1. POSSIBLE GAINS FROM THE FORMATION OF A CUSTOMS UNION

2. Reasons for the formation of Customs Union
Static gains: Better allocation of resources
Dynamic gains: Economies of scale etc.
Protectionism
Economic integration is a prerequisite for political integration

3. Static Gains Trade creation - Trade diversion Hard to measure:
Economic growth
Other factors affecting trade other than CU

4. Static Gains: Measurement of TC and TD
Standart Approach
Net TC = Total increase in imports by Home country –
the fall in imports from non-members caused by integration
Difficulties:
Trade figures are expressed in money terms, so it also shows the effects of relative prices
Non-integration influences must be excluded
Choice of dates for comparison (must allow some time)

5. Static Gains: Measurement of TC and TD
Another Approach
TC= Change in total imports / consumption
TD= Change in imports from non-members / consumption
(Between two years before and after integration)

6. Static Gains: Measurement of TC and TD
Balassa, 1967:
Income elasticities of import demand= M
M = Average annual change in imports
Average annual change in GNP
If M from intra-area   Gross trade creation
If M from all sources   Trade creation
If M from extra-area   Trade diversion

8. Dynamic Gains Improved terms of trade with the rest of the world
If the formation of the CU does not affect the demand for imports from the rest of the world, the union’s TOT will be unaffected. Otherwise, there will be a tendency for TOT to improve.
Increased capital inflows and increased rate of technological change (increases in quantity and quality of factor inputs)
Reduced uncertainty

9. Dynamic Gains
Increased competition among firms within the CU (which increases efficiency)
Economies external to the firm which may have a downward influence on both general and specific cost structures

10. Dynamic Gains
Better allocation of economies of scale for both firms and industries operating below optimum capacity before the integration occurs
Assumptions:
Domestic price = cost of imports from W + tariff
Homogenous product
W produces and supplies to H and P a constant prices
H and P is capable of producing at declining average costs

11. Dynamic Gains Pre-union possibilities: Production in both H and P
Production in one country
Production in neither

12. RISKS
Possible responses by firms in third countries who lose market share as a result of the CU and may seek to fight back.