Page 241 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 21 : Static and Dynamic Effects of a Custom Union and Free Trade Organization

Since the tariff structure favors production in these countries, then as more countries join the Customs Notes
Union, in the short run producers in these countries will gain additional profits and exports from the
additional protection they receive against rest of world imports in the new partner country markets.
Since the costs of protecting home producers will be borne in part by consumers in partner countries,
the strategy has an initial appeal in the countries whose producers receive the high protection. But,
because the benefits of a liberal trade regime to consumers are dispersed widely (presenting a free-
rider problem where it is not typically worth it to individual consumers to lobby their governments
for liberal trade actions) while the benefits of trade protection are concentrated in the industry receiving
protection (which provides an incentive for the industry to lobby its government for protection), the
kinds of preferential trade areas that will typically arise are those which are trade diverting (see
Grossman and Helpman (1995)). Thus, in order for the existing members of the Customs Union to
convince additional members to join, or at least to remain members over time, it is likely that the
tariff structure will have to change in a way that offers protection to producers of other CIS countries,
i.e., the existing members will have to offer protection in their markets to high priced products
produced in non-member CIS states.

A country will not participate in a Customs Union if the Customs Union offers neither
enhanced protection for its producers nor widespread benefits for its consumers.

If the external tariff is adjusted to accommodate the inefficient producers of new members, although
some of the producers of the existing member countries may still gain from a wider Customs Union,
the benefits to the countries as a whole are going to be reduced and countries could become net
losers. That is, the short-run gains to existing producers mask potential longer term costs of not
opening up trade to the rest of the world. It is likely that the entire CIS is not collectively large enough
to approximate world market efficiency in most products. Thus, a strategy of widening the protection
of domestic producers through a Customs Union of a set of the CIS countries, is really an import
substitution policy through protection on a slightly larger scale, a strategy that has retarded growth
in many countries .
Revenue Effects

Due to the potential impact on the fiscal deficit, macro stabilization and inflation, governments must
also be cognizant of the impact of preferential trade arrangements on their revenues. In this section,
we examine various aspects of this question for the CIS countries.
Tariffs
Joining the customs union is likely to have negative revenue implications on Individual new members.
As there will continue to be no tariffs on trade within the customs union, to the extent that rest of
world imports are displaced, tariff revenue will be lost to the customs union. In addition, despite the
fact that the customs union agreements stipulate that the tariff revenue will go to the country to
whom the imports are destined, one can not overlook the potential administrative problems associated
with obtaining tariff revenues from the customs offices of other member countries, especially given
the weakness in tax reserve collections in all these countries. And there are other reasons to believe
that revenues of imports from the rest of the world will be diminished. There are central administrative
institutions of a customs union that will have to receive funding. Funding for the administration of
the customs union or any centralized programs is typically done out of tariff revenue collected by the
customs union.
Excise Taxes: Accession to the customs union will increase pressure on members to harmonize excise
tax rates. These rates are presently rather diverse both within the CU countries and potential members.
The tax revenue implications of unified rates would have to be assessed in each case individually.
Value Added Taxes. The dominant practice among the CIS countries is to apply the value added tax
(VAT) on a mixed basis. That is, for trade outside of the CIS, imports are taxed but exports are not, the

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