Brexit will throw up many challenges for the UK’s trade with Turkey. A long period without a trade deal would be harmful to all sides, writes Onur Bulbul.
Onur Bulbul is the founder and president of InnoNative Advisors. He has previously served as a free trade agreement negotiator for Turkey, advisor to Turkish Minister of Economy and a commercial diplomat at the Turkish Embassy in Washington DC.
Confusing messages are coming from Turkey. The idea of putting Turkey’s EU bid to a referendum is being floated on the side, while discussions on the modernisation of Turkey-EU Customs Union are looming. Questioning Turkey’s EU adventure is a political game and whether this threat could spill over into commercial relations is not clear. Yet, on a pragmatic note, the economic implications of losing a single member of the customs union after Brexit, let alone freezing its EU bid, seem to be detrimental for the country.
The EU absorbs almost half of Turkey’s foreign trade. Britain is Turkey’s second biggest export market ($10.5 billion) and its 12th biggest supplier ($5.5bn). Trade with Britain not only helps finance Turkey’s current account deficit but is also vital for Turkey’s plans to rid itself of the middle-income trap and move up the value chain as medium and high-value added industrial goods constitute the lion’s share of Turkish exports to Britain.
Once Britain leaves the EU customs union, current Most Favored Nation (MFN) rates would apply to Turkish exports to Britain. These range from around 3% for electrical machinery and equipment to 12% for clothing and would be a huge burden for Turkish exports. In addition, non-tariff barriers such as diverging regulatory requirements may arise depending on the outcome of Brexit negotiations, combining with increased tariffs to further price Turkish exporters out of the market.
Without the customs union therefore, the best option for both sides would be a bilateral free trade agreement (FTA). It seems like the parties are already interested in this option. However, such a scenario comes with two caveats. The first is that, due to its current customs union obligations with the EU, Turkey can only sign an FTA with Britain after the EU agrees its own. Therefore, Britain first needs to sort out its trade relationship with the EU before it is able to enter into official FTA negotiations with Turkey.
Second, an FTA would require the traded goods to meet origin requirements in order to benefit from duty-free treatment. Even if the parties agree on keeping the EU’s main framework on origin rules with Euro-Med countries, for instance, Turkey must still meet the value-added criteria in its automotive exports to Britain (currently 40% of the value of components used in the final product must originate in the exporting country) or the double transformation requirement in its clothing exports (the final apparel must be manufactured from yarn, not from imported fabric). Currently, automotive (23%), and apparel (14%) constitute more than a third of Turkish exports to Britain and preferential origin requirements under an FTA would definitely impede the current flow of trade.
Turkey’s investment relations with the EU and Britain, however, are governed by bilateral investment treaties between Turkey and EU member countries. Yet, after Brexit, rising costs of trade between Turkey and Britain would certainly decrease the attractiveness of both markets for investors. A glimpse of what is at stake on this front reveals that Britain holds the third largest FDI stock in Turkey with $10.2bn and it is the ninth most attractive FDI destination for Turkey with a cumulative stock of $821 million.
The EU will also be negatively affected by such a divorce. In 2015, the UK was the third largest importer from the EU with a share of 10.2%. Hence, “Brexit max” will crudely translate into a 10% shrinkage in the EU internal market. Turkey, on the other hand, absorbs 4.4% of extra-EU exports. Therefore, despite souring relations with Turkey or a solid stance against British ‘cherry picking’, maintaining the customs union relationship with both countries will serve the EU’s interests as well.
Brexit, and a potential Trexit, generate discussions on a new form of external relations for the EU. Formulating new terms with a former member and enhancing the commercial relationship without accelerating the membership prospects of a candidate country are both difficult tasks. The coincidental timing of both restructuring processes also makes out-of-EU alliances possible, and arguments such as a potential Turkish-British alliance vis-à-vis the EU are under discussion.
However, it seems like major hiccups are on the horizon on this front as well. A potential Turkey-Britain alliance vis-à-vis the EU on services negotiations for instance, seems rather slim, given the countries’ diverging interests in this sector. The weight of services in both the British (80%) and Turkish (57.4%) economies is important. Yet, the composition, and therefore, priorities of Turkish and British services industries are quite divergent. Whereas the British services industry is dominated by financial services, which would not necessarily require free movement of people (perhaps the gravest concern for Brexiteers), Turkish interests lie mainly in sectors such as construction, logistics, tourism, air-transport, and other cross-border trade in services that do rely on the free movement of people.
A wake-up call?
While heading for “Brexit max”, Britain is desperately looking for alternative trade agreements with countries including Turkey. Turkey also seems to be in search for new opportunities, including an FTA with Britain and even membership to alternative blocs such as the Shanghai Cooperation Organisation. While a bilateral FTA seems to be the most sensible option after Brexit, it may not be a foregone conclusion. Even bringing together the Turkish and British positions on the EU seems to be a tough job. Drifting towards uncharted waters, on the other hand, bears the risk of deteriorating well-established commercial relations for both Turkey and the EU. Whether Brexit will trigger Trexit or serve as a wake-up call for all, however, remains to be seen.