An Analysis of the Dynamic Customs Union Theory Essay

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            The idea of a common market came to life with the economic integration of the European nations after the Second World War. The question thereafter lies whether the efficacy of this decision is quite effective or is working for the benefit of their common market.  In addition, the application of the ideas herein will be discussed with dissimilar analyses of the factors that discuss the economic implications of the regional integration.

X-Efficiency Analysis

There are a number of unlike potential efficiency effects of consolidation that may be able to be applied to either domestic or international M&As. In the current European Stock Market for example, we review the existing empirical research on a number of these types of efficiency (De Young, 2000). We include the scale and scope efficiency effects of M&As that increase the size and the count of different types of services offered by consolidated institutions. We also include several X-efficiency effects, or changes that move the consolidating institutions closer to or further from their optimal points on the best-practice efficient frontier.

Specifically, we consider the X-efficiency effects of geographic diversification and managing from a distance, and the X-efficiency consequences of the M&A process itself (De Young, 2000). For all of these types of efficiency, we consider both cost and revenue efficiency effects, and often include research on profit efficiency, which incorporates both cost and revenue efficiency.

For some of the types of efficiency, a change in the risks of consolidating institutions is also a consideration, because the risk of the consolidated institution affects its costs of funds and its ability to raise revenues. The research is drawn from many countries, including most of the European countries, although most of the studies use U.S. data. Dynamic effects is the term used in a variety of ways by different authors to cover anything beyond standard comparative statics or any effect that has to do with economies of scale and any effect that tackles technical change (De Young, 2000).

Static effects universally estimated at about 1%. With static effects only those resources who move activity gain (if they get re-employed). And gain is equal to the difference between uncompetitive (protected) activity and the new activity (assumed to have Comparative Advantage). Big effects are likely to come from scale economies and especially shift in cost curves. Cost reduction affects all existing production as well. Firms need regulatory certainty that they will get market access. Hence, incurs a lower risk premium on investment in other words, growth effects

Terms of Trade Effects

Other than the import regulations, industrial organizations also differentiate the consequence of import raise effects on the stock markets in the European Union. On the other hand, the course of the effect of import raise on focus is unclear. A study points out that the effect of imports on producer concentration is positive. Probable reasons of the raise in producer concentration ratio are the absence of inefficient firms as a result of import liberalization.

The other possible reason is the increase in mergers of domestic firms as a result of import threats. In addition, if imports are close substitutes for domestic production, sectors that have high import share may be expected to be characterized by a high degree of defensive concentration. Alternatively, it is also likely that imports would reduce concentration if producers were induced to improve efficiency and in turn increase the number of efficient firms. In the same way, the result of the increase in exports on producer concentration is also unclear (Nagy, 2005).

There is a positive relationship between export increases and concentration if an increase in exports reduces average cost because of scale economies from increased market size, and as a result producers engaged in exporting activities should be able to increase their market share. Because a larger market size resulting from export opportunities can support more producers, a negative relationship is more likely if the economies of scale in production or distribution are not that important.

Paralleling these theoretical developments in the industrial organization and international trade theory, there are a number of empirical studies examining the effects of trade liberalization on the price-cost margins.

The result of the studies point out that an import increase has a negative impact on the price cost mark-ups of highly concentrated industries. The EU is an exception to these studies because it suggests that there is no systematic evidence of the import discipline hypothesis for the EU economy (Nagy, 2005). Regarding the pro-competitive effect of economic integration, a study of Bottaso confirms the view that economic integration reduces the price cost mark-ups for Italy and Spain.

The idea of a free custom union around Europe emerged in 1950 as Customs Unions and Free trade areas have been seen as a step towards global free trade. This was previously supported by a provision on GATT 1947 Article I that required non discriminatory MFN trade.

However, Art. XXIV allowed CUs/FTAs covering substantially all trade and if overall degree of protection was no higher although the provision was not well defined as it created a further dilemma particularly on the implementation stage of the process.

Krugman argued that dividing the world into 3 blocs was worst possible outcome through impact on those excluded but later said benefits of deeper integration positive when Natural Blocs form. Kemp and Wan 1976 showed that any customs union could be welfare enhancing if the right tariff taxes and subsidies were adopted.  But high tariff CUs can have adverse terms of trade effects on an EU members partners and on trade partners. Deep integration can credibly ensure trade barriers not replaced by domestic measures:  trade barriers now often non-border measures and change business expectations.

