The Silent Success of Customs Unions

Membership in customs unions (CU) has proliferated in past decades; globally, 81 countries are now part of a CU. Much of this growth has been driven by countries upgrading their links from a free trade agreement (FTA) to CU. At the same time, the rapid formation of new FTAs among countries that had no prior agreement in place has largely overshadowed this growth, making CUs the silent success of regional integration. Using the canonical regionalism model, augmented to allow for political bias towards firm interests, we investigate the endogenous choice of trade agreement. We show that CUs are the most politically viable trade agreement, since they are rent-creating. But CU is also consistent with member social welfare maximization: as long as trade with the rest of the world does not cease entirely, a CU leads to higher social welfare than either FTA or no agreement. These gains come at the expense of third-country welfare. If past trends continue, one can expect more FTAs to be upgraded to CU with associated adverse consequences for outsiders