tHe develoPment Process, fUnctional evalUation, and imPlications of World free trade Zones

Review of

china officially launched a Pilot Free trade Zone (FtZ) in Shanghai on September 29, 2013, taking a solid step forward to boost reforms in the world's second-largest economy.Since then, many discussions and analyses of the connotations, functions, and system design of FtZs have started and are under way.People have high expectations for their role in promoting the deepening of china's economic reform.By November 22, 2013, data on the official website of the china (Shanghai) Pilot FtZ show more than 1400 new companies coming into the zone with a total registered capital of nearly rmB40 billion 1 (approximately US$6.6 billion).But as is well known, FtZ management that is "inside the border Xia lu is Assistant researcher at the marxist research Institute, Shanghai University of Finance and Economics, china.Her specialist research field is the contemporary capitalist economy and the distribution of wealth.Email: 9015223@qq.com while outside the customs territory" (i.e., tax exemptions, tax rebates and tax bonds) is not new.there are about 3500 FtZs located in 135 countries, and more than 170 active foreign trade zones (i.e., FtZs) in the USA alone (Bolle and Williams  2013).And more specifically, world-renowned free ports (one type of FtZ) like Singapore and Hong Kong, as well as typically business-based FtZs like dubai in the United Arab Emirates and colon in Panama, are now at the highest level of FtZ, with integrated functions.therefore, the Shanghai Pilot FtZ can learn from these world-renowned FtZs by playing to their strengths and rising above their weaknesses.Only in this way can we ensure the correct path for china's opening up and fundamentally promote its long-term economic development.

History and current situation of the World's ftZs
According to the Kyoto convention signed by the International customs council in 1973, a FtZ is defined as follows: it "refers to a part of the territory of a contracting Party where any goods introduced are generally regarded, insofar as import duties and taxes are concerned, as being outside the customs territory."In layman's terms, it means being "inside the border while outside the customs territory," which is fundamentally different from being "inside the border and inside the customs territory" like a bonded zone.In terms of nomenclature, FtZs are also called free ports, foreign trade zones, free zones, free economic zones, export processing zones, and so on in different countries and regions.In fact, the world's FtZs have experienced various forms of evolution and have different characteristics due to differences in geographical location, stage of economic development, and categories of goods and services.So it is necessary for us to investigate their emergence, development, and current situation, so as to fully understand the nature and characteristics of different types of FtZ.

Free Ports: Starting in Europe, with Transit Trade as Their Main Function
the FtZ was first created for trade facilitation.In 1547, the world's first free port-leghorn (livorno) Free Port appeared in the Gulf of Genoa, northwestern Italy (now tuscany, near Pisa).At that time, the basic functions of free ports were to attract foreign merchant ships and engage in transit trade, that is, to import foreign goods and then re-export them to foreign countries without processing and to provide tariff exemptions for the cargo vessels plying their trade.they mainly played the role of collection and distribution of goods, thus contributing to the economic development of the country or region adjacent to the free port.For example, the second-largest port in Europe, Hamburg, which was founded in 1189, was one of the world's largest transit ports for coffee, cocoa, spices, and carpets.this prototype of free ports in the modern sense mainly provided cargo handling and storage in the transit trade and required relatively little land.But the main advantage of free ports is that the majority of the foreign goods are duty-free, although the types of trading goods are relatively simple.

Post-War Export Processing Zones, with Attracting Investment and Employment as Their Main Function
After World War II, countries around the world gradually turned their attention to economic development, so the FtZs began to change from focusing on transit trade to attracting investment, creating jobs, and promoting the export of manufactured goods.the Irish Shannon Free Zone and Kaohsiung Export Processing Zone are two typical examples.
the Irish Shannon Free Zone, which was first set up in 1959, is generally considered to be the world's first FtZ in the modern sense.It was no longer established on the basis of famous harbors, but on Ireland's Shannon International Airport.At its inception, the free zone quickly gained an advantage by attracting large-scale investment from US companies by making export processing goods duty-free and having low transaction costs.this is one of the most important differences between the Shannon Free Zone and early free ports.
the Kaohsiung Export Processing Zone was established in taiwan Province of china in 1966.It is well known as the first FtZ to be called an export processing zone.It has three main features.First, it is specially designed for manufacturing, processing, and assembling commodities that are intended for export.Second, it provides enterprises in the zone with a range of preferential treatment in importing, manufacturing, and exporting, such as the reduction of tariffs and other operating conveniences.third, it no longer has transit trade as its main feature but regards foreign trade as an opportunity to develop the manufacturing sector, increase employment, promote technological progress, and upgrade management levels.
With the great success of the Kaohsiung Export Processing Zone, the 1960s-1980s became a golden age for the world's export processing zones, and nearly 200 export processing zones emerged in many countries throughout Asia, Africa, North America, and South America.Overall, as a new model of FtZ, export processing zones' main purpose has been to promote production by means of foreign trade, so the tax reductions and exemptions are mainly limited to the processing of raw materials for import and export and are not for all goods.this is one important difference between export processing zones and free ports.

