Free Trade Agreement

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21 Aug, 2024

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A Free Trade Agreement (FTA) is an arrangement or agreement between two or more nations seeking to reduce trade barriers. It works simply like a trade-off between nations. Its main goal is to facilitate cross-border transactions, increase investment prospects, promote mutual trade, and improve the ease of business.

Relaxations in export-import, reduction in tariffs, and easing restrictions are the features of FTAs. They do not correlate to no regulations but lesser regulations. With reduced tariff revenues and fewer trade restrictions on their part, countries benefit from the increased opportunities and prospects for their domestic businesses internationally.

Free Trade Agreement definition can be stated as a pact or treaty between countries. It can be unilateral (single nation), bilateral (two nations), or multilateral (more than two countries).
It aims to reduce export-import tax or tariff rates and remove trade barriers. But it does not mean that there will be no regulations at all.
FTAs are instrumental in promoting trade between countries and facilitating ease of doing business.
FTAs gained prominence as protectionism became less fashionable, and globalization and liberalization became popular.

Free Trade Agreement Explained

Free trade agreements were prevalent from the early 19th century itself, during the British colonization. But it gained prominence in the late 20th century with globalization and rapid liberalization trends worldwide. David Ricardo, the British economist, advocated the concept of free trade through his works.

An FTA is an understanding between two or more countries that import and export from each other frequently. Since they have an established trade relation, it is obvious that there might be some restrictions or procedures which traders find challenging. The demerits of such challenges eventually lead to strained relations and loss for both countries.

To prevent such a situation and encourage trade and provide a stimulus to parties involved in bilateral trade, countries' governments come together and decide on terms of trade. These terms can benefit both countries and mean they must simultaneously forego a part of their established standards and gains.

However, it does not mean that countries must accept a 'zero-restrictions' stand. Such a situation is impossible and not required practically. Generally speaking, FTAs are exchanges where both nations gain.

How Free Trade Agreements Happen?

Suppose countries A and B trade with each other frequently and in large volumes. The government realized that importers and exporters consider the tariff rates in both countries high. Hence, they decide to negotiate an FTA and decrease the tariff rates on all commodities by 10% of the current rate.

However, these new tariff rates are exclusive to A and B only. Suppose a country C trades with A and B; it will have to pay the actual tariff rates because the FTA between A and B does not apply to C.

FTAs are crafted and negotiated with utmost care not to allow the other party to exploit and take advantage of the country. Therefore, the government takes measures to protect the interests of domestic businesses and consumers. Also, the government doesn't permit the import of certain items like contraband or commodities which are against the country's culture.

For instance, the consumption of marijuana is legal in Uruguay, but that doesn't mean that it can export marijuana to China, where it is illegal. This follows even in the presence of an FTA between Uruguay and China. It is because marijuana is considered contraband and cannot be imported to China under any circumstance.

Features

Here are some of the key features of Free trade agreements

Exchange of benefits – FTAs are agreements that two countries benefit from, which will help the businesses flourish internationally, with limited restrictions.
Presence of regulations - FTAs do not mean the absence of barriers. Instead, it is a mixture of restrictions and relaxations. Free trade doesn't correspond to absolute freedom, and governments always have a specific level of control.
The number of parties involved - FTAs can be unilateral (one country removes restrictions for all), bilateral (two countries promote mutual trade), and multilateral (more than two countries, usually an association of countries making a pact).
Specific or general agreement - FTAs can be agreed for specific or a group of commodities from countries or on overall imports and exports.
Exclusivity - FTAs are exclusive to countries involved in the trade; only those parties can claim the benefits. Therefore, it does not apply to other nations.
Social transformation- Trade partners will eventually gain from each other in the forms of social reforms, exchange of ideas and cultures, etc.

Examples

Let's look at real-life examples to understand how FTAs work, apart from the simple example mentioned above.

Example #1

One of the most prominent FTAs is the North American Free Trade Agreement (NAFTA) between Canada, Mexico, and the United States. The pact was signed in 1992 and came into force in 1994. It is an example of a trilateral FTA. To date, it has eliminated many barriers and tariffs between the three countries.

