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Tuesday, November 29, 2022

How Free Trade Zones Can Drive Illicit Activity

Free trade zones (FTZs) have a long and established role in world trade, dating back to at least early 1700s. They provide numerous benefits to both businesses and countries. However, lightly regulated FTZs – of which there are many – are also attractive to parties engaged in illegal and criminal activities. They offer a relatively safe environment with both good infrastructure and limited oversight, enabling trade in counterfeit and pirated products, smuggling and money laundering.

Across the world, there are around 3,500 FTZs that generate over $500 billion in trade-related added value and employ approximately 66 million people. These zones have attracted multinational companies because of their ideal physical location, reduced red tape, and specialized infrastructure – thus offering multiple advantages for both host countries and businesses.

But this glossy picture skillfully masks the dark side of FTZs, which facilitate a near-perfect environment for criminal activities. The minimum customs controls and significantly reduced oversight employed at FTZs allow criminals to carry out their operations with little fear.

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 areas designated for commercial vessels destined for re-export with custom duties exemptions. These practices are still going on today, but the overall operations of free trade zones have been completely changed using different business models such as FTZs, 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 that 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 due to 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.

Today, several hundred FTZs are operating in developing countries across the world, providing them a good opportunity to have marked economic growth.

Benefits from Free Trade Zones

These zones play a vital role in creating employment opportunities with better wages and working conditions compared to other jobs, especially in smaller countries. They also attract foreign companies that are hesitant to operate in the host country, due to political and security environments, by providing a safe, designated zone free of conflict. This way, the host country can get access to much-needed foreign direct investments for its growth. These zones can also become the test labs for governments to assess the implications of different rules and regulations before implementing them at the national level. Finally, through large-scale productions, countries are able to diversify exports and reap the resulting benefits.

FTZs are also a popular choice for businesses as well. First, the cost of relocating to an FTZ is not high. In some cases, it is lower than the cost required to set up the industry outside the FTZ territory in the same host country. Depending on the zone a company decides to settle in, it can save a considerable amount of money in customs duties and income taxes. Additionally, a company will also have a less authoritative environment to conduct operations within. Also, since it is free of restrictions on corporate activities, a company operating in an FTZ can ship its goods to a variety of markets. 

Abused by criminals

The same aspects that make FTZs attractive to legitimate businesses also drive criminals to abuse these zones. In 2010, the Financial Action Task Force (FATF) found that FTZs had inadequate safeguards against terrorist financing and money laundering.

Due to little-or-no restrictions, and minimum supervision, illicit businesses often use FTZs to launder money and trade counterfeit products and narcotics. The relaxed monitoring at FTZs enables counterfeiting operations, as they ship to low-cost territories with many supportive industries on hand that can provide critical services from re-labeling to repackaging and others.

FTZs are also becoming gateways for the transnational shipping of illicit products. According to the Organisation for Economic Co-operation and Development (OECD) and the European Union Intellectual Property Office (EUIPO), every new FTZ drives a 5.9 percent increase in the value of counterfeit exports.

Recommendations to Improve Transparency in Free Trade Zones

The OECD’s task force on countering illicit trade has drafted a set of guidelines to enhance FTZ transparency.

Its 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

Today, FTZs too often are catalysts for unlawful activities, rather than achieving their intended purpose of increasing global trade. There is a balance that must be struck between facilitating trade, growth and profitability, and maintaining jurisdictional, border and customs controls that prevent dishonest and harmful practices. Implementing measures such as those recommend by the OECD is a good place to start.

Hernan Albamonte
Hernan Albamonte is head of Illicit Trade Prevention U.S., Philip Morris International, Inc. Albamonte has been with Philip Morris International, Inc. for 13 years. He started with the company in his native country of Argentina, worked in Mexico, Central America and Switzerland before coming to Washington D.C. to head PMI’s illicit trade prevention efforts domestically.

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