Definition Fta

8/8/2019 Definition Fta

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Definition

Treaty (such as FTAA orNAFTA) between two or

more countries to establish a free trade

area where commerce in goods and services can be conducted across

theircommon borders, without tariffs or hindrances but (in contrast to

a common market) capital orlabormay not move freely. Member countries

usually impose a uniformtariff(called common external tariff) on trade with

non-member countries.

Free trade is a system oftrade policy that allows traders to act and ortransact without interference from government. According to the lawofcomparative advantage the policy permits trading partners mutualgainsfrom trade of goods and services.

Under a free trade policy, prices are a reflection of true supply and demand,

and are the sole determinant ofresource allocation. Free trade differs fromother forms of trade policy where the allocation of goods and servicesamong trading countries are determined by artificial prices that may or maynot reflect the true nature of supply and demand. These artificial prices arethe result ofprotectionist trade policies, whereby governments intervene inthe market through price adjustments and supply restrictions. Suchgovernment interventions can increase as well as decrease the cost ofgoods and services to both consumers and producers.

Interventions include subsidies, taxes and tariffs, non-tariff barriers, such asregulatory legislation and quotas, and even inter-government managedtrade agreements such as the North American Free TradeAgreement (NAFTA) and Central America Free Trade Agreement (CAFTA)(contrary to their formal titles) and any governmental market interventionresulting in artificial prices.


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Most states conduct trade policies that are to a lesser or greater degreeprotectionist.

[1]One ubiquitous protectionist policy employed by states

comes in the form ofagricultural subsidies whereby countries attempt toprotect their agricultural industries from outside competition by creatingartificial low prices for their agricultural goods.[2]

Free trade agreements are a key element ofcustoms unions and free tradeareas. The details and differences of these agreements are covered in theirrespective articles.

Features of free trade

Free trade implies the following features[

trade ofgoods without taxes (including tariffs) or othertradebarriers (e.g., quotas on imports or subsidies for producers)

trade in services without taxes or other trade barriers

The absence of "trade-distorting" policies (suchas taxes, subsidies, regulations, orlaws) that give some firms,households, orfactors of production an advantage over others

Free access to markets

Free access to market information

Inability of firms to distort markets through government-imposed monopoly oroligopoly power

The free movement oflaborbetween and within countries

The free movement ofcapital between and within countri


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History of free trade

See also: History of international trade

Before the appearance of Free Trade doctrine, and continuing in opposition

to it to this day, the policy ofmercantilism had developed in Europe in the

16th century. Two early economists who were opposed to mercantilismwere David Ricardo andAdam Smith.

Economists that advocated free trade believed trade was the reason why

certain civilizations prospered economically. Adam Smith, for example,

pointed to increased trading as being the reason for the flourishing of not just

Mediterranean cultures such as Egypt, Greece, and Rome, but also of Bengal

(East India) and China. The great prosperity of the Netherlands after throwing

off Spanish Imperial rule and pursuing a policy of free trade[4]made the free

trade/mercantilist dispute the most important question in economics for

centuries. Free trade policies have battled

with mercantilist, protectionist, isolationist, communist, populist, and other

policies over the centuries.

Wars have been fought over trade, such as the Peloponnesian Warbetween

Athens and Sparta, the Opium Wars between China and Great Britain, and

othercolonial wars. All developed countries have used protectionism due to

an interest in raising revenues, protecting infant industries, special interest

pressure, and, prior to the 19th century, a belief in mercantilism.

Many classical liberals, especially in 19th and early 20th century Britain

(e.g. John Stuart Mill) and in the United States for much of the 20th century

(e.g. Cordell Hull), believed that free trade promoted peace. The British

economist John Maynard Keynes (18831946) was brought up on this belief,

which underpinned his criticism of the Treaty of Versailles in 1919 for the

damage it did to the interdependent European economy. After a brief flirtation

with protectionism in the early 1930s, he came again to favour free trade so

long as it was combined with internationally coordinated domestic economic

policies to promote high levels of employment, and international economicinstitutions that meant that the interests of countries were not pitted against

each other. In these circumstances, 'the wisdom of Adam Smith' again

applied, he said.

