Customs Unions

Questions

• What Benefits are Expected from Economic Integration?

• The rationale of a Customs Unions (CU).• Static and Dynamic Effects of a CU.

• Which are the elements of the external EU Trade Policy?

Advantages of economic integration

(a) Prevents wars

(b) Better use of existing resources• Specialisation (comparative advantage)• Price effects - intensified competition• Quantity effects • Location effects

Advantages of economic integration

(c) Growth effects• Accumulate more resources

(d) Strategic effects• Greater negotiating power (WTO)• Better Terms of Trade

The Customs Union

EEC as Customs Union

• Treaty of Rome Article 9 (1):‘The Community shall be based upon a customs

union which shall cover all trade in goods and which shall involve the prohibition between Member States of customs duties on imports and exports and of all charges having equivalent effect, and the adoption of a common customs tariff in their relation with third countries’

Theoretical assumptions

Allocation Efficiency as motivation behind free trade

Question is:How to allocate

a) resources to productionb) output to people

Allocation Efficiency …

Market system provides for:

• Competition in factor markets- prices reflect true scarcity & productivity

• Competition in goods markets - firms charge true resource cost of goods

Allocation Efficiency …

• Consumers pay true costs

- purchases determines resources to be allocated to production to reflect preferences

RESULT:- market price as mechanism of allocation

International trade (market allocation) barriers

• They restrict:

- international competition and

- distort market determination of prices

- The cost of protectionism: REDUCED welfare

The cost of protection

O

P

Q

Sdom (=MC)

Ddom

O

P

Q

Sdom (=MC)

S worldPW

Ddom

The cost of protection

O

P

Q

Sdom (=MC)

S world

a

c b

Q1 Q2

PW

Ddom

The cost of protection

y

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

c b

Q1 Q2

TariffPW + t

PW

Ddom

The cost of protection

y

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

c b

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom

The cost of protection

y

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

d

c b

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom

The cost of protection

y

e

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

dc b

f1 2 3 4

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom

The cost of protection

e

y

Effect of removal of tariffsGains from liberalisation (1+2+3+4 –1– 3):

add gains: extra consumer surplus: area 1 + area 2 + area 3 + area 4

subtract losses:loss of producer surplus: area 1loss of tariff revenue: area 3

RESULT: area 2 + area 4 = GAIN FROM LIFTING TARIFF

O

P

Q

Sdom (=MC)

S world + tariff

S world

a

d

c bf

1 2 3 4

Q1 Q2Q3 Q4

TariffPW + t

PW

Ddom

The cost of protection

e

gy

GATT/WTO

• Promotion of free trade

• Chapter XXIV: allowing regional trade liberalisation as contributor to global free trade (!?)

Effects of customs unions

• Static effects

• Dynamic effects

Static effects of a Customs Union

• trade creation

– With new partners in customs union

• trade diversion

– With the rest of the world

Trade Creation

Switch from high cost domestic production to

lower costs foreign production

Trade creation

O

P

Q

SUK

DUK

PEU + tariffP1

O

P

Q

SUK

Q2 Q1

DUK

P1 PEU + tariff

Trade creation

O

P

Q

SUK

Q2 Q1

DUK

PEU

P1

P2

PEU + tariff

Trade creation

O

P

Q

SUK

Q4 Q3Q2 Q1

DUK

PEU

P1

P2

PEU + tariff

Trade creation

O

P

Q

SUK

1 2 3 4

Q4 Q3Q2 Q1

DUK

PEU

P1

P2

PEU + tariff

Trade creation

O

P

Q

SUK

1 2 3 4

Q4 Q3Q2 Q1

DUK

PEU

P1

P2

Gains

PEU + tariff

Trade creation

See Sloman and Wride, pp. 694

Trade diversion

Switch from low cost foreign suppliers tohigher cost foreign suppliers in partner

country

Trade diversion

O

P

Q

SUK

Q2 Q1

DUK

PNZ + tariffP1

P3 PNZ

O

P

Q

SUK

Q4 Q3Q2 Q1

DUK

PEC

P1

P2

P3 PNZ

PNZ + tariff

Trade diversion

O

P

Q

SUK

1 2 3 4

Q4 Q3Q2 Q1

DUK

PEC

P1

P2

P3 PNZ

PNZ + tariff

Trade diversion

O

P

Q

SUK

1 2 3 4

Q4 Q3Q2 Q1

DUK

PEC

P1

P2

P3 PNZ

5

Gains

Losses

PNZ + tariff

Trade diversion

O

P

Q

SUK

1 2 3 4

Q4 Q3Q2 Q1

DUK

PEC

P1

P2

P3 PNZ5

Gains

Losses

PNZ + tariff

Trade diversion

See Sloman and Wride, pp. 694

Measuring trade creation and tradediversion

• Practical question – How can we quantify these?

