The Effect of the European Union Customs Union on the Balance of Trade in Turkey

Published date01 November 2017
Date01 November 2017
Subject MatterArticles
02_FTR660801.indd Article
The Effect of the
Foreign Trade Review
52(4) 219–232
European Union Customs
©2017 Indian Institute of
Foreign Trade
Union on the Balance of
SAGE Publications
Trade in Turkey
DOI: 10.1177/0015732516660801
Natalya Ketenci1
This article investigates the effect of the customs union between Turkey and
the European Union on the balance of trade in Turkey. The framework for
analysis is an extended trade gravity model onto which the impact of the cus-
toms union is applied. The gravity model of trade is estimated using dynamic
panel data which applies the generalized method of moments to a sample of
OECD countries. Separate estimates were made for the periods before and
after the process of trade liberalization in Turkey—1980–1995 and 1996–2012,
respectively—as well as for the full period—1980–2012. The main conclusion
is that when the European Union is accounted for as an econometric variable,
the empirical results are striking: Turkey’s gains resulting from taking part in
the customs union are noteworthy, with significant improvement in the trade
balance with European Union countries. However, the trade flows, and spe-
cifically imports, have been mainly with OECD countries that are themselves
not members of the EU. The model indicates that external common tariffs are
responsible for Turkey’s trade growth rather than tariffs abolished in the inter-
nal market of the customs union.
JEL: F13, F14, F15
Gravity model, GMM, customs union, European Union, OECD countries,
1 Department of Economics, Yeditepe University, Kayisdagi, Istanbul, Turkey.
Corresponding author:
Natalya Ketenci, Department of Economics, Yeditepe University, Kayisdagi 34755, Istanbul, Turkey.

Foreign Trade Review 52(4)
The customs union (CU) between Turkey and the European Union (EU) came
into effect on 31 December 1995. Since then, the EU has become Turkey’s
largest import/export partner.1 Turkey is also a party to 17 Free Trade Agreements
(FTAs), but by market size, the CU with the EU is larger than all of them.
As economies have become increasingly globalized, trade liberalization has
become popular government policy, the impact of which is not always as
expected. Many studies are thus devoted to investigating the implications of
trade liberalization for domestic and global trade flow. The methods of meas-
urement vary: some studies consider the episode from the point in time when
restrictions are reduced for a wide range of sectors up until the time when sig-
nificant change levels off (Li, 2003; Wu & Zeng, 2008). Other studies apply
dummy variables to indicate the year when trade liberalization was undertaken
in a given country (Pacheco-Lopez & Thirlwall, 2007; Santos-Paulino &
Thirlwall, 2004).
The count of FTAs is steadily increasing because they are deemed effective for
opening foreign markets to domestic exports, as well as a way to take advantage
of cheap imports. Correspondingly, the number of studies that consider FTAs as
dummy variables in order to investigate their effects on trade flow has also
increased (Baier & Bergstand, 2007; Frankel, 1997; Ghosh & Yamarik, 2004;
Roy, 2010). The most popular approach in the literature is to apply a gravity
model (Baier & Bergstrand, 2007; Carrere, 2006; Dai, Yotov, & Zylkin, 2014;
Frankel, 1997; Frankel, Stein, & Wei, 1995; Martinez-Zarzoso, Felicitas, &
Horsewood, 2009), and the first attempt to evaluate the effects of FTAs on trade
using the gravity equation was made by Timbergen in 1962. He postulated a sig-
nificant, positive effect of the FTA among trade partners in the British
Commonwealth, but an insignificant effect among members of the Benelux FTA.
Since then, the gravity equation has been widely applied to this question, and
while the political expectation is always for a positive impact, empirical studies
often suggest mixed results.
Frankel et al. (1995) examined the impact of FTAs grouped by regions, such as
East Asia, the European Community (EC) and North America. They found that in
1990, members of Mercosur were trading with one another at eight times the rate
of comparable, neighbouring countries elsewhere in the world. While the effect of
European Free Trade Association (EFTA) membership was found insignificant,
countries of the EC were claimed to trade three times more than if they had not
signed onto the agreement. Frankel (1997) examined Mercosur, the Andean Pact
and the EC and found a significant, positive effect of Mercosur on members’
trade, a significant, negative effect in the case of the EC and an insignificant effect
in the case of the Andean Pact. Baier and Bergstrand (2007) examined 96 coun-
tries in a regression aimed at answering the question of whether FTAs actually
increase the international trade of their parties. Using panel data of unbiased esti-
mates of average treatment effects, the authors found a positive effect and sug-
gested that on average, an FTA will increase two member countries’ trade by 100
per cent over 10 years.

