What is a Free Trade Agreement (FTA)? How does it work?

24 May, 2024

What is a Free Trade Agreement (FTA)?

An agreement that reduces import and export taxes between two or more nations is known as a free trade agreement. Under free trade policies, government exchange constraints in the form of tariffs, quotas, subsidies, or prohibitions are minimal or nonexistent, allowing the free flow of goods and services across international borders.

The purpose of these agreements is to lower trade barriers and enhance bilateral or multilateral trade relations by determining the tariffs and charges that each country imposes on imports.

Trade across international borders can occur via free trade agreements (FTAs) with little or no restrictions on government tariffs, quotas, or subsidies.

Trade protectionism and economic isolationism are concepts that are opposed by free trade agreements (FTAs).

Formal agreements between participating states are often employed in the modern world to create a free trade policy. 

India has signed thirteen free trade agreements (FTAs) with its trading partners in the recent five years. These include the India-Australia Economic Cooperation and Trade Agreement (IndAus ECTA), the India-Mauritius Comprehensive Economic Corporation and Partnership Agreement (CECPA), and the India-UAE Comprehensive Partnership Agreement (CEPA).

Classification of Free Trade Agreements:

Free trade policies can be divided into the following categories according to the degree of trade openness between the nations:

 Preferential trade agreement (PTA) 

It is an agreement between two or more nations to grant preferential entry rights to specific goods in exchange for lower tariffs.

Positive inventory, or the list of products to whom priority access is granted, is kept up to date.

Examples include the Preferential Trade Agreement (SAPTA) between India and SAARC and the MERCOSUR PTA.

Free Trade Agreement (FTA):

 A number of nations have decided to do away with tariffs on goods that are the subject of significant bilateral commerce.

The negotiating countries keep a negative list of goods and services for which the terms of the free trade agreement do not apply. For this reason, FTAs are more extensive than PTAs.

India and the South Asia Free Trade Area (SAFTA) are two such examples.

Comprehensive Economic Cooperation Agreement (CECA):

A complete set of agreements covering goods and services, investment, mutual recognition, e-commerce, intellectual property, and other topics is known as a complete Economic Cooperation Agreement (CECA).

Example:  India – Singapore CECA  and India – Malaysia CECA 

Customs Union (CU): 

Members of the Union can choose to trade duty-free amongst themselves and to keep common tariffs against the rest of the world.

Examples are the European Union and the Southern African Customs Union

Common Market:

 In a common market, participating nations provide unrestricted commerce as well as unrestricted capital and labor mobility.

Example-European Common Market

Economic Union:

Economic union is the extension of the common market through unified legislative, judicial, and fiscal policies as well as increased policy harmonization.

European Union (EU) as an example

How does a Free Trade Agreement work?

Formal agreements between participating states are often employed in the modern world to create a free trade policy. Still, a free-trade policy can just mean the lack of trade barriers.

The government does not have to take direct action to promote free trade. This laissez-faire mindset is referred to as “laissez-faire trade” or trade liberalization. Governments that enact free-trade agreements or policies don’t necessarily remove all protectionist restrictions or cede full control over imports and exports.

Governments that implement free-trade agreements or policies do not always give up all authority over imports and exports or do away with all protectionist measures. Few free trade agreements (FTAs) produce totally unfettered trade in the context of contemporary international commerce.

For instance, a country may permit free trade with another country, subject to restrictions that prohibit the entry of particular medications not authorized by its authorities, unvaccinated animals, or processed foods that don’t adhere to its regulations.

Alternatively, it might have regulations that exclude specific goods from tariff-free status, protecting home producers from foreign competition in a given field.

Economics of  Free Trade:

Free trade between states, municipalities, and neighbors is, in theory, no different from free trade on a global scale. The ability to import commodities that are uncommon or unavailable domestically, however, frees up firms in each country to focus on producing and selling things that maximize their resources.

By combining domestic manufacturing with international trade, economies are able to grow more quickly and better serve their customers’ requirements.

David Ricardo, an economist, first made this point of view prominent in 1817 with his book “On the Principles of Political Economy and Taxation.” He maintained that free trade allows a country to better utilize its own resources, expertise, and specialized skills while increasing the variety and bringing down the cost of the commodities produced there.