• Entity to measure– Rise in imports and exports to partners

- at the expense of other exports/imports? (trade diversion)

- at the expense of home sales?- purely additional? (trade creation)

Measuring trade creation and tradediversion

• We need:– to know actual pattern AND – what the pattern would have been

without integration •Big question - how to treat non-

integration (the counterfactual)?

Measuring trade creation and tradediversion

• Facts:– Large and growing share of imports

(for UK) from EC

•E.g. EC (6) Imports– 30% (1962) 45.9% (1984)

•E.g. EC (6) Exports– 18.5% (1962) 31.6% (1984)

Measuring trade creation and tradediversion

– In original six EU members

• rise in intra-EU trade of 15-30%

• for industrial goods (not agricultural goods)

– trade creating > trade diverting

•Effect of GNP growth: 0.15%

Dynamic effects of a Customs Union

• Scale economies• External economies• Polarization of economic activity• Economic efficiency

Given by:– lower transaction costs– competition

External EU Trade Policy

Common Commercial Policy

• Common External Tariff (CET)• Non-tariff Barriers• Export Subsidies• Intellectual Property• Labour Standards• Taxation• Competition Policy• Environmental Policy

Relevance

• Contributes to functioning of CU and Single Market

• EU laws and community right to conclude trade agreement

• Strengthens the bargaining power of EU versus individual states

Origins• Treaty of Rome

– Along with CU– (Art 110) Aim of:

• Harmonious development of world trade• Ultimate abolition of international trade

restrictions• Lower customs barriers

– (Art 113) Coverage: • Tariff level• Trade agreements• Export policy• Protection of trade (anti-dumping)

General liberalizing measures

(In line with WTO negotiations)

• 38% lower tariffs on manufactures• Import barriers on agriculture tariffs +

gradual reduction thereof (36%)• Phasing out quantitative restrictions

Policy Instruments

• Tariffs:•CET (1995): average 9.6%•Different by products (e.g. 26% for

agricultural goods)•Reductions through Uruguay Round•Into EU budget (less 10%)

• Quotas:• e.g. steel, bananas

Policy Instruments…

• Voluntary Export Restraints (!?):• E.g. Japanese car exports to EU no more than 2/3

of market growth or less than 2/3 of market shrinkage

• Anti-dumping measures:• Def: Selling in export markets below cost (‘normal’

price)• Frequency:

– 139-177 per annum (1988-1997)– US 302 per annum (1997)

EU preferential trading system

• Neighbours and former colonies• Hierarchy:

– Free access to EU industrial product market (Turkey, EEA countries, Maghreb)

– Discretionary preference system (Lome/ACP, the Generalized System of Preferences)

– Non-WTO members (e.g. Russia)

Preferential trading

• Direction: less discriminatory, in line with WTO

• Extension to new partners (e.g. Mexico, Mercosur)

• Cost of trade barriers estimates (Messerlin, 2000): 7% of GDP ($600 BN)

• 1/3 of global free trade gain to EU (GATT)

Trade structure

• Largest bloc; almost 1/4 of world exports

– (in 2007 17% of total merchandise and 28.5% of services trade)

• 45% of extra-EU trade to developed countries

• 15% of extra-EU trade to LDCs

Trade structure

• Intra-industry versus Inter-Industry trade

• Trade balance in modest surplus• Intra-EU trade in total trade 63% (1998)

vs. 42% (1961)• Rising extra-EU trade• High tech exports to developed

countries lagging behind

Major partners

• USA:

– Largest share of extra EU imports and exports (12.7% imports 21% exports in 2007)

– Frictions in minor areas– Enduring debate on agricultural products– Transatlantic free trade agreement would

mean 1%-2% GDP increase for EU (Boyd, 1998)

Major partners…

• China– rising partner, by 2007:– 16.2% of EU imports versus 5.8% of EU exports

• Japan– Narrow range of products– Reluctance of Japan to open markets– Lack of EU knowledge of Japanese market– 5.5% of EU imports versus even lower EU exports– VERs

Readings

• Baldwin, R. E., 1984. Towards an integrated Europe. London: CEPR. ch. 2

• Hitiris* - ch. 1 (customs union) • El-Agraa - ch. 7, ch. 24*, ch. 25• Sloman and Wride, Economics, ch. 24

• The customs policy of the European Union• External Trade• Essential EU Trade Statistics