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22 August 2022

Peter Holmes is a Fellow of the UK Trade Policy Observatory and Emeritus Reader in Economics at the University of Sussex Business School. Guillermo Larbalestier is Research Assistant in International Trade at the University of Sussex and Fellow of the UKTPO.

After time in the shade, Freeports are back in the news. The policy has been embraced and a subject of discourse by both PM candidates, Rishi Sunak and Liz Truss, as part of their “benefits from Brexit” claims and “levelling up” strategies. There has also recently been concern by some commentators that Freeports risk becoming ‘Charter Cities’.

The traditional concept of a free port harks back to an era in which trade barriers were very severe. They allowed merchants to import foreign goods in bulk without paying import tariffs to then sell to other markets (a concept known as “entrepot trade”). Thus, these goods would only pay the import tariffs once they reached their final destination.

The UK had free ports until 2012 and they are still allowed in the EU. In some parts of the world where tariffs and other trade barriers are high, however, free ports are common. Businesses operating within these zones can often enjoy savings on duty by importing parts and components duty-free, only then paying tax on the assembled or processed product once it is sold domestically or exported elsewhere. The potential for duty saving is significant when the tariff on the final products is lower than on its intermediates – a concept known as “tariff inversion.” For producers that are part of complex global supply chains, a free port may (a priori) offer some duty savings opportunity.

In 2016, the Centre for Policy Studies published a report by Rishi Sunak calling for new Freeports in the UK; he then, as Chancellor of the Exchequer, announced the eight successful bidders in March 2021. This was met with great fanfare but many commentators remained sceptical about the likely impact. In the current environment, the trade impacts of Freeports in the UK are likely to be limited for the following reasons.

First, deferring tariffs offers little benefit when tariffs are already low. The UK Global Tariff offers little opportunity for “tariff inversion“ as tariffs on finished goods are almost always higher than those on materials and components. In any case, duty deferral mechanisms, such as “Inward Processing”, already allow inputs to be temporarily imported duty-free for processing and export[1]; and “Customs Warehouses” allow businesses to store imported goods to delay duty payments. The creation of zones or warehouses set outside the national customs territory actually requires more and not fewer controls, as goods still have to be checked and declarations made at entry and exit.

Second, the overall potential for exports from Freeports is limited by the prospect of tax breaks and other financial incentives in Freeports being perceived as export subsidies by other countries. Additionally, exports containing duty-free inputs are, in many cases, not allowed to benefit from the preferential tariff rates in free trade agreements (FTAs) (e.g. UK FTAs with Canada, Mexico, Switzerland).[2] This means that exports to countries with whom the UK has an FTA may not be eligible for the preferential free trade tariffs but may instead have to pay tariffs. Moreover, trading partners may retaliate with countervailing duties if they perceive the financial incentives to be unfair subsidies.

This all suggests that any benefits of Freeports have to primarily come from the non-trade aspect: subsidies, tax breaks and looser regulation. Prospects of gain could likely be in urban redevelopment from relaxed planning rules (as was the case in London Docklands), but – to be effective – this requires availability of sites, prospect of land use and infrastructure and, of course, whether jobs and investment would simply be diverted from elsewhere.

Redevelopment initiatives in the short run are targeted at “Customs Sites” and “Tax Sites” within the “Outer Boundary”[3] of the Freeport, which – combined – represent a very small share of the whole demarcated Freeport area. The overall regeneration or “seed capital” funding promised by Government was £175m over eight Freeports (or up to £25 million for each Freeport).[4] For comparison, the “Levelling Up Fund” is £4.8 billion. The first round of levelling up spending amounted to £1.7 billion and involved 105 projects of an average value of £16 million.[5] A typical £20 million project would involve regeneration of a medium-sized town centre.[6]

So far, there is limited evidence on how much new activity there has been in those Freeports currently open for business, and indeed what “open for business” really means, since “Tax Sites” and “Customs Sites” are still under development.

In some of the more recent developments, Liz Truss has clearly spotted that the incentives offered by the Freeports programme in its current form are rather limited and has proposed a new programme of “Full Fat Freeports” combined with “Investment Zones”. There are to be “a lower burden” with “reduced planning restrictions” and “regulations that are tailored on a case-by-case basis and guarantee we maximise our post-Brexit opportunity to be a global leader in high value industries, such as AI.” Liz Truss also promises “giving power back to freeports to choose their own favoured sectors and tailor their incentives accordingly.“[7]

Liz Truss‘s proposals are not very detailed, but appear to offer little more than extend the existing plans, with primary focus on “Brownfield” sites and greater autonomy to the Freeport operators. Rishi Sunak’s proposals for pushing development of Brownfield site development also supports this agenda without proposing any changes to the Freeports policy in its current form.

