EU-Turkey Economic Relations in the Era of Geo-economic Fragmentation

Economic security

Recent geopolitical developments and tech­nological shifts have significant implications for the international economic order and the EU’s approach to global cooperation. As geopolitical competition intensifies, eco­nomic and security interests are increasingly intertwined.

In the heyday of globalisation, economic prosperity was seen as dependent on free trade and economic interdependence as a guarantee of peace and economic benefits. This paradigm has shifted, with governments and the private sector now forced to integrate new geopolitical realities into economic choices and assess security risks.

Reorganising and diversifying global supply chains to reduce dependence on single sources is key to enhancing economic security. This shift is driven by the strategic rivalry between China and the US, which poses challenges to Europe’s economy and security. The ongoing US-China economic and trade war may escalate further, espe­cially if Donald Trump is re-elected.

The EU is developing its own economic security strategy in response to this rivalry and broader geopolitical competition. The Covid-19 pandemic underscored the need to diversify supply chains, leading the EU to focus on ‘strategic autonomy’. The war in Ukraine has further highlighted the dan­gers of an over-reliance on Russian energy, especially for Germany.

In this context, resilience, renewed in­dustrial strategy, and de-risking (reducing the EU’s economic dependencies) are rele­vant. The EU aims to strengthen its position in key economic sectors amid global com­petition, particularly from China and the US. To counter this, the EU has introduced measures like the ‘economic security pack­age’, the European Chips Act, and the Crit­ical Raw Materials Act to reduce strategic dependencies and enhance economic security.

The normalisation of non-cooperation in a fragmented geo-economic order would definitely place the EU and also Turkey in a precarious situation. They could eventually be forced to choose sides if different eco­nomic blocs close their markets to one other. In this context, it remains to be seen how long the EU and Turkey can maintain an open trade policy. Moreover, where economic security is becoming a major issue, political relations between Turkey and the EU are also at a low ebb. In recent years, divergences between security and foreign policy priorities of the two sides have been evident in many areas, from Syria to the Eastern Mediterranean.

Recent developments have led to increased competition rather than cooperation, particularly in the context of regional conflicts. Or, as in the case of Russia’s in­vasion of Ukraine, although their interests and perspectives are aligned, their policies differ. Therefore, Turkey has been the sub­ject of measured or veiled criticism from the West on the issue of sanctions against Russia. As the EU has been critical of aspects of Turkey’s policy towards Russia, Ankara has been highly critical of the EU’s han­dling of the Gaza War, which has once again brought to fore broader strategic and normative decoupling between the two sides. According to the European Commission, the level of foreign policy convergence between Turkey and the EU is only 10 per cent.

At a time when economic relations will be increasingly influenced by geopolitics, improving political relations and addressing the mutual trust deficit seem essential for the future of EU-Turkey economic relations.

Decarbonisation and return of industrial policy

Decarbonisation is radically transforming the global economic system. It is creating new areas of competition and dependencies, altering energy flows, and leading to new transmissions of goods. This trans­formation means that the technological evolution required by decarbonisation in­creases the intensity of geopolitics and com­plicates the intersection of economic and security interests. Unless trade, environ­mental, and industrial policies are not care­fully managed, there is the risk that they will pursue conflicting objectives. These policies intersect and are used by different countries to address not only climate change but also geopolitical rivalries, the re-orien­tation of supply chains, and profound technological changes.

In addition, heightened geopolitical ten­sions and the climate crisis have raised concerns about the resilience of supply chains and economic and national security, leading to a resurgence in industrial policy. While some developing countries continue to use industrial policy through targeted state interventions, most developed coun­tries in the West have not employed it for many years.

Enormous financial resources, both public and private, are needed to finance the decarbonisation of the economy. Con­sequently, the global race for clean tech­nologies and critical minerals essential for decarbonisation, is intensifying worldwide. For instance, European countries are facing unprecedented dependence on China for solar energy panels, which could extend to electric cars as China increasingly dominates battery manufacturing.

Subsidisation is a growing trend. The increasing adoption of subsidy-based ap­proaches risks igniting an arms race in industrial policy. Recent industrial policies include provisions to encourage domestic producers, particularly in technologically advanced sectors, potentially at the expense of foreign producers.

