Background
Free ports, also known as foreign trade zones or free trade zones, are not uncommon in developed economies and developing countries.[1] There are a number of variants on the concept, but in essence a free port can be thought of as a zone where different customs procedures apply; though this status may only apply to small parts of the total area of today’s “UK Freeports.”
Free ports allow goods to be stored, assembled and/or processed without paying customs duties on entry, thus allowing payment to be deferred until the goods enter the rest of the domestic economy or are exported elsewhere for onward sales. For this reason, free ports can be most advantageous in countries with high tariffs; and were prevalent during earlier periods of high trade barriers to facilitate entrepot activity.[2]
In addition, free ports usually benefit from derogations from other taxes and regulations. Governments that implement free port policies do so hoping to incentivise investment and create jobs, but critics of free ports argue that they merely relocate economic activity; and that they foster illicit operations in weakly regulated environments or simply act as storage for high-value goods.[3]
Reintroducing free ports in the UK
The UK had free ports until 2012, when EU rules were changed and it was not felt worth adapting UK free ports to comply.[4] The main impetus to reintroduce free ports in the UK came from Rishi Sunak in 2016, who drew on the US Foreign Trade Zones (FTZs) experience. Extrapolating from the size of the US economy and the total number of jobs in FTZs, Sunak argued that 86,000 new jobs would be created (pro rata from FTZs).[5]
However, this extrapolation makes very little sense due to the specific nature of the US tariff regime, which contains many anomalies where duties on parts and components are higher than on finished goods, thus creating an incentive for FTZ assembly plants. This is known as “tariff inversion.” The US FTZ activity is heavily concentrated on these industries, such as automobiles where finished cars face tariffs of 2.5% which is lower than many of their parts and components.[6]
The 2019 Conservative Manifesto referred to free ports as one of the “benefits of Brexit” and promised to “create up to ten freeports around the UK.” The UK’s new Freeports Policy was then devised, and in November 2020 the UK Government opened a three-month bidding process in which prospective bidders consisting of public and private partnerships were required to demonstrate how their ambitions conformed to the Government’s policy objectives, summarised in three points:
- Establish Freeports as national hubs for global trade and investment.
- Promote regeneration and job creation.
- Create hotbeds for innovation.
The UK Freeports model, first detailed in the Freeports Bidding Prospectus, goes beyond the traditional concept of a free port and covers an area much wider than the port itself. The bids required bidders to propose a 45 km-wide boundary based around a much smaller main sea (or air) port where the Freeport policy measures including easier planning permissions, customs exemptions, tax benefits, regeneration spending, and innovation funds are to be made available. The Government committed £175m of seed capital funding for Freeports in England, £52m for Freeports in Scotland, and £26m for Freeports in Wales. These are modest sums.
Within the Freeport boundary, businesses operating inside designated areas known as “customs sites” can enjoy numerous customs benefits such as deferral of import duties and VAT, tariff inversion, and simplified import procedures. Customs sites do not eliminate administrative burdens as goods will still be subject to checks and declarations on entry and exit. There is no limit on the number of customs sites permissible in the Freeports, but they must comply with numerous conditions such as being enclosed with robust security measures. Their scope, however, is limited in the UK where tariffs are already low, especially on imported inputs.[7] Moreover, many of these benefits are already available to businesses under other schemes such as bonded warehousing and inward processing.
In addition, businesses operating inside “tax sites” within the Freeport boundary can enjoy tax breaks on land purchases, deductions on national insurance for employees’ earnings up to £25,000 p.a., and enhanced allowances on the purchase of buildings and capital. The latter are conditional on new investment in order to minimise the risk of displacement and encourage regeneration. It should be noted, however, that the Government has maintained generous investment allowances at a national level, especially since 2021.[8] Freeports can designate up to three tax sites, which combined can be no larger than 600 ha. This equates to approx. 0.4% of the maximum Freeport area.
In March 2021, Rishi Sunak, who at the time was the Chancellor of the Exchequer, announced the eight successful Freeports in England during his delivery of the budget to UK Parliament. Since then, two “Green Freeports” were announced in Scotland (January 2023), and two Freeports in Wales (March 2023).
The Government released a “selection decision-making note” in April 2021 showing how each Freeport performed against various decision criteria. The biggest “selling point” of the policy was undoubtedly the number of jobs each potential location claimed it would create. These ranged from 15,000 to 60,000, but the timescales and methodology used to determine these figures are vague. In addition, there remains controversy on the political bias in the selection decision (e.g., the Conservative-led Teesside Freeport bid over the more Labour-supporting North East Freeport bid).
The Truss Government proposed slightly more financial incentives in their short-lived proposals of ‘Full Fat Freeports’ or ‘Investment Zones’ with National Insurance rebates up to £50,000 p.a.. The Treasury soon abandoned the original plan in favour of a scheme which would essentially replicate the benefits of Freeport tax sites without being associated with Freeport status.[9]
Freeports and FTAs: Preferences and Origin
Could Freeports promote exports? A factor often overlooked is that the customs position of goods exported from free ports is very complicated. Whether or not a product manufactured, assembled or processed in a free port can take advantage of bilateral FTA preferences depends on a number of factors including whether production is deemed to be originating in the territory of the exporting country, how the bilateral arrangements treat “duty drawback” (i.e., goods exported without paying duty on their inputs), and whether the incentives offered by free ports are such as to be liable to anti-subsidy action under FTA or WTO rules.[10]
In other words, the output from Freeports may be excluded from preferential access to trading partners due to duty drawback bans and they may be subject to anti-subsidies penalties if they are thought to be getting an unfair advantage.
Firms considering operating in UK Freeports may have to choose between using the benefits offered by the policy or seeking preferences under an FTA. Most post-Brexit FTAs contain duty drawback bans so products from Freeports will be denied preferential access if they make use of the tariff exemptions. Interestingly, the UK-EU Trade and Cooperation Agreement (TCA) does not contain any bar to exports from Freeports being granted preferential access. However, there are provisions for the EU to retaliate against any form of subsidy that may affect trade, and Article 53 (Chapter 2, Section I) in the TCA provides for duty drawback provisions to be reviewed in 2023. The EU has already raised the question of Freeport subsidies in the Partnership Council.[11]
HMRC data on Overseas Trade Statistics for 2022 suggest that 30% of UK exports and 38% of UK imports transited a port located in a Freeport. But it is difficult to estimate with precision what fraction of UK trade may be affected (whether positively or negatively) by the Freeports policy. This is mainly because it is only the merchandise passing through customs sites that will benefit from customs exemptions, not necessarily all goods entering the ports located within the wider Freeport area.
Deregulation and R&D in Freeports
Our argument is that there are very few benefits from UK Freeports from a trade perspective. So, what are they for?
On the one hand, the subsidies offered are modest, but it remains to be seen the sort of investment that it will attract. This will, in turn, determine the number and quality of jobs it may create. On the other hand, Freeports could provide scope for “regulatory sandboxes”. This raised fears that Freeports would entail massive deregulation in the areas of money laundering, contraband, workers’ rights, land use or environment. However, the Freeports Bidding Prospectus states that Freeports must commit to compliance with the soft law OECD “Code of Conduct for Clean Free Trade Zones” to prevent money laundering. Similarly, bids were required to show compliance with existing environmental regulation and standards, and the policy was branded as an opportunity to drive the decarbonisation agenda.[12]
The experience of free ports showed that they are only really effective when trade and trade-related activities are subject to excessive regulation and over burdensome restrictions on imports, which is rarely the case in the UK. There may initially have been an agenda to use Freeports as models for “Charter Cities” but no evidence has since appeared of an intention to go down this road.[13] Overall, the Freeport plan was introduced with no new primary legislation thus making it hard to make very big changes in internal regulations.
This leaves one final possible benefit from Freeports, namely the promotion of R&D. On the face of it, run-down coastal areas are the last place where cutting edge innovation would occur. There is little to attract digital business and, at least presently, a lack of pull factors to create the necessary cluster effects for innovation to thrive. Nevertheless, recent events have shown that there are areas where Freeports could play a role, namely marine-related environmental research activity. There have also been developments to increase wind turbine production in the Humberside and Teesside Freeports, and planned projects on carbon capture and hydrogen production in Freeports.[14] The question, however, is whether Freeports help with this and if it makes sense for designated Freeports to be prioritised for funding for such activity.
