Customs Union

This article focuses on customs unions. It provides an overview of the main stages of national economic integration (including free trade agreements, customs unions, common markets, and economic unions) occurring as a result of globalization. The main points and origin of customs union theory are described. Numerous examples of customs unions are included as well as an exploration of the welfare consequences of customs unions for member and non-member nations.

Keywords Allied Powers; Common Market; Customs Union; Economic Integration; Economic Union; Free Trade Agreement; Globalization; Market; Nations; Tariff; Trade; World Bank

International Business > Customs Union

Overview

Customs unions, according to the Organization for Economic Co-operation and Development (OECD), are free trade areas that also establish a common tariff and other trade policies with non-member countries. A tariff is a form of tax imposed on a good imported into a country. Customs unions abolish tariffs among member countries and set common external tariffs in order to maximize the joint welfare of the member countries (Yi, 1996). Customs unions are affected by variables such as trends in globalization, location of production, consumption patterns, terms-of-trade, economies-of-scale, and levels of efficiency (Krauss, 1972). Increasing levels of international trade and investment are promoting and facilitating a growing number of customs unions around the world.

The following sections provide an overview of the main stages of economic integration, free trade agreements (FTA), customs unions (CU), common markets, and economic unions, and the main points and origin of customs union theory. This overview serves as the foundation for later discussion of active customs unions around the world and the welfare consequences of customs unions for member and non-member nations.

Stages of Economic Integration

Customs unions are one stage in the process of economic integration between nations. Economic integration between nations includes the following four stages: Free trade agreements (FTA), customs unions (CU), common markets, and economic unions (Holden, 2003).

Free Trade Agreements

Free trade agreements (also referred to as preferential trade agreements (PTAs)) state that products can be purchased and sold across country or regional borders without trade restrictions such as tariffs or quotas being levied. Examples of free trade agreements include the North American Free Trade Agreement (NAFTA) and the Central European Free Trade Agreement (CEFTA). Free trade agreements may be limited to a business or industry sector or applied to all levels and types of international trade. Free trade agreements tend to impose two main requirements on member nations:

  • Member nations must agree to follow dispute-resolution procedures.
  • Member nations must agree to follow rules of origin procedures for all third-party products entering the free trade area. Rules of origin, which are the legal stipulations, restrictions and administrative processes used to establish a product’s country of origin, is an expensive process for all free trade agreement member nations.

Free trade agreements tend to be applicable to a geographical region and form a free trade area. A free trade area, according to the Organization for Economic Co-operation and Development, refers to a grouping of countries within which tariffs and non-tariff trade barriers between member nations are generally abolished without instituting common trade policy toward non-members.

Customs Unions

Customs unions, which are free trade areas that also establish a common tariff and other shared trade policies with non-member countries, require trade policy harmony and cooperation between member nations. Customs unions implement a uniform external tariff (CET) and import quotas on products entering the customs union region from outside countries but also provide for the free movement of labor and capital between member nations. Customs unions offer four main benefits to member nations:

  • Customs unions eliminate the need for rules of origin and, as a result, provide member nations with significant administrative cost savings and efficiency gains.
  • Customs unions establish common trade remedy policies such as anti-dumping and countervail measures.
  • Customs unions require a level of cooperation that makes trade dispute-resolution procedures between member nations unnecessary.
  • Customs unions work together as a single entity to negotiate multilateral trade initiatives as a single bloc.

The benefits gained from participation in customs unions come at a cost to political and economic independence of member nations. Member nations exchange their independent trade and foreign policy freedoms for the benefits described above. One example of a successful and evolving customs union is the Southern Cone Common Market (MERCOSUR) of Argentina, Brazil, Paraguay and Uruguay. MERCOSUR, established in 1991, is actively working toward becoming a common market as member nations have become more economically integrated.

Common Markets

Common markets, as described by the Organization of Economic Co-operation and Development, are customs unions with provisions to liberalize movement or mobility of people, capital and other resources and eliminate non-tariff barriers to trade such as the regulatory treatment of product standards. Common markets are a significant step toward economic integration for member nations. Common markets tend to share labor policies as well as fiscal and monetary policies. Common markets, which facilitate increased economic interdependence, tend to produce increased economic efficiency for all member nations.

