Customs Union is a form of regional economic integration. In a custom union, member
countries trade freely among themselves, but agree on a common form of trade barriers with nonmember countries (Sloman, Hinde & Garatt, 2010). The main impact of the customs union is that it
creates a single large market among the member countries with common trade laws but protected by
non-member competition. Thus within the customs union, there will be a improved business climate
for businesses to exploit new opportunities and make better use of available resources. In essence the
immediate effect of customs union are the trade creation an trade diversion effects as it combines
principles of free trade with protectionism.
Effect on businesses within the Customs Union;
Trade creation can be beneficial to some firms and disadvantage to others. Trade creation occurs
when consumption shifts from a high-cost producer to low-cost producer within the union bloc
(Sloman, Hinde & Garatt, 2010). The effect on businesses within the union depends on their situation
prior to the formation of customs union. Greater competition among domestic firms due to trade
creation will force the firms within formerly protected industries to improve efficiency or lose out.
Also if a firm which is dependent on importing from outside the union bloc will be at disadvantage if it
faces a higher import tariffs due to common external tariffs imposed by the customs union. But overall
the businesses within the union bloc will benefit from trade creations and market expansion.
Customs Union effects on businesses can be summarized as resource allocation,
competitiveness economies of scale and investment. Free trade within the union bloc improves the
efficiency of resource allocation (Oatley, 2010). With the removal of trade barriers between member
countries, the resources among member countries will be applied to activities for which they have the
lowest opportunity costs among the member nations, thus gaining comparative advantages. Businesses
are able to expand their products to all over the union bloc as they now have a bigger population to sell
compared to selling domestically. They can reduce a significant amount in costs by producing more and
attaining benefits through economies of scale. As market gets competitive, inefficient firms are forced
to improve efficiency and innovate. Customs Union provides an incentive to foreign direct investment
to locate and produce in the countries within the union bloc. Businesses will increase output growth
through investments in latest technology that enhances efficiency and productivity
Effect on Business outside Customs Union;
Customs Union adopts elements of protectionism causing market distortions. External trade
barriers created by the union will have trade diversion effects. Trade diversion occurs when
consumption shifts from a lower-cost producer outside the customs union to higher-cost producer
within the customs union (Sloman, Hinde & Garatt, 2010). The disadvantage or benefit to the external
firms is dependent upon the level of tariffs they were facing before the formation of the union. Being
outside the customs union will often mean that a business loses out through the trade diversion effect,
as they are hindered the most by tariffs or quotas. If the firms outside the union now faces higher
import tariffs, then they are not able to export as much, as their goods are priced higher. The firms
within the union are benefiting from the tariff because they are protected by foreign competition.
On the other hand, if the firms outside the bloc now faces a lower import tariffs due to adoption
of common external tariffs by the customs union, then it will see a benefit as goods by the external
firms exporting to the regional bloc gets cheaper due to lower import tariffs and also they can sell more
goods as they get access to a larger market.
Implication on the Global economy
- Disadvantages ;
Customs unions are characterized by discriminating trade arrangements. Any kind of
protectionist policy will only benefit some at the expense of others (Oatley, 2010). The tariff will help
increase the producer surplus within the member countries, but the consumers pay a higher price for
products, so their quantity demanded has decreased along with their consumer surplus. The countries
outside the union bloc suffer with lower demand as their export cost has increased due to tariffs. Lower
demand leads to lower gross national product (GNP) which in turn leads to more unemployment in
non-member countries. Thus the non-member economies suffer because of custom unions.
The tariff decreases allocative efficiency as the global market cannot move to an equilibrium
state, i.e the point at which supply meets demand. By giving preferential treatment to member
countries, the production of the goods will shift from the lowest cost producer to a higher cost
producer. This represents a shift away from comparative advantage and a less efficient allocation of
resources. Global economy will eventually suffer when resources are not allocated efficiently.
Another unintended consequence of protectionism in a customs union, is that it creates import
substitution with tariffs, then the non-member countries will have trade deficit and hence less money to
import goods from the customs union members. Now the export demand of customs union will
decrease. This occurs when the level of import tariffs remains suboptimal or in worse case tariffs are
increased then the effect of trade diversion will outweigh the benefits of trade creation within the union
members (Frankel, 1997). So over all global economy suffers when the customs union doesn't adopt an
optimal level of trade barriers.
- Benefits to Global Economy;
Customs Union are considered a stepping stone towards global free trade (Oatley, 2010). As
long as the trade diversion affect doesn't outweigh trade creation effect then customs union will have a
positive spill over effect on the global economy. As the countries within the customs union experience
rising living standards, increased efficiency, higher rates of economic growth and regional political
stability,it will stimulate trade by shifting world's aggregate demand and aggregate supply.
Poverty has negative effect on global economy. Customs union has advantages over getting
under developed countries out of poverty trap. Customs Union will promote employment of local
factors of production and resources. Without union blocs the resources in these under developed
countries will never get exploited and thus they continue to remain within the poverty trap. By creating
a large economic to attract trade and foreign direct investment, and by adopting protectionism policies,
the member countries will decrease imports and increase exports. Regional demand increase creates job
opportunity for people which in turn can get them out of poverty trap and the growth rate of the gross
national product (GNP) will rise. Thus the customs union will shift these under developed economies
from high dependency to self-reliance.
Conclusion;
The creation of a customs union has some positive and some negative effects for businesses.
The firms within the union bloc will benefit with trade creation due to larger market and trade diversion
due to protectionism. But it is important that the union adopts an optimal tariff policy against nonmembers so that trade diversion effects does not outweigh the net benefits of trade creation.
Customs union can increase economic output of the member countries, and especially bring
under developed countries out of poverty trap. As the economies in the underdeveloped countries
grows it will reduce negative effects of poverty on global economy and at the same time stimulate
global economy further. And it is possible for a customs union to affect the external terms of trade
through tariff reduction and gradual union expansion, thus increasing global economic growth