The Single European Market and Trade Policy [1 ed.] 9781527502802, 9781443879026

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The Single European Market and Trade Policy

The Single European Market and Trade Policy Edited by

Angelo Santagostino

The Single European Market and Trade Policy Edited by Angelo Santagostino This book first published 2017 Cambridge Scholars Publishing Lady Stephenson Library, Newcastle upon Tyne, NE6 2PA, UK British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Copyright © 2017 by Angelo Santagostino and contributors All rights for this book reserved. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner. ISBN (10): 1-4438-7902-9 ISBN (13): 978-1-4438-7902-6

CONTENTS

Preface ....................................................................................................... vii Muhsin Kar, Dean of the Faculty of Political Sciences at Ankara Yildirim Beyazit University Synopsis...................................................................................................... ix Acknowledgements ................................................................................... xii Contributors ............................................................................................... xii Introduction ................................................................................................. 1 The Single Market and Trade Policy: The Two Main Assets of the EU and the Price UK should Pay for Giving Them Up Angelo Santagostino, Ankara Yildirim Beyazit University Part I: The Single European Market Chapter One ............................................................................................... 22 The Single Market and its Contribution to Economic Growth in the European Union Ileana Tache, Transilvania University of Brashov Chapter Two .............................................................................................. 37 Determinants of the Geographic Concentration of Industry in the EU-28 Burçak Muge Tunaer Vural, Izmir Dokuz Eylul University Chapter Three ............................................................................................ 55 Building the Genuine Single Market for Services in the European Union Magdalena Katarzyna Kąkol, Maria Curie-Skáodowska University of Lublin Chapter Four ............................................................................................ 100 The Single Market for Services and the Case of Tourism Policy Ilkay Taú Gürsoy, Izmir Dokuz Eylul University

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Chapter Five ............................................................................................ 126 Free Movement of Labour and People: A Liberal View Angelo Santagostino, Ankara Yildirim Beyazit University Chapter Six .............................................................................................. 142 Network Industries in the European Single Market Kadir Develi, Ankara Yildirim Beyazit University, Koray Gokal, Ankara, Ankara Yildirim Beyazit University Chapter Seven.......................................................................................... 154 Poland and Turkey as the Successful Catching-up Countries and their Bilateral Trade (2000-2015) Bogumiáa Mucha-Leszko and Tomasz Biaáowąs, Maria Curie-Skáodowska University of Lublin Part II: The EU Trade Policy Part II.I Features of the EU Trade Policy Chapter Eight ........................................................................................... 186 The EU Trade Policy from Multilateralism to Bilateralism Sevil Acar, Istanbul Kemerburgaz University, Mahmut Tekçe, Istanbul Marmara University Chapter Nine............................................................................................ 197 Unilateralism in EU Trade Policy Ozge Taylan, Ankara Yildirim Beyazit University II.2 Regional Trade Agreements Chapter Ten ............................................................................................. 218 The Transatlantic Trade and Investment Partnership Ayca Karaca, Under-secretary of the Turkish Treasury Chapter Eleven ........................................................................................ 252 The Current and Future State of Turkey-EU Economic Relations Mahmut Tekçe, Istanbul Marmara University

PREFACE

The Single European Market (SEM) and the Trade policy represent the very centre of the European Union. Without these two interrelated elements, the whole building would collapse. The European Monetary Union would not have any meaning without them. The SEM and Trade policy have been progressively developed since the entry into force of the Rome Treaty in 1958. They are now an articulated structure allowing the free circulation of productive factors within and outside the territory of the EU. It is a powerful engine for growth, to which the European citizens owe a large part of their well-being. Prosperity represents a pull factor for so many of the immigration flows to what is seen as a land of hope, as Europe is seen. It has not been easy to set up the SEM. This process started in 1958, reaching its first goal in 1969, with the establishment of the customs union (the elimination of tariff barriers). However, it took almost a quarter of a century, until 1993, to transform the customs union into a single market (the elimination of non-tariff barriers). Still today (2017), the SEM is an uncompleted construction. This is mainly in the case of services. A true SEM has not yet been built. This a quite serious stoppage, considering that services represent about 70% of the EU’s GDP. In the next years, the need to restore growth will call for incisive measures, by the EU institutions, to speed the completion of the SEM for services, especially as far as the digital market is concerned. Trade policy has been a quite successful tool, alongside the history of the EU. It has created an area open to international trade and foreign investments. After pursuing a multilateral approach to international trade, the EU has shifted, since the beginning of this century, to a more bilateral oriented policy. Today’s main challenges are the Transatlantic Trade and Investment Partnership and the modernization-reform of the customs union treaty with Turkey. However, the environment is not the most promising. Europe and its process of economic integration are living in difficult years. Growth is still low and fragile. Unemployment is still too high, despite some improvements. The migration issue is far from finding a lasting solution. The enlargement process is virtually blocked. Relations with Turkey are going through a problematic moment. Negotiations with the United Kingdom for Brexit appear to be long and hard. The far-right

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movement, claiming the dissolution of the EU, obfuscates the political horizon. Furthermore, both in Europe and in the United States protectionist tendencies are more and more considered as an instrument for restoring growth and for job creation. These tendencies are particularly dangerous for the EU as they affect the two main assets: the SEM and Trade Policy. Faced with this situation the European institutions (Parliament, Commission, and Council) have advanced some proposals for EU reform. It is the beginning of a debate, of an open-ended debate. Advances are expected and needed in fields such as common defence, migration policy and completion of economic and monetary union. It is however necessary that attention should not be diverted from the SEM and Trade Policy because an environment of growth and prosperity is the only one allowing for advances in political unity. Mushin Kar, Ankara, June 2017

SYNOPSIS

This book explores the space of the free circulation of goods, services and people. The purpose is to give the reader as wide as possible an insight into the working of the engine for growth. The introductory chapter wants to be a sort of guide for the reader, written with the purpose of facilitating the further exploration of the different constituting parts of the engine. This chapter contains an analysis of the possible consequences of Brexit. Actually, the main concern of the British government, after the vote of 23 June, is how to minimize the price of the UK’s withdrawal from the SEM and how to set up a new trade policy. Chapter one realizes an attentive overview of the main theoretical and empirical studies dedicated to the economic impact of the SEM, identifying its contribution to economic growth in different periods of EU evolution. The upgrading measures of the SEM taken in the years of the great recession are also analyzed relating to their ability for relaunching economic growth in the EU. Brexit is also considered on its impact on the SEM. Chapter two addresses the question of how the process of economic integration affected industrial location decisions within the EU. The existence and evolution of a core-periphery structure of the EU are investigated in its relationship to the dynamic integration process. An econometric estimation model is employed to analyse the determinants of industrial location and the evolution of concentration/dispersion patterns. The subsequent two chapters are dedicated to the single market for services, because of two reasons. The growing weight of the service sectors in the member states economies and the fact that it is not exaggerated to affirm that the SEM for services is unfinished. Therefore, chapter three argues that after over twenty years of formal functioning of the EU single market it is very fragmented as regards the service sectors and numerous barriers still exist between member states. The chapter, which among other issues assesses the degree of integration of the service sector within the SEM, identifies and analyses the major benefits of integration of the services and indicates the most important obstacles in attaining these potential gains. In chapter four, tourism is taken as a case to be analysed for services in the scope of the single market. The European

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Synopsis

Economic Community did not have a tourism policy at its inception. However, a tourism policy has incrementally been transferred to supranational. The Lisbon Treaty created a new legal basis devoted to tourism which gave the EU institutions the right to act especially when the competitiveness of undertakings in the tourism sector is at stake. Chapter five is dedicated to the free circulation of labour. It argues that liberal thought provides for a useful interpretation of labour mobility in the EU (of EU nationals) and of its interrelation with the free circulation of goods and services whose growth effect reduces the need to emigrate, acting as a sort of retaining factor. At the same time the growth of intraEU trade, the freedom of establishment and the creation of trans-border value chains have created new job opportunities for people with high skills and competencies. The quantitative diminution of flows has thus been accompanied by a qualitative upgrading of labour mobility. The analysis of the SEM is completed in chapter six, dedicated to the energy sector. The authors argue that it was not an easy decision for the member states to open their national markets to competition. Energy has been seen as a public good rather than private, and a political good and governments want to keep energy prices under their control. Finally, energy is a strategic good, so States want to improve their own energy supply security. Chapter seven examines issues related to both single market and trade policy. In a certain sense it is a bridge between the two parts of this book. The chapter compares GDP growth and stability in the economies of Poland and Turkey in 2000–2015 as well as their bilateral trade, under the customs union agreement. Results are that regional economic integration enables the speeding-up of the process of convergence with more developed countries. Chapter eight intends to shed light on the EU trade policy, which had swings between multilateralism and bilateralism, in parallel with global economic developments throughout the last decades. In addition, also discussed are the effects of the Great Recession on the development of multilateralism, the stance of the WTO, proliferation of bilateral trade agreements, and the trends in international trade. This chapter thus addresses two of the three dimensions of EU trade policy. The third one, unilateralism, is dealt with in chapter nine. The EU is a multilateral organization by its very nature, consequently tending to behave multilaterally, as a first approach. However, some external factors and the internal dynamics have affected this approach. Since external and internal dynamics have been intermingled and are equally important, the chapter

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explains the factors and dynamics which led the EU to develop specific unilateral instruments. Chapter ten is dedicated to the transatlantic partnership; specifically, to the Transatlantic Trade and Investment Partnership (TTIP). This is quite a debated and topical issue. The EU and the United States are each other’s main trading partners in goods and services and account for the largest bilateral relationship in the world. TTIP aims to achieve a further opening of both economies. This initiative has the long-term objectives of achieving sustainable growth and creating jobs by means of mutually eliminating regulatory barriers in a comprehensive way. Finally, chapter eleven addresses the EU-Turkey Customs Union. This chapter aims to explain the economic relations with Turkey and the situation of the Customs Union and discuss the possible scenarios for Turkey-EU relations with a focus on the changes in economic conditions, especially in the EU’s external trade policy in an international environment where the WTO’s Doha round is not proceeding.

ACKNOWLEDGEMENTS

This book is one of the research outputs of the project funded by the European Union: Erasmus+ Jean Monnet Project: “Building Bridges with Europe and with the World”, realized by the Jean Monnet Chair in European Economic Integration at the Faculty of Political Sciences (Department of Economics), of Ankara Yildirim Beyazit University, in the period 2014-2017. As editor and chair-holder I would like to thank the distinguished authors of this volume. In addition to their capability, they have also been great colleagues and friends, working hard to complete this work. I also wish to thank Sue Morecroft for her valuable proof-reading. It would not have been possible to finalise this book without the dedicated, timely, and always kind support of Camilla Harding and Victoria Carruthers at Cambridge Scholars Publishing. The views expressed in the twelve chapters reflect the perspectives and convictions of their respective authors. Angelo Santagostino Ankara Yildirim Beyazit University, June 2017

CONTRIBUTORS

Angelo Santagostino, ad personam Jean Monnet Chair in European Economic Integration at Ankara Yildirim Beyazit University. Ileana Tache, ad personam Jean Monnet Chair in European Economic Integration at Transilvania University of Brasov. Muge Tunaer Vural, Associate Professor of Economics, Izmir Dokuz Eylul University Magdalena Katarzyna Kąkol, Assistant professor of Economics at Maria Curie-Skáodowska University of Lublin. Ilkay Taú Gürsoy, Assistant professor of International Relations at Izmir Dokuz Eylul University Kadir Develi, Associate professor of Economics at Ankara Yildirim Beyazit University, Koray Gokal, Research assistant of Economics at Ankara Yildirim Beyazit University Bogumiáa Mucha-Leszko, Jean Monnet Chair in European Economic Integration Maria Curie-Skáodowska University of Lublin. Tomasz Biaáowąs, Assistant professor of Economics at Maria CurieSkáodowska University of Lublin Sevil Acar, Associate professor of Economics at Istanbul Kemerburgaz University. Mahmut Tekçe, Associate professor of Economics at Istanbul Marmara University. Özge Taylan, Research assistant of International Relations at Ankara Yildirim Beyazit University. Ayca Karaça, Officer at Undersecretary of Turkish Treasury, Ankara

INTRODUCTION THE SINGLE MARKET AND TRADE POLICY: THE TWO MAIN ASSETS OF THE EU AND THE PRICE UK SHOULD PAY FOR GIVING THEM UP ANGELO SANTAGOSTINO AD PERSONAM JEAN MONNET CHAIR IN EUROPEAN ECONOMIC INTEGRATION, ANKARA YILDIRIM BEYAZIT UNIVERSITY

Our internal market is Europe’s best asset in times of increasing globalisation It is anachronistic that the 21st century Europeans and Americans still impose duties on each other's products —Jean-Claude Juncker 2014

Introduction Europe has been severely hit by the Great Recession. Growth is sluggish and unemployment widespread. Restoring growth and improving employment are the priorities of the European Commission headed by Jean-Claude Juncker. Pundits, commentators, scholars, and in primis politicians do not hesitate to indicate “austerity”1 as the prime responsibility for the lack of growth. Some of these, the so-called hard Eurosceptics, blame the euro too as a further ingredient of the economic stagnation of the EU and, more specifically, of the Euro area. Consequently, expansive fiscal policies are invoked, along with the dismantling of the monetary union. 1

Austerity should not be confused with the sound management of public finances. The first is a sharp reduction of public deficit and public debt, because of lavish fiscal policies. The second is a responsible policy aiming to maintain the budget balance close to equilibrium and public debt at a sustainable level.

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Introduction

The combination of expansive fiscal policies and the re-establishment of national monetary sovereignty should produce the effect of propelling growth and job creation. A quite improbable theory! The Single European Market (SEM) and the EU’s Common Trade Policy represent the best asset of the EU. Without these two core elements, the EU simply could not exist. As we read in the Commission’s president priorities: Our internal market is Europe’s best asset in times of increasing globalisation. I therefore want the next Commission to build on the strength of our single market and to fully exploit its potential in all its dimensions. We need to complete the internal market in products and services.

Completing the SEM implies offering more integration-induced opportunities to EU and foreign investors within the territory of the 27 member states (Brexit is already a reality) or, better, within the European Economic Area. Trade Policy, with its open stance (except for agriculture) is the EU’s second engine for growth. Despite the crisis, the SEM remained open. Protectionist tendencies were rejected. Moreover, new free trade agreements have been implemented, while others are under negotiation. The ones already implemented, such as the Customs Union with Turkey, have progressed although imperfections of the CU mechanism could generate undesired negative effects for the latter. The solution, however, is to perfect the Customs Union and possibly transform into a European Economic Area, waiting to have Turkey within the single market, not moving back to a free trade area, as some commentators are arguing. As Juncker stated: Under my presidency, the Commission will negotiate a reasonable and balanced trade agreement with the United States of America […] It is anachronistic that, in the 21st century, Europeans and Americans still impose customs duties on each other’s products.

It is surely anachronistic; however trade negotiations on the Transatlantic Trade and Investment Partnership (TTIP) have been suspended, due to the negative stance of some EU governments. Europe has thus downscaled the potentialities of commercial policy as an engine for growth. The theory of real economic integration, de-fragmentation of markets and creation of pro-competitive effects within an integrated economic area, has been widely proven. Empirical analysis has shown how much the

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SEM has fostered competition. Various “Single Market Reviews”2 and other documents published by the European Commission have reached the conclusion that the SEM is a powerful instrument to promote economic integration and to increase competition within the EU and that it has been the source of large macro-economic benefits. However, these gains could have been substantially larger if the removal of most of the remaining cross-border barriers had been achieved.

1. Supply side structural reforms for growth and employment In recent years policy makers and economists have long discussed Europe, on austerity versus flexibility in the management of public finances in relation to growth and employment. The EU has been criticized for having looked only to austerity and not to growth. The debate is well-known. The single market, as well as trade policy were blatantly excluded from the discussion (we should credit the Eurosceptic former United Kingdom premier David Cameron for being the only one to stress their importance), mentioned only sporadically by the European leaders of the “Continent”. As we have already mentioned the TTIP negotiations with the United States have been suspended. Forgetting these two assets is serious, because it means forgetting the two most powerful growth engines of the EU. It also means forgetting the structural reforms that the EU can implement, most of them being costless. This is a "forgetfulness" in which there is a lot of ideology, furthermore a very shortsighted selfishness on the part of the policy makers. For a government, it is much easier to summon the merits of a public investment program or income support and so on in terms of State interventionism, than those arising from an agenda implemented at European level for measures in favour of the single market or trade agreements. Their effects cannot be linked to economic policies as easily and directly as public interventions. Then the fact that the first does not work, or has only scant relief effects, is quite secondary. So, what is liberal is always poorly palatable for the politician because its emphasis is not on the State or on the governing class, but on the individual and his freedom of action. The politician does not see any reward when his action is the product of liberal measures. Liberalism, as we know, does not have a mystique, while there is a vast one in speaking out against the market, its alleged distortions, failures and 2

See: https://ec.europa.eu/growth/single-market_en.

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Introduction

incapacity of self-regulation. Speaking out against the “Europe of merchants” and “Europe of banks” makes much more cash (in terms of votes) than happens in speaking in favour of economic freedom. Without claiming to build a mystique to the market and trade, the deepening of the single market and of trade policy represents structural reforms equipped with powerful engines for the development of incomes and employment. Their implementation requires only the political will of the EU partners, without requiring any treaty reform or requesting the pooling of more doses of national sovereignties. In a global market economy, as this is the reality we face today, growth and employment are a function of business competitiveness, which is in turn dependent on the efficiency of the markets. Market efficiency, in turn, is a function of well-conceived economic policies aiming at promoting growth. It is time to see which policies the EU will be able to implement and perform in a more efficient way than its member states. It is the so-called principle of subsidiarity, according to which: Under the principle of subsidiarity, in areas which do not fall within its exclusive competence, the Union shall act only if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member states, either at central level or at regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level. (TEU, art. 5)

The theory of fiscal federalism gives two clear indications in this respect: the single market and trade policy. The first and the second are the mandatory tasks of Einaudi’s project for a European Federation.3 In the TFEU customs union and common trade policies are part of the Union’s exclusive competencies (art. 3), while the single market is a shared competence (art. 4).4

2. The Single European Market Between 1996 and 2012, several assessments of the performance of the single market have been carried out by the Commission and by scholars. As the Single Market Review of 1996, a series of studies promoted by the 3

Luigi Einaudi, “The economic problems of the European federation”, Edizioni di Capolago, Lugano 1944. 4 The single market is a shared competence because the EU’s Directives have to be adopted by member states through their own internal legislative procedures.

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Commission have indicated that the expected results of the Cecchini Report5 had been achieved. In particular: a) competition to the single market had led to reductions in prices and costs and the consequent expansion of production; b) the single market had experienced trade creation effects, but not those of trade diversion; c) price reductions had been manifested in high-tech sectors, but also in more traditional sectors such as food and electrical machinery; d) finally, a greater price convergence had taken place. The following is a brief summary of the economic evaluation of the single European Market. As we read in the 2007 Single Market Review:6 [T]he Internal Market is a powerful instrument to promote economic integration and to increase competition within the EU and it has been the source of large macro-economic benefits. However, these gains could have been substantially larger if the removal of most of the remaining crossborder barriers was achieved (page 1). In particular, the initial expectations that the Internal Market would serve as a catalyst for creating a more dynamic, innovative and competitive economy at the world level have not been met. Various reasons for this are identified, namely: the slow and sometimes incomplete implementation of directives, the inadequacy of some instruments, the persistence of barriers to cross-border trade and investment, particularly in services, and the slow development of an Internal Market for knowledge. Building on the evidence and analysis provided, the paper concludes with eight suggestions to guide the design of policymaking for the Internal Market in the 21st century. It is time to see what, in the years ahead, the EU should do to improve efficiency, i.e. its ability to induce European and foreign investment.

In the Commission’s Single Market Act II we find:7 A lot has been achieved: from 1992 to 2008 the Single Market has generated an extra 2.77 million jobs in the EU and an additional 2.13% in GDP. For European consumers the Single Market means more choice at lower prices––a 70% reduction in mobile phone costs is but one example. 5

http://aei.pitt.edu/3813/1/3813.pdf. Fabienne Ilzkovitz, Adriaan Dierx, Viktoria Kovacs and Nuno Sousa, Steps towards a deeper economic integration: the Internal Market in the 21st century. A contribution to the Single Market Review, Directorate-General for Economic and Financial Affairs, European Commission, Brussels, Economic Papers, N° 271 January 2007: http://ec.europa.eu/economy_finance/index_en.htm. 7 European Commission, Single Market Act II, p.4: http://ec.europa.eu/internal_market/smact/docs/single-market-act2_en.pdf. 6

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Introduction For citizens, the Single Market has given them the capacity to travel freely, to settle and work where they wish. For young people it has opened up the opportunity to study abroad––more than 2.5 million students have seized this opportunity in the last 25 years. For the 23 million companies in the EU the Single Market has opened access to 500 million consumers. The message is clear, the evidence is there: a strong, deep and integrated Single Market creates growth, generates jobs and offers opportunities for European citizens which were not there 20 years ago.

The single market is, therefore, the great asset created by European integration, and its most beautiful product. Without the single market, the single currency, as well as the Schengen system, would not make sense, even a programme like Erasmus would not work. In short, the EU would not be conceivable without the single market. Its value is given by the intra-EU flow of goods and services, plus the flow of investments between member states: in essence, the total value of trade and intra-EU investment. Graphic 0.1 shows these values. In 2007, the last year before the crisis, the size of the single market touched 4,123 billion, amounting to the sum of the GDPs of Germany and Italy, equal to 32% of EU GDP. In 2014, the value of the single market reached (the last year for which all data are available) the level of 4,200 billion euro. This value corresponds to the sum of the GDPs of Germany, Spain, Estonia, Latvia, Lithuania and Malta of the same year, equal to 32% of EU GDP. It is worthwhile to notice two more things. First, the value of the single market has already surpassed the pre-crisis level. Second, this result is due to the dynamic of services and goods, while intra-EU direct investments are still lagging behind. These trends reconfirm the central role of the single market as a factor of growth, especially as far as services are concerned. The centrality of the single market is reaffirmed in the conclusions of the European Council of 26-27 June 2014, first among five priorities:8 Therefore, the priorities we set for the Union for the next five years are to: x fully exploit the potential of the single market in all its dimensions: by completing the internal market in products and services; by completing the digital single market by 2015; x promote a climate of entrepreneurship and job creation […]; x invest and prepare our economies for the future: by addressing overdue investment needs in transport, energy and telecom infrastructure as

8

European Council 26/27 June 2014 Conclusions: http://data.consilium.europa.eu/doc/document/ST-79-2014-INIT/en/pdf.

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well as in energy efficiency, innovation and research, skills, education and innovation; […]; reinforce the global attractiveness of the Union as a place of production and investment […] and complete negotiations on international trade agreements, in a spirit of mutual and reciprocal benefit and transparency, including TTIP, by 2015; make the Economic and Monetary Union a more solid and resilient factor of stability and growth […].

x

x

Graphic 0.1. Single European Market (in million euros)

4500 4000 3500

Intra EU28 goods

3000 Intra EU28 services

2500 2000

Intra EU 28 Inv.

1500 Total Internal Market

1000 500 0 2003 2005 2007 2009 2011 2013 2015 Source: Eurostat

In these documents the single market has the place it deserves. However, in the priorities put on display by politicians this happens a lot less. As already pointed out the expression “single market” is almost entirely absent from the political language of many European leaders. Their greater benchmark remains public spending, public investment and especially the anti-rigor policies. Flexibility in public accounts is invoked as the tool having the greater impact to make the recession dry up.

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8

The road map to fully exploit the potential for growth is clearly identified in the above-mentioned Single Market Act II, identifying four pillars around which to develop a set of key actions:9 The four drivers for new growth put forward in this Communication are: 1. Developing fully integrated networks in the Single Market; 2. Fostering the mobility of citizens and businesses across borders; 3. Supporting the digital economy across Europe; 4. Strengthening social entrepreneurship, cohesion and consumer confidence.

For the purposes of this introductory chapter it is important to highlight the liberal character of the Single Market Act II, namely the conformity of its actions with the principles of a free market economy.10 1. Network industries introduce competition in traditionally protected sectors where enterprises are considered as national champions (champions in losing money in a liberal perspective). Network industries provide services that citizens use every day from transport to energy. The single market in transport and energy offers consumers a real choice, while operators are free to propose their services "anywhere, anytime and to any customer on an equal basis". Since its inception, the single market has triggered significant advancements in network industries such as transport and energy. However much still needs to be done, particularly in transports by rail and sea; in electricity and gas. Consumers and businesses still pay too many extra prices derived from fragmented and inefficient markets. Still too many “rent-seekers” (privileged State, or Stateprotected, operators) operating in these areas, penalize the consumers purchasing capacity and business competitiveness. The actions identified by the Commission to introduce or expand the competition are: x Open domestic rail passenger services to operators from another Member State to improve the quality and cost efficiency of rail passenger services; x Establish a true Single Market for maritime transport; x Accelerate the implementation of the Single European Sky; x Improve the implementation and enforcement of the third energy package and make cross-border markets that benefit consumers a reality; 9

European Commission (2012) p. 5. The quoted expressions in this paragraph refer to the Single Market Act II.

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2. The mobility of people and businesses is another key element of the single market: The Commission will continue to work towards its vision of a Single Market where citizens, workers and businesses are free to move crossborder whenever and wherever they want to and without unjustified restrictions imposed by divergent national rules and regulations. Mobility is a precondition for the Single Market to deliver on its potential, be it social, cultural, political or economic.

Here we provide some examples. The "business environment" is essential for the development of entrepreneurship. The carrot of profits and the stick of bankruptcy are indispensable ingredients of the market. More possibilities must be made available to the honest entrepreneur who had the courage to attempt an innovation that has subsequently failed. Unfortunately, in too many member states the legislation is less tolerant of the entrepreneur who has failed. Europe needs modern insolvency laws that help basically sound companies to survive, encourage entrepreneurs to take reasonable risks and permit creditors to lend on more favourable terms. A modern insolvency law allows entrepreneurs to get a second chance and ensures speedy procedures of high quality in the interest of both debtors and creditors.

The "business environment" can be improved through common procedures and rules in terms of taxation. As the Commission proposes, it is not the harmonization of rates, but the procedures and rules for the payment of VAT. Even today, the fact that each Member State applies different regulations implies extra costs for businesses, an unnecessary administrative burden that reduces competitiveness. 3. The Internet economy is increasingly crucial for economic development. The Internet, to provide an example, can increase by 10% the productivity of small and medium enterprises. Europe is seriously lagging behind its competitors in the exploitation of the potential of the Internet. McKinsey has elaborated an indicator to evaluate the capability of a single country in four fundamental aspects of the Internet: human capital, financial capital, and infrastructure and business environment. These reveal the European delay. The United States is at an altitude of 76, followed by Sweden at 67, but then the picture gets worse: United Kingdom 54, France and Germany 51, and Italy 31. This is a delay that the implementation of the actions foreseen by the Commission aims to fill.

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Introduction

These include the improvement of payment and delivery services and better access to high-speed broadband: A 10% increase in broadband penetration can result in a 1-1.5% increase in GDP annually and 1.5% labour productivity gains […]. Yet despite the progress made, the EU is still suffering from underinvestment in the deployment of high-speed broadband networks across the Single Market.

4. The social market economy is a liberal concept. The TEU (article 3) stipulates that the EU shall endeavour to establish “a highly competitive social market economy". In the Single Market Act II, the call to the social market economy is in consonance with the need for “market surveillance”, which is required in a single market where goods circulate freely between member states. Market surveillance does not mean intervention in the market. Rather it evokes the Einaudian concept of a Member State which lays down certain rules and then watches (the plumes of the “carabinieri” hats hovering in the market, in the famous example) their application. Market surveillance should enable unsafe or otherwise harmful products to be identified and kept or taken off the market and dishonest and criminal operators to be punished. It should also act as a powerful deterrent.

3. The Common Commercial Policy The Common Commercial Policy is the second major asset of the EU: free trade means economic development; it has never been as true as it is today. The general objective of an EU trade policy is to improve the terms of trade for European companies. In terms of foreign trade, the EU certainly continues to be affected by the original sin of the CAP. In agriculture protectionism still prevails. Graphic 0.2 shows the values of the external dimension of the EU and of its components: exports and imports of goods and services and foreign investment inflows and outflows. The performance of the total curve and that of the individual series reveal two realities. The first, a structural feature, is the huge external dimension of the EU: above 5000 billion euros. In terms of GDP it is roughly the sum of Germany and France in 2013. The second and most important indication is that the pre-crisis levels have not been only recovered, but exceeded.

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Graphic 0.2. External dimension of the EU (million euro)

6000 Exports goods 5000 Imports goods 4000 Services exports 3000

Services imports

2000

FDIs ouflows

1000

FDIs inflows

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

0

Total external dimension

Source: Eurostat

In the years of the Great Recession the EU economic open trade stance, a combination of multilateral, bilateral and unilateral dimensions, has represented a security net. In years when the domestic demand is particularly weak, foreign trade becomes the main source of growth. The contribution of external demand to economic growth is bound to increase in future, as 90% of global economic growth in the next 10-15 years is expected to be generated outside Europe, a third of it in China alone. To be sustainable, economic recovery will need to be consolidated through stronger links with the new centers of global growth.11

11

European Commission, Trade, Growth and Jobs, 2013: http://trade.ec.europa.eu/doclib/docs/2013/april/tradoc_151052.pdf. The quoted expressions in this paragraph refer to this document.

12

Introduction

The EU is a major exporter and importer in the world. It is also the largest foreign investor and the largest recipient of foreign investment from the rest of the world. It is in the typological variety of existing trade agreements and negotiations, where we find a mixture of innovation and innovation in tradition, that it is worthwhile highlighting. Firstly, the concept of the European Economic Area is innovative. Today the most significant example of the application of the EEA concept is Norway, Switzerland and Iceland. However, the EEA could turn out to be an interesting evolutionary possibility for the current relations between the EU and Turkey, a country with which a Customs Union Treaty has been enforced. The European Economic Area could be a viable instrument for other countries, too. The EEA is an instrument which offers a country the possibility of full market integration without all of the other tough requirements and obligations of membership. This is the advantage. The cost is that the partner country does not have a say in the decisions taken by the Council of the EU on the single market. It just has to accept them. We will come back to this point in the next section while discussing Brexit. The so-called "deep and comprehensive free trade agreements" are innovative in tradition, far beyond the traditional concept of the free trade area. DCFTAs go beyond business, to enter the political sphere, as well as culture and cooperation. The one with Ukraine in 2014 is the latest example. This is an innovation that does not have other examples in the world, being peculiar to the deep and wide process of integration of the EU: a process with an inbuilt capability to look beyond national interests. This point deserves a few more comments. The single market and the common commercial policy are two sides of the same coin. They could not exist separately. The one implies the other. The common commercial policy exists because of the existence of the single market. The two are mighty growth engines that must work in harmony. Furthermore, when faced with a crisis they can help each other. The progressive creation of the internal market and its subsequent enlargement to twenty-eight countries has allowed companies to develop a European chain of value. In manufacturing, the final product contains more and more intermediate inputs which are the results of imports from other member states, as well as from the rest of the world. There is no doubt that the single market has facilitated the formation of this European chain of value. The exports of a given member state contain value created in other member states,

The Single Market and Trade Policy

13

A German export very often incorporates value created in the Czech Republic, Belgium or Poland. The distribution of jobs created by exports reflects this. For every two jobs created in a Member State where exports are counted, one job is created elsewhere in the EU.12

As this is the context what guidelines in the short to medium and long term should the EU's trade policy follow? In general terms, it should continue the liberal orientation of its three dimensions, but especially the bilateral one. Trade liberalization is a powerful structural reform. This is because they create stronger ties between member states making their growth more sustainable and their economy more competitive and improving the quality of their domestic and exportable supply. Trade liberalization is a powerful vehicle for the diffusion of innovations, as it helps a country to find the most convenient productive specialization, thus enhancing its productivity. The in fieri agreement with the United States could lead to an economic gain for the EU of 120 billion euros annually once it is fully operational (2027), while the one with Japan would trigger a 0.34% increase of European GDP as well as advance trade negotiations with the other 16 partners, including Canada, Singapore, China (an agreement on investment), Malaysia, Thailand, Vietnam and Mercosur.

4. Brexit, SEM and Trade Policy The debate and concerns about Brexit focus around two main issues: the single market and trade policy. Graphic 0.3 allows us to perceive the relative position of the UK for extra EU-28 exports. The mirror image of this figure is the relative position of the UK within the single market. UK exports are more concentrated on the rest of the world than on the single market. Furthermore, this is an ascending trend. Actually this is a general trend in the EU which is shared by its biggest economies, but it is clearly more accentuated for the British economy. The shift from the single market towards the external markets is linked to two factors. The first is the “preference for bilateralism” which has more and more characterized the EU trade policy since the beginning of the new century; the second is the higher rate of growth of emerging market economies like China or India.

12

Vide supra.

Introduction

14

Graphic 0.3. Extra EU-28 Exports of goods as a percentage of total exports

60

50

40 EU-28 UK

30

DE FR

20

IT 10

0 2009

2010

2011

1012

2013

2014

2015

Source: Eurostat

As a consequence of Brexit, the UK will have to renegotiate all bilateral trade agreements in which it is presently participating as an EU Member State. This will be true for both implemented agreements and under negotiation agreements. It is sufficient to have a look at the list of EU agreements to understand the magnitude of this task. Below we provide a few examples.13 x Europe. A Customs Union Treaty has been in force with Turkey since 1995. Negotiations for a Deep and Comprehensive Free Trade Area (DCFTA) have been concluded with Ukraine (2012), Georgia (2014) and Moldova (2014);

13 The whole list of the EU bilateral agreements is available at: http://trade.ec.europa.eu/doclib/docs/2006/december/tradoc_118238.pdf .

The Single Market and Trade Policy

15

x North America. The Comprehensive Economic and Trade Agreement (CETA) with Canada was signed on 30 October 2016. The negotiating directives were obtained in April 2009; x Negotiations have been under way with the United States since 2013, while a Global Agreement with Mexico has been operating since 1997; x South America. The EU-Colombia/Peru FTA has been applied since August 2013. Negotiations with Ecuador were competed in July 2014 and officially re-launched with Mercosur in May 2010. An Association Agreement has been operating with Chile since 2005; x East Asia. Negotiations with Singapore and Malaysia were launched in 2010, with Vietnam in June 2012 and with Thailand in March 2013. Negotiations for an FTA with the Philippines were launched in December 2015. The corresponding negotiation directives were obtained in 2007; x Trade negotiations with Japan started in November 2012; x Negotiations with India for an ambitious and broad-based FTA were launched in June 2007. An FTA has been in operation with South Korea since 2011. Negotiations for an EU-China investment agreement were launched in November 2013; x Africa. The EU has established a network of Association Agreements which include reciprocal FTAs with eight countries of the region (all except Libya and Syria). Trade liberalization with South Africa was completed in 2012. In October 2016 five southern African countries: Botswana, Lesotho, Namibia, South Africa and Swaziland, started a new chapter in their bilateral relations with the EU with the entry into effect of their Economic Partnership Agreement (EPA). The charter at page 24 provides a general view of the state of EU trade agreements. In the optic of Brexit and the consequent need for the UK to negotiate new trade agreements it is worthwhile to underline two issues. First, we can consider the length of this process. Years of negotiation, roughly from five to ten, are generally needed to find an agreement for an FTA. There is no reason to think that this period could be shorter for the UK in respect of its experience of the EU. Although the time span will be shorter between the signing of the agreement and its entry into force, it is particularly long for the EU due to the fact that international agreements have to go through the ratification process of member states’ parliaments.

16

Introduction

In any case this time, however long or short it proves to be, there will be a cost to the UK in terms of GDP. Second, we can consider the terms of the agreements. In this respect the crucial question is: “will the UK have enough strength to obtain the same conditions that the EU has been able to negotiate?” It is an open question that we leave to the reader. We just notice that the EU is the biggest trading block and that will continue even after Brexit. As far as the conditions of the agreements are concerned, the differential in respect to the ones negotiated by the EU will represent the cost that the UK will have to bear. This second cost, unlike the first which is temporary, is a long term one, thus representing a permanent loss to the UK. We can however think of a third cost, not specifically affecting the EU or the UK, but addressing the effectiveness of bilateralism, consequently hampering the efficiency of the global economy. Presently (2017) the UK’s external economic dimension is the second largest in the EU. Its share in the total of the EU’s export and import of goods and services is around 13%. It will be a (new) big player in the international economic arena. The presence of such a big player will further complicate the “spaghetti bowl” of regional trade agreements. As a consequence, discriminations within world trade will rise; global growth could thus be negatively affected. The UK is the biggest recipient, within the EU, in terms of FDI inflows and stock, with amounts that are respectively just below 50 billion euros (10% of the total EU inflows) and 1.500 billion euros (19% of the total EU stock) in 2014. About 50% of the stock of FDIs in the UK comes from the EU, and one-third of all the acquisitions of UK companies by overseas buyers between 2010 and 2015 have involved EU purchasers. This attractiveness will be eroded by Brexit, at least for that share which is absolutely majoritarian of FDI inflows and stock linked to the SEM. The UK financial sector is doomed to suffer major harms, as it will lose passporting rights. Actually, under EU passporting rules, a firm located in the SEM has a right to set up branches or conduct cross-border business across the EU without the need for additional local authorization. UKbased firms are the most active in using them, accounting for about 75% of passporting activities in the EU. Brexit could cause the loss of passporting rights, determining a significant disturbance to UK-based firms and to their customers. The centrality of the SEM in the whole process of European integration is highlighted by the fact that the UK premier Theresa May, just after taking office in July 2016, expressed the wish to remain in the SEM, as far as goods, services and capital are concerned, but keeping the

The Single Market and Trade Policy

17

right to control the free movement of labour and people. The answer from the EU leaders was that the SEM is a whole and cherry picking is not conceivable. In other words, you cannot have the benefits and spare the costs. In an integrated entity all players have to share equal rights and obligations. No discriminatory power can be accorded to any one of its members. The UK will thus have to accept a different and less favourable type of trade agreement. However another, no less important point has to be raised: namely the pound and its relation to the euro. The UK has enjoyed the privilege of opting out, as part of the Maastricht Treaty, of the setting up the European Monetary Union. By not adopting the euro, the UK has kept the right to use the instrument of devaluation in order to increase the competitiveness of its products in the SEM. In this respect, since the implementation of the euro the UK has played the role of a free rider in the SEM, not paying the cost of the non-opportunity to devaluate its own currency, which is paid by the members of the euro area. The UK is the second economy of the EU. Its public finances are in no worse a condition than some members of the Eurozone, and until 2007-08 both the public deficit and debt fully respected the Maastricht criteria. The UK had everything, as far as the economic system is concerned, to join the euro. Opting out was the cost that the EU had to pay to get the green light for the Monetary Union. This exorbitant privilege has distorted the level playing field of the SEM, providing UK governance with an instrument–– the modification of the exchange rate––which no longer exists in the euro area. This is an undeserved advantage and an unjustified gift that the UK has not even been able to appreciate. It is worthwhile to notice that between November 2015 and October 2016 the pound lost 25% of its face value to the euro. Such a huge devaluation has provided UK firms with an artificial and competitive gain that has altered the functioning of the single market. One may object that, besides the UK, other member states have retained the possibility of devaluating their currency in the SEM. There is however a problem of relative dimensions for these economies. As already noted, the UK is the second largest economy in the EU, its GDP accounts for 18% of the EU-28’s GDP and 6% of the intra-EU-28 exports (2015), while the biggest of the non-euro economies, Denmark, is only marginally at 3% as far as GDP is concerned and at 1.7% for the intra-EU-28 exports. If the SEM can tolerate the variation of the exchange rates of small economies, this cannot be the case for economies as big as the UK. A final crucial question: what will replace the SEM? A good solution would be to act as if nothing had happened, thus restoring the situation prior to 1973 and the United Kingdom to the then EEC accession date. In practice, this would mean a return to the EFTA. In

18

Introduction

1960, just to counterbalance the promising Common European Market, the British promoted a free trade agreement with the Scandinavian countries, Austria, Switzerland and Portugal. They were the first to leave, followed by others who joined the EU with the 1995 enlargement. Now (2017), the EFTA member states are: Iceland, Norway, Switzerland and Liechtenstein. The EFTA has a great appeal for the British as it does not call for any form of pooling of sovereignty. Each Member State shall retain the right to conclude bilateral agreements with third countries, including the EU. Norway, for example, is part of the European Economic Area, corresponding to single market membership, although it does not have voting rights. The EFTA option is not only good but also relatively simple. The United Kingdom would negotiate its exit with the EU. While it is with the EFTA the new conditions will have to be agreed. These would be, in fact, those currently in force between the EFTA and the EU. Only in a subsequent moment and perhaps without a significant economic impact, could the UK negotiate a special agreement with the EU. Things, however, do not end here. A second and no less important advantage of the UK’s reappearance in the EFTA is linked with extra-EU trade. Actually the Association has a wide variety of free trade agreements with Canada, Mexico, Chile, Turkey, and Hong Kong, to name just a few. The UK could be spared long and exhausting negotiations that are not conducive to growth.

Conclusion The SEM and the trade policy are two faces of the same coin: the coin of European economic integration. This coin has been gradually minted since the very beginnings of a story which started in 1958, and is still unfinished. Better, it is a process which is always perfectible. Challenges are continuously emerging due to technological change and to geopolitical movements (e.g. the digital market and the energy market). In the past sixty years, we have witnessed, although with different intensities, a positive dynamic that has created more and more freedoms inside and outside the continuously enlarging dimensions of the EU. People, material or immaterial products or capital, in other words any type of productive factor, have circulated in an inner and outer space where hurdles have been gradually reduced. This freedom to circulate has allowed the impressive increase in general prosperity that we experienced in the EU in the first fifty years of its existence. Things have dramatically changed since 2007-08. Europe is still (2017) in the grip of low growth and too-high unemployment, while poverty rates are increasing. Therefore, the wind is no longer blowing in favour of

The Single Market and Trade Policy

19

freedoms, but in the direction of protectionism, nationalism and absolute sovereignty. This is a dangerous stream, when we look at history. Present problems cannot be solved by going back to fragmented markets and to inward-looking commercial and economic policies. Walls against people and products, competitive devaluations and similar measures have the inevitable effect of worsening international relations; they are the breeding ground of conflicts and wars. Despite the adverse present tide, political (from federalism to neofunctionalism) and economic (from real to monetary unions) integration theories, both backed by a huge amount of empirical evidence, indicate that a viable alternative to interconnected markets does not exist. The road is always the one traced by the founding fathers of these theories and by the constructors of European integration. It is worthwhile to thus conclude with the words of one of the most influential among these thinkers and politicians: Luigi Einaudi:14 I will repeat what I wrote thirty years ago, and repeated vainly many times. I hope that it will not be in vain after the terrible experiences we have lived through. The mirage of the absolute state is the enemy of civilisation and prosperity and we must also add now of the very essence of nations. This fatal myth is the true origin of wars. It causes nations to fight to conquer living space, it pronounced the excommunication of immigrants from poor countries, it created trade barriers and by impoverishing people, made them think that by returning to the predatory economics of the wild they could conquer wealth and power. In a Europe in which everywhere is seen a return to the obnoxious myths of nationalism, in which suddenly passionate calls to patriotism return, from those who only yesterday believed in internationalism, in this Europe in which there are frightening warlike tendencies, this Europe is crying out for unification. A task, I say not preaching. It is useless to preach peace and understanding when Hannibal is knocking at the gates, when in the souls of too many Europeans nationalism has set a light again. It is not sufficient to preach a United States of Europe and call congresses of politicians. What is important is that the Parliaments of these tiny states which make up a divided Europe, give up part of their sovereignty to a Parliament in which they are represented, a house elected directly by the united people of Europe, without a distinction between states, proportionate to the number of inhabitants; to a house of the States, represented according to the number of the individual states. This is the 14

“The War and European Unity” speech at the Constituent Assembly, 1947. Now reprinted in: Angelo Santagostino (ed.), “Luigi Einaudi, una visione liberale a guida della storia: gli Scritti Europei, il Commiato,” (Bari: Giuseppe Laterza Editore, 2011).

20

Introduction only idea which is worth working for, the only idea that is able to save the true independence of the people, which does not mean arms, trade barriers or limits to the railways and other national infrastructure. It is to be found in the schools, the arts, the habits, and the cultural institutions, all of which gives life to the spirit and shows how every people can contribute something to the spiritual life of others. However, we will never achieve this conquest of a rich variety of national life freely working within the framework of a unified European existence, unless one of the European races becomes its banner holder.

Bibliography Ilzkovitz, Fabienne, Adriaan Dierx, Viktoria Kovacs and Nuno Sousa. 2007. Steps towards a deeper economic integration: the Internal Market in the 21st century. A contribution to the Single Market Review. Directorate-General for Economic and Financial Affairs, European Commission, Brussels, Economic Papers, January, N° 271. Einaudi, Luigi. 1944. I problemi economici della federazione Europea, (“The economic problems of the European federation.”) Edizioni di Capolago, Lugano. —. 2011. “The war and European unity”, a speech at the Constituent Assembly, 1947. Now reprinted in Angelo Santagostino (ed.), Luigi Einaudi, una visione liberale a guida della storia: gli Scritti Europei, il Commiato. Giuseppe Laterza Editore, Bari. European Commission. 2012. “Single Market Act II Together for new growth”, Brussels. —. 2013. “Trade, Growth and Jobs Commission contribution to the European Council”. European Council. June 2014. “Conclusions.”

PART I: THE SINGLE EUROPEAN MARKET

CHAPTER ONE THE SINGLE MARKET AND ITS CONTRIBUTION TO ECONOMIC GROWTH IN THE EUROPEAN UNION ILEANA TACHE TRANSILVANIA UNIVERSITY OF BRASOV

Introduction The Single European Market (SEM) is one of the EU’s greatest achievements. It has not only fuelled economic growth and made the everyday life of citizens and European businesses easier, but it has also opened up opportunities for European companies to successfully expand on the global market. The genesis of the single market is presented in Box 1.1. Box 1.1: SEM genesis 1986: The EU adopted the SINGLE EUROPEAN ACT, clearing the way for several decisions to create the single market; 1986-1992: The EU adopted nearly 280 pieces of legislation in many areas; 12 sets of national regulations from the then 12 member states were replaced by one common European law, vastly reducing the complications and costs for businesses wishing to market a product throughout the Union. In other areas, the member states simply agreed to give each other’s laws and technical standards the same validity as their own (the “mutual recognition” principle); 1993: The Single Market became a reality for 12 EU countries: Belgium, Denmark, Germany, Ireland, Greece, Spain, France, Italy, Luxembourg, the Netherlands, Portugal and the United Kingdom.

The Single Market and its Contribution to Economic Growth in the EU

23

As the SEM was only ostensibly complete by the end of 1992 and thus remains a project in continuous creation, every year the European Commission prepares the Internal Market Scoreboard about the progress made by member states in implementing and applying SEM regulations. This chapter intends to give an attentive overview of the main theoretical and empirical studies dedicated to the economic impact of the SEM, identifying its contribution to economic growth in the different periods of the EU’s evolution, including the episode of the global economic and financial crisis. This is followed by an analysis of the most recent SEM upgrading measures which could relaunch economic growth in the EU. Some interesting conclusions are derived, not only about the indisputable and beneficial effects of the SEM, but especially its still noncapitalized potential.

1. The impact of the SEM on economic growth– –a literature overview Towards the end of the 1980s, the European Commission launched the Cecchini Report, a large-scale study intending to scientifically evaluate the future economic impact of the SEM. It was stated that this study provides the hard evidence, the confirmation of what those who are engaged in building Europe have always known: that the failure to achieve a single market has been costing European industry dearly in unnecessary costs and lost opportunities; that the completion of the internal market will provide the economic context for the regeneration of European industry in both goods and services; and that it will give a permanent boost to the prosperity of the people of Europe. (The Commission of the European Communities, 1988)

In 1988, it was estimated that the total potential economic gain to the Community would be ECU 200 billion or more––expressed in 1988 prices. Overall, this would have added about 4.5% to the Community’s GDP. The respective calculation included not only the savings made by removing the barriers which were directly affecting intra-EC trade but also the effects of removing barriers which were hindering new market entrants and thus the free play of competition. The Cecchini Report considered four main factors for the accomplishment of the SEM: the abolition of border controls, the opening-up of public procurement, the liberalization of financial services and the impact on the supply side. In table 1.1 we can identify each factor’s contribution to the total 4.5 per cent of economic growth.

Chapter One

24

Table 1.1: Medium-term consequences for the Community’s relative changes in per cent

GDP Consumer prices Jobs in 1,000 Public finances % GDP Net exports % GDP

Border controls

Public procurement

Financial services

1.5 -1.4

Impact on supply side 2.1 -2.3

0.4 -1.0

0.5 -1.4

200

Total

4.5 -6.1

350

400

850

1,800

0.2

0.3

1.1

0.6

2.2

0.2

0.1

0.3

0.4

1.0

Source: Emerson, 1988: 179

An even greater influence on the general economy was envisaged by the Cecchini Report if the completion of the internal market were to be accompanied by active economic policy measures such as public investment and the reduction of direct taxation. In that case, the GDP was forecast to increase by as much as 7.5 per cent in the medium term, and the creation of up to 5.7 million new jobs was anticipated (Cecchini, 1988). According to Baldwin (1989) who built on the new growth theories, the above gains estimated by the Cecchini Report were underestimated because only the static effects on productivity (that only occur once) were taken into consideration. The anticipated numbers in the Cecchini Report are too small because it only measures the 1992 one-time effects on productivity and output. It does not attempt to quantify the growth effects. Yet if the latter exist, they are likely to dwarf the one-time gains. Baldwin argues that even if 1992 has no permanent effect on European growth, it will bring a medium-run growth bonus. Higher productivity will improve the savings and investment climate in Europe. The resulting extrainvestment will provide a medium-run output effect that is proportional to the one-time efficiency gain. This effect is likely to be of the same order of magnitude as the one-time effects measured by the Cecchini Report. Baldwin concludes that, with scale economies, completing the internal market may also permanently increase Europe’s growth rate. Attempts to

The Single Market and its Contribution to Economic Growth in the EU

25

quantify this influence suggest that it could be the largest of all. In Baldwin’s opinion, the dynamic effects of the single market could generate an annual growth stimulus of 0.2-0.9% of GDP. So, the Cecchini Report, which has often been considered too optimistic, may even have underestimated the overall impact by at least 40%. The Cecchini Report unleashed a huge debate and even many controversies (see Grin, 2003, Chapter Five––The Cecchini Report and its Controversies), but it remains a thorough analysis of the gains expected because of the 1992 programme for unifying the European Community’s internal market. Most reports that try to quantify the actual effects of the SEM make much lower estimates than the influential Cecchini Report. For example, Harrison et al. (1994) quantified the direct effect of the single market at just 0.5% of EU GDP. Combined with the long-term effects, they considered 1.2% to be realistic. They also estimated the additional potential that could be generated by full integration and the elimination of all border and standardization costs. The countries identified as the biggest potential winners were those with a high intra-EU trade intensity (especially Belgium and the Netherlands), with economic growth potentially being stimulated by more than 6% of GDP. For countries like Germany, Italy and Spain these authors considered feasible a rate of 2% and for the UK only 1.5%. An analysis with interesting results belongs to Badinger (2005). He estimates the growth effect of the single market by comparing EU integration with an alternative scenario with GATT-only liberalizations. The single market implementation is modelled as a 5% additional reduction in trade costs between the EU countries (over their GATT commitments). Badinger’s analysis found that economic integration brought important temporary growth effects––if there had been no integration since 1950, the European GDP per capita would have been roughly 20% lower in 2000. Each integration step leads to an improved temporary growth performance that has accumulated to 7% additional growth as compared to the GATT-only scenario over time. The single market programme has indeed translated into significant economic impacts (see Box 2), including an obvious increase in GDP.

Chapter One

26

Box 1.2: The estimated impact of the single market programme x EU GDP in 2006 was 2.15% higher due to the single market (an increase of € 518 per head); x about 2.75 million more jobs have been created since 1992; x intra-EU trade relative to GDP rose 30% between 1995 and 2005; x price dispersion decreased––the coefficient of variation of comparative price levels of final consumption (including indirect taxes) across the EU-15 decreased from 20% in 1991 to 13% in 2005; x intra-EU cross-border investments increased (the share of foreign direct investment among the ex-EU-15 rose from 53% in 1995 to 78% in 2005); x more open and competitive public procurement has led to savings of 10 to 30%; x 73% of respondents consider the single market to have contributed positively to the range of goods and services on offer and 53% indicate that single market rules have increased consumer protection. Source: Wallace et al. (2010): 126.

The results presented in the box above are based on Ilzkovitz et al. (2007), who combine micro and macroeconomic analyses to present a deep assessment of the aggregate effects of the single market until 2006. The general emerging picture is that the single market has been successful in promoting integration and competition. Aussilloux et al. (2011), presenting the estimates of an extreme and stylized scenario of a complete elimination of all of the remaining barriers to trade inside the EU,1 point to very strong positive benefits for all EU member states. After 10 years of implementing a programme based on the removal of all barriers, hence taking into consideration some of the dynamic gains of economic integration, the EU’s national income could be 14% higher than under a no-change scenario (see table 1.2).

1

The elimination of all remaining obstacles to trade across Europe was simulated using the MIRAGE dynamic computable general equilibrium model developed by Decreux and Valin (2007).

