Trade diversion
Categories: International trade | Economics and finance stubs
Trade diversion is an economic term related to international economics in which trade is diverted by the formation of a customs union.
| Trade Series |
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| International trade |
| History of international trade |
| Trade bloc |
| Free trade area |
| Customs union |
| Common market |
| Economic and monetary union |
| Trade creation |
| Trade diversion |
Contents |
Occurrence of Trade Diversion
When a customs union is formed, the member nations establish a free trade zone amonst themselves and a common external tariff on non-member nations. Previously a nation may have had a working trade relation with another nation outside the customs union in which each nation produced to their comparative advantages, the common external tariff may now make it not as efficient to trade with that non-member nation than with a nation within the member nation's free trade zone. In this respect, trade is diverted from the nation outside the union to a nation inside the union, lowering the total output of the good or service being traded.
Downside of Trade Diversion
Diverted trade may hurt the non-member nation economically and politically and create a strained relationship between the two nations. The decreased output of the good or service traded from one nation with a high comparative advantage to a nation of lower comparative advantage works against creating more efficiency and therefore more overall surplus. However, one can argue that the benefits of the free trade zone and trade creation will ultimately outweigh the introduction of trade diversion.