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  • 2. What is Free Trade Area?A free-trade area (FTA) is a trade bloc whose member countries have signed a free-tradeagreement (FTA), which eliminates tariffs, import quotas, and preferences on most (if notall) goods and services traded between them. If people are also free to move between thecountries, in addition to FTA, it would also be considered an open border. It can be consideredthe second stage of economic integration. Countries choose this kind of economic integration iftheir economical structures are complementary. If their economical structures are competitive,they are more likely to form a customs union.February 27, 2000 International participation in Free Trade Areas (FTAs) grew rapidly in thesecond half of the 20th century, and plans are underway to expand regional economic integrationin the century ahead. The reason is simple. FTAs are engines of growth and progress. Theyexploit country comparative advantages, accommodate specialization and division of labor,expand the size of export markets, and promote efficiency and competition within the free tradearea.Free Trade Areas are like flying geese that work together as a team to reach a desirable distantdestination. Individually, a single goose does not have the strength and endurance to make thejourney. However, flying in a V or chevron formation and working as a team makes it possiblefor the group to accomplish what they could not do alone. Flocks of geese can migratethousands of miles, and the bigger the flock the further they can travel.The largest and most successful "flock of nations" is the European Union (EU). It began with sixcountries (Belgium, France, Germany, Italy, Luxembourg, and the Netherlands) that signed theTreaties of Rome in 1957, forming the European Economic Community (EEC). The originalobjectives were to realize a political association that brought West Germany into the WesternEuropean Alliance and to develop a plan for the post war reconstruction of the region. Oversubsequent years it evolved to the present day 15 member European Union (EU), eleven ofwhich are members of the European Monetary Union (EMU). The EU represents 6.3% of theworlds population, 20% of world GDP, and over 40% of world exports. Page 2
  • 3. The eleven member European Monetary Union (EMU) represents the highest degree ofeconomic integration among nations. There are other less ambitious degrees of internationalcooperation. The most basic is a Free Trade Area which is an agreement between two (or more)countries to reduce or eliminate trade barriers among members, but each member nationmaintains its own external trade policy for non member countries. The North American FreeTrade Agreement (NAFTA) combining the United States, Canada, and Mexico is an example.The next level of integration is a Customs Union which is like a free trade area, but the membercountries have a common external trade policy for non members. The European EconomicCommunity (EEC) was originally a customs union. However, by the 1990s it had evolved to afull-fledged Common Market which, in addition to having a common external trade policy,allows for free mobility of labor and capital within its region. The final stage of economicintegration is a Monetary Union where the countries have a common currency and centralizedmonetary policy. The United States of America (USA) is a monetary union with the dollar as itscurrency and the Federal Reserves system as its central bank. It is also a Political Union with acommon set of laws and tax policies governing the 50 states.Free Trade Areas tend to involve countries within a geographic region, but the United Statesentered into its first free trade agreement with Israel in 1985. Later, it signed an agreement withCanada in 1989, and more recently Mexico was added in 1994 to form the North American FreeTrade Agreement (NAFTA). The three members NAFTA represents just over 5% of the worldspopulation, approximately 23% of world GDP, and about 18% of the worlds exports. Each ofthe three member countries derives significant benefit from their agreement to reduce tradebarriers. The United States needs resources from both Canada and Mexico, and it needs a largemarket for its export sector. Canada is a large industrialized country, rich in both resources andliteracy, but with a small population and domestic market. Mexico has an abundance of oil andnatural gas. It also has a rapidly expanding population and a relatively large semi-skilled andunskilled labor force.NAFTA is still a work in progress. It ultimately plans to eliminate tariffs among the threecountries on industrial products by the year 2004. Its rules of origin requires that a productcontain 62.5% domestic content (i.e., within the region) in order to qualify for tariff free Page 3
