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Mercosur is a free trade area between eastern countries in South America.

A free trade agreement is a contract under international law to guarantee free trade between the contracting states (or subjects of international law ). The contracting parties forego trade barriers with one another , but operate an autonomous foreign trade policy towards third countries. It can be a first step towards closer economic integration between countries.

Subject of free trade agreements

The agreement ensures free trade between the contracting parties. Customs duties and non-tariff trade barriers such as export restrictions , import quotas or national norms and standards will be abolished. In more recent free trade agreements, other state interventions such as subsidies, participation in companies or economic sectors or the state's control of patent law are also restricted. Some agreements also contain provisions on investment protection that provide for the use of arbitration tribunals in investor-state proceedings .

Free trade areas can arise from several free trade agreements or through multilateral agreements . Free trade agreements or free trade areas represent the first stage of economic integration because - unlike in a customs union  - the contractual partners of a pure free trade area maintain their respective national customs tariffs vis-à-vis third countries . In order to prevent the relocation of traffic and production and the distortion of competition, all free trade agreements contain rules of origin that ensure that goods are entitled to preferential treatment and can therefore be imported into the contracting state duty-free. This must be proven with a preference paper. Economic associations at a higher level of integration (customs union, common market , economic and monetary union ) are, however, always also free trade areas.


At the turn of the millennium, 172 regional trade agreements were listed in the World Trade Organization (WTO) ; on July 31, 2013, 377 were listed. Of these, the free trade agreements form the largest proportion with 221. This significant increase shows the increasing attention that this type of economic development is receiving. All WTO members have undertaken in principle to grant all other members the same tariff rates. This so - called most - favored nation principle forms an important basis for almost all WTO agreements. It means that if the duty rate for a good or a service is reduced for one trading partner, the same reduced duty rate must also be granted to all other WTO trading partners. Favorable trade agreements, to which the free trade agreements belong, violate this in principle. They are dismantling trade barriers between partner countries, while non-members remain unaffected by this agreement with regard to trade barriers. According to Article XXIV of the WTO, however, preferred trade agreements are excluded from the most-favored-nation treatment, which provide for a complete elimination of tariffs, include all large trading items and the tariff rate towards non-participating third countries after the formation of the trade bloc is no higher than before.

In principle, all those agreements are preferred trade agreements that allow their members to import goods at a more favorable tariff rate than is granted to third countries. A preferred form of trade agreement is the free trade agreement, which provides for the elimination of all trade barriers, especially tariffs, within the member states. The original tariff does not need to be set to zero in one step, but can also be reduced in annual rates, starting with an initial reduction. Complete elimination is thus achieved after a specified period of time. This is the case of the so-called "phase-in".

In addition to the free trade agreement, there is also the “customs union” as a preferred form of trade agreement. The main distinguishing feature of a free trade agreement and a customs union is that within a free trade agreement, each partner can set the import duty rate towards third countries, regardless of the free trade agreement partner country. In contrast, in a customs union, a single rate of duty is levied on products that are imported into the territory of the customs union.

The free trade agreement and the customs union are the first two levels of economic integration that are distinguished. On this basis, with the increasing degree of integration, there are uniform markets, economic unions, political unions and commercial unions.

Formation of a free trade agreement

According to Grossmann & Helpman (1995), governments will support the formation of a free trade agreement in two cases, with each government making the decision autonomously.

In the first case, the free trade agreement must increase the welfare of the citizens so that the government is re-elected at the next election. At the same time, the pressure of the lobby groups, which are negatively influenced by the free trade agreement, must not become so great that the free trade agreement is prevented. In the second case, the profits of the export-oriented industry must, through a possible free trade agreement, offset the losses of that part of the industry that has to compete with additional domestic competitors.

The welfare of a country in liberalizing its trade is influenced by several factors. These include the promotion of trade due to the “trade creation” effect and the inefficient allocation of resources due to the “trade diversion” effect (trade relocation).

The trade creation effect results from the displacement of more expensive domestic goods in favor of cheaper imported goods from the free trade partner countries. The elimination of customs duties reduces the price of a product, which increases consumption and generates welfare gains.

The trade shift effect ensures a shift in imports from non-free trade partners to a free trade partner country. The goods from the partner country, which are produced at higher production costs, become more competitive due to the import tariff. This leads to an inefficient allocation of resources and an associated loss of welfare.

Another effect that directly influences a country's prosperity is the change in the so-called “terms of trade” (exchange ratio). The exchange ratio is the price index of exports divided by the price index of imports. They indicate how many goods can be imported in the equivalent of one unit of exports. If the exchange ratio increases due to a reduction in the price level of imports, which is likely due to the elimination of customs duties, the exchange ratio improves. A country can afford more imports for the same amount of exports.

