Order Code RL31356
CRS Report for Congress
Received through the CRS Web
Free Trade Agreements: Impact on U.S. Trade
and Implications for U.S. Trade Policy
Updated December 11, 2003
William H. Cooper
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Congressional Research Service ˜ The Library of Congress

Free Trade Agreements: Impact on U.S. Trade and
Implications for U.S. Trade Policy
Summary
Free trade areas (FTAs) are arrangements among two or more countries under
which they agree to eliminate tariffs and nontariff barriers on trade in goods among
themselves. However, each country maintains its own policies, including tariffs, on
trade outside the region.
In the last few years, the United States has engaged or has proposed to engage
in negotiations to establish bilateral and regional free trade arrangements with a
number of trading partners. Such arrangements are not new in U.S. trade policy.
The United States has had a free trade arrangement with Israel since 1985 and with
Canada since1989, which was expanded to include Mexico and became the North
American Free Trade Agreement (NAFTA) effective in January 1994.
The United States has been conducting negotiations with 33 Western
Hemispheric countries with a stated goal of forming a Free Trade Area of the
Americas (FTAA) by 2005 and with various Asian and Pacific-Rim countries to
achieve free trade and investment by 2020. U.S. interest in bilateral and regional free
trade arrangements has surged and the Bush Administration has accelerated the pace
of negotiations since the enactment of the Trade Promotion Authority in August
2002. In December 2002, the United States completed negotiations with Singapore
and with Chile. On May 6, 2003, President Bush signed the agreement with
Singapore and signed the agreement with Chile on June 6. On July 24, 2003, the
House passed the implementing bill for the Chile agreement (H.R. 2738) and for the
Singapore agreement (H.R. 2739) by votes of 270-156 and 272-155, respectively.
The Senate passed the companion bills, S. 1416 (Chile) and S. 1417 (Singapore), by
votes of 66-31 an 66-32, respectively, and the President signed the bills into law (P.L.
108-77 and P.L. 108-78) on September 3, 2003. In 2003, the Bush Administration
launched negotiations to establish FTAs with Morocco, the South African Customs
Union, five countries of Central America, and Australia. The surge in U.S. interest
in FTAs comes at a time when major U.S. trading partners, such as, Canada, Mexico,
Japan, and the EU, are themselves negotiating and forming FTAs with various other
countries.
These efforts are of direct interest to Congress. United States participation in
free trade agreements can occur only with the concurrence of the Congress. In
addition, FTAs will affect the U.S. economy, with the impact varying across sectors.
FTAs are now a significant U.S. trade policy tool. Their rapid emergence raises
some important policy issues for the 108th Congress as it considers implementing
legislation and monitors negotiations as part of its oversight responsibilities: Do
FTAs serve or impede U.S. long-term national interests and trade policy objectives?
Which type of an FTA arrangement meets U.S. national interests? What should U.S.
criteria be in choosing FTA partners? Are FTAs a substitute for or a complement to
U.S. commitments and interests in promoting a multilateral trading system via the
World Trade Organization (WTO)? Experts differ sharply over these questions.
This report will be updated as events warrant.

Contents
What are Free Trade Areas? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Why Countries Form FTAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
FTAs in the Context of U.S. Trade Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Bush Administration Policy and Recent Developments . . . . . . . . . . . . . . . . . . . . 5
Economic Impact of FTAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
FTAs and the WTO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
The Debate Over FTAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Relevant Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Conclusions and Implications for Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Free Trade Agreements: Impact on U.S.
Trade and Implications for U.S. Trade Policy
In the last few years, the United States has considered bilateral and regional free
trade areas (FTAs) with a number of trading partners. Such arrangements are not
new in U.S. trade policy. The United States has had a free trade arrangement with
Israel since 1985 and with Canada since1989. The latter was suspended when the
North American Free Trade Agreement (NAFTA) that included the United States,
Canada, and Mexico, went into effect in January 1994.
U.S. interest in bilateral and regional free trade arrangements has surged. In
2000, the Clinton Administration began and completed negotiations with Jordan on
a bilateral free trade agreement (FTA), and the Bush Administration supported the
agreement. The U.S.-Jordan FTA went into effect with the enactment of the United
States-Jordan Free Trade Area Implementation Act (P.L. 107-43) on September 28,
2001. At the end of 2002, the Bush Administration completed FTA negotiations with
Chile and Singapore first begun by the Clinton Administration in 2000. On May 6,
2003, President Bush signed the agreement with Singapore and signed the agreement
with Chile on June 6. On July 24, the House passed the implementing bill for the
Chile agreement (H.R. 2738) and for the Singapore agreement (H.R. 2739) by votes
of 270-156 and 272-155, respectively. The Senate passed the companion bills, S.
1416 (Chile) and S. 1417 (Singapore), by votes of 66-31 an 66-32, respectively and
the President signed the bills into law (P.L.108-77, P. L. 108-78) on September 3,
2003.
Perhaps encouraged by the passage and enactment of legislation granting the
President trade promotion authority (TPA), as contained in the Trade Act of 2002
(P.L. 107-210 — signed into law on August 6, 2002), the Bush Administration has
moved ahead with a trade agenda that contains an unprecedented number of FTAs.
In 2003, the Bush Administration launched negotiations to establish FTAs with
Morocco, with the five countries of Central America (Costa Rica, El Salvador,
Guatemala, Honduras, and Nicaragua), with the South African Customs Union
(South Africa, Botswana, Lesotho, Namibia, and Swaziland), and with Australia.
The United States continues negotiations with 33 Western Hemispheric countries
with a goal of forming a Free Trade Area of the Americas (FTAA) by 2005 and with
various Asian and Pacific-Rim countries to achieve a free trade and investment area
by 2020. In addition, the President notified Congress of his intention to begin FTA
negotiations individually with the Dominican Republic, Bahrain, Thailand, and
Panama and to begin negotiations to form an FTA with the four Andean countries of
Bolivia, Columbia, Ecuador, and Peru.