The Single Market and its Contribution to Economic Growth in the EU

27

Table 1.2: Effect of full integration in the EU: change in national income in 2020 by area (%) Total EU 27 Benelux France Germany Italy Poland Spain Sweden UK Rest of the EU-27

14.1 25.3 11.6 11.5 13.6 10.8 9.5 10.2 7.1 27.9

Source: Aussilloux et al. (2011)

Vetter’s (2013) report shows that the single market has realistically increased GDP in the EU by some 2-3%. Exports and foreign direct investment have received a major boost. The dismantling of trade barriers has created cost advantages, intensified competition in the single market and made companies more performant in the global arena. The reduction of barriers to intra-EU trade has also made the EU countries more attractive for investment by foreign firms. In a study applied to countries that joined the EU in 1973, 1981, 1986, 1995 and 2004, and based on Abadie and Gardeazabal (2003), Campos et al. (2014) find that EU membership has spurred GDP growth by 12% on average, but the effects vary a lot between countries. Ireland is the EU-15 country with the highest pay-off from its EU membership (incomes in this country would be 43% lower at present had it not joined the EU). Other countries with large benefits that have resulted from joining the EU are Denmark, the UK, Portugal, Spain, Austria, Estonia, Latvia, Lithuania and Slovenia. Finland, Sweden, the Czech Republic, Poland and Slovakia had smaller but still positive effects. By contrast, the effect of Greece’s EU membership was negative. This could be explained by the fact that joining the common market in 1981 was too early and sudden for the relatively uncompetitive Greek industrial sector. In conclusion, the single market significantly contributed to the overall EU GDP, but with different effects for individual member states, depending on each country’s economic structure. We finish this short literature overview with the findings of Mariniello et al. (2015), who argue that identifying and quantifying the channels through which market integration is expected to engender economic

Chapter One

28

growth is methodologically complex. These authors conclude that the SEM’s positive impact has fallen short of initial expectations because: 1) Barriers continue to prevail in the EU, preventing the exploitation of the potential benefits of full market integration; 2) Complementary policies to support the single market were not, or were insufficiently, put in place; 3) The single market project has not sufficiently been framed as a key part of the process of Schumpeterian “creative destruction” (as explained by Baldwin and Wyplosz, 2012) that Europe needs to embrace to successfully modernize its economy. Table 1.3 presents a summary of the above discussed studies and the single market effects on growth in the EU. Table 1.3: Summary of studies and the main effects on economic growth in the European Union Study

GDP effect

Explanations

Cecchini et al. (1988)

4.25%-6.5%

Static effect

Baldwin (1989)

0.2%-0.9% addition to European Community long-term growth

Harrison et al. (1994)

1.2%

Badinger (2005)

7% additional growth as compared to the GATTonly scenario over time

Complements Cecchini’s static analysis with a dynamic approach Quantify the direct effect at just 0.5% of EU GDP, combined with long-term effects, they considered 1.2% to be realistic Estimates the SEM growth effect by comparing EU integration with an alternative scenario with GATT-only liberalization

The Single Market and its Contribution to Economic Growth in the EU

Ilzkovitz et al. (2007)

EU GDP in 2006: 2.15% higher due to the single market

Aussilloux et al. (2011)

With a complete elimination of all remaining barriers to trade, the EU’s national income could be, in 2020, 14% higher than under the no-change scenario The single market has increased GDP in the EU by some 2-3%

Vetter (2013)

Campos et al. (2014) Mariniello et al. (2015)

EU GDP per capita is 12% lower on average without EU integration Highlights methodological complications in quantifying the channels through which market integration is expected to engender economic growth.

29

This GDP increase represented € 518 per head, so a significant economic impact MIRAGE dynamic computable general equilibrium model

Explores SEM achievements, unfulfilled expectations and further potential. To the question “was the SEM successful?” the answer is affirmative, albeit not without some qualifications Synthetic counterfactual method Explains why the SEM’s positive impact has fallen short of initial expectations

2. The SEM confronted with the recent economic challenges While recognizing that the SEM brought enormous benefits for European citizens and businesses, the European Commission (2011) realized that the free movement of goods, services, capital and people has not always operated smoothly and that in some areas there is no truly integrated

Chapter One

30

European market as missing legislation, administrative barriers and a lack of enforcement leave the SEM’s full potential unexploited. Confidence in the single market was necessary to help stimulate economic growth in the EU. For these reasons, the European Commission adopted the Single Market Act––a series of measures to boost the European economy and create jobs. The Single Market Act presented by the European Commission in April 2011 sets out twelve levers to boost growth and strengthen confidence in the economy (see Box 1.3). Box 1.3: The twelve Single Market Act Key Action Proposals 1. 2. 3. 4.

A single market for venture capital; A modern system for the recognition of professional qualifications; Establishing a unitary patent system; Faster, easier and cheaper solutions to disputes between consumers and traders; 5. A more efficient European standardization system also covering services; 6. Reinforcing the single market’s energy and transport backbone; 7. Making the cross-border use of electronic identification, authentication and signature easier; 8. Introducing European Social Entrepreneurship Funds; 9. Energy taxation supporting environmental objectives; 10. Ensuring social cohesion; 11. Simpler accounting requirements for companies. Source: extracted from the European Commission (2011)

On October 2012 (the year that marked the SEM’s 20th anniversary), the European Commission proposed a second set of actions to further develop the single market and exploit its untapped potential as an engine for growth. Building upon the first Single Market Act, the European Commission (2012) identified four drivers around which to focus key actions towards “new growth”: 1. 2. 3. 4.

Developing fully integrated networks in the single market; Fostering the mobility of citizens and businesses across borders; Supporting the digital economy across Europe; Strengthening social entrepreneurship, cohesion and consumer confidence.

The Single Market and its Contribution to Economic Growth in the EU

31

The Single Market Acts I and II were intended to open new paths towards growth, employment and social cohesion in the EU. These initiatives showed the determination to create new growth through a common agenda, but they have been somehow downplayed by the economic crisis and so deserve reserved consideration. At present, a sluggish growth performance is being registered in the EU (see table 1.4). As Balcerowitz et al. (2013) state, the European economy has finally started growing again but the news to date is hardly a cause for celebration. Table 1.4 indicates: a) a modest level of economic growth, even though an increasing tendency appears (0.2% in 2013, 1.4% in 2014 and 1.9% in 2015); and b) large variations in GDP growth among EU countries (for example, in 2013, 4.3% in Luxembourg and -5.9% in Cyprus). The outlook for economic growth in 2016 is more feeble and uncertain following the sharp falls in the European equity markets, particularly of banking shares, since the start of the year. The extent of this setback to stock markets undermines consumer and business confidence, and is likely to drag down growth (The Economist, 18 February 2016). However, certain factors supporting growth are expected, such as low oil prices, favourable financing conditions and a low exchange rate for the euro. In 2016, the European economy is entering its fourth year of recovery and growth continues at a moderate rate, driven mainly by consumption. The global economic and financial crisis represented a severe test for EU economies and created immense social costs. Unemployment remains stubbornly high across Europe and low economic growth has affected people’s confidence in Europe. Unsatisfying levels of investment and barriers in goods and services markets have decreased productivity levels and the European economy’s competitiveness. Businesses often feel stifled by outdated and excessively burdensome regulations and are unable to find the information they need (European Commission, 2015a). The SEM is undoubtedly a victim of the economic crisis and the emerging protectionist reactions. On the background to the crisis, the eastern enlargement is not seen any longer as a win-win situation for both old and new member states. There are fears that the enlarged single market would threaten employment, especially in certain labour-intensive activities. The opposition to labour mobility is increasing with the crisis and the associated rise of unemployment.

Chapter One

32

Table 1.4: Real GDP growth in the EU Countries/period EU (28 countries) Belgium Bulgaria Czech Republic Denmark Germany Estonia Ireland Greece Spain France Croatia Italy Cyprus Latvia Lithuania Luxembourg Hungary Malta Netherlands Austria Poland Portugal Romania Slovenia Slovakia Finland Sweden United Kingdom

2013 0.2 0.0 1.3 -0.5 -0.2 0.3 1.6 1.4 -3.2p -1,7p 0.7 -1.1 -1.7 -5.9 3.0 3.5 4.3 1.9 4.1 -0.5p 0.3 1.3 -1.1 3.5 -1.1 1.4 -0.8 1.2 2.2

2014 1.4 1.3 1.5 2.0 1.3 1.6 2.9 5.2 0.7p 1.4p 0.2 -0.4 -0.3 -2.5p 2.4 3.0 4.1 3.7 3.7 1.0p 0.4 3.3 0.9e 3.0p 3.0 2.5 -0.7 2.3 2.9

2015 1.9 1.4 3.0 : 1.2 1.7 1.1 7.8 -0.2p 3.2p 1.2 1.6 0.8 1.6p 2.7 1.6 4.8 2.9 6.3 2.0p 0.9 3.6 1.5e 3.7p 2.9 3.6 0.5 4.1 2.3

Source of Data: extracted from Eurostat : = not available p = provisional e = estimated

In this context, a thorough upgrading of the SEM appears necessary. On 28 October 2015, the European Commission presented a new Single Market Strategy to deliver a deeper and fairer single market that will benefit growth in the EU. This strategy includes: An Investment Plan for

The Single Market and its Contribution to Economic Growth in the EU

33

Europe; the European Energy Union; the Digital Single Market Strategy; and the Capital Markets Union. The European Commission that came into office in 2014 launched its Investment Plan for Europe and the European Fund for Strategic Investments (EFSI). The Investment Plan focuses on removing obstacles to investment, providing visibility and technical assistance to investment projects and making smarter use of new and existing financial resources. To achieve these goals, the plan is active in three areas: a) mobilizing investments of at least €315 billion in three years; b) supporting investment in the real economy; and c) creating an investment friendly environment. This plan has already started to counter investment decline and drive economic recovery. The European Investment Bank (EIB) estimates that, by March 2016, the European Fund for Strategic Investments (EFSI) will have triggered around €76 billion of investment in Europe. The European Energy Union will ensure that Europe has secure, affordable and climate-friendly energy. Wiser energy use while fighting climate change is both a spur for new jobs and growth and an investment in Europe’s future (European Commission, 2015b). The state of the Energy Union shows the progress made since the Energy Union Framework Strategy was adopted to bring about the transition to a lowcarbon, secure and competitive economy. As Jacques Delors remarked (see Foreword in Andoura and Vinois, 2015), the EU currently implements common policies in key fields such as trade, agriculture and transportation, to name but a few. The EU has also created an economic and monetary union, a banking union regulated by the European Central Bank, and an area of free movement that is unique in the world. Why then, asked Jacques Delors, could energy not be promoted to this level, and take its logical and necessary place in the European project, in line with what European citizens have been demanding for several years now? The Internet and digital technologies are transforming our lives. But existing barriers online mean that citizens miss out on goods and services, Internet companies and start-ups have their horizons limited, and businesses and governments cannot entirely benefit from digital tools. In these conditions, it is the right time to make the EU’s single market fit for the digital age, tearing down regulatory walls and moving from 28 national markets to one. This could contribute €415 billion per year to the European economy and create hundreds of thousands of new jobs. The Capital Markets Union represents a key pillar of the Investment Plan of the new European Commission and it aims to tackle investment shortages by increasing and diversifying the funding sources for Europe’s

34

Chapter One

businesses and long-term projects. Alternative sources of finance, complementary to bank-financing––including capital markets, venture capital, crowd-funding and the asset management industry––are more widely used in other parts of the world and should play a bigger role in supplying financing to companies that struggle to get funding. All these measures of the Juncker Commission represent a very targeted approach. However, as Mariniello et al. (2015) remark, without comprehensive support from member states entailing not only the devolution of powers but also appropriate national redistribution policies, those initiatives are likely to face increasing political resistance, significantly affecting the chances that the single market will deliver the benefits expected of it since its inception. According to the same authors, at present, enthusiasm for the single market is relatively muted in some EU member states, especially among categories who view themselves as victims of globalization, which they often regard as synonymous with, or at least complementary to, European market integration.

Conclusion The SEM constitutes one of the cornerstones of European integration, a beneficial arrangement for all the 28 EU member states and the main driver for common economic growth, which helps the EU to survive the economic storms. The literature overview indicates the SEM’s beneficial impact on economic growth, but it is not as high as anticipated by the Cecchini Report. However, some conceived scenarios (the GATT-only scenario, the complete elimination of all barriers to trade, and no EU integration) undoubtedly confirm the huge capacity of the SEM as one avenue to boost EU growth. At the same time, it is difficult to compare the results of the various studies, considering that they were realized at different stages of European integration. There are also some methodological complications in quantifying the channels through which market integration is expected to create economic growth. The single market effects cannot be isolated from simultaneous developments, such as the economic and financial crisis or the consequences of globalization. The present sluggish growth rhythms are also attributable to global factors. Despite its prosperous past and great positive results, the single market still does not function perfectly and has not yet achieved its full potential. By completing and continuously upgrading the single market, the EU can

The Single Market and its Contribution to Economic Growth in the EU

35

helpfully contribute to economic growth prospects. The new Single Market Strategy adopted in October 2015 aims to deliver a deeper and fairer single market that will benefit growth in the EU. Any significant improvement of the SEM could change substantially the EU growth path for the years to come.

Bibliography Abadie, A., and J. Gardeazabal. 2003. “The Economic Costs of Conflict: A Case Study of the Basque Country”, American Economic Review 93: 113-132. Aussilloux, V., C. Emlinger, and L. Fontagné. 2011. “What benefits from completing the Single Market?” La Lettre du CEPII, Centre d’কtudes Prospectives et d’Informations Internationales, No. 316 15 December 2011. Balcerowicz, L., A. Rzonca, L. Kalina, and A. àeszek. 2013. Lisbon Council E-Book––Economic Growth in the European Union, Brussels. Baldwin, R. 1989. “The Growth Effects of 1992”, Economic Policy, October 1989, No. 9: 247-282. Baldwin, R., and C. Wyplosz. 2012. Economics of European Integration. New York: McGraw-Hill. Campos, N. F., F. Coricelli, and L. Moretti. 2014. “Economic Growth and Political Integration: Estimating the Benefits from Membership in the European Union using the Synthetic Counterfactuals Method,” IZA Discussion Paper No. 8162. Cecchini, P. 1988. The European Challenge. 1992: The Benefit of a Single Market. Aldershot. Commission of the European Communities. 1988. “Europe 1992––The Overall Challenge,” SEC (88) 524 final, Brussels, 13 April 1988. Decreux, Y., and H. Valin. 2007. “MIRAGE, Updated Version of the Model for Trade Policy Analysis: Focus on Agriculture and Dynamics”, CEPII Working Paper, No. 2007-15. Emerson, M. 1988. “Europas Zukunft–Binnenmarkt 1992. Eine Bewertung der möglichen wirtschaftlichen Auswirkungen der Vollendung des Europäischen Binnenmarktes, (Cecchini Bericht), Europäische Wirtschaft, 35. European Commission. 2011. Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions––Single Market Act: Twelve levers to boost growth and strengthen confidence. “Working together to create new jobs.” Brussels, COM (2011) 206/4.

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—. 2012. Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions––Single Market II: Together for new growth. Brussels, COM (2012) 0573 final. —. 2015a. Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions––Upgrading the Single Market: more opportunities for people and business. Brussels, 28.10.2015, COM (2015) 550 final. —. 2015b. Communication from the Commission––State of the Energy Union 2015. Brussels, 18.11.2015. Grin, G. 2003. The Battle of the Single European Market––Achievements and Economic Thought 1985-2000. London, New York, Bahrain: Kegan Paul. Harrison, G., T. Rutherford, and D. Tarr. 1994. “Product Standards, Imperfect Competition, and Completion of the Market in the European Union,” World Bank Policy Research Working Paper No. 1293. Ilzkovitz, E., A. Dierx, V. Kovacs, and N. Sousa. 2007. “Steps towards a Deeper Economic Integration: The Internal Market in the 21st Century”, European Economy, Economic Papers 271. Brussels: European Commission. Mariniello, M., A. Sapir, and A. Terzi. 2015. “The Long Road towards the European Single Market”, Bruegel Working Paper 2015/01, March 2015. The Economist. 2016. “Taking Europe’s pulse––the European economic guide,” 18 February. Vetter, S. 2013. The Single European Market 20 Years on––Achievements, unfulfilled expectations & further potential. Frankfurt am Main: Deutsche Bank Research. Wallace, H., M. A. Pollack, and A. R. Young, editors. 2010. Policy Making in the European Union. Oxford University Press.

CHAPTER TWO DETERMINANTS OF THE GEOGRAPHIC CONCENTRATION OF INDUSTRY IN THE EU-28 BURÇAK MUGE TUNAER VURAL DOKUZ EYLUL UNIVERSITY, IZMIR

Introduction Looking at the economic geography of the European Union, it is hard to assume there is equally distributed economic activity both in space and across the sectors. On the one hand the European manufacturing giants are located in Germany, Britain, France, and Italy. On the other hand, at the other end of the spectrum, countries such as Greece, Portugal, Slovenia, and Slovakia are known to hold the minor proportion of manufacturing production. The uneven spatial distribution of industrial activity has also been reflected in regional economic disparities, leading to the detection of core-periphery gradients. Since European cooperation involving 6 countries got underway in 1951, moves toward a closer integration turned into an economic and monetary union of 28 member countries by the year 2007. Along with several waves of enlargement, increased heterogeneity among the members of the EU raised concerns of economic disparities. Given the economic gap between the newcomers and the incumbents, the prosperity in the enlarged EU has become more dispersed than before. Furthermore, the geographic distribution of economic activity is likely to change as a result of economic integration. European economic integration can affect the geographical distribution of economic activity through different channels. Following the elimination of barriers to the free flow of products and factors, mechanisms of cumulative causation are supposed to produce self-reinforcing outcomes of centripetal and centrifugal forces. Backward-forward linkages, market size externalities, and technological spillovers are the centripetal forces that

38

Chapter Two

reinforce the agglomeration and concentration of economic activity. Centrifugal forces, on the other hand, are the opposing factors that are generally in the form of increases in the prices of immobile factors, such as agriculture. The centre-periphery structure is then a typical result of agglomeration from several possible outcomes (Brülhart, 1998). The standard core-periphery model, suggested by Krugman (1991), proposes that the international division of labour may reinforce a coreperiphery structure. While industrial agglomeration in core economies raises the income level together with industrial employment, the periphery lags behind with agricultural employment and lower income levels. The inherent endowment of factors of production, as well as gained competitive advantages, may be effective on the location of industry. The location of industry in turn, is effective on the development stages of local economies and their classification into core and periphery structures. Since the spatial distribution of economic activities also affects the geographical distribution of overall welfare, the question of whether economic integration brings out a new core-periphery structure becomes an important issue to address. This chapter addresses this question, and aims to investigate changes in the spatial distribution of economic activity in the enlarged EU. Section 1 attempts to clarify some theoretical links between trade liberalization and its possible effects on the location of economic activity. Section 2 presents some statistical evidence on the location of industrial activity in the EU. An econometric analysis is employed in section 3 to empirically investigate spatial concentration patterns and their determinants. The last section concludes with an overall summary and policy recommendations.

1. Liberalization of trade and the sectoral reallocation of resources Since Adam Smith defined the source of wealth as production, the geographical distribution of economic activity has mattered in the sense that it also determines the patterns of production and specialization, and therefore the distribution of wealth. The liberalization of trade commences a dynamic process of the spatial reallocation of economic resources. Mainstream theory suggests a specialization based production pattern for the trading partners, following trade liberalization. Locational patterns of production are thus supposed to be characterized by the degree of specialization, and the concentration of economic activity in a specific geography. The location of economic activity has been addressed by three

Determinants of the Geographic Concentration of Industry in the EU-28

39

theoretical approaches: (1) Neo-classical Theory, (2) New Trade Theory, and (3) New Economic Geography. The spatial distribution of economic activity has been attributed to the relative distribution of factor endowments across different geographies in standard theory of trade literature. Neo-classical theory is characterized by the assumptions of perfect competition. The location of production is determined by exogenous factors. In particular, these are termed as first nature factors by Krugman (1993), and refer to differences across countries in technology, natural endowments, and factors of production. These underlying differences among countries determine their comparative advantages and patterns of specialization. The domination of supply forces as the sole determinants of production leads to inter-industrial specialization patterns. Thus, the neo-classical theory of trade predicts that trade liberalization will induce industrial activity to be dispersed or concentrated according to the relative distribution of factor endowments. Models of new trade theory ignore the exogenous factors except for the size of the market. Market size is determined by the size of the labour force in a country, where labour is assumed to be immobile across countries. New trade theory also adopts a different approach by relaxing unrealistic assumptions of perfect competition thus allowing differentiated goods production, economies of scale, and imperfect competition. Krugman and Venables (1990) provided a rigorous formulation of these models, and explained their implications regarding the effects of economic integration on the location of economic activity. The model is based on a two-country two-sector setting, where two countries exhibit a different market access. There is assumed to be a core country with larger factor endowments than the peripheral smaller country, though both have the same relative endowments. As they have the same proportionality in terms of factor endowments, they are not supposed to have comparative advantages. However, the core country is characterized by better access to markets due to the absolute largeness of its factor endowments. In the case of high trade/transport costs, the location of production is driven by product market’s competition. If, for instance, the centre has more firms set up than its market size allows, then increased competition in product markets will force some firms to relocate in the periphery where fewer firms are established. However, when trade costs are low, the location of production is determined by competition in the factor markets. Under the immobility assumption of labour, firms tend to relocate in the periphery to take advantage of factor price differentials. Finally, when trade costs are neither too high nor too low, the tendency to locate in larger markets is stronger and the core-periphery division becomes evident.

40

Chapter Two

In new economic geography models, the location of production is determined by second nature factors. Second nature elements refer to the interaction between economic agents, as well as knowledge spillovers, economies of scale, product differentiation, and market size effects (Yrigoyen and García, 2010). The location of production becomes entirely endogenous and dependent on cumulative causation mechanisms. Building blocks of the model are increasing returns to scale, monopolistic competition, transport costs, and the existence of externalities. Krugman (1991) in his seminal paper developed a model of the geographical concentration of manufacturing that is based on the interaction of economies of scale with transportation costs. His analytical explanations suggested that with the existence of scale economies and lower transportation costs, manufacturing is concentrated in regions with a relatively large non-rural population leading to regional diversion in terms of a manufacturing core and an agricultural periphery. One of the most important implications of this conclusion would be that economic integration leading to a gradual decrease in transportation costs would create regional winners (core) and losers (periphery). In his model Krugman (1991) emphasizes the role of the mobility of skilled labour in generating agglomeration forces. Geographical proximity to larger markets enables the companies to sustain higher wages in these regions, which is an attractive force for further labour inflow. Whereas labour mobility increases both the production and consumption capacity in the region of inflow, a cumulative causation force of agglomeration comes into existence. However, the model may be considered to be highly restrictive in relying purely on labour mobility for the mechanism to work. Nevertheless, it provides insights for high levels of economic integration allowing labour mobility. Venables (1996) substitutes industrial linkages for labour mobility as an alternative explanation for agglomeration economies. Contrary to the Krugman model, Venables (1996) assumes factor immobility. Cost and demand linkages work to generate agglomeration with the existence of vertical linkages between monopolistically competitive upstream and downstream industries. Regions with a large manufacturing sector provide large markets with access to upstream industries in their intermediate goods supply to downstream industries (backward-demand-linkage). This, in turn, offers a cost advantage to downstream industries with better access to intermediate goods supplied by upstream industries in the same region (forward-cost-linkage). The process thus reinforces the concentration of economic activity in that region. The immobility of labour assumption makes the model applicable to the international as well as the interregional level.

Determinants of the Geographic Concentration of Industry in the EU-28

41

In a subsequent work Krugman and Venables (1995) analyzed the effect of globalization on real national incomes. Emphasizing multiple equilibria, they show that an initial decrease in transportation costs below some critical level will result in an industrialized core and a deindustrialized periphery. Backward and forward linkages working together will drive up the wages in the core region because of the higher demand for industrial labour and cause a divergence in real wages between the core and the periphery. However, as the world economy moves into a phase of closer integration leading to a further decline in transaction costs below a second critical level this is expected to outweigh the importance of forward and backward linkages. Because of labour immobility, wage differentials among regions together with continuing reductions in transportation costs will eventually lead to a reindustrialization of the low wage region (periphery). The process thus identifies a convergence of wage rates and economic structures eliminating the core and periphery distinction in further stages of economic integration and/or globalization. In a similar vein, Puga and Venables (1997) studied the effect of economic integration on regional disparities. They show that trade liberalization in the form of the FTA allows imperfectly competitive firms in the integrated countries to both export their output to and import their inputs from other member countries at lower trade barriers compared to firms outside the FTA. This gives rise to positive profits for firms located within the liberalized area and shifts the industry towards this area. The production shift is larger as input-output linkages are stronger. Thus, welfare accrues to the integrated regions at the expense of left-outs. Even though the integrated region benefits from trade liberalization as a whole, the benefits may not be evenly distributed among the member countries. During the intermediate stages of integration as trade barriers gradually fall below a critical level, markets with larger industry and expenditure become attractive locations. Thus, some regions of the FTA may gain production shifts at the expense of other regions leading to a divergence between the core and the periphery of the integrated area. However, a higher labour demand in the core region translates into higher wages compared to the periphery. As integration proceeds and the trade barriers continue to fall beyond another critical level, the location becomes increasingly sensitive to differences in production costs. Thus, the sustained wages differential between the core and the periphery due to labour immobility starts to attract industry back to the periphery. This conclusion supports the argument that any trade liberalization activity increases the welfare in member states and thus translates into a secondbest alternative for free world trade.

Chapter Two

42

2. Location of industrial production in the EU Earlier research shows that the division of labour has deepened, and specialization has increased between European member states in manufacturing production (Brülhart, 1998, 2001; Midelfart-Knarvik et al., 2000, Aiginger and Davies, 2004). Parallel to increased industrial specialization, Brülhart and Traeger (2005) detected core-periphery gradients in sectoral location patterns within the EU. The findings of this research, to a large extent, confirm the results from previous research. Table 2.1 shows the regional structure of European manufacturing, taking 20 member states into consideration. In the mid-1990s, 68.9 per cent of European manufacturing was located in France, Germany, Italy and Great Britain (countries accounting for nearly 60% of the European population). There has been a considerable decline in the share of these countries, reaching 62.9% by 2010. While the share of smaller European countries increased steadily by 3.6% the share of the 6 new member states nearly doubled. Table 2.1: Spatial Distribution of EU Manufacturing

Austria Belgium Czech Rep. Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Netherlands Poland Portugal Slovakia Slovenia Spain Sweden United Kingdom FRA+DEU+ITA+GBR

95-98 2.1% 3.5% 1.0% 1.4% 0.06% 1.7% 15.0% 25.3% 0.85% 0.71% 1.2% 15.9% 4.2% 1.9% 1.4% 0.45% 0.21% 7.1% 3.0% 12.7% 68.9%

99-02 2.1% 3.3% 1.2% 1.4% 0.09% 1.9% 14.8% 24.6% 0.88% 0.95% 1.8% 15.4% 4.1% 2.1% 1.3% 0.55% 0.28% 7.5% 3.1% 12.8% 67.6%

03-06 2.2% 3.3% 1.7% 1.3% 0.12% 1.8% 14.0% 24.8% 0.96% 1.2% 1.9% 15.4% 4.1% 2.5% 1.3% 0.74% 0.35% 8.3% 3.0% 10.9% 65.1%

07-10 2.5% 3.5% 2.3% 1.4% 0.13% 2.0% 12.9% 25.8% 1.1% 1.3% 2.0% 15.4% 4.5% 3.4% 1.2% 0.91% 0.38% 7.7% 2.9% 8.8% 62.9%

Determinants of the Geographic Concentration of Industry in the EU-28

AUT+BEL+DNK+FIN+IRL+ NLD+POL+PRT+ESP+SWE CZE+EST+GRC+HUN+ SVK+SVN GINI

43

27.5%

28.6%

29.7%

31.1%

3.28%

3.95%

5.07%

6.12%

0.624

0.606

0.590

0.573

Source: Own calculations from OECD STAN database Production data

In order to account for any concentration or dispersion trends, the Gini coefficient of concentration is also reported. A slight decrease in the Gini coefficient for overall manufacturing indicates a decrease in concentration. When we have a closer look at the Gini coefficient of concentration by individual industries, we acknowledge the decreasing concentration of individual industries throughout the selected time period. Table 2.2: Gini coefficient of concentration for individual industries Food products, beverages and tobacco Textiles, textile products, leather and footwear Wood and products of wood and cork Pulp, paper, paper products, printing and publishing Coke, refined petroleum products and nuclear fuel Chemicals and chemical products Rubber and plastic products Other non-metallic mineral products Basic metals Fabricated metal products, except machinery and equipment Machinery and equipment, n.e.c Office, accounting and computing machinery Electrical machinery and apparatus, n.e.c. Radio, television and communication equipment Medical, precision and optical instruments Motor vehicles, trailers and semi-trailers Other transport equipment Manufacturing n.e.c.; recycling

1995 0.58 0.67

2000 0.56 0.65

2005 0.55 0.65

2010 0.53 0.65

0.58 0.60

0.53 0.57

0.49 0.57

0.48 0.57

0.58

0.55

0.54

0.53

0.65 0.68 0.64 0.62 0.68

0.61 0.63 0.58 0.59 0.64

0.59 0.60 0.57 0.58 0.60

0.58 0.60 0.54 0.60 0.60

0.70 0.73

0.67 0.71

0.65 0.70

0.65 0.70

0.71 0.61

0.64 0.57

0.62 0.52

0.62 0.58

0.70 0.73 0.68 0.63

0.67 0.70 0.71 0.60

0.65 0.68 0.69 0.57

0.66 0.70 0.65 0.57

Source: Own calculations from OECD STAN database Production data for individual manufacturing industries

44

Chapter Two

When overall manufacturing is compared to the amelioration of the Gini coefficient by 5%, 6 industries display a faster decrease in concentration. These are wood and products of wood and cork; chemicals and chemical products; rubber and plastic products; other non-metallic mineral products; fabricated metal products, except machinery and equipment; and electrical machinery and apparatus, and n.e.c. The common characteristic of these industries is that they are associated with a low- or medium-skill intensity according to the classification by Midelfart-Knarvik et al. (2000). Among these industries, the highest decline in concentration is observed for electrical machinery and apparatus, and n.e.c. Production has moved from the largest producer––Germany––towards the new members of the European Union (the Czech Republic, Hungary, Poland, Slovakia and Slovenia). Germany lost her share in production by around 5% in chemicals and chemical products; rubber and plastic products; and other non-metallic mineral products and by 10% in fabricated metal products, except machinery and equipment. The Czech Republic, Estonia, Greece, Hungary, Ireland, Portugal, Slovakia, Slovenia, Spain, and Sweden increased their production shares in these industries. A high degree of concentration remains persistent for five industries: machinery and equipment, and n.e.c.; office, accounting and computing machinery; medical, precision and optical instruments; motor vehicles, trailers and semi-trailers; and other transport equipment. These industries, apart from motor vehicles, trailers and semi-trailers and other transport equipment, are characterized by high-skill intensity. More than 60% of motor vehicles, trailers and semi-trailers and other transport equipment are dominated by Germany, France, Italy and the UK. While France, Netherlands, and Italy in combination decreased their share by 6 percentage points, this production has been absorbed by Austria, the Czech Republic, Germany, Greece and Slovakia and has increased their shares in motor vehicles, trailers and semi-trailers. Results suggest that there have been de-concentration trends even in industries that have been detected as persistently concentrated by earlier research (Midelfart-Knarvik et al., 2000). This may partly be attributed to the aggregation of industries included in this study. However, findings also suggest that the enlargement of the EU by the early 2000s may also be the source of this trend. In order to detect further evidence on the determinants of industrial location in the EU the next section implements an econometric investigation on the issue.

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45

3. Empirical framework The analytical framework for this research is designed to test the relative importance of first and second nature elements. Recent empirical studies by Davis and Weinstein (1999, 2003), Ellison and Glaeser (1999), Midelfart-Knarvik et al. (2000), Wolf (2007), and Klein and Crafts (2012) distinguish between the implications of the Heckscher-Ohlin (H-O) and New Economic Geography (NEG) models. These models are not mutually exclusive; they present different implications for the choice of production location for firms. H-O theories predict that the industries that are intensive in the use of a factor of production will be located in places where the required factors of production are relatively abundant. On the other hand, NEG theories predict the greater impact of market potential on the location of production. Their methodological approach is based on the interaction of the characteristics of the production location and industries. Empirical methodology employed in this research follows earlier work, in particular, that of Midelfart-Knarvik et al. (2000). They present a model incorporating both comparative advantages and new economic geography effects by estimating a functional form that employs both H-O- and NEGtype interactions between country and industry characteristics. The model contains a number of countries and industries. Countries differ in terms of their many dimensions including their factor abundance, market potential, and technological characteristics. Industries also differ across many dimensions, such as their factor intensities, backward/forward linkages, and technological characteristics. These country- and industry-specific characteristics are predicted to interact with each other to determine the location of production. Thus, hypotheses about the location of economic activity are based on interactions between industry and country characteristics. These interactions are summarized in table 2.3. Table 2.3: Interaction Variables ௝

j=1 j=2 j=3

Country Characteristic (‫ݕ‬௜ ሻ AGRICULTURAL PROD. AS % of GDP UPPER SECONDARY AND HIGHER EDU. % POP. RESEARCHERS AND SCIENTISTS AS % OF LABOUR FORCE

Industry Characteristic (‫ ݔ‬௝ǡ௞ ሻ AGRIC. INPUT USE NON-MANUAL WORKERS RELATIVE TO MANUAL R&D SHARE IN VALUE ADDED

Chapter Two

46

j=4 j=5

MARKET POTENTIAL MARKET POTENTIAL

SALES TO INDUSTRY INTERMEDIATE INPUT USE

Interactions j=1, j=2, and j=3 are categorized as H-O-type interactions. These interactions predict that, industrial production is attracted to locations endowed with the factor intensively used by that industry. Interactions j=4 and j=5, on the other hand, define NEG-type interactions. These interactions capture the impact of forward and backward linkages on the location of production. Formally, the model can be written as follows: ௝

Ž൫‫ݏ‬௜௞ ൯ ൌ ܿ ൅ σ௝ ߚ ௝ ൫‫ݕ‬௜ െ

௝

൯ሺ‫ ݔ‬௝ǡ௞ െ ߯ ௝ ሻ ൅ ߝ௜௞

(1) ௝

where, ‫ݏ‬௜௞ is the share of industry ݇ in country ݅Ǣ‫ݕ‬௜ is the level of the ݆th country characteristic in country ݅; ‫ ݔ‬௝ǡ௞ is the industry ݇ value of the industry characteristic paired with the country characteristic ݆; ܿ is a constant and ߝ௜௞ is the error term. Finally, ߚ ௝ , ௝ and ߯ ௝ are the coefficients to be estimated. To understand the intuition behind this particular ௝ functional form, consider one characteristic: ݆ ൌ  ‫ݕ‬ሺܽ݃‫݁ݎݑݐ݈ݑܿ݅ݎ‬ሻ௜ . ‫ݔ‬ሺܽ݃‫݁ݎݑݐ݈ݑܿ݅ݎ‬ሻ௝ǡ௞ is the agricultural input intensity of industry ݇ and ௝ ‫ݕ‬ሺܽ݃‫݁ݎݑݐ݈ݑܿ݅ݎ‬ሻ௜ is the agricultural abundance of country ݅. Here, the existence of industry with agricultural input intensity, ߯ ௝ ǡ and the level of agricultural abundance in a country, ௝ , are assumed to be independent from each other. If ߚሺܽ݃‫݁ݎݑݐ݈ݑܿ݅ݎ‬ሻ ൐ Ͳ then industries with an agricultural input intensity that is greater than the reference level ߯ሺܽ݃‫݁ݎݑݐ݈ݑܿ݅ݎ‬ሻ will be attracted to countries with an agricultural abundance that is greater than the reference level ሺܽ݃‫݁ݎݑݐ݈ݑܿ݅ݎ‬ሻǤ Therefore, if agriculture is a significant determinant of the industrial location, a high value of ߚሺܽ݃‫݁ݎݑݐ݈ݑܿ݅ݎ‬ሻ must be detected. The specification tests the following hypotheses: H1: Industries that rely on agricultural inputs are located in countries with a high agricultural abundance. H2: High-tech industries, and sectors that require skilled labour, are located in technologically endowed geographies. H3: Industries with strong backward and forward linkages are attracted to locations closer to market demand.

Determinants of the Geographic Concentration of Industry in the EU-28

47

4. Results The regression equation specified for estimation in this research employs four country characteristics (agricultural abundance, the share of the upper secondary and higher educated population, the share of researchers and scientists in the labour force, and market potential), five industry characteristics (agricultural input intensity, intermediate input use––forward linkages, sales to industry––backward linkages, R&D intensity, and skilled labour intensity), a size variable, and country and industry dummies. The estimated equation can be expressed as follows: ݈݊ሺ‫ݏ‬௜௞ ሻ ൌ ߙ Žሺܵ‫ܻܴܷܱ݅ܶܰܥܰܫܦܧܶܣܥܱܮܩܰܫܴܷܶܥܣܨܷܰܣܯܷܧܮܣܱܶܶܨܱܧܴܣܪ‬ሻ ൅ ߚଵ ሺ   Ψ š   ሻ௜ǡ௞ ൅ ߚଶ ሺܷܲܲ‫  ܱܰܥܧܴܵܧ‬Ψ š െ  ሻ௜ǡ௞ ൅ ߚଷ ሺܴ‫ܵܶܵܫܶܰܧܫܥܵܦܰܣܴܵܧܪܥܴܣܧܵܧ‬Ψܱ‫ܴݔܧܥܴܱܨܴܷܱܤܣܮܨ‬Ƭ‫ܧܴܣܪܵܦ‬ ‫ܦܧܦܦܣܧܷܮܣܸܰܫ‬ሻ௜ǡ௞ ൅ ߚସ ሺ š ሻ௜ǡ௞ ൅ ߚହ ሺ š   ሻ௜ǡ௞ ൅ σ௜஌௜ ‫ ܻܴܷܱ݅ܶܰܥ‬൅ σ௞ణ௞ ‫ ܻܴܷ݇ܶܵܦܰܫ‬൅ ߝ௜ǡ௞ (2)

Estimation is undertaken for 20 EU member countries over the period 2000-2010. Equation (2) is estimated for the years 1995, 2000, 2005, and 2010 by OLS pooling across industries. The dependent variable is the fiveyear average of the industrial production share of country ݅ in the total output of industry ݇Ǥ The size variable is also calculated as five-year averages of the total manufacturing share of country ݅ in the EU. Timeinvariant industry characteristics are employed together with time-varying country characteristics. Detailed information on variables is provided in the Appendix. 18 individual industries are investigated which allows 360 observations. White's heteroscedastic consistent standard errors are reported for all hypothesis testing. The estimation results of the pooled OLS are reported in table 2.4. The first two rows give results for the constant and the size variable, the manufacturing share in total EU manufacturing. The next four rows display the estimated coefficients on country characteristics,‫ ݕ‬௝ Ǥ The next five rows provide the coefficients on industry characteristics, ‫ ݔ‬௝ . The estimated coefficients of country and industry characteristics are estimates of െߚ ௝ ‫ ݕ‬௝ and െߚ ௝ ‫ ݔ‬௝ , respectively, and they are expected to have negative signs. Finally, the next five rows give the coefficients for interaction

48

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variables, ‫ ݕ‬௝ ‫ ݔ‬௝ . These are the main variables of interest, and are estimates of ߚ ௝ , which are expected to be positive. The relative magnitude and statistical significance of the coefficients on interaction variables provide us with a measure of the sensitivity of industry location to the various factor endowments. The first three interaction variables are predicted by the Heckscher-Ohlin theory based on factor endowments, and the last two are predicted by NEG models. In terms of overall regression, the high value of ܴଶ indicates that the model is able to explain around 70% of all variation in locational production patterns by using five interactions. However, the decrease in ܴଶ may also indicate that there are some omitted explanatory variables becoming more important over time. The size variable appears statistically significant for all periods, indicating that the larger the manufacturing sector, the higher becomes the share of individual industries. Accordingly, individual industries are dominated by the largest economies of the EU: Germany, France, UK and Italy. Country and industry characteristics all have a negative sign, whereas all the interactions have a positive sign, as expected. A general overview of the estimation results in table 2.4 suggests that the H-O (factor endowment) interactions are stronger than the market potential interactions in explaining the location of production. Among the H-O interactions, R&D interaction is statistically significant for all subperiods, and increasing in strength through time. Similarly, skilled labour interaction becomes statistically significant and slightly increases in magnitude throughout the period. This reveals the increasing importance of a skilled labour force and R&D activity in attracting technology intensive industries. On the other hand, agriculture interaction is declining in strength and becomes statistically insignificant in 2010. Coefficients on NEG interactions remain insignificant except for sales to industry––backward linkages––in the year 1995. Even though statistically significant, a very low coefficient for sales to industry interaction in the year 1995 suggests that the location of industries with strong backward linkages has been highly insensitive to centrality/peripherality. Furthermore, the location of industries with strong backward or forward linkages can no longer be explained by their proximity to the market.

Determinants of the Geographic Concentration of Industry in the EU-28

49

Table 2.4: OLS Estimation Results Variable CONSTANT Size variables ln (manufacturing) Country Characteristics Market Potential Agriculture % GDP Secondary + education % of Labour Force R&D Personnel % of Labour Force Industry Characteristics Sales to industry % of output Intermediates % costs Agricultural Inputs % costs Non-manual to manual workers R&D % Value Added Interactions Market Potential * Sales to industry Market Potential * Intermediates % costs Agricultural %

1995 4.7196** (1.6608)

2000 -2.5385 (1.8531)

2005 1.1600 (2.9140)

2010 11.0063** (2.8089)

1.0516** (0.1011)

0.7554** (0.2668)

0.9248** (0.3226)

1.1083** (0.07471)

-0.1529 (0.8990) -0.0451 (0.0319) -0.0123 (0.0061)

-0.3792 (0.2722) -0.2520** (0.1152) -0.0222* (0.0135)

-0.2981 (0.2194) -0.1510 (0.1336) -0.0333* (0.0151)

-0.8801 (0.2132) -0.0853 (0.1249) -0.0356** (0.0148)

-0.0277 (0.0214)

-0.0176 (0.0349)

-0.0010) (0.0318)

-0.0030* (0.0247)

-0.1491 (0.1589) -0.2686* (0.1763)

-0.6855 (0.5713) -0.4478 (0.1588)

-0.0483 (0.5867) -0.2284 (0.3777)

-0.0420 (0.1467) -0.1426 (0.3811)

-0.0069 (0.0118) -0.3401 (0.0376) -0.0658** (0.0169)

-0.5048 (0.0353) -0.8626* (0.9315) -0.1289** (0.0341)

-0.6198 (0.2810) -0.2222** (0.1078) 0.0415* (0.0182)

-0.3448 (0.3816) -0.2388** (0.1088) -0.2035** (0.0496)

0.0925* (0.0136)

0.0558 (0.4310)

0.0961 (0.5093)

0.0168 (0.5201)

0.1749 (0.1481)

0.0063 (0.0257)

0.0409 (0.0322)

0.0891 (0.0301)

0.042*

0.0261**

0.0124*

0.0020

Chapter Two

50

GDP * Agricultural % costs Education * Non-manual to manual workers (skilled labour) R&D Personnel * R&D % Value Added Industry Dummy Country Dummy Diagnostics Adjusted ܴଶ Dependent Variable Number of observations

(0.0022)

(0.0859)

(0.0015)

(0.0039)

0.0294 (0.0557)

0.2998* (0.1236)

0.2311** (0.0863)

0.2620** (0.1120)

0.0655** (0.0018)

0.0404** (0.0116)

0.4210** (0.0180)

0.8915** (0.0138)

Yes Yes

Yes Yes

Yes Yes

Yes Yes

0.86 ݈݊ሺ‫ݏ‬௜௞ ሻ

0.78 ݈݊ሺ‫ݏ‬௜௞ ሻ

0.78 ݈݊ሺ‫ݏ‬௜௞ ሻ

0.68 ݈݊ሺ‫ݏ‬௜௞ ሻ

340

359

359

356

Conclusion While manufacturing industry in the EU has been dominated by the largest economies, Germany, France, UK and Italy, there has been a considerable decline in the concentration of production. Taking a closer look at the individual industries, we see that production has moved largely from these dominant producers towards the new members of the EU (the Czech Republic, Hungary, Poland, Slovakia, and Slovenia). The further dispersion of industrial production towards smaller countries and new members of the EU indicates amelioration in the core/periphery structure of Europe. An econometric analysis has been implemented in order to better understand the sources of this trend in the relocation of production in Europe after 2000. The empirical model used in this research incorporates both H-O (factor endowments) and NEG (market potential) forces to explain the industrial structure of the EU. Results indicate that a substantial proportion of the variation in industrial structure can be explained by these forces. However, results also suggest that there can be some omitted factors that become increasingly important over time. Evidence from this research strongly suggests that the factor endowments have been strong in explaining the location of industrial production. A skilled labour force and R&D activities, in particular, are

Determinants of the Geographic Concentration of Industry in the EU-28

51

found to be increasingly important over time to attract skilled labour and technology intensive industries. The findings of the research also reveal that there has been a loss in the importance of geography in explaining the distribution of production in manufacturing in the EU. This may be attributed to decreasing trade costs in Europe as a result of the enlarged single market of the EU. This confirms the predictions of Krugman and Venables (1995) regarding the phase of closer integration leading to a further decline in transaction costs below a second critical level that is expected to outweigh the importance of forward and backward linkages. Thus, economic integration and globalization render the promotion of R&D and the enlargement of a skilled labour force in order to attract high value added skills and technology intensive industries more and more important.

52

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Appendix: Description of Variables and Sources of Data 1. Dependent Variable: Manufacturing production data for country ݅, industry݇ሺ‫ݏ‬௜௞ ሻ. ‫ݏ‬௞ ݈݊ሺ‫ݏ‬௜௞ ሻ ൌ  ௜ ൘ σ௜ σ௞ ‫ݏ‬௜௞ Source: OECD STAN (Structural Analysis) database, national industrial data on the value of output, annual data. 2. Explanatory Variables 2.1. Industry Characteristics Agricultural Input Intensity: Use of agricultural inputs as a share of the value of production. Source: OECD STAN (Structural Analysis) database, INPUT-OUTPUT Tables, 2005. Skill Intensity: Share of non-manual workers in the workforce. Source: EUROSTAT Labour Input in Manufacturing. R&D Intensity: R&D Expenditures as a share of the gross value of output. Source: ANBERD (Analytical Business Enterprise Research), OECD. Forward Linkage: Total use of intermediates as a share of the gross value of output. Source: OECD STAN (Structural Analysis) database, INPUTOUTPUT Tables, 2005. Backward Linkage: Domestic sales to domestic manufacturing as a percentage of total sales. Source: OECD STAN (Structural Analysis) database, INPUTOUTPUT Tables, 2005. 2.2 Country Characteristics Market Potential: Internal Market Potential of country ݅ + External Market Potential of country ݅ with respect to partner ݉. ‫ܲܦܩ‬௜ Internal Market Potential: ൘ ඥ‫ܽ݁ݎܣ‬Ȁߨ ‫ܲܦܩ‬௠ ൗߜ ௜௠ ߜǣBilateral distance between capital cities of countries ݉ and ݅. Source: Gross Domestic Product data, World Bank Development Indicators. Agricultural Production: Gross value added of agriculture, forestry and fishery products as a percentage of all branches. Source: OECD. External Market Potential: σ௠

Determinants of the Geographic Concentration of Industry in the EU-28

53

Education of Population: Share of the population with upper secondary, post-secondary non-tertiary, first and second stage of tertiary education (levels 3-6) aged from 25 to 64. Source: EUROSTAT Researchers and Scientists: Researchers per 10,000 labour force. Source: OECD Science, Technology and Industry Scoreboard.

Bibliography Aiginger, K., and S. Davies. 2000. “Industrial Specialisation and Geographic Concentration: Two Sides of the Same Coin? Not for the European Union,” Journal of Applied Economics, 7 (2), 231-248. Brülhart, M. 1998. “Economic Geography, Industry Location, and Trade: The Evidence,” World Economy, 21 (6): 775-801. —. 2001. “Evolving Geographical Concentration of European Manufacturing Industries,” Review of World Economics, 137 (2): 215-243. Brülhart, M., and R. Traeger. 2005. “An Account of Geographic Concentration Patterns in Europe,” Regional Science and Urban Economics, 35 (6): 597-624. Combes, P-P., and H. G. Overman. 2004. “The Spatial Distribution of Economic Activities in the European Union.” In Handbook of Regional and Urban Economics, Edition 1, Volume 4, Chapter 64, edited by J. V. Henderson and J. F. Thisse, 2845-2909. Elsevier. Davis, R. D., and D. E. Weinstein. 1999. “Economic Geography and Regional Production Structure: An Empirical Investigation,” European Economic Review, 43: 379-407. Davis, R. D., and D. E. Weinstein. 2003. “Market Access, Economic Geography and Comparative Advantage: An Empirical Test,” Journal of International Economics, 59: 1-23. Ellison, G., and E. L. Glaeser. 1999. “The Geographic Concentration of Industry: Does Natural Advantage Explain Agglomeration?” American Economic Review Papers and Proceedings, 89: 311-316. Head, K., and T. Mayer. 2006. “Regional Wage and Employment Responses to Market Potential in the EU,” Regional Science and Urban Economics, 36: 573-594. Klein, A., and N. Crafts. 2012. “Making Sense of the Manufacturing Belt: Determinants of US Industrial Location, 1880-1920,” Journal of Economic Geography, 12 (4): 775-807. Krugman, P. 1991. “Increasing Returns and Economic Geography,” Journal of Political Economy, 99 (3): 483-499.

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—. 1993. “First Nature, Second Nature, Second Nature, and Metropolitan Location,” Journal of Regional Science, 33 (2): 129-144. Krugman, P., and A. J. Venables. 1990. “Integration and the Competitiveness of Peripheral Industry,” C.E.P.R. Discussion Papers, London. Krugman, P., and A. J. Venables. 1995. “Globalization and the Inequality of Nations,” Quarterly Journal of Economics, 110: 857-880. Midelfart-Knarvik, K. H., H. G. Overman, and A. J. Venables. 2000. “Comparative Advantage and Economic Geography: Estimating the Determinants of Industrial Location in the EU,” CEPR Discussion Paper No. 2618, London. Puga, D., and A. J. Venables. 1997. “Preferential Trading Arrangements and Industrial Location,” Journal of International Economics, 43: 347368. Venables, A. J. 1996. “Equilibrium Locations of Vertically Linked Industries,” International Economic Review, 37 (2), 341-360. Wolf, N. 2007. “Endowments vs. Market Potential: What Explains the Relocation after the Polish Reunification in 1918?” Explorations in Economic History, 44: 22-42. Yrigoyen, C. C., and A. M. L. García. 2010. “Evolution of the Influence of Geography on the Location of Production in Spain (1930-2005).” In Progress in Spatial Analysis edited by A. Páez, J. L. Gallo, R. N. Buliung and S. Dall’erba. Berlin Heidelberg: Springer-Verlag.

CHAPTER THREE BUILDING THE GENUINE SINGLE MARKET FOR SERVICES IN THE EUROPEAN UNION MAGDALENA KATARZYNA KĄKOL MARIA CURIE-SKàODOWSKA UNIVERSITY OF LUBLIN

Introduction The internal market for services is the area where the freedom of trade in services can be implemented on the basis of different internal market freedoms, and can take the form of a temporary or permanent presence of EU service providers in the markets of other member countries. In these cases, we deal with the taking advantage by economic entities of the freedom to provide services (Art. 56) and the freedom of establishment (Art. 49) enshrined in the Treaty on the Functioning of the European Union. However, if the service provider renders services under an employment contract he shall also be subject to treaty rules on the free movement of labour, and if the service is financial in nature, it is covered by the provisions on the free movement of capital. This interpenetration of various areas of the economy within the internal market for services means one can speak about the full integration of the services market no earlier than the stage of the common market which ensures the free movement of factors of production (Szypulewska-PorczyĔska, 2013: 73). Therefore, for many years, services have been on the sidelines of the integration of trade in goods and the process of creating the single market for services essentially began in the 1990s (together with or even after the completion of the European Single Market Project), and is still ongoing. Other difficulties in the liberalization process and the introduction of common rules into service sectors within the EEC/EU result from: the lack of tradability of some services, the existence of natural monopolies, the domination of state ownership in some service markets (especially those considered as strategic from an economic point of view or with a large

56

Chapter Three

share in overall employment) and the reference to a public service obligation to block their openness. There are many more market failures in the service sector than in the commodities market; hence it must be regulated (even after liberalization). However, the problem is not the mere existence of strict regulations (or overregulation) but the fact that they are extremely varied between member states which significantly reduce the potential benefits for businesses and consumers. The overall picture is even more complicated if we consider the coexistence of many legislators for different types of services and the patchwork of legislative regimes. Certain services are regulated at EU level, and other ones only by member states or simultaneously at EU and national levels. There are many sectorspecific regulations of a horizontal nature which function alongside the Service Directive, and very different methods of market integration including liberalization, harmonization and mutual recognition. Due to the special features of the services market its integration was ignored for decades and selective moves towards an internal services market were first made under the European Single Market Programme1992 for financial services and the six modes of transport (if we discount very restrictive forms of “mutual recognition” of diplomas in selected professional services introduced since the 1970s). However, many important service sectors were omitted from the White Paper or even envisaged but later dropped for various reasons, including the opposition of member states. This applies inter alia to telecommunications and the energy sector, the liberalization of which was delayed mainly as they were in public ownership (Bache et al., 2006: 419-421) (Kąkol, 2015c: 440), (Pelkmans, 2001: 119-120). Only since the 1990s has liberalization, EU policies as well as case law, begun to extend to further sectors: horizontal services (culminating in 2006 as the Services Directive), network industries (broadcasting, postal, gas and electricity, telecoms, and the networked air and rail transport sectors), and professional services. EU officials realized that more integrated services markets are crucial for the competitiveness of European industry. And with the arrival of the euro (1999), it became increasingly clear that shock absorption and permanent adjustment processes also depend on well-functioning services markets (Mustili et al., 2012: 3). However, despite many initiatives for the further opening of service sectors to competition from other member countries and for the deepening of integration via common laws and the broader use of mutual recognition, the process of building the genuine––not fragmented––EU internal market for services, which is not only internal in name, is still ongoing.

Building the Genuine Single Market for Services in the European Union

57

The aims of this chapter are: 1) to assess the degree of integration of the service sector within the internal market as compared to the goods sector on the basis of various market integration measures such as intraEU trade in relation to GDP or price convergence indices; 2) to identify the most and the least integrated areas of the single market for services in terms of sectors and forms of activity, and to assess the performance of member states; 3) to describe the main benefits deriving from the integration of the services market and to indicate the most important barriers that hamper the attainment of these potential gains; 4) to present the outcomes of selected empirical studies evaluating the impact of deepening the integration of the services market on the EU economy in terms of GDP, trade and investment; 5) to characterize the legislative regime of the internal market for services and the economic results of different methods of its integration; 6) to compare the heterogeneity and restrictiveness of regulations in service sectors among EU member countries, and between the EU, the US and OECD; and 7) to indicate the desirable action lines both for the EU and member states to indeed achieve a genuine internal market for services. The analysis is based mainly on Eurostat and OECD data. The evaluation of the state of integration of the EU services market was conducted within the following areas: regulation, cross-border trade in the internal market, intra-EU FDI flows and price convergence. The precious sources of knowledge proved to be the review of literature, empirical studies, reports of international organizations and EU documents concerning the subject.

1. Market integration in the service sector as an economic mechanism influencing the improvement in macroeconomic indicators within the EU–– a theoretical approach The deepening of the integration of the services market leads to increased intra-EU trade (through a better exploitation of the freedom to provide services across borders) and flows of foreign direct investment among member countries (through improved market access for foreign service companies from other EU countries because of the better use of the freedom of establishment). The elimination of barriers to the functioning of the internal market for services contributes to raised levels of competition, labour and capital productivity, employment, investment and GDP (fig. 3.1).

58

Chapter Three

Fig 3. 1. The impact of the completion of integration process within the internal market for services on the EU macroeconomic outcomes

Source: (Badinger et. al. 2008: 128).

