Free Trade Areas, Customs Union and Single Market Explained

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Free Trade Areas, Customs Unions, Single Markets – What are they, what are they for and what is the difference between them? Thats what we are going to explore. Let’s get into it.

The economic theory of what is known as ‘Economic Integration’ was laid out by an economist called Jacob Viner in 1950. 

It consists of seven stages which are accompanied by increasing political integration. 

This is essentially the model that is being pursued by the European Union in it’s process of political and economic integration.

As we explore these subjects we are going to refer to tariffs (another word for import taxes) and trade barriers so it might be worth watching our video on those subjects first – there is a link in the video description.

Preferential Trading Areas

These are the result of trade-deals between two or more nations that reduce tariffs and other trade barriers but don’t abolish them entirely. They are agreements that countries put in place to open their domestic markets to trade with other countries, in exchange for access to their markets.

(bilateral or multi-lateral shown in visuals).

Free Trade Areas

Free Trade Areas are groups of states that have signed free trade agreements to remove some or all tariffs, and other barriers to trade between them. 

The line between what constitutes a Preferential Trading Area vs a Free Trade Area is somewhat blurred but a Free Trade Area is loosely described as a more advanced stage of economic integration which may have removed ALL tariffs and trade barriers between members.

The purpose of both is to increase economic efficiency. Both have customs borders between nations and both still enable individual national governments to impose different tariffs and other trade barriers with nations outside the Free Trade Area.

One of the largest Free Trade Areas in the world is NAFTA (The North American Free Trade Agreement) between Canada, the USA and Mexico.

At this point it’s worth pointing out that there is no reason why nations should necessarily go beyond being part of Free Trade Areas unless they want to be politically integrated.

Customs Unions

A customs union is a group of countries who trade freely with each other without any trade barriers but who impose common tariffs and other trade-barriers for goods imports coming in from elsewhere in the world. There are no customs borders between nations within a customs union although in many cases there will still be border checks for things like contraband, drugs and human traffic and arrangements for different taxes to be collected.

A customs union can, in some instances, extend economic efficiency further than a Free Trade Area, but the purpose of a customs union is typically to establish closer political ties between member countries. 

Indeed, becoming part of a customs union does mean becoming politically integrated with other nations. Individual nations can no longer set their own tariffs or impose their own trade barriers and they can therefore no longer do independent trade deals with other nations across the world. Neither can they define their own product standards and regulations.

Becoming part of a customs union means an individual nation giving up some of it’s sovereign powers and losing control of important economic levers.

In the past, when customs transactions were paper-based, time-consuming and laborious this loss of sovereign power was perhaps offset to an extent by an economic saving from the elimination of customs controls. 

But today, due to computerisation and automation the overhead of importing goods via a customs border typically range from 1% down to 0.05% depending on the value, type and size of the consignment in question.

Risk-based and intelligence led checks now mean that less than 1% of goods are physically checked at customs borders. (UK).

There are a number of Customs Unions across the world. The smallest is a customs union between Switzerland and the tiny neighbouring state of Liechtenstein. This enables Liechtenstein, a tiny nation of under 40,000 citizens, to benefit from Switzerlands trade arrangements around the world.

The largest Customs Union by far, is the European Union’s Customs Union which consists of all the members states of the European Union.

Single Markets

Single markets go beyond Customs Unions by providing freedom of movement of goods, services, capital and people (or labour). So again result in nations giving up their sovereign powers to a centralised political authority.

The loss of sovereign powers over movement of people can have significant ramifications for nations on their employment levels, wages, housing supply and housing costs and the burden on public services.

Economic Unions

Economic Unions start to impose common external barriers to the supply of services, capital and labour, again removing sovereign powers from nation states.

Economic and Monetary Unions

These extend centralised power over monetary policy, through a central bank such as the European Central Bank, over short term borrowing and money supply and start to introduce centralised fiscal control of government revenue and expenditure. 

This is the stage of Economic Integration that the European Union has now reached.

Complete Economic Integration

This is the final stage at which national governments have given up all control over International Trade, product standards and regulations, external movement of services, capital and Labour and monetary and fiscal policy, which in other words means taxation and public spending.

The main reasons why economic integration is pursued are political. The powers of a nation to run it’s own economy are hugely important powers.

The economic, and broader political and legal integration of countries, within the European Union, has been described as a ratchet. Over time, powers have gradually moved from national European governments to the European Union in one direction.

However, in 2016 the people of the United Kingdom decided to Leave the European Union. After that vote, those who wanted to Leave were generally happy to revert to Free-Trade with the EU whilst those who wanted to Remain campaigned to Remain in the Customs Union and therefore still give up political power over key areas of economic policy.

In a future video we will look in further depth at the implications for the UK of Leaving the EU Single Market and Customs Union.

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