The surge in U.S. FTAs and proposed FTAs reflects a worldwide trend. As of
October 2003, 285 FTAs and customs unions had been notified to the GATT/WTO.
Of these, 124 had been notified during the existence of GATT (1948-1994) and 149

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have been notified since 1995 under the WTO. Some 215 FTAs and customs unions
are in force. The remaining FTAs and customs unions were largely superceded by
other agreements involving the same participants.1
These efforts are important to Congress. United States participation in free
trade agreements can occur only with the legislative concurrence of the Congress.
In addition, FTAs will affect the U.S. economy, with the impact varying across
sectors.
The emergence of FTAs raises some important policy issues for the108th
Congress as it considers implementing legislation and monitors negotiations as part
of its oversight responsibilities: Do FTAs serve or impede U.S. long term national
interests and trade policy objectives? What criteria should be used in choosing FTA
partners? Which type of FTA meets U.S. national interests? Are FTAs a substitute
or a complement to U.S. commitments and interests in promoting a multilateral
trading system via the World Trade Organization (WTO)?

This report will monitor pending and possible proposals for U.S. FTAs, relevant
legislation and other congressional interest in U.S. FTAs. The report will be revised
as events warrant.
What are Free Trade Areas?
Free trade areas are part of the broad category of trade arrangements under
which member-countries grant one another preferential treatment in trade.
Preferential trade arrangements include:
! free trade areas (FTAs) under which member countries agree to
eliminate tariffs and nontariff barriers on trade in goods within the
FTA, but each country maintains its own trade policies, including
tariffs on trade outside the region;
! customs unions in which members conduct free trade among
themselves and maintain common tariffs and other trade policies
outside the arrangement;
! common markets in which member countries go beyond a customs
union by eliminating barriers to labor and capital flows across
national borders within the market; and
! economic unions where members merge their economies even
further by establishing a common currency, and therefore a unified
monetary policy, along with other common economic institutions.
1 WTO Secretariat. Trade Agreements Section. Trade Policies Review Division. The
Changing Landscape of RTAs.
A paper prepared for a seminar on Regional Trade
Agreements and the WTO. November 14, 2003. p. 2.

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The European Union is the most significant example of a group of
countries that has gone from a customs union to an economic union.2
The process in forming an FTA usually begins with discussions between trading
partners to ascertain the feasibility of forming an FTA. If they agree to go forward,
then the countries undertake negotiations on what the FTA would look like. At a
minimum, participants in an FTA agree to eliminate tariffs and some other nontariff
trade barriers and agree to do so over a specific time period. In addition, the partner
countries usually agree on rules of origin, that is a definition of what constitutes a
product manufactured within the FTA and therefore is eligible to receive duty-free
and other preferential trade treatment. Rules of origin prevent products from
nonmembers entering an FTA market over the lowest tariff wall. Most FTAs also
include procedures on the settlement of disputes arising among members and rules
on the implementation of border controls, such as product safety certification and
sanitary and phytosanitary requirements. Most recent FTAs contain rules on
economic activities besides trade in goods, including foreign investment, intellectual
property rights protection, treatment of labor and environment, and trade in services.
The size and complexity of the FTA will largely reflect the size and complexity of
the economic relations. U.S. FTAs with Israel and Jordan are relatively basic, while
the NAFTA is very complex.
Why Countries Form FTAs
Countries form free trade areas for a number of economic and political reasons.
Most basically, by eliminating tariffs and some nontariff barriers, FTAs permit the
products of FTA partners easier access to one another’s markets. The 1989 FTA
between the United States and Canada was arguably formed for this purpose.
Developed countries have also formed FTAs with developing countries to encourage
them toward trade and investment liberalization.
FTAs may be used to protect local exporters from losing out to foreign
companies that might receive preferential treatment under other FTAs. For example,
some supporters of a U.S.-Chile FTA argued that U.S. firms are at a disadvantage
vis-a-vis their Canadian competitors whose exports face no Chilean tariffs under the
Canada-Chile FTA. Slow progress in multilateral negotiations has been another
impetus for FTAs. For example, when the 1986-1994 Uruguay Round negotiations
got bogged down, the impetus for the United States, Mexico, and Canada to form
NAFTA seemed to increase. Arguably the surge in FTA formation worldwide in the
2 Besides the arrangements described above under which member countries extend
reciprocal preferential treatment, there are trade arrangements under which one party agrees
to extend nonreciprocal preferential treatment to the imports of a country or group of
countries unilaterally. Such arrangements involve primarily developed countries extending
nonreciprocal preferential treatment to the imports from developing countries. For
example, the United States employs the Generalized System of Preferences (GSP), the
Andean Trade Preferences Act (ATPA), the Carribean Basin Initiative (CBI), and the Africa
Growth and Opportunity Act (AGOA). The main objective of these nonreciprocal
arrangements is to encourage economic development in developing countries.

