The Impact of a Customs Union with the EU on Turkey’s Welfare, Employment and Income Distribution: An AGE Model with Alternative Labour Market Structures

The economic implications and the income distribution effects of the customs union (CU) between Turkey and the European Union (EU) have been studied by applying a general equilibrium model to the Turkish economy under alter - native hypotheses for the labour market. The numerical results show that, regardless of the assumptions postulated for the labour market, manufacturing production and trade, in particular textiles, wearing apparel, leather and fur products, grow despite the protection loss; and the standard VAT rate has to increase to 21-22% for the trade policy to be revenue neutral. The CU is poten - tially Pareto superior. Urban (rural) groups are better (worse) off in the wage curve scenario, where wages and unemployment are negatively related; while urban (rural) groups are worse (better) off in the scenario with fixed or flexi -ble real wages. Also the impact on income inequality is ambiguous, rising (declining) in the wage curve (fixed and flexible real wage) scenario. This lat - ter result is partly driven by the large impact on income inequality between urban and rural groups. However, despite the relatively large fall in tariffs, the impact on overall income inequality is small. Regarding the impact on employ - ment, the model predicts the creation of 68,000 new jobs in the wage curve sce - nario, and the loss of almost 100,000 jobs in the scenario with fixed real wages.