Building the Genuine Single Market for Services in the European Union

59

The most important result of increased competition and trade is a rise in the productivity of production factors through (Frankel and Rose 1999): the use of economies of scale as a consequence of extending the size of the market, the deepening of international specialization according to the principle of comparative advantage and the spread of knowledge and technology in the common market. Frankel and Romer (1999: 394) estimated that an increase of 1 percentage point in the rate of foreign trade to GDP leads to a rise in per capita income by at least 0.5%, and a growth in the size of the domestic market by 1% means an increase in income of 0.1% or more. The rise in domestic and international trade is the result of a greater accumulation of capital and production for a given level of capital. Similar mechanisms occur in the case of foreign direct investments. There is a direct relationship between the inflow of investment and the productivity of the economy but it is unclear whether more FDI leads to more competition. However, if we assume that investments stimulate trade turnover they will also foster competition. More intense competition, in turn, increases productivity thanks to the lowering of prices to the level of marginal costs, which reduces distortions of the price mechanism, allows for a more efficient allocation of resources and the increased productivity of labour and capital (allocative efficiency). Competitive pressure reinforces incentives for managers to organize their businesses in a more efficient way and allows the growth in corporate profits because of increasing economies of scale, together with market enlargement (production efficiency). It can also contribute to the rise in dynamic efficiency through the creation of incentives for R&D and innovation, and thus stimulate technological progress and the growth of total factor productivity (Badinger et al., 2008: 129), (Mucha-Leszko, 2012: 19).

2. Significance of the service sector for the EU economy and potential benefits from full market integration In the EU, as in other developed economies, there have been structural changes involving a decline in the significance of industry and an increase in the share of services in GDP and total employment. Services accounted for 73.9% of the EU-28 total gross value added in 2015 (compared with 70.8% in 2001) and for 72.9% of the EU total employment in 2014 (compared with 66.1% in 2001) (tab. 3.1 and 3.2). Although market services represent over 50% of the EU gross value added in the last 15 years the importance of non-market services (including public administration, defence, education, and healthcare) has also increased (tab. 3.1).

60

Chapter Three

Table 3.1. Share of different sectors in the EU-28 gross value added in 2001, 2005 and 2009-2015 (in percent) and cumulated contribution of different sectors to the EU-28 real GDP growth (according to gross value added) in 2001-2015 (in percentage points)

Source: (Eurostat 2016) and own calculations

Building the Genuine Single Market for Services in the European Union

61

The service sector has also made the largest contribution to the growth of GDP and employment in the EU. In 2001-2015 its total contribution to the EU-28 real GDP growth amounted to 15.45 p.p. while that of manufacturing was 2.57 p.p. and of agriculture only 0.12 p.p. (tab. 3.1). In the analyzed period the following types of services had the greatest impact on GDP growth: wholesale and retail trade, transport, accommodation and food service activities (3.39 p.p.); information and communication (2.77 p.p.); business services (2.76 p.p.); public administration, defence, education, healthcare and social work activities (2.74 p.p.) and real estate activities (2.42 p.p.) The impact of services on job creation is relatively even greater, because it was the only sector of the EU-28 economy which positively affected the growth of employment in 2001-2014 with a total contribution amounting to 15.6 p.p. (tab. 3.2). Among the reasons for the growing importance of services when it comes to creating jobs one should mention their high labour intensity and typically lower labour productivity growth compared to other areas of the economy (Kąkol, 2015a: 113-114). According to the European Commission's estimates, the implementation of the Services Directive itself (at the barriers’ reduction level as at the end of 2011) contributed to an increase of 0.8% in the EU GDP. In a more ambitious scenario close to the abolishment of almost all restrictions, the additional gain could reach 1.8% of GDP, representing a total benefit from service market integration of 2.6% of GDP. The analysis also revealed a significant impact of the reduction of barriers on intra-EU trade (a rise of more than 7%) and internal FDI flows (by almost 4%), not including even further GDP growth over the longer term as a result of the anticipated increase in productivity (Monteagudo et al., 2012: 33-34). According to the Report of Copenhagen Economics (2012: 8-9) there are four main areas which impede the completion of the EU internal market: taxes, services, public procurement and mutual recognition (all closely interrelated). The better implementation and application of common market measures in the three key areas (taxes, services, and public procurement) might have generated an additional 2.4% of GDP, but one-third of this has been dampened because of the substandard implementation of EU legislation. In addition, in the area of mutual recognition there are potential economic gains of 1.8% of GDP (tab. 3.3).

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Chapter Three

Table 3.2. Share of different sectors in the EU-28 total employment in 2001-2014 (in percent) and their change in 2014 compared to 2001 (in thousands of persons and percentage points) as well as contribution of different sectors to the EU-28 employment growth (in percentage points)

Source: (Eurostat 2016) and own calculations

Building the Genuine Single Market for Services in the European Union

63

Table 3.3. Economic impact of better implementation and application by member states of the existing EU legislation concerning the internal market in terms of GDP Sector covered by legislation Taxation (1) Service sector (2) Public procurement (3) Mutual recognition (4) Total without mutual recognition

Expected gain as % of GDP 1.0 0.6 to 1.2 0.2 1.8 1.8 to 2.4

Potential not reaped as % of GDP -0.3* -0.2 to -0.4 -0.1* ? -0.6 to -0.8

Note: Due to the difficulties in estimating the potential not reaped from mutual recognition legislation, the expected gain from it is not included in the total. (1). Primarily VAT directive 2006/112/EC; (2). Primarily services directive 2006/123/EC; (3). Primarily procurement directive 2004/18/EC; (4) Primarily regulation 764/2008. Source: Copenhagen Economics (2012: 9)

The above calculations are confirmed by the European Parliament's report prepared in 2014. It points out that a more deeply integrated EU single market for services––comprising a fuller and more effective application of the Service Directive, further integration and deepening of the financial markets, investment in digital infrastructure, and net market integration in electricity and gas––could raise the level of long-run EU GDP by 2.6% to 5% (i.e. 338 to 637 billion euros) (Pataki, 2014: 8).

3. The legal tools to build the EU internal market for services: in search of the most effective method of regulation Different regulation methods are used in the process of building the single market for services, namely liberalization, harmonization and mutual recognition. Liberalization is a fundamental and primary tool for creating the internal market. It is based on the treaty arrangements concerning the cross-border provision of services as well as the freedom of establishment (Articles 56 and 49 TFEU). Liberalization aims at eliminating regulations hampering free trade in services and at introducing the ban against establishing new barriers. Harmonization, as in the case of liberalization, was envisaged in the Treaty of Rome when establishing the EEC. Currently, the legal basis for its application to the internal market is Art.

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114-118 TFEU. Harmonization relies on the approximation of the Member states' laws, regulations or administrative actions in order to replace national with European legislation. However, it has some disadvantages, like the long decision-making process or the necessity of being very detailed, which can quickly become outdated and possibly hinder innovation. Mutual recognition was introduced to EU law by the European Court of Justice in 1979 (the Cassis de Dijon judgement). It comes down to the acceptance of regulatory solutions that exist in other EU countries–– the headquarters of foreign-service providers, which require reliance on trust relationships. Mutual recognition complements harmonization or may be its alternative (Cini, 2007: 58-61), (Mousis, 2007: 89-92), (SzypulewskaPorczyĔska, 2013: 61-71). The approach to the methods of regulating the common market has changed together with the evolution of European integration, from the radical, recognizing the rightness of the universal elimination of barriers to a more moderate, more broadly accepting national autonomy in regulating and prohibiting discrimination (Szypulewska-PorczyĔska, 2013: 62). Initially, the predominant methods of market regulation were liberalization (however the section on services in the EEC Treaty contained no details on how, when and what should be liberalized) and the so-called "exhaustive harmonization" requiring great commitment of governments (Barcz et al., 2016: 150) (Pelkmans, 2001: 119). From the 1970s, and especially following the establishment of the principle of mutual recognition, the Commission as an alternative to detailed harmonization started to implement a more flexible regulatory strategy utilizing an approach based on a reference to standards, thereby transferring part of their duties and responsibilities to the private sector, mainly to the European standards bodies, such as CEN, CENELEC and ETSI (Cini, 2007: 59). In the Internal Market White Paper (1985) the Commission announced the new approach based on "minimum harmonization" which is to be limited to the so-called "essential requirements" when public health, safety, environmental and consumer protection are involved. The standards bodies have to define the technical specifications meeting the "essential requirements" indicated in EU directives, compliance with which will provide a presumption of conformity with these requirements. These specifications are referred to as harmonized standards. Their use is not obligatory but fulfilling them enables the placement of a product or service legally in the entire internal market. In matters not covered by harmonization the EU member states should accept each other's standards. The harmonization of technical standards is supposed to be supplemented

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by the broader use of the mutual recognition principle (El-Agraa, 2015: 103) (Bache and George, 2006: 409) (Geeroms et al., 2014: 74-75). This kind of harmonization is more convenient in the conditions of the emergence of new production technologies, ensures more flexibility for manufacturers and service providers and leads to lower production costs. The introduction of the ordinary legislative procedure for the adoption of EU measures within such harmonization in the Treaty of Lisbon (Art. 114 of TFEU) greatly facilitates the implementation of the internal market (Barcz et al., 2016: 151). However, Messerlin (2011) points to the shortcomings of the new approach that make it not much different from the old one: 1) the definition of "essential requirements" has to be negotiated between member states which takes much time and may reduce the scope of acceptable norms; and 2) the lax enforcement of conformity assessment and of market surveillance (before a product or service is placed in the market and after it). In order to solve these problems the Commission adopted "new legislative framework" in 2010 envisaging more harmonization in the EU policy on technical regulations. It provides for, among other things, the establishment of accreditation bodies (one per member state) to accredit the conformity assessment bodies (Geeroms et al., 2014: 75). Table 3.4 presents the comparison of legal tools to complete the internal market in terms of their economic outcomes for national economies and service providers as well as examples of their use in different service sectors. The cost-benefit effects for the national service providers resulting from the application of various methods to build the single market, may differ from the net economic impact on the national economies for which the best choice will be mutual recognition. If the offer of these service providers is directed mainly at the domestic market then for them mutual recognition could be inferior to harmonization (especially the voluntary harmonization, and in a country with a higher standard of services), and even liberalization (if it concerns non-discriminatory barriers) (SzypulewskaPorczyĔska, 2013: 72).

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Tab. 3.4. Comparison of the main instruments to build the internal market and their use in the selected service sectors Character of regulation

Liberalization

Discriminatory and nondiscriminatory provisions limiting access to the market

Harmonization

Nondiscriminatory provisions, including ones to reduce market failure

Mutual recognition

Nondiscriminatory provisions, including ones to reduce market failure

Economic results for service providers Benefits for domestic and foreign service providers in the case of nondiscriminatory barriers; Benefits for foreign service providers in the case of discriminatory barriers Costs on the side of foreign service providers from countries with a lower standard of services; Benefits for foreign service providers from countries with a higher standard of services Benefits for foreign service providers

Economic outcomes for national economies The balance of benefits depends on the size of the lost annuity in connection with the cessation of use of a country license fees

Examples of use in service sectors

The balance of benefits depends on the potential increase in prices of services in a domestic market as a result of harmonization

Road and water transport, financial services and only to a limited extent business services

Positive economic balance due to the consumption effect

Road and water transport, financial services and only to a limited extent: telecommunications, energy sector, postal and business services

Telecommunications, energy sector, road and water transport, postal, business and financial services

Source: Own elaboration based on: (Szypulewska-PorczyĔska 2013: 71-72 and 79)

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4. Legislative regime of the internal market for services Services in the EU are subject to various regulatory regimes. Non-economic services of general interest are excluded from the rules of the internal market; other services can be regulated in three ways using the horizontal method of regulation (the Services Directive), the sectorial method or regulation mainly on the basis of primary law. Therefore, we can distinguish three main groups of services in the internal market. A first, large category of services falls under the horizontal Services Directive 2006/123. Most of them are not too strictly regulated (except for some subsectors) and they are not covered by sectorial regimes at EU level (Mustilli & Pelkmans, 2012: 4). This group of services delivers more than 45% of EU GDP. They include, among others: business services, real estate, wholesale and retail distribution, construction, tourism and entertainment (Geeroms et al., 2014: 78, in Kąkol, 2015b: 83). The Directive was to facilitate the exercising of the freedom of establishment for service providers and the free movement of services in the internal market. However, regarding the free trade in services, it did not introduce the "country of origin" principle foreseen in the draft Directive of 2004 (i.e. the Bolkestein Directive). This principle was replaced by the principle of the freedom to provide services and control over the service provision was placed with the country of destination, though without the possibility of imposing discriminatory national requirements. In practice this has considerably reduced liberalization and the potential benefits that can be achieved from full market integration in the service sector. A very in-depth analysis of the consequences of resignation from the introduction of the "country of origin" principle was conducted by Santagostino (2012: 59-61, 73-74) who emphasizes that "the elimination of the Cop has introduced an element of asymmetry into the EU single market". The old member states' firms have been placed in the privileged position of being protected against competition from the newcomers while the new member states’ service enterprises have been disadvantaged because the removal of the Cop has eliminated their comparative advantage in terms of labour costs. A second category comprises four groups of service sectors that are EU-regulated to different degrees, namely: financial and transport services, network industries and professional services (which overlap to some extent with the regulated professions included in business services within the Services Directive). As emphasized by Mustilli and Pelkmans (2012: 4)

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Chapter Three a combination of EU diploma-recognition regimes and selective EU sector specific requirements (e.g. for auditing, etc.) has created a blend of EU and national regulation, now also influenced by the Services Directive (...).

The professions classified into the second group of services (in relation to which the Union has established the specific requirements) are: lawyers, accountants, architects, veterinarians, medical doctors, paramedical professions, pharmacists and the like. All the services included in the second category amount to around 20% of the EU GDP (Mustilli & Pelkmans, 2012: 4) (Kąkol, 2015b: 83). A third category covers certain activities of “special” services, which are hard to classify and are currently addressed at EU level in an ad hoc manner. They include temporary cross-border services provision, medical services to patients from other EU countries, gambling (where case law has grown but no EU rules exist as yet), taxis and ambulance services as well as private security services (Mustilli & Pelkmans, 2012: 5). The EU regulates some of these types of services either in the form of statutory law (usually directives) or in the form of case law (the EU courts' judgements) (Kąkol, 2015b: 83). It is worth taking a closer look at the regulated professions as legal solutions in this area have a significant impact on the extent to which the freedom of movement of workers within the internal market for services may be implemented. To overcome the problems associated with the limited access to some professions in other member countries the EU designed the Professional Qualifications Directive (2005/36/EC) consolidating fifteen earlier directives and containing the rules on the recognition of professional qualifications within three systems including different groups of workers. There are (Geeroms et al., 2014: 79), (European Commission, 2016a: 2) 1) an automatic recognition system for seven professions (architects, dentists, doctors, midwives, nurses, pharmacists and veterinary surgeons) where fulfilling minimal training requirements specified at the EU level authorizes member states to issue an appropriate diploma; 2) an automatic recognition system based on professional experience for professions belonging to craft, industry and trade; and 3) the general system for other professions requiring interested persons to apply to the competent authority in the EU country to which they are moving in order to have their qualification recognized and in the case of large differences in the length and content of training between the country of origin and the host country the latter may impose "compensation measures" on the applicant (an aptitude test or an adaptation period). The Professional Qualifications Directive was updated in 2013 (2013/55/EU) to make the recognition process easier. It introduced "the European Professional

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Card"––the first EU-wide digital certificate of professional qualifications that became available in January 2016 for general care nurses, physiotherapists, pharmacists, real estate agents and mountain guides (European Commission, 2016a: 6).

5. Heterogeneity and the restrictiveness of regulation, and the main barriers in the process of market integration It is primarily the heterogeneity of national service regulations, rather than their intensity or the mere fact that service markets are regulated by member states that hampers bilateral trade and investment within the EU. Service exporters are confronted with different regulations and qualification requirements in each destination country, and as a consequence have to incur the additional transaction costs if they decide to operate in another member state's market. These fixed and country-specific costs cannot be spread out over the entire production exported within the internal market; hence they hinder the realization of economies of scale by economic entities. They constitute a prohibitive barrier for entering export markets, in particular for small and medium-sized enterprises which are the majority of service providers in the EU (CBP, 2005: 3-5) (Kox et al., 2005: 20-21). Figure 3.2 illustrates the efficiency gains and cost effects for entities rendering services in the circumstances of a common regulation and its heterogeneity between member states when a service provider subsequently enters a number of EU export markets. The higher level of average costs in the situation of different national regulatory regimes affects the increased price levels of services, to the detriment of consumers and enterprises purchasing producer services. The other consequence is the restricted inflow of foreign-service providers with new products and innovative working methods which translates to fewer choices for consumers (CBP, 2005: 5). Therefore, the single legislative regime for the internal service market is most beneficial from the perspective of the entire EU economy. Kox et al. (2005: 25) emphasize that even if member states have various preferences for the level of regulation of service sectors, they might still work out a common architecture in service regulation and make more use of the mutual recognition of national provisions. In this way one can reduce the harmful outcomes of heterogeneity in regulation that acts as a trade barrier in the EU internal market.

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Fig. 3.2. Cost effect of regulation heterogeneity within the EU internal market (perspective of exporting firm)

Source: (Kox et.al. 2004: 21)

A set of indicators is used to assess the restrictiveness of national regulations that may restrict trade, investment and competition in the service market, including in particular those developed by the OECD such as: the Product Market Regulation (PMR) indicator, the Energy, Transport and Communication Regulation (ETCR) indicator, the Regulation in Professional Services indicators, the Regulation in Retail Trade indicator as well as the Service Trade Restrictions Index (STRI). Currently, the economy-wide PMR indicator mainly measures the restrictiveness of regulation in services markets in the following areas (Koske et al., 2015: 9-10) (Kąkol, 2015b: 83-84): 1) state control (including the scope and governance of state-owned enterprises, direct control over business enterprises, price controls or the government’s involvement in network sectors); 2) barriers to entrepreneurship (the complexity of procedures, the licences and permits system, administrative burdens for start-ups and legal barriers to entry); and 3) barriers to trade and investment (barriers to foreign direct investment and to trade facilitation, tariff barriers, and the differential treatment of foreign suppliers). The Energy, Transport and Communication Regulation (ETCR) indicator measures levels of openness to competition of seven network industries (electricity, gas, telecom, post, rail, air passenger transport, and road freight) and takes into account: entry regulation, public ownership,

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market structure, vertical integration, and price controls (Koske et al., 2015: 14). The other important sectorial indicators capturing the stance of anti-competitive regulation cover the four types of professional services (accounting, legal, engineering and architectural services) and the retail trade sector. The PMR, ECTR, and regulation in professional services and in retail trade indicators take values ranging from 0 to 6, where 0 means the total openness of the market and 6 means the most restrictive regulations resulting in the complete closure of the market to foreign competition. Assessing the restrictiveness of regulation in the European Union it must be stated that it has a slightly better situation than the average for OECD countries, and all the examined indicators presented in table 3.5 improved for the EU in 1998-2013 by at least one-third (in the case of the ECTR indicator it was even nearly 50%). It is difficult to compare the current openness of the European Union to competition with the US due to the lack of data. However, in 1998 and 2008, the United States was a much more competitive economy than the EU and this is also confirmed by sectorial indicators (tab. 3.5 and 3.6). Among the EU countries, the Netherlands has the most competitionfriendly regulatory environment, with the lowest overall score for the regulation of the total economy (0,92 in 2013). The Netherlands is followed by the United Kingdom, Austria, Denmark and Italy (with PMR indices from 1,08 to 1,26 in 2013). In terms of the lowest aggregate value of the ECTR indicator the first place belongs to the United Kingdom (0,79 in 2013) where state ownership is either small or non-existent in network sectors, such as electricity, gas and telecoms. Subsequent positions are taken by Germany, Austria, the Netherlands, Spain and Denmark. In one of the most important service sectors by the value added––retail trade––the following countries have the least restrictive regulations: Bulgaria, Latvia, Sweden, Slovenia, the Netherlands, Malta, Lithuania, Estonia, Finland and Ireland, i.e. these are mainly small economies. As regards the four categories of professional services it is easiest to provide them in Sweden, Finland, the United Kingdom, Denmark, Italy and the Netherlands. Taking into consideration all the indicators compiled in table 3.5 it is evident that there are a few countries which take the lead in almost all rankings. These are: the Netherlands, the United Kingdom and Denmark. Austria and Germany also have quite good positions according to the PMR and ECTR indicators while the Scandinavian and Baltic countries recorded the best indices in retail trade and in the regulated professions. The most overregulated economies in the EU in terms of the PMR and ECTR indices are: Croatia, Greece, Slovenia, Latvia and Cyprus as well as Romania and

Chapter Three

Austria Belgium Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Luxembourg Netherlands Poland Portugal Slovak Republic Slovenia

1,50 1,35 1,37 1,34 1,52 1,41 2,21 1,54 1,35 1,49 .. 1,44 0,96 2,04 1,69

1,62 1,89

2,64 1,66 .. 1,94 2,38 2,23 2,75 2,66 1,86 2,36 .. .. 1,82 3,19 2,59

.. ..

1,29 1,70

1,39 1,22 1,29 1,29 1,47 1,29 1,74 1,33 1,45 1,26 1,61 1,46 0,92 1,65 1,29 4,77 5,48

4,42 3,31 4,29 3,31 4,48 2,50 5,20 4,39 4,36 4,73 .. 4,10 3,39 4,71 4,63 2,28 3,41

2,45 1,70 2,60 2,61 2,77 1,33 3,13 1,87 2,49 2,45 .. 2,72 1,71 2,70 2,55 1,88 2,90

2,01 1,61 2,40 2,47 2,51 1,27 2,55 1,73 2,21 2,01 2,66 2,73 1,57 2,34 2,18

Aggregate ETCR

.. ..

0,93 3,00 .. 2,86 4,50 3,40 4,62 0,82 1,17 4,35 .. .. 1,67 3,12 3,46 1,04 0,90

1,23 1,83 1,40 2,89 3,80 2,88 3,85 1,44 1,53 4,06 .. 4,47 0,91 2,43 3,97 1,75 0,63

1,56 1,69 1,50 2,86 2,64 2,71 2,55 2,06 1,53 3,15 0,40 4,54 0,91 2,55 1,83 2,17 2,69

2,38 0,96 2,04 1,71 2,90 2,60 2,38 3,00 1,15 2,08 .. 3,23 2,13 3,40 3,17 2,79 2,15

2,10 0,19 1,04 0,00 3,25 2,75 2,58 2,46 0,19 1,96 2,06 3,35 0,00 2,83 3,00

2,83 1,96

1,71 0,00 1,04 0,00 0,00 1,69 2,58 1,92 0,19 1,96 2,06 3,35 0,00 2,83 1,65

3,79 3,46

3,27 2,15 3,02 0,77 3,23 3,56 4,48 4,83 3,48 2,40 4,29 3,96 2,79 3,90 3,88

2,90 2,57

2,37 0,83 1,79 0,62 2,35 2,65 3,01 3,05 1,25 2,10 2,80 3,47 1,23 3,24 2,93

Regulation in retail Regulation in professional services trade Accounting Architect Engineer Legal Average 1998 2008 2013 1998 2008 2013 1998 2008 2013 2013 2013 2013 2013 2013 2,12 1,37 1,19 3,91 1,84 1,55 4,07 3,30 2,40 2,38 2,42 2,42 3,63 2,71 2,30 1,52 1,39 3,61 2,08 1,84 4,65 4,56 4,06 3,23 2,35 0,00 4,31 2,47

PMR

Table 3.5. Restrictiveness of regulation in the EU and its member states, the US and OECD on the basis of PMR, aggregate ECTR, regulation in retail trade and in professional services indicators in 1998, 2008 and 2013

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Spain 2,39 1,59 1,44 3,69 1,65 1,59 4,20 3,48 2,88 2,83 Sweden 1,89 1,61 1,52 2,96 2,20 1,87 1,10 0,60 0,60 1,63 United Kingdom 1,32 1,21 1,08 1,89 0,98 0,79 3,38 2,18 1,79 1,75 Bulgaria .. .. 1,57 .. .. 2,45 .. .. 0,20 1,04 Croatia .. .. 2,08 .. .. 2,75 .. .. 1,42 2,65 Cyprus .. .. 1,65 .. .. 2,64 .. .. 1,67 2,90 Lithuania .. .. 1,52 .. .. 2,02 .. .. 1,11 1,00 Malta .. .. 1,57 .. .. 2,28 .. .. 1,09 1,33 Romania .. .. 1,69 .. .. 1,97 .. .. 1,80 2,60 EU-28* 2,24 1,52 1,44 4,01 2,26 2,10 3,02 2,51 1,92 2,27 United States 1,50 1,11 .. 1,98 1,65 .. .. 1,76 .. .. OECD average 2,21 1,77 1,62 3,74 2,31 2,13 2,70 2,22 1,98 2,31 Note: Index scale 0 to 6: from least to most restrictive. *In 1998 and 2008 the EU average usually for 21 countries or less due to the lack of data. Source: Own elaboration on the basis of OECD (2016a, 2016b, 2016c, 2016d).

1,75 0,00 0,00 .. 3,54 2,90 1,25 0,44 .. 1,46 .. 1,28

1,75 0,00 0,73 .. 3,54 2,94 1,29 1,25 .. 1,88 .. 1,60

Building the Genuine Single Market for Services in the European Union

0,79 3,96 5,08 3,71 3,88 3,60 4,00 3,36 .. 3,03

3,40 0,56 0,82 2,50 3,70 3,11 1,86 1,66 3,30 2,24 .. 2,06

2,43 0,55

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Aggregate ETCR By sector: Airlines 1,00 3,09 2,73 1,00 1,29 1,25 1,00 1,33 Telecoms 0,66 3,70 3,31 0,60 1,01 1,04 0,89 0,94 Electricity 2,00 4,78 4,59 1,56 2,37 2,61 2,05 2,40 Gas 1,43 4,73 4,45 1,54 2,65 2,78 2,26 2,36 Post 3,25 3,97 3,99 2,33 2,88 2,95 2,40 2,36 Rail 3,75 4,74 4,72 3,75 3,47 3,69 3,26 3,27 Road 1,75 2,96 2,42 0,75 2,18 1,94 2,14 2,09 By regulatory provision: Entry barriers 2,03 3,69 3,50 1,70 1,19 1,44 0,94 1,03 Public ownership 1,20 4,36 4,01 0,75 3,16 2,98 2,97 3,17 All but public ownership 2,21 3,84 3,67 2,04 1,87 2,06 1,58 1,64 Note: Index scale 0 to 6: from least to most restrictive; OECD average in 2013 does not include the US due to the lack of data. Source: (OECD 2016b)

US

1,80

1,18 2,95

1,03 0,93 2,47 2,53 2,55 3,53 1,94

1998 2008 2013 EU-21 OECD US EU-21 average OECD EU-21 average EU-28 average OECD average average average average 1,98 4,01 3,74 1,65 2,26 2,31 2,00 2,10 2,13

Table 3.6. The ECTR indicator by sector and regulatory provision in the EU, the US and OECD in 1998, 2008 and 2013

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Luxembourg, while those in retail trade and professional services are Belgium, Greece, and Luxembourg. A very high degree of regulation in professional services is also specific for Croatia, Hungary, Latvia and Romania, and in retail trade for Italy, Spain, Finland and Poland (tab. 3.5). Since the late 1990s the EU has significantly improved ECTR indicators and currently, the aggregate ECTR index is at a similar or even slightly lower level than the OECD average. Among the most liberalized network sectors in the EU are telecoms and airlines while the one that is least open is rail transport. There is also a large scope for improvement in electricity, gas and post, though the indicators concerning these service sectors are lower in the EU than the OECD average (tab. 3.6). The biggest obstacles to the full liberalization of network sectors in the EU are a high share of state ownership as well as insufficiently developed infrastructure. The next indicator used by the OECD––the Service Trade Restrictions Index (STRI) ––helps to identify which national policy instruments restrict trade. It measures the regulatory stance of countries and therefore overlaps to some extent with the PMR index. Nonetheless, there are important differences between the two indicators (Koske et al., 2015: 11). First, while the PMR aims at capturing regulations that limit productivity growth by constraining the activities of domestic or foreign firms, the STRI aims at capturing detailed at-the-border and behind-the-border restrictions that impede trade and that are relevant for foreign firms only. Second, while the STRI measures the most-favoured-nation (MFN) restrictions and, hence, does not take into account specific concessions such as for example, regional trade agreements or mutual recognition agreements, such specific concessions are taken into account in the PMR indicator. Third, while the PMR is an economy-wide indicator that covers a wide range of services and goods, the STRI includes service sectors only. The STRI takes into account various restrictions on trade in services including: barriers to competition, restrictions on foreign entry and the movement of people, other discriminatory measures as well as regulatory transparency. Currently it covers 22 service sectors. The index takes values from 0 to 1, where 0 is completely open and 1 is completely closed. However, a sector score above 0.1 means significant, and scores between 0.2 and 0.3 represent quite significant restrictions on international trade (OECD, 2014: 6).

Chapter Three

0,14 0,35 0,22

EU-22 US OECD

Source: OECD (2016e)

0,15 0,09 0,15 Courier

Logistics cargohandling 0,16 0,21 0,19 Motion pictures

EU-22 US OECD Sector

EU-22 US OECD Sector

Sector

0,11 0,11 0,12

0,21 0,29 0,24 Distribution

Logistics storage and warehouse 0,14 0,19 0,16 Broadcasting

0,15 0,08 0,15 Commercial banking 0,13 0,13 0,15

Logistics freight forwarding 0,10 0,17 0,13 Sound recording

0,15 0,22 0,16

0,14 0,13 0,18 Insurance

Logistics customs brokerage 0,12 0,21 0,17 Telecom

0,17 0,16 0,18

0,37 0,58 0,40 Computer

0,26 0,13 0,27 Air transport

Accounting

0,16 0,25 0,18

0,20 0,35 0,22 Construction

0,23 0,15 0,22 Maritime transport

Architecture

0,21 0,18 0,20 Road freight transport 0,15 0,11 0,14

Engineering

Table 3.7. The Services Trade Restrictiveness Index (STRI) in the EU-22, the US and the OECD in 2015

76

0,37 0,16 0,34 Rail freight transport 0,14 0,11 0,19

Legal

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The comparison of STRI values for the EU, the US and the OECD in 2015 (table 3.7) reveals that in the developed countries three sectors stand out as more restricted than others, on average: commercial establishments in air transport, legal services, and accounting services. Importantly, what these sectors have in common is that they provide significant inputs to and facilitate trade in other sectors, thus their liberalization could bring significant benefits not only to exporters, but also to local firms (OECD, 2014: 7). In the European Union the STRI values characterizing these three service markets are also the highest and range from 0,26 to 0,37. The least regulated service sectors in the internal market (with STRI values below 0,15) include: distribution, commercial banking, courier, telecom, certain logistics services and rail freight transport. The STRI is more favourable for the Union than for the United States in eight service sectors (all logistics services, air and maritime transport, broadcasting, courier, insurance and construction), less favourable in ten examined areas (including four regulated professions, motion pictures, sound recording, telecom, computer, and road and rail freight transport) and equal in two of them (distribution and commercial banking). Against the background of the OECD average the EU comes across far better than against the US as its STRI is inferior only in four sectors (three regulated professions and road freight transport). As regards the most important barriers to trade in various service sectors one should indicate the following (Kommerskollegium, 2016: 39) (OECD, 2014: 11): 1) foreign equity limitations that are most common in the backbone infrastructure sectors; 2) behind the border regulations related to licensing that constitute considerable barriers to trade in professional services; 3) access to the public procurement market which is particularly important for construction firms; 4) national treatment in relation to taxes and subsidies playing important role in all sectors, but especially in the transport and audio-visual service sectors; and finally 5) restrictions on the movement of natural persons which significantly hinder trade, particularly in skilled labour-intensive sectors such as computer services and professional services. The removal of barriers to FDI is of major importance for larger firms while the elimination of non-tariff barriers would more likely benefit SMSs (Hoorens, 2014).

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6. Integration of the services market related to cross-border trade In the single market for services the dominant activity is cross-border trade realized on the basis of the freedom to provide (or receive) services in an EU country other than the one where the company (or consumer) is established (art. 56 TFEU). The larger the intra-EU trade in the total of foreign trade, the more integrated is the internal market. Though trade in goods and services between the EU member countries accounts for over two-thirds of their total trade the situation in the service market is much worse compared to goods. Intra-EU trade in goods in relation to GDP (20,6% of nominal GDP in 2015) is three times higher than the same indicator for trade in services (6,4% of GDP). This difference has been almost constantly maintained for many years (except for 2009 when trade in goods collapsed due to the financial crisis and the following recession). Despite the slow, but still growing trend of intra-EU exports and imports of services as a percentage of GDP, the troublesome phenomenon is the decline in the trade of services between member countries in relation to the EU-28 total turnover of services in the long-run (notwithstanding the temporary improvement of indicators in some years). A similar tendency (though at slightly higher levels) is also characteristic for trade in goods (Kąkol, 2015c: 451). The share of intra-EU flows in the overall trade in services decreased from 60,2% to 57,3% in imports in 2004-2015 and from 58,4% to 54,4% in exports in 2004-2013, and then increased to 55,0% in 2015 (Kąkol, 2015b: 76), (tab. 3.8). The largest economies––Germany, France and the United Kingdom–– have the greatest significance in trade on the internal market for services although the good performance of some smaller countries is noteworthy, for instance Belgium, the Netherlands, Ireland and Luxembourg which have comparable or even slightly better results than the much bigger Italy. It is worthwhile noticing that the shares in intra-EU trade of some of these countries are higher for imports than for exports, indicating their relative openness to services from other member states. This regards Germany, France and Belgium where the shares in the intra-EU imports of services amounted to 17,0%, 14,1% and 8,0% in 2015 (while in exports 11,9% for the first two economies and 6,9% for the latter). Therefore, these countries are also characterized by a negative balance of exchange in services in the common market, and the largest deficit is that of Germany (32.663 million euros). At the same time, the largest surplus in trade on the internal market for services occurred in Spain, the United Kingdom, Luxembourg, Ireland and the Netherlands (tab. 3.9).

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Intra-EU imports in services in % of total EU service imports Extra-EU imports in services in % of total EU service imports Intra-EU exports and imports of services average in % of nominal GDP at current prices Intra-EU exports and imports of goods average in % of nominal GDP at current prices Note. Data does not include commercial services. Source: (Eurostat 2016) and own calculations

Intra-EU exports in services in % of total EU service exports Extra-EU exports in services in % of total EU service exports Intra-EU imports in services in million euro Extra-EU imports in services in million euro Intra+extra EU imports in services in million euro

Intra-EU exports in services in million euro Extra-EU exports in services in million euro Intra+extra EU exports in services in million euro 784 786,6 615 302,2 1 400 088,8 56,05 43,95 715 381,2 479 371,3 1 194 752,5 59,88 40,12 5,10 18,97

43,69 675 027,0 461 644,6 1 136 671,6 59,39 40,61 4,79 17,14

2011

733 823,5 569 466,7 1 303 290,2 56,31

2010

19,06

5,41

40,36

765 069,6 517 777,1 1 282 846,7 59,64

45,15

826 855,6 680 730,7 1 507 586,3 54,85

2012

19,07

5,62

40,66

793 904,5 544 064,6 1 337 969,1 59,34

45,60

858 535,6 719 640,9 1 578 176,5 54,40

2013

19,68

5,96

41,99

831 557,5 601 979,7 1 433 537,2 58,01

45,39

920 272,1 764 912,4 1 685 184,5 54,61

2014

20,58

6,39

42,73

885 227,9 660 482,8 1 545 710,7 57,27

44,98

992 361,0 811 230,9 1 803 591,9 55,02

2015

Table 3.8. Service trade value and share of intra- and extra-EU trade in total EU-28 trade in services in 20102015 in million euro and in % as well as averages of intra-EU exports and imports of services and of intra-EU exports and imports of goods in % of GDP

Building the Genuine Single Market for Services in the European Union

Chapter Three

Spain

Greece

Estonia Ireland

Germany

Bulgaria Czech Republic Denmark

Belgium

EU-28

992 361,0 68 531,0 4 508,9 14 361,4 24 816,7 118 095,0 3 617,6 64 203,0 17 619,0 63 051,0

IntraEU exports in services in mln euro

1 803 591,9 100 219,0 7 151,2 20 491,4 55 339,7 238 559,0 5 293,4 115 479,0 27 919,0 100 030,0

Intra+ extra EU exports of services in mln euro

63,03

63,11

68,34 55,60

49,50

44,84

63,05 70,09

68,38

55,02

Share of intraEU exports in total exports of services in %

33 938,0

885 227,9 70 829,0 2 893,2 12 289,5 26 311,6 150 758,0 2 777,8 51 818,0 6 791,0

IntraEU imports in services in mln euro

1 545 710,7 95 242,0 4 447,7 17 740,6 48 476,8 268 723,0 3 636,2 136 626,0 10 986,0 51 561,0

Intra+ extra EU imports of services in mln euro

65,82

61,82

76,39 37,93

56,10

54,28

65,05 69,27

74,37

57,27

Share of intraEU imports in total imports of services in %

-32 663,0 839,8 12 385,0 10 828,0 29 113,0

-1 494,9

1 615,7 2 071,8

107 133,0 -2 298,0

Balance in intraEU trade in services in mln euro

19 357,0

817,4 -33 532,0 6 105,0

2 499,0

8 357,8

1 087,8 678,9

150 748,1 7 275,0

Balance in extraEU trade in services in mln euro

6,08

10,03

17,86 25,10

3,89

9,32

9,96 8,60

16,70

6,75

IntraEU exports of services as % of GDP

3,27

3,87

13,72 20,26

4,97

9,88

6,39 7,36

17,26

6,02

IntraEU imports of services as % of GDP

4,68

6,95

15,79 22,68

4,43

9,60

8,17 7,98

16,98

Average of intraEU exports and imports of services as % of GDP 6,39

6,35

1,78

0,36 6,47

11,90

2,50

0,45 1,45

6,91

100,00

Share in intraEU exports of services in %

3,83

0,77

0,31 5,85

17,03

2,97

0,33 1,39

8,00

100,00

Share in intraEU imports of services in %

Table 3.9. Intra-EU28 trade in services by member countries in 2015 in million euro, in % of total trade in services and in % of nominal GDP (at current prices)

80

49 258,0 4 332,0 2 059,0 3 607,0 60 350,0 13 981,4 3 371,6 69 932,0 39 785,0 27 594,9 17 239,0 13 412,8 4 736,0 5 837,3 11 164,8 34 251,1 122 681,1

117 881,0 8 153,8

216 989,0 11 251,5 89 092,0 7 962,0 4 042,0 5 996,0 84 981,0 19 547,5 9 609,5 132 085,0 52 760,0 39 226,7 25 074,0 16 776,5 5 973,1 7 253,1 21 186,5 64 663,6 311 515,3

39,38

52,97

79,29 80,48 52,70

79,95

68,75

70,35

75,41

35,09 52,94

71,53

54,41 50,94 60,16 71,02

55,29

72,47

54,33

3 004,2 6 065,8 15 371,2 34 296,0 93 911,9

7 690,1

56 591,0 2 758,0 1 286,0 2 328,0 39 173,0 10 761,2 2 086,5 57 636,0 32 395,0 23 075,0 8 565,0

124 575,0 1 556,6

3 918,8 7 162,6 23 006,2 53 205,5 189 387,0

90 484,0 5 029,0 2 279,0 4 213,0 64 286,0 14 460,8 7 517,3 134 264,0 41 133,0 29 402,6 12 795,0 9 843,5

205 455,0 3 389,9

49,59

64,46

76,66 84,69 66,81

78,12

66,94

78,48

78,76

27,76 42,93

74,42

54,84 56,43 55,26 60,94

62,54

45,92

60,63

28 769,2

-44,9

1 731,9 -228,5 -4 206,3

5 722,7

8 674,0

4 519,9

1 285,1 12 296,0 7 390,0

1 574,0 773,0 1 279,0 21 177,0 3 220,3

-7 333,0

6 597,2

-6 694,0

11 503,0 93 359,1

322,5 319,0 2 386,7

1 210,3

3 605,0

5 304,2

807,1 -14 475,0 4 237,0

1 866,5

1 359,0 990,0 504,0 -482,0

5 941,0

18 228,0 1 264,5

4,76

7,66

12,28 7,42 5,44

8,36

9,60

6,45

11,71

38,36 10,34

12,75

24,56 8,46 9,66 117,83

3,00

18,60

5,40

3,64

7,67

7,79 7,71 7,48

4,80

4,77

5,39

9,53

23,74 8,52

9,81

15,64 5,28 6,24 76,49

3,45

3,55

5,71

Note: Data in the table does not include commercial services. Data for Spain and Finland for the year 2014. Source: (Eurostat 2016) and own calculations

United Kingdom

Sweden

Slovenia Slovakia Finland

Romania

Portugal

Poland

Austria

Malta Netherlands

Cyprus Latvia Lithuania Luxembourg Hungary

Italy

Croatia

France

Building the Genuine Single Market for Services in the European Union

4,20

7,67

10,03 7,56 6,46

6,58

7,19

5,92

10,62

31,05 9,43

11,28

20,10 6,87 7,95 97,16

3,22

11,07

5,56

12,36

3,45

0,48 0,59 1,13

1,35

1,74

2,78

4,01

0,34 7,05

1,41

0,44 0,21 0,36 6,08

4,96

0,82

11,88

10,61

3,87

0,34 0,69 1,74

0,87

0,97

2,61

3,66

0,24 6,51

1,22

0,31 0,15 0,26 4,43

6,39

0,18

14,07

81

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An assessment of the importance of trade in services in the internal market from the point of view of national economies can be performed on the basis of the average of intra-EU exports and imports of services in relation to GDP. It has the greatest significance for: Luxembourg (97,2% of GDP in 2015), Malta (31,1%), Ireland (22,7%), Cyprus (20,1%), Belgium (17,0%) and Estonia (15,8%), i.e. small economies. On the other hand it is of little importance for the larger economies, including: Italy (3,2% of GDP in 2015), the United Kingdom (4,2%), Germany (4,4%), Spain (4,7%), France (5,6%) and Poland (5,9%). Taking into account the shares of the intra-EU service trade in the overall exchange of services it can be observed that cross-border trade with other member countries is most important for: Slovakia, Romania, Slovenia, Austria, Hungary, the Czech Republic, Belgium, Estonia and Luxembourg (tab. 3.9). Figure 3 presents the sectorial structure of exports in services in the internal market in 2015. The most important kinds of services in crossborder exports to other EU countries include other business services and travel. These services fall within the scope of the Services Directive and together with construction, computer and information services, maintenance and repair, and some personal, cultural and recreational services account for about 60% of intra-EU service exports.

Building the Genuine Single Market for Services in the European Union

83

Figure 3.3. Structural breakdown of intra-EU28 service exports in 2015 in %

25 20

250000

22.45

22.25

200000

mln euro

17.78

150000

%

15 11.4

11.1

100000

10 4.8

50000

3.27 0.08 The other services

0 Government goods and services

Personal, cultural, and…

Other business services

Telecommunications, computer,…

Charges for the use of intellectual…

Financial services

1.27 0.81 Insurance and pension services

Construction

Travel

1.27 Transport

1.27 Maintenance and repair services

0

2.26 Manufacturing services on…

5

Note: Without commercial services due to the lack of current data. Source: (Eurostat 2016) and own calculations

7. Integration of the services market related to the freedom of establishment Due to the specific characteristics of many services, including a lack of convertibility, the freedom of establishment (art. 49 TFEU) enabling service enterprises to allocate foreign direct investment to other member countries has a large potential among all forms of internal market activities. However, the establishment of an undertaking in another

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member state must meet many more requirements than in the case of foreign trade (like the obligation of enterprises to adopt a specific legal form, and requirements relating to shareholding or capital), and as a result the internal market is dominated by trading activity (European Commission, 2013) (Kąkol, 2015b: 79). While in 2013 the value of the cross-border exports of services between member countries amounted to 858.535 million euros (tab. 3.8), the intra-EU-28 net FDI outward flows in services accounted only for 143.102 million euros (i.e. 16,7% of crossborder trade) (tab. 3.10). The weak integration of the internal market for services in terms of FDI flows is also confirmed by the relatively low foreign direct investment intensity indicators for EU member countries, compared to the trade openness indices (tab. 3.8 and 3.10). The average value of FDI intensity in the EU-28 in 2008-2012 was not more than half of the corresponding index for intra-EU trade flows. The highest investment intensity indicators were characteristic mainly for smaller economies such as Luxembourg, Malta, Ireland, Belgium, Cyprus, Estonia and Sweden (however in their case even one large investment project may significantly influence the value of the indicator). A very high value of investment stock and an extremely high rate of FDI intensity in the case of Luxembourg are particularly noteworthy. The reason for this is that foreign investors treat this country as a gateway to other markets and channel a substantial amount of investments via intermediary holding companies with headquarters in Luxembourg due to the remarkably favourable tax laws, but also it has a strategic location in the EU as well as easy access to a large banking sector and a multitude of investment funds offered by that place (European Commission, 2016b: 88). Among the bigger EU economies, only the United Kingdom attained a level of FDI flows slightly above the EU-28 average (tab. 3.10). However, empirical research by Maincent et al. (2013) indicates that operators in strategic network industries (telecommunications, energy and transport) still maintain relatively high market shares in small countries (e.g. Cyprus, Luxembourg and Slovakia) while large economies (Germany and the United Kingdom) have already opened their markets.

Building the Genuine Single Market for Services in the European Union

85

Table 3.10. Market integration concerning Foreign Direct Investments (FDI intensity) in the service sector in the EU-28 and member countries in 2008-2012 in %, intra-EU-28 net FDI outward stocks in services - end 2013 and intra-EU-28 net FDI outward flows in services in 2013 in mln euro GEO/ TIME

2008

2009

2010

2011

2012

Average in 20082012

EU-28

2,2

2,6

2,1

3,5

2,4

2,6

Belgium

40,9

1,9

5,3

9,8

3,3

12,2

Bulgaria Czech Republic Denmark Germany

10,2 2,4

3,4 1,0

1,8 1,8

1,9 0,5

1,8 2,5

3,8 1,6

2,2 1,1

1,7 1,4

-1,9 2,7

3,9 1,9

-4,3 1,4

0,3 1,7

Estonia Ireland

6,0 0,5

8,7 11,6

4,6 15,6

-2,5 5,0

5,4 14,4

4,4 9,4

Greece Spain

1,0 4,8

0,7 0,8

0,3 2,8

0,5 2,2

0,5 0,9

0,6 2,3

France

3,9

2,5

1,9

1,6

1,0

2,2

Croatia Italy

3,6 1,2

3,7 1,0

0,2 1,0

1,2 2,0

1,1 0,2

2,0 1,1

Cyprus Latvia Lithuania Luxembourg

8,2 2,2 2,4 220,5

8,2 0,1 0,2 436,4

3,1 0,8 1,1 410,7

9,2 2,7 1,7 677,8

2,1 2,3 1,3 698,6

6,2 1,6 1,3 488,8

Hungary Malta Netherlands

2,8 8,0 4,2

1,5 3,2 4,6

1,3 6,2 3,9

3,8 1,4 3,7

10,0 92,5 1,0

3,9 22,3 3,5

Austria Poland Portugal

4,4 1,8 1,5

2,5 2,2 0,8

1,4 2,2 -1,1

3,9 2,8 5,5

2,2 0,7 2,3

2,9 1,9 1,8

IntraEU-28 net FDI outward stocks in services 2013 in mln euro 4 356 586,7 189 259,0 549,9 :

IntraEU-28 net FDI outward flows in services in 2013 in mln euro

42 105,7 485 685,0 3 201,2 213 224,0 12 104,1 122 695,0 343 155,0 225,9 214 510,5 -1 670,0 578,0 1 670,2 1 225 495,0 64 207,2 906,2 837 256,0 : 13 178,1 :

-610,4 -1 438,0

143 102,9 3 902,0 122,4 :

212,0 13 674,0 -763,0 -1 954,0 11 860,0 88,8 2 252,7 -533,0 : 96,0 58 107,0 5 411,2 -129,7 41 338,0 : -2 007,9 :

Chapter Three

86 Romania Slovenia Slovakia Finland Sweden

3,5 3,1 2,8 1,5 6,9

1,4 -0,4 0,5 1,3 4,5

0,9 0,2 1,6 3,5 2,2

0,7 1,1 2,2 1,4 4,0

0,8 -0,4 1,6 2,2 4,3

1,5 0,7 1,7 2,0 4,4

United Kingdom

5,1

2,6

1,9

2,9

2,0

2,9

332,6 1 004,0 : 30 815,8 100 930,3 322 265,8

28,3 -29,0 : -513,0 3 271,6 -5 341,1

Note: Average value of inward and outward Foreign Direct Investment flows divided by GDP, multiplied by 100 Source: (Eurostat 2016)

The high volatility of annual investment flows means that it is better to base the analysis on cumulative values. Data in table 3.11 confirm that service activity has the advantage over manufacturing in terms of the share in FDI outward stocks that are both intra- and extra-EU. Table 3.11. Intra- and extra-EU-28 net FDI outward stocks in services and manufacturing in 2013 in mln euro and in % of all FDI Total services in mln euro

Manufacturing in mln euro

All FDI activities in mln euro

IntraEU-28 net FDI outward 4 356 stocks 586,7 1 504 626,7 ExtraEU-28 net FDI outward 3 064 stocks 888,7 1 495 171,3 Source: (Eurostat 2016) and own calculations

Services in % of all FDI

Manufacturing in % of all FDI

6 607 868,4

65,90

22,80

5 344 436,7

57,35

27,98

However, this advantage is greater within the internal market which may indicate some progress in the integration process and the reduction of barriers to investment in the service sector. On the other hand, despite services constituting the largest sector of the EU economy in terms of value added the achieved share in total investment flows in the internal market (65,9%) is much below their share in EU GDP (about 74%) whereas in the case of manufacturing its share in FDI stock (22,8%) is well above its share in GDP (15-16%).

Building the Genuine Single Market for Services in the European Union

87

The sectorial structure of the EU cross-border trade in services is dominated by areas under the scope of the Services Directive; in the case of FDI within the internal services market the financial and insurance activities prevail––they accounted for 51,8% in intra-EU-28 net FDI outward stocks at the end of 2013 and 42,9% in the corresponding EU outflows in 2013 (table 3.12 and fig. 3.4). Table 3.12. Intra-EU-28 net FDI outward stocks breakdown by service sector - end 2013, and intra-EU-28 net FDI outward flows breakdown by service sector in 2013, in mln euro and in %

Total services Wholesale and retail trade; repair of motor vehicles and motorcycles Transportation and storage Accommodation and food service activities Information and communication Financial and insurance activities Real estate activities Professional, scientific and technical activities Administrative and support service activities Public administration; activities of households and of extraterritorial organisations

Intra-EU28 net FDI Intra-EU28 net FDI outward stocks outward flows In mln In mln euro In % euro In % 4 356 143 586,70 100 102,90 100 388 332,40 8,91 21 722,10 15,18 52 018,30

1,19

1 217,20

0,85

25 731,90 523 034,30 2 256 448,90 108 374,90 827 006,20 146 648,00

0,59

3 753,10

2,62

12,01 14 904,00

10,41

51,79 61 331,70

42,86

15 057,50

Source: (Eurostat 2016) and own calculations

2,49

3 139,10

2,19

18,98 21 761,30

15,21

3,37 14 818,30

10,35

0,35

28,3

0,02

Chapter Three

88

Figure 3.4 . Intra-EU-28 net FDI outward stocks breakdown by service sector - end 2013, in mln euro and in %

60

2,500,000.00

51.79

50

mln euro

2,000,000.00

40

%

1,500,000.00

30 12.01

8.91

500,000.00 3.37

0.35

Professional, scientific and technical activities Administrative and support service activities Public administration; activities of households and of…

Accommodation and food service activities Information and communication Financial and insurance activities

0.00 Transportation and storage

Wholesale and retail trade; repair of motor vehicles and…

1.19 0.59 0

2.49 Real estate activities

10

1,000,000.00

18.98

20

Source: as in Table 12.

A relatively high degree of integration of financial services in terms of the use of the freedom of establishment is understandable given the long history of financial integration and the significant progress that has taken place not only due to the introduction of the common market, but also the monetary union. In 2011, the penetration rate in the banking sector via foreign branches and subsidiaries of other member countries amounted to 17% in the EU-27 (in 2007, i.e. before the financial crisis, even 21%) (Schoenmaker, 2013: 14, in Kąkol, 2015b: 80). Slovakia, the Czech Republic, Estonia and Luxembourg distinguish themselves by having the largest cross-border penetration (a percentage of total banking assets in the ownership of other EU countries) while the largest foreign investors in the

Building the Genuine Single Market for Services in the European Union

89

internal banking market are the United Kingdom, Austria, Italy, Germany, Spain, France and Sweden (Schoenmaker, 2013: 14). Whereas the financial sector is around half of the EU FDI stock, this sector only accounts for less than 3% of the value of the greenfield investment in the EU and the main destination countries for such investments in the financial sector in 2003-2014 were the United Kingdom (29,9%) and Poland (15,6%), (European Commission, 2016b: 88).

8. Price convergence The opening of the service market and increased competition should lead, according to the law of one price, to price equalization. Indeed, with the establishment of the common market (1992) price convergence in the EU accelerated significantly and in 2008 it was the greatest in history (both for services and goods), and then prices started to rise again at a more differentiated pace in member countries (fig. 3.5). It is noteworthy that price divergence on the internal market for services (measured by standard deviation in price levels between member countries) is much greater than in the case of goods, and this situation has persisted for many years. In fact, the difference in the price convergence of services and goods even increased in the period 2004-2013 (except 2011) and remains almost unchanged (in 2015 the standard deviation of the prices of services was 20.71 p.p. higher than for the prices of goods) (fig. 3.5). This can be simply explained. The divergence in the prices of goods was essentially lowered further in the second half of the 1990s (as a result of the effect of competition and the general reduction in the prices of durables) and the process can be continued easily due to the income effects associated with the catching up of the EU countries with a lower GDP per capita (Altomonte, 2014: 69), (Vetter, 2013: 10-11). However, in the internal market for services the price divergence is over twice as large and a decline in prices is hampered by the relatively lower productivity of the sector and the pursuit by those employed in services to earn as much as the more productive workers in the manufacturing sector as well as the specific characteristics of many types of services and the inability to transport them over long distances. Nevertheless, the upward (or even unchanged) trend in price divergence may indicate the persistence of intraEU barriers to trade in services and an insufficient intensity of competition in this sector of the economy (Kąkol, 2015b: 81-82).

Chapter Three

90

Figure 3.5. Price divergence between the EU28 member countries in services and goods (measured by standard deviation) in 2004-2015 in %

45 40

38.3 37.7

37.0 37.4 37.5 37.5

36.2

35.1 35.6 35.5

34.9

35

Total services

33.4

30

%

Total goods

25 20 15 10 5 0

20.2 20.7 20.5 20.7 19.5 19.1 18.8 18.2 18.4 18.4 19.2 17.9 20.4 19.0 18.0 16.7 16.7 17.0 16.8 16.5 15.9 16.1 16.3 15.0

Difference in standard deviations of prices of services and prices of goods in p.p.

