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A free trade area (FTA) is a pact between several countries in a specific region aimed at boosting trade and economic ties. Within an FTA, member countries agree to eliminate barriers to trade in goods amongst themselves. This can involve removing tariffs (taxes on imports) and quotas (restrictions on import quantities). By creating a larger market with fewer restrictions, FTAs offer the potential for increased economic activity and benefits for member countries. However, these agreements also raise concerns about potential job losses and unfair competition. Let’s delve deeper into the world of free trade areas, exploring their advantages and disadvantages and how they compare to other forms of economic integration.
Free trade areas: building blocks of a borderless economy
A free trade area (FTA) is an agreement between countries in a specific region to reduce or eliminate trade barriers, specifically for goods traded amongst themselves. Imagine a group of neighboring countries deciding to tear down trade walls, making it easier and cheaper to buy and sell goods across borders. These barriers can take the form of tariffs (taxes on imports) or quotas (restrictions on import quantities).
By eliminating these trade barriers, FTAs aim to boost economic activity within the member countries. This can happen in a few ways:
- Increased market access: Companies in each member country gain access to a larger market, with more potential customers for their products.
- Stimulated competition: The influx of goods from other member countries creates a more competitive environment, potentially leading to lower prices and higher quality goods for consumers.
- Encouraged specialization: As competition rises, countries may find it more efficient to specialize in producing goods where they have a natural advantage. This can lead to increased efficiency and productivity across the entire FTA.
It’s important to note that FTAs typically only focus on trade in goods. While some may include provisions for services, they generally don’t involve the free movement of labor or capital (like money and investments) across borders. Additionally, each member country maintains its own trade policies with non-member countries. This means they can set their own tariffs and quotas on goods coming from outside the FTA.
FTAs as stepping stones
Free trade areas represent the initial stage of a broader concept called regional economic integration. This refers to a gradual process of countries within a region removing trade barriers and increasing economic cooperation.
As economic integration deepens, countries can move beyond FTAs to establish customs unions, common markets, and even economic unions. These later stages involve not only free trade in goods but also deeper integration in areas like services, labor mobility, and even a common currency.
Examples of free trade areas
Citing from Wikipedia, some examples of free trade area agreements are:
- African Continental Free Trade Area (AfCFTA): This is the largest free trade area in the world by the number of countries involved. It aims to create a single market for goods and services across Africa.
- Andean Community: A trade bloc formed by Bolivia, Colombia, Ecuador, Peru, and Venezuela. Its goal is to promote balanced economic, social, and cultural development in its member countries.
- ASEAN Free Trade Area (AFTA): Established by Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand. It has grown to include Vietnam, Laos, Myanmar, and Cambodia. Aims to eliminate tariffs and non-tariff barriers between member countries.
- ASEAN – Australia – New Zealand Free Trade Area (AANZFTA): A free trade agreement between the 10 ASEAN member countries, Australia and New Zealand. Aims to eliminate or reduce tariffs on most goods traded between the parties.
- Central American Integration System (SICA): This system promotes economic integration and the free movement of goods, people, and capital in Central America. Its member countries are Belize, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and Panama.
- Central European Free Trade Agreement (CEFTA): Established by Poland, Hungary, Czechoslovakia, Slovenia and former East Germany. Aims to eliminate import duties on industrial goods traded between member countries.
- Common Market for Eastern and Southern Africa (COMESA): This initiative aims to create a free trade area, customs union, and monetary union among 21 eastern and southern African states.
- Greater Arab Free Trade Area (GAFTA): Established by the Arab League to promote trade among Arab countries. Aims to eliminate tariffs on most goods traded between the parties.
- East African Community (EAC): This regional intergovernmental organization consists of six countries in East Africa: Burundi, Kenya, Rwanda, South Sudan, Tanzania, and Uganda. It aims to promote economic and political cooperation among its partners.
- Eurasian Economic Union (EAEU): A regional economic union formed by Russia, Armenia, Belarus, Kazakhstan, and Kyrgyzstan. Aims to create a common market for goods, services, labor, and capital.
- Gulf Cooperation Council (GCC): A political and economic alliance between six Middle Eastern countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. Aims to promote economic, social, and political integration.
- Pacific Alliance Free Trade Area (PAFTA): A free trade agreement between Chile, Colombia, Mexico, and Peru, it aims to create deeper economic integration among its members.
Free Trade area vs. other integration stages
Free trade areas are the simplest form of regional economic integration. A more advanced stage of the free trade area is the customs unions.
Under a customs union, member countries adopt a uniform policy when they transact with non-member countries. For example, they set a single tariff when trading with non-members. This cooperation is usually to eliminate the effect of trade deflection, in which non-member countries take advantage of tariff differences between members of the free trade area to their benefit.
Furthermore, suppose the members agree to remove barriers to the flow of factors of production. In that case, they move towards common market cooperation. Under this agreement, capital and workers move freely between member countries, not only goods and services.
The more advanced stage of the common market is the economic union. In addition to eliminating barriers to goods, services, and production factors, members agree to build a common economic policy. They form joint institutions to integrate fiscal and monetary policy. An example is the European Union.
If later, an economic union member agrees to use the single currency, that is a monetary union. An example is the Eurozone.
Advantages of free trade areas
The free trade area offers several advantages, including:
Stimulating economic growth. Companies have greater market access. They have a more significant opportunity to sell more products, increase production, and absorb more labor. As a result, the economy grows higher and creates more jobs and incomes.
Increased efficiency. The free trade area increases competition between companies. To stay competitive, they will have to strive harder to increase efficiency and be more innovative.
Specialization. Tighter competitive pressures force member states to specialize in the most efficient products.
Reducing monopoly power. Goods and services flow freely between member countries, increasing competition.
Fairer competition. Member countries agree to remove various trade protection forms that benefit their domestic industries and businesses, such as subsidies. It makes the competitive field fairer for companies in member countries.
Price reduction. Because it removes trade protection, cheaper and better-quality goods should dominate the market due to high demand. It forces non-competitive producers out of the market.
Varied goods and services. Competition forces companies to develop higher-quality products to attract consumers. Free flow also allows consumers to have more choices to meet their needs and wants.
Technology transfer. Producers can import technology from member countries more cheaply. It indirectly contributes to technology transfer.
Reducing subsidy spending. Often, governments subsidize their industries to make their products more competitive in international markets. By removing subsidies, the government will save more on the budget.
Disadvantages of free trade areas
The free trade area also has several drawbacks, including:
Reduced income. Member countries can no longer earn revenue from tariffs.
Threats to intellectual property. Manufacturers can easily copy other member countries’ products. When law enforcement is weak, the threat to intellectual property is also higher.
Exploitation of natural resources. Free trade can lead to exploitative behavior. Member countries seek to increase exports to other members to take advantage of the free flow of goods and services.
Decreasing employment in the service sector. Companies are trying to take advantage of zero protection to outsource some non-core business services to member countries with lower wage rates. That reduces the absorption of domestic labor.
Get rid of the domestic industry. Increased competition forces non-competitive industries to die and raises unemployment. The effect is even more significant if most industries are uncompetitive.
New industries are difficult to grow. Before becoming mature, some industries need government protection. That won’t happen in a free trade area.
