Signing free-trade deals is not enough to secure real economic gains

FTAs can open doors, but real gains will depend on domestic factors

Free trade agreements (FTAs) are often presented as quick wins for trade and growth, promising lower prices for consumers and new markets for exporters. In practice, economic gains arise only under specific conditions. Success hinges not merely on tariff reductions, but on whether agreements induce sustained changes in production, investment, and competitiveness.

 

India is in one of its most active phases of trade diplomacy. It has concluded FTAs with the UAE, Australia, the European Free Trade Association (EFTA), the United Kingdom, New Zealand and Oman; negotiations with the United States are reportedly nearing completion, discussions with Canada have resumed, and region-wide talks with the European Union, the Gulf Cooperation Council and the Eurasian Economic Union continue. This push reflects India’s effort to secure market access, attract investment and integrate more deeply into global value chains (GVCs) amid geopolitical uncertainty and supply-chain realignments.

 

Experience shows that not all FTAs are created equal. Their economic logic lies in trade creation — replacing high-cost domestic production with lower-cost imports from partner countries, which generates welfare gains. Trade diversion, by contrast, merely shifts imports from more efficient non-members to less efficient partners and reduces welfare. Judging FTAs by bilateral trade balances misses this distinction; the real test is whether they promote trade creation.

 

FTAs between countries with different factor endowments typically yield larger gains. Agreements with high-income countries create natural complementarities, with India exporting labour-intensive goods and services while importing capital- and technology-intensive products. Such arrangements have greater trade-creation potential than FTAs among countries with similar production structures, where competition often dominates complementarity. Realising these gains, however, depends on the economy’s ability to reallocate resources towards sectors of comparative advantage, which in turn requires flexible factor markets.

 

India’s mixed experience with FTAs reflects these realities. Its withdrawal from the Regional Comprehensive Economic Partnership (RCEP), despite being a lead negotiator, was driven largely by concerns over trade deficits and import surges rather than by an assessment of trade creation versus trade diversion. Similarly, low utilisation rates and asymmetric outcomes under FTAs with the Association of Southeast Asian Nations (Asean), Japan, and the Republic of Korea are often viewed through bilateral trade balances and export shortfalls. While this has prompted reviews and renegotiations, it reflects a largely mercantilist framing. From a trade-creation perspective, these outcomes may stem as much from domestic supply-side constraints and limited adjustment capacity as from weaknesses in FTA design.

 

Signing an FTA is only the first step; effective use is another matter. While comprehensive utilisation data is scarce, available evidence suggests that India’s FTA usage remains low, largely due to stringent rules of origin (RoO). Intended to prevent misuse, these requirements often undermine FTAs by raising compliance costs above tariff benefits, prompting firms to trade instead under most-favoured nation tariffs.

 

India’s recent FTAs adopt a particularly strict approach to RoO, driven by fears of circumvention, even though evidence suggests that actual misuse has been limited. More importantly, such stringency makes little economic sense in GVC-intensive sectors, where restrictive rules discourage participation in cross-border production networks and undermine FTAs’ potential to deepen integration into global manufacturing and services chains.

 

Low utilisation also reflects small preferential margins and limited firm awareness. International evidence suggests many enterprises are unfamiliar with how to claim FTA benefits, and in India the absence of firm-level surveys makes it difficult to assess this gap and to design targeted interventions.

 

Beyond trade-policy design, the effectiveness of FTAs depends on the broader domestic policy environment. Exploiting new trade opportunities requires flexible labour and land markets, yet long-standing rigidities in India have constrained specialisation and resource reallocation. While the four labour Codes are steps in the right direction, uneven implementation across states may limit their impact, and long-pending land reforms continue to constrain manufacturing expansion and large-scale investment.

 

Facilitating foreign direct investment is a crucial complement to FTAs. Multinational firms are better equipped to meet stringent standards in advanced markets and can help integrate domestic suppliers into GVCs, generating technology and knowledge spillovers. Without a supportive investment climate and deeper domestic reforms, however, these dynamic gains are unlikely to materialise.

 

India’s FTA strategy must shift from headline signing to effective implementation and utilisation. This requires publishing utilisation data, simplifying and harmonising RoO, strengthening mechanisms to address non-tariff barriers, and modernising Customs administration. While newer-generation FTAs increasingly cover labour, environment, data and sustainability, caution is warranted when such provisions become de facto market-access conditions, as harmonising standards across countries with vastly different levels of development can impose disproportionate adjustment costs on developing economies.

 

India’s renewed push for FTAs aligns with its Foreign Trade Policy 2023, which emphasises competitiveness, facilitation and GVC integration. But FTAs are only a stepping stone: They can open doors, yet real gains will depend on domestic reforms that enable firms to compete, adapt and grow.  

 

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The authors are, respectively, director, Centre for Development Studies, Thiruvananthapuram, and  PhD scholar at Indira Gandhi Institute of Development Research, Mumbai