Pros and Cons of Free Trade Agreements

Michael Boyle is an experienced financial professional with more than 10 years working with financial planning, derivatives, equities, fixed income, project management, and analytics.

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Free trade agreements are treaties that regulate the tariffs, taxes, and duties that countries impose on their imports and exports. The most well-known U.S. regional trade agreement is the United States-Mexico-Canada Agreement (USMCA), which replaced the North American Free Trade Agreement (NAFTA) on July 1, 2020.

The advantages and disadvantages of free trade agreements affect jobs, business growth, and living standards. For example, they can lead to increased job opportunities and business expansion but may also result in job displacement and economic inequalities.

Key Takeaways

• Free trade agreements are contracts between countries to allow access to their markets.
• FTAs can force local industries to become more competitive and rely less on government subsidies.
• They can open new markets, increase gross domestic product (GDP), and invite new investments.
• FTAs can open up a country to degradation of natural resources, loss of traditional livelihoods, and local employment issues.
• Countries must balance the domestic benefits of free trade agreements with their consequences.

Advantages of Free Trade Agreements

Free trade agreements are designed to increase trade between two or more countries. Increased international trade has the following main advantages.

Increased Economic Growth

In 2003, the U.S. International Trade Commission estimated that NAFTA could increase U.S. economic growth by 0.1% to 0.5% per year. The USMCA is a modern trade agreement that recognizes the influence of technology on economies. It changed many original NAFTA rules and processes but also kept others intact.

According to the Brookings Institution, increased trade between the U.S., Canada, and Mexico since the USMCA took effect has helped the three countries account for almost a third of global GDP.

More Dynamic Business Climate

Before free trade agreements, countries often protected their domestic industries and businesses. This protection often made them stagnant and non-competitive in the global market. With the protection removed, they became motivated to become true global competitors.

Note

Free trade agreements also contribute to foreign investment. This adds capital to expand local industries and boost domestic businesses. It also brings in U.S. dollars to many formerly isolated countries.

Lower Government Spending

Many governments subsidize local industries. After the trade agreement removes subsidies, those funds can be put to use elsewhere.

Industry Expertise

Global companies have more expertise than domestic companies to develop local resources. That's especially true in mining, oil drilling, and manufacturing. Free trade agreements allow global firms access to these business opportunities. When the multinationals partner with local firms to develop the resources, they train them in the best practices. That gives local firms access to these new methods.

Technology Transfer

Local companies also receive access to the latest technologies from their multinational partners. As local economies grow, so do job opportunities. Multinational companies provide job training to local employees.

Disadvantages of Free Trade Agreements

The biggest criticism of free trade agreements is that they are responsible for job outsourcing. Here are some of the primary disadvantages.

Increased Job Outsourcing

Why does this happen? Reducing tariffs on imports allows companies to expand to other countries. Without tariffs, imports from countries with a low cost of living cost less. It makes it difficult for U.S. companies in those same industries to compete, so they may reduce their workforce. Many U.S. manufacturing industries laid off workers as a result of NAFTA. ​​​​One of the biggest criticisms of NAFTA is that it sent jobs to Mexico.

The USMCA sought to address and correct these criticisms, requiring—for the first time in a trade agreement—that 40% to 45% of North American auto content be made by workers earning at least $16 per hour.

Theft of Intellectual Property

Many developing countries don't have laws to protect patents, inventions, and new processes. The laws they do have aren't always strictly enforced. As a result, corporations often have their ideas stolen. They must then compete with lower-priced domestic knock-offs.

Crowding Out Domestic Industries

Many emerging markets are traditional economies that rely on farming for most employment. These small family farms can't compete with subsidized agri-businesses in developed countries. As a result, they lose their farms and must look for work in the cities. This aggravates unemployment, crime, and poverty.

Poor Working Conditions

Multinational companies may outsource jobs to emerging market countries without adequate labor protections. As a result, women and children are often subjected to grueling factory jobs in sub-standard conditions.