Economic Unions

Economic unions are common markets with provisions for the harmonization of certain economic policies such as macroeconomic and regulatory. The European Union is one example of a large-scale effective economic union. Economic unions, the last and greatest stage of economic integration between nations, share nearly all economic policies and regulations including monetary policies, fiscal policies, labor policies, development policies, transportation policies, and industrial policies. Economic unions generally share a common currency and a unified monetary policy that controls and coordinates national interest rates and exchange rates. Economic unions require supranational legal and economic institutions to regulate commerce and ensure uniform application of the economic union rules.

Nations choose different levels of economic integration based on variables such as the strength of their national economy and trade relationships and forecasted trade prospects. Nations may have multiple trade relationships and levels of economic integration with other countries or none at all. Nations that reject or do not pursue the stages of economic integration, as described above, are characterized as autarky. Autarky, or an autarkic nation, refers to self-sufficient countries that do not participate in international trade. Autarky, which means self-sufficiency in Greek and provides independence from other states, results in both benefits and costs (Anderson & Marcouiller, 2005).

Customs Union Theory

Customs union theory has its roots in the trade theory of the eighteenth century. Eighteenth century economists, such as Adam Smith (1723-1790) and David Ricardo (1772-1823), explored how trade between nations affected national economies. Modern customs union theory emerged post World War II. Modern customs union theory examines the way trade is impacted by the removal of barriers (such as quotas and tariffs) as related to the relationship between member countries and their establishment against other countries. Customs unions, and related theory, emerged post World War II as economic theory evolved and grew to address changing global economic relationships.

Trade Agreement & Economic Structures

After World War II, economists, world leaders, and governing bodies put trade agreements and economic structures into place, such as the World Bank, United Nations, World Trade Organization, and International Monetary Fund, to prevent the economic depressions and instability that characterized the years following World War I. National agreements promoted and facilitated free trade. Free trade is trade in which goods and services can be purchased and sold across country or regional borders without trade barriers such as tariffs or quotas being imposed. Post World War II, the allied powers, countries in opposition to the axis powers, promoted a limited form of free trade within a dollar-exchange monetary system. The General Agreement on Tariffs and Trade of 1947 prohibited quantitative restrictions on trade between leading industrialized economies. In the years following World War II, nations have been engaging in trade agreements as a means of increasing economic efficiency, productivity, and growth. Regional trade zones facilitate commercial expansion. Today, trade relationships between nations are also political relationships. Trade relationships, as expressed in customs unions, have become political-economic unions for the world's major trading powers including the United States, the countries of the European Union (especially those in Western Europe), Japan, China, and South Korea as well as developing nations.

Trade Creation & Diversion

Economic theory, post World War II, was deeply engaged with real world trade concerns and relationships. Modern customs union theory began with economists Jacob Viner (1892-1970). Viner's theory of customs unions argues that customs unions have two major effects: Trade creating and trade diverting. Trade creation refers to the shift of consumption of the importable good from a high-cost domestic producer to a lower-cost external foreign producer. Trade diversion refers to a switch from the lowest-cost external producers to a higher-cost producer. Viner's theory argues that trade creation always improves the country's welfare but trade diversion dampens the country's welfare. Critics of customs union theory argue that Viner's assumption that factors are perfectly mobile between industries in a country is not accurate. Critics argue that labor and capital are not uniformly mobile across regions and industries (Parai & Yu, 1989).

Applications

Active Customs Unions

Numerous active and anticipated customs unions exist around the world. Customs unions, which are one stage in the process of economic integration between nations, are an evolving economic relationship. Some customs unions progress to common market and economic union status and some customs unions remain as stable customs unions. Variables that affect customs unions include location of production, consumption patterns, terms-of-trade, economies-of-scale, and levels of efficiency (Krauss, 1972). The following list of customs unions includes small and large-scale customs unions:

