A Customs union is an agreement between two or more (usually neighboring) countries consisting of two elements: a single shared tariff for imports coming into any of the members of the customs union from nonmember countries; and a free trade zone among the member countries. The basic idea behind the creating a customs union is to eliminate tariffs and other trade barriers on mutual trade among members, while maintaining a common and unified customs policy to those countries outside the union.
Tariffs and other customs-related barriers generally reduce the quantity of trade between countries. Conversely, customs unions promote trade among members by making it easier and less-costly for members to trade among themselves. It allows members with similar trade policies and economic conditions to benefit from each other without exposing them to increased competition from sources outside the union. One key element of a customs union – and often the difficult part on which to reach agreement – is that members must agree on some method to share the revenue generated from tariffs on imported goods.
Shared tariff revenue creates an additional important consideration for a country deciding to join a customs union; namely whether its partners in the union will be capable of enforcing the common customs policy and collecting tariff revenues. If one member of a customs union lacks the capacity to collect tariffs, the resulting loss of revenue will affect all members of the customs union. From a strategic perspective, this means that a country will benefit from membership in a customs union only to the extent that the increased trade within the union is greater than any lost revenue on account of other countries collecting (or not collecting) tariffs.
Because barriers to trade are reduced within the customs union, countries are encouraged to find areas where their industry can specialize and become more productive at making just a few things. In this way, customs unions promote cross-border investment and served to attract investors into the region, as the enlarged market with minimal customs clearance formalities is more attractive to investors than the previously small individual national markets. Private sector operators based in the region with cross-border business operations are able to exploit the comparative and competitive advantages offered by regional business locations, without having to factor in the differences in tariff protection rates, and added business transaction costs arising from customs clearance formalities.
This type of fragmented production is most efficient in a large economic region (this is the secret behind the Chinese miracle). For smaller countries, the only way to attain the necessary size to allow for this level of specialization is to work together with other small countries. However, the economic region can only be meaningful if it is more than a simple aggregation of neighboring countries doing the same things. Instead, each country must specialize in some areas of production, and then trade more intensely with each other.
Let’s look at a few examples of customs unions from different parts of the world.
Eastern African Community (EAC)
The EAC is the regional intergovernmental organization of the Republics of Burundi, Kenya, Rwanda, Tanzania, and Uganda. It is headquartered in Arusha, Tanzania. The Agreement on establishment of the EAC was signed in 1999 and entered into force in 2000. On the average, the size of EAC countries is around 30 million people in population with a GDP of around US $10 billion. Before the Customs Union, trade in the region was carried out under different external tariffs, different customs regulations, procedures and documentation. It was very inefficient to trade with neighboring countries. However, by operating as a unified economic region through the Customs Union, the EAC becomes a market of over 133 million people and a combined GDP of around US$79 billion. Because goods can be traded in this region without incurring tariffs, producers can benefit from fragmented, highly-specialized production processes, where a producer of intermediate goods in Kenya, and a separate producer of intermediate goods in Burundi both supply a company in Tanzania, who combines the intermediate goods into final goods, and then exports those final goods to larger international markets like North America. The data from the EAC Secretariat shows that intra-EAC trade grew to $5.5 billion in 2012, up from $4.5 billion recorded in 2011. The EAC statistics indicate that the growth was driven by the increase of imports and exports that went up by 20.7 per cent and 23 per cent, respectively.[i]
EU and Turkey Customs Union
The Turkey-EU Customs Union Decision of 1995 required Turkey to eliminate all customs duties, quantitative restrictions, and other charges having equivalent effect of customs duties or quantitative restrictions in trade of industrial goods with the EU. In addition, Turkey was required to adopt the common customs tariffs of the European community (EC) against third-country imports and also adopt all of the preferential agreements the EU has concluded and will conclude with third countries.
The parties agreed that the union would be restricted to industrial and manufactured goods, and that the common customs tariff revenue would be collected by each party at the initial port of entry and that such revenue would accrue as income to the party collecting that revenue. This agreement on revenue was feasible only because the EU does not rely on tariffs as a significant source of government revenue. Thus the EU was willing to let Turkey retain the tariff revenue that would come from the importation of raw materials.
Since 1996, Turkey’s gross domestic product has increased more than 400%, making it one of the fastest growing economies in the world.[ii]
Customs Union Russia-Belarus-Kazakhstan
Belarus, Kazakhstan and Russia agreed to establish a Customs Union in November 2009. This is probably the first successful example in regional economic integration between countries of the former Soviet Union. The economic logic behind this union is to produce more competitive goods, establish efficient supply chains in the region, and to achieve higher real incomes for residents. This customs union is about more than just tariffs and has introduced mechanisms of trade integration, particularly by reducing non-tariff barriers. Since the creation of the union, trade among the three countries has doubled.
According to European Bank for Reconstruction and Development, the increase has been caused by post-crisis recovery, but also by reducing non-tariff barriers and to some extent by common tariffs. Non-tariff barriers – for example, the time that it takes to clear goods at borders – have traditionally been a major trade obstacle in these countries. Non-tariff barriers are much more important for trade than more traditional barriers, such as import duties.
According to the Eurasian Development Bank, established by Russian and Kazakhstan governments jointly, the economic impact of Tajikistan’s accession to this customs union would be substantially positive. The Bank indicates three main areas of impact: increased investment, increased productivity and improved labor migration. The Bank sees the additional increase to Tajikistan’s potential GDP growth to be 3.5% yearly after its joining to Customs Union.
The research from EDB highlights one main advantage for Tajikistan will be a single labor market within the customs union, which will lead to increased cash remittances as 15 to 25% of Tajik workers find better jobs in Russia or Belarus.
Tajikistan is a landlocked, Central Asian country. The low level of product diversification and reliance upon natural resources makes the Tajik economy especially vulnerable. Nevertheless, Tajikistan has taken steps to increase its global and regional integration through WTO accession in 2013 and by participating in the CIS free trade agreement. In order to further enhance trade competitiveness and create a more diverse economy, Tajikistan should consider the many benefits that would come from strategic membership in customs union with its neighbors. However, as the amount of benefit depends on the details of both the sectors covered by the agreement and the revenue sharing, Tajikistan must be certain to negotiate in its own interest.
[ii] Kalaycı, Cemalettin; Seyfettin Artan (17 June 2009). “The Impact of a Customs Union on Turkey’s Foreign Trade”