Customs Union Research Paper Starter

Customs Union

(Research Starters)

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


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

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,...

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