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past few years has been a result of the difficulties encountered in launching and
implementing the Dona Development Agenda round of negotiations in the WTO.
Political considerations are also a motivation to form FTAs. The United States
formed FTAs with Israel and, most recently, with Jordan to reaffirm American
support of those countries and to strengthen relations with them.
FTAs in the Context of U.S. Trade Policy
Post-World War II trade policy under various presidential administrations has
had several interrelated objectives. One has been to secure open markets for U.S.
exports. A second has been to protect domestic producers from foreign unfair trade
practices and from rapid surges in fairly traded imports. A third has been to control
trade for foreign policy and national security reasons. A fourth objective has been to
help foster global trade to promote world economic growth.
In fulfilling these objectives, U.S. political leaders have formed and conducted
trade policy along three tracks. One track has been the use of multilateral
negotiations to establish and develop a rules-based trading system. The United States
was a major player in the development and signing of the General Agreement on
Tariffs and Trade (GATT) in 1947. It was a leader in eight rounds of negotiations
that have expanded the coverage of GATT and that led to the establishment in 1995
of the World Trade Organization (WTO), the body that administers the GATT and
other multilateral trade agreements. The United States has continued this approach
by leading the effort in launching another round at the November 2001 WTO
Ministerial in Doha, Qatar.
U.S. policymakers have used a second track which can be labeled the
“unilateral” track. Unlike traditional negotiations where partners make balancing
concessions, under this approach, the United States used threats of retaliation, usually
in the form of restricting trade partners’ access to the vast U.S. market, in order to get
the partner to open its markets to U.S. exports or to cease other offensive commercial
practices and policies. The United States has employed this approach primarily
against foreign practices not covered by GATT/WTO rules or because the
multilateral dispute settlement process proved too slow and ineffective to meet U.S.
needs. For several decades, especially in the 1970s and 1980s, the United States
conducted its trade policy with Japan “unilaterally” to get Japan to amend domestic
laws, regulations and practices that prevented U.S. exporters from securing what they
considered to be a fair share of the Japanese market.
More and more, however, U.S. trade policy is becoming dominated by a third
track — bilateral and regional negotiations to establish FTAs. The United States
completed its first FTA with Israel in 1985 under President Reagan. It completed its
second with Canada under President Bush in 1989, whose Administration was
involved in the process of expanding it to Mexico, a process that was completed by
the Clinton Administration in 1993. However, even after the completion of NAFTA,
it was still unclear whether bilateral and regional FTAs had become a fixture in U.S.

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foreign trade policymaking or anomalies to cement already strong economic
relationships.
By 1994 it seemed apparent that FTAs were becoming a fixture when the United
States, under the Clinton Administration, led a group of trade ministers from 33 other
Western Hemispheric countries in agreeing to work toward establishing a Free Trade
Area of the Americas (FTAA) by 2005. In the same year, political leaders from the
United States and other member-countries of the Asian-Pacific Economic
Cooperation (APEC) forum signed a declaration in Bogor, Indonesia, to work toward
free trade and investment in the region by 2010 for developed countries and by 2020
for all member-countries.
The pursuit of FTAs continued when, on June 6, 2000, President Clinton and
Jordanian King Abdullah announced that their two countries would begin
negotiations on establishing a free trade area. An agreement was quickly reached and
was signed on October 24, 2001. Similarly, President Clinton and Singapore Prime
Minister Goh Chok Tong announced, somewhat unexpectedly, on November 16,
2000, that their two nations would launch negotiations to complete a free trade
agreement. And on December 6, 2000, the United States and Chile started
negotiations to establish an FTA. Chile had long been mentioned as a potential
addition to NAFTA or as a partner in a stand-alone FTA.
In the meantime, many countries, including the other major trading powers,
were actively negotiating free trade agreements. The WTO has reported that since
1995 it has received notification of more than 100 FTAs, roughly more than double
the number that was reported to the GATT from 1947 to 1995. For example, Canada
formed an FTA with Chile as did Mexico. The EU has formed FTAs with a number
of countries. Japan, which had shunned the use of FTAs, recently completed
negotiations with Singapore and is exploring the possibility of forming an FTA with
Korea.
Bush Administration Policy and Recent
Developments

The Bush Administration has affirmed the strategy of pursuing U.S. trade policy
goals through the multilateral trade system but is giving strong emphasis to building
bilateral and regional trade ties through free trade agreements. Lamenting that the
United States was involved in only two FTAs while most of its major trading partners
were negotiating many more, USTR Robert Zoellick stated early in the
Administration:
America’s absence from the proliferation of trade accords hurts our exporters...
If other countries go ahead with free trade agreements and the United States does
not, we must blame ourselves. We have to get back into the game and take the
lead. We are certainly in a position to do so. Indeed, the United States will be
pursuing a number of regional free trade agreements in the years ahead, though
not to the exclusion of global talks and the WTO process. The fact that the
United States can move on multiple fronts increases our leverage in the global
round, just as the Clinton Administration used the North American Free Trade