Note: Standard deviation estimated using price level indices in member countries (EU28=100) Source: Own calculations on the basis of: (Eurostat 2016)

Building the Genuine Single Market for Services in the European Union

91

Table 3.13. Total services price level indices in member countries in % of the average price level in the EU in 2015 (EU28=100)

EU28 Belgium Bulgaria Czech Republic Denmark Germany Estonia Ireland Greece Spain France Croatia Italy Cyprus Latvia Lithuania Luxembourg Hungary Malta Netherlands Austria Poland Portugal Romania Slovenia Slovakia Finland Sweden United Kingdom

2004 100,0 114,9 23,3 39,5 145,8 110,9 44,1 127,8 78,9 87,8 116,9 49,3 110,5 82,1 36,5 32,8 130,6 46,5 57,7 110,1 104,4 38,3 83,1 26,9 67,3 35,5 125,2 121,9 112,5

2015 Change in 2015 in relation to 2004 in p.p. 100,0 0,0 115,4 0,5 30,5 7,2 50,1 10,6 140,9 -4,9 102,0 -8,9 60,7 16,6 126,9 -0,9 71,7 -7,2 87,9 0,1 109,4 -7,5 51,3 2,0 100,1 -10,4 83,6 1,5 52,7 16,2 43,8 11,0 154,4 23,8 42,7 -3,8 67,3 9,6 115,9 5,8 110,9 6,5 42,1 3,8 69,9 -13,2 33,6 6,7 71,7 4,4 49,8 14,3 126,6 1,4 136,1 14,2 141,3 28,8

Source: (Eurostat 2016) and own calculations

The comparison of service prices in the EU countries in 2004 and 2015 (tab. 3.13) clearly confirms their very high divergence. Its reduction in the examined period was certainly a result of an increase in service prices in most Central and Eastern European (CEE) countries in association with the process of economic convergence as well as a significant drop in prices in such countries as Italy, Germany, France and Denmark. However, not all member states have worked hard enough to unify price levels in the

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internal market. Some of them have a very high price level compared to the EU average, and have considerably raised the prices of services over the last decade, and they were the United Kingdom, Luxembourg and Sweden, and to a lesser extent the Netherlands and Austria. Table 3.14 presents the standard deviation values of prices for certain types of services in the EU in 2015. Among these service sectors the greatest price divergence concerns education, health, and government services, while the ones most converged in terms of price are communication and transport as well as restaurants and accommodation services. There are also many empirical studies that indicate large variations in prices in network industries, including electricity and gas, and even telecommunications (e.g. Maincent et al., 2013, Pelkmans & Renda, 2011). Not only the convergence of prices, but also the levels of mark-ups may indicate the degree of integration of the service market. Thum-Thysen and Canton (2015) examined many important service sectors (retail, energy, communication, airlines, rail and road, and professional services) in all the 28 EU countries taking into account the strictness of product market regulation and found (with some exceptions) a declining trend of mark-ups in most EU countries and most sectors over the past 15 years. In the cross-country comparison their estimations point to generally low to medium mark-up levels in the UK, the Netherlands, and Denmark, and medium to high mark-ups for some sectors in Greece, Spain and France. As regards the comparison across sectors, they have found comparably high mark-ups in energy, communication and professional services which can be explained by sector-specific technological characteristics (e.g. high fixed costs in network sectors) or point to above-normal rents resulting from sheltered competition and restrictive product market regulation. Relatively low mark-ups were found for the retail and transport sectors. In each of the sectors analyzed, the mark-up reduction is driven by one particular factor related to product market regulations: in the communication sector––regulations promoting a more competitive market structure; in the energy sector––public ownership; in professional services––entry barriers; and in the retail sector––registration and licensing provisions. A certain role is also played by country-specific factors, including competition or labour market policies.

41,82

Health

Transport services 27,54 24,87

Communication 60,83

Education

Restaurants and hotels 27,73

Note: Standard deviation estimated using price level indices in member countries (EU28=100) Source: Own calculations on the basis of: (Eurostat 2016)

SD

Total services 37,49

Consumer services 36,20

93

Government services 40,44

Table 3.14. Price divergence between the EU28 member countries in selected service sectors (measured by standard deviation) in 2015 in %

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Conclusion Nearly a quarter century has passed since the formal introduction of the common market in the EU and the process of building a genuine internal market for services is still ongoing. Although the potential of the service sector in the EU is estimated to be much higher than for goods, as services account for almost 74% of EU GDP, their share in total intra-EU trade of only about 20%, is unsatisfactory. Intra-EU trade in services in relation to GDP (6,4% in 2015) is three times lower than the same indicator for trade in goods (20,6% of GDP). Price divergence between the EU countries in the service sector is twice as large as in the goods market, and the difference in the standard deviations of prices in these two sectors is generally growing. We can also observe the rise in price dispersion within the EU service sector over the past seven years. These developments confirm a much lower degree of market integration in the service sector as compared to goods. The main form of service activity within the EU internal market is cross-border trade while the flow of foreign direct investment is of much less importance (in absolute values and in relation to EU GDP). Cross-border trade is dominated by services within the scope of the Services Directive, and financial services play a major role in intraEU FDI flows. The greatest difficulties in the exercise of service activities within the common market include a large heterogeneity of regulation between member states. The most open economies include: the Netherlands, the United Kingdom and Denmark (in terms of the lowest restrictiveness of regulation) and the most overregulated ones are: Croatia, Greece, Slovenia, Latvia, Cyprus, Romania and Luxembourg. As for trade activity (STRI index), the least regulated service sectors in the internal market include distribution, commercial banking, courier, telecoms, certain logistics services and rail freight transport. According to the ECTR indicator, among the most liberalized network sectors in the EU are telecoms and airlines while rail transport is the least open. It should be noted that the liberalization of the European network industries is not an overall success. In several sectors there are substantial barriers between member states and many market distortions take place. Pursuant to Pelkmans et al. (2013) (in Geeroms, 2014: 121) only two markets are "competitive" (air transport and postal services), and two markets are barely "weakly competitive" (gas and rail freight). Only one market (air) can be recognized as "integrated" and one (postal) "nearly integrated". Some network industries require huge investments (air, e-communications, gas and electricity). The European Union is also characterized by

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relatively restricted regulation in professional services, in particular the legal ones. The financial market is quite well integrated, especially in respect of FDI flows. However, retail banking services and the mortgage credit market suffer from a lack of transparency that is detrimental to consumers, and capital markets are less developed than in the US (the last remark does not concern the United Kingdom). The integrated EU market is still a long way off as regards the digital economy as well as the energy sector. Despite the implementation of the horizontal Services Directive (2009) it was impossible to introduce the country of origin principle which significantly limits the potential benefits associated with the provision of services included in its range. Out of 800 regulated professions merely seven enjoy automatic recognition and the European Professional Card is available for only four occupations. The other important obstacles to the full liberalization of the EU service market and the exploitation of its potential include: a high share of state ownership; an insufficiently developed infrastructure (especially in network sectors); weak access to finance (mainly for small and medium sized firms and start-ups); the large fragmentation of public procurement markets; big administrative burdens and long procedures (in particular concerning the recognition of qualifications); the limited portability of welfare rights; and the relatively small size of many service enterprises constraining the benefits of economies of scale. To overcome these difficulties the EU should first of all aim at: broadening horizontal regulation on further types of services and adopting the country of origin principle; introducing single licences within different service sectors (modelled on a single banking licence) as well as extending the European Professional Card to new professions; reducing the number of regulated professions; supporting the development of infrastructure; taking actions to introduce the Capital Markets Union as soon as possible in order to reduce fragmentation in financial markets and improve access to finance for businesses; encouraging the development of e-commerce; promoting the wider use of mutual recognition by member countries; and assisting member states in carrying out reforms related to the services market. As emphasized by Mustili et al. (2012: 3) the EU’s role in accomplishing the building process of the internal market for services relies on a combination of cross-border intra-EU liberalization, EU regulation (which market failures so require) and EU competition policy, complemented where possible by mutual recognition.

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This is a complicated exercise given the huge variety of services and different market failures associated with them. The selection of the optimal combination of the methods of integration of the services market should be preceded by a thorough analysis of the potential benefits and costs conducted from the perspectives of the EU, individual member countries and different social groups (like exporters, importers, consumers, etc.). The estimated benefits from the completion of the process of market integration in the service sector account for more than half of the potential gains from closing all the gaps in the EU single market (Pataki, 2014: 9). A fully integrated EU market for services is crucial to the competitiveness of the whole EU economy because of its close links with other sectors (e.g. the contribution of the intra-EU service sector to manufacturing amounts to around 25%). Therefore, its integration should be supported both at the EU and member state levels. The success of the whole Single Market Project and the prosperity of EU citizens depend on the achievement of a genuine internal market for services.

Bibliography Altomonte, Carlo, Mario Mariniello, and Reinhilde Veugelers. 2014. "To the Commissioner for the Single Market and Industry" EU to Do in 2015-2019. Memos to the New EU Leadership, Bruegel 2014, http://eu2do.bruegel.org/single-market-and-industry/. Bache, Ian, and Stephen George. 2006. Politics in the European Union. New York: Oxford University Press. Badinger, Harald, Fritz Breuss, Philip Schuster, and Richard Sellner. 2008. "Macroeconomic Effects of the Services Directive." In Services Liberalisation in the Internal Market, edited by Fritz Breuss, Gerhard Fink, and Stefan Griller, 125-165. Wien: Springer-Verlag. Barcz, Jan, ElĪbieta Kawecka-Wyrzykowska, and Krystyna MichaáowskaGorywoda. 2016. Integracja europejska w okresie przemian. Aspekty ekonomiczne. Warszawa: PWE. Cini, Michelle. 2007. Unia Europejska: organizacja i funkcjonowanie. Warszawa: PWE. Copenhagen Economics. 2012. “Delivering a Stronger Single Market,” 22 June. CPB Netherlands Bureau for Economic Policy Analysis. 2005. “A quantitative assessment of the EU proposals for the Internal Market for Services,” CPB Communication (Revised), 5 October. El-Agraa, Ali M. 2015. The European Union Illuminated. Its Nature, Importance and Future. Palgrave Macmillan.

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European Commission. 2013. “On the Outcome of the Peer Review on Legal Form, Shareholding and Tariff Requirements under the Services Directive, Commission Staff Working Document,” SWD (2013) 402 final. —. 2016a. “Single Market Scoreboard. Performance per Policy Area: Professional Qualification.” http://ec.europa.eu/single-market-scoreboard. —. 2016b. “Towards a Foreign Direct Investment (FDI) Attractiveness Scoreboard,” written by Copenhagen Economics, May. Luxembourg: Publications Office of the European Union. Eurostat. 2016. “Eurostat Database.” http://appsso.eurostat.ec.europa.eu/ (7.10.2016). Frankel Jeffrey A., and David Romer. 1999. "Does Trade Cause Growth?" American Economic Review 89/3, June: 379-399. Geeroms, Hans, Stefaan Ide, and Frank Naert. 2014. The European Union and the Euro. Cambridge-Antwerp-Portland: Intersentia. Hoorens, Stijn, and Marco Hafner. 2014. “The Not-so-full-Monti: Will More ‘Europe’ Lead to More Trade in the Internal Market,” October 28. http://www.rand.org. Kąkol, Magdalena. 2015a. "Prowzrostowy potencjaá wewnĊtrznego rynku usáug Unii Europejskiej", Studia i Prace Wydziaáu Nauk Ekonomicznych i Zarządzania Uniwersytetu SzczeciĔskiego 41, t. 1: 111-126. —. 2015b. "StopieĔ zintegrowania wewnĊtrznego rynku usáug UE", Annales UMCS. Sectio H, Oeconomia 49/2: 73-89. —. 2015c. "Theoretical versus Real Benefits of the EU Internal Market" Proceedings ICABR 2015, Mendel University in Brno: 439-455. Kommerskollegium: National Board of Trade. 2016. “Protectionism in the 21st Century,” Stockholm, May. Koske, Isabell, Isabelle Wanner, Rosamaria Bitetti, and Omar Barbiero. 2015. “The 2013 update of the OECD product market regulation indicators: policy insights for OECD and non-OECD countries,” OECD Economics Department Working Papers 1200. Kox, Henk, Arjan Lejour, and Raymond Montizaan. 2005. "The free movement of services within the EU", CPB Netherlands Bureau for Economic Policy Analysis, CPB Document 69, revised September. Maincent, Emmanuelle, Dimitri Lorenzani and Attila Eordogh. 2013. "Market Functioning in Network Industries––Electronic Communications, Energy and Transport", European Economy, Occasional Papers 129, February.

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Messerlin, P. 2011. "The European Union single market in goods: between mutual recognition and harmonization," Australian Journal of International Affairs 60/4: 410-435. Monteagudo, Josefa, Aleksander Rutkowski, and Dimitri Lorenzani. 2012. "The economic impact of the Services Directive: A first assessment following implementation," European Economy, Economic Papers 456, June. Mousis, Nicholas. 2011. Access to the European Union: law, economics, policies, 19th updated edition. Euroconfidentiel. Mucha-Leszko, Bogumiáa. 2012. "KorzyĞci miĊdzynarodowej integracji gospodarczej a osiągniĊcia i problemy Unii Europejskiej" PrzyszáoĞü integracji europejskiej - konkurencyjnoĞü i rynki, ed. Wojcich BieĔkowski, Sáawomir I. Bukowski, GraĪyna Olszewska, CeDeWu, Warszawa: 15-42. Mustilli, Federica and Jacques Pelkmans. 2012. "Securing EU Growth from Services", CEPS Special Report 67, October. OECD. 2014. Services Trade Restrictiveness Index: Policy Brief, May. —. 2016a. Product Market Regulation Database. http://stats.oecd.org (7.10.2016). —. 2016b. Regulation in Energy, Transport and Communications Database. http://stats.oecd.org (7.10.2016). —. 2016c. Regulation in the Professional Services Database. http://stats.oecd.org (7.10.2016). —. 2016d. Regulation in the Retail Trade Database. http://stats.oecd.org (7.10.2016). —. 2016e. Services Trade Restrictiveness Index Regulatory Database. http://stats.oecd.org (07.10.2016). Pataki, Zsolt. 2014. “The Cost of Non-Europe in the Single Market. ‘Cecchini Revisited’. An overview of the potential economic gains from the further completion of the European Single Market, a study by the European Parliamentary Research Service,” European Added Value Unit, September––PE 510.981. Pelkmans, Jacques. 2001. European Integration. Methods and Economic Analysis, Second Edition. Pearson Education. Pelkmans, Jacques, and Giacomo Luchetta. 2013. “Enjoying a single market for network industries?” Studies and Reports Notre Europe Jacques Dolorse Institute, February. Pelkmans, Jacques, and Andrea Renda. 2011. "Single eComms market? No such thing..." CEPS Policy Brief 231, January.

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Santagostino, Angelo. 2012. "Permeability (Goods) and Impermeability (Services) in the EU Internal Market: a Liberal Perspective,” Eurolimes 13, Spring: 59-74. Schoenmaker Dirk. 2013. "Post-crisis Reversal in Banking and Insurance Integration: An Empirical Survey", European Economy, Economic Papers 496, April. Szypulewska-PorczyĔska, Alina. 2013. Budowa rynku wewnĊtrznego usáug w Unii Europejskiej, Oficyna Wydawnicza Szkoáa Gáówna Handlowa, Warszawa. Thum-Thysen, Anna and Erik Canton. 2015. "Estimation of service sector mark-ups determined by structural reform indicators", European Economy, Economic Papers 547, April. Vetter, Stefan. 2013. "The Single European Market 20 years on. Achievements, unfulfilled expectations and further potential", EU Monitor, Deutsche Bank, DB Research, October 31.

CHAPTER FOUR THE SINGLE MARKET FOR SERVICES AND THE CASE OF TOURISM POLICY øLKAY TAù GÜRSOY IZMIR DOKUZ EYLUL UNIVERSITY

The Community shall have as its task, by establishing a common market and progressively approximating the economic policies of Member States, to promote throughout the Community a harmonious development of economic activities, a continuous and balanced expansion, an increase in stability, an accelerated raising of the standard of living and closer relations between the States belonging to it. (Treaty of Rome, Art. 2)

Introduction The Treaty of Rome (1957) establishing the European Economic Community (EEC) sets the founding principles of European integration and, in a way, sheds light on the future of integration. Accordingly, the raison d’être of European integration is continuous and balanced growth, stability, harmony, increased living standards and closer relations among member states. As Article 2 of the Treaty of Rome clearly shows, the establishment of a common market and the gradual approximation of national economic policies are the tools envisaged for accomplishing the above-mentioned integration objectives. The aim of creating a Single European Market dates to the Spaak Report and the Treaty of Rome established a customs union as a starting point.1 The completion of the single market (internal market) is still at stake six decades after the launch of European economic integration. For example, in October 2015, “a new

1

Michelle Egan, “The Single Market,” European Union Politics, ed. Michelle Cini (Oxford: Oxford University Press, 2004), 31.

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Single Market Strategy” was announced by the European Commission for fairer and more competitive market integration.2 As described in chapter three, services account for the largest and most dynamic component of the economies of developed and developing countries.3 The share of services in the EU’s GDP and employment is over 70%.4 Besides, services provide crucial inputs into the production of most goods.5 On the other hand, the Single Market Integration and Competitiveness Report of 2016 draws attention to higher restrictions and a lower degree of integration in services trade in the EU, especially for regulated professional services. According to the 2016 report, cross-border trade in the EU remains below 5% of the turnover in these fields. Therefore, to reap benefits from the services in the internal market, the EU still needs to foster the elimination of barriers to trade, integration and investment.6 This chapter focuses on tourism within the scope of the single market for services. Tourism has been selected due to its links with other major segments of the single market and due to its contribution to EU objectives such as employment, economic growth, regional development, closer relations among member states, and the preservation of cultural and natural heritage. The European Economic Community did not have a tourism policy at its inception. However, in the process of integration, a tourism policy has incrementally been transferred to the supranational level with the expansion of the EU institutions’ tasks in both scope and level. Neo-functionalism is used as the theoretical framework for the purposes of this chapter. Neo-functionalism, with its core concept of spillover, helps us to understand the incremental process of integration that is expanding EU competencies to tourism. Tourism services in the single market or tourism-related policies of the EU do not exist and develop in a vacuum. Therefore, the first part of the chapter explores the conceptual underpinnings for European market integration. The second part puts 2

“Upgrading the Single Market: More Opportunities for People and Business”, European Commission, accessed December 26, 2016, http://ec.europa.eu/growth/single-market/strategy_en. 3 “Services Trade”, World Trade Organization, Accessed December 2, 2016 https://www.wto.org/english/tratop_e/serv_e/serv_e.htm. 4 “Single Market for Services”, European Commission, accessed February 2, 2016, http://ec.europa.eu/growth/single-market/services/index_en.htm. 5 World Trade Organization, “Services Trade”. 6 “Single Market Integration and Competitiveness Report 2016”, European Commission, accessed December 15, 2016, “http://ec.europa.eu/DocsRoom/documents/20210.

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tourism into a single European market context by discussing its wider social, political, and economic characteristics. The third part sets the theoretical framework: neo-functionalism. The fourth part discusses the political development of tourism in the European single market with neofunctionalist lenses.

1. Conceptualizing market integration Economic integration refers to the elimination of economic borders between two or more states and market integration plays a central role in the integration process.7 It is expected that the integration of Europe’s separated markets and the unification of European economies would enable European firms to have access to a bigger market and render European firms more efficient by lowering prices and raising quality and competitiveness.8 However, the removal of borders is not sufficient in itself for market integration.9 Market integration involves both negative and positive integration. Negative integration refers to market-making policies which aim to dismantle the barriers to market access such as the elimination of customs duties and the removal of technical barriers to trade.10 Steps taken for negative integration are followed by steps for positive integration (policy integration) which involves the establishment of new institutions and institutional tools or changes in the existing institutional framework.11 Market integration needs to be supported by policy integration and policy integration involves both market-making policies and marketcorrecting policies.12 Therefore, policy integration for the services in the single market is a re-regulation and a restructuring process.13 Internal 7

Jacques Pelkmans, European Integration: Methods and Economic Analysis (Essex: Pearson Education Limited, 2001), 2-3. 8 Richard Baldwin and Charles Wyplosz, Economics of European Integration (Berkshire: McGraw Hill, 2004), 147. 9 Jacques Pelkmans, European Integration, 2-3. 10 Federico Ortino, Basic Legal Instruments for the Liberalisation of Trade: A Comparative Analysis of EC and WTO Law (Oregon: Hart Publishing, 2004), 17; Michelle Egan, “The Single Market,” 38. 11 Ortino, 2004, 17. 12 Maarten P. Vink, “Negative and Positive Integration in European Immigration Policies”, European Integration Online Papers, 6 (2002): 3, accessed June 14, 2015, http://eiop.or.at/eiop/texte/2002-013a.htm. 13 Christian Joerges, “Deliberative Supranationalism––A Defence”, European Integration Online Papers, 5 (2001): 4, accessed January 24, 2015, http://eiop.or.at/eiop/pdf/2001-008.pdf.

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(intra-EU) and external (global) dynamics play intervening roles in the integration process. For example, globalization, which has effects on the flow of goods, people, capital, and services worldwide, is an external factor. Globalization influences the functioning of the single market either through competitive pressures or policy learning and adaptation. For instance, sustainability both as a global and internal concern influences the policies in the single market. Sustainability becomes a side issue when providing tourism services. While discussing the free movement of tourism services in the single market, green hotels or green aviation companies and sustainable tourism activities come to the policy agenda. Policy integration in the single market is closely related to a regulatory environment which sets integration rules. EU law, due to its unique characteristic, is different to national law and international law. EU law impacts on the national law and provides some rights and responsibilities to the individuals living in member states. National courts are required to implement EU rules which are directly binding as if they are part of national legislation.14 Therefore, national rules regulating service provision are under the influence of EU legislation. For example, the freedom to provide tourism services, the freedom to establish a tourismrelated business or the freedom to receive touristic services in another EU country are subject to EU legislation (acquis communautaire) because EU legislation sets the principles for the free movement of services in the internal market. The basic principles of the single market for services are (i) the freedom to establish a company in another EU country; and (ii) the freedom to provide or receive services in an EU country other than the one where the company or consumers are located. The freedom of establishment and the freedom to provide services are organized under the internal market (Article 26) and in Articles 49 to 55 (establishment) and 56 to 62 (services) of the Treaty on the Functioning of the European Union which is the last treaty amending previous EU treaties. The Services Directive (2006)15 sets the cornerstone for integration in services. The coverage of the Directive is large, including sectors such as tourism, retail, construction and business services which account for 46% of EU GDP. The evolutionary path of the European Union can be traced; as integration moves on, new policy issues come to the EU agenda and EU competences expand to new policy areas. Tourism is one of the policy areas which came 14

Tamara K. Hervey and Jean V. McHale, Health Law and the European Union (Cambridge: Cambridge University Press, 2004), 44. 15 European Commission, “Services Directive”, Accessed December 1, 2016, https://ec.europa.eu/growth/single-market/services/services-directive_en.

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under the EU’s influence in line with integration process dynamics. Policy integration takes place via various methods ranging from harmonization to coordination with differing degrees of uniformization. While some areas are shaped by binding legal tools such as regulations, some areas are left to the jurisdiction power of member states.16 Therefore, market integration should be seen not only as the centralization of administrative power or the harmonization of law, but it should be considered as a process encompassing various mechanisms relevant to the realization of European integration objectives.17

2. Contextualizing tourism in the European single market for services As of 2016, the share of tourism in global earnings remains significant; it is the third largest global export after fuel and chemicals. Tourism provides 1 out of 11 jobs in the world and it produces 10% of the world’s economic output.18 Tourism can be considered the world’s largest service sector industry, in terms of international trade.19 Lew denotes tourism as “a human behaviour that is supported in part by many other industries.”20 According to the World Trade Organisation’s (WTO) classification, the scope of tourism services is diverse as it includes services provided by hotels and restaurants (including catering), travel agencies and tour operator services, tourist guide services and other related services.21 However the boundaries of tourism services are not clear cut. Visitors and non-visitors both consume tourism and non-tourism commodities; tourism industries, as well as non-tourism industries produce both tourism and non-tourism commodities. In this regard, Smith points to the difficulties in measuring the volume of tourism. Smith proposes a composite view of tourism by arguing that tourism is not an industry in the traditional sense 16

Pelkmans, European Integration, 6-7. Hervey and McHale, Health Law, 31. 18 “Tourism and Travel-related Services”, World Trade Organization, accessed December 17, 2016, https://www.wto.org/english/tratop_e/serv_e/tourism_e/tourism_e.htm “Tourism sector highlighted as an important contributor to trade and development”, and World Trade Organization, accessed December 17, 2016, https://www.wto.org/english/news_e/news16_e/bus_13jul16_e.htm. 19 Alan A. Lew, “Tourism's Role in the Global Economy”, Tourism Geographies, 13 (2001): 149. 20 Alan A. Lew, “Tourism's Role in the Global Economy”, 150. 21 World Trade Organization, “Tourism and Travel-related Services”. 17

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and he offers the concept of tourism industries. In his terms, the tourism industry is “any industry that produces a tourism commodity.”22 The United Nations Statistical Programme defines tourism as the activity of visitors and defines visitors as travellers:23 taking a trip to a main destination outside his/her usual environment, for less than a year, for any main purpose (business, leisure or other personal purpose) other than to be employed by a resident entity in the country or place visited.

The above-mentioned descriptions focus on the production and consumption aspects of tourism. Hall, Williams and Lew criticize these descriptions for being “narrowly economic” and propose a broader conceptualization of tourism by highlighting its links to other social practices and behaviour. Accordingly, tourism can be seen as part of leisure. Figure 4.1 shows the social relationships surrounding tourism. Here, broken lines indicate “blurred” relationships. As figure 4.1 indicates, the relationships between work, education, leisure, recreation and tourism do not have rigid boundaries where business travel involves both business and tourism at the same time, and second homes lie at the intersection of recreation and tourism. Considering close business ties among EU member states or the popularity of second home ownership abroad, it can be argued that the significance of tourism for the EU is more than just economic benefits; it offers a broader spectrum for relationships in social, economic and political realms. For instance, a study of the United Nations Economic Commission for Europe reveals that on average 7% of visitors from European countries stay in their own vacation homes. This number is even higher for tourism destination countries such as Spain. 97% of visitors to Spain who stay in their own vacation homes originate from other European countries. The United Nations Economic Commission for Europe interprets this situation as a “sign of globalization and interrelationships among economies in the field of recreation and other

22 Stephen L. J. Smith, “The Measurement of Global Tourism: Old Debates, New Consensus, and Continuing Challenges”, in A Companion to Tourism, ed. Alan A. Lew et al. (Oxford: Blackwell Publishing, 2004), 31. 23 “International Recommendations for Tourism Statistics 2008”, The United Nations, Studies in Methods Series M No. 83/Rev.1, accessed December 21, 2016, http://unstats.un.org/unsd/publication/Seriesm/SeriesM_83rev1e.pdf#page=21 (21.12.2016).

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household-related issues..”24 Urry takees the above--mentioned frramework (figure 4.1) one step broaader and looks at tourism ((leisure and reecreation) as a social practice of modern life. Urry draws attention to how the organizationn of tourism and work is related to thhe social praactices of “modern” liife and how toourism as a leeisure activityy is intrinsically related to organizedd work. In othher words, Urrry argues thatt being a tourrist is one indicator of being modernn.25 Figure 4.1 Reelationships betw ween leisure, reecreation, and ttourism

Source: C. M Michael Hall, Allan M. Williams, and A Alan A. Lew, “Tourism: Conceptualizaations, Institutiions, and Issuees”, in A Com mpanion to Tou urism, ed. Alan A. Lew et al. (Oxford: Blackwell Publishing, 2004), 4.

Franklin andd Crang evaluuate tourism in i a broader ccultural conteext where tourism ceases to be a mere m economiic activity andd is seen as a cultural activity withh links to identity, naturee and social rrelations. Bessides, the authors claim m that tourism m consumptio on and producction have traanscended “its beginniings as a rellatively minorr and ephem meral ritual off modern national lifee to become a significant modality m througgh which tran nsnational

24

“Second H Homes”, The United Nation ns Economic C Commission fo or Europe, accessed Deccember 12, 20166, https://www.uunece.org/fileaddmin/DAM/statts/groups/wggnna/GuideByChaapters/Cha pter_12.pdf (12.12.2016). 25 John Urry, Tourist Gaze (L London: Sage Publications, P 20002), 2.

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modern life is organized.”26 The notion of a transnational social life is compatible with the multi-cultural living space in the EU which in turn impacts upon the European identity and the meaning of the European Union for its citizens. Therefore, when asked “what does the EU mean to you personally?” it is not surprising to see that almost half of European citizens (49.89 %) associate it with the freedom to travel, study and work anywhere in the EU. Cultural diversity (28.03%) comes as the third aspect after the euro according to the same Eurobarometer survey in May 2016.27 The EU values culture as an important asset for generating employment opportunities and as a tool for enhancing cultural harmony within the EU. This is reflected in the focus of the EU’s financial support on cultural tourism and cultural attractions for assisting regional economic development.28 In this regard, the EU supports festivals, films and intercultural dialogue and the restoration of European cultural heritage attractions which play a role in cultural tourism. Tourism is seen as a way to regenerate Europe’s declining industries, aging factories and falling population. As a tool for regional restructuring, industrial heritage tourism has been promoted in industrial areas across the EU. Industrial heritage (buildings, landscapes, etc.) is transformed into touristic activities which attract tourists looking for nostalgia or, sometimes just the opposite, looking for novelty. The EU provides financial assistance for developing tourism in these industrial and declining regions in the member states. Member states with a broad industrial background such as the UK, Germany, the Netherlands, Belgium, Austria, France, Spain and Italy have largely benefited from these funding opportunities.29 Industrial heritage was the common theme of the 2015 European Heritage Days. The EUmillenialsTOUR and the European Route of Industrial Heritage Project are among the projects within this scope that have been financed by the EU.

26

Adrian Franklin and Mike Crang, “The trouble with tourism and travel theory?” Tourist Studies 1 (2001): 7. 27 “Eurobarometer Survey, What does the EU mean to you personally”, European Commission, accessed December 21, 2016, http://ec.europa.eu/COMMFrontOffice/publicopinion/index.cfm/Chart/getChart/ch artType/gridChart//themeKy/33/groupKy/190/savFile/54. 28 Greg Richards, “The Development of Cultural Tourism in Europe”, in Cultural Attractions and European Tourism, ed. Greg Richards (Oxon: CABI Publishing, 2001), 5. 29 Gert-Jan Hospers, “Industrial Heritage Tourism and Regional Restructuring in the European Union”, European Planning Studies, 10 (2002), 398.

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Cooper and Hall conceptualize tourism as a geographical system composed of four basic elements: (i) a generating or source region; (ii) a transit route; (iii) a destination region; and (iv) the environment surrounding these other three regions.30 Table 4.1 shows different components of the tourism geographical system and the main elements of tourism production. The system approach to tourism highlights the interaction and co-functioning of sub-components in the system. Europe has long been performing as the world’s leading tourist destination in terms of tourism receipts and tourist arrivals. In 2016, 608 million tourists (51% of the total visitors worldwide) visited Europe and Europe earned 36% of the worldwide tourism revenue (451 US$ bn.).31 Table 4.1 Different components of the tourism geographical system and main elements of tourism production Generating Region Distribution and promotion channels for the destination in the source region x Travel agents x Tour operators x Online retailers and distributors Transport infrastructure

Transit Region Transport link between the source region and the destination

Destination Facilities and attractions

x Aviation services x Bus and train services x Cruise and ferry services x Private and hire cars Transit facilities, i.e. food, accommodation and toilets where tourists have to stop prior to the final destination

x Accommodation x Meetings and exhibitions x Theme parks x Casinos x Retail x Visitor centres x National parks x Restaurants x Activities x Amenity resources Transport infrastructure x Local transport Source: Chris Cooper and C. Michael Hall, Contemporary Tourism: An International Approach (Oxford: Butterworth-Heinemann, 2008): 8.

30 Chris Cooper and C. Michael Hall, Contemporary Tourism: An International Approach (Oxford: Butterworth-Heinemann, 2008), 8. 31 “Tourism Highlights 2016”, United Nations World Tourism Organisation, accessed December 27, 2016, http://www.e-unwto.org/doi/pdf/10.18111/9789284418145.

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In 2016, Europe maintained its position as the world’s largest source region. Europe generated half of the world’s international arrivals (50% of visitors according to the region of origin). The second source region is Asia and the Pacific with a huge difference in performance compared with Europe (24% of visitors according to the region of origin). The density of intra-EU flows played an important part in this situation. The large majority of international travel took place within the same region which means that about four out of five arrivals worldwide originated in the traveller’s own region.32 These statistics identify Europe as a mature region which embodies the qualities of a tourist generating region, a destination region and a transit region. The elements of tourism production described in table 4.1 such as travel agents, tour operators, online retailers, distributors, transportation services or destination facilities, and the hospitality infrastructure operate in the European single market. This means that these elements are under the influence of both the member states’ national regulations and the supranational regulatory framework of the acquis communautaire. Primary channels of EU influence on tourism are the EU regulatory framework in the fields of transportation policy; the free movement of people involving the freedom to travel, work and study; and the free movement of goods involving the free trade of food and beverages for tourism consumption. In a Eurobarometer survey in 2011, participants were asked for their understanding of the internal market and for their spontaneous associations. In terms of the free movement of people, the associations of participants were tourism and travel, the opportunity to work in another EU member state, cross-border shopping in supermarkets and department stores, the freedom to study abroad, and the admission of asylum seekers.33 Most of these associations relate to activities of the main components of the tourism system explained in table 4.1. Tourism related activities provide employment for over 12 million people in the EU of which almost 7 million are employed in the food and beverage industry, while 2 million are employed in transport.34 It directly generates over 5% 32

United Nations World Tourism Organisation, “Tourism Highlights 2016”, accessed December 27, 2016, http://www.e-unwto.org/doi/pdf/10.18111/9789284418145. 33 “Internal Market: Awareness, Perceptions and Impacts 2011”, Eurobarometer, accessed December 26, 2016, http://ec.europa.eu/public_opinion/archives/ebs/ebs_363_en.pdf. 34 “Tourism industries––employment”, Eurostat, accessed December 24, 2016, http://ec.europa.eu/eurostat/statistics-explained/index.php/Tourism_industries__employment.

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of EU GDP and when the indirect impact of tourism is taken into account, it produces more than 10% of EU GDP.35

3. Theoretical framework: neo-functionalism Neo-functionalism was born under the influence of behavioural movement in political science which focuses on political processes.36 The traces of this social scientific approach can be observed in the definition of political integration. Ernst Haas, the pioneer for scholars developing neofunctionalism, defines political integration as a process, whereby: political actors in several distinct national settings are persuaded to shift their loyalties, expectations and political activities toward a new centre, whose institutions possess or demand jurisdiction over the pre-existing national states. The end result is a new political community, superimposed over the pre-existing ones.37

Neo-functionalism tries to explain change rather than equilibrium and it argues that integration does not take place under constant conditions and it is not a terminated project. In Moravcsik's words, the neo-functionalist tendency to think of the EU as ‘becoming’ rather than ‘being’ remains at the heart of current debates on the future of the EU.38

Haas’ definition highlights three points. Firstly, integration is a process of persuasion which means that the integration process can go further as long as the actors agree. It is worth mentioning that the term "process" implicitly indicates change over time; the processes have their own dynamics and can create outcomes which were not planned by the decision

35 “Tourism and the European Union”, European Parliamentary Research Service, 2015, accessed December 2, 2016, http://www.europarl.europa.eu/RegData/etudes/IDAN/2015/568343/EPRS_IDA(2 015)568343_EN.pdf. 36 Ben Rosamond, Theories of European Integration (Hampshire: Palgrave MacMillan, 2000), 54. 37 Ernst B. Haas, The Uniting of Europe: Political, Social and Economic Forces 1950-1957 (Stanford, California: Stanford University Press, 1968), 16. 38 Andrew Moravcsik, “The European Constitutional Compromise and the Neofunctionalist Legacy,” Journal of European Public Policy 12 (2005), 350.

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makers at the outset.39 Secondly, there exists an international level which does not replace the national level but co-functions with it. This might indicate the multilevel nature of governance with co-existent and overlapping levels of political action and with relatively mobile political actors between various levels of governance.40 Thirdly, various actors are involved in the integration process. In terms of actorness, neo-functionalism acknowledges the importance of states particularly in the initiation and reshaping of regional integration by concluding treaties but the theory gives priority to non-state actors (interest groups, technocrats and supranational/central agencies) which can persuade states to further integrate.41 Non-state actors are considered as providing the dynamic for further integration. The relationship between member states and supranational institutions is an example of the principal-agent relationship. Member states (principals), which do not trust each other to respect mutual agreements faithfully and accurately, assign an independent agent and give this agent the duty to monitor and enforce the implementation of agreements when necessary. In this regard, the existence of a supranational secretariat (European Commission) and judiciary (Court of Justice of the EU) becomes a necessity for integration.42 Agents are given the responsibility of realizing some tasks and functions on behalf of the principals. The aim is to solve problems of incomplete contracting with the help of supranational agents. In fact, any institutional agreement such as EU treaties can be considered a contract. However, it is impossible to include every detail in the contract or to foresee the future challenges to the contract. Any institutional agreement can be considered a contract but as it is impossible to include every detail or to foresee future challenges, the contracting parties of the agreements may choose to delegate authority to agents when uncertainty is high and future decision making is expected to be time consuming and complex.43 39

Arne Nieman, “The PHARE Programme and the Concept of Spillover: Neofunctionalism in the Making,” Journal of European Public Policy 5 (1998), 429. 40 Ben Rosamond, “The Uniting of Europe and the Foundation of EU Studies: Revisiting the Neofunctionalism of Ernst B. Haas,” Journal of European Public Policy 12 (2005), 241. 41 Philippe Schmitter, “Neo-Neofunctionalism”, European Integration Theory, eds. Antje Wiener and Thomas Diez (Oxford: Oxford University Press, 2004), 46. 42 Philippe Schmitter, “Neo-Neofunctionalism, 50. 43 Mark Pollack, “Delegation, Agency, and Agenda Setting in the European Community,” International Organization 51 (1997): 104.

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Additionally, Kassim and Menon explain why the "sovereigntyconscious states" create and delegate authority to supranational international organizations. By delegating authority to a higher level the member states aim to overcome problems of collective action where actors anticipate benefits from long-term cooperation, to displace responsibility for unpopular decisions; and to improve the quality of policy in technical areas by delegating responsibilities to an agent with specialist knowledge.44 The functionalist ideas of David Mitrany influenced neo-functionalism. Both theories accept that an institutional structure in the post-nationalist era should focus on the welfare needs of citizens. However, neo-functionalism argues that technocratic automaticity suggested by Mitrany is not enough to create post-national political communities. The integration process will be shaped by the purposeful actors trying to fulfil their interests.45 Therefore, in terms of the controversial relationship between structure and agency in political science, neo-functionalism favours agency46 by accepting the capacity of individuals, groups or institutions to influence their environment either purposefully or unexpectedly.47 The creation of a central/regional agency demands a compromise among the state parties based on the understanding that certain common interests cannot be attained in any other way. The common interests of the parties or solutions to problems are deliberately or inadvertently upgraded to a higher level which implies the task expansion of the regional/supranational agency.48 Neo-functionalism envisages some prerequisites for the effective problem solving of the supranational institutions created during the integration process such as the real delegation of the decision making authority to supranational organizations; a cumulative and expansive process whereby a supranational organization slowly expands its authority.49 44 Hussein Kassim and Anand Menon, “The Principal-Agent Approach and the Study of the European Union: Promise Unfulfilled?” Journal of European Public Policy 10 (2003): 123. 45 Rosamond, Theories of European Integration, 55. 46 Ernst B. Haas, “Does Constructivism Subsume Neo-functionalism?” in The Social Construction of Europe, eds. Thomas Christiansen, Knud Erik Jorgensen and Antje Wiener (London: Sage Publications, 2001), 28. 47 Stuart McAnulla, “Structure and Agency,” in Theory and Methods in Political Science, eds. David Marsh and Gerry Stoker (New York: Palgrave Macmillan, 2002), 271. 48 Ernst B. Haas, “International Integration: The European and the Universal Process,” International Organization 15 (1961): 368. 49 Leon Lindberg and Stuart A. Scheingold, Europe’s Would-be Polity (Englewood Cliffs: Prentice-Hall, 1970), 7.

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Lindberg and Scheingold define political integration as system growth which refers to an increase in the institutional scope and capacity of the EU.50 In Lindberg and Scheingold's approach, scope relates to a range of policy fields and tasks on which the EU has responsibility and authority to act. The scope of integration refers to the extent of the EU system. The locus of integration gives an idea about the intensity of the system which means the relative importance of the EU-level decision making processes compared to the national-level decision making processes in a particular area.51 Accordingly, the expansion of supranational institutions' tasks lies at the centre of the integration process where new forms of decision making competences are created to cope with emerging problems and to achieve new goals. Pollack suggests thinking of the level of integration on the basis of policy outputs at the EU level and measures it in terms of legislation (directives, regulations, etc.) and budgetary expenditures related to the given policy area.52 Haas defines three conditions for successful international integration: a pluralist society,53 high economic and social development and common ideological frameworks. These conditions together form a driving force for upgrading national or subnational common interests to the supranational level.54 The original neo-functionalist model developed by Haas and Schmitter proposes three sets of variables which influence the expansion of economic-technical integration to the political sphere. These are background conditions: conditions at the time the union is negotiated and enters into force; and conditions emerging after the union becomes operative. The existence of a core area for collaboration is a key requirement and integration moves on gradually by starting in low politics areas (rather than high politics) which is important for all parties as member states tend

50

Leon Lindberg and Stuart A. Scheingold, Europe’s Would-be Polity, 99. Leon Lindberg and Stuart A. Scheingold, Europe’s Would-be Polity, 67-68. 52 Mark Pollack, “Creeping Competence: The Expanding Agenda of European Community," Journal of Public Policy 14 (1994): 96. 53 Pluralism considers the state as an entity representing the interests of the society not an independent actor pursuing its own way. The state reflects the interaction among its components, therefore non-state actors are seen as important as states in the national policy making processes. Carla A. Arena Ventura, Melissa Franchini Cavalcanti and Verônica Angélica Freitas de Paula, “The Systems Approach to the Pluralist Theory of International Relations: A Case Study of the European Union”, Journal of Systemic Practice and Action Research, 19 (2006): 479-481. 54 Ernst B. Haas, “The Challenge of Regionalism,” International Organization 12 (1958): 448. 51

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to bargain down to the position of the lowest common denominator.55 The difference between high and low politics is explained by Nye by drawing attention to the fact that the content of "high" politics is dependent on the context. high politics is symbol laden, emotive, and based on attitudes characterized by greater intensity and duration than low politics which is consequently more susceptible to the rational calculation of benefits associated with an economic problem.56

The spillover effect or the "expansive logic of integration" is one of the key concepts of neo-functionalism. As a process, spillover indicates that: political cooperation conducted with a specific goal in mind leads to the formulation of new goals in order to assure the achievement of the original goals. What this means is that political cooperation, once initiated, is extended over time in a way that was not necessarily intended at the outset.57

If member states are frustrated or dissatisfied by their performance in a sector where commitments are made and common goals are set, they will look for alternative means of reaching their goals. They may attempt to solve their dissatisfaction, either by developing collaboration in another related sector thus expanding the scope of integration, or intensifying their commitment to the original sector thus increasing the level of integration, or they may choose to apply both.58 Spillover thus covers both the expansive logic of increasing the range of economic functions drawn into the integrative web and the deepening logic of increasing the supranational regulatory capacity. As Rosamond states "politics would follow economics". But the spillover in economics needs political activism as well. The role of supranational central organizations is particularly important in persuading member states to give more commitment, and in directing and coordinating the spillover processes.59 In light of the key concepts and dynamics of integration explained above, the next part of the chapter is dedicated to an analysis of the expansion of European integration into the field of tourism. 55

Rosamond, Theories of European Integration, 61. Joseph S. Nye, "Patterns and Catalysts in Regional Integration," International Organization 19 (1965): 871. 57 Jensen, "Neo-functionalism", 84. 58 Philippe C. Schmitter, "Three Neo-functional Hypotheses about International Integration", International Organization 23 (1969): 162. 59 Rosamond, Theories of European Integration, 60-61. 56

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3.1 Political terms: shedding a neo-functionalist light on the tourism policy Tourism's importance for integration is explained in a Council resolution dating back to 1984 as follows: Article 2 of the Treaty of Rome assigns to the European Community the task of promoting closer relations between the States which belong to it. Tourism can assist the Community to achieve this goal and, by bringing the peoples of Europe into contact, it buttresses the edifice of European integration. Tourism is also an important economic activity in the spirit of Article 2 of the Treaty... A further measure of the importance of tourism to the Community is the large number of Community policies which, directly or indirectly, have a bearing on it.60

Tourism is an example of a functional low politics area which affects the daily life of people as both a consumer in the internal market buying a tourist product and as a citizen benefiting from the rights endowed by EU legislation such as the right of establishment and the freedom to provide tourist services. Such a trait of tourism makes it a good place for "planting the seeds of integration" but member states have been reluctant to cede some of their sovereignty to a supranational agent as it is traditionally considered a sphere of state intervention because of economic, cultural and environmental considerations. Member states resisted EU intervention and questioned the need for a tourism policy at that time. On the other hand, the EU was late in understanding the need for EU-wide tourism policies due to some reasons: during the first two decades of integration the EEC agenda was concerned with liberalizing the trade in industrial goods and establishing a common agricultural policy. Even when tourism started to be conceived as important and contributing common objectives, the attempts of the Commission remained weak and fragmented; tourism was thus subsumed within other policy initiatives such as regional development and agriculture.61 When the year 2009 came, tourism was one of the policy fields which gained a legal basis with the entry into force of the Lisbon Treaty. Article 195 of the Treaty on the Functioning of the European Union states: 60

Council Resolution of 10 April 1984 on a Community Policy on Tourism, OJ C115, 30.04.1984. 61 Allan M. Williams and Gareth Shaw, "Tourism Policies in a Changing Economic Environment", in Tourism and Economic Development European Experiences, eds. Allan M. Williams and Gareth Shaw (West Sussex: John Wiley and Sons, 1998), 377.

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Also in Article 2 of the Treaty, tourism is mentioned among the fields where the EU will have the competence to carry out actions to support, coordinate or supplement the actions of the member states. There is not a single European tourism policy; instead the Union aims to create a favourable framework for economic development and facilitate cooperation between member states in tourism. However, it is the first time that a treaty has created a new legal basis entirely devoted to tourism. With the introduction of tourism at the EU level it is obvious that both the scope and level of integration expanded. With this legal basis, the EU is given a new task and the authority to complement the actions of member states especially when the competitiveness of the undertakings in the tourism sector is at stake. The level of integration in tourism increased through decision making using ordinary legislative procedure. According to the scale developed by Lindberg and Scheingold, the level of integration in tourism policy ranks in the middle (low integration refers to all policy decisions taken by national processes, and high integration refers to all policy decisions taken by joint supranational processes).62 It may seem small, but this step towards integration in tourism policy is the final stage of a long and cumbersome journey which started in the 1990s with the European Commission's efforts. In 1982 the Commission issued a communication titled "A community policy on tourism: initial guidelines". It was the first comprehensive policy statement on tourism and was the result of pressure from public opinion especially concerning the environment and pressure from the European Parliament on the issue

62

Lindberg and Scheingold, Europe’s Would-be Polity, 69.

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of cultural heritage.63 Initial guidelines highlighted the importance of the tourism sector to the European economy and proposed policy measures in various areas such as the freedom of movement and the protection of tourists, working conditions for those engaged in tourism and transport, regional development through tourism and safeguarding the European heritage and tourism.64 In 1984, a Council resolution on "A community policy on tourism" was issued.65 The year 1990 was celebrated as the European Year of Tourism. The attempts of the Commission to reposition tourism in the EU policy framework led to its recognition in the Maastricht Treaty.66 On the functional front, the EU was concerned with completing the single market and tourism found a place in the Maastricht Treaty (1992) due to its functional linkage to various policy areas such as free movement, transport and regional policy. Tourism was listed amongst those areas which would be used to achieve EU objectives. During the period 1993-1995, the Action Plan to Assist Tourism was implemented for improving the geographical and seasonal distribution of tourism, the use of financial instruments for tourism and raising awareness for tourism. In 1995, the Green Paper on the Role of the Union in the Field of Tourism was prepared. The Green Paper discussed the added value of the European Community (EC) in the field of tourism and the possible ways of developing the EC’s role in tourism.67 For the period between 1997 and 2000, Philoxenia, the first multi annual programme for tourism was proposed. It was proposed but it was not put into force due to a lack of consensus among member states. This was an indicator of the member states' rejection of upgrading a common interest to a higher level. The development of common tourism policy tools for the realization of common objectives indicated in the 1982 Commission Communication Paper was not a viable solution for the 63

Rhodri Thomas, The Hospitality Industry, Tourism and Europe (London: Cassel, 1996), 6; and Williams and Shaw, "Tourism Policies in a Changing Economic Environment", 377. 64 "A Community Policy on Tourism: Initial Guidelines", European Commission, accessed May 1, 2013, http://bookshop.europa.eu/en/initial-guidelines-for-acommunity-policy-on-tourismpbCBNF82004/?CatalogCategoryID=X0gKABstUGQAAAEjwZAY4e5L. 65 Council Resolution of 10 April 1984 on a Community Policy on Tourism, OJ C115, 30.04.1984. 66 Allan M. Williams and Gareth Shaw, "Tourism Policies in a Changing Economic Environment", 379. 67 Green Paper on the Role of the Union in the Field of Tourism, COM(95)97 Final, 04.04.1995.

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member states. After this event the Commission changed its strategy for tourism; instead of proposing big programmes or preparing strategies on the EU’s involvement in tourism or an EU tourism policy, it started to focus on the relationship between tourism and employment. The Commission restarted the framing of tourism in low politics. Employment was a hot topic on the EU agenda at the Luxembourg “Jobs summit” of 1997. The Commission created a linkage between tourism and employment and kept tourism on the agenda as part of a bigger strategy (the European Employment Strategy). In 1999, the Commission prepared a communication titled "Enhancing tourism's potential for employment."68 This was followed by the communications on: “Working together for the future of European tourism”, “Basic orientations for the sustainability of European tourism”, “A renewed EU tourism policy” and “An agenda for a competitive and sustainable European tourism”, in the years 2001, 2003, 2006 and 2007 respectively. These years witnessed the problems and increasing awareness of sustainability and competitiveness issues. Through these communications the Commission highlighted the interdependence of these issues and again tourism’s contribution to these goals was emphasized. But this was not enough to persuade member states of the necessity for a new political framework. The impetus for a stronger EU competence in tourism came from the crises and challenges faced by the EU. In 2010, the Commission pointed out the crises and challenges to European tourism in the communication titled "Europe, the world's No. 1 tourist destination––a new political framework for tourism in Europe."69 The challenges facing the EU are given as an ageing population and new tourist expectations due to changes in the demographic profile; climate change, the scarcity of water resources, the pressure on biodiversity and the risks to the cultural heritage posed by mass tourism; the increasing use of information and

68

Communication From the Commission to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions, Enhancing Tourism's Potential for Employment, Follow-up to the Conclusions and Recommendations of the High Level Group on Tourism and Employment, 1999/C 178/03, 23.06.1999. 69 Communication From the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, Europe, the World's No. 1 Tourist Destination––a New Political Framework for Tourism in Europe, COM(2010) 352 final, 30.6.2010.

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communication technologies by consumers, and the lack of professional qualifications in tourism to meet these challenges.70 As we have already seen, the EU is the world-leading tourist destination. However, due to increasing global competition, EU tourism faced a significant decline. According to Eurostat, the EU-27’s share of worldwide tourist arrivals dropped between 1990 and 2011 from 52.9% to 39.2%.71 By 2020, East Asia and the Pacific, Asia, the Middle East and Africa are forecast to record growth at rates (5%) that are above the world average (4.1%). Europe and the Americas are anticipated to show lower growth rates than the average although Europe is expected to maintain the highest share of world arrivals.72 The Commission proposes a new consolidated political framework for tourism which takes account of the new EU priorities set out in the “Europe 2020” strategy, stimulating competitiveness in the sector. The need for a greater EU contribution to the tourism policy is stated as follows: In the face of the crisis and the increasing constraints on its activity, European tourism must evolve. This requires changes at all levels. The European Union must contribute to this...73

The eventual acceptance of the EU institutions as actors in the field of tourism, although not planned at the beginning, shows that once political cooperation in one field has started, it can be extended over time in a way that is not necessarily unforeseen at the outset.74 Hooghe and Marks note that the EU goes beyond traditional labels such as nation, state, region or federation and institutional change is always taking place. The unique nature of the EU, which is difficult to identify and moves with great speed,75 is one of the factors complicating the market integration process. Therefore, the regulatory and institutional framework for market integration is always incomplete and it is evolving as integration unfolds.

70 Communication from the Commission, Europe, the World's No. 1 Tourist Destination. 71 "Eurostat EU in the World 2013". 72 "UNWTO, Tourism 2020 Highlights". 73 Communication from the Commission "Europe, the World's No 1 Tourist Destination", 6. 74 Carsten Stroby Jensen, “Neo-functionalism” in European Union Politics, ed. Michelle Cini (Oxford: Oxford University Press, 2004), 84. 75 Liesbet Hooghe and Gary Marks, “European Union?” West European Politics, 31 (2008): 108.

