(a) What is a customs union? (b) State three advantages and two disadvantages of a customs union.

Answer Details

(a) A customs union is a form of economic integration in which member countries remove tariffs and other trade barriers on trade among themselves and, in addition, adopt a common external tariff against goods coming from non-member countries. It goes further than a free trade area, which only abolishes internal tariffs without a common external tariff.

(b) Three advantages:

• Larger market: free trade among members widens the market, allowing firms to enjoy economies of scale.
• Trade creation: members buy from the most efficient producer within the union, improving specialisation and efficiency.
• Stronger bargaining power against the rest of the world, plus increased investment and closer economic and political cooperation among members.

Two disadvantages:

• Trade diversion: the common external tariff may divert trade away from a cheaper outside producer to a dearer member producer, reducing efficiency.
• Loss of revenue and sovereignty: members lose customs revenue from internal trade and must surrender some control over their own trade policy to the union.