Free Trade Agreements: Their Impact, Types, and Examples

How Trade Agreements Lower Prices

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Trade agreements occur when two or more nations agree on the terms of trade between them. They determine the tariffs and duties that countries impose on imports and exports. All trade agreements affect international trade.

Definitions

Imports are goods and services produced in a foreign country and bought by domestic residents. That includes anything shipped into the country even if it's by the foreign subsidiary of a domestic firm. If the consumer is inside the country's boundaries and the provider is outside, then the good or service is an import.

Exports are goods and services that are made in a country and sold outside its borders. That includes anything shipped from a domestic company to its foreign affiliate or branch.

Below you can see a world map with the largest trade agreements in 2018. Hover over each country to get a rounded breakdown of imports, exports, and balances.

3 Types of Trade Agreements

Trade agreements are usually unilateral, bilateral, or multilateral.

Unilateral Trade Agreement

These occur when a country imposes trade restrictions and no other country reciprocates. A country can also unilaterally loosen trade restrictions, but that rarely happens. It would put the country at a competitive disadvantage. The United States and other developed countries only do this as a type of foreign aid in order to help emerging markets strengthen strategic industries that are too small to be a threat. It helps the emerging market's economy grow, creating new markets for U.S. exporters.

Bilateral Trade Agreements

Bilateral agreements involve two countries. Both countries agree to loosen trade restrictions to expand business opportunities between them. They lower tariffs and confer preferred trade status on each other. The sticking point usually centers around key protected or government-subsidized domestic industries. For most countries, these are in the automotive, oil, or food production industries. The Obama administration was negotiating the world's largest bilateral agreement, the Transatlantic Trade and Investment Partnership with the European Union. 

Multilateral Trade Agreements

These agreements among three countries or more are the most difficult to negotiate. The greater the number of participants, the more difficult the negotiations are. By nature, they are more complex than bilateral agreements, as each country has its own needs and requests.

Once negotiated, multilateral agreements are very powerful. They cover a larger geographic area, which confers a greater competitive advantage on the signatories. All countries also give each other most-favored-nation status—granting the best mutual trade terms and lowest tariffs.

The largest multilateral agreement is the United States-Mexico-Canada Agreement (USMCA, formerly the North American Free Trade Agreement or NAFTA) between the United States, Canada, and Mexico.

Over the agreement's first two decades, regional trade increased from roughly $290 billion in 1993 to more than $1.1 trillion by 2016. Critics disagree about the net impact on the U.S. economy, but some estimates put the net domestic job losses due to the agreement at 15,000 per year.

The United States has one other multilateral regional trade agreement: the Dominican Republic-Central America FTA (CAFTA-DR). This arrangement with Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, and Nicaragua eliminated tariffs on more than 80% of U.S. non-textile manufactured goods exports.

The Trans-Pacific Partnership would have replaced the USMCA as the world's largest agreement. In 2017, President Donald Trump withdrew the United States from the agreement.

All told, the U.S. currently has 14 trade agreements involving 20 different countries.

The Role of the WTO in Trade Agreements

Once agreements move beyond the regional level, they need help. The World Trade Organization steps in at that point. This international body helps negotiate and enforce global trade agreements.

The WTO currently enforces the General Agreement on Tariffs and Trade.

The world almost received greater free trade from the next round, known as the Doha Round Trade Agreement. If successful, Doha would have reduced tariffs across the board for all WTO members. 

Doha round talks were off and on for over a decade, and the reasons for their failure are complex. Many of the issues hinged on the two most powerful economies—the U.S. and the EU. Both resisted lowering farm subsidies, which would have made their food export prices lower than those in many emerging market countries. Low food prices would have put many local farmers out of business. The U.S. and EU refusals to cut subsidies, among other issues, doomed the Doha round.

The failure of Doha allowed China to gain a global trade foothold. It has signed bilateral trade agreements with dozens of countries in Africa, Asia, and Latin America. Chinese companies receive rights to develop the country's oil and other commodities. In return, China provides loans and technical or business support.

Effects of Trade Agreements

There are pros and cons to trade agreements. By removing tariffs, they lower prices of imports and consumers benefit. However, some domestic industries suffer. They can't compete with countries that have a lower standard of living. As a result, they can go out of business and their employees suffer. Trade agreements often force a trade-off between companies and consumers.

On the other hand, some domestic industries benefit. They find new markets for their tariff-free products. Those industries grow and hire more workers. These trade-offs are the subject of endless debate among economists.

The Bottom Line

Free trade allows for the unrestricted import and export of goods and services between two or more countries. Trade agreements are forged to lower or eliminate tariffs on imports or quotas on exports. These help participating countries trade competitively.

Trade agreements assume three different types:

  • Unilateral: Only one country enjoys fewer restrictions.
  • Bilateral: This agreement between two countries loosens trade restrictions.
  • Multilateral: Three or more nations are involved in this agreement. The USMCA (formerly NAFTA) is the largest trade agreement to date

The Doha Round would have been the largest global trade agreement if the United States and EU had agreed to lower their agricultural subsidies. In the wake of its failure, China gained global economic ground by garnering profitable bilateral agreements with countries in Asia, Africa, and Latin America.

The WTO helps negotiate global trade agreements. It enforces the General Agreement on Tariffs and Trade (GATT).

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