Free Trade Agreements, Their Impact, Types, and Examples

How Trade Agreements Lower Prices

Sheikh and European Businessmen
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Trade agreements are 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.

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 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 in US$ millions.

Three Types of Trade Agreements

There are three types of trade agreements. The first is a unilateral trade agreement. It occurs 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. They want 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 are between two countries. Both countries agree to loosen trade restrictions to expand business opportunities between them. They lower tariffs and confer preferred trade status with each other. The sticking point usually centers around key protected or subsidized domestic industries. For most countries, these are in the automotive, oil or food production industries. The United States has 16 bilateral agreements. The Obama administration was negotiating the world's largest bilateral agreement.

Multilateral trade agreements are the most difficult to negotiate. These are among three countries or more. The greater the number of participants, the more difficult the negotiations are. They are also more complex than bilateral agreements. Each country has its own needs and requests.

Once negotiated, multilateral agreements are very powerful. They cover a larger geographic area. That confers a greater competitive advantage on the signatories. All countries also give each other most favored nation status. They agree to treat each other equally. 

The largest multilateral agreement is the North American Free Trade Agreement. It is between the United States, Canada and Mexico. Their combined economic output is $20 trillion. NAFTA quadrupled trade to $1.14 trillion in 2015.  But it also cost between 500,000 to 750,000 U.S. jobs. Most were in the manufacturing industry in California, New York, Michigan and Texas. For more, see Pros and Cons of Free Trade Agreements

The United States has one other multilateral regional trade agreement. The United States negotiated the Central American-Dominican Republic Free Trade Agreement. It was with Costa Rica, Dominican Republic, Guatemala, Honduras, Nicaragua, and El Salvador. It eliminated tariffs on more than 80 percent of U.S. exports.

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

Effects

There are pros and cons to trade agreements. By removing tariffs, they lower prices of imports. Consumers benefits. But 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. 

The Role of the WTO in Trade Agreements

Once agreements move beyond the regional level, they usually need help. The World Trade Organization steps in at that point. It is an international body that helps negotiate global trade agreements. Once in place, the WTO enforces the agreements and responds to complaints.

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.

Unfortunately, the two most powerful economies refused to budge on a key sticking point. Both the United States and the EU resisted lowering farm subsidies. These subsidies 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. When that happens, they must look for jobs in congested urban areas. The U.S. and EU refusals to cut subsidies doomed the Doha round. It is a thorn in the side of all future world multilateral trade agreements.

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,