The logic of the mechanism for achieving the benefits of Freeports is somewhat opaque. However, the Government recently released a strategy document for Monitoring and Evaluation (M&E) of the Freeports. It contains a list of 32 “assumptions” which would have to be true if the project is to work. Interestingly, while most of these are described as “high confidence” some of the most important ones are marked “low confidence.” For example:

“20. New jobs created are high quality jobs with salaries, or upskilling, that increase per capita income in the Freeport zone – Low confidence…

29. Displacement of economic activity from Freeports’ local areas or other non-Freeport low-productivity areas in the UK can be minimised – Low confidence”

In essence, these premises need to be realised for the Freeport programme to deliver jobs that are high-quality and actually additional (not just displaced).

Freeports have also recently been the subject of much debate. Brexit commentator Chris Grey has been exercised by two rather strong claims that have recently been getting a lot of support among anti-Brexiters.[8]

The first claim is that Freeports, as currently planned, are in fact “Charter Cities” – namely, enclaves removed from national jurisdiction and put under the control of private corporations. This idea was proposed for developing countries by the economist Paul Romer and has been taken up by the UK Government’s Brexit adviser Dr Shanker Singham.[9] A slightly less extreme version of this idea is that Freeports are – or will be – zones where money-laundering, tax avoidance and storage of stolen property is facilitated.

The second claim that Grey disputes is that Freeports indicate a very clear intention to move towards Charter Cities.[10]

The first fear is, as Grey shows, manifestly false. Financial accounting rules, and the monitoring of goods entering and leaving the very small areas affected, are designed to stop abuses such as money laundering etc. UK Freeports are simply not currently “Charter Cities”. Liz Truss’s critique of the Sunak plan indicates their limitations from a deregulatory perspective.

As to the second fear, Grey pointed out that the Freeports have been introduced using very limited new legislation. Charter Cities – along with many other kinds of extreme deregulation – could be introduced at any time through new laws. Freeports could turn into Charter Cities. There is no sign of this yet – but watch this space!

Given the real uncertainties on the one hand regarding trade effects and the overall economic benefits of Freeports, and on the other hand regarding concerns about Freeports as Charter Cities, the Government and the two candidates for the role of Prime Minister should be clearer about what the evidence base is for the benefits of Freeports, and what the plans are for the policy going forward.

In summary, Freeports are now being attacked from both sides. First, as they are seen by some to be dangerous attacks on democracy by giving private corporations the power to run cities. Second, they are dismissed by others as not giving anywhere near enough local autonomy. At the same time, Government M&E documentation offers very little clarity on how the Freeports scheme would actually create benefits.

It is therefore vital that close attention be paid to the details of what is being implemented, and its effects on trade and regional development.


Footnotes

[1] According to a paper by L. Cernat and M. Pajot for the European Commission (2012): 3.8% (€65 bn) of EU imports and 9.6% (€148 bn) of EU exports were conducted under the inward processing trade regime. https://trade.ec.europa.eu/doclib/docs/2012/october/tradoc_150006.pdf

[2] This is due to duty drawback prohibition provisions in many FTAs. See forthcoming Briefing Paper (UKTPO) by Peter Holmes, Anna Jerzewska and Guillermo Larbalestier

[3] The “Outer Boundary” is a 45 km-wide boundary that defines the Freeport area: “The Freeport measures – the tax sites, the customs sites, and the planning, regeneration spending and innovation measures outlined in subsequent sections – must all be applied within this Outer Boundary” (see Section 3.1(ii) of the Freeports Bidding Prospectus).

[4] For more details see our article: https://www.publicfinance.co.uk/analysis/2021/04/long-read-beginners-guide-freeports

[5] See Government Guidance: https://www.gov.uk/government/collections/new-levelling-up-and-community-investments; For a list of the successful first round bidders: https://www.gov.uk/government/publications/levelling-up-fund-first-round-successful-bidders.

[6] For example, Gloucester Town Centre Regeneration as indication of what £20 million may offer: https://www.businessinnovationmag.co.uk/gloucester-launches-ambitious-20-million-city-centre-regeneration-bid/

[7] Source: Truss Press release, Aug 7th 2022.

[8]  Sam Lowe has written in agreement with Chris Grey https://mostfavourednation.substack.com/p/most-favoured-nation-charter-cities?r=2mhk3&s=r&utm_campaign=post&utm_medium=email

[9] https://www.theatlantic.com/international/archive/2013/07/should-struggling-countries-let-investors-run-their-cities/277720/

[10] See also: https://www.theguardian.com/commentisfree/2022/aug/17/freeport-turbocapitalism-tramples-over-british-democracy-teesside-plymouth

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