ChainWhat it assumes · how to break it
Start
A country joins a customs union, removing tariffs on trade with member states and charging a common external tariff on imports from the rest of the world, as members of the EU customs union do.
1
As a result, imports from member countries become cheaper and replace higher-cost domestic production, which is trade creation.
trade creation
trade creation
Best link to attack
Assumes: Member countries are lower-cost producers than domestic firms and than suppliers outside the bloc.
Assumes: Member countries are lower-cost producers than domestic firms and than suppliers outside the bloc.
But: The common external tariff may divert imports away from lower-cost producers outside the bloc towards higher-cost members, which is trade diversion.
2
This means exporters gain tariff-free access to a larger market, so they can expand and gain economies of scale.
economies of scale · specialisation
economies of scale · specialisation
Assumes: The bloc's market is large and exporters can compete in it.
But: Firms that already sold to members at low tariffs gain little, and non-tariff barriers may remain.
3
Consequently, firms from outside the bloc invest inside it to avoid the common external tariff, bringing capital and jobs.
FDI
FDI
Assumes: The country is an attractive location within the bloc.
But: Investors may choose other members with lower costs or better access to the largest markets.
4
Therefore, productivity and investment rise, shifting LRAS to the right and increasing long-run growth.
productivity · LRAS
productivity · LRAS
Assumes: The efficiency gains outweigh any losses.
But: Members lose the freedom to sign their own trade deals, which may limit trade with fast-growing economies outside the bloc.
End
Trade creation, economies of scale and inward investment raise productivity, increasing long-run growth.
Evaluation chain
- E1However, the growth gain depends on trade creation outweighing trade diversion.
- E2When the common external tariff is high and the most efficient producers are outside the bloc, imports switch from the cheapest world suppliers to dearer member suppliers.
- E3As a result, consumers pay more and resources are used less efficiently than under free trade with the whole world.
- E4So joining a customs union raises growth most when the members are already efficient, major trading partners, and adds little where trade diversion is large.
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Questions this answers
- Assess the benefits to a country of joining a customs union.
- Evaluate the view that trading blocs reduce world efficiency.
- Explain the difference between trade creation and trade diversion.
Diagram
Customs union diagram: domestic supply and demand, with the import price falling from the world price plus tariff to the partner's price. Label the trade creation areas, and the trade diversion loss when the partner's price is above the world price.
Reverse and related
Leaving a customs union → tariffs return on trade with former members, reducing trade and investment, but the country can set its own trade policy.