Some degree of Protectionism is nevertheless the norm throughout the world.

In most developed nations, controversial agricultural tariffs are maintained.

From 1820 to 1980, the average tariffs on manufactures in twelve industrial


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countries ranged from 11 to 32%. In the developing world, average tariffs on

manufactured goods are approximately 34%.[5]:66

Currently, the World Bank believes that, at most, rates of 20% can be allowed

by developing nations; but Ha-Joon Chang believes higher levels may be

justified because the productivity gap between developing and developed

nations is much higher than the productivity gap which industrial countries

faced. (A general feature is that the underdeveloped nations of today

are notin the same position that the developed nations were in when they

had a similar level of technology, because they are weak players in a

competitive system; the developed nations have always been strong players,

although formerly at an overall lower level.) If the main defense of tariffs is to

stimulate infant industries, a tariff must be high enough to allow domestic

manufactured goods to compete for the tariff to be possibly successful. This

theory, known as import substitution industrialization, is largely considered to

be ineffective for currently developing nations,[6]:311

and studies by the WorldBank have determined that export-oriented industrialization policies correlate

with higher economic growth as observed with the Four Asian Tigers. These

assessments are based mainly on theory and observational study of

correlations, and thus suffer from a number of weaknesses such as small

sample size and numerous confounding variables (see the critical review

section below).

The United States and free trade

Free Tradeclipper ship

Trade in colonial America was regulated by the British mercantile system

through theActs of Trade and Navigation. Until the 1760s, few colonists

openly advocated for free trade, in part because regulations were not strictly

enforcedNew England was famous for smugglingbut also because


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colonial merchants did not want to compete with foreign goods and shipping.

According to historian Oliver Dickerson, a desire for free trade was not one of

the causes of theAmerican Revolution. "The idea that the basic mercantile

practices of the eighteenth century were wrong," wrote Dickerson, "was not a

part of the thinking of the Revolutionary leaders".[7] Free trade came to what

would become the United States as a result ofAmerican Revolutionary War,

when the British Parliament issued the Prohibitory Act, blockading colonialports. The Continental Congress responded by effectively declaring economic

independence, opening American ports to foreign trade on April 6, 1776.

According to historian John W. Tyler, "Free trade had been forced on the

Americans, like it or not."[8]

The 1st U.S. Secretary of the Treasury,AlexanderHamilton, advocated tariffs

to help protect infant industries in his "Report on Manufactures." This was a

minority position, though the "Jeffersonians" strongly opposed for the most

part. Later, in the 19th century, statesmen such as SenatorHenryClay continued Hamilton's themes within the Whig Party under the name

"American System." The opposition Democratic Party contested several

elections throughout the 1830s, 1840s, and 1850s in part over the issue of

the tariff and protection of industry. The Democratic Party favored moderate

tariffs used for government revenue only, while the Whig's favored higher

protective tariffs to protect favored industries. The economist Henry Charles

Carey became a leading proponent of the "American System" of economics.

This mercantilist "American System" was opposed by the Democratic Party

ofAndrew Jackson, Martin Van Buren, James K. Polk, Franklin Pierce,

and James Buchanan.

The fledgling Republican Party led byAbraham Lincoln, who called himself a

"Henry Clay tariff Whig," strongly opposed free trade and implemented a 44

percent tariff during the Civil Warin part to pay for railroad subsidies, the war

effort, and to protect favored industries.[9] President William McKinley stated

the United States' stance under the Republican Party (which won every

election for President until 1912, except the two non-consecutive terms

ofGrover Cleveland) as thus:

"Under free trade the trader is the master and the producer the slave.

