To some extent they do, who knows? Certainly they lose some sovereignty in foreign and military policy, as Starfleet's purpose is to defend the Federation.
But Member worlds do seemingly retain the ability of both independent foreign policy and independent military action. In Allegiance the Bolians had a military conflict with the Moropa and made the decision not to bring in Starfleet. Today, nations do fight wars, and don't ask their allies for help, even when they can.
The Bolians pursued an independent foreign policy. And we've seen examples that the Vulcans do the same thing, have their own armed starships, a independent foreign policy, and exchange embassies with foreign powers. The Betazed have their own planetary defense forces.
Plus there is the evidence from Cloud Minders that the Federation Council is basically powerless to tell it's Members what to do.