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Conclusion Developments in the EU’s tourism policy corresponded with efforts to deal with internal (e.g. completion of the single market) and external pressures (e.g. competitiveness) on European integration, but remained limited due to a lack of consensus among member states on the need for a tourism policy and due to their reluctance to transfer authority to a higher level. With the Lisbon Treaty, the EU has achieved a basis (limited though) for intervening in tourism policy. Decisions on tourism policy measures complementing member states' actions will be taken by ordinary legislative procedures. This puts the European Parliament on an equal footing with the Council of the European Union. In the future, member states which do not want to share sovereignty with the EU will have to accept that it is just not enough to develop and apply tourism-specific policies. They should focus on both horizontal and vertical linkages within the national and European economy when planning national tourism policies. The expansion of EU tasks related to tourism witnessed both functional and cultivated spillover processes. European legislation is not designed for tourism but there are many measures directly and indirectly affecting tourism. Interdependency among other economic sectors (e.g. transportation) and policy fields (e.g. environment) created functional spillover processes. Due to the member states’ rejection of an increasing EU contribution to the tourism policy, the conditions were not suitable for political spillovers. The Commission, which was not only acting as a mediator but also a policy entrepreneur at the beginning of the 1990s, started to focus on technical and functional aspects in the late 1990s. The year 2000 was marked by the strategic decision of the EU to get prepared for the challenges arising from globalization and the knowledgedriven economy with a package of measures aiming to strengthen employment, economic reform and social cohesion as part of a knowledgebased economy. In line with the Lisbon agenda, the Commission issued communications on tourism's potential to contribute to EU goals such as competitiveness and sustainability. The year 2010 was welcomed with the frustrations/dissatisfactions of previous years marked by economicfinancial crises and the natural crisis of the Eyjafjöll volcano. According to neo-functionalism, frustrations/dissatisfactions are susceptible areas for spillovers since member states tend to change the scope or/and level of integration. The Commission, in the communication document titled "Europe, the world's No. 1 tourist destination" explained the challenges and crises faced by member states and proposed a new and consolidated

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political framework for tourism. Here the Commission acted as a policy entrepreneur and established links between problem areas and cultivated functional links to reach its aim. Neo-functionalism argues that when an organized civil society perceives that it can reach its goals through establishing links to the supranational level, and that supranational agents better serve their interests than national agents, then they tend to shift their loyalties and cluster around the supranational agent. The number of interest groups with activities on the European level has increased and most of them get funding from the EU such as HOTREC, the umbrella association of national trade associations representing the hotels, restaurants, cafés and similar establishments in Europe; European Travel Agents and Tour Operators Associations; the European Network for Rural Development, the European Enterprise Network; and the European Regions Research and Innovation Network. Tourism does not affect, but is affected by, the legislation related to other policy fields which is a problematic situation for the sector’s workers. The Lisbon Treaty created a positive impact on those waiting for more comprehensive measures for a tourism policy. Sector representatives who are dissatisfied with the fragmented policy measures and the lack of a tourism focus hope to have better regulations adapted to sector-specific conditions. The speech below, given by Marguerite Sequaris, CEO of HOTREC, summarizes the expectations from the Lisbon Treaty: The treaty...giving competences in relation to tourism (to the Union) that has to support the tourist policies of the member states, will give some impetus to put tourism higher on the agenda of the European institutions. We have a lot of European legislation affecting our industry...For example, taxation. We have been touched by all sorts of EU legislation, and now we hope that something can be done in the field of tourism per se. We count a lot on the new commissioner, Antonio Tajani, we condone him to make use of those new competences to take tourism more seriously into account.76

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Hotelsnewsnow,"Tourism on agenda of European Union's Lisbon Treaty", accessed December 10, 2016, http://www.hotelnewsnow.com/articles/4824/Tourism-on-agenda-of-EuropeanUnions-Lisbon-Treaty.

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—. “Single Market Integration and Competitiveness Report 2016.” Accessed December 15, 2016, http://ec.europa.eu/DocsRoom/documents/20210. —. “Upgrading the Single Market: More Opportunities for People and Business.” Accessed December 26, 2016. http://ec.europa.eu/growth/single-market/strategy_en. European Parliamentary Research Service. “Tourism and the European Union 2015”. Accessed December 2, 2016, http://www.europarl.europa.eu/RegData/etudes/IDAN/2015/568343/E PRS_IDA(2015)568343_EN.pdf. Eurostat. “Tourism industries––employment”. Accessed December 24, 2016, http://ec.europa.eu/eurostat/statistics-explained/index.php/Tourism_ industries_-_employment. Franklin, Adrian, and Mike Crang. 2001. “The trouble with tourism and travel theory?” Tourist Studies 1: 5-22. European Commission. “Green Paper on the Role of the Union in the Field of Tourism,” COM(95)97 Final, 04.04.1995. Haas, Ernst B. 2001. “Does Constructivism Subsume Neo-functionalism.” In The Social Construction of Europe, edited by Thomas Christiansen, Knud Erik Jorgensen and Antje Wiener, 22-31. London: Sage Publications. —. 1961. “International Integration: The European and the Universal Process,” International Organization 15: 366-392. —. 1958. “The Challenge of Regionalism,” International Organization 12: 440-458. —. 1968. The Uniting of Europe: Political, Social and Economic Forces 1950-1957. Stanford California: Stanford University Press. Hervey, Tamara. K., and Jean V. McHale. 2004. Health Law and the European Union. Cambridge: Cambridge University Press. Hooghe, Liesbet, and Gary Marks. 2008. “European Union?” West European Politics, Vol. 31: 108-129. Hospers, Gert-Jan. 2002. “Industrial Heritage Tourism and Regional Restructuring in the European Union,” European Planning Studies, 10, 397-404. Jensen, Carsten Stroby. 2004. “Neo-functionalism.” In European Union Politics, edited by Michelle Cini, 80-92. Oxford: Oxford University Press. Joerges, Christian. 2001. “Deliberative Supranationalism––A Defence”, European Integration Online Papers, 5: 4. Accessed January 24, 2015, http://eiop.or.at/eiop/pdf/2001-008.pdf.

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Kassim, Hussein, and Anand Menon. 2003. “The Principal-agent Approach and the Study of the European Union: Promise Unfulfilled?” Journal of European Public Policy 10: 121-139. Lew, Alan A. 2001. “Tourism's Role in the Global Economy,” Tourism Geographies, 13: 148-151. McAnulla, Stuart. 2002. “Structure and Agency.” In Theory and Methods in Political Science, edited by David Marsh and Gerry Stoker, 271291. New York: Palgrave Macmillan. Moravcsik, Andrew. 2005. “The European Constitutional Compromise and the Neo-functionalist Legacy,” Journal of European Public Policy 12: 349-386. Nieman, Arne. 1998. “The PHARE Programme and the Concept of Spillover: Neo-functionalism in the Making,” Journal of European Public Policy 5: 428-446. Nye, Joseph. S. 1965. "Patterns and Catalysts in Regional Integration," International Organization 19: 871. Ortino, Federico. 2004. Basic Legal Instruments for the Liberalisation of Trade: A Comparative Analysis of EC and WTO Law. Oregon: Hart Publishing. Hotelsnewsnow. “Tourism on the agenda of the European Union's Lisbon Treaty". Accessed December 10, 2015, http://www.hotelnewsnow.com/Articles.aspx/2477/Tourism-onagenda-of-European-Unions-Lisbon-Treaty. Pelkmans, Jacques. 2001. European Integration: Methods and Economic Analysis. Essex: Pearson Education Limited. Pollack, Mark A. 1997. “Delegation, Agency, and Agenda Setting in the European Community,” International Organization 51: 99-134. Pollack, Mark. 1994. “Creeping Competence: The Expanding Agenda of the European Community," Journal of Public Policy 14: 95-145. Richards, Greg. 2001. “The Development of Cultural Tourism in Europe”. In Cultural Attractions and European Tourism, edited by Greg Richards, 3-30. Oxon: CABI Publishing. Rosamond, Ben. 2005. “The Uniting of Europe and the Foundation of EU Studies: Revisiting the Neo-functionalism of Ernst B. Haas,” Journal of European Public Policy 12: 237-254. —. 2000. Theories of European Integration. Hampshire: Palgrave MacMillan. Schmitter, Philippe. 1969. "Three Neo-functional Hypotheses about International Integration," International Organization 23:161-166.

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—. 2004. “Neo-Neofunctionalism.” In European Integration Theory, edited by Antje Wiener and Thomas Diez, 45-74. Oxford: Oxford University Press. Smith, Stephen L. J. 2004. “The Measurement of Global Tourism: Old Debates, New Consensus, and Continuing Challenges.” In A Companion to Tourism, edited by Alan A. Lew, Michael Hall, and Allan M. Williams, 25-35. Oxford: Blackwell Publishing. Thomas, Rhodri. 1996. The Hospitality Industry, Tourism and Europe. London: Cassel. United Nations Economic Commission for Europe. “Second Homes.” Accessed December 12, 2016, https://www.unece.org/fileadmin/DAM/stats/groups/wggna/GuideByC hapters/Chapter_12.pdf (12.12.2016). United Nations World Tourism Organisation. “Tourism Highlights 2016.” Accessed December 27, 2016, http://www.e-unwto.org/doi/pdf/10.18111/9789284418145. United Nations. “International Recommendations for Tourism Statistics 2008.” Studies in Methods Series M No. 83/Rev. 1. Accessed December 21, 2016, http://unstats.un.org/unsd/publication/Seriesm/SeriesM_83rev1e.pdf#p age=21. Urry, John. 2002. Tourist Gaze. London: Sage Publications. Ventura, Carla, A. Arena, Melissa Franchini Cavalcanti and Verônica Angélica Freitas de Paula. 2006. “The Systems Approach to the Pluralist Theory of International Relations: A Case Study of the European Union,” Journal of Systemic Practice and Action Research, 19: 479-481. Vink, Maarten P. 2002. “Negative and Positive Integration in European Immigration Policies,” European Integration Online Papers, 6: 3. Accessed June 14, 2015, http://eiop.or.at/eiop/texte/2002-013a.htm. Williams, Allan M., and Gareth Shaw, 1998. "Tourism Policies in a Changing Economic Environment." In Tourism and Economic Development European Experiences, edited by Allan M. Williams and Gareth Shaw, 375-391. West Sussex: John Wiley and Sons. World Trade Organization. “Tourism sector highlighted as important contributor to trade and development. Accessed December 17, 2016, https://www.wto.org/english/news_e/news16_e/bus_13jul16_e.htm. —. “Services Trade”. Accessed December 2, 2016, https://www.wto.org/english/tratop_e/serv_e/serv_e.htm. —. “Tourism and Travel-related Services”. Accessed December 17, 2016, https://www.wto.org/english/tratop_e/serv_e/tourism_e/tourism_e.htm.

CHAPTER FIVE FREE MOVEMENT OF LABOUR AND PEOPLE: A LIBERAL VIEW ANGELO SANTAGOSTINO ANKARA YILDIRIM BEYAZIT UNIVERSITY

Introduction Liberal thought asserts the right of every person to live and work wherever he pleases. This is a right that is closely related to private property and the freedom of trade. In liberal theory, the rights of individuals find their limits in the rights of other individuals. No one can get into other people's property without the agreement of the owner. The right to property implies, in fact, the right to exclusion. For the liberal, if a person in country A wants to work in country B and if in this country there is an employer who is interested in taking him on, this is sufficient for this person to migrate to country A and work there. Especially if we think that in the country of destination there must be many other people seeking to establish with the immigrant additional contractual relations, rent, sale, supplies (electricity and gas) and so on. In the liberal view the state must desist from banning immigration, because immigration is considered convenient by those concerned. In more general terms, if on the part of certain individuals of a certain country there is the will and interest to establish a contract with a person from another country, there is no reason why the state should oppose it by excluding him from the territory. In this case, the state behaves as if it were the owner of the whole territory. The state, therefore, makes an illegal use of the right of exclusion. For the liberals, therefore, each person must be free to offer his services wherever he considers working and each person must be free to accept it or not. Freedom of movement does not

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mean that a person is free to go wherever he wishes, but that he can go freely where there is the will to receive him, and to offer him a job. The above implies that among a group of nations that have adopted liberal principles, citizens can freely move from one country to another, but on the condition that wherever they go there will be jobs that allow them to support themselves and their families. For the liberal, then, the best immigration policy is no immigration policy, or even better, to eliminate government intervention in society. Under the label of immigration policy, in fact, the state grants the right to discriminate against those defined as foreigners because of the nationality criterion, a form of state racism. It is state intervention in the right of exclusion that creates the problem of immigration. The problem is not immigration; the problem is the state. In a speech to the Constituent Assembly on July 29, 1947, Luigi Einaudi, regarding European countries after World War II, said: The European states have become a historical anachronism. [...] In vain these sovereign states raised around themselves high customs barriers in order to maintain their own economic self-sufficiency. The barriers were useful only to impoverish the people, to make them angry with each other, to talk to each of them a strange nonsense of living space, a geopolitical necessity, and to make each of them pronounce excommunications against foreign immigrants, they were almost lepers and an almost fierce shrinking of each people in itself could, instead of misery and discontent, create wealth and poverty. Let us come now to the economic effects of immigration. Often, today and in the past, we hear pleas and limits on immigration based on alleged negative effects on employment and real wages. In liberal thought, immigration is neither due to unemployment, nor does it generate a decline in real wages. These fears arise from the classical conception of microeconomics concerning decisions taken and being given the purposes and the means. The liberal approach is due to Mises and to his idea of human action, under which the individual takes decisions to "get better and to eliminate discomfort". It is certain that if we take employment as a given, every immigrant takes a job from a national worker. Similarly, if we take production processes and capital stock as a given, through the replacement of capital with labour and the diminution of the marginal product of the latter, a reduction in wages will follow. However, things are different. Employment is indeed limited by productivity, but if the latter rises the former grows too. Immigrants tend to save money, often more than nationals, and this increases the stock of capital, thus increasing the

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productivity of labour. Labour’s highest productivity increases wages. These effects may be reinforced if a country is receiving skilled immigrants. The highest manifestation of this phenomenon is the migration of brains. Qualified individuals are the most creative and innovative. Consequently, their employment leads to increased labour productivity. These phenomena occur in their fullness if the state does not intervene with subsidies for immigration. Immigration policies such as family reunification, the regularization of illegal immigrants, and the generous grants of political asylum, encourage the immigration of people with low or no qualifications who are driven by poverty but also attracted by the prospect of such a subsidy. The definition that Frédéric Bastiat gave to the state is well known: "this fiction by which everyone tries to live at the cost of everyone else". So, immigration policies end up by leveraging the prospect of living at the expense of others. It follows that when the immigration of the less productive is encouraged, real wages may tend to decrease. The problem is not immigration, but the immigration policy. Free trade, namely the free movement of goods and services, would be meaningless without it being accompanied by the free movement of persons. "Laissez aller" and "laissez passer" refer also to the people, but particularly to these. In fact, any exchange would not be possible, without the freedom of movement of people. Restrictions on freedom of movement have effects that are not dissimilar from those of protectionism. If in a country there is a shortage of people willing to do a specific job (for example, plumbers, electricians, and computer engineers), in the absence of free movement of persons the protected workers of that sector will benefit from a rent position (extra-salary). This will be to the detriment of the consumers, who will pay higher prices for the services they buy from such workers. It will even be to the detriment of companies that cannot find employees with specific knowledge and will lose opportunities; therefore they will invest, produce and export less and will create fewer additional jobs, compared to the conditions of free movement of labour. On the other hand, the workers who are prevented from emigrating are not able to take advantage of better job opportunities, giving rise to the phenomenon of intellectual unemployment. At the level of the whole human society there is a lowering of labour productivity, and a consequent loss of welfare, just as with trade protectionism. The liberal theory of the free circulation of labour exposed above brings us to identify a diametrical difference between the effects of the free movement of goods and those of the free movement of labour. Free trade leads to a sharp increase in international trade, which is then its great

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benefit. On the other hand, the freedom of migration, namely the lack of state obstacles and prohibitions on immigration, minimizes immigration flows, but in this case, we can conclude that this is its great benefit. In a liberal economic space, the SEM is a good approach to a liberal economic space; migration flows tend to decrease over time until they become very low in terms of quantity, but with more and more highquality content, expressed in terms of professional qualifications, or of the human capital level of those who emigrate. The effect of migration flows that are limited in quantity but of high quality, is to raise the productivity of the liberal economic space. Let us examine what can now be seen regarding the EU.

1. The intra-European labour mobility situation in 2005 When liberals state, as seen above, that the best immigration policy is no immigration policy, they make a statement of principle. This is valid only in the context of the liberal policies implemented by many countries. More precisely, the principles above are valid only between countries adopting liberal principles, especially in terms of the free movement of goods, services and capital. That being so, in fact, the free movement of labour does not need a real policy, but only common rules to ensure that the worker who emigrated can enjoy the same rights as the local one. This is what is happening in the EU. It is well known that among the EU countries exists the free movement of labour, which, essentially, has as a reference the principles provided in the preceding paragraph. We face a level playing field on which the rules are the same for all workers; member states have removed the obstacles to their freedom of movement. Therefore, if a worker wishes to migrate to another member state he just needs a contract of employment. If a Spanish employer wants to hire an Italian or a German he can do so under the same conditions as a national worker. What is decisive, therefore, is the liberal principle whereby if a person considers working in another country where there is an employer who is interested in hiring him, this is sufficient for the former to go there and work there. The state does not intervene and subsidies, prohibitions or limitations of any kind do not exist. The state has only prepared, through legislative harmonization or through mutual recognition, the legislative framework ensuring the level playing field. The economic effects of the free movement of labour are those provided by liberal theory. Immigration among the EU-15 relates almost exclusively to people with high qualifications of skills and studies. These flows increase labour productivity, because they are determined by the

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search for a more efficient allocation of human capital. They help to create more jobs and increase the level of salaries and wages, resulting in a higher quality of life. Figure 5.1 shows the immigration data of nine EU-15 countries in 2005. With the partial exception of Luxembourg, immigration to these countries from the EU-15 is just a fraction below 10% of the total. New member countries, essentially the EU-12, will follow. The most relevant rate is the one for non-EU countries. Figure 5.1

Immigration, 2005, % comp. 120 100 80 60 40 20 0 DK

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The EU-15 situation in 2005 was the result of a long evolution. During the previous half-century intra-EU-15 migration flows underwent major quantitative and qualitative changes. From a quantitative point of view, as illustrated by the data in figure 5.2, the mobility of intra-EU-15 workers has been declining strongly. The result is an inverse relationship between the progressive realization of a European area of free movement of labour and its mobility. This trend is closely linked to the changing economic conditions in the countries which are the source of emigration. Trade liberalization and the resulting greater degree of the division of labour created by the process of European integration have generated an increase in labour productivity which has led to higher levels of income;

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consequently wage differences weakened between member countries and this fact has limited migration flows. Wage differences, as many empirical studies show, are the primary cause of emigration. More generally, limited labour mobility is a consequence of the progressive balance that has emerged in the EU-15 among the push and pull factors of migration. These are the factors associated with the countries of origin and of destination. The former are the levels of unemployment, low incomes, poverty, political instability and population growth. Among the latter are high salaries, the availability of jobs, social security systems and political stability. There was decreased mobility for intra-EU-15 workers in the 1950s and by 2005 there was the resulting decline of push factors such as unemployment and poverty (consider the case of Italian emigration to Germany, France and Belgium in the 1950s). At the same time, pull factors such as social security and other employment conditions, and wage levels have lost much of their force of attraction. Social systems have become more homogeneous, precisely because of the free movement of labour policies, while wage differences have attenuated. It is true that there are still differences, but these are not enough to push emigration. The second transformation is qualitative. Whereas in the past people with low qualifications migrated, now people with medium to high qualifications migrate. This phenomenon, at least in the EU-15, has little to do with the brain drain. This can be deduced by the fact that inflows and outflows of people with medium to high skills apply to all EU-15 countries. Rather their cause must be sought in the fact that in 2005 the economies of the fifteen were increasingly integrated.

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r populaation of working g age Figure 5.2: Peercentage of forreigners in the resident

Source: E Eurostat

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2. Extra-EU and intra-EU migration in 20141 As we have seen in the previous section, migration is influenced by a combination of economic, political and social factors either in a migrant’s country of origin (push factors) or in the country of destination (pull factors). The relative economic prosperity and political stability of the EU member states have exerted a considerable pull effect on immigrants. In this section, we will develop a closer view of the situation of immigration from the perspectives of extra-EU and intra-EU migrations.

2.1 Migration flows According to Eurostat: A total of 4.7 million people immigrated to one of the Member States during 2015, while at least 2.8 million emigrants were reported to have left an EU Member State. These total figures do not represent the migration flows to/from the EU as a whole, since they also include flows between different EU Member States.

Among these 4.7 million: a) About 1.6 million were citizens of non-member countries, i.e. extra-EU immigrants. As far as intra-EU migration is concerned: b) About 1.3 million migrants had citizenship of an EU member state that was different from the one to which they immigrated. In other words, these are pure intra-EU migrants. c) Around 870 thousand people migrated to an EU member state of which they had citizenship as returning migrants or nationals born abroad. We will refer to them as national immigrants. In 2014, the relative share of national immigrants was highest in Romania (91% of all immigrants), Lithuania (80%), Estonia (65%), Poland (57%), Latvia (57%), Slovakia (55%), Hungary and Portugal (both 52%). In these 1

This section is based on the figures provided in: Eurostat, “Migration and migrant population statistics”. Available at: http://ec.europa.eu/eurostat/statistics-explained/index.php/Migration_and_ migrant_population_statistics.

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countries, national immigration accounted for more than half of the total number of immigrants, as indicated in figure 5.3. .

Figure 5.3

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Information on citizenship has often been used to study immigrants with a foreign background. However, since citizenship can change over a person’s lifetime, it is also useful to analyze information by their country of birth. The relative share of native-born immigrants within the total number of immigrants was highest in Lithuania (72% of all immigrants), followed by Romania (68%) and Poland (50%). By contrast, Italy, Spain, Germany, Austria and Luxembourg reported relatively low shares of native-born immigrants: less than 10% of all immigration in 2014. In 2014, the flow of extra-EU immigrants was just below 2 million. In addition, intra-EU migration reached the level of 1.8 million people. Luxembourg received the largest share of intra-EU immigrants (91% of total), followed by Slovakia (80%) and Romania (75%); relatively low shares were reported by Bulgaria (19% of all immigrants), as well as Italy and Sweden (both 29%), as shown in table 5.4.

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Figure 5.4

2.2 Migrant population In the EU-28 in 2015 there were 34.3 million people living in their member state who were not born there. At the same time, there were some 18.5 million persons who were born in an EU member state that was different to the one in which they were living as residents. Only in Hungary, Ireland, Luxembourg, Slovakia and Cyprus was the number of

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persons born in other EU member states higher than the number of those born outside the EU-28. Always according to the Eurostat report: The number of people residing in an EU Member State with citizenship of a non-member country on 1 January 2015 was 19.8 million, representing 3.9% of the EU-28 population. In addition, there were 15.3 million persons living in one of the EU Member States on 1 January 2015 with the citizenship of another EU Member State.

The largest numbers of non-nationals living in the EU member states in 2015 were found in Germany (7.5 million persons), the United Kingdom (5.4 million), Italy (5.0 million), Spain (4.5 million) and France (4.4 million). Non-nationals in these five member states collectively represented 76% of the total number of non-nationals living in all of the EU member states, while the same five member states had a 63% share of the EU-28’s population. In relative terms, the EU member state with the highest share of nonnationals was Luxembourg, as non-nationals accounted for 46% of its total population. A high proportion of non-nationals (10% or more of the resident population) was also observed in Cyprus, Latvia, Estonia, Austria, Ireland and Belgium. It is important to underline that, in most EU Member states, most nonnationals were citizens of non-member countries (table 5.2); the opposite was true only for Luxembourg, Slovakia, Cyprus, Ireland, Belgium, the Netherlands, Hungary, the United Kingdom, Malta and Austria. In the case of Latvia and Estonia, the proportion of citizens from non-member countries was particularly large due to the high number of former Soviet Union citizens, who were permanently resident in these countries but had not acquired any other citizenship. In all of the EU member states except for Estonia, the Czech Republic and Latvia, the number of people born in a non-member country was larger than the number of people with citizenship of a non-member country.

2.3 Education and mobility Figures 5.5 and 5.6 provide an analysis of the proportion of residents who moved home during the 12-month period prior to the census, by occupation and by economic activity. In both cases the information for people moving home is compared with that for all persons in employment.

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Figure 5.5 shows that the likelihood of someone moving home was higher for a range of occupations associated with higher levels of educational attainment, for example, professionals and technicians were more likely to move, whereas the propensity to move was lower among those with craft and related trades, agriculture, forestry and fishery, or clerical support occupations. Figure 5.6 presents a similar analysis by economic activity and confirms the results observed in figure 5.5. Those people working in traditional activities such as industry, agriculture, forestry and fishing or construction moved less often than their overall share in total employment, while those employed in professional, scientific, administrative and support services, distributive trades, transport, accommodation and food services, or information and communication services were more likely to move. Note that many services are omnipresent, while specific industrial or agricultural activities may only be in a few regions. There is some evidence to support the view that those with more developed skills and competencies have a higher propensity to consider employment opportunities over a wider geographical area: changing region or country may be more a part of the professional culture of certain highly-educated workforces in areas such as professional and scientific services or information and communication services.

140 Figure 5.6

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Conclusion Liberal thought provides a useful interpretation of labour mobility in the EU (of EU nationals) and of its interrelation with the free circulation of goods and services. As we have previously seen these two freedoms act in opposite directions. Free circulation of goods and services enhances their flows. This stimulates the growth of the enterprise dimension and the birth of new ones, and consequently new jobs are created. More job opportunities at home reduce the need to emigrate, acting as a sort of retaining factor. At the same time, however, the growth of intra-EU trade and intra-EU delocalization, the freedom of establishment and the creation of trans-border value chains have created new job opportunities for people with high skills and competencies. The quantitative diminution of flows has thus been accompanied by a qualitative up-grading of the demand for labour. This phenomenon, which is a peculiar effect of the EU’s integration process, has been accompanied by an increasing flow of immigrants from non-EU countries. Massive flows of mainly unskilled labour outstrip the intra-EU flow of nationals of EU countries.

Bibliography Einaudi, Luigi. 2011. “The War and European Unity.” In Luigi Einaudi, una visione liberale a guida della storia: gli Scritti Europei, il Commiato, edited by Angelo Santagostino. Bari: Giuseppe Laterza Editore. Eurostat. 2015. “Migration and migrant population statistics.” Luxembourg. Salin, Pascal. 2000. Libéralisme. Paris: Odile Jacob. von Mises, Ludwig. 1996. Human Action, fourth revised edition. Fox and Wilkes.

CHAPTER SIX NETWORK INDUSTRIES IN THE EUROPEAN SINGLE MARKET KADIR DEVELI AND KORAY GOKAL ANKARA, ANKARA YILDIRIM BEYAZIT UNIVERSITY

Introduction The EU energy market, serving about half a billion people in 27 member states, with a yearly electricity demand above 3000 terawatt-hours (TWh, corresponding to one trillion Wh) and a yearly gas demand of about 430 million tonnes of oil equivalent (Mtoe), is the largest integrated energy market in the world (Vasconcelos, 2009). Each of the countries that make up the world's largest energy market have different objectives and face several problems in their internal energy markets such as the security of energy supplies, economic stability, climate change and social development. However, these objectives and problems cannot be overcome by the member states acting individually. They need to work together to ensure competitive, sustainable and secure energy. The EU and its member states must transform their individual objectives into a common policy. The Single European Act in 1986 led to a concerted attempt for a completely common policy. Europeans contemplated a single European energy policy in the form of an open energy market for the first time. In fact, a coherent European energy market was vital to the development of the Single European Market (SEM). However, many governments were very cautious in opening their energy industry to liberal market forces at the beginning because it was clear that the competitive pressures of the single market would force their local companies to become more efficient and for their governments to deregulate and liberalize their market conditions. It was not an easy decision for member states to open up their national markets to competition.

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This chapter investigates the steps towards the single energy market after the 1986 Act, in the context of different member states’ behaviours and what was done to achieve the single energy market in the EU. In the next section, an outline of the integration process in the context of the European Single Market is provided; the second section discusses the energy policy of the EU; the third explains the regulatory steps towards the Single Energy Market in the EU within a historical perspective. The fourth, fifth and sixth sections are about unbundling, effective regulation, infrastructure, transparency and network security, respectively. The debate on whether energy is a private or public good is the subject of the eighth section. Finally, the ninth section concludes.

1. The integration process and the European single market The process of transferring authority from the member states to the EU is always a controversial issue. How much integration does the EU need? This question is related to the authority of the countries and integration levels. More cooperation on economic, political and cultural issues can bring more integration. Integration can be defined as the transferring of autonomous bodies of nation states to rules and policies determined by a supranational institutional structure (Huelshoff, 1993: 233). Integration means coalescence and harmony. It is defined as “the process of political actors” directing their loyalty, expectations and political deeds to a new centre within nation states at a certain level (Corbey, 1995: 2) Integration can be divided into political and economic integration. Political integration is the process whereby political actors in several distinct national settings are persuaded to shift their loyalties, expectations and activities to a new centre (Haas, 1958: 16). Political integration has been related to high policies of member states, such as security. But member states are reluctant to share their sovereignty with institutions. Economic integration is more feasible. It was the common idea for the EU. When countries form economic coalitions, their efforts represent a partial movement towards free trade; this is an attempt by each participating country to obtain some of the benefits of a more open economy (Dennis R. Appleyard and Alfred J. Field, 2014: 396). The approach of member countries to the integration process is not completely clear. The EU has two policies for integration. The first is a low policy including economic, societal and cultural relations. The second is a high policy which includes foreign policy and security issues. Low policy provides a wide area for economic, social and cultural cooperation;

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the EU has succeeded in this. Broad cooperation on cultural, economic and social integration has been seen in the EU. But the security issues have still been under the control of each member country, because member states have followed their domestic interests as far as security and energy are concerned. European integration aims to further economic and political integration. Cooperation is an opportunity for integration. Common economic interests lead to strong economic and political relations among the countries and spark greater economic and political integration. The process of market unification that began when the original EU members started making the customs union process in 1958 was still incomplete 30 years later. In the Single European Act of 1986 (which modified the founding treaty of Rome), EU members took the crucial political steps to remove the remaining internal barriers to trade, capital movements, and labour migration (Paul R. Krugman, Maurice Obstfeld and Marc J. Melitz, 2012: 593). From the beginnings of integration, one of the most important policies of the EU has been the realization of full economic integration. The single market is one of the EU’s greatest achievements. It has fuelled economic growth and made the everyday life of European businesses and consumers easier. The single market refers to the EU as one territory without any internal borders or other regulatory obstacles to the free movement of goods and services (https://ec.europa.eu/growth /single-market_en). The EU single market approximately accounts for 500 million consumers and 21 million small- and medium-sized enterprises (SMEs). The enlargement process and migration from extra-EU countries have increased these numbers continuously. The final goal of the commission is the free movement of goods and services within the market, providing the standardization of safety for consumers and the protection of the environment. Services are a crucial issue for the single market due to economic activity and employment. Over 70% of all economic activity in the EU belongs to services and a similar proportion is present in employment. EU companies have the freedom to establish themselves in other EU countries and the freedom to provide services in countries other than the one in which they are established. The free movement of goods and services in the single market has created opportunities for a greater network of cooperation among economic agents belonging to different member states. The process of setting up and enforcing rules with the cooperation and support of all the parties, in order to benefit from the single market, has been defined as standardization. Standards are voluntary technical

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specifications that apply to various products, materials, services and processes. EU standards primarily aim for greater safety, health, property rights and environmental protection. They can help to reduce costs, improve safety, enhance competition and facilitate the acceptance of innovation. Standards are also the components and needs of network industries. Standardization has allowed the European Commission to work to remove or reduce barriers to intra-EU trade. Energy has a crucial role in the EU integration process, because it provides great economic and political opportunities for cooperation. Unlike most economic issues, energy is high policy.

2. The EU energy policy The EU has been trying to develop its own common energy policy. This attempt has been difficult because member states’ priorities are based on their own interests. Gas crises as well as temporary cuts in gas supply in 2006 and 2009, led to a raising of the issue of a “common energy policy”, which is in particular “secure, sustainable and affordable energy’’. The EU imports 53% of its energy consumption. This situation makes cooperation necessary. Energy cooperation among member states is necessary for the competitive market structure and for developing network industries. The energy challenge is thus one of the greatest tests which Europe must face. The EU has tried to develop a more secure and sustainable energy policy since the 1980s. A common EU energy policy has evolved around the common objective to ensure the uninterrupted physical availability of energy products and services on the market. According to the Lisbon Treaty the central goal of the EU energy policy is security of supply, competitiveness and sustainability. Citizens in most member states have not had to experience any lasting disruption of their energy supply. But the cutting off of Ukrainian energy has made energy security a crucial issue. The European Commission defines energy security as: meeting the future energy needs from national sources, making use of strategic reserves under reasonable conditions, being able to gain access to strategic energy stocks and the ability to purchase energy from reliable external sources. (European Commission, 2000: 30)

Borton defines energy security as the ability to gain access to energy sources without risk and serious failure in service for the citizens and the people engaged in this activity and the whole nation. (Barton et al., 2004: 5)

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In short, energy security can be expressed as the supply of sustainable and safe energy at reasonable prices (Bahgat, 2005: 8). To promote closer cooperation that is beneficial for all member states, the following points are crucial: 1. Immediate actions aimed at increasing the EU's capacity to overcome a major disruption during the winter of 2014/2015; 2. Strengthening emergency/solidarity mechanisms including the coordination of risk assessments and contingency plans; and protecting strategic infrastructure; 3. Moderating energy demand; 4. Building a well-functioning and fully integrated internal market; 5. Increasing energy production in the EU; 6. Further developing energy technologies; 7. Diversifying external supplies and related infrastructure; 8. Improving the coordination of national energy policies and speaking with one voice on the external energy policy (European Commission, 2014: 2).

The EU should develop an energy policy over all the states. Decisions on a common energy policy must be adopted by all member states. Fragmented markets not only undermine the security of supply, they also limit the benefits which energy-market competition can bring. The time has come for energy policy to become truly European. The new energy strategy of the EU focuses on five priorities: 1. Achieving an energy efficient Europe; 2. Building a truly pan-European integrated energy market; 3. Empowering consumers and achieving the highest levels of safety and security; 4. Extending Europe's leadership in energy technology and innovation; 5. Strengthening the external dimension of the EU’s energy market (European Commission, 2010: 1).

An integrated industrial approach is needed to support competition and an efficient market structure for companies. Energy is a burden for the industrial aspects of cost and risk. Therefore, the EU must also consolidate its competitiveness in energy technology markets. The industrial sector needs to incorporate energy-efficiency objectives and energy technology innovation in order to gain a resource efficiency policy (European Commission, 2010: 1).

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3. Regulatory steps towards the single energy market in the EU From the early stages of EU integration, constituting a single energy market and implementing a common energy policy in the EU have been major political and economic issues among member states. The EU has established three main objectives for an energy policy: competitive prices, sustainable clean energy and energy security. A well-functioning and integrated energy market is the only condition for achieving these objectives. In a recent study, the net economic benefits of a single energy market in the EU have been estimated at about 40 billion euros per year. Most of the member states are aware of these potential economic benefits and there has been a concerted effort to establish a single market, despite all the complexities caused by the political exigencies, legislation and economic structure of the member states. The first and most important step towards the single energy market in the EU is the "third party access (TPA)" policy (Fiedler, 2015). According to this policy, adopted in 1991 by the European Commission, all European consumers whether individuals or manufacturers could buy gas or electricity from a producer they requested with the lowest cost on the continent. However, the state-owned monopolies were the main obstacle to the implementation of TPA. These monopolies were available in almost every member state and they produce, transmit and distribute electricity and gas across the country. Unbundling state-owned monopolies was not as easy as it looked because of the political and technical difficulties. Therefore, although liberalization accelerated in most sectors, the energy sector resisted for a long time. The first liberalization process in the energy sector began with the Electricity Directive (1996) and the Gas Directive (1998). These directives enforced the member states to open up their energy markets to competition and remove trade barriers in domestic markets. In 2003, the EU prepared the Second Energy Package. In this package, the EU requested the unbundling of energy suppliers from member states. In 2004 the EU achieved the largest single expansion. The ten new member states, sometimes referred to as the "A10" countries, have quite different views on an energy policy and different energy market structures. After that enlargement, the context for the single energy market in the EU was characterized by the harmonization of regulations for the new member states. In January 2006, the EU faced an unexpected situation while dealing with harmonization problems. The dispute between Ukraine and Russia

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over gas contracts led to supply problems in the EU, as the main pipeline infrastructure passes over Ukrainian territory. The emerging instability in the region raised the energy security issue among the member states. However, the raising of energy security concerns in the EU was mainly due to new-member Eastern European countries being dependent on Russian gas. Indeed, some EU members completely depend on Russia for their entire gas imports, like Estonia, Finland, Latvia and Lithuania, or consume almost all of their natural gas from Russia, like the Czech Republic, Slovakia and Bulgaria. This dependence makes their economies not only vulnerable to supply shocks, but their governments susceptible to political pressure. Countries like Germany and Romania with relatively high domestic gas production also have considerable import rates from Russia. Only countries with significant domestic gas production like the Netherlands and Norway or countries far away from Russia like the UK and Spain are independent of Russian gas (Paque, 2015). Consequently, the dependence of new member states on Russian energy resources is seen as the biggest obstacle to the harmonization of regulations and the constitution of a single energy policy in the EU. Another issue that formalizes the single energy market policy in the EU is the raising of public pressure on climate change after the 2000s. Actually, climate change and renewable energy sources were not on the EU agenda in the first single market initiatives. The first regulations attached importance to liberalization and competitiveness issues rather than the environmental sensitivities (Hirschl, 2009). However, increasing public awareness about environmental protection forced the EU to insert environmental regulations in the single market concept. The first and most important step was Directive 2001/77/EC on the promotion of electricity produced from renewable energy sources in the internal electricity market. According to the directive, member states have to set a national indicative target of the share of renewable energy sources in their gross electricity consumption. These national targets should be consistent with the European Community’s indicative target of 12% of gross national energy consumption by 2010 and in particular with the 22.1% indicative share of renewable energy sources in the Community’s total electricity consumption by 2010 (Swider et al., 2008). In 2007, the European Commission announced a strategy document called "An Energy Policy for Europe". This document mentions the measures that need to be taken with the objective of creating a European Gas and Electricity Grid and a truly competitive single energy market (European Commission, 2007c). These measures can be listed under unbundling, effective regulation, transparency, infrastructure and network

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security and energy as a public service. These measures are explained in detail in the following sections.

4. Unbundling The Commission recommends two options for unbundling. One of them is a full Independent System Operator and the other is ownership unbundling. The Independent System Operator has responsibility for controlling access to and the use of the transmission grid by competing generators and retailers. Transmission assets may still be owned by a single generation company or retailer, but the real-time control of their operation is vested in the Independent System Operator (Pollitt, 2012). However, under ownership unbundling a separate company owns and operates the network assets (distribution and/or transmission). This company is then not allowed to also own the non-regulated generation and/or retail activities. Ownership unbundling can therefore be viewed as vertical disintegration (Nillesen and Pollitt, 2011). Although both options are proposed, the Commission prefers ownership unbundling instead of the Independent System Operator as a form of organization in electricity and gas markets.

5. Effective regulation From the Commission's point of view, there is a relationship between unbundling and effective regulation. The unbundling option requires the regulator to be more intrusive in the market to prevent discrimination. However, the national regulators are inadequate to take the necessary steps for effective regulations because of their different priorities. This situation makes the creation of a single energy market difficult and often impossible. Additionally, the European Regulators' Group for Electricity and Gas (ERGEG), a formal advisory group to the European Commission created by the Commission in 2003 (Palacio, 2003), cannot provide the necessary support to national regulators for harmonizing the relevant technical standards. So, in 2011 a new organization called the Agency for the Cooperation of Energy Regulators (ACER) was established following the entry into force of the third energy liberalization legislative package in 2009. The main task of the ACER is to cooperate with NRAs and other EU institutions to develop common rules for the single energy market and the operation of the European energy grids. Moreover, the ACER’s role is to complement the activity of NRAs by providing EU-level regulatory oversight (Michetti, 2012). Additionally, the ACER has the legal power to

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take and enforce binding decisions. However, the Commission is reluctant to give the ACER power over the European associations of TSOs in practice (Wallace et al., 2014).

6. Infrastructure, transparency and network security According to the Commission, the EU will need to invest €900 billion in new electricity generation, gas will need €150 billion of investment in gasfired power plant and an additional €220 billion is needed for gas infrastructure until 2030 (European Commission, 2007c). Achieving the infrastructure investment target is only possible with a well-functioning energy market providing the correct investment signals. Transparency is essential for the correct signals. In 2011, the Regulation on Wholesale Energy Market Integrity and Transparency (REMIT) was designed to increase the transparency of the European energy markets. The REMIT contains prohibitions of a) using inside information; b) disclosing inside information; and c) recommending or inducing another person to use or disclose inside information (ACER, 2011). The ACER has been tasked with the supervision and regulation of energy markets in accordance with the REMIT. Network security has been part of energy security. There are two opposing beliefs about network security in the EU. Some believe that the incomplete liberalization of the EU energy system is a risk for network security. Others consider liberalization to be a risk for network security because of the delayed investments in infrastructure (Boersma, 2015). Whatever the reason, common minimum and binding network security standards are necessary in the EU to increase the reliability of the EU's electricity system.

7. Energy as a public service The most common political difficulty relates to how energy characteristics are seen from the point of view of governments: is energy a private or a public good? Energy has mostly been seen as a public good rather than private one, so governments believe that energy must be provided by the state rather than the private sector. However, this belief is inconsistent with the economic realities and constitutes a barrier to a single energy market policy in the EU. The concept that electricity and gas are public services is widely accepted in positive law in the EU; consequently, existing European legislation already requires respect for Public Service Obligations. However, this finding of positive law does not coincide with economic reality and ignores economic motivations. In such a manner, a

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sector which is competitive in terms of inputs is defined as a public service. The fact that goods and services, which are economically private goods, are supplied by the state or by a means other than the free-market mechanisms, leads to the production of these goods more or less efficiently. The characteristic of a public good also requires that it is a political good. So, energy has been seen as a political good by most of the governments and these governments want to keep energy prices under their control. This belief puts off many EU governments from taking the necessary steps to liberalize their energy markets and privatize stateowned monopolies. However, the Commission looks at the issue of whether energy is a public good only in terms of energy poverty and the protection of consumers in contrast to governments. In the 2007 strategy document, the Commission defined four key goals to protect customers in the EU: to help EU citizens deal with increases in energy prices, to help them choose between supply options, to reduce paperwork and protect them from selling practices (European Commission, 2007c).

Conclusion The most important result of the single energy market concept in the EU for the member states is to open up their national markets to competition. However, this was not an easy decision for EU member states because of three basic reasons First of all, energy has been seen mostly as a public good rather than a private one, and consequently governments believe that energy must be provided by the state rather than by the private sector. Secondly, energy has been seen as a political good by most governments and governments want to keep energy prices under their control. Thirdly, energy is a strategic good so states want to improve the security of their own energy supply and do not tolerate any negative impact of the single market on their own national energy sectors. For these reasons, the responses of the member states were different to the logic of the single energy market in the EU. Some of them have provided transparency and deregulation in their markets, while others often fight to maintain much of its direct control. However, problems in internal energy markets cannot be overcome by the member states acting individually. They need to work together to ensure competitive, sustainable and secure energy. The EU and its member states must transform their

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individual objectives into a common policy in the single energy market concept.

Bibliography ACER. 2011. “Guidance on the Application of the Definitions Set Out in Article 2 of Regulation (EU) No 1227/2011 of the European Parliament and of the Council of 25 October 2011 on Wholesale Energy Market Integrity and Transparency,” 1st Edition, Dec. 20, 2011. Appleyard, D. R., and Alfred J. Field Jr. 2014. International Economics, 8th edition, McGrow-Hill. Bahgat, G. 2005. “Energy Security: The Caspian Sea.” Minerals & Energy––Raw Materials Report, 20 (2): 3-15. Boersma, T. 2015. Energy Security and Natural Gas Markets in Europe: Lessons from the EU and the United States. Routledge. Commission of the European Communities. 2007c. “Communication from the Commission to the European Council and the European Parliament: ‘An energy policy for Europe’”. SEC 12, 10 January. Communication from the Commission to the European Parliament and the Council. European Energy Security Strategy /* com/2014/0330 final. De Palacio, L. 2003. Commission Decision of 11 November 2003 on Establishing the European Regulators Group for Electricity and Gas (2003/796/EC), Official Journal of the EU L, 296, 34-35. European Parliament and the Council. 1996. Directive 96/92/EC of the European Parliament and of the Council of 19 December 1996 Concerning Common Rules for the Internal Market in Electricity, Official Journal L 027, 30 January 1997. —. 1998. Directive 98/30/EC of the European Parliament and of the Council of 22 June 1998 Concerning Common Rules for the Internal Market in Natural Gas, Official Journal L 204, 21 July 1998. Fiedler. 2015. “The making of the EU Internal Energy Market,” Rosa Luxemburg Stiftung, Brussels Office Policy Paper. Haas, E. B. 1958. The uniting of Europe: Political, social, and economic forces, 1950-1957 (No. 42). Stanford University Press. Hirschl, B. 2009. “International renewable energy policy––between marginalization and initial approaches,” Energy Policy, 37 (11): 44074416. Huelshoff, M. G. 1993. “European integration after the SEA: the case of the Social Charter,” Political Research Quarterly, 46 (3): 619-640.

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Krugman, P. R., M. Obstfeld, and M. Melitz. 2012. International Economics. Boston et al. Michetti, E. 2012. European Energy Markets Transparency Report––2012 Edition. Nillesen, P. H., and M. G. Pollitt. 2011. “Ownership unbundling in electricity distribution: empirical evidence from New Zealand,” Review of Industrial Organization, 38 (1), 61-93. Paque, K. H. 2015. “Europe’s Dance on the Russian Gas Flame: Challenges and Perspectives for European Energy Security,” Friedrich-Naumann-Foundation for Freedom, Berlin. Pollitt, M. G. 2012. “Lessons from the history of independent system operators in the energy sector,” Energy Policy, 47: 32-48. Swider, D. J., L. Beurskens, S. Davidson, J. Twidell, J. Pyrko, W. Prüggler, H. Auer, K. Vertin, and R. Skema. 2008. “Conditions and costs for renewables electricity grid connection: examples in Europe,” Renewable Energy, 33 (8): 1832-1842. Vasconelos, J. 2009. “Energy regulation in Europe: regulatory policies and politics of regulation,” European Review of Energy Markets, 3 (3): 112. Wallace, H., M. A. Pollack, and A. R. Young, eds. 2015. Policy-making in the EU. USA: Oxford University Press.

CHAPTER SEVEN POLAND AND TURKEY AS THE SUCCESSFUL CATCHING-UP COUNTRIES AND THEIR BILATERAL TRADE (2000-2015) BOGUMIàA MUCHA-LESZKO AND TOMASZ BIAàOWĄS MARIA CURIE-SKLODOWSKA UNIVERSITY, LUBLIN

Introduction Poland and Turkey can both be considered members of the group of emerging economies that managed to significantly diminish their development gap towards the EU-15 through dynamic economic growth. Poland and Turkey are great examples of countries which seized their chances in the catching-up process due to the progress achieved and the impact of systemic reforms, EU integration, and integration with global markets on structural changes in both economies. In each case the process was spread differently over time. In Turkey it started in the 1980s and in Poland in the 1990s but it was more dynamic. Nevertheless the main factor contributing to structural changes and economic convergence from emerging economies to advanced economies was institutional and there was real integration with the European Union. For Turkey the turning point was the creation of a customs union with the EU in 1995 which coincided with the completion of the GATT Uruguay Round and the foundation of the World Trade Organization as well as the ever-growing globalization of markets and economic activity. The customs union contributed not only to an increase in trade and investment flows but also allowed Turkish companies to join European production networks (especially in automobiles and clothing production) (World Bank, 2014: 1). The institutional base for trade relations was strengthened as a result of

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the harmonization of Turkish law with wide-ranging EU legislation in order to eliminate technical barriers to trade. The process of building market economies in Central and Eastern European countries began in 1989-91 with the fall of the bloc of nations functioning under the Soviet Union’s hegemonic control. The disintegration of the economies of the former Council for Mutual Economic Assistance limited their resources and development capabilities. Therefore, the reorientation of economic ties and formal integration with the European Union were the main priorities of Poland's economic policy as well as that of other CEECs. Poland's economic advancement chances were limited before the transformation compared to Western European economies and it resulted in the preservation of the development gap. The largest losses in terms of development occurred in the 1980s when its average GDP growth rate was -0,4% while in Spain it was 2,5% and in Ireland 2,7% (Bukowski et al., 2006: 15). The first years of systemic transformation and the realization of the Balcerowicz Plan from 1990 were a sort of shock therapy and included: economic liberalization, the reform of the banking and tax systems, the development of the capital market, the stabilization of the Polish zloty and the privatization of state-owned national wealth. The costs of those reforms were steep: a decrease in production, growing unemployment rates, falling real wages, and decreasing demand. Cumulative losses in GDP in the first 3 years of the transformation were estimated at 13% in Poland and Czechoslovakia, 25% in Bulgaria and 3040% in Romania and the Baltic states (Roaf et al., 2014: 11-13). The public financial state also worsened due to diminishing tax revenues. The first signs of economic stabilization in Poland appeared in 1992, but the productive capacity of the economy remained under-utilized. P. Biaáowolski's calculations point to a negative deviation of real product compared to the potential product in 1992-1994 which gradually fell from 4% through 2% to reach 0 (Biaáowolski, 2005: 46). Production capacity utilization had been improving since January 1995 and the real product surpassed the potential by October 1998 ranging between 1 and 2% (Biaáowolski, 2005: 46). The Polish economy's ability to grow was a result of investment activity. However, by the end of the 1990s the condition of the economy clearly declined. The slump was caused by two main factors: a slowdown in reforms strengthening the market mechanism, competition and competitiveness, as well as the crisis in Russia in 1998. Another demand shock was a consequence of the worldwide recession that began in 2001 in the United States and Europe and lasted nearly 3 years. The real GDP in Poland fell below the potential level in January 1999 and the low growth rates continued until mid-2003. A significant increase in the Polish

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GDP rate occurred in 2003 and was associated with assuming EU membership in 2004. The growth of Poland's interdependence within the common EU market includes economic relations with Turkey connected with the set market by a customs union agreement. In 2014 Poland and Turkey celebrated the 600th anniversary of establishing mutual diplomatic relations. It was an opportunity for many discussions and meetings of the highest authorities of the two countries and for new initiatives to intensify bilateral economic cooperation. This paper offers some contributions to the discussion foregoing in Poland, which emphasizes Turkey's role as a major economic and particularly trading partner in the region of the Middle East and Asia. New opportunities for developing Poland’s economic relations with Turkey opened with political and economic changes (since the 1990s in Poland) and the Polish accession to the European Union. The aims of this chapter are: í the comparative analysis of economic growth and macroeconomic stability in Poland and Turkey including an assessment of the convergence process in the period 2000-2015 as well as the resistance to economic shocks during the crisis of 2008-2009. The reference countries are Germany and Spain; í the assessment of achievements in the development of trade between the two countries; í the deeper analysis of the mutual trade in goods including: trade dynamics, structural changes, factors of competitive advantage, and development prospects as well as barriers. The mutual trade flows are assessed from the bilateral as well as the European point of view. The analysis covers the years 2000-2015 with some historical references. The main outcomes of the analysis are: í the identification of major drivers of high economic growth in Poland and Turkey in the last two decades; í the assessment of the resilience of both economies to the 20082009 crisis; í the identification of prospective areas for Polish and Turkish economic relations; í the assessment of opportunities for the development of Polish exports to Turkey adjusted to Turkish domestic demand.

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1. Macroeconomic analysis––convergence and identification of the main factors contributing to high economic growth in Poland and Turkey in 2000-2015 1.1. Theoretical framework Modern theories of economic growth and empirical analysis are valuable sources of knowledge on varying levels of economic development and per capita income. Neoclassical economists claim that the most important explanation lies within factors of production and their declining productivity. A meaningful supplement to this concept was the inclusion of investment in physical as well as human capital––while the neoclassical approach was limited to physical capital (Ben-David, Loewy, 2003; Lucas Jr., 1988: 39; SiwiĔski, 2005: 734). This increased the utility of theories for analyzing economic growth. P. Romer (1990), G. Grossman and E. Helpman (1991) focused on factor productivity stemming from knowledge (human capital) and R&D activity contributing to technological improvement and the growth of factor productivity. A further interpretation of technology's impact on economic growth comes from including international spillovers of knowledge and technological progress. Obtaining knowledge by itself does not guarantee production efficiency growth, but the costs of adaptation and the use of technology are lower as it is not necessary to bear the R&D cost as well (MuchaLeszko, 2014: 18). A breakthrough in research on the economic convergence process was brought about by the work of R. Barro and X. Sala-i-Martin (1990, 1991, 1992) published in the early 1990s. It initiated the introduction of new research methods (models) and concepts on assessing convergence. The main focus of the research was beta and sigma convergence. The first kind (beta convergence) can be defined as the ability of less developed economies (with a lower GDP per capita) to grow faster than the more developed ones. The growth rates determine the dynamics of closing the development gap with the high-income countries (the catching-up process). Sigma convergence is a result of beta convergence and refers to a reduction in the dispersion of levels of per capita GDP across economies measured by standard deviation. X. Sala-i-Martin (1996) proposed the hypothesis that sigma convergence also occurs across smaller territorial units such as regions, but it is more difficult to assess especially from a short-term perspective. Empirical analyses carried out during the last two decades that aimed to verify beta convergence and its rate clearly confirm this phenomenon regardless of the number of countries in the study or its

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timeframe. However, the results pertaining to the rate of convergence are varied.1 Closing the development gap depends on the force of factors affecting economic growth––the increase in labour input and labour productivity. Growth in labour productivity is a result of capital input and Total Factor Productivity (TFP). EU membership created new chances for stimulating economic growth due to the free movement of goods, services and production factors––capital and technology in particular and economies of scale arising from the creation of a large internal market–– which speeded up convergence as a result of fiscal transfers and financial aid to countries and regions through Structural Funds. The potential ability to reach and maintain a high economic growth rate is mainly contingent on a country's economic policy. This is crucial for shaping more favourable or less favourable conditions for the utilization of foreign capital and technology to stimulate the economy, thus creating new demand and structural changes.

1.2. Empirical analysis Table 7.1 and figure 7.1 reflect the effects of Poland and Turkey's economic convergence with Germany and Spain in 2000-2015. The baseline for the analysis is average GDP per capita (EU-28=100). It is clear that Poland was closing the gap most rapidly. The dispersion of GDP per capita to Germany lowered from 72 p.p. to 56 p.p. and to Spain––from 49 p.p. to 26 p.p. Turkey also managed to converge towards both reference countries. Nevertheless, Turkish GDP per capita remains significantly lower than Spanish or German GDP. In 2000 it was lower than German GDP per capita by 78 p.p. and in 2015––by 72 p.p. The results of Turkey’s convergence with Spain are more favourable. The dispersion of GDP per capita was 55 p.p. in 2000 and it fell to 39 p.p. in 2014. The significant growth of both Poland and Turkey’s convergence with Spain is a result of the process of divergence of the Spanish economy since 2008 (tab. 7.1).

1

Results of over 50 research products of selected authors from the period 19922008 including analysis of beta convergence in various country groups compiled by M. Próchniak and B. Witkowski (2012: 48-51).

47

Spain

Poland

46

98

118

2001

35

47

100

116

2002

35

48

100

117

2003

39

49

100

117

2004

41

50

100

117

2005

43

50

102

117

2006

44

53

103

117

2007

46

54

101

118

2008

45

59

101

116

2009

48

62

97

121

2010

Germany

Spain

Poland

Turkey

51

64

94

124

2011

53

66

92

124

2012

53

67

91

124

2013

53

68

91

126

2014

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Data in table 1

0

20

40

60

80

100

120

140

Figure 7.1: Real GDP per capita in PPS (EU-28=100) in Poland, Turkey, Germany and Spain

Turkey 41 36 Source: Eurostat (2016).

