Endogenous tariff creation and tariff diversion in a customs union

The common external tariffs of the EEC declined after it was formed. We label as ‘tariff diversion’ the four forces pushing down external tariffs after EEC formation (endowment effects of capital deepening, reduced EEC versus country industry concentration, general industry prosperity and greater export specialization). We label as ‘tariff creation’ the three forces pushing up external tariffs after EEC formation (terms of trade effects, increased industry concentration and industries hurt by rapid growth in intra-EEC imports). There was virtually no evidence that EEC tariffs increased because of terms of trade effects. We quantify these forces using Magee et al.'s (1989) endogenous tariff model and Lee's (1996) model of free riding and find that even after adjustment for GATT tariff declines, the common external industry tariffs of the EEC declined in the first 15 years after formation (from 1968–1983) because the tariff diversion effects exceeded the tariff creation effects.