Free Trade Agreement and India:

The most recent free trade agreement (FTA) that India has is the India-UAE CEPA.

  • In 2020, India chose not to participate in the massive Asia-Pacific Regional Comprehensive Economic Partnership.
  • Due to the inconsistent past performance of free trade agreements, the Confederation of Indian Industry has called for an evaluation of the current trade accords.
  • Limited growth in bilateral trade and limited diversification of exports have come from India’s free trade agreement with Sri Lanka.
  • India has not benefited significantly from the trade agreement with ASEAN as, according to the country’s free trade agreement, imports of capital goods, petroleum, and transportation equipment have decreased while imports of food and drink, consumer products, and industrial supplies have increased.
  • There aren’t many advantages to India’s Free Trade Agreement with South Korea.
  • India’s productivity has increased due to the increased imports of capital goods, transportation equipment, and industrial supplies as a result of the free trade agreement with Japan.

Significance of Free Trade Agreement (FTA):

  • FTAs encourage companies in member nations to concentrate on manufacturing and marketing products that make the best use of their resources, while other companies import commodities that are hard to find or unavailable domestically.
  • FTAs lead to an increase in the production and consumption of goods traded globally since they enable each country to create a certain set of items at a reduced cost.
  • FTAs make it easier to combine domestic manufacturing with foreign trade, which promotes economic growth.
  • FTAs contribute to supply chain diversification by lowering the cost and simplifying cross-border business transactions for more companies.
  • From the perspective of the customer, free trade agreements (FTAs) would benefit both nations’ consumers by increasing product variety and affordability.
  • Free trade agreements (FTAs) are crucial in cementing the relationship between nations.
  • FTAs promote foreign direct investments (FDI), which promotes the flow of capital and the development of jobs.
  • FTAs aid in the elimination of monopolies.

Concerns about the Free Trade Agreement (FTA):

  • The ultimate effectiveness of trade agreements will depend on how much more commerce is created by comparative advantage, which will boost trade and economic growth.However, the overall effect of the FTA will be unfavorable if it leads to significant trade diversion from more competitive countries to the FTA members.
  • Risk to intellectual property rights: large businesses can readily copy the works of local creators.
  • Loss of income that was collected through tariffs and import levies.
  • The misuse of domestic labor and resources as a result of foreign company growth.
  • It makes trade in products and services more reliant on other nations.
  • The unrestricted flow of imported commodities influences domestic goods, resulting in losses for the home industries.

Way Forward:

  • To enable a less difficult compliance process, terms and conditions pertaining to non-tariff barriers should be negotiated into free trade agreements.
  • Increased market access for India might benefit countries like Africa, Central and Southeast Asia, and others. India should investigate more regions that are prepared for a trade deal with India.
  • To increase the scope of the free trade policy, the geopolitical problems should be settled and the trade partner selection procedure should be changed.
  • Reviewing and renegotiating current trade agreements that are not yielding the desired benefits is crucial.
  • India should take action to increase its export potential and competitiveness since it is believed that its low export competitiveness has prevented it from fully utilizing the FTAs.

India’s merchandise exports are expected to reach USD 450 billion in the current fiscal, despite geo-political challenges in recent times, said Ashwani Kumar, the new president of the Federation of Indian Export Organisations (FIEO)

India’s exports increased to USD 437 billion in FY 2022–23 from USD 331 billion in FY 2018–19, the pre-pandemic level. Despite its commendable trade achievements, India still has a lot of untapped potential.

The estimations provided by India’s Trade Portal show a significant discrepancy between India’s potential exports and actual exports in a number of industries, particularly chemicals, pharmaceuticals, gems, and jewelry. Therefore, in order to effectively profit from exports across sectors, it is important to solve market- and sector-specific issues.

These free trade agreements (FTAs) address a broad range of subjects, including reduced tariffs that affect the entire manufacturing and agricultural sectors, regulations governing the trade of services, digital concerns like data localization, intellectual property rights that could affect the availability of pharmaceuticals and the facilitation, promotion, and protection of investment.

India is concentrating on negotiating free trade agreements with several partners, both bilateral and regional, to boost export-oriented domestic manufacturing.


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