engleski

Welfare enhancing Customs Union: Kemp-Wan issue

This paper ponders all aspects of Customs Union (CU) formation in order to explain welfare effects on countries involved. Viner's classical model of FTA/CU creation leaves more space for interpretation of welfare issues due to ambiguity of trade creation and trade diversion effects. An absence of tariffs in intra trade guarantees positive welfare effects for integrating countries through higher volume of trade. On the other side, trade diversion from the most efficient producer outside the CU to the less efficient producer in the CU leads to suboptimal allocation of scarce resources. Net effects are the ones that count and are the sum of trade creation and trade diversion effects. In this respect Kemp-Wan theorem is introduced as a mean of achieving Pareto improvement through free trade and lumpsum compensation scheme for all countries that form Customs Union and the world itself. According to Kemp-Wan proposition there exists common tariff vector that leads to competitive equilibrium in which each individual country is not worse off than before the customs union creation. Although theoretically feasible compensation scheme through transfers lacks political approval due to the fact that not all countries would be willing to make trade concessions without reciprocity. Special emphasis in this paper is set on accession of the Western Balkan countries to the European Union and possible consequences that may arise. Moreover, the case of Croatia is analysed as a most probable EU country member in a near future.

Customs union; trade creation; trade diversion; Kemp-Wan theorem; lumpsum transfers

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