Reduced Tax Revenue

Many smaller countries struggle to replace revenue lost from import tariffs and fees.

Degradation of Natural Resources

Emerging market countries often don't have many environmental protections. Free trade leads to the depletion of timber, minerals, and other natural resources. Deforestation and strip mining reduce their jungles and fields to wastelands.

Note

In addition to threatening environmental resources, free trade agreements threaten native populations as well. As development moves into isolated areas, indigenous cultures can be destroyed. Local people are uprooted. Many suffer disease and death when their resources are polluted.

How to Create Effective Trade Agreements

Free trade agreements are designed to combat trade protectionism, which has its own downsides. Trade protectionism produces high tariffs and only protects domestic industries in the short term. In the long term, global corporations will hire the cheapest workers wherever they are in the world to make higher profits.

A better solution than protectionism is the inclusion of regulations within trade agreements that protect against the disadvantages.

Note

Environmental safeguards can prevent the destruction of natural resources and cultures. Labor laws prevent poor working conditions. The World Trade Organization enforces free trade agreement regulations.

Developed economies can reduce their agribusiness subsidies, keeping emerging market farmers in business. They can help local farmers develop sustainable practices and then market them as such to consumers.

Countries can insist that foreign companies build local factories as part of the agreement. They can require these companies to share technology and train local workers.

Frequently Asked Questions (FAQs)

What was the purpose of NAFTA?

NAFTA was created to promote cross-border trade among the U.S., Mexico, and Canada. The three countries sought to create a free trade agreement that would foster competition, increase investment opportunities, and create procedures for handling trade disputes. Although it had some serious downsides, NAFTA largely succeeded in achieving those goals. The United States-Mexico-Canada Agreement (USMCA) officially replaced NAFTA on July 1, 2020, to achieve the modern trade goals of the digital age.

What is the difference between free trade and fair trade?

Although these terms are often confused, there are significant differences between free trade and fair trade. Free trade agreements are aimed at fostering open trade between nations to improve economic growth among all involved parties. The fair trade movement is focused on fostering economic equity on a global scale so that workers who make goods in other countries receive fair wages and improve their lives and communities.

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

1. Office of the United States Trade Representative. "United States-Mexico-Canada Agreement."
2. United States International Trade Commission. "The Impact of Trade Agreements: Effect of the Tokyo Round, U.S.-Israel FTA, U.S.-Canada FTA, NAFTA, and the Uruguay Round on the U.S. Economy," Page 32.
3. Northwestern Journal of International Law and Business. "Trade and Technology Within the Free Trade Zone: The Impact of the WTO Agreement, NAFTA, and Tax Treaties on the NAFTA Signatories," Page 84.
4. Congressional Research Service. "The North American Free Trade Agreement (NAFTA)," Page 27.
5. Congressional Research Service. "The United States-Mexico-Canada Agreement (USMCA)," Page 11.
6. Northwestern Journal of International Law and Business. "Trade and Technology Within the Free Trade Zone: The Impact of the WTO Agreement, NAFTA, and Tax Treaties on the NAFTA Signatories," Page 72.
7. ADB Institute. "Exploring the Trade-Urbanization Nexus in Developing Economies: Evidence and Implications" Pages 2, 7-13.
8. Brookings Institution. "Workers' Rights: Labor Standards and Global Trade."
9. European Union Directorate-General for External Policies. "Addressing Developing Countries' Challenges in Free Trade Implementation," Page 8.
10. World Trade Organization. "World Trade Report 2010: D. Trade Policies and Natural Resources," Pages 126, 134, 136.
11. American University International Law Review. "Indigenous Peoples, Indigenous Farmers: NAFTA's Threat to Mexican Teosinte Farmers and What Can Be Done About It," Page 1393.
12. Congressional Research Service. "The United States-Mexico-Canada Agreement (USMCA)," Pages 1, 23-24.

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