trade diversion

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The effect of a customs union in replacing trade with non-members by trade between members. This occurs because the tariff-free prices of goods from members are lower than the tariff-inclusive prices of non-members who formerly supplied them. Trade diversion involves shifting sourcing of imports from lower to higher cost suppliers, and is generally welfare-decreasing. It is distinguished from trade creation, where new or increased trade between member countries resulting from the elimination of tariffs is generally welfare-increasing. A customs union is beneficial to its members in the short run if their losses from trade diversion are less than their gains from trade creation.

Subjects: Economics.

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