Is Unilateral Tariff Reduction Preferable to a Customs Union? The Curious Case of the Missing Foreign Tariffs

Abstract

During the past decade and a half, an important part of the literature on customs unions has dealt with the question of whether a country might obtain the gains it would achieve from a customs union (CU) in an alternative way, by a unilateral tariff reduction (UTR). (UTR may involve a partial reduction in tariffs, or a reduction all the way to zero.) A widely accepted conclusion (see Eitan Berglas, p. 329; C. A. Cooper and B. F. Massell, 1965b, pp. 745-47; Roma Dauphin, ch. 2; Harry Johnson, p. 280; Melvyn Krauss, pp. 417-19; and Peter Robson)' is that UTR does indeed hold out the prospect for all the gains from a CUwithout the disadvantagesif two important simplifying assumptions are made; namely, that we ignore economies of scale and the effects of a customs union on the terms of trade.2 In the words of Berglas: It is important to note that if a [preferential] trade agreement does not affect the terms of trade, then it does not allow for any mutually beneficial policy opportunities which are not open to each of the member countries separately [through UTR] (p. 329). If this conclusion is correct, it is very important, in that it undercuts the earlier literature on customs unions. The question asked by Jacob Viner in his pioneering work whether a CU represents a net gain or a net loss in economic efficiencybecomes unimportant, except insofar as a customs union is based on terms-of-trade effects3 or economies of scale,4 since a CU can be summarily rejected in favor of UTR. The UTR case would mean that, for economists, the puzzle is not to identify the efficiency gains (or losses) from a CU, but rather to explain why countries form customs unions in the first place (Berglas, p. 329; Cooper and Massell, 1965b, p. 247; and Johnson, p. 270). Indeed, in his survey of CU theory, Krauss identifies the problem raised by Cooper and Massellof why countries form customs unionsas . . . the theoretical issue of the past decade [the 1960's] just as in the prior one the major issue, as explicitly defined by Jacob Viner (1950), was whether a customs union represented a movement towards freer trade or greater protection (p. 413). The typical reply to the Cooper-Massell question is: Countries tend to form a CU for noneconomic reasons (Berglas, pp. 329-30).5