Reasons that indirectly influence the welfare of a country and also speak in favor of the formation of a free trade agreement are the safeguarding of the reform of the domestic economic policy, the increased negotiating power at the international level and the secured market access for small countries.

Safeguarding the reform is achieved because it is more difficult to change existing trade positions after an international agreement has been established. The improved starting situation in future negotiations results from the greater influence of a free trade area. This also secures access to markets.

Comparison of a free trade agreement and a customs union

All positive welfare effects that are implied by a free trade agreement can also be generated under a customs union. At the same time, however, a free trade agreement causes welfare costs that do not arise in a customs union. The cost includes several points:

(1) Within a free trade agreement, certain goods can be exempted from duty by means of a so-called "Exclusion List" or slowly brought up to complete elimination using a special method. This is especially true for sensitive goods of a country, which are characterized by a strong lobby.

(2) The possibility for lobby groups to shape the free trade agreement according to their ideas leads to another problem. Lobby groups will only be in favor of trade liberalization if it benefits them. Otherwise, they will try with all means to maintain existing hurdles. Within a customs union, it is more difficult for individual lobby groups to assert their interests than in bilateral negotiations, because their influence there is relatively small.

(3) In addition, there are costs to prevent the trade diversion effect. When importing, importers use the country that offers them the most favorable conditions for importing goods and services. These goods are then exported duty-free to another country within the free trade agreement. The import into the first country takes place exclusively to save customs costs. In order to prevent this diversion of action, rules of origin are included in a free trade agreement as trade barriers.

Despite these additional costs, Clausing (2000) does not see the strict superiority of a customs union over a free trade agreement. He argues that the level of the common tariff of a customs union and the required share of local value added are decisive for whether a free trade agreement or a customs union is better off a country in terms of welfare. Regardless of which agreement is superior in terms of welfare, free trade agreements are more widespread.

Rules of origin for free trade agreements Rules of Origin


Rules of Origin are basically divided into two types. The “Preferential” and the “Non-Preferential” Rules of Origin. The country in which a good was produced is determined with the help of the “Non-Preferential” Rules of Origin. In contrast, “Preferential” rules of origin are qualification criteria that, depending on the structure of the agreement, must be achieved individually or in combination in order to qualify a product for the free trade agreement tariff rate. They ensure that only products that have been produced in part in one of the partner countries benefit from the tariff concessions. Since the “Preferential” Rules of Origin have established themselves as a qualification feature in trade agreements, they have been equated with the term Rules of Origin. Krishna (2005) distinguishes the following three most widespread possibilities for this, which qualify a good for the application of the free trade agreement tariff rate:

(1) The first possibility is the definition in terms of customs categories. Each product can be classified and classified according to its nature using the internationally established "Harmonized System". If, for example, a brake is brought from Mexico to the USA, it is registered as a brake at customs and imported with the corresponding tariff. This is installed in a car in the USA. This changes the tariff for this brake. When the finished car is exported back from the USA to Mexico, the brake is no longer registered as an individual part, but the car as a whole is registered with customs and cleared. The change in the "Harmonized System Number" from brake to car is the qualification feature (1). Depending on the structure of the agreement, a major or minor change in the goods is required in order to obtain the change in tariffs required for the application of the free trade agreement.

(2) Another variant is that certain processes must be carried out within the free trade agreement area in order to be able to use the free trade agreement tariff rate. Within NAFTA, for example, the law of “triple transformation” applies to clothing. This means that in the manufacture of clothing, the wool or the starting product for the manufacture of the thread is manufactured within the NAFTA area. The thread must then be produced from this, from which the actual clothing must be cut and sewn within the NAFTA area. So there are three stages of change taking place within the NAFTA area.

(3) The third variant is the achievement of the Rules of Origin, with the help of a share of the local added value in a product in monetary or physical terms. In physical terms, a certain percentage of the weight, for example of domestic tobacco, can be prescribed in cigarettes. The definition as a share of local added value in monetary terms means that a certain pre-defined value of the preliminary products of the final product has to be produced within the area of ​​the free trade agreement. For example, if a car has production costs of 10,000 euros and a share of local added value of 20% of the costs is stipulated, intermediate products from the free trade agreement area of ​​at least 2000 euros must be used in production. This is a common practice in free trade agreements, where the rules of origin are seen as the minimum share of local added value in the price or cost of a product. This has the advantage that clearly defined values ​​are used on the basis of which calculations can be made.

Reasons for and against the inclusion of rules of origin in a free trade agreement

One aspect for the inclusion of the "Rules of Origin" in a free trade agreement is the prevention of trade diversions. Here goods are exported to the country with the lower tariff in order to export them from there using the free trade agreement. Without rules of origin, neglecting transport costs would in this case lead to a trade war, because every reduction in the tariff in a country leads to a complete shift in the flow of goods to that country. Accordingly, the country with the marginally lower tariff rates will generate the entire tariff income. The result would be a reduction in the partner country's tariff rates so that it can generate all of the income for itself. Countries compete for revenue with the end result of a complete elimination of all tariffs. Then none of the partner countries will take customs duties without rules of origin.

