Regional Economic Integration EU-MED: Focus on the Free Trade Area

Euro-Mediterranean relations have since the mid-1990s been guided by a number of initiatives and programs. The Barcelona Process continued the process of creating an area of shared prosperity in the Mediterranean, started in the late 1970s with the establishment of Cooperation Agreements with many countries in the Mediterranean region, with an emphasis on creating a Free Trade Area (FTA).

This led to the signing of Association Agreements (AAs) with Algeria, Egypt, Israel, Jordan, Lebanon, Morocco, and Tunisia. An interim Association Agreement guides the relations between the EU and the Occupied Palestinian territory. The timing of the signing and enactment of these AAs varied across countries. While the Tunisia AA was the first to come into force (1998), the Lebanon AA came into force only in 2006 (Table 1).

Table 1: Barcelona Process: Association and Cooperation Agreements

These AAs provide for the gradual establishment of a free trade area for goods originating in the EU and the signatory country over a twelve year period as of the coming into force of the AA. Different provisions are provided for industrial and agricultural commodities. Goods need to have a certificate that complies with the rules of bilateral cumulation of origin with the EU to benefit from the preferential tariff rates. Exceptions are provided for goods listed in the Annex of the AA, in the context of protection of infant industries, for goods that originate in industries that are being restructured and have serious social consequences. Goods with an agricultural component are subject to Community rules for agricultural imports.

The liberalization of agricultural and fishery products are subject to detailed rules that provide for the elimination or reduction of customs duties, and tariff quotas for goods specified in the Agreement. These negotiations are ongoing and proceed at rhythms that differ across countries. The AAs provide for suitable and effective protection of intellectual, industrial and commercial property rights, in line with the highest international standards.

Also, non-legally binding provisions of the AA include:

– right of establishment of one Party’s firms on the territory of the other,

– deepening the commitments to the stipulated adhesion to the WTO GATS obligations, particularly the obligation to grant reciprocal most-favored-nation treatment in the service sectors covered by that obligation,

– enforcement of competition rules, including state aid, with some exceptions,

– cooperation for standardization and conformity assessments,

– commitment to enhance intra-regional trade with the Maghreb countries,

– investment promotion and protection measures,

• and trade facilitation pertaining to the simplification of customs checks and procedures.

The dismantlement of tariffs on EU imports has largely proceeded as scheduled but, with its late, start tariffs on EU imports are still substantial and differ across ME D countries (Table 2).

Table 2: Average tariffs applied by MED countries on their imports (% Unweighted Average)

The Survey’s respondents show a great awareness of the contribution that the Euro-Mediterranean FTA can make to the region and how the added value gained from the FTA compares with the added value obtained from globalization in general and from global trends of trade liberalization. Only 7% of respondents indicate that they have no opinion, which is low compared with the responses to the other Survey questions. The general average of all respondents is slightly positive (6.6 out of 10), and does not differ substantially from that of the respondents from the Mediterranean Region (Graph 1).

Graph 1: The added value of emfta in relation to the general process of globalization and trade liberalization (average on a scale of 0-10, where 0 stands for no added value, and 10 for very high added value)

Graph 1a: Grading the added value of EMFTA in relation to the general process of globalisation (%)

Euro-Mediterranean FTA Performance on Trade

A recent study that analyzed the trade between the EU and eight Mediterranean countries between 1996 and 2006 suggest that exports from these MPCs to the EU rose by an annual rate of 6.4% versus a rate of 15.6% to the rest of the world (hereafter, RO W) (see Table 6). Moreover, exports to NAFTA countries rose by an annual rate of 14%, while those to the Gulf Cooperation Council (hereafter, CC G) rose by an annual rate of 18%. Notwithstanding, nearly half of all exports of MPCs are directed towards the EU, confirming the dominant position of the EU in Mediterranean trade relations (Table 3) despite some exceptions (Table 4). In contrast, it must be stressed that, in terms of trade, MPCs are secondary partners for the EU (Table 5).

