they have used for irri- "deficiency payments" or premiums was intro- gation, whether privately extracted or supplied by a duced in 1993 in place of floor prices. The High public scheme, even though farmers who grew Planning Council announced a target price for crops on irrigated land did contribute to the cost of those crops as well as an intervention price, and the operating and maintaining the infrastructure. But target price moved in parallel with the world prices. even in this situation the bulk of operating and Farmers selling their crop to ASCUs or commodity maintenance costs were financed through budget exchanges received the difference between the price allocations. obtained and the target price in the form of a pay- Supply control measures, the third component of ment directly from the state-owned Turkish Bank Turkish agricultural policies, have been used to of Agriculture. The payment was then reimbursed control the fiscal cost of support policies. Tobacco, by the Treasury. The deficiency payments were hazelnuts, and tea have been under area or produc- implemented for sunflower seed, soybean, cotton, tion control. Sugar beet output has been indirectly and olive oil. Tea growers were also fully compen- controlled to some extent by the state-owned sugar sated for the costs incurred in implementing the company (S¸eker) through contracts with growers. strict pruning requirements to control supply. Tobacco farmers have received payments to com- Direct payments were, until recently, only a minor pensate for the area controls, and tea producers to part of the agricultural support system. The main compensate for lost production from pruning. types of direct payments were natural disaster Agricultural producers have also received gen- relief, the return on sugar beet pulp, deficiency eral services either free or at subsidized prices. The payments for oilseeds and cotton, and incentive measures taken to improve the production basis premiums for milk and meat. of agriculture were mainly research, training and Input subsidies are a second important compo- extension services, inspection, pest and disease nent of agricultural support policies. The most control, and land improvements (including capital important have been the credit, fertilizer, and irri- investments in small-scale irrigation works). In gation subsidies. Short-term and investment credit addition, only the large farms are required to pay for agriculture has long been subsidized by the gov- income tax. In all transactions related to agricul- ernment at interest rates well below inflation and ture, a 5 percent sales tax is applied at the point of commercial rates. The result is that interest rates on sale. Consumers have not benefited from subsidies Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 45 directly. They are protected indirectly through price with the MFN tariff rates shown in table 2.5 for the controls, market intervention, and a lower value- other agricultural commodities, reveals that the added tax on food. three sectors with the highest simple average tariff rates are meat and edible offal (HS 02), with a tariff rate of 116.52 percent; milk and dairy products Agricultural Trade Policy (HS 04), 99.60 percent; and products made from Table 2.5 shows the applied most-favored-nation meat, fish, and crustacea (HS 16), 76.90 percent. (MFN) tariff rates for the major agricultural com- The three sectors with the highest weighted average modity groups during 2002. The table reveals that tariff rates applied on imports from the EU are edi- the agricultural sector is highly protected in Turkey. ble fruits and citrus fruits (HS 08) with a tariff of The three sectors with highest simple average tariff 120.17; milk and dairy products (HS 04), 101.79; rates applied to imports from third countries are and meat and edible offal (HS 02), 71.40 percent. the products made from meat, fish, and crustacea The preferential regime applied by the EU to (HS 16) with a tariff rate of 132.70 percent; meat and imports of agricultural products originating in edible offal (HS 02), 116.52 percent; and milk and Turkey is determined by Decisions No. 1/72, 1/80, dairy products (HS 04), 105.20 percent. The three and 1/98 of the EC­Turkey Association Councils of sectors with the highest weighted average tariff 1972, 1980, and 1998, respectively. Under these rates applied to imports from third countries are decisions, almost all of the agricultural commodi- products made from meat, fish, and crustacea (HS ties originating in Turkey are imported by the 16) with a tariff rate of 124.08 percent; sugar and European Community free from ad valorem duties, sweets (HS 17), 124.08 percent; and edible fruits and the EU applies tariff quotas only for a relatively and citrus fruits (HS 08), 120.17 percent. The table small number of commodities (see chapter annex also reveals that Turkey, upon becoming a member tables 2.17 and 2.18). These tables reveal that those of the EU, could have to change its tariff schedule commodities made up about 30 percent of Turkish on agricultural commodities substantially. To align exports to the EU during 1999. In addition, the EU its tariff schedule with the current EU schedule, applies an entry price system for about 30 fruits and Turkey would have to increase its tariffs on cereals; vegetables such as tomatoes, artichokes, courgettes, processed tobacco and substitutes; residues of the tangerines, lemons, and apples. For these com- food industry and fodders; alcoholic and nonalco- modities, specific duties are applied as long as the holic beverages; vegetable lacquers, resins, and bal- value of consignment falls below the entry price. sams; cotton; and vegetable plaiting materials. In all These commodities, shown in annex table 2.19, other categories, Turkey would have to decrease its made up about 4.8 percent of Turkish agricultural tariff rates. exports to the EU during 1999. As for the market access conditions for agricul- Finally, a sanitary ban on the import of livestock tural commodities imported from the EU, the pref- and meat products has remained in place. Export erential regime applied by Turkey to imports of subsidies, applied to a number of products and agricultural products originating in the EU is limited to a maximum of between 10 percent and determined by Decision No. 1/98 of the EC­Turkey 20 percent of the export values and between 29 per- Association Council of 1998. Under this decision, cent and 100 percent of the quantities exported, Turkey must grant a large number of commodities have continued for processed fruits and vegetables, duty-free access to the Turkish market up to the fruit juices, olive oil, potatoes, apples, poultry meat, quota limits specified in the decision. A look at the and eggs. quota levels and trade data for the agricultural The considerations just described reveal that commodities specified in Decision No. 1/98 of the substantial border measures still affect trade be- EC­Turkey Association Council reveals that for tween the EU and Turkey and that the external most of the commodities the quota limits have tariffs applied by the EU and Turkey to third coun- been exceeded. Thus "out of quota" tariff rates are, tries' imports differ significantly. Completion of the in general, applicable to imports of these com- customs union between the EU and Turkey to cover modities from the EU. Consideration of the "out of agricultural products implies the abolition of all quota" tariff rates for these commodities, together border measures and the adoption of the EU external 46 TABLE 2.5 Most-Favored-Nation Tariff Rates of EU and Turkey, 2002 Tariff Rates Tariff Rates Tariff Rates Tariff Rates Tariff Rates Tariff Rates Applied by EU Applied by Turkey Applied by EU Applied by Turkey Number of Applied by Turkey Applied by Turkey to Imports from to Imports from to Imports from to Imports from HS Tariff to Imports from to Imports from Third Countries Third Countries Third Countries Third Countries Code Description Lines EU (simple) EU (weighted) (simple) (simple) (weighted) (weighted) Live animals and animal products 01 Live animals 27 27.85 1.72 19.72 27.85 56.69 1.72 02 Meat and edible offal 10 116.52 71.40 55.89 116.52 68.55 71.40 03 Fish and sea products 89 38.90 19.61 11.39 78.30 11.61 37.60 04 Milk and dairy products; 72 99.60 101.79 55.16 105.20 69.17 103.22 eggs; honey 05 Other animal products 30 2.50 7.00 0.35 2.80 0.11 7.09 Vegetable products 06 Plants and floriculture 37 17.90 7.49 9.25 18.50 12.90 8.46 products 07 Vegetables, plants, roots, 78 22.20 20.44 13.30 22.30 13.80 20.44 tubers 08 Edible fruits; citrus fruits 93 48.10 120.17 8.56 48.10 12.15 120.17 09 Coffee, tea, spices 45 37.70 46.13 6.11 38.00 4.32 47.27 10 Cereals 39 25.60 16.97 66.35 25.70 79.15 16.97 11 Products of the milling 40 36.30 28.86 35.87 36.70 44.47 29.65 industry 12 Oilseeds, various seeds/ 88 16.40 5.29 3.65 17.20 0.98 5.55 fruits; industrial plants 13 Vegetable lacquers, resins, 29 1.40 1.54 2.88 2.60 2.76 2.06 balsams 14 Vegetable plaiting materials 14 0.00 0.00 0.10 0.00 0.01 0.00 Animal or vegetable oils and fats 15 Animal or vegetable oils 107 18.10 17.74 15.49 20.20 22.90 17.86 and fats Foodstuffs, beverages, tobacco 16 Products made from meat, 39 76.90 65.27 21.32 132.70 22.79 124.08 fish, crustacea 17 Sugar and sweets 53 58.90 63.18 22.79 79.70 48.46 124.08 18 Cocoa and cocoa products 24 38.60 22.38 7.12 99.30 3.06 51.11 19 Cereal products, wheat 66 58.20 54.45 26.05 83.90 22.88 78.96 floor, pastries 20 Foods made of vegetables, 173 58.50 62.41 25.47 60.80 27.59 73.92 fruits, and other plants 21 Various foods 54 25.20 28.64 13.42 42.02 15.89 42.37 22 Alcoholic and nonalcoholic 41 11.90 2.01 22.52 17.04 13.87 6.27 beverages 23 Residues of food industry; 49 6.30 1.12 18.03 7.81 26.96 2.84 fodders 24 Processed tobacco and 17 14.70 0.22 51.55 33.78 51.01 23.98 substitutes Hides, wool and cotton 4101­4103 Hides and skin 44 0.00 0.00 0.00 0.00 0.00 0.00 5101­5103 Wool and animal hair 36 0.00 0.00 0.00 0.00 0.00 0.00 5201­5203 Cotton 15 0.00 0.00 0.18 0.00 0.01 0.00 Source: The authors. 47 48 Turkey: Economic Reform and Accession to the European Union tariff applied to third countries.5 As a result, the · To privatize most state enterprises in agriculture prices of agricultural products for which border and to turn the agricultural sales cooperative measures still exist would become much closer in unions (ASCU) into true private sector unions the EU and Turkey, with the remaining differences of producer-owned cooperatives in order to due to quality and to transportation and marketing reduce government involvement in the market- costs. Such a development would, however, require ing and processing of agricultural products. that the parties harmonize their agricultural price · To introduce a unified national program of policies. direct income support (DIS). These reforms are intended to increase the efficiency of the agri- cultural sector and thereby help Turkey meet the Agricultural Reform Implementation Project preconditions for accession to the EU. The overly generous system of agricultural support policies pursued until the late 1990s was fiscally Implementation of ARIP began in 2000 with a expensive and unsustainable, and they encouraged pilot program of income support payments applied waste and abuse (World Bank 2000). They did not to four regions. An important part of the pilot pro- provide a cost-effective way for addressing policy gram was preparation of a farm registry and testing objectives such as alleviation of rural poverty and of the eligibility conditions. All agricultural land regional development, and the "duty loss" system users received $50 per hectare of agricultural land, of administration burdened the Treasury with up to a maximum of 20 hectares per farmer. The enormous debts. There were other problems as program was extended nationwide in 2001­02. well. Support and administered prices were Table 2.6 shows the intervention prices and direct announced only after key production decisions had payments for selected commodities over the period been made, and payments were delayed by inter- 1998­2002. The table reveals how the government vention agencies. These problems confirm the dif- has tried to compensate for the drop in interven- ficulties inherent in trying to administer outcomes tion prices with increases in direct payments. in a dynamic, complex market. Neither the overall The intention of direct income support is not to demand-supply balance nor the equilibrium in the fully compensate every farmer for income lost by very complex intertemporal, spatial, and quality removal of the old subsidy system, but rather to dimensions could be achieved. The Turkish gov- cushion the blow and continue to provide adequate ernment recently tried to replicate the market by support to the agricultural sector in an incentive- establishing more quality-differentiated prices. But neutral way. Within the existing legal framework, success in duplicating the price flexibility of freely the DIS payments should be usable as collateral, functioning commodities market was limited. thereby giving farmers enhanced access to credit. In the late 1990s, Turkey decided to reform its Payments under the DIS system will be ongoing but agricultural policies. Beginning in late 1999, with should become more explicitly targeted or merged support from the International Monetary Fund with the general social safety net system. Thus DIS (IMF) and the World Bank, the government devel- allows the government to disengage from its current oped the Agricultural Reform Implementation support mechanism in a politically acceptable and Project (ARIP) to phase out current production- and humane way. The government is also easing the input-oriented support and replace it with area- transition for growers of certain crops that were based income support payments during the 2001­04 grossly overproduced (i.e., tobacco and hazelnut) period.ARIP was intended to achieve following: by making onetime payments to farmers to cover their cost of switching to alternative activities. This · To phase out the unsustainable and distor- program is distinct from, and in addition to, DIS. tionary system of subsidies for fertilizer--credit After the policy change, the fertilizer subsidy and price supports that disproportionately ben- decreased from 31 percent in 1999 to almost 20 per- efited large farmers, placed a regressive tax on centbytheendof 2000,anditwasphasedoutin2002. consumers, and cost about $5 billion a year. By 2002, credit subsidies channeled through Ziraat ARIP was determined to link domestic prices to Bank, as well as most other input subsidies, were also world prices. phased out. In addition, price supports for grains Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 49 TABLE 2.6 Agricultural Supports: Turkey, 1998­2002 (US$ millions) 1998 1999 2000 2001 2002 Market price support Cereals 425.8 356.7 183.0 27.8 0.0 Tobacco 276.9 146.6 81.8 43.3 26.7 Sugar beet 245.2 141.6 70.5 40.1 0.0 Payments based on inputs used Fertilizer 476.7 238.6 153.4 60.5 0.0 Pesticides 33.0 24.7 19.2 14.7 0.0 Seed 6.6 3.4 4.6 0.8 0.0 Development of animal husbandry 0.0 0.0 19.2 31.9 50.1a Incentive premiums Milk 31.5 25.6 19.2 9.8 0.0 Compensation payment Tea 13.8 7.1 25.2 22.1 26.7 Natural disaster relief 29.7 37.2 22.4 0.0 0.0 Credit subsidy 1,663.2 1,675.3 562.7 274.8 0.0 Deficiency payments 0.0 265.8 298.2 280.5 145.1 Direct income support 0.0 0.0 0.0 68.1 1,159.0 Total 3,202.4 2,922.6 1,459.6 874.4 1,357.5 a. The figure includes the milk premium. Source: Turkish Ministry of Agriculture and Rural Affairs. were reduced, with the aim of eliminating the sup- 2002. Payments based on input use are the other ports completely by 2002.Even though grain support category of support to producers. This category as a priceswerenotannouncedbyadecreebythegovern- share of total support decreased from 22 percent in ment in 2002, the Turkish Grain Board (TMO) 1999 to 8 percent in 2001, and further to 2 percent announced its purchasing prices based on produc- in 2002. By contrast, the total transfers to the agri- tion,its stocks,and expected market conditions. cultural sector measured by the total support esti- mate (TSE) amounted to $13.84 billion in 1998 Estimates of Support in Agriculture (6.9 percent of GDP) and $12.1 billion in 1999 (6.6 percent of GDP). The TSE decreased to Agricultural production in Turkey is protected. $5.4 billion (3.6 percent of GDP) in 2001, but According to the official estimates of the Organisa- increased again to $7.7 billion (4.1 percent of GDP) tion for Economic Co-operation and Development in 2002. At the same time, the corresponding fig- (OECD), total transfers from consumers and ures for all OECD countries fell from 1.39 percent taxpayers to agricultural producers, as measured by of GDP in 1998 and 1999 to 1.2 percent in 2002. the producer support estimate (PSE), amounted to The TSE for the EU fell from 1.52 percent of GDP a peak of $9.955 billion in 1998 (almost 25 percent in 1999 to 1.3 percent in 2002. Over the same of producers' receipts) and fell slightly to $6.8 bil- period, the PSE in the EU, as a percentage of pro- lion (21 percent) in 2000. As a result of the reform ducers' receipts, fell from 43 percent to 36 percent. efforts, the PSE decreased to $2.251 billion (10 per- cent) in 2001, but increased to $6.1 billion (23 per- The Common Agricultural cent) in 2002. According to the OECD (2003a), Policy of the EU market price support remained the most important type of support, for a share of 69 percent of total The Common Agricultural Policy (CAP) of the support to producers in 2001 and 75 percent in European Union, which was set up against the 50 Turkey: Economic Reform and Accession to the European Union backdrop of the food shortages and rations that role in setting prices and allow prices to be closely followed World War II, had five founding aims: linked to world prices, while compensating farmers (1) higher productivity, (2) a fair standard of living for income losses with area-based direct payments for farmers, (3) stable markets, (4) regular food that would not be linked to output or input use. supplies, and (5) reasonable prices for consumers. Under the Agenda 2000 agreement, some interven- It was based on the principles of a single market in tion prices were set at levels so low that they would farm products with common prices and the free be binding only in years of very low world prices, movement of agricultural goods within the com- and other intervention prices were reduced greatly, munity, preference for community members, and with producers compensated by direct income sup- shared costs. Its main mechanisms were support port payments. The agreement represented a signif- prices set above world price levels and the use of icant shift from price supports to direct payments, import taxes, nontariff barriers to imports, and and it helped to reduce the economic distortions of export subsidies to maintain the higher internal the CAP. It will go some way toward helping agri- prices. As production responded to higher prices, culture to meet the challenges of further trade lib- surpluses became chronic and increasingly expen- eralization and enable the formulation of an inte- sive. As a result, the CAP has been subjected to var- grated EU rural development policy that shifts the ious reforms. In particular, production has been emphasis from production support to environmen- artificially constrained by mechanisms such as milk tal and rural economy measures in the future. But, quotas and compulsory set-asides for arable crops; as described in the rest of this section, further prices have been cut, and producers have normally reforms also are under way. been given direct payments in compensation; and more emphasis has been put on rural development and encouraging farmers to look to markets and Common Organization of Market diversified forms of income to reduce their depend- Within the CAP framework, the Common Organi- ence on subsidies. zation of Market (COM) is the basic instrument The CAP is financed by the European Agricul- used to manage agricultural production and to sta- tural Guidance and Guarantee Fund (EAGGF), bilize markets in accord with the declared objec- which is an integral part of the EU's budget. In the 2003 EU budget of 99.69 billion, appropriations tives of the CAP. COMs, which were introduced for the EAGGF accounted for about 44.78 billion. gradually, now cover most EU agricultural prod- ucts, accounting for 90 percent of the final agricul- In addition to budget costs, the CAP imposes a cost tural output of the European Community. The on EU consumers through higher food costs. The essential features of the current CAP under Agenda additional cost to consumers varies according to 2000 reform is summarized in the following sections movements in world prices, but in 2003 it was esti- mated by the OECD at about 55.5 billion. (see Europarl 2002 and Csaki and others 2002). In the EU, like in Turkey, it eventually became clear that price supports, import tariffs and nontar- COM for Cereals In the past, at the core of the iff barriers, export subsidies, and the other govern- COM for cereals was a state intervention system ment interventions required by the CAP were creat- based on guaranteed prices, but after the 1993/94 ing unsustainable pressures on the EU budget and marketing year, compensation payments per friction in international trade relations. Further- hectare became the main mechanism.6 The inter- more, they were not achieving the social objectives vention price was set at a very low level to serve as of environmental preservation and equity. The EU only a safety net in years of extremely low world therefore embarked on a far-reaching reform pro- prices. It was 101.31 per metric ton from the gram for CAP that is still under way. The reform 2001/02 marketing year, and it would decline fur- began with the McSharry reforms of 1992 and was ther, to a little over 90 per metric ton under the accelerated with the Agenda 2000 agreement, which CAP Mid-term Review proposals described later in was approved at the Berlin Council in March 1999. this chapter. This intervention price applies to a The underlying principle of the reform was the predefined "standard quality" that meets the regu- same as that of ARIP: to minimize the government's lations on moisture content and specific weight. Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 51 Direct area payments to cereal producers, set in Organization (WTO), the EU can levy an import euros per metric ton, were introduced to compen- duty on cereal imports from third countries, which sate farmers for reductions in price supports. To is payable by the European Community importer. receive such compensation, farmers must withdraw Within the limit of the agreement, the duty cannot 10 percent of their land from production. Small exceed the intervention price, increased by 55 per- farmers with a total output of less than 92 metric cent less the representative CIF (cost, insurance, tons are exempt from set-aside as a compulsory freight) price. Under these rules, the EU is allowed requirement to receive compensation payments. to vary the tariffs for cereals over time. For the 2001/02 marketing year, these direct pay- ments were fixed at 63 per metric ton of the his- COM for Oilseeds The McSharry reforms torical yield. For durum wheat, the supplementary removed the system of institutional prices for direct area­based income payment per hectare oilseeds (i.e., rapeseed, sunflowers, and soybeans), amounts to 344.5 in traditional areas (traditional but since the 1993/94 marketing year their produc- durum wheat aid) and 138.9 in other areas (well- ers also qualify for compensatory payments.11 established durum wheat aid). These payments are aligned with the one applicable To apply for direct area payments, each member for cereals (63 per metric ton of reference yield state must draw up a regionalization plan by taking since 2002). The area grown with oilseeds is taken into account specific factors that influence yields into account in determining the individual farmer's such as soil fertility. The area concerned must not set-aside obligation as described under the regula- exceed the region's "base area"--that is, the average tions for cereals. As a prerequisite for the imposi- number of hectares in the region allocated to grow- tion of specific oilseed production provisions, pro- ing crops or set aside within the context of the pub- duction area constraints for the member countries lic assistance scheme in 1989, 1990, and 1991.7 If have been implemented under the Blair House the total eligible claims exceed the base area, then agreement. This agreement includes a system of all claims are reduced proportionately. Article 9 of reduced aids for regions where the predetermined Council Regulation No. 1251/1999 states that the agricultural area is exceeded. For nonedible oilseeds base areas of future member states will be estab- for industrial use, specific regulations apply and lished by the European Commission. Finally, aid for require that set-aside areas, for example, be planted the production of "traditional durum wheat" is with several oil-bearing crops for industrial pur- limited to certain regions that are mentioned in poses. Currently, there is no regulatory levy on Annex II to Council Regulation No. 1251/1999, and imports, and the Common Customs Tariff rates per member state a maximum area that may be eli- apply. gible for the "traditional durum wheat aid" is fixed in Annex III of that regulation.8 COM for Sugar Beet The EU sugar market is According to Article 3 of Council Regulation highly protected.12 Besides protection at the border, No. 1252/1999, the historical reference yield for the CAP on sugar is implemented through a mar- cereals should be the average of the median three keting quota system. Sugar beet quotas are allo- years of the five-year period 1986/87­1990/91.9 For cated to and administered through sugar refineries maize, a specific yield can be set, possibly distin- on the basis of equity shares. The intervention price guishing between irrigated and nonirrigated areas. for refined beet sugar is set, since the 1998/99 mar- In the areas thus defined, per hectare payments are keting year, at 631.9 per metric ton for white sugar calculated by multiplying the basic amount per and 523.7 per metric ton for raw sugar in order to metric ton by the historical average cereal yield for guarantee a basic price for sugar beet of 47.67 per the area. Article 7 of Council Regulation No. 1252/ metric ton. Intervention is provided for limited 1999 states that applications for payments may not quantities corresponding to a production quota for be made for land that on December 31, 1991, was which there is an almost total guarantee (quota A) under permanent pasture, permanent crops, or and a quota with a partially guaranteed price trees, or was used for nonagricultural purposes.10 (quota B). For net importers, quota A equals net As for import duties, export taxes, and export production, and quota B equals 10 percent of quota refunds, under commitments to the World Trade A. For net exporters, quota A equals that part of net 52 Turkey: Economic Reform and Accession to the European Union production consumed domestically, and quota B and processors. The aid level is fixed per hectare of equals net exports. The EU insists that the total of specialized area harvested, on the basis of the aver- quotas A and B should not exceed internal con- age yield per hectare of the area concerned. sumption plus the quantity that can be exported within the limits of the WTO commitments. Fur- COM for the Wine-Growing Sector The com- thermore, the COM is based on a system of sugar mon market organization for wine (Council Regu- and isoglucose production levies to cover the cost lation No. 1493/1999) aims to maintain a balance of storage and production refunds for the manu- between supply and demand in the European Com- facture of certain chemical products. The regula- munity market, thereby giving producers a chance tions are complemented with import tariffs and to bring production into line with market develop- warrants of export refunds. Agricultural areas ments and to allow the sector to become competi- planted with sugar beets are not eligible for com- tive. This goal is pursued by financing the restruc- pensatory area payments and are not subject to set- turing of a large portion of the present vineyards, aside obligations. and it should give rise to products in demand at home and abroad. The Common Customs Tariff COM for Fruits and Vegetables In late July 1996, rates apply to imports of wine into the European the European Council reached a political agreement Community. To prevent imports from having to reform the fresh and processed fruit and vegetable adverse effects, and subject to compliance with the sector.13 The reform was intended to improve the rules of the WTO, an additional import duty may organization of supply by strengthening producer be imposed. organizations (POs), tightening up the criteria for recognizing POs, and setting up an operation fund COM for Milk and Dairy Products The market co-financed by the EU for promotion and quality for milk and dairy products is one of the most campaigns and the cessation of farming operations important (about 18 percent of the total value of that are not covered by European Community com- agricultural production) and most regulated mar- pensation schemes, which, with this reform, will kets in the EU.14 The current market regime com- provide on-retributive compensation--that is, they prises the target price for milk (2000­05, 309.80 will not encourage production. Based on the first per metric ton), intervention price for butter year's experience, some rules were modified in 2001 (2000­05, 3282.00 per metric ton), interven- to simplify the regime, to make it more flexible, and tion price for skimmed milk powder (2000­05, to increase producer responsibility. 2,055.20 per metric ton), a producer quota sys- EU-wide aid schemes are in place to assist pro- tem, support of prices by the imposition of tariffs ducer organizations supplying tomatoes, peaches, on dairy products, warrant of export subsidies, the pears, and citrus fruits. This aid is granted for the guaranteed purchase and storage of butter and fresh produce delivered during prescribed periods. skimmed milk powder through intervention agen- Aid is paid to recognized producer organizations, cies, and a milk quota system introduced in 1984 which then pay out to the growers. Delivery (117.49 million metric tons, EU total). Farmers to approved processors is based on contracts who exceed this reference amount of their quota specifying the quantities they cover, the price, are subject to a payable levy. Since 1998, milk quo- and the schedule of supply. These contracts require tas have been transferable from one individual to the processor to process the products delivered. another within one EU member state through sale, The minimum characteristics of the raw material lease, or inheritance. Also related to these measures supplied for processing and the minimum quality are a public intervention scheme, private storage, requirements for the finished products are defined. production aids for using milk in animal feedstuffs Annual EU thresholds have been established to and processing milk into casein, special measures to limit the total volume of aid, and there are penalties reduce stocks, and some aids for reducing or ceas- for overrunning thresholds. Aid per hectare is avail- ing production. Import levies and export refunds able to growers of grapes for use as dried muscatel are also applied. grapes, sultanas, and currants, within a maximum From 2005 on, intervention prices for butter and guaranteed area. Contracts must be concluded skimmed milk powder will be reduced by 15 per- between the producer or producer organizations cent in three equal steps of 5 percent each. In the Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 53 final stages of reform, they will amount to July 2002 by a basic price for storage, fixed at 2,224 2,789.70 per metric ton and 1,746.90 per metric per metric ton. The payment for private storage is ton, respectively. According to the EU's impact granted when the average Community market price analyses, these changes will put the intervention level is less than 103 percent of the basic price. As of price after 2007 below the expected world price lev- July 2002, producers also could benefit from a safety els. Benefits for farmers will be provided by three net intervention system. When the average market complementary measures: (1) increasing available price for bulls or steers in a member state falls to less milk quotas by 1.5 percent in three equal steps over than 1,560 per metric ton of carcass weight, the three years in parallel with the price reductions EU buys beef into intervention stores. starting in 2005, (2) retaining a crop premium for Since 2002, steer and bull premiums have been silage cereals, and (3) implementing a new yearly set at 150 and 210 per head, and the premium for payment for dairy cows. The payment for dairy suckler cows at 200 per year.Although the bull pre- cows is to be paid on a flat rate basis per metric ton mium is paid once a lifetime for bulls older than of the quota held in the 1999/2000 marketing year nine months or at a minimum carcass weight of and amounting to 17.24 per metric ton in the 185 kilograms, the steer premiums are paid twice a final stages of reform. lifetime, at the age of 9 months and after 21 months. On June 26, 2003, EU farm ministers adopted a The suckler cow premium is granted per calendar fundamental reform of the CAP. With the reform, year and per holding within the limits of regional the intervention price for butter will be reduced by ceilings for not more than 90 animals. These premi- 25 percent over four years, which is an additional ums are granted provided that the stocking density price cut of 10 percent compared with that of on the holding is not more than two livestock units Agenda 2000 reforms. per unit of forage area used for these animals. In addition to these premiums, a slaughter premium COM for Beef and Veal In 1999 the beef support applicable at slaughter or export to a third country "regime" was altered significantly as part of the of 80 has been introduced for bulls, steers, suckler Agenda 2000 CAP reform process; the practice of cows, and heifers over the age of eight months, and EU-subsidized purchases of surplus beef from the of 50 for calves more than one and less than seven market (intervention buying) was reduced to a min- months in age (with an upper limit of 160 kilo- imal"safety net."In return for this reduction in mar- grams).15 The slaughter premium is paid directly to ket price support, farmers received direct aid in the the farmer, provided that the eligible animals have form of premiums based on the number of cattle been held for a minimum period of two months. they held in a reference period. Extensive production (stocking density less than Direct aid includes various types of direct 1.4 livestock units per hectare) may qualify for an farmer support measures (Council Regulation [EC] additional payment of 100 per premium granted.16 No. 1254/1999 and Commission Regulation [EC] The reform of the CAP agreed to in June 2003 No. 2342/1999). They are designed to compensate changes the way the EU supports its farm sector. In for the reductions in the intervention price January 1, 2005, a single-payment scheme replaced (slaughtering premium and the special beef pre- most of the direct aid payments currently offered to mium), support the incomes of producers who are farmers, and it is not linked to what a farmer specialized in beef production (suckler cow produces. The amount of the payment is calculated premium), encourage producers to undertake on the basis of the direct aids a farmer received in a extensive farming (extensification payment), assist reference period (2000­02). Member states may producers in less favored areas or in member states delay implementation of this scheme up to 2007,but highly specialized in beef production (additional by 2007, at the latest, all member states must have at suckler cow premium), balance the market least introduced the scheme. Full decoupling is the throughout the year (deseasonalization premium), general principle from 2005 onward. However, and permit member states to support specific pro- member states may decide to partially implement duction systems (national expenditure envelopes). the single-payment scheme and grant additional The intervention price was set for the 2001/02 payment to the beef producers by way of choosing marketing year at 3,013 per metric ton of carcass from the options for partial decoupling of direct weight (for R3 classification) and was replaced in payments. Under such partial decoupling, member 54 Turkey: Economic Reform and Accession to the European Union states may opt to keep up to 100 percent of the Mid-term Review of the CAP in January. The thrust slaughter premium for calves. However, member of the reforms is to continue to reduce the reliance of states may also opt to keep up to 100 percent of the theCAPonmarket-distortingmeasuressuchasprice suckler cow premium and up to 40 percent of the supports and to channel more of the support given to slaughter premium for calves coupled.Alternatively, farmers through payments linked to environmental, they could keep up to 100 percent of the slaughter food safety, general rural development, and animal premium coupled or,instead,up to 75 percent of the welfare objectives (i.e., to receive direct income pay- special male premium. ments, farmers would have to comply with the con- The relatively high internal price supports are ditions tied to these objectives). The catchphrase for complemented by measures affecting imports of this refocusing of the mechanisms of support is beef and veal to the EU and by refunds on EU "support for producers, not for production." The exports to third countries.A basic import tariff (less reform program is supposed to be budget-neutral. than 20 percent for most beef products) and an The key elements of the reforms are as follows:18 additional variable levy (ranging from 180 to 390 percent) are imposed. Exports are subsidized, and · Most support will take the form of a single the refunds are set by the European Commission, decoupled farm payment for EU farmers, inde- depending on world market conditions, the present pendent from production, with member states and anticipated condition of the EU market, and allowed to maintain limited coupled elements the competitive environment in third-country mar- (up to 25 percent of the value of current pay- kets. Under the WTO Uruguay Round agreement, ments) to avoid abandonment of production. these levels are to be reduced in the future. · This payment will be linked to the respect for environmental, food safety, animal and plant COM for Ovine Meat This COM comprises a health, and animal welfare standards, as well safety net intervention system and a direct payment as to the requirement to keep all farmland in for ewes of 21 (16.8 for female goats and for good agricultural and environmental condition ewes kept for milk production) per head and year ("cross-compliance"). since 2002.17 Each member state has an upper limit · There will be a strengthened rural development on the number of animals eligible for direct pay- policy with more EU money and new measures ment for ewes. to promote the environment, quality, and The reform of the CAP agreed to in June 2003 animal welfare and to help farmers meet EU means that this simplified premium system will be production standards starting in 2005. incorporated into a new support structure. Full · Direct payments for bigger farms will be reduced decoupling will be the general principle from 2005 ("modulation") to finance the new rural devel- onward. However, member states may decide to opment policy. maintain a proportion of direct aids to farmers in · A mechanism will be implemented for financial their existing forms, notably where the states discipline to ensure that the farm budget fixed believe agricultural markets may be disturbed or until 2013 is not exceeded. production may be abandoned because of the move · Specific revisions to the market policy of the to the single-payment scheme. Fifty percent of the CAP include: sheep and goat premiums under the 2001 system -- Making asymmetric price cuts in the milk sec- can continue to be granted as coupled payments. tor, with the intervention price for butter Future Evolution of the CAP reduced, as noted earlier, by 25 percent over fouryears.Forskimmedmilkpowder, a15per- Although the Agenda 2000 reforms made the CAP cent reduction over three years,as agreed on in much more efficient, it is recognized that the budg- Agenda 2000,is retained. etary pressures of accession and international trade -- Reducing the monthly increments in the obligations will require further reform in the same cereals sector by half while maintaining the direction. current intervention price. Reforms from the Mid-term Review and Future -- Implementing reforms in the rice, durum Directions In June 2003, the EU endorsed a series wheat, nuts, starch potatoes, and dried fodder of additional reforms that had been proposed in the sectors. Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 55 According to the Mid-term Review, the reforms European countries would have for an unreformed have the following objectives: CAP--the reforms would have other salutary effects outside the EU. Most important, they will · First, enhance the competitiveness of EU agricul- reduce the need to rely on export subsidies to dis- ture by setting intervention as a real safety net pose of surplus production, and they will provide measure, allowing EU producers to respond to an alternative way to support farmers' incomes market signals (i.e., world prices), while protect- without high domestic prices. Thus the reforms ing them from extreme price fluctuations. The will increase the EU's flexibility to agree in the reforms as adopted by the member states did not Doha negotiations to phase out export subsidies go as far as was proposed in the Mid-term Review, and increase market access (i.e., to reduce tariffs which had included further reduction in the sup- and nontariff barriers). This point is important, port price for cereals, but they still represented because the EU is almost alone in its position-- progress toward this goal. maintained throughout the WTO's Cancun minis- · Second, promote market-oriented, sustainable terial meeting in September 2003--that export agriculture by completing the shift from product subsidies should not be phased out (only reduced) to producer support with the introduction of a under the Doha Round agreement. Most other decoupled system of payments per farm,based on WTO members interpret the Doha Declaration's historical references and conditional upon cross- wording that export subsidies would be reduced compliancetoenvironmental,animalwelfare,and "with a view to eliminating" them as meaning that food quality criteria.Again, the Mid-term Review the eventual agreement will require that these sub- proposal was more ambitious than the program sidies eventually be totally eliminated. actually adopted, because it will allow member Although the magnitudes have not been esti- states to pay up to 25 percent of support (or more mated definitively, the reform process would also for durum wheat and certain kinds of beef pay- lead to some direct improvements in international ments) as coupled payments if necessary to avoid market conditions for developing country (and abandonment of production. It is expected, how- other) producers. The European Commission's ever,that few states will use this exception. simulations estimate that by 2009­10 EU exports of · Third, strengthen rural development by transfer- cereals will fall by 3.8 percent and exports of beef ring funds from the first pillar (payments to by 60 percent. Eurocare estimates that the EU will producers) to the second pillar (funding to become a net importer of beef. Other simulations promote rural development) of the CAP. This indicate an effect on world cereal prices of 2 per- transfer process is known as "dynamic modula- cent or less, although, because it would entail a tion." Payments under the second pillar will be move from a very trade-distorting mechanism increased to 30 percent of the CAP budget from of support to one with relatively small trade- its current 10 percent. Because small farmers distorting effects,19 there is some reason to think will be exempt from modulation, it would affect that the impact may be more substantial. 25 percent of farmers, who now receive about 80 percent of the direct payments. Funds saved Beyond the Mid-term Review The adoption of by "modulation" will be redistributed to the the proposals in the Mid-term Review would member states based on several criteria, and the essentially decouple payments from production in southern states are expected to be the net gain- the grain and oilseed markets and partially decou- ers. The reform will also expand the scope of the ple them in beef, but some important sectors are currently available instruments for rural devel- not touched by the reforms, including sugar and opment to promote food quality, meet higher tobacco. The same motivations for reform are standards, and foster animal welfare. present in these sectors, and other pressures will be operating to ensure that these sectors also are Although this reform process is being eventually reformed, using much the same model driven largely by the internal needs of the EU-- used for grains and oilseeds. One of these motiva- particularly the need to simplify the CAP and tions is the Doha negotiations. As noted, the EU control the potentially explosive budgetary impli- will be under tremendous pressure to agree to the cations that accession of the Central and Eastern elimination of export subsidies. Another very 56 Turkey: Economic Reform and Accession to the European Union important motivation--especially for sugar--is · Cotton. Sixty percent of the current coupled pay- the "Everything but Arms" (EBA) initiative. Under ments would be converted into single-farm pay- the EBA, the EU has eliminated tariff and nontariff ments. The other 40 percent would be retained barriers20 to the imports of all products from the as an area-based payment, based on cotton hec- developing countries. For most products, this sys- tarage. Thus this 40 percent would remain fully tem has been in effect since 2001, but for rice, coupled, though based on area rather than pro- bananas, and sugar there are phase-in periods. For duction. The new area payment would be given sugar, the phase-in period is until 2009, but after for a maximum number of hectares, but admin- 2009 sugar will enter the EU duty- and quota-free istered in the same way as current blue box from developing countries, clearly ending the measures, with area ceilings set on a regional sugar regime under the CAP. Before the regime basis and any excess in the region resulting in a ends, sugar prices in the EU will have to fall to reduction in payments to all farmers in the something much closer to world prices, and pro- region.21 This situation implies that the measure ducers may have to be brought under the direct may not be very effective in controlling the area payment system. The EU is also currently negotiat- planted, because farmers have little incentive to ing Economic Partnership Agreements with many stay below the ceiling. other developing countries. Although it is not clear · Sugar. There is no specific proposal but rather what form these agreements will take, the basic two options: (1) relatively small changes in the intention is that essentially they will be reciprocal current system, or (2) radical reform, with free trade agreements. Such agreements will put domestic prices lowered to world market levels even more pressure on the CAP to complete the and direct support payments increased in com- transition to a regime of very low import barriers pensation. In view of the pressures facing the for products that can be produced in developing CAP sugar regime, it seems likely that some- countries and a regime in which farmers are com- thing close to the second option will have to be pensated for income losses by decoupled direct adopted. payments. In September 2003, the European Commission Impact of Introducing the Common tabled its proposal for reforms in the cotton, Agricultural Policy in Turkey tobacco, sugar, and olive oil sectors. The main fea- tures of the proposals are the following: This section employs a partial equilibrium model of the Turkish agricultural sector to simulate the · Tobacco. The production-coupled premium on effects of introducing the CAP.22 The model pro- tobacco would be completely eliminated, with vides information about the likely impact of the most of it rolled into the decoupled single-farm CAP on farmers' and consumers' incomes and payment and the rest put into a fund for restruc- its budgetary implications. Because the CAP has turing tobacco-producing areas. been a "moving target," the model does not incor- · Olives. The current system of production-linked porate the most recent reforms, but rather uses the payments would be eliminated. For farms under Agenda 2000 scenario. Subsequent reforms have 0.3 hectares, coupled payments would be elimi- been of the same variety as those in the Agenda nated and replaced with only single-farm pay- 2000 program, but they have moved further in ments. For large farms, 60 percent of their cou- reducing support prices and distributing support as pled payments would be converted into decoupled payments. These later reforms could single-farm payments. The rest of the budget then be generally expected to result in lower that would have funded the coupled payments domestic producer and consumer prices than those for these farms would be converted into pay- produced by Agenda 2000 reforms, but with higher ments based on hectares or number of trees to direct payments. ensure the permanence of olive trees in marginal The model considers 11 major agricultural prod- areas or low-output olive groves. This measure ucts: wheat, barley, maize, sunflower, sugar beet, may act as a production incentive, but it is potato, grapes, milk, beef, poultry, and ovine meat. intended to be an environmental measure. Table 2.7 shows the base period results for the major TABLE 2.7 Base Period Results of Model for Major Activities Border Equivalent Quantity VA, Inclusive Actual Price Price Produced GOV Direct (thousand TL (thousand TL (thousand GOV (billions Share Payments VA Share per metric ton) per metric ton) metric tons) of TL) (percent) (billions of TL) (percent) Wheat 97,325 73,412 15,866.67 1,544,223.37 18.10 781,454.26 16.16 Barley 80,765 56,850 6,189.17 499,868.64 5.86 284,464.38 5.88 Maize 90,000 64,475 2,152.33 193,709.97 2.27 74,848.48 1.55 Sunflower 292,692 141,069 816.67 260,259.67 3.05 205,825.27 4.26 Sugar beet 36,612 20,585 16,807.79 618,223.98 7.25 543,851.74 11.25 Potato 132,444 100,017 5,081.33 672,992.07 7.89 595,596.29 12.32 Grapes 280,139 222,260 3,250.67 910,638.60 10.67 847,373.01 17.52 Milk 167,041 97,945 7,466.33 1,450,093.01 16.99 682,852.63 14.12 Beef 2,153,528 1,085,793 444.67 1,086,378.40 12.73 326,386.03 6.75 Poultry 748,350 469,748 725.00 542,553.75 6.36 180,598.86 3.73 Sheep 2,244,433 1,762,319 237.67 753,628.09 8.83 312,353.42 6.46 Intermediate Intermediate VA, Border Inputs, Inputs, Border VA, Actual Price NPR on Actual Price Price Equivalent Price Equivalent Tradable (thousand TL (thousand TL (thousand TL (thousand TL NPR EPR Inputs per metric ton) per metric ton) per metric ton) per metric ton) (percent) (percent) (percent) Wheat 48,074 45,462 49,251 27,949 32.57 76.22 5.74 Barley 34,803 32,153 45,962 24,697 42.07 86.10 8.24 Maize 55,224 52,335 34,776 12,140 39.59 186.45 5.52 Sunflower 66,654 59,687 252,031 81,381 107.48 209.69 11.67 Sugar beet 4,425 4,243 32,357 16,342 77.86 98.00 4.29 Potato 15,231 13,486 117,213 86,531 32.42 35.46 12.94 Grapes 19,462 19,684 260,677 202,576 26.04 28.68 -1.13 Milk 102,760 76,925 91,458 47,712 70.55 91.69 33.59 Beef 1,709,127 1,301,899 734,001 83,372 98.34 780.39 31.28 Poultry 499,248 382,865 249,102 86,882 59.31 186.71 30.40 Sheep 1,856,693 1,370,015 1,314,248 1,350,414 27.36 2.68 35.52 Note: Gross output value (GOV) comprises the output value from main products and, if applicable, from by-products. Consequently, value added (VA) is calculated on the basis of these gross output values. All variables are measured in terms of 2000 prices. TL = Turkish liras; NPR = nominal protection rate; EPR = effective protection rate. 57 Source: The authors. 