Free Trade Area

Free Trade Area

Free Trade Area, an arrangement between two or more countries to eliminate customs and other trade barriers between them while allowing each to retain its tariff against other countries. It is contrasted with a customs union, which provides similarly for free trade between members but adopts a common external tariff. Management of a customs union calls for some degree of integration of the fiscal, monetary and social policies of member countries. A free trade area permits more financial autonomy among members but creates problems in the treatment of re-exports within the free trade area of goods imported from outside. Since traders in high-tariff member countries gain by importing from outside the area through a low-tariff member rather than by importing directly, the effective rate of duty on imports of any commodity from outside tends to be reduced to that of the lowest-tariff member. Hence in practice free trade between members is rarely complete but tends to be confined to commodities produced wholly or mainly in the member countries.

Both free trade areas and customs unions tend to divert trade from countries outside and to promote trade within them. Trade diversion is likely to be more, and trade creation smaller, the less competitive the economies of the member-countries. Both create zones of preferential treatment and in terms of the possible advantages of international division of labour are inferior to more general liberalization of trade. But they may be economically advantageous as politically necessary first steps in this direction. A free trade area may lend itself more to extension in this way than does a customs union, since a common external commercial policy may lead to pressure for increased protection to fence it in and facilitate financial or other forms of autarky. This is a math doubt that some economists have had about the Common Market.

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