how a free trade agreement fta works
in the modern world free trade policy is often implemented by means of a formal and mutual agreement of the nations involved however a free trade policy may simply be the absence of any trade restrictions a government doesn t need to take specific action to promote free trade this hands off stance is referred to as laissez faire trade or trade liberalization governments with free trade policies or agreements in place do not necessarily abandon all control of imports and exports or eliminate all protectionist policies in modern international trade few free trade agreements ftas result in completely free trade the benefits of free trade were outlined in on the principles of political economy and taxation published by economist david ricardo in 1817 1for example a nation might allow free trade with another nation with exceptions that forbid the import of specific drugs not approved by its regulators animals that have not been vaccinated or processed foods that do not meet its standards it might also have policies in place that exempt specific products from tariff free status in order to protect home producers from foreign competition in their industries in principle free trade on the international level is no different from trade between neighbors towns or states however it allows businesses in each country to focus on producing and selling the goods that best use their resources while other businesses import goods that are scarce or unavailable domestically that mix of local production and foreign trade allows countries to experience faster growth while better meeting the needs of their consumers this view was first popularized in 1817 by economist david ricardo in his book on the principles of political economy and taxation he argued that free trade expands the diversity and lowers the prices of goods available in a nation while better exploiting its homegrown resources knowledge and specialized skills 1free trade modelsprior to the 1800s global trade was dominated by the theory of mercantilism this theory placed priority on having a favorable balance of trade relative to other countries and accumulating more gold and silver in order to attain a favorable balance of trade countries would often place trade barriers like taxes and tariffs to discourage their residents from purchasing foreign goods this incentivized consumers to purchase locally made products thereby supporting domestic industries ricardo introduced the law of comparative advantage which states that countries can attain the maximum benefits through free trade ricardo demonstrated that if countries prioritize producing the goods that they can produce more cheaply than other countries i e where they have a comparative advantage they will be able to produce more goods in total than they would by limiting trade 2advantages and disadvantages of free tradefree trade has allowed many countries to attain rapid economic growth by focusing on exports and resources where they have a strong comparative advantage many countries have been able to attract foreign investment capital and provide relatively high paying jobs for local workers for consumers free trade creates a competitive environment where countries strive to provide the lowest possible prices for their resources this in turn allows manufacturers to provide lower prices for finished goods ultimately increasing the buying power for all consumers however there are economic losers when a country opens its borders to free trade domestic industries may be unable to compete with foreign competitors causing local unemployment large scale industries may move to countries with lax environmental and labor laws resulting in child labor or pollution free trade can also make countries more dependent on the global market for example while the prices of some goods may be lower in the world market there are strategic benefits for a country that produces those goods domestically in the event of a war or crisis the country may be forced to rebuild these industries from scratch allows consumers to access the cheapest goods on the world market allows countries with relatively cheap labor or resources to benefit from foreign exports under ricardo s theory countries can produce more goods collectively by trading on their respective advantages competition with foreign exports may cause local unemployment and business failures industries may relocate to jurisdictions with lax regulations causing environmental damage or abusive labor practices countries may become reliant on the global market for key goods leaving them at a strategic disadvantage in times of crisis public opinion on free tradefree trade divides economists and the general public research suggests that economists in the u s support free trade policies at significantly higher rates than the general public 3in fact the american economist milton friedman said the economics profession has been almost unanimous on the subject of the desirability of free trade 4free trade policies have not been as popular with the general public the key issues include unfair competition from countries where lower labor costs allow price cutting and a loss of good paying jobs to manufacturers abroad the call on the public to buy american may get louder or quieter with the political winds but it never goes silent not surprisingly the financial markets see the other side of the coin free trade is an opportunity to open another part of the world to domestic producers moreover free trade is now an integral part of the financial system and the investing world american investors now have access to most foreign financial markets and to a wider range of securities currencies and other financial products however completely free trade in the financial markets is unlikely in our times there are many supranational regulatory organizations for world financial markets including the basel committee on banking supervision the international organization of securities commission iosco and the committee on capital movements and invisible transactions examples of free trade agreementsthe european union is a notable example of free trade today the member nations form an essentially borderless single entity for the purposes of trade and the adoption of the euro by most of those nations smooths the way further 56it should be noted that this system is regulated by a central bureaucracy that must manage the many trade related issues that come up between representatives of member nations 7the united states currently has a number of free trade agreements in place these include multi nation agreements such as the united states mexico canada agreement usmca which covers canada and mexico and the central america dominican republic free trade agreement cafta dr which includes costa rica the dominican republic el salvador guatemala honduras and nicaragua there are also separate trade agreements with nations from australia to peru 8910collectively these agreements mean that about half of all industrial goods entering the u s come in free of tariffs according to government figures the average import tariff on industrial goods is 2 11all these agreements collectively still do not add up to free trade in its most laissez faire form american special interest groups have successfully lobbied to impose trade restrictions on hundreds of imports including steel sugar automobiles milk tuna beef and denim 