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The EU-Turkey Customs Union and Greece: who is the loser?

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Abstract

The purpose of this paper is to first apply the theory of trade in vertically differentiated products in a Customs Union context and second to find out the effects of the Customs Union between the European Union and Turkey. This is done both at a theoretical and at an empirical level. Based on these assumptions, the theoretical analysis indicates that the benefits of admitting Turkey into the Customs Union will be unevenly spread between Germany and Greece. In particular, Germany will definitely benefit, whereas Greece may suffer losses. In the empirical part of the paper, it is examined whether the predictions emanating from the theoretical analysis find any empirical support. For this purpose, the behavior of Greek and Turkish exports to the European Union is examined using desegregated data. The evidence is supportive of the theoretical predictions. (JEL F15, 050)

Introduction

Turkey signed its Association Agreement with the European Community (EC) in 1963. The Additional Protocol, which came into force in 1973, designed all details dealing with the Customs Union (CU) and all related subjects of the Association under consideration. The CU between the European Union (EU) and Turkey took place in 1996. However, EC member-states have been gradually abolishing tariff and non-tariff barriers against Turkish imports since 1973. Consequently, during the decade of the 1980s when Greece became full member-state, most Turkish exports circulated freely in the EC.

The purpose of this paper is to first apply the theory of trade in vertically differentiated products in a CU context and second, to inquire within the context as to the effects of the recent CU between the EU and Turkey. This is done both at a theoretical and at an empirical level. The theory of CUs and Free Trade Areas (FTA) has been mainly preoccupied with trade in homogeneous products. The only exceptions to this trend are papers which deal with trade in horizontally differentiated products (see, for example, Levy [1997]).

This paper concentrates on trade in vertically (according to quality) differentiated products. A distinguishing characteristic of such products is that (household) income determines the quality of goods demanded. Linder [1961] was the first to draw a sharp distinction between trade in primary goods and trade in manufacturing products. For the latter, he argued that the principal determinant of the distribution of demand between high and low quality varieties would be the level of per-capita income. Households with high incomes would not only consume more cars, for example, but also high quality cars. Flam and Helpman [1987] have formalized Linder's idea in the context of a North-South model. (1) This study draws on their specification of technology and preferences in order to build a simple model which examines the effects of a CU between an already existing CU (consisting of two countries) and a third country.

The paper identifies the two countries of the pre-existing CU as Germany and Greece, and the third country as Turkey. It is assumed that Germany is the most technologically advanced country of the three countries, and that Turkey is the least technologically advanced. In terms of comparative advantage (CA), this assumption is translated into a definite pattern of vertical intra-industry trade: Germany has a CA in (and exports) high quality varieties of differentiated products, whereas Turkey has a CA in (and exports) low quality varieties (Greece, under this specification, will obviously have a CA in (and export) middle quality varieties). In tandem with this assumption regarding the technological capabilities of the three countries, it is assumed that Germany is the country with the highest per capita income, and Turkey is the country with the lowest. Based on these assumptions, the theoretical analysis which follows indicates that the benefits of admitting Turkey into the CU will be unevenly spread between Germany and Greece. In particular, Germany will definitely benefit, whereas Greece may suffer losses.

The empirical part of the paper inquires whether the predictions emanating from our theoretical...

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