Economies of Scale Analysis

Recent academic studies regarding international trade gives us specific gains from trade derived from theories both from classical and neo-classical economic approaches. Among what these theories suggests is the pro-competitive effects of trade liberalization with the emphasis on the expansion of the market size in terms relative to the change in the number of firms that are present.

Consequently, the pro-competitive effects advocate that trade differentiates the intensity of competition in the market; including the companys price cost mark-ups, their relative scale and production output. New several theoretical readings regarding international trade have had several implications upon the European Union economic customs integration. The purpose and significance of the welfare services involved in the new theory applied to the regional economic integration has widened the range of possible benefits from the European Union countries integration further than that put forward by the standard customs union theory patterned on a perfect competition structure and constant returns to scale (Akkoyunlu-Wigley, 2005).

Accordingly, one of vital issue is that customs union theory concentrates more on the outcome of the economic integration rather than the market structure efficiency and the productivity of firms. For that reason customs union theory is not anymore viewed as one theory subsequent to the classical Vinerian ideas of the conception of trade and trade diversions. It is often debated that the pro-competitive aspect of trade liberalization is suitable under both the theory of monopolistic competition and the oligopolistic market structures.

Obtained on the assumption of monopolistic competition, it is illustrated that trade liberalization leads to an increase in firms scale and decrease in average cost and prices by increasing the elasticity of demand. Likewise, under the theory of oligopolistic interaction between the European Union member countries, trade liberalization also creates a decrease in price cost mark-ups and produces an increase in the overall firm scale by heavily moving the market power of the firm in home markets (Akkoyunlu-Wigley, 2005).

With respect to the pro competitive implication in the case of customs union, the significance of the pro-competitive effect as one of the outcomes of customs union and propose that regional ones, such as the European Union oppose global unions that will then intensify the pro-competitive result. Specifically, due to the production shifting effect, the exact figure of firms in a country that would boost the integrated area involved which in turn would reduce the home market shares of companies in the European Union.

Alternatively, new empirical studies also show developed industrial organization theories that test the implications of trading on the current market structure as well as profitability. The import discipline hypothesis within the framework of the SCP paradigm is being tested as far as import liberalization is concerned. Then again, industrial organization theory also looks onto the implications of imports on price-cost margins (Akkoyunlu-Wigley, 2005).

Similarly, an increase in imports of EU countries for instance as a result of trade liberalization would cause a decline in the price-cost margin by means of reduction in the market power of domestic firms or through the increase in competition. Also, since the competing imports will increase, the number of alternatives available to domestic consumers will increase and may raise the demand elasticity and therefore reduce the price-cost margins.

Likewise, the other countries that have an interest in replicating what Europe had done may not necessarily run after the economic integration just so to experience the benefit it curtails. Some countries may not really have to. Instead, what governments must do to replicate the benefits without risking much of the variable discussed is through the multilateral cutting of the tariffs that the involved countries may have on certain products that either one or both of them produce. The concept of competitive advantage enters here as the devaluation that would follow suit which would create and ensure a full employment for both countries involved.

Growth Effects Analysis

The first systematic albeit descriptive investigation of output effects of economic integration was carried out under the heading dynamic effects of integration. According to Balassa these dynamic effects are rooted in internal and external economies of scale, faster technological progress as a result of economies of scale in the R&D-sector, enhanced competition, and reduced uncertainty, the creation of a more favorable environment for economic activity and lower costs of capital due to the integration of financial markets. The revival of growth theory in the mid-80s led to a more formal reconsideration of the effects of integration on growth and shed more light on the questions involved (Badinger, 2001).

At the outset, a terminological clarification is in order here. The most important distinction relates to the persistence of the effects of economic integration on the growth rate: Permanent growth effects lead to a change in the steady-state growth rate, resulting in a steeper growth path of the economy. On the other hand there are temporary growth effects (or level effects), which cause only an upward shift of the growth path, while leaving its slope unchanged in the long-run, i.e. after the transition period the growth rate falls back to its steady-state level. Following the level effects can be further subdivided into static effects that lead to more output from the same amount of inputs and dynamic effects that influence the accumulation of factors.

Also referring to the channels through which growth effects materialize the terms integration-induced technology-led growth and integration-induced investment-led growth (Badinger, 2001). Although first used in the context of level effects, this distinction equivalently applies to permanent growth effects. To analyze the consequences of integration for economic growth in a systematic way, two lines of theory have to be distinguished: neoclassical and endogenous growth theory. In neoclassical growth theory, economic integration and other institutional aspects or economic policy measures have no effect on the steady-state growth rate, which is solely determined by the exogenous rate of technological progress.

