Do Special Enterprise Zones Undermine Capitalism and Our Safety?

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Smugglers are adept at taking advantage of the myriad tariffs and tax rates between jurisdictions. With increasingly cheap globalized transport and tax free zones cropping up all over the globe, smugglers, terrorist financiers and organized crime have found boundless illicit opportunities. Even in the more regulated zones within wealthy countries, opportunities for wrongdoing still exist, often driven by punitive tax rates on unfashionable consumer products like cigarettes.

These threats will be discussed next week at the MacDonald-Laurier Institute in Ottawa, Canada. One specific problem security experts will examine is the smuggling of goods through the St. Regis Mohawk reservation in the U.S. and its equivalent Akwesasne Reserve in Canada. These reservations of the Akwesasne people have their own rules and tax rates, which when coupled with ineffective border controls, attract organized crime and transform these zones into key hubs for the illegal movement of narcotics, weapons, humans, tobacco, and counterfeit goods, between Canada and the U.S.

For the most part, however, industrialized countries manage to maintain civil institutions and the rule of law, even in tax free zones, so that corruption and organized crime cannot take control. The same cannot be said for zones within developing countries, particularly those with weak political institutions.

There are over 2,000 free trade zones (FTZs) in emerging economies, where taxes and tariffs are suspended, often with most national regulations.

Prudent policymakers typically encourage the creation of zones in order to liberalize markets hindered by government corruption or ideological rigidity. They often become home to multinational manufacturers producing goods such as clothing or consumer electronics, or to firms repackaging products like cigarettes and pharmaceuticals for re-export. Thus FTZs may speed local development, as well as signal the advantages of free markets to other localities within the country. Think of the "special economic zones" through which Deng Xiaoping introduced capitalism to post-Maoist China.

There are many examples where policymakers have encouraged FTZs for personal gain or to advance a particular narrow interest. In some cases, FTZs make it possible for autocratic regimes to perpetuate illiberal societies - for example, North Korea which uses them to generate desperately needed foreign exchange. More commonly, FTZs become havens for smugglers and money launderers, who pay off the officials who run -- or are supposed to oversee -- the zones. All these problems can discredit free trade and regulatory reform by equating the resulting crony capitalism and mafia-dominated business with true capitalism and free markets.

Panama's Colón Free Trade Zone, located near the Canal, is one of the busiest FTZs in the world, and awash in illicit activity. The Panamanian military has colluded 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 that mix radical politics with crime across South America. Colombian cartels and Paraguayan criminals use multiple FTZs to funnel cocaine revenues to Hezbollah in exchange for protected access to Mideast drug consumers.

The Jebel Ali FTZ in Dubai is one of Europe's largest sources of counterfeit goods, including fake medicines.

Numerous Asian FTZs also facilitate the packaging/rebranding of medicines not licensed by the patent holder, leading to uncertain provenance and hence concerns about quality. Zones in China are also regularly implicated as transit points for bogus drugs traded over the internet.

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. In the early 1990s, Aruba became a haven for the Sicilian-based Caruana-Cuntrera family, which controlled 60 percent of all property on the island. It was an ideal waypoint for 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.

Under pressure from multinational corporations (and foreign governments) the Aruban government finally grew the backbone to overhaul its laws. It implemented comprehensive background checks, tightened oversight of incoming and outgoing shipments, and maintained 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, but the turnaround shows that some FTZs of developing countries are not beyond the influence of Western interests.

Not that Western interests get everything right. After all some of the problems in the zones of the North American Akwesasne people are driven by aggressively high tax rates in surrounding areas, which create incentives to smuggle. If New York State lowered its consumption tax rates, a lot of the smuggling from Canada would probably disappear.

Low tax zones provide a great opportunity for business development and should demonstrate the benefits of capitalism. Unfortunately too many zones are simply conduits for corruption and criminal enterprise. To ensure that the benefits dwarf the costs, what is required is enough political will to limit corruption and shut down organized crime.

Roger Bate is a resident scholar at the American Enterprise Institute, and the author of "Phake: The Deadly World of Falsified and Substandard Medicines." He is writing a book on the costs and benefits of free trade zones. 

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