58 Turkey: Economic Reform and Accession to the European Union activities carried out under the agricultural policies livestock). Agricultural policies with an impact on followed during 2000.23 From the table it follows input prices, output prices, or other direct monetary that wheat, milk, and beef are the most important transfers translate into changes in the value added, commodities considered, because these commodi- defined as the difference between the value of gross ties have the highest shares of total gross output. But output and the value of intermediate inputs, or, in the order changes to grapes, wheat, and milk when terms of factor payments, the return to land, labor, we consider the value added shares, and to grapes, and owned capital. This effect is computed using the wheat, and potato when we consider the value effective protection rate (EPR).26 Table 2.7 displays added shares measured at border price equiva- the value added of the analyzed activities at domestic lents.24 The table reveals that crop products consti- prices in relation to value added at border price tute 68.93 percent of total value added generated by equivalents. As expected, the levels of effective pro- the 11 commodities and that animal products tection are more pronounced than those of nominal account for 31.07 percent of the total value added. protection. The incomes of producers of crop and livestock products are all implicitly subsidized under the agricultural policies followed during 2000 except Impact on Producers for the incomes of producers of sheep. The extent of The domestic prices of the commodities shown in relative subsidization measured by the EPR is highest table 2.7 diverge considerably from the border price for beef, and this measure decreases for sunflower, equivalents. Examination of the profile of nominal poultry, maize, sugar beet, milk, barley, wheat, protection rates (NPRs)25 reveals the height of pro- potato, and grape production. Sheep production has tection in agriculture in Turkey observed earlier in a negative EPR, with an absolute value less than 100, table 2.5 for aggregates such as cereals and oilseeds. indicating the comparative advantage of the country Table 2.7 shows a similar picture for the 11 com- in the production of sheep. modities analyzed. The NPRs of these commodities are all positive, and NPR exceeds 100 percent for Alternative Agricultural Policy Options sunflower. Indeed, the NPRs lie between 50 percent for Turkey and 100 percent for beef, sugar beet, milk, and poultry, and are between 20 percent and 50 percent We assume that, as a new entrant, Turkey will have to for barley, maize, wheat, potato, sheep, and grapes. adjust to the EU and accept its legislation and poli- To examine the effects of agricultural policies on cies. Accession negotiations will therefore focus on farmers' incomes, we consider first the NPRs of how long Turkey will have to adopt the EU legisla- purchased intermediary inputs to agriculture. Con- tion and how it will do so. However, agricultural pol- sider, for example, wheat production. Although the icy in the EU is also evolving beyond the changes cost of intermediate inputs per metric ton of wheat introduced under the McSharry reforms andAgenda amounts to TL 48.074 million, the cost of interme- 2000. Because it is not easy to anticipate what EU diate inputs evaluated at border price equivalents agricultural policies will be at the time of Turkey's amount to TL 45.463 million. Thus, the intermedi- accession, we use a simulation approach to analyze ate inputs are taxed on average by 5.74 percent. the potential impacts, using the following scenarios: Among the inputs, the most important cost posi- tions are fertilizers (28.2 percent), seeds (25 per- · Scenario A1: partial adoption of Agenda 2000 cent), and fuel (21.4 percent). A comparison of the without direct payments domestic prices of each of these inputs with their · Scenario A2: complete adoption of Agenda border price equivalents reveals an implicit taxa- 2000, including direct payments equal to those tion of 32.6 percent for seed and subsidization of currently applied in the EU 3.4 percent for fertilizers. · Scenario B: adoption of the European Commis- Farmers' income is determined by the difference sion proposal similar to that given CEE coun- between input costs and revenues originating from tries, including direct payments at a level of the sale of agricultural produce, and by any non- 35 percent of payments granted in the EU mem- price-related monetary transfers to farmers (e.g., per ber countries hectare payments for crops or per head payments for · Scenario C: free trade with direct payments. Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 59 Simulation results for Scenario A1 are presented following the EU proposals for Central and Eastern in table 2.8a. When Turkey adopts Agenda 2000 European countries, on a level of 35 percent of without direct payments, domestic prices decrease direct payments granted to agricultural producers substantially for all commodities except grapes, in the EU. The final results of the introduction of milk, and poultry. For example, the price of wheat the CAP will depend on the positions taken by the decreases from TL 97,325,000 per metric ton in the government of Turkey and the European Commis- base case scenario to TL 73,412,000 per metric ton. sion. Because the negotiations have not yet started, Similarly, the prices of barley, maize, sunflower, we analyze only the effects of the introduction of sugar beet, potatoes, beef, and sheep fall signifi- direct payments at the rate of 35 percent of EU lev- cantly. With the decrease in output prices, the gross els.27 Table 2.10 shows the positions taken in agri- output value decreases for all commodities under cultural negotiations between the Slovak Republic consideration except poultry and milk. Similar con- and the European Commission. The table reveals siderations hold for the value added; it decreases for that the main issues in the agricultural negotiations all commodities except grapes, milk, poultry, and will be the shares of compensation payments for sheep. Relative to the base case scenario, the largest crops and livestock as a percentage of the EU direct decreases occur for sunflower, beef, and wheat. payments, the level of reference yield for crop com- Finally, the share of crop products in total value pensation payments, the level of quotas for sugar added generated by the 11 commodities decreases and milk, slaughter premiums, suckler cow premi- from 68.93 percent in the base case scenario to ums, and ewe ceilings. 62.66 percent in Scenario A1. In Scenario B, the value added generated in the In Scenario A2 Turkey adopts Agenda 2000 in full production of wheat, barley, maize, sunflower, and introduces direct payments to agricultural pro- milk, beef, and sheep decreases considerably com- ducers equal to those applied in the EU (table 2.8b). pared with the value added generated in Scenario Because prices are basically the same as in Scenario A2. The change in value added compared with the A1, only those activities to which the direct payment base case becomes negative for wheat, maize, and schemes apply will be affected. Among the produc- beef production, indicating the extreme vulnerabil- tion activities considered are wheat, barley, maize, ity of the sectors to changes in direct payments. The sunflower, milk, beef, and sheep. As a result of the share of crop products in total value added gener- direct payments, the value added relative to the base ated by the 11 commodities decreases now from period increases as shown in table 2.8b by 71.42 per- 68.93 percent in the base case to 62.52 percent in cent for barley,57.72 percent for beef,and 48.06 per- Scenario B. cent for sheep. For sunflower, the decline in value Table 2.9b presents the results of Scenario C-- added in Scenario A2 (Agenda 2000 with direct pay- removal of current trade interventions but with ments) is smaller than that in Scenario A1 (Agenda direct payments as under Agenda 2000. In the free 2000 with no direct payments). For wheat, barley, trade scenario with direct payments, the value maize,and beef,the decline in value added turns into added increases compared with the base case for increases in value added.Whereas wheat production wheat, barley, beef, and sheep production. For all declines by 41.78 percent in Scenario A1, it increases other commodities, the value added decreases. in Scenario A2 by 38.62 percent relative to the base The share of crop products of total value added run. Similar considerations apply for barley, maize, generated by the 11 commodities remains almost and beef. The increase in milk production goes up unchanged. from 24.47 percent in Scenario A1 to 45.82 percent in ScenarioA2,and the increase in sheep production Effects of Policies on Producers' Incomes goes up from 6.28 percent in Scenario A1 to in the Medium Term: Adjusting for Supply 48.06 percent in ScenarioA2.As for the share of crop Response Effects products generated by the 11 commodities, in total value added, it decreases from 68.93 percent in the The discussion so far has been based on the base case to 62.32 percent in Scenario A2. assumption that the output levels for all analyzed Table 2.9a displays the results of Scenario B. In activities remain constant (i.e., the assumption of this scenario, direct payments are introduced, but, totally inelastic supply). This is a simplifying 60 TABLE 2.8a Simulation Results for Partial Adoption of Agenda 2000 without Direct Payments (Scenario A1) Domestic NPR, Quantity GOV Change NPR, VA Change Price Main Produced GOV Relative Intermediary VA VA Relative (thousand TL Outputs (thousand (billions to Base Run Inputs (billions Share EPR to Base Run per metric ton) (percent) metric tons) of TL) (percent) (percent) of TL) (percent) (percent) (percent) Wheat 73,412 0.00 15,867 1,164,796 -24.57 -1.60 455,001 10.17 2.60 -41.78 Barley 74,155 30.44 6,189 458,955 -8.18 5.56 248,900 5.56 62.84 -12.50 Maize 76,283 18.31 2,152 164,187 -15.24 1.97 49,326 1.10 88.78 -34.10 Sunflower 141,069 0.00 817 115,206 -55.73 -2.70 67,777 1.52 1.98 -67.07 Sugar beet 26,867 30.52 16,808 451,569 -26.96 0.98 379,559 8.48 38.19 -30.21 Potato 100,017 0.00 5,081 508,220 -24.48 -3.14 441,846 9.88 0.49 -25.81 Grapes 376,586 69.43 3,251 1,224,157 34.43 -1.13 1,160,892 25.95 76.29 37.00 Milk 180,301 84.08 7,466 1,512,916 4.33 15.43 849,966 19.00 138.60 24.47 Beef 1,614,137 48.66 445 846,529 -22.08 15.97 175,193 3.92 372.56 -46.32 Poultry 888,077 89.05 725 643,856 18.67 19.13 313,190 7.00 397.21 73.42 Sheep 2,055,348 16.63 238 708,689 -5.96 15.69 331,980 7.42 3.44 6.28 TABLE 2.8b Simulation Results for Adoption of Agenda 2000 with Direct Payments (Scenario A2) Quantity Direct GOV Change VA Change Domestic Price Produced Payments GOV Relative to VA VA Relative to (thousand TL (thousand (billions (billions Base Run (billions Share EPR Base Run per metric ton) metric tons) of TL) of TL) (percent) of TL) (percent) (percent) (percent) Wheat 73,412 15,867 628,217 1,793,013 16.11 1,083,218 17.85 144.26 38.62 Barley 74,155 6,189 238,716 697,671 39.57 487,616 8.04 219.01 71.42 Maize 76,283 2,152 41,339 205,526 6.10 90,665 1.49 246.98 21.13 Sunflower 141,069 817 70,112 185,318 -28.80 137,889 2.27 107.47 -33.01 Sugar beet 26,867 16,808 0 451,569 -26.96 379,559 6.26 38.19 -30.21 Potato 100,017 5,081 0 508,220 -24.48 441,846 7.28 0.49 -25.81 Grapes 376,586 3,251 0 1,224,157 34.43 1,160,892 19.13 76.29 37.00 Milk 180,301 7,466 145,791 1,658,707 14.39 995,757 16.41 179.52 45.82 Beef 1,614,137 445 339,577 1,186,106 9.18 514,770 8.48 1288.54 57.72 Poultry 888,077 725 0 643,856 18.67 313,190 5.16 397.21 73.42 Sheep 2,055,348 238 130,488 839,176 11.35 462,468 7.62 44.09 48.06 Note: All variables are measured in terms of 2000 prices. TL = Turkish liras; NPR = nominal protection rate; GOV = gross output value; VA = value added; EPR = effective protection rate. Source: The authors. TABLE 2.9a Simulation Results for Adoption of Agenda 2000 with Direct Payments at 35 Percent (Scenario 2B) Border GOV Change VA Change Equivalent NPR Domestic Quantity Direct Relative NPR Relative Price Main Price Produced Payments GOV to Base Intermediary VA VA to Base (thousand TL Outputs (thousand TL (thousand (billions (billions Run Inputs (billions Share EPR Run per metric ton) (percent) per metric ton) metric tons) of TL) of TL) (percent) (percent) of TL) (percent) (percent) (percent) Wheat 73,412 0.00 73,412 15,867 219,876 1,384,672 -10.33 -1.60 674,877 13.41 52.18 -13.64 Barley 56,850 30.44 74,155 6,189 83,550 542,506 8.53 5.56 332,451 6.61 117.50 16.87 Maize 64,475 18.31 76,283 2,152 14,469 178,656 -7.77 1.97 63,794 1.27 144.15 -14.77 Sunflower 141,069 0.00 141,069 817 24,539 139,745 -46.31 -2.70 92,316 1.83 38.90 -55.15 Sugar beet 20,585 30.52 26,867 16,808 0 451,569 -26.96 0.98 379,559 7.54 38.19 -30.21 Potato 100,017 0.00 100,017 5,081 0 508,220 -24.48 -3.14 441,846 8.78 0.49 -25.81 Grapes 222,260 69.43 376,586 3,251 0 1,224,157 34.43 -1.13 1,160,892 23.07 76.29 37.00 Milk 97,945 84.08 180,301 7,466 51,027 1,563,943 7.85 15.43 900,993 17.91 152.92 31.95 Beef 1,085,793 48.66 1,614,137 445 118,852 965,381 -11.14 15.97 294,045 5.84 693.16 -9.91 Poultry 469,748 89.05 888,077 725 0 643,856 18.67 19.13 313,190 6.22 397.21 73.42 Sheep 1,762,319 16.63 2,055,348 238 45,671 754,360 0.10 15.69 377,651 7.51 17.67 20.90 TABLE 2.9b Simulation Results for Adoption of Free Trade with Direct Payments (Scenario 2C) Domestic Quantity Direct GOV Change VA Change Price Produced Payments GOV Relative to VA VA Relative to (thousand TL (thousand (billions (billions Base Run (billions Share EPR Base Run per metric ton) metric tons) of TL) of TL) (percent) of TL) (percent) (percent) (percent) Wheat 73,412 15,867 628,217 1,793,013 16.11 1,071,679 24.17 141.66 37.14 Barley 56,850 6,189 238,716 590,568 18.14 391,569 8.83 156.17 37.65 Maize 64,475 2,152 41,339 180,111 -7.02 67,468 1.52 158.21 -9.86 Sunflower 141,069 817 70,112 185,318 -28.80 136,573 3.08 105.49 -33.65 Sugar beet 20,585 16,808 0 345,981 -44.04 274,666 6.20 0.00 -49.50 Potato 100,017 5,081 0 508,220 -24.48 439,691 9.92 0.00 -26.18 Grapes 222,260 3,251 0 722,494 -20.66 658,508 14.85 0.00 -22.29 Milk 97,945 7,466 145,791 1,076,369 -25.77 502,024 11.32 40.93 -26.48 Beef 1,085,793 445 339,577 955,562 -12.04 376,650 8.50 915.98 15.40 Poultry 469,748 725 0 340,567 -37.23 62,990 1.42 0.00 -65.12 Sheep 1,762,319 238 130,488 777,044 3.11 451,437 10.18 40.66 44.53 Note: All variables are measured in terms of 2000 prices. TL = Turkish liras; NPR = nominal protection rate; GOV = gross output value; VA = value added; 61 EPR = effective protection rate. Source: The authors. 62 Turkey: Economic Reform and Accession to the European Union TABLE 2.10 Selected Positions in Agricultural Negotiation between the Slovak Republic and European Commission (EC) Slovak EC Proposal Proposal Share of compensation payments for crops and livestock (% of EU)a 35 100 Reference yield for crop compensation payments (cereal metric ton per hectare)b 4.16 4.99 Sugar quota--type A (metric tons)c 189,800 190,000 Sugar quota--type B (metric tons)c 19,000 45,000 Milk quota (metric tons) 946,150 1,235,000 Slaughter premium--adults (head)d 204,062 260,000 Slaughter premium--calves (head)d 62,841 60,000 Suckler cow premium (head)d 39,708 50,000 Ewe ceilings (head)d 219,360 370,000 a. As percent of payments granted to farmers in EU member countries. b. Reference yield used in calculation of compensatory payments for crops. c. Sugar beets used to produce sugar up to the A quota secure a higher price (about 46.72 per metric ton in 2000). Sugar beets used to produce sugar above the A quota and up to the B quota secure a slightly lower price (about 32.42 per metric ton in 2000). Sugar production exceeding the sum of both quotas has to be exported at world market prices (i.e., without export refunds). It is known as C sugar. d. Number of head eligible for compensation payments. Source: Csaki and others 2002. assumption, but one that presumably captures the large farmers, under Agenda 2000 the payments per essence of short-run effects. However, after some hectare for cereals and oilseeds have been progres- time producers would begin to adjust to the new sively aligned, and by the end of the Agenda 2000 price situation, readjusting the output mix and the period they will be virtually equal.30 Thus the pay- overall level of resource intensity. The medium- to ments will not affect whether a large farmer long-term supply response in the model is deter- chooses to plant, say, wheat or sunflower, or the mined by the elasticities of supply.28 farmer's decision on how much seed or fertilizer to When supply effects are taken into considera- use. They will, however, affect the amount of arable tion, modeling the impact of introducing the CAP land in cultivation. In this sense, the direct pay- with direct payments becomes tricky for the follow- ments do have an impact on agricultural produc- ing reason: the direct payments are made per tion, but they do not have as much of an effect on hectare currently planted, with the amount per incentives to plant individual crops as would addi- hectare computed by multiplying a basic per metric tional income from higher prices for the products. ton payment amount by a historical regional yield This factor makes it difficult to model the pay- for the 1986­91 baseline period. The payments are ments' effects. In the simulations, we first treat the not based on the individual farmer's current levels payments as if they do not come from higher prices. of production (yield). For this reason, the direct The resulting supply response should then be payment should not affect the farmer's cultivation regarded as a lower bound (Case I).31 In Case I, the decisions,29 but it does affect the farmer's decision payments do not produce any supply response, but on how many hectares to plant. Under Agenda they do increase value added. Next, we treat the 2000, these payments were originally crop-specific payments as if they come from higher prices and for large farmers (the "professional farmer" thus generate an increase in production. The result- scheme) and non-crop-specific for small farmers ing supply response should be regarded as an upper (the "small producer" scheme). However, even for bound (Case II). Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 63 We adjust the medium-run supply elasticities, ei, under inelastic supply and by 44.36 percent under to capture the difference in the ratio of value added the elastic supply assumption. Note that in Scenario to price. In particular, the adjusted elasticities, i , C, the value added increases despite the lower prices are calculated (as emphasized by Valdes 1973) by for wheat, barley, beef, and sheep. As a result, the multiplying the unadjusted elasticities with the quantity produced increases under elastic supply ratio of value added to product price so that and Case II--5.26 percent for wheat, 4.50 percent = eivi, where vi is the ratio of the per unit value for barley, 1.78 percent for beef, and 15.64 percent added at base run prices to the base period price. for sheep production. In all other cases, the quantity The supply response is then computed by applying produced decreases by 0.53 percent for maize, the relation 4.64 percent for sunflower, 14.87 percent for sugar beet, 21.78 percent for potato, 2.07 percent for qj VAjA 2 (2.1) = - 1 grapes, 17.11 percent for milk, and 40.75 percent qj VAjBase for poultry. where qj indicates the quantity of product j, VAjA 2 the value added generated in the production of Impact on Consumers commodity j in Scenario A2 (Agenda 2000 with direct payments), and VAjBase the value added gen- Changes in agricultural output prices also have an erated in the production of commodity j in the base impact on consumers through food prices. Lower case. Here we first incorporate the direct payments food prices lead to a decrease in consumer spend- under Agenda 2000 as part of the value added; ing on food. A consumer with a fixed, nominal dis- thereafter we abstract from considering direct pay- posable income (i.e., a fixed amount of money ment as part of value added. available for consumption) is able to increase his or Table 2.11 shows the effects of the alignment to her overall consumption of total goods and services Agenda 2000 under alternative elasticities of sup- by a percentage derived from multiplying the ply. For each commodity, the first column shows absolute value of the percentage decrease in food the results under the assumed medium-run supply expenditure by the share that food expenditure elasticities and the second column the results under makes up of total consumption. This increase in the the assumption of a completely inelastic supply consumer's ability to purchase goods and services is response. The table reveals that output quantities equivalent to an increase in his or her real income. under the Agenda 2000 scenarios decrease, on aver- The relative increase in real consumer incomes is age, by 3.7 percent for Scenario A1 and increase by highest for households with low disposable 2.5 percent for Scenario A2 under Case II. As incomes, because poor households allocate a higher expected, the introduction of direct payments gives share of expenditures to food products. In the incentives to increase the output relative to the case medium to long term, consumers will adjust to in Scenario A1. the new set of relative prices, moving away from the Furthermore, the changes in total value added in consumption of foods that have become relatively the simulations with a supply response are larger more expensive as a result of the policy changes. than under a totally inelastic response. Similarly, The medium- to long-term impact on income, Case II results in higher changes in total value added therefore, is expected to be more moderate than the compared with Case I. Consider, for example, wheat short-run impact. The exact amount will be deter- production. Whereas total value added generated in mined by the price elasticity of demand for each wheat production increases by 38.62 percent in Sce- product, which regulates the extent of consumers' nario A2 (Agenda 2000 with direct payments) under adjustments to changes in food prices. the inelastic response assumption and Case II, the To trace the effects of changes in output prices increase goes up to 46.20 percent under the elastic on consumers, we start with the information on supply assumption and Case II. By contrast, under expenditure given in table 2.12 and annex table 2.20 elastic supply the value added under Case I increases for the average consumer and for the average by only 30.41 percent. Under free trade with direct consumer in urban and rural areas, respectively. payments (Scenario C) and Case II,value added gen- Consider a commodity such as bread. Annex table erated in wheat production goes up by 37.14 percent 2.20 reveals that for the average consumer the 64 TABLE 2.11 Simulation Results for Alignment to Agenda 2000 under Positive Supply Response (percent change relative to 2000 base run) Wheat Barley Maize Sunflower Sugar Beet Potato Grapes Milk Beef Poultry Sheep Elastic Inelastic Elastic Inelastic Elastic Inelastic Elastic Inelastic Elastic Inelastic Elastic Inelastic Elastic Inelastic Elastic Inelastic Elastic Inelastic Elastic Inelastic Elastic Inelastic Scenario A1 Alignment, excluding direct compensatory payments Price change 24.57 24.57 8.18 8.18 15.24 15.24 51.80 51.80 26.62 26.62 24.48 24.48 34.43 34.43 7.94 7.94 25.05 25.05 18.67 18.67 8.42 8.42 Quantity change 5.92 0.00 1.49 0.00 1.84 0.00 9.24 0.00 9.08 0.00 21.48 0.00 3.44 0.00 15.81 0.00 5.37 0.00 45.94 0.00 2.21 0.00 GOV change 29.04 24.57 9.56 8.18 16.80 15.24 59.82 55.73 33.59 26.96 40.70 24.48 39.06 34.43 20.83 4.33 26.26 22.08 73.19 18.67 3.89 5.96 Total VA change 45.22 41.78 13.81 12.50 35.31 34.10 70.11 67.07 36.54 30.21 41.75 25.81 41.72 37.00 44.15 24.47 49.21 46.32 153.09 73.42 8.63 6.28 Scenario A2(a) Complete alignment, including direct compensatory payments (Case I) Price change 24.57 24.57 8.18 8.18 15.24 15.24 51.80 51.80 26.62 26.62 24.48 24.48 34.43 34.43 7.94 7.94 25.05 25.05 18.67 18.67 8.42 8.42 Quantity change 5.92 0.00 1.49 0.00 1.84 0.00 9.24 0.00 9.08 0.00 21.48 0.00 3.44 0.00 15.81 0.00 5.37 0.00 45.94 0.00 2.21 0.00 GOV change 9.24 16.11 37.49 39.57 4.14 6.10 35.37 28.80 33.59 26.96 40.70 24.48 39.06 34.43 32.47 14.39 3.32 9.18 73.19 18.67 13.81 11.35 Total VA change 30.41 38.62 68.85 71.42 18.90 21.13 39.20 33.01 36.54 30.21 41.75 25.81 41.72 37.00 68.88 45.82 49.25 57.72 153.09 73.42 51.33 48.06 Scenario A2(b) Complete alignment, including direct compensatory payments (Case II) Price change 24.57 24.57 8.18 8.18 15.24 15.24 51.80 51.80 26.62 26.62 24.48 24.48 34.43 34.43 7.94 7.94 25.05 25.05 18.67 18.67 8.42 8.42 Quantity change 5.47 0.00 8.53 0.00 1.14 0.00 4.55 0.00 9.08 0.00 21.48 0.00 3.44 0.00 29.60 0.00 6.69 0.00 45.94 0.00 16.88 0.00 GOV change 22.46 16.11 51.48 39.57 7.31 6.10 32.03 28.80 33.59 26.96 40.70 24.48 39.06 34.43 48.25 14.39 16.48 9.18 73.19 18.67 30.15 11.35 Per unit VA change 38.62 38.62 71.42 71.42 21.13 21.13 33.01 33.01 30.21 30.21 25.81 25.81 37.00 37.00 45.82 45.82 57.72 57.72 73.42 73.42 48.06 48.06 Total VA change 46.20 38.62 86.05 71.42 22.52 21.13 36.05 33.01 36.54 30.21 41.75 25.81 41.72 37.00 88.99 45.82 68.27 57.72 153.09 73.42 73.06 48.06 Scenario C(a) Free trade with direct payments (Case I) Price change 24.57 24.57 29.61 29.61 28.36 28.36 51.80 51.80 43.78 43.78 24.48 24.48 20.66 20.66 41.36 41.36 49.58 49.58 37.23 37.23 21.48 21.48 Quantity change 6.13 0.00 5.53 0.00 3.52 0.00 9.33 0.00 14.87 0.00 21.78 0.00 2.07 0.00 30.90 0.00 10.27 0.00 40.75 0.00 0.97 0.00 GOV change 9.00 16.11 11.61 18.14 10.29 7.02 35.44 28.80 52.36 44.04 40.93 24.48 22.31 20.66 48.71 25.77 21.08 12.04 62.81 37.23 4.10 3.11 Total VA change 28.73 37.14 30.04 37.65 13.03 9.86 39.84 33.65 57.01 49.50 42.25 26.18 23.90 22.29 49.20 26.48 3.55 15.40 79.34 65.12 45.92 44.53 Scenario C(b) Free trade with direct payments (Case II) Price change 24.57 24.57 29.61 29.61 28.36 28.36 51.80 51.80 43.78 43.78 24.48 24.48 20.66 20.66 41.36 41.36 49.58 49.58 37.23 37.23 21.48 21.48 Quantity change 5.26 0.00 4.50 0.00 0.53 0.00 4.64 0.00 14.87 0.00 21.78 0.00 2.07 0.00 17.11 0.00 1.78 0.00 40.75 0.00 15.64 0.00 GOV change 22.22 16.11 23.46 18.14 7.52 7.02 32.10 28.80 52.36 44.04 40.93 24.48 22.31 20.66 38.47 25.77 10.47 12.04 62.81 37.23 19.24 3.11 Total VA change 44.36 37.14 43.84 37.65 10.34 9.86 36.72 33.65 57.01 49.50 42.25 26.18 23.90 22.29 39.06 26.48 17.46 15.40 79.34 65.12 67.14 44.53 Note: GOV = gross output value; VA = value added. Source: The authors. Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 65 TABLE 2.12 Structure of Household Expenditures (1994 prices, Turkish liras) Average Rural Urban Total expenses per household 111,044,759 66,698,941 167,764,049 Food, beverages, and tobacco per household 39,552,432 30,202,155 51,511,644 Food and nonalcoholic beverages per household 36,457,528 28,287,252 46,907,494 Expenditure shares (% of total expenditure) Cereals and pasta 7.24 9.54 6.07 Meat and meat products 5.18 5.69 4.92 Milk, dairy products, and eggs 4.61 5.84 3.99 Fat 3.00 4.76 2.10 Fruit, fresh or dried 7.82 9.65 6.89 Sugar and sugar products 1.95 3.07 1.38 Other food and nonalcoholic beverages 3.03 3.86 2.61 Alcoholic beverages 0.34 0.30 0.36 Tobacco 2.45 2.57 2.39 Total food, beverages, and tobacco 35.62 45.28 30.70 Source: Turkish State Institute of Statistics. expenditure share for bread is 3.5371 percent. expenditure, F for food expenditure in the base Next, we consider the value share of the primary case, and F for food expenditure evaluated commodity in bread, wheat. Multiplying the expen- at Agenda 2000 prices, F can be defined as diture on bread with this share, we obtain the value E = F + (E - F ). The effect on consumer wel- of the analyzed primary commodity (wheat) in the fare is then calculated as (E - E )100/E .32 bread expenditure. Considering the price relation Table 2.13 summarizes the main results of the pi = pi (1 + NPRi), where pi denotes the domes- simulations. For each scenario, we estimated the tic price, pi the Agenda 2000 price of wheat, and impact of changes in food prices on, first, the nom- NPRi the nominal protection rate on wheat, we inal expenditure (change of food expenditure obtain the relation pi = Pi 1+NPRi . We then normalize relative to the base period food expenditure) and the domestic price so that pi = 1 for wheat in the second, consumers' real income (reduction in pur- base case. By means of the NPR, we determine chasing power of nominal income induced by the foreign price of wheat. Then, by multiplying the changes in the expenditure on food). The table expenditure on bread in the form of wheat with the reveals that, on average, the price changes under the foreign price, we can determine the value of the pri- Agenda 2000 scenario (Scenarios A and B) produce mary commodity (wheat) evaluated at foreign a 5.91 percent decrease in the expenditure on food, prices in the bread expenditure. By adding the value beverages, and tobacco. As for the expenditure on of the contents of bread other than wheat, we arrive food and nonalcoholic beverages only, consumers at the value of bread evaluated at Agenda 2000 would have to spend 6.41 percent less than under prices. Based on the expenditure of the average the current base period market conditions. In the income group on bread evaluated at base year Agenda 2000 scenario, the greatest decreases in prices and the expenditure on bread evaluated at expenditure occur in the groups fat (30.53 percent), Agenda 2000 prices, we determine the effect of sugar and sugar products (13.44 percent), and meat Agenda 2000 on the bread expenditure in percent- and meat products (9.48 percent). Because of the age terms. Once we conduct similar calculations for significant price changes in the main agricultural all the commodities under consideration, we obtain products of the Agenda 2000 scenario (compared the expenditure on food, beverages, and tobacco with the prevailing prices in Turkey), decreases in evaluated at Agenda 2000 prices. If E stands for total expenditure were recorded for all food product 66 Turkey: Economic Reform and Accession to the European Union TABLE 2.13 Simulation of Scenario Effects on Real Income, Selected Household Types Inelastic Demand Own Price Elasticities Reference Scenario (removal of all divergences) Average Rural Urban Average Rural Urban Change in real income 5.50 8.09 4.23 3.91 5.97 2.89 Change in nominal expenditure (%) Food, beverages, and tobacco 14.64 16.53 13.23 10.56 12.45 9.14 Food, and nonalcoholic beverages 15.88 17.64 14.52 11.45 13.29 10.03 Cereals and pasta 13.21 18.41 9.06 12.04 16.90 8.16 Meat and meat products 29.12 27.79 29.90 13.20 12.63 13.54 Fish and fish products 0.00 0.00 0.00 0.00 0.00 0.00 Milk, dairy products, and eggs 25.85 26.44 25.40 18.75 19.14 19.82 Fat 37.10 37.11 37.10 29.16 28.56 29.86 Fruits, fresh and dried 0.00 0.00 0.00 0.00 0.00 0.00 Vegetables and potatoes 2.54 3.01 2.15 2.34 2.78 1.98 Sugar and sugar products 22.10 24.39 19.51 20.68 22.82 18.24 Other food and nonalcoholic beverages 0.00 0.00 0.00 0.00 0.00 0.00 Alcoholic beverages 1.08 1.09 1.08 0.87 0.88 0.87 Tobacco products 0.00 0.00 0.00 0.00 0.00 0.00 Inelastic Demand Own Price Elasticities Agenda 2000 Scenario Average Rural Urban Average Rural Urban Change in real income 2.15 3.43 1.51 1.87 3.03 1.28 Change in nominal expenditure (%) Food, beverages, and tobacco 5.91 7.32 4.85 5.14 6.49 4.13 Food, and nonalcoholic beverages 6.41 7.82 5.33 5.58 6.93 4.53 Cereals and pasta 8.03 11.19 5.51 7.22 10.11 4.91 Meat and meat products 9.48 9.44 9.50 5.20 4.86 5.41 Fish and fish products 0.00 0.00 0.00 0.00 0.00 0.00 Milk, dairy products, and eggs 4.96 5.07 4.88 2.87 2.92 2.83 Fat 30.53 29.36 31.88 27.96 27.14 28.91 Fruits, fresh and dried 0.00 0.00 0.00 0.00 0.00 0.00 Vegetables and potatoes 2.54 3.01 2.15 2.34 2.78 1.98 Sugar and sugar products 13.44 14.83 11.86 12.44 13.73 10.98 Other food and nonalcoholic beverages 0.00 0.00 0.00 0.00 0.00 0.00 Alcoholic beverages 0.12 0.14 0.11 0.10 0.11 0.09 Tobacco products 0.00 0.00 0.00 0.00 0.00 0.00 Source: The authors. groups under the assumptions of Scenarios A and B reveal an increase in consumers' real income of except for milk and dairy products. Scenario C (free 2.15 percent as an impact of food price changes on trade with direct payments) also induces a decrease average households. The increase is more pro- in consumers' expenditure on food, beverages, and nounced in the lower-income group,the rural sector. tobacco of about 14.64 percent. Expenditures for Because food makes up a higher share of their total almost all product groups will be reduced. expenditures and because their food consumption The results in table 2.13 of the simulated intro- basket has a different mix, lower-income households duction of EU-type agricultural policies in Turkey experience a more significant change in real income Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 67 than the average of all groups. The immediate intro- imported commodities such as sunflower. For duction of Agenda 2000 in Turkey would increase exported commodities, the product can be consid- the real incomes of the households with the lowest ered the decrease in export subsidies, as long as the incomes by 3.43 percent, which is significantly base period domestic price exceeds the Agenda higher than the increase of 1.51 percent for house- 2000 price, such as for wheat. Finally, for poultry holds with the highest income--that is, the urban the Agenda 2000 price exceeds the base period sector. domestic price. Because poultry is an imported Columns 4­6 of table 2.13 present the results of commodity, the product is considered to be an the simulation of changes in consumers'real income increase in tariff revenue. and in nominal expenditures under the elastic Table 2.14 shows that after adoption of the demand assumption.33 As expected, the effects of Agenda 2000 policies Turkey will incur a net trade- the "elastic" scenarios are substantially lower than related revenue loss of 226 million. In the longer those of the "inelastic" scenarios. Under the Agenda term, the losses could become even greater as pro- 2000 scenario, real income increases in the elastic ducers and consumers adjust to the new price lev- variant are 1.87 percent instead of 2.15 percent in els. These results account only for expenditure on the inelastic demand. The pattern of impacts on the the commodities analyzed in this study. Thus they different groups of households under the elastic are likely to underestimate the true trade-related variant is principally the same as just described. budgetary effects of an implementation of CAP- type market regimes in Turkey. The budgetary effects of direct income transfers Impact on the State Budget can be determined for each agricultural commod- In addition to the implications for farmers' incomes ity such as wheat, barley, maize, and beef. For and for consumers, the implementation of EU poli- wheat, direct income support can be determined cies would have wide budgetary implications. The from the relation [direct payments (euros/metric most important budgetary effects are the direct ton)] [exchange rate (lira/euro)] [historical effectsoninternalpricesupportmeasures(e.g.,inter- grain yield for the EU compensatory area payments vention purchases and border measures) and those (metric tons/hectare)] [quantity of wheat pro- stemming from direct income transfers. duced (metric tons)]/[actual yield in 2000 per When estimating the effects of the policy changes hectare (metric tons/hectare)]. The direct income on tariff revenues and export refunds, we assume support for other commodities can be similarly that before accession Turkey will adopt the EU-like determined. A close look at the figures in table 2.14 agricultural policies on its own and will not receive reveals that direct payments to agriculture will any compensation from the EU budget for doing so. amount to 2.772 billion under Scenarios A1 and Under this assumption, we suppose that any subsi- A2 and to 970 million under Scenario B. dies to agriculture resulting from adoption of the Overall, the budgetary costs to Turkey of EU-like agricultural policies will have to be financed adopting EU-like agricultural policies when from the Turkish Treasury.34 Later, we relax this uncompensated by the EU budget for introducing assumption by considering the case in which Turkey those policies will be 2.998 billion under Scen- would receive compensation from the EU budget for ario A policies and 1.196 billion under Scenario B introducing the EU-like agricultural policies. It policies. should be noted that the total trade-related budget- After accession to the EU, Turkey will be eligible ary effects under Scenarios A1,A2, and B are similar, for payments under the EU's Structural Funds and because the level of domestic support prices is the Cohesion Fund. But after accession, Turkey will also same for all scenarios under consideration. have to contribute to the EU budget in the form of The trade-related budgetary implications of VAT-based and GNP-based contributions.TheVAT- adopting EU-like agricultural policies are analyzed based contribution is determined by the relation by multiplying the net traded quantity by the dif- 0.008522 0.55 GDP, where the value of 0.008522 ference between the base period domestic price and denotes the proportion used in calculation of the the Agenda 2000 price. Whenever the base period VAT-based contribution, and the parameter value domestic price exceeds the Agenda 2000 price, the of 0.55 is derived from the relation that the VAT product determines the loss in tariff revenue for base may not exceed 55 percent of national GDP. 68 Turkey: Economic Reform and Accession to the European Union TABLE 2.14 Trade-Related Budget Effects and Direct Payments under Agenda 2000 Agenda 2000 Net Exports, Trade-Related Direct 1999­2001 Effects on Payments Average Budget (billions of TL) (metric tons) (billions of TL) Scenario A Scenario B Wheat EX 617,845 16,729 628,217 219,876 Barley EX 160,508 1,061 238,716 83,550 Maize IM 881,072 12,085 41,339 14,469 Sunflower IM 394,310 66,002 70,112 24,539 Sugar beet IM 31,675 309 0 0 Potato EX 91,237 3,467 0 0 Grapes EX 470,095 45,339 0 0 Milk IM 146,669 1,945 145,791 51,027 Beef IM 69,392 37,429 339,577 118,852 Poultry IM 374 52 0 0 Sheep EX 42,162 7,972 130,488 45,671 Total 129,939 1,594,239 557,984 Total ( millions) 226 2,772 970 Total budgetary cost ( millions): Scenario A 2,998 Scenario B 1,196 Note: Because of the prevailing sanitary ban by Turkey on imports of livestock and meat products, the 1990­96 average of net exports for beef, sheep, and poultry is used. TL = Turkish liras; EX = export; IM = import. Source: The authors. Table 2.15 shows that Turkey's VAT-based contribu- countries, trade-related net subsidies from the EU tion will amount to 1.023 billion. The GNP-based will be 23 million. The payments under the Struc- contribution is determined by the relation 34.46 tural Funds that Turkey may receive from the EU (exchange rate) (share of Turkish GDP in EU after accession can be calculated, assuming that GDP), where 34.46 denotes the amount measured Turkey falls under Objective 1 of the Structural in terms of billions of euros that must be met by the Funds.36 According to the European Commission EU budget requirement by the GNP-based contri- (2002), per capita payments under Objective 1 cur- bution.35 From table 2.15, we note that Turkey's rently amount to 217 per inhabitant per year. GNP-based contribution will be 878 million. Therefore, assuming Objective 1 applies to Turkey, After accession, Turkey will receive from the EU the country would receive about 14.6 billion-- budget direct income support payments, trade- that is, about 6.75 percent of the 2000 GDP. Turkey's related net subsidies, payments under the Structural potential gains from the Cohesion Fund have Funds and Cohesion Fund. The direct income sup- been estimated on the basis of the payments port will amount to 2.772 billion in Scenarios A1 granted to Greece, Ireland, Portugal, and Spain. and A2 and to 970 million in Scenario B. Trade- Cohesion Fund payments are granted to countries related net subsidies, consisting of subsidies on with a per capita GNP of less than 90 percent of the exports minus tariff revenues on imports, are deter- EU average. The total amount to be spent in 2002 mined by multiplying the net traded quantity was about 45 per inhabitant. If Turkey receives (exports minus imports) from third countries by equal payments, it could expect to receive about the difference between the Agenda 2000 price and 3 billion. the border price. Basing the calculations on the The calculations just presented are optimistic, average 1999­2001 net trade figures with third because, according to EU rules, transfers from the Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 69 TABLE 2.15 Contributions to and Revenues from EU Budget Turkish Liras Euros (billions) (millions) Contributions to EU budget VAT-based contribution 588,682 1,023 GNP-based contribution 505,112 878 Total contribution 1,093,793 1,902 Revenues from EU budget Direct payments to agriculture Scenario A 1,594,239 2,772 Direct payments to agriculture Scenario B 557,984 970 Trade-related budgetary effects 13,473 23 Structural Funds 8,421,079 14,641 Cohesion Fund 1,746,307 3,036 Total revenue Scenario A 11,775,099 20,472 Total revenue Scenario B 10,738,843 18,670 Net revenue from EU budget Unrestricted Scenario A 10,681,305 18,570 Unrestricted Scenario B 9,645,050 16,768 Structural operations (restricted) Agenda 2000 4,983,338 8,664 Restricted Scenario A 5,497,258 9,557 Restricted Scenario B 4,461,002 7,755 Source: The authors. Structural Funds and Cohesion Fund cannot are located in a member state covered by the exceed 4 percent of GDP. Thus this requirement Cohesion Fund, the European Community contri- places an upper bound on the amount that Turkey bution may rise, in exceptional cases, to a maxi- can receive from the EU under these funds. For mum of 80 percent of the total eligible cost. The Turkey, this requirement is binding, and therefore second ceiling is a maximum of 50 percent of the the payments under the Structural Funds and total eligible cost and, as a general rule, is at least Cohesion Fund cannot exceed 8.664 billion. 25 percent of the eligible public expenditure for The total annual net revenue that Turkey can measures carried out in areas covered by Objec- receive from the EU under accession will therefore tives 2 and 3. Assuming that Turkey will qualify for be about 9.557 billion under Scenario A and assistance under Objective 1 and the Cohesion 7.755 billion under Scenario B. Fund, and assuming an EU participation rate (on Furthermore, an assessment of Turkey's poten- average) of 75 percent, the EU's contribution of tial gains from the Structural Funds must bear in 8.664 billion would have to be accompanied by a mind that funding of projects under the priority Turkish co-financing share of about 2.9 billion objectives are subject to a co-financing mecha- from the national budget. nism. The amount just estimated therefore consti- tutes the EU's share of project funding and must Welfare Effects be complemented by funds from the national budget. The EU's contribution to structural fund- The situation just described reveals that, in Turkey, ing is subject to two ceilings. The first is a maxi- integration into the EU will lead to substantial mum of 75 percent of the total eligible cost and, as changes in the agricultural incomes of producers, general rule, is at least 50 percent of the eligible the welfare levels of the consumers, and the budget public expenditure for measures carried out in the revenues of the government. On the effects of inte- regions covered by Objective 1. When the regions gration into the EU, we have five observations. 70 Turkey: Economic Reform and Accession to the European Union TABLE 2.16 Impact of Changes in Agricultural Policies on Agricultural Incomes Value Added Gross Agricultural Inclusive Direct Output Payments (billions of TL) (billions of TL) Base run with current policies 8,532,570 4,835,604 Agenda 2000 without direct payments 7,799,080 4,473,629 Agenda 2000 with direct payments 9,393,319 6,067,868 Agenda 2000 with 35 percent direct payments 8,357,064 5,031,613 Free trade with direct payments 7,475,246 4,433,256 Note: All variables are measured in terms of 2000 prices. TL = Turkish liras. Source: The authors. First, the impact on farmers' incomes of the intro- sumers' real income. In fact, the model estimates duction of EU-type agricultural policies (Scenarios that, in the medium to long term, EU-like policies A1, A2, B, and C) will be driven mainly by the (Scenarios A1, A2, and B) will lead to a 1.87 percent amount of CAP-like compensation payments increase in real household incomes in Turkey. This granted to the farmers (see table 2.16), and the impact is higher (2.15 percent) in the short term, impact will be greater in the medium to long term before consumers can adjust to the higher prices for as farmers adjust to the new policies. The largest some food products. Therefore, although farmers reduction in farmers' incomes is produced by as a group could lose from the new policies, Agenda 2000 policies without direct payments depending on the amount of direct payments, the (Scenario A1). From the point of view of the farm- population as a whole stands to gain from the ers, the best alternative among the various EU poli- introduction of these policies. Furthermore, cies considered is the Agenda 2000 scenario with because food makes up a higher share of their total direct payments given at the EU levels. expenditures and their food consumption basket Second, the impact will not be uniformly dis- has different mixes, lower-income households (i.e., tributed across all agricultural products; some rural households) experience a more significant farmers will gain and others will lose from the increase in real income. reforms as a result of changes in relative rates of Fifth, the budgetary costs to Turkey of adopting protection. EU-like agricultural policies (when Turkey will not Third, EU-type agricultural policies will reduce receive any compensation from the EU budget for agricultural prices substantially in Turkey, leading introducing these policies) will amount to 2.998 to lower food prices. In the short term, food expen- billion under Scenario A policies and to 1.196 ditures are projected to fall by as much as 5.91 per- billion under Scenario B policies. Yet after the EU cent compared with the current base period condi- accession, Turkey will be a net recipient of funds tions. In the medium to long term, EU-like changes from the EU; it can expect to receive from the EU in agricultural policies (Scenarios A1, A2, and B) 9.557 billion in net transfers under ScenarioA and would induce a 5.14 percent average drop in food 7.755 billion in net transfers under Scenario B.37 expenditures. Expenditures are projected to fall for the major food product groups, with the largest Institutional Development decreases projected for fat products (30.53 per- and EU Accession cent), sugar and sugar products (13.44 percent), and meat and meat products (9.48 percent). The institutional and human capital enhancements Fourth, because Turkish households spend on implied by EU membership require significant average about 36 percent of their disposable effort and investment during the preaccession income on food and beverages, policy reforms that period. Not only is the alignment of legislation affect food prices will undoubtedly affect con- necessary; Turkey also must develop the judicial Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 71 and administrative capacity to implement and a subsidized price later in the year, which has been enforce the acquis communautaire. In preparation the case in the past. TMO's new purchase and sales for joining the EU and adopting regulations and pricing policies have been very successful in elimi- policies of the EU, Turkey will have to strengthen nating its deficit (TMO 2002). some institutions and create others. This section The Turkish Bank of Agriculture is, as explained first outlines Turkey's key institutions for agriculture early in this chapter, the principal supplier of agri- in the context of implementation of the acquis and, cultural credit for crop and livestock production. It in particular, the mechanisms to operate the CAP. was the channel through which the bulk of the The section then briefly discusses Turkey's status credit was extended to farmers through the agricul- and ability to adopt and implement the acquis. tural credit cooperatives (ACCs) and the agricul- tural sales cooperatives unions (ASCUs). Virtually all of these loans carried negative real interest rates, Implementing Agencies for Agricultural Policies with losses covered by the Treasury. The ACCs pro- The Ministry of Agriculture and Rural Affairs vided short- and medium-term credit in the form (MARA), Ministry of Industry and Trade, Turkish of a limited cash payment (up to 25 percent of the Bank of Agriculture, and Treasury are the main total loan) plus production inputs (e.g., seed, fertil- organizations responsible for the formulation and izer, feed, and machinery.). The ACC system was a implementation of agricultural policy in Turkey. retail network of the Turkish Bank of Agriculture The main task of MARA is to assist in the elabora- for the distribution of subsidized credit in kind to tion and implementation of agricultural policies, small farmers, with some independence from the particularly services such as research and develop- government since 1995. It was the only source of ment, quarantine and inspection, rural develop- production credit for smallholder farmers. Because ment, and small-scale irrigation works. almost all of the financial requirements were pro- MARA also carries out commercial functions vided by the Turkish Bank of Agriculture, the cost- through the Turkish Grain Board (TMO), an affili- effectiveness of the ACCs was never a concern. ated state economic enterprise. For more than six Recently, the Turkish Bank of Agriculture was com- decades, the TMO has functioned as a buffer stock mercialized (about 500 branches were closed in agency in order to stabilize the grain prices received rural areas), and the credit subsidy was eliminated. by producers and paid by consumers. The board Since then, an alternative arrangement for provid- announces the purchase prices, which are later re- ing small farmers with credit has not yet been determined based on market conditions. The TMO established. uses its stock capacity to regulate the market, so In the past, the ASCUs operated under the con- that prices in the bread and pasta industries are sta- trol of the Ministry of Industry and Trade.They were bilized, and so producers and consumers do not face authorized to set prices for members' commodities high price fluctuations (MARA 2002). Under the and to implement support purchases from produc- Agricultural Reform Implementation Project, ers on behalf of the state. They also were authorized the prices of the TMO will be increasingly linked to set up facilities such as warehouses and primary to the world price (with a margin equal to the tariff) processing and packing plants and to market com- in order to allow state procurement to function only modities in accordance with wholesale and retail as a "buyer of last resort," which is now the case in market practices. Today, within the framework of the EU. The TMO also declares a sales price for the Agricultural Reform Implementation Project grain no less than either (1) the TMO's purchase (ARIP), financial aid is granted to assist the restruc- price plus the storage cost up to the date of sale, turing and transformation of ASCUs into genuine including imputed interest charges on stocks, or (2) cooperative organizations--that is, independent, the tariff-inclusive import parity price for grain of financially autonomous, self-managed cooperatives equivalent quality as of the time the grain is sold. that sell and process members'production. Prices increase in general to take into account the Financial aid is also provided for improving pub- depreciation of the Turkish lira. This system dis- lic services to facilitate reform implementation.Reg- courages wheat buyers from letting the TMO incur ulations are in place to control water and soil pollu- all of the storage costs and then buying the grain at tion and to protect wetlands. National and regional 72 Turkey: Economic Reform and Accession to the European Union plans distribute information on ways to combat balance through a system of production quotas like desertification and reduce discharges of nutrients. that used in the EU. In the tobacco sector, the Turk- The government plays a large role in investment in ish Parliament adopted a new law restructuring the infrastructure, especially irrigation works. Directorate General for the Tobacco and Tobacco Products, Salt and Alcohol Industry (TEKEL). The Status of Implementation of the Acquis law converts TEKEL from a monopoly to a com- in Agriculture mercial enterprise that will operate under free- This section examines Turkey's status and ability to market conditions. Parliament also adopted new assume the obligations of EU membership. regulations on tobacco, tobacco products, and alco- holic beverages. The processing facilities of TEKEL Adoption of the Common Market Organizations are to be privatized. In January 2002, a tobacco law The markets policy is the most important instru- was adopted that aimed to end state-subsidized ment of the CAP. As noted earlier, it places products tobacco purchases as of 2002 and to introduce auc- or a group of products under a particular regime, tion sales, individual purchasing contracts between the Common Organization of the Market (COM), producers and buyers, and liberalization of the so that common rules govern production and trade. market. The CAP is seeking to gradually reduce institutional In this restructuring, some firms were liqui- prices toward the world market levels, while consol- dated, such as the Turkish Agricultural Supply idating direct aid as the basic support mechanism Corporation, the state firm responsible for input for European Community farming. The acquis supply. Although the achievements described are requires that the intervention agencies be capable of considerable, Turkey, according to the European carrying out tasks such as regular market and price Commission (2004), lags behind in adopting the monitoring, buying-in, public storage, and sales EU's common market organizations. and stock control in premises that meet Commu- nity standards. Furthermore, the acquis specifies Implementation of the Integrated Administra- precise rules for producer organizations, which tion and Control System of Payments Accord- must be fulfilled if such an organization is to ing to the acquis, the administrative structures benefit from Community support. Finally, the and systems needed for handling the CAP expendi- COMs require specific administrative structures for ture under the Guarantee Section of the European operation of the Community supply-management Agricultural Guarantee and Guidance Fund must instruments such as production quotas in the sugar, meet certain requirements. In particular, the pay- dairy, and starch sectors. ing agencies must be accredited and must offer During late 1990s, Turkey, with the introduction sufficient guarantees that the admissibility of of ARIP, completely reformed its prevailing output claims and compliance with European Community price support and input subsidy policies. The rules are checked before payment is authorized ASCUs were restructured, and the TMO was down- and that the payments effected are correctly and sized. The TMO will preserve the assets needed to fully recorded in accounts. To help combat fraud carry out a minimum level of purchases and stor- and ensure that the direct payments scheme is age and will liquidate the rest of its assets. effectively applied, the EU introduced the Inte- In addition, a process of privatizing the agricul- grated Administration and Control System. Farm- tural state economic enterprises has begun. The ers wishing to claim direct payments must com- sugar law adopted on April 19, 2001, opens the plete detailed IACS forms, which are designed to market to competition, reduces state interference, ensure that only eligible land is entered into the and aims to maintain stable and self-sufficient scheme and that only one claim is made on any sugar production. The state-owned sugar company individual piece of land. According to the acquis, will operate on a commercial basis, and sugar mills the IACS must have a computerized database, an will be transferred to the Privatization Agency. In alphanumeric identification system for agricultural addition, a sugar board was established. The sugar parcels, and a system for identifying and recording law aims to maintain the demand and supply animals. Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 73 Turkey realizes that direct income support is at registration system in Turkey developed under the the heart of ARIP and that registration of farmers is DIS is certainly a start on an IACS. It includes a a critical part of the DIS program. Two approaches very comprehensive audit and financial manage- have been used to build an adequate registry of ment system that is in line with the kind of control farmers in Turkey. The first approach is based on system mentioned earlier. the existing land registry records (cadastre), and By the end of 2004, all EU member states will the second is based on certificates of farmers. Land be required to use a land register and parcel identi- registry was used where it exists, but it was comple- fication control system based on GIS analysis of mented by farmer certificates. In addition, MARA digital images. Turkey could adopt this system developed a farm registry system in collaboration from the outset. Over time, GIS maps of the whole with related organizations. The database of this sys- territory of Turkey should be prepared. Such a sys- tem includes information on the number of farm- tem will derive the basic data from the cadastre ers, their demographic characteristics and assets, map of the Turkish territory, which needs to be the number and the size of land parcels, and land digitized. The cadastre data will then be superim- use. This information is more accurate than formal posed with ortho-photomaps, which will allow statistics, and to access it, all provinces and districts identification of the exact borders of cultivated are provided an online connection to the MARA agricultural land and of less favored areas. The Registration Center. The 2.6 million farmers regis- processed ortho-photomaps, along with other rele- tered hold a total of 16.4 million hectares of land, of vant cadastre data (on disadvantaged areas, pro- which 16.3 million hectares are eligible for direct tected areas, environmentally sensitive areas, and income support. The number of parcels registered so forth), will be given to an institution in charge is 15.5 million. In 2001, direct payments of about of the data processing, and the result is expected to TL 500 trillion were made, paid in two installments. be an entirely new register of land use. Because DIScontinuedin2002withapaymentof TL135mil- introduction of the IACS and establishment of an lion ($85) per hectare of land up to 50 hectares. agency to disburse direct payments and other sub- Transition payments to help farmers divert from sidies to farmers are prerequisites for the function- hazelnut and tobacco increased in 2002 to $0.2 mil- ing of the CAP, it appears that Turkey must extend lion, and transition payments were to be granted the present system in order to develop the land until 2004. In addition to the farmer registry, a register and parcel identification control system Geographic Information System (GIS) and Remote like those of the EU and establish the associated Sensing Department was established within MARA payment agency. to classify and map agricultural land, estimate production and production capacity for various Food Safety and Quality Standards Food safety products, and create a database for land use plan- issues in the EU are spread over food, veterinary, ning purposes. phytosanitary, and animal nutrition legislation. These are considerable achievements. Yet, Food legislation includes general rules for hygiene according to the European Commission (2004), and control, food labeling, food additives, food Turkey has achieved little progress in introducing packaging, and genetically modified foods. Veteri- an IACS for payments. This situation is particularly nary legislation addresses animal health, animal serious because the data required for IACS are not welfare, animal identification and registration, easily available. It requires a uniform, centralized internal market control systems, external border database that would allow payments control at the controls, and public health requirements for central level, and an integrated system of on-the- establishments in relation to animal products. spot controls needs to be developed. According to Phytosanitary legislation includes plant health EU legislation, the individual member states are (harmful organisms, pesticides), seeds and propa- obliged to control areas that have at least 5 percent gating material, and plant hygiene. Finally, animal of applicants for payments. Fifty percent of the feed legislation includes the safety of feed materials requested area must be verified--one part on-site and additives, labeling, contaminants in feed, con- and one part perhaps from aerial photography. The trols, and inspections. 74 Turkey: Economic Reform and Accession to the European Union The acquis requires that each member state have inspection. Turkey has formally adopted a number appropriate administrative structures to inspect and of typical elements of food safety regulations and control the implementation of all food legislation. control systems by adopting some of the EU rules In particular, the various hygiene control officials and regulations. In particular, Turkey has started to must be trained in inspection and in the Hazard set up the Rapid Alert System for Food and Feed, Analysis and Critical Control Point (HACCP) sys- and has revised the regulation on the Establishment tem. Food operators must implement HACCP, and and Duties of Province Control Laboratories. laboratories used in hygiene and foodstuff analysis Accreditation has been initiated for some of the must comply with the European Community sys- laboratories involved in the ring test organized by tem on accreditation, method of sampling, and the Food Analysis Performance Assessment Scheme analysis.38 In the realm of plant and animal health and Turkish Scientific and Technical Council. Fif- and nutrition, the acquis requires that appropriate teen provincial laboratories have been brought up inspection arrangements be available at the site of to EU standards. The Plant Health Regulations, origin,that nondiscriminatory checks be performed which are the Turkish equivalent of the basic during transport and at the destination point, and Council Directive 2000/29/EC, dating back to 1991, that satisfactory testing arrangements be available. were amended in 2003. HACCP control instruc- A recent white paper on food safety stated that tions have been prepared to improve food process- the commission is determined to set the highest ing. In the veterinary area, Turkey amended the standards of food safety (see European Commis- Law on Animal Health and Surveillance in 2004, sion 2000). The white paper proposes the follow- creating the legal bases for banning the administra- ing: (1) establishment of an independent European tion of certain substances to animals and imposing Food Authority with responsibility for independent sanctions in this regard. It has also upgraded the scientific advice on all aspects of food safety, opera- control performance of the veterinary service, tion of rapid alert systems, and communication of including the implementation of residue monitor- risks; (2) an improved legislative framework cover- ing plans.40 ing all aspects of food products "from farm to table"; (3) greater harmonization of national con- Trade and Border Control Implementation of the trol systems; and (4) dialogue with consumers and CAP requires the establishment of effective customs other stakeholders. According to the white paper, control for trade with third countries. Because imported foodstuffs and animal feed should meet Turkey's borders will become EU borders at the point health requirements at least equivalent to those set of accession, Turkey will have to protect its long bor- by the European Community for its own products. ders and ensure, for example, an adequate veterinary The white paper on food safety also states that it is infrastructure to manage livestock inspection and essential that the EU candidate countries imple- control disease. Thus Turkey needs to assess the cur- ment the basic principles of the treaty establishing rent conditions and to design technical specifications the European Community, pass food safety legisla- for construction of other veterinary and phytosani- tion, and put in place control systems equivalent to tary border crossings along its future EU border. those in place within the European Community. EU controls on third-country imports require Similar considerations will certainly apply to that a system of border inspection posts (BIPs) be Turkey. Because the EU will not take any risks that completed to EU standards at external borders with might lead to lower food safety standards or affect third countries. Currently, some 283 EU BIPs are EU consumers, it is of prime importance that operated by national authorities. Most of these are Turkey comply with the EU's acquis on food safety. at ports and airports; others are at road or rail links In Turkey, food legislation has been updated located, in particular, on the eastern borders of continually since 1985. The harmonization of the EU. "Good Agricultural Practices" has been completed, The accession of Turkey will extend the EU's east- and the regulation on agricultural quarantine has ern frontier with Georgia, Armenia, Iran, Iraq, and been in force, and regularly strengthened, since Syria. Veterinary checks on imports at the BIPs 1991.39 A food act was passed in 1995, according to include documentary, identity, and physical checks which all stages of food production are targeted for of the animals or animal products.After these checks Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 75 at the first border crossing into the EU, animals and One important difference between Turkey and products can in principle circulate freely in the inter- the accession countries of Central and Eastern nal market. It is therefore essential that BIP facilities Europe is that in most of the latter, agricultural andproceduresareadequatetomaintainanimaland prices were lower than those in the EU at the time public health safety. Setting up border inspection those countries began accession negotiations. In posts for veterinary and other controls in the new Turkey, the converse is true, which implies that the member states requires that buildings, equipment, prices for many major agricultural products in and staff be in place to carry out the required border Turkey will have to be reduced at some point checks. EU legislation sets out minimum standards between now and accession. As quantified in this for BIP facilities,depending on the types of products chapter, such a reduction would be of great benefit to be checked. to Turkish consumers, especially the poor. It would, however, require adjustments on the part of Turkish farmers. Under its current reform pro- Conclusion gram, ARIP, Turkey has made a good start in this Accession to the EU implies some major changes, adjustment process. The way in which it has done both in the incentive structure for agricultural pro- this--by partially compensating farmers by means duction and in the institutions of the sector. This of an incentive-neutral, WTO-compatible direct chapter modeled and quantified the probable income support system--is fully consistent with changes in the incentive structure and examined the mechanisms of the CAP. By bringing agricul- their implications for the structure of production, tural prices in Turkey more in line with world value added in primary agriculture, and welfare of prices, the reforms will begin to make Turkish agri- producers and consumers. It also investigated qual- culture more efficient. This improvement, in turn, itatively what changes will be needed in major would help Turkey to meet one of the EU's pri- institutions by comparing those existing currently mary criteria for accession countries--that its pro- in Turkey with those of the EU's Common Agricul- ducers be able to compete in the unified market tural Policy. that follows from membership. Of course, an The results of any modeling exercise should be important lesson from other reform-minded taken with a grain of salt, and that is even truer of countries is that to realize the benefits of the those in this chapter. One reason is that the CAP is a reform program in increased competitiveness, pro- moving target undergoing fundamental reforms. ducers must be supported by having the appropri- The general direction of the reform program is clear, ate infrastructure and services, as well as continued but how far it will have gone by the time of Turkey's sectoral and economy-wide reforms. accession is not. It is quite possible--some would As for institutions, Turkey has made a good start argue likely--that the price structure in the EU will in some areas, but it still has a long way to go in in another 5­10 years be very close to that prevailing others. The DIS system in Turkey lays the founda- in world markets, but this development depends on tion for a system to administer direct payments some future political decisions,and so is by no means under the CAP, and the financial management sys- certain. Clearly, however, prices will be much lower tem of the DIS should be a good basis on which to than they are at present.Because of the uncertainties, build the Integrated Administrative and Control this chapter modeled several different scenarios, but System of payments. But some improvements will all results should be interpreted as indicative of gen- clearly be needed. For example, the system will have eral orders of magnitude rather than as precise to be based on GIS analysis of digital images, numerical forecasts. If the model were run using the implying that GIS maps will have to be prepared for scenario of the recently adopted reform program all of Turkey. Food safety and quality standards will that is an extension of Agenda 2000, Turkey's have to be improved, as will veterinary border producers and consumers would face lower prices. posts. But with a good investment program and Turkish consumers would gain even more than they support from the EU and international commu- would under the Agenda 2000 scenario, and produc- nity, Turkey should find it feasible to complete ers would lose more in price supports but would the improvements in the period leading up to receive substantially higher direct payments. accession. 76 Annex TABLE 2.17 Arrangements Applicable to European Community Importation of Agricultural Products, Other than Fruits and Vegetables Originating in Turkey Ad Valorem Duty Specific Duty Tariff Rates on Imports from Turkey on Imports from Turkey Over- 1999 Applied by EU Tariff Tariff Quota Duty Turkish Exports on Imports from Ad Valorem Quota In-Quota Quota on Imports HS Description to EU (US$) Third Countries Duty (metric tons) Duty (metric tons) from Turkey 0204 Meat of sheep or goat 123,880 78.10­157.20 0 -- 0 200 020725 Frozen turkeys -- 20.85 1,000 02072510 -- ECU/t 170 02072590 -- ECU/t 186 020727 Frozen cuts of turkeys -- 27.64 02072730 -- ECU/t 134 02072740 -- ECU/t 93 02072750 -- ECU/t 339 02072760 -- ECU/t 127 02072770 -- ECU/t 230 040690 Cheese 67.76 04069029 338 0 1,500 ECU 67.19/100 kg 04069031 804,042 04069050 -- 04069086 -- 04069087 -- 04069088 -- 0811 100 08111011 Frozen strawberries 125,928 25.27 0 -- 0 08112011 Frozen raspberries -- 19.89 0 -- 0 08119019 Other fruits, frozen 1,122 18.93 0 -- 0 10020000 Rye -- 103.90 Reduction according to Article 3(4) 1107 Malt 1,538 110710 50.40 Reduction of ECU/t 6.57 11072000 29.30 Reduction of ECU/t 6.57 1509 Olive oil 15091010 -- 81.30 10% reduction 15091090 121,068,014 81.30 10% reduction 15099000 -- 69.90 5% reduction 151000 Other olive oil 15100010 -- 79.20 10% reduction 15100090 2,201,779 79.20 5% reduction 2002 Prepared tomatoes 8,000 200210 3,622,783 16.80 0 20029011 485,353 16.80 0 20029019 78,337 16.80 0 2002 Prepared tomatoes 20029031 12,924,543 16.80 0 30,000 t 20029039 4,760,473 16.80 0 20029091 5,718,862 16.80 0 20029099 256,187 16.80 0 2007 20079130 Prep. of citrus fruit, with sugar -- 32.50 0 -- 0 100 20079939 Other preparations with sugar 1,000,696 39.26 0 -- 0 100 200850 Apricot pulp 600 ex 20085092 481,445 25.39 0 ex 20085094 27,604 25.39 0 2204 Wine 220410 Sparkling wine 32,099 9.80 0 -- 220421 Other wine, 2 liters or less 4,196,588 8.70 0 -- 220429 Other 2,224,958 17.70 0 -- 220600 Other fermented beverages 2,358 8.51 0 -- ex 2007 Undenatured ethyl alcohol -- 28.00­39.26 0 -- 200900 Vinegar and substitutes -- 0 -- Note: ECU/t = European currency unit per metric ton. Source: Decision 1/98 of the EC-Turkey Association Council of February 25, 1998. 77 78 TABLE 2.18 Arrangements Applicable to European Community Importation of Fruits and Vegetables Originating in Turkey Tariff Rates Applied by EU 1999 Tariff Rates on Imports from Turkish Exports Applied by EU Turkey during Tariff to EU on Imports from Specified Quota HS (US$) Third Countries Time Period Time Periods (metric tons) ex 070190 Potatoes 805,142 13.85 January 1­March 31 0 -- 070310 Onions 444,377 11.20 ex 07031011 February 15­May 15 0 -- ex 07031019 February 15­May 15 0 -- ex 07031011 May 16­February 14 0 2,000 ex 07031019 May 16­February 14 0 2,000 070820 Beans 460,017 13.37 ex 07082020 November 1­April 30 0 -- ex 07082095 November 1­April 30 0 -- ex 07089000 July 1­April 30 0 -- 070930 Aubergines 1,546,945 14.90 ex 070930 January 15­April 30 0 -- ex 070930 May 1­January 14 0 1,000 070940 Stick celery 8,598 14.90 ex 07094000 January 1­April 30 0 -- 070990 Fresh or chilled vegetables NES 179,561 13.08 07099071 Courgettes December 1­end of February 0 -- ex 07099073 Courgettes December 1­end of February 0 -- ex 07099079 Courgettes December 1­end of February 0 -- 070990 Fresh or chilled vegetables NES 500 ex 07099073 Courgettes March 1­November 30 0 -- 07099075 Courgettes March 1­November 30 0 -- 07099077 Courgettes March 1­November 30 0 -- ex 07099079 Courgettes March 1­November 30 0 -- ex 07099090 Pumpkins and courges December 1­end of February 0 -- ex 07099090 Other wild onion February 15­May 15 0 -- 080221- 22 Fresh or dried hazelnuts 354,662,275 3.70 08022100 3 -- 08022200 3 -- 080610 Fresh table grapes 21,850,312 16.10 08061021 Nov. 15­April 30, June 18­July 31 0 -- ex 08061029 Nov. 15­April 30, June 18­July 31 0 -- 08061030 Nov. 15­April 30, June 18­July 31 0 -- ex 08061040 Nov. 15­April 30, June 18­July 31 0 -- ex 08061050 Nov. 15­April 30, June 18­July 31 0 -- 08061061 Nov. 15­April 30, June 18­July 31 0 -- 08061069 Nov. 15­April 30, June 18­July 31 0 -- 080711 Watermelon 784,893 ex 08071100 April 1­June 15 0 -- ex 08071100 June 16­March 31 0 14,000 080719 Melons 1,437,680 ex 08071900 November 1­May 31 0 -- 080940 Plums 1,278,413 ex 08094010 May 1­June 15 0 -- ex 08094020 May 1­June 15 0 -- Note: NES = not elsewhere classified. Source: Decision 1/98 of the EC-Turkey Association Council of February 25, 1998. 79 80 Turkey: Economic Reform and Accession to the European Union TABLE 2.19 Agricultural Products for Which EU Entry Price System Applies 1999 Turkish Exports to EU HS Description (US$) 07020000 Tomatoes 2,306,800 07070005 Cucumbers 1,303,757 07091000 Artichokes 9,307 07099070 Courgettes 1,417,562 08051030 Oranges 5,191,270 08051050 Oranges 174,027 08052010 Clementine 439,670 08052030 Satsumas 69,803 08052050 Mandarins -- 08052070 Tangerines -- 08052090 Citrus hybrids 8,010,676 08053010 Lemons 13,367,259 08061010 Grapes 21,834,061 08081000 Apples -- 08081050 Apples--Granny Smith 1,735 08081090 Other Apples 5,350 08082010 Pears -- 08082050 Other pears 1,520,560 08091000 Apicots 674,115 08092005 Sour cherries 189,787 08092095 Table cherries 37,176,175 08093010 Peaches -- 08093090 Other peaches 310,744 08094005 Plums 1,270,287 20096011 Fruit juices -- 20096019 Fruit juices--grapes 410,950 20096051 Fruit juices--grapes 271,163 20096059 Fruit juices--grapes 768 22043092 Wine of fresh grapes -- 22043094 Wine of fresh grapes -- 22043096 Wine of fresh grapes -- 22043098 Wine of fresh grapes 16,965 Total 95,972,791 Source: Turkish State Institute of Statistics. Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 81 TABLE 2.20 Structure of Household Expenditures (1994 prices, Turkish liras) Average Rural Urban Total expenses per household 111,044,759 66,698,941 167,764,049 Food, beverages, and tobacco per household 39,552,432 30,202,155 51,511,644 Food and nonalcoholic beverages per household 36,457,528 28,287,252 46,907,494 Expenditure shares (% of total expenditure) Cereals and pasta Rice 0.7659 1.1584 0.5663 Flour 1.6416 3.9502 0.4677 Bread 3.5371 2.6741 3.9759 Bread and bread products Pasta 0.3113 0.5020 0.2144 Other bread products 0.4088 0.7150 0.2532 Confectionary products Rolls (fancy cake) 0.2885 0.1857 0.3408 Rolls (ordinary) 0.0634 0.0730 0.0585 Rolls (durable) 0.2251 0.2840 0.1952 Meat and meat products Meat Pork Veal 1.5659 1.2013 1.7513 Beef 0.5351 0.8484 0.3758 Sheep, lamb, and goat 1.5581 2.1953 1.2341 Poultry 0.7116 0.6450 0.7454 Subproducts and edible offal 0.1471 0.1772 0.1318 Smoked products 0.2997 0.2515 0.3243 Canned meat products Fish and fish products Fresh and frozen fish 0.3588 0.3698 0.3532 Processed fish Other water animals 0.0011 0.0016 0.0008 Fish ready-to-cook and fish dishes Milk, dairy products, and eggs Milk Fresh milk 1.0733 1.2479 0.9845 Dry (powder) and condensed milk 0.8019 1.2451 0.5765 Dairy products Cheese and curd 1.9321 2.4456 1.6710 Ice cream 0.0758 0.0290 0.0996 Other dairy products 0.0205 0.0395 0.0109 Eggs 0.7103 0.8310 0.6489 Fat Vegetable fat Vegetable oil 1.6869 2.6487 1.1977 Margarine 0.7650 1.0891 0.6001 Animal fat Dairy butter 0.5337 0.9984 0.2974 Lard/fat 0.0117 0.0193 0.0078 82 Turkey: Economic Reform and Accession to the European Union TABLE 2.20 (Continued) Average Rural Urban Fruit, fresh or dried Fresh fruit Fresh fruits, temperate zones 2.2800 2.4176 2.2101 Fresh fruits, tropical zones 0.1158 0.0812 0.1333 Dried fruit and nuts 0.4174 0.4317 0.4101 Fruit, canned Frozen fruit 0.0068 0.0084 0.0060 Bottled fruit Jam, marmalade, and jelly 0.2569 0.3638 0.2026 Fruit juices, syrups, and nectars 0.0845 0.0528 0.1006 Vegetables and potatoes Fresh vegetables and mushrooms 3.0108 3.6075 2.7073 Dried vegetables 1.0826 1.7756 0.7302 Frozen vegetables 0.0587 0.0962 0.0396 Potatoes Potatoes 0.5085 0.8146 0.3529 Potato products 0.0013 0.0007 0.0017 Sugar and sugar products Sugar 1.3920 2.4582 0.8498 Sugar products--nonchocolate 0.2004 0.2435 0.1785 Chocolate products 0.1588 0.0993 0.1891 Honey 0.1953 0.2680 0.1583 Other food and nonalcoholic beverages 3.0312 3.8650 2.6072 Coffee, tea and cocoa Coffee--all sorts 0.0840 0.0541 0.0991 Tea, including dried herb and others 1.0452 1.7319 0.6961 Cocoa 0.0067 0.0058 0.0071 Other food 1.5310 1.8555 1.3659 Soft drinks Fizzy soft drinks 0.3415 0.2098 0.4085 Mineral water 0.0228 0.0078 0.0305 Alcoholic beverages Spirits 0.2095 0.1852 0.2218 Wine 0.0151 0.0121 0.0166 Beer 0.1132 0.1017 0.1190 Tobacco Cigarettes 2.4142 2.4970 2.3721 Tobacco products 0.0352 0.0749 0.0150 Source: Turkish State Institute of Statistics. Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 83 Notes 15. Ceilings have been established per member state on the basis of slaughterings and exports registered in 1995. Where the 1. The authors are grateful to Mr. Antonio Nucifora for his national ceiling is exceeded, the premiums are reduced propor- assistance and advice on the model used in this paper to quanti- tionately. tatively estimate the effects of adopting the Common Agricul- 16. In particular, member states may choose between two tural Policy of the European Union. formulas for granting additional extensification premiums on 2. EU15 refers to the 15 members of the EU prior to the 2004 suckler cows and special beef payments: (1) a simple supplement enlargement in which 10 more countries joined the EU. The of 100 per premium where the stocking intensity is less than 15 countries are Austria, Belgium, Denmark, Finland, France, 1.4 livestock units per hectare; or (2) as of 2002, 40 where the Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, stocking intensity is between 1.8 and 1.4 livestock units per Portugal, Spain, Sweden, and the United Kingdom. hectare and 80 if less than 1.4 livestock units per hectare. 3. The last agricultural census was carried out in 2001, but the 17.OvinemeatisgovernedbyRegulation(EC)No.2529/2001. results of this census are still not available. The large number of 18. More information on the reforms is available at multiparcel agricultural land holdings, the landless peasants in http://europa.eu.int/comm/agriculture/mtr/index_en.htm. some parts of eastern Turkey, and the feudal structures in eastern 19. Even decoupled payments involve some distortion as and southeasternAnatolia are three of the major problems in Turk- they are currently administered. But, according to an analysis by ish agriculture. The land fragmentation is in part a consequence of the OECD, this distortion is very small. See OECD (2001) and the inheritance provisions of the 1926 Civil Code, which is pat- Dewbre, Anton, and Thompson (2001). terned after the Swiss Civil Code. To attack the problem of landless 20. This elimination of barriers does not include food safety, peasants, the government has pursued various agrarian reforms sanitary, and phytosanitary requirements, and it is subject to since the formation of the Republic, but more work needs to be rules of origin. done.Finally,thelocallord'shegemonyineasternandsoutheastern 21. In WTO terminology, subsidies in general are identified Turkey is a peculiarity of the Turkish agricultural setting. by "boxes" given the colors of traffic lights: green (permitted), 4. All dollar amounts are U.S. dollars unless otherwise amber (slow down--that is, will be reduced), and red (forbid- indicated. den). The Uruguay Round agreement on agriculture has no red 5. A review of the tariff binding commitments of Turkey and box, although domestic support exceeding the reduction the EU under the World Trade Organization (WTO) on agricul- commitment levels in the amber box is prohibited. A blue box tural products reveals that by 2004 Turkey's tariff bindings will refers to an amber box with conditions designed to reduce dis- all be almost above the EU final bound levels under the Uruguay tortions. Subsidies that are tied to programs that limit produc- Round agreement, which will be further reduced by the ongoing tion are included in the blue box. Doha Round negotiations. Thus, under the accession process, 22. For a discussion of the modeling methodology, see Csaki Turkey will have to conform to the lower EU levels. and others (2002). 6. For the COM on cereals, see Council Regulations (EC) No. 23. The policies have been projected using the 2000 price 1251/1999 and No. 1253/1999. and cost situation, because complete data for later periods were 7. See Article 2 of Council Regulation No. 1251/1999. In the not available at the time of preparation of this chapter. Central and Eastern European (CEE) countries, the arable base 24. The exchange rates used in the study for 2000 were TL area for each accession country has been determined by taking 624,325 to the U.S. dollar and TL 575,179.98 to the euro. the average for the years 1997, 1998, and 1999. 25. Given the domestic price of commodity i, pi, and its bor- 8. In the CEE countries, aid for durum wheat applies to the der equivalent price, pi , the nominal protection rate (NPR) is durum wheat used to produce pasta. The glassiness of the vari- defined as ety grown should be higher than 73 percent. Furthermore, Pi durum wheat must have been grown for a minimum of some NPRi = - 1 100 20 years to qualify for aid. Finally, aid is contingent on the area Pi under durum wheat production constituting at least 2 percent of 26. The effective protection rate (EPR) is computed on the the total area under cereal production. basis of the ratio of value added in the production of i measured 9. For CEE countries, the reference yields have been deter- at domestic prices (VAi ) over such value added at border prices mined as the average of the median three years of the period (VAi ) and is shown by 1994/95­1998/99. The reference yields have been set at 4.26 met- VAi ric tons per hectare for Hungary, 2.96 tons per hectare for EPRi = - 1 100 Poland, and 4.16 tons per hectare for Slovakia. VAi 10. For CEE countries, the date is December 31, 2000. EPR > 0 implies direct protection of domestic producers of the 11. The regulations that apply to sunflower seed are gov- commodity; EPR < 0 implies underlying disincentives to erned by Council Regulation (EC) No. 1251/1999 amending domestic producers of the commodity; and EPR = 0 implies a Regulation No. 3405/93. neutral structure of net incentives. 12. Sugar beets are governed by Council Regulation (EC) 27. We do not consider the effects of the imposition of quo- No. 1260/2001. tas on sugar and milk production by the EU. 13. Fruits and vegetables, including grapes, are governed by 28. The assumed output supply elasticities, taken largely Regulation (EC) No. 2699/2000 amending Council Regulation from Koç, Uzunlu, and Bayaner (2001), are 0.28 for wheat, 0.21 (EC) No. 2200/1996, No. 2201/1996, and No. 2202/1996. for barley, 0.14 for maize, 0.16 for sunflower, 0.34 for sugar beet, 14. Milk and dairy products are governed by Council Regu- 0.94 for potato, 0.10 for grapes, 1.18 for milk, 0.34 for beef, 1.88 lation (EC) No. 1255/1999 on the COM for milk and dairy prod- for poultry, and 0.60 for sheep. ucts. Also applicable is Council Regulation (EC) No. 1256/1999 29. This is why these kinds of payments are classified under amending Regulation (EEC) No. 3950/1992 establishing an WTO rules as "green box"--that is, payments that minimally additional levy in the milk and milk products sector. distort trade. 84 Turkey: Economic Reform and Accession to the European Union 30. For a description of the direct payments and an estimate ensure the elimination of any harmful microbes. Fourth, estab- of their effects, see OECD (2003b). lish procedures to monitor the critical control points. Such pro- 31. In Case I, there is a negative supply response to the drop cedures might include determining how and by whom cooking in prices due to the alignment with Agenda 2000 prices (except time and temperature should be monitored. Fifth, establish the grapes, the price of which increases), and no compensating corrective actions to be taken when monitoring shows that a crit- increase in price or production from the direct payments. In ical limit has not been met--for example, reprocessing or dis- Case II, the negative effect of alignment with Agenda 2000 prices posing of food if the minimum cooking temperature is not met. is offset by the direct payments. Sixth, establish procedures to verify that the system is working 32. Note that this approach determines the equivalent varia- properly--for example, testing time and temperature recording tion in consumer income. Alternatively, one could determine the devices to verify that a cooking unit is working properly. Seventh, change in consumer surplus. establish effective recordkeeping to document the HACCP sys- 33. The assumed price elasticities of demand, taken largely tem. This documentation would include records of hazards and from Koç, Uzunlu, and Bayaner (2001), are 0.12 for bread and their control methods, the monitoring of safety requirements, pasta, 0.81 for beef, 0.7 for sheep meat, 1.23 for poultry, 0.5 for and action taken to correct potential problems. Each of these milk, 0.3 for dairy products, 0.2 for fat, and 1.09 for butter. principles must be backed by sound scientific knowledge--for 34. This assumption helps to highlight the impact of EU-like example, published microbiological studies on time and temper- agricultural policies on the state budget. ature factors for controlling food-borne pathogens. 35. Note that the EU budget must be balanced during each 39."Good Agricultural Practices" refers to applying available fiscal year. So this value of 34.46 will change from year to year by knowledge to use of the natural resource base in a sustainable the requirements of the budget during that year. way for the production of safe, healthy food and nonfood agri- 36. Structural Funds allow the EU to grant financial assis- cultural products in a humane manner, while achieving eco- tance to resolve structural economic and social objectives. nomic viability and social stability. Objective 1 of the Structural Funds is the main priority of the 40. See chapter 10 of Oskam and others (2004) for a discus- EU's cohesion policy. The EU aims to narrow the gap between sion of animal and plant health issues in Turkey. the development levels of the various regions. "Objective 1 regions" refers to areas lagging behind in their development and References in which GDP is below 75 percent of the European Community average. Objective 2 of the Structural Funds aims to revitalize all Çagatay, S., C. Saunders, and R. Amor. 2001."The Impact on the areas facing structural difficulties, whether industrial, rural, Agricultural Sector of the Potential Extension of the Cus- urban, or dependent on fisheries. Objective 3 covers the entire toms Union Agreement to Cover Agricultural Commodi- EU territory outside of areas covered by Objective 1 and serves ties." Unpublished paper, Lincoln University, New Zealand. as a reference framework for all measures to promote human Çakmak, E. H., and H. Kasnakoglu. 2001. "Tarim Sektöründe resources in the member states. It takes account of the title on Türkiye ve Avrupa Birligi Etkiles¸imi: Türkiye'nin AB'ye employment in the Treaty of Amsterdam and the new European Üyeliginin Analizi" [The Turkey­European Union Interac- strategy for employment. tion in Agricultural Sector: Analysis of Turkey's of EU Mem- 37. For alternative quantitative analyses of the effects of bership]. Working Paper, Agricultural Economics Research adopting the CAP, see Çakmak and Kasnakoglu (2001); Çagatay, Institute, Ministry of Agriculture and Rural Affairs, Ankara. Saunders, and Amor (2001); Grethe (2004); and Oskam and Csaki. C., A. Nucifora, Z. Lerman, T. Herzfeld, and G. Blaas. others (2004). Whereas Çakmak and Kasnakoglu (2001) study 2002. Food and Agriculture in the Slovak Republic: The Chal- the impact of the CAP on producers, consumers, and foreign lenges of EU Accession. Washington, DC: World Bank. trade, Çagatay, Saunders, and Amor (2001) concentrate only on Dewbre, J. H., J. Anton, and W. Thompson. 2001. "The Transfer the effects on producers and foreign trade. Both papers abstract Efficiency and Trade Effects of Direct Payments." American from consideration of the impact on the state budget. According Journal of Agricultural Economics 83: 1204­15. to Çakmak and Kasnakoglu (2001), adoption of Agenda 2000 Europarl. 2002. "European Parliament Fact Sheets." http://www. policies with direct payments equal to those currently applied in europarl.eu.int/factsheets/default_en.htm. the EU will lead to reductions in producers' welfare, which is European Commission. 2000. "White Paper on Food Safety." contrary to our results summarized in table 2.16. The compre- COM (1999) 719 final. Brussels: EC. hensive study by Oskam and others (2004) analyzes the likely --------. 2002. "Regional Policy Interim Report." http://www. consequences for Turkey's agricultural and agrifood sectors europa.eu.int/comm/regional_policy/sources/docoffc/ should it become an EU member in 2015. official/reports/pdf/interim1/report_en.pdf. 38. HACCP is a system that establishes process control --------. 2004. "2004 Regular Report on Turkey's Progress through identification of the production points most critical to Towards Accession." COM (2004) 656 final. Brussels: EC. controlling and monitoring the production process. It involves Grethe, H. 2004. "Turkey's Accession to the EU: What Will the seven principles. First, analyze hazards. Potential hazards associ- Common Agricultural Policy Cost?" Humboldt University ated with a food and measures to control those hazards are iden- Working Paper 70/2004. Berlin. tified. The hazard could be biological such as a microbe, chemi- Koç, A., V. Uzunlu, and A. Bayaner. 2001. "Türkiye'de Tarimsal cal such as a toxin, or physical such as ground glass or metal Ürün Projeksiyonlari 2000­2010" [Forecasts for Agricultural fragments. Second, identify critical control points. These are Products in Turkey for the Period 2000­2010]. Agiicultural points in a food's production--from its raw state through pro- Economics Research Institute, Ankara. cessing and shipping to consumption by the consumer--at MARA (Ministry of Agriculture and Rural Affairs). 2002. "Data which the potential hazard can be controlled or eliminated. files." Research Planning and Coordination Council, MARA, Examples are cooking, cooling, packaging, and metal detection. Ankara. Third, establish preventive measures with critical limits for each OECD (Organisation for Economic Co-operation and Develop- control point. For a cooked food, for example, this might include ment). 2001. "Market Effects of Crop Support Policies." setting the minimum cooking temperature and time required to OCED, Paris. Analysis of the Impact of EU Enlargement on the Agricultural Markets and Incomes of Turkey 85 --------. 2003a. "Agricultural Policies in OECD Countries: TMO (Turkish Grain Board). 2002. TMO files. http://www. Monitoring and Evaluation."OECD, Paris. tmo.gov.tr. --------. 2003b. "Risk Related Non-price Effects of the CAP Valdes, A. 1973. "Trade Policy and Its Effects on the External Arable Crop Regime: Results from an FADN Sample." Agricultural Trade in Chile, 1945­1965. 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Wageningen University, Wageningen. 3 Integration and the Manufacturing Industry Sübidey Togan, Hüsamettin Nebioglu, and Saadettin Dogan This chapter studies the effects of European Union 1996, to adopt by 2001 all of the preferential trade (EU) integration on the manufacturing sector.1 The agreements the EU has concluded over time, first section describes the main developments in and to implement on the commercial policy side Turkey's trade regime and trade performance, and measures similar to those of the European the second examines the structure of protection- Community's commercial policy. Adhering to the ism. Market access issues emphasizing contingent stipulations of the Customs Union Decision, protectionism and the issues related to technical Turkey maintained rates of protection above those barriers to trade are the subjects of the third and specified in the CCT for certain "sensitive" prod- fourth sections. The fifth section analyzes condi- ucts until 2001. In order to adopt EU's preferential tions of competition, and the final section offers trade agreements, Turkey signed FTAs with the conclusions. European Free Trade Association countries, Israel, and the Central and Eastern European (CEE) countries. FTAs are being discussed with the Main Developments in Turkey's Mediterranean countries. As for export subsidies, Trade Regime Turkey joined the Tokyo Round Agreement on In 1994 Turkey signed the agreement establishing Subsidies and Countervailing Duties of the the World Trade Organization (WTO), and a cus- General Agreement on Tariffs and Trade (GATT), toms union was created between Turkey and the agreeing to eliminate export subsidies by 1989. EU as of January 1, 1996. According to the Customs Recently, Turkey eliminated most of the export Union Decision (CUD) of 1995, all industrial incentives that were introduced during the 1970s goods, except products of the European Coal and and 1980s. Within this context, GATT legal subsi- Steel Community (ECSC), that comply with the dies such as research and development subsidies European Community norms could circulate freely and subsidies to facilitate the adaptation of plants between Turkey and the EU as of January 1, 1996. to new environmental regulations were introduced For ECSC products, Turkey signed a free trade in 1995. agreement (FTA) with the EU in July 1996, and as Basic data on Turkey's merchandise trade are a result, ECSC products have received duty-free shown in table 3.1. The table reveals that in 2003 treatment between the parties since 1999.2 Turkish merchandise exports amounted to US$47.2 The Customs Union Decision required Turkey billion and merchandise imports to $69.3 billion.3 to implement the European Community's Com- Exports to the EU15 made up 49.7 percent of total mon Customs Tariffs (CCTs) on imports of indus- exports, and imports from the EU made up trial goods from third countries as of January 1, 42.8 percent of total imports.4 The table further 87 88 TABLE 3.1 Exports and Imports, Turkey, 1990­2003 Annual Annual Total Percentage Growth Rate Exports Percentage Share of Growth Rate of Exports, Distribution, of Exports, to the EU, Distribution, Exports to EU Exports to EU, 2003 Total 1990­2003 2003 Exports of Sectoral 1990­2003 SITC Commodity (US$ millions) Exports (percent) (US$ millions) to EU Exports (percent) Agricultural products 0 + 1 + 4 + 22 Food 4,735 10.03 2.01 1,949 8.31 41.17 2.32 2 - 22 - 27 - 28 Agricultural raw materials 522 1.11 2.56 220 0.94 42.24 0.41 Mining products 27 + 28 Ores and other minerals 572 1.21 4.23 246 1.05 42.95 2.56 3 Fuels 980 2.08 7.93 211 0.90 21.53 -0.31 68 Nonferrous metals 457 0.97 8.64 222 0.94 48.45 9.03 Manufactures 67 Iron and steel 3,342 7.08 5.12 939 4.00 28.09 16.52 Chemicals 51 Organic chemicals 171 0.36 1.53 107 0.46 62.55 4.28 57 + 58 Plastics 545 1.15 9.20 112 0.48 20.50 5.40 52 Inorganic chemicals 230 0.49 5.99 80 0.34 34.68 5.38 54 Pharmaceuticals 220 0.47 10.28 72 0.31 32.64 17.99 53 + 55 + 56 + 59 Other chemicals 726 1.54 10.19 65 0.28 8.97 4.00 6 - 65 - 67 - 68 Other semimanufactures 4,143 8.77 12.52 1,645 7.01 39.70 12.21 Machinery and transport equipment 71 - 713 Power generating 246 0.52 24.80 85 0.36 34.47 22.77 machinery 72 + 73 + 74 Other nonelectrical 1,566 3.32 18.16 537 2.29 34.29 17.73 machinery 75 + 76 + 776 Office machines and 1,978 4.19 17.99 1,569 6.68 79.30 17.27 telecommunications equipment 77 - 776 - 7783 Electrical machinery 2,076 4.40 16.83 999 4.26 48.14 14.64 and apparatus 78 - 785 - 786 + Automotive products 4,928 10.44 24.42 3,139 13.38 63.70 29.30 7132 + 7783 79 + 785 + 786 + Other transport 1,542 3.27 20.70 853 3.63 55.31 23.07 7131 + 7133 + equipment 7138 + 7139 65 Textiles 5,262 11.14 10.14 2,340 9.97 44.48 7.50 84 Clothing 9,962 21.10 7.21 7,079 30.17 71.07 5.94 8 - 84 - 86 - 891 Other consumer goods 2,675 5.67 16.37 954 4.06 35.66 12.44 9 + 891 Other products 335 0.71 30.17 44 0.19 13.02 16.10 Total 47,211 100 9.01 23,466 100 49.70 8.56 Annual Annual Total Percentage Growth Rate Imports Percentage Share of Growth Rate, Imports, Distribution, of Imports, from EU, Distribution, Imports from EU Imports from EU, 2003 Total 1990­2003 2003 Imports of Sectoral 1990­2003 SITC Commodity (US$ million) Imports (percent) (US$ million) from EU Imports (percent) Agricultural products 0 + 1 + 4 + 22 Food 2,789 4.03 3.29 548 1.85 19.65 1.70 2 - 22 - 27 - 28 Agricultural raw materials 2,471 3.57 6.42 894 3.01 36.19 6.76 Mining products 27 + 28 Ores and other minerals 2,262 3.26 4.58 670 2.26 29.61 -0.05 3 Fuels 11,575 16.71 8.06 460 1.55 3.97 7.71 68 Nonferrous metals 1,411 2.04 9.55 308 1.04 21.80 4.23 Manufactures 67 Iron and steel 3,282 4.74 5.46 1,232 4.15 37.53 1.91 Chemicals 51 Organic chemicals 2,102 3.03 7.39 1,059 3.57 50.39 6.83 57 + 58 Plastics 2,837 4.09 12.80 1,645 5.54 58.00 11.57 52 Inorganic chemicals 543 0.78 2.82 178 0.60 32.78 0.99 54 Pharmaceuticals 2,302 3.32 17.09 1,546 5.21 67.14 17.05 53 + 55 + 56 + 59 Other chemicals 2,643 3.82 7.00 1,560 5.26 59.03 7.65 6 - 65 - 67 - 68 Other semimanufactures 3,489 5.04 8.27 2,245 7.56 64.33 7.66 Machinery and transport equipment 71 - 713 Power generating 758 1.09 12.52 382 1.29 50.34 12.44 machinery 72 + 73 + 74 Other nonelectrical 7,250 10.46 5.21 4,607 15.52 63.54 4.18 machinery 75 + 76 + 776 Office machines and 4,166 6.01 10.95 1,618 5.45 38.83 12.15 telecommunications equipment 77 - 776 - 7783 Electrical machinery 2,065 2.98 6.82 1,175 3.96 56.93 5.75 and apparatus 78 - 785 - 786 + Automotive products 6,209 8.96 11.67 5,150 17.35 82.95 13.91 7132 + 7783 79 + 785 + 786 + Other transport 1,012 1.46 1.80 711 2.40 70.29 4.88 7131 + 7133 + equipment 7138 + 7139 65 Textiles 3,441 4.97 13.03 1,185 3.99 34.43 13.49 84 Clothing 422 0.61 24.93 204 0.69 48.26 21.68 8 - 84 - 86 - 891 Other consumer goods 3,540 5.11 10.07 1,910 6.44 53.96 9.27 9 + 891 Other products 2,714 3.92 27.10 391 1.32 14.42 18.75 Total 69,283 100 8.27 29,678 100 42.84 8.06 89 Note: SITC = Standard International Trade Classification. Source: The authors. 