Interestingly, the Scottish “Green Freeports” plan essentially chose places where there was already hydrogen production activity.[15] But, Scottish Government Cabinet Secretary Michael Matheson MSP told the House of Commons Scottish Affairs Committee that the Green Freeports “will not play a key part in helping to deliver and realise our ambitions for the hydrogen economy in Scotland”.[16]
Conclusion
In a nutshell, the trade dimension of the Freeports policy is limited when tariffs are low and regulations are unconstraining. Any gains that could come on the import side present few benefits beyond those of bonded warehouses; anti-dumping duties will still be levied on items entering a Freeport. On the export side, goods produced in Freeports risk being denied preferences and subject to countervailing duties or penalties under WTO or FTA rules.
It remains to be seen if tax incentives are enough to attract investment and create new jobs; but the key issue is whether any new jobs attracted to Freeports would be net job creation or just job displacement. Moreover, deregulation is worth little if regulations are already relaxed; and Freeports were developed with no new primary legislation that would allow big regulatory changes.
There are some indications of environmental R&D in Freeport areas but there is little evidence that they were generated by the Freeport schemes. Lastly, investment in infrastructure is crucial for regional development, but public funding is limited.
Posted by Peter Holmes and Guillermo Larbalestier (UK Trade Policy Observatory at the University of Sussex)
Suggested citation: P Holmes and G Larbalestier, “The UK Freeports Policy”, REALaw blog available at https://wp.me/pcQ0x2-F2
[1] UNCTAD estimates that there are about 5,400 free zones around the world. See: World Investment Report 2019, Chapter IV: Special Economic Zones.
[2] A prime example is the Speicherstadt (‘Warehouse City’ or ‘City of Warehouses’) in Hamburg, Germany built in 1881, which operated as a free port until 2013. Other notable examples of free ports and free trade zones around the world include the Shannon Free Zone in Ireland, the Shenzhen Special Economic Zone in China, and the UAE’s Free Zones.
[3] See, for instance, the case of the Geneva free port as reported by The New York Times.
[4] Holmes, P. and Serwicka, I. (February 2019) “What is the extra mileage in the reintroduction of ‘Free Zones’ in the UK?”UKTPO Briefing Paper 28.
[5] See “The Freeports Opportunity” published by the Centre for Policy Studies (November 2016).
[6] See European Central Bank Economic Bulletin, Issue 1/2020.
[7] In the UK Global Tariff (the UK’s external tariff schedule), 47% of all tariff lines are duty-free and the average tariff rate for all products is 5.7%. Moreover, the UK has FTAs in force with almost 70 countries, and offers lower or zero rates to exports from lower-middle and low income countries by means of the Generalised Scheme of Preferences (GSP).
[8] More information on this can be found in the Budget 2021 – Super-deduction and Spring Budget 2023 Policy Paper.
[9] Policy Paper (Gov.uk), Investment Zones (March 2023).
[10] Holmes, P., Jerzewska, A. and Larbalestier, G. (September 2022) “Exporting from UK Freeports: Duty Drawback, Origin and Subsidies.” UKTPO Briefing Paper 69.
[11] Second meeting of the Trade Partnership Committee under the UK-EU Trade and Cooperation Agreement, 1 December 2022: Minutes
[12] Section 4.1: “Contribution to decarbonisation and environmental impact;” and Section 4.2: “Preventing illicit activity” in the Freeports Bidding Prospectus.
[13] See UKTPO blog post by P. Holmes and G. Larbalestier (August 2022).
[14] More information in the UK Freeports Programme Annual Report 2022 by Gov.uk (December 2022).
[15] See also https://ukandeu.ac.uk/scotlands-freeports/.
[16] See House of Commons Scottish Affairs Committee Report on “Hydrogen and carbon capture in Scotland” (paragraph 24).
