This is, of course, something which may generate as many new problems as it solves existing ones.Įconomic-integration ww w. Closer integration and cooperationįinally, the establishment of a customs union may pave the way for closer economic integration and political collaboration, including the formation of a single internal market, (common market) monetary union, and fiscal union. This is precisely what the original six members of the European Economic Community (EEC) did when they formed a European Customs Union in 1968. This trade deflection is avoided if Germany and France (and others) form a customs union.Ī common external tariff, along with ‘ rules of origin‘, are likely to eliminate some of the problems that would occur with tariff differentials that may exist in a simple FTA. Hence, without a unified external tariff, trade flows would become distorted.įor example, assuming Europe operated a simple FTA, rather than a customs union, and if Germany imposes a high 40% tariff on Japanese cars, while France imposes just a 10% tariff, Japan would export its cars to French car dealers, and then re-sell them to Germany on a free-trade basis. Trade deflection occurs when non-members ship their goods to a low tariff FTA member (or set up a subsidiary in the low tariff country) and then re-ship to a high tariff FTA member. One of the strongest arguments for a customs union (over a simple free-trade agreement) is that it solves the problem of trade deflection. If they do, then membership of a customs union will increase the welfare of member countries. However, with trade diversion, more efficient non-members may now sell fewer goods to members, creating an opportunity for less efficient members to capitalise by selling more within the union.įollowing the work of Jacob Viner, economists often start their analysis of customs unions by assessing whether the gains from trade creation outweigh the losses from trade diversion. With trade creation, more efficient members can now sell more to less efficient (domestic) members. The effect of a customs union is commonly explained in terms of trade creation and trade diversion. How beneficial this is depends upon whether membership of a customs union increases or decreases the efficient allocation of scarce resources, and the satisfaction of the wants and needs of consumers and producers. However, while the removal of trade barriers between members will encourage trade between them it is likely to reduce trade between members and non-members. Like an FTA, the main positive effect of a customs union is that trade between members is likely to increase. The advantages of a customs union Increased trade flows Tariff revenue may then be shared between members, with the possibility that the country that collects the duty retaining a share (between 20 and 25% in the European customs union) to cover the additional administration costs associated with border trade. Once inside the union goods can move freely without additional tariffs. Countries that export to other countries in the customs union only need to make a single payment (duty), once the goods have passed through the border.
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