Introduction
In an increasingly globalised world, where international trade is constantly growing, the creation of free trade areas and the facilitation of trade are more and more at the centre of debate. It is generally believed that trade is beneficial as it allows countries to use their comparative advantage on specific products, leading to lower prices and greater choice for consumers; however, trade is often hindered by trade barriers such as tariffs and waiting times among others (OECD, 2005). The creation of a FTA offers a solution to these problems. Depending on the economic and political situation of the countries entering the agreement, a different model of free trade area might be chosen; for example, free trade areas where tariff barriers are abolished for member countries but no single policy on tariffs with external countries or custom unions that include a common policy on tariffs with non member countries. The most advanced trade bloc is currently the European Union, with a single market and currency and freedom of movement of people, goods, resources and capital (European Union 2013). But what is the impact of FTAs on member countries and the rest of the world?
Free trade areas: direct effects in the short run
In the short run, forming an FTA impacts the national and global markets in two ways; the first is trade creation and leads to boost trade in member countries that can now sell their products exempt from tariffs to other member countries. The second is trade diversion and it implies the transfer of consumption from a lower cost producer to a higher cost producer within the FTA.
Figure 4 Trade creation and diversion
As illustrated in Figure 4, when establishing a trade agreement with a partner country, bot...
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References
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Princeton, 1963. Hailstone, Thomas and Rothwell, John. Managerial Economics, pp. 93-95. Prentice Hall, 1993.
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Trade creation occurs when low cost producers within free trade area replace high cost domestic producers. These agreements create more opportunities for countries to trade with one another by removing the trade barriers and investment. Trade creation allows member countries for a wider selection of goods and services not previously available. They can acquire goods and services at a lower cost after trade barriers due to lowered tariffs or removal of tariffs which will encourage more trade between member countries the balance of money spend from cheaper goods and services, can be used to buy more products and services. Regional economic integration significantly contributes to the relatively high growth rates in the nation. By removing trade barriers between members countries the factor of production can be move