Free Trade Agreements

Recently India has entered into Free Trade Agreements (FTA) with the United Arab Emirates (UAE) and Australia which has brought the spotlight on FTAs. After British PM Johnson’s visit,  there is a buzz of a FTA with UK. Let’s discuss - What are FTAs and what are advantages or disadvantages for the concerned countries and their economies.

What are FTAs ?

By definition a FTA connotes a treaty between multiple countries (set of two or more) whereby they agree, on a reciprocal basis, to open up access to their respective markets for trade and other economic activities, without restrictive entry barriers or export and import tariffs. To quote Encyclopedia Britannica “free trade, also called laissez-faire, a policy by which a government does not discriminate against imports or interfere with exports by applying tariffs (to imports) or subsidies (to exports). A free-trade policy does not necessarily imply, however, that a country abandons all control and taxation of imports and exports”.

India first entered into a FTA with Sri Lanka in 1998, followed by Singapore in 2005, South Korea (2010), ASEAN countries (2010), Malaysia (2011), Japan (2011), and now UAE and Australia in 2022.

Scope of FTAs                                                                             

FTAs are reciprocal arrangements between a set of countries, regulated by Article XXIV of the General Agreement on Tariffs and Trade (GATT), 1947 (replaced by World Trade Organization -WTO wef 1st January 1995). While GATT covered only trade, WTO has brought services also under the ambit of FTAs.  

Free trade is the absolute opposite of trade protectionist policy. It is aimed at introducing transparency and predictability in trade relations between the two countries. FTAs generally encompass the following –

-    Countries to the treaty agree on reciprocal basis, to facilitate trade in goods and services, free from any restrictions and barriers including quotas and restrictive tariffs (imports) or subsides (exports). Such restrictions are generally imposed by countries to protect domestic economy (Protectionism).

-       Tariffs (taxes on imports) are either reduced or totally eliminated , providing such imports a level playing field at par with domestic economy ;

-   Underlying principle is that a country should stick to its core competency, producing goods which it can produce at a competitive lower rate, while importing goods which can be sourced from another country at a rate lower than domestic production ;

-      FTAs result in both trade creation ie creating new business opportunities for both countries as well as trade diversion ie. movement of trade opportunities from less efficient economies to more efficient economies ;

Advantages of FTA

-     Free movement of goods and services creates new business opportunities enabling either country to take benefit of manufacturing  and commercial advancement of the other participating country at a reasonable cost ;

-      Reduction and elimination of tariffs resulting in free flow of goods and services without restrictions, helps in investment in industry including foreign direct investment from the partner country (fuelled by more trade opportunities) and increased employment avenues ;

-      It results in building economies of scale and increases efficiency as countries tend to produce only those goods which can be produced at a comparatively lower cost while rest are outsourced.

-        Increases availability of goods at cheaper prices.

-     FTAs encourage innovation as domestic companies strive to compete with foreign imported goods and services. It may also open up opportunities for technology transfer. This makes the entire economic ecosystem more dynamic.

-      Introduces a trade regime antagonistic to monopolistic trade practices  

-      As trade without barriers bring benefits to both economies, it improves relations between countries at political level.

-      Countries save on subsidies which would have otherwise been extended to make domestic products cheaper as compared to imported goods.

-      FTAs do not necessarily mean freeing of finished goods. They can and do cover intermediates which ease the supply chain for domestic industry, helping even the local industry to grow

 

Disadvantages of FTA

-      Inhibits growth of domestic industry as goods which can be manufactured locally are imported at competitive pricing ;

-      May result in unemployment in the weaker economy as the country may now import goods (due to cheaper pricing) which were being produced locally. Moreover, local jobs could be outsourced due to comparatively free movement under FTA

-      May also introduce an element of dependence on outside supplies in place of self-dependence “atmanirbharta”

-      Goods which may be freely available under FTA, may be cloned by unscrupulous elements in the importing country. Such goods could be marketed locally at an even cheaper price, thus threatening intellectual property. This may be more pronounced if a country doesn’t have adequate laws for protection on patents.

-      Reduction or elimination of duties and tariffs may result into revenue loss for the country

-      It is generally believed that FTAs can be an instrument of economic advantage and prosperity only if both the countries have existing  substantial trade between themselves, which which can be further developed through FTAs.

 

Variations of FTA

While FTAs connote open trade, there are certain variations also, based on degree of openness  -

Preferential Trade Agreement (PTA): Under this arrangement, two countries agree to provide preferential entry to certain goods by reduction of duties. Basic difference between FTA and PTA is that in the latter case, a positive list of goods is maintained which are eligible for preferential treatment, while in the case of FTA a negative list of goods and services, not eligible for concessions,  is  maintained  

Customs Union (CU): Under this arrangement a group of countries may agree to trade between themselves at zero duty, while maintaining an uniform duty structure against external world eg European Union (EU). Thus the basic difference between FTA and CU is in collective dealing with non-member countries. A Single Market (SM) concept is a further variation of CU, whereby it additionally allows citizens of all countries within SM to move and work freely.

 

Conclusion

FTAs are mainly directed towards trade liberalization as against trade protectionism. Here we should not confuse latter with Atmanirbharta or self-reliance. While protectionism doesn’t allow competition , self reliance encourages domestic industry to improve standards so as to face competition. Despite disadvantages enumerated above, many countries pursue FTAs, as advantages to be derived out of a free global economy outweigh disadvantages.  Regional FTAs like Australia-New Zealand or between US-Canada-Mexico have been very successful. But in Indian context, instead of looking at our neighbors, we should strive towards finalizing FTAs with our major trading partners ie. USA and UK as soon as possible. This may help us to achieve the USD 5 trillion target at the earliest.