Paper: 08, International Business Operations

Module: 30, Economic Integration: RTA & FTA

Prof. S P Bansal
Principal Investigator Vice Chancellor
Maharaja Agrasen University, Baddi

Co-Principal Investigator Prof YoginderVerma

Pro–Vice Chancellor
Central University of Himachal Pradesh. Kangra. H.P.

Paper Coordinator Dr. Shafali Nagpal

Bhagat Phool Singh Mahila Vishvidlaya,
Khanpur, Sonepat

Content Writer Dr. Vishal Kumar

School of Management,
Maharaja Agrasen University, Baddi (H.P.)

International Business Operations

Management
Economic Integration: RTA & FTA
 Items Description of Module

Subject Name Management

Paper Name International Business Operations

Module Title Economic Integration: RTA & FTA

Module Id Module no-30

Pre- Requisites Basic knowledge about RTA & FTA

Objectives  To study the meaning and concept of RTA & FTA

 To study the advantages and disadvantages of RTA & FTA
Keywords Economic Integration, RTA, FTA

QUADRANT-I

Module 30: Economic Integration: RTA & FTA

1. Learning Objective
2. Introduction
3. Meaning of Regional Trade Agreements/Arrangements
4. Factors behind the Proliferation of RTAs
5. Advantages of RTA
6. Types of Economic Integration
7. Impediments to the Integration
8. Free Trade Agreements (FTA)
9. Advantages of FTA
10. Disadvantages of FTA
11. Summary

1. Learning Objective
After completing this module, you will be able to:
i. Understand the meaning of RTA & FTA
ii. Understand the factors behind the proliferation of RTA
iii. Know about various types of Economic Integration
iv. Understand the advantages and disadvantages of FTA

International Business Operations

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 ECONOMIC INTEGRATION: RTA & FTA

2. Introduction
During the past two decades, nearly every country that participated in GATT or the WTO has also joined with
neighbouring countries in some form of regional trade arrangement. These regional trade arrangements differ in
structure and in the issues that they negotiate, but they have a common objective: to increase trade and
prosperity through the mutual reduction of barriers to the exports of neighboring countries. A key premise of
these regional trade arrangements is that neighbouring countries, which sometimes share cultural and language
ties, can expand trade more rapidly which is difficult otherwise.

Regional trade agreements have proliferated in recent years. Bilateral and regional “free-trade agreements” have
also played a larger role in recent years, seeking not only to reduce but also to eliminate nearly all restrictions on
trade among participating countries. Arrangements that partially or fully embrace free trade among countries
within a given region have been established in North America, Europe, Southeast Asia, the southern part of
South America and in several African sub-regions.
3. Meaning of Regional Trade Agreements

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 A regional trade agreement refers to free trade among a number of nations in a specified area or region. It is an
economic trade agreement to reduce tariffs and non-tariff barriers on trade between two or more nations to
promote trade and investment. Bilateral and multilateral trade agreements could be mutually beneficial to both
the countries. However Regional trade agreements (RTAs) could accelerate trade liberalization and set higher
benchmarks for the multilateral system.

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Regional trade agreements regulate more than one half of global trade, according to the Inter-American
Development bank. Member nations signing a regional trade agreement agree to eliminate trade tariffs on
exports and imports. This promotes and increases trade among member nations of a free trade agreement bloc. A
regional trade agreement requires the approval of the legislators of the countries which sign the trade agreement.
4. Factors behind the Proliferation of RTAs
The need for regional trade agreements has arisen from a number of socio-economic, political and security
considerations. Increasingly, RTAs are also viewed as a way to link developing and developed countries in a
common project of economic development. RTAs encourage investment, facilitate productivity gains in
participating developing countries and accelerate their economic growth. A classic example of deep economic
integration among nations through an RTA is the European Union. In the EU all internal trade barriers have
been eliminated and a common external tariff is exercised on all non-members. All EU members also share a
common currency and a set of macroeconomic policies.
Countries have embraced regional trade agreements primarily due to the following reasons:
1. To derive benefits of increased preferential access to highly competitive larger markets
2. The slow progress in trade liberalization under the WTO
3. The failure of multilateralism based trade talks
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 4. A sharp increase in FTAs around the world, which has prompted other countries not involved in
regional trade agreements to also consider engagement in such agreements – termed as ‘demonstration
effect’
5. To promote liberalization and bring about policy reforms
6. To attract more foreign direct investment into the country
7. Political and security considerations
5. Advantages of RTA

