Are Customs Unions Really So Scarce?

Abstract

We show that generalised customs unions (CUs), in which members choose different external tariff rates while still maximising total member welfare, are always welfare‐superior to both standard CUs with common external tariffs and free trade areas (FTAs). Since generalised CUs are indistinguishable from FTAs in practice, our analysis implies that observed trade agreements (TAs) that have the appearance of FTAs may, in fact, be CUs. This possibility offers one potential explanation for the design of the WTO’s rules on regional TAs, in particular the WTO’s specification of a common external tariff as the defining feature of a CU. Our results also suggest that empirical estimates of the different impacts of FTAs and CUs may be subject to a TAs misclassification bias.