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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 within the said region signs an agreement that seals the economic cooperation among them. The FTA’s main aims 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 each other’s 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 another 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, as well as the measures that are applied to member countries as they trade with each other. This means that there is no common set of policies that apply to all members and that each country in the free trade area imposes its own tariffs and quotas.

Another thing about a free trade area is that anything imported from outside usually cannot be traded freely within the area. For example, two countries that are members of a free trade area such as the US and Mexico refrain from imposing tariffs on each other. However, if the US imports bananas from South America, for example, it may apply a specific set of tariffs.

 

2. Customs union

A customs union, on the other hand, features a common set of tariffs and quotas imposed on and by its member countries. It also further allows the free movement of imports within the area and among its members. For example, a non-member country’s goods that are imported by a member of a customs union can also be imported free of tariffs to other countries that are members of the union.

 

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 throughout the area freely.

 

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 without being too expensive.

 

2. Specialization of countries

When there is tough competition, countries will tend to produce more products or goods that they are most efficient at. This is because they take less time to complete and their output is higher.

 

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 easier and cheaper, consumers will 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 come in more easily, domestic producers can easily access them, allowing them to copy the ideas and sell them as knock-offs. With many countries with little to no laws on intellectual property, it would be easy to steal ideas.

 

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

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