Trade Agreement

Updated on April 8, 2024
Article byGayatri Ailani
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Trade Agreement?

A trade agreement between two or more nations defines how they cooperate in conducting trade. The main purpose of the agreement is to ease the flow of goods and services from one country to another on mutually agreed terms and conditions. 

Trade Agreement

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It gives a competitive advantage to the countries signing the agreement. In an export-import scenario, the exporting country is exposed to and access foreign market that helps gain new customers, thus spurring growth and revenue. In contrast, the importing country has access to the goods and services it cannot produce. 

Key Takeaways

  • A trade agreement between two or more nations describes the framework and rules for trade in goods and services. 
  • The main types are preferential and free trade agreements.
  • It increases global competitive advantage and gives access to a diversified range of goods and services.
  • Various issues are associated with following the agreements, such as misuse of intellectual property rights, depletion of natural resources, and unhealthy working conditions for workers. 

How Do Trade Agreements Work?

Trade agreements or pacts are contracts between two or more countries. These pacts between two nations are signed when both countries are willing to lessen or eliminate trade barriers to improve international trade and economic prospects.

It produces a framework for conducting trade and a prerequisite for managing and regulating trade between countries. Countries can design trade pacts in different ways. Furthermore, efficient taxes, tariffs, and trade treaties can contribute to rapid economic growth, satisfy consumer demands, and synergize domestic and foreign manufacturing business units.

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Types

There are different types of trade pacts, depending on the terms and conditions of the participating countries.

The main two types are the following: 

  • Free Trade Agreements (FTA): FTA is an agreement to create a free-trade space between the collaborating countries. Bilateral and multilateral agreements are two different sorts. A bilateral trade agreement is created when two nations relax their barriers, usually to increase commercial prospects. The most challenging to negotiate and agree upon is multilateral trade pacts, agreements between three or more nations.
  • Preferential Trade Agreements (PTA): A trading bloc is a preferential trade area formed due to a PTA that grants preferred access to specific items from the member nations. As a result, tariffs are reduced but not eliminated. It is the beginning of the economic integration process. An illustration of a PTA is a regional trade agreement (RTA).

Examples

Let us look at trade agreement examples to understand the concept better:

Example #1

Fifteen nations signed the largest FTA in history via video link on the last day of the 37th ASEAN Summit in 2020. Australia, China, Japan, New Zealand, South Korea, and the other ten nations that make up the Association of Southeast Asian Nations (ASEAN) are all members of the Regional Comprehensive Economic Partnership (RCEP).

The historic trade pact is expected to lower tariffs and boost supply networks. Additionally, it will emphasize e-commerce, improve online consumer and personal protection transparency and information, and roll out streamlined customs processes and paperless trading.

Example #2

Taiwan is a large trading partner of America. The U.S. and Taiwan signed a Trade and Investment Framework (TIFA) to further their economic ties in 1994. Reviewing trade and investment flows, locating areas for enhancing and furthering trade and investment, and identifying policies obstructing bilateral trade and investment flows are all objectives.

Additionally, Taiwan joined the WTO in 2002, which considerably supported the expansion of bilateral commerce. The free trade agreement contributes to developing both nations’ overall trade, exports, and GDP.

Pros And Cons

Some of the important pros and cons of the trade agreements are the following: 

Pros

  • Economic growth of the country increases significantly as trade pacts open up the market of goods and services that create more job opportunities, decrease poverty and thus increase the country’s GDP (gross domestic product).
  • With FTAs, countries’ economies remove the restrictions and try to avoid protectionist policy measures that hinder growth and development. In this scenario, the local business climate of the countries improves, countries become more globally competitive, and they gain access to diversified and high-quality products.
  • The technology transfer from one country to another also increases the advantage of producing goods and services locally, which could not have been possible otherwise. Thus there is an influx of dollars into the economy by selling products and services.

Cons

  • Several issues crop up due to intellectual property rights. First, exporting goods and services to the importing country can have repercussions as the importing country might end up copying the products and start manufacturing in their own country.
  • It increases employee migration and brain drain.
  • Competition from foreign firms can negatively affect small-scale domestic entities.
  • The mass production of goods and services also depletes the country’s natural resources if there is a high demand for naturally produced goods outside the country. 
  • Foreign firms can overexploit the workers engaged in their outsource work. 

Frequently Asked Questions (FAQs)

What does NAFTA stand for?

The North American Free Trade Agreement (NAFTA) was introduced to facilitate trade among the United States, Canada, and Mexico. The agreement removed the tariffs on trade between the three countries. The goal of NAFTA was to promote economic activity among three major economic powers of North America: Canada, the United States, and Mexico.

What is a Regional Trade Agreement (RTA)?

An RTA is an agreement between two or more nations to lower trade barriers such as tariffs and quotas. In addition, the agreements cover intellectual property protection and trade in goods and services.

How can trade agreements impact a country?

These agreements positively affect countries and help trading partners by improving the policy climate for foreign trade and investment. Their efficient design involves balancing interests between different members and non-member countries.

This has been a guide to What is Trade Agreement. Here, we explain its types, its examples, and pros and cons. You may also find some useful articles here –