Free Trade Agreements

A free trade agreement (FTA) consists in a trade treaty between two or more countries that
have agreed to eliminate tariffs, quotas and preferences on most, if not all, goods and services
traded between them. Usually these agreements have the aim to give each other access to markets
by lowering or removing border protection measures, such as border taxes on exports and imports,
and other barriers, such as standards or processes. Free Trade Agreements can cover trade in goods,
such as agricultural or industrial products, or trade in services, such as banking or construction.
FTAs can also cover other areas, as follows: intellectual property rights, investment, or
government procurement and competition policy. FTAs aim to remove the barriers to trade and
investment, so that trade can grow as a result of specialization, division of labor and most
importantly through comparative advantage. They create an easier flow of goods, services,
investment and people. Unlike a customs union, members of a free trade area do not have a
common external tariff. Furthermore, to avoid evasion, which can be a result of re-exportation, the
countries use the system of certification of origin, commonly known as rules of origin, where there
is a requirement for the minimum extent of local material inputs and local transformations adding
value to the goods.
The World Trade Organization (WTO) establishes a framework for trade policies, but it
does not define or specify outcomes. Five principles are of particular importance when referring
to WTO, as follows:
- Non-discrimination: It has two major components: the most favored nation (MFN) rule,
and the national treatment policy. Both are embedded in the main WTO rules on goods, services,
and intellectual property, but their precise scope and nature differ across these areas. The MFN
rule requires that a WTO member must apply the same conditions on all trade with other WTO
members, i.e. a WTO member has to grant the most favorable conditions under which it allows
trade in a certain product type to all other WTO members. National treatment means that imported
goods should be treated no less favorably than domestically produced goods (at least after the
foreign goods have entered the market) and was introduced to tackle non-tariff barriers to trade
(e.g. technical standards, security standards et al. discriminating against imported goods).
- Reciprocity: It reflects both a desire to limit the scope of free-riding that may arise because
of the MFN rule, and a desire to obtain better access to foreign markets. A related point is that for
a nation to negotiate, it is necessary that the gain from doing so be greater than the gain available
from unilateral liberalization; reciprocal concessions intend to ensure that such gains will
materialize.
- Binding and enforceable commitments: The tariff commitments made by WTO members
in a multilateral trade negotiation and on accession are enumerated in a schedule (list) of
concessions. These schedules establish "ceiling bindings": a country can change its bindings, but
only after negotiating with its trading partners, which could mean compensating them for loss of
trade. If satisfaction is not obtained, the complaining country may invoke the WTO dispute
settlement procedures.
 - Transparency: The WTO members are required to publish their trade regulations, to
maintain institutions allowing for the review of administrative decisions affecting trade, to respond
to requests for information by other members, and to notify changes in trade policies to the WTO.
These internal transparency requirements are supplemented and facilitated by periodic country-
specific reports (trade policy reviews) through the Trade Policy Review Mechanism (TPRM). The
WTO system tries also to improve predictability and stability, discouraging the use of quotas and
other measures used to set limits on quantities of imports.
- Safety valves: In specific circumstances, governments are able to restrict trade. The
WTO's agreements permit members to take measures to protect not only the environment but also
public health, animal health and plant health
Free trade occurs when there are no artificial barriers put in place by governments to restrict
the flow of goods and services between trading nations. When trade barriers, such as tariffs and
subsidies are put in place, they protect domestic producers from international competition and
redirect, rather than create trade flows.
1. Increased production: Free trade enables countries to specialize in the production of
those commodities in which they have a comparative advantage. With specialisation countries are
able to take advantage of efficiencies generated from economies of scale and increased output.
International trade increases the size of a firm’s market, resulting in lower average costs and
increased productivity, ultimately leading to increased production.
2. Production efficiencies: Free trade improves the efficiency of resource allocation. The
more efficient use of resources leads to higher productivity and increasing total domestic output
of goods and services. Increased competition promotes innovative production methods, the use of
new technology, marketing and distribution methods.
3. Benefits to consumers: Consumers benefit in the domestic economy as they can now
obtain a greater variety of goods and services. The increased competition ensures goods and
services, as well as inputs, is supplied at the lowest prices.
4. Foreign exchange gains: When one country exports overseas it receives hard currency
from other countries that buy the goods. This money is then used to pay for imports that are
produced more cheaply overseas.
5. Employment: Trade liberalization creates losers and winners as resources move to more
productive areas of the economy. Employment will increase in exporting industries and workers
will be displaced as import competing industries fold (close down) in the competitive environment.
6. Economic growth: The countries involved in free trade experience rising living
standards, increased real incomes and higher rates of economic growth. This is created by more
competitive industries, increased productivity, and efficiency and production levels. The below
table1 depicts the change in macroeconomic variables across the countries since FTA has been
initiated. Singapore and Malaysia gain the most in terms of all the selected macroeconomic
indicators. Conversely, India benefits the least. The ASEAN countries that are beyond the scope
of FTA are adversely affected, except that they all experience employment increases and falls in
average
As every coin has two sides, although free trade has benefits, there are a few disadvantages
of the free trade. These include:
 1. With the removal of trade barriers, structural unemployment may occur in the short term.
This can impact upon large numbers of workers, their families and local economies.
2. Increased domestic economic instability from international trade cycles, as economies
become dependent on global markets. This means that businesses, employees and consumers are
more vulnerable to downturns in the economies of our trading partners.
3. International markets are not a level playing field as countries with surplus products may
dump them on world markets at below cost. Some efficient industries may find it difficult to
compete for long periods under such conditions. Further, countries whose economies are largely
agricultural face unfavorable terms of trade (ratio of export prices to import prices) whereby their
export income is much smaller than the import payments they make for high value added imports,
leading to large CADs and subsequently large foreign debt levels.
4. Developing or new industries may find it difficult to become established in a competitive
environment with no short-term protection policies by governments, according to the infant
industries argument. It is difficult to develop economies of scale in the face of competition from
large foreign transnational corporations. This can be applied to infant industries or infant
economies (developing economies).
5. Free trade can lead to pollution and other environmental problems as companies fail to
include these costs in the price of goods in trying to compete with companies operating under
weaker environmental legislation in some countries.
6. Pressure to increase protection during the GFC: During the global financial crisis and
recession of 2008-2009, the impact of falling employment meant that protection pressures started
to rise in many countries. In New South Wales, for example, the state government was criticized
for purchasing imported uniforms for police and firefighters at cheaper prices rather than
purchasing Australian made uniforms from Australian companies. Similar pressures were faced
by governments in the United States, Britain and other European countries.