  • European Free Trade Agreement (EFTA): The European Free Trade Agreement, established in 1960, is a free trade convention between Iceland, Liechtenstein, Norway, and Switzerland. European Free Trade Agreement member nations have jointly established free trade agreements with other non-member nations, including Bosnia and Herzegovina in Europe, and Costa Rica and Panama in Central America (EFTA Signs, 2013). The European Free Trade Agreement member nations are part of the European Economic Area (EEA). The European Economic Areas, established in 1992, includes the EFTA member nations as well as the twenty-five European Community member states.
  • Southern African Customs Union (SACU): The Southern African Customs Union, established in the Customs Union Agreement of 1910, includes the five member states of Botswana, Lesotho, Namibia, South Africa and Swaziland. The South African Customs Union agreement was revised in 1969 and 1994. The Southern African Customs Union has multiple goals: Regional integration, the facilitation of trade between the members of the Agreement, improved Trade Negotiations between SACU and third parties, and improved economic development of the Member States. The Southern African Customs Union, which provides shared decision-making and a sustainable revenue-sharing arrangement, has been very active in the years following the end of apartheid in 1994. The Southern African Customs Union is challenged by the member nations' varying trade policies and trade policy divergences. The Southern African Customs Union, eager to increase the benefits from economic cooperation, is involved in active trade negotiations with both the European Union and the United States (Kirk & Stern, 2003).
  • Gulf Cooperation Council (GCC) Customs Union: The Gulf Cooperation Council Customs Union, established in 2002, is comprised of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. The Gulf Cooperation Council Customs Union is a single customs zone with a unified customs tariff of 5% on most goods. The Gulf Cooperation Council Customs Union, a unified trading bloc, is involved in active negotiation with the European Union to reduce tariffs on products, such as aluminum, that are particularly significant in the economies of GCC member nations. Members of the Gulf Cooperation Council Customs Union have the power to impose higher or lower tariffs on certain goods as they see fit. For example, Saudi Arabia, the nation with the largest economy in the GCC Customs Union, places higher external tariffs than the GCC Customs Union 5% tariff on approximately 800 goods and products (Matthews & Issa, 2003).
  • Monetary and Economic Community of Central Africa (CEMAC): The Monetary and Economic Community of Central Africa, established in 1992, includes the six member nations of Cameroon, Central African Republic, Chad, Republic of the Congo, Equatorial Guinea, and Gabon. The Monetary and Economic Community of Central Africa has the following goals and objectives: Promote the establishment of a Central African Common Market; eliminate the obstacles to trade between member nations; and coordinate development programs to benefit underprivileged countries and areas.
  • European Commission Taxation and Customs Union: The European Commission Taxation and Customs Union, which includes all member nations of the European Union, imposes no taxes on goods moving between member nations, imposes a common external tariff on all goods entering the European Union, and negotiates with non-member nations as a unified trade block. The European Union Taxation and Customs Union has the following goals and objectives: "Manage, defend and develop the customs union as a vital part of protecting the external borders of the EU; tackle the tax obstacles that currently prevent individuals and companies from operating freely across borders and from exploiting the full benefit of the Internal Market and encourage changes to tax systems so that they support Community objectives such as competitiveness and sustainable development; respond effectively to the international challenges associated with customs and tax policies; facilitate better co-operation between Member States to combat tax and customs fraud" (Franckx, 2005, p.65). The European Union also has customs unions with Turkey, Andorra and San Marino. These customs union agreements are viewed as a step in the process of Turkey and San Marino becoming full members of the European Union.
  • Southern Cone Common Market (MERCOSUR): The Southern Cone Common Market, more commonly referred to as MERCOSUR, was established in 1991 by the Treaty of Asuncion. MERCOSUR, founded on an agreement between Brazil, Argentina, Uruguay and Paraguay, is a customs union working toward becoming a common market. Paraguay was temporarily suspended in 2012 during a period of political instability, and Venezuela joined (Paraguay's Dispute, 2013). MERCOSUR includes the following goals and objectives: negotiating free trade agreements between MERCOSUR and the other member nations of the Latin American Association of Integration; implementing the Inter-Regional Framework Agreement for Economic and Trade Co-operation (approved in December of 1995 by MERCOSUR and the European Union; and co-ordinating views regarding the scope of trade discussions in forming the Hemispheric Free Trade Area.
  • West African Economic and Monetary Union (UEMOA): West African Economic and Monetary Union (UEMOA): The African Western Union Economic and Monetary, established in 1994, includes the member nations of Benign, Burkina Faso, the Ivory Coast, Mali, Niger, Senegal, Guinea-Bissau, and Togo. The West African Economic and Monetary Union facilitates trade through the use of a common currency. The West African Economic and Monetary Union has the following goals and objectives: reinforcing economic competition among member states within an open and competitive market; ensuring the equalization of activities and economic policies of member states by instituting a process of multilateral managing; creating a common market characterized by the free movement of people, goods, services, capital; ensuring the right of establishment for persons participating in an independent or lucrative activity; coordinating uniform actions and policies in terms of human resources, regional planning, agriculture, energy, industry, mines, transportation, infrastructure, and telecommunications; and facilitating the operation of the common market, the legislations of the member states, and the shared mode of taxation.

