Customs Unions with Global Trade Agreements

Abstract

The Kemp-Wan proposition on the existence of Pareto-improving customs union is extended by allowing the customs union to make trade agreements with non-members. We show that given some unused gains from trade a customs union improving its member' welfare with unchanged non-members' welfare exists as long as relative prices within the union and in some non-member country differ from each other. In this sense customs unions always have an incentive to build a multilateral harmonised trading system. In this system the customs union would reap all the gains from trade. This result contrasts with the original Kemp-Wan insight that customs unions can always expand with new members also increasing their welfare.

Keywords: Customs union, Kemp-Wan proposition, Pareto-improving customs union, Trade agreements

JEL Classification: F11, F13, F15