BUS613: Advanced International Business

There are many possible rationales for choosing a CU over an FTA, including political and economic ones. Some regional groupings consider the establishment of a CU a prerequisite for the future establishment of a political union, or at least some deeper form of economic integration, such as a common market. The African Economic Community provides an illustration. The Abuja Treaty of 1991 envisaged gradual implementation in the following stages: (a) creation of regional blocs, by 1999; (b) strengthening of intrabloc integration and interbloc harmonization, by 2007; (c) establishment of an FTA and then a CU in each regional bloc, by 2017; (d) establishment of a continentwide customs union, by 2019; (e) realization of a continentwide African Common Market (ACM), by 2023; and (f) creation of a continentwide economic and monetary union (and thus also a currency union) and a parliament, by 2028.

Some groups, such as CARICOM, consider a CU to be a useful way of pooling market power, coordinating trade policies, and combining efforts to negotiate with the rest of the world. The more intense degrees of coordination and interaction associated with a CU can foster trust and familiarity among the parties and may even decrease the risk of conflicts, as has been the case with the European Union (EU). The fact that the external tariff is agreed with other parties through a legal agreement may help reformminded governments lock in their trade policies and can shelter them from domestic lobbies.

On a lower level, a customs union can simply be a practical device for avoiding trade deflection while facilitating more fluid trade flows among member states. In the simplest form of an FTA, member countries grant free trade to each other but effectively maintain sovereignty over the conduct of trade policy vis-à-vis the rest of the world. Thus, the tariffs charged to nonmember suppliers will vary across members. This could lead to opportunities for trade deflection – a situation in which goods from outside the FTA are shipped to a low-tariff country and then transshipped tariff-free to the high-tariff country. Such roundabout shipping patterns, which have the sole purpose of exploiting the existing tariff differential, are inherently inefficient and can create friction among members.

One way to avoid such wasteful trade deflection is for the members of the FTA to adopt a rules-of-origin system. Rules of origin can take various forms, but generally they require that goods (or value added) qualifying for tariff-free trade be produced within the FTA and that imports from outside the FTA pay the tariff of the final destination country, even if they pass through another member country. In practice, rules of origin are particularly complex, and their implementation costs can be high. They necessitate significant internal border controls to ensure compliance and to collect the relevant customs duties.

Another way to prevent trade deflection is to establish a customs union, which would require all members to apply the same external tariff to imports coming from outside the union. Because of the common external tariff (i.e., the absence of tariff differentials across members), the potential for trade deflection and the need for intra - union border inspections are, theoretically, minimized. In a fully implemented customs union, it is no longer necessary to maintain internal border controls for customs duty purposes or to design and implement the cumbersome and costly rules of origin that are necessary in a free trade area in which members have different external tariff structures. The simplification offered by a CU can greatly facilitate cross-border trade, which is especially relevant because existing CUs generally involve geographically contiguous countries, reflecting the traditional objective of regional integration. In this regard, a CU can approximate a larger single market (as compared with a number of separate markets in an FTA), which can generate greater economies of scale, as well as procompetitive pressures. These, in turn, can greatly benefit consumers and can translate into lower business costs and enhanced competitiveness for member countries.