26 September 2019

Dr Peter Holmes is Reader in Economics at the University of Sussex, Director of Interanalysis and Fellow of the UK Trade Policy Observatory. Interview by Kate Beaumont. This article was first published on Lexis®PSL Commercial on 5 September 2019.  

How will the establishment of free ports enable the UK to benefit from Brexit trade opportunities? Dr Peter Holmes, reader in economics at the University of Sussex, considers the pros and cons of these special ports where normal tax and customs rules do not apply.

What are free ports?

Free ports are zones within a country’s land area but outside the customs territory. They were particularly useful when tariffs were very high and governments relied on them for revenue. They were used in early modern Europe— especially in Italy—so that traders could bring goods in from foreign sources and re-export them.

Today tariffs tend to be much lower, so the burden of avoiding tariffs on imports of goods you will later export is far less for most industrial countries. Free ports therefore tend to be more broadly focused free zones where a wider range of fiscal and regulatory burdens are alleviated. They are particularly useful in developing countries, with high tariff rates and inefficient bureaucracies.

How will free ports benefit the UK economy?

There is much less benefit of free ports for countries where tariffs are already low and regulations sensible. In the US there are many ‘Foreign Trade Zones’ (FTZs) into which goods can be imported, processed and then either reexported or sold on into the US economy. There are 420,000 jobs in these zones. Proponents of free ports in the UK suggest that if we had the same percentage of employment in free ports as the US in its FTZs, there could be as many as 86,000 jobs.

However, there is an important difference between UK and US rules. In the US tariff code, there are a number of products where the final good carries a lower duty rate than the parts and components. This is particularly true in the automotive sector. It therefore pays car firms to import components duty-free into the FTZs and assemble them for sale into the home market. Free ports do not exempt trade going through them from tariffs—they simply defer payment until the arrival at the final destination, overseas or in the rest of the country.

For the UK there is no such ‘tariff inversion’ to motivate creating free ports. To be a success they would need to offer more than just temporary duty-free access to port zones and must be ‘Enterprise Zones’ (EZs) with a broader range of incentives. One successful UK example was the Isle of Dogs EZ, which was created in 1982. Here when the traditional docklands declined new infrastructure was built, and planning regulations were relaxed. Many new jobs were created including in the Canary Wharf complex, but they were not processing jobs due to duty deferred imports.

During the presentation of our UK Trade Policy Observatory report on free ports, Paul Swinney, director of policy and research, at the Centre for Cities (CfC) argued in discussion that the free ports would need far more elements—eg tax breaks, deregulation including relaxed planning laws, infrastructure etc.

The Institute for Government (IFG) summed it up neatly: ‘The last government proposed to set UK tariffs at zero for 87% of goods (the big exception being agricultural produce). This suggests an economic benefit might be enjoyed from a reduction in paperwork, but little from the tariff exemption itself. As such, the benefits would depend on other tax incentives and subsidies—but this risks falling foul not just of EU rules (if that is where the UK intends to re-export) but also WTO rules’.

What are the disadvantages of free ports?

Recent research by the CfC concluded that the free ports aspect was unlikely to promote high skill jobs that would create future growth. Free ports as such would promote low value added warehousing jobs etc. The CfC found that the gross impact of EZs has been far below promises (above all in Humberside). A total of 13,000 jobs were ‘created’ between 2012 and 2017 as opposed to the 54,000 predicted, and these are gross rather than net. Most of these jobs were in warehousing and similar, and could make little contribution to long-term regeneration. There could only be large benefits from free ports if they were accompanied by generous tax or infrastructure benefits or major deregulation. But as the IFG points out: ‘As such, the benefits would depend on other tax incentives and subsidies— but this risks falling foul not just of EU rules (if that is where the UK intends to re-export) but also WTO rules’.

A point forcefully made by many studies is that the gross impact of free zones and free ports is a lot less than the net effect. If there are tax breaks for one area, jobs will be shifted to the privileged zone at the expense of competing and especially neighbouring areas. On the other hand, if, say, ten free ports are created the effect will be rather diluted.

On a separate note, the European Parliament and other commentators have noted that free zones encourage money laundering activity, tax evasion and possibly the harbouring of illegal items.

How quickly can they be set up?

Even a customs duty-deferral only freeport requires significant physical and administrative infrastructure. There needs to be a physical barrier around the perimeter and systems for monitoring and checking, which would depend on what other regulatory variations were permitted in the zone. Health and safety checks might still be needed at both borders. This will take time to set up.

Are there currently any free ports in the UK or in the EU? Which countries have made a success of free ports?

The UK did have free ports until 2012, but when the EU rules were changed it was not considered worth keeping them. There are about 90 other free zones in the rest of the EU, notably in Poland and Spain and also Luxembourg where it is alleged by the European Parliament that illicit activity may be facilitated.

There have been successes from the use of free zones. Ireland’s Shannon airport stimulated a remote region. The Middle East, especially the Jebel FZ of Dubai, has been able to promote entrepot trade in the region. The most obvious success story is the Shenzhen zone of China where a highly regulated communist regime was able to use this area to experiment with deregulation for the rest of the economy.

How do free ports work alongside/are they compatible with other customs & excise regulations elsewhere in the UK/EU?

The essence of a free port is that it is outside the jurisdiction of the surrounding territory. In principle therefore, it can coexist with almost any context, but the more the tax and regulatory regimes offer special privileges, the more scrutiny there has to be at the border.

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