Trade Diversion:

Trade diversion is an economic term related to international economics in which trade is diverted by the formation of a customs union. The term was coined by Jacob Viner in The Customs Union Issue in 1950. The trade diversion effect exists because countries within trading blocs, protected by trade barriers, will now find they can produce goods more cheaply than countries outside the trade bloc. As a result, production will be diverted away from those countries outside the trade bloc that have a natural comparative advantage to those within the trading bloc. When a customs union is formed, the member nations establish a free trade zone amongst themselves and a common external tariff on non-member nations. Previously a nation may have had a working trade relation with another nation outside the customs union in which each nation produced to their comparative advantages, the common external tariff may now make it not as efficient to trade with that non-member nation than with a nation within the member nation's free trade zone. In this respect, trade is diverted from the nation outside the union to a nation inside the union, lowering the total output of the good or service being traded. Diverted trade may hurt the non-member nation economically and politically and create a strained relationship between the two nations. The decreased output of the good or service traded from one nation with a high comparative advantage to a nation of lower comparative advantage works against creating more efficiency and therefore more overall surplus. However, one can argue that the benefits of the free trade zone and trade creation will ultimately outweigh the introduction of trade diversion. An example of trade diversion is the UK's import of lamb, before Britain joined the EU most lamb imports came from New Zealand, the cheapest lamb producer.