As a result of diminishing returns to capital the capital stock and output per efficient worker grow only to the point where the investment ratio equals depreciation plus the rate of technological progress (for constant labor). (Badinger, 2001) The growth of capital stock and output per worker in equilibrium is then given by the constant rate of technological progress (g). Institutional changes, increases in efficiency or changes in the investment-ratio have only temporary effects on the growth rate; after a transition period it falls back to its steady-state level. Thus, neoclassical growth theory clearly rejects the hypothesis of permanent growth effects.

Nevertheless, both static and dynamic level effects occur. Static effects arise from three main sources: lower trade costs, increased competition and enhanced factor mobility. This increase in efficiency leads to more output from the same amount of inputs in a first round (static effects). But this is not the end of the story. Given a constant investment-ratio, the increase in output also leads to higher investment and an increase in the capital stock, which in turn increases output in a second round (dynamic effects).


The European Union is the concern over the effects on competitiveness of the member countries when it comes to pricing behavior and market structure. The European Stock Markets indicate that the higher the volume of trade the lower the price will be and the price cost margins as well as industry market power. It is then safe to assume that the liberalization of trade would eventually cause gains in output and welfare. However, articles on trade liberalization bring out flaws regarding the effects of custom unions about the ability to raise trade volumes on the market structure and price cost margins of industries.

Studying the implications of key variables involved, related indicators on the European Union member countries after the implementation of the customs union between the 1950s and to date, it can be concluded that the volume of the internal trade within the manufacturing industry of EU member countries significantly increased on the average.

Furthermore, the price cost and concentration ratios of the manufacturing industry declined on the average during the same time frame. As we examine the relationship that is causal between the increasing volumes of trade with EU countries and the decreasing cost of price margins as well as the concentration ratios of the manufacturing industry sector.  Price cost margins and concentration ratio equations will then use trade ratios with EU countries as explanatory variables in order to interpret the results obtained.

            Results on estimation that are presented in this paper present the effect of pro-competitive increase in trade volumes of the EU member countries. We then estimate the price cost margin equation to illustrate an inverse relationship between the margins and import ratios.

This implicates a theory that when there is a rise in import to the EU countries after the creation of a customs union would then create a competitive effect and would cause the decrease in price of cost margins within the manufacturing industry. Such an inverse relation supports the point that trade volume increases and export levels within EU countries are forcing the companies in the manufacturing industry to implement lower price cost margins (Breuss, 2001).

            Generally, it can be said that the creation of a customs union and the rise in the levels of trade volume within European Union countries seemingly illustrates an increase in competitive gridlocks which will end up in falling price cost margins in certain countries.

At the same time, putting an emphasis in the manufacturing industry, positive implications of trade liberalization in the aftermath of the establishment of customs unions is also supported with the results of the estimation schemes intended for the concentration ratio equation. Furthermore, a negative strong correlation can be found between the import variables and the Herfindahl concentration ratios. The concept suggests that raising outputs as well as the imports to the European Union will bring down the marginalized concentration ratios and seclude the market power in the manufacturing industry.

            Also according to the results of the estimation method, it would look like that there is no direct relation between the export variables used and the concentration ratios for the manufacturing industry. Furthermore, the concentration ratio equation estimate directs that unobserved time which is previously deemed insignificant and the invariant sector specific factors are as well responsible for the variations in the concentration sectors.

            In total, still according to the estimation results, it can be suggested that the increase in trade volumes brings about beneficial implications on the European Union economy as a whole after the custom union period through the increase in competitive pressure coming form other EU member countries as well as the one for falling mark-ups on prices of consumer goods and market power. Therefore, it would be then be concluded that implications on the welfare side of the economies involved are results of varying changes in the pricing behavior as well as the entire market structure of the European Union member countries.



AKKOYUNLU-WIGLEY, A. (2005) Effects of Customs Union with European Union on the Market Structure and Pricing Behaviour of Turkish Manufacturing Industry. Pearson Education International.

BADINGER, H. (2001) Growth Effects of Economic Integration The Case of the EU Member States(1950 2000). Center for European Studies.

BREUSS, F. (2001) WTO Dispute Settlement from an Economic Perspective More

Failure than Success. Center for European Studies.

DE YOUNG, R. (2000) Efficiency Barriers to the Consolidation of the European Union. Center for European Policy Studies.

NAGY, M. (2005) Bank Efficiency in the Enlarged European Union. European Commission.

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