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Customs union

Customs union - What is a customs union?

A customs union is an agreement between multiple countries that share borders to eliminate or decrease the duty usually charged on imports and exports

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Customs unions are established to help facilitate and simplify trade, generally between countries that commonly do business across borders. It does so primarily by removing the usual tariffs that come with cross-border transactions.

A customs union includes only those countries that have joined the union. For countries outside the union involved in trade, a general tariff is applied to trade with the customs union.

The benefits of a customs union

Countries involved often agree to a customs union due to the wide range of benefits that are offered to those involved in the arrangement. Some of these benefits include the following:

  • Increases in trade between countries: Because the union helps to simplify and speed up the trade process, this generally results in increases in trade. It can also contribute to increased political cooperation as it is in the interest of the countries involved.
  • Better trade creation and diversion: Trade creation refers to when the countries that are more efficient sell to those that are less efficient, improving the use and distribution of available resources. Trade diversion refers to how the less efficient countries can build a stronger standing within the union because countries outside the union face tariffs when trading with the union and therefore offer less competition.
  • Decreases trade deflection: Free trade agreement (FTA) countries have varying levels of tariffs. When a country buys from a low-tariff country and resells to a high-tariff country, this creates what is known as trade deflection, which can distort trade. Customs unions prevent this by applying one external tariff.

These are the main benefits of a customs union for member countries. While these are very positive, a customs union is not without issues.

The downsides of a customs union

Despite the positives, as with most things there are drawbacks to the formation and operation of a customs union. The main ones include:

  • Decrease in economic sovereignty: Because they are now part of a union, countries are not allowed to negotiate their own trade deals with non-union countries. However, the negotiations must take place and all countries must do so as the union.
  • Uneven revenue distribution from tax: Generally, higher percentages of the revenues are kept by the countries in the union that actually collect the revenue due to the added costs involved.
  • Tariff rate setting difficulties: Because countries are part of one union and charge tariffs to external countries conducting trade, this rate must be determined as a whole. This is especially true if a particular country in the union must give up trade of a certain product because another member is doing so more efficiently.

While customs union can help to bolster countries with smaller economies, it can also take certain production from countries, to be handled by those within the union that can efficiently produce them, leading to a better overall situation for the union.

Example of a customs union

The most obvious example of a customs union is the European Union Customs Union. This is the largest customs union in the world when measured by its economic output, it is formed by the 28 countries of the EU.

As part of the EU Customs Union, members enjoy a standardisation of customs duty rates for imported goods, as well as the distribution of tariff-free goods within the union (both goods created within and imported from external countries).

The EU Customs Union handles a huge volume of goods - 16% of worldwide imports, in fact. It also implements protective regulations to enforce security for members: from the handling of potentially dangerous goods, to the protection of endangered animals from smuggling, to helping law enforcement tackle illegal goods and activities such as drugs & weapons, or tax evasion.