What this lesson teaches
I can explain why a government may sign trade agreements or protect its industries to meet its aims.
Syllabus 9570, 3.3.1(e). Globalisation, International Trade and Economic Co-operation: Governments may decide to engage in economic co-operation and trade agreements between countries or impose protectionist measures to achieve macroeconomic aims
Make a guess
A free trade agreement cuts tariffs to zero for a member country, but a non-member makes the same part more cheaply. Will buyers always benefit?
- No. Free trade agreements never lower prices.
- Not always: buyers may switch to a dearer member.
- Yes. Lower tariffs always mean cheaper goods for the country.
Show the answer
Not always: buyers may switch to a dearer member.
Once the tariff is gone for members only, a member's part can look cheaper than a non-member's even if it costs more to make. Trade is diverted from the cheaper source.
Free trade agreements lower barriers between members, expanding markets, but the gains depend on firms actually using them.
Countries cooperate to reduce trade barriers through free trade agreements (FTAs) and regional agreements.
These lower tariffs, simplify customs procedures and make rules more predictable, which cuts costs and opens markets for exporters and investors.
Singapore has a wide network of FTAs, including the CPTPP and RCEP, which give its firms access to large markets despite its small home market.
But firms must meet rules of origin to qualify for lower tariffs, which costs time and paperwork. Preferences for members can also divert trade away from cheaper non-member suppliers.
- FTAs
- Lower barriers between members.
- Limits
- Rules of origin; trade diversion.
Worked example: A cheaper partner is not always cheaper
An agreement removes a tariff on a component from a partner country. Another supplier, outside the agreement, still faces the tariff but can produce the component more cheaply.
- A firm may switch to the partner's supplier because the tariff is gone.
- But the non-member was the lower-cost producer.
- Trade has been diverted from the cheaper source, a hidden cost of preferential agreements.
- Small firms may also skip the preference if the paperwork costs more than the tariff saved.
Watch out for this
Signing an FTA automatically raises trade and growth.
Firms must meet the rules to use it, and some trade may simply be diverted from non-members.
Check your understanding
Why might a small exporter not use an FTA's lower tariff?
- Small firms are left out of FTAs, which cover large exporters and not them.
- FTAs raise tariffs on small orders, so small exporters end up paying more than before.
- Proving its goods meet the rules of origin costs more than the tariff saved.
Show the answer
Proving its goods meet the rules of origin costs more than the tariff saved.
Right. Paperwork can outweigh the benefit for small shipments.