What Is a Free Trade Area? Definition, Benefits and Disadvantages

What Is a Free Trade Area?

A free trade area is a region in which a number of countries have signed a free trade agreement and maintain little or no barriers to trade in the form of tariffs or quotas among one another. Free trade areas facilitate international trade and the associated gains from trade along with the international division of labor and specialization, but they have been criticized for costs that are associated with increasing economic integration and for artificially restraining free trade.

Understanding Free Trade Areas

A free trade area is a group of countries that have agreed to put up few or no barriers to trade in the form of tariffs or quotas among them. Free trade areas tend to increase the volume of international trade among member countries and allow them to increase their specialization in their respective comparative advantages.

To develop a free trade area, participating nations must set rules for how it will operate. What customs procedures will each country have to follow? What tariffs, if any, will be allowed, and what will their costs be? How will participating countries resolve trade disputes? How will goods be transported for trade? How will intellectual property rights be protected and managed? How these questions are answered in a specific free trade agreement tends to be based on political influences within and power relations among countries. This shapes the scope and degree of how “free” the trade will actually be. The goal is to create a trade policy that all countries in the free trade area can feasibly agree upon.

Benefits

The benefits of free trade areas include providing consumers with increased access to less expensive and/or higher quality foreign goods and the lowering of prices as governments reduce or eliminate tariffs. Producers can acquire a greatly expanded market of potential customers or suppliers. Free trade areas can also encourage economic development in countries as a whole, benefiting some of the population through increased living standards.

Costs

With regard to costs, workers in some countries and industries will lose jobs and face related hardships as production moves to areas where comparative advantage or home market effects make those industries less costly to run and more efficient overall. Some investments in fixed physical capital and human capital will end up losing value or as entirely sunk costs. Producers may struggle with increased competition.

Arguments For and Against Free Trade Areas

The history of international trade agreements is a long one, but the current general acceptance of free trade agreements dates to the Bretton Woods Conference in the aftermath of Word War II. Free trade is favored by some advocates of free market economics because they say it increases access to high-quality, low-price goods; promotes economic growth; improves efficiency and innovation; drives competitiveness; and promotes fairness.

Others argue that free trade areas threaten domestic jobs and industries by allowing production to migrate overseas, can make an economy too dependent on just a few products, prevent the growth of infant industries that need economic protection, endanger security if a country becomes too dependent on imports of vital resources, and can force countries to lower environmental standards in order to compete.

More recently, President Trump moved the country away from free trade agreements, instituting tariffs as a form of economic warfare. President Biden has yet to rescind these tariffs.

Free Trade Areas and the United States

The United States participates in 14 free trade areas with 20 countries as of 2022. One of the best known and largest free trade areas was created by the signing of the North American Free Trade Agreement (NAFTA) on Jan. 1, 1994. This agreement, signed by Canada, the United States, and Mexico, encouraged trade among these North American countries.

In 2018 the same three countries signed the United States-Mexico-Canada Agreement (USMCA) to replace NAFTA. The USMCA took effect on July 1, 2020. In addition to the USMCA, there is the Central American Free Trade Area-Dominican Republic (CAFTA-DR), which includes the Dominican Republic, Costa Rica, El Salvador, Nicaragua, Honduras, and Guatemala. The United States also has individual free trade agreements with Australia, Bahrain, Chile, Colombia, Panama, Peru, Singapore, Israel, Jordan, Korea, Oman, and Morocco.

The United States began negotiations in March 2010 for the Trans-Pacific Partnership (TPP), which was intended to create a “high-standard, broad-based regional pact” for a regional Asia-Pacific trade agreement. However, President Donald Trump pulled the U.S. out of the agreement on Jan. 30, 2017, one of his first official acts, and it proceeded without the United States as a participant.

An attempt to negotiate a free trade agreement with the European Union (EU), the Transatlantic Trade and Investment Partnership (T-TIP), was intended as a companion to TPP. It came to naught in 2016 after the environmental activist group Greenpeace leaked 248 classified pages from the negotiations. Currently, there is no free trade agreement between the EU and the U.S., but in August 2020 a reduction of tariffs between the two entities was announced that was intended to “increase market access for hundreds of millions of dollars in U.S. and EU exports.”

The Bottom Line

A free trade area is an agreement among a group of nations to reduce or eliminate trade barriers such as quotas or tariffs. There are potential advantages as well as disadvantages for a member nation, including improved access to high-quality, low-priced goods and increased economic development on the plus side and job migration out of a country as well as developing a dependence on two few goods on the down side. The U.S. currently participates in 14 free-trade areas with 20 different countries.