What is a free-trade zone?

Director of Foreign Trade Research Center Trade+ in cooperation with KSE, Maryna Khorunzha addresses this question. 

What is the Free Trade Agreement? 


Free Trade Agreement is an agreement between two or more countries that agree on its terms in order to decrease or neutralize import duties and other trade barriers among them. While simplifying conditions and future intensification of trade between countries are the main goals of the free-trade zone (FTZ), such agreements usually assume additional regulations, “related to trade”, or the regulations that should “facilitate” trade, in particular, regulations of investing, intellectual property, etc.


What are the types of FTZ?


If FTZ agreement regulates only or mainly the conditions of international trade, this integration is “shallow” and only developing countries are interested in it because a decrease of import duties to developed countries is an incentive for small open economies. Instead, developed countries prefer “deep integration”, when a decrease and neutralization of import duties for developing countries are rather a reward for improvement of investing and protection of intellectual property rights. Deep and Comprehensive Free Trade Agreement (DCFTA) between Ukraine and the EU is an example of the “deep” FTZ because it implies not only a two-sided decrease or neutralization of import duties, but a gradual harmonization of Ukrainian law, standards and EU-regulated processes. 


What is the difference between FTZ and customs union? 


Customs unions, as well as FTZ, are to liberalize, i.e. ease a trade between countries, and identify it. A key difference is that FTZ regulates relationships only within the free-trade zone and doesn`t create obligations for its members in regards to other countries. On the other hand, all members of the customs union are obliged to set identical “external” tariffs for non-member countries. 


How do the rules of FTZ and WTO differ?


One of the main principles of World Trade Organization is the “most favored nation” rule that requires a WTO member to set import duties and quotas at the same level for other members of WTO. There are only two exceptions from this rule, both of which are addressed to significant improvement of trade terms with another country: 1) if a country enters FTZ or customs union, or 2) if developed country decreases or neutralize customs for goods of developing countries. Ukraine is a member of WTO since 2008.


Has a trade between Ukraine and the EU reached its full potential? Why not? 


Despite the Deep and Comprehensive Free Trade Agreement (DCFTA) and signs of two-sided relationship improvement, the trade between Ukraine and the EU is too far from achieving its potential. Ukraine was 24th country in the rating of the biggest importers to the EU in 2018 and its import has reached 16,7 billion euros. Ukraine has become 22nd biggest market of EU export destination (20,2 billion euros). Moreover, the Ukrainian import of agricultural goods is dominant in the structure of the two-sided market and, on the contrary, consumption goods in the EU. This indicated that Ukraine hasn`t integrated into European production chains. These tendencies can be explained by the low productivity of Ukrainian firms and that there are still “hidden” trade barriers, non-tariff restrictions, between Ukraine and the EU.


What are non-tariff barriers for international trade? 


Non-tariff (non-customs) barriers or non-tariff measures of controlling international trade became widely used along with a decrease of tariff levels in the world (from 8,5% in 1994 to 2,6% in 2017). Non-tariff barriers are an instrument of providing appropriate quality and safety of goods as well as it is commonly used by countries with a protectionist goal in order to prefer domestic producers. WTO`s “national treatment” principle implies that all members should create equal conditions for trade with domestic and imported goods, but this principle mostly concerns tariff barriers. Since most of the countries in the world are members of WTO (164 members), the opportunity of avoiding the “national treatment” principle, that is provided by non-tariff barriers (technical and phytosanitary standards, licensing requirements, etc) can explain their widespread. 


How to get rid of non-tariff barriers in the trade relationship with the EU?


Within DCFTA the EU has canceled 94,7% of import tariffs for Ukraine in 2014 and should cancel 99,1% in the long-term; Ukraine needs to cancel import tariffs gradually to 98,1% until 2023. Consequently, the main barrier for two-sided traded will be non-tariff barriers – technical, sanitary, licensing requirements, etc. 

The standard system is complicated and can sufficiently limit access of Ukrainian companies to the European market. For non-food items, this system has harmonized law (5 thousands of harmonized standards for specific goods) and around 30 obligatory directives. The safety of European food items is facilitated by sanitary and phytosanitary measures. Within the Union Association Agreement, Ukraine has to improve sanitary and phytosanitary measures by European standards and to implement more than 200 directives and regulations of the EU.

Even though Ukraine is getting its regulations closer to Europe, there are still a lot of necessary changes. Future well-timed harmonization of Ukrainian law, standards, and processes with the European will ease export of Ukrainian goods. 


Translated by KSE student Yana Tkachenko.