What is the difference between a customs union and a free trade area?
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While a customs union and a free trade area are similar in some ways, they are also different. A customs union represents a higher level of economic integration than a free trade area does.
A free trade area is simply an area in which countries have agreed to trade with one another freely. There are no (or at least not many) tariffs or other trade barriers that impede the flow of goods and services from one country to another. An example of this is the North American Free Trade Agreement (NAFTA). There are essentially no trade barriers between the NAFTA countries.
A customs union is a free trade area. There is free trade between all the countries in a customs union. However, that is not all there is to it. The countries in a customs union also have a common foreign trade policy. They have one set of policies for trading with countries outside the union. They have a common tariff that applies to goods being imported into the customs union. The United States, Canada, and Mexico do not have such a common policy and therefore they are not a customs union.
A customs union is made up of a free trade area and includes the introduction of the same import quotas, custom duties which apply to imports within the region. What this does is it eradicates re-exporting that would otherwise be practiced by member countries. An example of a customs union is the Southern African Customs Union (SACU).
A free trade agreement on the other hand refers to the eradication of import quotas, tariffs and some if not all trade preferences. An example of free trade area is the ASEAN Free Trade Area (AFTA).
The major difference between a customs union and a free trade area is that in a free trade area there is no common external tariff imposed. This means that they may interact differently with non-members with regards to trade. A customs union seeks to establish a standard of how member countries should interact with non members. This brings the issue of diminished customer choice because the products available may just be from the member countries.
In summary according to Krueger:
"A free trade agreement is preferential arrangement in which tariff rates among members are zero, although external tariffs may be at different rates for different members of the arrangement.
Customs union is an arrangement in which there is zero duty between members on imports of goods and services, and common external tariff."
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