What do you think of when countries trade with one another? Does it sound like a painstaking process that is riddled with strict regulations? Or maybe it sounds like the most efficient process in all of economics! The reality is, it can be both. Depending on the trade arrangements that countries have with one another, trading can be quick and efficient, or slow and tiresome. Want to learn what exactly makes trade between countries efficient? Continue reading to learn more about free trade zones!
Free Trade Zones Examples
Before we discuss free trade zone examples, let's define a free trade zone.
Free trade zones allow for increased trade between different countries! Let's take a look at some real-world examples of free trade zones.
The United States-Mexico-Canada Agreement (USMCA), formerly known as NAFTA, is a free trade zone that is located in North America.1 This free trade zone facilitates trade between the United States, Mexico, and Canada. Here, the free trade zone promotes trade by lowering tariffs and other trade barriers between the three countries. By establishing this regional free trade zone, trade can increase between the three countries.
The European Union (EU) is a free trade zone that started with 15 member states in 2003, and now includes 27 member states in Europe. Between its member states, tariffs and import quotas were abolished. Member states also came to an agreement on common tariffs that would be applied to nations outside of the EU. Capital and labor were also liberalized between member states. Like USMCA, the EU aimed to facilitate trade between member states by lower trade barriers between them. However, compared to other free trade zones, the EU has the more ambitious goals of economic and political integration.
Fig. 1 - A cargo ship carrying goods
Want to learn more about trade agreements? Check out our explanation: Trade Agreements.
Free Trade Zone Benefits
A majority of the benefits of free trade zones come from increased trade itself. With more trade, countries will see increased specialization, greater productivity, and faster economic growth. How is this possible through free trade zones? Let's take a deeper look at each to see why trade engenders these benefits!
Specialization
When countries agree to be a part of a free trade zone, each country will be specializing in a particular good or service. Rather than having each country produce everything for its citizens, engaging in trade with other countries allows each country to be productive in a few products, rather than be semi-productive in all products. This brings us to productivity.
Productivity
Productivity is increased since each country can specialize in what it has a comparative advantage.
Comparative advantage occurs when a producer can produce goods or services at a lower opportunity cost than other producers.
Instead of the United States using all of its resources to produce everything in the country (which is not efficient), it can use its resources for industries in which it does have a comparative advantage. Now, productivity will not falter in the United States since it doesn't have to put resources towards other industries where it does not have a comparative advantage in.
Economic Growth
Now that the United States can specialize and focus on the industries it is productive in, the United States can look towards other countries that specialize in their own goods to engage in trade with. Now, the United States will be "filling the gaps" by trading with other countries that specialize in other goods. Increased trade will result in economic growth since countries are all increasing output in the goods they have a comparative advantage. Free trade is linked to higher Gross Domestic Product (GDP) growth in countries!
Gross Domestic Product is the value of all goods and services produced in a country in a certain period of time.
Want to learn more about trade? Check out these articles:
- Specialization
- Comparative Advantage
- Opportunity Cost
- Gross Domestic Product
Foreign-Trade Zones
There is also another type of free trade zones that is sometimes called foreign-trade zones. These are small areas in countries with policies that facilitate export-oriented industries. In general, there will be minimal trade regulations in these free trade zones. Recall that the purpose of free trade zones is to limit intervention from authorities to speed up the trade process. Therefore, in terms of trade regulations, there will not be that many regulations in place for free trade zones. However, there are regulations that need to be put in place before a free trade zone is established.
The Foreign-Trade Zones Act of 1934 established a Foreign-Trade Board to approve free trade zones before they are formally established.2 In this way, free trade zones can't be extemporaneously established by countries. As you can see, it is wrong to say that there are no regulations in regard to free trade zones; administrative regulations exist to maintain stability and structure for free trade zones. However, regulations in terms of tariffs and other trade barriers are minimal.
Want to know about trade barriers? Start from these explanations:
- Tariffs and Quotas
- Import Quotas
Importance of Free Trade Zone
What is the importance of free trade zones? The importance of free trade zones is that they make trade easier to engage in for countries. Trade allows for specialization, increased productivity, and more economic growth in countries — all admirable things for a country to have! In addition to the gains from trade, some also argue that more trade may foster improved relations between countries as well.
For example, let's look at the USMCA agreement, which involves the United States, Mexico, and Canada. Since these three countries are tied together through this trade agreement and free trade zone, it is in the best interest of each country to avoid conflicts with one another. If any of the three countries get into a military conflict with one another, it can hurt the economy of each country since their economies are so connected through trade. Therefore, the free trade zone established by the USMCA agreement may help preclude conflicts between these countries.
This theory says that free trade zones not only provide more economic growth for the countries involved but also contribute to stability and security within the international system!
Advantages of Free Trade Zones
At face value, the advantages of free trade zones are that they can speed up trade and improve relations with other countries engaging in the free trade zone. However, to get a better understanding of the advantages, we must examine what would happen to countries without free trade zones. How might countries be affected if no free trade zones were established? We can take a closer look at the European Union for this example.
Without free trade zones, countries would not see the same amount of gains from trade that they do now, and conflicts could become more likely. Let's apply this theory to the European Union.
The European Union would engage in less trade between member states, which would severely limit the productivity and growth of those countries. In addition, without the member-states being connected through trade, conflict is much more likely between them.
In fact, economic integration enabled by the EU and its predecessors is credited with ensuring lasting peace between its member countries on the European continent for 70 years. The EU was awarded the Nobel Peace Prize in 2012.3
As you can see, the advantages of trade are not inconsequential. While it may be difficult to appreciate the advantages of free trade zones just by listing their benefits, looking at the alternative helps us appreciate just how much they benefit countries!
Free Trade Zone - Key takeaways
- A free trade zone is an area between countries that are formed by free trade agreements.
- The benefits of a free trade zone are a result of increased trade: specialization, productivity, and economic growth.
- Examples of free trade zones are the USMCA and the EU.
References
- U.S. Customs and Border Protection. "USMCA". https://www.cbp.gov/trade/priority-issues/trade-agreements/free-trade-agreements/USMCA
- U.S. Customs and Border Protections. "About Foreign-Trade Zones and Contact Info." https://www.cbp.gov/border-security/ports-entry/cargo-security/cargo-control/foreign-trade-zones/about#:~:text=The%20Foreign%2DTrade%20Zones%20Act%20of%201934%20created%20a%20Foreign,adequately%20%22the%20public%20interest%22
- European Union. "Achievements." https://european-union.europa.eu/priorities-and-actions/achievements_en
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