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6 May, 2021updated 01 Nov 2021 10:31

Ben van der Merwe

Opinion: The UK’s free ports are a gamble with no upside

The UK's free ports risk undermining tax authorities and attracting criminal activity, for no apparent benefit to trade or investment.

felixstowe-freeport-uk

Felixstowe in Sussex will be the location of one of the UK’s new free ports, but how can nearby towns and cities such as Ipswich expect to compete for investment with somewhere offering tax incentives? (Photo by Ben Stansall/AFP via Getty Images)

In March, the UK government announced the locations of eight free ports to be established in England, with the first expected to become operational later in 2021. While the intention might be to boost trade, investment and job creation, they are more likely to be a boon for tax dodgers and money launderers.

A recent report by the UK Parliament’s International Trade Committee suggested that the trade-related benefits of free ports to businesses, workers and consumers are likely to be “limited”.

The reasons are not particularly complicated. The UK is unlikely to become a major trans-shipment hub because, unlike Singapore and Hong Kong, it does not sit along any major long-haul trade routes.

Why the UK can’t emulate Singapore or Hong Kong

Chancellor Rishi Sunak, in his days as a backbencher, published a report advocating for the UK’s adoption of free ports, explicitly citing Singapore and Hong Kong as models to emulate. 

A more fitting analogy might be the Falkland Islands, where the UK established a free port in the 19th century that was quickly rendered pointless by the Suez Canal. Once heralded as a “new Gibraltar”, in 2020 only 44 ships arrived in its ports – putting it one spot ahead of North Korea as a global shipping hub, according to UN statistics.

Moreover, the UK already offers businesses much of what they want from a free port. Bonded warehouses have existed in UK ports for decades, and allow both short and long-term exemptions from tariffs for the storage of goods for trans-shipment.

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Free zones aren’t just about trans-shipment, however. When a country charges higher tariffs on intermediate goods than on the final product, businesses can save money by doing all their manufacturing within the free zone and importing only final products into the domestic market.

Yet, the UK already has incredibly low tariffs on intermediate goods, which is one reason why comparisons with free zones in the US miss the mark.

The UK Trade Policy Observatory found that almost 60% of intermediate goods entering the UK did so duty free, with a weighted average duty of just 1.6% (compared with 8.8% for finished goods).

It also found that tariffs on intermediate goods are only higher than tariffs on final goods for a select few, relatively low-tech industries, including the manufacturing of cheese, wine and animal feed.

High tech and half-baked

The UK government has been keen to stress that its vision for free ports goes far beyond trade, and it sees them as the engines of high-tech ‘innovation hubs’ and local regeneration. However, the thinking behind this seems equally half-baked.

The government plans to offer a range of financial incentives for companies to invest in the free ports, including tax breaks and government subsidies. Yet, the idea that businesses are being put off from investing in the UK due to the costs of finance has no relationship to economic reality.

Interest rates have been at record lows for years, with interest rates on US Treasury bonds even dipping into negative territory. It has been more than a decade-and-a-half since the US Federal Reserve’s Ben Bernanke identified a “global savings glut”. There is an excess of capital waiting to be invested, not a scarcity.

The Covid ‘super deduction’ has further reduced the cost of investing in the UK – and is significantly more generous than anything being offered by free ports. The scheme allows companies to reduce their taxable revenues by 130% of the cost of new investments.

“The shortage is of ideas – there is ample capital,” says Richard Murphy, director of the Corporate Accountability Network and a visiting professor of accounting at Sheffield University. “The development of a free port doesn’t improve the number of ideas that are available for activity.”

The shortage is of ideas – there is ample capital. The development of a free port doesn’t improve the number of ideas that are available for activity. Richard Murphy, the Corporate Accountability Network

If the cost of capital is not the barrier to investment, there is no reason to think that government subsidies and tax breaks on investment spending will have any effect on business decision-making.

