Customs Union and Income Distribution

Abstract

The efficiency aspect of forming a customs union has been extensively discussed the publication of Viner's celebrated book in 1950. The static analysis of the welfare aspect of the customs union is mainly concerned with the effect of tariff cuts on trade creation and trade diversion. By using a simple three country model, the conditions for trade creation and trade diversion are specified. The condition for trade creation is that the tariff cut induces the more efficient producers to and the less efficient cease to produce but instead import the product from the former. The condition for trade diversion is that the tariff cut induces the less efficient producers to produce and the more efficient cease to produce. The 'cease to produce' can be interpreted as 'cease to export' in the trading relationship of non-member country with member countries of a customs union. This analysis of the production effect of a customs union has since been supplemented by the introduction of the consumption effect in other studies. Although there are a fair number of articles on the effect on income distribution of tariff protection, there has been little work done in specifying the effect of forming a customs union or income distribution within member countries. No attempt will be made here to define an equitable distribution of income; simply the effect on income distribution of forming a .customs union will be investigated. From the outset a distinction must be made between the effect of tariff on real income and income distribution. This article will be concerned with the latter only. Theoretically, tariff change can affect real income without affecting the distribution of income, and vice versa. In reality, it may change both simultaneously. By income distribution here is meant distribution between different factors of production as is usually the case in thc pure theory of international trade and not amongst different income groups as in the theory of public finance.