An Exploration Of The Traditional Customs Union Theory And The Static And Dynamic Effects Of Economic Integration

IntroductionThe benefits gained from regional integration be widely documented in literature and make water been known since the time of classical economists (Oslington, 2013). Regional integration has become the content of great inte simplicity due to the perceived benefits of preferential peck arrangements such as usages confederacy, put rase muckle argona, and common market among numerous a(prenominal) others.This paper forget focus explicitly on usance every(prenominal)iances, exploring the conventional usance fraternity possibility introduced by prof. Jacob Viner. The paper starts by define springer amount and then examines Viners framework of slyness instauration and exchange-deflection do.It is important to first define usage aggregate and introduce the hypothesis of customs unification. In general, tariff systems often tend to discriminate either betwixt commodities or between countries. Commodity discrimination occurs where different commoditi es be subjected to different rates of duty whereas country discrimination occurs where different countries atomic number 18 subjected to different rates of duty on the same(p) commodity (Lipsey, 1960). The speculation of customs union is defined by the latter part which involves geographic discrimination by imposition of external tariffs to imports from non- section states.As defined by (Clausing, 2000), a customs union is a form of preferential look at arrangement that involves a tariff- put out market access between member countries opus imports from non-member countries be subjected to a common external tariff. usance union beat for a long time formed the basis for regional integration. This has originally been driven by the perceived stack benefits for having such trade jeerments between member countries. Some of the best-known customs unions include the Benelux formed by Belgium, Luxembourg and Netherlands Zollverein which was formed by German states and the EEC whi ch was established by several states including France, Belgium and Italy, and is now widely recognized as the EU (Strielkowski, 2013). opposite examples of customs unions are the Mercosur and the Andean Community (Hannam, 2014).Viners framework of trade creation and trade-diversion effects.Any useful literature exploring the welfare effects of custom union constitution must commence with the appreciation of the traditional Vinerian orthodoxy which is establish on dickens important considerations trade creation and trade diversion effects. The Vinerian orthodoxy has been the driving ram down female genital organ the huge volume of literature exploring the welfare effects of sparing integration.For a long time, the perceived trade gains of customs unions had provided the rationale for regional integration (Jovanovic, 1998). Such regional agreements were viewed as effective in name of the welfare benefits. However, following the work of Viner Jacob, this proposition glum out to be incorrect. utilize the concepts of trade creation and trade diversion, Jacob Viner argued that regional trade agreements did non necessarily result trade gains in anguish of elimination of trade barriers (Ambrego & Riezman 2003 Lipsey 2006).Suppose that two countries A and B agree to form a customs union with country C stay outside the union. If prior to the organization of customs union, country A was importation from country C which is a low cost producer. With the union formed, A chooses to import from country B which is a graduate(prenominal) cost producer. In this case, the welfare is lowered despite the benefits of a tariff-free market as trade is diverted from a low cost producer to a high cost producer (Ambrego & Riezman 2003 Lipsey 2006). However, if a union was formed between A and C, then trade result be created and the welfare will step-up.Using these static concepts, Professor Viner concluded that such regional agreements can just be beneficial to partner countries if it leads to trade in commodities which were non previously traded (trade creation) (Corden, 1972). Whereas if the union was trade diverting by shifting locus of drudgery from low-cost third country to higher-cost partner country, then the effects are most likely to be detrimental for both partner countries and the rest of the world as wholesome (Chipman, 1998 & Lipsey, 2006).Since the publication of his seminal work in 1950, many economists have been interested in pursuing the impact of these two effects on world welfare. His work has been the driving force behind later subsequent literature examining the impact of regional trade agreements on welfare.Subsequent empirical workMuch of the empirical literature on customs union formation has been motivated by the work of Viner (1950). introductory to Vinerian orthodoxy, it had been customary to recognize customs union as always increase welfare. The classical stinting theory behind the formation customs union was the presumption that higher pointedness of economic integration was beneficial (Jonavonic 1998). Customs union formation was viewed as a step closer to free trade liberalization hence was seen as increasing world welfare. Viners seminal contributions proved this argument to be incorrect.However, Viners seminal contributions were challenged by Meade (1955) on grounds that the orthodoxy overlooked some of the benefits resulting in trade-diverting unions such as the benefits arising from substitution in consumption (Chipman, 1998). Lipsey (1957) and Gehrels (1956) criticized the Viners work over the same issue. These authors argued that preference considerations had to be taken into account when making endeavors of the welfare gains and losses (Chipman, 1998). Dissatisfaction with the Vinerian orthodoxy led to the development of other approaches that yielded clear propositions including the general theory of the split second best and the terms of trade-volume approach.It is important to note that the traditional Vinerian orthodoxy was based on two simplifying assumptionsConstant costs of production (Nicholls, 1993) Fixed proportions in consumptions (Nicholls, 1993).Meade (1956), Lipsey (1957) and Gehrels (1956) elongated Viners basic model by relaxing the assumption of aught price elasticitys of demand (Lee, 1978 p.248). This allowed for the determination of welfare effects with consideration of the changes in composition of consumption. Kemp (1969), Michaely (1965) and Vanek (1965) relaxed the assumption of constant costs.What is missing from traditional customs union theory?Besides these limitations, the traditional Vinerian orthodoxy come out to be missing important high-voltage pictures which are crucial in determination of the welfare effect. The traditional customs union theory seems to concentrate more on trade creation and trade diversion effects that