Protection is but the law of nature, the law of self-preservation, of self-

development, of securing the highest and best destiny of the race of man. [It

is said] that protection is immoral. Why, if protection builds up and elevates

63,000,000 [the U.S. population] of people, the influence of those 63,000,000

of people elevates the rest of the world. We cannot take a step in the

pathway of progress without benefitting mankind everywhere. Well, they say,


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Buy where you can buy the cheapest'. Of course, that applies to labor as

to everything else. Let me give you a maxim that is a thousand times better

than that, and it is the protection maxim: Buy where you can pay the easiest.'

And that spot of earth is where labor wins its highest rewards."[10]

On the other side:

The growing Free Trade Movement sought an end to the tariffs andcorruption in state and federal governments by every means available to

them, leading to several outcomes. The first and most important was the rise

of the Democratic Party with Grover Cleveland at its helm. The next most

important were the rise of the "Mugwumps" within the Republican party. For

many Jeffersonian radicals, neither went far enough or sufficiently effective in

their efforts and looked for alternatives. The first major movement of the

radical Jeffersonians evolved from the insights of a young journalist and

firebrand, Henry George. - Kenneth R. Gregg, George Mason

UniversityHistory News Network

The tariff and support of protection to support the growth of infrastructure and

industrialization of the nation became a leading tenet of the Republican Party

thereafter until the Eisenhower administration and the onset of the Cold War,

when the Democratic and Republican parties switched positions.

Since the end ofWorld War II, in part due to industrial supremacy and the

onset of the Cold War, the U.S. government has become one of the most

consistent proponents of reduced tariff barriers and free trade, having helped

establish the General Agreement on Tariffs and Trade (GATT) and later

the World Trade Organization (WTO); although it had rejected an earlier

version in the 1950s (International Trade Organization or ITO). Since the

1970s U.S. government has negotiated numerous managed trade

agreements, such as the North American Free Trade Agreement (NAFTA) in

the 1990s, the Dominican Republic-Central America Free Trade

Agreement (CAFTA) in 2006, and a number of bilateral agreements (such as

with Jordan).

Current status


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Current free trade areas with more than three member countries.

Status of WTO negotiations: members (including dual-representation with the European

Union) Draft Working Party Report or Factual Summary adopted Goods and/or Services offers

submitted Memorandum on Foreign Trade Regime submitted observer, negotiations to start later or

no Memorandum on FTR submitted frozen procedures or no negotiations in the last 3 years no

official interaction with the WTO

Most (but not all) countries in the world are members of the World Trade

Organization (see map), which limits in certain ways but does not eliminate

tariffs and other trade barriers. Most countries are also members of

regional free trade areas (see map) which lower trade barriers among

participating countries.

Most countries prohibit foreign airlines from cabotage (transporting

passengers between two domestic locations), and foreign landing rights aregenerally restricted, but open skiesagreements have become more common.

Notable contemporary trade barriers include ongoing tariffs, import

quotas, sanctions and embargoes, currency manipulation of the Chinese

yuan with respect to the U.S. dollar,agricultural subsidies in developed

countries, and buy American laws.

Economics of free trade


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Economic modelsTwo simple ways to understand the potential benefits of free trade are

through David Ricardo's theory ofcomparative advantage and by analyzing

the impact of a tarifforimport quota.

The pink regions are the net loss to society caused by the existence of the tariff.

A simple economic analysis using the law ofsupply and demand and the

economic effects of a tax can be used to show the theoretical benefits of free

trade.[11]

The chart at the right analyzes the effect of the imposition of animport tariffon some imaginary good. Prior to the tariff, the price of the good

in the world market (and hence in the domestic market) is Pworld. The tariff

increases the domestic price to Ptariff. The higher price causes domestic

production to increase from QS1 to QS2and causes domestic consumption to

decline from QC1 to QC2. This has three main effects on societal welfare.

Consumers are made worse off because the consumer surplus (green

region) becomes smaller. Producers are better off because the producer


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surplus (yellow region) is made larger. The government also has additional

tax revenue (blue region). However, the loss to consumers is greater than the

gains by producers and the government. The magnitude of this societal loss

is shown by the two pink triangles. Removing the tariff and having free trade

would be a net gain for society.[12][13]

An almost identical analysis of this tariff from the perspective of a net

producing country yields parallel results. From that country's perspective, the

tariff leaves producers worse off and consumers better off, but the net loss to

producers is larger than the benefit to consumers (there is no tax revenue in

this case because the country being analyzed is not collecting the tariff).