Lower Prices
Advantages of RTA

International Export
Advantage

Dispute Resolution

Rewarding Allies

1) Lower Prices
Regional trade agreements reduce the tariffs between the countries which are part of the trade agreement. The
World Trade Organization requires regional trade agreements to reduce tariffs between countries, but does not
allow these countries to increase tariffs on countries which do not participate. Tariff reductions allow people to
purchase goods from other countries at lower prices.
2) International Export Advantages
Regional trade agreements provide trade advantages for all countries in a region which improve their worldwide
competitiveness, including in the markets of countries not included in the trade agreement. A car manufacturer

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 that can purchase cheap steel from a country with which it has a regional trade agreement can sell cars elsewhere
at a lower cost.
3) Dispute Resolution
Regional trade agreements include processes to settle trade disputes. Countries come into conflict with one
another over agricultural subsidies, dumping products at low prices, and currency manipulation. The trade
agreement includes standardized arbitration rules and ensures that trade disputes are resolved according to
consistent rules. Trade agreements often specify the forum in which trade disputes are resolved, reducing
disputes about which organization has jurisdiction over the trade dispute.
4) Rewarding Allies
Allies can receive rewards through a regional trade agreement. The United States delayed signing trade
agreements with the nations of Chile and New Zealand since these nations opposed the Iraq War. A country can
also reward nations that establish similar economic and political systems with a free trade agreement, and refuse
to sign a free trade agreement with nations which violate human rights.
6. Types of Economic Integration
Most RTAs are meant not merely to slash tariffs but also to reduce impediments in international trade and to
promote trade by reducing either tariff or non-tariff measures. They also essentially include rules and
regulations that improve the overall investment climate. RTAs range across different levels of economic
integration and differ significantly in their scope and coverage.
RTAs are commonly classified into the following categories:
a. Preferential Trade Agreements: Preferential trade agreement is a trading agreement giving
preferential access to certain products from certain countries. This involves reducing tariffs but not their
elimination. This is the weakest form of economic integration. The South Asian Preferential Trade
Arrangement (SAPTA) between Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka
was one such agreement.
b. Free Trade Agreement (FTA): A free trade agreement is the most widespread form of RTAs. In an
FTA, member countries eliminate or reduce internal tariff and nontariff trade barriers (to trade in goods,
and also increasingly in services) among members, while each member is free to maintain different
most-favored-nation (MFN) barriers on non-members. The best known free trade agreements are the
European Free Trade Association (EFTA), the North American Free Trade Agreement (NAFTA), and
the Association of Southeast Asian Nations (ASEAN).

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 c. Customs Union: The next level of integration is a Customs Union (CU). A CU moves beyond an FTA
by establishing a common external tariff (CET) on imports from non-member countries. Typically,
customs unions contain mechanisms to redistribute tariff revenues among member countries. Some
examples of Customs Unions include South African Customs Union (SACU), East African Community
Customs Union (EAC), Gulf Cooperation Council (GCC), and Central American Customs Union
(CACU).

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 d. Common Market: Common Markets are a form of ‘deep integration’, where member countries attempt
to harmonize institutional arrangements and laws and regulations among themselves. While all the
features of a customs union are present under a common market system, the latter also provides for free
movement of factors of production (labour and capital) among the member countries, in addition to the
free flow of products (output). The Southern Cone Common Market (MERCOSUR) and the Common
Market of Eastern and Southern Africa (COMESA) are examples of well known common markets.
Other prevailing Common Markets include Caribbean Community and Common Market (CARICOM),
and the Central American Common Market (CACM).

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e. Economic and Monetary Union: The most comprehensive RTA is an Economic and Monetary
Union, in which members remove all internal trade barriers, permit the free movement of
capital and labour, erect common external trade barriers, and unify their fiscal and monetary
policies. Here, member countries share a common currency and macroeconomic policies. The best
known and most successful form of a Regional Trade Agreement in the world, in the form of an
Economic and Monetary Union is the European Union. Other Economic and Monetary Unions
include the West African Economic and Monetary Union (WAEMU), Economic and Monetary
Community of Central Africa (CEMAC) and the Economic Cooperation Organization (ECO).

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7. Impediments to the Integration
Despite strong economic and political arguments in support, integration has never been easy to achieve or
sustain for two main reasons:
1. First, although economic integration aids the majority, it has its costs. While a nation as a whole may
benefit significantly from RTA, certain groups may lose moving to a free trade regime involves painful
adjustments. For example; as a result of 1994, establishment of NAFTA, some of the Canadian & US firms
moved production to Mexico. Thus the workers in industries like textile which employ low skilled and low
cost labour lost their jobs.
2. The second one arises from concerns over national sovereignty. This arises because close economic
integration demands that countries give up some degree of control over key issues like monetary policy,
fiscal policy etc. This has been a major stumbling block in EU. To achieve full economic union, the EU
introduced the common currency, the Euro controlled by the central Euro bank.
Although the tide has been running strongly in favour of RTA in recent years, some economists have expressed
concern that the benefits of Regional integration have been oversold, while the cost have often ignored. They
Half
argued that the benefits of regional integration are determined by the extent of trade creation as opposed to
Video trade diversion. Trade creation occurs when high-cost domestic production is replaced by low-cost imports
within the free trade area. And Trade diversion occurs when low cost external suppliers are replaced by high
cost suppliers with the free trade area. A RTA will benefit the world only if the amount of trade it creates
exceeds the amount it diverts.

