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Customs Union
Prerequisites
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Trade Bloc
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Introduction
  • A trade bloc is a group of countries (or states, territories, etc) in which trade is made easier between members by removing or reducing tariffs and other barriers to trade.
  • There are 5 types of trade bloc:
    1. Preferential Trade Area
    2. Free Trade Area
    3. Customs Union
    4. Common Market
    5. Economic and Monetary Union (EMU)
Free Trade Area
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Introduction
  • A free trade area (FTA) is a type of trade bloc in which members have signed a free trade agreement.
  • Free trade area members improve trade between each other by heavily reducing or completely removing barriers to trade in the form of tariffs and quotas.
Advantages
  • Producers can:
    • Focus on producing goods and services which they are comparatively more efficient at making.
    • Take advantage of a bigger market to export to.
    Consumers have:
    • More access to foreign goods, which can be cheaper or higher quality.
    • Increased living standards through encouraged economic development.
disadvantages
  • Some industries may suffer if another member has a competitive advantage.
    • For example, another country may have more fertile soil, and is able to produce and export crops for a cheaper amount than can be produced locally.
External Tariffs
  • An external tariff comprises of the tariffs and quotas applied to countries outside the free trade area.
  • Countries inside the free trade area do not need to share the same external tariffs.
  • A free trade area in which all countries do share the same external tariffs is called a customs union.
Rules of Origin
  • If a country outside the FTA wants to export goods to a country inside the FTA it will be subject to external tariffs.
  • However it is possible to get around this by:
    • Exporting to the country inside the FTA with the lowest external tariffs
    • Once the goods are inside the FTA, it can take advantage of tariff free trade to export to other countries
  • Rules of origin are the method in which external tariffs are enforced.
  • They do this by keeping track of which country a product originated from.
  • If the product originated outside of the FTA then it is not eligable for the reduced internal tariffs when traded inside the FTA.
  • However things can get more complicated if only part of the product was imported from outside of the FTA:
    • A country inside the FTA may import raw materials from a country outside the FTA
    • Once imported, the materials can be used to manufacture goods
    • These goods will then originate from the country that imported them
  • To change the origin of a product, a 'substantial transformation' must have been applied.
  • Criteria for what counts as a substantial transformation can be complex.

Customs Union

Introduction
  • A customs union is a free trade area in which all members shares the same tariffs and quotas when importing from non members.
  • this is called a 'common external tariff'.
  • Having the same external tariff simplifies the free trade area as there is no need to prove the origin of a product.
  • Any tariffs collected at the point goods enter the customs union are shared amongst all members.
    • The country that imports the goods may recieve a larger share as it may incur adminitrative costs when collecting the tariff.
Trade Creation and Diversion
  • As tariffs drop between members, the flow of trade will change.
    • More trade will happen between members inside the customs union, while trade with producers on the outside will drop.
  • However the total overall trade will increase.
    • This is because the reduction in tariffs will create a drop in prices, leading to higher demand.
    • The increase in total trade is called 'trade creation'.
  • Producers outside the customs union will lose out on trade to producers on the inside.
    • Even if the new producer is less efficient at producing the goods, they can take advantage of the reduced tariffs to gain a competitive advantage.
    • This is called 'trade diversion'.
Advantages
  • Total trade will increase through trade creation.
  • Unlike an FTA, there is no need to prove the origin of a product due to each member sharing the same external tariff.
  • The customs union can negotiate trade deals as a whole. This increased buying power can be used as leverage to get a better deal.
Disadvantages
  • Members of a customs union are not free to seek independent trade deals.
  • They also cannot impose their own tariffs on imports.
    • This makes it difficult to protect a declining industry.
  • Members must impose all tariffs outlined by the customs union.
    • For example, the customs union may put a 10% tariff on pineapples.
    • Every member must impose this tariff.
    • For members that do not produce their own pineapples, there is no domestic industry to protect.
    • The only effect of this tariff will be to raise prices for consumers.
  • There can also be issues with sharing tariffs fairly.
    • The country that collected the tariff might not get its fair share of the revenue.
  • Finally, the reduction in tariffs in trade across the customs union will lead to a loss in revenue, and other taxes may have to rise to compensate.