The political economy of noncompliance in customs unions
| Author | Joshua C. Fjelstul |
| DOI | http://doi.org/10.1177/09516298221130262 |
| Published date | 01 January 2023 |
| Date | 01 January 2023 |
| Subject Matter | Articles |
The political economy of
noncompliance in customs
unions
Joshua C. Fjelstul
Department of Political Science and International Relations,
The University of Geneva, Geneva, Switzerland
ARENA Centre for European Studies, The University of Oslo, Oslo,
Norway
Abstract
States create customs unions to accrue consumer welfare gains. Given the incentives to cheat to
protect domestic firms from foreign competition, they create regulatory regimes with inter-
national courts to manage noncompliance. I develop a formal model that explains how the politics
of compliance in regulatory regimes systematically distorts the welfare gains that states accrue
from developing customs unions. The model predicts that regulatory regimes are most effective
at enforcing compliance (i.e., at reducing trade barriers) in industries with intermediate levels
of firm homogeneity in terms of productivity. In highly homogenous industries, regulatory regimes
are not effective because noncompliance is minimal enough that litigation is not cost-effective; in
highly heterogenous industries, regulatory regimes are not effective because courts, concerned
about noncompliance with their rulings, are unlikely to rule against the defendants, deterring
the plaintiffs from bringing cases. The model also predicts the downstream consequences for
the performance of individual firms and consumer welfare.
Keywords
European Union, formal model, international courts, international trade, noncompliance
Corresponding author:
Joshua C. Fjelstul, Department of Political Science and International Relations, The University of Geneva, 1205
Geneva, Switzerland.
Email: joshua.fjelstul@unige.ch
Article
Journal of Theoretical Politics
2023, Vol. 35(1) 31–57
© The Author(s) 2022
Article reuse guidelines:
sagepub.com/journals-permissions
DOI: 10.1177/09516298221130262
journals.sagepub.com/home/jtp
States create customs unions—a form of economic integration in which a regional trade
bloc eliminates discriminatory internal trade barriers—to improve consumer welfare.
1
Customs unions are critical in the modern global economy. Both the United States and
the European Union (EU)—the two largest economies in the world—are customs
unions.
2
Like trade agreements, customs unions improve consumer welfare by altering
the composition of the economy: productive, exporting firms gain market share at the
expense of unproductive, import-completing firms, causing prices to drop, and improving
consumer welfare (Melitz, 2003; Chaney, 2008).
3
However, governments also have
short-term political incentives to cheat by imposing discriminatory trade barriers that
protect those unproductive, import-completing firms from foreign competition, thereby
reducing the negative impact of the customs union on their profitability. Given these
incentives to cheat, under what conditions do customs unions actually generate the
intended welfare gains?
In this paper, I argue that customs unions can generate welfare gains, but because of the
politics of the regulatory regimes that states establish to enforce them, how well they actually
work in practice varies by industry. The primary contribution of this paper is to identify the
characteristics ofthe industries in whichthese regulatoryregimes are most effective at enfor-
cing the rules of customs unions, as these will be the industries in which customs unions are
most effective at generating welfare gains for their member states—the reason they are
created. Contemporary models of trade in economics (e.g., Melitz, 2003; Chaney, 2008)
imply that customs unions should be most welfare-enhancing in industries where firms
are highly heterogeneous in terms of their productivity (there is more price competition, cre-
ating incentives for governments to protect domestic firms from foreign competition).
4
In
contrast, the main finding of my analysis is that, because of the politics of noncompliance,
customs unions generate the largest welfare gains in industries with intermediate levels of
heterogeneity in terms of firm productivity.
This finding builds on several insights from the recent literature on international institu-
tions and noncompliance. Aware of the incentives to protect unproductive domestic firms,
governments create regulatory regimes by empowering courts—like the United States
Supreme Court (USSC) and the Court of Justice of the European Union (CJEU)—to adju-
dicate disputes in which a member state government isaccused of violating the rules of the
customs union. This will only improve welfare gains (by improving compliance with the
rules of the customs union) when (a) private plaintiffs or prosecutors (like the Justice
Department in the US and the Commission in the EU) are willing to bring cases against non-
compliant member states and (b) courts are willing to rule against those member states.
However, recent research shows that courts care about noncompliance with their rulings,
and are therefore hesitant to rule against defendants when it is costly for the defendant to
come into compliance (Carrubba and Gabel, 2015). Research also shows that prosecutors,
anticipating this strategic behavior, only bring cases they expect to win (König and
Mäder, 2014; Fjelstul and Carrubba, 2018).
In highly heterogeneous industries, where the potential welfare gains of a customs
union are greatest (allowing in foreign firms by lowering trade barriers will reduce con-
sumer prices), governments have the strongest incentives to protect unproductive, import-
competing firms. These are the industries in which courts are needed to prevent cheating.
However, in these industries, courts will be more hesitant to rule against noncompliant
32 Journal of Theoretical Politics 35(1)
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