Free Trade Zones: A Driver For Illicit Trade

Across the world, there are around 3,500 FTZs that gen­er­ate over $500 bil­lion in trade-relat­ed added val­ue, besides employ­ing around 66 mil­lion peo­ple. These places have attract­ed multi­na­tion­al com­pa­nies and busi­ness­es because of their ide­al phys­i­cal loca­tion, lib­er­al and lenient reg­u­la­tions, and spe­cial­ized infra­struc­ture the com­bi­na­tion of which brings a mul­ti­tude of advan­tages for both host coun­tries and busi­ness­es.

Evolution in Time: From Free Ports to Free Trade Zones

For hun­dreds of years, gov­ern­ments have sought ways to facil­i­tate inter­na­tion­al trade in their ports. The ear­li­est mech­a­nisms were called free ports which were the areas des­ig­nat­ed for com­mer­cial ves­sels des­tined for re-export with cus­tom duties excemp­tions. These prac­tices are still going on. But the over­all oper­a­tions of free trade zones have been com­plete­ly changed using dif­fer­ent busi­ness mod­els such as: Free Trade Zones, Export Pro­cess­ing Zones, Spe­cial Eco­nom­ic Zones, and Indus­tri­al Zones

These zones allow duty-free imports of raw mate­r­i­al for export pro­duc­tion. Firms in these zones enjoy long-term tax incen­tives so that they can increase their out­put. While these zones are also set up to re-export the goods pro­duced, some coun­tries allow some of the zones’ out­put to be sold domes­ti­cal­ly.

The pop­u­lar­i­ty, and wide accep­tance, of FTZs, is main­ly because of their incen­tives. They act as a one-stop shop for investors and traders who don’t have to go through mul­ti­ple steps to acquire per­mits or invest­ment appli­ca­tions or oth­er relat­ed doc­u­ments. This makes it eas­i­er for both domes­tic and for­eign investors to estab­lish their busi­ness units in a time­ly man­ner.

One of the most famous free zones was set up at Shen­zen, in Chi­na, in 1979. Today, sev­er­al hun­dred free zones have been oper­at­ing across the world, pro­vid­ing a good oppor­tu­ni­ty for devel­op­ing coun­tries, espe­cial­ly, to have marked eco­nom­ic growth.

Benefits from Free Trade Zones

The pop­u­lar­i­ty of FTZs is main­ly due to the fact that it pro­vides numer­ous ben­e­fits to host coun­tries. These zones play a vital role in cre­at­ing employ­ment oppor­tu­ni­ties, espe­cial­ly in small­er coun­tries. The min­i­mum wage and oth­er work­ing con­di­tions are bet­ter in these zones as com­pared to what an employ­ee will get out­side this spe­cial area. In addi­tion, FTZs pro­vide safe zones to for­eign com­pa­nies that hes­i­tate to oper­ate in the host coun­try because of its polit­i­cal and secu­ri­ty envi­ron­ment. This way, the host coun­try can get access to the much-need­ed FDIs for its growth. These zones can also become the test labs for gov­ern­ments to assess the impli­ca­tions of dif­fer­ent rules and reg­u­la­tions and then imple­ment them at the nation­al lev­el. Final­ly, through a large-scale pro­duc­tion, the coun­try will also be able to diver­si­fy its exports and enjoy their ben­e­fits.

FTZs are also a per­fect choice for busi­ness­es as well. First, the cost of relo­cat­ing to the FTZ is not high. In some cas­es, it is low­er than the cost required to set up the indus­try in the host country’s out­side the FTZ ter­ri­to­ry. Depend­ing on the zone they decide to set­tle in, they can save a con­sid­er­able amount of mon­ey in cus­toms duties and income tax­es. They will also have a less author­i­ta­tive envi­ron­ment to car­ry out their busi­ness activ­i­ties. Also, since they will not have any restric­tions on cor­po­rate activ­i­ties, they can ship their goods to a vari­ety of mar­kets.

Abused by criminals

The point­ers that make FTZs attrac­tive for legit busi­ness­es are exact­ly what dri­ves peo­ple with mal-inten­tions to abuse these spaces. FTZs have lit­tle to no restric­tions and very minute super­vi­sion. Besides engag­ing in envi­ron­men­tal abus­es, and in some cas­es, poor labor prac­tices, illic­it busi­ness­es often used the space to laun­der mon­ey and trade coun­ter­feit prod­ucts and nar­cotics.

The Finan­cial Action Task Force (FATF) in 2010 car­ried out a detailed analy­sis of the work­ing of FTZs and found that these places had inad­e­quate safe­guards against ter­ror­ist financ­ing and mon­ey laun­der­ing. This lack of vig­i­lance is also the haven for coun­ter­feit­ing. For a coun­ter­feit­er, FTZs are low-cost ter­ri­to­ries with tens of indus­tries that can pro­vide all kind of ser­vices from rela­belling to repack­ag­ing.