Comprehensive Development of Modern FTZs in the 21st Century Accompanied by the Functional Upgrading of Seaports
FtZs are usually based on seaports or airports, whether in the form of free ports or export processing zones.therefore, the evolution of FtZs is closely related to the transformation of port functions.With the advent of the 21st century, many countries have made great efforts to upgrade their major ports to attract and promote the development of foreign trade in order to win a profitable position in the global industrial chain.therefore, port functions have been greatly diversified and have integrated many new elements.this is mainly manifested in the following: First, ports have gradually developed to be deep-water and operated with highly mechanized equipment due to the ever larger scale of container ships and oil and dry bulk cargo ships, as well as the improvement of port infrastructure.
Second, ports are changing from distribution hubs to one part of the supply chain and are becoming more refined and externally integrated.the aim is to maximize the value added to the whole logistics network by lowering service costs.these trends have led ports to develop high-end integrated logistics services.
third, ports are becoming comprehensive hubs that integrate the flow of cargo, capital, information, and technology, etc.
thus, the functional upgrading of the ports is definitely bringing about the integrated development of port-based FtZs, becoming an important feature of today's FtZs.

The US Foreign Trade Zone: A Unique Mode of FTZ Composed of General-Purpose Zones and Subzones
the US FtZ Program was created by the US Foreign trade Zones Act in 1934 in the midst of the Great depression.It was designed to accelerate US trade in the wake of the restrictive impact of the Smoot-Hawley tariff Act of 1930, which raised US tariffs on imported goods as high as 53 percent.It was not until 1999 that USFtZs developed rapidly, when the original "Foreign trade Zone Act" was amended to allow certain companies to establish a subzone dedicated to manufacture.
Generally speaking, there are two major advantages in the US type of FtZ.One is its openness, that is, any public or non-profit company can apply for the establishment of a foreign trade zone.Geographically, it is easy to apply for, as long as there are customs authorities located within less than a 90-minute ride.Another advantage is flexibility.Both the general-purpose zone and the subzone have a complete entry and exit mechanism which means that they can temporarily "sleep" (cease operations) until they are "deactivated" (completely abolished).you can also "reactivate" them within a certain period (resume operations), thus eliminating "idle" foreign trade zones to achieve a dynamic allocation of foreign trade zones.And so the US Foreign trade Zones have effectively promoted the economic growth of the USA, making this model of FtZ a highlight among modern FtZs.

functional strengths and Weaknesses of ftZs
Judging by how the FtZ is established and developed, we can be quite clear that its original target was to promote free trade in goods, so that the economy of the heartland and the nation where it was located could make substantial progress.From the free ports of the past to the comprehensive FtZs at present, worldwide FtZs have contributed greatly to the world's and the nation's trade liberalization.However, the modern FtZ has gradually developed into liberalizing investment, finance, and transportation as well, which does benefit the nation or region where the FtZ is established, but also brings along with it potential risks.the following parts will discuss FtZ's functional strengths and weaknesses from an economic perspective.

