What Is a Free Trade Area?

A free trade area is a region in which several countries sign a free trade agreement and maintain little to no barriers to trade in the form of tariffs or quotas among one another. Free trade areas facilitate international trade and any associated gains along with the international division of labor and specialization. These deals are highly criticized for costs associated with increasing economic integration and for artificially restraining free trade.

Understanding Free Trade Areas

Contrary to what it sounds like, a free trade area isn't necessarily a physical location. Rather, it is an agreement between a group of countries that 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. They must address the following questions:

• 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 degree of how free the trade is and its scope. The goal is to create a trade policy upon which all participating countries can feasibly agree.

Benefits of Free Trade Areas

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.

Free trade is favored by some advocates of free market economics because they say it improves efficiency and innovation by encouraging competition. They also suggest that it promotes fairness in the markets and economy as it eliminates monopolies that can hurt consumers This lowers the barriers to entry for new competitors.

Criticism of Free Trade Areas

Critics argue that free trade areas can hurt the economies of participating countries and, to some extent, the global economy. For instance, certain workers may 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 and human capital will end up losing value or as entirely sunk costs. Producers may struggle with increased competition. This can lead to a deterioration of workplace environments, especially if companies look for cheap labor by outsourcing jobs in developing nations.

Other drawbacks include making an economy too dependent on just a few products, preventing the growth of infant industries that need economic protection, endangering security if a country becomes too dependent on imports of vital resources, and forcing countries to lower environmental standards to compete.

President Donald Trump was highly critical and moved the country away from free trade agreements, instituting tariffs as a form of economic warfare. President Biden and his administration have not rescinded Trump's tariffs despite calls to do so.

Example of Free Trade Areas

The United States participates in 14 free trade areas with 20 countries. 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.

These three countries replaced NAFTA with the United States-Mexico-Canada Agreement (USMCA) in 2018. It went into effect on July 1, 2020. The U.S. also participates in the Central American Free Trade Area-Dominican Republic (CAFTA-DR), which includes the Dominican Republic, Costa Rica, El Salvador, Nicaragua, Honduras, and Guatemala. Individual agreements are in place between the U.S. and Australia, Bahrain, Chile, Colombia, Panama, Peru, Singapore, Israel, Jordan, Korea, Oman, and Morocco.

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

The Transatlantic Trade and Investment Partnership (T-TIP) was intended as a companion to TPP by creating an agreement with the European Union (EU). The agreement fell through in 2016 after Greenpeace leaked 248 classified pages from the negotiations. Although no free trade agreement exists between the EU and the U.S., a reduction of tariffs in August 2020 was announced 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.