What is a Free Trade Area?

A Free Trade Area or FTA consists of a group of countries or regions that trade with each other with reduced or no trade barriers. This means that they export and import goods and services to/from each other without taxes, quotas, etc.

If two or more countries have a trade agreement where trade barriers do exist, but they are much lower than they are in other parts of the world, they might say that they belong to an FTA.

Put simply, a free trade area operates with trade barriers that are either completely eliminated or significantly reduced to facilitate easier and less costly exchange of goods and services.

The primary aim of a free trade area is to encourage international trade between member countries, thereby boosting their economies.

Free trade areas – not a new concept

Free trade areas have been around for a very long time, dating back to at least the 16th century, when the Hanseatic League, a commercial and defensive confederation of merchant guilds and market towns in Northwestern and Central Europe, operated.

Wikipedia.com has the following definition of the term:

“A free trade area is the region encompassing a trade bloc whose member countries have signed a free trade agreement (FTA). Such agreements involve cooperation between at least two countries to reduce trade barriers, import quotas and tariffs, and to increase trade of goods and services with each other.”

Maps of 2 major Free Trade Areas - European Union and USMCA in North America
Image created by Market Business News.

Trade barriers that FTAs minimize or eliminate

Examples of trade barriers include tariffs, which are taxes that the government imposes on exports and imports, and quotas, which are limits on import/export volumes of certain products.

Other trade barriers include subsidies, where governments give financial support to local businesses to make them more competitive against foreign companies; standards and regulations, which refer to specific requirements that products have to meet to be sold in a market and can vary greatly between countries; and customs procedures, which are the processes that goods go through when they enter or leave a country, and can sometimes be used to delay or discourage imports. These barriers can significantly affect how and what countries trade with each other.

Free trade areas – non-members

In an FTA, member countries maintain their own policies regarding trade with non-member nations. This means that while member countries agree to trade freely with one another, they can have different tariffs, quotas, and rules for trade with nations outside the FTA.

In this kind of arrangement, member countries can benefit from increased trade opportunities with each other without having to give up their sovereignty over their external trade policies.

Different levels of trade agreements

A free trade area is the first level in the realm of trade agreements. Let’s take a look at some more levels, all they way up to “political union”:

  • Free Trade Area (FTA)

Member nations remove or reduce tariffs, quotas, and preferences on most goods and services traded between them. However, they have own trade policies with non-member countries.

  • Customs Union

This is the next step up. Member countries not only remove trade barriers between themselves but also adopt a common external tariff on all goods entering the union. This means that all members charge the same import duties to countries outside the union.

  • Common Market or Single Market

This arrangement includes the features of an FTA and a Customs Union with the addition of free movement of services, capital, and labor.

  • Economic Union

Encompasses all the features of a common market. Additionally, it requires member countries to harmonize their monetary policies, taxation, and government spending, thus requiring a degree of political integration.

  • Monetary Union

Member countries not only harmonize their economic policy but also adopt a common currency. The Eurozone is a prime example, where most European Union (EU) nations have adopted the euro as their currency.

Not all members of the EU are in the Eurozone. Denmark, for example, is not in the Eurozone; it has held onto its own currency, the Danish krone, but it is an EU member.

  • Political Union

This is the most integrated form of regional cooperation, involving a common government and a unified foreign and defense policy.

USMCA (formerly NAFTA)

The United States-Mexico-Canada Agreement (USMCA), which replaced the North American Free Trade Agreement (NAFTA), is one of the most well-known examples of a free trade area.

UMSCA and NAFTA have significantly boosted trade between the US, Canada, and Mexico by eliminating most tariffs, quotas, and other trade barriers.

Other free trade areas include (N.B. the European Union is integrated at a much higher level than a basic FTA):

  • European Union (EU) – Founded in 1993

A political and economic union of 27 European countries. It has its own currency, the euro, which is used by 19 of the member states.

  • Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA) – Established in 1992

A regional free trade area among ten Southeast Asian countries: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.

  • Southern Common Market (MERCOSUR) – Created in 1991

A South American trade bloc that includes Argentina, Brazil, Paraguay, Uruguay, and Venezuela.

  • Common Market for Eastern and Southern Africa (COMESA) – Formed in 1994

A free trade area with twenty-one member states stretching from Tunisia to Eswatini (formerly Swaziland).

  • South Asian Free Trade Area (SAFTA) – Launched in 2006

An agreement reached by the South Asian Association for Regional Cooperation (SAARC) that includes countries like India, Pakistan, Nepal, and Sri Lanka.

Pros and cons of FTAs

Pros:

  • Increased Economic Growth: Enhances economic activity within member countries.
  • Lower Consumer Prices: Reduces the cost of imported goods and services.
  • More Variety for Consumers: Offers a wider selection of products.
  • Efficiency and Innovation: Encourages competition, leading to innovation and efficiency.
  • Export Opportunities: Expands market access for domestic producers.

Cons:

  • Job Losses: Can lead to job losses in industries unable to compete internationally.
  • Income Inequality: May increase income inequality within countries.
  • Loss of Sovereignty: Nations might have to conform to trade rules not in their favor.
  • Environmental Degradation: Increased production and trade can lead to environmental harm.
  • Dependence on Foreign Markets: Countries may become too reliant on international trade.