Q37+-+International

//** What are the main features of a free trade area? **//

A free trade area is formed when a group of nations abolish tariffs and quotas on selected goods amongst themselves, whilst maintaining the right to impose individual external tariffs and quotas against non-members.

Free trade areas differ from preferential trading areas in that tariffs are completely abolished instead of being merely lowered.

There are various repercussions of free trade area formation. One such implication is a greater incentive for increased trade amongst member nations. Members would, however, encounter a decrease in tariff revenues. On the other hand, economic welfare in member countries would be gained as prices fall and consumer/producer inefficiency losses are lessened. Additionally, dynamic benefits like benefits of scale and technological spread can be derived from more competition. A disadvantage though is that non-members may be more efficient and consequently misallocation could occur.

An example of a free trade area is the North American Free Trade Agreement abbreviated NAFTA. Other free trade areas include the Asia-Pacific Economic Cooperation (APEC), the Association of South East Asian Nations (ASEAN), and the Mercado Común del Sur (MERCOSUR).

Re-export tariffs and local content requirements – also known as rules of origin – are two concepts that relate to free trade areas. Re-export tariffs are implemented when non-members export to members where tariffs are lowest and then re-export to another member where the good was initially destined for. To tackle this situation, non-members establish assembly plants in the low tariff member nations and import goods in parts. This is done because if goods are produced within a free trade area, they are exempt from tariffs. Here is where local content requirements come into effect whereby "minimum requirements are set on value-added of final goods within the free trade area". __For example, NAFTA has a requ__ __ irement that 62.5% of the content of any automobile sold in the U.S. from Mexico must come from within the FTA. __

Source: Page 524, //Econom// //ics //by Matt McGee   The diagram above is a suitable representation of the nature of a free trade area. Letters A, B, and C denote three member nations. The two-way arrows represent trade between these nations and is incoming and outgoing (imports and exports), as well as, free from any tariffs or barriers. Each of the three countries though, imposes tariffs on imports from non-members. Country A imposes a tariff of 5%, country B of 9%, and country C of 7%. Therefore, it also accurately reflects how each nation can apply tariffs of different proportions.