| Abstract: | Customs unions constitute agreements to engage in free intra‐union trade and to levy common external tariffs on trade with nonmembers. Existing theoretical models do not agree on how the common external tariffs are chosen. In this paper, a model of customs union formation is developed in which the Pareto principle and the assumption of unanimity are used to construct a mechanism for the choice of common external tariffs. The model is structured as a three‐stage game in which union members select common external tariffs yielding utility outcomes that are Pareto optimal and dominate the standalone alternative. Numerical examples demonstrate the wide range in the nature of these outcomes. Our results are discussed in relation to the delegation principle developed by Gatsios and Karp and to modeling approaches reported in the customs union literature. The paper emphasizes the importance of modeling the formation of the customs union agreement. |
