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Trade Coordination In Free Trade Agreements And Customs Unions

Objective – This paper explains why free trade agreements (FTA) are more popular than customs unions (CUs) when it comes to customs coordination. Design/Methodology – This paper uses a theory of the balance of trade agreements with customs coordination. I have set up a three-country model of partial equilibrium with competing exporters. Domestic and exporting companies decide on their optimal production under certain tariffs and each country collects its customs duties under trade agreements. I found the stability of customs coordination implicit and each country`s preference between a free trade agreement and a CU. Results – I show that two FTA members can maintain their external tariffs higher than the separately decided external tariffs by maintaining the status quo. But each country can also coordinate “implicitly” by maintaining the status quo after the creation of a free trade agreement. But the opposite statement is also possible – that is, if a free trade agreement causes more trade diversion than trade creation, the free trade agreement can be an obstacle to a country`s well-being. This case is actually very interesting because it indicates that a free trade movement by a group of countries can actually reduce the national well-being of the countries concerned.

This means that a move towards a more effective free trade policy must not increase economic efficiency. Although this result may seem counterintuitive, it can be easily reconciled with the theory of the second best. Free trade agreements are international agreements concluded between two parties (countries or transnational groups) in order to guarantee free trade.

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