Definition
A Free Trade Area is a region or group of countries within which goods, services, and labor can flow freely, without tariffs or restrictions. It aims to boost commerce between its member countries by eliminating trade barriers. However, each participating country maintains its own trade policies with nations outside the agreement.
Phonetic
The phonetic pronunciation of “Free Trade Area” is: /friː treɪd ˈeriə/.
Key Takeaways
- Elimination of Trade Barriers: A Free Trade Area (FTA) primarily involves the elimination of trade barriers among member countries. These barriers can include tariffs, import quotas, and non-tariff barriers, enabling goods and services to flow freely among the member nations.
- Economic Growth: The FTA encourages economic growth and prosperity by fostering competition, improving productivity, creating jobs, and attracting foreign direct investment. It can enhance economic integration and stability among the member nations.
- Sovereignty on External Trade Policies: Unlike a customs union, each member of a FTA maintains sovereignty over its own external trade policies. This means countries can independently determine their trade policies with non-members, including tariffs and trade agreements.
Importance
A Free Trade Area (FTA) is a critical concept in business and finance as it represents a significant regional or multinational agreement that eliminates tariff barriers, import quotas, and preferences on most, if not all goods traded between them. FTAs are important because they foster economic integration and stimulate growth by encouraging competition, reducing trade distortions, and promoting efficiency in resource allocation. This leads to benefits such as the enlargement of market access, cost reductions, enhanced consumer choice, and the stimulation of foreign direct investment. Hence, FTAs have far-reaching implications for global commerce and financial prosperity, contributing to open and fair international trade systems.
Explanation
The primary purpose of a Free Trade Area (FTA) is to encourage economic activity among its member countries by removing barriers to trade, such as tariffs and import quotas. This makes it more appealing for member countries to trade with each other. The underlying assumption is that increased trade generates more robust economic activity, leading to economic growth and improvement in the standard of living. An FTA provides member countries with access to each other’s markets, which may offer larger consumer bases, more variety of inputs for production and additional investment opportunities. The use of Free Trade Areas can be significant in promoting regional net economic gains. Businesses within an FTA can access raw materials, technology, and labour at more competitive prices, thus integrating supply chains across borders making it financially viable. Also, they can export their goods and services to other member countries free of trade barriers, increasing competitiveness. This inspires businesses to diversify their products and services, improve quality and adopt innovative practices. For consumers, the increased competition within an FTA usually translates into a wider variety of goods and services at lower prices. Likewise, it can lead to job creation in multiple sectors of the member economies.
Examples
1. North American Free Trade Agreement (NAFTA): Established in 1994 between the United States, Canada, and Mexico, NAFTA is one of the most well-known free trade areas. The agreement eliminated the majority of tariffs on products traded among the three nations, encouraging free trade and investment between them. 2. European Free Trade Association (EFTA): This is an intergovernmental organization established in 1960 by Austria, Denmark, Norway, Portugal, Sweden, Switzerland, and the United Kingdom to promote free trade and economic integration. Today, its members comprise of Iceland, Liechtenstein, Norway, and Switzerland.3. ASEAN Free Trade Area (AFTA): Established in 1992, AFTA is a trade bloc agreement by the Association of Southeast Asian Nations supporting local manufacturing in all ASEAN countries. The AFTA agreement aims to decrease tariffs on all goods to 0-5% as well as work to handle non-tariff obstacles. The participating countries include Brunei, Indonesia, Malaysia, Philippines, Singapore, and Thailand. Vietnam, Laos, Myanmar, and Cambodia have later joined this Free Trade Area as well.
Frequently Asked Questions(FAQ)
What is a Free Trade Area (FTA)?
A Free Trade Area refers to a specific region where member countries have signed a free trade agreement. These agreements reduce or eliminate tariffs, quotas and other trade restrictions on items traded between them.
How does a Free Trade Area benefit member countries?
Trade barriers are reduced or eliminated within a Free Trade Area, allowing countries to import and export goods/services freely. This can stimulate economic growth, improve productivity, create jobs, and offer consumers a broader array of products at lower prices.
Does Free Trade Area involve a common external tariff?
No. Unlike a Customs Union, an FTA does not have a common external tariff. Each country in an FTA can establish its own trade policies with non-member countries.
What are some examples of Free Trade Areas?
Examples of Free Trade Areas include the North American Free Trade Agreement (NAFTA), now replaced by the United States-Mexico-Canada Agreement (USMCA), the European Free Trade Association, and the ASEAN Free Trade Area.
Can a Free Trade Area lead to trade diversion?
Yes. Since countries within the FTA eliminate tariffs for each other but still maintain tariffs for non-member countries, there can be a diversion of trade away from efficient non-member producers to less-efficient member producers.
Is a Free Trade Area the same as a single market?
No. A single market involves more integration than an FTA, including free movement of goods, services, people and capital, along with harmonization of national laws to enable the operation of businesses across the border. An FTA mainly pertains to the free movement of goods.
Is it easy to create a Free Trade Area?
While the concept of a Free Trade Area seems straightforward, setting one up can be complex and time-consuming. It often involves lengthy negotiations between the member countries over the exact terms and rules of the agreement.
Related Finance Terms
- Tariff Barriers
- Trade Liberalization
- Economic Integration
- Customs Union
- Import Quotas
Sources for More Information
- Investopedia – https://www.investopedia.com/terms/f/free-trade-area.asp
- World Bank – https://www.worldbank.org/en/topic/trade/publication/regional-integration-in-africa-tracer
- International Monetary Fund – https://www.imf.org/external/pubs/ft/fandd/basics/trade.htm
- European Commission – https://ec.europa.eu/trade/policy/countries-and-regions/agreements/#_mutual-recognition-agreements