Ketenci 221
Due to their relative complexity, the number of CUs is significantly lower than
FTAs, a fact that is further reflected in the lower number of studies investigating
the effects of CUs. Some studies have been theoretically and empirically devoted
to a comparison of the relative effect on trade of FTAs vis-à-vis CUs (Clausing,
2000; Facchini, Silva, & Willmann, 2013; Fiorentino, Verdeja, & Toqueboeuf,
2007; Krueger, 1997; Park & Park, 2009; Roy, 2010). Roy (2010), for example,
found that a CU accounted for higher increases in trade because it specifically
encouraged bilateral trade among members more than FTAs.
Turkey is the member of the EU CU and, as noted above, 17 FTAs. However,
most of the FTAs are relatively new; it is too early for an empirical investigation
of their effects. Most studies on Turkey’s trade liberalization and its impact on
trade have therefore concerned its membership in the CU (Adam & Moutos, 2008;
Akkemik, 2011; Demirci & Aydin, 2011; Lejour & de Mooij, 2005; Neyapti,
Taşkin, & Üngör, 2007; Nowak-Lehmann, Herzer, Martinez-Zarzoso, & Vollmer,
2007;Togan, 2000). Neyapti et al. (2007) employed an unbalanced panel of 150
countries and controlled for the effects of the real exchange rate and income
levels. The authors found that the CU significantly increased Turkish trade,
while the elasticity of income from exports and imports was lower for the period
after the CU came into effect. At the same time, they discovered that the effects
on the real exchange rate in exports from Turkey to EU countries was stronger,
suggesting that an overvalued Turkish currency was having a destabilizing
effect on trade with the EU. Nowak-Lehman et al. (2007) employed an extended
gravity model to evaluate the impact of the CU on Turkey’s exports at a sectoral
level. Adam and Moutos (2008) found that the CU has had an asymmetric effect
on trade between Turkey and the EU-15. Lejour and de Mooij (2005) suggested
that the CU grants Turkey only a limited access to the EUs internal markets,
artificially limiting the apparent effects of the liberalization of trade. Demirci
and Aydin (2011) simulated the effects of common external tariffs on trade in
Turkey with a computable general equilibrium model. The authors calculated
likely gains for Turkey that come about due to Turkey’s own reductions of
tariffs on EU imports, as well as due to increased allocative and endowment
This article investigates the effect of the CU on the balance of trade in Turkey,
applying a panel sample of OECD countries and quarterly data from 1980 to
2012. Estimates are made for three periods: the first, from 1980 to 1995, is the
period before Turkey joined the EU CU. The second, from 1996 to 2012, is the
period of CU activity. And the last is the full 32 years, covering both the pre-
and post-liberalization periods. Estimates are made using data on bilateral trade
flow between Turkey and its partners from the OECD sample. The independent
variables include the real exchange rate, partners’ incomes and Turkey’s own
income. The EU dummy variable is used to detect whether a country from the
OECD sample belongs to the EU. Data were extracted from the official statistical
site of the OECD and the Turkish Statistical Institute.
The novelty of this study is the dynamic panel data approach, which distin-
guishes it from typical static study designs. The remainder of the paper is organized
as follows: the second section presents the gravity model applied in this...

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