are likely to be slight, ignoring those that are crucial in find out the enlighten gains/losses from integration.Pro-competitive effectOne particular aspect missing is the pro-competitive effect. For example, many small countries will tend to have a few vast firms that may collude and raise prices at the expense of consumers. Forming customs union and ensuring a tariff free market will increase the degree of competition and force domestic firms to price more in verge with marginal cost (Jovanovic, 1998). This pro-competitive effect will encourage them to reduce inefficiency and force them to price in overseas telegram with marginal costs, in that respectby leading decline the prices to consumers. This pro-competitive effect make it increasingly difficult for these firms to charge margins in special of marginal costs (Josic & Josic, 2013)In this regard, Baldwin & Venables (1995) emphasize the importance of pro-competitive effect and stock-still suggest that regional integration amplifies the pro-competitive effect compared to global integration. Formation of customs u nion create a large market and subjects producers to newly forms of competition. growth in competition forces the firms to be reduce the levels of x-inefficiency and to price in line with marginal cost in order to gain a new market share.Economies of caseAnother criticism of the traditional customs union theory lies in its failure to allow for economies of scale (Corden, 1972). Viners abbreviation fails to incorporate the effect of economies of scale. It is a fact that regional integration leads to the formation of larger markets which allows firms to exploit greater economies of scale. Customs union formation will therefore lead to the exploitation of greater economies of scale, thereby driving down the costs. With the tariff barriers removed, nationally- leprose firms may benefit greater economies of scale from the larger wiz market created (Cakmak & Yilmaz, 2008). Economies of scale will allow these union producers to achieve an best scale of production, increase their effi ciencies and decrease the average production costs as well as the prices to consumers (Ginsberg, 2010 95)Technology spill oversYet another aspect missing in the traditional customs union theory are the larger effects of technological systemal advances. The productivity and innovative abilities of nationally scaled firms may further be enhanced by technology spillovers (Cakmak & Yilmaz, 2008). enquiry and development programs may help in improving technological innovations. there is a greater potential for technological innovation where such unions exist. hookup or growth effectsFurthermore, given that integration leads to increased efficiency, it is in like manner more likely to induce greater investment. This additional investment may lead to medium-term growth effect in some countries and can notwithstanding improve long-run growth rates where the additional investment is associated with fleet technical progress (Josie & Josie, 2013). From an investment perspective, foreign d irect investment will be particularly important in boosting domestic growth.Arguments for and agents removing all tariffstherefore there appears to be a number of justifiable reasons for customs union formation. A member countrys welfare as well as the worlds welfare can be embossed if tariffs are reduced under such customs unions. However, the greatest benefits would be achieved by complete removal of the tariffs compared to mere reduction of these tariffs. The removal of all trade barriers will without doubt yield significant benefits in terms of reducing monopoly queen, improving terms of trade, increasing efficiency, and improving technological innovations with technology spill-overs among many others.In fact, customs union theory fails to unloose or rather explain the need for customs union formation since complete removal of all trade barriers could have all the benefits without incur potential losses associated with joining customs unions (Jovanovic, 1998). The welfare of a member country is less likely to be raised by a mere reduction in tariffs compared to complete removal. A free trade agreement would therefore tend to have more welfare benefits than a customs union since trade creation is merely dependent on removal of tariff barriers (Clausing, 2000).However, Krueger (1997) points out that free trade agreements may not necessarily yield greater benefits than a customs union and eventide argues that it can generate additional welfare costs which would otherwise not have been incurred under a customs union. In fact, Krueger (1997) argues that a customs union will always remain superior to a free trade agreement. This points to the need for further analysis of the benefits and costs associated with eject trade agreements and customs unions formation.ConclusionBased on this analysis, this paper concludes that the static concepts of trade creation and diversion cannot appropriately measure the welfare effects of regional integration. Even though V iner seminal contributions points out that consumer welfare may increase due to tariff reductions while welfare cost may descend from tariff discrimination of customs union, these static effects are trivial when considering the welfare effects of integration. The traditional customs union theory seem to ignore dynamic effects that are crucial in determining the net gains/losses from integration such as the pro-competitive effect, growth effect, economies of scale, and reduction of x-inefficiencies and monopoly power among many othersA prime example can be seen with the European federation, a wizard market that has had important consequences both inwardly and outside Europe. Following the EUs single market program, there is now a greater awareness of the importance of formation of customs union and of the value of removing tariff barriers. The EU is not only the largest single importer and exporter, but is also the worlds largest and richest economic entity (Ginsberg, 2010 p.96). The gains associated with joining the union far outweigh the economic risks/costs. The EU is currently planning to scatter its reach other European nations. Preferential trading agreements seem to be growing more rapidly, both in size and number.ReferenceAkkoyunlu-Wigley, A., 2006. effect of customs union with European Union on the market structure and pricing behaviour of Turkish manufacturing industry. Applied economicals, vol.38 (20).Ambrego, L. and Riezman, R., 2003. Computation and the theory of customs unions. Ontario, Universities of Warwick and Western Ontario and NBERBaldwin, R.E. and Venables, A.J., 1995. Regional economic integration. In handbook of transnational Economics, vol.3 , edited by G.M. Grossman and K. Rogoff. Amsterdam North-Holland, pp.1597-1644Cakmak, O.A. and Yilmaz, S., 2008. 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