Free Trade Area

A specific region wherein a group of countries within the said region signs an agreement that seals the cooperation among them

What is a Free Trade Area?

A free trade area (FTA) refers to a specific region wherein a group of countries signs a trade agreement that seals the economic cooperation among them. The FTA’s main goals are to bring down barriers in trading, specifically tariffs and import quotas, and encourage the free trade of goods and services among its member countries.

 

Free Trade Area

 

What are Free Trade Agreements?

Free trade agreements are entered into by two or more countries who want to seal the economic cooperation among themselves and agree on the terms of trading. In the agreement, member countries specifically identify the duties and tariffs that are to be imposed on member countries when it comes to imports and exports.

The key terms of free trade agreements and free trade areas include:

  • Import goods are products that were manufactured from a foreign land and are brought into another country and consumed by its domestic residents.
  • Export goods are the opposite of import goods – a manufacturer located in one country sells its products to buyers in a foreign country.

 

Free Trade Area vs. Customs Union vs. Single Market

Free trade area and customs union both deal with tariffs and trading. However, they are different in many ways.

 

1. Free trade area

A free trade area is concerned with removing tariffs, and regulations that are applied to member countries who trade with each other. Members establish a common set of policies that regulate trade terms, tariffs, and quotas.

Another thing about a free trade area is that imports from outside the area do not confer the benefit of the free trade agreement. For example, two countries that are members of a free trade area, such as the U.S. and Mexico, refrain from imposing tariffs on each other. However, if a U.S. company imports bananas from South America, they would be subject to tariffs.

 

2. Customs union

A customs union, similar to an FTA, also removes tariffs between its members, but it also sets up a common external tariff to non-members on imported and exported goods. The main difference between an FTA and a customs union is that more compliance (bureaucracy) is involved under an FTA transaction.

 

3. Single market

A single market runs deeper than a customs union because it promotes frictionless trading. Every member recognizes that every single product manufactured by the group’s members is suitable for sale, for distribution to all members, and for consumption.

A single market basically creates a level playing field for every member and not only encompasses tradable products and goods but also allows the citizens of each member country to work freely throughout the area.

 

Advantages of a Free Trade Area

A free trade area offers several advantages, including:

 

1. Increased efficiency

The good thing about a free trade area is that it encourages competition, which consequently increases a country’s efficiency, in order to be on par with its competitors. Products and services then become of better quality at a lower cost.

 

2. Specialization of countries

When there is intense competition, countries will tend to produce the products or goods that they are most efficient at. Efficient use of resources means maximizing profit.

 

3. No monopoly

When there is free trade, and tariffs and quotas are eliminated, monopolies are also eliminated because more players can come in and join the market.

 

4. Lowered prices

When there is competition, especially on a global level, prices will surely go down, allowing consumers to enjoy a higher purchasing power.

 

5. Increased variety

With imports becoming available at a lower cost, consumers gain access to a variety of products that are inexpensive.

 

Disadvantages of Free Trade Area

Despite all the benefits brought about by a free trade area, there are also some corresponding disadvantages, including:

 

1. Threat to intellectual property

When imports are freely traded, domestic producers are often able to copy the products and sell them as knock-offs without fear of any legal repercussions. Therefore, unless the FTA includes provisions for intellectual property laws and enforcement there are no protections for exporting companies.

 

2. Unhealthy working conditions

Outsourcing jobs in developing countries can become a trend with a free trade area. Because many countries lack labor protection laws, workers may be forced to work in unhealthy and substandard work environments.

 

3. Less tax revenue

Since member countries are no longer subject to import taxes, they need to think of ways to compensate for the reduced tax revenue.

 

More Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Bilateral Agreements
  • Regional Trading Agreements
  • Trade Barriers
  • Transfer Pricing

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes!