Free trade agreements remove tariffs and other barriers between nations. This has the effect of lowering prices and allowing each nation to devote additional resources to the areas in which it has the greatest competitive advantage. Moreover, if the theory is correct and free trade also promotes peace among nations, it can be a powerful foreign policy tool.
What Is Free Trade?
Free trade exists when tariffs and barriers are removed from exports and imports between countries. The result of removing the trade barriers is lower costs for imported goods than would exist if tariffs and other barriers to entry were in place. Moreover, it provides price transparency; true supply and demand can affect the marketplace as they should.
Low-Cost Imports
By removing tariffs and barriers, goods become available to consumers at the lowest cost. People's purchasing power increases as they now have access to the imported goods. Increased purchasing power translates to a higher standard of living because goods that once were not affordable are now financially within reach.
Expanded Markets for Exports
While benefiting from the availability of better-priced imports, a nation engaging in a free trade agreement can gain from exporting goods that it is especially efficient in producing. Exports produce jobs and add to the nation's income. This in turn makes the nation wealthier and improves the standard of living of its citizenry.
Examples of Free Trade Agreements
The North American Free Trade Agreement (NAFTA) and the European Community offer the two most famous international free trade regimes. However, there are other regional pacts as well. For example, there is a Central American Free Trade Agreement and trade pacts among the nations of southeast Asia.
Specialization of Labor and Capital
A nation engaging in free trade can focus on producing the goods and services for which it is best equipped both in raw materials and in skills. The amount of resources devoted to making things that can be acquired via import more efficiently is reduced. For example, a country very good at producing computers while very poor at making shoes can buy imported shoes and shift labor and capital to producing even more computers.
