What is a Free Trade Agreement?

A Free Trade Agreement (FTA) is a pact or an understanding between two or more countries over certain requirements and responsibilities to facilitate the smooth flow of goods and services. The agreement aims to protect investors and intellectual property rights, among other things. For the US, the key objective of such agreements will be to reduce barriers in the movement of goods into the US to protect its interests while competing abroad and enhance the rule of law in the FTA partner countries.

The US at present has 14 FTAs with 20 countries. These pacts make it easier for nations to participate and compete in the global marketplace by taking advantage of the zero or reduced tariff as well as enjoy other provisions mentioned under the FTA. While the specifics do vary in every FTA, the core objective is to reduce trade barriers and create a stable, transparent trading and investment environment. FTAs also make it easy for US companies to export their products and services to trading partner markets.

Significance of FTA in Foreign Trade

As more and more countries across the globe continue to compete and enter into collaborations with one another, it has become crucial for the US to establish leadership and nurture its trade relationships. At the same time, US businesses should have well-defined paths to succeed in global trade. FTAs help achieve this vital objective.

Besides this, the following are the advantages of entering into an FTA:-

  • Promotes trade, creates competitive environment

Trade helps create robust business opportunities while increasing competition between foreign and local players. Industries in the US can leverage these developments to establish their presence in foreign markets. FTAs can also help create job opportunities and economic benefits for businesses of all sizes.

An increase in competition also forces organizations to manage their resources responsibly and allocate them efficiently. FTAs also result in benefits such as enhanced economic output and improved wages due to a rise in productivity. The US consumers and businesses benefit because increased trade may lead to the lower pricing of some goods and services. In some sectors, it can even lead to a wider range of products available for purchase.

  • Gives a boost to economies

The North American Free Trade Agreement (NAFTA) was signed by Canada, Mexico, and the US. It was the world’s largest trade agreement back then and had a huge impact on businesses. A report released by the Congressional Budget Office (CBO) revealed that NAFTA accounted for 34% of the trade growth of the three countries during the first seven years of the agreement. Furthermore, it said, overall, NAFTA accounted for 7% of the US's total trade growth during that same period. NAFTA is an indicator of how an FTA can boost the economy of a country. We will read more about NAFTA later below.

FTAs have also helped stimulate the flow of Foreign Direct Investment (FDI). This is done mostly by encouraging more US investment in the economies of member countries. FTAs thus indirectly impact productivity, output, and employment in the US.

How does an FTA Work?

Although an FTA represents a mutual agreement between all the participating countries, it doesn’t necessarily mean that the government will not have any control over imports and exports or do away entirely with protectionist policies. In modern international trade, there are very few FTAs that allow free trade without any barriers.

However, in the US, FTAs do not come with any regulation and oversight. For instance, the US may allow free trade with another nation with some exceptions such as forbidding the import of specific drugs that are not approved by the regulators or requiring import license for certain goods.

Free Trade Agreement Examples

The European Union is a remarkable example of free trade, today. All the member nations of the FTA form a borderless single entity for trade purposes. By adopting a common currency, these nations made trade processes smooth and seamless. The system is regulated by a bureaucracy whose role is to control and manage the various trade-specific issues that often crop up between member union representatives.

Benefits of FTAs

Benefits of FTA

Earlier, we read some advantages of entering into an FTA. We shall now see some more benefits, in-depth.

  • Creates a dynamic business climate

Countries tend to keep their domestic businesses protected in the absence of FTAs. There is a lack of competition as well, often leading to stagnancy and complacency. When that element of protection is wiped off and nations enter into FTAs, businesses become motivated to compete on a global field.

  • Minimizes government spending

Often, local industries enjoy the benefit of government subsidies. FTAs remove such subsidies and put those funds to better use.

  • Encourages FDI

The chances of investors making a beeline to the country in search of business opportunities will increase once countries enter into FTAs. This helps in the flow of capital for expanding the local industries and also for boosting domestic businesses. It even creates the flow of US dollars to many formerly isolated countries.

  • Provides next-level expertise

Global companies are empowered with a higher level of expertise than domestic companies to develop local resources. That is especially true in industries powered by high-tech processes. FTAs allow global firms to avail of these business opportunities. When multinationals collaborate with local industries to develop resources, they provide an insight into the best market practices. That gives local firms access to new and emerging technologies and useful insights.

  • Creates technology transfer opportunities

Local companies can get access to a continuous stream of the latest technologies from their multinational partners when they are part of an FTA. This can spur growth and create more job opportunities.

United States Free-Trade Agreements

Given below are some important FTAs of the US.

  • The North American Free Trade Agreement

NAFTA was designed to establish a free trade zone in North America. Signed in 1992, Canada, Mexico, and the US were its participating countries. NAFTA took effect on January 1, 1994, which resulted in the immediate lifting of tariffs on the majority of goods produced by the signatory nations. It also advocated the gradual elimination of nearly all the barriers to cross-border investments and movement of goods and services among the three countries. The time frame set to achieve this was 15 years.

  • The United States-Mexico-Canada Agreement

The United States-Mexico-Canada Agreement (USMCA) replaced NAFTA and came into effect on July 1, 2020. It has a lifespan of 16 years and will expire if not renewed. The USMCA will have a broader impact on trade of all kinds between the three named nations-- the US, Mexico, and Canada as compared to NAFTA.

  • The Africa Free Trade Agreement

The African Continental Free Trade Area (AfCFTA) aims to increase intra-trade of Africa with other signatory countries through better harmonization and enhanced coordination of trade liberalization. The key objective is to create a single continental market for goods and services and also ensure free movement of people and investments. This agreement came into force in 2018 and is expected to create more markets for products and services, thus boosting sustainable investments and jobs.

  • Dominican Republic-Central American Free Trade Agreement

The Dominican Republic-Central American Free Trade Agreement (DR-CAFTA or CAFTA) includes the seven-member nations of Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, and the US. CAFTA took effect on January 1, 2006. It aims to eliminate tariffs, trade barriers and increase opportunities for workers, manufacturers, consumers, farmers, ranchers, and service providers of all the countries at their respective regional levels.

CAFTA also focuses on expanding and diversifying trade, promoting a level playing ground and fair competition, increasing investment opportunities, protecting and enforcing intellectual property rights, and establishing a framework for enhanced bilateral, regional, and multilateral cooperation among the signatory countries.

  • The Australia – United States Free Trade Agreement

The Australia-United States Free Trade Agreement came into force on January 1, 2005. The immediate outcome was the elimination of tariffs on more than 99% of US manufactured goods exported to Australia. Before the FTA, these goods attracted a tariff of 4.3% on average. The huge benefits and profits it incurred in a wide range of business sectors was another major result of the FTA.

The agreement also created business opportunities in newer markets for services such as life insurance. It ensured faster clearance and delivery, and improved protection of intellectual property. The FTA helped facilitate American investments through predictable access and a stable business environment. It has also made it possible for many sectors to compete for the Australian government’s purchases on a non-discriminatory basis for the first time. US farm exports too benefitted from the FTA. Processed food, fruits and vegetables, corn, and soybeans were exported to newer markets.

The FTA also benefited e-commerce businesses in both countries who are now more easily able to sell products to a wider range of customers. The same is the case with the pharmaceutical industry in both nations.

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