Free Trade Agreements

—By Charu Latha

According to Investopedia, a free trade agreement (FTA) is a pact between two or more countries to reduce barriers to imports and exports between them. Under a free trade policy, goods and services can be bought and sold across international borders with little or no government tariffs, quotas, subsidies, or prohibitions that hinder their exchange. The concept of free trade is the opposite of a closed economy and trade protectionism. A government need not implement any specific policy to implement free trade, it needs to follow a laissez-faire approach to economy. Laissez-faire (French for ‘allow to do’) is a policy of minimum governmental interference in the economic affairs of individuals and society. Free trade policy is a formal and mutual agreement between nations. A free trade pact between two countries does not necessarily mean eliminating all the policies of control (tariffs, taxes, duties, quota) over their imports and exports, but it only means rationalising these controls so that they do not hurt consumers and businesses in their respective countries. It needs to be understood that even with a free trade pact, countries do impose some measures to control imports and exports.

Free trade allows businesses in each country to focus on the commodities which they specialise in or commodities that they can produce at a relatively lower price by efficiently utilising the resources available. The mix of both domestic production and foreign trade allows economies to satisfy their consumers as well as grow faster.

India is a fairly open economy with overall trade (exports plus imports) as a percentage of gross domestic product (GDP) around 40 per cent. Over half of the international trade happens through regional trade agreements (RTAs). According to data from Ministry of Commerce and Industry, as of April 2022, India has signed 13 FTAs with its trading partners such as Sri Lanka, South Asian Free Trade Area Countries (SAFTA), Nepal, Bhutan, Thailand Early Harvest Scheme (EHS), Singapore Comprehensive Economic Cooperation Agreement (CECA), the ASEAN, South Korea Comprehensive Economic Partnership Agreement (CEPA), Japan, Malaysia, Mauritius Comprehensive Economic Cooperation and Partnership Agreement (CECPA), UAE and Australia Economic Cooperation and Trade Agreement (ECTA). In addition to these FTAs, India has signed six limited coverage preferential trade agreements (PTAs). The economic impact assessment of FTAs reveals that there has been growth in both exports and imports with FTA partners.

Benefits of FTAs

1. Elimination of trade barriers: FTAs facilitate free trade, eliminate trade barriers and give easier access to markets and encourage the cross-border movement of products and services.
2. Increased integration and technology sharing: With increased trade between countries entering into trade pact, there is a better integration of markets. This can also facilitate transfer of skills and technology.
3. Increased competition: The import and export of commodities in a country could create competitiveness among the local industries. This could make them more productive and efficient. FTAs could also decrease the dependence of local industries on the government for support and protection from foreign competition.
4. Competitive prices: In the absence of free trade, domestic industries enjoy monopoly in the domestic market and could charge high prices for their products. But, once the foreign companies enter the domestic market with comparatively lower prices and better quality products, the domestic companies also face competition and will maintain competitive prices by either improving their efficiency or lowering their prices.
5. Improves regional cooperation: FTAs help in establishing a better framework for cooperation among the member countries. These also help in facilitating multilateral negotiations and reducing complexities.

Disadvantages of FTAs

1. Increased job outsourcing: With reduction in tariffs and trade barriers as a result of free trade pact between countries, there is an increased flow of goods and services, including mobility of capital and labour. Due to the increased competition, the firms could lay off workers and offer the jobs to other countries (outsourcing) where labour may be cheaper.
2. Crowding out domestic industries: In many developing countries, farming is the primary occupation and the majority of the population depends on agriculture for employment and livelihood. With free trade pacts and the resultant openness of the economy, domestic industries are exposed to increased competition. At times, competition becomes very intense for the domestic industries and they may not be able to survive. As a result, some or many of the domestic industries are forced to shut down.
3. Poor working conditions: As a result of inadequate labour protection framework, workers’ jobs and salaries are not protected in underdeveloped and developing countries. With free trade in place and outsourcing of jobs in developing countries (due to the availability of cheaper labour there), employers may try to extract the maximum work out of their employees. Workers may be forced to work in unhealthy and exploitative work environments.
4. Issues with intellectual property right (IPRs): Many developing countries do not have proper laws in place to protect intellectual property such as inventions, new processes, and patents. Even if there are laws related to intellectual property, they are at best weakly enforced. With free trade and inflow of imports into the country, foreign products, at times, get copied by domestic producers. This happens due to high prices of imports. All these take place due to weak enforcement of intellectual property rights.
5. Degradation of natural resources: Given the fact that environmental protection framework is relatively weak in underdeveloped and developing countries, free trade exacerbates the environmental protection problem. Free trade, in absence of sound environmental regulations, leads to an increased exploitation of resources such as minerals, timber, flora and fauna and other natural resources. Degradation of land, deforestation, pollution of water bodies are some of the examples.

With respect to FTAs entered by India, the following are some of the observations:

• India’s exports to FTA countries have not outperformed the export growth to the rest of the world. This shows that the export capacity of India has not been much affected due to FTAs.
• FTAs have a bigger impact on metals on importing side and textiles on exporting side, according to Economic Survey 2016–17. A 10 per cent reduction in tariffs for metals increases imports by 1.4 per cent. India exports iron ore.
• FTAs have led to more increases in imports than the increase in exports.
• After the FTAs with Korea, Japan, and ASEAN came into effect, trade deficit of India has widened with them, showing that India imported more than it exported to them.
• The utilisation of RTAs by Indian exporters is very low (between 5 per cent and 25 per cent).

India’s recent surge in exports could mostly be attributed to an increase in foreign demand, favourable global conditions, and diversification of the export basket in terms of both the number of commodities and the destination of exports. Another important aspect is that India’s exports are more responsive to income changes as compared to price changes. This means that the elimination of tariffs to reduce prices does not significantly boost exports.

FTAs have both advantages and costs. But it is important for the country taking part in the negotiations to review and refer to its existing FTAs such that it can evaluate the benefits and the drawbacks of the agreements it entered into and the resultant patterns of trade that followed. India should review its existing trade pacts and concentrate on FTAs or bilateral agreements where the cost-to-benefit ratio is low and such that it entails benefits in the long run. Another important thing to be kept in mind while negotiating agreements is that they should have mutually reciprocal terms and focus on products and services which have maximum export potential.

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