Furthermore, rules of origin prevent products from being processed superficially just to qualify them for the reduced free trade agreement tariff rates. This avoids, for example, that a finished car without tires from Germany is fitted with tires in the USA and thus qualifies for NAFTA tariff rates. They also offer producers an incentive to buy local primary products in order to achieve the required share of local added value. Without the local preliminary products, the requirements of the local added value cannot be achieved. They thus offer domestic products a competitive advantage over products from non-free trade partner countries. It can happen that companies buy more expensive preliminary products from the free trade agreement partner country in order to achieve the share of local added value and thus to be able to sell the end product there duty-free. These effects also have a political impact. Securing domestic production against the relocation of production steps abroad makes a free trade agreement with rules of origin easier to enforce.

Nevertheless, there are also reasons that speak against anchoring rules of origin in a free trade agreement. The incentive to use local preliminary products in production can also have negative consequences. Theoretically cheaper pre-products from third countries are substituted by local pre-products because the share of local added value has to be achieved. This leads to an inefficient allocation of resources. As a result, it can happen that the production of a good takes place in a free trade agreement partner country despite higher production costs than in a third country. This is the welfare-reducing trade shift effect.

In addition, rules of origin offer lobby groups the opportunity to influence economic policy in a non-transparent but very direct way. This is because rules of origin can be designed in such a way that domestic producers have only a few competitors in the domestic market. If you know the production costs of the competitors from the free trade agreement partner country, you can influence the required share of local added value in such a way that the production costs of these competitors are above your own after the free trade agreement has been formed.

In addition to the general costs, companies also have additional costs. On the one hand, the effort involved in proving the local value-added share in a product is a decisive factor. Proof of origin must be provided for all primary products used in order to be able to prove the proportion of local primary products in a product. According to estimates, the “Free on Board” price is 3–5% in order to provide the necessary evidence.

On the other hand, reaching the local value-added share is also associated with costs. Local preliminary products must be used in production in such a way that the local added value is achieved. It can therefore be advantageous for producers not to use the reduced tariff rate, as the costs of achieving the local added value are greater than the customs costs. A decisive criterion for whether it makes sense to comply with this or to pay the regular tariff is the assessment basis of the rules of origin.

Types of tax base for the share of local added value

The two types of measurement of the local value added share are the cost-based and the price-based method for calculating the share of local value added. The first variant is the cost-based calculation of the local value added share. This must make up a certain proportion of the cost of the end product. Formula 3.1 Assessment basis for local content


The required share of local added value results from the price of the individual preliminary products, multiplied by the respective amount of the individual factors. stands for the price of the products that are produced domestically, for those that are produced within the free trade agreement, and for those that are produced outside of it. The respective quantities are represented by , and . The costs of domestic and free trade agreement products are related to the total costs in order to calculate the share of local value added in a product.

An interesting question is which costs can be included in the calculation of α. During the negotiation of the free trade agreement between the USA and Canada, the question was discussed whether, for example, interest costs could be included in the calculation of the local share of added value. An inclusion would mean that the share of local added value is easier to achieve than if the costs were omitted. Krishna & Krueger (1995) define the price-based method as follows: The share of local added value is the minimum share α of a final price in a country , reduced by the value of all non-free trade agreement preliminary products , in relation to . Formula 3.2 Assessment basis for local content


Formula 3.3 Basis for assessment for local content


Both formulas are intended to underline that the method for calculating the local content (share of local added value) affects its accessibility. If the price of a good increases, it is either easier or more difficult to achieve the required percentage , depending on the variant of the local content calculation .

Depending on the achievement of , the companies can decide whether or not to use the free trade agreement in production. You then produce under either the unconstrained total cost function or the constrained total cost function . If the former is used, the free trade agreement cannot be used; if the other is used it can be used. If no minimum proportion α is required for the use of the free trade agreement, i.e. no rules of origin are included in the free trade agreement, then both cost functions are identical.

Goal of free trade agreements and free trade areas

The aim of the free trade agreement between both contracting parties is to achieve advantages in the distribution of goods and an increase in foreign trade through free trade. They thus correspond to the basic idea of ​​the (neo-) classical foreign trade theory , which is based on David Ricardo's model of comparable cost advantages , according to which welfare gains can be achieved for all participating states through free trade between states .

In addition, the trade barriers have a negative impact on economic growth and reduce the efficiency of the economy. This is due to inefficient use of resources. Because national economies that do not have free trade zones then only produce the goods and services that appear most attractive through state intervention, and not those that provide a comparable advantage. Because this is the real point of trading. The consequences are welfare losses for the states.