Lowering the Costs of Production and Transaction
1. Low taxation delivered by various preferential taxation policies.Although the functions and the regulatory policies of the modern FtZ vary from country to country and region to region, one of their central metrics is to provide tax preferences.there are various kinds of tax deductions and exemptions in FtZs, such as tariffs, corporate and individual income taxes, and turnover tax (value-added tax (VAt) rebates included).For example, besides the general tariff reduction and exemption, there are tax preference terms like delayed tariff payments and tariff shifts in the US foreign trade areas.A delayed tariff payment occurs when goods are transferred among zones and the customs duty can be deferred and paid when the goods finally enter the customs territory from the last zone; an inverted tariff means that the manufacturers are free to choose to pay the tariffs according to the materials and components and parts at the relatively low tax rates of the zone, so that they can enjoy lower taxes.As for income tax, corporate income tax generally has a preferential tax rate which is less than the country's standard tax rate or even less than other countries' tax rates: the corporate income tax in Ireland's Shannon Free Zone is only 12.5 percent compared with 28 percent in the UK, 40 percent in the USA, 29.37 percent in Germany, and 25 percent in china (cui 2013).there are also specific policies, such as exempting some specific merchandise and services from tax, offering preferential import VAt, and so on.Ultimately, low tariffs, low income tax, and low turnover tax have come to be the core criteria for reducing companies' production and transaction costs and have brought those companies in a FtZ their greatest "dividend."2. Trade convenience and cost savings under supply chain management.companies in an FtZ can enjoy a number of convenient trade policies besides tax preference, including exemption from cargo declaration procedures, centralized declaration, and efficient computerized customs.most importantly, many FtZs with ports alongside have moved from being simple distribution centers to the supply chain management model, which means optimizing the flow of cargo, capital, and information to reduce costs in the processes of storage, processing, distribution, and transportation and to save companies' production and transaction costs.
3. Subsidies for specific products and services.If companies' strategies correspond to the nation's or region's long-term development goal, in order to boost that industry, the zone will subsidize it to reduce its costs.Generally speaking, the zones have subsidies for product research and development (r&d), workforce employment, and skills training.

Promoting the International Flow of Production Factors and the Efficient Allocation of Global Resources
trade liberalization has ended up propelling the liberalization of investment under globalization.One function of the modern FtZ is to drive investment by open policies and regulations in the FtZ which optimize resource allocation.
1. the zones have become the distribution and allocation centers for bulk cargo (crucial productive resources).A lot of FtZs across the world that feature transport interchange or integrated functions provide a convenient international flow of the factors of production.take the world famous Port of rotterdam, for example; its annual cargo throughput hit 442 million metric tons in 2013, among which coal, ore, petroleum, and grains were the main products. 2the zone is an international transfer station where bulk cargoes are stored, distributed, and processed, and then sent to the Netherlands and places all over Europe by road, rail, waterways, air freight, and sea transportation.Because of its advanced port facilities and distribution equipment and its convenient communication with inland Europe, rotterdam is able to provide manufacturers, shipping companies, and distribution companies with global logistics support.In this case, more than half of American and Japanese companies have built their European distribution center here.Singapore and Hong Kong in Asia, the UAE's dubai, and colon in South America are all important transfer stations for such international cargoes.
2. the FtZ makes full use of the law of "comparative advantage," and takes part in the international division of labor so as to develop competitive industries and increase resource utilization.the FtZ in Africa that is export processing oriented usually chooses industries with a comparative advantage as its leading industries and then mobilizes global resources to realize joint production, maximizing its revenue.For example, the export area funded in Kaohsiung, taiwan, only exported labor-intensive products at the very beginning, due to its cheap labor resources, as that was then the most important way of allocating local resources.In addition, the zone's leading industry was also adjusted in accordance with the competitive environment of the international market, upgrading its industry structure.the export area in Kaohsiung restructured its industries to be capital-and technologyintensive and high value-added in the 1980s.
3. Zones are competing to deregulate and open the investment market, and trade liberalization has been extended to the liberalization of investment so as to attract international investment and foster the international flow of the factors of production.the main approaches include relaxing restrictions on the inflow of foreign capital, exchange freedom, capital account liberalization, and offshore financial operations; these are the main characteristics of the modern FtZ and its future trend.All of the above have a positive effect on maximizing profit from global capital flows and upgrading resource utilization.more importantly, the trade and investment liberalization of FtZs have demonstration and projection effects on that of the hinterland, accelerating the capital flows of the country or region where the zone is located and also making full use of capital.

Increasing Consumer Welfare
Since the advent of the 21st century, many investors in FtZs have gradually transformed their functions.they invest in imported materials, and after a certain amount of processing and assembly, the output is then sold on the domestic market, benefiting consumers.For instance, American Foreign trade Zones (also known as FtZs) are divided into general-purpose zones and subzones, and the export function of the latter has now been weakened as its leading industry has changed to become import processing.companies there purchase cheap raw materials (petroleum and fuel products included) and parts from abroad, and then do the processing and assembling in the subzones, which has reduced the prices of domestic products and helped to sustain a low inflation rate, benefiting consumer welfare.the USA's cheap gasoline is a prominent outcome of such actions.the subzones in the US import barrels of crude oil from the middle East and then sell them to the domestic markets after deep processing.In addition, this makes cars and electronics much cheaper for consumers.