Table 3: Mediterranean Partner Countries’ (excluding Turkey) trade with the EU (2004-2010)

Table 4: MPC’s trade relations by origin and destination

Table 5: EU trade relations by destination, 2010

The slower growth rate of exports to the EU (Table 6) is explained by the fact that

– MPCs already enjoyed basically duty-free access to the EU before the coming into force of AAs,

– that during this period the EU grew at a slower pace than the rest of the world and

– international trade negotiations led to substantial worldwide reduction in Most Favored Nation (hereafter, MFN) tariffs, thereby reducing the tariff preference enjoyed by the MPCs in trade with the EU. Also, exports from these MPCs to the EU are slowed by a considerable array of Non-Tariff Measures, which on balance are more stringent trade restrictions than the tariff measures themselves. However, it is paramount to note that differences across countries are very significant.

During this same period imports from the EU into MPCs rose by an annual rate of 4.7% as compared with a rate of 11.6% for imports from the RO W. In 2004, imports to MPCs from the EU stood at 45%, again confirming the dominant position of the EU-ME DS trade relations. The slow growth of EU imports is also in part explained by the gradual nature of the tariff dismantlement as discussed above and by the late coming into force of some AAs. Again, in regard to MPCs, differences across countries are very significant (Table 6).

Table 6: Annual growth rate of non-oil trade (1996-2006)

Accordingly, the responses in relation to the progress of the implementation of the Euro- Mediterranean Free Trade Area differ greatly according to the nationality of the respondents (Graph 2). For instance, Algerian respondents rank the added value of the EU-ME D FTA at 2.5, the lowest of all responses to this question. This should not come as a surprise when considering that exports from Algeria to the EU fell by an annual 10% between 1996 and 2006, while exports to the RO W rose by an annual rate of 18%.

Graph 2: Assessing the progress of the implementation of the Euro-Mediterranean Free Trade Areas between the EU and its Mediterranean Partner Countries. Nationals respondents assessing their own country (average on a scale of 0-10, where 0 stands for very disappointing, and 10 for very positive)

In regard to trade dynamics in FTAs, the analysis of the use of the rules of origin by traders is of the utmost importance. The Pan-Euro-Med system used to determine the origin of a product system, and, thus, its access to preferential tariff treatment permits diagonal cumulation – which means that products which have obtained originating status in one of the 43 countries may be added to products originating in any other of the 43 without losing their originating status within the Pan-Euro-Med zone. In practice, countries of the Pan-Euro-Med zone can only cumulate originating status of the goods if the free trade agreements including a Pan- Euro-Med origin protocol are applicable between them. This is the case for the countries that have an AA or cooperation agreement with the EU.

A smooth functioning of the AAs requires that partners can actually take advantage of the preferences available, which implies that they can produce certificates of origin without incurring excessive costs. Various Business Surveys have illustrated that traders complain about a complex system and that the hassle and cost of obtaining these certificates of origin at times exceed the tariff preferences granted upon import into the EU. A recent study of imports into the EU for five MPCs suggested that in excess of 80% or more of exports came in duty-free, leaving up to 10% of exports (18% for Jordan) in categories where there should have been a zero tariff but where a non-zero MFN rate was actually paid. Some products are more likely than others to enter the EU without the certificate of origin; these include articles of apparel, mineral fuels and edible vegetables. This is thought to be a common issue where tariff preferences are very low and the cost of obtaining certificates of origin is high. Misclassification and high cost of obtaining the certificates of origin are also thought to be responsible for this non-use of certificates of origin. Another reason for the low utilization of the Pan-Euro-Med Rules of Origin is that inputs from the EU zone are expensive compared with inputs from other countries.

The Survey results in part agree with the findings of the above analysis in that they report the system to be complex (28% of responses), not well adapted to their needs (12%) and costly to operate (8%). Importantly, however, the majority of respondents (41%) note that trade operators are not well informed about the system, which suggests that a greater effort should be made to better disseminate the cumulative system and assist traders to implement the system.

FTA and Liberalization of Services

As far as liberalization of services is concerned, negotiations were opened in 2005 – in the framework of the ENP – for a restricted number of countries: Morocco, Egypt, Israel and Tunisia. As for the FTA negotiations, services are classified in four different ways depending on how they can be supplied. These are known as “modes” in GATS terminology: cross-border supply, consumption abroad, commercial presence, and presence of natural persons. In the negotiations on the FTA in services that the EU has concluded so far (Mexico, Chile, and Caribbean countries), modes 1 (cross-border supply) and 3 (commercial presence) were the primary objectives of services liberalization negotiations.