The main objectives of NAFTA are to remove maximum possible trade barriers, promote trade between the countries, secure intellectual property rights and implement environmental regulations. In 2020, the United States-Mexico-Canada Agreement (USMCA) replaced NAFTA.

The USMCA has broader functions than NAFTA. Free trade is just one part of USMCA. It also focuses on agriculture, labor, resolving conflicts, etc. For example, according to recent reports by Bloomberg, the United States has raised complaints against Mexico regarding the latter's state-favoring energy policies, which violates the FTA. But the countries will resolve the issue as per the USMCA guidelines.

Example #2

Another important example is that of India. Being the fastest growing economy, FTAs are an important part of India's trade initiatives. It has 13 FTAs, including the Agreement on South Asian Free Trade Area (SAFTA), India-Japan Comprehensive Partnership Agreement (CEPA), India Australia Free Trade Agreement, the Economic Cooperation and Trade Agreement (ECTA), etc.

Most of the Indian FTAs are with Asian countries. It can be seen as strategic and helps the country establish decent trade relations with its neighbors. The most recent Free Trade Agreement of India is the India-UAE CEPA, which has been signed but is yet to be implemented. Both the countries are expected to benefit immensely, with an estimated 99% of Indian exports to UAE receiving preferential access concerning tariffs.

Example #3

The example of the African Continental Free Trade Area (AfCFTA) is worth mentioning. It was established by the African Continental Free Trade Agreement in 2018. 54 African countries have signed the pact. It sought to eliminate trade barriers and reduce tariff rates between the countries. It was drafted by carefully understanding each country's economy and level of development.

The United Nations Economic Commission for Africa (UNECA) estimates that, by 2022, the AfCFTA would increase intra-continental trade by 52% and GDP by 4%. It is a much-needed boost for the continent's Least Developed Countries (LDCs).

Importance

In this globalization era, the importance of FTAs is massive. It has the potential to contribute greatly to economic growth. Here are the reasons why FTAs are important.

FTAs facilitate trade between countries. In addition, it serves as an impetus to importers and exporters.
It makes a market attractive for foreign sellers and investors, thus helping it develop.
FTAs also provide opportunities for domestic businesses to expand and enter new markets.
It encourages global competition and provides greater choices to consumers at a better price. It also increases the efficiency of domestic businesses.
FTAs promote investment from developed to developing countries, where businesses in both countries benefit.
Free trade encourages better utilization of resources.
It also supports technology and knowledge transfer between nations.

Despite the importance of FTAs, it receives many criticisms. For example, some believe that FTAs can destroy local businesses when compelled to compete with diverse offerings from foreign brands and lead to the exploitation of natural resources. Another argument is that massive outsourcing of jobs can be detrimental to developed economies. The bad execution of FTA frameworks can create negative effects on the economy too. There is also a risk of currency manipulation. Sometimes FTA trade frameworks also turn a blind eye to environmental protection.

Frequently Asked Questions (FAQs)

What is the North American Free Trade Agreement?

NAFTA is the free trade pact between the U.S., Canada, and Mexico, which was enforced in 1994. Its main goal was to reduce tariff rates and trade regulations between the three countries. The United States-Mexico-Canada Agreement (USMCA) has replaced NAFTA from 2020.

Which countries India has free trade agreement with?

The Free Trade Agreement of India extends to 13 countries and associations, namely Sri Lanka, SAARC countries, Nepal, Bhutan, Thailand, Singapore, ASEAN, South Korea, Japan, Malaysia, Mauritius, UAE, and Australia.

What is the purpose of free trade agreements?

The main purpose of FTAs is to reduce the trade restrictions and tariff rates on exports and imports between countries. It opens domestic borders, encourages global trade, and contributes to economic growth.

Which country has the freest trade agreements?

The European Union has the highest number of FTAs, with 45 agreements. But the country with the greatest number of FTAs is the United Kingdom, with 35 pacts.