FREE TRADE AGREEMENT: CHARACTERISTICS, OBJECTIVES, ADVANTAGES - ECONOMY - 2025

A free trade agreement (FTA) is a multinational agreement, in accordance with international law, to form a free trade zone between cooperating states. FTAs can be a first step towards economic integration.

FTAs, which are a form of trade pact, determine the tariffs and tariffs that countries impose on imports and exports, with the aim of reducing or eliminating trade barriers, thus affecting international trade.

Source: pixabay.com

These treaties focus on a section that provides preferential tariff treatment, but also include clauses to facilitate trade and rule-making in areas such as investment, intellectual property, public procurement, technical standards, and health issues.

Once the treaties go beyond the regional level, they usually need help. At this point the World Trade Organization (WTO) intervenes, an international body that helps negotiate global trade agreements. Once signed, the WTO enforces the agreements and responds to complaints.

Treaties and zones

Trade agreements occur when two or more countries agree on the terms of trade between them. They determine the tariffs and tariffs that these nations impose on their imports and exports to each other.

Imports are goods and services produced in a foreign country and purchased by national residents. This includes everything that is shipped to the country.

Exports are the goods and services that are made in a country and sold outside its borders. This includes everything that is sent from a national company to its foreign affiliate.

A free trade area is the result of a free trade agreement between two or more countries.

Free trade zones and agreements cascade to a certain point: if some countries sign an agreement to form a free trade zone and choose to negotiate together, as a trading bloc, another FTA with other countries, then the new FTA will consist of the Old FTA plus new countries.

What is a free trade agreement?

It is a concept where the signatory countries trade with each other in an open market, without trade barriers, or restrictions on import or export quotas, or regulatory terms.

No country prevails over the others. Therefore, countries are free to sell their products to others in the international market, and to buy without quantity restrictions or tariffs.

No protectionist measures are allowed in multilateral trade activities. This means that the local products of the countries run a high risk of being replaced by the influence of the other countries.

Therefore, nations with free trade agreements agree to a consensus to establish some degree of preventive measures.

Types of trade agreements

Unilateral

A country can unilaterally cease trade restrictions, although this rarely happens as it would put the country at a competitive disadvantage.

Only developed countries do this, as a form of foreign aid. They seek to help emerging markets strengthen their strategic industries, which are too small to be a threat.

Bilateral

They are between two countries. They agree to ease trade restrictions to expand business opportunities for each other. Tariffs are lowered and preferential trade status is conferred.

Multilateral

These are between three or more countries. They are more complex to negotiate than bilateral treaties, because each country has its own needs and requests.

These treaties cover a larger geographic area, giving the signatories greater competitive advantages.

characteristics

- Trade in products and services without tariffs or other trade barriers, such as quotas on imports or subsidies to producers.

- Absence of policies that distort trade, such as subsidies, regulations or laws that give some companies an advantage over others.

- Unregulated access to markets and market information.

- Impossibility of companies to distort markets through monopolies or oligopolies imposed by the government.

- Establishes a free trade zone, where you can trade products and services across common borders.

Free trade areas

They are regions in which a group of countries signs a free trade agreement. They allow signatory nations to focus on their competitive advantage and trade in the goods they do not manufacture, increasing the efficiency and profitability of each country.

To open a free trade area, participating nations must develop rules on how this new area will operate. The objective is to create a trade policy agreed upon by all the countries in that area.

Rules of origin

In a free trade agreement, members do not have a common external tariff. For this reason, FTAs ​​are required to have rules to define whether a good produced by a NAFTA partner is eligible to be treated as duty-free.

Countries use a system of certification of origin, called rules of origin, in which a minimum amount of materials and local transformations are required to add value to the goods.

Only products that meet these requirements are entitled to the special treatment provided by NAFTA.

History

The rise of nationalist ideologies and bleak economic conditions after World War I disrupted world trade that characterized the 19th century.

This prompted the newly formed League of Nations to organize the First World Economic Conference in 1927, to outline a multilateral trade agreement.

However, this agreement would have little effect, as the onset of the Great Depression started a new wave of protectionism.

Multilateral regionalism

The United States and Great Britain after World War II devised a plan for a more cooperative and open international system.

The International Monetary Fund, the World Bank and the International Trade Organization (ICO) emerged from the Bretton Woods Agreement of 1944. However, the ICO did not materialize.

The OIC plan would be assumed by the GATT (in Spanish, General Agreement on Customs Tariffs and Trade), established in 1947.

In 1951 Europe began a program of regional economic integration with the creation of the European Coal and Steel Community. It would eventually become what is now known as the European Union (EU).

Wider regionalism

In the mid-1990s, the EU established bilateral trade agreements with countries in the Middle East.

The United States also began its own trade negotiations, forming an agreement with Israel in 1985, as well as the North American Free Trade Agreement (NAFTA) with Mexico and Canada, in the early 1990s.

In 1995, the WTO succeeded the GATT as the supervisor of world trade, after the Uruguay Round.

The WTO had more than 145 members at the beginning of the 21st century. China joined the WTO in 2001.

goals

The objective of a free trade agreement is to reduce barriers to buying and selling, so that trade can grow as a consequence of the division of labor, specialization and a comparative advantage, which is the most important thing.

The theory of comparative advantage indicates that in an unrestricted market, every production company will be inclined to specialize in those activities in which it has a comparative advantage.

