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Talking Trade blog

A downside of more trade: The growth of illicit trade in FTZs

Published 21 March 2018

While the Asian Trade Centre is generally supportive of efforts to improve trade opportunities for companies globally and within Asia, there are challenges that come with greater flows of goods and services.

In particular, individuals and organized criminal groups can benefit from increased traffic in cross-border trade, especially with the growing rise of smaller shipments through e-commerce channels and the proliferation of free trade zones (FTZs).  Such routes have made it easier for traffickers to ship narcotics, tobacco, counterfeit goods and other illegal products. 

Free Trade Zones were originally set up to help facilitate trade.  Since the creation of such areas, the numbers have exploded to more than 3500 globally.  They are especially prominent in developing countries.

There has also been a proliferation of terms and conditions that apply to these zones, ranging from Free Trade Zones (FTZs) to Export Processing Zones (EPZs) to special economic zones.  At the moment, there is little consensus about the differences between these types of arrangements and limited recognition of these zones in international agreements like the World Trade Organization (WTO) or Free Trade Agreements (FTAs).  Only a handful of countries have agreed to the annex covering zones in the World Customs Organization (WCO).

Most zones are meant to serve as a driver of economic growth, stimulating inbound foreign direct investment and jobs and economic gains that are assumed to come along with such investment. 

Because there are so many different types of zones today, the conditions that apply to companies operating in the zones also vary.  Most involve the reduction or elimination of duties and taxes for goods that are produced within the zone.  In many cases, the final product may have lower duties than the inputs, allowing firms to claim lower tariffs overall (use “inverted” tariffs) or to defer duty payments until the products are transferred out of the zone.

Not all zones are in developing countries.  The FTZ Board in the United States reported that 3300 companies used the 195 active FTZs within the United States in 2016.  The largest industries using the zones included: oil refining, automotive, electronics, pharmaceutical, and machinery/equipment sectors.  Given the geographical reach of zones, many are now located closer to final customers making it easier to respond quickly and build more agile supply chains. 

While FTZs come with the promise of lower regulations, they were never meant to be places of business without any government oversight at all.  In many jurisdictions, however, government regulation has become increasingly lax, allowing for growing levels of illicit trade and other criminal activities through FTZs.

To clamp down on illicit trade in products flowing through FTZs, many governments need not create new regulations or legislation.  In many circumstances, officials simply should use legal tools they already have in their possession.

For example, customs officials have the authority to supervise flows of goods in and out of FTZs.  As the OECD recommends, such measures include requiring sufficient information on goods that move through supervised FTZs; applying penalties for the misuse of zones; and enhancing security screenings. 

All FTZs have managers.  These operators should be held accountable for illicit activities that take place within zones. 

Illicit goods do not leave zones by magic.  They are transported in and out, leaving ample room for officials in law enforcement the opportunity to hold logistics operators and freight forwarders more accountable for cargo. 

While FTZs seem to present many challenges for illicit trade, two stand out on a 2016 OECD country survey: illicit trade in cigarettes and counterfeit consumer goods. 

For tobacco, one particular issue is the production and smuggling of “illicit whites.”  These products are produced inside FTZs and potentially designed for legal use, but are often smuggled into local markets without having the proper final market labels applied showing that all duties and taxes have been paid, and are therefore sold illegally.  These unlicensed and unpaid products are a major problem for legal tobacco companies.

Stamping out counterfeit products from FTZs may be more challenging that simply requiring that all products leaving zones have final market labeling applied.  While this solution would go a long way towards addressing the issues of tobacco, especially when coupled with additional enforcement of transport operators found to be carrying illegal cargo, it may not solve issues of fake consumer products leaving zones. 

However, at a minimum, greater integration of customs oversight in zones would improve the situation, as well as additional enforcement of existing rules on intellectual property right infringement. 

The Economist is holding an interesting public/private dialogue on illicit trade in Kuala Lumpur tomorrow (March 22) to explore the topic in greater detail.  These types of discussions are badly needed as the challenges posed by illicit trade through new channels seem to be growing.  Governments should be actively engaging with a range of stakeholders to consider how to more effectively use existing tools and what additional regulations might be needed in the future.

As officials design new trade agreements, some of the issues of illicit trade might usefully be brought into the conversations.  Given the lack of a global institutional structure surrounding FTZs and various other permutations for zones, it may be time for new thinking on how these elements can be included in future trade rules at the bilateral and regional levels.

© The Hinrich Foundation. See our website Terms and conditions for our copyright and reprint policy. All statements of fact and the views, conclusions and recommendations expressed in this publication are the sole responsibility of the author(s).

Dr. Elms is Head of Trade Policy at the Hinrich Foundation in Singapore.  Prior to joining the Foundation, she was the Executive Director and Founder of the Asian Trade Centre (ATC). She was also President of the Asia Business Trade Association (ABTA) and the Board Director of the Asian Trade Centre Foundation (ATCF).

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