24 Aug 2015 20:58 IST

Free Trade Agreement: A blessing or a curse?

FTAs can have negative effects on domestic industry. The focus should be on policies promoting wealth stabilisation

“Free trade is not based on utility but on justice” said Edmund Burke. Free trade agreements (FTAs) are intended to stimulate trade between countries by reducing or eliminating restrictions such as tariffs, quotas, special fees and taxes. The purpose is to facilitate transactions and promote more business between countries or areas based on comparative economic advantages that should allow both sides to benefit. FTAs can help more businesses enter and compete in the global marketplace by levelling the international playing field.

FTAs and PTAs (Preferential Trade Agreements) are often used synonymously; however, they are not. In a PTA, two or more partners agree to reduce tariffs on an agreed number of tariff lines. PTAs do not cover substantially all trade. In FTAs, tariffs on items covering substantial bilateral trade are eliminated between the partner countries. However, each maintains an individual tariff structure for non-members.

The key difference between an FTA and a PTA is that while in a PTA there is a positive list of products on which duty is to be reduced; in an FTA there is a negative list on which duty is not reduced or eliminated. Thus, compared to a PTA, FTAs are generally more ambitious in coverage of tariff lines (products) on which duty is to be reduced.

Enabling competition

FTA can help strengthen business climates and encourage economic growth by allowing for greater competition. By reducing tariffs and duties, the agreements bring down the costs that businesses in each country incur in selling their goods and services in the partner country, making it more profitable for them to compete. This can lead to a wider choice of products and lower prices for consumers, especially when there are relative competitive advantages between the partners to the agreement.

In addition to reducing the cost of transactions between countries, recently, FTAs are evolving to reduce non-tariff barriers that pose a threat to international trade (such as quota restrictions, licensing requirements). The government of each country adopts non-discriminatory rules and regulations and more transparent procedures. Breaking the stereotypical trade in goods, recently, countries have been executing economic co-operation / partnership agreements to include trade in services also. Economic FTAs can include provisions to protect intellectual property rights, open up government procurement opportunities and ease foreign investment rules.

There are generally provisions for facilitating Customs procedures, granting access to financial services, easing restrictions on the entry of foreign nationals for business trips, and dispute settlement.

FTAs promote regional economic integration and build shared approaches to trade and investment, including through the adoption of common Rules of Origin, and add domestic value through a broader acceptance of product standards.

Some of the major regional trade agreements include the European Union, the European Free Trade Association (EFTA), the North American Free Trade Agreement (NAFTA), the Southern Common Market (Mercosur), the Association of Southeast Asian Nations (Asean) Free Trade Area (AFTA), and the Common Market of Eastern and Southern Africa (Comesa). However, FTAs have been a double-edged sword ever since their inception.

Make in India

FTAs that provide for nil or concessional rates of Customs duties can be adverse for the Indian market. In such a situation, a buyer would be better off if his goods are imported into India rather than purchased within India. A small numerical example would be as follows.

FTAs make it easier for big businesses to import products from poor countries because lower trade barriers allow them to take advantage of cheap labour costs. The problem is that cheap labour often has a high human cost. For instance, after Jordan signed a free trade agreement with the United States, major American retailers ordered millions of dollars worth of clothing from Jordan, where manufacturers promised low prices.

They kept this promise by allegedly forcing employees to work up to 20 hours a day, often for less than the state-mandated minimum wage. Without the free trade agreement, it’s unlikely that American retailers would have placed so many orders in Jordan as trade barriers would have made the clothes too expensive.

Impact on domestic industry

Free trade agreements often damage a nation’s domestic industries by exposing it to competition from foreign producers with lower costs. On an honest footing, the world doesn’t really require such hollow and lopsided policies as FTAs. Rather, what we require are fairer wealth distribution policies.

Today, the wealth accumulated by the hundred richest persons in the world is enough to end global poverty four times over. Shockingly, the wealth of the top one per cent has increased by 60 per cent over the last two decades and was not even affected by the last financial crisis. And there is every likelihood that any FTA-driven Indian economic growth, if at all, would be a jobless one, and might not be sustained in the long run.

An appreciable aspect of the FTAs negotiated by the Indian Government is the importance given to value addition in the country of origin (so as to avoid imposition and dumping of goods). Though India has been a recipient of mixed benefits on account of FTAs, we don’t need FTAs with other nations to increase their wealth but we need wealth stabilisation policies for our people and it is time the Government realised this.

To read more from the Tax Talk section, click here .