90 Turkey: Economic Reform and Accession to the European Union reveals that the three export commodities with of total EU exports, and imports from Turkey were the highest shares of total exports were clothing, also 2 percent of total EU imports. The table fur- 21.1 percent; textiles, 11.1 percent; and automotive ther reveals that the three export commodities with products, 10.4 percent. The three import commodi- the highest shares of total EU exports were other ties with the highest shares of total imports were nonelectrical machinery, 12.1 percent; other con- fuels, 16.7 percent; other nonelectrical machinery, sumer goods, 10.3 percent; and automotive 10.5 percent; and automotive products, 9 percent. products, 10 percent. The three import commodi- Similarly, the three export commodities with the ties with the highest shares of total EU imports highest shares of exports to the EU were clothing, were office machines and telecommunications 30.2 percent; automotive products, 13.4 percent; equipment, 14.3 percent; fuels, 14.1 percent; and and textiles, 10 percent. The three commodities other consumer goods, 10.3 percent. During the with the highest shares of imports from the EU period 1990­2001, total EU exports grew at an were automotive products, 17.4 percent; other non- annual rate of 8.2 percent and total imports at the electrical machinery, 15.5 percent; and other semi- rate of 7.5 percent. The export commodities with manufactures, 7.6 percent. the highest growth rates were office machines During the period 1990­2003, Turkey's total and telecommunications equipment, 15.4 percent; exports grew at an annual rate of 9 percent and pharmaceuticals, 14.2 percent; and organic chemi- total imports at a rate of 8.3 percent. The export cals, 11 percent. The three import commodities commodities with the highest annual growth rates with the highest growth rates were pharmaceuticals, were other products, 30.2 percent; power generat- 12.4 percent; electrical machinery and apparatus, ing machinery, 24.8 percent; and automotive prod- 12.1 percent; and office machines and telecommu- ucts, 24.4 percent. The import commodities with nications equipment, 11.8 percent. Examination of the highest growth rates were other products, 27.1 Turkey's share of total sectoral EU exports reveals percent, clothing, 24.9 percent; and pharmaceuti- that the highest shares of exports to Turkey are held cals, 17.1 percent. Similarly, the export commodi- by ores and other minerals, 5.7 percent; plastics, ties to the EU with the highest growth rates were 5 percent; and agricultural raw materials, 4.6 per- automotive products, 29.3 percent; other transport cent. Among the sectors considered, food, clothing, equipment, 23.1 percent; and power generating and fuels have the lowest shares of exports to machinery, 22.8 percent. The imported commodi- Turkey. The three sectors with the highest shares of ties from the EU with the highest growth rates were imports from Turkey of sectoral EU imports are clothing, 21.7 percent; other products, 18.8 percent; textiles, 11.7 percent; clothing, 11.2 percent; and and pharmaceuticals, 17.1 percent. iron and steel, 6.4 percent. Among the sectors con- A look at the EU's share of total sectoral exports sidered, fuels, pharmaceuticals, and other chemi- reveals that the highest shares of exports to the EU cals have the lowest shares of imports from Turkey are held by office machines and telecommunica- of sectoral EU imports. tions equipment, 79.3 percent; clothing, 71.1 per- As noted earlier, as of January 1, 1996, Turkey cent; and automotive products, 63.7 percent. and the EU entered a customs union. Table 3.3 Among the sectors considered, other chemicals, shows the evolution of Turkish trade with the EU other products, and plastics have the lowest shares. over the period 1990­2003. The data reveal that The three sectors with the highest EU shares of sec- with the formation of the customs union, the share toral imports are automotive products, 83 percent; of imports from the EU of total imports went up other transport equipment, 70.3 percent; and phar- from 47.2 in 1995 to 53 percent in 1996, but then maceuticals, 67.1 percent. Among the sectors con- began to decrease, reaching 45.4 percent in 2003. sidered, fuels, other products, and food have the Comparison of the growth rate of Turkish imports lowest EU shares of sectoral imports. from the EU prior to formation of the customs Table 3.2 shows similar information for the EU. union with that observed after formation of the It reveals that in 2001 the EU's merchandise exports customs union shows that the average growth rate amounted to ECU (European currency unit) of imports from the EU has even declined, from 982.6 billion and merchandise imports were ECU 9.1 percent during 1990­95 to 1.5 percent during 1,028 billion. Exports to Turkey made up 2 percent 1996­2003. On the other hand, annual average TABLE 3.2 Exports and Imports, EU, 1990­2001 Total Annual Exports Share of Total Annual Imports Share of Exports, Growth Rate to Turkey, Exports to Turkey Imports, Growth Rate from Turkey Imports from 2001 of Exports, 2001 of Sectoral 2001 of Imports, 2001 Turkey in Sectoral (thousands Percentage 1990­2001 (thousands Exports, (thousands Percentage 1990­2001 (thousands Imports, SITC Commodity of ECU) Distribution (percent) of ECU) 2001 of ECU) Distribution (percent) of ECU) 2001 Agricultural products 0 + 1 + 4 + 22 Food 54,042,390 5.50 4.80 378,968 0.70 66,571,904 6.48 4.52 2,094,348 3.15 2 - 22 - 27 - 28 Agricultural raw 10,740,870 1.09 7.48 491,794 4.58 23,074,732 2.24 1.14 228,864 0.99 materials Mining products 27 + 28 Ores and other 4,860,506 0.49 5.76 275,558 5.67 17,659,307 1.72 5.50 270,064 1.53 minerals 3 Fuels 23,892,389 2.43 7.25 311,131 1.30 144,980,806 14.10 5.81 246,383 0.17 68 Nonferrous metals 11,936,772 1.21 6.99 197,170 1.65 23,351,448 2.27 6.51 239,103 1.02 Manufactures 67 Iron and steel 19,976,063 2.03 2.97 667,511 3.34 14,075,992 1.37 4.47 905,075 6.43 Chemicals 51 Organic chemicals 33,838,441 3.44 11.04 676,813 2.00 20,696,334 2.01 9.25 89,717 0.43 57 + 58 Plastics 20,724,369 2.11 7.67 1,027,062 4.96 10,758,582 1.05 4.68 114,084 1.06 52 Inorganic chemicals 5,388,087 0.55 4.72 81,981 1.52 6,264,051 0.61 7.71 128,624 2.05 54 Pharmaceuticals 43,908,279 4.47 14.16 915,569 2.09 22,620,592 2.20 12.37 42,924 0.19 53 + 55 + 56 + 59 Other chemicals 38,460,679 3.91 7.48 1,229,805 3.20 17,193,103 1.67 7.44 44,913 0.26 6 - 65 - 67 - 68 Other semimanufactures 87,731,435 8.93 8.24 1,509,193 1.72 68,710,081 6.68 5.46 1,509,363 2.20 Machinery and transport equipment 71 - 713 Power generating 34,903,182 3.55 9.54 595,281 1.71 24,777,213 2.41 11.57 92,876 0.37 machinery 72 + 73 + 74 Other nonelectrical 118,584,299 12.07 6.77 2,719,502 2.29 53,724,194 5.23 6.99 404,780 0.75 machinery 75 + 76 + 776 Office machines and 96,408,088 9.81 15.37 1,909,617 1.98 146,734,704 14.27 11.75 1,005,984 0.69 telecommunications equipment 77 - 776 - 7783 Electrical machinery 50,751,415 5.17 10.10 896,479 1.77 47,678,281 4.64 12.06 845,547 1.77 and apparatus 78 - 785 - 786 + Automotive products 97,777,703 9.95 9.16 1,920,099 1.96 50,701,618 4.93 8.21 1,892,016 3.73 7132 + 7783 91 92 TABLE 3.2 (Continued) Total Annual Exports Share of Total Annual Imports Share of Exports, Growth Rate to Turkey, Exports to Turkey Imports, Growth Rate from Turkey Imports from Turkey 2001 of Exports, 2001 of Sectoral 2001 of Imports, 2001 in Sectoral (thousands Percentage 1990­2001 (thousands Exports, (thousands Percentage 1990­2001 (thousands Imports, SITC Commodity of ECU) Distribution (percent) of ECU) 2001 of ECU) Distribution (percent) of ECU) 2001 79 + 785 + 786 + Other transport 63,162,827 6.43 10.38 972,860 1.54 56,327,638 5.48 10.78 706,280 1.25 7131 + 7133 + equipment 7138 + 7139 65 Textiles 24,739,564 2.52 6.07 978,099 3.95 19,178,029 1.87 5.02 2,242,208 11.69 84 Clothing 17,559,440 1.79 4.29 218,928 1.25 53,910,204 5.24 8.05 6,060,245 11.24 8 - 84 - 86 - 891 Other consumer 101,086,773 10.29 7.32 1,443,680 1.43 106,259,111 10.34 8.11 867,501 0.82 goods 9 + 891 Other products 22,106,890 2.25 2.54 398,968 1.80 32,781,100 3.19 2.83 124,630 0.38 Total 982,580,462 100 8.23 19,816,069 2.02 1,028,029,024 100 7.48 20,155,528 1.96 Note: SITC = Standard International Trade Classification; ECU = European currency unit. Sources: Data provided by Eurostat; the authors. TABLE 3.3 Trade with EU, 1990­2003 Growth Rate Growth Rate Growth Rate Growth Rate Total Imports from of Total of Imports Share of Imports Total Exports to of Total of Exports Share of Exports Trade Balance Real Imports EU Imports from EU from EU of Exports EU Exports to EU to EU of with EU Exchange (US$ millions) (US$ millions) (percent) (percent) Total Imports (US$ millions) (US$ millions) (percent) (percent) Total Exports (US$ millions) Rate 1990 22,302 9,898 -- -- 44.38 12,959 7,177 -- -- 55.38 -2,721 99.67 1991 21,047 9,987 -5.63 0.90 47.45 13,594 7,348 4.90 2.38 54.05 -2,639 96.66 1992 22,870 10,656 8.66 6.70 46.59 14,719 7,937 8.28 8.02 53.92 -2,719 100.94 1993 29,429 13,875 28.68 30.21 47.15 15,348 7,599 4.27 -4.26 49.51 -6,276 91.59 1994 23,270 10,915 -20.93 -21.33 46.91 18,105 8,635 17.96 13.63 47.69 -2,280 124.35 1995 35,708 16,861 53.45 54.48 47.22 21,636 11,078 19.50 28.29 51.20 -5,783 116.72 1996 43,627 23,138 22.18 37.23 53.04 23,224 11,549 7.34 4.25 49.73 -11,589 116.67 1997 48,559 24,870 11.30 7.49 51.22 26,261 12,248 13.08 6.05 46.64 -12,622 110.32 1998 45,921 24,075 -5.43 -3.20 52.43 26,974 13,498 2.72 10.21 50.04 -10,577 100.42 1999 40,687 21,417 -11.40 -11.04 52.64 26,589 14,349 -1.43 6.30 53.97 -7,068 94.30 2000 54,509 26,610 33.97 24.25 48.82 27,775 14,510 4.46 1.12 52.24 -12,100 85.17 2001 41,399 18,280 -24.05 -31.30 44.16 31,334 16,118 12.81 11.08 51.44 -2,162 106.33 2002 51,554 23,321 24.53 27.57 45.24 36,059 18,459 15.08 14.52 51.19 -4,863 96.11 2003 69,340 31,496 34.50 35.05 45.42 47,253 24,350 31.04 31.92 51.53 -7,146 88.23 Average 1990­95 8.31 9.13 46.62 9.90 7.46 51.96 Average 1996­2003 4.20 1.46 50.38 8.39 9.30 50.68 -- Not available. Note: An increase in the real exchange rate (RER) indicates depreciation of the RER. Source: State Planning Organization (http://www.dpt.gov.tr); the authors. 93 94 Turkey: Economic Reform and Accession to the European Union growth rate of Turkish exports to the EU, which 1999, the Marmara area of Turkey was hit by a was 7.5 percent prior to formation of the customs severe earthquake, which was followed by a further union, increased to 9.3 percent over the period large shock in the Bolu area in November 1999. As a 1996­2003. Similarly, the share of exports to the EU result of these shocks, real GNP shrank by 6.1 per- of total exports increased from 51.2 percent in 1995 cent in 1999. At the end of 1999, Turkey embarked to 54 percent in 1999, but thereafter the share upon a stabilization program, but a severe banking declined to 51.5 percent in 2003. Finally, table 3.3 crisis arose in November 2000. Developments in reveals as well that Turkey has run a trade deficit February 2001 led to a total loss of confidence in with the EU during every year of the period the government's stabilization program and a seri- 1996­2003 and that the deficit has been substantial ous run on the Turkish lira. With the floating of its by any standard. It reached $12.6 billion in 1997 currency, the country faced its severest economic and $7.1 billion in 2003. crisis. The loss of income and wealth and the associ- These findings reveal that the formation of the ated social and political stresses were unprecedented. customs union between Turkey and the EU did not As a result of these developments, the country saw lead initially to considerable increases in trade with substantial decreases in import demand during the EU. Substantial increases in trade with the EU 1994, 1999, and 2001. were achieved only during the period 2002­03. The Fourth, with the substantial reductions in trade reasons vary. First, the formation of the customs barriers on the Turkish side during 1996,the increase union did not lead to considerable reductions in in imports was inevitable, so long as it was not trade barriers on the EU side, because the EU had accompanied by a real devaluation of the Turkish abolished the nominal tariff rates on imports of lira. As table 3.3 reveals, there was no change in the industrial goods from Turkey on September 1, real exchange rate during 1996, and it then began to 1971, long before the formation of the customs appreciate until the currency crisis of 2001. The real union. But at that time certain exceptions were appreciation of the Turkish lira stimulated the made. The European Community had retained the import growth and hampered the growth of exports, right to charge import duties on some oil products leading to higher trade balance deficits. Also during over a fixed quota and to implement a phased the period 2001­03, the euro appreciated against the reduction of duties on imports of particular textile U.S. dollar, leading to increases in the dollar value of products. Moreover, the trade in products within EU exports, which was then reflected in the higher the province of the ECSC have been protected by dollar trade values of Turkish imports from the EU the Community through the application of nontariff and of exports to the EU. barriers and, in particular, antidumping meas- Table 3.4 shows the commodity composition of ures. With the formation of the customs union, Turkish exports to the EU and imports from the quotas applied by the EU were abolished, but the EU, as well as the shares of Turkish exports to the EU retained the right to impose antidumping EU of total EU imports and the shares of Turkish duties. imports from the EU of total EU exports over Second, not until 2003 did Turkey incorporate the period 1995­2001. The table reveals that in into its internal legal order the European Commu- absolute terms Turkey achieved large increases nity instruments related to removal of technical in exports for clothing, automotive products, tex- barriers to trade that would allow Turkish industrial tiles, other semimanufactures, office machines and products to enter into free circulation in the EU. telecommunications equipment, and iron and steel. Third, during the 1990s economic crises began For these commodities, Turkey experienced consid- to affect Turkey with increasing frequency. Periods erable increases in the shares of its exports to the of economic expansion alternated with periods of EU of total EU imports. As for Turkish imports, equally rapid decline. After a year of severe reces- again in absolute terms, large increases in imports sion in 1994 when the gross national product were observed for chemicals, office machines and (GNP) shrank by 6.1 percent, the economy went telecommunications equipment, automotive prod- through a boom period of above-trend growth ucts, and other consumer goods. For those com- between 1995 and 1997. Then, in 1998, the econ- modities, the shares of Turkish imports from the omy was badly hit by the Russian crisis. In August EU of total EU exports also increased. TABLE 3.4 Effects of Customs Union between Turkey and EU, 1995­2001 (thousands of ECU) Turkish Exports to EU SITC Commodity 1995 1996 1997 1998 1999 2000 2001 Agricultural products 0 + 1 + 4 + 22 Food 1,488,476 1,551,769 1,812,357 1,780,063 1,907,213 1,841,607 2,094,348 2 - 22 - 27 - 28 Agricultural raw 179,233 205,765 216,488 210,663 213,382 213,457 228,864 materials Mining products 27 + 28 Ores and other 221,117 212,143 237,159 239,314 243,109 322,824 270,064 minerals 3 Fuels 128,412 122,060 125,193 81,415 127,553 191,871 246,383 68 Nonferrous metals 86,544 97,097 99,635 157,722 152,601 216,471 239,103 Manufactures 67 Iron and steel 294,209 229,501 371,900 545,231 592,639 791,231 905,075 5 Chemicals 237,583 198,285 258,291 274,909 297,999 386,476 420,262 6 - 65 - 67 - 68 Other semimanufactures 572,754 638,208 776,036 879,443 979,327 1,234,435 1,509,363 Machinery and transport equipment 71 - 713 Power generating 31,551 48,097 73,328 81,867 86,265 89,163 92,876 machinery 72 + 73 + 74 Other nonelectrical 106,447 129,455 175,601 211,566 261,858 330,166 404,780 machinery 75 + 76 + 776 Office machines and 167,685 214,597 388,026 688,309 671,934 936,482 1,005,984 telecommunications equipment 77 - 776 - 7783 Electrical machinery 301,881 386,368 449,078 574,577 614,099 714,463 845,547 and apparatus 78 - 785 - 786 + Automotive products 270,766 357,760 301,337 389,917 995,122 1,212,181 1,892,016 7132 + 7783 79 + 785 + 786 + Other transport 391,498 625,377 485,647 670,554 665,531 675,812 706,280 7131 + 7133 + equipment 7138 + 7139 65 Textiles 1,013,714 1,110,291 1,440,550 1,663,269 1,774,158 2,041,595 2,242,208 84 Clothing 3,434,992 3,636,313 4,175,655 4,632,190 4,808,707 5,576,756 6,060,245 8 - 84 - 86 - 891 Other consumer goods 271,714 347,685 403,340 442,251 582,351 679,154 867,501 9 + 891 Other products 45,150 48,420 54,352 75,862 69,906 74,247 124,630 Total 9,243,725 10,159,191 11,843,971 13,599,124 15,043,754 17,528,392 20,155,528 95 96 TABLE 3.4 (Continued) Turkish Imports from EU SITC Commodity 1995 1996 1997 1998 1999 2000 2001 Agricultural products 0 + 1 + 4 + 22 Food 615,174 607,284 632,062 605,447 501,142 579,811 378,968 2 - 22 - 27 - 28 Agricultural raw 393,666 459,321 589,606 447,182 379,080 533,469 491,794 materials Mining products 27 + 28 Ores and other 487,556 528,444 462,002 269,811 152,588 261,142 275,558 minerals 3 Fuels 119,124 227,392 264,755 271,988 387,760 763,082 311,131 68 Nonferrous metals 183,778 228,589 260,355 224,136 180,355 253,115 197,170 Manufactures 67 Iron and steel 586,834 694,789 845,798 641,451 479,250 880,515 667,511 5 Chemicals 2,043,193 2,441,128 3,184,322 3,213,593 3,465,937 4,569,685 3,931,231 6 - 65 - 67 - 68 Other semimanufactures 978,841 1,339,036 1,568,580 1,567,096 1,400,645 1,912,605 1,509,193 Machinery and transport equipment 71 - 713 Power generating 178,837 252,654 393,062 555,062 442,280 545,555 595,281 machinery 72 + 73 + 74 Other nonelectrical 2,372,464 3,786,516 3,994,368 3,678,348 2,596,553 3,538,331 2,719,502 machinery 75 + 76 + 776 Office machines and 765,742 1,023,595 1,523,088 1,995,757 2,799,791 4,055,137 1,909,617 telecommunications equipment 77 - 776 - 7783 Electrical machinery 546,930 769,613 1,065,654 1,226,264 1,059,906 1,300,772 896,479 and apparatus 78 - 785 - 786 + Automotive products 1,237,308 1,909,360 3,201,332 2,866,472 2,304,918 5,568,748 1,920,099 7132 + 7783 79 + 785 + 786 + Other transport 690,618 1,214,031 968,872 941,586 946,855 1,032,438 972,860 7131 + 7133 + equipment 7138 + 7139 65 Textiles 584,726 786,038 997,564 946,855 859,326 1,063,715 978,099 84 Clothing 64,034 122,894 171,487 205,098 174,845 248,766 218,928 8 - 84 - 86 - 891 Other consumer goods 808,246 1,041,430 1,324,120 1,391,441 1,331,107 1,750,501 1,443,680 9 + 891 Other products 690,158 514,377 185,256 447,875 406,893 567,749 398,968 Total 13,347,228 17,946,494 21,632,282 21,495,462 19,869,232 29,425,136 19,816,069 Share of Imports from Turkey of EU Imports SITC Commodity 1995 1996 1997 1998 1999 2000 2001 Agricultural Products 0 + 1 + 4 + 22 Food 2.955 2.948 3.225 3.075 3.327 2.966 3.146 2 - 22 - 27 - 28 Agricultural raw materials 0.871 1.151 1.067 1.058 1.099 0.850 0.992 Mining products 27 + 28 Ores and other minerals 1.767 1.718 1.597 1.650 1.778 1.798 1.529 3 Fuels 0.198 0.155 0.147 0.132 0.163 0.129 0.170 68 Nonferrous metals 0.531 0.719 0.586 0.885 0.889 0.855 1.024 Manufactures 67 Iron and steel 2.942 2.754 4.000 4.424 5.813 5.454 6.430 5 Chemicals 0.552 0.447 0.501 0.495 0.506 0.542 0.542 6 - 65 - 67 - 68 Other semimanufactures 1.490 1.578 1.688 1.816 1.827 1.861 2.197 Machinery and transport equipment 71 - 713 Power generating machinery 0.349 0.438 0.529 0.497 0.439 0.360 0.375 72 + 73 + 74 Other nonelectrical machinery 0.371 0.413 0.500 0.529 0.605 0.618 0.753 75 + 76 + 776 Office machines and 0.245 0.290 0.440 0.681 0.584 0.581 0.686 telecommunications equipment 77 - 776 - 7783 Electrical machinery and apparatus 1.251 1.530 1.491 1.736 1.632 1.392 1.773 78 - 785 - 786 + Automotive products 1.278 1.555 1.024 1.073 2.309 2.506 3.732 7132 + 7783 79 + 785 + 786 + 7131 + Other transport equipment 1.797 2.549 1.458 1.665 1.407 1.219 1.254 7133 + 7138 + 7139 65 Textiles 7.796 8.397 9.287 10.134 11.041 10.800 11.692 84 Clothing 11.049 10.863 10.768 11.306 10.999 10.878 11.241 8 - 84 - 86 - 891 Other consumer goods 0.487 0.580 0.578 0.589 0.702 0.662 0.816 9 + 891 Other products 0.282 0.284 0.300 0.332 0.310 0.217 0.380 Total 1.695 1.749 1.761 1.914 1.929 1.696 1.961 97 98 TABLE 3.4 (Continued) Share of Exports to Turkey of EU Exports SITC Commodity 1995 1996 1997 1998 1999 2000 2001 Agricultural Products 0 + 1 + 4 + 22 Food 1.488 1.399 1.296 1.286 1.078 1.101 0.701 2 - 22 - 27 - 28 Agricultural raw materials 4.901 5.835 6.835 5.484 4.259 4.812 4.579 Mining products 27 + 28 Ores and other minerals 14.852 15.620 10.797 8.375 4.228 5.376 5.669 3 Fuels 0.893 1.469 1.544 1.941 2.337 2.564 1.302 68 Nonferrous metals 2.635 3.061 3.021 2.716 2.190 2.122 1.652 Manufsactures 67 Iron and steel 3.532 3.959 4.475 3.625 3.204 4.515 3.342 5 Chemicals 2.781 3.081 3.414 3.349 3.250 3.529 2.762 6 - 65 - 67 - 68 Other semimanufactures 1.764 2.225 2.327 2.339 1.998 2.247 1.720 Machinery and transport equipment 71 - 713 Power generating machinery 1.139 1.427 1.815 2.232 1.723 1.808 1.706 72 + 73 + 74 Other nonelectrical machinery 2.889 4.141 3.951 3.663 2.744 3.225 2.293 75 + 76 + 776 Office machines and 1.825 2.169 2.550 3.143 3.913 4.014 1.981 telecommunications equipment 77 - 776 - 7783 Electrical machinery and apparatus 1.945 2.417 2.899 3.228 2.715 2.700 1.766 78 - 785 - 786 + Automotive products 2.339 3.306 4.764 4.075 3.220 6.166 1.964 7132 + 7783 79 + 785 + 786 + 7131 + Other transport equipment 1.966 3.280 2.153 1.945 1.918 1.729 1.540 7133 + 7138 + 7139 65 Textiles 3.480 4.376 4.947 4.667 4.269 4.532 3.954 84 Clothing 0.561 0.953 1.235 1.450 1.275 1.565 1.247 8 - 84 - 86 - 891 Other consumer goods 1.354 1.611 1.781 1.865 1.701 1.833 1.428 9 + 891 Other products 6.328 3.878 1.296 2.557 1.965 2.486 1.805 Total 2.328 2.866 3.000 2.931 2.614 3.126 2.017 Note: For abbreviations, see table 3.2 Source: Data provided by Eurostat; the authors. Integration and the Manufacturing Industry 99 Structure of Protection sector j, M j total imports of sector j, and k the To study the structure of applied tariffs, we con- number of commodities in sector j ( j = 1, . . . , 68). Table 3.5 shows the nominal and effective pro- sider tariff and tariff-like charges on imports in tection rates for the 68 tradable sectors of the 1996 trade with the EU, with countries with whom the input-output table prepared by Turkey's State Insti- EU has free trade agreements, and with third coun- tute of Statistics. The table reveals that the weighted tries. In each case, we use the 12-digit Harmonized average nominal protection rate (NPR) during Commodity Description and Coding System (HS) 2002 in trade with the EU is 1.95 percent; in trade data on customs duties and the mass housing fund tax.5 Let tc denote the rate of customs duty on com- i with Romania, a representative country among the economies with which Turkey has free trade agree- modity i and tis the ad valorem equivalent of the ments, 1.76 percent; and in trade with third coun- mass housing fund tax rate. The relation between tries, 5.3 percent. By contrast, the weighted average domestic prices and foreign prices is written as pi = (1 + tc + tis ) E pi , where pi denotes the i $ effective protection rate (EPR) is 11.24 percent.6 Table 3.6 shows the frequency distribution of domestic price of commodity i, pi the foreign $ the NPRs and EPRs. Forty-eight out of 68 sectors price of commodity i, and E the nominal exchange have zero NPRs in trade with the EU and in trade rate. To calculate the ad valorem equivalent of the with the countries with which Turkey has FTAs. In mass housing duty, we let Mi denote the CIF (cost, trade with the EU, five sectors have NPRs larger insurance, freight) value of the import of commod- than 50 percent, and seven sectors have NPRs of ity i measured in Turkish liras; mi the quantity of between 10 percent and 50 percent. Similar consid- the import of commodity i measured in units (the erations apply for NPRs in trade with countries U.S. dollar­denominated housing fund tax is reported); FUNDi1 the U.S. dollar­denominated with which Turkey has FTAs. The NPRs in trade with third countries are larger than 50 percent in mass housing fund tax rate on commodity i; seven sectors, between 10 percent and 50 percent FUND2 the ad valorem housing fund tax rate on i in 10 sectors, and positive but less than 5 percent in commodity i; and E the exchange rate (Turkish lira 38 sectors. Concomitant with the relatively low per U.S. dollar). NPRs are the low EPRs. Six sectors have EPRs above The base of the customs duty is the CIF price. Therefore, this duty is calculated as tc Mi. The mass i 50percent,andsixsectorshaveEPRsbetween10per- cent and 50 percent. In 20 sectors the EPRs are neg- housing fund tax levy is usually specific. For those taxes, the ad valorem equivalents of the specific ative but larger than -100. The EPR is less than rates must be calculated. Given the foreign price of -100 in only one sector. the commodity, p$j = Mj Table 3.5 shows that NPRs in trade with the EU , the Turkish lira equiva- mj E and with countries with which Turkey has FTAs are lent of the U.S. dollar­denominated levy is calcu- lated as FUNDi1mi E = (Mi(FUNDi1/pi )). The ad $ all zero for industrial commodities and positive for agricultural and processed agricultural commodi- valorem mass housing fund tax rate is given by FUNDi2Mi. The sum total of all the above taxes and ties. For trade with third countries, the average NPRs are high for food products, 11.1 percent for surcharges is denoted by iron and steel, 10.92 percent for wearing apparel, 10.28 percent for footwear, 7.01 percent for textiles, (3.1) ti = tc + FUNDi1 pi i $+ FUNDi2 and 6.74 percent for plastics. The most protected sectors measured in terms of EPRs are the manu- Next we consider the tradable sectors in the 1996 facture of sugar; manufacture of bakery products; input-output table. The average applied tariff in processing and preserving of fruits and vegetables; sector j is then calculated as growing of fruits, nuts, beverage and spice crops; and manufacture of cocoa, chocolate, sugar confec- k tionary, and other food products. The sectors indi- (3.2) applied tariff j = tij Mij M j i=1 cating a clear-cut comparative advantage include the manufacture of textiles; casting of metals; man- where ti denotes the applied tariff rate on commod- j ufacture of fabricated metal products; manufacture ity i of sector j, Mi the import of commodity i into j of furniture; manufacture of office, accounting, 100 Turkey: Economic Reform and Accession to the European Union TABLE 3.5 Nominal and Effective Protection Rates, 2002 (percent) NPR, NPR, NPR, I-O Code Sector EU EU with FTAs Other EPR 01 Growing of cereals and other crops NEC 8.83 8.84 8.84 9.93 02 Growing of vegetables, horticultural 14.37 16.00 16.00 17.74 specialties, and nursery products 03 Growing of fruit, nuts, beverage and 74.23 70.49 78.46 82.18 spice crops 04 Farming of animals 2.33 2.29 2.74 -2.60 05 Agricultural and animal husbandry service 21.82 26.35 26.35 48.50 activities, except veterinary activities 06 Forestry, logging, and related service activities 0.22 0.28 0.28 0.08 07 Fishing 30.10 12.80 56.06 50.42 08 Mining of coal and lignite 0.00 0.00 0.00 -0.17 09 Extraction of crude petroleum and natural gas 0.00 0.00 0.00 -0.17 10 Mining of metal ores 0.00 0.00 0.77 0.05 11 Quarrying of stone, sand and clay 0.00 0.00 0.00 -0.27 12 Mining and quarrying NEC 0.00 0.00 0.02 -0.16 13 Production, processing, and preserving 1.51 1.52 1.52 -1.52 of meat and meat products 14 Processing and preserving of fish and 14.25 9.48 28.48 19.92 fish products 15 Processing and preserving of fruit, 55.54 46.79 65.09 90.68 and vegetables 16 Manufacture of vegetable and animal 13.82 9.37 14.59 18.24 oils and fats 17 Manufacture of dairy products 107.61 107.46 109.49 a 18 Manufacture of grain mill products, starches, 21.71 17.12 24.78 46.99 and starch products 19 Manufacture of prepared animal feeds 6.36 6.36 6.57 -0.08 20 Manufacture of bakery products 83.23 8.72 109.61 b 21 Manufacture of sugar 78.49 78.49 78.49 b 22 Manufacture of cocoa, chocolate, sugar 34.64 12.16 55.61 54.49 confectionery and other food products NEC 23 Manufacture of alcoholic beverages 2.73 2.90 4.03 0.86 24 Manufacture of soft drinks; production 0.11 0.01 9.03 -5.47 of mineral waters 25 Manufacture of tobacco products 2.01 17.29 17.29 11.37 26 Manufacture of textiles 0.00 0.01 7.01 -2.95 27 Manufacture of other textiles 0.00 0.00 3.02 -0.07 28 Manufacture of knitted and crocheted 0.00 0.00 10.25 3.70 fabrics and articles 29 Manufacture of wearing apparel, except 0.00 0.00 10.92 7.01 fur apparel 30 Dressing and dyeing of fur; manufacture 0.00 0.00 2.05 0.62 of articles of fur 31 Tanning and dressing of leather; manuf. of 0.00 0.00 1.17 -0.85 luggage, handbags, saddlery, and harnesses 32 Manufacture of footwear 0.00 0.00 10.28 8.87 33 Sawmilling and planing of wood 0.00 0.00 0.71 -0.41 34 Manufacture of wood and of products of 0.00 0.00 4.95 3.23 wood and cork 35 Manufacture of paper and paper products 0.00 0.00 1.49 0.18 36 Publishing 0.00 0.00 1.53 0.55 37 Printing and service activities related to 0.00 0.00 2.18 0.88 printing Integration and the Manufacturing Industry 101 TABLE 3.5 (Continued) NPR, NPR, NPR, I-O Code Sector EU EU with FTAs Other EPR 38 Manufacture of coke, refined petroleum 0.00 0.00 2.91 1.96 products 39 Manufacture of basic chemicals, plastics in 0.01 0.01 6.31 2.79 primary forms and synthetics rubber 40 Manufacture of fertilizers and nitrogen 0.00 0.00 6.49 4.00 compounds 41 Manufacture of pesticides, other 0.00 0.00 6.00 2.92 agrochemicals and paints, and varnishes 42 Manufacture of pharmaceuticals, medicinal 0.00 0.00 0.97 0.12 chemicals, and botanical products 43 Manufacture of cleaning materials, cosmetics, 0.01 0.02 4.29 1.07 and other chemicals and manmade fibers 44 Manufacture of rubber products 0.00 0.00 3.61 1.38 45 Manufacture of plastic products 0.00 0.00 6.74 3.30 46 Manufacture of glass and glass products 0.00 0.00 4.90 2.32 47 Manufacture of ceramic products 0.00 0.00 4.76 2.63 48 Manufacture of cement, lime, and 0.00 0.00 1.94 0.87 plaster-related articles of these items 49 Cutting and finishing of stone and man. of 0.00 0.00 1.21 0.40 other nonmetallic mineral products NEC 50 Manufacture of basic iron and steel 0.00 0.00 11.10 6.23 51 Manufacture of basic precious and 0.00 0.00 3.40 1.54 nonferrous metals 52 Casting of metals 0.00 0.00 0.00 -1.89 53 Manufacture of fabricated metal products, 0.00 0.00 2.29 -0.87 tanks, reservoirs, and steam generators 54 Manufacture of other fabricated metal 0.00 0.00 2.55 -0.06 products; metalworking service activities 55 Manufacture of general-purpose machinery 0.00 0.00 2.53 0.16 56 Manufacture of special-purpose machinery 0.00 0.00 1.65 -0.06 57 Manufacture of domestic appliances NEC 0.00 0.00 2.55 0.61 58 Manufacture of office, accounting, and 0.00 0.00 0.06 -0.35 computing machinery 59 Manufacture of electrical machinery and 0.00 0.00 2.77 0.58 apparatus NEC 60 Manufacture of radio, television, and 0.00 0.00 2.95 1.25 communication equipment and apparatus 61 Manufacture of medical, precision and optical 0.00 0.00 1.81 0.32 instruments, watches, and clocks 62 Manufacture of motor vehicles, trailers, 0.00 0.00 4.33 1.71 and semitrailers 63 Building and repairing of ships, pleasure 0.00 0.00 0.25 -0.22 and sporting boats 64 Manufacture of railway and tramway 0.00 0.00 1.69 0.48 locomotives and rolling stock 65 Manufacture of aircraft and spacecraft 0.00 0.00 0.00 -0.02 66 Manufacture of transport equipment NEC 0.00 0.00 4.03 1.60 67 Manufacture of furniture 0.00 0.00 1.14 -0.66 68 Manufacturing NEC 0.00 0.00 3.29 1.36 Average 1.95 1.76 5.30 11.24 Note: I-O = input-output table; NPR = nominal protection rate; FTA = free trade agreement; EPR = effective protection rate; NEC = not elsewhere classified. a. Less than -100. b. More than 100. Source: Turkish State Institute of Statistics; the authors. 102 Turkey: Economic Reform and Accession to the European Union TABLE 3.6 Frequency Distribution of Protection Rates, 2002 (percent) NPR, NPR, NPR, EU EU with FTAs Other EPR 50.00 5 3 7 6 10.01­50.00 7 7 10 6 5.01­10.00 2 5 8 4 0.01­5.00 6 5 38 31 0 48 48 5 0 -0.01­100.00 0 0 0 20 -100.00 0 0 0 1 Total 68 68 68 68 Note: For abbreviations, see table 3.5. Source: The authors. TABLE 3.7 Nominal and Effective Protection Rates, 2002 (percent) NPR, NPR, NPR, EU EU with FTAs Other EPR Commodity groups Primary commodities 18.23 18.06 20.21 25.57 Mining and energy 0.00 0.00 0.08 -0.17 Manufacturing 3.07 2.07 6.11 4.50 Trade categories Export industries 11.64 10.06 22.26 21.54 Export- and import- competing industries 0.53 0.36 5.89 1.81 Import-competing industries 3.90 3.90 5.73 3.82 Non-import-competing industries 24.62 20.12 28.72 27.03 Note: For abbreviations, see table 3.5. Source: The authors. and computing machinery; manufacture of basic Calculations presented in the upper part of precious and nonferrous metals; manufacture of table 3.7 reveal that primary commodities receive the basic iron and steel; and mining products.7 most protection, contrary to the tendency for pro- Now we move from the structure of protection at tection to escalate from the lower to higher stages of the industry level to a more aggregate level. Table 3.7 fabrication. The lower part of the table shows that presents the NPR and EPR for broad industry the most protected sectors are the export industries groups. In the upper part of this table, industries and the non-import-competing industries. have been classified into three industry groups. In the lower part, they have been divided into Contingent Protectionism four trade categories: export, export and import competing, import competing, and non-import Article 36 of the Customs Union Decision of 1995 competing.8 specifies that as long as a particular practice is Integration and the Manufacturing Industry 103 incompatible with the competition rules of the on levels. These products were cotton yarn, poly- customs union as specified in Articles 30­32 of the ester fibers and yarns, semifinished products of decision and "in the absence of such rules if such alloy steel, and asbestos cement pipes. After 1996, practice causes or threatens to cause serious preju- the EU opened new investigations involving dice to the interest of the other Party or material Turkish exports of cotton fabrics, bed linen, iron injury to its domestic industry," the European and steel products, paracetamol, color television Community or Turkey may take the appropriate receivers, and hallow sections. By contrast, at the measures. Article 42 allows antidumping actions as end of 1995 Turkey had imposed duties on three long as Turkey fails to implement effectively the commodities: benzoic acids, printing and writing competition rules of the customs union and other papers, and polyester. After 1996, Turkey opened relevant parts of the acquis communautaire. In such two new investigations involving imports of ball cases, Article 47 of the Additional Protocol signed bearings and polyvinyl chloride from the EU and in 1970 between Turkey and the European Com- imposed antidumping duties in the case of the munity remains in force. According to the article, latter. the Association Council, if it finds dumping, will Both the EU and Turkey have been active users of address recommendations to the persons with contingent protection measures, but the EU even whom such practices originate. The injured party more so. The results indicate that the formation of may take suitable measures if the Council has made the customs union does not grant protection from no decision within three months and if the dump- antidumping by the European Community. The EU ing practices continue. In the event a party needs an has continued to protect its sensitive sectors immediate action, it may introduce an interim pro- through contingent protection measures and has tection measure such as antidumping duties for a protected the sectors most where Turkish penetra- limited duration. But the Council may recommend tion measured by the share of Turkish exports of EU the abolition of those interim measures. Finally, imports was highest (see table 3.2). With Turkey's Article 61, which addresses safeguards, states that accession to the EU, the contingent protection safeguard measures specified in Article 60 of the measures will no longer be available to both parties. Additional Protocol will remain valid. According to Article 60, the Community or Turkey may take the Technical Barriers to Trade necessary protective measures if serious distur- bances occur in a sector of the economy of the Technical barriers to trade are said to exist as long Community or Turkey or if they prejudice the as the EU and Turkey impose different technical external financial stability of one or more member regulations as conditions for the entry, sale, and use states or Turkey, or if difficulties arise that adversely of commodities; as long as the two parties have dif- affect the economic situation in a region of the ferent legal regulations on health, safety, and envi- Community or Turkey. ronmental protection; and as long as the parties Table 3.8 shows the products that were subject to have different procedures for testing and certifica- definitive antidumping and antisubsidy measures tion to ensure conformity to existing regulations or by both parties at the end of 1995 and those subject standards.9 The different country requirements for to antidumping and antisubsidy investigations dur- the entry, sale, and use of commodities can be ing the period 1996­2002. The table reveals that at imposed by governments in the form of technical the end of 1995, eight products exported from regulations and by nongovernmental organizations Turkey were subject to definitive antidumping and in the form of standards. Technical regulations that antisubsidy measures by the EU. Ad valorem duties relate to either technical specifications or testing or were imposed in five cases, a duty and "undertak- certification requirements are mandatory, and the ings" were imposed in one case, and in the remain- product must comply with the specifications to ing cases undertakings were imposed. In undertak- which it is subjected. However, standards are volun- ings, the Turkish firms must commit themselves to tary, not legally binding, and arise from the desire raising the export prices in the European Commu- of producers or consumers to improve the infor- nity market to agreed-on levels or to restrict the mation in commercial transactions and to ensure quantities exported to the Community to agreed- compatibility between products. 104 TABLE 3.8 Products Subject to Antidumping Investigations, 1996­2002 Commodity OJ Reference Measure Investigations by EU Definitive antidumping and antisubsidy measures in force as of December 31, 1995 Cotton yarn L82, 27.03.1992 and L289, 24.11.1993 Duties Cotton yarn L182, 27.07.1994 Duties Polyester fibers and yarns L272, 28.09.1991 Undertakings (countervailing) Polyester yarns (man-made staple fibers) L88, 3.04.1992 Duties Polyester yarns (POY and PTY) L347, 16.12.1988 Duties Semifinished products of alloy steel L182, 2.07.1992 Duties and undertakings Synthetic textile fibers of polyester L306, 22.10.1992 Duties Asbestos cement pipes L209, 31.07.1991 Undertakings New investigations after January 1, 1996 Cotton fabrics, unbleached C50, 21.02.1996 Provisional duty imposed, but no definite measure imposed Cotton fabrics, unbleached L295, 20.11.1996 Provisional duty imposed Cotton fabrics L42, 20.02.1996 Terminated without the imposition of measures Bed linen L171, 07.05.1996 Terminated without the imposition of measures Cotton fabrics, unbleached C210, 11.07.1997 Terminated without the imposition of measures Steel wire rod C144, 22.05.1999 Terminated without the imposition of measures Steel ropes and cables C127, 05.05.2000 Duties Paracetamol C134, 13.05.2000 Terminated without the imposition of measures Colour television receivers C202, 15.07.2000 Terminated without the imposition of measures Welded tubes and pipes, of iron and nonalloy steel C183, 29.06.2001 Duties Flat rolled products of iron and nonalloy steel C364, 20.12.2001 Pending Steel ropes and cables L34, 03.02.2001 and L211, 04.08.2001 Undertakings Hallow sections C249, 16.10.2002 Pending Investigations by Turkey Definitive antidumping and antisubsidy measures in force as of December 31, 1995 Benzoic acids 14.08.1991 Duties Printing and writing papers 20.05.1992 Duties Polyester ELYAF 08.01.1993 Duties New investigations after January 1, 1996 Ball bearings 26.12.1998 Terminated without the imposition of measures Polyvinyl chloride 02.11.2001 Duties Note: OJ = Official Journal of the EU. Sources: Undersecretariat of Foreign Trade and various issues of the reports of the Commission on Anti-Dumping and Anti-Subsidy Activities. Integration and the Manufacturing Industry 105 Technical barriers have two aspects: (1) the con- Court of Justice, as set out in the 1979 Cassis de tent of the norms (regulations and standards), and Dijon judgment. In this ruling, the court stated that (2) the testing procedures needed to demonstrate Germany could prohibit imports of a French bever- that a product complies with the norm. The techni- age (cassis de Dijon) only if it could invoke manda- cal barriers to trade (TBTs) thus come in two basic tory requirements such as public health, protection forms, content-of-norm TBTs and testing TBTs. In of the environment, and fairness of commercial either case, the costs of the product design adapta- transactions. In other words, the court introduced a tions, reorganization of production systems, and very wide definition of Article 28 (ex 30) of the multiple testing and certification needed by Treaty of Rome, which prohibits quantitative exporters can be high. These costs are both up- restrictions on imports between member states and front and onetime--for example, learning about "all measures having equivalent results." As a result the regulation and bringing the product into of this ruling, the European Commission stated conformity--and ongoing, such as periodic testing. that a product lawfully produced and marketed in TBTs are said to distort trade when they raise the one member state shall be admitted to other mem- costs of foreign firms relative to those of domestic ber states for sale, except in cases of mandatory firms. As emphasized by Baldwin (2001), liberaliza- requirements (the Mutual Recognition Principle). tion requires closing the gap between the costs of Thus, the basic EU approach under the MRP has the foreign and domestic firms. The two main been to promote the idea that products manufac- dimensions to such a step are content of norms and tured and tested in accordance with a partner conformity assessment. Liberalization of the con- country's regulations could offer levels of protec- tent of norms involves making product norms tion equivalent to those provided by corresponding more cosmopolitan and thus narrowing the cost domestic rules and procedures. Mutual recogni- advantage of domestic firms. Liberalization of the tion, in other words, reflects the existence of ex ante second involves lowering the excess costs that for- trust between the trading partners. eign firms face in demonstrating the compliance of The European Commission (1998) divides the their goods to accepted norms. The European traded products into regulated and nonregulated Commission (1998) has pointed out that the commodities. The regulated products are those removal of technical barriers to trade will lead to whose commercialization is governed by the regu- four types of benefits: (1) economies of scale; lations of member states, and the nonregulated (2) rationalization of products or production, products are those for which no regulations have increased efficiency, and price reductions as a result an impact on commercialization. The regulated of increased competition; (3) restructuring of products are further divided into commodities industry (e.g., plant closures, mergers, reorganiza- under the harmonized sphere and those under the tion, relocation) to gain comparative advantage; nonharmonized sphere. Products under the har- and (4) innovation, stimulated by the dynamics of monized sphere are covered by European rules for the single market. the harmonization of regulations and mandatory specifications. Commodities under the nonhar- monized sphere are governed by national rules. The EU Approach to Technical Barriers to Trade The MRP is considered the first line of defense The basic objective of the EU policy and against technical barriers in the regulated nonhar- approaches to removing technical barriers to trade monized sphere. is to achieve free trade within the European Com- The principal examples of success of the MRP munity. Currently, this policy has two approaches: are those regulations that are new and have been enforcement of the Mutual Recognition Principle notified to the European Community under the (MRP) and harmonization of technical regulations. 83/189 procedures, but then they have been negoti- ated away or had specific mutual recognition Mutual Recognition Principle Mutual recogni- clauses inserted into the regulations.10 Any problem tion refers to the principles enshrined in the Treaty in implementation of the MRP is harder to identify, Establishing the European Economic Community because it relies on complaints from firms or trade (Treaty of Rome), interpreted by the European associations. 106 Turkey: Economic Reform and Accession to the European Union In its relations with third countries, the European health, consumer protection, environmental, or Community has advocated the use of mutual recog- other regulations at whatever level it deems neces- nition agreements (MRAs) in many regional or sary, as long as they comply with international bilateral forums. These agreements are based on the obligations. These obligations require that each mutual acceptance of test reports, certificates, and side have full confidence that the certification marks of conformity issued by conformity assess- process on the other side can wholly satisfy its ment bodies of one of the parties to the agreement, requirements. in conformity with the legislation of the other party. Such agreements were signed with Australia,Canada, Harmonization of National Regulations and Israel, Japan, New Zealand, Switzerland, and the Standards The EU legislation on harmonizing United States. The European Community also nego- technical specifications has followed two distinct tiated protocols to the Europe Agreements on Con- approaches, the old approach and the new formity Assessment and Acceptance of Industrial approach. The old approach was based on the idea Products (PECAs) with some of the then-candidate that the EU would become a unified economic area countries. PECAs represent recognition of the functioning like a single national economy. It dealt progress made in adopting and implementing the with the content-of-standards issue using negoti- relevant Community legislation on industrial prod- ated harmonization, and it sought adoption of a ucts and in creating the necessary administrative single standard that laid out in detail technical reg- infrastructure. The agreements cover a wide range ulations for single products or groups of products. of sectors, from medical devices to pressure vessels The regulations were implemented by the directives and electrical equipment. of the European Council, and the designated bodies In 1992 the European Economic Area (EEA) in EU nations performed the conformity assess- Agreement was signed between the European Free ments. Technical regulations were harmonized Trade Association (EFTA) countries and the EU. In using the old approach for products such as chemi- extending the EU Single Market to the EFTA coun- cals, motor vehicles, pharmaceuticals, and food- tries, the EU felt that ongoing and effective surveil- stuffs. Under this approach, the Council issued lance and enforcement were essential. Accordingly, directives such as Directive 70/220/EEC on the har- the EFTA Court of Justice and the EFTA Surveil- monization of the member states' laws related to the lance Authority were established in 1992. Through measures to be taken against air pollution caused by the EEA Agreement, the EFTA countries Iceland, gases from positive-ignition engines of motor vehi- Lichtenstein, and Norway participate fully in the cles. The directive detailed EU specifications apply- EU internal market and thus in the establishment ing to the related products and their testing require- of common product requirements and methods of ments. Under the old approach, European standards conformity assessment. Outside the areas covered institutions such as CEN (Comité Européen de by EEA legislation related to product requirements, Normalisation) and CENELEC (Comité Européen EEA states are permitted to introduce national de Normalisation Electrotechnique) were not man- product requirements, if it can be proved that such dated to draw up supplementary technical specifica- requirements are needed to meet public health, tions. But over time, the need was recognized to environmental, safety, and other social considera- reduce the intervention of the public authorities tions. To ensure transparency, the EEA states are prior to a product being placed on the market. So required to notify the EFTA Surveillance Authority the "new approach" was adopted and applied to and the European Commission of all draft national products that have "similar characteristics" and that technical rules for products. Finally, the EEA Agree- have been subject to a widespread divergence of ment forces the EFTA countries to accept future technical regulations in EU countries. European Council directives on the Single Market Under the new approach, only"essential require- without formal participation into the formation of ments"are indicated. This approach gives manufac- these new laws. turers greater freedom on how they satisfy those In summary, MRAs seek to facilitate trade while requirements by dispensing with the "old" type of safeguarding the health, safety, and environmental exhaustively detailed directives. Directives under objectives of each party. Each party is free to set its the new approach provide for more flexibility by Integration and the Manufacturing Industry 107 using the support of the established standardiza- manufactured in conformity with the requirements tion bodies--CEN, CENELEC, and the national of the directive, but also that the manufacturer has standards bodies. The standardization work is eas- followed all the prescribed procedures for conform- ier to update and involves greater participation ity assessment. It ensures free access to all of the EU. from industry. Meanwhile, the manufacturer or its local represen- Under the new approach, the European Coun- tative is required to keep all necessary technical cil issues a directive that lays down "essential documentation as proof for the relevant authorities requirements"--the 1989 machinery directive is that the requirements have been satisfied.11 one example. So far, 23 directives have been The final stage of implementation of the new adopted on the basis of this approach. Examples of approach system consists of market surveillance product sectors regulated in accordance with the procedures that develop a common approach to new approach are toys, machines, construction enforcement. Market surveillance consists of the products, medical equipment, telecommunications control that the relevant authorities in the member terminal equipment, and recreational craft. Once a states are required to carry out to ensure that the new approach directive has been issued, member criteria for CE marking have been satisfied--after states must conform their national laws and regula- the products have been placed on the market. The tions to it. The European Commission is empow- control is intended to prevent misuse of the CE ered to determine whether the national measures marking, to protect consumers, and to secure a are equivalent to the essential requirements. The level playing field for producers. Basically, market Council refers the task of formulating detailed surveillance is carried out in the form of random standards meeting the essential requirements to inspections to ensure that the technical documen- CEN, CENELEC, and the European Telecommuni- tation as required by the directive is available, but it cations Standards Institute. also may include examination of the documenta- tion or the product itself. Conformity Assessment and Market Surveillance To ensure that products meet the requirements laid Coverage of EC Technical Regulations Table 3.9 down in the new approach directives, special provides crude estimates of the sectoral value conformity assessment procedures have been estab- added covered under the old approach and the new lished. They describe the controls to which prod- approach. A large proportion of European Com- ucts must be subjected before they are considered munity value added in manufacturing has been compatible with the essential requirements and covered by the Community's technical regulations thus placed on the internal market. The extent of policy: 33 percent by the old approach directives the controls a product must