Trade Creation - LeFonch

What is Trade Creation?

When higher-cost imports are replaced by lower-cost imports due to the formation of a trading bloc or trade agreement.

If a trading bloc is a customs union (or a higher level of trading bloc), there may be trade creation.
Trade creation occurs when the entry of a country into a customs union leads to the production of a good or service transferring from a high-cost producer to a low-cost producer.
- For example, consider a scenario where Bulgaria enters the EU.
- Previously Bulgaria had not been exporting potatoes, as it faced a tariff from the EU.
- However, after joining the tariff on Bulgarian potatoes is relaxed and it can trade with Poland, as it is more efficient at producing potatoes.
Trade creation leads to increased consumer surplus and reduction in price, leading to an overall welfare gain.
- However, like all free trade, local firms might have to downsize as they are unable to compete with imports.
The diagram for trade creation is similar to that of free trade.

When lower-cost imports are replaced by higher-cost imports due to the formation of a trading bloc or trade agreement.

A customs union might also lead to trade diversion.
Trade diversion occurs when the entry of a country into a customs union leads to the production of a good ore service transferring from a low-cost producer to a high-cost producer.
- For example, consider Turkey joining the EU.
  - Previously, they had been importing cheap steel from China.
  - But once they join the EU, they also adopt its tariffs against importing steel, leading to reduced steel imports from China into Turkey.
  - Thus there is now less trade and an overall welfare loss as Turkey imports from relatively inefficient EU producers instead.

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