Under similar analysis, export tariffs, import quotas, and export quotas all

yield nearly identical results. Sometimes consumers are better off and

producers worse off, and sometimes consumers are worse off and producers

are better off, but the imposition of trade restrictions causes a net loss to

society because the losses from trade restrictions are larger than the gainsfrom trade restrictions. Free trade creates winners and losers, but theory and

empirical evidence show that the size of the winnings from free trade are

larger than the losses.[11]

Trade diversionAccording to mainstream economic theory, global free trade is a net benefit to

society, but the selective application of free trade agreements to some

countries and tariffs on others can sometimes lead to economic

inefficiency through the process oftrade diversion. It is economically efficientfor a good to be produced by the country which is the lowest cost producer,

but this will not always take place if a high cost producer has a free trade

agreement while the low cost producer faces a high tariff. Applying free trade

to the high cost producer (and not the low cost producer as well) can lead to

trade diversion and a net economic loss. This is why many economists place

such high importance on negotiations for global tariff reductions, such as

the Doha Round.[11]

SEAN India FTA: Sensitivenalysis of the Textiles and


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Clothing Sector of IndiaBy : P Nayak & Shakeel Ahamed

Source:Textiles Committee, Ministry of Textiles, Government o

India Mumbai

Implementation of the Free Trade Agreement (FTA) with Association

of South East Asian Nations (ASEAN)from 1st January 2010, India

has achieved an important milestone in pursuance of its objective toexpand its economic and political relationship with the neighbouring

nations. ASEAN consists of 10 countries namely Brunei Darussalam,

Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines,

Singapore, Thailand and Vietnam. The ASEAN-India FTA (AIFTA) is

considered a major step of India into the formidable regional trade

block of south Asia. Indias engagement with ASEAN started with theLook East Policy in 1991 and became a sectoral dialogue partner in

1992, further upgraded to Summit level in November 2001. A

framework agreement on Comprehensive Economic Cooperation

between ASEAN and India was signed on 8th October 2003. The

IFTA of trade in goods (TIG) was signed in August 2009.The

agreement enshrined progressive liberalization of duty to enhance

bilateral trade. Under the agreement each of the partner countries are

allowed to keep a small number of products out of the coverage of the

agreement and size of those products will not exceed 5 percent of the

bilateral traded imports. Since ASEAN is more efficient in some


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sectors of production such as agriculture, light manufacturing

(includes T&C, plastic manufacturing etc), auto and auto

components, etc, India resorted to a negative list approach to these

sensitive products and without a provision of protection, these

industries would be adversely affected.

The macro scenario

The rationale behind the AIFTA is clearly in favour of Indias entry

into the formidable south Asian regional trade block which has

greater significance in political maneuvering than trade. In the angle

of trade, the negative trade balance of India with ASEAN has been

perpetuity in the recent years. In spite of the fact that India has

preferential trade regimes with Thailand, Singapore and Myanmar

separately and/or as a part of the Bay of Bengal Initiatives for Multi-

Sectoral Technical and EconomicC

ooperation (BIMSTEC

) tradegroup, the performance of Indian trade has not improved much. India

has adverse balance of trade with these partners and over the years, it

is worsening (See table 1). The overall Indo-ASEAN bilateral trade

deficit during 2007 is around US$15 billion and that too has

significantly gone up to this level very recently. In spite of this,

economic theory propounds inherent trade creating possibilities othe FTAs by better flow of goods and services between the regions

besides helping transfer of technology for better production practices.