undergo varies accord- and 42 percent by the new approach directives, ing to the risk attached to use of the product. with each approach dominating different sectors. Requirements may range from a declaration by the Finally, columns four and five show the share that manufacturer stating that certain standards have each sector holds in intra-EC trade and world been applied, to extensive testing and certification trade. The table reveals that sectors dominated by by independent, third-party conformity assessment the old approach represent 29 percent of EC value bodies (notified bodies). In 1993 Council Decision added, 26 percent of intra-EC trade, and 17 percent 93/465/EEC was adopted in connection with the of EC imports from the rest of the world. Sectors new approach directives. It provides an overview of dominated by the new approach represent 33 per- all the conformity assessment procedures available cent of EC value added, 43.5 percent of intra-EC under the directives, divided up into modules and trade, and 56 percent of EC imports from the rest grouped by category of risk. of the world. For products regulated by the new approach directives, a CE (Conformité Européne) marking Turkish Policies and Approaches confirms conformity with the essential require- ments of the directives and is required for a product With the formation of the EU-Turkey customs to be placed on the internal market. The CE mark- union, Turkey has removed all customs duties and ing indicates not only that the product has been equivalent charges as well as quantitative restrictions 108 Turkey: Economic Reform and Accession to the European Union TABLE 3.9 EC Technical Regulation Directives and European Community (EC) Imports, 1995 Coverage of EC Technical Regulations (percent of Import Structure sectoral value added) (percent) Old New Intra-EC ISIC Manufacturing Sector Approach Approach Total Imports World 200 Mining 96 0 96 0.4 2.4 311­312 Agribusiness 100 0 100 5.8 3.8 313 Beverages and sugar 63 37 100 3.2 1.1 321 Textiles 0 59 59 3.6 4.2 322 Clothing 0 77 77 2.3 5.6 323 Leather goods 0 0 0 0.4 1.0 331 Wood and wood products 0 100 100 1.9 2.2 341 Paper and paper products 63 0 63 4.7 2.5 351­352 Chemicals 22 76 98 14.7 9.2 353 Petroleum refineris 100 0 100 1.5 1.6 354 Petroleum and coal products 0 100 100 0.8 8.5 355 Rubber and rubber products 54 0 54 3.7 2.1 361 Pottery, china, etc. 0 79 79 0.3 0.6 369 Nonmetallic products 11 55 66 1.9 1.0 371 Iron and steel 0 24 24 6.9 7.1 381 Metal products 0 43 43 3.1 2.2 382 Machinery 0 93 93 14.0 16.5 383 Electrical and electronic goods 18 82 100 10.0 13.5 384 Transport equipment 74 19 93 15.6 8.3 Other manufactured goods 0 62 62 5.3 6.7 All sectors 33 42 75 100.0 100.0 Note: Coverage of EC technical regulation is measured in percentage value added. ISIC = International Standard Industrial Classification. Source: Messerlin 2001. on industrial products.12 Thus industrial products meantime, the number of instruments that Turkey move freely between the EU and Turkey--with the has to incorporate into its legal order has increased exception of contingent protection measures and to 560, and Turkey has incorporated 276 of them. technical legislation. According to Decision 1/95 of Thus, progress has been rather slow. the EC-Turkey Association Council establishing the Turkey also must establish the so-called quality customs union, Turkey must harmonize its techni- infrastructure, a generic term encompassing the cal legislation with that of the EU. Decision 2/97 of operators and operation of standardization, testing, the Association Council listed the areas in which certification, inspection, accreditation, and metrol- Turkey must align its legislation. This work should ogy (industrial, scientific, and legal). In the EU, have been finalized before the end of 2000, but, national quality infrastructures that function unfortunately, it was not completed until the begin- according to the same principles and obey the same ning of 2005. According to Annex II of Decision rules are a critical element of the free circulation of 2/97, Turkey was supposed to incorporate into its goods in the Single Market. Turkey, as a member of internal legal order 324 instruments that corre- a customs union with the EU and as a candidate spond to various European Economic Community country, has to align its national quality infrastruc- or European Community regulations and directives. ture to the European one. Products manufactured Currently, Turkey has incorporated into its legal in a future EU member state must satisfy the same order only 203 of these 324 instruments. In the requirements prevailing in the EU, and conformity Integration and the Manufacturing Industry 109 to these requirements must be demonstrated in the prepared to select notified bodies, they made same "harmonized" way and according to the same accreditation one of the criteria for their selection principles. by signing protocols with the Turkish National Recently, Turkey has taken major steps to align Accreditation Body, TURKAK.15 However the fact with the acquis. Law 4703 on the Preparation and that TURKAK has been a member of European Implementation of Technical Legislation on Prod- Accreditation Agency since 2003 and yet has not ucts, which entered into force in January 2002, has signedanymultilateralagreementwiththeEuropean been supplemented by secondary legislation. This partners makes its accreditation non-functional. framework law provides the legal basis for harmo- Thus, even though TURKAK has given accreditation nization with the EC legislation. It defines the prin- to potential notified bodies, this accreditation is ciples for product safety and for implementation of meaningless in the eyes of national accreditation the old and new approach directives, including the bodies of the EU. conditions for placing products on the market; the Because of this the market is also reluctant to obligations of the producers and distributors, con- use TURKAK, because TURKAK accreditation is formity assessment bodies, and notified bodies; not accepted within the EU. This situation presents market surveillance and inspection; withdrawal of Turkish conformity assessment bodies with a dis- products from the market; and notification proce- advantage. The relatively large Turkish firms wish- dures.13 The legislation on market surveillance, use ing to obtain CE marking for products exported to and affixing of the CE conformity mark, working the EU market usually contact local subsidiaries of principles and procedures for the conformity European notified bodies that use their European assessment bodies and notified bodies, and notifi- laboratories for testing. But for other Turkish com- cation procedures between Turkey and the EU for panies this process seems to be expensive and slow. technical regulations and standards which apply to The small and medium-size enterprises (SMEs) non-harmonized regulated area entered into force that export products find it particularly difficult to during 2002.14 Furthermore, Turkey has adopted all pay the high costs. In Turkey, marking and certifi- of the 23 new approach directives that require affix- cation parallel to the EU system are implemented ing the CE conformity marking, and 18 of the only in the automotive sector, which is subject to directives entered into force up to the present time. the old approach directives. Istanbul Technical Uni- They cover commodities and product groups such versity (ITU) does automotive testing under the as low-voltage equipment, toys, simple pressure authorization of the Ministry of Industry and vessels, construction products, electromagnetic Trade, and it performs acoustic, emissions, and compatibility, gas appliances, personal protective other tests. The Turkish Standards Institute (TSE),16 equipment, machinery, medical devices, nonauto- Tofa¸s-Fiat, and Ford-Otosan also have engine and matic weighing instruments, telecommunications emissions test facilities; Seger has an audible warn- terminal equipment, hot water boilers, civil explo- ing devices laboratory; Tam-Test is implementing sives, lifts, and recreational crafts. testing and certification in the case of agricultural Overall, then, Turkey has advanced the harmo- tractors; Fren Teknik has test facilities for brakes nization of its technical legislation both on a sec- and Brisa has a pneumatic tires laboratory. Turkey toral (vertical) basis and at a horizontal level. It is in is implementing all relevant automotive EC direc- the process of establishing the necessary structures tives via these facilities.17 Crash tests, electromag- on conformity assessment and market surveillance. netic compatibility (EMC), and other tests on com- By now Turkey has the legal basis on which accred- plete cars are largely conducted abroad; as of May itation could be based. In order to assign the noti- 2003 the National Metrology Institute (UME) was fied bodies that would deal with the certification of able to run the EMC tests on vehicles.18 products, the ministries have established the crite- Other than for the automotive sector, as of 2005 ria for the selection of such bodies for the prod- Turkey is suffering from a lack of certification bod- ucts covered by certain new approach directives. ies (see European Committee for Standardization Although in Europe, as in Turkey, accreditation is 2003). To make its conformity assessment compati- not mandatory to be appointed as a notified body, ble with that in the EU, Turkey has opened up the since the Turkish Ministries did not feel adequately certification, testing, and calibration market to 110 Turkey: Economic Reform and Accession to the European Union other Turkish actors. However, Turkish firms are these the TSE occupies a monopoly position, and reluctant to enter the market for conformity assess- for 500 of them TSE certification is mandatory. For ment bodies as long as uncertainties prevail regard- these mandatory standards, manufacturers mostly ing the acceptance of notified bodies by the Euro- need first a TSE certificate and then a Ministry of pean Commission. Some of the Turkish firms in Industry and Trade license to put the products on cooperation with the notified bodies in the EU have the market. entered the Turkish market. Over time competition The system in use in Europe, for those areas will ensure lower costs for conformity assessment. under the new approach directives, is in-market The expense, time, and unpredictability incurred in control. Under this system, the responsibility for obtaining approvals can then be reduced by having placing a product on the market is left to the pro- products evaluated in Turkey once the Turkish ducer, so long as it is certified that the product sat- notified bodies are accepted by the European Com- isfies the minimum requirements set under the mission and joint ventures with notified bodies in directives. Market surveillance, the safeguard of the the EU increase. These savings can be particularly system, is the responsibility of public authorities. important where rejection of products in the EU The market surveillance authorities carry out their can create delays and necessitate additional ship- operations in an impartial and nondiscriminatory ping or other costs. In addition, the SMEs can ben- way. They shall have the power, competence, and efit from procedures in which all testing and certifi- resources to regularly visit commercial, industrial, cation steps are carried out locally at lower costs. and storage facilities; to regularly visit, if appropri- Turkish firms, and in particular the SMEs, can then ate, workplaces and other premises where products be expected to increase their competitiveness in the are put into service' to organize random and spot EU market checks; to take samples of products and subject Although, in principle, standards are voluntary them to examination and testing, and to require all in Turkey, in the absence of a proper market sur- necessary information. Through this system, meas- veillance system the technical ministries and the ures are taken in the EU to ensure that products Undersecretariat of Foreign Trade have turned the meet the requirements of the applicable directives, standardization regime and licensing before pro- that action is taken to bring noncompliant prod- duction into a mandatory regime in order to pro- ucts into compliance, and that sanctions are tect the market and the consumers. This pre- applied when necessary. Member states are free to market control system gives the TSE a great deal choose the type of sanction they are going to use. power. According to the European Committee for The only requirement is that the penalties be effec- Standardization (2003), the TSE has misused its tive, proportionate, and dissuasive. power in several cases of imports and has created technical barriers to trade. The TSE asked for the Technical Barriers and Trade between technical files of the imported products when they the EU and Turkey entered the Turkish market, and the processing of the files took an usually long time. There are also To determine those sectors and products in which cases in which products bearing the CE marking technical regulations are important for Turkish were asked for further inspection. Yet the Turkish exporters, we used data produced by a study under- internal market is regulated largely through taken by the European Commission (1998). This mandatory standards and marking issued by the study provides information, at the three-digit level TSE.Since2004productscoveredbydirectivesontoy of the NACE (Nomenclature Générale des Activités safety, medical devices, active implantible medical Économiques dans les Communautés Européennes) devices, low voltage electrical equipment, electro- classification, about whether trade is affected by magnetic compatibility and machinery are not sub- technical regulations and the dominant approach ject to mandatory controls when imported and used by the European Commission to remove used in the internal market. But products covered such barriers in the EU.19 It classifies the technical by the remaining 12 new approach directives are regulations as follows: those in which barriers are subject to mandatory controls. overcome using mutual recognition, old approach, In Turkey, 500 standards are mandatory for the new approach, and those in which there are no domestic market as well as for imports. For all of technical barriers. Integration and the Manufacturing Industry 111 TABLE 3.10 Trade Coverage of Technical Regulations and of Different Approaches to Their Removal, 1990­2001 (percent) Subject to Technical No Technical Old Approach Mutual Recognition New Approach Barriers Barriers Manufacturing Imports of EU 1990 24.507 28.463 29.869 82.838 17.162 1991 23.662 29.839 29.187 82.689 17.311 1992 23.550 29.692 29.165 82.407 17.593 1993 21.970 30.615 28.662 81.248 18.752 1994 21.925 29.543 30.041 81.508 18.492 1995 19.078 30.497 31.459 81.034 18.966 1996 18.593 31.266 31.331 81.189 18.811 1997 18.700 32.269 30.435 81.404 18.596 1998 18.795 32.990 30.632 82.418 17.582 1999 18.663 33.245 30.627 82.535 17.465 2000 17.407 31.318 33.835 82.560 17.440 2001 18.108 31.602 32.538 82.248 17.752 Manufacturing Exports of Turkey to EU 1990 8.815 63.561 14.911 87.287 12.713 1991 9.436 66.096 10.349 85.881 14.119 1992 8.735 66.411 10.694 85.840 14.160 1993 7.334 68.648 9.470 85.452 14.548 1994 9.048 64.839 10.607 84.494 15.506 1995 10.029 61.501 12.685 84.215 15.785 1996 10.143 61.589 12.267 83.998 16.002 1997 10.096 58.503 13.465 82.064 17.936 1998 12.474 56.552 13.042 82.069 17.931 1999 16.432 52.961 13.545 82.939 17.061 2000 17.634 50.762 14.332 82.728 17.272 2001 20.707 47.358 14.887 82.951 17.049 Note: The variables show the percentages of different approaches to the removal of technical barriers to trade in total manufacturing imports for the EU and in Turkish manufacturing exports to the EU. Source: The authors. Table 3.10 shows the overall trade coverage of The table demonstrates that a very high propor- technical regulations and of the different tion of EU manufacturing imports and of Turkish approaches to their removal in the EU and to their manufacturing exports to the EU are subject to application to Turkish exports to the EU. Here we technical barriers. The average value of the propor- aggregated, following the approach of Breton, tion over the period 1990­2001 is 82.0 percent for Sheehy, and Vancauteren (2001), the value of man- the EU and 84.2 percent for Turkey. In the EU, ufacturing imports across the four-digit Standard sectors subject to old approach directives make up Identification Trade Classification (SITC) cate- on average 20.4 percent; mutual recognition and gories, which are subject to old approach directives, new approach directives, 31 percent each; and sec- new approach directives, mutual recognition, and a tors subject to no technical barriers, 18.0 percent. residual.20 We then identified the proportion of total For Turkish exports to the EU, the average values of imports value in sectors subject to old approach the shares are 11.7 percent for old approach prod- directives, new approach directives, mutual recogni- ucts; 60.0 percent, mutual recognition; 12.5 per- tion, and a residual. cent, new approach products; and 15.8 percent, 112 Turkey: Economic Reform and Accession to the European Union sectors subject to no technical barriers. Sectors with also to be quite an efficient producer of goods from no significant technical barriers to trade include the sectors under mutual recognition as well as nonferrous metals, footwear, and sawing and pro- from the new approach sectors. Thus if trade cessing of wood. Old approach products include between Turkey and the EU is constrained by tech- mainly motor vehicles and parts, and new approach nical barriers to trade, then with the accession of products include sectors specified earlier, such as Turkey, competition in the EU for these products machinery. may intensify. Developments in the proportions of sectors sub- This analysis reveals that, for Turkey, sectors ject to technical barriers over the period 1990­2001 subject to technical regulations in the EU account reveal that the proportion of manufacturing for considerable shares of Turkish exports to the imports subject to technical barriers has been rela- EU. The calculations demonstrate that accession tively stable in the EU and that for Turkish exports will affect the exports of Turkish old and new to the EU declined from 87.3 percent in 1990 to approach products to the EU, and that Turkey has a 82.9 percent in 2001. In the EU, the proportion of comparative advantage in sectors subject to new sectors subject to mutual recognition and new approach directives. Therefore, it is of utmost approach directives has increased slightly over importance that Turkey establish the quality infra- time, and the proportion of sectors subject to old structure needed, encompassing the operators and approach directives has correspondingly declined. operation of standardization, testing, certification, As for Turkish exports to the EU, the proportion of inspection, accreditation, and metrology. The sectors subject to the new approach has been rela- Turkish quality infrastructure has to function tively constant. As the share of sectors subject to according to EU principles and obey the same rules the old approach has increased, a corresponding as in the EU. Only then will Turkey be able to par- decline appears in the share of sectors subject to ticipate in the free circulation of goods in the mutual recognition. enlarged Single Market. We now turn to consideration of the index val- ues of revealed comparative advantage (RCA) Conditions of Competition defined as (Xi/X) Over the past few decades, Turkey has used inten- (3.3) RCAi = ln (Mi /MEU) EU sively three tools of industrial policy: investment incentives, export incentives, and a policy of state- where Xi denotes Turkish exports of commodity i to owned enterprises.In using these measures,the gov- the EU, X the total value of Turkish manufacturing ernment has tried to obtain a preferred allocation of exports to EU, Mi EUthe total EU imports of com- resources. The purpose of the investment incentive modity i, and MEU the total value of EU imports. scheme has been to increase investment and over- Equation 3.3 considers the share of commodity i come the barriers imposed by capital market imper- exports to the EU of total Turkish exports to the EU fections to entry into industry. But investment relative to the share of commodity i imports by the incentives in Turkey have also been a barrier to com- EU to total EU imports. If this ratio is greater than petition. Through the incentive system, established 1, the natural logarithm of the variable will be posi- firms have obtained cost advantages that have tive. In that case, the country is said to have a com- helped them to consolidate their market position. parative advantage in producing that product, and Entrants, competing with scarce fiscal resources, the higher the value, the more competitive the have been at a disadvantage relative to well- product. Using the index of revealed comparative informed incumbents. The credit incentives, which advantage, it is possible to determine in which were supposed to promote entry, have often turned product categories Turkey has the greatest compar- into instruments that have reinforced the position ative advantage. Table 3.11 shows the nine sectors of large incumbents. Furthermore, the government, with the highest RCA values by the different EU with its large share of the banking system, has also approaches to technical barriers to trade. The table directly controlled the allocation of credit, and reveals that the highest RCA values are attained in credit from public banks has often been extended the sectors with no technical barriers. Turkey seems on the basis of political considerations. Overall, TABLE 3.11 Sectors with Highest RCA Values in Each Category Turkish Exports to EU, RCA, 1999­2001 Average SITC 1999­2001 (thousands of ECU) Old approach 7831 Public transport-type passenger motor vehicles 3.2198 181,834 5238 Other metallic salts, peroxysalts of inorganic, acids 2.9270 65,203 7611 Television receivers, color, whether or not combined 2.2189 725,383 5323 Synthetic inorganic tanning matter; preparations 1.4908 895 5237 Percarbonates; commercial ammonium carbonate 1.3940 26,140 7139 Parts, NES, for the engines of 7132, 7133 and 7138 1.1439 217,582 5234 Polysulphides, dithionites, sulphites, sulphates 0.8834 5,148 5233 Hypochlorites; chlorites; chlorates; bromates; iodates 0.8047 1,190 8986 Magnetic tapes, recorded 0.7545 4,692 Mutual recognition 6534 Fabrics, woven, 85% synthetic staple fibers, mixed 3.1060 101,494 8462 Panty hose, socks, and other hosiery, knitted 2.5733 285,684 or crocheted 6542 Fabrics, woven, 85% wool or fine animal hair 2.4675 29,022 8454 T-shirts, singlets and other vests, knitted 2.4476 984,273 or crocheted 6529 Other woven fabrics of cotton 2.4372 4,265 8442 Suits, ensem., dresses, skirts, trousers, knitted, 2.3862 349,327 women 6513 Cotton yarn, other than sewing thread 2.3166 235,351 6524 Other woven fabrics > 85% cotton, 2.2850 85,496 weight 200 g/m2 6536 Fabrics, woven, 85% artificial staple fiber 2.2635 21,646 (excluding pile) New approach 7753 Dishwashing machines of the household type 3.4565 11,569 6624 Nonrefractory ceramic bricks and similar products 2.7997 117,996 6762 Rods (excluding 6761), iron, steel, hot-rolled, 2.6528 188,512 hot-drawn 6761 Bar and rods, hot-rolled, irregular wound coils, 2.4310 114,585 iron, steel 6612 Hydraulic cements, whether or not colored, clinkers 2.4192 160,431 8121 Boilers (excluding 711), radiators, etc., not electrical 2.2241 83,012 6794 Other tubes, pipes, and hollow profiles of iron, steel 2.1659 132,205 7752 Household-type refrigerators and food freezers 2.0630 152,836 6652 Glassware for domestic use 1.8532 105,440 (excluding 66511, 66592, 66593) No technical barriers 7753 Dishwashing machines of the household type 3.4565 11,569 6581 Sacks and bags of textile materials, for packing goods 2.8222 109,778 6579 Special products of textile materials 2.5383 39,282 6564 Tulles and other net fabrics; lace, in the piece 2.5145 10,051 8122 Ceramic sinks and similar sanitary fixtures 2.3625 58,256 6584 Bed, table, toilet, and kitchen linen 2.3485 471,456 6112 Composition leather, basis of leather, slabs, sheets 2.0423 1,380 6931 Stranded wire, ropes, slings, and the like, of metal 1.9921 44,441 6252 Other knitted or crocheted fabrics, noncoated, etc. 1.7149 70,236 Note: RCA = revealed comparative advantage; SITC = Standard International Trade Classification; NEC = not elsewhere classified. Source: The authors. 113 114 Turkey: Economic Reform and Accession to the European Union established firms benefit from the investment incen- icy is not fully integrated into the general policy tive schemes such as investment allowances, but new framework for regulation. Turkey's competition entrants do not, because to benefit from devices law has no rule equivalent to Article 86 of the such as investment allowances, they must show pos- Treaty Establishing the European Community to itive profits in their income statements first. govern the permissible operations of monopolies In Turkey, the investment incentive scheme has providing public services. Nevertheless, special been used while no specific competition legislation rules limit competition in some sectors such as the or competition policy has been enforced in the financial sector, tobacco industry, mineral prod- country. To promote competition within the coun- ucts, agriculture, and postal services. In addition, try, Turkey eliminated quantitative restrictions in Turkey has to control its anticompetitive state aid foreign trade during the 1980s and substantially policy.21 decreased the levels of nominal and effective pro- It could be said, then, that Turkey has achieved tection rates. With the formation of the customs considerable progress in the fields of investment union with the EU, all of the tariff barriers on and export incentives, but it has not achieved simi- imports of industrial commodities from the EU lar progress in dealing with public enterprises. were completely eliminated, as noted earlier. Although privatization has become a prominent On the export side, over the 1980s Turkey used part of the Turkish structural adjustment program, various export incentive measures. But in 1985 it since 1983 privatization has not gained momentum. agreed to eliminate export subsidies by 1989. After Table 3.12 presents basic data on Turkey's man- 1989, Turkey eliminated most of the export incen- ufacturing sector for 2000. The data are taken from tives, introduced GATT legal subsidies, and two surveys, "Annual Manufacturing Industry reduced substantially the nominal and effective Statistics" and "Small Manufacturing Industry Sta- export subsidy rates. The reduction in the nominal tistics," published by the State Institute of Statistics. and effective protection and subsidy rates was not The first survey covers all firms in the public sector sufficient, however, to ensure proper functioning of and private firms employing 10 or more employees. markets in Turkey. During the 1950s, a similar situ- The second survey covers all private firms employ- ation in Europe had led to the adoption of compe- ing less than 10 employees. The table reveals that tition policies aimed at ensuring effective competi- the sectors with the highest shares of total value tion, allocating resources efficiently, and creating added of the manufacturing sector were petroleum the best possible climate for fostering innovation and coal, 12.49 percent; textiles, 12.29 percent; food and technical progress. processing, 11.45 percent; and chemicals, 9.71 per- In June 1989, Turkey adopted the law titled cent. The sectors with the highest shares of total On the Prevention of Unfair Competition in manufacturing employment were textiles,18.56 per- Importation, containing both antidumping and cent; food processing,15.41 percent;wearing apparel antisubsidy provisions. Turkey adopted its compe- and footwear, 9.62 percent; and metal products, tition policy during December 1994 with the Law 7.98 percent. The sixth column of the table gives on the Protection of Competition. The key provi- the share of 1998 public sector value added of the sions of the competition law are based on the EU's total value added of the corresponding manufac- competition law: agreements, decisions, and con- turing subsector. From the table, it follows that the certed practices in constraint of competition; abuse average share of public sector value added of the of dominant position; and mergers and acquisi- total manufacturing industry value added was tions. The statute contains not only rules on forbid- 18.91 percent. Petroleum and coal had the highest den practices and provisions against the abuse of share with 89.83 percent, followed by the tobacco a dominant market position, but also regulations industry with 78.25 percent, and the beverages on acquisitions and mergers. The Competition industry with 50.58 percent. Authority responsible for the implementation and The seventh and eighth columns of table 3.12 enforcement of the prohibitions set out in the law indicate exposure to international trade. Column opened its doors in October 1997. As indicated by seven provides a measure of competitiveness on the OECD (2002) competition policy, institutions in domestic market measured by the rate of import Turkey are in place and active, but competition pol- penetration. If Q, X, and M stand, respectively, for TABLE 3.12 Characteristics of Turkish Manufacturing Industries, 2000 Rate of Share of Share of Public Sector Share of Public Exposure Value Sector of Sector of Value Sector of Import Export to International Added Total Manuf. Total Manuf. Added Total Sectoral Penetration Ratio Competition (US$ millions) Value Added Employment Employment (US$ millions) Value Added (percent) (percent) (percent) ISIC Sector (1) (2) (3) (4) (5) (6) (7) (8) (9) 311 + 312 Food processing 4,687.9 11.45 255,437 15.41 609.8 13.01 7.47 9.44 16.20 313 Beverages 908.2 2.22 11,194 0.68 459.4 50.58 0.77 1.98 2.74 314 Tobacco 1,063.8 2.60 18,951 1.14 832.4 78.25 1.97 5.28 7.15 321 Textiles 5,030.6 12.29 307,689 18.56 56.0 1.11 17.31 39.88 50.29 322 + 324 Wearing apparel and footwear 1,533.9 3.75 159,561 9.62 19.1 1.25 30.70 86.35 90.54 323 Fur and leather products 110.8 0.27 10,358 0.62 0.0 0.00 50.93 38.19 69.67 331 Wood and cork products 526.7 1.29 67,688 4.08 0.0 0.01 12.03 3.99 15.54 332 Furniture and fixtures 449.2 1.10 72,072 4.35 0.0 0.01 53.63 44.26 74.16 34 Paper and products 1,314.5 3.21 56,459 3.41 111.5 8.48 27.49 5.30 31.33 351 + 352 Chemicals 3,977.7 9.71 59,537 3.59 287.9 7.24 49.13 13.66 56.08 353 + 354 Petroleum and coal 5,112.4 12.49 9,882 0.60 4,592.3 89.83 17.08 2.34 19.02 355 + 356 Rubber and plastic products 1,574.5 3.85 60,577 3.65 4.3 0.27 9.01 8.90 17.11 36 Nonmetallic minerals 2,712.5 6.62 92,160 5.56 23.1 0.85 9.01 20.84 27.98 37 Basic metals 2,216.0 5.41 65,729 3.96 454.8 20.52 40.04 27.04 56.25 381 Metal products 1,946.2 4.75 132,276 7.98 50.2 2.58 15.95 11.20 25.36 382 Machinery 1,822.5 4.45 100,594 6.07 96.5 5.29 63.39 18.98 70.34 383 Electrical machinery 2,218.8 5.42 68,616 4.14 44.4 2.00 62.00 38.25 76.53 384 Transport equipment 3,218.6 7.86 84,358 5.09 82.0 2.55 48.87 25.22 61.76 385 Professional and sci. measuring equip. 251.1 0.61 11,327 0.68 12.0 4.80 69.28 11.23 72.73 39 Other manufacturing industries 271.9 0.66 13,647 0.82 5.9 2.16 56.67 61.23 83.20 3 Manufacturing 40,947.8 100.00 1,658,112 100.00 7,741.6 18.91 33.10 21.78 47.67 Note: ISIC = International Standard Industrial Classification. Source: Annual manufacturing industry statistics and small manufacturing industry statistics provided by Turkish State Institute of Statistics. 115 116 Turkey: Economic Reform and Accession to the European Union sectoral output, exports, and imports, the domestic FIGURE 3.1 Average Value of Markups for demand D will be equal to D = Q ­ X + M, and Manufacturing, 1980­2000 the rate of import penetration will equal 600 [M 100/D]. A low level of penetration does not Turkey necessarily mean that there are barriers to entry. Belgium 500 The table reveals that the professional and scientific measuring equipment sector had the highest 400 import penetration with 69.28 percent, followed by the machinery sector with 63.39 percent and elec- 300 trical machinery with 62.00 percent. Column eight 200 of table 3.12 gives the export ratio, defined as [X 100/Q]. From the table, it follows that the 100 wearing apparel and footwear sector had the highest export ratio at 86.35 percent, followed by 0 other manufacturing industries at 61.23 percent, furniture and fixtures at 44.26 percent, and textiles 1975 1980 1985 1990 1995 2000 2005 at 39.88 percent. Finally, column nine gives the rate of exposure to international competition, defined (ISIC 353 + 354); other manufacturing (ISIC 39); as [(export ratio) + [1 ­ (export ratio/100)] import and wood and products of wood (ISIC 331). The penetration]. The construction of this indicator lowest average markups in Turkey relative to those rests on the idea that the exported share of produc- in Belgium, [(1 + )/(1 + )], are found in the tion is 100 percent exposed and that the share sold sectors paper and paper products (ISIC 341); on the domestic market is exposed in the same pro- leather, leather products, and footwear (ISIC 323 + portion as the penetration of the market. The table 324); and nonferrous metals (ISIC 372). Figure 3.1 reveals that the wearing apparel and footwear sec- plots the average value of the markup for the man- tor had the highest exposure to international com- ufacturing industry over the period 1980­2000. On petition with an index value of 90.54 percent, fol- the other hand, defining the markup as lowed by the other manufacturing industries sector (output - labor cost - material cost) with an index value of 83.20 percent and the elec- (3.5) = (labor cost + material cost) trical machinery sector with an index value of 76.53 percent. we note from the last two columns of table 3.13 that Defining the markup by the relation the markups in Turkey exceed those in Belgium except in the sectors electrical and optical equip- (value added - labor cost) (3.4) = ment (ISIC 383 + 385); iron and steel (ISIC 371); labor cost and publishing, printing, and reproduction of we note from the first two columns of table 3.13 recorded media (ISIC 342). The average markup in that the markup calculated for three-digit Interna- Turkey relative to that in Belgium, [(1 + )/ tional Standard Industrial Classification (ISIC) sec- (1 + )], is now highest in the sectors tobacco tors in Turkey are much higher than the markup in products (ISIC 314); other nonmetallic mineral Belgium, a small open economy considered to be products (ISIC 36); and coke, refined petroleum the benchmark country in the analysis. The data in products, and nuclear fuel (ISIC 353 + 354). The this table were obtained from the "Annual Manu- results are striking. They indicate the lack of com- facturing Industry Statistics" of the State Institute petition in the Turkish manufacturing sector. of Statistics for the period 1999­2000 for the Turk- To further illustrate the arguments about the ish economy, and from the OECD STAN Database conditions of competition in the Turkish manufac- for Belgium for the period 1997­99. The table turing sector, we consider in table 3.14 the four-firm shows that the markups in all other sectors in concentration ratios. The table reveals that the con- Turkey exceed those in Belgium, and that the aver- centration ratios are relatively high and that the age markup in Turkey relative to that in Belgium, most concentrated sectors are the manufacture of [(1 + )/(1 + )], is highest in the sectors coke, coke coal and briquettes (ISIC 3542), manufacture refined petroleum products, and nuclear fuel of sporting and athletic goods (ISIC 3903), Integration and the Manufacturing Industry 117 TABLE 3.13 Average Markups, Turkey and Belgium (percent) Markup I Markup II Turkey, Belgium, Turkey, Belgium, ISIC Commodity 1999­2000 1997­1999 1999­2000 1997­1999 31 Food and beverages and tobacco 311 + 312 + 313 Food products and beverages 347.52 80.03 46.49 29.66 314 Tobacco products 362.79 100.54 74.76 19.78 32 Textiles, apparel, and leather 321 Textiles 268.62 53.29 52.69 37.66 322 Wearing apparel, dressing, 252.56 45.01 45.73 26.52 and dyeing of fur 323 + 324 Leather, leather products, 211.08 55.45 49.84 47.96 and footwear 33 Wood products 331 Wood and products of 427.71 51.09 59.09 39.72 wood and cork 332 Furniture; manufacturing NEC 381.65 45.59 66.02 43.22 34 Paper, paper products 341 Paper and paper products 215.81 71.33 57.24 47.09 342 Publishing, printing, and 312.06 60.19 54.77 61.46 reproduction of recorded media 35 Chemical products 353 + 354 Coke, refined petroleum 1,628.89 174.81 52.48 14.53 products, and nuclear fuel 351 + 352 - 3522 Chemicals, excluding 384.18 80.80 67.88 43.63 pharmaceuticals 3522 Pharmaceuticals 404.26 115.64 107.81 76.67 355 + 356 Rubber and plastics products 312.54 66.59 66.74 42.76 36 Nonmetallic minerals 36 Other nonmetallic 387.83 60.35 109.65 56.55 mineral products 37 Basic metals 371 Iron and steel 202.95 37.78 34.65 38.63 372 Nonferrous metals 196.86 44.10 30.97 19.69 38 Fabricated metal 381 Fabricated metal products, 290.62 42.38 74.69 49.58 except machinery and equipment 382 Machinery and equipment NEC 239.35 50.04 62.49 54.58 383 + 385 Electrical and optical equipment 274.18 39.49 55.84 59.07 384 Transport equipment 274.78 36.18 47.63 24.37 39 Other manufacturing 39 Manufacturing NEC 479.38 51.03 49.40 37.72 Note: ISIC = International Standard Industrial Classification; NEC = not elsewhere classified. Sources: OECD STAN Database and annual manufacturing industry statistics provided by the Turkish State Institute of Statistics. manufacture of aircraft (ISIC 3845), manufacture of In summary, with the formation of the EU- watches and clocks (ISIC 3853), tire and tube indus- Turkey customs union Turkish industries became tries (ISIC 3551), and petroleum refineries (ISIC subject to greater competition. But markups and 3530). The most competitive sectors are manufac- concentration ratios are still high compared with ture of wearing apparel (ISIC 3222); spinning, those in benchmark countries such as Belgium.22 weaving, and finishing textiles (ISIC 3211); manu- It seems that Turkey has to complete the harmo- facture of plastic products (ISIC 3560); and knitting nization of technical regulations, privatize its mills (ISIC 3213). public enterprises, liberalize entry and exit into 118 Turkey: Economic Reform and Accession to the European Union TABLE 3.14 Concentration of Domestic Activity, 1997­2000 (four-firm concentration ratios) ISIC Rev 2 Commodity 1997 1998 1999 2000 3111 Slaughtering, preparing, and preserving meat 34.15 29.64 32.45 31.13 3112 Manufacture of dairy products 51.54 50.25 51.55 49.57 3113 Canning and preserving of fruits and vegetables 19.08 17.34 16.16 18.90 3114 Canning, preserving, and processing of 91.72 89.85 81.40 84.98 fish and crustacea 3115 Manufacture of vegetable and animal oils and fats 46.66 42.28 43.25 43.92 3116 Grain mill products 17.01 17.97 25.46 24.30 3117 Manufacture of bakery products 29.52 30.37 31.30 34.81 3118 Sugar factories and refineries 39.14 33.43 35.94 31.62 3119 Manufacture of cocoa, chocolate and sugar 58.61 49.26 51.03 53.03 confectionery 3121 Manufacture of food products NEC 25.47 28.75 21.88 24.94 3122 Manufacture of prepared animal feeds 22.66 26.41 27.40 28.95 3131 Distilling, rectifying, and blending spirits 60.97 66.08 71.99 74.50 3132 Wine industries 74.24 74.21 80.89 75.16 3133 Malt liquors and malt 74.56 80.12 69.04 76.49 3134 Soft drinks and carbonated waters industries 63.17 64.82 60.90 66.06 3140 Tobacco manufactures 54.81 58.92 57.64 70.82 3211 Spinning, weaving, and finishing textiles 9.90 7.68 9.44 11.08 3212 Manufacture of madeup textile goods, 21.74 22.99 24.71 25.32 except wearing apparel 3213 Knitting mills 14.93 12.20 22.89 13.95 3214 Manufacture of carpets and rugs 43.34 41.66 43.84 39.65 3215 Cordage, rope, and twine industries 82.12 88.77 70.69 95.91 3219 Manufacture of textiles NEC 67.88 65.07 66.28 65.04 3221 Manufacture of fur and leather products 23.98 23.95 22.03 24.89 3222 Manufacture of wearing apparel, except 12.03 7.45 8.79 9.21 fur and leather 3231 Tanneries and leather finishing 21.42 30.47 19.40 19.42 3233 Manufacture of products of leather and 58.23 68.77 57.75 61.04 leather substitutes 3240 Manufacture of footwear, except vulc. or 34.04 32.18 38.43 28.27 molded rubber 3311 Sawmills, planing, and other wood mills 37.98 34.23 38.27 35.16 3312 Manufacture of wooden and cane containers 61.99 47.05 64.11 51.02 and small cane ware 3319 Manufacture of wood and cork products NEC 67.83 60.53 63.29 60.22 3320 Manufacture of furniture and fixtures, except 45.99 44.06 44.37 49.66 primarily of metal 3411 Manufacture of pulp, paper, and paperboard 55.42 42.42 39.29 38.82 3412 Manufacture of containers and boxes of paper 24.46 25.52 27.95 26.09 and paperboard 3419 Manufacture of pulp, paper, and paperboard articles 45.79 41.45 56.87 47.00 3421 Printing, publishing, and allied industries 63.28 40.42 50.08 45.55 3511 Manufacture of basic industrial chemicals, 47.00 53.20 54.64 67.81 except fertilizers 3512 Manufacture of fertilizers and pesticides 56.58 54.43 55.28 54.65 3513 Manufacture of synthetic resins, plastic materials 92.64 88.30 90.34 86.91 3521 Manufacture of paints, varnishes, and laquers 49.15 45.49 39.82 38.84 3522 Manufacture of drugs and medicines 31.28 31.59 29.74 33.37 3523 Manufacture of soap and cleaning preparations, 62.17 66.35 71.32 63.36 perfumes 3529 Manufacture of chemical products NEC 37.67 44.02 44.98 43.68 3530 Petroleum refineries 97.81 97.86 97.51 97.39 Integration and the Manufacturing Industry 119 TABLE 3.14 (Continued) ISIC Rev 2 Commodity 1997 1998 1999 2000 3541 Manufacture of asphalt paving and 88.54 73.54 72.19 92.33 roofing materials 3542 Manufacture of coke coal and briquettes 100.00 100.00 100.00 100.00 3543 Compounded and blended lubricating 87.51 85.54 79.22 88.25 oils and grease 3544 Liquid petroleum gas tubing 88.96 84.60 87.49 84.17 3551 Tire and tube industries 97.88 98.03 98.24 99.08 3559 Manufacture of rubber products NEC 28.85 22.80 25.84 23.66 3560 Manufacture of plastic products NEC 18.01 16.38 16.48 14.41 3610 Manufacture of pottery, china, and earthenware 74.71 58.05 60.97 69.81 3620 Manufacture of glass and glass products 43.64 40.68 42.21 39.51 3691 Manufacture of structural clay products 47.09 43.91 41.59 42.78 3692 Manufacture of cement, lime, and plaster 31.23 29.52 33.68 34.95 3699 Manufacture of nonmetallic mineral products 27.70 26.82 25.89 20.08 3710 Iron and steel basic industries 32.29 31.76 36.69 32.91 3720 Nonferrous metal basic industries 40.27 42.40 44.92 49.06 3811 Manufacture of cutlery, hand tools, and 28.72 33.58 20.19 24.52 general hardware 3812 Manufacture of furniture and fixtures, primarily 49.40 43.18 45.58 40.87 of metal 3813 Manufacture of structural metal products 23.59 24.04 24.80 24.41 3819 Manufacture of fabricated metal products 26.31 25.96 27.67 23.85 3821 Manufacture of engines and turbines 92.31 88.68 86.78 92.53 3822 Manufacture of agricultural machinery 81.46 81.59 79.93 80.73 and equipment 3823 Manufacture of metal and wood working machinery 46.89 45.84 37.63 35.70 3824 Manufacture of special industrial machinery 26.99 26.61 21.65 21.16 and equipment 3825 Manufacture of office, computing, and accounting 75.13 86.06 82.19 90.88 machinery 3829 Machinery and equipment, except electrical 51.73 49.54 54.52 48.10 3831 Manufacture of electrical industrial machinery 58.63 56.01 57.51 53.22 and apparatus 3832 Manufacture of radio, television, and communication 75.40 69.75 64.74 62.37 equipment 3833 Manufacture of electrical appliances and housewares 48.54 51.99 51.95 45.45 3839 Manufacture of electrical apparatus and supplies 27.08 24.94 29.73 26.14 3841 Ship building and repairing 50.28 46.01 48.48 52.18 3842 Manufacture of railroad equipment 98.04 98.78 96.62 94.21 3843 Manufacture of motor vehicles 40.81 40.60 46.44 47.32 3844 Manufacture of motorcycles and bicycles 78.79 77.45 80.31 76.12 3845 Manufacture of aircraft 100.00 100.00 100.00 99.78 3849 Manufacture of transport equipment NEC 94.08 95.81 94.22 100.00 3851 Controlling equipment NEC 34.87 43.34 36.34 55.93 3852 Manufacture of photographic and optical goods 62.06 76.78 81.98 84.30 3853 Manufacture of watches and clocks 100.00 100.00 100.00 98.73 3854 Other 79.65 81.46 65.87 65.64 3901 Manufacture of jewelery and related articles 48.80 46.02 47.12 53.39 3902 Manufacture of musical instruments 100.00 100.00 -- -- 3903 Manufacture of sporting and athletic goods 100.00 100.00 100.00 100.00 3909 Manufacturing industries NEC 31.38 32.74 39.74 45.58 -- Not available. Note: For abbreviations, see table 3.13. Source: Turkish State Institute of Statistics. 120 Turkey: Economic Reform and Accession to the European Union various sectors of the economy, and impose hard implement the whole body of EU legislation--that budget constraints on all public and private enter- is, the acquis communautaire, and in particular the prises. Further integration with the EU will then rules on competition, intellectual, industrial, and remove the distortions in the price system, which, commercial property rights, and the whole body of in turn, will boost the allocative efficiency in the technical legislation on a sectoral as well as a hori- economy. zontal level. Conclusion Notes Although customs duties and equivalent charges, as 1. The authors wish to thank their discussant, Bernard well as quantitative restrictions on industrial prod- Hoekman, and anonymous referees for helpful comments. Ibrahim Yilmaz and Harun Çelik provided excellent research ucts, were eliminated with the formation of the support. customs union in 1996 between Turkey and the EU, 2. For a discussion of the trade regime during the 1980s, see the free movement of industrial products between Togan (1994). the parties could not be established until 2003. The 3. All dollar amounts are U.S. dollars unless otherwise indicated. two remaining issues are contingent protectionism 4. EU15 refers to the 15 members of the EU prior to the 2004 and technical barriers to trade. Article 44 of the enlargement in which 10 more countries joined the EU. The Customs Union Decision allows the EU to impose 15 countries are Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, antidumping measures until Turkey implements Portugal, Spain, Sweden, and the United Kingdom. effectively the competition rules and the rules on 5. The mass housing fund tax is a specific tariff imposed the intellectual, industrial, and commercial prop- mainly on agricultural commodities. 6. The average rates of nominal protection were derived by erty rights of the customs union. Similar considera- weighting nominal rates estimated as applied rates for the sec- tions apply for Turkey. Since 1996, both parties tors by sectoral outputs valued at world prices. The average rates have been active users of these measures. of effective protection were obtained by weighting effective rates On another front, under Decision 2/97 of the estimated for the sectors by sectoral value addeds evaluated at world market prices. Association Council, Turkey had to incorporate 7. These are the sectors with negative EPRs and with values into its internal legal order, before the end of 2000, greater than -100. 324 instruments corresponding to various Euro- 8. The classification of the sectors into four trade groups fol- lows the same rule adopted by Balassa and others (1982). The pean Economic Community and European Com- export category includes sectors whose exports amount to more munity regulations and directives on technical leg- than 10 percent of domestic production and whose imports islation. But the work has still not been completed. account for less than 10 percent of domestic consumption. For sectors classified as export and import competing, both of these In addition, Turkey has to align its national quality shares exceed 10 percent. The import-competing and non- infrastructure to the European one. Products man- import-competing categories include sectors whose exports ufactured in Turkey must satisfy the same require- amount to less than 10 percent of domestic production. In sec- ments as those prevailing in the EU, and the tors in the import-competing category, imports exceed 10 per- cent of domestic consumption. In sectors in the non-import- demonstration of conformity to these require- competing category, imports are less than 10 percent of ments must be done in the same "harmonized" way domestic consumption. and according to the same principles as in the EU. 9. The authors are grateful to Ela Yazici Inan for her contri- butions to this section. On technical barriers to trade, see Sykes Recently, Turkey has taken major steps to align its (1995). legislation with the acquis. But it still has to estab- 10. Directive 83/189/EEC, amended by Directive 98/34/EC, lish the operators and operation of standardization, established the requirements that member states notify draft regulations and that national standards bodies notify work on testing, certification, inspection, accreditation, and new standards. metrology according to the same principles and 11. Consider the machinery directive that applies to all obeying the same rules as in the EU. Once these machinery and to safety components. The directive defines a problems are solved, competition will increase in machine as "an assembly of linked parts or components, at least one of which moves." Annex I of the directive gives a compre- the economy, leading to decreases in markups and hensive list of the hazards that may arise from the design and concentration ratios, provided it is complemented operation of machinery, and gives general instructions on what with privatization and adoption of appropriate hazards must be avoided. The directive requires the machine manufacturer to produce a "technical file" of documentary evi- competition policies. Thus, to benefit from free dence that the machinery complies with the directive, the form trade between the parties, Turkey has to adopt and and content of which is dictated in the directive. Machinery Integration and the Manufacturing Industry 121 meeting the requirements of the directive is required to have the Scientific and Technical Research Council (TUBITAK) the CE symbol clearly affixed to indicate compliance. An item of power to accredit are still in force. equipment may only display the CE mark when the equipment 16. The TSE was established in 1954 to draw up standards for satisfies all relevant directives--for example, machines with all kinds of products and services. electrical controls must also comply with the requirements of 17. For automotive products, the "e" sign confirms the low voltage and electromagnetic compatibility (EMC) direc- conformity. tives. For most items of machinery, the manufacturer (or its 18. UME is organized as part of TUBITAK. UME has cali- authorized representative) can self-certify--that is, it designs its bration laboratories in mechanics, physics, electricity, ionizing products to meet the requirements of the directive and signs a radiation, and chemicals. The laboratories under construction Declaration of Conformity. This declaration of conformity must include EMC, acoustics, and liquid flow. be backed up with the technical file. The file must be retained for 19. We use four-digit SITC trade data and correspondences a period of 10 years after the manufacture of the machine (or the between the NACE, International Standard Industrial Classifica- last machine of a production run). For certain especially danger- tion, and Standard Identification Trade Classification classifica- ous items of machinery (known as Annex IV machines), justifi- tions provided by the Eurostat's Classification Server (http:// cation of use of the CE mark must be independently verified by europa.eu.int/comm/eurostat/ramon/). a recognized authority (called an "approved body" or "notified 20. Manufactures are defined as consisting of sectors under body"). Manufacturers of Annex IV machines are required to SITC sections 5, 6, 7, and 8 minus division 68 and group 891. compile a technical file that shows how the machinery has been 21. Although Turkey realizes that the major pillars of a com- constructed to meet the requirements of the directive. The file is petition policy must comprise privatization, liberalization of then audited by the notified body to confirm that the directive's entry and exit, imposition of hard budget constraints on all pub- requirements have indeed been met, and a sample of the lic and private enterprises, and a very liberal trade regime, it machinery is examined to confirm that it is constructed as faces difficulties in implementing these principles. described in the file. If a harmonized standard for a particular 22. For concentration ratios in Slovakia and Belgium, see type of Annex IV machine exists, the manufacturer can avoid Djankov and Hoekman (1998). the expense of type examination by manufacturing the machine fully in accordance with the standard. All that is then required is References that the file be lodged with a notified body, but the notified body does not have to give an opinion on the machine--it simply acts Balassa, B. 1982. Development Strategies in Semi-Industrial as an independent repository for the file. This procedure can Economies. Baltimore: Johns Hopkins University Press. only be applied to machines that are manufactured fully in Baldwin, R. E. 2001. "Regulatory Protectionism, Developing accordance with the harmonized standard. If there are any devi- Nations and a Two-Tier World Trade System." Brookings ations from the standard (e.g., a light guard is fitted where the Trade Forum 3: 237­80. standard says a physical guard is required), the full type approval Breton, P., J. Sheehy, and M. Vancauteren. 