The US Inflation Reduction Act (IRA) is a good example of the return of industrial policy. This flagship green legislation is a monumental energy transition plan de­signed to encourage the production and development of clean energy in the US through tax credits for businesses and households. It also aims to re-industrialise the country and exclude China-linked com­panies from the US supply chain. Many view the IRA as a protectionist effort to attract the fast-growing green industry to the US at the expense of other competitors, particularly China and Europe. The IRA is also perceived as violating the rules of the WTO, for which the US has historically been the most powerful sponsor.

The EU’s Green Deal industrial plan and the Net Zero Industry Act can be understood as responses to the IRA, aimed at preventing clean energy companies from leaving the EU for the US or other markets. The EU aims to provide a more supportive environ­ment for scaling up its manufacturing capacity and is increasingly integrating climate factors into its external economic relations and trade policy, which will change the way it trades with its partners. With measures such as the Carbon Border Adjustment Mechanism (CBAM), the EU is committed to protecting its domestic indus­tries. Europe’s significant market size pro­vides it with substantial normative power, which it is preparing to use to advance the climate ambitions of its trade partners.

The EU has adopted several measures in recent years, such as an investment screen­ing mechanism, an anti-subsidy policy, and an anti-coercion instrument, to ensure a level playing field for European businesses versus non-EU external actors. These mea­sures and decisions raise concerns about their impact on international trade, indi­cating that climate action and related sub­sidies will potentially lead to further geo-economic fragmentation. For instance, the EU has recently launched several trade investigations into Chinese companies, accusing cleantech groups of benefiting from overly generous subsidies.

As trade and decarbonisation become increasingly intertwined, the EU-Turkey economic relationship will evolve based on whether they use decarbonisation processes to strengthen their cooperation or use it as an area of competition in trade and invest­ment relations. However, one thing is clear: CBAM-like measures will affect Turkey’s trade relations with the EU because they will have a significant impact on goods and services and all carbon-intensive production. The decarbonisation process will also have substantial consequences for Turkish and European value chains largely inte­grated through the Customs Union. Turkey needs to accelerate its decarbonisation process to maintain its current trade with the EU and take advantage of new opportunities. While closer harmonisation of legis­lation, environmental regulations, and standards on decarbonisation between the EU and Turkey could encourage cooperation, the gap in these areas will hinder many joint initiatives.

Implications for EU-Turkey economic ties

Both the EU and Turkey’s economic models significantly depend on foreign trade. They heavily rely on external demand for their products and imports in strategically crucial sectors, such as energy, critical materials, minerals, and semiconductors. Turkey’s trade openness (i.e., trade as a percentage of GDP) is 67 per cent and the EU’s is 97 per cent, compared with the world average of 63 per cent. In contrast, trade openness is only 27 for the US and 37 per cent for China. While trade openness has sharply declined in China since the mid-2000s and slightly declined in the US over the last decade, it has continued to rise in the EU.

The EU’s strategy for now is to remain open while embracing greater strategic autonomy. In several key strategic sectors, such as semiconductors, electric vehicles and batteries, renewable energy technologies, and digital technologies, Europe is at disadvantage in terms of production and price compared to China or the US. There­fore, diversifying Europe’s supply chains is necessary and establishing stronger trade links with different countries would make sense.

How the EU and Turkey navigate these changes will determine Turkey’s future within the European economic structure. Therefore, a new approach is required, based on the radically different (geo)politi­cal, (geo)economic, and environmental parameters emerging. Both sides must adapt to these processes, affecting their bilateral economic relations. Moreover, the basis of their trade relations, namely the Customs Union, is not fully adapted to today’s economic and political realities with its limited scope. Given the fading of a membership prospect for Turkey in EU, economic and trade relations will become the most important focus for the foresee­able future between Ankara and Brussels.

