Direct Price Effect of Economic Integration Through Customs Unions

The formation of a customs union and the adjustment of the world economies to it is a long- lasting process. In fact, the customs union produces many dynamic effects in the world economies as under:

1. The increase in the size of market caused by the creation of a customs union leads to intense competition. The protected industries, therefore, face challenges. So they have to innovate and renovate. Thus, the marginal or inefficient firms are forced to improve their efficiency.

2. It would generate economies of scale and accelerate the rate of growth of member countries. This follows because of a marked correlation between the size of the market and the degree of productivity. Perhaps, for this reason alone, a customs union for underdeveloped countries may be advocated.

3. It may induce a rapid technological advancement. For, with the expansion in size of the market, large industrial enterprises will find it feasible and worthwhile to spend more on research and advancement of technology.

4. When productive efficiency improves as a result of creation of customs union, national income of member countries would rise, so that saving may increase which would enable them to have more investments, larger capital formation and acceleration of economic growth, attainment of full employment in the general standard of living and common welfare.

5. As a result of customs union, a member country’s terms of trade against non-member countries may improve, when its imports from these countries are curtailed, or its bargaining power may be enhanced, or the supply of exports to them is reduced. Of course, this kind of benefit will be more to the country which is the chief supplier in the world market. When the terms of trade are improved, the balance of payments position may also improve.

6. As has been suggested by D.G. Mayes, the direct price effect of economic integration through customs unions can be estimated by using the following simple model:

Where,

M = Imports

Pm = the price of imports

Ph = the price in home product

GNP = the gross national product

u – the error them.

In short, the following major advantages of economic itegration through customs union are usually claimed:

1. Improved Productivity:

(i) Due to greater specialisation facilitated by the customs union, production tends to be more efficient in the member countries.

2. Economies of Scale due to Enlarged Market:

Customs union enlarges the size of market for the exports of the member countries. This implies production of output on a larger scale, reaping the economies of scale.

3. Improved Terms of Trade:

The customs union enables the member countries to have a greater bargaining strength in the globaJ-market which may lead to a favourable terms in trade.

4. Higher Rate of Growth of GNP:

With expansion of trade of the member countries their growth rate of gross national product (GNP) tends to rise.