2001."Technical Barri- route must be followed. ers to Trade in the European Union: Importance for Accession 12. This section reports the state of affairs on technical barri- Countries." Journal of Common Market Studies 39: 265­84. ers to trade in Turkey as of 2003. Djankov, S., and B. Hoekman. 1998. "Conditions of Competi- 13. Law 4703 is based on Council Directive 92/59/EEC on tion and Multilateral Surveillance." World Economy 21: general product safety, Council Regulation 85/C 136/01 on the 1109­28. new approach to technical harmonization and standards, and the European Commission. 1998. Technical Barriers to Trade. Vol. 1, Council resolution of December 1989 on the global approach to Subseries III, Dismantling of Barriers, The Single Market conformity assessment. Review. Luxembourg: Office for Official Publications of the 14. The legislation on market surveillance was prepared using European Communities (OOPEC). Council Directive 92/59/EEC on general products safety, the --------. 2000. Guide to the Implementation of Directives based Council resolution of December 1989 on the global approach to on the New Approach and the Global Approach. Brussels. conformity assessment, Council Directive 88/378/EEC on the --------. 2002. 2002 Regular Report on Turkey's Progress approximation of the laws of the member states on the safety of towards Accession. Brussels. toys, and on a European Commission implementation guide European Committee for Standardization. 2003. Support to the (2000). The legislation on working principles and procedures for Quality Infrastructure in Turkey: Country Report 2003. the conformity assessment bodies and notified bodies was pre- Brussels: CEN. pared using the material in chapter 6 of the European Commis- Messerlin, P. A. 2001. Measuring the Costs of Protection in Europe: sion guide (2000). The legislation on the use and affixing of the European Commercial Policy in the 2000s. Washington, DC: CE conformity mark is based on Council Decision 93/465/EEC Institute for International Economics. on the modules for the various phases of the conformity assess- OECD (Organisation for Economic Co-operation and Develop- ment procedures and the rules for affixing and the use of the CE ment). 2002. Turkey: Crucial Support for Economic Recovery. conformity marking. Finally, the legislation on notification pro- OECD Reviews of Regulatory Reform. Paris: OECD. cedures between Turkey and the EU for technical legislation and Sykes, A. O. 1995. Product Standards for Internationally Integrated standards is based on Council Directive 98/34/EC, laying down a Goods Markets. Washington, DC: Brookings Institution. procedure for the provision of information in the field of techni- Togan, S. 1994. Foreign Trade Regime and Trade Liberalization in cal standards and regulations and the relevant section of Decision Turkey during the 1980's. Avebury, UK: Ashgate Publishing. 2/97 of the EC-Turkey Association Council. Undersecretariat of Foreign Trade. 2002. "Türkiye'nin AB Teknik 15. Under a law published on October 27, 1999, TURKAK is Mevzuatina Uyumu--Çerçeve Kanun, Uygulama Yönet- the national accreditation body in all fields. But the regulations melikleri" [Harmonization of Turkish Regulations on Tech- that gave the Turkish Standards Institute (TSE) and Turkish nical Barriers to Trade to EU Approaches]. Ankara: UFT. 4 Accession of Turkey to the European Union: Market Access and Regulatory Issues Joseph Francois The European Union (EU) has been at the center of tions of EU regulation for the sector. The first sec- a recent explosion in regional trading schemes. A tion discusses the context of membership, espe- combination of economic and political factors-- cially the Customs Union between the EU and including greater peace and stability in the EU hin- Turkey, but also the other protocols agreed to and terland, support for democratic reforms in devel- under negotiation between the EU and Turkey. oping countries, greater trade and investment That section is followed by a brief quantitative dis- liberalization in developing countries, and access to cussion of the likely impact of full membership on new markets for EU exports--have been advanced trade and on the transport sector itself. Because the as motives for the EU to conclude such agreements. customs union covers many of the steps needed for For developing countries, the attraction has been membership, the incremental impact of the last preferential access to the large EU market and the necessary steps for the transport sector is relatively prospect of increased EU aid. The reality is that minimal. Other possible effects are then identified everybody, except the North American and high- through a detailed assessment of the regulatory income Asian economies, now seems to have pref- regime in Turkey for transport as compared with erential access to the EU.1 the one in effect for the rest of the EU. Here, too, For those countries that are immediate neigh- the major steps have already been taken, implying bors of the EU, the big prize has been the promise that EU membership will have little direct impact, of accession to the EU (see Baldwin and Francois institutionally or economically, on the domestic 1997). Turkey is no exception. Although Turkey was transport sector. Effects may be related to EU struc- not included in the list of new members for the tural funds (which was the case in Spain and Portu- next round of accession, an ongoing process (with a gal), but in view of the size of the looming enlarge- very long history) is supposed to lead eventually to ment, such funds are likely to be limited. EU membership. This chapter explores the implications of even- The Customs Union tual Turkish accession to the EU. The potential impacts of regulatory reform under such a process The primary difference between the current list of are examined by focusing on the transport sector, new EU members and membership for Turkey is the broadly defined to include air, land, rail, and other. depth and long history of trade integration in place Two issues studied are the linkage between trade between the EU and Turkey. The EU-Turkey cus- effects and the transport sector, and the implica- toms union has been a long time in the making. In 123 124 Turkey: Economic Reform and Accession to the European Union 1963 the Treaty of Ankara envisaged Turkey becom- Article XXIV of the General Agreement on Tariffs ing a full member of the EU, with preparation and Trade (GATT) of 1994, particularly Section 8 occurring over a series of stages. In 1970 a protocol requiring coverage of "substantially all trade" and to this Ankara agreement outlined a framework of the Understanding on Article XXIV (especially the the customs union between the EU and Turkey. preamble, which states that "no major sector is Even though Turkey's 1987 application for full excluded"). The EU seeks to resolve this dilemma membership in the EU was rejected, it continued to by interpreting World Trade Organization (WTO) pursue unilateral trade liberalization with the EU. rules as requiring free trade to be established on As a result, when the customs union was finally 90 percent of total bilateral trade flows. established for industrial products on January 1, Because EU tariffs on most industrial products 1996, after a transition period of 22 years, much of are zero or very low (exceptions are, for example, the required tariff changes for industrial products clothing and motor vehicles), the EU has little diffi- had already been implemented. culty in liberalizing imports of all, or practically all, The existence of the customs union, along with industrial products. Moreover, because imports of the protocols that go with it, has important impli- agricultural and fisheries products are limited by cations for the discussion that follows of the likely (sometimes prohibitive) border protection, they effects of full EU membership. The average reduc- account for only a small proportion of existing tion in tariffs required by the CU for Turkey has total imports from the partner country. As a result, been estimated to be only 7 percent (Harrison, the EU is able to make a sufficient contribution to Rutherford, and Tarr 1997). The combination of the fulfillment of the 90 percent criterion by liber- adopting the Common Customs Tariff (CCT) alizing only around 60 percent of its imports of structure and Uruguay Round commitments agricultural products. Similar calculations, it is should have produced a trade-weighted average argued by the EU, also enable the partner country tariff on industrial goods of 3.5 percent by 2001 to protect sensitive industrial and agricultural (WTO 1998). In theory, the objective of the sectors of its economy while remaining within customs union agreement is to prepare Turkey the EU's interpretation of the requirements of for full membership in the EU, and the agree- Article XXIV. ment is, therefore, not only deeper than the EU's Given these constraints, the pattern of tariff free trade agreements, but also goes well beyond reductions in the developing country usually takes the basic requirements of a customs union agree- the form of abolishment of the duties on capital ment. In particular, it requires Turkey to introduce and intermediate goods before duties on final con- a wide range of legislation covering all aspects sumer goods, which are also subject to significantly of trade; competition law; industrial, commer- higher initial duties and which are liberalized only cial, and intellectual property rights; and to adopt toward the end of the transitional period. It is in EU technical standards.2 In this sense, the the area of trade in agricultural and fisheries prod- customs union agreement carries with it many of ucts that the agreements fall significantly short of the consequences that would follow from full EU free trade. The EU routinely excludes products such membership. as beef, sugar, a range of dairy products, some cere- Table 4.1 compares the current EU arrangement als and cereal products, rice, some fresh fruits and with Turkey with recent and ongoing agreements vegetables, some cut flowers, and fisheries prod- (in the form of free trade agreements, FTAs) with ucts. The partner developing country also excludes selected developing countries and regions. Behind a range of agricultural products, not least to protect all of these agreements is a mix of politics and eco- its agriculture from imports of subsidized agricul- nomics. A basic dilemma facing EU negotiators of tural goods from the EU, such as beef, sugar, dairy these free trade agreements is that, according to products, and cereals. As a result, in the agreement their negotiating mandate, they must not under- with Mexico only 62 percent of bilateral trade in mine the finely tuned border protection of the agricultural products is fully liberalized. In the EU's Common Agricultural Policy (CAP) and the agreement with South Africa, 62 percent of EU Common Fisheries Policy. At the same time, they imports are liberalized, while South Africa fully lib- must ensure that agreements are compatible with eralizes 82 percent of its imports from the EU. No Accession of Turkey to the European Union: Market Access and Regulatory Issues 125 TABLE 4.1 Structure of EU Free Trade Agreements with Selected Developing Countries Egypt South Africa Mexico Turkey Rationale: EU Security Reinforce Access to NAFTA; Customs union democracy; regional hub agreement in regional hub industrial products; objective of membership in EU Partner Maintain Improve access to Reduce preferences; EU market; dominance of lock in reforms; attract FDI; lock United States; attract FDI in reforms improve access to EU market; attract FDI Transitional period: EU Immediate 10 years 10 years Turkey's customs legislation now Partner 12­15 years 12 years 10 years almost same as that of EU Industry coverage: EU All Almost all, most All by 2003 All by 2006 Partner All, less than half 87% and All by 2007, most All by year four, end-weighted by 2003 end-weighted on most protected Agricultural coverage: EU Approx. 60%+ of imports, entry prices, plus preferences Separate preferen- with tariff quotas tial agreement covering range of products, some with tariff quotas Partner Very limited; Substantial; some Some, such as some duty wines subject to dairy, tobacco, reductions tariff quotas processed foods within tariff quotas Rules of origin: EU EU rules; bilateral cumulation with EU; derogations EU rules can be requested. Partner Part MEDA Full SACU Relaxation in some cumulation an cumulation; sectors due to objective partial SADC lack of raw cumulation with materials and one country components Safeguards Standard EU clause for both parties plus transitional EU rules arrangements for partner Antidumping Standard WTO rules Intellectual Protected under TRIPS plus list of Special committee TRIPS plus list of property rights international agreements to solve international difficulties agreements 126 Turkey: Economic Reform and Accession to the European Union TABLE 4.1 (Continued) Egypt South Africa Mexico Turkey Competition rules Outlaws collusion/ Each retain own Own laws; EU policy abuse of rules; outlaws detailed dominant collusion/abuse statement on position of of market cooperation; enterprises, power, etc.; technical which distorts cooperation assistance competition in plus EU trade (except assistance for ECSC products) State aids Must not distort competition in trade between EU and partner, but are permissible for public or policy objectives (EU Article 92) Public procurement Consultation "Fair, equitable and National Agreement to be with aim of transparent" treatment and reached in liberalization nondiscrimina- future tion phased in over 10 years, except some public utilities and transport Rights of GATS plus possibility of further Trade in most National establishment liberalization services treatment; and services liberalized plus services most modes of agreement supply by 2004; under transitional negotiation as period of part of customs 10 years; union national treatment Capital movements Free movement of capital relating Program of Export of large to direct investment plus interest liberalization sums from profits and dividends relating to Turkey unclear investment plus protection of investment Standards Aim of reducing differences (especially Cooperation; Working toward SPS) and mutual recognition Special implementation Committee on of EU rules SPS Measures Custom For example, exchange of information, introduction of single EU commercial cooperation administration document, simplification of controls and policy and rules procedures for clearance, cooperation on rules of origin Aid, economic MEDA programs Multiannual n.a. MEDA plus EIB development (grants) to indicative preaccession cooperation support all programs of loan facility Euro-Med grants and agreements; loans three-year rolling national indicative programs Institutions Joint EU/Partner Association/Cooperation Council at Association Council; ministerial level supported by committees (high official) CU Joint and technical working groups Committee; Joint Consultative Committee Accession of Turkey to the European Union: Market Access and Regulatory Issues 127 Egypt South Africa Mexico Turkey Dispute settlement Association Cooperation Joint Committee Association Council by Council or or arbitration; Council or "decision" or arbitration; rules for arbitration by arbitration stages time procedures, binding on limited; no time-limited, both parties; enforcement stages, no time limit or procedures compensation enforcement procedures General Political dialogue; social and cultural cooperation; democratic principles and respect for human rights; scientific, technical, and technological cooperation Other Money Wine and spirits Turkey to adopt laundering; agreement; all of EU's drug trafficking; fisheries (not preferential migrant workers concluded); trade and illegal regional agreements immigration; cooperation regional integration n.a. Not applicable. Note: NAFTA North American Free Trade Agreement; FDI foreign direct investment; MEDA is the financial instrument of the Euro-Mediterranean Partnership; SACU South African Development Community; SADC South African Development Community; WTO World Trade Organization; TRIPS Agreement on Trade-Related Aspects of Intellectual Property Rights; ECSC European Coal and Steel Community; GATS General Agreement on Trade in Services; SPS sanitary and phytosanitary; EIB European Investment Bank; CU Customs Union. Source: Francois, McQueen, and Wignaraja 2003. comparable figures are published for trade in agri- The customs union agreement is part of the cultural products with Egypt or Turkey. more general program of preparation for EU mem- Agricultural products are not included in the bership, signaled in particular by the Helsinki customs union agreement with Turkey, but because agreement to include Turkey as a candidate coun- the objective is full membership in the EU, both try for accession to the EU and by Turkey's adop- parties have agreed to progressively improve their tion on March 19, 2001, of the "National Pro- preferential regime in the agricultural sector with gramme for the Adoption of the Acquis" (the the aim of allowing Turkey to adapt its agricultural acquis communautaire is the entire body of legisla- policy to the EU's Common Agricultural Policy. tion of the European Communities and Union). However, no time frame has been applied to this This program includes the economic aspects of the process, and the system of preferences does not acquis, in particular the "four freedoms" (related to "restrict in any way the pursuance of the respective goods, persons, services, and capital) that form the agricultural policies of the Community or Turkey."3 basis for the operation of the internal market. As In addition, both countries have a safeguard clause discussed in other chapters in this volume, these that can be activated if "either quantities or the economic aspects have immediate implications for prices of imported products from the other Party in services trade. respect of which a preferential regime has been cre- ated, causes or threatens to cause a disturbance of A Quantitative Assessment the Community or Turkish market." The European Commission estimates that 93 percent of Turkey's As noted earlier, the customs union between the agricultural exports to the EU and 33 percent of EU EU and Turkey already covers most, if not substan- agricultural exports to Turkey are covered by the tially all, trade. To analyze the impact of Turkey's 1998 scheme of preferences. accession to the EU, this section describes the 128 Turkey: Economic Reform and Accession to the European Union application of a global general equilibrium model favored-nation (MFN) duties have been abolished (the model, which is described in annex 2, is based for live bovine (pure breeding animals) and meat on Francois, McQueen, and Wignaraja 2003). The or fish unfit for human consumption. For a fairly policy experiments involve a summary of the esti- short list of other products, duties are abolished mated economic effects of the customs union and within small tariff quotas, including products listed of its extension, under membership, to cover all in table 4.2. trade. Turkey has undertaken "far-reaching structural The EU-Turkey customs union agreement is and legislative reforms within the framework of really designed for industrial products; the final the customs union agreement" (WTO 1998). The stage was completed in 2000. As such, there is unre- adoption of the CCT has meant that Turkey's level stricted trade in all industrial products between of border protection on industrial products and the two countries, and Turkey applies the CCT to the industrial component of processed foods has imports of industrial products from third countries. declined significantly. As a result, even though Agriculture is largely excluded from the agreement, there may be some concerns about the possibility although there is a preferential trade regime for a of relative trade diversion, the absolute level limited range of agricultural products (see table 4.2 of imports from third countries should have for a summary). increased, not only because border measures of EU imports of products not listed in table 4.2 protection have declined significantly, but also are exempt from ad valorem duties, but they are because the adoption of EU customs regulations still subject to specific duties and quotas. Even has provided exporters with greater certainty of where preferences are given for some food products treatment. Turkey illustrates as well some of the (fruits and vegetables), they are only available substantial difficulties that developing countries between certain dates. Turkey has liberalized even experience in implementing far-reaching structural less in the area of food and agriculture. Most- reforms even when, like Turkey, they have both the TABLE 4.2 Processed Food Concessions under the EU-Turkey Customs Union EU Concessions Turkey Concessions Tomato paste Live bovine animals Poultry meat Frozen meats Sheep and goat meat Butter Olive oil Cheese Cheese Vegetable and flower seeds Some fresh fruit and vegetables Flower bulbs Hazelnuts Apples and pears Fruit juices Potatoes Marmalade and jams Cereals Refined/raw vegetable oil Sugar Tomato paste Some alcoholic beverages Some animal foods Note: Products not listed by the EU are exempted from ad valorem duties, but they are still subject to quotas and specific duties. Examples are beef and sugar. Turkey has liberalized some agricultural tariffs within very narrow tariff-rate quotas. Source: Francois, McQueen, and Wignaraja 2003. Accession of Turkey to the European Union: Market Access and Regulatory Issues 129 incentive of full membership in the EU and the the current level of discrimination against their backing of substantial financial and technical exports. resources. Agriculture is, however, an important sector of Because the customs union reflects political sen- the Turkish economy, accounting for about 11.4 sitivities in the EU and Turkey, areas of significant percent of its gross domestic product and 34 per- potential (agricultural) trade have been excluded cent of employment. The omission of this sector by both parties to the agreement. Reflecting the from the customs union agreement must produce customs union as just described, the scenario for significant distortions in the allocation of resources application of the computable general equilibrium in the economy and in the economic effects of the (CGE) model is summarized in table 4.3.4 agreement. Of immediate interest here is the sectoral impact The macroeconomic effects of the customs of the actual customs union and of a full free trade union are summarized in table 4.4. Consider first scenario. The omission of the agricultural sector national welfare (measured as current welfare from the customs union agreement almost cer- derived from economy-wide consumption pat- tainly means that the agreement does not conform terns). The customs union, as currently constructed, with Article XXIV of the GATT. Interestingly, this yields a boost in Turkish welfare (measured as a per- issue was raised in the WTO review of the report centage of base national income) of over 1.3 percent of the Trade Policy Review Board (TPRB) on relative to the baseline with MFN industrial tariffs. Turkey (no response by Turkey was recorded), but Based on 1997 values, this gain is comparable to a no WTO member state has so far challenged the boost in real GDP of US$2.2 billion.5 The static agreement, presumably because those states feel effect is slight, adding less than 0.1 percent to that adoption of the CAP by Turkey would increase welfare through induced capital accumulation. TABLE 4.3 Customs Union Scenario Full Partial No Liberalization Liberalization Liberalization Grains Turkey EU Other agriculture EU, Turkey Mining EU, Turkey Other primary production EU, Turkey Sugar Turkey EU Dairy Turkey EU Meats EU, Turkey Processed foods EU, Turkey Textiles EU, Turkey Clothing EU, Turkey Leather EU, Turkey Wood and paper EU, Turkey Chemicals EU, Turkey Refineries EU, Turkey Steel EU, Turkey Nonferrous metals EU, Turkey Motor vehicles EU, Turkey Electronics EU, Turkey Other machinery EU, Turkey Manufactures, NEC EU, Turkey Note: Partial liberalization is modeled as 50 percent. NEC not elsewhere classified. Source: Author's definition of model aggregation. 130 Turkey: Economic Reform and Accession to the European Union TABLE 4.4 Summary of Macroeconomic Effects of Customs Union for Turkey A B C A B D Long-Run Effects of Long-Run Actual Effects of Static Dynamic Customs Full EU Effects Effects Union Membership Welfare (% of national income) 0.91 0.4 1.31 1.36 Welfare (millions of US$) 1,558.92 678.31 2,237.23 2,335.73 Terms of trade (%) 2.64 0.91 1.73 1.95 Value of exports (%) 10.6 3.46 14.06 15.21 Unskilled worker wages (%) 2.02 0.22 2.24 2.62 Skilled worker wages (%) 1.28 0.43 1.71 1.72 Capital stock (%) 0.00 1.24 1.24 1.24 Value of GDP in dollars (%) 3.17 0.36 2.81 3.01 Real exchange rate (%)a 3.05 1.1 1.95 2.16 GDP quantity index (%) 0.11 0.74 0.85 0.84 a. Real exchange rate is the dollar price of the base period GDP basket. Source: Author's calculations. A comparable improvement appears in Turkey's misses substitution effects in production and con- terms of trade through static effects--the gap sumption--but it is a common metric for govern- between export and import prices widens by over ment monitoring of economic climate. The 2.5 percent. However, there is an interaction changes in both the value and quantity of GDP between long-run capital accumulation and the (based on a fixed 1997 basket of goods and serv- terms of trade that erodes terms-of-trade gains over ices) fail to track welfare gains in any meaningful the medium run. The agreement, as modeled, way. yields a considerable boost in the capital stock How does the actual customs union compare (1.24 percent).Normally,a large boost in real income with a full customs union? A comparison of the would follow. In fact, the quantity index for GDP last two columns of table 4.4 reveals the differ- does expand. But because of the erosion in the ences. The EU-Turkey customs union does not terms of trade in the medium to long run, the value cover all potential EU-Turkey trade, but Turkey is of GDP (in dollar terms) falls somewhat. Even so, at a stage of development where critical market the initial terms-of-trade gains are strong enough access revolves around manufactured goods rather to outweigh these effects. than agriculture. As a result, the actual customs Consider next the impact on wages. Both skilled union does cover enough trade to generate gains and unskilled workers gain from the agreement, that are broadly similar to those of a full cus- with a 2.2 percent and 1.7 percent boost, respec- toms union. The differences between the two tively, to real incomes (net of changes in the con- columns are within the margin of error for this sumer price index, CPI) over the long run. Such kind of modeling exercise. Broadly speaking, the wage changes are considerable, given that they table does not reveal a significant difference, in are realized in the context of a trade agreement. terms of welfare, between a full customs union and The positive wage effects imply that, overall, the the EU-Turkey customs union. But there is some customs union will not make labor market condi- expansion of trade (primarily in food) under full tions worse. membership. The next set of indicators reported in table 4.4 Although the overall macro effects of the actual relate to real exchange rates and GDP. GDP is not customs union are comparable with those of a full an appropriate measure of economic welfare--it customs union, some slight differences emerge at Accession of Turkey to the European Union: Market Access and Regulatory Issues 131 TABLE 4.5 Change in Output by Sector in Turkey (percent) A B C A B D Long-Run Long-Run Effect of Effect of Static Dynamic Actual Full EU Sector Effects Effects FTA Membership Grains 0.76 0.67 0.09 1.18 Other agriculture 0.89 0.78 0.11 2.3 Mining 4.14 0.65 3.49 4.67 Other primary production 0.28 0.34 0.62 0.4 Sugar 0.4 0.61 0.21 4.6 Dairy 0.09 0.39 0.48 0.09 Meats 0.77 1.03 0.26 2.96 Processed foods 0.84 1.06 1.9 1.61 Textiles 21.81 4.43 26.24 25.46 Clothing 49.16 6.46 55.62 54.86 Leather 0.81 3.92 4.73 4.88 Wood and paper 0.76 0.05 0.71 0.87 Chemicals 2.31 1.21 1.1 1.14 Refineries 0.85 0.97 0.12 0.1 Steel 3.93 0.74 3.19 3.67 Nonferrous metals 7.09 2.23 4.86 5.5 Motor vehicles 17.12 2.05 15.07 15.73 Electronics 11.6 1.46 13.06 12.7 Other machinery 6.35 1.81 4.54 5.08 Manufactures, NEC 1.0 0.39 0.61 0.81 Transport 0.43 0.87 0.44 0.35 Construction 3.47 2.77 0.7 0.64 Business services 3.71 1.83 1.88 2.13 Other services 1.07 0.78 0.29 0.41 Note: NEC not elsewhere classified. Source: Author's calculations. the sectoral level (see table 4.5). Under a full motor vehicle sector in the EU applied strong pres- customs union, EU grain production squeezes sure on the motor vehicle and parts sector in Turkey, Turkey's production, with a projected drop in out- which shrank by 15 percent. Another sector that put of 1.18 percent. However, under the actual benefits is (consumer) electronics, which enjoyed a agreement this sector is largely sheltered, with pro- 12 percent increase in production. duction projected to drop only 0.09 percent from The sector-level results also point to no real baseline levels. A similar story holds for meat pro- great adjustment pressures within Turkey, except duction, which is largely insulated under the current in heavy manufacturing. The motor vehicle, agreement. machinery, and equipment sectors are squeezed. Outside of food production, the largest effects This situation is consistent with expectations about are in textiles, clothing, and motor vehicle produc- Turkey's comparative advantage, with an advantage tion. Textiles and clothing have benefited tremen- in lighter manufactures and a relative disadvantage dously from improved EU access. Production is in some heavy manufacturing sectors. 25 percent and 50 percent higher, respectively, than The trade results largely mirror the results for without preferred access. At the same time, the production. One outlier is motor vehicles.Although 132 Turkey: Economic Reform and Accession to the European Union production is squeezed and imports go up substan- the EU.This would follow from roughly $100 million tially, exports also go up substantially. Mexico's in additional services imports from the EU. experience with the North American Free Trade Agreement (NAFTA) was similar. The motor vehicle A Factor Analysis of Regulatory sector is forced to restructure, and in the process it Structures becomes more deeply integrated with the European industry. As a result, significant growth is projected Membership in the EU involves not only market in both imports and exports in the sector relative to a access, but also community rules and regulations. baseline with continued MFN protection for the sec- In this section, the regulation database of the tor.Theresultforsugarunderthefullcustomsunion Organisation for Economic Co-operation and reflects the subsidies to EU production and a large Development (OECD) is used to examine the struc- increase in a small export base for Turkey (small ture of competition and regulation in the transport changes in small flows can lead to large percentage sector across OECD countries. The goal is to com- changes). In the actual customs union agreement, pare the regulatory status of Turkey's transport sec- these effects are sterilized. tor with those of EU members. In the end, it turns What happens to the transport sector under the out that the Turkish regulatory regime is not at all customs union? The static effect is contraction, as inconsistent, by these measures, with the broad pat- resources are pulled out of the sector and into manu- tern observed within the EU. This finding may facturing. However, because the customs union is reflect the long, ongoing process of Turkish integra- estimated to have positive investment effects (i.e.,the tion. In any event, it suggests that the sector may capital stock expands),there is a projected expansion require little overall realignment of regulation in of thesectorinthemediumtermof roughly0.44per- view of what is currently allowed within the EU. cent. Because the agreement is already in place, the The 2000 OECD International Regulation Data- interpretation is that the transport sector is almost a base includes more than 1,100 variables for each half percent larger than it would be otherwise. OECD member on both economy-wide product What happens to the transport sector under market regulation and regulation at the sector level. actual EU membership (the focus here is on the For the purposes of this study, it includes data trade-related effects)? Again, the impact is positive on regulation in road transport, national and inter- relative to no preferential trade at all. However, national air transport, and rail transport (see because full membership would extend access to the Nicoletti, Scarpetta, and Boylaud, 1999, for a EU food markets (food production is a large share of detailed description of the data). In general, the Turkey's economy), resources would be pulled out data of interest here are centered around 1998. of the service sectors and into agriculture. The OECD database may contain over 1,100 vari- Finally, what happens to direct trade in trans- ables, but only a limited number apply to transport. port services? The Global Trade Analysis Project In addition, many remain unanswered by a large (GTAP) database reveals that Turkey's trade in number of members, and many others simply defy transport services is relatively small, with imports quantification. For this reason, the full set of trans- of roughly $1.207 billion in 1997. Based on gravity port questions has been reduced to the set covered in estimates of services trade barriers, the import tar- table 4.6. The 18 variables listed for air transport are iff equivalent for cross-border transport service classified into domestic competition, international imports into Turkey is roughly 8.9 percent (see competition, and government ownership and regu- annex 1). Assuming an import demand elasticity of lation. The 15 variables for road transport and the ­3.9 (equal to the import substitution elasticity in six for rail are roughly classified into domestic com- demand in the GTAP model for this sector) and petition and government ownership and regulation. deadweight trade costs, a back-of-the-envelope cal- Within each set of variables, the assigned values culation yields gains of roughly $126 million per year range from 0 to 6 (so that for dummies, yes is gener- from full trade liberalization in the sector. The EU ally 6 and no is 0),and the assigned weights are based accounts for roughly 25 percent of this total, or only on the number of variables in a sector:category set. about $30 million per year in welfare gains in the sec- In this factor analysis of the variables, the result of tor from direct trade related to liberalization vis-à-vis this scaling is a set of regulatory indexes ranging Accession of Turkey to the European Union: Market Access and Regulatory Issues 133 TABLE 4.6 Variables Used from OECD International Regulation Database Data Set OECD Survey Variable Question No. Question Name 17 Does national, state, or provincial government hold equity stakes in ATOR1 business company? 7,131 air transport carriers 52 Do national, state, or provincial laws or other regulations restrict in at ATOR2 least some markets the number of competitors allowed to operate a business? 7,131 air transport carriers 547 Air travel/national market structures: domestic market share of the largest ATDC1 airline (incl. subsidiaries) (more than 500,000 passengers a year) 548 Air travel: market structure: domestic routes (all routes): share of traffic ATDC2 (passengers/km) of the incumbent carrier 558 Air travel: market structure: international routes (all routes): share of ATIC1 traffic (passengers/km) of the largest carrier in the international traffic of national carriers 566 Air travel: Is the largest operator in international routes also the largest ATIC2 operator in domestic routes? (all routes) 567 Air travel/national market structures: share of 100 international routes ATIC3 with more than three carriers 572 Air travel/national regulations and government ownership: government ATOR3 ownership in largest airline (%) 573 Air travel/national regulations and government ownership: government ATOR4 golden share in a major airline 579 Air travel/national regulations and government ownership: government ATOR5 loss makeups in major airlines in the past five years 580 Air travel/national regulations and government ownership: the largest ATOR6 airline has public service obligations 611 Air travel/national regulations and government ownership: domestic ATOR7 market deregulated 612 Air travel/national regulations and government ownership: Open Sky ATIC4 agreement with United States 613 Air travel/national regulations and government ownership: Open Sky ATIC5 agreement older than six years 618 Air travel/national market structures: international market share of the ATIC6 largest airline (incl. subsidiaries) (more than 500,000 passengers a year ) 619 Air travel/national market structures: Herfindahl concentration index in ATDC3 domestic market 620 Air travel/national market structures: Herfindahl concentration index in ATIC7 international market (%) 1120 Air travel: ceiling on foreign ownership allowed in national air transport ATOR8 carriers 13 Does national, state, or provincial government hold equity stakes in RTOR1 business company? 7,114 road freight 48 Do national, state, or provincial laws or other regulations restrict in at RTDC1 least some markets the number of competitors allowed to operate a business? 7,114 road freight 492 Road freight: Is there a firm in the road freight sector that is publicly RTOR2 controlled (i.e., national, state, or provincial governments hold the largest single share)? 493 Road freight: Is registration in any transport register required in order to RTOR3 establish a new business in the road freight sector? 494 Road freight: In order to operate a national road freight business (other RTOR4 than for transporting dangerous goods or goods for which sanitary assurances are required) do you need to be granted a state concession or franchise by any level of government? 134 Turkey: Economic Reform and Accession to the European Union TABLE 4.6 (Continued) Data Set OECD Survey Variable Question No. Question Name 495 Road freight: In order to operate a national road freight business do you RTOR5 need to obtain a license (other than a driving license) or permit from the government or a regulatory agency? 496 Road freight: In order to operate a national road freight business do you RTOR6 need to notify any level of government or a regulatory agency and wait for approval before you can start operation? 505 Road freight: Does the regulator, through licenses or otherwise, have any RTDC2 power to limit industry capacity? 513 Road freight: Are there any regulations setting conditions for driving RTOR7 periods and rests? 515 Road freight: Do regulations prevent or constrain: backhauling? RTDC3 516 Road freight: Do regulations prevent or constrain: private carriage? RTDC4 517 Road freight: Do regulations prevent or constrain: contract carriage? RTDC5 520 Road freight: Within the last five years, have laws or regulations removed RTOR8 restrictions on: commercial, for-hire shipments? 521 Road freight: Are retail prices of road freight services in any way regulated RTOR9 by the government? 522 Road freight: Does the government provide pricing guidelines to road RTDC6 freight companies? 10 Does national, state, or provincial government hold equity stakes in RROR1 business company? 7,111 railways 45 Do national, state or provincial laws or other regulations restrict in at least RRDC1 some markets the number of competitors allowed to operate a business? 7,111 railways 528 Railways: freight transport: total number of operators RRDC2 538 Railways: Please indicate if the government has any liability for losses made RROR2 by a railway company (excluding subsidies related to service obligations). 539 Railways: Did the government in the past five years make up for any losses RROR3 made by railway companies? 540 Railways: Are companies operating the infrastructure or providing railway RROR4 services subject to universal service requirements (e.g., obligation to serve specified customers or areas)? Note: Questions have generally been rescaled from 0 to 6, with 0 being a positive indicator (more competition, less regulation, less participation by government through ownership, golden shares, price setting, and so forth). Questions have also been assigned inverse weights (i.e., if there are four domestic competition questions for air, each gets a 1/4 weighting for the domestic competition for air transport factoring and scoring exercise). Source: OECD International Regulation Database, 2001. from 0 (generally open, competitive regimes with Factor analysis is applied first to the regulatory minimal regulation) to 6 (generally more regulated, variables grouped by sector and type of regulation, with less or no competition). thereby yielding a set of indicators for road trans- Multivariate factor analysis is a standard tech- port, air, and rail, which are listed in tables 4.7, 4.8, nique for summarizing patterns in regulatory data and 4.9. The critical point to pick up from these (see Nicoletti, Scarpetta, and Boylaud 1999 and indexes is that in all three transport sectors Turkey's Boylaud 2000). Factor analysis yields factors that are regulatory regime is fully consistent with the linear combinations of the variables observed and regimes of current EU members. For example, that, in theory, identify latent variables or indicators the road transport regime in Turkey has fewer limits that lurk behind the observed data. In the present on competition (including pricing guidelines) than context, this approach allows the construction of Germany, Greece, Finland, and the Netherlands. indexes of regulatory frameworks in the sample. Overall,theroadtransportsectorcomparesfavorably TABLE 4.7 Regulation Indexes, Air Transport Public International Service Public Service Reservation Obligation, Government Regulation Obligations for Dominant Competition Regulation of Regulated Government Ownership or Government and Limits on and Custom Domestic International Domestic and Price Industry Customer Ownership Overall Management Bailouts Restructuring Guarantees Competition Competition Carrier(s) Air Road Rail Regulation Structure Access and Bailouts United States 2.1 2.5 2.7 1.7 0.8 1.1 2.4 3.7 2.1 1.4 2.6 0.827486135 0.639225018 0.373642805 0.451764654 Japan 3.6 2.5 2.6 1.3 0.9 2.2 4.7 3.8 3.6 1.2 1.7 1.608383946 0.398000994 0.440217734 0.397295435 Germany 4.6 2.7 2.5 2.7 1.5 3.4 5.9 4.0 4.6 1.6 1.2 2.001897264 0.760787878 0.464155476 0.478902558 France 3.8 4.7 3.5 2.1 1.3 2.5 5.7 3.4 3.8 1.0 1.9 1.648319644 0.690636245 0.58446881 0.551299765 Italy 4.1 4.6 3.5 2.1 2.2 3.1 5.8 3.5 4.1 2.1 2.0 1.802392871 0.653592598 0.710903353 0.539211452 United Kingdom 3.7 2.7 1.7 2.3 2.8 1.9 4.7 4.4 3.7 1.9 0.9 1.41077272 0.838287495 0.998012427 0.190062094 Canada 3.4 2.5 1.9 0.7 1.2 2.3 4.7 3.2 3.4 1.4 1.8 1.634645345 0.316644254 0.4247025 0.304681501 Finland 4.0 4.4 1.4 2.4 1.2 3.4 6.0 2.8 4.0 2.1 1.9 1.854702305 0.722343477 0.560720801 0.32557426 Greece 4.2 4.7 3.4 1.5 2.2 3.8 5.9 3.0 4.2 2.4 2.1 1.95420938 0.461873888 0.714813349 0.543616231 Mexico 2.1 4.2 3.5 1.7 1.1 2.0 3.4 1.8 2.1 1.0 1.3 1.353502801 0.694882568 0.570964691 0.522586274 Netherlands 4.0 4.0 2.2 3.7 0.2 3.6 5.4 3.2 4.0 1.8 1.6 1.768005014 1.039911684 0.309726703 0.337963967 New Zealand 4.5 2.7 2.7 3.5 1.2 3.7 6.0 3.0 4.5 2.8 0.7 2.010288982 0.905292063 0.478973959 0.385442689 Norway 3.3 4.3 1.4 2.4 1.1 2.2 5.6 1.9 3.3 2.8 1.9 1.550070023 0.703961664 0.571637512 0.309285763 Portugal 4.2 4.7 3.4 1.5 2.2 3.9 5.9 3.1 4.2 1.4 1.9 1.927716035 0.537816601 0.712804139 0.52197316 Spain 3.7 4.7 3.6 2.9 1.0 2.5 5.6 3.1 3.7 1.2 1.9 1.682086662 0.927405698 0.473408351 0.55497655 Sweden 4.0 4.2 2.1 2.8 0.7 3.1 6.0 2.9 4.0 1.7 1.9 1.836297304 0.773933652 0.427582084 0.399262966 Switzerland 4.2 3.7 1.4 1.6 0.5 3.5 6.0 3.0 4.2 2.2 1.9 1.90027128 0.545283018 0.315114694 0.280302128 Turkey 4.1 4.8 1.3 1.6 2.2 3.7 5.8 3.3 4.1 2.3 1.9 1.740053875 0.631766305 0.758792739 0.343861905 Czech Rep. 3.8 4.7 1.3 1.7 1.3 3.8 5.9 1.9 3.8 1.5 1.4 1.976677595 0.599534062 0.47354244 0.250246189 Hungary 2.8 4.4 1.3 1.8 1.1 2.6 4.9 1.0 2.8 2.1 1.9 1.512782968 0.653479446 0.495375794 0.162857349 Korea, Rep. of 3.9 2.6 2.5 2.1 1.5 3.2 4.8 3.6 3.9 0.6 0.3 1.830529419 0.767582267 0.66823034 0.245312432 Poland 3.7 4.9 1.3 1.6 1.3 3.7 5.7 2.1 3.7 1.4 1.7 1.875180579 0.60420922 0.557323214 0.26365386 Note: Indexes, which range from 0 to 6, are based on rotated factor loadings. The overall index is based on the first factor for the summary indexes, with 90 percent of the variance explained. Source: Author's calculations. 135 136 TABLE 4.8 Regulation Indexes, Road Transport Limits on State Backhauling, Limits on Concession Regulatory Private Competition State Requirements Approval Carriage, and (Including Government Ownership/ and Price Required for Other Contract Price Overall Licensing Concessions Regulation Establishment Regulations Carriage Guidelines) United States 1.4 4.7 1.9 1.3 1.8 1.2 0.8 1.7 Japan 1.2 4.7 1.4 2.3 0.6 1.4 0.5 1.7 Germany 1.6 4.6 2.3 1.2 2.1 1.3 1.2 2.4 France 1.0 4.9 3.5 1.1 0.3 1.3 0.5 1.7 Italy 2.1 4.4 1.6 3.9 1.8 2.0 0.7 1.5 United Kingdom 1.9 4.6 1.8 1.4 1.7 2.1 0.9 1.7 Canada 1.4 4.7 1.9 1.3 1.8 1.2 0.8 1.7 Finland 2.1 4.4 2.2 1.3 1.2 2.2 1.2 3.9 Greece 2.4 4.4 1.6 3.9 1.8 2.0 0.7 4.1 Mexico 1.0 4.8 1.7 1.2 1.8 0.2 0.7 3.4 Netherlands 1.8 4.5 1.8 1.4 1.0 2.1 0.8 2.9 New Zealand 2.8 3.0 1.8 1.4 2.7 2.1 0.0 1.7 Norway 2.8 3.2 3.9 1.1 2.2 2.3 0.2 2.1 Portugal 1.4 4.7 1.9 1.3 1.8 1.2 0.8 1.7 Spain 1.2 4.6 1.9 1.3 1.1 1.2 0.8 1.8 Sweden 1.7 4.5 1.8 1.4 1.0 2.1 0.8 1.7 Switzerland 2.2 1.8 1.8 1.6 0.6 1.4 0.9 3.4 Turkey 2.3 1.8 2.3 1.5 1.6 1.5 1.4 1.7 Czech Rep. 1.5 4.6 4.2 2.6 1.9 1.1 1.1 1.7 Hungary 2.1 4.6 1.8 1.4 1.7 2.1 0.9 3.2 Korea, Rep. of 0.6 4.7 1.7 1.2 1.1 0.2 0.6 1.7 Poland 1.4 4.5 4.2 2.6 1.2 1.1 1.0 1.7 Note: Indexes, which range from 0 to 6, are based on rotated factor loadings. The overall index is based on the first factor for the summary indexes, with 90 percent of the variance explained. Source: Author's calculations. Accession of Turkey to the European Union: Market Access and Regulatory Issues 137 TABLE 4.9 Regulation Indexes, Rail Transport Government Financial/ Operational Government Domestic Overall Interventions Ownership Competition United States 2.6 1.9 1.7 0.2 Japan 1.7 1.7 1.8 1.3 Germany 1.2 1.7 1.8 1.9 France 1.9 3.4 1.8 1.3 Italy 2.0 3.4 1.8 1.2 United Kingdom 0.9 2.2 0.3 1.3 Canada 1.8 1.9 1.7 1.2 Finland 1.9 1.3 2.2 1.3 Greece 2.1 3.0 2.2 1.3 Mexico 1.3 1.7 1.8 1.8 Netherlands 1.6 2.3 1.4 1.3 New Zealand 0.7 1.3 1.1 1.9 Norway 1.9 1.3 2.2 1.3 Portugal 1.9 3.4 1.8 1.3 Spain 1.9 3.4 1.8 1.3 Sweden 1.9 1.3 2.2 1.3 Switzerland 1.9 3.4 1.8 1.3 Turkey 1.9 3.4 1.8 1.3 Czech Rep. 1.4 3.4 1.8 1.9 Hungary 1.9 3.4 1.8 1.3 Korea, Rep. of 0.3 2.2 0.3 1.9 Poland 1.7 1.9 1.7 1.3 Note: Indexes, which range from 0 to 6, are based on rotated factor loadings. The overall index is based on the first factor for the summary indexes, with 90 percent of the variance explained. Source: Author's calculations. with that of the EU,as does air and rail (see figure 4.1, important summary indictor is competition and which compares Turkey with 21 other OECD price regulation (37.4 percent), followed by regula- members on the overall sector indexes). tion of industry structure (23.2 percent), public Another set of indicators, for the transport sec- service obligations and regulation of customer tor broadly defined, is presented in table 4.10. Like access (22.5 percent), and indicators of government those in tables 4.7, 4.8, and 4.9, these indicators are ownership and bailouts (16.9 percent). based on a factor analysis of the regulatory vari- The indexes in table 4.10 are summarized in fig- ables. In table 4.10, however, the full set of sector ure 4.2. The figure presents a breakdown (based on indicators in the previous three tables are combined the weights in table 4.10) of the contribution of to yield a set of four factors used to construct the each factor to the total index. Note the level of composite index--that is, a set of overall regulatory Turkey in relation to the average level for the EU. It indicators for competition, regulation of industry reveals for all of transport, as it was for the individ- structure, public service obligations, and financial ual subsector indicators, a rough congruence involvement of government--as well as an overall between the Turkish regulatory regime and the index, based on these four factors and aggregated range of regimes tolerated by the European Union. using rotated factor loadings. These four factors What do these indicators say? Overall, the regime explain roughly 90 percent of the regulatory vari- in Turkey appears to be consistent with regimes able variance, because they are constructed from existing within the EU, including, for example, sector indicators. For the overall index, the most Greece, Spain, Italy, Germany, and Portugal. Thus, 138 Turkey: Economic Reform and Accession to the European Union FIGURE 4.1 Comparison of Regulatory Regimes 5.0 Air transport Road transport Rail transport 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 of Italy States Japan France Spain Sweden Turkey Poland Germany KingdomCanadaFinlandGreeceMexico ZealandNorwayPortugal Republic HungaryRep. Netherlands United Switzerland New United Czech Korea, Source: The author. TABLE 4.10 Regulation Indexes, All Transport Public Service Obligation, Competition Regulation of Regulated Government and Price Industry Customer Ownership and Overall Regulation Structure Access Bailouts United States 2.3 2.2 2.8 1.7 2.7 Japan 2.8 4.3 1.7 2.0 2.4 Germany 3.7 5.3 3.3 2.1 2.8 France 3.5 4.4 3.0 2.6 3.3 Italy 3.7 4.8 2.8 3.2 3.2 United Kingdom 3.4 3.8 3.6 4.4 1.1 Canada 2.7 4.4 1.4 1.9 1.8 Finland 3.5 5.0 3.1 2.5 1.9 Greece 3.7 5.2 2.0 3.2 3.2 Mexico 3.1 3.6 3.0 2.5 3.1 Netherlands 3.5 4.7 4.5 1.4 2.0 New Zealand 3.8 5.4 3.9 2.1 2.3 Norway 3.1 4.1 3.0 2.5 1.8 Portugal 3.7 5.2 2.3 3.2 3.1 Spain 3.6 4.5 4.0 2.1 3.3 Sweden 3.4 4.9 3.3 1.9 2.4 Switzerland 3.0 5.1 2.3 1.4 1.7 Turkey 3.5 4.6 2.7 3.4 2.0 Czech Rep. 3.3 5.3 2.6 2.1 1.5 Hungary 2.8 4.0 2.8 2.2 1.0 Korea, Rep. of 3.5 4.9 3.3 3.0 1.5 Poland 3.3 5.0 2.6 2.5 1.6 Weight 0.374 0.232 0.225 0.169 Note: Indexes, which range from 0 to 6, are based on rotated factor loadings. The overall index is based on the first factor for the summary indexes, with 90 percent of the variance explained. Source: Author's calculations. Accession of Turkey to the European Union: Market Access and Regulatory Issues 139 FIGURE 4.2 Decomposition of Overall Transport Regulation Index 4.0 EU average 3.5 3.0 2.5 index 2.0 1.5 Composite 1.0 0.5 0.0 of Italy States Japan France Spain Sweden Turkey Poland Germany KingdomCanadaFinlandGreeceMexico ZealandNorwayPortugal Republic HungaryRep. Netherlands United Switzerland New United Czech Korea, Competition and price regulation Regulation of industry structure Public service obligation, regulated Government ownership and bailouts customer access Source: The author. given what is tolerated within the EU, there is no threats of pressure for restructuring, surges in clear indication that Turkey will need to realign its imports, or, as a consequence, significant income regulatory stance upon accession to the EU. This gains from the sector. The second set of issues situation probably reflects, in part, the country's involves regulatory convergence. Here, factor analy- already long history of regulatory alignment. sis of a database of regulatory variables indicates that, overall, the two regimes (Turkey and the EU) Summary and Conclusions are broadly consistent in their regulatory stance (e.g., degree of competition, price regulation, gov- This chapter has explored the possible implications ernment financial intervention). This consistency of Turkish accession to the EU, particularly regula- most likely reflects the long process of negotiation tory issues in the transport sector in Turkey. The and regulation that has accompanied evolution of transport sector is important to the general condi- the customs union. It means as well that pressure to tions for economic performance and growth. restructure for broad regulatory reasons may be Because it serves as an important intermediate minimal. input, both nationally and internationally, changes in the trade and regulatory regime of the sector can Annex 1: Tariff Equivalents have important economic effects. The chapter has for Transport Services addressed two sets of issues. The first is the quanti- tative impact, through direct trade and economy- This annex describes a basic methodology for the wide effects, of full membership. These effects have estimation of sector-specific gravity equations in been examined through reference to computable relation to global trade levels. The results are general equilibrium analysis and partial equi- reported in table 4.11. Basically, services trade data librium analysis. Because of the existence of the are fitted to a simple gravity model of total imports EU-Turkey customs union, deeper integration by country. These equations have been estimated at along this front does not appear to carry significant the level of transport services. 