  • 4. movement. That way other nations cannot locate final assembly plants or distribution centers inMexico and then ship them to the large US market duty free.NAFTA demonstrates that free trade agreements have their detractors. One of the fears is thatjobs will be lost in the home country to (more efficient) producers in the other membercountries. This was an especially large issue in the United States when Mexico joined NAFTA.Many people were opposed to Mexicos entry out of concern that American jobs would be lost toMexican workers who work for lower wages. There was also a concern that Mexicos lowerenvironmental standards gave Mexican firms an unfair comparative advantage. There is anelement of validity to both of these concerns. When a free trade agreement is initially launched,there are shifts in resource utilization and trade patterns. Each region begins to specialize in itscomparative cost advantage. Mexico has a distinct cost advantage in products that are producedwith relatively low and semi-skilled labor. On the other hand, importing duty free componentsfrom Mexican companies into the United States benefits many producers in the United States andtheir customers. Consumers are the biggest beneficiaries of a free trade agreement, because theyget better products for lower prices. Ironically, most consumers are not conscious of this.Recent opinion polls taken in the United States indicate that most Americans have a negativeopinion of NAFTA. Respondents also indicate that they do not want the United States to enterinto any more free trade agreements in the future.Although most Americans have a negative opinion of free trade agreements, negotiations areunderway to form the most ambitious free trade area of them all. The Asia-Pacific EconomicCooperation (APEC) currently involves 21 countries spanning 4 continents. It includes largecountries like the United States, Japan, Canada, Russia, Australia and the Peoples Republic ofChina as well as small countries like Chile, Peru, Indonesia, Thailand, Brunei Darussalam,Philippines, and Vietnam. Originally, the Osaka Action Agenda in 1995 set a goal to form a freetrade area among the developed country members by the year 2010, and the developing countrieswere to be enjoined in 2020. More recently, the focus has shifted to bring about free trade morerapidly among all members in nine product sectors including energy, chemicals, medicalequipment, fish, and forest products. APECs 21 countries currently account for over 40% ofworld trade. Page 4
  • 5. Many of the members of APEC already belong to the 10 country Association of Southeast AsianNations (ASEAN) which was originally formed by 5 Southeast Asian nations in 1984 and added4 more nations in the 1990s. ASEAN is comprised of small, developing nations with a combinedGDP of less than US $600 billion, but earlier this month representatives met in Jakarta,Indonesia to consider the feasibility of an Asian Free Trade Area (AFTA) alliance with Australiaand New Zealands Closer Economic Relations (CER). The preliminary date for inauguration ofAFTA-CER is 2010.An AFTA-CER alliance would not be the first time that two distinct geographic free trade areasconsidered merging. A merger between the European Union (EU) and the Southern Cone FreeTrade Area (MERCOSUR) in South America is already scheduled for full completion in the year2005. MERCOSUR was formed in 1991 and is comprised of 6 countries: Argentina, Brazil,Paraguay, and Uruguay are the original members; Bolivia and Chile joined as associate membersin 1996. Following its inception, relations between Brazil and Argentina improved and tradewithin the region increased dramatically. However, it underscores another problem with freetrade areas called the trade diversion effect. When a country enters into a free trade agreementwith its associate members, it diverts trade from outside the region to more trade within its ownarea because of the tariff reduction or elimination. Maintaining relatively high tariffs for nonmembers gives members an advantage, but it precludes imports from non member countries thatmay otherwise have a comparative advantage. Consumers benefit from more trade within theregion, but they must pay higher prices for products produced outside the region. In other words,there is a positive trade creation effect but also a negative trade diversion effect. The broaderthe free trade area, the smaller the trade diversion effect. For this reason, some experts think thatMERCOSUR is the natural and logical foundation for a larger South American Free Trade Area(SAFTA) to be formed sometime in the not too distant future, and it was the impetus for itsmerger with the European Union (EU).Plans are also underway that would eventually merge the European Union (EU), the EuopeanFree Trade Area (EFTA), and the Central European Free Trade Area (CEFTA). The latter is thenewest free trade area in Europe comprised of Poland, Hungary, Slovakia, the Czech Republic,Slovenia, and Romania. Since its inception in 1993, the macro economic performance of Page 5
  • 6. CEFTA members has improved dramatically. In each nation GDP is up, unemployment is down,and inflation has subsided.The acceleration of free trade agreements in the second half of the 20th century was an integralpart of economic globalization. Some see the world evolving into three distinct trade regions --Europe, the Americas, and the Asia Pacific Rim -- with their participants being forged intothriving economic regions. On the other hand, populist sentiment is running againstglobalization in many local communities and specific sectors within countries. The battlegroundis the political arena -- not economics academia. The vast majority of economists favor freetrade, whether it is between just two countries or among a large group of nations. Buteconomists dont have very many political votes, and politicians need votes to get elected and re-elected. If they perceive their constituents to be against free trade agreements, then they willforestall any further regional economic integration and in some instances revoke agreementsalready in progress.Free Trade AgreementsFree trade