A NAFTA Customs Union

Abstract

INTRODUCTIONThe idea of a customs union between Canada, the United States, and Mexico is evoked with some regularity by North American business, political, and academic leaders and commentators. At the highest level, it is Mexican President Vicente Fox who has given support to that notion. Furthermore, many Canadians, believing that the United States would be more open in negotiations with Canada than with Mexico, tend to think mostly in terms of a bilateral Canada-US customs union. From a US perspective, however, it would be difficult to ignore Mexico's likely desire to be included in any negotiations with Canada.A customs union opens the flow of trade between its members to a greater extent than does a free trade area. The latter removes customs duties between member countries on products substantially originating from within the free trade area, but requires continued restrictions at internal borders to ensure that the appropriate duties are assessed on products that do not meet this origins test. In a customs union, members agree to maintain a single schedule of duties and of non-tariff barriers against goods from third countries. Thus, with everyone maintaining the same trade policy toward third countries, the need for verifying the origin of goods circulating across borders within the customs union disappears.A customs union would thus reduce the need for border checks on trade and, as we will see, remove other important trade distortions within the NAFTA. However, I will argue that these expected gains do not constitute a sufficient reason for Canada, the United States, and Mexico to formally engage in customs union negotiations. While a customs union would, indeed, remove costly distortions to efficient exchanges and investments in North America, I will subsequently also argue that:* many of these distortions can be substantially reduced without the trappings of a customs union;* a customs union, in and of itself, would be far from sufficient to reduce substantially many other important border impediments that have little to do with customs duties and rules of origin;* the political capital that would be required to address the most sensitive issues in negotiating a formal customs union would best be spent setting up a process for removing these other border impediments between Canada, the United States, and Mexico; and,* a customs union would by no means be a necessary step toward more harmonious and productive relations between the NAFTA countries regarding regulatory issues, temporary entry of legitimate workers, the environment, continental security, border delays, and other issues, and could thus easily be leapfrogged.CUSTOMS UNIONS AND FREE TRADE AREASBoth customs unions and free trade areas create beneficial trade within the area, but also distortions on trade between their members and with third parties. Thus, the NAFTA tariff preference toward North American goods results in the diversion toward North American producers of purchases that would otherwise have been made from more efficient or cheaper third party sources. This diversion of trade, while beneficial to North American firms whose exports within the area have now been given a competitive boost vis-a-vis third parties, is not inherently beneficial to the importing country that has just shifted the source of its purchase to North America from a third country. This is because the goods are not the best that they could purchase. They only seem less expensive to the purchaser of a North American product because tariffs continue to be imposed on third-party products, but not on North American products. In the meantime, however, the importing country loses the customs revenues it would have raised from these imports. Thus, for the country as a whole, switching the source of imports is costly.What usually makes a free trade area a winning proposition for those members that join is that, in addition to diverting its members' imports away from the cheaper global source (a loss), it creates much new trade within the area that would not have taken place at all. …