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Agreement and the APEC summit to help squeeze the European Union to
complete the Uruguay Round of GATT.3
Zoellick has also stated, “By moving on multiple fronts, [the United States] can
create a competition in liberalization (italics added) that will increase U.S. leverage
and promote open markets in our hemisphere and around the world.”4
The Bush Administration continued negotiations that the Clinton Administration
initiated. At the end of 2002, the Bush Administration completed FTA negotiations
with Chile and Singapore first begun by the Clinton Administration in 2000. On May
6, 2003, President Bush signed the agreement with Singapore and signed the
agreement with Chile on June 6. On July 24, the House passed the implementing bill
for the Chile agreement (H.R. 2738) and for the Singapore agreement (H.R. 2739)
by votes of 270-156 and 272-155, respectively. The Senate passed the companion
bills, S. 1416 (Chile) and S. 1417 (Singapore), by votes of 66-31 an 66-32,
respectively, and the President signed the bills into law (P.L.108-77and P. L. 108-78)
on September 3, 2003.
President Bush reaffirmed the U.S. commitment to complete negotiations on the
FTAA. At the 2001 Summit in Quebec, he and the other leaders adopted draft
agreements in 9 negotiating areas that are designed to form the basis of final
negotiations. The nine areas are: market access; agriculture; investment; services;
government procurement; intellectual property rights; subsidies, antidumping, and
countervailing duty; competition policy; and dispute settlement.5 In addition,
President Bush participated in the October 2001 APEC leaders meeting in Shanghai
recommitting the United States support of fulfilling the objectives of the Bogor
Declaration.6
In addition to pursuing negotiations on FTAs launched by its predecessors, the
Bush Administration has broadened the use of FTAs as a policy instrument. In 2003,
the Bush Administration launched negotiations to establish FTAs with Morocco, with
the five countries of Central America (Costa Rica, El Salvador, Guatemala,
Honduras, and Nicaragua), with the South African Customs Union (South Africa,
Botswana, Lesotho, Namibia, and Swaziland), and with Australia. The United
States continues negotiations with 33 Western Hemispheric countries with a goal of
forming a Free Trade Area of the Americas (FTAA) by 2005 and with various Asian
and Pacific-Rim countries to achieve a free trade and investment area by 2020. In
2003, the President notified Congress of his intention to begin FTA negotiations
3 Office of the United States Trade Representative. 2001 Trade Policy Agenda and 2000
Annual Report.
Washington. 2001. p. 4.
4 Statement of the Honorable Robert B. Zoellick, United States Trade Representative.
Testimony Before the Subcommittee on Trade of the House Committee on Ways and
Means. Hearing on Summit of the Americas and Prospects for Free Trade in the
Hemisphere. May 8, 2001.
5 For details, see A Free Trade Area of the Americas: Status of Negotiations and Major
Policy Issues.
CRS Report RS20864.
6 For details, see Asian Pacific Economic Cooperation (APEC), Free Trade, and the 2001
Summit in Shanghai
. CRS Report RL31035.

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individually with the Dominican Republic, Bahrain, Thailand and Panama and to
begin negotiations to form an FTA with the four Andean countries of Bolivia,
Columbia, Ecuador, and Peru.7
Economic Impact of FTAs
The surge in U.S. interest in FTAs and in the formation of FTAs worldwide
raises the question of their impact on the countries included in an FTA and on the rest
of the world. It is an issue that economists have long studied and debated. Interest
in the issue has peaked at various times in the post-World War II period. The first
time was the formation of the European Common market. Interest has peaked again
with the current trends in FTAs. The debate has relied largely on theory since
empirical data are scarce save for the experience of the European Union. The debate
has also divided economists between those who strongly oppose FTAs as an
economically inefficient mechanism and those who support them as a means to build
freer trade.
Economists usually base their analysis of the impact of FTAs on the concepts
of trade creation and trade diversion. These concepts were first developed by
economist Jacob Viner in 1950.8 Viner focused his work on the economic effects
of customs unions, but his conclusions have been largely applied to FTAs and other
preferential trade arrangements. His analysis was also confined to static (one-time)
effects of these arrangements.
Trade creation occurs when a member of an FTA replaces domestic production
of a good with imports of the good from another member of the FTA, because the
formation of the FTA has made it cheaper to import rather than produce
domestically. The creation of the trade is said to improve economic welfare within
the group because resources are being shifted to more efficient uses. Trade diversion
occurs when a member of an FTA switches its import of a good from an efficient
nonmember to a less efficient member because the removal of tariffs within the group
and the continuation of tariffs on imports from nonmembers make it cheaper to do
so. Trade diversion is said to reduce economic welfare because resources are being
diverted from an efficient producer to a less efficient producer.
In most cases, it appears that FTAs lead to both trade diversion and creation
with the net effects determined by the structure of the FTA. Therefore, even if two
or more countries are moving toward freer trade among themselves in an FTA, the
FTA could make those countries and the world as a whole worse off if the FTA
7 For update information on FTA negotiations, see Trade Negotiations in the 108th
Congress
, CRS Issue Brief IB10123.
8 Viner, Jacob. The Customs Union Issue. Carnegie Endowment for International Peace.
1950. New York.

