Free trade agreements
What are free trade agreements?
Free trade agreements are agreements between two or more countries with the aim of simplifying trade between countries. The trade agreements create free trade areas in which states do not impose tariffs on each other and do not limit the quantity of goods traded. In contrast to a customs union, the countries involved can still make independent trade policy decisions vis-à-vis third countries. Thus, protectionism against countries with which there is no agreement continues.
Countries around the world have entered into agreements with one or more countries on the free trade of goods and services. Some of the world’s best-known free trade agreements include:
- NAFTA: Abbreviation for North American Free Trade Agreement as free trade area between the US, Canada and Mexico
- CPTPP: Abbreviation for Comprehensive and Progressive Agreement for Trans-Pacific Partnership as a trade agreement between Australia, New Zealand, Singapore, Canada, Japan, Vietnam, Brunei, Chile, Malaysia, Peru and Mexico
- JEFTA: Abbreviation for Japan-EU Free Trade Agreement
- CEFTA: Abbreviation for Central European Free Trade Agreement as trade agreement between seven Eastern European countries
- CETA: Abbreviation for Comprehensive Economic and Trade Agreement as EU-Canada trade agreement
- AFTA: Abbreviation for ASEAN Free Trade Area as Free Trade Agreement between Southeast Asian countries
Negotiations on the proposed Transatlantic Free Trade Agreement between the European Union (EU) and the US, called the Transatlantic Trade and Investment Partnership (TTIP), came to a halt after the election of Donald Trump as US president, as the US government suspended free trade with the EU.
When two or more countries conclude agreements, they waive barriers to cross-border trade between the parties. Tariffs and so-called non-tariff barriers, such as import quotas, design regulations or other foreign trade restrictions, will be abolished between the participating states. Moreover, if countries form a customs union, they also impose common tariffs and import restrictions on products from non-participating countries. The conclusion of a trade agreement is preceded by long negotiations between the parties, which can drag on for decades.
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How does a free trade agreement come about?
If a company does not only want to sell its products domestically, it has to expect tariffs and trade restrictions on exports. In order to facilitate foreign trade, exporters turn to their government to negotiate a free trade agreement with certain countries. Importers are also approaching their government to import simpler and cheaper raw materials and finished products.
Governments also have an interest in international agreements. Global trade can support the domestic economy. This leads to cost reductions for companies, safeguards jobs and ensures that votes are cast at the next election. Exporting nations, such as Germany, are also dependent on the export of goods. For other countries, exports mainly mean foreign exchange income needed to buy raw materials and food that are scarce at home.
Trade agreements ensure global trade in goods and services. If products are to be sold abroad, imports and exports of the goods must be permitted and prices must not be increased by customs duties. To this end, the participating States conclude detailed agreements. The treaties include numerous decisions to facilitate free trade. In addition to a list of duty-free products, states agree to take further measures to reduce barriers to international trade relations and to ensure a strong export and import.
How are trade barriers removed?
One of the objectives of a trade agreement is to remove barriers to cross-border trade. In doing so, the States distinguish between Tariff and non-tariff barriers.
Tariff barriers include:
- Export tax or export duty
- Import tax or import duty
- Subsidies for imports and exports
Here is a list of the main non-tariff barriers:
- Legal provisions
- technical regulations
- Design specifications
- Safety standards
- Food law and pharmaceutical law
- Registration conditions for machinery and vehicles
If two or more states want to loosen their own country’s protectionism and reach an agreement on free trade, the above-mentioned barriers to trade must be removed or watered down. To this end, either individual countries negotiate with each other or the EU takes over the negotiations for all member states.
In May 2017, the European Court of Justice (ECJ) issued an opinion that new free trade agreements no longer need to be ratified by both the European Union and all member states. The EU can also make agreements on investment protection agreements on its own. Only if sub-areas are mixed competences must individual countries explicitly approve the agreement. An example of mixed competence is the Comprehensive Economic and Trade Agreement(CETA),which has so far been ratified by 14 EU countries. The other states have yet to approve the agreement. Until then, CETA has entered into force provisionally.
What is the difference with preferential agreements?
In the case of a preferential agreement, one State grants another country duty-free and other advantages. There are both unilateral preferential agreements and reciprocal agreements. The arrangements are either made by individual governments with specific countries or the EU makes agreements with whole groups of countries. The parties differ between two forms of preference:
- Free movement preference: Goods already taxed and taxed do not have to be taxed again in the recipient country.
