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6/17/2012

Free Trade Area

What is Free Trade Area?

A free-trade area (FTA) is a trade bloc whose member countries have signed a free-trade agreement (FTA), which eliminates tariffs, import quotas, and preferences on most (if not all) goods and services traded between them. If people are also free to move between the countries, in addition to FTA, it would also be considered an open border. It can be considered the second stage of economic integration. Countries choose this kind of economic integration if their economical structures are complementary. If their economical structures are competitive, they are more likely to form a customs union.

February 27, 2000 International participation in Free Trade Areas (FTAs) grew rapidly in the second half of the 20th century, and plans are underway to expand regional economic integration in the century ahead. The reason is simple. FTAs are engines of growth and progress. They exploit country comparative advantages, accommodate specialization and division of labor, expand the size of export markets, and promote efficiency and competition within the free trade area. 

Free Trade Areas are like flying geese that work together as a team to reach a desirable distant destination. Individually, a single goose does not have the strength and endurance to make the journey. However, flying in a V or chevron formation and working as a team makes it possible for the group to accomplish what they could not do alone. Flocks of geese can migrate thousands of miles, and the bigger the flock the further they can travel. 

The largest and most successful "flock of nations" is the European Union (EU). It began with six countries (Belgium, France, Germany, Italy, Luxembourg, and the Netherlands) that signed the Treaties of Rome in 1957, forming the European Economic Community (EEC). The original objectives were to realize a political association that brought West Germany into the Western European Alliance and to develop a plan for the post war reconstruction of the region. Over subsequent years it evolved to the present day 15 member European Union (EU), eleven of which are members of the European Monetary Union (EMU). The EU represents 6.3% of the world's population, 20% of world GDP, and over 40% of world exports. 

The eleven member European Monetary Union (EMU) represents the highest degree of economic integration among nations. There are other less ambitious degrees of international cooperation. The most basic is a Free Trade Area which is an agreement between two (or more) countries to reduce or eliminate trade barriers among members, but each member nation maintains its own external trade policy for non member countries. The North American Free Trade Agreement (NAFTA) combining the United States, Canada, and Mexico is an example. The next level of integration is a Customs Union which is like a free trade area, but the member countries have a common external trade policy for non members. The European Economic Community (EEC) was originally a customs union. However, by the 1990s it had evolved to a full-fledged Common Market which, in addition to having a common external trade policy, allows for free mobility of labor and capital within its region. The final stage of economic integration is a Monetary Union where the countries have a common currency and centralized monetary policy. The United States of America (USA) is a monetary union with the dollar as its currency and the Federal Reserves system as its central bank. It is also a Political Union with a common set of laws and tax policies governing the 50 states. 

Free Trade Areas tend to involve countries within a geographic region, but the United States entered into its first free trade agreement with Israel in 1985. Later, it signed an agreement with Canada in 1989, and more recently Mexico was added in 1994 to form the North American Free Trade Agreement (NAFTA). The three members NAFTA represents just over 5% of the world's population, approximately 23% of world GDP, and about 18% of the world's exports. Each of the three member countries derives significant benefit from their agreement to reduce trade barriers. The United States needs resources from both Canada and Mexico, and it needs a large market for its export sector. Canada is a large industrialized country, rich in both resources and literacy, but with a small population and domestic market. Mexico has an abundance of oil and natural gas. It also has a rapidly expanding population and a relatively large semi-skilled and unskilled labor force. 

NAFTA is still a work in progress. It ultimately plans to eliminate tariffs among the three countries on industrial products by the year 2004. Its rules of origin requires that a product contain 62.5% domestic content (i.e., within the region) in order to qualify for tariff free movement. That way other nations cannot locate final assembly plants or distribution centers in Mexico and then ship them to the large US market duty free. 

NAFTA demonstrates that free trade agreements have their detractors. One of the fears is that jobs will be lost in the home country to (more efficient) producers in the other member countries. This was an especially large issue in the United States when Mexico joined NAFTA. Many people were opposed to Mexico's entry out of concern that American jobs would be lost to Mexican workers who work for lower wages. There was also a concern that Mexico's lower environmental standards gave Mexican firms an unfair comparative advantage. There is an element of validity to both of these concerns. When a free trade agreement is initially launched, there are shifts in resource utilization and trade patterns. Each region begins to specialize in its comparative cost advantage. Mexico has a distinct cost advantage in products that are produced with relatively low and semi-skilled labor. On the other hand, importing duty free components from Mexican companies into the United States benefits many producers in the United States and their customers. Consumers are the biggest beneficiaries of a free trade agreement, because they get better products for lower prices. Ironically, most consumers are not conscious of this. Recent opinion polls taken in the United States indicate that most Americans have a negative opinion of NAFTA. Respondents also indicate that they do not want the United States to enter into any more free trade agreements in the future. 

