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Common Market

A formal trading agreement wherein member countries adopt a common external tariff

What is a Common Market?

A common market is a formal agreement where a group is formed among several countries in which each member country adopts a common external tariff. In a common market, countries also allow free trade and free movement of labor and capital among the members in the group. The trade arrangement is used to promote free trade and free movement of production factors.

 

Common Market

 

The most famous example of a common market is the European Common Market, which aims to provide the free movement of goods, capital, services, and labor within the European Union.

 

Conditions Required to be Defined as a Common Market

To be defined as a common market, the following conditions must be satisfied:

  1. Tariffs, quotas, and all barriers regarding importing and exporting goods and services among members of the common market are eliminated.
  2. Common trade restrictions such as tariffs on other countries are adopted by all members of the common market.
  3. Production factors such as labor and capital are able to move freely without restriction among member countries.

 

If one of the conditions is not satisfied, the resulting market is not a common market. For example, if production factors such as labor and capital are not able to move freely without restriction among member countries, it would be defined as a customs union.

 

Benefits of a Common Market

 

1. Free movement of people, goods, services, and capital

In addition to the removal of tariffs among member countries, the key benefits of a common market include the free movement of people, goods, services, and capital. Therefore, a common market is often regarded as a “single market” as it allows the free movement of production factors without the obstruction created by national borders.

 

2. Efficiency in production

For an economy, a common market facilitates efficiency among members – factors of production become more efficiently allocated resulting in stronger economic growth. As the market becomes more efficient, inefficiency companies will eventually shut down due to fiercer competition.

Companies that remain typically benefit from economies of scale and increased profitability, and innovate more to compete in a more intense competitive landscape.

 

Costs of a Common Market

 

1. Decline in competitiveness

The transition to a common market comes with a few drawbacks. For one, companies that have previously been protected and subsidized by the government may struggle to remain afloat in a more competitive landscape. The migration of production factors to other countries may hinder the economic growth of that country and lead to increased unemployment.

 

2. Trade diversion

Trade diversion occurs when efficient non-members are crowded out of the common market. Furthermore, a country may exhibit depressed wages if it faces an influx in the migration of production factors where supply exceeds demand.

 

Real World Example of a Common Market

In July 2010, Kenyan President Mwai Kibaki formed the East African Common Market to accelerate economic growth and development in the region. The establishment of a common market in East Africa was an expansion of an existing customs union, which was created in 2005 and was made up of six countries in eastern Africa: Burundi, Kenya, Rwanda, South Sudan, Tanzania, and Uganda.

The EACM was established to provide the “four freedoms,” with the aim of boosting the economy and increasing productivity. The four freedoms are:

  1. The free movement of goods
  2. The free movement of labor
  3. The free movement of services
  4. The free movement of capital

 

Following the creation of the EACM in 2010, a protocol was signed in 2013 detailing the plan to further integrate member countries by means of a monetary union. Recently, in 2018, a committee was formed to begin the drafting process of a regional constitution.

 

More Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Bilateral Agreement
  • Economic Union
  • Free Trade Area
  • Regional Trading Agreements

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