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 8. Free Trade Agreements (FTA)
Free trade agreements are pacts between nations which express the desire to commit to engaging in free trade.
The pact usually includes a detailed list of points which each party must satisfy, ensuring that trade between the
partners is truly free and open. Multiple countries can also band together to create a free trade area of two or
more countries in which free trade is actively promoted and encouraged. Pacts are an important way to make a
free trade system work effectively, showing that all member nations are bargaining in good faith.

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In free trade, two countries can trade with each other without any limits. Tariffs, quotas, taxes, and other burdens
to trade are lifted, while government subsidies, tax reductions, and other perks which are designed to benefit
domestic producers are also halted. This removes disincentives to trade, encouraging nations to exchange goods,
services, and labour as needed, promoting the free flow of capital, ideas, and goods across international
boundaries. Proponents of free trade believe that it helps to lower costs while promoting innovation in the
member nations, especially if a free trade area includes a large number of countries.
Objectives of Free Trade Area:
1. To create favourable conditions for greater economic cooperation and promote fair competition;
2. Progressively liberalize and eliminate barriers to trade in, and facilitate the cross-border movement of goods
and services between the territories of the Parties on a reciprocal basis as well as create a transparent, liberal
and facilitative investment regime; and
3. Explore new areas and develop appropriate measures for closer economic cooperation between the Parties.

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 Measures for Comprehensive Free Trade Area (FTA)
The Parties agree to expeditiously negotiate for establishing FTA with a view to strengthening and enhancing
liberalization of trade through the following:
 Progressive elimination of tariffs and non-tariff barriers in substantially all trade in goods between the
Parties;
 Progressive liberalization of trade in services between the Parties with substantial sectoral coverage;
 Establishment of an open and competitive investment regime that facilitates and promotes investment within
and between the Parties;
 Establishment of effective trade and investment facilitation measures, including, but not limited to,
simplification of customs procedures and development of mutual recognition arrangements;
 Expansion of economic co-operation in areas as may be mutually agreed between the Parties that will
complement the deepening of trade and investment links between the Parties and formulation of action plans
and programmes in order to implement the agreed sectors/areas of cooperation; and
 Establishment of appropriate mechanisms for the purposes of effective implementation of this Agreement.
9. Advantages of FTA
Free trade area is a trade block that allows traders to transact business without any sort of interference or
intervention from the government. It is believed that free trade area leads to mutual benefits for both the trading
partners. It differs from other forms of trade in that there is no creation of artificial prices, or a false demand and
supply of products. In a protectionist trade economy, government intervenes in the form of subsidies, taxes,
tariffs, etc to lower prices of goods or adjust supply of products. Free trade area overcomes all this and gives a
true picture of the actual demand and supply. To understand how free trade area creates a better market and trade
environment, let’s take a look at its benefits.
1. Comparative Advantage
In 1776 Adam Smith stated, "If a foreign country can supply us with a commodity cheaper than we ourselves
can make it, better buy it of them with some part of the produce of our own industry, employed in a way in
which we have some advantage." Smith's comment states the largest advantage of free trade: countries, by
specializing in goods that have lower opportunity costs, lead to an increase in the economic welfare of all
countries. The theory is self-explanatory. Each country does what it is best in and trades with other for its needs.
In this manner the market represents true supply and demand, and trade benefits all the countries.
2. Economies of Scale
When countries specialize in certain goods that they can produce, they can take advantage of economy of scale
and produce these goods at lower average costs. This is more useful to industries where the fixed cost of
production is very high or where the investment required is very high. By specializing in such products, the
industry can ultimately gain from economy of scale and lower production costs. This would transfer to the
consumer as lower prices for the finished goods.
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3. Consumer Satisfaction
Because free trade area leads to a global market, consumers benefit from the competition and variety of goods
brought to the market. When other countries produce some items cheaper, the consumer’s purchases products
for less price. Another benefit to consumers is increased innovations. As free trade expands, competition also
expands. To stay competitive, companies must seek ways to create the comparative advantage. This leads to
increased innovation that improves products.

