Free trade or penalty-free crime?

Reuters

A policeman stands with a detained suspect after protesters looted stores during protests against a new government law, which allows for the sale of land in Panama's free trade zone of Colon, in Panama City October 26, 2012.

Article Highlights

  • The worst FTZs encourage cronyism, corruption, and illegal trafficking

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  • The worst FTZs can discredit capitalism

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Economists love free trade, but it draws a decidedly mixed reception elsewhere. Since the Uruguay Round paved the way for the WTO in 1995, there's been no significant multilateral movement towards removing the remaining barriers to global commerce. And while new regional trade pacts have been inked all over the place, much of the political focus has been on more limited unilateral fixes -- notably the creation of free trade zones to smooth the multi-stage, multi-country supply chains that have come to dominate commerce in industrial goods.

There are roughly 3,500 free trade zones worldwide in which most national regulation is suspended -- more than 2,000 of them in developing and transition economies. And while policymakers typically promote FTZs as a means of job creation, more often than not the real purpose is to liberalize markets hindered by interest group conflict, local government corruption, or ideological rigidity.

Usually, these zones are established in the poorest parts of countries that would otherwise languish for lack of infrastructure or business-friendly governance. They often become home to multinational manufacturers of middle- and low-tech goods, such as clothing and consumer electronics, or to firms repackaging products like cigarettes and pharmaceuticals for re-export. Thus FTZs may speed local development, as well as signaling the advantages of free markets to other localities within the country. Think of the "special economic zones" in which Deng Xiaoping introduced capitalism to post-Maoist China.

All is not roses, though. FTZs sometimes make it possible for autocratic regimes to perpetuate illiberal societies -- for example, North Korea -- using them to generate desperately needed foreign exchange. More commonly, FTZs become havens for smugglers, money launderers, and terrorists in search of hard currency. And these problems can discredit both open trade and regulatory reform by equating the free-for-all of cowboy capitalism with free markets.

A few FTZs in rich countries, such as the St Regis-Mohawk Reservation in New York State that serves as a major transit point for smuggled cigarettes, illustrate the downside. But for the most part, highly industrialized countries manage to maintain civil institutions and the rule of law in FTZs without undermining their attraction to investors. The same can't be said for developing countries, particularly those with weak political and economic institutions.

Panama's Colón Free Trade Zone, with its proximity to the Canal, is one of the busiest FTZs in the world -- and a beehive of illicit activity. The Panamanian military has been known to collude with importers seeking to evade regulation, getting a cut of the savings on goods otherwise subject to stiff tariffs. More ominously, it has cooperated with smugglers to transport weapons and illicit goods to private militias across South America that mix radical politics with crime.

Perhaps not surprisingly, organized crime often fills the power vacuum left by the absence of regulation: The environment of "no rules" becomes one of rule by the most brutal. For example, laissez-faire and corruption allowed Aruba to become a haven for the Sicilian-based Caruana-Cuntrera family, which controlled 60 percent of all property on the island in the early 1990s. 

Aruba's nearness to Colombia and anything-goes ethos within its FTA made the country an ideal waypoint in the American-European narcotics trade. By the mid-1990s, Aruba's reputation had also made it a no-go zone for legitimate foreign investors wishing to avoid guilt by association. And under pressure from multinational corporations (and foreign governments), the Aruban government finally grew the backbone to overhaul its laws.

Evidence of counterfeit goods passing through FTZs has led business trade groups to call for greater regulation of free trade zones elsewhere. The Jebel Ali FTZ in Dubai is one of Europe's largest sources of counterfeit goods. In 2008, the year I visited the zone to investigate the fake-pharmaceutical supply chain, 15 percent of incidents of seized counterfeits at EU borders were in transit from United Arab Emirates.

FTZs also facilitate the packaging/rebranding of pharmaceuticals not licensed by the patent holder, leading to uncertain provenance and hence concerns about quality. A public health inspector found label-modification activities in the FTZs of the Netherlands Antilles; zones in China, Panama, and the UAE are also regularly implicated. When my research group bought pharmaceuticals from bogus Canadian websites, the drugs would often come from China via Dubai, with payment going to accounts held in Panama.

The FTZ-terrorism connection is especially disturbing. There's evidence that a Colombian cartel used FTZs to funnel cocaine revenues to Hezbollah in exchange for protected access to Mideast drug consumers. Lax banking laws in one Asian country allowed the traffickers to launder the funds through what's called a "black market peso exchange." Colombian traffickers would deposit money in an Asian bank account and then buy the currency back with pesos, using the currency to move the drug shipments in and out of Panama (including the Colon FTZ). The network utilized a peso exchange system in Miami as well.

An FTZ in the Ciudad del Este, located at the juncture of Brazil, Paraguay, and Argentina, has also been a source of concern for security experts. The "Tri-Border Area" (TBA) became infamous for the trafficking of illicit goods due to lax border security, thanks to a mix of corruption and a desire to attract tourists with hassle-free entry. After 9/11, Paraguayan police responded to U.S. pressure by arresting a Lebanese immigrant whose electronics store fronted for a massive money-laundering and DVD piracy scheme that funded Hezbollah.

Some economists have argued that the kinds of corruption we see in FTZs do more good than harm by giving investors a way to duck costly, inefficient government bureaucracies. But, more typically, the cowboy-capitalist FTZs offer nothing positive. While the better-managed FTZs provide millions worldwide with employment and trade benefits, the worst encourage cronyism, corruption, and illegal trafficking, discrediting a concept that can be immensely beneficial.

Moreover, the problem is not beyond solution: As noted above, Aruba eventually stood up to entrenched interests, implementing comprehensive background checks, tightening oversight of incoming and outgoing shipments, and maintaining better inventory controls. In fact, as Aruba's FTZ went legitimate, it became more prosperous; it is now the preferred venue for Venezuelan investors seeking relief from their country's corrupt, regulation-bound government.

Aruba still has problems with inventory management, and it does not have the oversight of American FTZs. But the turnaround shows that developing country FTZs are not beyond the influence of western interests, both authorities and multinational corporations -- and can actually make a bigger buck by treading the straight and narrow.

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