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Free Trade Areas, Their Functions and Effects

Introduction

There are five fundamental groupings for regional economic integration, ranging from regional cooperation for development, which requires the least amount of integration, to the ultimate integration of political union. On one end of the spectrum lie the regional cooperation groups, such as the regional cooperation for development: the most basic economic integration and cooperation.

A free trade area (FTA) can be called the second stage of economic integration as it requires more cooperation and integration the RCD. It is an agreement between two or more countries to reduce or eliminate customs duties and non-tariff trade barriers among partner countries while members maintain individual tariff schedules for external countries. Essentially, an FTA provides its members with a mass market without barriers to impede the flow of goods and services (Cateora & Graham, 2005).

The free trade area is different from a customs union, the next transition in economic cooperation, as members of a FTA do not have a common external tariff on products imported from countries outside of the union or other same policies with regards to non-members. To reduce incidences of evasion, the member countries follow a system known as rules of origin through which they determine the origin of the goods. Under this system, there is a minimum threshold of local inputs and local transformations in the value chain of the goods and goods which do not fulfill this bar can not claim the privileges of the free trade area provisions (Cateora & Graham, 2005).

When two or more countries consent to a free trade agreement, the result is a free trade area. The ASEAN Free Trade Area (with Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam), the Dominican Republic-Central America Free Trade Agreement (between the U.S., Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras and Nicaragua) and the Greater Arab Free Trade Area (between Bahrain, Egypt, Iraq, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Qatar, Saudi Arabia, Sudan, Syria, Tunisia, the UAE and Yemen) are some examples of multilateral free trade agreements and areas.

As far as bilateral free trade agreements are concerned, the U.S. has implemented them with Australia, Bahrain, Chile, Israel (Palestinian Authority included), Jordan, Morocco, Peru and Singapore (Bilateral and Regional Trade Agreements Notified to the WTO).

Function of a Free Trade Area

Barriers to trade, both tariff and non-tariff, are one of the major issues in international trade, management and marketing. While there are few, if any at all, significant barriers to entry within an industrialized country, and usually no differences in taxation and regulation between parts of a country, the real issue arises because of the prevalence of many such barriers, impeding the exchange of goods between countries.

Import duties (when goods enter a country) and levels of sales taxes and laws are different for different countries often leading to difficult trade conditions and even trade disputes, such as the oft quoted disputes between the U.S. and Japan due to the latter’s trade barriers and high tariffs (Cateora & Graham, 2005).

Therefore, what a free trade area tries to do is to reduce such barriers and facilitate the exchange so that trade between countries increases. Free trade often results in specialization, division of labor and as popular economic theory proposes, comparative advantage, which explains how trade benefits involved parties if they have varying opportunity costs of production. Proponents of free trade agreements believe that in an unrestricted, balanced market, a country even if it is without any absolute advantage of any product, can still gain a comparative advantage over others by specializing in the activity/product in which it has a comparative advantage by cashing in on its lowest opportunity cost of production.

This way, there will be an overall increase income and enhanced wealth/well-being for all participants in the free trade area. However, critics often denounce this principle of comparative advantage saying it doesn’t specify anything about the actual distribution of wealth.

Free trade, specially for developing countries, has positive effects on economic prosperity, civil liberties and the allocation of resources. The economic concept of comparative advantage is strongly related to free trade as it leads to lower prices, higher employment, increased output and a higher standard of living for the people in these countries. The American economist, Jeffrey David Sachs phrased it perfectly in his 2005 book, The End of Poverty when he said, “One of the ironies of the recent success of India and China is the fear that… success in these two countries comes at the expense of the United States.

These fears are fundamentally wrong and, even worse, dangerous. They are wrong because the world is not a zero-sum struggle… but rather is a positive-sum opportunity in which improving technologies and skills can raise living standards around the world” (Sachs, 2005). Free trade areas, as will be evident in the paper, play a vital role in enhancing world markets and ensuring easy exchange of goods across borders.

Impact on International Trade of Member Countries

To truly understand the impact of free trade areas on the international trade activities and economies of member countries, one need only examine some examples of free trade areas more closely.