The combined Gross Domestic product (GDP) of the ASEAN10 is

larger than India and has a much larger per capita income of the

SEAN indicating economic development of the later (Table 2). The


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per capita income (PCI) of Singapore is approximately 38 times o

that of India, Brunei Darussalam about 36 times, Malaysia more than

8 times, Thailand about 4 times and Indonesians income is double o

the Indians. The combined import of the ASEAN from the world

during 2008 is US$ 895 billion about 4.7 fold of the Indian export to

the world. Given the economic and development strength of the

SEAN, the FTA between India and ASEAN may trigger a positive

trade flow of goods and services in this region. Studies indicate that

the trade between India and ASEAN is below its potential

(Bhattacharya, R and Mandal Avijit, 2009).A large number of studies

are strongly pitching in favour of AIFTA (Sen, Asher and Rajan

(2004), Mehta (2005), Yong (2005), Joseph and Parayil (2004),

Joseph (2009), Karmakar (2005), Mukherji et al (2003). Though

overall gain on account of expanded bilateral trade is predicted, there

has been widespread skepticism on trade diversion and sensitivity o

some sectors (Agriculture, Textiles, Auto and auto components,Electronics etc) that are vulnerable to the ASEAN imports, the sectors

in which the member countries of ASEAN have efficient production

systems in place. There is also skepticism that India may not benefit

from the tariff liberalization of ASEAN as most members have low

prevailing duty and further lowering of duty will not provide enough

room for accelerating exports from India (Pal, P and Dasgupta, M(2008)).

India Sees Red As Eu Allows Duty-Free Access

NEW DELHI: India will oppose preferential access given to Pakistans


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the devastating floods, a move that could render Indiasexports to the region uncompetitive.

The three-year favourable access to the27-country strong market will begin from January

next year, giving duty-free access to a number oftextile products from Pakistan.

This measure clearly violates the principle ofGeneral Most Favoured Nation Treatment (of the WTO), DK Nair, secretary general of the Confederation of IndianTextile Industry , wrote to the textiles ministry.The ministry has not given any assurance, but said it willoppose the proposal , Mr Nair said.

Some officials, however, feel that India may not have a strong case.The WTO actually has nothing substantial against preferential tarifMoreover, the EU has expressed its intention to ask forrelevant waivers, an official said.

The WTO cannot interfere till a country imposes a measure,say a quota on imports ,which allow imports from only some countrieswhile preventing others, said Ajay Sahai ,secretary of exporters body Fieo.

The only way in which India could challenge the moveis to expedite conclusion of its freetrade

agreement with the EuropeanUnion so that it too gets preferential access, he added.

The EU had, in October, introduced emergencyautonomous trade preferences for Pakistan to helpit recover from the devastating floods earlier this year.It decided to allow duty-free import 75 products from the country,


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64 of them textiles,amounting to almost 900 million in import value.

The move would put Indias textile exports to the EU ata serious disadvantage as its products would continue to face

6- 12% import duty. India exported textiles and clothing worth$5.9 billion to the EU in 2009 while Pakistans

what the Multi-Fibre Agreement was and why it was feltnecessary. It will then show, via a supply and demand analysis, the

effects of the MFA on both developed economies and less developedcountries (LDCs). The analysis will then identify who benefited and lostout from the MFA, the likely effects of removing the quota, includingidentifying who will gain most from doing so.

The Multi-Fibre Agreement was set up in 1974 as a set of formal quotaagreements and restrictions, governing textiles and the clothing tradebetween developing countries and the developed world. The MFA

replaced the 1964 Agreement in International Trade in Cotton Textiles.There are a number of reasons cited for the introduction of the MFA,although the most widely accepted is that of the developed world using itas a form of protectionism to secure their own textile industries againstthe threat posed by low-cost competition from less developed countries.

However, by giving quotas to individual nations, it also gave them aguaranteed share of the rich countries. (BBC News, 2004) This is in

contrast to some other justifications for the MFA, for example

a major aimof the multi-fibre agreement has been to provide greatest scope for newlyindustrialised countries to increase their share of world trade in textileproducts whilst at the same time maintaining some stability for textileproduction in the developed economies. (Griffiths and Wall, 1997)

The quotas, operated under the Agreement on Textiles and Clothing(ATC), were originally introduced under the MFA. A key feature of these


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quotas is that they are imposed only by a subset of countries and only onexports from a subset of exporters. (Hamilton, 1990) Another importantfeature is that the importers allow exporters to allocate the quotas andhence potentially to benefit from the higher prices in the restrictedmarkets. (Martin, Manole and Van Der Mensbrugghe, 2004)

The following supply and demand diagrams outline the theoretical affectsof imposing quotas such as the MFA.

