Strategic Formation of Customs Unions

In this paper, we analyze the static eects of customs unions formation on national welfare under oligopolistic competition, accounting for market sizes, the number of rms and marginal costs. We build a basic four-country model, analyzing the members and non-members' welfare situation moving from tari-ridden trade to a single customs union and then to a double customs union situation, before analyzing a free trade option. Our analysis confirms that customs union formation generates positive eects on consumers and, under certain conditions, on producers within the union, while it has a negative impact on the rest of the world. We also identify conditions under which all countries may improve with several customs union formation . This exercise provides a simple yet direct explanation to the proliferation of trade agreements when these occur in waves. To this end, we solve a game with at least four countries and show that -under tari-ridden trade- the Nash equilibrium entails two customs unions formation between similar countries and under specic market conditions. However, whenever possible free trade remains the preferred option.