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diverts more trade than it creates, according to economic theory.9 (See box below for
illustrative examples of trade diversion and trade creation.)
Trade Creation or Trade Diversion?
Economist Robert Z. Lawrence has provided the following example to illustrate
the difference between trade creation and trade diversion:
“Assume that prior to implementing a free trade agreement with the United States,
all television sets purchased in Mexico are subject to a tariff of 10 percent. Assume that
Japan produces TVs under competitive conditions, which it sells at a cost of $100, but
the United States could only produce such sets at $105. Initially, all TVs sold in Mexico
and elsewhere would be Japanese. These would be imported at a price of $100 from
Japan and sold to Mexican consumers for $110, with the additional $10 representing the
tariff that would be paid by Mexican consumers to the Mexican government. Assume
now that a free trade agreement is signed between Mexico and the United States which
removes tariffs between Mexico and the United States but retains Mexican tariffs on
other countries. Mexican consumers will now have a choice between buying American
TVs, which will sell in Mexico at $105, or Japanese TVs, which will sell at $110. They
will buy the U.S. TVs and be better off. However, the Mexican economy as a whole will
be worse off. Before the agreement, Mexico bought TVs from Japan. Although
consumers paid $110, $10 was just a transfer from Mexican consumers to the Mexican
government. The economy as a whole, therefore, spent $100 per TV. After the
agreement, however, Mexico is spending $105 per TV. TV prices in Mexico do not
reflect their social opportunity costs. The impact of the agreement is to expand TV
production in the United States, which is relatively less efficient, and to reduce it in
Japan, which is relatively more efficient.
“Of course, not all of the increased trade between partners will represent expansion
from a less efficient source. Pure trade creation would also result. Assume in the
example that initially Mexico could produce TV sets for $107. In this case, prior to the
agreement Mexico would not have imported them from Japan, instead it would have
supplied these TV sets domestically. In this case, Mexico would benefit from the
agreement, which would allow it [to] pay only $105 per TV, although of course it would
have done better by liberalizing fully and buying the sets from Japan.”
Source: Lawrence, Robert Z. International National Economies: Regionalism,
Multilateralism, and Deeper Integration. Brookings Institution. Washington. 1996. p.
24-25.
9 This conclusion is called the General Theory of the Second Best and was developed by
economists Richard Lipsey and Kelvin Lancaster. Lipsey, Richard and Kelvin Lancaster.
The General Theory of the Second Best. Review of Economic Studies. vol 24. p. 11-32.
Cited and discussed in Lawrence, Robert Z. International National Economies:
Regionalism, Multilateralism, and Deeper Integration.
Brookings Institution. Washington.
1996. p. 22.

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Trade policymakers encounter circumstances much more complicated than what
are depicted in economic theory. Many functioning and proposed FTAs encompass
more than two countries and involve a range of products, both goods and services,
making it much more challenging to evaluate their economic impact. To provide an
analytical framework, some economists have developed sets of conditions under
which, they have concluded, an FTA would create more trade than its diverts. They
state that trade creation is likely to exceed trade diversion —
! the larger the tariffs or other trade barriers among members before
the FTA is formed;
! the lower the tariffs and other barriers in trade with nonmembers;
! the greater the number of countries included in the FTA;
! the more competitive or the less complementary the economies
joining the FTA; and
! the closer the economic relationship among the members before the
FTA was formed.10
Economists also have determined that, along with the immediate, static effects
of trade diversion and creation, FTAs generate long-term dynamic effects that might
include:
! increased efficiency of production as producers face increased
competition with the removal of trade barriers;
! economies of scale, that is decreased unit costs of production as
producers can have larger production runs since the markets for their
goods have been enlarged; and
! increased foreign investment from outside the FTA as firms seek to
locate operations within the borders of the FTA to take advantage
of the preferential trade arrangements.11
Until recently not many FTAs were in operation; therefore, available data on
their impact have been limited to the experience of the formation of the European
Common Market and subsequently the European Union. Most studies have
concluded that the European Community has resulted in more trade creation than
trade diversion, but in some sectors such as agriculture, the net effect has been trade
10 Salvatore, Dominick. International Economics. Fifth Edition. Prentice Hall. Englewoods
Cliffs, New Jersey. 1995. p. 305-306.
11 Ibid, p.307.