Substitution Effect on Bilateral and Multilateral Trade Agreements and Complementary Effect on Trade
In the development framework of economic globalization, a series of organizations, like the World trade Organization (WtO), European Union (EU), North American Free trade Area (NAFtA), and the Association of Southeast Asian Nations (ASEAN) are the result of world economic integration and regional economic integration.they set up free trade agreements mainly by negotiations between countries or regions, so that the members within the organization can enjoy reciprocal trade.At the same time, the agreements exclude the countries outside the organization, which becomes a major obstacle to their entry into the international market.the trans-Pacific Partnership Agreement (tPP) and the transatlantic trade and Investment Partnership (ttIP) that the USA has recently tried to establish were both this kind of agreement.therefore, one way to break down such barriers is the offer of favorable policies by host countries, which will have a substitution effect on trade and investment.the substitution effect can be well demonstrated by the case of the 1940s-1950s, when bilateral and multilateral agreements among the USA, Brazil, and Belgium were substituted for the US Foreign trade Zone.this held back its growth considerably.It was not until the 1970s that foreign trade zones soared to be the US major force in competing with Japan and the EU.

Promoting Regional and Even National Employment
Whether it is Shannon Free Zone, the taiwan export processing zone, or the US Foreign trade Zone, they all play an indispensable role in creating jobs for their regions or even the whole country.FtZs, with their low tax rates, low costs, and various subsidies and preferential policies, definitely attract a large amount of investment as well as creating employment.A FtZ like Shannon, though facing transitional problems, has already hosted over a hundred companies, employing more than 7000 people (Shi 2014).While in the USA, since permanent residence is not allowed in the zone and employers are required to hire local workers, statistics showed that in 2010 alone, the FtZs in the USA created 320,000 jobs (luo 2013).the FtZ does promote employment substantially.

Boosting the Fictionalization and Diversity of the Regional Economy
Basically, a country can establish several FtZs, with each executing different industrial development strategies.thereby, it will stimulate the fictionalization of the regional economy, and provide a good plan for regional development nationwide to diversify the nation's economy.For instance, general-purpose zones and subzones in the USA have different responsibilities, with the subzones' setting up being consistent with the needs of industry and company strategy.New york, where the first US Foreign trade Zone was located, is famous for its financial services and many other high-end services, dominating the industry with over 40 percent of the world's financial capital, and Silicon Valley is second to none in the world's hi-tech industry.Similarly, in dubai, there are many active FtZs, including Jebel Ali Free Zone, dubai Airport Free Zone, dubai Internet city, dubai media city, Gold and diamond Park, dubai Auto Zone, dubai Knowledge Village, and so on, with each occupying a different economic field.to avoid the overuse of resources and vicious competition, a diversified FtZ construction plan plays a coordinating role in achieving the goal.

Functional Weaknesses
despite the positive effect a FtZ has on a nation or region's economic development, it is by no means trade liberalization, but a result of economic liberalization, which contains within it financial liberalization and deregulation.therefore, it is the weaknesses of economic liberalization itself that have caused the weaknesses of the FtZ.

Overtrading, Overconsumption, and the Hollowing-Out of Industry
the FtZ practices a policy of "inside the borders while outside the customs territory," which has created an open foreign trade environment.With low tariffs and low costs, goods in the zone have a relative price advantage, and this is a great stimulus to foreign trade.On one side, the FtZ has increased countries' dependence on cheap imported goods, leaving no room for domestic companies and related industries, which will ultimately cause the hollowing-out of industry.On the other side, with millions of cheap merchandise flowing in, people will easily over consume.this is not only a waste of natural resources, but also does great harm to capital accumulation and impedes further economic growth.trade-oriented FtZs (strong in trade, while weak in adjacent industries) will usually present the above functional weaknesses worldwide.For example, Hong Kong is a typical free port with a duty-free and quota-free trade market.Since the market there has no industry backup and puts too much emphasis on pure trade and services, Hong Kong has suffered an economic downturn and been in the doldrums for some years.to sum up, generally, only with the support of substantial industries can the FtZ fully play its positive role.

