EU Integration and Turkish SME

EU Enlargement and the Wider Neighbourhood


Turkey and the European Union

The European Commission’s October 2005 invitation to begin formal accession negotiations marks a milestone in Turkey’s relationship with the EU. Turkey’s first formal application for membership in the EU (then the European Economic Community) dates back to July 1959, when the EEC offered a roadmap to a customs union, as a prelude to Turkey’s eventual membership. This roadmap was formalized by the 1963 Ankara Agreement and its supplemental protocol of 1970, which led to the establishment of the customs union in 1995. The Customs Union between Turkey and the EU was a unique experience in that Turkey was the first (and the only country until 2002) that entered into such integration without being a member of the Union. Moreover, Turkey’s agreement with the EU goes well beyond the classical definition of a customs union1: Turkey has pledged to harmonize its commercial and competition policies (including intellectual property laws) with those of the EU, as well as extend most of the EU’s trade and competition rules to the Turkish economy.

Like other parts of Turkey’s business community, Turkish SMEs have already spent 10 years working within the framework of the customs union. This experience suggests some of the possible effects on the SME sector that could result from Turkey’s possible accession to, or at least closer integration with, the EU.

Turkish small to medium sized enterprise (SME) export competitiveness and EU integration

SMEs play a critical role in the Turkish economy. According to a recent study, the SME sector accounted in 2000 for 99.8 per cent of total number of enterprises, 77 per cent of total employment, 38 per cent of capital investment, 27 per cent of value added and roughly 10 per cent of exports in Turkey.2 These estimates may understate SMEs’ importance for Turkey’s trade balance: legislation encourages SMEs to conduct export-import operations via specialized foreign trade companies, which are not themselves counted as SMEs.3 With the exception of the financial services and capital-intensive sectors like energy and cement production, SMEs are strongly represented across all sectors. In the 15 years between 1990 and 2005, Turkey’s per-capita exports increased from $230 to $1019, while the ratio of exports to GDP rose from less than 9 per cent to over 20 per cent during this time. These improvements reflect Turkey’s efforts to liberalize its economy (which began in the 1980s) as well as its growing integration with the EU - both of which were promoted by the EU customs union. At present, roughly half of Turkey’s foreign trade is conducted with EU countries.

The supplementary protocol to the 1963 Ankara Agreement foresaw mutual, asymmetric reductions of customs duties on trade in manufactured goods between Turkey and the EEC, so that barriers to Turkish exports on European markets fell faster than barriers to European exports in Turkey. By 1995, the EU had already significantly reduced the protection applied against Turkish imports, so that Turkish exporters had already captured many of the customs union’s market access benefits before the customs union was formally established. Turkey’s exports to the EU therefore did not jump in 1995; instead, the share of EU exports in total exports actually declined. By assuming the EU’s common external tariff regime, Turkey opened its markets not only to EU members, but also to other countries with which the EU had preferential trade agreements.

Significant increases in competitive pressures ensued for Turkish SMEs, most of which at that time were accustomed to competing on price by leveraging on relatively low costs of labour and raw materials and hiding behind trade protectionism. Having lost these protective barriers, Turkish SMEs started to look for new competitive advantages. Turkey’s trade data suggest that this search paid off, particularly after 2000. Average annual export growth nearly tripled to 22 per cent during 2001-2005 from 8 per cent during 1990-2000. While many factors contributed to this increasing export competitiveness, Turkey’s progress towards EU accession was certainly one of the most important.