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diversion because of the EU’s Common Agricultural Policy that raised barriers to
agricultural trade outside the EU.12
FTAs and the WTO
A basic principle of the General Agreement on Tariffs and Trade (GATT) that
is administered by the WTO is the most-favored nation (MFN) principle. Article I
of GATT requires that “any advantage, favour, privilege, or immunity granted by any
contracting party to any product originating in or destined for any other country shall
be accorded immediately and unconditionally to the like product originating in or
destined for the territories of all other contracting parties.” FTAs, by definition,
violate the MFN principle, since products of FTA member countries are given
preferential treatment over nonmember products. However, the original GATT
signatories recognized that FTAs and customs unions, while violating the MFN
principle, improve economic welfare of all members, if certain conditions are met to
minimize trade diversion.
Article XXIV of the GATT requires that FTA members shall not erect higher
or more restrictive tariff or nontariff barriers on trade with nonmembers than existed
prior to the formation of the FTA. Furthermore, Article XXIV requires the
elimination of tariffs and other trade restrictions be applied to “substantially all the
trade between the constituent territories in products originating in such territories.”
In addition, Article XXIV stipulates that the elimination of duties and other trade
restrictions on trade within the FTA to be accomplished “within a reasonable length
of time,” meaning a period of no longer than 10 years, according to the
“Understanding of the Interpretation of Article XXIV of the General Agreement on
Tariffs and Trade” reached during the Uruguay Round. Member countries are
required to report to the WTO their intention to form FTAs. In addition to Article
XXIV, the “Enabling Clause,” agreed to by GATT signatories in 1979, allows
developing countries to form preferential trading arrangements without the conditions
under Article XXIV.
Article V of the General Agreement on Trade in Services (GATS), the
agreement that governs trade in services under the WTO, provides for the preferential
treatment of trade in services within FTAs or similar regional trading arrangements.
Article V lays out requirements of substantial coverage of the elimination of trade
restrictions and the prohibition on the ex post facto imposition of higher restrictions
on services trade with nonmember countries.
The WTO formed the Committee on Regional Trade Agreements (CRTA) in
1996 to review pending and operating FTAs and customs unions to determine
whether they conform to WTO rules under the GATT and the GATS. However, the
rules are sufficiently ambiguous as to be the subject of continuing debate within the
CRTA. For example, the members have been unable to agree on what constitutes
“substantially all trade” under Article XXIV (GATT) or “substantially all sectors”
12 CRS Report 97-663. Regional Trade Agreements: Implications for U.S. Policy, by
George Holliday. p. 11.

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under Article V (GATS).13 The number of FTAs and customs worldwide has
increased at a rapid rate. As of October 2003, 285 FTAs and customs unions had
been notified to the GATT/WTO. Of these, 124 had been notified during the
existence of GATT (1948-1994) and 149 have been notified since 1995 under the
WTO. Some 215 FTAs and customs unions are in force. The remaining FTAs and
customs unions were largely superceded by other agreements involving the same
participants.14
Yet, none of the reports of notifications has been completed because CRTA
members have not been able to reach a consensus on any of them. Nevertheless, the
vast majority of the FTAs have gone into operation. For example, the CRTA has not
completed its report on NAFTA, which went into effect in January 1994. The
proliferation of FTAs and disagreements on rules have crippled the WTO review
process and led WTO members to place review of the rules on regional agreements
on the agenda for the new round of negotiations, the so-called Doha Development
Agenda. The Doha Ministerial Declaration, which established the agenda for the
new round, states that the negotiations will strive at “clarifying and improving
disciplines and procedures under the existing WTO provisions applying to regional
trade agreements.”
The Debate Over FTAs
Interest in a new wave of FTAs is driving a spirited debate among experts,
policymakers, and other observers over whether they promote or damage U.S.
economic interests and the economic interests of the world at large. The differing
views can be categorized into three main groups. One group consists of those who
oppose FTAs because, they assert, FTAs undermine the development of the
multilateral trading system and act as a “stumbling block” to global trade
liberalization. A second group supports FTAs because, they believe, FTAs act as a
“building block” to multilateral trade liberalization. The third category are those
individuals and groups that are opposed to trade liberalization in general because they
believe trade liberalization’s impact on workers in import-sensitive sectors or on the
environment is unacceptable, or because, they assert, it undermines U.S. sovereignty.
Among representatives of the first group of experts are international economists
Jagdish Bhagwati and Anne O. Krueger, who have strongly advocated that the United
States and other national governments should not pursue FTAs at the expense of
multilateral negotiations in the WTO. Bhagwati has concluded that FTAs are by
definition discriminatory and therefore trade diverting. He argues that tariffs remain
high on many goods imported into developing countries and even on some labor-
intensive goods (such as wearing apparel and agricultural products) imported into
developed countries. Consequently, he asserts, trade diversion will likely result when
13 The CRTA meets several times during the year.
14 WTO Secretariat. Trade Agreements Section. Trade Policies Review Division. The
Changing Landscape of RTAs.
A paper prepared for a seminar on Regional Trade
Agreements and the WTO. November 14, 2003. p. 2.