The end result will be an increase in income and, ultimately, the well-being and wealth of everyone in the free trade zone.

Objectives of ANASO

One can take as an example the objectives of the free trade agreement of ANASO (Association of Southeast Asian Nations), where these countries are part: Brunei, Cambodia, Indonesia, Lao, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam:

- Progressively liberate and facilitate trade in products and services between the parties through the progressive elimination of tariff and non-tariff barriers in practically all trade in goods between the parties.

- Facilitate, promote and improve investment opportunities between the parties, through further development of favorable investment environments.

- Establish a cooperation framework to strengthen, diversify and improve commercial, investment and economic ties between the parties.

- Provide special and differential treatment to the member states of ANASO, especially to the new member states of ANASO, to facilitate their more effective economic integration.

Advantage

Same treatment for all

The free trade agreement means that all signatories are treated in the same way. No country can give better trade agreements to one country than to another. That levels the playing field. It is especially critical for emerging market countries.

Many of them are smaller in size, which makes them less competitive. Most favored nation status confers the best trade terms that a nation can obtain from a trading partner. Developing countries benefit the most from this trade status.

Trade increase

Trade increases for each participant. The companies enjoy low rates. That makes exports cheaper.

By eliminating tariffs, import prices are lowered and consumers benefit.

On the other hand, some local industries benefit. They find new markets for their products duty free. Those industries are growing and they are also hiring more workers.

Regulation standardization

Trading regulations are standardized for all trading partners. Companies save legal costs, since the same rules are followed for each country.

Negotiation with more than one country

Nations can negotiate trade agreements with more than one country at the same time. These trade agreements go through a detailed approval process.

Emerging markets

Free trade agreements tend to favor the country with the best economy. That puts the weaker nation at a disadvantage. However, strengthening emerging markets helps the developed economy over time.

As these emerging markets develop, their middle-class populations increase. That creates new rich customers for everyone.

Disadvantages

Are complex

The biggest disadvantage of free trade agreements is that they are complex. That makes them difficult and slow to negotiate. Sometimes the length of the negotiation means that it will not take place at all.

Negotiations are misunderstood

The details of the negotiations are very particular to commercial and business practices. For this reason, the public often misinterprets them. As a result, they receive a great deal of press, controversy, and protests.

Small businesses cannot compete

A free trade agreement gives giant multinational companies a competitive advantage. As a result, small businesses cannot compete.

Therefore, they lay off workers to cut costs. Others move their factories to countries with a lower standard of living.

If a region depended on that industry, it would experience high rates of unemployment. That makes multilateral agreements unpopular.

Trade diversion

The selective application of free trade agreements in some countries and tariffs in others can lead to economic inefficiency through the process of trade diversion.

It is economically efficient for a good that is produced by the lowest-cost producing country, but this does not always happen if a high-cost producer has a free trade agreement, while the low-cost producer faces a high tariff.

The application of free trade to the high-cost producer and not to the low-cost producer can lead to commercial diversion and also to a net economic loss.

Examples of free trade agreements

Most nations are today members of the WTO multilateral trade agreements. Free trade is further exemplified by the European Economic Area and Mercosur, which have established open markets.

North American Free Trade Agreement

One of the largest multilateral agreements is the North American Free Trade Agreement (NAFTA). It is an agreement between the United States, Canada and Mexico, from 1994. Their combined economic output is $ 20 billion.

During the first two decades, regional trade increased from about $ 290 billion in 1994 to more than $ 1.1 trillion in 2016. However, it also costs between 500,000 and 750,000 jobs in the United States.

European Free Trade Association (EFTA)

It is an intergovernmental organization that works to promote free trade and the economic integration of its member states. It was founded in 1960 by Austria, Denmark, Norway, Portugal, Sweden, Switzerland and the United Kingdom. Later Finland, Iceland and Liechtenstein joined.

However, there are currently only four countries in EFTA, Iceland, Liechtenstein, Norway and Switzerland, as the other members withdrew at different times to join the European Union.

EFTA is responsible for managing the European Economic Area Agreement, which allows three of its four members to access the EU's internal market. Switzerland trades with the EU on the basis of a series of bilateral treaties.

Relations with the EU are at the core of EFTA activities, with the first free trade agreements signed in the early 1970s. EFTA is also actively seeking trade agreements with countries in Asia and America.

References

1. Kimberly Amadeo (2019). Free Trade Agreements, Their Impact, Types, and Examples. The Balance. Taken from: thebalance.com.
2. Wikipedia, the free encyclopedia (2019). Free trade agreement. Taken from: en.wikipedia.org.
3. Kimberly Amadeo (2018). Multilateral Trade Agreements With Their Pros, Cons and Examples. The Balance. Taken from: thebalance.com.
4. AANZFTA (2019). Establishment Of Free Trade Area, Objectives And General Definitions. Taken from: aanzfta.asean.org.
5. The UK in a Chnging Europe (2019). What is a free trade agreement? Taken from: ukandeu.ac.uk.
6. Will Kenton (2016). The European Free Trade Association (EFTA). Taken from: investopedia.com.
7. Will Kenton (2018). Free Trade Area. Taken from: investopedia.com.
8. Matthew Johnston (2018). A Brief History of International Trade Agreements. Taken from: investopedia.com.