Trade Agreement

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Trade Agreement

A Brief Introduction About the Trade Agreement

Two or more countries often enter into an arrangement to govern their trade relationship that includes the exchange of goods and services. This exchange is known as ‘trade.’ The simplest form of a trade agreement is an agreement created between the two countries. So, what is a trade agreement? It is a set of terms to determine the trading relationship between the countries by removing or reducing tariffs, taxes, duties, etc. under certain agreed-upon conditions – this is the trade agreement definition.

The trade agreement is a result of negotiations between sovereign nations. It can be a bilateral trade agreement or a multilateral one. Unilateral trade agreements also exist. These agreements are known to play a role in establishing peace between the two countries in the world — for example, the pacific trade agreement. The most common type of these agreements is preferential (regional) and free. In the case of preferential trade contracts, tariffs or taxes are decreased for some countries, and in case of free trade contracts, these taxes are eliminated.

What is a free trade agreement?

A free trade agreement (FTA) establishes a free trade area, where the goods and services can move freely across the borders of the countries that are a party to such a contract, without any tariffs or taxes. Often, the goal of trade negotiations is to create a free trade contract that helps in boosting a country’s economic growth massively. Most preferential trade agreements have a goal of transforming into free trade agreements. An agreement can be called an FTA even if taxes and duties are removed on some of the goods and not all. Signing an FTA doesn’t mean that everything is made free.

Who Takes the Trade Agreement?

The agreement is entered into by two or more sovereign countries who want to set rules regarding trading with each other like adding or removing tariffs, trade restrictions, quotas, etc. The trade contract is also known as a trade pact is a taxes, tariffs, and trade treaty that includes investment guarantees. It is often an instrument for establishing peace between two nations who want to boost their economies and facilitate import and export.

Purpose of the Trade Agreement

The primary purposes of an agreement for trade are to improve the relationship between two or more sovereign nations and to aid the economic growth of the countries participating in the agreement. It is also entered into by two or more parties to prevent the manipulation of terms of trade in the future as it is proof of what was agreed upon. They also facilitate liberalization in terms of trade.

The purpose of a preferential trade agreement to decrease tariffs, taxes, etc. while the purpose of a free trade agreement to eliminate the taxes, restrictions, etc. A trading contract clearly states what is agreed upon by the two nations so that in the future, there is security in case of a breach. The agreement also includes penalty provisions. It creates security and confidence. It also deepens the interdependence between two independent countries.

Contents of the Trade Agreement

The trade agreement must contain:

  1. Title and preamble.
  2. The names of the countries.
  3. Definitions of terms.
  4. The time period of the agreement.
  5. The main text, detailing the trade relationship, including taxes, levy, tariffs, quotas, etc. and whether they are reduced, eliminated, or anything else.
  6. Final clauses, including the entire agreement clause, indemnity clause, etc.

Points to Consider While Preparing the Trade Agreement

The following points are to be kept in mind while drafting the trade contract:

  1. Start with a simple agreement which can be improved upon with negotiations.
  2. Do not use vague words and be consistent. Don’t use different words for the same thing; it can create confusion. Use short sentences.
  3. The agreement may be drafted in a language that you are not fluent in. Get in checked by someone who knows the language well. It is advisable to draft the agreement in a language that is understood by all countries.
  4. Refer to precedents as international law is not uniform.
  5. Use one system of numbering throughout the document.
  6. Clearly, list down the trade arrangements and the obligations of both the parties.
  7. Include a duration and termination clause.
  8. If there are any pre-conditions to be met, mention that in the agreement.
  9. Include a dispute resolution clause, referring the disputes to organizations like WTO or other international groups.
  10. Ensure that reciprocity is achieved.
  11. Consider whether the Most-Favoured Nation(MFN) clause must be included. The MFN clause prevents a party to the agreement from further lowering their taxes or duties for another country. For example, if A promises a 10% reduction in import duties to B and agrees to an MFN clause. Then if A decreases the import duty by 20% for C, A has to do the same for B or give the 10% rate to C.
  12. Include the ‘National Treatment of Non-Tariff Barriers’ clause to deal with provisions that are not related to the tariffs.

Negotiation Strategy

The agreements of trade are entered into after multiple rounds of negotiations that last for a long period of time. Almost the whole of the agreement is a result of the negotiation rounds. Thus a good negotiation strategy can impact the economic well-being of a nation. ‘Reciprocation’ is extremely important in a trade contract. If both the parties do not stand to gain from the agreement, it is not successful. Negotiations can help arrive at an agreement that truly creates a win-win. Diplomacy is at the core of such agreements and plays a key role in creating successful inter-nation trade relationships.

Benefits and Drawbacks of the Trade Agreement

The advantages of entering into a trade agreement are:

  • The agreement lowers the prices of imports for the benefit of the citizens of a country.
  • It improves the relationship between countries.
  • Increases the probability of long-term cooperation.
  • Eliminates barriers to investment.
  • It works as proof of what was agreed upon between the two nations.
  • It helps create an open market.


  • It can cause less-profiting small scale companies to go out of business.
  • In case of a violation of the agreement, the methods for dispute resolution may not be binding.
  • It can increase job outsourcing, and local workers may lose their jobs.
  • Sometimes, trade barriers are created for reasons that are not economical. They could be created to protect the local culture of a country from alien influence, which is why a trade agreement can put a country’s local culture at risk.

There are many tools to determine the effect of the agreement on the prices of goods and services for the citizens of a country. For example, the free trade agreement tariff tool allows US businesses to find information on all the products covered under the trade agreements.

What Happens in Case of a Violation?

A violation of a trade contract can happen when one country dishonors a term of the contract. This breach can have indirect causes like a strained diplomatic relationship. When one country violates the trade agreement, the aggrieved country can approach organizations like WTO, GATT, or any other organization written in the original agreement as a part of the dispute resolution procedure. Monitoring by international organizations is often required. The damages can be a measure of ‘counter-retaliation’ through which the injured party also raises their tariffs, taxes, etc.

One of the major byproducts of the violation of a trade contract is a strained relationship between the two countries. This creates a dangerous situation as if these countries have a history of war, it can create a hostile environment that may breed another war in the future.

Trade contracts are the need of the day. In 1934(1), the U.S. passed a law that allowed the President to bring about a reduction in foreign tariff rates without the approval of Congress. This empowered the President to enter into a reciprocal trade agreement with other countries.

Rather than being purely legal, trade contracts are economical and political in nature(2). International organizations like the WTO have expressed concern about “incoherence, confusion, an exponential increase of costs for business, unpredictability and even unfairness in trade relations.”

A trading contract, when adhered to, has good short-term and long term effects for a nation. It can give impetus to the economic growth of a country, help create more jobs, lower costs, and contribute to creating an open market. However, trade contracts need to be drafted with extreme precision, and the inputs of both the policymakers and the legal representatives must be taken before the agreement is signed.