Page 244 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes exporters from the rest of the world, their exports would also be subject to the tariff. But since the
negotiated tariff of the Customs Union is based on the Russian external tariff, it tends to be high in
those items important to Russian producers. That is, products important to the exports of the CIS
tend to be inputs into production in Russia and therefore have relatively low tariffs in the Customs
Union.
Although we must again be cautious since this effect will vary from country to country and we do not
have precise estimates, this implies that most CIS countries outside Russia, Belarus and Kazakstan
likely derive little terms of trade gain on their exports to the Customs Union, from the fact that they
are in the Free Trade Agreement. That is, most CIS countries perhaps with the exception of Ukraine,
would likely be able to sell the vast majority on their products in the same markets with small losses
losses that are considerably smaller than the losses suffered by their consumers from having to pay
higher prices to the exporters from the Customs Union.
Moreover, the dynamic effects of the free trade area could also be negative, for all its members. It would
be desirable for CIS exporters to find alternate marketing channels outside of the CIS Customs Union
countries. This would reduce dependence on a limited number of countries for markets and
transportation facilities. Absent Free Trade Agreements, it will become even more imperative for
exporters from the CIS to find alternate markets and marketing channels. Moreover, while finding new
markets outside of the Customs Union countries may require a difficult adjustment period, the experience
of the Baltic countries between 1992 and 1994 demonstrates that rapid adjustment is possible.
Converting the Free Trade Area to a Customs Union
Now consider the impact of imposing the common external tariff at the rate t', starting from the Free
Trade Agreement in place. The supply curve including the tariff of the rest of the world and the new
equilibrium price increases to PR (1+t'), where the quantity demanded for imports declines to M1.
Partner country suppliers also receive this higher price and then the quantity they supply increases
to Q1. The quantity supplied from the rest of the world declines to M1 - Q1.
The welfare costs to country A are strongly negative, and may be decomposed into three parts. First,
there are consumer deadweight losses because country A consumers are induced to reduce their
consumption of total imports from Mo to M1 in favor of alternate goods available that were previously
less preferred (this could include domestic substitutes in this product category or goods in other
product categories). These were equal to the triangle ADL in the initial equilibrium, but they increase
to BCL. The difference is the shaded area ABCD, representing the increase in consumers' deadweight
loss due to the common external tariff. Second, there is an increase in the triangle of producers'
deadweight losses, from NGH to NFE.
The difference is the shaded area FEHG, representing the increase in producers' deadweight loss due
to the imposition of the common external tariff. Partner country producers are able to obtain higher
prices in country A, which attracts less efficient higher cost supply. Absent a tariff, supplies from the
rest of the world would have been available at the price PR. Third, part of the higher prices received
by partner country suppliers results in an increase in their profits or producers' surplus. The increase in
partner country profits or producers surplus is HIJE; this is a transfer from country A consumers to
producers in partner countries. Overall the loss of moving to the customs union, given that a Free Trade
Agreement is already in place, is the sum of the three shaded areas in Figure 1: ABCD + FEHG + HIJE.
The losses to the economy of increasing tariffs through the common external tariff of the customs
union, given a Free Trade Agreement, are considerably greater than non-preferential tariff increases
from an average rate of t to t'. That is, if tariffs were applied in a non-preferential manner and were
increased from t to t', the costs to the economy of the increase in the tariff would be the shaded area
ABCD. The customs union imposes the additional costs equal to the areas FEHG and HIJE, representing
inefficiency losses and transfers to partner country suppliers, respectively.
Combined Loss of the Customs Union and the Free Trade Agreement
The combined loss of the Free Trade Agreement and the customs union is larger than the loss of the
customs union or the Free Trade Agreement alone and equals the triangle BCL plus the rectangle

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