trade agreement

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Concept illustration of the world showing trade relationships between countries.

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trade agreement, any contractual arrangement between states concerning their trade relationships. Trade agreements may be bilateral or multilateral—that is, between two states or more than two states.

For most countries international trade is regulated by unilateral barriers of several types, including tariffs, nontariff barriers, and outright prohibitions. Trade agreements are one way to reduce these barriers, thereby opening all parties to the benefits of increased trade.

In most modern economies the possible coalitions of interested groups are numerous, and the variety of possible unilateral barriers is great. Further, some trade barriers are created for other, noneconomic reasons, such as national security or the desire to preserve or insulate local culture from foreign influences. Thus, it is not surprising that successful trade agreements are very complicated. Some common features of trade agreements are (1) reciprocity, (2) a most-favoured-nation (MFN) clause, and (3) national treatment of nontariff barriers.

Reciprocity is a necessary feature of any agreement. If each required party does not gain by the agreement as a whole, there is no incentive to agree to it. If agreement takes place, it may be assumed that each party to the agreement expects to gain at least as much as it loses. Thus, for example, Country A, in exchange for reducing barriers to Country B’s products, which thereby benefit A’s consumers and B’s producers, will insist that Country B reduce barriers to Country A’s products, thereby benefiting Country A’s producers and perhaps B’s consumers.

The most-favoured-nation clause prevents one of the parties to the current agreement from further lowering barriers to another country. For example, Country A might agree to reduce tariffs on some goods from Country B in exchange for reciprocal concessions. Without a most-favoured-nation clause, Country A could then further reduce tariffs for the same goods from Country C in exchange for other concessions. As a result, Country A’s consumers would be able to purchase the goods in question more cheaply from Country C because of the tariff difference, while Country B would get nothing for its concessions. Most-favoured-nation status means that A is required to extend the lowest existing tariff on specified goods to all its trading partners having such status. Thus, if A agrees to a lower tariff later with C, B automatically gets the same lower tariff.

A “national treatment of nontariff restrictions” clause is necessary because most of the properties of tariffs can be easily duplicated with an appropriately designed set of nontariff restrictions. These can include discriminatory regulations, selective excise or sales taxes, special “health” requirements, quotas, “voluntary” restraints on importing, special licensing requirements, etc., not to mention outright prohibitions. Instead of trying to list and disallow all of the possible types of nontariff restrictions, signatories to an agreement demand treatment similar to that given to domestically produced goods of the same type (for example, steel).

Even without the constraints imposed by most-favoured-nation and national treatment clauses, sometimes general multilateral agreements are easier to reach than separate bilateral agreements. In many cases the possible loss from a concession to one country is almost as great as that which would result from a similar concession to many countries. The gains that the most efficient producers realize from worldwide tariff reductions are large enough to warrant substantial concessions. Since the institution of the General Agreement on Tariffs and Trade (GATT, implemented in 1948) and its successor, the World Trade Organization (WTO, created in 1995), world tariff levels have dropped substantially and world trade has expanded. The WTO includes provisions for reciprocity, most-favoured-nation status, and national treatment of nontariff restrictions. It has had a hand in the architecture of the most comprehensive and important multilateral trade agreements in modern times. Examples of these trade agreements and their representative institutions include the North American Free Trade Agreement (1993) and the European Free Trade Association (1995).