1. FREE TRADE AREAS

2. Free Trade Areas Trade between member countries is free.
The member countries retain the power to fix their own separate tariff rates on imports from the rest of the world.
The area is equipped with rules of origin, designed to confine intra-area free trade products originating in, or mainly produced in the area.

3. Free Trade Areas
The purpose of rules of origin is to limit trade deflection.
Trade deflection is the redirection of imports through the country with the lowest tariff, for the purpose of exploiting the tariff differential.
Indirect trade deflection: One of the member countries may export all of its production to member countries and satisfy the domestic demand by imports from third countries.

4. Free Trade Area vs. CU
FTA is better than a CU, because it does not involve a CET
No fundamental differences between FTA and CU with regard to trade creation
Trade diversion is larger in a FTA
In FTA, there may be trade deflection (if no rules of origin)

5. FTA vs. CU Trade deflection: Foreign investments Rules of Origin:
Final goods
Inputs
Foreign investments
Rules of Origin:
Domestic producers: lobby for protection
Costs of bureaucracy

6. FTA vs. CU Political Economy Approach Faces less opposition
Trade creation: Viewed as being “at the expense” of domestic producers (Domestic producers lose market at the expence of other nations).
Trade diversion will generally not arouse domestic interests (At the expence of producers external to the members).
Faces less opposition