- Preference of origin: According to the rule of origin, the goods must have been processed or processed in prescribed steps. In addition, the origin of the products must be established. The goods will then be imported either duty-free or favoured by customs duties.
Germany maintains a generalised system of preferences with around 80 developing countries. Preferential agreements have also been concluded with other countries and groups of countries around the world. Entrepreneurs can inquire about the so-called preferential areas. It lists the individual countries with duty-free or special conditions for the import and export of goods and services.
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What free trade agreements does the EU have?
The Federal Ministry of Economics and Energy announces on its website that the European Union has trade agreements with more than 30 countries. Some of the agreements have been in place since the 1970s. In order to facilitate global trade relations, new agreements are regularly added. The list is constantly updated and supplemented with the most recent financial statements. These include:
- February 2019: Japan-EU Free Trade Agreement JEFTA as Investment Protection Agreement and Trade Agreement with Japan
- March 2020: EU-Vietnam Free Trade Agreement EVFTA as trade agreement between the European Union and Vietnam (EV)
Negotiations on a new agreement drag on for so long, among other things, because the negotiators also have to reach agreement on compliance with and the protection of certain standards. In particular, the issues of environmental protection, labour law, data protection and public services of general interest are handled differently in different countries and must be adapted.
What are the benefits of free trade agreements?
Free trade offers these benefits to businesses, consumers and governments:
- Simplified exchange of goods and services
- falling prices
- larger sales markets
- more jobs
- rising economic growth
- higher tax revenues
- international transfer of technology and know-how
- Reducing bureaucracy
If a company can sell its products duty-free and unbureaucratically abroad, the sales market increases and sales and profits increase. This secures jobs and raises tax revenues in the home country. Due to the larger production, the goods can be offered more cheaply both at home and abroad. Consumers benefit from this and rising sales ensure steady economic growth.
The importing country benefits from new technology and new products. The more the business relationship between the States deepens, the more stable the relationship with each other. The risk of conflict decreases when one country is dependent on obtaining certain products or raw materials from another country. Despite the many advantages, there are also critics of free trade who point out the disadvantages involved.
Are there any drawbacks?
Critics point out these disadvantages of global trade relations:
- Job losses in less developed countries
- Exploitation of raw materials and natural resources
- Theft of foreign technology and imitations
- poor working conditions in some countries
When negotiating free trade with another country, politicians must consider all the social, economic and environmental consequences and try to find agreement. If they succeed, both citizens and businesses in each country will benefit from the benefits.
How do companies benefit from free trade?
International suppliers can use the open markets to reduce costs. Large companies often have their own foreign department, which is responsible for the dispatch and customs clearance of the goods. Once a trade agreement has been concluded with the importing country, tariffs will disappear and the bureaucracy for logistics will also be significantly reduced. This results in less time for the exporter, which saves costs as a result.
Importers also benefit from open markets. Goods or raw materials can be imported more cheaply and more quickly by eliminating customs costs and by simplifying import formalities. As a result, your own products can be produced more quickly and delivered to buyers. This ensures greater customer satisfaction and increases sales. In addition, if safety standards or technical requirements are aligned, the importer can add more foreign products to its inventory that comply with German regulations. The larger offer acquires new customers and also increases sales.
What are the advantages for small and medium-sized enterprises?
There are also advantages for small and medium-sized enterprises, as shown, among others, by the JEFTA agreements with Japan or EVFTA between the EU and Vietnam (EV). Small and medium-sized enterprises (SMEs) are the employers of about two thirds of all employees in Germany. The sales markets in Asia have so far been difficult for these companies to reach. There is often a lack of trained staff to meet the complex legal and administrative requirements of foreign trade operations. In addition, companies must either add the customs costs to the selling price or deduct them from their profits. For this reason, the Asian market has not been very interesting for SMEs.
This has changed with JEFTA and EVFTA. SMEs can now import goods from Asia duty-free or offer their products on the Asian market. However, companies must bear in mind that not all customs duties are eliminated at the beginning of the trade agreement. As a rule, a gradual adjustment is foreseen, which lasts for several years. In the first place, only certain goods benefit from the tariff reduction. However, the list of goods may change and be extended at a later date. SMEs should therefore regularly inquire about the ongoing negotiations and new decisions on open markets around the world.
Once an agreement has been concluded and trade restrictions are eliminated, SMEs should seize the opportunity to explore new markets in Asia or overseas. With an experienced logistics partner at their side, SMEs can supply foreign business partners and thus increase turnover and profit!
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