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an FTA is formed. Bhagwati argues that firms actually prefer bilateral or regional
FTAs to multilateral trade liberalization because they are able to achieve preferential
treatment over their non-member country competitors.15
Both Bhagwati and Krueger cite the “rules of origin” and other conditions of an
FTA’s establishment for strong criticism. Bhagwati claims, for example, that the
rules of origin in one FTA more than likely do not coincide with the rules of origin
in many of the other FTAs. Furthermore, he argues, the schedule of implementation
of the tariff reductions and other conditions for one FTA will not match the schedule
of other FTAs. The incongruity of these regulations across FTAs has created what
Bhagwati sees as a customs administration nightmare and calls the spaghetti-bowl
phenomenon.16
In her criticism, Krueger claims that in order to meet the input thresholds of
rules of origin requirements, producers in one FTA partner will be encouraged to
purchase as many inputs as possible from other partner countries, even if a non-FTA
member can produce and sell the inputs more cheaply and even if the tariff rate on
inputs from non-FTA producers is zero. Importing inputs from within the FTA to
meet the rules of origin threshold allows the producer to sell the final product within
the FTA duty free. Under such circumstances imports of inputs are diverted from
efficient producers outside the FTA to less efficient producers inside the FTA. A
corollary to Krueger’s conclusion is that the higher the threshold established in the
rules of origin, the greater the chance that trade diversion will take place.17
A range of economists, policymakers, and other experts embrace a second view
that FTAs can enhance trade and should be pursued. Economist Robert Z. Lawrence
argues, for example, that recent FTAs involve much more economic integration than
the elimination of tariffs. NAFTA, he points out, has led to the reduction in barriers
on services trade, foreign investment, and other economic activities not covered by
the GATT/WTO. In addition, under NAFTA, Mexico has affirmed its commitment
to economic reform, making its economy more efficient. Lawrence asserts that the
theory traditionally applied to FTAs (by Bhagwati, Krueger, and others) does not take
into account these dynamic welfare enhancing characteristics of FTAs which he
believes are likely to outweigh any trade diversion that results from the elimination
of tariffs.18
15 Bhagwati, Jagdish. The Wind of the Hundred Days: How Washington Mismanaged
Globalization.
The MIT Press. Cambridge, Mass. 2000. p. 240-245.
16 Ibid.
17 Krueger, Anne O. “Free Trade Agreements As Protectionist Devices: Rules of Origin.
in Melvin, James R., James C. Moore and Raymond Riezman (eds.). Trade, Theory, and
Econometrics: Essays in Honor of John C. Chipman.
Routledge Press. New York. 1999.
p. 91- 101.
18 Lawrence, Robert Z. Regionalism, Multilateralism, and Deeper Integration: Changing
Paradigms for Developing Countries.
in Mendoza, Miguel Rodriquez, Patrick Low, and
Barbara Kotschwar (eds.). Trade Rules in the Making. Organization of American
States/Brookings Institution Press. Washington. 1999. p. 41-45.

CRS-13
A CATO Institute study by economist Edward L. Hudgins argues that while it
may be preferable to liberalize trade multilaterally, countries should take any
available avenue, including bilateral or regional FTAs, even if they lead to some
trade diversion. Furthermore, Hudgins asserts that FTAs can be more efficient
vehicles for addressing difficult trade barriers than the WTO, where the large
membership requires compromise to the least common denominator to achieve
consensus. FTAs have also have provided momentum for GATT/WTO members
to move ahead with new trade rounds, he claims.19
Economist C. Fred Bergsten holds a position similar to the one expressed in the
CATO study, that in lieu of multilateral trade negotiations, FTAs are the next best
thing and promote global trade liberalization. Bergsten has advocated establishing
U.S. FTAs with New Zealand and with South Korea. Economist Jeffrey Schott
argues that some U.S. firms are being discriminated against because FTAs are rapidly
forming in which the United States is not a participant; therefore, in his review, the
United States must negotiate FTAs. He cites the example of Canadian firms which
have obtained competitive advantages over American firms because Canada has an
FTA with Chile.20
Bergsten and others have also advocated structuring FTAs in a manner that
could serve as building blocks of a global free trade system. Using the APEC plan
as a model, Bergsten argues for an FTA based on “open regionalism,” that is
establishing the road map for free trade and investment in the Asian-Pacific region
for 2010/2020 among the members but allowing other countries to join if they agree
to accede to the conditions. In order to minimize trade diversion, he suggests that
trade and investment could be implemented on an MFN principle, perhaps
conditional MFN in order to limit the “free rider” effects. Other countries, and other
regional groupings, Bergsten presumes, would be willing to accept the conditions
having been enticed by the trade and investment opportunities until most of the
membership of the WTO would be engaged in forming a free trade area.21 A Heritage
Foundation report draws up a similar proposal for a “Global Free Trade
Association.”22
A third group opposes FTAs but also trade liberalization or “globalization” in
general. Included in this group are representatives of import-sensitive industries, for
example labor unions, and representatives of social action groups such as some
environmentalists, who question the wisdom of trade liberalization whether done
through multilateral negotiations or through bilateral and regional trading
19 Hudgins, Edward. L. Regional and Multilateral Trade Agreements: Complementary
Means to Open Markets. Cato Journal. Vol. 15. No. 23. Fall/Winter 1995/96.
20 Schott, Jeffrey J. Free Trade Agreements: The Cost of U.S. Nonparticipation. Testimony
before the Subcommittee on Trade. House Ways and Means Committee. March 29, 2001.
[http://www.iie.com].
21 Bergsten, C. Fred. Open Regionalism. Working paper 97. Institute for International
Economics. 1997.
22 Hulsman, John C. and Aaron Schavey. The Global Free Trade Association: A New Trade
Agenda.
The Heritage Foundation Backgrounder No. 1441. May 16, 2001.

