This document discusses customs unions and free trade areas, comparing their effects. It finds:
1) In a hypothetical scenario with countries H and P, a free trade area leads to trade creation in country H with no excess costs or gains in country P, while a customs union creates trade for country H but costs country P from adverse production/consumption effects.
2) In general, a customs union arrangement appears inferior to a free trade area based on comparisons of trade creation vs. trade diversion.
3) For a full comparison, any production-distorting effects of non-harmonized tariffs on intermediate inputs in a free trade area must also be considered, as these could upset the relative advantage of
This document discusses customs unions and free trade areas, comparing their effects. It finds:
1) In a hypothetical scenario with countries H and P, a free trade area leads to trade creation in country H with no excess costs or gains in country P, while a customs union creates trade for country H but costs country P from adverse production/consumption effects.
2) In general, a customs union arrangement appears inferior to a free trade area based on comparisons of trade creation vs. trade diversion.
3) For a full comparison, any production-distorting effects of non-harmonized tariffs on intermediate inputs in a free trade area must also be considered, as these could upset the relative advantage of
This document discusses customs unions and free trade areas, comparing their effects. It finds:
1) In a hypothetical scenario with countries H and P, a free trade area leads to trade creation in country H with no excess costs or gains in country P, while a customs union creates trade for country H but costs country P from adverse production/consumption effects.
2) In general, a customs union arrangement appears inferior to a free trade area based on comparisons of trade creation vs. trade diversion.
3) For a full comparison, any production-distorting effects of non-harmonized tariffs on intermediate inputs in a free trade area must also be considered, as these could upset the relative advantage of
the rest of the world would be available, so that two equilibrium
prices would exist in the area.
In this case country H would experience only a trade creation
effect (a+c). Country P would incur no excess costs of consumption or production, but it would enjoy a gain in government revenue, equal to the hatched area, which would represent an increase in its national income.
If instead countries H and P formed a customs union (Figure
2.4b), the common external tariff would be effective, with demand and supply approximately in balance at that level, the price in the union being a little higher than in the free trade area case. Country H would experience trade creation. Country P would benefit, on balance, from its ability to export to country H at a higher price, but at the cost of adverse production and consumption effects, denoted by d and e.
A comparison of these two situations shows that in this second
case, just as in the first, the customs union alternative is inferior to the free trade area arrangement. This conclusion appears to be generally valid for the alternatives of a tariff-averaging customs union and a free trade area, irrespective of the particular market conditions assumed. These comparisons of a customs union with a free trade area refer o trade and tariffs with respect to final products. If, as is possible in a free trade area, tariff disparities also exist on intermediate inputs, hese differences may give rise to distortions in the area’s pattern of production at that level. If processing costs were identical, production in a free trade area would tend to concentrate in the country whose input tariff was lowest. In general, however, it is not possible to say whether such tariff disparities would encourage a concentration of production of inputs in more efficient or less efficient member countries. In comparing the merits of a customs union with those of a free trade area, it is clearly necessary to take into account any such production-distorting effects of a non-harmonized tariff at the input stage that may upset the relative advantage of a free trade area in comparison with a customs union.
NOTE
1 These particular definitions of trade creation and trade diversion are
those of Johnson (1962). They differ from those initially employed by Viner (1950), Meade (1955a) and Lipsey (1960), who have used the