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Trade Agreements: Definition & Effects

Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.

A country's economy can benefit from both importing and exporting goods. In this lesson you'll learn how countries use trade agreements to coordinate the exchange of goods between producers and consumers in both markets.

Definition of Trade Agreement

Trade agreements are the product of negotiations between two or more sovereign nations that dictate the terms of the acceptable exchange of goods and services between the parties. As sovereign nations, each of the approximately 200 countries in the world has the authority to say what they will allow to come in and go out of their country. Every country has realized, albeit to varying degrees, that they can't survive as complete isolationists. As soon as the potential for trade between two countries is evident, trade negotiations usually begin.

Complexities of International Trade Agreements

Some laissez-faire economists may believe that trade agreements should really be quite simple. Parties could simply agree, 'Producers in your country can export to my country, and producers in my country can export to your country.' While it is certainly true that parties to a trade agreement could agree to that, the reality is that international trade is much, much more complex than simply imports and exports.

Trade agreements are important because different countries have relative advantages in the production of certain goods. In North America, Mexico is able to produce textiles much cheaper than the United States, but the United States has more access to natural gas than Mexico. When one country produces a good that another country needs, the trade agreement is straight forward; both countries benefit by allowing open trade of that good. The producing country gains access to new consumers and the importing country gains access to needed goods.

Trade agreements become complex when foreign producers actually compete with domestic producers. For example, even with transportation costs, China is able to produce steel at a lower cost than US manufacturers. Chinese steel companies want access to US customers, but US steel companies would be hurt by the competition. The United States can't simply tell China that they can't sell their steel in the US; if they did that, China could easily respond by denying US clothing manufacturers access to the Chinese market. That back and forth can quickly turn into a trade war, which will ultimately hurt both countries.

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