Freeports Must Not Come at the Expense of Broader Free Trade

This article appeared on UK Telegraph on August 9, 2019.
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Liz Truss has wasted little time burnishing her liberalising credentials as the new Secretary of State for International Trade. Last week her department announced a panel to advise on creating 10 British “freeports”– areas around existing ports and airports with business-friendly incentives on tariffs, taxes and regulations.

The idea itself is nothing new. Since 1981, the Adam Smith Institute has advocated that areas around ports be designated foreign territory for economic purposes. Yet last time the concept was adopted here, the benefits were stamped out by the EU and UK governments’ unwillingness to cede meaningful exemptions to taxes and red tape.

Outside the EU’s clutches and with a pro-market government, advocates hope for a meaningful second attempt at implementation. Struggling towns around existing ports are understandably keen to win designation.

Around the world, freeports operate with different levels of freedom. The US equivalents, for example, are called “foreign trade zones”. Physically located in the US, these fall outside domestic administrative jurisdiction for assessment of customs duties.

Such areas therefore allow manufacturers the opportunity to import intermediate inputs tariff-free and without complying with extensive customs rules and red tape. Value-added activity using these inputs can take place within the FTZ, with tariffs only paid when products enter the rest of the domestic economy. If finished products or the inputs are re-exported, there’s no customs duties at all.

Freeports then can be considered true uninhibited “free trade” areas, pushing customs borders further inland. Cost reductions and deferrals for businesses are the major policy innovation. Freeports also afford firms “tariff inversion” benefits — taking advantage of situations where final manufactured goods face lower eventual tariff rates when entering the full economy than their component parts (which enter the freeport tariff-free).

Truss wants all this, plus to add in a streamlined planning processes, a lighter-touch regulatory environment and pro-investment tax incentives, increasing cost savings to businesses further. Her freeports would be a kind of love child of American FTZs and Margaret Thatcher’s enterprise zones.

This framework brings obvious and widely highlighted costs. Policy preferentialism unavoidably displaces some activity from other areas of the UK into the freeport. There will be a fiscal cost too, given the tariff and tax exemptions — the shortfall for which must result in spending reductions, other tax rises or more borrowing.

Inevitably, then, freeports tend to be discussed as a tool of regional regeneration. Of moving activity around to poorer areas. Critics will compare any fiscal shortfall against estimates of jobs created and argue that most observable activity comes at the expense of elsewhere and the taxpayer, a claim that will be partly correct.

The estimate of the net creation of up to 86,000 jobs from Rishi Sunak, the Chief Secretary to the Treasury, may well prove optimistic based on the trade policy components alone. But all too often critics themselves only paint a partial picture.

The UK already “intervenes” regionally through vast social welfare spending. Creation of new manufacturing jobs for export and the income taxes and national insurance they provide will offset at least some of this direct cost. So long as designation is granted to areas with real potential for growth, then there’s no reason per se to expect failure.

Make no mistake, much freeport activity will be genuinely additional. Reducing business costs improves profitability, making more businesses and investments viable. Centre for Cities’ analysis suggests that just under half of jobs in Mrs Thatcher’s enterprise zones, for example, were genuinely additive.

To assume otherwise, that all freeport activity will just be displaced from elsewhere, is to deny that tax and regulation has any effect on aggregate activity. That seems a bold claim given how much more successful Hong Kong has been historically to, say, mainland China.

No, the tax and regulatory alleviation that comes with freeports will improve the productive potential of the economy. If it facilitates regional hubs of high-value added manufacturing activity and Britain leading the way in port innovation technologies, those productivity benefits could be greater still. The real open question is what freeports imply about the Government’s broader post-Brexit trade agenda.

If successful, freeports will expose the destructive cost of current protectionism. Any new value-added activity highlights the folly of existing tariffs which raise UK exporters’ input costs and reduce their pricing competitiveness in world markets. Indeed, freeports are deemed necessary precisely as relief against tariffs and customs procedures.

But that also means the ports’ relative success becomes dependent on the continuation of protectionism in the rest of the country. Freeports’ very existence may create an interest group for the preservation of the status quo policy mix and against further liberalisation.

A voice could now exist to oppose unilateral tariff reductions or any otherwise beneficial free trade agreements that incorporate provisions that cut across a freeports’ relative position of strength.

If that means tariffs that would otherwise be abolished are maintained, we will be trading off the interests of consumers and non-freeport producers against the health of manufacturing firms in freeports.

Now that zero-sum outcome is not inevitable. Freeports can be used as laboratories to test out other policies to improve the whole economy. Big gains could be made from targeted attempts to streamline the planning system, a nut that Margaret Thatcher’s enterprise zones failed to crack.

But in the trade policy area, it’s important to always look ahead to your eventual desired destination. Freeports, by reducing costs for input importers who export final products, shift us in a free-trade friendly direction. Truss must ensure these regional interests don’t then become a bulwark against the whole country moving towards free trade in future.

Ryan Bourne

Ryan Bourne is the R Evan Scharf Chair for the Public Understanding of Economics at the Cato Institute.