Trade diversion

Trade diversion occurs when a trade agreement’s preferential tariffs shift imports from a lower-cost supplier outside the agreement to a higher-cost member supplier.

Customs union: A trade agreement in which members remove internal trade barriers and apply a common external tariff. Its shared external tariff can favor member suppliers over lower-cost outsiders.
Welfare economics: The study of how economic policies and resource allocation affect social well-being. It provides the framework for assessing gains and losses from diverted trade.
Jacob Viner: A Canadian-born economist known for influential work on international trade and the history of economic thought. His analysis introduced trade creation and diversion as tools for judging customs unions.
North American Free Trade Agreement: A 1994 trade agreement among Canada, Mexico, and the United States, replaced by the USMCA in 2020. Its preferences provide a setting for assessing shifts toward member-country suppliers.
Preferential trade agreement: A pact that gives participating countries more favorable trade terms than nonparticipants receive. Its tariff preferences create the price gap that can redirect imports.
Consumer surplus: The difference between what consumers are willing to pay and what they actually pay. Preferential sourcing may change prices and therefore consumers’ gains from trade.
The Customs Union Issue: Jacob Viner’s 1950 book analyzing the economic effects of customs unions. It sets out the framework from which the concept became widely known.
European Union Customs Union: A customs union in which EU members trade without internal customs duties and share a common external tariff. Its common external tariff can create preferences between members and outside suppliers.
Tariff: A tax imposed on imported goods, often collected at the border. A tariff on outsiders can make a higher-cost member supplier appear cheaper.
Tariff revenue: Government income collected from taxes on imported goods. When imports shift to tariff-exempt members, revenue from outsider imports can fall.

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