What are Free Trade Agreements?

As the name suggests, a free trade agreement is an agreement between two or more countries that creates a free trade zone. A free trade zone involves loosening international trade restrictions between the countries involved, which typically translates to the lowering or elimination of import duties and tariffs. Some of the most notable free trade agreements including the North American Free Trade Agreement (NAFTA), which has since been succeeded by the United States Mexico Canada Agreement (USMCA).

Free trade agreements are meant to encourage international trade among their signatory countries, primarily via the lowering or elimination of trade barriers and duties. In other words, if an importer is bringing in a shipment of goods from a country of origin that has a free trade agreement with the importing country, they can expect lower landed costs and fewer trade barriers. An importer is therefore encouraged to import from a country that their jurisdiction has a free trade agreement with.

The fundamental difference between a free trade agreement and a preferential trade agreement is that a preferential trade agreement can be unilateral. In other words, they are relaxations on trade restrictions from one country towards another, without the other country necessarily reciprocating. Typically extended by developed countries towards developing countries as a form of diplomatic patronage, preferential trade agreements typically need waivers granted by the World Trade Organization, at least for member states.

While they are very similar in a lot of ways, free trade agreements and customs unions differ in one key regard. In a customs union, all participating countries agree to a common customs tariff that is applied by all of them for all non-member countries. In other words, a country not a part of a customs union will contend with the same tariffs, duties, and restrictions when importing to any country that is a part of said custom union. A free trade agreement makes no such stipulations and allows each member state to maintain its own independent customs tariff schedule.

The best way to understand the difference between a free trade agreement and a customs union is to look at the most well-known examples of each – USCMA is a free trade agreement, whereas the European Union common market is a customs union.

The exact process to determine whether or not a shipment qualifies for FTA benefits varies based on the shipment, the country of origin, the importing country, and the free trade agreement. However, in general terms, the process comes down to being able to determine and demonstrate that the product(s) being imported originated, either in whole, or beyond a defined threshold as stated in the free trade agreement, in a country of origin that is party to the FTA. Most FTAs also include provisions for products that may not necessarily have originated from a member state of the free trade agreement in the strictest or most technical sense, but still underwent substantial “transformation” (e.g., raw materials being processed or manufactured into finished goods), which still qualifies those goods for benefits. If an importer determines that the products being imported may qualify, they must demonstrate this via specific documentation (typically called “certificate of origin”) to customs authorities. There are software solutions available that can help importers determine eligibility of their shipments for FTA benefits.