We assume that there are three countries in the world: countries A, B and C. Each country has the supply and demand for a homogeneous product in a representative industry. Countries A and B will form a free trade area. (Note that diversion and business creation can occur regardless of whether a preferential trade agreement, free trade area, or customs union is formed. For the sake of simplicity, we call the arrangement a free trade area [FTA].) In this analysis, the focus will be on Country A, one of the two FTA members. We assume that country A is a small country in international markets, which means that it takes international prices for granted. Countries B and C are assumed to be large countries (or regions). Thus, country A can export or import as much product as it is at will with countries B and C, at the prevailing price in these markets. Mercosur countries have gradually removed trade barriers and established a free trade area since 1991, but remain barriers in some sectors. In 1994, the Treaty of Asuncion was amended and updated by the Treaty of Ouro Preto.
The 1994 Treaty helped to improve the institutional structure of Mercosur and launched a new phase in the member States` trade relations in order to promote their objective of achieving a common market. Bolivia, Chile, Colombia, Ecuador, Peru and Venezuela have associate membership in Mercosur. Associate members do not participate in Mercosur`s most important trade negotiations and may choose not to abide by its trade rules. In addition to NAFTA, there is the Dominican Republic-Central America Free Trade Area (RCAF-RD), which includes the Dominican Republic, Costa Rica, El Salvador, Nicaragua, Honduras and Guatemala. The United States also has free trade agreements with Australia, Bahrain, Chile, Colombia, Panama, Peru, Singapore, Israel, Jordan, Korea, Oman, and Morocco. The United States recently withdrew from the Trans-Pacific Partnership (TPP), although the agreement continues without U.S. participation. The U.S. has also been working on a European trade agreement called the Transatlantic Trade and Investment Partnership (T-TIP), with the goal of creating a “high-quality, broad-based regional pact,” according to the Office of the U.S.
Trade Representative. One might ask, if free trade is the most economically effective policy, how is it that a move towards free trade by a group of countries can reduce economic efficiency? The answer is quite simple if we put the history of FTA education in the context of the theory of the second best. Let us remember that the theory of the second best suggests that if there are distortions or imperfections in a market, the addition of another distortion (such as trade policy) could actually increase prosperity or economic efficiency. In the case of a free trade agreement, the policy change is to remove barriers to trade rather than adding a new trade policy. However, the theory of the second best works in the same way. Effects of the free trade area on the government of country A. Since the original duties were prohibitive and the product was not originally imported, there was no initial customs revenue. Thus, the FTA does not result in any loss of revenue. The TPL expires in June 2007 and the renewal of the Trade Act is uncertain. All trade agreements under negotiation by the United States must be finalized before this deadline in order to receive expedited procedures under the PCPA. Regional integration also has political implications for the United States. Some observers see this as the impetus given to trade liberalization both politically and economically.
There are several issues that policymakers could consider. To what extent do trade agreements promote a country`s political stability? Are they a useful tool for building a more democratic, secure and prosperous region? A fundamental question is whether the United States should further deepen trade integration in North and South America and, if so, whether the negotiation of bilateral trade agreements is the most appropriate trade policy. As mentioned earlier, some analysts do not believe that bilateral trade agreements are the best course of action, as they divert attention from the revival of FTAA negotiations and slow down the process. Others believe that RTAs have led to the consolidation of trade agreements in major free trade areas in other parts of the world, and that the same could happen over time in the Western Hemisphere. In particular, the agreements should contribute to a greater free flow of trade between RTA countries without creating barriers to trade with the outside world. In other words, regional integration should complement the multilateral trading system, not threaten it. The creation of free trade areas is considered an exception to the most-favoured-nation (MFN) principle of the World Trade Organization (WTO), as preferences granted exclusively to each other by parties to a free trade area go beyond their membership obligations.  Although Article XXIV of the GATT allows WTO members to establish free trade areas or to conclude interim agreements necessary for their establishment, there are several conditions relating to free trade areas or interim agreements leading to the formation of free trade areas.
Since there are both positive and negative elements, the net effect of national well-being can be positive or negative. Figure 9.10 “Harmful Trade Diversion” shows where the free trade agreement reduces national welfare. Visually, it seems obvious that the area e is greater than the sum of a and b. In these circumstances, the free trade agreement with trade diversion would lead to a decline in national welfare. Regional trade agreements are mutual trade agreements between two or more partners (nations). Almost all countries are part of at least one RTA. Under a RTA, countries “pile up” and form an international community that facilitates the flow of goods and services between them. Let us take a look at some examples of regional trade agreements: the Mercosur countries began the transition to a common market in 1994 with the aim of completing internal free trade by the year 2000 and a common market by 2006. The goal of free trade has been delayed due to economic difficulties in member countries. The 2002 crisis, in which Argentina experienced its worst economic downturn in its independent history, was one of the most serious setbacks. Mercosur has a common external tariff (CET) organized in 11 stages with tariffs of 0 to 20% and an average level of 13.5%, which entered into force in 1995.
The TEC provides for some exceptions with special customs regulations for the sugar and automotive sectors. Member States have approved common regional rules on trade in services, safeguard measures, anti-dumping measures and dispute settlement, but these have only been partially implemented. Mercosur`s executive body, the Joint Market Council (JCA), has approved a work programme focused on removing remaining barriers to market access. (44) The countries of the Western Hemisphere have been concluding regional trade agreements since 1961, when the Central American Common Market was created. .