Free Trade Area

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is Free Trade Area?

Free Trade Area is trade agreements that can be undertaken on a regional basis or as trading blocs under which there is no barrier to import defined goods and services as well as to export the same in a defined area among the member countries of such agreement. Among the popular example of free trade, the area is the North American Free Trade Agreement (NAFTA).

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However, it is pertinent to note that nations that intend to be a part of the Free Trade Area must create a balanced trade-off to ensure the competitiveness of the Domestic Industry remains intact while benefiting from the larger demand base of its member country.

Key Takeaways

  • Free Trade Areas (FTAs) are regional or trading bloc agreements characterized by the absence of restrictions on exporting and importing specific goods and services among the participating countries. A prominent example is the North American Free Trade Agreement (NAFTA). 
  • FTAs are founded on agreements between nations to create a platform for economic growth, promote trade relations through the free flow of goods and services, and generate opportunities for all members. 
  • Free trade fosters stronger ties between participating nations and drives growth in various related industries, such as travel and hospitality.

Free Trade Area Explained

Free Trade Area is one of the many international trade agreements through which various countries come together to create a competitive market landscape with the ultimate objective of creating a more streamlined trade and tariff structure. Further, this area promotes efficiency, expands the market base for member nations.

Free Trade Area is based on the agreement among the nations which come together to create a common platform to develop the region, prosper trade relation through the free movement of goods and services thereby creating ample opportunities for all of its members. The concept goes a long way back and is based on the premise that each nation has a certain advantage in particular goods or services compared to others.

Sometimes, a group of countries from a continent also enter into such agreements to form a continental free trade area. By allowing each member nation to freely trade goods and services between them, it results in optimum utilization of relative efficiency and cost optimization along with regional development.

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Examples

These trade agreements can be signed by countries or a collection of countries such as the European free trade area. Let us understand the concept with the help of a few examples.

Free-Trade-Area

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A lot of Free Trade area is created to promote regional growth. Some of the popular noteworthy Free Trade Area is enumerated below:

  1. North American Free Trade Agreement (NAFTA): It was created in 1994 and removes most trade barriers for investment among Canada, Mexico, and the United States of America.
  2. Association of Southeast Asian Nations’ (ASEAN): It was created in 1967 and with the main objective of economic growth and trade development of its nations, namely Indonesia, Malaysia, Singapore, Thailand, and the Philippines.
  3. The Southern Common Market (MERCOSUR): It was created in 2002 with major state parties, including Argentina, Brazil, Paraguay, Uruguay, and Venezuela, with the main objective of regional development of its member nations.
  4. The African Continental Free Trade Area (AFCFTA): It was created in 2018 and is a recent Free trade area and comprises all African nations (as of date, 29 nations) to promote free movement of goods and services in the member region.
  5. European Free Trade Association (EFTA): It was created in 1960 and comprises Iceland, Liechtenstein, Norway, and Switzerland as member nations with the main objective of enhancing free trade among its members and regional growth and economic development.

Advantages

Let us understand the advantages of entering into a bi-country or a continental free trade area through the discussion below.

Disadvantages

Despite acting as a source of great volume of import, export, and overall growth of the economy, there are a few factors that act as serious disadvantage. Let us understand them through the explanation below.

  • Free Trade has an inherent disadvantage that it leads to complete closure of certain industries where other member countries have a comparative advantage. As a result, there is excess reliance on such products leading to monopolistic conditions.
  • Free trade promoted with the main intent of regional development has led to concentrated growth with few member countries gaining more traction than others.
  • They require close monitoring by member nations to avoid the exchange of goods and services, which are detrimental to public health and national security.

Free Trade Area vs. Common Market

Both these concepts have been discussed under similar natures. However, there are quite a few differences in their fundamentals and implications. Let us understand them through the comparison below.

BasisFree Trade AreaCommon Market
DefinitionUnder this movement of Labor and Capital are restricted among the member countries; however, there is no restriction on goods and services trade.Under this, Labor and Capital are free to move among the member countries; however, economic policies are conducted independently by each member country.
ExamplesPopular examples are NAFTA etc.Popular Common Market Examples are Caribbean Community and Common Market (CARICOM).
Trade with other Countries (Non-Member)Under this area, each member country can have a different tariff trade structure for trade between non-member countries. For example, if Country A, B, and C are having a Free Trade Agreement and Country A and B undertake trade with Country D ( a non-member), they can have different tariff trade structure with Country D.Under a Common Area, each member country will have the same tariff trade structure for trade between non-member countries. For example, if Country A, B, and C are having a Common Market Agreement and Country A and B undertake trade with Country D ( a non-member), they will have the same tariff trade structure with Country D.

Frequently Asked Questions (FAQs)

1. What is the relevance of free trade?

The relevance of free trade lies in its ability to foster economic prosperity and international cooperation. By removing trade barriers like tariffs and quotas, countries can access a wider range of goods and services, leading to increased consumer choices and competitive prices. Free trade also encourages specialization and efficiency, as countries focus on producing what they do best, ultimately boosting global economic growth and raising living standards.

2. What are the types of free trade?

There are two main types of free trade: unilateral and multilateral. Unilateral free trade involves a country independently removing trade barriers and promoting open markets. Multilateral free trade agreements involve multiple countries mutually reducing trade barriers, promoting cooperation, and creating a more integrated global economy.

3. How does free trade promote economic growth?

Free trade promotes economic growth by facilitating efficient resource allocation and market access. It allows countries to specialize in producing goods and services where they have a comparative advantage, leading to higher productivity and output. Additionally, free trade enhances competition, which drives innovation and technological advancement, ultimately benefiting consumers with better products at lower prices. By fostering economic growth, free trade contributes to poverty reduction and higher standards of living.

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