The Survey shows that one third of respondents are not aware of the progress regarding these negotiations. Box 4 shows the complexity of being updated on these negotiations. Among those who responded, there was a moderate to positive opinion and a slightly more positive assessment was seen among EU countries (Graph 3). This could be explained because while the EU has a comparative advantage in modes 1 (cross-border supply) and 3 (commerce presence) the MPCs have interests in liberalization of modes 2 (consumption abroad) and 4 (presence of natural persons). The European member states are reticent to make concessions on mode 4, which discourages the MPCs from granting right of establishment for service providers to European companies.

Graph 3: Assessment on the progress of on-going negotiations for services liberalization by origin of the respondents (average on a scale of 0-10, where 0 stands for very negative, and 10 for very positive)

Euro-Mediterranean FTA’s Performance on Foreign Direct Investment Promotion

AAs identified the objective of improving the investment climate and of promoting foreign direct investment (FDI). The anticipated positive effects of FDI on the host economy have widely served as a basis for policies recommending the opening up of the economy to foreign investors. Attracting FDI also provides an impulse to improve the investment climate in general and create much needed employment growth. Policymakers in developing countries have increasingly viewed FDI as the best and fastest way to get access to foreign technologies, markets, and increase foreign currency earnings as well as building domestic production capabilities and exports. But policies that aimed at greater reliance on FDI in several countries needed to overcome fears about their possible negative effects in terms of increased competition with established national firms and had to counter political criticism, seen among developing coun-tries as a colonial relic aimed at taking control of national resources.9 Based on this suspicion of the impact of FDI, many developing countries passed legislation restricting foreign ownership, repatriation of capital, conditioning FDI on performance requirements and technology transfer, among others. The official aim was to maximize the benefits of foreign participation in national economies using public policy as a tool to channel investments to critical sectors, gather knowledge and protect the economy from international competition. Arab and Southern Mediterranean countries were not exceptions to this trend and imposed for some time strict limits on FDI. However, these attitudes have gradually changed and restrictions on FDI have slowly been eased. As a result, inflows have slowly increased partly as a result of a less restrictive framework. Yet they remain still highly disappointing and most probably below their potential. Data on FDI in the Mediterranean region are very weak and are available with great delay, also because such data often refer to FDI-financed projects rather than to FDI actual transfers.

Graph 4 presents the figures of FDI in the region compared to developing economies (except China) and African economies (except South Africa). Overall, the region receives a small share (1.2%) of the world’s total flow of FDI. Between 1995 and 2004, the ME D-11 received on average little more than $8 billion against $17 billion received by the new EU Member countries. But the ME D11FDI/GDP ratio rose from 1.1 in 1998 – amongst the lowest globally – to 5.6% in 2006, when it was the highest followed by Europe and Central Asia where the ratio stood at 5.1%.

Graph 4: FDI inflows in the med-11 area in relation to developing economies* and africa**, 1985-2008

There are, however, notable differences across countries. Abstracting from Israel and Turkey, which accounted for about half of the inflows to the Region in 1985-2008, FDI went predominantly to a few countries such as Tunisia, Egypt and Morocco, while the others and particularly Libya were the lowest recipients (Graph 5). Inflows were particularly directed to tourism, banking, telecommunications, manufacturing and construction activities, probably reflecting market and efficiency-seeking investments.

Graph 5: MED-11 country share of fdi inflows (1985-2005) and stocks (1985-2008)

The origin of FDI differs greatly from country to country and reflects cultural and other ties between the recipient country and the country where FDI originates (Graph 6). Based on the analysis for a subset of the countries with which the EU singed an AA, EU investment represents 65% of the total FDI in Morocco, as compared to only 5% in Jordan. Investments originating in the Gulf countries and ME NA dominate FDI in both Tunisia and Jordan. FDI from the US-Canada dominate in Israel with a share of 87%.