This is why FTZs are one of the favorite zones of all coun­ter­feit­ers. This suf­fi­cient evi­dence is enough to high­light the fact that FTZs are becom­ing gate­ways for the transna­tion­al ship­ping of illic­it prod­ucts. To quan­ti­fy this claim here’s a fact: accord­ing to the OECD (Organ­i­sa­tion for Eco­nom­ic Co-oper­a­tion and Devel­op­ment) and EUIPO (Euro­pean Union Intel­lec­tu­al Prop­er­ty Office) a new FTZ is linked with a 5.9% increase in the val­ue of coun­ter­feit exports.

Recommendations to Improve Transparency in Free Trade Zones

After thor­ough analy­sis and tak­ing notice of the unlaw­ful activ­i­ties that being car­ried out through FTZs, the OECD, through its task force on coun­ter­ing illic­it trade, has draft­ed a set of guide­lines to enhance the trans­paren­cy of FTZs. Their rec­om­men­da­tions include:

1. Cus­toms Access: Pro­vide uncon­di­tion­al access to the cus­toms and law enforce­ment agen­cies of the juris­dic­tion where they are estab­lished to car­ry-out unob­struct­ed, ex offi­cio enforce­ment checks of oper­a­tors in sup­port of inves­ti­ga­tions of vio­la­tions of applic­a­ble law.

2. Access to Infor­ma­tion: Ensure that eco­nom­ic oper­a­tors active in the FTZ are required to grant access to their detailed dig­i­tal records upon request of the FTZ author­i­ty, the cus­toms author­i­ties or any oth­er com­pe­tent pub­lic author­i­ty in the juris­dic­tion where the zone is estab­lished. FTZ Admin­is­tra­tions should appoint a ded­i­cat­ed point of con­tact with the nec­es­sary skills and resources to respond effec­tive­ly to such requests for infor­ma­tion from pub­lic author­i­ties, and to lead due dili­gence and com­pli­ance ver­i­fi­ca­tions on com­pa­nies and per­sons oper­at­ing with­in FTZ.

3. Infor­ma­tion Exchange: Encour­age inter­na­tion­al coop­er­a­tion in the exchange of law enforce­ment infor­ma­tion (finan­cial and admin­is­tra­tive) and con­sult with appro­pri­ate author­i­ties and affect­ed indus­tries in inves­ti­ga­tions and oth­er legal pro­ceed­ings con­cern­ing spe­cif­ic cas­es of mis­use of FTZ relat­ed to illic­it trade.

4. Record Keep­ing: Ensure that eco­nom­ic oper­a­tors active in the FTZ main­tain detailed dig­i­tal records of all ship­ments of goods enter­ing and leav­ing the zone, as well as all goods and ser­vices pro­duced with­in it, suf­fi­cient to know what is inside the zone at any giv­en time.

5. Pay­ments: Deter cash pay­ments for any com­mer­cial or finan­cial trans­ac­tion of the eco­nom­ic oper­a­tors active in the FTZ occur­ring inside or orig­i­nat­ing from the FTZ, and for large cash trans­ac­tions, doc­u­ment the details and report to the cus­toms author­i­ty.

6. Aware­ness: Pro­mote aware­ness amongst the busi­ness com­mu­ni­ty includ­ing all rel­e­vant stake­hold­ers, from ship­ping lines to logis­tic com­pa­nies, ship­ping agents, cus­tom bro­kers and freight for­warders. (e.g. major inter­me­di­aries includ­ing ship­ping agents, freight for­warders, cus­toms bro­kers and logis­tics com­pa­nies) to under­stand the major risks relat­ed to FTZ.

7. Pub­lic-Pri­vate Part­ner­ships: rein­forc­ing aware­ness efforts to encour­age the busi­ness com­mu­ni­ty that makes use of FTZs, or that finances oper­a­tors with­in FTZ, to refrain from doing busi­ness in FTZ that are not com­pli­ant with these rec­om­men­da­tions.

Striking the Balance

The cur­rent sce­nario depicts a dis­mal pic­ture and it looks as if the FTZs that were meant to increase glob­al trade has end­ed up facil­i­tat­ing unlaw­ful activ­i­ties. To achieve what was intend­ed for FTZs, there must be a bal­ance between incen­tiviz­ing eco­nom­ic growth and main­tain­ing juris­dic­tion­al, bor­der and Cus­toms con­trols that pre­vent dis­hon­est and harm­ful prac­tices. Over­reg­u­la­tion sti­fles busi­ness devel­op­ment, growth and prof­itabil­i­ty with ade­quate and prop­er reg­u­la­tion pro­motes it by cre­at­ing a pre­dictable envi­ron­ment and by dis­cour­ag­ing unfair and preda­to­ry acts.