Trade agreements are a fundamental part of international shipping. Not only do they facilitate the smooth and efficient movement of goods across borders by reducing tariffs, they are also key when it comes to harmonising regulations, and promoting economic cooperation among participating countries.
This article provides a comprehensive overview of free trade agreements. We look at all aspects of free trade agreements, including what free trade agreements are and how they work. Then we look at the difference between free trade agreements and customs unions, and the advantages that free trade agreements offer.
What are free trade agreements?
A free trade agreement is a mutually-agreed legal pact between two or more nations to make it easier to import and export goods and services between them, resulting in what is known as a free trade zone.
Another way to think of a free trade agreement is to see it as a set of rules for how two or more countries will treat one another when importing, exporting, investing, or doing any other business together. The aim of free trade agreements is to encourage trade between the participating countries.
How do free trade agreements work?
Are you wondering how free trade agreements work? Put in simple terms, the participating countries agree to reduce or eliminate import tariffs, duties, and/or other trade barriers between one another. That means that a free trade agreement enables the signatory countries to buy and sell goods and services across international borders with relatively few barriers. In some instances, a free trade agreement is simply the absence of any trade restrictions between two or more countries. Whatever the specific details of a free trade agreement, they are intended to encourage international trade between the participating parties.
Let’s look at a practical example to better understand how free trade agreements work: imagine country A and country B have a free trade agreement with one another. When country A exports goods to country B they can expect lower landed costs and fewer trade barriers. This therefore encourages country B to import the goods from country A, rather than another country with which they do not have a free trade agreement.
What is the difference between free trade agreement and customs union?
Let’s look at the difference between free trade agreements and customs unions because, while at first glance they may appear to be more or less the same thing, there is in fact one key difference.
In a customs union, all member countries agree to charge the same customs tariff on any goods from non-member countries. For example, if countries A, B, and C form a customs union, country D (and any other country that is not part of the customs union) will have to pay the same duties, and face the same restrictions, when importing to country A, B, or C. In other words, countries A, B, and C agree on an identical customs tariff that they charge to all other countries.
On the other hand, a free trade agreement allows for each member state to set their own customs tariffs. To use the example above, countries A, B, and C can all charge country D different customs tariffs that they set independently of one another.
Despite this key difference, both customs unions and free trade agreements include internal arrangements to make trading between the participating countries easier.
Advantages of free trade agreements
As we learned above, free trade agreements are designed to foster strong international trading relationships between the participating countries. This results in a wide range of benefits for consumers, for businesses, and for a country’s wider economy. The advantages of free trade agreements include:
- Encouraging rapid economic growth by offering new trade and investment opportunities, as well as attracting foreign investment and creating comparatively high-paying jobs for local workers.
- Greater consumer access to competitively-priced finished goods and services because free trade encourages the development of a more competitive marketplace, which leads to lower prices.
- Making it easier and cheaper for companies to participate in the global marketplace because free trade agreements ensure reduced or eliminated tariffs, as well as removing other trade barriers otherwise involved in freight forwarding.
- Providing security for importers, exporters, and investors because free trade agreements, by their very nature, are legally binding.