Graph 6: FDI inflows into med5 by origin 2003-2007

Available data also suggest that overall FDI inflows into the MED region remain very low and stagnate over time while FDI stocks grow faster than inflows, suggesting that established companies become either more profitable (which may increase their share value), reinvest a part of their profit or become more indebted to their parent companies (Graph 7). FDI flows are greatly affected by the business climate. Data provided by the Doing Business Survey, an-nually produced by the World Bank, suggest that – aside from Israel, Tunisia and Turkey – the other Mediterranean countries score rather low. To the extent that the EU-Mediterranean FTA improved this climate it will benefit these flows.

Graph 7: FDI flows and stocks in the med-11 area (in millions of current usd ), 1985-2008

Respondents to the Survey indicate, in general, their positive view of FDI with about three out of four respondents indicating a positive or very positive view (given a 5 or more as response). Respondents from Turkey and Syria followed by Egypt give the most positive view of FDI while respondents from Algeria and Palestine give a rather disappointing view (Graph 8).

Graph 8: Assessment on the impact of the EMFTA on economies of MPCs in terms of impact on growth, competitiveness and FDI (average on a scale of 0-10, where 0 stands for very negative impact, and 10 for very positive impact)

Graph 9: Assessing the impact of the EMFTA in the economies of the Mediterranean Partner Countries in terms of: impact on growth, competitiveness and Foreign Direct Investment. Nationals respondents assessing their own country (average on a scale of 0-10, where 0 stands for very disappointing, and 10 for very positive)

Euro-Mediterranean FTA Impacts on Domestic Economies of MPCs

FTA and State Revenue

As import tariffs deriving from the trade activities of MPCs with the EU were a major source of MPCs’ revenues, trade liberalization trends, in general, and the Euro-Mediterranean FTA, in particular, are bound to have detrimental effects on state revenue in light of the implied reduction and eventual elimination of tariffs. With customs revenue still an important source of fiscal revenue in many Mediterranean countries, these trends need to be compensated with greater emphasis on the non-distortional revenue sources, such as value added taxes. A number of countries have efficiently replaced the customs duties with value added taxes. Others have been less successful at this switch in revenue sources.

Respondents appear evenly distributed amongst those that hold a positive, very positive and negative view on the impact of the FTA on state revenue (Graph 9). This is likely to reflect the success with which countries have been able to undertake this shift in state revenue sourcing.

Graph 10: Assessment on the impact of the EMFTA on economies of MPCs in terms of fiscal impact (average on a scale of 0-10, where 0 stands for very disappointing, and 10 for very positive)

Graph 11: Assessment on the impact of the EMFTA on economies of MPCs in terms of fiscal impact (average on a scale of 0-10, where 0 stands for very disappointing, and 10 for very positive)

FTA and Employment

As is generally agreed, FTA impacts on employment are narrowly related to the comparative advantages of products being traded. As international trade models show, countries will export products that use their abundant and cheap factor(s) of production and import products that use the countries’ limited factor(s). This trade dynamic has its specific outcomes, among others entailing social impacts. For the Euro-Mediterranean Free Trade Area, as the Sustainability Impact Assessment (SIA) study identifies, some social impacts in MPCs are beneficial in the short term as well as the long term, and others may be significantly adverse unless effective mitigating action is taken (BOX 2).

In addition, the SIA identifies the potential impacts of greater concern that should be object of appropriate preventive and mitigating measures, including a significant short-term rise of unemployment due to industrial and agriculture trade liberalization between the European Union and the MPCs. Increased unemployment will bring a fall in wage rates. There are other impacts not strictly related to unemployment but, added to a rising unemployment scenario, alerts on the need for effective mitigating measures for the trade liberalization process to success. Namely, we can mention:

– a significant loss in government revenues in some countries, with potential for consequent social impacts through reduced expenditure on health, education and social support programs;

– greater vulnerability of poor households to fluctuations in world market prices for basic foods;

– adverse effects on the status, living standards and health of rural women, associated with accelerated conversion from traditional to commercial agriculture.

Notwithstanding, the EM FTA impact on employment as well as its social impact has an intermediate evaluation. This could be based on the expectations so far (BOX 3) even if the assessment by countries shows a heterogeneity from positive to negative impact on employment (Graph 9).