140 Turkey: Economic Reform and Accession to the European Union TABLE 4.11 Regression Results for Gravity Equation on Cross-Border Trade Regression Statistics Multiple R 0.967335 R-square 0.935736 Adjusted R-square 0.926556 Standard error 0.179688 Observations 25 ANOVA df SS MS F Significance F Regression 3 9.872914 3.290971 101.9261 1.12E-12 Residual 21 0.678044 0.032288 Total 24 10.55096 Coefficients Standard Error t Statistic Intercept 2.48491 1.213893 2.04706 log(POP) 0.901064 0.064715 13.92348 LOG (PCGDP) 1.43188 0.693996 2.063239 log(PCGDP)sq 0.0585 0.098696 0.59275 Source: Author's calculations. The gravity equations are estimated using ordi- cross-border trade in the sector at the EU15 level-- nary least squares with the variables that is, including all 15 member states. Barriers may emerge, however, at the level of individual member (4.1) Xi a1 ln(POPi) a2 ln(PCGDP)i states (see Francois, van Meij, and van Tongeren a3 ln(PCGDP)i 2 i forthcoming). where Xi represents imports from the world, POP represents population, and PCGDP per capita Annex 2: The Model income in the importing country. In the regressions, Hong Kong (China) is broken This annex describes the basic structure of the stan- out as a free trade"benchmark."Deviations from pre- dard multiregion computable general equilibrium dicted imports, relative to this free trade benchmark, model used in this study. The model is imple- are taken as an indication of barriers to trade. These mented in GEMPACK, a software package designed tariff equivalent rates are then backed out from a con- for solving large applied general equilibrium mod- stant elasticity import demand function as follows: els.6 It is solved as an explicit nonlinear system of equations, using techniques described by Harrison, T1 M1 1/e (4.2) = Horridge, and Pearson (2000).7 The national T0 M0 accounts data were organized into 24 sectors and Here, T1 is the power of the tariff equivalent (1 29 regions. The sectors and regions for this 24 29 t1) such that in free trade T0 1, and [M1/M0] is the aggregation of the data are detailed in table 4.12. ratio of actual to predicted imports (normalized rel- The data were taken from various sources. Data ative to the free trade benchmark ratio for Hong on production and trade are based on national Kong). In this reduced form, actual prices and con- accounting data linked through trade flows and stant terms drop out because ratios are formed. The drawn directly from the GTAP Version 5 dataset term e is the demand elasticity (taken to be 3.9). (GTAP 2001; also see Reinert and Roland-Holst, This approach yields an estimated tariff equiva- 1997, for a discussion of the organization of such lent for Turkey's imports of transport services of data for CGE models).The GTAPVersion 5 dataset is 8.9 percent, and the EU data reveal no barriers to benchmarked to 1997 and includes detailed national Accession of Turkey to the European Union: Market Access and Regulatory Issues 141 TABLE 4.12 Sectoring Scheme of Model Model Regions Model Sectors Australia and New Zealand Grains China Other agriculture Hong Kong (China) Mining Japan Other primary production Korea Sugar Taiwan Dairy Other ASEAN Meats Vietnam Processed foods Bangladesh Textiles India Clothing South Asia Leather Canada Wood and paper Mexico Chemicals United States Refineries Caribbean Basin Initiative countries Steel Andean Trade Pact Nonferrous metals MERCOSUR Motor vehicles Chile Electronics Other Latin America Other machinery European Union (EU15) Manufactures, NEC Central European Associates Trade, transport, communications Turkey Construction SACU Business services Botswana Other services Malawi Mozambique Rest of Southern Africa North Africa and Middle East Rest of world Note: ASEAN Association of South East Asian Nations; MERCOSUR Southern Cone Common Market (Mercado Común del Sur); SACU Southern African Customs Union; NEC not elsewhere classified. Source: Author's definition of model aggregation. input-output, trade, and final demand structures. land, labor, and capital and combining these with Significant modifications were made to the basic intermediate inputs. Firm output is purchased by GTAP database. The basic social accounting and consumers, government, the investment sector, trade data were supplemented with trade policy and other firms. Firm output also can be sold for data,including additional data on tariffs and nontar- export. Land is employed only in the agricul- iff barriers. The dataset was also updated to better tural sectors, while capital and labor (both skilled reflect actual import protection for goods and serv- and unskilled) are mobile between all production ices (for example, the basic GTAP database includes sectors. Moreover, capital is fully mobile within no information at all on trade barriers for services). regions. However, capital movements between regions are not modeled, but rather are held fixed in all simulations. Labor mobility is discussed below. General Structure All demand sources combine imports with The general conceptual structure of a regional domestic goods to produce a composite good, as economy in the model is represented in figure 4.3. indicated in figure 4.3. These are Armington Withineachregion,firmsproduceoutput,employing composites. 142 Turkey: Economic Reform and Accession to the European Union FIGURE 4.3 Armington Aggregation Nest taxes can be placed on domestic or imported inter- mediate inputs and may be applied at differential Armington rates that discriminate against imports. Where composite relevant, taxes are also placed on exports and on pri- mary factor income. Finally, where relevant (as indi- CES cated by social accounting data), taxes are placed on final consumption and can be applied differentially to consumption of domestic and imported goods. Domestic Composite Trade policy instruments are represented as goods imports import or export taxes/subsidies. This includes applied most-favored-nation tariffs, antidumping CES duties, countervailing duties, price undertakings, export quotas, and other trade restrictions. The one exception is services sector trading costs, which are M1 M2 MR discussed in the next section. Note: CES constant elasticity of substitution. The basic data on current tariff rates are taken Source: The author. from the UN Conference on Trade and Develop- ment (UNCTAD) and WTO data on applied and bound tariff rates, and they are integrated into the core GTAP database. These data are supplemented Dynamics with those from the U.S. Trade Representative (USTR) and U.S. International Trade Commission An important feature of the model is a dynamic (USITC) on regional preference schemes in the link, whereby the static or direct income effects of Western Hemisphere. For agriculture, protection is trade liberalization induce shifts in the regional based on OECD and U.S.Department of Agriculture pattern of savings and investment. These effects (USDA) estimates of agricultural protection, as have been explored extensively in the trade litera- integrated into the GTAP core database. Tariff and ture, including Baldwin and Francois (1999), Smith nontariff barrier estimates are further adjusted to (1976, 1977), and Srinivasan and Bhagwati (1980). reflect the remaining Uruguay Round commit- Several studies of the Uruguay Round have also ments, including the phasing out of the remaining incorporated variations on this mechanism. Such textile and clothing quotas under the Agreement on effects compound initial output welfare effects over Textiles and Clothing (ATC).Data on post­Uruguay the medium run and can magnify income gains or Round tariffs are taken from recent estimates losses. How much these "accumulation effects" will reported by Francois and Strutt (1999), which are supplement static effects depends on various fac- taken, in turn, primarily from the WTO's integrated tors, including the marginal product of capital and database, with supplemental information from the underlying savings behavior. This application World Bank's recent assessment of detailed pre­ and employs a classical savings-investment mechanism post­Uruguay Round tariff schedules. All of this (Francois, McDonald, and Nordstrom 1997), which tariff information was concorded to the model sec- means modeling medium- to long-run linkages tors. The services trade barriers are based on the between changes in income, savings, and invest- estimates described in Annex 1. ment. The results reported here therefore include changes in the capital stock and the medium- to long-run implications of such changes. Trade and Transport Costs International trade is modeled as a process that Taxes and Policy Variables explicitly involves trading costs, which include both Taxes are included in the theory of the model at sev- trade and transportation services. These trading eral levels. Production taxes are placed on interme- costs reflect the transaction costs of interna- diate or primary inputs, or on output. Some trade tional trade, as well as the physical activity of trans- taxes are modeled at the border. Additional internal portation itself. Those trading costs related to the Accession of Turkey to the European Union: Market Access and Regulatory Issues 143 international movement of goods and related logis- the services sector. These costs represent the real tic services are met by composite services purchased resource costs associated with producing a service from a global trade services sector in which the for sale in an export market instead of the domestic composite "international trade services" activity is market. Conceptually, a linear transformation tech- produced as a Cobb-Douglas composite of regional nology was implemented between domestic and exports of trade and transport services. Trade cost export services. This technology is represented in margins are based on reconciled free on board figure 4.4. The straight line AB indicates, given the (FOB) and cost, insurance, and freight (CIF) trade resources needed to produce a unit of services for data, as reported in Version 5 of the GTAP dataset. the domestic market, the feasible amount that can A second form of trade costs, known in the liter- instead be produced for export using those same ature as frictional trading costs, is implemented in resources. If there are no frictional barriers to trade in services, this line has a slope of 1. This free trade FIGURE 4.4 Trading Costs in the Services case is represented by the line AC. As trading costs Sector fall, the linear transformation line converges on the SDomestic free trade line, as indicated in the figure. Production Structure A The basic structure of production is depicted in fig- ure 4.5. Intermediate inputs are combined, and this composite intermediate is in turn combined in fixed proportions with value added. This yields sec- tor output Z. Composite Household and Final Demand Final demand is determined by an upper-tier SExport Cobb-Douglas preference function that allocates B C income in fixed shares to current consumption, Source: The author. investment, and government services. This process FIGURE 4.5 Basic Features of the Simulation Model Specification of production in a representative sector Production and trade flows Output Domestic Exports Leontief production Final demand Value Intermediate Primary Composite added inputs factors goods CES Leontief Imports Land Labor Capital Composite goods Note: CES constant elasticity of substitution. Source: The author. 144 Turkey: Economic Reform and Accession to the European Union yields a fixed savings rate. Government services are 3. Decision No. 1/98 of the EC­Turkey Association Council, produced by a Leontief technology, with house- February 25, 1998, on the trade regime for agricultural produc- tions (98/223/EC). hold/government transfers being endogenous. The 4. See Francois, McQueen, and Wignaraja (2003; technical lower-tier nest for current consumption is also annex) for a detailed discussion of the model. Also see the specified as a CDE (constant difference of elastici- related background report cited therein. 5. All dollar amounts are U.S. dollars unless otherwise indi- ties) demand function. The regional capital mar- cated. kets adjust so that changes in savings match 6. See Hertel (1996: chap. 2) for a detailed discussion of the changes in regional investment expenditures. (Note basic algebraic model structure represented by the GEMPACK code. The capital accumulation mechanisms are described in that the Cobb-Douglas demand function is a spe- Francois, McDonald, and Nordstrom (1996). cial case of the CDE demand function, as is the CES 7. More information can be obtained at http://www. or constant elasticity of demand specification. The monash.edu.au/policy/gempack.htm. Social accounting data are Cobb-Douglas version of the CDE is implemented based on Version 5 of the GTAP dataset (GTAP 2001), with an update to reflect post­Uruguay Round protection. through GEMPACK parameter files.) References Labor Markets Baldwin, R. E., and J. F. Francois. 1997. "The Costs and Benefits The default closure involves modeling labor markets of Eastern Enlargement: The Impact on the EU and Central as clearing with flexible wages. This fits with the Europe." Economic Policy 12 (24): 125­76. --------. 1999. Applied Issues in Dynamic Commercial Policy "long-run"approach in which labor markets tend to Analysis. Cambridge: Cambridge University Press. be more flexible.A situation is specified in which the Boylaud, O. 2000. "Regulatory Reform in Road Freight and basic structural rigidities of labor markets (and the Retail Distribution." 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"Trade Liberalization and the Capital Stock in the GTAP Model." assumption that, for institutional reasons (and GTAP consortium technical paper, http://www.agecon. because some skills are sector-specific), labor is not purdue.edu/gtap/techpapr/tp-7.htm. fully flexible in its application across sectors. This --------. 1997. "Capital Accumulation in Applied Trade Mod- els." In Applied Methods for Trade Policy Analysis: A Hand- representation of labor markets seems reasonable. book, ed. J. F. Francois and K. A. Reinert. Cambridge: To the extent that wage rigidities are important, the Cambridge University Press. direction of aggregate employment effects may be Francois, J. F., M. McQueen, and G. Wignaraja. 2003. "An Overview of EU FTAs." Paper presented at the Vienna World inferred from wage effects. (Hertel, 1996, refers to Economics Institute Workshop on WTO Issues, April. this as "sluggish" factor movements). A theoretical Francois, J. F., H. van Meij, and F. van Tongeren. 2005. 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Reinert. New York: Payments, ed. J. S. Chipman and C. P Kindelberger, chap. 12. Cambridge University Press. Amsterdam: North-Holland Publishing. Smith, M. A. M. 1976. "Trade, Growth, and Consumption in WTO (World Trade Organization). 1998. Trade Policy Review: Alternative Models of Capital Accumulation." Journal of European Union 1997. Geneva: WTO. International Economics 6 (November): 385­88. 5 The Turkish Telecommunications Sector: A Comparative Analysis Erkan Akdemir, Erdem Bas¸çi, and Gareth Locksley The telecommunications industry has many inter- The second and third aspects of the telecom- esting aspects.1 First, it is a network industry, with munications industry--its rapid technological high fixed costs and low marginal costs. Second, it progress and its role in providing the infrastructure is subject to rapid technological progress. Third, it for the information society and knowledge econ- serves as the infrastructure for the information omy--are central to investments and economic society and knowledge economy. Finally, it provides development. Private investments are becoming the direct utility to the end users of telecommunica- main source of technology development and capac- tions services. ity building in the telecommunications industry. The first aspect--the telecommunications in- Licensing and privatization are the two main chan- dustry as a network industry--has been a challenge nels to attracting initial private capital and paving to both economic theorists and policymakers in the way for further investments. Human capital for- general. How to maintain an efficient outcome by mation and innovation are facilitated by means of an appropriate mix of competition and regulation sharing knowledge at almost no cost. The easy inter- policies is still an active research area (e.g., Baumol action between universities and research institu- and Sidak 1994; Laffont and Tirole 1996, 2000; tions also encourages research and innovation. Armstrong 1997, 1998; Shy 2001). The legal and Moreover, easy access to networks promotes social regulatory arrangements have been evolving quite cohesion and inclusiveness. Finally, government- fast in the last decade as well (e.g., World Bank citizen and government-business relations are sim- 2000; OECD 2003; 1997 and 2002 acquis commu- plified through e-government projects. In this area, nautaire of the European Union on telecommuni- Turkey has signed the eEurope+ 2003 Action Plan cations services). Turkey has already adopted the along with other EU candidate countries. Some 1998 acquis of the European Union (EU) in tele- progress has been made in areas of liberalization communications, and it has shown some progress and licensing, but very little progress has been made in regulatory capacity building and liberalization of in privatization. mobile phone (GSM) services. A crucial milestone The fourth aspect of the telecommunications was reached in May 2004, when the first licenses for industry--its direct utility to the end users of the provision of voice telephony services by alter- telecommunications services--can be measured native operators were issued. roughly by the share of telecommunications 147 148 Turkey: Economic Reform and Accession to the European Union spending of households as a fraction of gross domes- A Quantitative Comparison tic product (GDP). Other indicators are per capita Broadly speaking, the Turkish telecommunications number of fixed plus mobile lines (teledensity) and sector is comparable with those of the accession Internet use and the urban-rural teledensity ratio. In countries2 that have with a similar level of GDP. some of these measures, Turkey has shown substan- Turkey scores better in terms of total teledensity tial progress; in others, it is still lagging behind. and the urban-rural teledensity ratio, but lags The focus in recent years, however, has shifted behind in Internet usage. from building infrastructure to regulatory and The total expenditure on telecommunications market structure issues. For example, using data services constitutes a significant portion of GDP in from 23 Organisation for Economic Co-operation both EU members and candidate countries. Fig- and Development (OECD) countries over the ure 5.1 shows this statistic to be about 3 percent for 1991­97 period, Boylaud and Nicoletti (2000) find both Turkey and candidate countries and slightly significant price, quality, and productivity effects lower for EU members. for both prospective and effective competition. They Figure 5.2 shows that in terms of fixed-line tele- measure prospective competition by the number of phones per household, Turkey scores better than years remaining until liberalization and measure both the candidate countries and the EU. However, effective competition by the share of new entrants in terms of the fixed-line penetration rate (i.e., the or by the number of competitors. Legal competi- number of fixed lines per 100 inhabitants) Turkey tion in fixed lines became effective in Turkey as of seems to lag behind (figure 5.3). The striking differ- January 2004. ence between figures 5.2 and 5.3 can be attributed Likewise, a recent paper by Fink, Mattoo, and to the large families in Turkey. Therefore, the rela- Rathindran (2002) based on data from 86 develop- tively low penetration rate in fixed lines need not be ing countries finds that both the privatization and seen as a deficiency. liberalization of fixed lines significantly increase The urban-rural teledensity ratio (Istanbul ver- mainline penetration and productivity. They also sus the rest of the country) is shown in figure 5.4. show that competition without privatization is not This figure reflects the fact that most of the invest- significant on these two performance measures. ments of Türk Telekom were carried out with the The sequencing also matters. According to Fink and implicit understanding that it would provide uni- his colleagues, simultaneous privatization and com- versal service throughout the country. The figure petition have a greater impact on mainline penetra- also is indicative of the significant investments tion than the privatization-before-competition scenario. The estimated quantitative impact of FIGURE 5.1 Telecommunications complete reform is 8 percent higher mainline pene- Revenue in GDP tration and 21 percent higher productivity com- Percent of GDP pared with the case of no reform. 4 This chapter is organized as follows. The first 3.4 section gives a quantitative comparison of recent 3.1 indicators for price, quantity, and quality of various 3 services for Turkey, EU member countries, and EU 2.6 accession countries. The second section summarizes developments in the liberalization and regulation of 2 the sector, and the third discusses the brief history of the privatization process for Türk Telekom. 1 A comparison of the legal infrastructure and insti- tutional aspects of Turkey's telecom sector with those of the EU follows in the fourth section. The 0 concluding section provides an overview of needs Turkey Candidate EU average assessment in market structure, legislative, regula- countries average tory, and taxation issues in light of EU accession and the eEurope+ Action Plan. Source: ITU 2001. The Turkish Telecommunications Sector: A Comparative Analysis 149 FIGURE 5.2 Households with Fixed-Line FIGURE 5.4 Largest City/Overall Country Telephone Service Teledensity Ratio Percent Ratio 100 2.0 90 87 86 1.7 80 77 1.5 1.5 70 1.2 60 50 1.0 40 30 0.5 20 10 0 0.0 Turkey Candidate EU average Turkey Candidate EU average countries countries average average Source: eEurope+ 2003. Source: ITU 2001. FIGURE 5.3 Fixed-Line Penetration Rates FIGURE 5.5 Investment in (fixed lines per 100 inhabitants) Telecommunications Number of lines Percent of revenue 80 40 29.7 60 57 30 23 40 36 20 29 11.9 20 10 0 0 Turkey Candidate EU average Turkey Candidate EU average countries countries average average Source: eEurope+ 2003. Source: ITU 2001. made by Türk Telekom during the 1980s. In 1980 Figure 5.5 also supports the investment slow- the ratio of Türk Telekom investments to the gross down reported by Yilmaz (2000). The slowdown national product (GNP) was about 0.3 percent. can be attributed largely to the financial squeeze in This ratio steadily increased to 1 percent of GNP in the government's budget and the use of TT profits 1987. Afterward, it sharply declined and fell back to contribute to the primary budget surplus of the on average to about 0.3 percent during the second general government under the International Mone- half of the 1990s (Yilmaz 2000). The significant tary Fund (IMF) program. slowdown in investments by TT brought stagnation The mobile penetration rate is also significant. in improvements in the fixed-line teledensity. According to figure 5.6, Turkey has a mobile 150 Turkey: Economic Reform and Accession to the European Union FIGURE 5.6 Mobile Penetration Rates FIGURE 5.8 Regular Users of Internet (per 100 inhabitants) in Population Number of mobile phones Percent 80 100 76 80 60 60 39 40 48 30 40 20 20 15 3 0 0 Turkey Candidate EU average Turkey Candidate EU average countries countries average average Source: eEurope+ 2003. Source: eEurope+ 2003. FIGURE 5.7 Households with Internet FIGURE 5.9 Internet Access Costs Access (purchasing power standard [PPS]­adjusted) Percent 100 Euros per hour 6 80 60 4 3.1 40 38 2 1.7 20 11 7 0.7 0 Turkey Candidate EU average 0 countries Turkey Candidate EU average average countries average Source: eEurope+ 2003. Source: eEurope+ 2003. penetration rate comparable with that of the candi- date countries. Given Turkey's population, this rate price of Internet services, and the second is related translates into a large mobile market in Europe. to the availability of Internet facilities--that is, data In line with the 2002 acquis and the eEurope+ lines and personal computers (PCs). 2003 Action Plan, Internet use and related data Figure 5.9 shows that the cost of connecting to services are also important. Figures 5.7 and 5.8 the Internet is significantly lower in Turkey than in indicate that both the Internet availability per the other countries. Connection prices are less than household and Internet use per individual are low half of the EU average and less than a quarter of the in Turkey compared with the rates even in the can- candidate countries' average. Thus the only possible didate countries. There are two possible explana- obstacle to use of the Internet in Turkey would tions for this observation. One is related to the be the availability of PCs. Although significant The Turkish Telecommunications Sector: A Comparative Analysis 151 progress has been achieved in recent years, mobile FIGURE 5.12 Personal Computer Use Internet technologies serve a niche market and do (estimated number of PCs per not seem to contribute to Internet penetration. 100 inhabitants) Likewise, figures 5.10 and 5.11 show Turkey as Number of PCs an outlier to the negatively sloped demand curve 35 33 on cost versus use of the Internet. 30 In Turkey, the PC penetration is low--only about 4 PCs per 100 persons, compared with about 25 FIGURE 5.10 Regular Use versus Dial-up 20 Access Costs of Internet (cost per hour, PPS­adjusted) 15 13 Euros 10 4.0 5 4 3.1 Candidate countries 0 3.0 Turkey Candidate EU average countries average 2.0 Source: eEurope+ 2003. 1.7 EU 1.0 13 PCs for candidate countries and 33 PCs for the 0.7 Turkey EU member states (figure 5.12). Therefore, low Internet use can be linked to low PC penetration 0.0 0 10 20 30 40 50 60 rates in Turkey. The 2002 "Progress Report" of 3 16 48 eEurope+ 2003 (2003) elaborates on the low PC use Regular users (percentage of population) in primary, secondary, and higher education in Turkey. The same document also points out that Source: eEurope+ 2003. Turkey does not have any public Internet access FIGURE 5.11 Penetration versus Dial-up points (PIAPs or telecenters).3 Access Costs of Internet As for the prices of fixed-line telephone services, (cost per hour in euros, both Turkey and other candidate countries have rel- PPS­adjusted) atively high call rates and relatively low fixed Euros monthly fees (see figure 5.13 for a comparison of 4.0 the fixed monthly access fees). Turkey, with an aver- age monthly fee of about 4, is below the averages of 3.12 Candidate countries both the EU and candidate countries. The country- 3.0 specific fixed access fees are reported in tables 5.1 and 5.2 in the chapter annex. Figure 5.14 compares local call rates. Turkey's 2.0 EU 1.70 price is slightly above the average for the candidate countries and significantly above the EU average. 1.0 Turkey's position can be attributed to Türk 0.68 TR Telekom's monopoly in fixed-line services. The country-specific local charges are given in tables 5.1 0.0 and 5.2 in the chapter annex as well. 0 5 10 15 20 25 30 35 40 One measure of quality of service is faults per 7 11 38 100 main lines per year. In this area, Turkey scores Percentage of households with Internet access worse than both the candidate and EU countries Source: eEurope+ 2003. (see figure 5.15). 152 Turkey: Economic Reform and Accession to the European Union FIGURE 5.13 Residential Monthly Access FIGURE 5.15 Quality of Service Fee (Including Value Added (faults per 100 main lines per year) Tax) for Fixed-Line Telephone Number of faults Service 75 Euros 20 56 50 15 14.5 29 10 25 7.2 8 5 4.3 0 Turkey Candidate EU average 0 countries Turkey Candidate EU average average countries Source: ITU 2001. average Source: World Bank 2002. FIGURE 5.14 Cost (Including Value Added FIGURE 5.16 International Telephone Traffic Tax) of a Three-Minute (minutes per subscriber) Economy Local Call Number of minutes Euros 280 0.20 253 240 200 0.15 0.129 160 0.107 0.10 120 115 80 0.05 0.05 39 40 0 0.00 Turkey Candidate EU average Turkey Candidate EU average countries countries average average Source: ITU 2001. Source: World Bank 2002. In the final measure--international calling-- liberalize its sector. To this end, in 1998 the Turkish Turkey, possibly because of its high international government had committed itself, in accordance tariffs, ranks far behind both the candidate and EU with World Trade Organization (WTO) guidelines, countries. to liberalize its fixed-line telephone network and services no later than the end of 2004. However, the telecommunications law (No. 4502) enacted in Competition Policy and Regulation January 2000 shifted the liberalization timetable to As of January 2004, Turkey's telecommunications the end of 2003. sector was fully open to competition, making After taking the important step of opening Turkey the last of the OECD countries to fully up fixed lines for competition, the government The Turkish Telecommunications Sector: A Comparative Analysis 153 addressed the institutional capacity of the inde- · As a state-owned corporation, Türk Telekom pendent Telecommunications Authority (TA), would find it difficult to undertake risky and Telekomünikasyon Kurumu. The TA was established ambitious projects and restructuring plans. by the 2000 telecommunications law. Some criticism was directed at the authority's initial composition Since 1994, when the postal and telecommuni- and the excessive amount of power that it was given cations services of the General Directorate of Post, to apply sanctions if national security or public Telegraph, and Telephone (PTT) were separated, order were imperiled (OECD 2002; Goldstein 2003). various attempts have been made to privatize Türk Nevertheless, the secondary legislation was broadly Telekom. Earlier attempts were turned down by the completed by the TA before January 2004. Supreme Court. After addressing the legal issues In fact, limited competition had been under way more carefully, the government offered a tender in in mobile phone services since 1994, when two pri- 2000 that left 51 percent of the shares with the Trea- vate firms, Turkcell and Telsim, were given the sury, but it was not successful in part because of rights to offer GSM services through revenue- poor market conditions in the telecommunications sharing agreements with Türk Telekom. In 1998 the sector worldwide. Law No. 4673 of May 2001 left a government sold the two operators licenses, by golden share of Türk Telekom to the Treasury, means of a concession agreement, to operate their which means, in fact, to one strong member of the GSM 900 networks for 25 years in return for board of directors. Türk Telekom employees are US$500 million apiece.4 entitled to 5 percent of the shares, and the remain- In April 2000,the Ministry of Transportation ten- ing are available for block sale or for initial public dered two new GSM 1800 licenses by means of con- offerings (IPOs). The restriction on foreign owner- cession agreements. A third license was reserved for ship was removed by the foreign direct investment Türk Telekom at the price of the first auction. law of 2004. Because of the auction design, only one of the In December 2003, the Council of Ministers licenses was sold, but. the revenue generated was adopted a new privatization plan for Türk Telekom. higher than expected. Is¸bank-Telecom Italia Mobile The plan called for a block sale of 51 percent of (TIM) consortium (Aria) won the first auction with shares in 2004. Since then, the valuation committee a bid of $2.5 billion. This number was then the min- and the tender committee have been preparing for imum price for the second auction,and thus the auc- that sale. Law No. 5189 of July 2004 provided tion attracted no bidders.5 Türk Telekom decided to further amendments to foster the privatization launch its own GSM 1800 operator, Aycell. As of the process. end of 2003, the four GSM operators--Turkcell, Telsim, Aria, and Aycell--had market shares of 68 percent, 18 percent, 7 percent, and 7 percent, Legal and Institutional respectively. The two small operators, Aria and Comparisons with the EU . Aycell, merged in 2004 under TT-Is¸bank-TIM with The most recent legal development in the EU is the the brand name Avea. acceptance of the 2002 acquis in telecommunica- tions. The European Parliament and the European Council approved and published a set of new direc- Privatization of Türk Telekom tives in 2002. The directives considered here are the The already delayed privatization of Türk Telekom framework directive, authorization directive, access bears urgency, because competition between the directive, and universal service directive. This sec- company and potential private entrants will not be tion, in light of the EU directives, describes the easy. Some of the difficulties facing Türk Telekom recent progress of Turkey in each area. It also com- in its competition with others are as follows: pares price regulation practices in EU and Turkey. · Turkey's Treasury does not permit the state- Framework owned corporation to borrow funds for invest- ments. The purpose of the 2002 EU legislation is to pro- · Only a small fraction of net profits can be used vide a common regulatory framework and compe- for investments.6 tition principles and practices for the electronic 154 Turkey: Economic Reform and Accession to the European Union communications sector, comprising telecommuni- conformity with Article 46(1) of the Treaty, in cations, media, and information technology serv- particular, measures regarding public policy, ices (the framework does not regulate content). public security and public health. (Emphasis The purpose of introducing the new directives is added.) to address the technological convergence observed A general authorization is available for every serv- in these three sectors. Under the framework ice provider. Yet the member states may at most directive, require a notification from the service provider. Other than the notification, no permissions or · Member states are to guarantee the independ- other administrative barriers to entry will be ence of the national regulatory authority (NRA). imposed (Article 3.2). In cases in which there is a · Telecommunication service providers have the technical need to limit the number of rights of use right of appeal against NRA decisions. granted, such as the allocation of radio frequencies, · NRAs are responsible for the gathering and dis- the selection criteria must be objective, transparent, semination of sector-related information. nondiscriminatory, and proportionate. Time limits · All potential service providers have the right to are imposed on the administration to finalize the install facilities in a timely, nondiscriminatory, applications (Articles 5.2, 7.4). and transparent manner. Although obtaining a general authorization is as · Facility sharing among service providers is nor- simple as it can be, an undertaking that does not mally voluntary, but the NRAs can also make it comply with the general conditions laid down compulsory under exceptional circumstances. by the NRAs may be subject to financial penalties · NRAs are responsible for identifying service and even be prevented from providing service providers that have a "significant market power" (Article 10). in the relevant market. In Turkey, the government monopoly on fixed- · In cases in which significant market power is line services dates back to 1924 and the telegram identified, the NRAs are supposed to impose and telephone law (No. 406). This monopoly regulations ex ante on the company with signifi- ended, however, at the beginning of 2004 under the cant market power. telecommunications law (No. 4502). Licensing was · If access and interconnection negotiations mentioned in legal arrangements for the first time between companies fail, the NRA resolves the in 1995, when a value added telecommunications dispute within four months. services regulation was enacted.In 2000 the telecom- munications law brought with it a new approach to In Turkey, an important reform process began in licensing. Based on this approach, the Ministry of 2000 in the telecommunications sector. The previ- Transportation issued a new telecommunications ous legislation, which dates back to 1924, was services regulation. amended. The new legislation is broadly compati- In May 2001, by means of Law No. 4673, the right ble with the EU perspective. In June 2001, Turkey, to issue licenses was transferred to the Telecom- along with the other EU candidate countries, was a munications Authority. Accordingly, the TA pub- signatory to the eEurope+ Action Plan by which it lished a Licensing Communiqué in 2002. The committed itself to achieving certain measurable communiqué states the conditions to be met by goals in the electronic communications sector. applicants, the time limits, and the other procedural details for issuing licenses. The minimum license fees Authorization are determined by the Council of Ministers. These fees are broadly consistent with the average adminis- The most recent EU document on licensing and trative fees set in the EU. related issues is the authorization directive In 2002, new licenses were issued by the TA. (2002/20/EC). The objective of the directive is These were general authorizations and telecommu- to create a legal framework to ensure the freedom nications licenses for some existing Internet serv- to provide electronic communication networks ice provider, very small aperture terminal, and and services, subject only to the conditions laid satellite platform operators. The licenses for long- down in this Directive and to any restrictions in distance telephony operators have been issued since The Turkish Telecommunications Sector: A Comparative Analysis 155 May 2004. Although some applications for telecom- fixed public telephone network connecting the munications services, such as fixed wireless access, network termination point at the subscriber's are outstanding, the TA is expected to issue licenses premises to the main distribution frame or equiva- in the fourth quarter of 2004. lent facility." The 2000 telecommunications law contains The access directive establishes the rights and clauses on licensing with four types of authoriza- obligations of operators regarding interconnec- tion: (1) authorization agreement, (2) concession tions and access. It also defines the NRA objectives agreement, (3) telecommunications license, and and procedures regarding access. The main points (4) general authorization. The approach in the EU are as follows: is general authorization and allocation rules for individual licenses for radio frequencies based on · Private negotiations between undertakings for competitive principles. In Turkey, the four different interconnections cannot be restricted by mem- arrangements for licensing are confusing and diffi- ber states. cult to implement. · Operators cannot be obliged to discriminate The latest telecommunications services reg- between different undertakings for equivalent ulation should be updated to reflect changes in service. legislation (mainly Law No. 4502 and No. 4673). · Operators are obliged to negotiate interconnec- Authorization agreements and concession agree- tion when others ask for it. ments could be converted to individual licenses, · The NRAs can impose, when necessary, obliga- and telecommunications licenses could be con- tionsonanoperatortofacilitateinterconnections. verted to general authorizations or permits. Rev- · Theobligationsmaybeimposedonlyonanobjec- enue share agreements also could be converted to tive, transparent, proportionate, and nondis- licenses. There is no genuine license concept in cur- criminatory basis. rent arrangements because the TA can change · With the permission of the European Commis- license conditions unilaterally. sion, the NRAs can impose additional measures related to access on operators with significant market power. Access The most recent EU documents regulating access to Likewise, the local loop unbundling regulation the network of other firms are the access directive aims to facilitate access to the "least competitive (2002/19/EC) and the regulation on unbundled segments of the liberalized telecommunications access to the local loop (No. 2887/2000). The access market." It is recognized that the new entries will be directive defines access as "the making available of difficult, given the high costs of fixed-line infra- facilities and/or services, to another undertaking, structure, and that the existing infrastructure has under defined conditions, on either an exclusive or been financed by monopoly rents.Yet the eEurope+ non-exclusive basis, for the purpose of providing Action Plan, in order to substantially reduce the electronic communication services" and intercon- costs of using the Internet, identifies unbundled nection as access to the local loop as a short-term priority. According to the local loop unbundling regula- the physical and logical linking of public com- tion, the NRA has the following responsibilities: munications networks used by the same or a dif- ferent undertaking in order to allow the users of · To identify notified operators (NOs) as those that one undertaking to communicate with users of have significant market power in fixed public the same or another undertaking, or to access telephone networks services provided by another undertaking. . . . · To ask NOs to publish a reference offer for unbun- Interconnection is a specific type of access imple- dledaccesstotheirlocalloopsandrelatedfacilities mented between public network operators. · To supervise NOs in their cost-based pricing and Local loop unbundling is based on the definition in in providing other operators with transparent, the local loop regulation in which the "`local loop' fair, and nondiscriminatory unbundled access to is the physical twisted metallic pair circuit in the the local loop. 156 Turkey: Economic Reform and Accession to the European Union The clauses in Turkey's Law No. 4502 on inter- Thus the main and secondary legislation for uni- connection and roaming are in harmony with the versal service needs to be put in place, and new pro- EU acquis. The law also includes a dispute resolu- grams should be developed for a low-user scheme tion mechanism for interconnection via the TA. and special needs. As for financing the burden of However, no direct legal basis exists for local loop the universal service organization, a fund or a unbundling. The secondary legislation for national budgetary mechanism must be established. roaming, interconnection, and local loop unbundling were put in place in 2002, 2003, and Price Regulation 2004, respectively. According to the EU acquis, only firms with signifi- cant market power can be regulated. The same Universal Service principle carries over to the telecommunications Universal service is defined in the 2002 acquis as services. National regulatory authorities are sup- "the provision of a defined minimum set of serv- posed to define the relevant markets and then, in ices to all end-users at an affordable price." The EU each relevant market, determine the presence of views universal service as an obligation of its mem- firms with SMP. Where SMP exists, the NRA would ber states (see Article 3.1 of the universal service implement price regulation. directive). However, care is taken not to distort the The economics literature discusses two possible market mechanism while safeguarding the public waysof priceregulation:pricecapregulationandrate interest (Article 3.2). of return (or cost plus) regulation. For price cap reg- The minimum service requirements in the uni- ulation,theregulatordeterminesa"reasonableprice" versal service directive can be summarized as the for the base year and then for the following years provision of applies a consumer price index (CPI) inflation - X percent adjustment on the base year's price.Price cap · Access to a fixed telephone at every reasonable regulation is desirable because it provides an incen- fixed location tive for a firm to find ways to cut its production cost. · Directory inquiry services and directories The disadvantages are a greater need to regulate the · Public pay phones quality of services and the difficulty encountered in · Special measures for disabled users setting the base price and the X factor--that is, the · Affordable tariffs expected growth in productivity (see Weisman 2002 · Adequate quality of service for an interesting discussion). Rate of return regula- · Number portability. tion also has negative aspects. First, the NRA must be cautious about the costs reported by the firm. How much of the obligation of universal service Second, the incentives to improve productivity and that should be allocated on the service providers thus cut costs are not there. has been greatly debated (see, e.g., Choné, Flochel, The trend in Europe, as well as in Australia, the and Perrot 2002 for a theoretical investigation). The United States, and South America, over the past universal service directive of the 2002 acquis 15 years has been toward implementing price cap imposes certain obligations on all undertakings, regulation (Weisman 2002: 350). In Turkey, the including the competitive ones, but it imposes extra price cap method is also used. Turkish telecom law obligations on firms with significant market power has several clauses on price regulation. The 2001 (Articles 16­19). Nevertheless, the financing of an Pricing (Tariff) Regulation and 2001 Price Cap important part of the universal service obligations Communiqué for SMP operators are in force. GSM is left to the member states (Articles 12­14). tariffs are subject to price regulation based on the In Turkey, universal service is covered by various operators' concession agreements. But their X laws, but no explicit mechanism is in place. The factor is fixed at 3 percent (CPI ­ 3 percent [CPI]), Ministry of Transportation is responsible for uni- which is much lower than that of Türk Telekom. versal service policy, and the burden is carried Türk Telekom is subject to price regulation as mostly by Türk Telekom. As for the rights of users, well. For the years 2002­03, the voice telephony the legislation contains no solid regulation, except services of TT were subject to an X factor of 7.5 per- for the general consumer rights protection law. cent, which was changed to 4 percent in 2004. By The Turkish Telecommunications Sector: A Comparative Analysis 157 contrast, the leased-line tariffs price cap method that the TA be strengthened in its technical, legal, was used for 2002. The TA approved cost-based and economics capabilities. Finally, after full liberal- tariffs for leased lines in 2004, which were in force ization of the sector, the successful privatization of by June 2004. Türk Telekom would benefit not only the sector but Another important issue lagging behind sched- also significantly benefit the Turkish economy. ule for the TA and Türk Telekom is the rebalancing of the local, long-distance, and international prices of TT. Rebalancing is central to price regulation. Annex: Price Comparisons The new structure, which is based on a monthly FIGURE 5.17 Basket of National rental fee and a reduction in the tariffs of national Calls and international calls in order to eliminate cross Euros per month subsidy, came into effect in August 2004. A whole- 90 sale tariff is needed for resale and new entrants. For GSM operators, the inconsistency between 80 their concession agreements and tariff regulation 70 should be removed. For operators with significant 60 market power, a flexible price regulation similar to 50 the one in the EU should be followed. 