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A regional trade agreement (RTA) is a pact between several countries in a specific geographic region. These agreements aim to break down trade barriers and foster deeper economic ties between member countries. By creating a more integrated economic zone, RTAs can potentially bring a range of benefits to member countries but also come with some challenges. Let’s delve deeper into the world of regional trade agreements, exploring their impact and the various stages of integration they encompass.
Understanding Regional Trade Agreement
A regional trade agreement (RTA) is a formal pact between several countries in a specific geographic region. These agreements act as stepping stones towards deeper economic integration. In essence, they aim to create a more interconnected economic zone among member countries by breaking down trade barriers. This can involve eliminating tariffs (taxes on imports), reducing quotas (restrictions on import quantities), and establishing common rules for trade.
RTAs come in various forms, reflecting different levels of economic integration achieved by member countries. A free trade area, for example, focuses primarily on eliminating trade barriers for goods and services. In contrast, a customs union goes a step further, establishing uniform external tariffs for goods traded with non-member countries.
The most advanced form of economic integration is an economic union. Here, member states not only enjoy free trade but also coordinate economic policies, allowing for the free movement of labor and capital across borders. Some economic unions even establish a common currency, like the Eurozone within the European Union, forming a monetary union.
The agreements themselves usually include various internal rules that apply only to member countries. How these countries interact with non-members depends on the specific stage of economic integration. For instance, a free trade area agreement might allow members to maintain different trade policies with non-members, while a customs union would require them to adopt uniform external tariffs.
Importance of regional trade agreements
Trade agreements are important because they generally seek to reduce trade barriers between member countries. It allows for more significant trade flows, provides business growth opportunities, and increases consumer choice.
In many regional trade agreements, the agreement not only removes barriers to trade in goods and services but also factors of production. Labor and capital are free to flow to member countries.
So, if designed efficiently, the agreement can increase trade traffic and investment and promote economic growth and social welfare. World Bank research shows that regional trade agreements increase trade in goods by more than 35% and trade in services by more than 15%.
Types of Regional Trade Agreements
There are six stages of a regional trade agreement. Among others are:
- Preferential trading area
- Free trade area
- Customs union
- Common market
- Economic union
- Monetary union
Preferential trading area
The preferential trade area requires the lowest level of commitment to reducing trade barriers. Member states do not remove trade barriers; instead, they lower rates and provide preferential access to certain products.
Free trade area
Under the free trade area agreement, member countries agree to remove trade barriers in goods and services between them. Therefore, they can freely transact goods and services between members without trade protection.
However, each member still maintains its own policies regarding non-member countries. So, they may apply different tariffs when trading with non-member countries.
Non-member countries may exploit the difference for their own benefit. For example, they will export products to a member country that has the lowest tariffs. Then, to sell to other member countries, they will ship it from that member instead of sending it outright. That way, they only bear the one-time tariff because trade between member countries is zero tariffs. This phenomenon is what we call trade deflection.
Customs union
A customs union represents a significant step forward in economic integration. Under this agreement, member countries not only eliminate trade barriers amongst themselves but also adopt a common external trade policy. This means they agree on a uniform set of tariffs and quotas that apply to goods imported from non-member countries. Imagine it as a group establishing the same customs checkpoint with the same rules for all outsiders.
A key benefit of a customs union is the elimination of trade deflection. In a free trade area (a less integrated stage), non-member countries could exploit differences in tariffs between members. For example, a good might be shipped to a member country with a low tariff and then re-exported to other members tariff-free. A customs union prevents this by ensuring all members apply the same external tariffs.
Common market
The common market builds upon the foundation of a customs union, taking economic integration a step further. In addition to the free flow of goods and services, a common market also allows for the free movement of production factors. These factors include:
- Capital: Businesses can freely invest and raise funds across member countries.
- Labor: Workers can move and seek employment opportunities within the common market.
This free movement fosters a more integrated economic environment, allowing businesses to optimize their operations and resources. Think of it as removing border checkpoints for goods and opening the borders for workers and investments to flow freely. A common market represents a significant step towards a highly integrated economic zone.
Economic union
An economic union represents the most advanced stage of economic integration within an RTA. It incorporates all the features of a common market but goes beyond that by establishing common economic policies. This involves coordinating fiscal (taxation and spending) and monetary (interest rates and inflation control) policies across member countries. Economic unions often create dedicated institutions to manage these joint economic policies. The European Union is a prime example of an economic union.
Some economic unions adopt a common currency, which creates a monetary union, like the Eurozone within the EU. A common currency eliminates exchange rate fluctuations and simplifies trade and financial transactions within the bloc. Economic and monetary unions represent the deepest level of economic integration achievable within an RTA.
Benefits of regional trade agreements
In general, the benefits of regional trade agreements are:
- Wider market access. Companies can more easily sell to member countries and compete fairly with others because there is no trade protection.
- Encouraging economic growth. Member countries take advantage of the free flow of goods and services to increase exports and domestic production.
- Creating more jobs. The wider market encourages businesses to increase production, which creates more jobs and income in the domestic economy. When free flow includes production factors, workers can find work in other member countries, increasing their mobility.
- Better access to cheaper and more abundant capital. If capital flows freely between member countries, it makes it easier for companies to raise cheaper funds to finance investments.
- Stronger position in international treaty negotiations. The formation of an economic union, for example, increases the size and strength of the European Union’s economy and bargaining power in non-member country trade agreements.
- More choices. Consumers benefit from the free flow of trade. They have more access to higher quality and cheaper products. The elimination of trade barriers increases not only the supply and variety of products but also lower prices.
- Quality improvement and innovation. Trade agreements open up competition. Increased competition forces businesses to remain competitive to survive in the market, leading to innovation, a variety of quality, or less expensive products.
Drawbacks of Regional Trade Agreements
Critics point out that the selective elimination of tariffs may not improve welfare. Tariff preferences can shift trade from efficient producers in non-member countries to less efficient producers in member countries.
For example, east Asian textile exporters found themselves at a disadvantage in competing with Mexican suppliers in the US market after NAFTA was signed. NAFTA benefits Mexican companies even though they are less efficient than Asian exporters.
Some of the other downsides of regional trade agreements are:
- Trade deflection. If the agreement reached only the free trade area stage, non-member countries would take advantage of the tariff differences for their own benefit.
- Increase economic dependence. When a member country goes into recession, it can quickly spread to other member countries. The Eurozone debt crisis in late 2009 is an example. The crisis started in Greece and then immediately spread to countries such as Italy and Spain.
- Reduction of economic sovereignty and independence of economic policies. Under economic unions, member states adopt joint economic policies. It may be unsuitable for the economic interests of individual member countries. Policies may favor member countries with large economies and tend to ignore the interests of other members.
- Domestic industry bankruptcy. Increased competition kills the domestic industry due to inefficiency and low competitiveness. The pressure is getting heavier if the industry absorbs a significant workforce. Labor mobility is also low if regional trade agreements are only at the free trade area stage.
