Free Trade Agreements

A free trade agreement (FTA) is a reciprocal agreement in which two or more economies remove or reduce tariffs and other trade barriers on trade among themselves. Under the multilateral trading system, it is a permitted departure from the most-favoured-nation principle, because members grant preferential treatment to their FTA partners while retaining separate trade policies toward non-members.

Place within WTO rules

The WTO permits regional trade agreements subject to disciplines intended to prevent them from becoming barriers to wider multilateral trade.

• For trade in goods, Article XXIV of GATT 1994 permits free-trade areas and customs unions.
• An FTA must eliminate duties and other restrictive regulations of commerce on substantially all trade among its members.
• Duties and trade regulations applied by each FTA member to non-members should not become higher or more restrictive than those existing before the FTA.
• For trade in services, Article V of GATS permits economic integration agreements having substantial sectoral coverage and eliminating substantially all discrimination among participating economies.

How an FTA operates

An FTA grants preferential market access only to goods or services satisfying its agreed conditions. Unlike a customs union, each FTA member retains its own external tariffs and trade policy toward non-members.

• Rules of origin identify goods that genuinely originate within member economies and therefore qualify for preferential tariffs.
• An FTA may cover goods, services, investment, intellectual property, government procurement and regulatory cooperation, depending on its negotiated scope.
• WTO members notify regional trade agreements to the WTO, where they are considered under the relevant transparency and legal provisions.

Economic significance

FTAs can enlarge markets, improve competition and support specialization, but their welfare effects depend on how trade patterns change.

• Trade creation occurs when lower-cost imports from a partner replace higher-cost domestic production.
• Trade diversion occurs when preferential imports from a partner replace lower-cost imports from a non-member.
• Different rules of origin and overlapping agreements can raise compliance costs and complicate the multilateral trading system.