On Tariff Preferences and Delegation Decisions in Customs Unions: A Heckscher–Ohlin Approach

Abstract

This paper studies preferences of customs union (CU) members over common external tariff (CET) levels and extends the literature on delegation decisions over trade policy in models with production. In a model with similar CU members, we prove that most-preferred CETs can be ranked with the help of compensated price elasticities of import demand functions. In the Heckscher–Ohlin trade model, we show these elasticities depend on inter-country differences in relative factor endowments and inter-sectoral differences in technology. This helps identify the optimal policy maker in a CU and demonstrates delegation decisions over trade policy can be integrated into mainstream trade theory. The proliferation of preferential trade agreements (PTAs) in the 1990s has presented policy analysts with a dual challenge: to identify how these arrangements affect policy makers’ incentives to intervene in trade and to predict their implications for welfare. Economists responded to this challenge vigorously. Thanks to their research efforts, a substantial body of work is now available addressing these issues under alternative assumptions regarding the theoretical environment considered – including the objectives of policy makers, the nature of their interactions, the (GATT) rules that might constrain these interactions, market structure, the process of coalition formation, etc. 1 Still, while undeniably valuable, the recent literature on regionalism has shed limited light on an important issue: how heterogeneity among partners in a PTA shapes their national preferences over external tariff levels and how these preferences in turn manifest themselves in the formation of actual trade