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Free Trade Agreement (FTA): How It Works, With Example

File Photo: Free Trade Agreement (FTA) Definition: How It Works, With Example
File Photo: Free Trade Agreement (FTA) Definition: How It Works, With Example File Photo: Free Trade Agreement (FTA) Definition: How It Works, With Example

What Exactly Is a Free Trade Agreement (FTA)?

Several nations signed a free trade agreement to lower import and export obstacles. Free trade allows commodities and services to traverse borders without government tariffs, quotas, subsidies, or bans. The concept of free trade opposes trade protectionism and economic isolationism.

How Does a Free Trade Agreement Work?

Modern governments generally agree to pursue free-trade policies. However, a free-trade approach may merely eliminate trade prohibitions.

A government does not need to take explicit actions to encourage free trade. This hands-off approach is known as “laissez-faire trade” or trade liberalization.

Governments with free-trade agreements may not abolish import and export controls or protectionist restrictions. Few free trade agreements (FTAs) result in free commerce in modern international trade.

A country may allow free commerce with another. Still, it may ban the entry of medications not approved by its authorities, unvaccinated animals, or processed foods that do not satisfy its requirements.

In 1817, economist David Ricardo wrote “On the Principles of Political Economy and Taxation,” which detailed the benefits of free trade.1

Or, it may exclude some items from tariff-free status to shield domestic manufacturers from international competition.

Free Trade Economics

International trade works similarly to trade between neighbors, municipalities, or states. Businesses in each nation can focus on manufacturing and selling commodities that best use their resources, while others import limited or unavailable goods. That balance of local production and overseas commerce boosts growth and meets consumer wants.

In 1817, economist David Ricardo popularized this perspective in his work, “On the Principles of Political Economy and Taxation.” He believed that free trade increases a nation’s variety, lowers prices, and better uses its resources, expertise, and specialized talents.

Free-trade models


Mercantilism ruled global trade before 1800. This philosophy emphasized amassing gold and silver and having a good trade balance.

Countries used trade obstacles like taxes and tariffs to dissuade locals from buying foreign goods to improve their trade balance. These incentives encouraged people to buy local items, supporting the domestic industry.

Compared Advantage

Ricardo proposed the comparative advantage law, stating that free trade maximizes advantages for countries. Ricardo showed that nations may create more commodities by prioritizing their comparative advantage (i.e., their most cost-effective items) above trade barriers.

Pros and Cons of Free Trade

Developing Fast

Many nations have increased due to free commerce. Countries have attracted international investment and created high-paying employment for local workers by focusing on exports and resources where they have a significant comparative advantage.

Lower Global Prices

Free trade makes nations compete to provide customers with the lowest costs for their resources. This helps producers cut product prices, boosting customer buying power.

Joblessness and Business Losses

A country that opens its borders to free commerce experiences economic losses. Domestic industries may struggle to compete with foreign firms, producing unemployment. Large enterprises may shift to nations with low environmental and labor standards, causing child labor or pollution.

Increased global market dependence

Free trade can increase globalization and dependence. While certain items are cheaper internationally, a country that manufactures them locally has strategic advantages. The government may have to reconstruct these industries after a war or disaster.

Pros and Cons of Free Trade


  • Allows consumers to get the lowest global items.
  • It benefits nations with inexpensive labor or resources from exporting.
  • Ricardo believed countries might generate more things by trading on their advantages.


  • Foreign export competition may create local unemployment and business failures.
  • Lax rules may cause environmental harm or harsh labor practices when industries move.
  • Countries may grow dependent on the global market for critical products, putting them at a strategic disadvantage in emergencies.

Public Opinion on Free Trade

Few subjects split economists and the public as much as free trade. According to research, faculty economists at American colleges are seven times more likely to endorse free-trade policies than the general population. Milton Friedman, an American economist, stated that the economics profession has mostly agreed on the benefits of free trade.

The popularity of free-trade policies has declined. These include unfair competition from nations with lower labor costs that can slash prices and the loss of good-paying employment to foreign firms.

The political winds may change the Buy American cry, but it never stops.

The Financial Market View

Naturally, financial markets see the other side. Free trade allows native producers to expand globally.

Free trade is now part of the financial system and investment world. Most international financial markets and a more excellent choice of securities, currencies, and other financial instruments are now available to American investors.

Currently, total free trade in financial markets is improbable. Several supranational regulatory bodies oversee global financial markets, such as the Basel Committee on Banking Supervision, IOSCO, and the Committee on Capital Movements and Invisible Transactions.

Actual Free Trade Agreements

Today, the EU exemplifies free trade. Most member states have adopted the euro, making commerce between them borderless. The Brussels bureaucracy regulates this system and handles trade concerns between member states.


US free trade agreements are many. These include multi-nation accords like NAFTA, which covers the U.S., Canada, and Mexico, and CAFTA, which covers most Central American nations. Different trade agreements exist with Australia and Peru.

The government estimates that these agreements free half of U.S. goods from tariffs. The average industrial import duty is 2%.

These agreements do not constitute laissez-faire free trade. American special interest groups won trade restrictions on hundreds of goods, including steel, sugar, cars, milk, tuna, meat, and denim.

Why were free-trade zones created in China?

China started creating free trade zones around ports and coasts in 2013. National rules were eased to encourage international investment and enterprise.

What Is a Free Trade Area?

Free trade areas are groups of nations that have agreed to reduce or abolish trade restrictions. This permits participating nations to benefit from lower tariffs while preserving trade safeguards with non-area countries.

What are the counterarguments to free trade?

Free trade opponents say it fosters foreign rivalry with native companies, causing job losses and hurting critical sectors. Free trade may encourage industries to shift to nations with fewer rules, rewarding polluters and abusive laborers. In other circumstances, poor IP rules allow governments to steal foreign technology.

Bottom Line

Free commerce allows cheap imports and exports without tariffs or other trade impediments. A free trade agreement lowers tariffs or other barriers to increase commerce between countries. All countries get reduced pricing and access to each other’s resources.


  • Free trade agreements remove international trade restrictions.
  • Trade protectionism opposes free trade.
  • Under U.S. and EU free trade agreements, laws and monitoring apply.

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