DP337 | Delegation Games in Customs Unions

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We study a model in which a customs union trades with countries that behaved strategically. If the members of the customs union are similar but not identical, one country will want to delegate authority for making union policy to its partner. Even if side-payments within the union are permitted, union welfare may be higher if one country chooses union policy to maximize its own welfare, rather than having a supra-national agent choosing union policy to maximize joint welfare. The delegation decision depends on whether the policies used by union and non-union countries are strategic substitutes or complements and on which union member is more "aggressive".