11.6.3—Trade creation/diversion

Trade creation occurs when integration lets members import from a lower-cost partner instead of producing domestically. Trade diversion occurs when a member switches from a more efficient non-member to a less efficient member because the common external tariff changes relative prices.

Creation tends to improve efficiency and consumer welfare; diversion can reduce it, although dynamic investment, bargaining and wider integration benefits may alter the overall judgement.

If domestic cost is 12, member cost is 8 and non-member cost is 6, a customs union may create trade if the member replaces domestic output, but divert trade from the non-member if the tariff makes the member supplier cheaper at the border.

Membership does not guarantee net welfare gains: compare the old supplier, the new supplier, tariff revenue and consumer/producer effects.