CRS-14
arrangements. They assert that trade liberalization unfairly affects workers by
exporting jobs to countries with lower wages and undermines the nation’s ability to
protect the environment by allowing companies to relocate to countries with less
stringent environmental regulations.23 For example, the United Auto Workers
(UAW) union has stated the following position regarding the FTAA:
Such an agreement would provide broader protections for the rights of
corporations, further undermine the ability of governments in the region to
regulate their economies in the interests of their citizens and intensify the
downward pressure on workers’ incomes through competition for jobs and
investments. All of this would take place in the absence of any counter-balancing
protections for workers, consumers or the environment. This is why the UAW
has consistently opposed the direction of these negotiations, the positions taken
by the U.S. government, and worked closely with other organizations in the
region to oppose the creation of an FTAA.24
Relevant Legislation
A number of bills related to FTAs were introduced in the 107th Congress and a
couple of major pieces of legislation were signed into law. On July 28, 2001, the
House passed the United States -Jordan Free Trade Agreement Implementation Act
(H.R. 2603), and the Senate passed it on September 24. On September 28, President
Bush signed it into law (P.L. 107-043). It was the first FTA the United States had
entered into since the creation of NAFTA, and some observers consider it as a model
for future FTAs.
The most significant legislation enacted during the 107th Congress was the trade
promotion authority (TPA), formerly called fast-track authority. The debate over
granting the authority proved to be highly contentious. On August 6, 2002, President
Bush signed the Trade Act of 2002 (P.L. 107-210) Title XXI of which is the TPA
as the Bipartisan Trade Promotion Act of 2002. Not only does the Congress grant
the President the authority to negotiate trade agreements that would come to the
Congress under expedited procedures but it also establishes negotiating priorities
which it expects to be met in any trade agreements that are negotiated under the
authority. Moreover, under the law the Congress requires the Administration to
consult with the Congress during the negotiations.
On July 24, 2003, the House passed the implementing bill for the Chile
agreement (H.R. 2738) and for the Singapore agreement (H.R. 2739) by votes of 270-
156 and 272-155, respectively. The Senate passed the companion bills, S. 1416
(Chile) and S. 1417 (Singapore), by votes of 66-31 an 66-32, respectively, and the
President signed the bills into law (P.L. 108-77 and P. L. 108-78) on September 3,
2003.
23 For more information, see for example, the United Auto Workers positions on trade policy
at [http://www.uaw.com] and the positions of Public Citizen’s Global Trade Watch at
[http://www.citizen.org].
24 [http://www.uaw.com].

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Conclusions and Implications for Congress
Free trade agreements are viewed by many as a significant trade policy vehicle
for the United States and for other major trading nations. Over the last 5-10 years,
the debate in U.S. trade policy has shifted from, “Should the United States form
FTAs?” to “Should the United States form any more FTAs and, if so, with whom,
when, and under what conditions?” Congress has a direct role in addressing those
questions. Before any FTA can go into effect, the Congress must review it as part of
implementing legislation. The Congress likely will soon be asked by the Bush
Administration to approve FTAs with Chile and Singapore. In addition, discussions
are moving toward FTAA, and many new FTA negotiations are being proposed.
A number of questions will likely arise as Members consider legislation on
FTAs and as they evaluate operating FTAs through their oversight responsibilities.
One question pertains to the economic impact of an FTA. As with any trade
liberalizing measure, an FTA can have positive effects on some sectors and adverse
effects on others. An FTA may create trade for one sector of the U.S. economy but
divert trade away from others. A Member of Congress is placed in the position of
weighing the effects on his/her constituency versus the overall impact on the United
States and other trading partners. Because conditions can differ radically from one
FTA to another, the evaluation will likely differ in each case. Furthermore, Members
might take into account not only the immediate static effects of FTAs but also the
long-term, dynamic effects which could play an important role in evaluating their
contribution to U.S. economy.
A second, broader question is whether bilateral and regional FTAs are the
appropriate trade policy strategy to promote U.S. national interests. Economic
specialists differ sharply on this question with some viewing the proliferation of
FTAs as leading to confusion and serving as stumbling blocks to the development of
a rules-based multilateral trading system. Other specialists consider FTAs as
appropriate trade policy vehicles for promoting freer trade, as building blocks to a
multilateral system and as necessary to protect U.S. interests against the FTAs that
other countries are forming without the United States. Still others oppose trade
liberalization in any form as counter to U.S. interests.
A third question is whether the Office of the United States Trade Representative
and other trade policy agencies have sufficient time and human resources to negotiate
a number of FTAs simultaneously while managing trade policy in the WTO and other
fora. USTR Zoellick has clearly indicated that it can be done. Others might find
some U.S. interests being short-changed.
A fourth question is to what degree, if any, should non-trade concerns be
included in FTAs? This issue has emerged in a number of completed and ongoing
FTA negotiations. The U.S.-Jordan Free Trade Agreement contains provisions
regarding labor rights and environmental protection. Some opponents of the
inclusion of such issues have argued that the U.S.- Jordan FTA is just an anomaly
while proponents consider it a model for future FTAs.

CRS-16
A fifth overarching question is what criteria should the United States employ in
determining which countries would make appropriate FTA partners. For example, to
what degree should political factors be given weight over economic factors? The
countries that the Bush Administration has chosen for the next round of negotiations
include a several continents and levels of economic development.