Free trade agreement
A free trade agreement (FTA) or treaty is an agreement according to international law to form a free-trade area between the cooperating states. There are two types of trade agreements: bilateral and multilateral. Bilateral trade agreements occur when two countries agree to loosen trade restrictions between the two of them, generally to expand business opportunities. Multilateral trade agreements are agreements among three or more countries, and are the most difficult to negotiate and agree.[1]
FTAs, a form of trade pacts, determine the tariffs and duties that countries impose on imports and exports with the goal of reducing or eliminating trade barriers, thus encouraging international trade.[2] Such agreements usually "center on a chapter providing for preferential tariff treatment", but they also often "include clauses on trade facilitation and rule-making in areas such as investment, intellectual property, government procurement, technical standards and sanitary and phytosanitary issues".[3]
Important distinctions exist between customs unions and free-trade areas. Both types of trading bloc have internal arrangements which parties conclude in order to liberalize and facilitate trade among themselves. The crucial difference between customs unions and free-trade areas is their approach to third parties. While a customs union requires all parties to establish and maintain identical external tariffs with regard to trade with non-parties, parties to a free-trade area are not subject to such a requirement. Instead, they may establish and maintain whatever tariff regime applying to imports from non-parties as they deem necessary.[4] In a free-trade area without harmonized external tariffs, to eliminate the risk of trade deflection, parties will adopt a system of preferential rules of origin.[5]
The General Agreement on Tariffs and Trade (GATT 1994) originally defined free-trade agreements to include only trade in goods.[6] An agreement with a similar purpose, i.e., to enhance liberalization of trade in services, is named under Article V of the General Agreement on Trade in Service (GATS) as an "economic integration agreement".[7] However, in practice, the term is now widely used in politic science, diplomacy and economics to refer to agreements covering not only goods but also services and even investment. Environmental provisions have also become increasingly common in international investment agreements, like FTAs.[8]: 104
Legal aspects of free trade agreements[edit]
The formation of free trade areas is considered an exception to the most favored nation (MFN) principle in the World Trade Organization (WTO) because the preferences that parties to a free-trade area exclusively grant each other go beyond their accession commitments.[11] Although Article XXIV of the GATT allows WTO members to establish free-trade areas or to adopt interim agreements necessary for the establishment thereof, there are several conditions with respect to free-trade areas, or interim agreements leading to the formation of free-trade areas.
Firstly, duties and other regulations maintained in each of the signatory parties to a free-trade area, which are applicable at the time such free-trade area is formed, to the trade with non-parties to such free-trade area shall not be higher or more restrictive than the corresponding duties and other regulations existing in the same signatory parties prior to the formation of the free-trade area. In other words, the establishment of a free-trade area to grant preferential treatment among its member is legitimate under WTO law, but the parties to a free-trade area are not permitted to treat non-parties less favorably than before the area is established. A second requirement stipulated by Article XXIV is that tariffs and other barriers to trade must be eliminated to substantially all the trade within the free-trade area.[12]
Free trade agreements forming free-trade areas generally lie outside the realm of the multilateral trading system. However, WTO members must notify to the Secretariat when they conclude new free trade agreements and in principle the texts of free trade agreements are subject to review under the Committee on Regional Trade Agreements.[13] Although a dispute arising within free-trade areas are not subject to litigation at the WTO's Dispute Settlement Body, "there is no guarantee that WTO panels will abide by them and decline to exercise jurisdiction in a given case".[14]
A free trade agreement is a reciprocal agreement, which is allowed by Article XXIV of the GATT. Whereas, autonomous trade arrangements in favor of developing and least developed countries are permitted by the Decision on Differential and More Favorable Treatment, Reciprocity and Fuller Participation of Developing Countries adopted by signatories to the General Agreement on Tariffs and Trade (GATT) in 1979 (the “Enabling Clause”). It is the WTO's legal basis for the Generalized System of Preferences (GSP).[15] Both free trade agreements and preferential trade arrangements (as named by the WTO) are considered as derogation to the MFN principle.[16]
Economic aspects of free trade agreements[edit]
Trade diversion and trade creation[edit]
In general, trade diversion means that an FTA would divert trade away from more efficient suppliers outside the area towards less efficient ones within the areas. Whereas, trade creation implies that an FTA area creates trade which may not have otherwise existed. In all cases trade creation will raise a country's national welfare.[17]
Both trade creation and trade diversion are crucial effects found upon the establishment of an FTA. Trade creation will cause consumption to shift from a high-cost producer to a low-cost one, and trade will thus expand. In contrast, trade diversion will lead to trade shifting from a lower-cost producer outside the area to a higher-cost one inside the FTA.[18] Such a shift will not benefit consumers within the FTA as they are deprived the opportunity to purchase cheaper imported goods. However, economists find that trade diversion does not always harm aggregate national welfare: it can even improve aggregate national welfare if the volume of diverted trade is small.[19]
FTAs as public goods[edit]
Economists have made attempts to evaluate the extent to which FTAs can be considered public goods. They first address one key element of FTAs, which is the system of embedded tribunals which act as arbitrators in international trade disputes. These serve as a force of clarification for existing statutes and international economic policies as affirmed in the trade treaties.[20]
The second way in which FTAs are considered public goods is tied to the evolving trend of them becoming “deeper”. The depth of an FTA refers to the added types of structural policies that it covers. While older trade deals are deemed “shallower” as they cover fewer areas (such as tariffs and quotas), more recently concluded agreements address a number of other fields, from services to e-commerce and data localization. Since transactions among parties to an FTA are relatively cheaper as compared to those with non-parties, FTAs are conventionally found to be excludable. Now that deep trade deals will enhance regulatory harmonization and increase trade flows with non-parties, thus reducing the excludability of FTA benefits, new generation FTAs are obtaining the essential characteristics of public goods.[21]
Qualifying for preferences under an FTA[edit]
Further information: Rules of origin
Unlike a customs union, parties to an FTA do not maintain common external tariffs, which means they apply different customs duties, as well as other policies with respect to non-members. This feature creates the possibility of non-parties may free-riding preferences under an FTA by penetrating the market with the lowest external tariffs. Such risk necessitates the introduction of rules to determine originating goods eligible for preferences under an FTA, a need that does not arise upon the formation of a customs union.[22] Basically, there is a requirement for a minimum extent of processing that results in "substantial transformation" to the goods so that they can be considered originating. By defining which goods are originating in the PTA, preferential rules of origin distinguish between originating and non-originating goods: only the former will be entitled to preferential tariffs scheduled by the FTA, the latter must pay MFN import duties.[23]
It is noted that in qualifying for origin criteria, there is a differential treatment between inputs originating within and outside an FTA. Normally inputs originating in one FTA party will be considered as originating in the other party if they are incorporated in the manufacturing process in that other party. Sometimes, production costs arising in one party is also considered as that arising in another party. In preferential rules of origin, such differential treatment is normally provided for in the cumulation or accumulation provision. Such clause further explains the trade creation and trade diversion effects of an FTA mentioned above, because a party to an FTA has the incentive to use inputs originating in another party so that their products may qualify for originating status.[24]