For this reason, the World Trade Organization (WTO) promotes the formation of free trade areas and the conclusion of free trade agreements.

Free trade agreements, which are intended to give developing countries access to the markets of industrialized countries , are important for development policy ; To this end, the EU is conducting negotiations with countries in Africa, the Caribbean and the Pacific , which should lead to the conclusion of free trade agreements (see Economic Partnership Agreement ).

According to a study by the World Bank, a complete liberalization of world trade would have generated 300 billion US dollars in additional income annually from 2005 to 2015.

Types of free trade cooperation

  1. Free trade agreement: trade barriers will be abolished, but each member state will remain politically independent. (Example: European Free Trade Association )
  2. Customs unions : Here, a union of states forms a common customs union. Common tariffs will be abolished. In addition, the tariffs of third countries that belong to member states will be aligned. (Example: Eurasian Economic Union )
  3. Internal market (common market): The internal market behaves like the customs union. In addition, it prescribes the free movement of all production factors (goods, services, labor, capital). (Example: European Economic Area )
  4. Economic union : Union of states with conditions similar to that of the domestic market. In addition, there is a desire for a common economic policy. (Example: European Union )
  5. Monetary union : is the highest level of economic integration. Here the economic union is expanded to include a common currency. (Example: Eurozone )

Examples of free trade agreements

Economic and Monetary Union

Economic union

Common market (internal market)

Customs and Monetary Union

Customs union

Multilateral free trade area



Currently negotiated free trade agreements are:

Currently planned free trade agreements are:

Criticism of free trade agreements

Criticism of globalization is directed against many of the assumptions used to establish free trade agreements . The actual realization of the welfare gains according to the model of comparable cost advantages therefore presupposes, for example, that production factors can be shifted from one economic sector to another at will, which in reality is often not given, especially in the short term. Therefore, when creating regional free trade zones as well as with global trade liberalization , the question always arises as to which countries and groups of people will be among the winners and losers, at least in the short and medium term.

The Public Services International union describes the course of negotiations in the 2010s for all free trade agreements as a constantly running machine of negotiations and renegotiations , the program of which is oriented towards purely business interests. Exemptions once made would result in a debate in later rounds of talks that was hastily and regularly conducted in secret.


The ISDS clauses , which are supposed to guarantee the protection of foreign direct investments within a free trade area by arbitration tribunals, became part of a modern free trade agreement for the first time with the entry into force of NAFTA in 1994. It is criticized that such arbitral tribunals are filled with business lobbyists and that an independent jurisdiction is not guaranteed, but that there is a risk of immense claims for damages by investors against states. Opponents of this agreement refer to the numerous claims for damages by US investors against the state of Canada, which were made possible by the ISDS clauses, and complain that it is not only the state liquidity , but also the sovereignty of Canada is impaired, since legislative proposals that one Violation of ISDS clauses could mean, may have been omitted in advance ( chilling effect ). The Canadian CETA chief negotiator countered this by stating that the amount of damages that Canada had actually been sentenced to pay was US $ 150 million over 20 years and was therefore negligible.

Poverty in Developing Countries

Another special feature of NAFTA is that when it came into force, a free trade agreement between industrialized and developing countries was agreed for the first time and is therefore regarded as the archetype for future agreements of this kind. Development in the primary sector was perceived as problematic . With the dismantling of the trade barriers between Mexico and the United States, Mexican agriculture lost a massive amount of competitiveness, since American agriculture was highly subsidized and therefore cheaper. A US corn import restriction from Mexico led a US food company to claim damages in 2009, which ended in a settlement . In general, the typically high subsidies of industrialized countries in agriculture represent a hurdle for the conclusion of free trade agreements, since developing countries fear scenarios similar to those in NAFTA.

Free trade agreements between exclusively industrialized countries promote trade within the free trade area at the expense of trade links with other industrialized countries, but also with developing countries.

See also


  • Hartwig Schulz: Regulation of origin of the free trade agreements between the EEC and EFTA states. 7th edition. Purschke and Hensel, Berlin 1991.
  • Hans-Peter Durić: The free trade agreement between the EC and Switzerland . The legal problem. 3rd revised edition. Self-published, Freiburg (Breisgau) 1998.
  • Hans-Peter Duric, legal basis for a determining administrative act in the magazine for customs duties and excise taxes 2006, 306 ff and 2007, 38 f.

Web links

Wiktionary: Free trade agreement  - explanations of meanings, word origins, synonyms, translations

Individual evidence

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  4. Dieter Bender (2003): Vahlens Compendium of Economic Theory and Economic Policy - International Trade | 8th edition | Franz Vahlen
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