119

96

Germany

2000

Table 7.1: Real GDP per capita in PPS (EU-28=100) in Poland, Turkey, Germany and Spain

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53

69

92

125

2015

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2000 4,3 6,8 3,2 5,1

Source: IMF (2016)

Poland Turkey Germany Spain

2001 1,2 -5,7 1,8 4,0

2002 1,4 6,2 0,0 2,9

2003 3,6 5,3 -0,7 3,2

2004 5,1 9,4 0,7 3,2

2005 3,5 8,4 0,9 3,7

2006 6,2 6,9 3,9 4,2

2007 7,2 4,7 3,4 3,8

2008 3,9 0,7 0,8 1,1

2009 2,6 -4,8 -5,6 -3,6

2010 3,7 9,2 3,9 0,0

2011 5,0 8,8 3,7 -1,0

2012 1,6 2,1 0,6 -2,6

2013 1,3 4,2 0,4 -1,7

2014 3,3 2,9 1,6 1,4

2015 3,6 3,8 1,5 3,2

Table 7.2: Gross domestic product, constant prices (percentage change) in Poland, Turkey, Germany and Spain, 2000-2015

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In the analyzed period Turkey's gap with Poland grew, as in 2000 GDP per capita in Poland was higher than in Turkey by 6 p.p. and in 2015 the dispersion enlarged to 15 p.p. The Turkish economy turned out to be more cyclically-sensitive than the Polish economy and as a result the fall in GDP in 2001 in Turkey was 5,7%. In 2008 the Turkish economy grew only by 0,7% and in 2009 the negative GDP rate was 4,8% (tab. 7.2). The main drivers of convergence were the following: increased economic activity, the growth of employment, the improvement of labour productivity, and structural changes that contributed to the movement of workers towards more productive sectors and enterprises. Structural changes varied in Poland and Turkey. In Poland there was a flow of workers from closed state-owned enterprises to newly-created privatelyowned enterprises in manufacturing as well as the newly-developing service sector. The movement was from less productive towards more productive enterprises. According to research carried out in the European Bank for Reconstruction and Development the high rate of Total Factor Productivity (TFP) growth in Poland, as well as other transitional economies of Central and Eastern Europe was a result of the transfer of human resources to more productive enterprises (Raiser et al., 2016). In Turkey, on the other hand, the main factor of TFP growth was the movement of the labour force from the agricultural sector to manufacturing and services. Agriculture remains an important part of the Turkish economy and the share of the employed in the primary sector in the total labour force is significant. It is crucial to point out that intensive industrialization was the main component contributing to the growth of labour productivity and GDP growth. The comparability of Poland and Turkey's economies stems from their structural characteristics. The share of employment in the manufacturing sector in Turkey and Poland is around 20%. We expanded our empirical analysis and included GDP growth factors, unemployment rates and the central budget balance, as well as the current account balance in order to better evaluate the economic results, the sources of GDP growth and the macroeconomic balance of Poland and Turkey compared to Spain and Germany in 2000-2015. Considering the varied consequences of the financial and economic crisis in 2008-2009 throughout the European Union, the analysis includes the two separate periods of 2000-2007 and 2008-2015. The average annual indicators for the two periods are provided in table 7.3. Data in table 3 reveal that the average annual real GDP growth rate was highest in Poland and Turkey in both periods. Turkey’s advantage in this respect was bigger in 2000-2007 while in the period of recession in

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2008-2015 the rate dropped to 0,3 p.p. Until the crisis the average GDP growth in Spain was also quite high, close to Poland's result of 4%. The German economy, on the other hand, experienced lower growth rates which were caused by the too restrictive monetary policy of the European Central Bank after the introduction of the euro when it had to be adjusted to the average euro area inflation rate. Table 7.3: Main macroeconomic indicators for Poland, Turkey, Germany and Spain, 2000-2015

Poland Turkey German Spain Poland Turkey German Spain Poland Turkey German Spain Poland Turkey German Spain Poland Turkey German Spain

2000-2007 2008-2015 Gross domestic product, constant prices (percent change) 4,1 3,1 5,2 3,4 1,6 0,9 3,7 -0,4 Growth of labour productivity per hour worked (percent 3,8 2,7 4,8 0,7 1,7 0,5 0,4 1,4 Growth of labour productivity per person employed (percent 3,8 2,5 4,7 0,1 1,2 0,1 0,1 1,4 Growth of Total Factor Productivity (estimated as a Tornqvist 2,0 0,3 0,3 -2,0 1,0 -0,2 -0,8 -0,6 Employment growth (percent change) 0,4 0,7 0,5 3,2 0,4 0,8 3,7 -1,7

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Unemployment rate (percent of total labour force) 16,8 8,9 8,5 10,1 9,3 6,0 10,5 21,0 Inflation, average consumer prices (percent change) Poland 3,4 2,3 Turkey 26,9 8,1 Germany 1,7 1,4 Spain 3,3 1,5 General government net lending/borrowing (percent of GDP) Poland -4,2 -4,7 Turkey -6,6 -2,2 Germany -2,3 -0,8 Spain 0,4 -7,8 Current account balance (percent of GDP) Poland -4,1 -3,6 Turkey -3,0 -5,8 Germany 2,8 6,6 Spain -6,0 -2,1 Poland Turkey Germany Spain

Sources: own calculation based on: gross domestic product, gross domestic product per capita, unemployment rate, inflation, general government net lending/borrowing and current account balance: IMF(2016); Growth of labour productivity, growth of Total Factor Productivity and employment growth: The Conference Board (2016).

During the second of the analyzed periods (2008-2015) there were two waves of recession and recovery is weak in most EU countries. Still, Poland and Turkey maintain relatively high growth rates, and in the case of Spain and Germany the previous tendencies were reversed. Spain suffered from negative growth rates and in Germany there was a slight slowdown but the average GDP growth was 0,9%. The dynamics of the economy are contingent on the input of labour productivity and employment to GDP growth as well as the impact of Total Factor Productivity on labour productivity. In 2000-2007 the highest growth in labour productivity was in Poland and Turkey, but it was also relatively high (for a developed country) in Germany. This was not the case for Spain––the high GDP growth was caused by growing employment in low productive sectors such as the production of construction materials and housing.

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In analyzed countries during 2008-2015 there was a large differentiation of labour productivity and employment input to GDP growth. Labour productivity rates fell significantly in Turkey and Germany, but Turkey maintained its economic growth due to increasing employment, in particular in 2010-2011 (6,2%, 6,7%). Employment also grew in Germany––in relation to 2000-2007; in 2011-2012 employment growth rates were respectively 1,4% and 1,2% (The Conference Board, 2016). It was only in Poland that labour productivity remained as the main growth factor. An apparent improvement of average annual labour productivity growth occurred in Spain––from 0,1% to 1,4% (tab. 7.3). However, it was not a result of the real growth of GDP per person employed or per hour worked, but due to the collapse of enterprises especially in the construction sector, the reduction of employment, the improvement of the capital-labour ratio and the elimination of the least productive market players. TFP, which reflects the role of technological progress in GDP growth, was highest in Poland in both periods. In Germany it declined in 2008-2015 reaching negative levels, in Turkey it fell considerably––from 0,3% to -2,0% (tab. 7.3), and in Spain TFP was declining in both periods. Foreign Direct Investment (FDI) is one of the crucial factors impacting the pace of the convergence process and in particular the process of closing the technology gap and structural changes in emerging markets. The presented data prove that FDI had more impact on stimulating economic activity and productivity in Poland. In Turkey in 2000-2004 FDI amounted to just a small percentage of GDP (below 1%). Its role started growing in 2005 and in 2008 the share of the FDI inflow in Turkish GDP surpassed the same indicator for Poland. However, during the worldwide crisis and the post-crisis economic slowdown, especially in Europe in 2009-2014, FDI in Turkey remained at a low but stable level of around 2,1% to 1,2% of GDP. In Poland the fluctuations of GDP inflow were much wider––from 3,5% of GDP in 2011 to almost zero in 2013. Nevertheless, their impact on the economy was much greater compared with Turkey (figure 7.2).

5.5

0.4

1.7

2.9

2.0

0.5

2000 2001 2002 Source: UNCTAD (2016)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2003

0.6

1.8

0.7

2004

4.9

2005

2.1

3.2

3.8

2006

5.4

2007

3.4

5.0

2.7

2008

2.6

2009

1.4

2.7

2010

1.2

2.7

2011

2.1 1.7

2013

0.0

1.5

Turkey

2012

1.4

Poland

3.5

Figure 7.2: Foreign direct investment in Poland and Turkey in 2000-2014 (inward, % of GDP)

Poland and Turkey as the Successful Catching-up Countries

1.5

2014

2.5

165

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The labour market situation during the crisis improved considerably in Poland, significantly in Germany (due to the labour market policy), and slightly deteriorated in Turkey; in Spain the unemployment rate in 2011 surpassed 21%, in 2013 it peaked at 26,1% and afterwards started falling (to 22,1% in 2015) (IMF, 2016). A high inflation rate remained the weakness of the Turkish economy, but in 2008-2015 it was much lower than in 2000-2007––it fell from 26,9% to 8,1%. Still, compared to Poland, inflation rates are quite high and contribute to diminishing export competitiveness. In terms of the central government balance, in 2000-2007 Poland and Turkey were no match for Germany or Spain, but the crisis changed the situation. The average budget balance in 2008-2015 deteriorated in Poland, but mostly in Spain which had a surplus before, but in 2008-2015 an average deficit of 7,8% of GDP. Turkey and Germany had the lowest rates of government deficit (2,2% and 0,8% of GDP, respectively). A good central budget balance can be considered an asset of the Turkish economy. On the other hand, a serious disadvantage can be pointed out in terms of the current account balance. The longstanding deficit deepened in 2008-2015. Poland's deficit is not that high and in 2013-2015 it was on a declining trend––between -2,0% and -0,5% of GDP (IMF, 2016). The analysis of Poland and Turkey's economic indicators concludes that both countries have considerably reduced their development gap within the last 15 years. Economic progress is quite clear in comparison to highly developed EU economies such as Germany or Spain. It is worth pointing out that Poland and Turkey remained on an upward GDP growth trend during the crisis and the post-crisis recession. The power source for economic activity came from domestic demand. In Poland all the elements of domestic demand contributed to economic growth: investment, private and government consumption. In Turkey the most important contribution to GDP resulted from private consumption that grew due to increases in employment and wages as well as a favourable credit policy. Growth forecasts for 2016-2017 are optimistic and similar to Poland (3,4% to 3,5%) and Turkey (3,9% to 3,7%), but in Poland the discrepancy between forecasted and potential GDP is much smaller (OECD, 2016a: 19; OECD, 2016b: 16).1 According to the OECD, to maintain economic growth Turkey needs to eliminate barriers. Creating low productive jobs will not result in sustainable economic growth or a comparative advantage in trade. The main barriers limiting Turkish growth are: 1) low labour 1

But the last IMF forecasts for 2016-2021 are lower: 3,13%, 3,37%, 3,32%, 3,08%, 2,98% and 2,98% for Poland; 3,28%, 2,98%, 3,22%, 3,32%, 3,46% and 3,51% for Turkey.

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productivity and a slowing growth rate, low R&D expenses and the insufficient interest of foreign investors in choosing Turkey as their destination; 2) low export competitiveness stemming from low labour productivity, low innovativeness and a lack of export specialization in the high-tech product sector as well as low price competitiveness caused by a high inflation rate; 3) insufficient savings as a consequence of the growing propensity to consume; and 4) too many small, low productive enterprises limiting the overall productivity of the economy. In the case of Poland, the main conditions allowing it to remain on an upward growth and convergence trend are: 1) the growth of private investment; 2) the transfer of resources towards higher technology production; 3) the enhancement of workers' qualifications; and 5) a change from temporary contract employment, which is less conducive to labour productivity growth.

2. European integration as the driving force of mutual trade and participation in the global value chains The relatively high growth of GDP and labour productivity in Poland and Turkey, and also in the case of Poland that of Total Factor Productivity in 2000-2015, was reflected in the increased export potential of both countries. The average growth of the volume of world exports in 20002007 was 6,4%, while in Poland the average growth of the volume of exports was 15,3% and in Turkey––14%. This is much higher than Germany (6,6%) or Spain (5,3%) (tab. 7.4). The worldwide financial and economic crisis of 2008-2009 resulted in a slowdown of trade. The growth rate of the volume of world exports fell to an average of 2,5% in 20082015. The dynamics of Polish and Turkish exports also declined in comparison to 2000-2007, but remained higher than in Spain or Germany. Table 7.4: Growth of the volume of exports in 2000-2015 in %

World Germany Poland Spain Turkey Source: WTO (2016)

2000-2007 6,4 6,6 15,3 5,3 14,0

2008-2015 2,5 2,1 5,7 2,9 4,3

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A higher growth in exports in Poland and Turkey contributed to improving their positions in world trade. The share of Poland in world merchandise exports in 2000-2015 grew from 0,49% to 1,2%, and in the case of Turkey––from 0,43% to 0,87; while Germany's share fell from 8,53% to 8,03%, and Spain's––from 1,78% to 1,70% (tab. 6.5, figure 3). Table 7.5: World export market shares

Germany Poland Spain Turkey

2000 8,53 0,49 1,78 0,43

2008 8,96 1,06 1,74 0,82

2015 8,03 1,20 1,70 0,87

Source: UNCTAD (2016) Figure 7.3: World export market shares (2000=100) 300 Germany 250

Poland Spain

200 Turkey 150

100

50 2000200120022003200420052006200720082009201020112012201320142015

Source: UNCTAD (2016)

A remarkably high intensity of trade between Poland and Turkey began in 2004 when Poland joined the EU. An analysis of Polish-Turkish trade relations in 2000-2015 reveals a number of trends. Firstly, the value of

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bilateral trade grew much faster than overall Polish exports. Total exports grew more than six-fold and exports to Turkey––more than twenty-four times (tab. 7.6, figure 7.4). A particularly high growth rate occurred in 2004-2008 and 2010-2011. Since 2012 Polish exports to Turkey have been on a downward trend––except for 2014. Table 7.6: Value and growth rate of Poland's trade with Turkey in 1995-2015 (thousands of USD and %)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Value Exports 74422 58613 59702 55292 84516 128741 133437 249769 351455 901353 1197210 1304478 1508193 1772063 1755061 2483137 3291202 3099789 3041471 3129542 3100730

Source: UNCTAD (2016)

Imports 76119 93160 129961 158777 193630 203437 385495 613234 855050 1111079 1314437 1576014 2137612 2519997 1925811 2119995 2324135 2137691 2415907 2691010 2861407

Trade balance -1697 -34547 -70260 -103485 -109114 -74696 -252058 -363465 -503595 -209725 -117226 -271536 -629419 -747934 -170750 363142 967067 962098 625564 438533 239323

Growth rates (%) Exports Imports -21,2 1,9 -7,4 52,9 52,3 3,6 87,2 40,7 156,5 32,8 9,0 15,6 17,5 -1,0 41,5 32,5 -5,8 -1,9 2,9 -0,9

22,4 39,5 22,2 22,0 5,1 89,5 59,1 39,4 29,9 18,3 19,9 35,6 17,9 -23,6 10,1 9,6 -8,0 13,0 11,4 6,3

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Secondly, in 2000-2009 Poland continued to have a trade deficit with Turkey. A surplus appeared for the first time in 2010 as a result of the dynamics of a high growth in exports (2010-2011) and a decline in imports. Thirdly, despite the growing role of Turkey as Poland's trading partner––its share remained low. In 2015 Turkey's share in Polish exports was just 1,6% and in imports––1,5%. The Turkish market was important in the exports of machinery and transport equipment (2,8% in 2015) and chemicals and related products (1,6%). In Polish imports from Turkey the merchandise groups with higher shares were: miscellaneous manufactured articles (2,4% in 2015), manufactured goods classified chiefly by material (2,0%) and food and live animals (1,8%) (UNCTAD, 2016). Figure 7.4: Growth of Polish exports and Polish exports to Turkey (2000=100) 3000 2500 2000

Turkey

World

1500 1000 500 0 2000200120022003200420052006200720082009201020112012201320142015 Source: UNCTAD (2016)

Fourthly, there were many changes in the commodity structure of Poland's trade with Turkey in 2000-2015. Shares of machinery and transport equipment in Polish exports to Turkey grew by 23,3 p.p. and in imports by 13,1 p.p. Within the machinery and transport equipment group there was an increase in the share of telecommunications, sound-recording and reproducing apparatus and equipment (by 14,3 p.p.), power-generating machinery and equipment (by 13,5 p.p.) and road vehicles (by 9,5 p.p.).

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There was a fall in the share of electrical machinery (by 22,5 p.p.) In 2015 the main product groups in Polish exports to Turkey were: machinery and transport equipment (69%), manufactured goods classified chiefly by material (13,1%) and chemicals (8,7%). There was a higher share of products having a lesser degree of processing, and being less technologically advanced and more labour-intensive in Polish imports from Turkey. Still, just like in exports the highest share of imports was held by machinery and transport equipment (41,2%) (see tab. 7.7). Table 7.7: Poland's trade with Turkey by product groups in 20002015 (share of total exports and imports in %) Exports Year 2000 2015 Food and live animals 3,3 3,6 Beverages and tobacco 0,6 0,1 Crude materials, inedible, except fuels 0,7 0,7 Mineral fuels, lubricants and related materials 3,0 0,2 Animal and vegetable oils, fats and waxes 0,0 0,0 Chemicals and related products, n.e.s. 16,4 8,7 Manufactured goods by material 26,9 13,1 Machinery and transport equipment 45,6 69,0 Miscellaneous manufactured articles 3,2 4,5 Commodities and transactions, n.e.s. 0,3 0,1 Total all products 100,0 100,0

Imports 2000 2015 9,8 8,9 4,1 0,5 2,3 1,9 0,0 0,0 0,0 0,0 9,7 5,8 33,2 23,3 28,2 41,2 12,8 18,4 0,0 0,0 100,0 100

Source: UNCTAD (2016)

An analysis of structural changes in exports and imports aimed at improving competitiveness and gains from trade requires an increase in the share of technology-intensive products and a decrease in material- and labour-intensive products. According to R. Knap's calculations, Poland's trade with Turkey is favourable to Poland. Polish exports were dominated by technology-intensive products and imports were dominated by material- and labour-intensive products (tab. 7.8). The major products in bilateral trade flows have a high degree of processing.

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Table 7.8: The structure of Polish exports to Turkey and Polish imports from Turkey divided by the factor intensity of the goods for the years 2000-2014 (in %) 2000 2003 2006 2009 2012 2013 2014 Export Material-intensive

9,7

11,5 3,9

9,6

9,0

4,8

4,3

Labour-intensive

19,5 13,3 10,2 9,3

Capital intensive Technology-intensive easy to imitate difficult to imitate

24,3 13,0 37,5 26,9 27,3 33,1 32,6

10,7 11,6 13,1

5,5 4,6 5,4 20,1 26,3 17,2 18,0 40,7 57,5 42,9 34,0 26,7 33,2 31,8

Import Material-intensive

11,7 4,8

10,3 7,8

8,9

9,3

9,4

Labour-intensive

40,3 38,8 35,6 39,8 36,2 35,0 37,0

Capital intensive Technology-intensive easy to imitate difficult to imitate

31,2 32,5 29,6 23,8 31,4 31,3 29,9 10,1 4,9 4,5 9,0 5,9 5,8 4,8 6,7 19,0 19,6 19,1 17,6 18,6 18,8

Source: Knap (2015: 76, 77)

One of the key drivers of Poland and Turkey's growing role in the world economy and in particular world trade is their participation in global value chains. Integration with European, especially German, production networks contributes to an improvement in competitiveness and labour productivity and enables their expansion to world and EU markets. There can be two types of integration with production networks. Backward integration means using foreign input for the production of intermediate and final goods that can be exported. This kind of connection is conducive to knowledge and technology transfer through trade as well as FDI. Forward integration means producing intermediate goods which are then used in the production of final goods exported by other countries. This type of integration requires an improvement of the quality of products according to global standards and thus expands export capabilities and results in the better utilization of production resources. The basic methodological approach for the analysis of international trade based on the share of value added in gross exports is an ability to assess the domestic input to the final product's value. So gross exports are

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a sum of domestic direct and indirect value added exported to other countries and foreign value added that includes previously imported foreign components, parts and materials used in the production process. Table 7.9 contains data on the degree of the analyzed economies’ integration with global value chains. The backward participation index is defined as the share of foreign value added in a country's gross exports. Forward participation is defined as the ratio of domestic value added embodied in foreign countries' exports over gross exports. The last available data are for 2011 and in that year Poland had the highest share of foreign value added in gross exports (32,39%). This means that one-third of Polish exports were previously imported components, so the integration of global chains was a crucial factor of growth in value and the dynamics of foreign trade. The share of foreign value added in Turkey was a couple of percentage points lower––closer to Germany and Spain. However, one needs to point out the enormous growth of this indicator––it doubled over the period 2000-2011, which was the most impressive result among the analyzed economies. Table 7.9: Participation in global value chains

Poland Turkey Germany Spain

Backward index 2000 23,95 13,06 20,22 25,83

participation 2011 32,39 25,73 25,54 26,88

Forward index 2000 20,6 14,7 22,6 16,0

participation 2011 23,3 15,3 24,1 19,7

Source: OECD-WTO (2016)

The forward participation index is much more important from the point of view of international competitiveness. In 2011 Germany had the highest level of this indicator (24,1%). This means that close to a quarter of their gross exports was used as intermediate input used in the exports of other economies. In Poland the forward participation index was close to Germany's level (23,3%). Spain and Turkey had the lowest levels of forward integration, respectively 19,7% and 15,3%. In other words, the capacity of Turkish firms to play a role in the upstream parts of value chains has remained very limited compared to other countries (OECD, 2016b: 92). Analysis of the foreign value added share in various categories of gross exports allows us to point out sectors that are most integrated with global

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production networks. In both Turkey and Poland the highest value added share was in exports of the following goods: automotive, electrical, metals, machinery and chemicals. Only in 3 categories of exports (metals, machinery and other manufacturing) was Turkey's share of foreign value added in exports higher than Poland's. In all the remaining categories Poland was much more integrated with European production networks, and integration was especially strong in services (figure 7.5). Figure 7.5: Share of foreign value added in gross exports of Poland and Turkey in 2011 (in %)

Agriculture

20.15

9.94

Turkey

Mining

16.97 13.25

Food

17.09

Textile

Poland

24.23

22.68

33.76

29.01 23.44

Wood Chemicals

31.64

40.41 41.91

Metals Machinery Electrical

48.04

37.2

Automotive

43

Other manufacturing

36.45 39.21

Electricity, gas and water

15.54

47.2

25 25.48 22.93

Construction Wholesale and retail

6.53

13.1

12.33 10.84

Hotels and restaurants Transport and telecom Financial intermediation

5.35

9.94 11.57

Business activities

8.03

Social and personal services

7.46

0 Source: OECD-WTO (2016)

48.27

36.9 38.37

20.92

14.44 14.08

20

40

60

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Analysis of Turkish and Polish companies’ links within global value chains reveals their strong integration with German production networks (figures 7.6 and 7.7). In 2011, in Germany's gross exports around 12 billion USD was foreign value added originating in Poland and about 3 billion USD originated in Turkey; this was respectively one-fifth and onetenth of Poland and Turkey's forward linkages. In Turkey's gross exports foreign value added originating in Germany amounted to 3,8 billion USD and in Polish exports German value added was 12,8 billion USD (OECD, 2016b: 96; OECD-WTO, 2016). Comparing Poland and Turkey's structure of global chains it becomes apparent that Polish exporters mostly take part in German value chains, so their trade in value added is mainly bilateral (with Germany). The second largest partner for Polish intra-industry trade is Russia. Turkey's trade links are more diversified and global. Value added in Turkish gross exports comes from Russia, Germany, the United States, China and Italy. Bilateral Polish-Turkish trade in value added is limited and in 2011 it amounted to 1204 million USD. Only 0,89% of foreign value added in Polish gross exports originated in Turkey and in Turkish value added Poland had a share of 1,31% (OECD-WTO, 2016).

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0.0

JPN

IND POL CZE

KOR

0.5

Source: OECD (2016b: 97)

0

1

2

3

4

Backward participation 5

ESP

1.0

USA

FRA GBR

RUS

1.5

Figure 7.6: Turkey's main global value chain partner countries

176

2.0

CHN

2.5

ITA

3.0 3.5 Forward participation

DEU

Source: OECD-WTO (2016)

Backward participation 14 13 12 11 10 RUS 9 8 7 6 CHN 5 ITA 4 FRA GBR USA 3 SWE 2 JPN 1 TUR 0 0.0 2.0 4.0

CZE

6.0

Figure 7.7: Poland's main global value chain partner countries

8.0

10.0

Poland and Turkey as the Successful Catching-up Countries

12.0 14.0 Forward participation

DEU

177

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When it comes to the perspectives of Poland's trade with Turkey, there can be a number of factors contributing to the further growth in bilateral turnover, such as: 1) growth of production links within global value chains and the development of intra-industry trade in parts and components; 2) improving innovativeness of the Polish economy resulting in structural changes in exports leading to raising its competitiveness on the Turkish market; 3) further growth of purchasing power in Turkey and growth in consumer demand for Polish goods and services. Turkish companies' links within European value added chains developed swiftly in 2000-2011, however there could be many more gains from their participation in those networks provided that some conditions named by OECD experts are fulfilled (OECD, 2016b: 38-39):  Raise the quality of basic institutions;  Improve ICT infrastructure, in particular Internet-based and software-based business;  Increase cross-border cooperation and reduce cumbersome custom procedures;  Deepen trade agreements;  Reduce entry barriers for foreign capital in services;  Improve business conditions to attract more FDI;  Raise R&D spending;  Raise the standards of corporate governance and managerial skills. The Polish economy is not one of the innovation leaders, but within many innovativeness measures there has been a slow and steady improvement. The best figures pertain to the potential for innovation and a serious reorientation of the existing model of supporting the innovation and development of economic policy more favourably for innovative enterprises could thus contribute significantly to an improvement of the innovativeness of Polish exports (Wojtas, 2014: 146-147). This provides an opportunity for an increased share in world exports, and more so in EU exports and through that, the strengthening of Poland's position in Turkish imports from the European Union. High economic growth and continuous income convergence with EU countries linked with an exceptionally high share of household consumption in Turkey’s GDP (66,6% in 2015) allow for an optimistic

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view of demand level including demand for imported goods (OECD, 2016c). However, to further improve Poland's share in Turkish imports, an adjustment of Polish products is necessary––in terms of price and even more so in terms of quality. An increase in the society's wealth can result in a growing demand for commercial services that can successfully be exported by Polish companies provided that existing administrative and technological barriers are removed.

Conclusion Analysis of Poland and Turkey's economic indicators in 2000-2015 confirms a hypothesis that both countries, as a result of liberalizing the economies and participating in European integration, achieved high average growth rates in 2000-2007, respectively 4,1% and 5,2%. Despite the financial and economic crisis of 2008-2009, the average GDP growth rate in 2008-2015 remained high (3,1% in Poland and 3,4% in Turkey). The high dynamics of the economies were caused by positive effects of numerous factors such as: 1) strengthening of the market mechanism and competition in both countries; 2) an increase in FDI and technology inflows; 3) growth in labour productivity; 4) structural changes and the reallocation of human resources into more productive sectors of the economy; 5) intensification of European as well as global trade links due to participation in the EU internal market; 6) the development of export specialization and intra-industry trade as well as the role of external markets in stimulating economic activity; and 7) growth in income and domestic demand. It is important to emphasize Poland and Turkey's impressive results in closing the development gap due to growing domestic demand allowing for more stable economic growth. In Poland the main factor of GDP growth was an increase in labour productivity while in Turkey it was an increase in employment. The development outlook for both countries looks good, but it depends on growing innovativeness, the quality of human resources and competitiveness. Trade is the basis for Polish-Turkish bilateral economic relations. An increase in bilateral turnover started in 1999 with the launch of Poland's EU accession negotiations. Data clearly prove that bilateral turnover has doubled with the progress of the negotiation since 2002. Another spectacular step in Poland's trade liberalization was their EU accession in 2004. An interesting phenomenon is the dynamic growth of Poland's exports to Turkey in the period 2010-2011. There was a slight drop in the following two years and then a stable flow in the period 2014-2015.

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Potential opportunities for developing bilateral trade are considerable. They depend upon maintaining positive economic growth in both countries, increasing the role of intra-industry trade, growth in the trade of high-tech products and a competitive advantage in the EU market, but also to a large extent relying on bilateral dialogue and the activity of Polish and Turkish authorities in promoting economic ties in the sector as well as at company level.

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—. 2016c. OECD.Stat, http://stats.oecd.org. OECD-WTO. 2016. Statistics on Trade in Value Added (database). http://stats.oecd.org. Próchniak, Mariusz and Bartosz Witkowski. 2012. "Konwergencja gospodarcza typu beta w Ğwietle bayesowskiego uĞredniania oszacowaĔ", Bank i Kredyt 43/2: 25-58. Raiser, Martin, Marina Wes, and Ayberk Yilmaz. 2016. "Beyond convergence: Poland and Turkey en route to high income", Central Bank Review 16/1: 7-17. Roaf, James, Ruben Atoyan, Bikas Joshi, Krzysztof Krogulski, and IMF Staff Team. 2014. "25 Years of Transition Post-Communist Europe and IMF", IMF Regional Economic Issues Special Report, International Monetary Fund. Romer, Paul.1990. "Endogenous Technological Change", Journal of Political Economy 98/5: S71-S102. Sala-i-Martin, Xavier. 1996. "Classical Approach to Convergence Analysis", Economic Journal, 106/437: 1019-1036. SiwiĔski, Wáodzimierz. 2005. "MiĊdzynarodowe zróĪnicowanie rozwoju gospodarczego: fakty i teoria", Ekonomista 6: 723-747. The Conference Board. 2016. The Conference Board Total Economy Database. http://www.conference-board.org/data/economydatabase. UNCTAD. 2016. UNCTADStat. http://unctadstat.unctad.org. Wojtas, Monika. 2014. "InnowacyjnoĞü gospodarki" Pozycja gospodarcza Polski w Unii Europejskiej, ed. Bogumiáa Mucha-Leszko, Wyd., 123149. Lublin: UMCS. World Bank. 2014. Evaluation of the EU-Turkey Customs Union. WTO. 2016. Statistics database. http://stat.wto.org/Home/WSDBHome.aspx?Language=E.

PART II: THE EU TRADE POLICY

II.1 THE THREE FEATURES OF THE EU TRADE POLICY

CHAPTER EIGHT THE EU TRADE POLICY FROM MULTILATERALISM TO BILATERALISM SEVIL ACAR ISTANBUL KEMERBURGAZ UNIVERSITY

AND MAHMUT TEKÇE MARMARA UNIVERSITY, ISTANBUL

Introduction: A short history of multilateralism in the 20th century Following World War II, countries engaged in plans to revive their economies and boost foreign trade. As one of the crucial steps, the General Agreement on Tariffs and Trade (GATT) was signed with the aim of reducing tariffs and other international trade barriers. It was in effect for about fifty years culminating in the Uruguay Round of Trade Talks, which was finalized in 1994. Similarly, the Uruguay Round enclosed a bundle of rules regarding international trade in services, intellectual property, dispute settlement, and trade policy reviews. As a result of the Uruguay Round, the World Trade Organization (WTO) was established in 1995. The WTO was a result of the achievements of GATT in reducing trade barriers in manufacturing and other sectors. The next step would be to deal with intellectual property rights and non-traditional barriers to trade such as non-tariff measures. Moreover, the recessions of the 1970s brought concerns about national economies, which urged them to adopt more protective measures against international competition. These concerns even led to the search for new markets via bilateral initiatives. Another weakness of the GATT in the globalizing era was that it failed to cover newly developing trade areas as well as trade in services. As a consequence, the WTO was formed in order to act as a forum for trade

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negotiations, to administer trade agreements, tackle trade disputes, provide assistance to developing countries, and so on (WTO, 2007). In 2001, new negotiations were set up by WTO member countries in Doha, Qatar. The so-called Doha Development Agenda (DDA) was considered a stepping stone for the global multilateral trade system. Additionally, it proposed a new item for the international agenda, which was neglected in the Uruguay Round. This new round was to promise developing countries a better-integrated and more equitable trade regime. If successful, the DDA would accelerate growth and foster development in the world through the multilateral trading system. However, the DDA has not been concluded. First, in 2006, the indefinite suspension of the trade talks was formally announced. Second, in 2007, the agenda was pushed forward again in Potsdam, Germany, but it failed. As a third attempt to conclude the Doha round of negotiations, the July 2008 package was released to come to an agreement on the “modalities” in agriculture and non-agricultural market access (NAMA). These “modalities” included the “formulas and other methods to be used to cut tariffs and agricultural subsidies, and a range of related provisions” (WTO, 2008). The meetings took place in Geneva from 21 to 30 July 2008. Finally in 2013, a package of issues was agreed upon during the WTO’s Bali Ministerial Conference in order to facilitate trade, provide developing countries with more options for ensuring food security, trigger the trade of the least developed countries and aid development from a more general perspective. It was argued that the “Bali Package” was a crucial step forward being a precursor of the completion of the Doha round (WTO, 2013). Meanwhile, the world has witnessed a very severe financial crisis that began in 2007 and peaked in 2008. This crisis had considerable negative consequences, comparable to those of the Great Depression, for the financial institutions, capital markets, and “real economy” sectors in many countries. Some experienced a significant decline in growth rates that could be attributable to the collapse of financial markets as well as shrinking trade and investments. These necessitated the reorganization of trade and the multilateral system by international economic institutions such as the International Monetary Fund (IMF), G7, G20, and the WTO. This chapter intends to shed light on the trade policy of the European Union (EU), which has had swings between multilateralism and bilateralism in parallel with global economic developments throughout the last decades. Additionally, the effects of the recent global crisis on the development of multilateralism, the stance of the WTO, the proliferation

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of bilateral trade agreements, and trends in international trade are briefly discussed.

1. The EU’s trade policy amidst the swings between multilateralism and bilateralism To begin with, the EU’s trade policy was mainly shaped by multilateralism embraced by the Doha Development Agenda (DDA) until 2006. Afterwards, it was focused on regional trade policies accompanied by bilateral or regional negotiations. The formation of the European Economic Community (EEC) in 1957 and the European Free Trade Association (EFTA) in 1960 resulted in the first remarkable examples of regional trade agreements. On the other side of the Atlantic, the US was keeping a multilateralist approach to trade liberalization, based on the negotiated rules of the General Agreement on Tariffs and Trade (GATT). While Europe was integrating in the 1960s and 1970s, the US was rejecting proposals for a North Atlantic Free Trade Area (Panagariya, 1999: 481). Thus, since the 1980s, RTAs were mostly limited to Western Europe and regionalism was mainly a “European” concept. According to Bhagwati (1993), “the first wave of regionalism that took place in the 1960s failed to spread because the US supported a multilateral approach.” Following Bhagwati’s terminology, the “second wave of regionalism” started after the failure of the GATT multilateral trade negotiations in November 1982, whereas this time the US changed its position and favoured RTAs. This wave of regionalism affected both developed and developing countries and led to the formation of several regional groupings including the EU, NAFTA and Mercosur. Hence the EU, as an example of regional integration, has been an early promoter of regional trade agreements, and the 1970s and 1990s witnessed several preferential trade agreements of the EU with different countries. However, in the mid-1990s, the EU turned its attention to multilateralism. The conclusion of the Uruguay Round of multilateral trade negotiations in 1994, and the establishment of the WTO in 1995 to provide institutional support to multilateral trade agreements, enhanced expectations that a world trading system based on common rules and multilateral liberalization could be formed. There was an expectation that exceptions to multilateralism, such as regional trade agreements (...) would either become less of an alternative policy option for countries or will need to be adapted and conducted in such a manner as to become outwardoriented, not inward-looking, and thus constitute building blocks for the new multilateralism ushered in by the WTO. (Mashayekhi et al., 2005: 3)

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The EU’s steer towards multilateralism was reinforced when Romano Prodi, the president of the EC, appointed Pascal Lamy as the European Commissioner for Trade in 1999. Lamy was a strict proponent of multilateralism and during his period as Commissioner, the EU maintained an effective suspension of the opening of bilateral or regional negotiations to conclude free trade agreements (FTAs), and championed the multilateral trading system. Lamy (2002) explained this policy as one “pursu[ing] all existing mandates for regional negotiations with vigour and fairness, but not to begin any new negotiations” (2002: 1412). This trade strategy was based on two reasons: first, it favoured the multilateral approach of the Doha Development Agenda (DDA) and the EU did not want to take any initiative that might detract from its completion; and second, the EU had a “deep integration” approach in FTAs and these agreements were complex and time-consuming to negotiate (Lamy, 2002: 1412-1413). Increasing the number of bilateral agreements has been labelled as a “spaghetti bowl” of overlapping trade rules that erode the principle of non-discrimination and raise the transaction costs of doing business, and it was assumed to complicate the international trading system as a whole. The EU announced its strict loyalty to the completion of a comprehensive multilateral round of the WTO, but certain developments were creating some disturbances in this trade policy stance. The first development was that the US started to pursue an activist FTA policy based on “competitive liberalization” after the Bush Administration restored the Fast Track Negotiating Authority (also known as the Trade Promotion Authority) in 2002, which had expired and not been in effect since 1994. With the Authority, the US saw an opportunity to catch up with the EU’s long record of pursuing preferential agreements (CRS, 2006) and started FTA negotiations with several countries including Chile, Singapore, Australia and Morocco. Second, the DDA, which was set to conclude in December 2006, started to show a significant slowdown in progress towards multilateral liberalization. Especially after the Cancun talks collapsed in 2003, and three of the “Singapore issues” were dropped from the DDA in 2004, the wisdom of multilateralism started to be questioned in the EU. Even Lamy argued, in the Trade Policy Assessment document that summarizes his five-year term as Trade Commissioner, that, our arguments in favour of a better regulated multilateral world have been less effective. Indeed, arguably as a result, trade policy or the WTO has too often been the sole focus for efforts to strengthen international governance, which risks weakening its legitimacy both internally within the Union, and in the outside world. I don’t believe the WTO can or

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Lamy had stuck to his initial policy of keeping the moratorium on FTAs during his service in the Commission, but he also had given the first signs of a probable change in EU trade policy.

2. A stronger focus on FTAs In July 2006, negotiation talks in Geneva failed to reach an agreement and the DDA was officially suspended. This development threw multilateralism into a bleak future. Regarding the fact that the biggest competitor, the US, had been pursuing FTAs with many countries, especially with developed and emerging markets in East Asia, the EU had to act as soon as possible to avoid trade diversion and a shift in the EU’s trade strategy had already become inevitable. With the suspension of the DDA, the multilateralist position of the EU lost ground and the Commission was forced to change its trade policy focus. The European Commission revealed a new trade policy strategy in October 2006, under which the EU would pursue bilateral FTAs with major economies in order to secure the market access and competitiveness of European companies in important markets. The core of the new trade strategy of the EU was summarized by the Commission as: “rejection of protectionism at home, accompanied by activism in creating open markets and fair conditions for trade abroad” (European Commission, 2006). The new trade policy strategy primarily focuses on the need to identify and remove tariff and non-tariff barriers (NTBs) to market access for goods and services that are important for European exporters. With the FTAs, the Commission also aims to solve some behind-the-border issues, especially the Singapore issues of investment protection, competition policy, and transparency in government procurement, which cannot be tackled by the DDA. The new trade policy strategy report also revealed an agenda aiming to influence the forces driving change, to seize the opportunities of globalization and to manage the risks and challenges posed by the emerging economies especially in Asia and South America. The FTA strategy constitutes a very important part of this trade policy. The EU already has quite a large number of bilateral deals: agreements with the EFTA countries, the CU with Turkey, the goods agreements with the Euromed countries and the preferential arrangements offered to the sub-Saharan African, Caribbean and Pacific (ACP) countries. The EU had also signed FTAs with Chile, Mexico and South Africa. Furthermore, as recent developments in the world trade system made it necessary for the

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EU to enhance its access to new markets in order to protect and improve the competitiveness of European business, the Commission defined economic criteria, target countries and coverage for future FTAs. The European Commission defines the key economic criteria for new FTA partners as market potential and the level of protection (tariffs and NTBs) against EU export interests. In this sense, the Commission defines the Association of Southeast Asian Nations (ASEAN), South Korea and Mercosur as major FTA partners, and India, Russia and the Gulf Cooperation Council as countries of direct interest. China, on the other hand, despite meeting many of the criteria, is not defined as a possible FTA partner, but a country of special attention because of the opportunities and risks that it presents (European Commission, 2006: 1011). The EU's new FTA strategy aims for the highest possible degree of trade, investment, and services liberalization, in addition to a ban on export taxes and quantitative import restrictions. The main targets are regulatory convergence, non-tariff barriers and stronger provisions on intellectual property rights (IPRs) and competition. These trade relations could also include the incorporation of new cooperative provisions in areas relating to labour standards and environmental protection. In this sense, the EU would also have to take into account the erosion of its existing trade preferences when negotiating FTAs, which could translate into sheltering certain products from tariff cuts (ICTSD, 2006). The trade policy change in the EU raised concerns that the EU was shifting its attention from the WTO to bilateral agreements, and the revival of the DDA would become more difficult. Although the strategy report clearly states that “there will be no European retreat from multilateralism and the EU remains committed to the WTO” (European Commission, 2006: 10), the rising number of FTA negotiations and proposals in the years after the policy shift keeps these concerns alive. To sum up, reasons for bilateral trade agreements have started to come to the fore as multilateral trade has encountered some obstacles and as solutions to these obstacles can only be sought through FTAs between individual partners. The EU has adapted itself to evaluate the best strategy with its potential partners in order to deepen integration, expand its share in world exports, incorporate dialogue on universal issues such as migration and environment and promote good governance and development cooperation.

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3. Multilateralism after the global financial crisis of 2007-2008 In the aftermath of the global economic turmoil, which revealed itself with the collapse of Lehman Brothers in September 2008, the effects quickly spread around, first in the form of a credit crunch and then towards the real economy. Output and international trade volumes narrowed down not only in the US but also in other regions including Europe (see figure 8.1). Figure 8.1. Trade (% of GDP) in selected regions during the period 1960-2014

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Central Europe & the Baltics

120 100

Middle East & North Africa

80

Europe & Central Asia

60 40

Sub-Saharan Africa

20 2010

2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

0

Latin America & Caribbean

Source: World Development Indicators (2016)

Meanwhile, the G20 countries have emphasized their interest in and loyalty to the “maintenance of a robust multilateral trading system” on several occasions (Thirlwell, 2013: 3). They even pledged to complete the Doha Round (Thirlwell, 2013: 12): …we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO’s Doha Development Agenda with an ambitious and balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to assist directly, as necessary. We also agree that our countries have the largest stake in the global trading system and therefore each must make the positive contributions necessary to achieve such an outcome.

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In their Washington Summit in November 2008 right after the crisis, they repeated the profound importance of international trade (Thirlwell, 2013: 8): We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems.

At the same summit, they announced the following (Thirlwell, 2013: 8): We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports.

This kind of a standstill was renewed several times in the latter summit meaning a commitment to the multilateral system. However, although countries did not lean back on protectionism as a reaction to the financial crisis, most of them increased government intervention in trade flows leading to significant distortions (Thirlwell, 2013). Meanwhile, attempts to revive international trade have continued by engaging in bilateral and regional agreements. This usually leads to discrimination against the non-members of such agreements and is considered to be risky for the sustainability of global trade based on WTO rules. The Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP) are two such projects that are potential risks for the distortion of multilateralism. Baldwin (2016: 114) argues that these partnerships will create an international trading system marked by fragmentation (because they are not harmonized among themselves) and exclusion (because emerging trade giants like China and India are not members now and may never be).

Conclusion Along with the proliferation of bilateral and regional trade agreements and the suspension of the Doha Round in the last 15 years, the development of multilateralism and the WTO seem to be frozen in time (Baldwin, 2016). The European Community (later the European Union) has been a landmark for regionalism. By promoting its own model of regional

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integration throughout Europe and its neighbouring countries, the EC/EU aimed to enhance its reach to different markets. Nevertheless, it also supported the multilateral trade liberalization of the GATT/WTO, albeit not as loyally as the US. In the late 1990s, the EU shifted its attention entirely to the completion of multilateral WTO negotiations and put a moratorium to all bilateral agreement talks. However, the collapse of the WTO negotiations in Cancun in 2003, the proliferation of FTA negotiations by the US, and finally the suspension of the DDA in July 2006 forced the EU to pursue bilateral FTAs in order to protect the competitiveness of European businesses. The shift of the trade policy focus of the EU from multilateralism to bilateralism raised concerns about the future of the WTO. Although the strategy paper of the new trade policy clearly expressed that there will be no European retreat from multilateralism and that the EU is still loyal to WTO principles, the question still remains: will it be feasible (or even necessary) to revive the DDA after concluding several FTAs? There is a significant difference between the “new generation” FTAs of the EU and its previous bilateral trade agreements and the European integration scheme. Former FTAs were mainly concluded with neighbouring states or former colonies and the essential motives behind those FTAs were dominantly foreign policy and enlargement. The new trade policy of the EU, on the other hand, puts a strong emphasis on economic arguments by linking FTAs to purely economic criteria, such as the market potential of the partner and the existing tariff and non-tariff barriers to EU exports. Having completed economic integration in almost all of Europe and its neighbourhood, the EU now targets the emerging economies in Asia and Latin America. Another noteworthy characteristic of the new generation of FTAs is that, in the absence of the WTO negotiations, the EU sees these FTAs as an opportunity to negotiate regulatory and beyond-the-border issues that are not included in the DDA, and also to deal with “tough” issues like agriculture which seems almost impossible to solve in the multilateral talks. Relying upon these motivations, the surveyed research on the potential consequences of FTAs between the EU and selected countries evidence the gains from increasing free trade and cooperation. The recent surge of FTAs makes the revival of the DDA more difficult, although both the US and the EU express that they are still loyal to multilateralism. As major trade partners achieve their goals in increasing bilateral trade by removing trade barriers, the marginal gains from the results of multilateral negotiations diminish. Hopes for agreements on multilateral free trade based on common WTO rules seem to be fading

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away, but this does not mean that “free trade” is weakening; bilateralism and FTAs became the new tools of globalization and free trade. As for the Doha Round, as the Trade Minister of India, Kamal Nath said, “the round is not dead, but between intensive care and the crematorium”, and several years after the suspension of the talks, we can say that each FTA makes the DDA one step closer to the crematorium.

Bibliography Acar, S., and M. Tekce. 2008. “From Multilateralism to Bilateralism: The Evolution of Global Trade Policies”, Marmara University Journal of Faculty of Economic and Administrative Sciences, Vol. XXIV, No. 1: 105-123, ISSN: 1300-7262. Acar, S., and M. Tekce. 2008. “Multilateralism or Bilateralism: Trade Policy of the EU in the Age of Free Trade Agreements”, Proceedings of the Conference on Emerging Economic Issues in a Globalizing World, 2008: 272-284, ISSN: 200817, Papers of the Annual IUESUNY Cortland Conference in Economics. Baldwin, R. 2016. “The World Trade Organization and the Future of Multilateralism”, Journal of Economic Perspectives, 30 (1): 95-116. Bhagwati, J. 1993. “Regionalism and Multilateralism: An Overview.” In New Dimensions in Regional Integration, edited by J. de Melo and A. Panagariya. Cambridge University Press, Cambridge. CRS. 2006. “Regional Trade Agreements: An Analysis of Trade-related Impacts,” Congressional Research Service Report no. RL31072, by G. J. Wells. European Commission. 2004. Trade Policy in the Prodi Commission, 1999-2004: An Assessment. Brussels: DG External Trade. —. 2006. Global Europe: Competing in the World, Commission Staff Working Document. Brussels: DG External Trade. ICTSD. 2006. New EU Trade Strategy: Pursue Bilateral FTAs, Reduce NTBs, International Centre for Trade and Sustainable Development Bridges Weekly News Digest, Vol. 10, No. 33. Lamy, P. 2002. “Stepping Stones or Stumbling Blocks? The EU's Approach Towards the Problem of Multilateralism vs. Regionalism in Trade Policy”, The World Economy, Vol. 25: 1399-1413. Mashayekhi, M., L. Puri and T. Ito. 2005. “Multilateralism and Regionalism.” In Multilateralism and Regionalism: The New Interface, edited by M. Mashayekhi and T. Ito. UNCTAD: New York. Panagariya, A. 1999. “The Regionalism Debate: An Overview”, The World Economy, Vol. 22, No. 4: 477-511.

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Thirlwell, M. 2013. “Saving Multilateralism: The G20, the WTO, and Global Trade”, Lowy Institute for International Policy, Studies Centre. WTO. 2007. Understanding the World Trade Organization, available at http://www.wto.org/english/thewto_e/whatis_e/tif_e/understanding_e.p df.

CHAPTER NINE UNILATERALISM IN THE EUROPEAN UNION ÖZGE TAYLAN ANKARA YILDIRIM BEYAZIT UNIVERSITY

Introduction The growing influence of the European Union (EU) on international relations has been a widely debated issue over the last decades. After having experienced destructive wars in Europe for centuries, states began to cooperate to prevent these atrocities and get rid of their negative effects more quickly. Especially, relations that began in the economic field jumped into other fields with a spillover effect which resulted in the emergence of the sui generis actor in the international arena, i.e. the EU. Because of the growing influence of the EU’s role and actorness on creating a global system for fair and open trade, it is important to examine the economic effects of EU trade policies. The EU, in order to achieve its trade policy goals, has been in accord with action that has taken place on four levels: multilateralism, bilateralism, protectionism and unilateral strategies. These strategies occurring on different levels have shown different trends in different periods of time. This article will first briefly examine other “lateralisms” because unilateralism is contrasted to multilateralism, bilateralism and protectionism to clarify it. The European Union is a multilateral organization by its very nature, and tends to behave multilaterally and adopt the “multilateralism first” approach. However, there are some external factors and internal dynamics that have affected this approach. Since external and internal dynamics have been intermingled and are equally important, this study will elaborate the factors and dynamics through which the EU has chosen unilateralism. This chapter, after analyzing the concept of unilateralism, will deal with the unilateral trade policy and trade defence instruments of the EU. The question of why unilateralism is still on the agenda as an alternative to other options and periods will be examined by an eclectic approach

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without making a division between politics and economics; and external factors and internal dynamics. The paper will conclude with Brexit and its effects.

1. “-lateralism” in the international arena The constituent parts of the international trade and commercial system have been discussed for a long time. According to Richard Baldwin, world trade is regulated by a motley assortment of unilateral, bilateral and multilateral trade agreements.1 A prominent scholar, Jagdish Bhagwati, says that a “spaghetti bowl” of trade deals has three main constituents, which are multilateralism, unilateralism and regionalism.2 However, protectionism, minilateralism, and plurilateralism are all part of the trade system. So, we can enumerate five major trade strategies, which are multilateralism, bilateralism, regionalism, unilateralism and protectionism. Trade agreements can also be classified accordingly. Among these, unilateralism has not necessarily been studied. That is why this chapter aims to examine unilateral EU trade policies within the context of the international political economy, and the interaction between these intertwining five types of agreement. In terms of foreign policy analysis, multilateralism refers to a system by which nations consult others in matters of foreign policy, by way of organizations such as the United Nations, the World Trade Organization, etc. In the simplest way, multilateralism means cooperation in an international political economy. In an international economy, multilateralism, which is at the centre of the system, is carried out within the framework of the General Agreement on Tariffs and Trade’s (GATT) rounds of negotiations and the World Trade Organization (WTO). Yet, multilateralism is not limited to these. One of the most referenced works on the concept of multilateralism is the article titled "Multilateralism Matters" written by John Ruggie3 which goes through a quantitative and qualitative separation and treats these as two complementary categories of multilateralism. In this context, according to Ruggie, multilateralism refers to cooperation between three or more states, coordinated within some general principles and norms. The 1

Baldwin, R., “Multilateralising Regionalism Spaghetti Bowls as Building Blocs on the Path to Global Free Trade, World Economy, 29 (11) (2006): 1451. 2 Bhagwati, J., “US Trade Policy: The Infatuation with Free Trade Agreements,” Columbia University Discussion Paper Series, 726 (1995): 4. 3 Ruggie, J. G., Multilateralism Matters: The Theory and Praxis of an Institutional Form (New York: Columbia University Press, 1993).

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scholars Stephen Krazner, Robert O. Keohene, and Joseph Nye are in favour of approaching multilateralism within the framework of norms, principles and rules. One of the key turning points in world trade was the establishment of the WTO: the legal and institutional basis of the multilateral trading system, that officially took effect on 1 January 1995. Since then, with regard to the history of the GATT, the multilateral trading system has been run under the auspices of the WTO. The WTO facilitates the integration of the Uruguay Round agreements with a multilateral trading system, a forum where international trade orientation is identified, member organizations that resolve trade problems without resorting to unilateral measures, and countries with developmental links. The EU approach to multilateralism is based on the commitment to rules made by the international community. The EU advocates that rules set by multilateral forums like the IMF, WTO and WB will determine the economy; and arbitrary behaviours cannot override international law. The EU represents a mentality that seeks legitimacy on international grounds, is open to prospects and negotiations, and promotes the economic direction of globalization. Regionalism refers to political structures that both reflect and shape the strategies of governments, business corporations and a variety of nongovernmental organizations and social movements.4 So basically, it is necessary to highlight that this is a process and belief in promoting progressively higher levels of coordination, cooperation and integration among geographically contiguous states bound by shared goals and interests. Regionalism can be either bilateral or multilateral.5 The main components of regionalism are geographic proximity, interdependencies (in ideas, communication, peoples, good, etc.), and cooperation for mutual gains and identity (domestic elements such as a common religion, history, free trade, belief in democracy, traditions, external elements such as the definition of “others”, identity, etc.). One of these elements, i.e. the economy, can be a conscious initiative to control opportunities and constraints. CUs, common markets, economic unions or free trade areas are some platforms that forge regional economic integration. The key example is the European Union. The European Economic Community (EEC), established by six European countries in 4

Katzenstein, P. J., “Regionalism and Asia,” New Political Economy, 5 (3), (2000): 354. 5 Mittelman, J. H., “Resisting Globalisation: Environmental Politics in Eastern Asia,” in Globalisation and the Asia-Pacific: Contested Territories, eds. Olds et al. (London: Routledge, 1999), 75-80.