(Taken from Griffiths & Wall, 1997)

The diagram assumes that world supply is perfectly elastic, andrepresented by point Pw, the point of production assuming free trade.Production of clothes and textiles in the developed economy isrepresented by 0Q1; and the level of demand for these products isrepresented by 0Q2. There is clearly a difference between the levelsupplied and demanded at this price; therefore, the developed worldneeds to import Q2-Q1 from the developing world economies.

Assume now the introduction of the MFA, which is represented by theimplementation of a quota, Q3-Q1, limiting imports from the developingeconomies to the developed world. The total supply into the developedeconomies is now represented by SH+Q, which results in a price risefrom Pw to Pw, and a reduction in demand from 0Q2 to 0Q5. In turn, the


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level of imports from the developing nations is reduced by the amount Q3 Q1.

The imposition of the MFA therefore, leads to a situation of reducedconsumer surplus, indicated by area 1+2+3+4. There is however, an areaof producer surplus, indicated by area 1 on the diagram, although the

quota leaves a net welfare loss represented by area 2+3+4.

This diagram explains the principles of the MFA as a quota system, andits effects. However, the MFA operates under a system where somecountries are restricted and others are not. The following diagram looks atthe effects of this situation.

(Adapted from Faini, De Melo and Takacs, 2001)

The assumptions for this diagram are as follows: there are two countriesexporting an identical textile product. D represents the demand curve fordeveloped countries, and S1 and S2 are supply curves for two developing

countries exporting to the developed country. If free trade existed, thenP0 would be the equilibrium price, and each country would export atlevels X1 and X2 respectively, where their supply curves intersect at P0.The MFA is now used to introduce an export quota on country 2, placinga cap on the number of imports, reflected by level Q2. Country 2s supplycurve now becomes vertical at the level of the quota, because theycannot export further goods beyond this point. The total level of supply tothe developed world now becomes S1+SQ2, raising the equilibrium price


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to P1. The level of exports from the country without a quota nowincreases to XQ1, to compensate for the loss of exports from the othercountry.

This diagram shows the inefficiencies created by implementing the MFA,through its restriction of imports from low-cost countries, shifting

production to higher costs countries. If the MFA were removed, allowingthe developing countries to produce at a cheaper rate then the productionsavings are represented by the grey area on the diagram. Therefore,consumers in developed countries pay more for their goods, and LDCs,subject to quotas, cannot generate the level of export earnings which theyotherwise could.

There is an argument that developing countries actually benefit through

the MFA, because they receive quota rents, meaning they receive higherprices than they would be guaranteed in a free market, as shown by area1 on the first diagram above. However, this is not likely to be a validargument given that a study by Balassa and Michalopoulos (1985)showed that the value of lost output, as highlighted by the diagrams,exceeds the quota rent by 9 times to the US, and by 7 times to the EU. Inaddition, quotas on imports of textiles in the US have restricted thesupply of certain apparel products and increased their price by as much

as 70% (Tanzea, 2000 cited in Hill).

It is therefore argued that the bilateral quotas that make up the MFAarbitrarily divide up markets and prevent trade flows from efficientlyallocating production and efficiently distributing goods among consumersin different countries. (Faini, De Melo and Takacs, 2001)

In 1994, as part of the Uruguay Round of multilateral trade negotiations, itwas decided that the MFA should be phased-out by January 1st 2005, as

part of the Agreement on Textiles and Clothing. This was to ensure thatthe clothing and textile industry become better aligned with the principlesof WTO, and the promotion of free trade. (See Appendix I for the QuotaRemoval under the ATC)


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