Trade agreements between two or more countries involve reaching an understanding on tax, tariff and restrictions applicable on the export and import of goods and services. These treaties, which also include investment guarantees, typically aim to establish a ‘free trade area,’ where goods and services can be exchanged across territorial boundaries without imposing tariffs. The countries (regions) forming a free trade area impose a common tariff on goods and services sold to non-member countries.
Features of Trade Agreements
Trade agreements are critical in easing trade between two regions or countries. The implementation of trade agreements can reduce barriers to trade and eliminate several prohibitions, which are typically created to ensure national economic growth and security. Trade agreements typically include:
- Most-Favored-Nation (MFN) Clause: By adding this clause in a trade agreement, a country awards another country the privilege of paying the lowest tariffs. All members of the World Trade Organization (WTO) are required to award the MFN status to each other.
- National Treatment of Non-Tariff Restrictions Clause: Most non-tariff restrictions can be crafted to include the properties of tariff in them. Thus, by adding this clause, countries signing a trade agreement agree to offer the same treatment that is provided to domestic good producers.
- Reciprocity Feature: By adding this feature, countries in a trade agreement agree to provide mutual concessions in tariffs and other commercial restrictions. These concessions agreed upon by both the countries are exclusive and do not necessarily apply to other countries with which they have a commercial treaty.
Types of Trade Agreements
Trade agreements are of two types:
- Bilateral trade agreements: They are trade pacts between two nations. Bilateral agreements aim at improving trade relations by incorporating favorable custom duties, fiscal regulations, transportation provisions and levies on exports and imports.
- Multilateral trade agreements: These agreements involve more than two nations having similar trade interests. Multilateral agreements were born out of the effect of trade restrictions imposed between WW I and WW II. One of the earliest multilateral agreements was the General Agreement on Tariffs and Trade (GATT), formed in 1947.
The Importance of Trade Agreements
Trade agreements encourage the unrestricted flow of goods and services and their cheaper availability. They can prove to be a boon especially for smaller businesses, which lack funds for opening factories in other countries and need to export their goods to explore foreign markets. Smaller firms are more affected by tariffs and non-tariff barriers (NTB) and benefit much more from trade agreements than their multinational counterparts. Trade agreements also help companies:
- Target multiple markets.
- Protect themselves from the risk of the confiscation or expropriation of exported goods.
- Eliminate the possibility of a shipment facing the risk of an ‘import ban’ after it has been dispatched.
Evolution of Trade Agreements
The GATT was dissolved because its members realized that the agreement was not in-line with the evolving global economy. In 1986, the Uruguay Round led to the review of the original GATT agreement. The review was aimed at extending the trading boundaries by including the intellectual property and services sectors.
NAFTA, a tri-lateral trade pact between the US, Canada and Mexico, was signed on December 17, 1992. Though it faced considerable opposition in the US parliament, it came into effect from January 1, 1994.
Some important trade agreements are:
- Treaty of Asunción (1991)
- Canada - Chile Free Trade Agreement (CCFTA) (1996)
- EU - Mexico Free Trade Agreement (2000)
Trade pacts come with an investment guarantee. However, some trade agreements have been considered politically controversial, as they increased interdependence and affected the economy of the country.