Issues

Welfare Consequences of Customs Unions

Economists debate the effects that customs unions have on the welfare of member and non-member nations. Member nations of customs unions, a set of countries which agree to abolish tariffs among member countries and to set common external tariffs in order to maximize the joint welfare of the member countries, establish their own external tariffs on non-member countries. The variations and variability in trade relationships between customs union member nations and non-member nations creates a wide range of welfare outcomes. Nations, aware of the effect that customs unions have on member nations and non-member nations alike, are increasingly working to create welfare-maximizing customs unions (Yi, 1996). Potential customs union members estimate both the union's net economic costs and the union's non-economic benefits to assess whether or not the union benefits the community (Krauss, 1972). In an efficient economic market, customs unions are believed to increase welfare if the exportable sector pays higher prices to all member nations (Parai & Yu, 1989). Ultimately, there are multiple incentives for nations to form customs unions. The welfare consequences of customs unions include economic and non-economic benefits for member and non-member nations (Yeh, 1998).

Conclusion

In the final analysis, economic integration of nations, which includes the integration of commercial and financial activities among countries through the abolishment of nation-based economic institutions and activities, includes four fluid and dynamic stages of integration. The four stages of economic integration are being actively negotiated by nations eager to achieve the economic benefits of increased productivity, growth, and trade. Customs unions exist between the stages of free trade agreements and common markets. Nations will move between these stages based on their interest in and ability to facilitate economic partnership.

Terms & Concepts

Allied Powers: Countries (including the United States, Britain, France, New Zealand, India, Canada, and Greece) that opposed the axis powers during World War II.

Common Markets: Customs unions with provisions to liberalize movement or mobility of people, capital and other resources and eliminate non-tariff barriers to trade such as the regulatory treatment of product standards,

Customs Unions: Free trade areas that establish a uniform external tariff (CET) and import quotas on products entering the customs union region from outside countries but also provide for the free movement of labor and capital between member nations.

Economic Integration: Eliminating economic discrimination in order to merge commercial and financial activities between countries.

Economic Unions: Common markets with provisions for the harmonization of certain economic policies such as macroeconomic and regulatory.

Free Trade Agreements: Agreements stating that products can be purchased and sold across country or regional borders without trade restrictions such as tariffs or quotas being levied.

Globalization: A process of economic and cultural integration around the world caused by changes in technology, commerce, and politics.

Market: An arrangement allowing buyers and sellers to obtain information and engage in a voluntary transfer of goods and services.

Nations: Large aggregations of people sharing rules of law and an identity based on common racial, linguistic, historical, or cultural heritage; rarely act unilaterally.

Tariff: A tax imposed on a good imported into a country.

Trade: The export and import of goods and services.

World Bank: An international economic development assistance organization that was founded in 1944.

Bibliography

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Suggested Reading

D'Arge, R. (1969). Note on customs union and direct foreign investment. Economic Journal, 79, 324-333. Retrieved August 20, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=4537684&site=ehost-live

Kenna, J., & Riezman, R. (1990). Optimal tariff equilibria with customs unions. Canadian Journal of Economics, 23, 70. Retrieved August 20, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=6138767&site=ehost-live

Yeh, Y. (2002). Teaching note — customs unions vs. non-preferential quotas. Singapore Economic Review, 47, 269. Retrieved August 20, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=9473995&site=ehost-live

Essay by Simone I. Flynn, Ph.D.

Dr. Simone I. Flynn earned her Doctorate in cultural anthropology from Yale University, where she wrote a dissertation on Internet communities. She is a writer, researcher, and teacher in Amherst, Massachusetts.