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4. Employment and Economic Growth
Although free trade may cause jobs in one particular industry to wind up overseas, jobs in the exporting and
importing sides will increase. When productivity increases in importing and exporting, wages also tend to rise.
As the U.S. has lowered its trade restrictions, the gross domestic product has risen. Since consumers can
purchase quality products for cheaper, they have more expendable income.
5. Effective use of raw materials
Free trade not only brings about economic growth but also effectively uses raw materials, especially highly
valuable and highly limited raw materials. For instance, the Middle East is a rich source of oil, but there isn’t
much else in these countries. Trade is what ensures that this limited resource is distributed to different countries
which lack this resource and the Middle East, in turn, gets the products necessary for their day-to-day living and
business.
6. Foreign Exchange Gains and Decreased Poverty
When a country purchases a product from another country with money, they essentially send the exporting
country non-interest IOUs in exchange for real goods. The exporting country, though, must use the money
within the country that imported the products. For example, the United States purchases steel from China with
U.S. money at the current market value. China will later use the U.S. money to purchase computer programs
from the United States at the future market value. Countries that open their trade barriers to allow free trade have
the chance to enter the global market, which will increase income for the country. In the 1990s, developing
countries that lifted trade restrictions tended to grow three times faster than countries that restricted trade.

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 7. Increased Export
Countries with stringent trade restrictions often cause animosity with other countries. Therefore, the country
with the restrictions also limits its own ability to export. When a country removes their trade restrictions, other
countries are more willing to accept the exports.
10. Disadvantages of FTA:
Free trade refers to the removal of any barriers, taxes, tariffs, quotas or any other governmental restrictions on
international trade which would allow the involved countries to more easily exchange particular commodities.
For the most part, free trade is considered a good thing because the lack of trade barriers makes exportation easy
and relatively inexpensive. In this way, a country can focus its resources more efficiently and achieve a higher
real income. Despite the overall benefit of free trade to a nation's economy, there can be some significant
disadvantages to the establishment of free trade agreements.
1. Expensive
Even though free trade is primarily meant to lower costs on items, it can actually end up being quite expensive.
There are complicated rules and contract conditions that go into the making of free trade agreements to protect
the interests of the countries involved. As such, there is usually the need to establish several committees and
working groups to handle the free trade agreements. For example, the NAFTA agreement involved a contract
that was more than 1,000 pages long and more than 25 committees. In essence, free trade can be resource
intensive, requiring multiple agreements, ways of enforcing rules and compliance among the partner countries.
2. Competition
The removal of international trade barriers can open up some domestic industries to unsustainable competition.
Some international markets are not on the same level as the domestic industry and are able to produce a certain
commodity way below cost. As such, this surplus commodity gets flooded into the local market at much cheaper
prices and essentially takes over that industry. Many local industries, even efficient ones, may be unable to
compete under these conditions.

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3. Domestic Instability
Free trade can also increase domestic economic instability as the local markets become dependent on global
imports. It basically decreases the self-sufficiency of a nation so that a crisis in a significant trade partner
country can directly affect the economy of the home country. In addition, it can encourage pollution and other
environmental problems as imports and exports are encouraged, and environmental concerns are not a priority in
a lot of countries with cheap labour.
4. Destruction of Domestic Industries
Trade agreements boost competition. While some producers manage to conquer foreign markets, others prove
unable to compete internationally, lose market share, and eventually disappear. As a result, the economy
becomes dependent on a limited number of industries, while many important sectors of the economy are
"outsourced" abroad.
5. Unemployment
Because many domestic industries are hammered by foreign competitors, unemployment rises. Even though
some foreign firms move their operations into the country, the net effect is often negative, as foreign producers
prefer to employ their own workers rather than provide employment to foreign ones. Generally, work moves to
countries with lower labour costs, while countries with relatively high wages import unemployment.

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 6. Loss of National Identity
As international trade increases, national identity decreases. The world's diversity suffers as a result of trade
agreements and subsequent rises in cross-border trade. Indigenous peoples adopt Western ways of life, watch
Hollywood blockbusters and dine at McDonald's. While the general standard of living rises, local culture and
national identity withers away.
12. Summary: The principal point of Free Trade Agreements is to secure trade liberalisation. While the
traditional debate about FTAs is the danger that they can divert rather than create trade, the record to date
suggests there has been little diversion and that FTAs and regional agreements have been effective in
encouraging wider trade liberalization. A practical advantage of FTAs is that they are quicker and easier to
negotiate than multilateral agreements because fewer parties are at the table. Parties can secure advantages that
are harder to win in bigger forums. The disadvantages are twofold. If FTAs are not set up within the right
framework of policies, they can diminish rather than enhance economic welfare. The second disadvantage is that
they are not good vehicles for liberalizing trade in sectors on which parties outside the agreement have a major
influence. RTA (Regional trade agreements) have proliferated in recent years. Bilateral and regional “free-trade
agreements” have also played a larger role in recently, seeking not only to reduce but also to eliminate nearly all
restrictions on trade among participating countries.

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