agreements (FTAs) are generally made between two countries. Many governments,throughout the world have either signed FTA, or are negotiating or contemplating new bilateralfree trade and investment agreements.The agreements are like stepping stones towards international integration into a global freemarket economy. There is another way to ensure that governments implement the liberalization,privatization and deregulation measures of the corporate globalization agenda.It is assumed that free trade and the removal of regulations on investment will head to economicgrowth reducing poverty and increasing standards of living and generating employmentopportunity.Past evidences show that these kinds of agreements allow transnational corporations (TNCs)more freedom to exploit workers shaping the national and global economy to suit their interests.In simple terms it removes all restrictions on businesses. Page 6
  • 7. FTAs severely constrain future governments in their policy options and help to lock in existingeconomic reforms which may have been imposed by the IMF, World Bank or AseanDevelopment Bank, or pursued by national governments of their own volition. It works towardsremoving all restrictions on businesses as other free trade and investment agreements perform.FTAs are sometimes of narrow range in their dealing of traded goods. You can note the US-Cambodia bilateral textile trade agreement which was extended in January 2002 for a further 3years.India and Sri Lanka signed a free trade agreement in December 1998 with India agreeing to aphase out of tariffs on a wide range of Sri Lankan goods within 3 years, while Sri Lanka agreedto remove tariffs on Indian goods over eight years. One of its objectives which was stated was tocontribute, by the removal of barriers to bilateral trade "to the harmonious development andexpansion of world trade".Other FTAs are much more comprehensive and cover other issues including services andinvestment. These agreements generally take existing WTO agreements as their benchmark.Regional trading groups and emergingmarketsDuring the last decade two opposing views prevailed regarding the direction of global trade inthe future. One view suggested that the world is dividing into major regional trading groups suchas the European Union, NAFTA, and the ASEAN Free Trade Area that are now and willcontinue to be the major markets of the future. The other view was that global economic powermay be shifting away from the traditional industrialized markets to the developing world and itsemerging markets. China’s ascendancy and the continuing networking among countries throughbilateral and multilateral trade agreements such as the WTO are yielding a third view: Thedominant trend is a new globalization of markets where the notion of nation is becoming lessimportant and the desires of consumers begin to dominate. Page 7
  • 8. The most important argument given in support of this last view is that developed countries havemature, stable markets dominated by global companies. Thus their economies will grow moreslowly than emerging markets and offer less opportunity for new trade. Conversely, enormousdemand will be created as emerging economies continue the rate of economic developmentexperienced over the last decade. These emerging economies will need highways,communications networks, utilities, factories, and the other capital goods necessary forindustrialization. And as their economies continue to prosper, consumer goods will be needed tosatisfy the demands of a newly affluent consumer market. Rather than international trade beingdriven by the major industrialized countries, emerging economies may be the engine for globalmarket growth. Many exports predict that over the next 50 years the majority of global economicgrowth will be in the developing world, principally in those countries now on the threshold to thedesire for economic development and industrialization and may soon be among the futureemerging markets.Example: Free Trade Agreements -Considering U.S exportsFree Trade Agreements (FTAs) have proved to be one of the best ways to open up foreignmarkets to U.S. exporters. Trade Agreements reduce barriers to U.S. exports, and protect U.S.interests and enhance the rule of law in the FTA partner country. The reduction of trade barriersand the creation of a more stable and transparent trading and investment environment make iteasier and cheaper for U.S. companies to export their products and services to trading partnermarkets. Forty-one percent of U.S. goods exports went to FTA partner countries in 2010, withexports to those countries growing at a faster rate than exports to the rest of the world from 2009to 2010, 23% vs. 20%. Page 8
  • 9. With which countries does the United States have an FTA?The United States has 12 FTAs in force with 17 countries. In addition, the United States hasnegotiated FTAs with Korea, Panama and Colombia, but these agreements have not yet enteredinto force. The United States is also in the process of negotiating a regional FTA, the Trans-Pacific Partnership, with Australia, Brunei Darussalam, Chile, Malaysia, New Zealand, Peru,Singapore and Vietnam. Page 9
  • 10. U.S. FTA Partner Countries Australia Bahrain Chile DR-CAFTA: Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, & Nicaragua Israel Jordan Morocco NAFTA: Canada & Mexico Oman Peru Singapore Page 10
  • 11. References: http://global INTERNATIONAL MARKETING By: Philip Cateora, John L Graham, Prashant Salwan Page 11