Even if trade creation gains exceed trade diversion losses, this is not an adequate explanation as to
why a country might wish to form a customs union with high-cost trading partners." Discuss this
with reference to the East African Customs Union / Common Market
The formation of a customs union can lead to increased trade creation as a result of reduced trade barriers and increased integration among member countries. However, the benefits of trade creation may not be enough to justify forming a customs union with high-cost trading partners. This is because such a union could lead to significant trade diversion losses, as inefficient producers within the high-cost partner countries would be protected at the expense of efficient producers in lower-cost non-member countries.
The case of the East African Customs Union / Common Market (EAC) provides a useful example. The EAC was formed in 2005, and its main objective was to promote economic integration and development by reducing trade barriers among its member countries (Kenya, Tanzania, Uganda, Rwanda, Burundi, and South Sudan). The EAC has eliminated tariffs on goods traded within the bloc and implemented policies to facilitate the movement of goods, services, capital, and people.
On the one hand, the formation of the EAC has led to increased trade creation among member countries, especially in sectors such as agriculture, manufacturing, and services. Tariff elimination has resulted in lower prices for consumers and increased opportunities for businesses to expand their markets. The EAC has also contributed to regional stability and cooperation, helping to address common challenges such as insecurity and disease.
On the other hand, the EAC has faced significant challenges in terms of trade diversion losses. High tariffs on imports from non-member countries have led to complaints from countries outside the bloc, particularly those with more competitive industries. For example, Kenya has been accused of protecting its domestic sugar industry through high tariffs on imports from Brazil, which are cheaper than domestic alternatives. This has resulted in higher prices for consumers and reduced access to cheaper goods.
Furthermore, some critics argue that the EAC benefits certain member countries more than others, as some countries have a comparatively lower cost of production and may enjoy a greater competitive advantage in certain sectors. For instance, Kenya has a more diversified economy with strong manufacturing and services sectors, while countries like Rwanda and Burundi are more reliant on agriculture. This may result in uneven gains and potential tensions among member countries.
In conclusion, while trade creation gains can be a significant benefit of forming a customs union, they may not be enough to justify the formation of such a union with high-cost trading partners. The EAC example shows that high tariffs on imports from non-member countries can lead to trade diversion losses, which may outweigh the benefits of increased trade among member countries. It is therefore important for countries to carefully consider the potential costs and benefits of customs unions before deciding to join or form one.
The decision for a country to form a customs union with high-cost trading partners cannot be solely explained by the fact that trade creation gains exceed trade diversion losses. In the case of the East African Customs Union/Common Market, there are several additional factors that could influence this decision.
1. Political considerations: Forming a customs union with neighboring countries can have political benefits. It can help foster closer political ties, increase regional cooperation, and promote stability and peace among member nations. In the case of East Africa, where there is a history of regional conflicts, the customs union can promote peaceful relations and enhance regional integration.
2. Economic diversification: By forming a customs union with high-cost trading partners, a country can encourage economic diversification. It allows the country to access a wider range of goods, services, and investment opportunities that may not be available in their domestic market. This access to diverse economic activities can help stimulate growth and development in industries that were previously not present or less competitive.
3. Market access: Joining a customs union with high-cost trading partners can provide expanded market access for domestic industries. This can be particularly advantageous for small and less-developed economies. By integrating their markets with larger economies, smaller countries can gain access to a larger pool of consumers, potentially leading to increased exports, foreign direct investment, and economic growth.
4. Regional development and infrastructure: A customs union often involves cooperation in areas such as infrastructure development, transportation networks, and trade facilitation measures. By joining forces with high-cost trading partners, countries can benefit from shared investments in infrastructure projects that aim to improve connectivity within the region. This can lead to more efficient movement of goods and services, reducing trade barriers and enhancing overall trade performance.
5. Global competitiveness: Joining a customs union with high-cost trading partners can help enhance a country's global competitiveness. By creating a larger integrated market, countries can achieve economies of scale, which can lower production costs and promote efficiency. This can make their products more competitive on the international stage, allowing them to compete with other global players.
In summary, while the gains from trade creation exceeding trade diversion losses can be an important consideration, the decision to form a customs union with high-cost trading partners, like the East African Customs Union/Common Market, is influenced by a multitude of factors. Political considerations, economic diversification, market access, regional development, and global competitiveness all play a role in shaping the decision to form such a union.