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1957, and the European Free Trade Association (EFTA) that was set up in 1960 are the most important examples of the first wave. There was a reaction towards the superpower dominance of the regional security arena between 1965 and 1985. By the end of the 1980s, with the end of the Cold War, globalization and a rising uncertainty about the future of multilateralism, a second wave pushed more and more countries to create free trade areas. Regionalism and bilateralism have thus superseded multilateralism. Between 1995 and 2008, 214 new regional trade agreements entered into force. The EU has free trade agreements (FTAs) with individual countries throughout the world. The last 30 years have witnessed an increasing surge in the number of FTAs, CUs and other forms of bilateral and regional agreements. Beyond the usual chapter providing for preferential tariff treatment, these agreements include clauses on trade facilitation and rulemaking in areas such as investment, intellectual property, government procurement, technical standards and sanitary issues.6 Regionalism has long been part of a response to the increasingly unequal dynamics of the global economy. As in the EU’s case, regionalism is not simply the mutual liberalization of trade. Actually, the new regionalism highlights common cultural values among states which share the same geography, cohesion, social rights, and so on. Bilateralism, which is directly linked to regionalism, is the conducting of political, economic, or cultural relations between two sovereign states. It contrasts with unilateralism and multilateralism which are activity by a single state or jointly by multiple states, respectively. For example, the current international trade regime has a strong multilateral component as its core, centred on the World Trade Organization (WTO), while the foreign direct investment (FDI) regime is mainly organized by bilateral agreements.7 When economics is analyzed within a historical process, protectionism and free trade policies are regarded as the two main components of this process. In this respect, those who advocate the necessity of free trade for the expansion and growth of the world economy, speaking against those who advocate inward-looking policies, argue that the starting point of economic crises comes from protectionism. The one that has gained a 6

See: http://exporthelp.europa.eu/thdapp/display.htm?page=cd%2fcd_FreeTradeAgreem ents.html&docType=main&languageId=en (Accessed 10 September 2016). 7 Thompson, A., & Verdier, D., “Multilateralism, Bilateralism and Regime Design,” 58 (1) (2014): 1. Available at: http://politicalscience.osu.edu/faculty/athompson/Lateralisms.pdf Accessed 21 August 2016).

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global dimension since 2008 became one of the major factors in directing global trade, with the increasing popularity of protectionist policies as a pragmatic solution. Non-tariff barriers, as a measure for the protection of domestic markets and national industries, became the main instrument used by countries to cope with the economic problems of this period; the most common were anti-dumping, anti-subsidy, state aids and export financing. During a crisis countries are tempted to favour protectionist tools rather than a free market policy. According to the data of the World Bank,8 in the period from October 2008 to February 2009, governments of certain countries implemented 47 restrictive tools of trade policy.9 Developed countries such as the USA and France, as well as developing countries such as Brazil and China, pursued protective policies in this period. The G-20 leaders, who when meeting advocated avoiding protective measures, are the same leaders who, when arriving home, took the 47 restrictive measures just mentioned. Free movement of goods is one of the success stories of the EU, and the main one of the four basic freedoms of circulation (people––labour, services and capital are the remaining three). On the basis of this principle, customs taxation, export and import quantity restrictions and the ban on the use of invisible obstacles to trade are addressed. Member countries have thus to comply with the common trade policy and the standards of commercial goods, which are determined by treaty and European laws (directives and regulations). However, as indicated in the report published by the European Commission:10 The continuous increase in the number of trade restrictions world-wide underlines the importance of a strong multilateral trade framework that can effectively address such protectionist measures. The slight slowdown of world economy and relatively weak global trade activity in 2015 were accompanied by an increased resort to potentially trade restrictive measures.

8

Gamberoni, E., and R. Newfarmer. “Trade protection: Incipient But Worrisome Trends, Trade Note 37” (2009) (Washington, DC: World Bank, International Trade Department). 9 Wrobel, A. “Multilateralism or Bilateralism: The EU Trade Policy in an Age of the WTO Crisis,” Ekonomika, 92 (3) (2013): 11. 10 Available at: http://trade.ec.europa.eu/doclib/docs/2016/june/tradoc_154665.pdf (Accessed 10 September 2016).

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The EU therefore continues to be a strong supporter of furthering the multilateral trade agenda that remains the linchpin of the EU’s trade policy.

2. Unilateralism Unilateralism is increasingly coming to the fore in international relations literature, often with ambiguity. Although the concept is often recalled, it has not been studied so much in disciplinary studies. It merely plays a marginal role in the theoretical and practical debates. A multitude of meanings are attached to the idea of unilateralism. A relevant concept is still being developed, extended, and revised according to the most recent events. The current decade demonstrates why unilateralism is so important. Financial difficulties and economic challenges, which have a serious spillover effect, occurred especially in the Middle East and Europe and show how these have the power to affect states and markets. The problems of the present century require a multilateral approach but indeed this is not enough by itself. The major powers try to find solutions through multilateral, bilateral, and unilateral initiatives or by increased participation in the activities of international agencies and institutions. Unilateralism is a neologism coined to be an antonym for multilateralism. Other “-lateralisms” have much been studied. Yet, unilateralism has not been studied like the others. It is understood as the antidote to multilateralism, but it is more than that. In the literature, at first, the concept of unilateralism was developed in conjunction with law-related, foreign policy and trade matters. In the simplest terms, unilateralism can be defined as any doctrine or agenda that supports one-sided action. According to its lexical meaning, it is the process of acting, reaching a decision, or espousing a principle unilaterally.11 Another definition is: “A tendency of nations to act on their own, or with only minimal consultation and involvement with other nations.”12 According to another comprehensive definition unilateralism can be defined as the decision to act in violation of such rules or as self-exemption from these rules and common attitudes; that is, it is resorting to self-help in areas in which at least hypothetically, diplomatic solutions would suggest or oblige 11

Available at: https://en.oxforddictionaries.com/definition/unilateralism (Accessed 10 June 2016). 12 Bodansky, D., “What’s So Bad about Unilateral Action to Protect the Environment, EJIL,” 11 (2) (2000): 340.

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compliance with the existing rules and agreed attitudes.13 In terms of economic policy actions, unilateralism deals with the means whereby a country individually modifies its trade barriers either directly or by inducing bilateral negotiations. In relation with this definition, another meaning of unilateralism attached to international trade law finds its basis especially in trade sanctions applied by individual states when they enforce legislation on other states or on private persons or corporations that are not within their jurisdiction.14 After all these definitions, as it is one sided in nature, unilateralism by a specific state in international politics is usually regarded suspiciously; it is quite probable that perceptions of imperialism or hegemony will lead to vivid reactions by other states.15 As we have seen, unilateralism is mostly regarded as one-sided actions. That is why in the multilateral order, which is fluid and volatile, thought is the prevention of unilateral freewheeling within a multilateral trading system. One of the most important cases is that of the United States. Unilateral acts play an important role in American political processes such as the national security strategy, economic policy and trade policy. One of the examples is the unilateral trade activity carried out by the USA against Japan, India and Brazil in 1989 (section 301 of the trade act of 1974). In this case, which is often referred to in the literature, the US and the EU came face to face, and the EU voiced its own complaints about US trade practices. From the viewpoint of the EU, the main cause of commercial disputes with the United States, unilateral measures imposed to force other markets to open up to free trade, such as section 301 of the US Trade Act 1974 and section 301 of the Omnibus Trade Act 198816 allow the US to apply unilateral trade sanctions and boycotts to another country without having to apply to the GATT beforehand, which is labelled as “aggressive unilateralism” by Jagdish Baghwati. 17 In other words, the EU made efforts to protect the status quo at that time but reacted against these practices. It is considered 13

Malone, D., and Khong, Y. F. Unilateralism and US Foreign Policy: International Perspectives (USA: Lynne Rienner Publishers, 2003), 322. 14 Jansen, B. “The Limits of Unilateralism from a European Perspective,” EJIL, 11 (2) (2000): 530. 15 Malone & Khong Op. Cit. (2003): 258. 16 Gero, J., “Trade and Innovation: Unilateralism v. Multilateralism,” 21 (16), Can.-US L.J., (1995): 84. 17 Bhagwati, J., & H. Patrick (eds.), Aggressive Unilateralism: America’s 301 Trade Policy and the World Trading System, (Ann Arbor, University of Michigan Press, 1990).

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to be one of the commercial tensions between the US and the EU and the attitude of the EU. The concept of unilateralism is frequently used in the literature about nuclear weapons. The treaty on the proliferation of nuclear weapons (NPT) is a multilateral agreement signed by 190 countries, which aims to prevent the spread of nuclear weapons and technology, to promote cooperation in the peaceful uses of nuclear energy, and to further the goal of achieving nuclear disarmament. Normally, countries should get rid of all of their own nuclear weapons, without waiting for other countries to do the same. Nevertheless, the presence of countries that are both nonmembers and non-compliant with the multilateral rules leads to a reduced compliance with multilateralism and an increased tendency towards unilateralism. Therefore, in this sense, unilateralism has a negative meaning as states having or not having nuclear weapons, have mutual obligations to each other. That means that this cannot be unilateral. As for the EU, it aims to reduce the proliferation of weapons of mass destruction (WMD). In its 2003 European Security Strategy it has been underlined that the proliferation of WMD is seen as one of the biggest and most serious threats to the EU’s security. This is why the EU also has its own strategy against the Proliferation of Weapons of Mass Destruction.18 These show us that the EU prefers multilateralism and unilateralism itself by showing greater unity. The European Union has also attached importance to different approaches at different times but has not excluded anything. Meunier and Nicolaidis19 argue that the EU’s trade power is composed of bilateral, regional and global relations. Elsig, Aggarwal and Fogarty20 claim that the EU has three main venues in which it negotiates trade agreements: bilateral, interregional and multilateral. Leal-Arcas21 asserts that the EU

18

Smetana, M., “Stuck on disarmament: the European Union and the 2015 NPT Review Conference,” International Affairs, 92 (1) (2016): 138. Available at: https://www.chathamhouse.org/sites/files/chathamhouse/publications/ia/INTA92_1 _07_Smetana.pdf (Accessed 10 June 2016). 19 Meunier, S., & Nicolaidis, K., “The European Union as a conflicted trade power,” Journal of European Public Policy, 13 (6) (2006): 906. 20 Elsig, M., “The EU’s Choice of Regulatory Venues for Trade Negotiations: A Tale of Agency Power?” JCMS, 45 (4) (2007): 927. 21 Leal-Arcas, R., “The European Union and New Leading Powers: Towards Partnership in Strategic Trade Policy Areas,” Fordham International Law Journal, 32 (2) (2008): 355. Available at: https://pdfs.semanticscholar.org/b87b/a0cbe1a8f0db63720cd8e5fb81e0eb7ccfa3.p df (Accessed 10 September 2016).

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uses three legal instruments or types of liberalization, which are unilateralism, multilateralism/globalism and bilateralism/regionalism. Regarding the determinants of these strategies, while the institutionalist approach points to the roles of the main EU institutions, the pluralist approach draws attention to the influence of local interest groups. Apart from the wide range of platforms and trade strategies of the European Union, external factors such as the stagnation of the WTO, the Doha Round, and developments in the international political economy have also caused the EU to identify more trade strategies. This is a systemic approach which draws attention to external constraints and factors. However, as these approaches concentrate on a single factor, none can produce a complete explanation. That is why an eclectic approach will be adopted in an interactive manner to try to determine the direction of the relationship that exists between these factors and note that each plays a separate role in defining EU trade strategies.

3. EU Trade policy and unilateralism Trade has been a source of wealth and prosperity throughout history. Trade policy has a significant impact on creating jobs and income levels in both domestic politics and regions within countries. For the EU, trade policy is a very important area for the development and deepening of its own integration process, as well as for its role as one of the main actors in world trade through economic and commercial power. Therefore, developments in world trade and the “place” of the EU in world trade are noteworthy for the Union itself. At the domestic level, states use a broad range of instruments of trade policy such as import tariffs, export subsidies, import quotas, voluntary export restraints, and local content requirements. In addition to this, regional (like the EU and ASEAN) and global (like UNCTAD and the WTO) non-state actors have their own trade policies and instruments like the state actors and every decision taken or put into practice under these formations has great effects on global trade networks. The EU accounts for only 7% of the world's population, but 25.8% of world GDP and around 20% of global exports and imports with the rest of the world (excluding trade within the EU).22 These figures make the EU the world's largest exporter, importer and investor and the largest economy in terms of GDP. It is the place where the most foreign direct investment is 22

Available at: http://ec.europa.eu/eurostat/statistics-explained/index.php/The_ EU_in_the_world_-_international_trade (Accessed 2 October 2016).

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made, because the scope of trade is not limited to goods but goes beyond it. Because of the growth of international trade, trade policy has become important for the Union and has been constantly revised. As a regional trade bloc with a deep level of economic integration and shared sovereignty at its core and as one of the key members of the WTO, it is indisputable for the EU to be multilateral by nature and vocation. However, the EU uses multilateral, unilateral, bilateral and agricultural protectionism as tools to achieve the goal of global governance. Since the EU has multiple venues, it is unfair to limit the EU’s scope. The EU has developed and actively engaged with a huge network of all these components. Examining external trade policies of such a successful example will shed some light on both its history and the future. First and foremost, unilateralism remains at the national, regional and global levels. While smaller EU member states tend to prefer multilateralism, unilateralism remains the main foreign policy instrument of larger powers. At the national level a clear example of recent unilateralist behaviour within a framework of multilateralism and Union was Germany’s decision to abstain from the UNSC vote on the humanitarian intervention in Libya.23 The EU’s trade strategies of unilateralism and bilateralism, that are preferential in nature, are applied for preferential concessions given away by the EU to the developing and least-developed countries without demanding any reciprocity as can be seen in lots of cases. The shift in trade policy can also be seen in the preferential trade agreements which have been implemented by the EU towards third parties; this is the narrowest-scope economic integration stage in which contracting parties reduce the customs tariffs on certain goods unilaterally or bilaterally such as the customs union, economic union, free trade areas, and common markets. As mentioned in the first section, in parallel with the five main trade strategies, trade agreements can also be classified accordingly. However, it is often difficult to go to a specific classification; in general, trade agreements are divided into two. The first one is the preferential or nonpreferential and customs agreements. These first-group trade agreements are also divided into two. The first provides for the mutual granting of certain concessions by the partners in the form of tariff reductions and/or reductions of other trade barriers. The second type of agreements includes 23

Gratus, S., “Can the EU Strategic Partnerships deepen multilateralism?” 109, Working Paper, Fride, (2011): 2.

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those under which the EU unilaterally grants preferences to its trading partners. The second one includes mixed agreements on trade and economic cooperation, which are more extensive than trade agreements.24 The aim of the EU’s Common Trade Policy is to prevent member states from acting independently of one another. For this, EU bodies need to have the necessary powers and means. At the forefront of these tools comes the Common Customs Tariff. Other vehicles are commercial protection instruments for imports and other regulations regarding the regulation of export. In addition, the Generalized Preferences System (GPS), consisting of preferential trade agreements based on reciprocity and unilateral commercial concessions, is among the instruments of the Common Trade Policy. The EU has a well-developed system of trade preferences. It concludes with preferential trade agreements of two types. The first of these provides for the mutual granting of certain concessions by the partners in the form of tariff reductions and/or by reducing other trade barriers.25 The second type of agreement includes those under which the EU grants unilateral preferences to its trade partners. In this sense, unilateralism in trade policy does not always have to be negative. One of the most important examples of this is the Generalized Preferences System (GPS) that is made up of preferential trade agreements based on reciprocity and unilateral commercial concessions, which are among the instruments of the Common Trade Policy. At the second conference of UNCTAD held in 1968, it was decided that exports of industrial goods of the developing countries should increase, and that the developed countries should put into effect the Generalized System of Preferences (GTS), a system for identifying a certain concessionary margin in the imports made by these countries. Thus, developed countries will unilaterally cancel out or reduce their tax on the industrial goods they import from developing countries, except for the "reciprocity" principle. The EU uses unilateralism for the preferential concessions granted by itself to the developing and the least-developed countries without demanding any reciprocity. The GTS regime, which has been in practice since 1971 in the European Union, is already an important element of the EU Common Trade Policy. The EU regulation on the current GTS regime entered into force on 1 January 2014. It is envisaged that the Regulation will remain in practice for 10 years until 2023. Since the founding of the EEC, many preferential agreements have been concluded with trade 24 25

Wrobel, Op. Cit. (2013): 15. Ibid., p. 15.

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partners. These agreements vary in nature, i.e. in the scope of preferences granted. On the basis of the criterion of declining trade preferences (mainly customs duties), trade agreements concluded by the EU can be presented in the form of the so-called “pyramid of preferences”.26 Thus, we can distinguish the agreements or unilateral decisions of the European Union which are establishing a customs union, building a free trade area, granting unilateral trade preferences and establishing no preferences. The Union often revises the GTS regime and, for example, after the January 2015 revision, the ones excluded from the GTS and those involved were renewed. The EU has made the GTS regime a dynamic legislation especially within the scope of country-based evolutions. Unilateralism is also seen in trade defence and its instruments. WTOmember countries use "Trade Policy Defence Instruments" against such market disruptions. The "Trade Policy Defence Instruments," referred to in the relevant agreements of the WTO context, is the generic name given to all the damping measures: protection against subsidies, and protection and surveillance measures, which are resorted to in order to prevent serious damage to domestic producers that have similar or directly competing goods. So, under the WTO law, there are three types of TDIs that are also recognized by the EU which are anti-dumping (AD), anti-subsidy (AS); and safeguard instruments. Ethier, who is one of most well-known scholars on unilateralism, determined four instruments of unilateralism which are voluntary export restraints, anti-dumping duties, counter veiling duties and safeguard provisions.27 Thus, as can be seen, there is an overlap between TDIs and instruments of unilateralism. These instruments with different application objectives and procedures ensure that member states comply with the WTO and free trade rules. These tools provide protection to domestic industry both directly and indirectly in two ways. The first is the "Safeguard Measures" in Article 19 of the GATT 1994 Treaty. The safeguard measures implemented under Article 19 are used to increase the competitiveness of domestic production against imports and to enable the restructuring of national industry. The second group of instruments used for the protection of the domestic 26

At the top of the pyramid are the 70 African, Caribbean and Pacific countries linked to the EU through the Lome Convention. Lower down are the developing Mediterranean countries, while at the bottom of the pyramid are to be found the Asian and Latin American countries, as well as a number of Middle East oilproducing countries, like Iran, Iraq and Kuwait. 27 Ethier, W. J., “The International Commercial System, Essays in International Finance,” 210, (1998): 4. Available at: https://www.princeton.edu/~ies/IES_Essays/E210.pdf (Accessed 19 August 2016).

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economy are measures against unfair competition practices. The basic condition for using these instruments is that trade activity that requires measures has an element of unfair competition, which will create a deviation in trade. In other words, trade policy defence instruments are being used against distortions in trade channels and the economic damage induced by unfair trade practices. As a result, both instruments serve the purpose of protecting domestic industry while being qualitatively different. In order to protect the domestic market from imports of noncompetitive products and in the context of the WTO Agreements against increasing trade with all the subsidizing and dumping in the world with the 2008 crisis, the use of TDIs has been increased. Trade defence is one of the important components of EU trade policy. The EU, like other WTO members, is one of the main actors that use trade defence instruments globally against market disruptions. The EU’s trade defence policy and measures include anti-dumping, defence measures and compensatory customs taxes to prevent damage to domestic industry. The EU sees these instruments as perpetuating its commitment to open markets and preventing unfair trade practices and unfair international competition. This instrument is the unilateral side of EU trade policy-making, which provides a much-needed complement to the dominant focus in the literature on the bilateral and multilateral dimensions of the EU’s trade policy.28 Despite having one of the most technical and far-reaching TDI systems in the world, the EU often modernizes its TDIs to ensure fair competition for the EU and improve its system with regard to transparency and the legal certainty of its applications.29 In general, as the EU’s TDI system is already the most liberal among WTO members, any unilateral implementation of another “WTO plus” measure may lead to a competitive disadvantage for EU industry as opposed to its trading partners’ respective practices.30

28

Eckhardt, J., “EU Unilateral Trade Policy-making: What Role for Importdependent Firms?” JCMS, 51 (6) (2013): 990. 29 Available at: http://www.ceced.eu/site-ceced/policy-areas/Smart-Living-andCompetitiveness/International-Trade/Trade-Defence-Instruments.html (Accessed 20 October 2016). 30 Available at: http://www.ceced.eu/site-ceced/policy-areas/Smart-Living-andCompetitiveness/International-Trade/Trade-Defence-Instruments.html (Accessed 20 October 2016).

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4. Unilateralism and Brexit Brexit happened in June 2016. The main arguments for the realization of Brexit are that Britain will be liberated from the excessive bureaucratic, economic and legal regulations of the EU, that it will be able to act unilaterally in foreign trade and investment policies and that regulations will make England more fair, free and rich. So the answer to the question “does the UK need trade agreements in order to prosper from being a part of the international economy” is “no”. 31 Some argue that the UK should have a defensible trade policy, which is unilateral free trade. So she should reduce all tariff and non-tariff barriers and allow British consumers to import goods from all over the world without constraint. However, on the one hand, this means that consumers can buy more cheaply since these goods will have lower prices in the shops. On the other hand, this complex notion of unilateral free trade can lead to free trade in services that also necessitates the worker’s mobility which is difficult to cope with. Thus, the UK can reject EU membership to eliminate all its bargaining chips unilaterally. Its trading partners can accept this new line of trade policies,32 but WTO membership still brings duties like “No WTO member can unilaterally decide what its rights and obligations are.”33 Actually, unilateralism represents an important issue both in the free trade doctrine and in 19th British practice. Bhagwati states: with the ideas of Adam Smith, international economists have been aware that this presupposes the exogeneity of the foreigners' trading offer to one's policy: else, one could strategically use tariff (and other) policy to gain yet more from international trade. The issue was discussed at length when the British, faced by rising competition from the United States and Germany, began debating the wisdom of their unilateral free trade in the face of protection of these emergent economic powers. They opted for

31

Minford, P., “No Need to Queue: The benefits of free trade without trade agreements,” 51 (2016). Available at: https://iea.org.uk/wp-content/uploads/2016/08/No-need-to-queue-PDF.pdf (Accessed 20 June 2016). 32 Available at: https://www.theguardian.com/politics/2016/jul/13/brexit-theresamay-pro-leave-economists-urge-embrace-unilateral-free-trade https://iea.org.uk/blog/post-brexit-britain-should-adopt-unilateral-free-trade https://www.ft.com/content/2a009b7c-2d71-11e6-bf8d-26294ad519fc (Accessed 10 November 2016). 33 Available at: https://www.wto.org/english/news_e/spra_e/spra126_e.htm (Accessed 10 November 2016).

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unilateralism on many diverse grounds, among them recent politicaleconomy type worries about the capture by protectionists of retaliatory tariffs for their own use, indulgence towards others' infant-industry tariffs, British lack of sufficient economic power, etc. 34

This subject was hotly debated in the literature. On the one hand, there were political economists, with roots in orthodoxy, who claimed that the policy which urged England to move unilaterally towards completely free trade threatened the destruction of her predominance.35 Robert Torrens challenged the view that unilateral free trade would be useful to Great Britain. But some scholars like Robert Peel, in neglecting the principle of reciprocity and moving toward a unilateral free trade, were turning against the system of Pitt and Huskisson.36 In general, those who focus on the negative effects of unilateral decisions on trade policy argue that unilateral acts have mostly a defensive nature to protect local industries from foreign competition. It can also be offensive to expand markets abroad.37 Yet, some argue that in the 19th century, to a great extent, Britain’s rapid growth was an outcome of unilateral free trade rather than the result of complicated bilateral or multilateral trade deals. Since Brexit, models have been discussed again. Some examples are the models or options of Norway, Switzerland, Turkey, Canada and Hong Kong. Furthermore, as trade liberalization has run into a cul-de-sac, some scholars argue that the solution can be unilateral liberalization; leaders should focus on reminding voters of the enormous benefits that will come to countries that open up unilaterally.38 The unilateral free trade model, which is practised by Hong Kong and Singapore, is based on the concept of unilaterally lifting all barriers to trade without seeking reciprocal action on the part of foreign governments. Economists have long claimed that 34

Bhagwati, J., “Departures from Multilateralism: Regionalism and Aggressive Unilateralism,” The Economic Journal, 100 (403) (1990): 1313. 35 Semmel, B., The Rise of Free Trade Imperialism: Classical Political Economy the Empire of Free Trade and Imperialism 1750-1850, (Cambridge: CUP, 1970), 186. 36 See detailed discussion in Semmel, B. (1970). 37 Joslng, T., “Multilateralism: A Constraint on Unilateralism and Regionalism in Agricultural Trade,” American Journal of Agricultural Economics, 75 (3) (1993): 804. 38 Dieter, H., “The Virtue of Free-trade Unilateralism when multilateral deals stall, leaders should break (2014). Available at: http://www.swpberlin.org/fileadmin/contents/products/medienbeitraege/Dieter_TheVirtueofFreeTr ade-Unilateralism_WSJ_Sep2014.pdf (Accessed 18 June 2016).

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unilateral free trade is economically desirable, and realworld examples such as Hong Kong and Singapore prove the point. Unilateral free trade agreements are just one type of free trade agreement. Others are bilateral and multilateral free trade agreements. The World Trade Organization defines a unilateral trade preference, or a preferential trade agreement, as any trade agreement granted by one nation that is not reciprocated. Unilateral trade policies occur whenever one country imposes a trade restriction, such as a tariff, on all imports. Unilateral free trade is the concept that refers to lifting unilaterally all barriers to trade without seeking reciprocity on the part of foreign governments. This is a topic that has been debated for a long time by different countries especially the US and the UK. Patrick Minford, who is a wellknown and long-standing opponent of the UK’s membership of the EU, asserts that being in the Single Market is damaging to the UK compared with the best policy that the UK can follow which is to be outside with no trade barriers against the rest of the world (“unilateral free trade”) so that “we trade at world prices with all including the EU, our own regulation and our own migration controls”.39 Today, China’s rapid growth, for example, has had little indebtedness to trade agreements, considering that China was not even a member of the WTO until 2001. More recently, New Zealand struck out as a unilateral free trader in the 1980s and has been proved able as a successful exporter fully integrated into the world economy.

Conclusion It is clear that the problems of the 21st century require multilateralism. As seen on many platforms, it is difficult to achieve success in classical multilateralism. The economic crises and the post-Brexit era show that actors including the EU choose to diversify their routes and policies. Therefore, in this century, multilateralism will be different from what we are used to. We will see more alternatives such as regionalism, a different multilateralism and unilateralism. A trading system in which all is regulated will be more useful. Regarding the strategy of unilateralism, even though unilateralism and 39

Minford, P., “Trading Places Consumers v. Producers in the New Brexit Economy,” POLITEIA (2016): 2. Available at: http://www.politeia.co.uk/wpcontent/uploads/2016/11/PoliteiaMinford2018th20September20PM20JML20111.pdf (Accessed 20 October 2016).

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protectionism have been deployed under certain circumstances or due to specific reasons, as necessitated by the international trade environment or changing dynamics, the EU only entered into preferential relations with close neighbours, potential members and former colonies by taking into consideration its and its members economic and political interests.

Bibliography Baldwin, R. 2006. “Multilateralising regionalism Spaghetti bowls as building blocs on the path to global free trade,” World Economy, 29 (11): 1451-1518. Bhagwati, J. 1990. “Departures from Multilateralism: Regionalism and Aggressive Unilateralism,” The Economic Journal, 100 (403): 13041317. —. 1995. “US Trade Policy: The Infatuation with Free Trade Agreements,” Columbia University Discussion Paper Series, 726: 123. Bhagwati, J., and H. Patrick eds. 1990. Aggressive Unilateralism: America’s 301 Trade Policy and the World Trading System. Ann Arbor: University of Michigan Press. Bodansky, D. 2000. “What’s So Bad about Unilateral Action to Protect the Environment,” EJIL, 11 (2): 339-341. Dieter, H. 2014. “The virtue of free-trade unilateralism when multilateral deals stall, leaders should break.” Available at: http://www.swpberlin.org/fileadmin/contents/products/medienbeitraege/Dieter_TheVir tueofFreeTrade-Unilateralism_WSJ_Sep2014.pdf (Accessed 18 June 2016). Eckhardt, J. 2013. “EU Unilateral Trade Policy-making: What Role for Import-dependent Firms?” JCMS, 51 (6): 989-1005. Elsig, M. 2007. “The EU’s Choice of Regulatory Venues for Trade Negotiations: A Tale of Agency Power?” JCMS, 45 (4): 927-948. Ethier, W. J. 1998. “The International Commercial System, Essays in International Finance, 210.” Available at: https://www.princeton.edu/~ies/IES_Essays/E210.pdf (accessed 19 August 2016). Gamberon, E., and R. Newfarmer. 2009. “Trade protection: Incipient But Worrisome Trends, Trade Note 37.” Washington, DC: World Bank, International Trade Department. Gero, J. 1995. “Trade and Innovation: Unilateralism v. Multilateralism,” 21 (16), Can.-US L.J.: 81-98.

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Gratus, S. 2011. “Can EU Strategic Partnerships deepen multilateralism?” 109, Working Paper, Fride. Jansen, B. 2000. “The Limits of Unilateralism from a European Perspective,” EJIL, 11 (2): 309-313. Joslng, T. 1993. “Multilateralism: A Constraint on Unilateralism and Regionalism in Agricultural Trade,” American Journal of Agricultural Economics, 75 (3): 803-809. Katzenstein, P. J. 2000. “Regionalism and Asia,” New Political Economy, 5 (3): 353-368. Leal-Arcas, R. 2008. “The European Union and New Leading Powers: Towards Partnership in Strategic Trade Policy Areas,” Fordham International Law Journal, 32 (2): 345-416. Available at: https://pdfs.semanticscholar.org/b87b/a0cbe1a8f0db63720cd8e5fb81e0 eb7ccfa3.pdf (accessed 10 September 2016). Malone, D., and Y. F. Khong. 2003. Unilateralism and US Foreign Policy: International Perspectives. USA: Lynne Rienner Publishers. Meunier, S., and K. Nicolaidis. 2006. “The European Union as a conflicted trade power,” Journal of European Public Policy, 13 (6): 906-925. Minford, P. 2016. “No Need to Queue: The benefits of free trade without trade agreements, 51.” Available at: https://iea.org.uk/wp-content/ uploads/2016/08/No-need-to-queue-PDF.pdf (accessed 20 June 2016). —. 2016. “Trading Places Consumers v. Producers in the New Brexit Economy,” POLITEIA. Available at: http://www.politeia.co.uk/wp-content/uploads/2016/11/PoliteiaMinford 2018th20September20PM20JML2011-1.pdf (accessed 20 October 2016). Mittelman, J. H. 1999. “Resisting Globalisation: Environmental Politics in Eastern Asia.” In Globalisation and the Asia-Pacific: Contested Territories edited by Olds et al., 72-87. London: Routledge. Ruggie, J. G. 1993. Multilateralism Matters: The Theory and Praxis of an Institutional Form. Columbia University Press, New York. Semmel, B. 1970. The Rise of Free Trade Imperialism: Classical Political Economy the Empire of Free Trade and Imperialism 1750-1850. CUP, Cambridge. Smetana, M. 2016. “Stuck on disarmament: the European Union and the 2015 NPT Review Conference,” International Affairs, 92 (1): 137-52. Available at: https://www.chathamhouse.org/sites/files/chathamhouse/publications/i a/INTA92_1_07_Smetana.pdf (accessed 10 June 2016).

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II.2 REGIONAL TRADE AGREEMENTS

CHAPTER TEN THE TRANSATLANTIC TRADE AND INVESTMENT PARTNERSHIP AYCA KARACA MINISTRY OF TREASURE, ANKARA

Introduction The European Union (EU) and the United States (US) are the two most integrated economies in the world. This is due to their trade in services, investments and a strong commercial presence in each other’s economies. The two regions are each other’s main trading partners in goods and services and account for the largest bilateral relationship in the world. To achieve a further opening of both economies, the leaders of the EU and the US officially opened negotiations on a Transatlantic Trade and Investment Partnership (TTIP) in July 2013. The aim of the agreement is to further liberalize trade and encourage investment between the two economies by establishing a comprehensive free trade agreement. This initiative has the long-term objectives of achieving sustainable growth and creating jobs by means of mutually eliminating regulatory barriers in a comprehensive way. On the other hand, like other regional agreements, the TTIP can create a trade diversion effect on third countries. If the country’s economy depends on exports to the TTIP countries, it could be affected more strongly. Turkey’s economy would also be affected because of Turkey’s customs union agreement with the EU. This current international issue is very vital for Turkish economic interests. Within this framework, this article will analyze the main drivers that led the EU and the US to initiate such a mega deal as the TTIP. It evaluates the main topics in the negotiating agenda. It also assesses the possibly challenging issues during the negotiations and the effect on the process of the election of Donald Trump as the new President of the USA.

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1. Historical background The TTIP is a wide-ranging trade agreement currently being negotiated between the EU and the United States that could affect several sectors, from technology and manufacturing to agriculture. The agreement will remove trade barriers, making it easier for the buying and selling of goods and services between the EU and the US. The transatlantic trade relationship is a deep one, rooted in centuries of shared economic history. In the post-war period this has been reflected not only in the early shared steps leading ultimately to the modern multilateral trading system, but also the periodic initiatives to form a regional trade agreement. With the rising importance of global and regional production chains and international firms, the logic for a regional, transatlantic agreement seems compelling. Together, the two economies account for roughly half of the world’s output and world trade. They are, mutually, each other’s most important partners as well. In 2012, a comprehensive dialogue was initiated between the EU and the United States, regarding possibilities for the deepening of transatlantic trade and investment relations. Discussions regarding the possible deepening of these links are on-going. This chapter offers a quantification of the effects of a trade and investment agreement under a range of possible policy options. Both the EU and the US have relatively low MFN tariffs but given the magnitude of both trade and investment flows between the EU and the US, removing even relatively minor impediments to these flows will have a significant impact, with potential substantive benefits for both economies. In addition, since the existing non-tariff barriers also act as impediments to trade and investment there are good reasons to believe that there are significant untapped gains from a deeper trade and investment relationship. In February 2013, an EU-commissioned “ad-hoc high-level expert group” published a paper, highlighting the need for a free-trade area between the EU and the United States. This was immediately taken up by major political leaders, with US President Obama including it in his 2013 State of the Union address and European Commission President Barroso announcing it on the following day.1 1

Bizarri, K., “A Brave New Transatlantic Partnership: The Proposed EU-US Transatlantic Trade and Investment Partnership (TTIP/TAFTA), and its Socioeconomic & Environmental Consequences”, Seattle to Brussels Network (S2B) October, 2013.

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In his State of the Union address on 13 February 2013, President Obama announced that “we will launch talks on a comprehensive TTIP with the EU––because trade that is free and fair across the Atlantic supports millions of good-paying American jobs”––a claim that has been echoed by EU Trade Commissioner Karel De Gucht: For Europe, the income effects of the deal that we are now trying to achieve should be between 0.5% and 1% of GDP, meaning hundreds of thousands of jobs… It brings new customers for our producers, cheaper components for our producers and more competition to make all our companies more efficient. The first round of negotiations of the so-called Transatlantic Trade and Investment Partnership officially kicked off in Washington in July 2013.2

2. EU-USA economic relationships Together the EU and US are the largest, the most open and bilaterally most integrated economies in the world. A long, shared history of trade and intellectual exchange, and a similar rate of economic development have led to this close and commercially significant relationship and the proposal to negotiate the TTIP. Currently: x Joint EU and US GDPs stood at around 46% of global GDP as an average of the 2013-2016 period; x Tariffs are presently at very low levels (2.2% for the US and 3.3% for the EU); x The bilateral goods trade amounted to €517.1 billion in 2014, and the services trade to €375.7 billion; x The EU-US merchandise trade climbed to more than 620 billion euros in 2015;3 x The US is the EU’s main extra-EU trading partner for goods and services; x The US is the EU’s main FDI destination (1.985 billion-euro stock in 2015), while the US investment stock in 2015 was at about 1.810 billion;4

2

http://www.political-intelligence.com/ttip-a-brief-overview/. Eurostat. 4 Eurostat. 3

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x Per the estimations of the Center for Transatlantic Relations, US FDI outflows to Europe in 2015 totalled $185 billion, a 7.7% rise from the $171.8 billion registered in 2014;5 x US-controlled enterprises created 5.9 million jobs in the EU, equal to 19% of all jobs supported by export, and 50% of all jobs supported by the exports of countries outside the EU in 2011; x Around 4.7 million EU jobs are associated with production for exports to the US in 2011.6

Trade side On the trade front, divergent growth and the depreciation of the euro against the US dollar have manifested themselves in America’s widening trade gap in goods with the EU. The trade gap reached $153 billion in 2015, another record high. America’s trade deficit with the EU increased six years in a row, and more than doubled between 2009 and 2015. In the first eleven months of 2015, US imports from the EU rose 2.1% from the previous year, while US exports slipped 1.2% in the same period, boosting America’s trade deficit with the EU by 8.6%7 (figure 10.1). Reflecting the growth differential between the United States and Europe over the past few years, US exports to the EU last year—estimated at $275 billion—slipped below the pre-crisis level of $277 billion recorded in 2008. Notable spots of weakness are US exports to Germany, Greece, Portugal and Spain, which remain below pre-crisis levels. Nearly half of America’s EU trade deficit in 2015 emanated from Germany—Europe’s largest economy and its largest trader. For the year, the US merchandise trade deficit with Germany totalled $74.2 billion in 2015, relatively flat from the year before. However, America’s trade deficit with Germany last year was larger than America’s trade gap with Japan.8

5 https://transatlanticrelations.org/wp-content/uploads/2016/10/Pages-fromTransatlantic-Economy-2016-Chapter-5.pdf. 6 “http://trade.ec.europa.eu/doclib/docs/2015/june/tradoc_153502.pdf. 7 https://transatlanticrelations.org/wp-content/uploads/2016/10/TransatlanticEconomy-2016-Chapter-1.pdf . 8 https://transatlanticrelations.org/wp-content/uploads/2016/10/TransatlanticEconomy-2016-Chapter-1.pdf.

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Figure 10.1. US-EU Merchandise Trade Balance (Billion Dollars)

Source: US Census Bureau

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Total goods trade (exports plus imports) goes up from €430 billion in 2002 to over €520 billion in 2014. Total services trade increases from €230 billion to €390 billion. Additionally, the EU had a consistently positive trade balance vis-à-vis the US. In 2014 the EU had the largest surplus for the period under consideration, with EU combined goods and services exports to the US worth €508 billion and EU imports from the US worth €397 billion, amounting to a surplus of €111 billion in 20149 (figure 10.2). First, the US has been a significant trading partner for the EU, as (since 2002) on average 23% of EU exports have been directed to the US, while on average 18% of EU imports originated in the US. Second, the relative importance of the US as a trading partner for the EU (and vice versa) declined between 2002 and 2009, reflecting the relative increase of developing countries in terms of trade volumes. Third, the US has been more important to the EU as an export destination than as a producer of EU imports10 (figure 10.3). Regarding the share of US exports directed towards the EU as well as the share of US imports originating from the EU, the strong economic relationship between the EU and the US has been confirmed: on average, 24% of US exports were directed to the EU while on average 21% of US imports originated from the EU. Note also that the EU as a destination for US exports and as a producer of US imports have been almost equally important in relative terms. This relative importance has been quite stable since 200211 (figure 10.4).

9

“Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 40. 10 “Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 50. 11 “Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 50.

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Figure 10.2 EU exports and imports from the USA (nominal billion euros)

Source: Eurostat

The Transatlantic Trade and Investment Partnership Figure 10.3. Relative importance of the US as a trading partner for the EU

Source: Eurostat

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Figure 10.4. Relative importance of the EU as a trading partner for the USA

Source: US Bureau of Economic Analysis

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Foreign Direct Investment The investment between the EU and the United States is the real driver of the transatlantic relationship, contributing to growth and jobs on both sides of the Atlantic. Moreover, it influences trade figures positively, as it is estimated that a third of the trade between the EU and the United States consists of intra-company transfers. The EU and the US are not only economically linked through the exchange of goods and services, but also––and even more so––through investments. Here we focus on the role of the US in receiving the EU FDI flows. Figure 10.4 shows how EU FDI to the US peaked shortly before the financial crisis (2007), then dropped, and peaked again in 2011. In 2007 the EU invested almost €180 billion in the US, representing approximately 14% of total EU FDI outflows. In the following years, EU FDI to the US dropped sharply to €60 billion in 2010. After 2010 FDI flows picked up again. The share of total FDI outflows directed to the US rose to 25% in 2012. In other words, the US has been a major destination for EU investments abroad and in relative terms one that has become more important again in recent years.12 In 2015 global FDI flows increased by 36%, reaching their highest level since the 2008-09 financial crisis. A strong growth in FDI flows was reported in both the EU and the US. FDI inflow in the US even quadrupled (to the highest level since 2000), but this was partly due to a historically low level in 2014. Thus, the US returned to being the largest host economy of FDI inflows. After three years of decline, inflows to the EU increased again13 (figure 10.5). Similarly, the US has not only been an important destination country for EU FDI, it has also been an important source country for FDI into the EU. In figure 10.5, we show that FDI flows are large. Also, the impact of the financial crisis is clearly visible, leading to a decline of US FDI directed to the EU in 2008 and 2009. In 2011, FDI from the US to the EU peaked at almost €260 billion even though in the following year investments more than halved. The share of total EU FDI inflows originating from the US shows a positive trend, however, peaking at 28% in 201114 (figure 10.6). 12

“Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 51. 13 “Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 51. 14 “Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 51.

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Figure 10.5. EU FDI Outflows to the US

Source: Eurostat

The Transatlantic Trade and Investment Partnership Figure 10.6. EU FDI Inflows from the US

Source: Eurostat

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Figure 10.7. Foreign Direct Investment Flows with the US-EU-27 between 20042012 (billion euros)

Source: Eurostat

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EU-27 FDI stocks in the United States more than doubled between 2004 and 2012, and the United States' FDI stocks in the EU-27 doubled over that period. Since 2006, the EU has recorded a positive balance vis-à-vis the United States, with outward stocks exceeding inward stocks.15 Total EU-27 FDI outflows to the United States increased to EUR 163.4 billion in 2011 and dropped again in 2012, down to EUR 62.9 billion. Inward flows, i.e. the flows from the United States to the EU-27, also decreased in 2012 by more than a half from the previous year, down to EUR 98.8 billion (figure 10.7). Table 10.1 Cumulative US FDI outflows

All Countries

Europe as a % of world

Europe

1950-1959

20,300

3,997

19,60%

1960-1969

40,600

16,220

39,90%

1970-1979

122,271

57,937

47,20%

1980-1989

171,880

94,743

55,10%

1990-1999

869,489

465,336

53,50%

2000-2009

2.056.009

1.149.810

55,90%

2010Q1-2015Q3

1.850.513

1.042.439

56,30%

Source: Bureau of Economic Analysis

As table 1 highlights, Europe continues to attract more than half of the US aggregate FDI outflows. The region’s share of US FDI has remained relatively constant at 56% of the total over this decade, basically unchanged from the first decade of this century but up slightly from the 1990s’ level. When US FDI flows to Caribbean offshore financial centres are subtracted from the total, Europe’s share of US investment climbs to over 60%.16 According to the estimations of the Center for Transatlantic Relations, US FDI outflows to Europe in 2015 totalled $185 billion, a 7.7% rise from 15

http://ec.europa.eu/eurostat/statistics-explained/index.php/USA-EU_-_intern ational_trade_and_investment_statistics. 16 https://transatlanticrelations.org/wp-content/uploads/2016/10/Pages-fromTransatlantic-Economy-2016-Chapter-5.pdf.

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the $171.8 billion registered in 2014. Since hitting a post-crisis peak of $235 billion in 2011, US FDI outflows to Europe have increased for four consecutive years. On a global basis, in contrast, US FDI outflows in 2015 were basically flat compared with a year earlier, totalling an estimated $316 billion for the year. The upshot is that Europe accounted for a larger global share of US FDI outflows in 2015—or nearly 60% of the total, up from 54% in 2014.17 i) Services As highlighted in many other sources, services are the sleeping giant of the transatlantic economy, and a key area offering significant opportunities for stronger and deeper transatlantic linkages. That said, transatlantic ties in services—both in trade and investment— are already quite large. Indeed, the service economies of the United States and Europe have become even more intertwined over the past decade, with cross-border trade in services and foreign affiliate sales of services continuing to expand in the post-crisis environment. By sector, transatlantic linkages continue to deepen in insurance, education, telecommunications, transport, utilities, advertising and computer services. Other sectors such as aviation, e-health and e-commerce are slowly being liberalized and deregulated.18 On a regional basis, Europe accounted for 37.6% of total US exports of services and for 43% of total US imports of services in 2014. Four out of the top ten export markets for US services in 2014 were in Europe. The United Kingdom ranked 1st, followed by Ireland (5th), Germany (8th), and Switzerland (9th). Of the top ten services providers to the United States in 2014, six were European states, with the United Kingdom ranked first, Germany second, Switzerland fifth, France seventh, and Ireland eighth. The United States enjoyed a $64.5 billion trade surplus in services with Europe in 2014, versus a $134 billion trade deficit in goods with Europe.19

17

https://transatlanticrelations.org/wp-content/uploads/2016/10/Pages-fromTransatlantic-Economy-2016-Chapter-5.pdf. 18 https://transatlanticrelations.org/wp-content/uploads/2016/10/TransatlanticEconomy-Chapter-2.pdf. 19 https://transatlanticrelations.org/wp-content/uploads/2016/10/TransatlanticEconomy-Chapter-2.pdf.

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Figure 10.8. US-Europe Services Linkages

Source: Bureau of Economic Analysis Majority owned bank and non-bank affiliates. Services supplied in the US estimate for 2014

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Figure 10.9. Europe-US Services Linkages

Source: Bureau of Economic Analysis Majority owned bank and non-bank affiliates. Services supplied in the US estimate for 2014

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US services exports to Europe reached a record $267.5 billion in 2014, up 6% from the year before, and nearly 30% from the cyclical slows of 2009, when exports to Europe plunged 9.3%. Services exports (or receipts) have been fuelled by several services-related activities like travel, passenger fares, education and financial services.20 In terms of transport, the top five export markets in 2014 ranked in order were Japan, Canada, the UK, Germany and China. The United Kingdom ranked as one of the largest markets for exports of insurance services; the UK and Belgium-Luxembourg also ranked in the top five in financial services. Ireland was the top export market for US trade in intellectual property—or charges or fees for the use of intellectual property rights. The United Kingdom ranked number one in telecommunications, computer and information services. As for “other business service exports,” i.e., activities like management consulting and R&D, Ireland ranked number one in 2014, followed by the UK and Switzerland. As for US services imports from Europe, figures for 2014 were at alltime highs as well. US services imports from Europe totalled $203 billion, up 3.6% from the previous year. The United Kingdom, Germany, Ireland, Switzerland, France and Italy all ranked as top services importers to the United States.21

3. Expected effects of the TTIP The TTIP is the largest bilateral trade and investment agreement ever to be negotiated. It will be a unique agreement where (traditional) tariff liberalization is complemented by significant commitments on regulatory cooperation and a joint rules-based framework for bilateral trade and investment, fit for modern globalized commerce. The future agreement will consist of three pillars: market access, regulatory co-operation and rules. Within these three parts respectively, the TTIP aims to remove nearly all customs duties, improve EU and US access to each other's services and public procurement markets; address and reduce behind-the-border barriers to trade and investment with full regard and respect for the consumer, labour, and environmental, health and other public policy goals; and to set new and clear rules on horizontal issues governing bilateral trade and investment, such as sustainable 20

https://transatlanticrelations.org/wp-content/uploads/2016/10/TransatlanticEconomy-Chapter-2.pdf. 21 https://transatlanticrelations.org/wp-content/uploads/2016/10/TransatlanticEconomy-Chapter-2.pdf.

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development, competition policy and how to integrate small business in trade, which may serve as examples to the rest of the world.22 The TTIP currently under negotiation by the United States and the EU promises to unleash significant opportunities to generate jobs, trade and investment across the Atlantic. At the time of going to print fourteen negotiating rounds had been concluded since the talks first commenced in 2013. However, the negotiations did not complete before the end of the Obama Administration; that said, the Donald Trump administration is expected to embrace and carry on with the TTIP negotiations. An ambitious agreement would include the harmonization of food safety standards, e-commerce protocols, and data privacy issues. It would also encompass the standardization of a myriad of service-related activities in such sectors as aviation, retail trade, architecture, engineering, maritime, procurement rules and regulations, and telecommunications. This all equates to more jobs and income for workers on both sides of the pond.23 The move towards a more barrier-free transatlantic market would also include product standardization so that, for example, a car tested for safety in Bonn can be sold without further tests in Boston or a drug approved by the Federal Drug Administration in Washington is deemed safe and market-ready in Brussels. Labelling and packaging requirements on both sides of the pond would be standardized, saving companies millions of dollars in the long term. Technical regulations and safety standards are hardly headline grabbing topics but when these hurdles to doing business are stripped away, the end results are lower costs for companies, reduced prices for consumers and more aggregate demand of goods and services. That in turn spells more transatlantic trade and investment, as well as more jobs and incomes for US and European constituents. Over the medium term, the TTIP would not only drive an increase in trade and FDI (foreign direct investment) between the US and Europe. It would also encourage more FDI for both markets from the developing nations; large firms in India, China, South Korea and others would strategically seek to be “inside” the transatlantic economy, and would most likely accomplish this through mergers and acquisitions. “Losers” would be firms outside the TTIP framework—as outsiders, these firms

22

“Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 1. 23 Quinlan, Joseph, “The Case for Investing in Europe in 2016”, AmCham EU, December 2016: 34.

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would find it much harder to compete against the “insiders,” who would enjoy the scale and first mover advantage. If the TTIP evolves as an underlying success, the deal would attract other TTIP-wannabes and help deepen global integration. In addition, the competitiveness of both the United States and Europe would be enhanced by a deal that provides more scale to the global operations of US/EU firms; reduces costs in various sectors and activities; and spurs/underwrites more innovation and R&D in the transatlantic economy. More profit-generating policies would (theoretically) give firms more capital for investment, R&D and other related activities. If the TTIP becomes the global golden standard in many industries, this would bestow a first mover advantage on US/EU firms relative to firms from Japan, South Korea, China and other nations. Firms outside the TTIP would have to adjust to the standards and regulations of the transatlantic economy. If the TTIP results in a more integrated transatlantic energy market and harmonized technological standards, both dynamics would help to boost the global competitiveness of the US and EU.24 Then there are the geo-strategic implications of the TTIP as this deal is about more than trade. It is about creating a more strategic, dynamic and holistic US-EU relationship that is more confident, more effective at engaging third countries and addressing regional and global challenges, and better able to strengthen the ground rules of the international order. The transatlantic economy, the largest commercial artery in the world, would be revived. The global clout and credibility of the United States and Europe would be restored. By coming together as opposed to drifting apart, the US and Europe would remain the standard bearers of the global economic architecture. Whatever the common standards of a free trade agreement, and whatever the harmonization and standardization of industry/sector regulations, a transatlantic deal could become the template (industry-by-industry) by which the United States and Europe negotiate with various emerging market economies, China and Russia included.25

24

Quinlan, Joseph, “The Case for investing in Europe in 2016”, AmCham EU, December 2016: 35. 25 Quinlan, Joseph, “The Case for investing in Europe in 2016”, AmCham EU, November 2016: 35.

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Table 10.2. Comparing Mega-regional Trade Agreements (Billions of Dollars unless otherwise specified) Transatlantic TransNAFTA Trade and Pacific Investment Partnership Partnership

GDP (Purchasing Power Parity)

18,64

12,325

3,745 3,40%

% of World Total

17,10%

11,30%

Population (thousands)

510,476

491,723 159,324

% of World Total

7,00%

6,80%

2,20%

Per Capita Income (USD)

36,294

21,615

19,309

Personal Consumption Expenditures* % of World Total Exports % of World Total Imports % of World Total US Outward FDI Stock to… % of US Total US Inward FDI Stock from… % of US Total US FDI Income Earned Abroad % of US total Foreign FDI Income Earned in the US % of US total Foreign Affiliate Sales of US MNCs in… % of US total US Affiliate Sales of Foreign MNCs from… % of US total Source: IMF

10,245

6,540

1,891

23,80%

15,20%

4,40%

5,914

2,755

872

32,10%

15,00%

4,70%

5,907

2,898

947

31,90%

15,40%

5,00%

2,514

1,020

494

51,10%

20,70%

10,00%

1,724

722

279

59,40%

24,90%

9,60%

209

90

40

46,60%

20,10%

8,80%

95

38

15

58,10%

23,20%

8,90%

2,315

1,829

879

38,60%

30,50%

14,70%

2,006

1,073

304

50,70%

27,10%

7,70%

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As table 10.2 demonstrates, the TTIP stacks up far more favourably in many metrics than either the recently concluded Trans-Pacific Partnership or NAFTA. The combined GDP of TTIP members, for instance, is 51% larger than those participants of the TPP. TTIP members are also wealthier. The average per capita income of the TTIP of $36,294 is more than two-thirds larger than the average for the TPP ($21,615). While the latter accounts for 15% of global consumption, the TTIP accounts for nearly one-quarter. Whether trade or investment flows, the figures for the TTIP are larger than the TPP. Finally, US FDI income in the TTIP is more than double that of the TPP, while foreign affiliate sales in the TTIP are nearly 27% larger than comparable figures for the TPP.26

TTIP Macroeconomic Effects The Centre for Economic Policy Research’s (CEPR, 2013) study presents the most suitable approach to date for analyzing the potential impact of the TTIP. From this ambitious 2030 scenario’s impact results, the main expected economic impacts from the TTIP are moderate but with annual economic gains: x GDP is set to be 0.5% higher each year for the EU and 0.4% higher for the US; x National income is set to be 0.3% higher each year for the EU and for the US; x Wages for both high- and low-skilled workers are expected to go up by 0.5% in the EU, compared with 0.3% for high-skilled and 0.4% for low-skilled workers in the US; x Total exports will increase for both the EU (+8.2%) and the US (+11.3%) and so will total imports for the EU (+7.4%) and the US (+4.6%). The EU's terms of trade are expected to increase by 0.5% (i.e. the absolute changes in exports are larger than the absolute changes in imports and the trade surplus increases), whereas in the US these are expected to worsen by 0.3%; x Bilateral trade is expected to increase significantly from its already high level, with an increase of 27% in EU exports to the US and a

26

https://transatlanticrelations.org/wp-content/uploads/2016/10/TransatlanticEconomy-2016-Chapter-1.pdf.

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35.7% increase in US exports to the EU, though as noted above, the EU’s trade surplus with the US increases in absolute terms.27 The updated results indicate that the TTIP will generate positive gains with the estimated impact on GDP ranging between 0.3% and 0.5% each year for the EU and between 0.2% and 0.4% each year for the US (depending on whether the TTIP is ambitious). Given the size of the economies in absolute terms this is a considerable gain and a gain that accrues each year. Furthermore, there is a substantial extra estimated gain in GDP when comparing the less ambitious scenario with the ambitious scenario for both the EU and the US––from this perspective, the more ambitious the TTIP, the higher the expected gains. Modelling simulations show that GDP effects in the EU are slightly higher than in the US. The decomposition of the model’s results shows that the estimated gains are linked mostly to the lowering of NTMs in goods for both the EU and the US. For the EU, tariff liberalization matters significantly28 (figure 10.10). The positive GDP effect of the TTIP is 0.5% each year for the EU on average in the ambitious scenario. The figure below shows that all EU member states are expected to gain from the TTIP. However, across EU member states there is considerable variation. Ireland, Belgium, Lithuania, and Austria stand to gain the most, while Malta and Poland gain the least. There are several potential explanations for these differences, including the depth of economic integration with the US, the different sectoral strengths of each member state, and the fact that the results do not consider any reduction in NTMs for processed foods. This is particularly significant for countries such as Greece, Latvia, Bulgaria, Spain, Croatia, France, Cyprus, Italy, the Netherlands and Poland which could otherwise see significant value added in processed foods exports to the US because of NTM reductions in this sector29 (figure 10.11).