40 30 Conclusion and Recommendations 20 The liberalization of telecommunications services Business, excluding value added tax 10 Residential, including value added tax in the EU has had a substantial impact. During 0 1998­2002, the prices of telecommunications serv- 1998 1999 2000 2001 2002 ices fell substantially, ranging from 14 percent in Note: Figure shows estimates of the average monthly residential national calls to 70 percent in interna- spending by a typical "European business/residential tional business calls (see figures 5.17 and 5.18 in the user" for fixed national calls. chapter annex). Turkey is also expected to benefit Source: European Commission 2002. from a reduction in prices and increase in quality by adopting the EU regulatory framework and by liberalizing the market for fixed lines. This chapter has shown that Turkey scores rea- FIGURE 5.18 Basket of International Calls sonably well when compared with the EU candi- Euros date countries in terms of the significance of 1.8 telecommunications services in GDP, the mainline and mobile penetration rates, the urban to rural 1.6 penetration rates (i.e., universal service), and Inter- 1.4 net service prices. However, performance needs to 1.2 be improved in some areas. Examples are invest- 1.0 ments in fixed lines such as fiber cables, Internet usage, tariff rebalancing by means of higher fixed 0.8 access fees and lower marginal fees, and the quality 0.6 of services offered by Türk Telekom. 0.4 Therefore, a clear need exists for a new, single Business, excluding value added tax 0.2 telecommunications act that would update the Residential, including value added tax 0.0 century-old telegraph and telephone law (Law 1998 1999 2000 2001 2002 No. 406), eliminate conflicting clauses in the amend- ing laws, and harmonize with EU regulations. The Note: Figure shows the average price of a single call from the originating country to all other OECD desti- main problems facing Turkey are related to the nations. A full description of the methodology can be implementation of the new legislation and, by impli- found in OECD 1990. cation, the quantitative targets. It is also important Source: European Commission 2002. 158 Turkey: Economic Reform and Accession to the European Union Annex: TABLE 5.1 Monthly Residential Access Fee and Local Call Tariffs: 15 EU Member States and Washington, DC, July 1, 2002 Monthly Residential Cost of Three-Minute Local Access Fee, Including Value Economy Call, Including Country Added Tax (euros) Value Added Tax (euros) Austria 17.44 0.09 Belgium 16.20 0.12 Denmark 15.74 0.08 Finland 13.79 0.16 France 12.55 0.13 Germany 12.69 0.05 Greece 11.77 0.09 Ireland 19.60 0.04 Italy 14.88 0.07 Luxembourg 18.40 0.05 Netherlands 16.42 0.07 Portugal 14.10 0.17 Spain 13.54 0.08 Sweden 13.25 0.08 United Kingdom 15.51 0.05 EU average 14.46 0.05 Washington, DC 10.67 0.05 (Verizon), low-user, flat fee per call (excluding tax of $2.69 and other charges and levies of $6.00) Source: World Bank 2002. TABLE 5.2 Monthly Residential Access Fee and Local Call Charges: 13 EU Preaccession Countries (PAC), March 31, 2002 Monthly Residential Cost of Three-Minute Local Access Fee, Including Value Economy Call, Including Country Added Tax (euros) Value Added Tax (euros) Bulgaria 3.00 0.022 Cyprus 9.50 0.076 Czech Republic 9.70 0.136 Estonia 5.90 0.096 Hungary 12.30 0.111 Latvia 6.30 0.143 Lithuania 5.50 0.130 Malta 5.30 0.132 Poland 11.80 0.970 Romania 3.50 0.940 Slovakia 5.90 0.141 Slovenia 9.90 0.084 Turkey 4.30 0.129 PAC average 7.15 0.107 Source: PWC Consulting 2002. The Turkish Telecommunications Sector: A Comparative Analysis 159 Notes Fink, C., A. Mattoo, and R. Rathindran. 2002. "Liberalizing Basic Telecommunications: Evidence from Developing Countries." 1. The authors would like to thank Izak Atiyas, Andrea Paper presented at the OECD-World Bank Services Experts Goldstein, Sübidey Togan, Kamil Yilmaz, Tolga Kiliç, and S¸ahin Meeting, Organisation for Economic Co-operation and Ardiyok for their comments and encouragement. The usual dis- Development, Paris. claimer applies. Goldstein, A. 2003. "The Political Economy of Regulatory 2. In this chapter, the term accession or candidate countries Reform: Telecoms in the Southern Mediterranean." Paper refers to the 10 countries that joined the EU in May 2004, presented at the Fourth Mediterranean Social and Political together with Bulgaria and Romania. Research Meeting, Florence-Montecatini Terme. 3. PIAPs are government-initiated centers within the context ITU (International Telecommunications Union). 2001. "World of universal service policies. Telecommunications Indicator." March. 4. All dollar amounts are U.S. dollars unless otherwise Klemperer, P. 2002. "How (Not) to Run Auctions: The European indicated. 3G Telecom Auctions." European Economic Review 46: 5. The auction design for mobile phone service licenses is 829­45. heavily discussed in the literature, especially after the so-called Laffont, J. J., and J. Tirole. 1996. "Creating Competition through UMTS auction tragedy in Europe (UMTS is a third-generation Interconnection: Theory and Practice." Journal of Regulatory mobile system). See Klemperer (2002) and van Damme (2002) Economics 10: 227­56. for possible reasons why the UMTS auctions in Europe during --------. 2000. Competition in Telecommunications. 2000 and 2001 produced incredibly different outcomes. Cambridge, MA: MIT Press. 6. See the paper by Li, Qiang, and Xu (2001) for cross- Li, W., C. Z. Qiang, and L. C. Xu. 2001. "The Political Economy country evidence that supports the "cash cow" hypothesis, of Privatization and Competition: Cross Country Evidence among other reasons, for delayed privatization of the telecom- from Telecommunications Sector." World Bank, Washing- munications sector. ton, DC. OECD (Organisation for Economic Development and Co- operation). 2002. "Regulatory Reform in the Turkish References Telecommunications Industry." In Review of Regulatory Reform in Turkey. Paris: OECD. Armstrong, M., 1997. "Competition in Telecommunications." --------. 2003. Communications Outlook. Paris: OECD. Oxford Review of Economic Policy 13: 64­82. PWC Consulting. 2002. "1st Report on Monitoring of EU --------. 1998. "Network Interconnections." Economic Journal Candidate Countries (Telecommunication Services Sector)." 108: 545­64. July 25, Brussels. Baumol, W. J., and G. Sidak. 1994. Toward Competition in Local Shy, O. 2001. The Economics of Network Industries. Cambridge: Telephony. Cambridge, MA: MIT Press. Cambridge University Press. Boylaud, O., and G. Nicoletti. 2000. "Regulation, Market Struc- van Damme, E. 2002. "The European UMTS-Auctions." Euro- ture and Performance in Telecommunications." Economics pean Economic Review 46: 846­58. Department Working Paper No. 237, Organisation for Weisman, D. L. 2002."Is There`Hope' for Price Cap Regulation?" Economic Co-operation and Development, Paris. Information Economics and Policy 14: 349­70. Choné, P., L. Flochel, and A. Perrot. 2002. "Allocating and World Bank. 2000. Telecommunications Regulation Handbook. Funding Universal Service Obligations in a Competitive http://www.infodev.org/projects/314regulationhandbook. Market." International Journal of Industrial Organization --------. 2002. European Universal Service Atlas. Washington, 1247­76. DC: World Bank. eEurope+ 2003. 2003. "eEurope+ Progress Report." Prepared by Yilmaz, K. 2000. "Türk telekomünikasyon sektöründe reform: the EU membership candidate countries with the assistance özelles¸tirme, düzenleme ve serbestles¸me" [Reform in the of the European Commission, Ljubljana, June 3­4, 2002. Turkish Telecommunications Sector: Privatization, Regula- European Commission. 2002. "Eighth Report from the Com- tion and Liberalization]. In Devletin Düzenleyici Rolü [The mission on the Implementation of the Telecommunications Regulatory Role of the State], ed. Izak Ati yas. Istanbul: Regulatory Package. COM(2002) 695. Brussels. TESEV Yayinlari. 6 Accession to the European Union: Potential Impacts on the Turkish Banking Sector Ceyla Pazarbas¸ioglu Turkey's prospects of accession to the European initial fiscal costs of the resolution of the Turkish Union (EU) are highly dependent on the progress banking crisis were about 50 billion (about made with political and economic reforms.1 Of 34 percent of the gross domestic product, GDP), these reforms, financial sector­related issues are an which, with servicing costs, implies an annual cost important component of the criteria associated of 5 billion. These restructuring costs must be with full membership. Most of the issues are con- taken into account in an assessment of the potential centrated in the banking sector, because banks costs to the Turkish banking sector of EU accession. account for more than 90 percent of the total assets In effect, much of the adjustment costs have already of the Turkish financial system. been borne because of the major bank restructur- Turkey adopted a comprehensive disinflation ing that took place during 2001­03. program, supported by the International Monetary In implementing structural reforms, Turkey has Fund (IMF), at the beginning of 2000. Before met nearly all of the conditions set for the banking adoption of this program, macroeconomic instabil- sector so that it complies with EU norms.Indeed,the ity, crowding out by the public sector, systemic dis- sector has made the necessary amendments as dic- tortions created by state banks, inadequate risk tated by the Turkish"National Program,"which puts assessment and management systems, and a lack of forth the criteria for accession to the EU.Setting cap- independent and effective supervision were all fac- ital adequacy standards, redefining "own funds" and tors contributing to the major structural weak- subsidiaries,setting related lending limits,regulating nesses of the Turkish banking system. In September accounting practices, and ensuring transparency of 2000, the Banking Regulation and Supervision financial reporting are among the issues addressed Agency (BRSA), an independent institution with in the recent regulations that have been adopted and responsibility for regulating and supervising the that are in full compliance with EU principles. banking sector, began operations. Soon after its for- Despite the relatively small asset size and low mation, the BRSA had to manage a major banking degree of intermediation of the Turkish financial crisis brought on by the escalating political uncer- system, Turkey's potential and its regional situation tainties, the loss of credibility by the exchange rate make it an attractive market. The entry of foreign regime, and, finally, the abolition of the pegged banks into Turkey's financial markets is expected to exchange rate system in February 2001. enhance competition in the financial sector and As in many other countries, the restructuring of improve the quality of banking services and finan- Turkey's banking sector has been very costly. The cial products. Furthermore, the Turkish banking 161 162 Turkey: Economic Reform and Accession to the European Union system, with its high-technology systems and The exchange rate­based disinflation program regulatory compliance, is a strong candidate for introduced in January 2000 had a major impact on becoming a member of the EU financial system. banks' balance sheets. Deposit and lending rates fell The remainder of this chapter is organized as sharply during the initial stages of the program's follows. The next section provides an overview of implementation phase. Funding in foreign currency the major reforms undertaken in restructuring the became cheaper because of the preannounced Turkish banking sector during 2001­03 and the exchange rate and the real appreciation of the associated costs.2 That overview is followed by a Turkish lira.As a result, banks borrowed short term, comparison of the Turkish banking sector with leading in turn to a maturity mismatch because those of the EU member states and other EU acces- outstanding loans had longer durations. Moreover, sion countries in order to evaluate the impact of the open foreign currency positions increased sharply. greater competition that may result from joining The financial crises of November 2000 and February the EU. The chapter then summarizes the current 2001 led to the abolition of the pegged exchange situation in relation to compliance with EU bank- rate system and triggered another severe hit on the ing legislation. The final section is devoted to an Turkish banking sector. assessment of the general findings. The Bank Restructuring Strategy The Restructuring of the Turkish The Banking Regulation and Supervision Agency, Banking Sector and Related Fiscal Costs established in 2000, is a financially and administra- tively independent institution funded by the pre- Intheearly1980s,theTurkisheconomyunderwenta miums collected from Turkish banks. Before the significant policy shift from financial repression formation of the BRSA, the Undersecretariat of toward liberalization. Compared with its stance Treasury was responsible for preparing and issuing before the 1980s, Turkey became an outward- prudential banking regulations and conducting oriented economy and experienced significant bank examinations under the Banks Act, and the changes in foreign trade and external capital move- Central Bank of the Republic of Turkey conducted ments. During the same period, Turkey also experi- off-site monitoring of banks under the Central encedhighinflation,coupledwithhighpublicsector Bank Act. deficit financing. High real interest rates and greater In May 2001, in the aftermath of the crises, the macroeconomic instability became the defining BRSA announced the Banking Sector Restructuring features of the Turkish economy after the 1980s. Program (see BRSA 2001). The main objective of Turkey's banks therefore found themselves oper- the program was to eliminate distortions in the ating in an environment of macroeconomic insta- financial sector and adopt regulations to promote bility, characterized by high and volatile inflation an efficient, globally competitive, sound Turkish rates and fragile external capital flows. Because of banking sector (see figure 6.1). The restructuring the high interest rates resulting from the high program was based on four main pillars: (1) restruc- public sector deficits, banks invested in risk-free turing the state banks, (2) seeking prompt resolu- government securities. The systemic distortions tion of the intervened banks, (3) strengthening the created by the state banks and the inadequate risk private banks, and (4) strengthening the regulatory management and internal control procedures of and supervisory framework. Despite various chal- the sector exacerbated the vulnerability of the lenges, much progress has been achieved in all of banks to financial crises. In the aftermath of the these areas. 1994 financial crisis, the strength of the Turkish As in many other countries, the costs of re- banking sector was severely tested. The recovery structuring the banking sector have been high (see that began in 1995 was negatively affected by the table 6.1). During the restructuring of the state East Asian and Russian crises of 1997­98. The dev- banks (the first pillar), the Treasury issued govern- astating earthquakes of 1999 also had negative ment bonds worth about 18 billion in 2001 to effects on the Turkish economy in general and the securitize the state banks' losses arising from subsi- banking sector in particular. dized lending (so-called duty losses). At the same Accession to the European Union: Potential Impacts on the Turkish Banking Sector 163 FIGURE 6.1 Turkish Bank Restructuring Strategy State bank reform Strong capital Sound banking base Banking Sector Cost Restructuring efficiency Strong Program economy and sustainable Efficient growth supervision environment Market discipline and transparency Corporate Structural reform restructuring · Macroeconomic stability Source: The author. TABLE 6.1 Initial Fiscal Costs of Turkish Operational restructuring was a very important Banking Crisis, 2000­01 component of the overall restructuring of the state banks. The number of branches was reduced from Cost in 2,494 as of December 2000 to 1,685 as of December 2001 Ratio of Cost (billion to 2001 2002, and the number of personnel was reduced euros) GDP (%) to 30,399 from 61,601. State banks became more efficient in organization, technology, human State banks' duty 18.5 12.8 losses resources, financial control, planning, and risk Capital support to 2.9 2.0 management, so that they can operate in line with state banks the requirements of modern banking and interna- Resolution of SDIF 27.1 18.7 tional competition. banks The second pillar of the restructuring strategy Public resources 24.6 17.0 was the resolution of the banks taken over by the Private resources 2.5 1.7 Savings Deposit Insurance Fund (SDIF). The SDIF, Total costs 48.5 33.5 run by the Central Bank of Turkey since 1983 with the mandate to insure saving deposits, was also Source: Banking Regulation and Supervision charged with resolving insolvent banks in 1994. It Agency of Turkey. was transferred to the BRSA on August 31, 2000. time, legislation was introduced to prevent the Twenty banks were transferred to the SDIF during future accumulation of duty losses. Meanwhile, the 1997­2002. An Asset Management Unit was created banking license of the third largest state bank and charged with recovering the value of the assets (Emlak) was revoked, and the management of the of the banks taken over by the SDIF. As of the date remaining two state banks, Ziraat and Halk, was of transfer, the total liabilities of the banks taken strengthened through the establishment of a joint over were 33 billion, and the total losses of these board of management. The total resources trans- banks amounted to about 18 billion. ferred to the state banks to eliminate duty losses The funds needed for the resolution of the banks and to provide capital support amounted to about in which the SDIF intervened were met by govern- 22.5 billion as of the end of 2001. ment bonds issued by the Treasury (18.5 billion) 164 Turkey: Economic Reform and Accession to the European Union and the SDIF's own resources (5 billion). The schedules and statements focused on four areas: main source of the SDIF revenues were premiums (1) capital adequacy, (2) credit portfolio and coun- collected from the banking sector, as well as pro- terpart risk, (3) risk groups to which the bank ceeds from the sale and collection of the assets of belongs, and (4) structured transactions and other the intervened banks. Thus the private sector also income recognition issues. shared the burden of the costs of restructuring. In preparation of the financial statements the fol- To avoid even greater losses and to accelerate the lowing central issues were taken into consideration: resolution process, the SDIF has subjected the trou- bled banks to an intensive financial and operational · Inflation accounting restructuring. The speed of the resolution has been · Consolidated reporting very rapid compared with the international experi- · Inclusion of material changes to financial state- ence. As of May 2003, only two banks remained ments after December 2001 under management of the SDIF. One was a bridge · Special issues related to the assessment bank used for asset management purposes; the · Loan portfolio assessment and provisioning other bank was put up for sale. · Evaluation of derivative instruments The third pillar of the restructuring strategy was · Evaluation of swap bonds the establishment of a sound private banking sec- · Valuation of foreign currency accounts. tor. The financial structure and profitability of the private banks deteriorated sharply in the aftermath The bank recapitalization phase began with the of the crises. During the first stage of the restruc- BRSA's notification to the banks. During this phase, turing program, measures were put in place to ordinary general assemblies were convened, and the recapitalize the private banks, limit foreign cur- financial situation of the banks, as determined dur- rency open positions, and encourage mergers and ing the assessment phase, was presented to the acquisitions. In line with the program, important shareholders. The shareholders made the required steps were taken toward strengthening the capital resolutions for the recapitalization of the banks base of the private banks with their own resources. whose capital adequacy ratio fell below the 8 per- The deeper-than-expected recession in 2001 cent minimum required. and the general global economic conditions high- The public recapitalization phase was designed to lighted the need to further bolster the private banks provide public capital support for solvent banks by strengthening their capital through public sup- that did not satisfy the minimum capital adequacy port if necessary, by resolving the nonperforming ratio (8 percent) on a pari passu basis with the loans of the banking sector through the Istanbul majority shareholders. The public support took the Approach,3 and by establishing asset management form of a capital injection or subordinated debt companies. with the appropriate contingencies and safeguards. The recapitalization program consisted of three phases.4 During the assessment phase, the financial Banking Sectors in the EU status of all private commercial banks using inter- and Turkey: A Comparison national accounting standards was obtained by of Structural Indicators means of a three-phase audit procedure carried out This section presents an overview of the structural on a fair and impartial basis. An independent audit characteristics of the Turkish banking sector and company appointed by the bank undertook the first compares these characteristics with those of the audit. A second audit was conducted by another banking sectors of the EU member countries as independent audit company to ensure that the first well as the countries included in the EU enlarge- audit was carried out according to the agreed-on ment process.5 principles. The BRSA conducted the final audit. This multiphase auditing procedure was utilized to Concentration Ratio, Entry to the Sector, Public increase transparency and credibility. The audits Share, and Capital Adequacy were based on the financial statements of the banks, as well as on the supplementary reporting The five largest Turkish banks have a market share schedules completed, based on the detailed instruc- of 60 percent of total assets, which is similar to the tions of the BRSA. The supplementary reporting average for the EU's five largest banks (see figure 6.2 Accession to the European Union: Potential Impacts on the Turkish Banking Sector 165 FIGURE 6.2 Concentration Ratios of Five FIGURE 6.3 Share of Assets of State-Owned Largest Banks, 2003 Banks, 2003 (percent) (percentage of total assets) Percent Percent 72 70.8 35 32.7 70 30 68 25 66 64 20 62.8 62 15 60.0 60 11 10 7.6 58 5 56 54 0 EU average Candidate Turkey EU average Candidate Turkey countries (June 2004) countries (June 2004) average average Sources: World Bank, and the Banking Regulation and Sources: World Bank, and the Banking Regulation and Supervision Agency of Turkey. Supervision Agency of Turkey. and annex 1).6 This ratio is a little higher for the EU FIGURE 6.4 Capital Adequacy Ratios, 2003 candidate countries, reflecting the entry of large (percent) foreign banks in the financial markets of these Percent countries. The concentration of the large Turkish 30 banks is significantly higher than in the late 1990s 25.42 because of the significant merger and acquisition 25 activities, as well as the state's intervention into the failed banks. The launching of negotiations with 20 16.67 the EU and thus the expected "convergence play" 15 are likely to generate more consolidation in the 12.5 banking industry and increased interest by both 10 domestic and foreign participants. The 11 million in capital required to license a 5 bank in Turkey is in line with the EU average of 12 million (see annex 1, table 6.3). Licensing 0 requirements have become much more onerous in EU average Candidate Turkey countries (June 2004) Turkey since the bank failures of 2000­01. average Although the withdrawal of the state from the banking sector in many EU member countries is Sources: World Bank, and the Banking Regulation and Supervision Agency of Turkey. significant, state banks still play a dominant role in Turkey, accounting for one-third of total assets as of June 2004 (see figure 6.3). However, a key pillar ratio that measures a bank's capital as a percentage of the bank restructuring strategy (as discussed in of its risk-weighted assets--is a regulatory require- the earlier section) is the restructuring and privati- ment intended to ensure that banks maintain ade- zation of state banks. quate capital to support their risk exposures. The The average capital adequacy ratio of the Turkish capital adequacy ratio of a bank is a good indication banking system is high compared with the EU aver- of its vulnerability to potential shocks and thus the age and that of the candidate countries (see fig- health of that bank. The capital adequacy regula- ure 6.4). A minimum capital adequacy ratio--the tions in Turkey are in line with those of the EU. 166 Turkey: Economic Reform and Accession to the European Union Deposit Insurance as of the end of 2003 an EU member country had on average 500 banks with 11,500 branches and An explicit full deposit guarantee for the banks in 140,000 employees (see annex 1, table 6.3). As of which the state intervened was extended to avoid end of June 2004, Turkey had 49 banks with 6,000 the deposit runs that occurred during the 2001 branches and 126,000 employees. financial crisis in Turkey. However, because of the An average EU bank is almost twice as large as distortions and the moral hazard such a blanket an average Turkish bank. The average asset size per guarantee creates, the BRSA subsequently imple- bank (calculated as total assets divided by number mented a partial deposit guarantee system in line of banks) in EU countries is about 5.3 billion, with EU regulations. This system was put into place compared with about 3.1 billion in Turkey. The in 2004 with a one-year notice period. average asset size of banks in the candidate coun- Compared with the GDP and per capita national tries is about 1 billion (see figure 6.6). income of the EU countries,it can be argued that the level of protection of deposits in Turkey--27,000 An average bank in Turkey has 125 branches, per account holder--is very high.7 Although the much higher than the comparable number for EU member and EU candidate countries. In the EU level of deposit protection (guarantee or insurance) varies between 20,000 and 60,000 in the EU member countries, the average number of branches per bank is 36, and the average number of employ- countries, the average amount of insured deposits is about 29,000 (figure 6.5). The average deposit ees per branch is 27 (see figures 6.7 and 6.8). Simi- guarantee amounts to nearly 13,000 in the candi- lar figures apply to the EU candidate countries. The date countries.8 average number of personnel per branch in Turkey is 21, which is comparable to that of EU member and candidate countries. Number of Banks, Average Size, and the Staff Employed Asset, Deposit, and Loan Indicators Compared with EU averages, the Turkish banking system has fewer banks that have a high-density net- The total asset size of the banking system of Turkey works and a high level of employment. Although is about 152 billion, compared with the EU aver- there is wide variance among EU member countries, age of 1.7 trillion. One of the large banks in FIGURE 6.5 Size of Deposits Subject to FIGURE 6.6 Average Bank Size, 2003 Insurance, 2003 (total assets per number of banks, in (euros) millions of euros) Euros Value (millions of euros) 40,000 6,000 5,323 35,000 5,000 30,000 28,973 27,691 4,000 25,000 3,113 20,000 3,000 15,000 12,892 2,000 10,000 1,024 1,000 5,000 0 0 EU average Candidate Turkey EU average Candidate Turkey countries (June 2004) countries (June 2004) average average Sources: World Bank, and the Banking Regulation and Sources: European Banking Federation and Banking Supervision Agency of Turkey. Regulation and Supervision Agency of Turkey. Accession to the European Union: Potential Impacts on the Turkish Banking Sector 167 FIGURE 6.7 Number of Branches FIGURE 6.9 Selected Indicators, 2003 per Bank, 2003 (percent) Number of branches Percent 140 450 422 125 EU average 400 120 Candidate countries average 350 Turkey (June 2004) 100 300 80 250 60 200 169 147 150 40 36 33 111 100 64 69 55 20 50 40 20 0 0 EU average Candidate Turkey Assets/GDP Deposits/GDP Loans/GDP countries (June 2004) average Sources: World Bank, Banking Regulation and Supervision Agency of Turkey, European Banking Sources: European Banking Federation and Banking Federation, and Eurostat. Regulation and Supervision Agency of Turkey. 147 percent in the EU member countries and 55 per- FIGURE 6.8 Number of Personnel cent in candidate countries.Similar observations can per Branch, 2003 be made about deposit mobilization (figure 6.9). Number of personnel 30 27 Profitability 25 25 The return on equity of Turkish banks has been 21 20 very volatile, reflecting the macroeconomic devel- opments. For example, the ratio of the term profit9 15 of the Turkish banking sector to total equity (return on equity) was -80 percent as of December 2001,10 10 reflecting the financial crises of 2000­01 and the adoption of inflation accounting (figure 6.10). 5 During 1995­2000, this ratio averaged about 22 percent. However, these figures are estimated to 0 be close to the 8­10 percent levels under inflation EU average Candidate Turkey countries (June 2004) accounting. The average return on equity of the EU average member countries' banks was about 10 percent Sources: European Banking Federation and Banking (after deduction of tax and extraordinary items) in Regulation and Supervision Agency of Turkey. 2003 (see figure 6.11 and annex 1).11 However, the return on equity of the large-scale banks is much higher than that of the other bank segments. Europe, Deutsche Bank, had total assets of about 803 billion as of December 2003, which is five and a half times larger than that of the whole Turkish Income, Expenditure, and Cost Structure banking sector. In terms of the ratio of loans to GDP, Turkey fares In banks in the EU countries, net interest income poorly, reflecting the crowding out of the real sector accounts for almost 60 percent of total income, but by the government. The loans-to-assets ratio was it accounts for only 14 percent of the total income 20 percent in Turkey in June 2004, compared with of Turkish banks. The share of other operating 168 Turkey: Economic Reform and Accession to the European Union FIGURE 6.10 Return on Equity: Turkey and FIGURE 6.12 Personnel Expenses EU Banking Sectors, 2003 to Total Assets, 2003 (percent) (percent) Percent Percent 15 0.90 0.88 0.88 0.86 9.87 10 0.84 8.03 6.75 0.82 0.80 5 0.79 0.78 0.76 0 0.74 European Turkey Turkey European Union Turkey (June 2004) Union (June 2003) (June 2004) Sources: EU Banking Sector Stability (European Central Sources: EU Banking Sector Stability (European Central Bank 2004) and Banking Regulation and Supervision Bank 2004) and Banking Regulation and Supervision Agency of Turkey. Agency of Turkey. Figure 6.13 Personnel Expenses to Total Expenditures, 2003 FIGURE 6.11 Return on Equity of EU Banks (percent) by Asset Size, 2003 (percent) Percent 80 Percent 20 61.43 60 15 40 10.89 9.87 10 8.73 6.2 20 12.51 5 0 European Union Turkey (June 2004) 0 All banks Large- Medium- Small- Sources: EU Banking Sector Stability (European Central scale scale scale Bank 2004) and Banking Regulation and Supervision Agency of Turkey. Source: EU Banking Sector Stability (European Central Bank 2004). Asset Quality The ratio of nonperforming loans to total loans in income (net) is the largest item in the total income Turkish banks (6.3 percent) is more than double that of Turkish banks. for the average EU bank (figures 6.14 and 6.15).With The staff expenses of EU banks constitute about the onset of the severe financial crises in Turkey in 61 percent of total expenditures (figures 6.12 and 2000­01, the quality of the assets of Turkish banks 6.13), whereas such expenses account for only deteriorated sharply, with the ratio of nonperform- 13percentof thetotalexpendituresof Turkishbanks. ing loans reaching about 22 percent in 2001. The Accession to the European Union: Potential Impacts on the Turkish Banking Sector 169 FIGURE 6.14 Total Loans to Total Assets, FIGURE 6.16 Debt Securities to Total 2003 Assets, 2003 (percent) (percent) Percent Percent 50 50 45 41.5 40 40 32 30 30 22.61 20 20 10 10 0 0 European Union Turkey (June 2004) European Union Turkey (June 2004) Sources: European Banking Federation and Banking Sources: EU Banking Sector Stability (European Central Regulation and Supervision Agency of Turkey. Bank 2004) and Banking Regulation and Supervision Agency of Turkey. FIGURE 6.15 Nonperforming Loans (Gross) to Total Loans, 2003 percent for the EU banks when nongovernment (percent) securities are included, indicating the dominance Percent of the real sector in the securities portfolio (fig- 7 ure 6.16). The nongovernment securities holdings 6.3 of Turkish banks are about 1.5 percent of total assets. 6 5 Financial Strength Ratings 4 Turkish banks have much lower financial strength 3.1 3 ratings than banks in the EU member countries. In a study conducted by Moody's Investors Service in 2 March 2003, all countries were rated by their finan- cial strength by assigning weights to their assets 1 (figure 6.17). E was the lowest rating and A was the 0 highest. The average rating mark of the EU mem- European Union Turkey (June 2004) ber states was B­; the average rating mark of the Sources: European Banking Federation and Banking candidate countries was D; and Turkey's rating Regulation and Supervision Agency of Turkey. mark was D­ (figure 6.17). situation improved during 2002­03 because of the Foreign Bank Entry acceleration of out-of-court settlements and volun- tary debt restructuring arrangements. The low share of foreign banks in Turkey (less than 10 percent) offers a striking contrast with the shares of foreign banks in newly liberalized or liberalizing Share of Government Debt Securities Central and Eastern European countries (close to Government debt securities held by Turkish banks 70 percent). Persistent macroeconomic instability amounted to 40 percent of total assets as of June appears to be the main reason for the very small 2004, compared with less than 2 percent for EU share of foreign banks in Turkey. A positive correla- banks at the end of 2003. This ratio increases to 22.6 tion exists between the volume of foreign direct 170 Turkey: Economic Reform and Accession to the European Union FIGURE 6.17 Financial Strength Rating of the area of EU directives. Several initiatives have the Sector (Moody's), 2003 been taken in the context of the ongoing regulatory 10 efforts of the EU. B­ After establishing the BRSA,12 Turkey increased its effort to harmonize Turkish legislation with the 8 related EU directives. The new Banks Act and the regulations issued by the BRSA are in line with 6 international standards, and the Turkish banking legislation in force is almost fully in compliance D 4 with the EU in many areas. D­ The remaining pieces of legislation that need to 2 be introduced or amended in order for Turkey to achieve full alignment with the EU legislation are on the agenda, and they are expected to be realized 0 EU average Candidate Turkey within the framework of the National Program that countries is currently being revised by the Secretariat General average for the EU in cooperation with the related Turkish Source: Moody's Investors Service authorities, including the BRSA. The comprehen- (http://www.moodys.com). sive table in annex 2 of this chapter describes both the legislation in force in banking in the EU and the corresponding Turkish legislation to give a picture investment and foreign bank expansion in the host of the current state of play in legislative compliance. country originating from the same parent country. In 2003 the net foreign direct investment in Turkey was about $1 billion. In addition to macroeco- Adoption of the Capital Adequacy Directive nomic instability, the delays in implementing Parallel with the consultative process of the Basel financial sector reforms in Turkey have prevented Committee on Banking Supervision for the final- foreign investors from entering the Turkish market. ization of the New Basel Accord (Basel II), the Host country regulations also determine foreign European Union released an advance draft of a new bank entry. Foreign banks prefer countries with directive on the EU capital framework known fewer regulatory restrictions for investment. as Capital Adequacy Directive 3 (CAD 3), which Since completion of the Turkish bank restruc- translates Basel II into EU legislation and applies turing program, the banking sector has become Basel-type provisions to investment firms and more resilient to economic shocks, regulations have domestic credit institutions as well as to interna- been streamlined with international standards, and tional banks. Unlike Basel II, which addresses inter- overall bank soundness has improved. As a result, nationally active banks, CAD 3 will be applied to all the interest of foreign investors in Turkish banks credit institutions in the EU (including building has begun to increase. Ongoing efforts to decrease societies). It also will be applied to nonbank invest- high intermediation costs and implement limited ment firms authorized under the Investment Ser- deposit insurance are expected to accelerate foreign vices Directive (ISD). The directive will take effect entry. in 2007. In parallel with CAD 2 principles, the commu- Compliance with EU Banking niqué on capital adequacy was amended in February Legislation 2001 to cover market risks,and further amendments Because of the European Commission's work in par- were made in January 2002 to include options and to allel with the Basel Committee on Banking Supervi- address some other specific issues, such as the inclu- sion, Turkey's efforts to prepare changes in the sion of Tier 3 capital and structural positions. The banking system regulations serve both bodies' pro- regulation requires banks to incorporate their mar- posals (and thus directives). Specifically, Turkey's ket risks into their regulatory capital calculation, compliance with EU banking legislation is mainly in and it stipulates that banks must separate their Accession to the European Union: Potential Impacts on the Turkish Banking Sector 171 books into a banking book and a trading book. The one of Basel II. The results of the study, in which calculation of market risk covers the interest rate participant Turkish banks have applied simpler risk and equity risk of the trading book, and the for- approaches for credit and operational risks,13 have eign exchange risk covers both the trading book and been shared with the QIS Working Group of the the banking book. Banks are permitted to use either Basel Committee on Banking Supervision. the standard approach or the model approach to The results of the QIS 3, in which 365 banks calculate their market risks. Banks implementing from 43 countries participated, convey significant the internal model approach will calculate their information about the potential impact of Basel II market risk­based capital requirements on the basis on Turkey as well as other on participant countries. of their their value-at-risk (VaR) figure. Banks are The results are generally in line with the Basel also required to conduct a regular stress testing pro- Committee's objectives: the minimum capital gram. Whether a bank can use the model approach requirements would be broadly unchanged for is determined by compliance with the qualitative large, internationally active banks under the inter- and quantitative criteria defined in the regulation. nal ratings­based (IRB) approach, and the propos- Currently, all banks are using the standard approach als would offer an incentive for internationally to report their market risk capital charges on both a active banks to adopt more sophisticated solo basis (since January 2002) and on a consoli- approaches. The summary of worldwide results, dated basis (since July 2002). which reflects the impact of the last consultative The BRSA has prepared a draft "Circular paper of Basel II (Consultative Paper 3), is pre- Regarding the Evaluation of Risk Measurement sented in table 6.2. Models of Banks by the Agency," which sets out the The results show that under three different principles and procedures for assessment of the risk approaches for credit risk (standardized approach, measurement models to be used for regulatory foundation IRB approach, and advanced IRB reporting purposes by banks. Whether a bank can approach), both the G-10 countries and the EU use the model is determined on the basis of a care- countries have lower capital requirements.14 How- ful and comprehensive set of checks to grant per- ever, other countries incur a small increase in credit mission for its use. risk capital requirements under the standardized To gauge the impact of Basel II (and CAD 3), six approach. For operational risk capital charges, all of the top 10 Turkish banks (ranked by asset size) banks incur on average nearly an 8­10 percent participated in the third Quantitative Impact Study increase in risk-weighted assets. (QIS 3) under the guidance of the BRSA (Basel The table also reveals that there is considerable Committee 2003). The study focused on the pro- variation in the extent to which capital requirements posed minimum capital requirements under pillar will rise or fall under Basel II for different banks. TABLE 6.2 Results, Quantitative Impact Study, 2003 (percent) Foundation IRB Advanced IRB Standardized Approach Approach Approach Average Max Min Average Max Min Average Max Min G-10 Group 1 11 84 15 3 55 32 2 46 36 Group 2 3 81 23 19 41 58 EU Group 1 6 31 7 4 55 32 6 26 31 Group 2 1 81 67 20 41 58 Other Groups 1 12 103 17 4 75 33 and 2 Note: IRB internal ratings­based approach; for definition of G-10 countries, see note 14. Sources: Quantitative Impact Study Results, Basel Committee on Banking Supervision, 2003. 172 Turkey: Economic Reform and Accession to the European Union This variation reflects the differences between bank banks of the Banks Association of Turkey, was portfolios. The variation in results for the standard- formed in February 2003 to prepare a road map for ized approach also largely stems from the relative the adoption and implementation of Basel II and importance of retail portfolios for different banks. CAD 3 principles by the Turkish banking sector. Moreover, the level of specialization in different lines of activities will imply different capital charges Conclusion for operational risk between banks. The results of the third quantitative impact Turkey has fulfilled most of the conditions required study (QIS 3) imply that the implementation of for the banking sector to comply with the integra- new capital adequacy regulations will mean that tion process for the EU. Within the National Pro- Turkish banks must incur significant costs to meet gram, the necessary legislation on various issues their credit and operational risk capital require- has been amended or enacted in line with EU direc- ments and the cost of funding. Even though the tives. Examples are indirect loans; definitions of said effects have been verified by the QIS 3, the capital and subsidiary; related lending limits; prin- potential effects of CAD 3 are not expected to be ciples on the establishment and operations of significantly different from the effects of Basel II. banks and special finance houses; regulation on This expectation is based on the assumption that accounting practices; steps to ensure transparency there is a negligible difference between CAD 3 and on financial reporting; principles on bank mergers Basel II, in view of the fact that CAD 3 has so far and acquisitions; the issues surrounding decreasing suggested Basel-type provisions. Because the new the public share within the financial sector; steps to directive requires additional inputs and new ensure the efficiency of supervision and surveil- methodologies for capital adequacy, the inherent lance in cross-border banking; capital adequacy, costs appear in three main areas: input gathering, including market risk; and risk management and system design, and additional charges for capital internal control systems.15 requirements and cost of funding. The BRSA has revised the regulations on deposit Contrary to the relatively low data intensiveness insurance in line with international standards; the of CAD 2, which basically requires the location of introduction of the new scheme was announced in the counterparty (whether it is an Organisation for 2004 (with a one-year transition period). Areas that Economic Co-operation and Development country need further improvements in regulations are the or not) and the type of collateral, CAD 3 requires a business of electronic money institutions and sup- comprehensive amount of technical data, such as plementary supervision of financial conglomerates. external ratings, probability of default or of a loss- Various directives such as the one for cross-border given event for credit risk, and a new type of data payments in euros will become effective with full for operational risk (such as event data or gross EU membership. Thus the preparation at this stage income by business lines). Providing this data will is restricted to the technical evaluations. obviously be a difficult task for Turkish banks and Despite the adverse macroeconomic conditions, banks elsewhere and will require modifications in the core Turkish banking sector proved to be the accounting and reporting framework and resilient. Many of these banks are comparable to information technology restructuring. New data their European counterparts in terms of selected requirements can be met only by means of an effi- indicators, such as high quality of human resources, cient infrastructure such as the existence of a well- technological infrastructure, a nationwide branch functioning rating system and liquid markets for network, and high-quality service provided in a collaterals. variety of financial products. However, it will be dif- The BRSA aims to implement CAD 3 by 2007. ficult for Turkish banks to compete with the larger This target also includes working on the potential European banks with their large assets and capital effects of Basel II and CAD 3, as well as clarification strength.Thus the initiation of negotiations with the of the provisions of CAD 3 by taking the country- EU and the expected"convergence play"are likely to specific issues into consideration. To serve this pur- generate more consolidation in the banking indus- pose, a steering committee, pioneered by the BRSA try and increased interest of both domestic and for- and consisting of representatives of the member eign participants. Accession to the European Union: Potential Impacts on the Turkish Banking Sector 173 Because of the crowding out by the government, be competitive in the EU banking sector, or at the share of consumer and corporate loans of total least to form partnerships based on solid ground assets or deposits is very low. However, under a with EU banks, Turkish banks must further convergence scenario it is clear that the Turkish strengthen their equity structures during the tran- financial sector has important future growth sition period. potential. The convergence to the EU implies not The Turkish banking system has become more only convergence of the capital structure, prof- resilient and sound since the extensive restructur- itability, and management techniques, but also of ing program and implementation of international accounting standards, transparency guidelines, and standards. This development inevitably implied a corporate structure.16 large fiscal cost in which the initial fiscal burden of There is no doubt but that the Turkish banking the bank restructuring reached levels close to one- sector will be exposed to certain costs during third of GDP. Thus a large portion of the cost that integration with the EU. EU banks tend to keep will emerge from full membership and full conver- their profitability high through restructuring their gence to the EU banking sector has already been activities and improving their risk management borne. Furthermore, the confidence that will result techniques. Competitive pressure on the Turkish from the convergence to the EU is expected to have banking sector may arise from EU banks that are significant positive externalities on the banking sec- well known for their strong capital base and their tor that should at least partially offset the impact of capability for managing risks. It appears that, to competition from strong EU banks.17 174 Annex 1: Banking Sector Statistics--The EU, New Member States, and Turkey TABLE 6.3 Statistics on Banking Sectors of EU15 and Turkey, 2003 Percentage Percentage of Banking of Banking System's System's Concen- Assets Assets Deposit Scale tration Minimum Risk- in Banks in Banks Insurance Moody's Corres- Ratio of Capital Entry Number Number Number Adjusted 50% or More 50% or More per Total Total Total Rating ponding to Five Largest Requirement of of of CAR Capital Government- Foreign- Account Assets Deposits Credit GDP (March Moody's Banks (%) ( millions) Banks Branches Staff (%) Ratio (%) Owned Owned () ( billions) ( billions) ( billions) ( millions) 2003) Rating Austria -- 5 896 4,401 62,674 8 -- 0.0 -- 20,000 605 370 288 199,603 C+ 8 Belgium 88.0 62.5 109 4,935 72,210 8 12.7 0.0 -- 20,000 891 420 397 269,546 B 10 Denmark 90.0 5 198 2,014 38,740 8 9.7 0.0 0.0 47,728 312 125 126 187,951 B 10 Finland 99.5 5 343 1,527 23,372 8 10.5 0.0 6.2 25,000 177 64 81 142,518 B- 9 France 60.0 7 925 25,789 -- 8 -- 0.0 -- 70,000 3,779 978 1,196 1,557,245 B- 9 Germany 20.0 5 2,465 36,599 712,000 8­12.5 10.6 42.2 4.3 20,000 6,471 2,448 3,025 2,128,200 C 6 Greece 73.9 18 59 3,095 61,074 8 13.6 22.8 10.8 20,000 200 116 101 153,045 D+ 5 Ireland -- 6.3 91 856 42,126 8 -- -- -- 20,000 575 160 249 134,786 B- 9 Italy 51.2 6.3 788 30,502 337 8 13.4 10.0 5.7 -- 2,170 596 1,039 1,300,926 C+ 8 Luxembourg 27.9 8.7 169 200 22,529 8 12.7 5.1 94.6 20,000 656 218 118 23,956 B- 9 Netherlands 88.1 5 147 4,000 144,000 8 11.5 3.9 2.2 -- 1,911 1,263 1,096 454,276 B+ 11 Portugal 79.8 17.5 52 5,431 54,089 8 9.5 22.8 17.7 -- 318 139 181 129,908 C+ 8 Spain 53.2 18 265 39,506 240,210 8 13.0 0.0 8.5 -- 1,430 807 813 744,754 B 10 Sweden 62.0 5 126 1,900 38,200 8 19.9 0.0 -- 27,000 287 123 123 267,251 B 10 U.K. 23.0 5 356 11,624 455,500 8 -- 0.0 46.0 -- 6,786 3,493 3,283 1,591,412 B+ 11 EU average 62.8 12 466 11,492 140,504 8 12.5 7.6 20 28,973 1,771 755 808 619,025 B- 9 Turkey 60.0 11.1 49 6,126 126,274 8 25.4 32.7 3.2 27,691 152.5 95 48 237,723 D- 3 -- Not available, not applicable, or negligible. Note: In June 2004, 1 euro = TL 1,805.605; in December 2003, 1 euro = TL 1,757.480. Sources: Data on concentration, minimum capital, capital adequacy ratio (CAR), public share, foreign share, deposit insurance: "2003 World Bank Banking Survey," http://www.worldbank.org; other banking indicators: European Banks Federation (FBE), http://www.fbe.org; GDP figures: Eurostat, http://www.europa.eu.int. Unless otherwise stated, data on Turkey are from national sources. Concentration, number of banks, number of branches, realized capital ratio data are as of June 2004, http://www.bddk.org.tr. Turkish data can be found in BRSA 2004. TABLE 6.4 Statistics on Banking Sectors of EU15 and Turkey, 2001 Personnel per Number of Branches Total Assets/ Total Deposits/ Total Credit/ Deposits/Credit Credit/Assets Assets/Number of Branch per Bank GDP (%) GDP (%) GDP (%) (%) (%) Banks ( millions) Austria 14 5 303 185 144 128 48 675 Belgium 15 45 331 156 147 106 45 8,173 Denmark 19 10 166 67 67 100 40 1,577 Finland 15 4 124 45 57 80 46 517 France -- 28 243 63 77 82 32 4,085 Germany 19 15 304 115 142 81 47 2,625 Greece 20 52 130 76 66 114 51 3,384 Ireland 49 9 427 119 185 64 43 6,321 Italy 0 39 167 46 80 57 48 2,754 Luxembourg