Although most Americans have a negative opinion of free trade agreements, negotiations are underway to form the most ambitious free trade area of them all. The Asia-Pacific Economic Cooperation (APEC) currently involves 21 countries spanning 4 continents. It includes large countries like the United States, Japan, Canada, Russia, Australia and the People's Republic of China as well as small countries like Chile, Peru, Indonesia, Thailand, Brunei Darussalam, Philippines, and Vietnam. Originally, the Osaka Action Agenda in 1995 set a goal to form a free trade area among the developed country members by the year 2010, and the developing countries were to be enjoined in 2020. More recently, the focus has shifted to bring about free trade more rapidly among all members in nine product sectors including energy, chemicals, medical equipment, fish, and forest products. APEC's 21 countries currently account for over 40% of world trade. 

Many of the members of APEC already belong to the 10 country Association of Southeast Asian Nations (ASEAN) which was originally formed by 5 Southeast Asian nations in 1984 and added 4 more nations in the 1990s. ASEAN is comprised of small, developing nations with a combined GDP of less than US $600 billion, but earlier this month representatives met in Jakarta, Indonesia to consider the feasibility of an Asian Free Trade Area (AFTA) alliance with Australia and New Zealand's Closer Economic Relations (CER). The preliminary date for inauguration of AFTA-CER is 2010. 

An AFTA-CER alliance would not be the first time that two distinct geographic free trade areas considered merging. A merger between the European Union (EU) and the Southern Cone Free Trade Area (MERCOSUR) in South America is already scheduled for full completion in the year 2005. MERCOSUR was formed in 1991 and is comprised of 6 countries: Argentina, Brazil, Paraguay, and Uruguay are the original members; Bolivia and Chile joined as associate members in 1996. Following its inception, relations between Brazil and Argentina improved and trade within the region increased dramatically. However, it underscores another problem with free trade areas called the trade diversion effect. When a country enters into a free trade agreement with its associate members, it diverts trade from outside the region to more trade within its own area because of the tariff reduction or elimination. Maintaining relatively high tariffs for non members gives members an advantage, but it precludes imports from non member countries that may otherwise have a comparative advantage. Consumers benefit from more trade within the region, but they must pay higher prices for products produced outside the region. In other words, there is a positive trade creation effect but also a negative trade diversion effect. The broader the free trade area, the smaller the trade diversion effect. For this reason, some experts think that MERCOSUR is the natural and logical foundation for a larger South American Free Trade Area (SAFTA) to be formed sometime in the not too distant future, and it was the impetus for its merger with the European Union (EU). 

Plans are also underway that would eventually merge the European Union (EU), the Euopean Free Trade Area (EFTA), and the Central European Free Trade Area (CEFTA). The latter is the newest free trade area in Europe comprised of Poland, Hungary, Slovakia, the Czech Republic, Slovenia, and Romania. Since its inception in 1993, the macro economic performance of CEFTA members has improved dramatically. In each nation GDP is up, unemployment is down, and inflation has subsided. 

The acceleration of free trade agreements in the second half of the 20th century was an integral part of economic globalization. Some see the world evolving into three distinct trade regions -- Europe, the Americas, and the Asia Pacific Rim -- with their participants being forged into thriving economic regions. On the other hand, populist sentiment is running against globalization in many local communities and specific sectors within countries. The battleground is the political arena -- not economics academia. The vast majority of economists favor free trade, whether it is between just two countries or among a large group of nations. But economists don't have very many political votes, and politicians need votes to get elected and re-elected. If they perceive their constituents to be against free trade agreements, then they will forestall any further regional economic integration and in some instances revoke agreements already in progress. 


Free Trade Agreements


Free trade agreements (FTAs) are generally made between two countries. Many governments, throughout the world have either signed FTA, or are negotiating or contemplating new bilateral free trade and investment agreements. 

The agreements are like stepping stones towards international integration into a global free market economy. There is another way to ensure that governments implement the liberalization, privatization and deregulation measures of the corporate globalization agenda. 

