The role of European Union Candidacy on FDI: the case of Turkey

1. The role of European Union Candidacy on FDI: the case of Turkey Bulent Esiyok

2. Introduction • An Overview of Inward FDI in Turkey • Previous Empirical Literature: EU effect on FDI in Turkey • Research Question and Contributi0n to the Literature • Conceptual Framework • Econometric Methodology • Summary of Results • Policy Implications.

3. An Overview of Inward FDI in Turkey • Record levels of Inward Foreign Direct investment stocks between 1982 and 2007, increasing from 9 to 150 billions of $US (UNCTAD, 2009). • More than 130 billions $US of it came after 2002 (UNCTAD, 2009) and 86% of this investment originated from the EU. • This suggests that accession to the EU may have increased FDI from the EU countries in Turkey.

4. Turkey’s accession process to the EU • Application for EU Membership 1987. • Customs Union (CU) Agreement with the EU 1996. • Candidate Status given to Turkey 1999. • Start of Membership Negotiations with EU 2004.

5. How accession process may affect FDI going to candidate countries? • Relocation within the regional bloc, locating labour intensive production in countries where labour is cheaper. • Free Trade with the EU member states (backward or forward integration). • Harmonisation of legal and business framework to adopt to the EU.

6. Previous Empirical Literature:EU effect on FDI in Turkey • Halicioglu (2001)finds that application for EU membership in 1987 affect inward FDI in Turkey positively. • Clausing and Dorabantu (2005) show that candidate status has no significant effect on inward FDI in Turkey.

7. Research Question and Contribution to the Literature • Did the process of accession to the EU affect foreign direct investment coming from EU countries into Turkey? • The effect of Customs Union and membership negotiations with the EU on inward FDI in Turkey has not been investigated in empirical studies, this study aims to fill this gap in the literature.

8. Conceptual Framework • Knowledge-Capital Model (Markusen et al, 1996 and 1997, Carr, 2001)combines vertical and horizontal motives and it relates foreign direct investment between two country to their country characteristic such as; - sum and similarities of country sizes’ - skilled or unskilled labour endowment of each country and - trade and investment cost between them and suggests;

9. Conceptual Framework cont’d • FDI will increase with a rise in sum and similarity of GDPs (for country size) • High trade cost between two country increases horizontal investment and decreases vertical investment. • Low investment costs between two country encourage direct investment.

10. Specification • I augment Knowledge-Capital model with EU dummy variable FDI = f(GDP sum +GDP similarity +Trade cost+ skill ratio difference+ investment cost + EU effect); to capture the effect of Customs Union with EU and following EU announcements on inward FDI in Turkey.

11. Construction of Explanatory Variables • GDP Sum: sum of investing and destination country GDPs. • Similarity : ranging from nearly 0 (indicating high difference in country size) to 0.5 (same size). • Trade cost : matched partner data(c.i.f./f.o.b.) as a proxy for trade cost.

12. Construction of Explanatory Variables cont’d • Skill ratio difference: difference of the ratio of university students between the origin country of investment and Turkey. • Investment cost: bilateral investment treaties between the origin country of investment and Turkey. • EU effect : dummy variable 1 for the customs union after 1996, candidate status after 1999 and start of membership negotiation after 2004 and 0 otherwise.

13. Expected signs

14. Data Sources • FDI: OECD Data (ESDS) and various Central Banks. • GDP: IMF (ESDS) • Skill Ratio: Number of students , UNESCO missing values intra- and extrapolated. • Trade Cost: IMF (ESDS). • Bilateral Investment Treaties: Ministry of Treasury, Turkey.

15. Sample Characteristics • 19 OECD countries (13 EU and 6 non-EU countries) that report annual FDI outward stock in Turkey between 1982-2007. • Due to missing values, we have an unbalanced panel with 288 annual observations. • Variables are stationary (fisher unit test is used, Maddala Wu, 1999).

16. Econometric Methodology • OLS is not appropriate because of significant country specific effects, in light of F test of fixed effects. • Fixed effects model chosen over Random effects; in the guidance of Hausman test. • Due to autoc0rrelation in residuals of fixed effects model, dynamic panel model (Arellano and Bond, 1991) is chosen by using lagged value of FDI as an explanatory variable.

17. Summary of Results • Only start of membership negotiations is significant, and affects inward FDI stocks positively. • Sum of GDPs and Trade cost variable indicate that inward FDI is horizontal in nature and this confirms previous findings (Erdal and Tatoglu, 2002). • Unskilled labour is not an advantage to attract FDI in the case of Turkey. • Investment cost is not found to be significant. • Lagged FDI variable is significant.

18. Diagnostic Tests and Interpretation of Lagged FDI • Sargan Test and Arellano Bond(1991) serial correlation test confirm that our results are valid. • The coefficient of lagged FDI variable (0.619) suggests that foreign investors’ incremental knowledge about investment opportunities in Turkey is important. • The coefficient of partial adjustment (1-0.619=0.381) implies a large role for persistence in the pattern of FDI in Turkey.

19. Policy Implications • Government should speed up reforms in order to revive the hopes for full membership to receive more FDI. • Government should also accelerate the privatisation program to attract further FDI.

20. Thank you.