Transparency in the Backbone of Global Supply Chains: Foreign Trade Zones

Worldwide, trade zones need greater transparency. Foreign trade zones (FTZs) form the backbone of global supply chains and are the lubricant to the cogwheels of globalisation. Yet their importance is frequently overlooked or misunderstood in everything from international development goals to efforts at combating terrorism, transnational organised crime and trade fraud.

Foreign trade zones anywhere are defined by three key characteristics:

1. Zones are geographically delineated areas considered to be outside of the normal customs area.
2. Zones have a management authority that can be public, private or mixed.
3. Zone authorities offer special benefits in exchange for locating within the zone.

At their best, zones are an imaginative pathway to economic development using market principles. By allowing firms to move goods around the world duty-free, only paying taxes when goods exit the zone and enter a normal customs area, companies and countries can better leverage comparative advantages in labour, resources and geography. FTZs have helped achieve highly ambitious development plans in Dubai and Singapore. However, FTZs can be double-edged swords that enable security threats and introduce other risks and costs.

Three Inconvenient Truths

The risks and added costs of FTZs are as follows:

1. There is no accurate census or even a simple count of how many zones exist.
2. There is no international consensus on basic rules and regulations for zones.
3. Where there are low levels of transparency and/or high levels of state economic control, zones are a hotspot for criminal, terrorist and corrupt activities.

Presumably, there are no reliable numbers because FTZs go by many different names. In South and East Asia, they are commonly referred to as special economic zones (SEZs) or export processing zones (EPZs). In Central and South America, they are typically called free trade zones (a term which also uses the FTZ acronym). Elsewhere, zones exist under a host of other names, including freeports, industrial parks or Dubai’s various development cities (also referred to as simply ‘free zones’). In Mexico, they are maquiladoras, or sometimes free trade areas (often confused with free trade agreements, such as the North American Free Trade Agreement, NAFTA, which is not a FTZ). Other times, Mexican zones are labelled with the Asian ‘SEZs’ name.

There are also exclusive economic zones (EEZs), controversial in and of themselves, but EEZs refer to marine resource rights and are not FTZs. The term foreign trade zones (and the FTZ acronym) is used exclusively here to describe all types of zones. Why? Trade zones are designed to attract foreign economic activity (such as trade and investment). Zones began with the US’s Foreign Trade Zones Act of 1934, passed by Congress as a partial repeal of the disastrous Smoot–Hawley tariffs in 1930 that intensified the Great Depression. The first zone opened in New York in 1937. The first European zone began in Ireland in 1959.

The common narrative today is that 3,500–4,000 zones exist worldwide. This oft-repeated estimate is wholly unsatisfying from a data-science perspective, and it should be from business and government perspectives as well. There is no insurmountable reason why a more definitive number does not exist.

FTZs are not Inherently Bad, or Good

FTZs are useful although, like any tool, good or bad outcomes are dependent upon the user. For states with relatively low levels of governance capacity, such as many African or Latin American states, zones often become a weak spot where corrupt or incompetent customs officials allow goods to be leaked into the marketplace without customs duties ever being paid. This can create a downward spiral of decreasing government revenues and increased black market activity. FTZs can also allow terrorist groups, such as Hizbullah or Boko Haram, and drug cartels access points to the global marketplace.

In places with higher state capacity but poor labour and transparency standards, such as Dubai or China, FTZs are still vulnerable to abuse by sophisticated criminal organisations, terrorist groups and multinational corporations. Out of these groups, only multinational corporations face real economic risks because they seek to maintain a public reputation and market legitimacy. Therefore, they should be, and generally are, a keen ally in securing and growing the world’s FTZ supply chain. However, the labour and transparency standards within FTZs are limited by the status of standards outside of zones in the host countries. This is where international regulations could help.

Standard Operating Procedures for FTZs

The simplest way to address the inconvenient truths of FTZs is with transparency, but not the type of transparency many may be thinking of. Objective transparency is better seen simply as credible economic data. For example, Singapore publishes more believable data about its economy than most regional countries and appears to have comparatively fewer issues with terrorist financing and money laundering activity in its FTZs. The OECD recently crunched numbers on illicit trade in FTZs and issued guidance for enhancing transparency in FTZs. The OECD guidelines are a clear starting point for developing general regulatory norms.

One might wish to assert that a very secretive state, such as North Korea, which has at least four FTZs, would not allow such data collection. But the fact remains that if zones are set up to attract legitimate foreign investment or trade, they have to advertise internationally. This implies that there is data already out there just waiting to be collected. And there is. The internationality of FTZs also suggests that multinational corporations and foreign governments can pressure places like North Korea to implement greater standards inside zones.

The absence of a standardised set of regulations for zones means that in many places they are the ‘Wild West’ of globalisation, cowboy capitalism at its worst (see the Golden Triangle Special Economic Zone of Laos). Sticking with the Western theme, as America expanded westward, people knew that saloons were hotspots for criminality. But businessmen also knew taverns were the place to get things done. FTZs often serve a similar purpose. They don’t have to.

On Transparency, Standards and Political Will

Transparency, in the form of credible aggregate economic data, addresses problems with lawlessness. Better data makes FTZs more successful in their political goals of economic development. Furthermore, when private and public actors (such as firms, academics and law enforcement) have easy access to the same credible data points, they tend to wittingly or unwittingly coordinate future decisions and resource allocations. Firms want more goods produced and moved, law enforcement desire less crime, and academics seek more knowledge. Coordination of this kind leads to greater efficiency in any sector.

FTZs continue to mainly operate in the shadows, briefly breaking into the headlines on occasions when, say, Boris Johnson floats a proposal to build freeports in the UK. It is understandable that FTZ operators anywhere typically desire to maintain a low profile. In democracies, voters sometimes disparage zones as tax giveaways. Elsewhere zones are often at the centre of corruption, drug trafficking or even sanctions evasion. However, the increasing complexity and interconnectivity of global supply chains requires that FTZs everywhere be brought into the light with data, standardisation of regulations and the political will to make it happen.

Clay R Fuller is a Visiting Fellow in Foreign and Defense Policy Studies at the American Enterprise Institute in Washington, DC. This is the third commentary in a series of contributions on tackling illicit trade and trade-based money laundering. The first two commentaries are available here and here.

The views expressed in this Commentary are the author's, and do not represent those of RUSI or any other institution.