Turkey’s heavy dependence on foreign trade and investment underscores the im­portance of global players (the EU, US, and China) in shaping the country’s economic development. However, there is no doubt that Turkey will be most affected by the EU’s changing economic and trade policies. The strong economic ties between Turkey and the EU, embodied in trade and invest­ment, are evident. The EU is by far Turkey’s top trading partner. It is the main destination for Turkish exports, the most impor­tant source of imports, and the primary source of investment. Data shows that 41.3 per cent of Turkey’s exports are ab­sorbed by the EU. It is also important to note that the EU is more open in terms of inward and outward foreign direct invest­ment (FDI) than other regions and its FDI is significantly higher than that of China and the US. Thus, Turkey’s interests as a coun­try benefiting from trade and open econom­ic relations, align with those of the EU.

From an economic perspective, Turkey is also important for the EU as it is a large market and production base with 85 mil­lion inhabitants and the EU’s 5th largest trading partner (trade in goods). Therefore, it is in the interest of both sides to preserve and further develop these relations. Turkey indeed holds significant potential to con­tribute to the EU’s strategic autonomy, particularly in the context of developing alternative supply chains in neighbouring geographies.

Turkey’s geographical proximity and strategic location are significant advant­ages. The EU’s economic and financial de­coupling from Russia strengthens Turkey’s rising position in the global supply chain as a link between Central and East Asia and Europe. Connectivity is an important factor in global trade and Turkey could play a crucial role. Additionally, thanks to the Customs Union, Turkey’s industrial sector is well integrated into EU value chains. Turkey is also in a good position globally in terms of export diversification. While the number of countries Turkey exports ex­ten­sively to was 69 in 2003, it reached 108 in 2022. Over the same period, the number of products exported competitively increased significantly, from 1,331 products in 2002 to 1,718 in 2022. This shows the potential for Turkey to specialise in genuinely new, sophisticated products. Moreover, the Cus­toms Union has also directly and in­directly increased Turkey’s alignment with the EU acquis, rules, production norms, and stan­dards.

Energy interconnections, mature infrastructure, and significant industrial capac­ity (industry remains a significant part of GDP) are other strengths of Turkey. Dis­cussions and calls for re-industrialisation are multiplying in Europe, but the EU can­not produce everything it needs and will have to source many products from neigh­bouring countries. Turkey’s exports to the EU are already relatively sophisticated, focusing on manufactured goods, machinery, transport equipment, and miscellaneous manufactured items. If Turkey can upgrade and utilise its energy connections and industrial capacity to align with decar­bonisation, its attractiveness as an investment destination and market for the EU will increase. However, macroeconomic uncertainties and shortcomings in the rule of law will need to be addressed to fully leverage and strengthen Turkey’s strong potential with the EU. These factors play a crucial role in trade-related decisions through supply chains and long-term in­vest­ments.

Outlook and Recommendations

The reconfiguration of global value chains is increasingly debated as an economic policy tool to secure the supply of critical products and establish strategic autonomy at the EU level. The EU’s position within international production networks is likely to undergo restructuring to ensure strategic autonomy. Turkey, as a neighbouring country and part of the Customs Union, is already largely integrated into European industrial supply chains. Strengthening the economic relationship between the EU and Turkey is possible and beneficial for both sides.

In light of the shifting dynamics, new tools are emerging for the EU to reformulate and develop its economic cooperation with Turkey. These include extending the Customs Union, further integrating Turkey into its supply chains shaped by the search for strategic economic autonomy, including Turkey in decarbonisation and energy trans­formation efforts, and cooperation through investments and other channels. These collaborations will have important economic, strategic, and ecological impli­cations for both, while also significantly affecting their future relations in general. Turkey’s untapped renewable energy poten­tial highlights the importance of trade in electricity and future hydrogen production as key opportunities for enhancing coopera­tion on the energy transition.

However, the question of a trust deficit in their relations needs to be addressed. In this new era, economic relations will be increasingly shaped by geopolitical consid­erations. According to the IMF, the EU’s outward FDI has become more sensitive to geopolitical distance since 2017, with the EU’s FDI increasingly driven by geopolitical alignment rather than geographic distance or other economic considerations.

Years of political crises have fuelled mis­trust between Turkey and the EU. Therefore, serious mechanisms must be established to encourage dialogue in preparation for the new geopolitical and geo-economic era, which promises to be challenging for both sides. The EU and Turkey will need to find ways to protect themselves from geo­political economic tensions. They will need each other to navigate these challenges successfully.