Financial Liberalization and Capital Flight
Along with the development of FtZs worldwide and the upgrading of ports, FtZs have transformed themselves from simply offering tariff reductions and exemptions to giving greater free access to the trade market, especially the service industry, including liberalization of finance, shipping, commerce and trade, culture, and so on.In the modern FtZ, relaxing control on market access and setting up offshore finance businesses are two of the most important features.However, financial liberalization is closely related to capital flight.
First, if there is a net interest spread between local and foreign currency, opening the capital account will drain out a large amount of local currency.Under these circumstances, international hot money without any real trade backup will take advantage of the policies offered by FtZs, conducting arbitrage without any regulation, which usually will be a huge shock to the local capital market and the real economy.
the offshore financial market is another central means of capital flight.Offshore financial markets can be classified into three types: one is a mixture of external and internal services, i.e., there is no separation of domestic and foreign financial transactions, as in london and Hong Kong; another has a separation of external and internal services, i.e., a non-resident account is distinguished strictly from a domestic account, as in Singapore and New york; and the last is a "tax haven," i.e., it only offers registration for offshore companies without any actual operations, like the British Virgin Islands and cayman Islands.One property the three types share in common is that companies there can avoid financial regulation where they are based and can have perfect capital mobility.therefore, offshore financial centers are often an important channel of capital flight.massive amounts of domestic money can be drained out rapidly through offshore finance; at the same time, foreign hot money also takes offshore financial centers as its main channel to evade financial regulation when engaging in legal or illegal capital export, which results in rapid monetary inflows and outflows.In the British Virgin Islands, e.g., preliminary statistics from the United Nations conference on trade and development showed that in 2013 alone, the total amount of foreign investment the Islands attracted hit US$92 billion, ranking fourth in the world and exceeding that of Brazil and India. 3But for the Islands, most of the capital is only rapidly transferred from one account to another or internally within an international company; this has made them the breeding ground of international corrupt money, money laundering, and tax evasion.

Homogeneous Competition among FTZs and Waste of Resources
the core tool the FtZ holds is the advantage brought by the policy of "inside the border while outside the customs territory," since companies there can enjoy tariff exemption, tax preference and convenient examination and approval.But this one strength can be easily copied by other nations' FtZs, leading to identical FtZs all over the world.many of them have been forced to transform themselves or be weeded out. the Shannon Free Zone is quite an appropriate example.Although the first FtZ in the world, it has experienced ups and downs during past decades and had to adjust its strategy when the corporate income tax was reduced to 12.5 percent in the 1980s, so as to answer the competition from other FtZs.
If there are several FtZs within a nation, homogeneous competition will surely result in different jurisdictions' racing to provide better policies, which is not good for the development of all the FtZs and is a terrible waste of resources.In addition, there is a substitution effect between the FtZ and FtZs in a broader sense.For instance, the once world famous German Port of Hamburg lost its raison d'être under the policy of European integration and was at last abolished, with its barriers and financing platform so as to promote the full-scale development of china's financial, trade, transportation and manufacturing industry.

The Supportive Role of Advanced Manufacturing Industries for the Zone Should Be Maintained
In the construction of the Shanghai Pilot FtZ, we should not only be concerned about the abolition of current restrictions on market access but should also base the liberalization of trade and investment on the foundation of the complete and coordinated development of related industries, especially advanced manufacturing and high-tech industries.For example, FtZs in New york put great emphasis on the integration of technology, industry, and commerce.therefore, it is necessary for the Shanghai Pilot FtZ to give support to the development of those industries with advanced productivity.Only in this way can we realize the sustainable development of both trade and investment, and promote industrial upgrading in Shanghai and our country as a whole.

Reducing the Risks of Financial Liberalization and Avoiding Its Potential Impact on the Real Economy
A good financial regulatory framework is needed for any FtZ promoting financial liberalization because it enables it to appropriately avoid potential financial risks.Finance is one of the most important foundations of modern economic development and it has a direct bearing on the economic prosperity and stability of other sectors of the economy.However, the financial industry is typically one with high risks and uncertainties.therefore, we must pay more attention to the construction of the legal framework of the financial system in relation to FtZs.At the same time, because of the strong externalities of the financial industry, not only is the supervision of individual financial institutions necessary, but overall macroprudential financial supervision and international supervisory cooperation should be emphasized.

Implementation of Differential Development Strategies in Different Domestic FTZs
In addition to the Shanghai Pilot FtZ, china also plans to extend the experience of the Shanghai Pilot FtZ to other areas and establish more FtZs in other cities of china so as to promote further opening up and economic development.But we should draw on the USFtZ model and that of the United Arab Emirates; that is, we should implement differential development strategies in different FtZs and reduce the vicious competition among FtZs within one country that results from their having almost the same preferential tax policies.So an overall opening up framework should first be set up for the organization of all FtZs in china.