EU integration and the labour market

Growing competitive pressures led many SMEs to seek to reduce costs by raising productivity.4 For the labour-intensive sectors that dominate the Turkish industry, this created incentives for lay-offs, wage cuts, and unfortunately reverting to such illegal means as not providing workers with social security coverage or deploying child labour. However, Turkey’s EU integration provided natural brakes on this ‘race to the bottom’. Turkey’s textile and clothing industries, for example, rely heavily on such European buyers as H&M and Marks and Spencer, whose rules for their suppliers prohibit the employment of children or unregistered workers. Companies in these sectors therefore began to invest in human capital by establishing vocational training schools to improve the quality of blue-collar labour. They also invested in such skill areas as design and innovation, thereby creating new employment opportunities for more skilled workers. Other SMEs responded to these pressures by moving their plants to Turkey’s less developed regions where labour costs were lower, thereby creating employment opportunities in Turkey’s poorer regions.

Closer integration within the EU could accelerate the brain drain of Turkish specialists, particularly the managers needed to make Turkey’s SMEs more competitive. However, movement of labour between Turkey and the EU is not free now, and the restrictions imposed on the new EU member states following their May 2004 accession suggest that such movement would not be immediately and completely liberalized for Turkey. In the interim, Western Europe’s needs for imported specialists are likely to be at least partly met by the new member states. Hence, by the time the Turkish labour force acquires the right to move freely in the EU, the EU’s demand for skilled labour might be lower than it is today, so brain drain pressures would be weaker as well.

Foreign direct investment in Turkish SMEs

The 10 new EU member states attracted some € 80 billion in foreign direct investment (FDI) during 1997-2015. During this time Turkey - with a roughly similar population - was able to attract only some € 7 billion. While at the macro level FDI inflows finance external deficits and contribute to economic growth, the short-term impact on SMEs need not be uniformly positive, especially if it means stronger competition from global giants. Competition for skilled labour intensifies, local consumers become more sophisticated and demanding in the face of increased variety and choice, and so on.

So far, however, the impact of FDI linked to European integration has been largely positive, particularly for the automotive sector. The spare parts industry, which is dominated by SMEs, has significantly grown in terms of numbers of companies, employment, and production. In 2005, exports of the automotive and automotive spare parts industries exceeded that of Turkey’s textile and clothing industries. This suggests that FDI linked to export-oriented sectors focusing on the EU market is beginning to modernize manufacturing in Turkey - as occurred in the Central European countries, during their run-up to EU accession.

Instead of a conclusion

As a candidate country Turkey might have ‘missed the boat’ in terms of EU’s pre-accession financial assistance. On the other hand, lessons learned from previous accession experiences might be invaluable. In any case, prospects for absorbing EU financial assistance for the SME sector depend more on the capacity of the Turkish authorities to identify, articulate and address the needs of SMEs, and less on the amounts of financial assistance available. Since the EU has to date provided very little pre-accession financial assistance to Turkish SMEs, there is not much evidence to analyse. The opportunities associated with the programmes that have been initiated (focusing among other things on female entrepreneurship and clustering) have yet to be fully exploited by Turkey’s SMEs.

While Turkey’s negotiations with the EU are ongoing, Turkish SMEs have been discharging the de facto obligations of membership since 1995. This 10-year period has helped change the mindsets in the SME sector and created new ways for them to generate income, employment and value added. As Turkish SMEs have become more competitive during this time, it can be argued that EU integration has made the ‘backbone’ of the Turkish economy stronger. The biggest challenges, however, lie in improving the innovative capacity of Turkish industry, without which improvements in competitiveness cannot be sustained. Unfortunately, progress in this area has not been satisfactory. Turkey’s widening regional disparities pose another set of risks. Many of the positive statements made here are only applicable to SMEs located in Turkey’s developed western and central regions: SMEs in the underdeveloped east and southeast are still struggling.

The 10-year experience with the customs union has already generated some important benefits for Turkey’s SME sector, in the form of significant FDI inflows into the automotive sector and its local sub-contractors. Equally, a prolonged accession period could help Turkish industry and SMEs to prepare fully for the competitive pressures of the single market. Many of the countries that joined the EU in May 2004 captured many of the benefits of membership years before their formal accession, and Turkey may do likewise.

Murat Gursoy is a project manager in UNDP’s Country Office in Turkey.