Free trade zone

From CEOpedia | Management online

Free trade zones are one of the many types of special economic zones. They are geographical locations where trade can be carried out without government interference such as customs duty, protective tariffs among others. They are usually situated close to International airports, seaports and other locations that have trade advantages. Free trade zones can also be called free zones, maquiladoras, duty-free export processing zones, investment promotion zones or free ports depending on its context or country (Tiefenbrun 2013, p.153).

Characteristics of free trade zones

From the above definitions, the common characteristics of the free trade zones are (Valentines 2005, p.6):

  1. Above average business infrastructure: The tenants of the industrial estate are provided with high-quality services and infrastructure in comparison with the standards of the country hosting it. These infrastructures and services include office space, logistics services, utilities, land, business services and other facilities.
  2. Flexible business regulations: The activities of the customs services are narrowed down, the red tape is kept to the barest minimum, often through one-stop shopping for investment applications and permits. Legislations about businesses and labour are more flexible in comparison with the regulations and laws applied to businesses in other parts of the host country.
  3. An offshore location: Free trade zones are chosen as locations for trading and commercial activities going offshore, away from the regular markets where the finished products are sold in search of a low or lower cost manufacturing basis.
  4. Focus on export: Enterprises located within the zones produce mainly or exclusively for foreign markets, markets outside the host country.
  5. Attractive incentive packages: Major component of the free trade zones are the high incentives offered to foreign investors. These incentives include:
  • Unlimited duty exemptions from import duties on intermediate inputs, raw materials and capital goods used in the manufacture of exported products and services.
  • The investors are usually exempted from the payment of sales tax on all goods and services used in the manufacture of all exported product purchased locally and on the exported product itself.
  • The investors enjoy tax holidays and rebates on corporate profits that are linked to the export performance of companies in the free trade zones.

History of free trade zones

Free trade zones dated as far back as 100 BC. The first known free-trade zone in the world was established in Delos, an island in Greece in the year 166 BCE. It lasted for about a hundred years until pirates took over the island. At the rise of the Roman empire, they had many free cities called “Civitas Libera”. In these cities, they do not pay tributes annually to the Roman emperor, they also had the liberty of making their own laws making it easy for business transactions to thrive. These practices continued and gained popularity until at least the first millennium.

In the early 12th century, the Hanseatic League started their operations in the Northern parts of Europe and putting trading colonies in place all over Europe. Good examples of these Free Trade Zones are the Steelyard in London and the one in Hamburg. The London Steelyard among other Hansa stations, has its own counting houses, warehouses, and residential quarters enclosed in a different walled community (Evert, Selzer, 2016, p. 11).

In 1959, Shannon Free Zone which is reputed to be the first modern free trade zone was established in Shannon Ireland. This “modern” zone was created to assist the airport in the city to adjust to changes in aircraft technology that allowed long-range aircraft to skip previously mandatory refuelling in Shannon. This attempt by the government of Ireland to ensure employment remains around the airport so that the revenue generation of the airport to the Irish economy continues. The move was very successful and is still in use to date. Other notable free trade zones are the Indian Kandla Free Zone, which started around 1960, and the Taiwanese Kaohsiung Export Processing Zone which began Operation in 1967. In the late 20th century, the number of free-trade zones increased exponentially.

Advantages of free trade zones

A free trade zone has many advantages which include (Valentines 2005 p.7):

  1. Increased efficiency: The beautiful thing about a free trade zone is its ability to breed competition, which in turn raise the efficiency of a country. This Internal competition helps the country to be on par with other countries competing for dominance in different sectors. The competition also helps increase the quality of goods and services while keeping the prices relatively low.
  2. Specialization of countries: When the competition is quite tough, countries will tend to produce more goods or services that they produce easily and at very high efficiency. They specialize in these products or services because they have a high output at their production rate and at an incredibly lesser time compared to their subordinates.
  3. No monopoly: In a free trade zone, there are lots of exemptions and elimination of market quota and the likes. This enables more investors and players to thrive in the market thereby crushing monopoly in the process.
  4. Lowered prices: The competition brewed as a result of free trade zones leads to the reduction of the prices of goods and services on a global level. This Reduction will in turn allow product users and consumers to wield a stronger purchasing power.
  5. Increased variety: With the specialization of different countries in specific products and services, there will be diversities of products and services for consumers to choose from.

Disadvantages of free trade zones

Irrespective of all the benefits accompanying a free trade zone, there are also some disadvantages which include (Klein 2000, p.204):

  1. Threat to intellectual property: Free trade zones give rise to easy importation which can make local producers access these products. These local producers can decide to copy these ideas, reproduce them and sell them off quickly as knockoffs. It is easy to steal ideas in so many countries as there are sometimes no sufficient laws to protect intellectual properties.
  2. Unhealthy working conditions: As a result of limited labour protection laws in many countries with free trade zones, many companies may resort to outsourcing jobs to workers. Due to the loopholes in the labour laws, the workers may be coerced into working in substandard work environments.
  3. Less tax revenue: Since most countries with free trade zones exempt import taxes, they become burdened with other ways to make up for the reduction of tax revenues.

References

Author: Promise Akabudu