It is assumed that free trade and the removal of regulations on investment will head to economic growth reducing poverty and increasing standards of living and generating employment opportunity.

Past evidences show that these kinds of agreements allow transnational corporations (TNCs) more freedom to exploit workers shaping the national and global economy to suit their interests. In simple terms it removes all restrictions on businesses. 

FTAs severely constrain future governments in their policy options and help to lock in existing economic reforms which may have been imposed by the IMF, World Bank or Asean Development Bank, or pursued by national governments of their own volition. It works towards removing all restrictions on businesses as other free trade and investment agreements perform.

FTAs are sometimes of narrow range in their dealing of traded goods. You can note the US-Cambodia bilateral textile trade agreement which was extended in January 2002 for a further 3 years.

India and Sri Lanka signed a free trade agreement in December 1998 with India agreeing to a phase out of tariffs on a wide range of Sri Lankan goods within 3 years, while Sri Lanka agreed to remove tariffs on Indian goods over eight years. One of its objectives which was stated was to contribute, by the removal of barriers to bilateral trade "to the harmonious development and expansion of world trade". 

Other FTAs are much more comprehensive and cover other issues including services and investment. These agreements generally take existing WTO agreements as their benchmark. 


Regional Trading Groups and Emerging Markets


During the last decade two opposing views prevailed regarding the direction of global trade in the future. One view suggested that the world is dividing into major regional trading groups such as the European Union, NAFTA, and the ASEAN Free Trade Area that are now and will continue to be the major markets of the future. The other view was that global economic power may be shifting away from the traditional industrialized markets to the developing world and its emerging markets. China’s ascendancy and the continuing networking among countries through bilateral and multilateral trade agreements such as the WTO are yielding a third view: The dominant trend is a new globalization of markets where the notion of nation is becoming less important and the desires of consumers begin to dominate. 

The most important argument given in support of this last view is that developed countries have mature, stable markets dominated by global companies. Thus their economies will grow more slowly than emerging markets and offer less opportunity for new trade. Conversely, enormous demand will be created as emerging economies continue the rate of economic development experienced over the last decade. These emerging economies will need highways, communications networks, utilities, factories, and the other capital goods necessary for industrialization. And as their economies continue to prosper, consumer goods will be needed to satisfy the demands of a newly affluent consumer market. Rather than international trade being driven by the major industrialized countries, emerging economies may be the engine for global market growth. Many exports predict that over the next 50 years the majority of global economic growth will be in the developing world, principally in those countries now on the threshold to the desire for economic development and industrialization and may soon be among the future emerging markets. 


Example: Free Trade Agreements - Considering U.S exports


Free Trade Agreements (FTAs) have proved to be one of the best ways to open up foreign markets to U.S. exporters. Trade Agreements reduce barriers to U.S. exports, and protect U.S. interests and enhance the rule of law in the FTA partner country. The reduction of trade barriers and the creation of a more stable and transparent trading and investment environment make it easier and cheaper for U.S. companies to export their products and services to trading partner markets. Forty-one percent of U.S. goods exports went to FTA partner countries in 2010, with exports to those countries growing at a faster rate than exports to the rest of the world from 2009 to 2010, 23% vs. 20%. 

With which countries does the United States have an FTA? 
The United States has 12 FTAs in force with 17 countries. In addition, the United States has negotiated FTAs with Korea, Panama and Colombia, but these agreements have not yet entered into force. The United States is also in the process of negotiating a regional FTA, the Trans-Pacific Partnership, with Australia, Brunei Darussalam, Chile, Malaysia, New Zealand, Peru, Singapore and Vietnam. 

U.S. FTA Partner Countries:

  • Australia 
  • Bahrain 
  • Chile 
  • DR-CAFTA: Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, & Nicaragua 
  • Israel 
  • Jordan 
  • Morocco 
  • NAFTA: Canada & Mexico 
  • Oman 
  • Peru 
  • Singapore 

References:


  • http://trade.gov/fta/ 
  • http://www.worldgameofeconomics.com/FreeTradeAreas.htm 
  • http://en.wikipedia.org/wiki/Free_trade_area 
  • http://exim.indiamart.com/free-trade-agreement/ 
  • http://global economicgames.com 
  • INTERNATIONAL MARKETING By: Philip Cateora, John L Graham, Prashant Salwan

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