27

“Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 67. 28 “Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 67. 29 “Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 67.

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Figure 10.10. Decomposition of total GDP effects for the EU and the US (% of total effect)

Source: Updated CEPR 2013 results

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nario Figure 10.11. GDP impacts, ambitious scen

Source: Updaated CEPR 20133 results

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The big promise of the TTIP is that it will make trade between the EU and the US easier. That is not just because the aim is to reduce most tariffs to zero. In fact, average transatlantic tariffs negotiated under World Trade Organization treaties are already low––5.2% in the EU and 3.5% in the US. Instead, the TTIP’s big promise is that it can remove many non-tariff barriers (NTBs), such as rules and technical standards that constrain trade across the Atlantic. When the London-based Centre for Economic Policy Research looked at the benefits of the TTIP, it found reducing NTBs represented as much as 80% of the €119 billion (£87.5 billion) annual gain for the EU. “The total potential gains come from cutting costs imposed by bureaucracy and regulations, as well as from liberalising trade in services and public procurement,” it said.30

The TTIP’s economic impact on Turkey Given the special relationship between Turkey and the EU, it is important to discuss the potential impact on Turkey in this separate section. On the 12th of September 1963, Turkey signed the Association Agreement with the European Economic Community. Since 1995, Turkey has had a customs union (CU) with the EU, and since 1999, Turkey has officially been a candidate country. In addition to the customs union, Turkey has a bilateral side-agreement with the EU that covers trade in a few agricultural products. A second reason to pay specific attention to Turkey is the deep economic relationship between Turkey and the EU. As the 18th largest economy in the world with an average annual growth of 4% over the last 15 years, EUTurkey economic relations are set to become even larger over time. As things currently stand, Turkey is the EU’s sixth-largest trading partner whereas the EU is Turkey’s number one trading partner and accounts for 70% of FDI in Turkey. Around 40% of goods traded by Turkey come from or go to the EU. The US on the other hand is a relatively small trading partner of Turkey, although it is the third most important export destination for Turkey (after the EU and Iraq); only 4% of total exports go to the US. Also for imports the US is the third most important trading partner for Turkey (after the EU and China); 5.4% of total imports come from the US. The CU includes the free movement of goods between the EU and Turkey, and covers goods produced by both parties or imported goods from third countries, common rules of origin and common customs duties 30

http://economia.icaew.com/en/features/april-2015/ttip-of-the-iceberg.

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on imports from outside the EU. Owing to the existence of the CU, Turkey's trade policy is closely related to the trade policy of the EU, and Turkey is subject to the trade agreements that the EU establishes with third countries. Therefore, because of the CU, a negotiated TTIP agreement between the EU and the US will have a direct impact on Turkey––but Turkey is not a party at the negotiating table, nor does it automatically get an FTA with the US. Mavuú (2013) indicates that there are also side effects to the CU, two of which are of interest for the ongoing TTIP negotiations:31 x The first issue relates to the fact that Turkey does not have any right to participate in or comment directly on the ongoing negotiations. However, the EU regularly updates Turkey on the state of play of the negotiations; x The second issue relates to the TTIP’s rules of origin and customs duties. Once the TTIP is in force, the US will benefit from the elimination of tariffs when exporting to the EU and to Turkey via the EU. Turkey, on the other hand, cannot make use of the elimination of tariffs between the EU and the US by exporting via the EU to the US if clauses concerning the Rules of Origin end up in the final agreement.32 The potential effect of the TTIP on Turkey is positive but limited in terms of GDP, national income and wages (0.1%). Turkey’s total exports and imports are expected to increase by 2.0% and 1.4% respectively (figure 12). The impact on Turkey's trade with the US is worth highlighting, however. Because of Turkey's customs union with the EU, it is obliged to adjust its tariffs in line with any changes to the EU's common external tariff. Tariffs on US exports to Turkey would therefore be eliminated or reduced under the TTIP in parallel with the EU's. However, Turkey would not have the same access to the US, as it is not party to the TTIP and does not have any separate trade agreement with the US. Figure 13 shows the potential result. In the model, Turkey’s bilateral imports from the US surge by 23.7%, while Turkish exports to the US go up by only 1.3% in the ambitious scenario.

31 Mavus, Merve, “The Possible Effects of TTIP on Turkish Economy,” MPRA Paper No: 51900, 2013. 32 “Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016: 105.

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Figure 10.12. Expected TTIP impact on Turkey’s GDP, National Income, Total Trade and Wages––ambitious scenario (% age change)

Source: Updated CEPR 2013 results

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Chapter Ten

Figure 10.13. Turkey-US Bilateral exports. Ambitious scenario

Source: Updated CEPR 2013 results

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Turkish Central Bank experts also analytically analyzed the economic impacts of the EU-US TTIP on Turkey by differentiating as per Turkey’s inclusion in and exclusion from the Free Trade Areas. By using the Global Trade Analysis Project (GTAP) database and a general equilibrium model, the effects of various scenarios on GDP are studied within the framework of four-regional-consolidation: the EU, the US, Turkey and the rest of the world. The obtained results show that Turkey could have a gain of 35 billion USD if Turkey is included in the FTA compared to if she is excluded from the FTA. Moreover, Turkey’s inclusion in the FTA is not only in favour of Turkey but also in favour of the EU and the USA in terms of higher GDP growth rates.33

4. The TTIP negotiation process The United States and the EU have had 14 rounds of talks over three years on a trade and investment deal aimed at creating the world’s largest trading zone, but they are making slow progress. Facing stiff headwinds in Europe (over wariness about the influence of business) and the United States (because of mounting scepticism over free trade), the negotiations have languished. The most recent round of talks concluded last July with no breakthroughs announced. At its core, the deal seeks to provide an economic stimulus by bolstering trade in the aftermath of the financial and European sovereign debt crises. But there is more at stake. A grander goal of the negotiations has been to enable western countries to compete with rising economic powers like China and India by setting mutually agreed standards in areas like car safety, cosmetics and chemicals. A backlash against globalization on both sides of the Atlantic, however, makes the deal a test case for the west’s commitment to trade liberalization.34

Main Problems Relatively straightforward parts of the talks—like lowering tariffs— remain under discussion, and both sides face making delicate trade-offs. The Europeans are seeking concessions so that their companies can do 33 Gunes, Didem, Mavus, Merve, and Oduncu, Arif, “AB-ABD Serbest Ticaret Anlaúmas ve Türkiye Üzerine Etkileri”, TCMB Paper, 2013-30, 26 Kasm 2013: 7-8. 34 http://www.nytimes.com/2016/07/16/business/international/eu-us-trade-ttip. html?_r=1.

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more business with federal and state authorities in the United States that are currently required to buy American goods and services. They also want to protect the names of foods like Parma ham and Roquefort cheese from being used by American manufacturers. On the other side, the United States wants firm protections for investments by American companies in Europe, in case a member state fails to uphold the terms of the pact. They also want far greater access to European food and agricultural markets to sell more of their produce, including beef, which is banned in Europe if treated with growthpromoting hormones.35

Brexit Surprise Britain has long been among the most enthusiastic supporters of free trade in Europe, but its vote in June 2016 to leave the EU will make the country less of a force in the negotiations. Although Britain is expected to remain a member of the EU for at least two more years, it will most likely turn its attention to seeking new trade deals with other parts of the world. This could put pressure on the Europeans to make concessions to complete the deal, but it could also strengthen the influence of other big member states like France, which generally takes a more protectionist approach to trade than Britain. According to L. Daniel Mullaney, the chief American negotiator, “The withdrawal of the UK from the EU market would affect the value of the EU market.” He noted that a quarter of the United States’ exports to the EU go to Britain, and that the prospect of Britain’s dropping out of the deal was like that of the United States, saying, “maybe the TTIP will not apply to California.”36

5. The Trump era: the end of the TTIP? The seven decades since the end of World War II were an era of trade agreements. The world’s major economies were in a perpetual state of trade negotiations, concluding two major global multilateral deals: the General Agreement on Tariffs and Trade (GATT) and the treaty establishing the World Trade Organization. In addition, more than 500 35

http://www.nytimes.com/2016/07/16/business/international/eu-us-trade-ttip. html?_r=1. 36 http://www.nytimes.com/2016/07/16/business/international/eu-us-trade-ttip. html?_r=1.

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bilateral and regional trade agreements were signed––the clear majority of them since the WTO replaced the GATT in 1995. According to Dani Rodrik: The populist revolts of 2016 will almost certainly put an end to this hectic deal-making. While developing, countries may pursue smaller trade agreements, the two major deals on the table, the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP), are as good as dead after the election of Donald Trump as US president.37

Free trade, the notion of international trade with few restrictions and low tariffs, is likely to be among the losers in a Donald Trump administration. The billionaire businessman won the presidency after a tumultuous and divisive election, partly by his blaming what he called bad trade deals for massive job losses in US manufacturing. As a result, the pending Trans-Pacific Partnership (TPP), a 12-nation free-trade zone that combined, accounts for nearly 40% of the world's economic output, is essentially dead in Congress. Given Trump's protectionist rhetoric, EU Trade Commissioner Cecilia Malmstrom thinks a pending US free-trade deal with Europe—the TTIP— is probably not moving forward anytime soon. "There is strong reason to believe that there would be a pause in TTIP, that this might not be the biggest priority for the new administration," Malmstrom said.38 If it had been completed, the TTIP would have led to a drastic reduction in transatlantic trade tariffs and the removal of barriers to investment. Although it was not much mentioned specifically during the campaign, Trump took a determined stand against existing and proposed multilateral trade agreements, saying he could negotiate more favourable deals bilaterally with national capitals. The TTIP has also faced significant opposition in Europe, largely because it could infringe consumers’ and citizens’ rights in favour of corporations.39

37

Rodrik, Dani, “Don’t Cry Over Dead Trade Agreements”, Project Syndicate, December 2016. 38 http://www.voanews.com/a/international-trade-likely-loser-trump-administra tion/3603015.html. 39 https://www.theguardian.com/world/2016/nov/15/germany-trump-ttip-tradedeal.

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Conclusion The TTIP currently under negotiation by the United States and the EU promises to unleash significant opportunities to generate jobs, trade and investment across the Atlantic. A transatlantic free trade pact would not only be about reducing tariffs. It would also be about reducing non-tariff barriers and harmonizing the web of regulatory standards that inhibit transatlantic trade and investment flows and add to the cost of doing business on both sides of the ocean. A deal would be a win-win for both parties, with large transatlantic firms, as well as medium- and small-sized firms reaping benefits. • A free trade deal would help create jobs and income on both sides of the pond, and spur more cross-border trade and investment in goods and services. The more far-reaching the agreement, the greater the impact on key sectors of the transatlantic economy, notably in services where there is plenty of scope for further integration. • A transatlantic free trade agreement would serve notice to the developing nations that the world’s two largest economies can still work together, and when they do, they still have a great deal of global economic leverage over most, if not all, developing nations. Although the TTIP may look dead and buried, this is still far from certain. The post-crisis global economy is still being reshaped, with the ultimate configuration still unknown. But in a world of perpetual change, one strand of continuity remains the deep integration of the United States and Europe, with each party drawing strength and stability from the other. More broadly speaking, the transatlantic partnership remains the bedrock of the global economy. With many key emerging markets in recession (Russia and Brazil), or struggling to find a new growth path (China) or in the throes of tumult and turmoil (the Middle East and North Africa), the US-EU economic alliance remains critical to the long-term health of the global economy. Simply put: the transatlantic partnership is too big to fail. And it will not fail.

Bibliography 1. Gunes, Didem, Merve Mavus, and Arif Oduncu. 2013. “AB-ABD Serbest Ticaret Anlaúmas ve Türkiye Üzerine Etkileri”, TCMB Paper, 2013-30, 26 Kasm: 7-8. 2. Bizarri, K. 2013. “A Brave New Transatlantic Partnership: The Proposed EU-US Transatlantic Trade and Investment Partnership (TTIP/TAFTA),

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and its socio-economic & environmental consequences”, K. Bizarri Seattle to Brussels Network (S2B) October, 2013. 3. Rodrik, Dani. 2016. “Don’t Cry Over Dead Trade Agreements”, Project Syndicate, December. 4. Quinlan, Joseph. 2016. “The Case for Investing in Europe in 2016”, AmCham EU, December. 5. Mavus, Merve. 2013. “The Possible Effects of TTIP on the Turkish Economy,” MPRA Paper No: 51900. 6. “Trade SIA on the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA Interim Technical Report”, ECORYS, July 2016. 7. http://economia.icaew.com/en/features/april-2015/ttip-of-the-iceberg. 8. http://ec.europa.eu/eurostat/statistics-explained/index.php/USA-EU__international_trade_and_investment_statistics. 9. http://www.nytimes.com/2016/07/16/business/international/eu-ustrade-ttip.html?_r=1. 10. http://www.political-intelligence.com/ttip-a-brief-overview/. 11. https://www.theguardian.com/world/2016/nov/15/germany-trump-ttiptrade-deal. 12. https://transatlanticrelations.org/wpcontent/uploads/2016/10/Transatlantic-Economy-2016-Chapter-1.pdf. 13) https://transatlanticrelations.org/wpcontent/uploads/2016/10/Transatlantic-Economy-Chapter-2.pdf. 14) https://transatlanticrelations.org/wp-content/uploads/2016/10/Pagesfrom-Transatlantic-Economy-2016-Chapter-5.pdf. 15) http://trade.ec.europa.eu/doclib/docs/2015/june/tradoc_153502.pdf. 16) http://www.voanews.com/a/international-trade-likely-loser-trumpadministration/3603015.html.

CHAPTER ELEVEN THE CURRENT AND FUTURE STATE OF TURKEY-EU ECONOMIC RELATIONS MAHMUT TEKÇE MARMARA UNIVERSITY, ISTANBUL

Introduction Turkey and the EU have traditionally been strong partners in terms of economic relations and political alliances. The official story of Turkey’s efforts to be a member of the EU started in 1963, with the Ankara Association Agreement, which was “determined to establish ever closer bonds between the Turkish people and the people brought together in the European Economic Community” (European Communities, 1973: 2). The agreement defined a stage-by-stage integration process concluding eventually with full membership of the Customs Union following the successful completion of the preparatory and transitional stages, and a movement towards free mobility of labour between Turkey and the EEC at some future date. The formation of the Customs Union, followed by the launch of Turkey’s accession negotiations with the EU have clearly reinforced the already strong relations between two parties. Since then, however, we have clearly observed that Turkey’s membership prospects have not proceeded as expected and currently we have reached a situation where Turkey’s membership of the EU is not predicted to take place by either party in an unforeseeable future. This situation is related to the actions of both sides; Turkey has long failed to fulfil certain political and economic criteria for the accession, and on the other hand, the EU has long been very reluctant to take Turkey into the Union. This chapter aims to explain the economic relations between Turkey and the EU and the situation of the Customs Union and discuss the possible scenarios for Turkey-EU relations with a focus on the changes in

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economic conditions, especially in the EU’s external trade policy in an international environment where the WTO’s Doha round is not proceeding.

1. The EU-Turkey Customs Union and beyond 1.1 Impacts of the Customs Union The signature of the Ankara Agreement, followed by the Additional Protocol of 1970 that defines Turkey’s road map of for the harmonization of institutions to those of the EEC, has been a motivating factor for Turkey’s economic and institutional reforms since the 1970s. Regarding the economic relations between Turkey and the EU, the most important step taken was the formation of the Customs Union that became effective in 1996. Thanks to the Customs Union, all industrial goods complying with EU norms and standards could circulate freely between Turkey and the EU. Traditional agricultural goods were left out of the agreement, but processed agricultural products became subject to a system in which Turkey would differentiate between industrial and agricultural components of the duties applied on those products. With the agreement, Turkey adopted the EU’s Common External Tariff for trade with third countries, and it also necessitated Turkey to align itself with the signed FTAs of the EU. The Customs Union agreement was not only a simple reduction of bilateral trade restrictions and the adoption of a common external tariff, but also a tool for the reform of various regulatory border and behind-theborder policies, including investment and competition policies, industrial property rights, administrative procedures and public procurement regimes, which led to a significant change in the Turkish economy during the preparation and application phases of the agreement. With the Customs Union, Turkey’s tariff protection significantly diminished both against the EU and third countries. Prior to the formation of the Customs Union, Turkey’s economy-wide nominal protection rate (NPR) in trade with the EU amounted to 10.2 per cent, and in trade with third countries, 22.1 per cent (Togan, 1997). After the formation of the Customs Union, NPRs decreased further in almost all sectors. Table 11.1 below shows Turkey’s NPRs before and after the Customs Union with the EU. Tariff concessions in the agricultural sectors, fishery and meat products were minimal, but other sectors, such as textiles and clothing, wood, paper, rubber and plastic products, cement, machineries and motor vehicles, have seen substantial decreases in NPRs.

Chapter Eleven

SECTOR NAME

Agriculture

Animal husbandry

Forestry

Fishery

Coal mining

Crude petroleum

Iron ore mining

Other metallic ore mining

Non-metallic mining

Stone quarrying

Slaughtering and meat

Fruits and vegetables

Vegetable and animal oil

Grain mill products

I-0 CODE

1

2

3

4

5

6

7

8

9

10

11

12

13

14

41.33

16.31

72.49

10.21

1.95

9.09

0.13

0.00

0.00

3.33

47.92

0.01

3.48

41.27

NPR with EU in 1994 (%)

41.02

16.31

68.01

10.21

0.00

0.00

0.00

0.00

0.00

0.00

47.84

0.01

1.37

41.26

NPR with EU After CU (%)

41.33

16.38

72.62

10.21

2.18

11.02

2.22

2.22

0.00

3.33

54.08

0.10

4.18

41.65

NPR with Third Countries in 1994 (%)

41.02

16.29

68.01

10.21

0.02

0.95

0.00

0.00

0.00

4.00

47.84

0.01

1.37

41.26

Average MFN Tariff Rates after CU (%)

Table 11.1: Turkey’s Nominal Protection Rates before and after the Customs Union with the EU

254

41.02

16.29

68.01

10.21

0.00

0.95

0.00

0.00

0.00

0.00

47.84

0.01

1.37

41.26

Average Tariff Rates for GSP Beneficiaries after CU (%)

Printing and publishing

Fertilizers

Pharmaceutical production

Other chemical production

Petroleum refining

Petroleum and coal products

28

29

30

31

32

33

Footwear

24

Paper and paper products

Leather and fur products

23

27

Clothing

22

Wood products

Textiles

21

Wood furniture

Ginning

20

26

Processed tobacco

19

25

Alcoholic beverages

Non-alcoholic beverages

18

Other food processing

16

17

Sugar refining

15

5.62

22.54

10.79

3.33

8.22

8.23

13.59

26.22

15.25

24.40

7.85

14.75

21.19

0.00

44.40

56.92

72.10

26.47

28.79

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

5.25

18.31

28.79

7.52

24.35

17.62

8.99

16.38

10.79

17.58

32.64

18.97

35.70

12.57

20.65

27.10

2.22

99.91

69.81

94.28

28.99

28.79

The Current and Future State of Turkey-EU Economic Relations

2.15

2.70

8.71

5.30

8.10

4.52

2.70

5.50

2.00

22.50

10.20

19.90

17.30

0.72

9.40

14.83

11.28

18.31

28.79

0.00

0.00

0.04

0.00

0.00

0.00

0.00

0.00

0.05

9.10

2.80

9.30

7.60

0.72

0.00

0.00

7.35

18.31

28.79

255

1.34 14.48

10.22 17.68

Non-metallic mineral

Iron and steel

Non-ferrous metals

Fabricated metal products

Non-electrical machinery

Agricultural machinery

Electrical machinery

Shipbuilding and repairing

Railroad equipment

Motor vehicles

Other transport equipment

Other manufacturing industries

Mean

38

39

40

41

42

43

44

45

46

47

48

49

Standard Deviation Source: Togan (1997)

0.00

2.92

Cement

0.01

27.33

0.00

6.13

9.69

6.98

7.36

18.36

4.52

8.00

18.33

30.45

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

37

24.61 16.85

Plastic products

Glass and glass products

0.00

36

19.57

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35

Rubber products

34

256

15.36

22.14

8.19

1.76

33.10

4.61

12.89

16.64

12.18

12.50

25.29

8.43

10.70

23.21

32.88

21.94

31.68

23.91

13.79

6.92

2.95

1.60

9.40

4.04

0.50

8.30

3.50

4.40

6.00

3.20

5.50

5.47

3.14

5.76

9.90

5.60

14.51

2.71

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.11

0.50

3.30

0.00

0.00

0.00

0.00

0.03

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257

As mentioned above, the Customs Union with the EU was beyond a tariff elimination agreement for Turkey. It was a stepping stone for the integration of the Turkish economy into the world economy, and for the formation of the export-oriented growth strategy that Turkey had been trying to develop since the early 1980s. This transformation has mostly been in the form of the modernization of major institutions of the Turkish economy. As stated in the EU’s official documents, the Customs Union agreement includes the EU Customs Code and its implementing provisions, the combined nomenclature, common customs tariff and provisions on tariff classification, customs duty relief, duty suspensions and certain tariff quotas, and other provisions such as those on customs control of counterfeit and pirated goods, drugs precursors, export of cultural goods as well as on mutual administrative assistance in customs matters and transit.1

Therefore, with the Customs Union agreement, Turkey had to adopt the EU’s customs provisions in the fields of i) origin of goods, ii) customs value of goods, iii) introduction of goods into the territory of the Customs Union, iv) customs declarations, v) release for free circulation, vi) suspensive arrangements and customs procedures with economic impact, vii) movement of goods, viii) customs debt and ix) right of appeal. (Togan, 2012: 4) To this aim, Turkey applied customs rules similar in substance to those contained in the EU’s Customs Code, made reforms regarding technical barriers to trade, and founded the Turkish Accreditation Agency for a well-functioning quality certification system. The Customs Union also required Turkey to adopt EU competition rules, including measures regarding public aid. To this aim, the Competition Authority became active after 1999. The Competition Authority was based on the “Law on the Protection of Competition”, which was accepted in 1994, but has not been activated since then. In order to be in harmony with the Customs Union agreement, Turkey also went through a significant modernization process in the field of intellectual property rights (IPRs) in industries, including the harmonization of rules for the legal protection of patents, trademarks and designs. Turkey participated in the European Patent

1

These are required for all candidates for EU accession. See, for example, Screening Report for Turkey, http://ec.europa.eu/enlargement/pdf/turkey/screening_reports/screening_report_29 _tr_internet_en.pdf.

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Convention and European Patent Organization to be in line with the EU’s rules for the protection of industrial designs, patents and trademarks.

1.2 Accession negotiations Shortly after the launch of the Customs Union, in the 1999 Helsinki Summit of the EU, it was announced that “Turkey was a candidate State destined to join the Union on the basis of the same criteria as applied to the other candidate States” (European Council, 1999). On December 17, 2004, the European Council agreed to open full-membership negotiations with Turkey. The accession negotiations were officially launched after the completion of the screening meetings in October 2005, where the European Council emphasized that the ‘negotiations are an open-ended process, the outcome of which cannot be guaranteed beforehand’, but ‘while having full regard to all Copenhagen criteria, including the absorption capacity of the Union, if Turkey is not in a position to assume in full all the obligations of membership it must be ensured that Turkey is fully anchored in the European structures through the strongest possible bond’. (European Council, 2005)

During the membership talks, Turkey needed to successfully complete negotiations with the European Commission on each of the 35 chapters of the acquis communautaire of the EU to gain full membership. The first chapter to be successfully opened and provisionally closed in June 2006 was Chapter 25, Science and Research. However, in December 2006, the continued dispute over the official recognition of the Republic of Cyprus by Turkey2 prompted the EU to freeze talks on eight chapters (Free Movement of Goods, Right of Establishment and Freedom to Provide Services, Financial Services, Agriculture and Rural Development,3 Fisheries, Transport Policy, Customs Union, and External Relations) and stated that no chapters would be closed until a resolution is reached. In June 2007, France vetoed three more chapters (Economic and Monetary Policy, Regional Policy and Coordination of Structural Instruments, and Financial and Budgetary Provisions) from proceeding to the next stage. In January 2007, the negotiations were back on track on the chapters that were not suspended. Between 2013 and 2015, France officially removed its veto over the chapters it blocked in 2007. However, this time 2

Turkey refuses to recognize the Republic of Cyprus, represented by the Greek Cypriot government in the south of the island, which has international recognition. 3 Also vetoed by France.

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negotiations of six chapters (Freedom of Movement for Workers, Energy, Judiciary and Fundamental Rights, Justice, Freedom and Security, and Education and Culture) faced a veto from Cyprus in December 2009. To date, 16 chapters have been under negotiation, as seen in table 11.2 below. Table 11.2: Turkey’s Progress on Negotiating the Chapters of the Acquis Chapter Chapter Name No 1

Free Movement of Goods

Negotiations Additional Information Closed EU Council Suspension since 2006

4

Freedom of Movement of Workers Right of Est. and Freedom to Provide Services Free Movement of Capital

5

Public Procurement

6

Company Law

7

Intellectual Property Rights

8

Competition Policy

9

Financial Services

EU Council Suspension since 2006

10

Information Society and Media Agriculture and Rural Development Food Safety, Vet. and Phytosanitary Policy

EU Council Suspension since 2006

2 3

11 12 13

Fisheries

14

Transport Policy

15

Energy

16

Taxation Economic and Monetary Policy Statistics

17 18 19 20

Social Policy and Employment Enterprise and Industrial Policy

Veto by Cyprus in 2009 EU Council Suspension since 2006

EU Council Suspension since 2006 EU Council Suspension since 2006 Veto by Cyprus in 2009

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260 21 22 23 24

Trans Regional Pol. and Coord. of Structural Instr. Judiciary and Fundamental Rights Justice, Freedom and Security

25

Science and Research

26

Education and Culture

27

Environment Consumer and Health Protection

28 29

Customs Union

30

External Relations

31 32 33 34

Foreign, Security and Defence Policy Financial Control Financial and Budgetary Provisions Institutions

Veto by Cyprus in 2009 Veto by Cyprus in 2009 June 12, 2006 Veto by Cyprus in 2009

EU Council Suspension since 2006 EU Council Suspension since 2006 Veto by Cyprus in 2009

35 Other Issues As of December 2016. Source: http://ec.europa.eu/enlargement/countries/detailedcountry-information/turkey/index_en.htm.

1.3 Trade between Turkey and the EU The EU has been a major partner for investment and trade for Turkey ever since the EEC was established in 1957, and the value of bilateral trade between the two parties has increased considerably since then. During the 1970s and 1980s, more than 40 per cent of Turkey’s total trade was associated with EU countries. This close partnership continued after the establishment of the Customs Union and the start of the official membership negotiations but has not changed radically in terms of trade share. Table 11.3 shows Turkey’s exports and imports vis-à-vis the world and the EU since 1990. Between 1996 and 2015, Turkey’s exports to the EU increased fivefold while Turkey’s exports to the world grew by more than six times. However, Turkey’s imports from the EU increased threefold over the period, but imports from the rest of the world increased by 4.75 times. It is evident that Turkey’s trade with the EU continued on

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an upward trend after the formation of the Customs Union; however, the EU’s share in Turkey’s total trade declined after 2007, at a record low share of 39 per cent of exports in 2012 and 36.6 per cent of imports in 2014. Turkey’s trade with the Middle East and North African countries began to rise after that period. The decline in the EU’s trade share is more evident in Turkey’s exports, rather than imports, and led to an increase in Turkey’s trade deficit against the EU. Table 11.3: Turkey’s Foreign Trade with the World and the EU

EXPORTS

Year 1990

1991

1992

1993

1994

1995

1996

1997

IMPORTS Value Value Share (million Partner (million USD) (%) USD) World

12,959

EU-28

7,468

World

13,593

EU-28

7,769

World

14,715

EU-28

8,446

World

15,345

EU-28

8,237

World

18,106

EU-28

9,376

World

21,637

35,709

EU-28

12,188

18,006

World

23,224

EU-28

12,590

World

26,261

EU-28

13,471

Turkey’s Share Trade Deficit (million USD) (%)

22,302 57.63

10,595

9,343 47.51

21,047 57.15

10,676

7,454 50.73

22,871 57.40

11,511

14,922

50.33

56.33

11,643

50.71

24,349

50.04

26,128

2,267 14,072

50.43

5,818 20,403

55.81

48,559 51.30

6,685 5,164

43,627 54.21

3,065 14,083

23,270 51.79

2,907 8,156

29,428 53.68

3,127

11,759 22,298

53.81

12,657

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1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

World

26,974

EU-28

14,837

World

26,587

EU-28

15,454

World

27,775

EU-28

15,688

World

31,334

EU-28

17,576

World

36,059

EU-28

20,458

World

47,253

EU-28

27,479

World

63,167

EU-28

36,699

World

73,476

EU-28

41,533

World

85,535

EU-28

48,149

World

107,272

EU-28

60,754

World

132,027

EU-28

63,719

World

102,143

EU-28

47,228

World

113,883

EU-28

52,934

45,921 55.01

25,297

18,947 55.09

40,671 58.13

22,538

14,084 55.41

54,503 56.48

28,552

19,841

52.39

25,698

47.93

35,157

49.85

48,131

50.70

52,781

49.34

59,448

45.20

68,472

42.59

74,513

40.26

56,616

36.89

72,391

10,794 38,785

40.17

185,544 46.48

7,718 69,937

140,928 46.24

11,299 62,791

201,964 48.26

11,248 54,041

170,063 56.64

11,432 43,298

139,576 56.29

7,678 34,373

116,774 56.53

5,240 22,087

97,540 58.10

2,265 15,495

69,340 58.15

12,864 10,065

51,554 56.73

7,084 26,728

41,399 56.09

10,460

9,388 71,661

39.02

19,457

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2011

2012

2013

2014

2015

World

134,907

EU-28

62,589

World

152,462

EU-28

59,398

World

151,803

EU-28

63,040

World

157,610

EU-28

68,514

World

143,839

240,842 46.39

91,439

105,935 37.97

236,545 38.96

87,657

92,458

37.06

88,784

28,259 99,858

36.74

242,177 43.47

28,850 84,083

251,661 41.53

263

29,418 84,567

36.66

207,234

20,270 63,395

63,998 44.49 78,681 37.97 14,683 EU-28 Source: Turkish Statistical Institute and World Development Indicators

2. Challenges of the Customs Union4 As explained above, the Customs Union has significantly contributed to the transformation of the Turkish economy, mainly through the modernization of the institutions of the Turkish economy, and increased competition from European firms. The Customs Union strengthened the alignment of Turkey’s technical legislation and its quality of infrastructure with that of the EU, streamlined customs procedures and eliminated the need for rules of origin on its trade with the EU (World Bank, 2014: 19). However, the Customs Union came with some disadvantages for the Turkish economy and most of these disadvantages remain as unresolved issues in Turkey’s trade policy and its relations with the EU. According to Akman (2010), the main problems are: i. The EU has its own priorities reflected in its FTAs that are concluded, and these agreements do not take into account Turkey’s special interests; ii. Turkey suffers tariff revenue losses. In particular, imports from 4

This section depends on the Korea Institute for International Economic Policy (KIEP) study: Tekçe, M., “Whıther Turkey’s Integratıon to the European Union? Economic and Political Challenges in Turkey-EU Relations” in Studies in Comprehensive Regional Strategies (Seoul: KIEP, 2017).

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third countries by way of trade deflection via the EU induce tariff revenue losses for Turkey. Import tariff revenues fell from 2.8 per cent of total tax revenues in 1995 to an average of 1.1 per cent over the period 2001-05 (Taymaz and Yılmaz, 2007); iii. Turkey cannot enter into FTAs with third countries with which the EU has not accorded a deal; iv. There are latecomer effects. In particular, Turkey can conclude FTAs only after the EU has concluded the FTAs. This puts Turkish exporters in a disadvantageous position with regard to EU exporters, who can obtain preferential status by penetrating third country markets several years earlier; v. Some of the EU’s trade partners that have concluded FTAs with the EU or continue to negotiate FTAs with the EU refrain from concluding FTAs with Turkey despite the “Turkey Clause” included in the FTAs concluded by the EU. In this study, the criticisms of the Customs Union will be examined under two subheadings; the disadvantages due to the shallow coverage of the agreement, and the disadvantages stemming from the EU’s trade policy shift.

2.1 Coverage of the Customs Union as a challenge As explained above, the Customs Union covers only industrial goods and processed agricultural goods, which comprise only 20 per cent of the national economy. This shallow coverage prevents Turkey from taking advantage of several aspects of the Customs Union, and makes it more difficult to harmonize its economy in line with the standards of the EU economies, which is crucial for Turkey’s prospective membership to the EU. In particular, Turkey's private sector has been demanding the expansion of the Customs Union agreement since its launch. The private sector faces challenges not only from the shallow coverage of the Customs Union, but also from the exceptions in the liberalization of the trade in goods; in other words, the scope of the Customs Union has been narrower than its official coverage, and this has been caused by both Turkey and the EU. Although the Customs Union includes industrial goods and processed agricultural goods, in principle it has a few exceptions; among the most important are Turkey’s ban on used machinery imports including used vehicles, and the non-application of the principle of the exhaustion of intellectual property rights for the pharmaceutical sector. Furthermore, in order to protect its automobile

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industry, Turkey continued the application of trade defence instruments such as anti-dumping and anti-subsidy measures by both parties, which are contradictory to the principles of the Single Market and not utilized in intra-EU trade, and these have proved significant obstacles for the Turkish private sector.5 Another challenge faced by the private sector is that the Customs Union does not cover the service sector. Up to 70 per cent of the Turkish economy is composed of the service sector and the sector has the potential to successfully integrate into the European markets in the event of liberalization. According to a study by the World Bank (2014), liberalization of the service sector between Turkey and the EU is expected to increase Turkey’s GDP by 0.2 per cent, which is around USD 1.5 billion in 2014. Turkish private sector actors are expecting an expansion of the Customs Union to cover the service sector, through legal harmonization between the two parties. Finally, Turkish private sectors are expecting the customs union to be modernized so that it covers the liberalization of public procurement markets. The opening of the Turkish public procurement market to European firms would introduce a more competitive environment for Turkish companies, but on the other hand, certain Turkish companies, especially in the construction and transportation sectors, would enter the EU public procurement markets with a competitive edge and expect to benefit from this environment. In addition, the removal of visa obstacles for the temporary movement of workers would be particularly important for the construction and contracting industries in which Turkey is highly competitive (Ülgen and Yenigün-Dilek, 2015).

2.2 New trade policy of the EU as a challenge to the Customs Union The biggest challenge for the sustainability of the Customs Union is related to the FTAs of the EU. Article 13 of the Customs Union agreement requires Turkey to align itself with the EU’s common commercial policy in relation to countries that are not EU members. Articles 16 and 54 reinforce this by explicitly requiring Turkey to progressively align itself with the preferential customs regime of the EU (World Bank 2014: 24). Furthermore, according to Article 14 of the Customs Union agreement,

5

See the TUSIAD (Turkish Industry and Business Association) report by Ülgen and Yenigün-Dilek (2015).

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Turkey should not apply an import tariff lower than the CET for any products. Consequently, as expressed by the World Bank (2014: 24), the EU sets the CET in line with its priorities and in many cases applies lower duties in the framework of FTAs. This has led to a progressive liberalization of Turkish tariffs on most industrial products, and a selective liberalization of agricultural ones, from third countries with which the EU has negotiated FTAs.

This fact became a significant challenge for the Turkish economy after the EU announced its new trade policy in 2006. The EU had been keeping a multilateralist position in global trade policy after the formation of the World Trade Organization (WTO). At the time of the launch of the WTO Doha round, the trade policy of the EU was “pursu[ing] all existing mandates for regional negotiations with vigour and fairness, but not to begin any new negotiations” (Lamy, 2002: 1412). However, this multilateralist position became unsustainable when the Doha round was officially suspended in July 2006. As stressed by Acar and Tekçe (2008: 275), regarding the fact that the biggest competitor, the US, has been pursuing FTAs with several countries, especially with the developed and emerging markets in East Asia, the EU had to act as soon as possible to avoid trade diversion and a shift in the EU’s trade strategy had already become inevitable.

The European Commission revealed a new trade policy strategy, Global Europe,6 in October 2006, under which the EU would “pursue bilateral FTAs with major economies in order to secure the market access and competitiveness of European companies in important markets” (Guerin et al., 2006: 58). The core of the new trade strategy of the EU has been summarized by the Commission as; “rejection of protectionism at home, accompanied by activism in creating open markets and fair conditions for trade abroad” (European Commission, 2006: 6). The FTA strategy constitutes a very important part of this trade policy. By that time, the EU already had quite a significant number of bilateral trade agreements: agreements with the EFTA countries, the Customs Union with Turkey, the goods agreements with Euromed countries and the preferential arrangements offered to the sub-Saharan African, Caribbean and Pacific countries (Guerin et al., 2006: 58). Before the Global Europe strategy, the 6

Full text available at: http://trade.ec.europa.eu/doclib/docs/2006/october/tradoc_130376.pdf.

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EU had also signed FTAs with Chile, Mexico and South Africa. In the EU’s new trade policy, the European Commission defined the key economic criteria for new FTA partners as “market potential (economic size and growth) and the level of protection against EU export interests (tariff and non-tariff barriers)” and set the priority targets as ASEAN, Korea and Mercosur. India, Russia and the Gulf Cooperation Council were defined as “the countries of direct interest to the EU”, and significant importance has been attached to an empowered transatlantic trade partnership (European Commission, 2006: 11, 12). The EU quickly took action in the context of its new trade policy and started FTA negotiations with Korea and ASEAN in 2007, and with Mercosur in 2010. The first results of this FTA-oriented trade strategy of the EU were achieved by the signature of the EU-Korea FTA in 2010, which has been in effect since July 2011. The negotiations with ASEAN were paused in 2009 and re-launched in 2010, but only with Singapore and Malaysia. Moreover, the EU began FTA negotiations with Canada in 2009 and last, but absolutely not the least, the US and the EU started negotiations on the Transatlantic Trade and Investment Partnership (TTIP) in July 2013. The shift in the trade policy of the EU has been alarming news for Turkey. As explained above, the Customs Union was negotiated with the expectation that it would be a transitional arrangement to be made before Turkey’s eventual full membership in the EU. However, full membership has not taken place and the transitional agreement became a permanent situation for both parties. According to Article 16 of the Customs Union agreement,7 Turkey has to align itself progressively with the preferential customs regime of the EC within five years from the date of entry into force of the Customs Union. This alignment will concern both the autonomous regimes and preferential agreements with third countries. To this end, Turkey committed itself to taking the necessary measures and negotiating agreements on a mutually advantageous basis with the countries concerned.

While the EU stepped up efforts to sign FTAs with larger countries, Turkey faced the serious problem of “trade deflection”. According to Krueger (1997), when transport costs are assumed as zero, any FTA would become a customs union, where importers would import goods through the country with the lowest tariff and then transship (or deflect) them to the 7

EU-Turkey Association Council Decision 1/95.

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country where they were in demand. In order to avoid such negative consequences of a Customs Union, rules of origin become a central feature of both Customs Unions and FTAs. As Francois et al. (2005: 1554) stress, all preferential trade agreements require rules of origin to prevent trade deflection, and the EU insists on its own rules of origin being applied in all of its preferential trade agreements, and determining the origins becomes complex when processing or manufacturing uses imported intermediate material in production, since both parties will wish to exclude from preferences, third country goods which have undergone only superficial working or processing in the partner country. (Francois et al., 2005: 1555)

According to Decision No. 1/95 of the Turkey-EC Association Council, (European Communities, 1996), free movement would be valid for goods either wholly produced in either parts of the agreement or put into free circulation after their importation from third countries in either Turkey or the EC. The proof of this customs status of “goods in free circulation” is established by an ATR.1 (Admission Temporaire Roulette) movement certificate.8 The ATR.1 is not a certificate of origin, but rather certifies that the exported goods are manufactured in or have free circulation status within the EU, which means that the product has gone through the importation procedure in either country. Once the EU signs an FTA, the partner country gains automatic unrestricted access to Turkish markets without any customs duties as long as it receives an ATR.1 certificate in one of the member countries. Turkey, on the other hand, unable to take part in the formation of the EU’s common commercial policy, “finds itself in a position of opening its markets to countries that it did not even negotiate with, and under the conditions determined by the interests of the EU and the partner country” (Tekçe, 2010: 68). Furthermore, it faces trade barriers in the markets of that country, where Turkish firms do not receive automatic reciprocal access to those markets. This situation not only puts Turkey in an uneven position in its bilateral trade with the partner country by weakening Turkey’s trade negotiating position, but also leads to a serious fall in its customs revenues and risks the imposition of origin controls that could undermine the benefits of the Customs Union. Before the announcement of the new “Global Europe” trade policy strategy of the EU, Turkey also faced the risk of trade deflection, but the EU’s FTA partners were either relatively small in economic size or had a relatively insignificant trade volume with Turkey. As stated in the 8

European Communities (1996).

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Customs Union agreement, Turkey aimed to take the necessary measures and negotiate agreements with the EU’s FTA partners, but some of these counties, like Algeria, South Africa and Mexico, have been reluctant to start trade talks with Turkey. As stated by Tekçe (2010: 69), “as Turkey fails to come to an agreement with the country that signed an FTA with the EU, and the time lag between the FTAs of two parties expands, Turkey’s loss from trade deflection rises”. Table 11.4 below shows the FTAs concluded by the EU after 2000, and their comparison with Turkey. Table 11.4: Comparison of the FTAs of Turkey and the EU Country Mexico Morocco South Africa Jordan Lebanon Egypt Algeria Chile Korea

Year the FTA Came into Force EU Turkey 2000 Negotiations did not start 2000 2006 2000 Negotiations did not start 2002 2011 2003 Signed, not in force 2004 2007 2005 Negotiations did not start 2005 2011 2011 2013

Source: Republic of Turkey Ministry of the Economy FTA portal (2016)

As seen in table 11.4, with the exception of the FTA with Korea, there is a time lag between the partner countries’ FTAs with the EU and Turkey, which increases the costs of trade deflection for Turkey. Furthermore, currently, the EU has completed or is negotiating FTAs with larger economies and with a deeper coverage. Turkey faces serious challenges in this process: First of all, there is no binding clause for these countries to sign an agreement with Turkey; they may want to enjoy the tariff-free access to Turkey if they have concerns about opening their own markets to Turkey. Second, it is the first time for Turkey to negotiate an FTA with country groups (except for the Turkey-EFTA FTA in 1992) instead of single countries, and also to negotiate deep FTAs instead of agreements with only tariff and quota removal. (Tekçe, 2015: 401)

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As seen in table 11.5, Turkey has completed 23 FTAs (18 are in force) and is negotiating 13 FTAs9 at the moment. Table 11.5: Free Trade Agreements of Turkey Party EFTA Israel Macedonia Bosnia Herzegovina Palestine Tunisia Morocco Syria Egypt Albania Georgia Montenegro Serbia Chile Jordan S. Korea Mauritius Malaysia Lebanon Kosovo Moldova Faroe Islands Singapore

Year of Signature 1991 1996 1999 2002 2004 2004 2004 2004 2005 2006 2007 2008 2009 2009 2009 2010 2011 2014 2012 2013 2013 2014 2015

Entry into Force 1992 1997 2000 2003 2005 2005 2006 2007 2007 2008 2008 2010 2010* 2011 2011 2013 2013 2015 Pending Pending Pending Pending Pending

Source: Republic of Turkey Ministry of the Economy FTA portal (2016)

It is obvious that negotiating these FTAs with broad coverage like the EU would be a challenge for Turkey’s foreign trade policy in the forthcoming

9

Peru, Ukraine, Colombia, Ecuador, Mexico, Japan, DR Congo, Cameroon, Seychelles, Gulf Cooperation Council, Libya, MERCOSUR and Chad. (The FTA negotiations with Ghana were completed in 2013, but the agreement has not been signed yet.) * Suspended by Turkey in 2011.

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years. The challenge stems from Turkey's current position in FTA talks, which is as follows; as a result of the Customs Union with the EU, Turkey is unable to select its FTA partners in line with its economic interests, it has to pursue the EU’s FTA partners for an agreement, and it faces trade deflection especially as the EU plans FTAs with large economies (like Canada and US) unless it signs FTAs with these countries immediately after the EU signs. (Tekçe, 2015: 403)

Turkish policymakers expressed their complaints to the European Commission, and demanded that the EU should give Turkey a role in the FTA negotiations or bind the partner to pursue simultaneous FTA negotiations with Turkey; however, these attempts have been fruitless. The Commission states that it negotiates its FTAs on behalf of its 28 member states only, and the inclusion of Turkey is, legally and practically, not plausible. Turkey, unable to become a direct party to the EU’s FTAs, tried to take some measures to overcome the trade deflection problem. For example, Turkey has introduced a protection measure based on the rules of origin for the import of cars from Mexico in order to reduce trade deflection, but the use of such measures led to further costs in customs due to origin requirements. Turkey has also decided to apply additional customs duties for some textile products originating from some countries outside the EU and the EU’s FTA partners. In order to apply these differentiated duties, origin controls are being conducted based on customs declarations, but no physical check is yet being conducted, which largely undermines the success of these measures (World Bank, 2014: 25). The EU added a “Turkey Clause” to its FTAs, signalling the intention for the EU’s FTA partners to start negotiating an agreement with Turkey based on the findings of a joint feasibility study. However, this clause was non-binding. For example, South Africa refused to add the Turkey Clause to the FTA text. In the FTA between the EU and Korea, the Turkey Clause was diluted to a declaration.10 While the Commission has also been actively writing to Mexico and Algeria, urging them to start negotiating FTAs with Turkey, these attempts have been unsuccessful (World Bank, 2014: 29). So far, the Turkey Clause is far from being a solution to Turkey’s trade deflection problem. The only feasible option left for Turkey is signing an FTA with the FTA partner of the EU immediately after the EU signs the agreement, 10 Although this Turkey Clause still provided the process with impetus as within less than a year Korea also agreed to an FTA with Turkey.

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which largely depends on the negotiation abilities of Turkish policymakers and the political connectedness of the two parties, as the other country has no obligation to sign the agreement. Turkey failed to even start a negotiation process with Mexico and South Africa, but managed to come to an agreement with Morocco, Jordan, Egypt and Chile. However, all these FTAs were signed three to nine years after they concluded an FTA with the EU. The most successful case for Turkey was its FTA with Korea; the FTA was concluded less than a year after Korea’s FTA with the EU, and the agreement came into force in 2013.

2.3 The Transatlantic Trade and Investment Partnership and the Customs Union In this regard, the biggest challenge for Turkey in terms of the Customs Union is the possibility of the Transatlantic Trade and Investment Partnership (TTIP) between the EU and the US. Provided that it succeeds, the TTIP is expected to be the largest and most comprehensive FTA the EU has ever signed, and is expected to create a free trade zone comprising nearly half of global economic output and 30 per cent of world trade. The TTIP is expected to include all aspects of trade (both goods and services), tariff and non-tariff barriers (especially regulations) and FDI. The negotiations will also include discussions on government procurement, trade facilitation, environmental and labour policies, competition policy, state-owned enterprises and intellectual property rights.11 According to Francois et al. (2013: 47), the gains from a comprehensive liberalization of trade would be EUR 119 billion for the US and EUR 95 billion for the EU per year. While the parties of the TTIP are expecting substantial gains from the agreement, according to the study conducted by the Ifo Institute (2013), the countries with which either the EU or the US already has free trade agreements are expected to be the main losers. The study estimates that real income losses for Canada and Mexico, both with preferential trade agreements with the US and the EU, would be 9.48 and 7.24 per cent respectively, while Turkey’s potential loss is put at around 2.5 per cent (Ifo Institute, 2013: 6). The report by Bertelsmann Stiftung (2013) estimates that Turkey could lose close to 95,000 jobs as a result of the TTIP. Not being party to the TTIP leaves Turkey with the biggest risk of trade deflection it has ever faced. This issue has been a subject of 11

See Pelkmans et al. (2014) for a comprehensive survey.

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discussion between the authorities of Turkey and the EU on several occasions. However, no concrete step has been taken in order to alleviate Turkey’s concerns. This leaves Turkey with two options; negotiate and sign a TTIP-like FTA with the US, or reform the Customs Union with the EU and transform it into a comprehensive FTA in order to minimize the effects of trade deflection. The first option is not easy, but feasible and strategic. If Turkey manages to sign an FTA with the US, with conditions similar to those of the TTIP, the agreement, covering several areas mentioned above, would have a deeper coverage than the Customs Union with the EU. Such an agreement and growing economic relations between Turkey and the US would be a natural impetus for the expansion of the Customs Union between Turkey and the EU, in which case the EU would not take the risk of the diversion of Turkish trade to the US. Under the current state of affairs, trade deflection resulting from the EU’s current or prospective FTAs, especially from the TTIP, seems to be one of the biggest challenges for relations between Turkey and the EU. Neither party has managed to solve or suggest a feasible solution for this issue. As mentioned above, a joint FTA negotiation is institutionally impossible, even though that would be the best option for Turkey. The “Turkey Clause” attached to the TTIP may be a sign of goodwill, but it has no binding power and is practically ineffective. The only feasible and plausible option left is the revision of the Customs Union in line with the changing economic environment. Although this is not an easy task to complete, some important steps have been taken. Turkey and the EU agreed to launch the modernization negotiations in 2017, and declared their goodwill. A revision of the Customs Union is not an easy task to perform, but it is crucial and urgent for both parties in order to continue a healthy bilateral economic relationship.

Conclusion Turkey and the EU have very strong economic, political and cultural ties; thanks to the Customs Union, the two parties have been enjoying tarifffree trade in the last two decades, and Turkey has been negotiating the chapters of the acquis since 2005 with the prospect of joining the EU eventually. However, not only the actions of the current governments, but also the recent developments in the world economy and global politics make Turkey’s accession to the EU almost impossible in the foreseeable future. Given the fact that Turkey is not likely to become a member of the EU, the Customs Union, with its current shallow coverage, has a potential to

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create more problems than benefits. In order to maintain more healthy and stable relations, it become imperative for both parties to accelerate their efforts on the modernization of the Customs Union, which was originally designed as a transitionary phase before Turkey’s full membership of the EU. As the Customs Union does not cover the service sector, the benefits for Turkey have been limited. Also, the increasing number of the EU’s FTAs with important economies has become a significant threat for the Turkish economy as those FTAs are far from taking Turkey’s interests into consideration, and Turkey usually cannot sign FTAs with third countries with which the EU has not accorded a deal. This adverse effect would probably be in its most extreme form if the EU finishes the FTA talks with the US and the TTIP enters into force. The Customs Union needs a change, a change that would be beneficial for both parties with its coverage, to include agriculture, services, nontariff barriers, IPR issues, food safety, investment, competition, public procurement, labour standards, environmental issues, and dispute settlement provisions. If the necessary steps are not taken in the short term, the longer term consequences run the risk of harming the already not-verybright relations between Turkey and the EU, and it is historically proven that keeping on track the relations between the EU and Turkey is clearly beneficial for both parties.

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13/02/1996, Brussels http://eur-lex.europa.eu/LexUriServ/LexUriServ. do?uri= CELEX:21996D0213(01):EN:HTML. European Commission. 1993. European Council Meeting in Copenhagen, 21-22 June 1993, SN 180/1/93, Brussels. —. 2006. Global Europe: Competing in the World, Commission Staff Working Document, DG External Trade, Brussels. —. 2012. Commission Staff Working Document Impact Assessment Report on EU-Japan Trade Relations, Brussels. —. 2016. Implementing the EU-Turkey Statement, Fact Sheet, 15 June 2016, Brussels, http://europa.eu/rapid/press-release_MEMO-16-1664_ en.htm. Francois, J. F., M. McQueen, and G. Wignaraja. 2005. “European Union– –developing country FTAs: overview and analysis.” World Development 33.10: 1545-1565. Francois, J., M. Manchin, H. Norberg, O. Pindyuk, and P. Tomberger. 2013, “Reducing Transatlantic Barriers to Trade and Investment: An Economic Assessment”, Centre for Economic Policy Research Project prepared under the implementation of Framework Contract TRADE10/A2/A16. Guerin, S., H. Edwards, G. Glania, H. Kim, H. Lee, J. Matthes, and M. Tekçe. 2007. A Qualitative Analysis of a Potential Free Trade Agreement between the European Union and South Korea. Study submitted by a consortium consisting of CEPS and KIEP to DG Trade European Commission. Krueger, A. O. 1997. “Problems with Overlapping Free Trade Areas.” In Regionalism versus Multilateral Trade Arrangements, edited by T. Ito, and A. O. Krueger. University of Chicago Press. Lamy, P. 2002. “Stepping Stones or Stumbling Blocks? The EU's Approach Towards the Problem of Multilateralism vs. Regionalism in Trade Policy”, World Economy, 25: 1399-1413. Pelkmans, J., A. Lejour, L. Schrefler, F, Mustilli, and J. Timini. 2014. “The Impact of TTIP: The underlying economic model and comparisons”, CEPS Special Report, No. 93. Republic of Turkey Ministry of Economy FTA portal. 2016. http://www.ekonomi.gov.tr/sta/. Secretariat General for EU Affairs, Turkey-EC Customs Union Agreement. http://www.abgs.gov.tr/files/_files/Gumruk_Isbirligi/okk1.pdf. Taymaz, E., and K. Yılmaz. 2007. “Productivity and trade orientation: Turkish manufacturing industry before and after the Customs Union”, Journal of International Trade and Diplomacy, 1 (1): 127-154.

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Tekçe, M. 2010. “Free Trade Agreement between Korea and Turkey: Challenges, Opportunities and Economic Cooperation.” In CRES Visiting Scholar’s Paper Series, edited by Yang-Hee Kim, KIEP. —. 2015. “The Future of the Customs Union between Turkey and the EU in the Context of the Trade Policy Agenda of the EU”, Marmara Üniversitesi ø.ø.B. Dergisi, 37 (2): 397-408. Togan, S. 1997. "Opening up the Turkish Economy in the Context of the CU with the EU", Journal of Economic Integration, 12: 157-179. —. 2012. The EU-Turkey Customs Union: A Model for Future Euro-Med Integration, MEDPRO Technical Report No. 9. United Nations COMTRADE Statistics Database. 2016. http://comtrade.un.org/db/. Ülgen, S., and P. Yenigün-Dilek. 2015. Gümrük Birli÷i’nde Yeni Dönem ve Iú Dünyasi (A New Era for the Customs Union & the Business World), TUSIAD Report No: T/2015, 10-568. World Bank. 2014. Evaluation of the EU-Turkey Customs Union, Report No. 85830-TR, 28.