What is the difference between a customs union and a free trade area?

A customs union is an agreement between two or more countries to eliminate tariffs and other trade barriers on goods traded between the member countries. Additionally, a customs union establishes a common external tariff on imports from non-member countries. In other words, all member countries apply the same tariff rates on imported goods from countries outside the customs union.

A free trade area is an agreement between two or more countries to eliminate tariffs and other trade barriers on goods traded between the member countries. However, unlike a customs union, each member country maintains its own external tariff on imports from non-member countries. This means each country in a free trade area may have different tariff rates on imported goods from countries outside the free trade area.

Both customs unions and free trade areas promote trade liberalization and integration between member countries by eliminating tariffs and trade barriers. However, the main difference between these two types of agreements lies in how they handle tariffs on imports from non-member countries. In a customs union, member countries have a common external tariff, which simplifies and harmonizes trade relations with non-member countries. In contrast, a free trade area does not have a common external tariff, allowing each member country to set its own tariffs on goods imported from non-member countries.

To make the concepts of customs union and free trade area more relatable, it's helpful to provide real-world examples. An example of a customs union is the European Union (EU), which has a common external tariff for goods imported from non-EU countries. An example of a free trade area is the North American Free Trade Agreement (NAFTA), which existed between the United States, Canada, and Mexico until it was replaced by the United States-Mexico-Canada Agreement (USMCA) in 2020. Each of the NAFTA member countries could set its tariffs on imports from non-NAFTA countries. In conclusion, the main difference between a customs union and a free trade area lies in their approach to external tariffs on imports from non-member countries. Both types of agreements promote trade integration and liberalization by eliminating trade barriers between member countries, but a customs union also has a common external tariff, whereas a free trade area allows each country to set its own external tariffs.