Graph 12: Assessment on the impact of the EMFTA on economies of MPCs in terms of impact on employment and social impact. Nationals of each country assessing their own country (average on a scale of 0-10, where 0 stands for very negative, and 10 for very positive)

Implementation of South-South FTA: PAFTA, General Arab Free Trade Agreement, Arab Maghreb Union

All AAs stressed the importance of enhancing South-South trade integration. In this respect, two main agreements are currently operating. Firstly, the Pan Arab Free Trade Area (PAFTA), which came into force in 1998 and liberalized nearly all tariff lines amongst its signatories. Secondly, the Agadir Agreement (Egypt, Jordan, Morocco and Tunisia), which came into force in 2007, created an FTA amongst its signatories. Where lowering tariff rates stimulate trade and cause the familiar trade creation and trade diversion forces, the Agadir Agreement did not see any major changes in 2007, given that all its signatories were already party to the PAFTA agreement. Hence the shallow integration effects of this agreement are hard to capture and to disentangle from the shallow integration effects of the PAFTA agreement (Graph 11).

Fig 1: Preferential trade agreements in the Euro-Mediterranean region 2008

Despite the existence of the aforementioned South-South Free Trade Areas, intra-regional trade is rather small (Table 7) mainly due to factors related to MPCS’ production structures. Namely, the potential benefit from integration between MPCs can be analyzed by comparing a country’s exporting structure with the importing structures of the partners of the regional integration initiative. The more similar these structures are the more scope there is for trade creation – such as contracting with trade diversion – as regional supply can potentially respond to regional demand. An analysis of data for 2006 suggests little evidence that MPCs’ supply structures are well suited to other demand structures of MPCs. Moreover, a comparison of export structures (such as proxy for production structure) of a select group of Mediterranean countries in order to find the potential for intra-industry trade – which has proven to be a very potent source of bilateral trade – also suggest that the scope for intra-industry based trade creation is at present rather low. Both facts suggest that the potential for strong trade effects from S-S integration is likely to be modest. In addition to structural constraints, the low level of intra-regional trade is also related to the high level of non-tariff measures (barriers) in trade between MPCs. Indeed, after the elimination of tariffs under PAFTA, new non-tariff measures (barriers) have been used excessively by MPCs in order to protect domestic industry and agriculture.

Table 7: Trade flows between MED countries in 2007

Consistently, respondents had a very negative view of the South-South trade initiatives whether it refers to the Agadir Agreement, the Pan Arab Free Trade Agreement or the Arab Maghreb Union (their implementation is respectively ranked at 4.72, 4.22 and 3.58 out of 10). This is likely to reflect the low level of intra-regional trade and the remaining barriers to such trade.

A Step Forward Towards Economic Integration: EU-Turkey Customs Union

Turkey applied for associate membership of the EU – then the European Economic Community (EEC ) – as early as 1959. The application ultimately resulted in the signing of the Association (Ankara) Agreement in 1963. The Additional Protocol to the Ankara Agreement was signed in 1970, and became effective in 1973. More than 20 years later, in 1995 a Customs Union (hereafter, CU) between Turkey and the EU was agreed upon to start on 1st January 1996 (BOX 4)

A recent evaluation of this CU concluded that the EU-Turkey CU of 1995 has been a major instrument of integration into the EU and global markets, offering powerful tools to reform the Turkish economy. By opening its market to EU competition and streamlining its customs procedure, the CU has credibly locked Turkey into a liberal foreign trade regime for industrial goods and holds a promise of Turkey’s participation in the EU internal market for industrial products. As a result, Turkish producers of industrial goods have become exposed to competition from imports and they operate in one of the largest, if not the largest, free trade areas for industrial products in the world. They are now protected by tariffs from external competition to exactly the same extent as EU producers are and as such face competition from duty-free imports of industrial goods from world-class pan-European firms. In return, Turkish industrial producers have duty-free market access to the European Economic Area (EU-27 and EFTA).15 Fulfilling the requirements of the CU has been challenging for Turkey, particularly with respect to the elimination of Technical Barriers to Trade (hereafter, TBTs), adoption and implementation of the EU’s competition policy provisions on state aid, and ensuring adequate and effective protection of intellectual property rights.

