What is a trade agreement?

A trade agreement is a contract/agreement/pact between two or more nations that outlines how they will work together to ensure mutual benefit in the field of trade and investment. Such trade agreements may involve co-operation in the field of R&D, the lowering of import duties to be levied on the other partners’ exports, guaranteeing any investments made by the partner(s) in the home market, co-operation on the tax front, etc.

Bilateral and multilateral agreements

Trade agreements (also sometimes referred to as ‘trade pacts’) are usually bilateral or multilateral. Bilateral trade agreements – as the name suggests – is an agreement between two nations, while a multilateral trade agreement involves more than two nations.

Trade agreements and trading blocs

These two concepts are close related. A trade agreement general leads to a trading bloc being formed. A trading bloc is generally defined as “two or more countries bound by a specific agreement which determines some or all of their international trade practices and which usually provides for common import tariffs on certain, if not all, imported products.” Some economists argue that although trading blocs are see as a means of reducing trade restrictions (between the countries involved), they themselves represent a form of trade barrier as they exclude non-members. Click here to learn more about trading blocs.

Different types of trade agreements/trading blocs

Trade agreements/trading blocs also come in different forms, involving increasing levels of co-operation. Examples include:

  • Free Trade Areas (FTA) – This is the simplest kind of trading bloc and incorporates a two or more countries that have agreed to eliminate tariffs and other barriers to trade amongst members, but individually each country retains its own tariffs on imports from other non-member countries. Perhaps the best example of a FTA is the North American Free trade Area (NAFTA). Click here to read more about NAFTA.
  • Common Monetary Area (CMA) – A Common Monetary Area is when countries usually geographically closely located to each other agree to accept one dominant currency as legal tender.
  • Customs Union – A Customs Union goes one step further than an FTA in that it abolishes all tariffs among member countries, while members agree to a single, external tariff on goods imported from outside the Customs Union. Revenue generated by the Customs Union is shared among members based on a specific formula.
  • Common Market – In a Common Market, like with a Customs Union, a common tariff is placed on imports from other non-member countries, while no tariffs are exist on goods produced by one member country and sold in the other member country’s. The main additional difference between a Customs Union and a Common Market is that with the latter, the free movement of labour and is capital is also permitted. In other words, any restrictions on immigration, emigration and cross-border investment (amongst member countries) are abolished. The current European Union developed from the European Economic Community, a form of Common Market. The Common Market for Eastern and Southern Africa (COMESA) and the Caribbean Community – formerly the Caribbean Community and Common Market (CARICOM) are perhaps the two best examples of Common Markets.
  • Monetary Union – In the case of a Monetary Union, member countries agree to use a single currency or to fix their rates of exchange for the respective currencies. Essentially, a Monetary Union includes a Common Market Area (discussed above), the difference being, that a Monetary Union involves far greater integration and co-operation among member countries. The best example of a monetary union is European Union in which member countries have agreed to use a new, single currency – the euro! There are many other Monetary Unions in place – click here to learn more.
  • Economic Union – Beyond the free movement of labour and capital, an economic union incorporates the harmonization of economic policies amongst member states, including the integration of monetary policies, economic policies, taxation and other regulatory requirements. European Union is perhaps the only true Economic Union in place today.
    Trade agreements and marketing

The purpose of trade agreements is to reduce the barriers to trade between countries and to make it easier to do business (i.e. to trade) between the countries concerned. Clearly, any agreement that reduces the barriers to trade is likely to have a positive effect on the exports of goods to the partner country(ies). It is essential that you keep tabs on such negotiations by reading the newspaper and keeping track through websites such as ExportHelp.

If you know about a trade agreement that is being negotiated, you should inform yourself as to the possible benefits you may get as a result of the agreement. In some instances, there may be little benefit because there are already no duties levied on your products. On the other hand, if your product is subject to high duties, an agreement may prove very beneficial to your product and you would want to be ready to act as soon as any agreement came into effect.

Generalized System of Preferences (GSPs)

The Generalized System of Preferences, or GSP, is a formal, non-reciprocal system of exemption from the more general rules of the World Trade Organization (WTO). Specifically, it’s a system of exemption from the Most Favored Nation principle (MFN) that obligates WTO member countries to treat the imports of all other WTO member countries no worse than they treat the imports of their “most favored” trading partner. In essence, MFN requires WTO member countries to treat imports coming from all other WTO member countries equally, that is, by imposing equal tariffs on them, etc.

GSP, however, exempts WTO member countries from MFN for the purpose of lowering tariffs for developing countries (without also doing so for rich countries). The idea of tariff preferences for developing countries was the subject of considerable discussion within UNCTAD in the 1960s. Among other concerns, developing countries claimed that MFN was creating a disincentive for richer countries to reduce and eliminate tariffs and other trade restrictions with enough speed to benefit developing countries. Source: Wikipedia