The six-member Central European Free Trade Area is the newest free trade area in Europe which was organized in 1993 by Poland, Hungary, Slovakia and the Czech Republic and later joined by Slovenia and Romania. Initially, import duties were removed from 60% of items and there was a commitment to abolish all duties and quotas within five years. The CEFTA successfully removed barriers to trade and in 1997, all tariffs were abolished. Economically, CEFTA has been a success story. Tariff reductions are on schedule and there was a growth in the gross domestic product, falling unemployment, and a slowdown of inflationary trends for all members of the association (Cateora & Graham, 2005).

NAFTA, the largest common-market agreement in Latin America came into effect in 1994 and today is the largest trade bloc in the world in terms of combined GDP of its members. NAFTA requires the U.S., Canada and Mexico to remove all tariffs on North American industrial products and barriers over 15 years but each country will have an individual system of tariffs with nonmember countries. In addition to elimination of tariffs, Mexico will eliminate non-tariff barriers and other trade-distorting restrictions.

This will benefit U.S. exporters as import licenses, which acted as quotas and limited the import of products into the Mexican market, will be removed. Through NAFTA other Mexican barriers, such as local-content, local-production, and export-performance requirements, that limited U.S. exports have also been eliminated. While the verdict on NAFTA remains uncertain, World Bank statistics showed that in the ten years since its passage, unemployment has declined, GDP per capita, foreign direct investment inflows, and exports have risen for all three countries. Most, however, agree that it has been a “public policy success, by every reasonable measure” (Griswold, 2003).

Other key provisions of NAFTA included rules for determining origin (to prevent free riders from benefiting through minor processing or transshipment of non-NAFTA goods), customs administration (agreement on implementing uniform customs procedures such as rules-of-origin documentation, recordkeeping and verification), Investment (elimination of investment conditions that restrict the trade of goods and services to Mexico), Services (set of principles governing services trade), Intellectual Property, Government Procurement and Standards (prohibits the use of standards and technical regulations used as obstacles to trade) (Cateora & Graham, 2005). Hence the above discussion shows how free trade agreements incorporate certain terms and conditions which facilitate trade between member countries.

The U.S.-Australian Free Trade Agreement

This FTA came into effect on 1 January 2005 and is a preferential trade agreement between the United States and Australia. It was modeled on the NAFTA and is in accordance with the content of the General Agreement on Tariffs and Trade as well as the General Agreement on Trade in Services. It aims to open exchange of goods and services; abolish barriers in the agricultural sector, investment, and government procurement; and increase protection for intellectual property. It has a number of similarities with the NAFTA and attempts to solidify U.S.-Australian economic ties and enhance trade between both countries by billions of dollars.

Australia is a crucial export market for the U.S., and 48 of the 50 states count it as one of the top 25 most important export destinations. Washington, California, Illinois, Texas, Michigan, New York, Ohio, Pennsylvania, and Florida all export to Australia and for American manufacturers of aircrafts, automobiles and parts, machinery, computers and electronic products, chemical, wood and paper products, Australia is a prime market. Hence, this agreement was a major step in opening markets and boosting trade (Landmark U.S.-Australia Free Trade Agreement Goes Into Effect Today).

The Future

Today there are a number of proposed free trade agreements in the pipeline, one being the Transatlantic Free Trade Area, between the U.S. and the European Union. Another is the Free Trade Area of the Americas, an agreement to reduce or eliminate all tariffs and trade barriers between countries in the Americas. In the future, there is a possibility that the world will divide into major trading groups such as the European Union, NAFTA and the ASEAN Free Trade Area that are now and will continue to be major markets of the future. Those who support this view advocate that these three Triads will dominate trade patterns in the years to come. Hence, the importance of economic cooperation and integration is only growing as the swing is definitely in favor of more open world markets.

References

Bilateral and Regional Trade Agreements Notified to the WTO. Web.

Cateora, Philip, and John Graham. International Marketing. 12th ed. McGraw-Hill, 2005.

Griswold, D. “NAFTA at 10.” World Trade 16.3 (2003): 10.

Landmark U.S.-Australia Free Trade Agreement Goes Into Effect Today. Embassy of the United States in Canberra, Australia, Information Resource Center. Web.

Sachs, Jeffrey. The End of Poverty: How we can make it happen in our lifetime. London: Penguin Books, 2005.