69% of respondents from Turkey noted that they have a good knowledge of the impact of the EM FTA and the EU-Turkey CU which reflects both the recent discussion between Turkey and the EU regarding EU membership and the visibility of these discussions in the Turkish political arena as well as the impact that the establishment of the CU had on producers and consumers alike.

Graph 13: Awareness Rate on the Impacts of EMFTA and EU-Turkey Customs Unions. Knowledge or a clear perception of the impact of the Euro-Mediterranean Free Trade Area and the EU-Turkey Customs Union: MPC respondents by country (%)

In contrast, 70% of all respondents to the Survey appear to be unaware of the Turkey-EU CU and the EM FTA suggesting that this aspect of economic integration has received little visibility in the Mediterranean region and that the lessons learned from this initiative could still be more broadly disseminated.

Final Considerations: Deep versus Shallow Integration

Free Trade Agreements that focus solely on the reduction of tariffs foster trade integration, but by leaving outside of the negotiation many factors that inhibit trade. Such negotiations have been termed “shallow” integration compared with “deep” integration, which refers to trade agreements that, in addition to reducing tariffs, aim at reducing all other elements that impact on trade flows. These other factors include both Non-Tariff Measures (hereafter, NTM) whose effect or objective is to protect domestic production against imports, as well as other structural elements that impact on trade, such as competition policies, procurement rules, standards and conformity assessments.

In recent years, several efforts have been made to quantify NTMs and compare their trade impact with the tariffs. In the process, researchers have calculated ad valorem tariff equivalents (AVE) for the NTM. Péridy has build on earlier methodologies to estimate the AVEs for a selection of six MPCs. Graph 14 compares the levels of tariffs with the levels of AVE for these countries. An inspection of that table suggests that the AVE levels are high in these countries and higher than tariff levels; in combination, the overall protection granted to domestic producers remains significant in Mediterranean countries despite efforts to reduce tariffs. The relative importance of NTM versus tariff levels as protection arsenals has been confirmed by a recent World Bank report on ME NA countries which identified that NTMs remain a significant barrier to enhancing trade in general and exports in particular in this region. Hence, trade integration initiatives need to be broadened to include those NTMs whose objective is to protect domestic producers. Also, those NTMs that a have legitimate objectives – which can often be excessively cumbersome in their implementation phase either by design or enforcement – need to be considered.19 Support for such initiatives could come in the context of support for “deep” integration initiatives of the FTA.

Graph 14: Overall protection in Mediterranean Countries: tariffs and NTMs (%)

Another aspect of “deep” trade integration and that in the last few years has attracted substantial attention relates to the transport costs and other logistics costs affecting trade costs. The World Bank has now issued its second Survey of Trade Logistics Indicators (TLI)20 (World Bank, 2011b). These TLI are substantially better in European countries than in Mediterranean ones (Graph 14). For instance, Lebanon’s TLI, which are the best of the ME D region, are still substantially lower than the TLI of the average EU member state. Yet they are much better than those recorded for Jordan, Morocco, Algeria and Libya. Péridy estimated how improvements in these TLI could expand imports from the EU into the ME D region and exports from the ME D region and found that both transport costs and low TLI substantially hamper trade. Reducing tariffs further would only marginally lead to trade expansion between the EU and ME D, but reducing transport costs and improving the TLI would result in substantial trade expansion.

Graph 15: The Logistics Performance Index in the Euromed area, 2010

Question C11 provided a “targeted” definition of deep integration with explicit reference to liberalization of agricultural and service trade as well as approximation of standards and technical legislation, which can be understood by the respondents to refer to the issues covered by NTM. The various respondents to the Survey indicate their general agreement with the view that deep integration would provide considerable added value over and above the shallow integration that is based solely on tariff reductions. Nearly 90% of respondents that expressed any view on the subject indicated that “deep” integration would have positive and very positive added value.

Graph 16: Assessment on the added value of the New Deep and Comprehensive Free Trade Areas to be established by the EU with the MPCs