Of course, businesses might invest in free zones for other reasons – chief among them  being, in the government’s eyes, the benefits to be accrued from operating in close proximity to other businesses in the same sector. The government hopes these ‘agglomeration benefits‘ will lead each free port to become an ‘innovation hub’ for a particular area of high-tech manufacturing.

However, there is little evidence that manufacturers want to operate in ‘hubs’. As Andrew Carter of the Centre for Cities told the Parliamentary committee: “All the evidence tells us agglomeration effects for manufacturing firms are massively lower than they are for services firms. Manufacturing firms get very few additional gains from being in close proximity to another manufacturing firm.”

Relocation, not creation

If neither subsidising capital expenditure nor offering industrial hubs is likely to spur new investment, the investment that does come to free ports is likely to come at the expense of the rest of the UK.

Indeed, the UK in a Changing Europe initiative argues that the main impact of free ports “is likely to be to relocate rather than create economic activity and jobs”.

Even if free ports don’t actually encourage manufacturers to shutter their existing factories and head for these new zones, there is a good chance that much of the future investment in free ports would otherwise have happened anyway – just in a place where it would be taxed more.

“I don’t get what this is all meant to be about – unless it is simply another bung,” says Murphy. “Bluntly, that is what I see it as – cronyism.”

For these meagre and uncertain benefits, the UK is taking enormous risks. 

By displacing economic activity from elsewhere in the UK, free ports may force other parts of the UK to offer their own tax incentives, igniting a damaging race to the bottom and undermining the ability of local authorities to fund key services.

“Across every one of those borders, there is an opportunity for tax and regulatory arbitrage,” says Murphy. “And is this going to create a profile of risk? Yes, of course it is. Is it going to put downward pressure on the business rate in nearby communities? Yes, of course. Why would Suffolk be able to charge much higher business rates in the port of Ipswich than it is in the port of Felixstowe, a free port?”

This may be why greater fiscal decentralisation, the ability of subnational governments to set their own tax rates, is associated with higher levels of household income inequality.

“I see [free ports] as the development of an ongoing process of deregulation, which is then designed to spill over into society,” says Murphy. “I do not see there being a fixed barrier around the free port. I think they are meant to create spillover effects in the rest of the country, which creates downward overall pressure on regulation, tax rates and legal protection.”

Free ports could similarly intensify international tax competition, forcing other countries to lower their tax rates in order to keep their businesses from flocking to the UK. This would be particularly harmful for countries facing serious fiscal pressures from Covid-19. In its 1998 report Harmful Tax Competition, the OECD explicitly identified “ring-fenced” low-tax regimes such as free ports as potentially damaging.

Are free ports a haven of criminality?

Perhaps the most worrying aspect of all, however, is the potential for free ports to attract crime. “The words ‘free port’ and ‘crime’ just go together,” says Murphy.

The words ‘free port’ and ‘crime’ just go together. Richard Murphy

In its recent report, the UK’s International Trade Committee noted that one of the main risks posed by free ports is their potential to be used as a place to store illicit goods, such as drugs and illegal wildlife, or high-value items for the purposes of money laundering. The OECD made the same observation in 2019, noting that the more relaxed customs regimes of free ports made them attractive to criminals.

In a damning 2018 report, the European Parliament said of free ports: “With their preferential treatment, they resemble offshore financial centres, offering both high security and discretion and allowing transactions to be made without attracting the attention of regulators or direct tax authorities.”

Similarly, the Financial Action Task Force, an intergovernmental organisation created to combat money laundering and terrorist financing, has said that “the same characteristics that make free trade zones attractive to legitimate business also attract abuse by illicit actors”.

For instance, the Geneva Freeport is thought to be home to an estimated 1.2 million works of art, including 1,000 Picassos, and three million bottles of wine. Although technically ‘in transit’, such goods can be bought, sold and stored indefinitely, free from capital gains or sales tax. In the underworld of terrorist financing and money laundering, such high-value goods can act as an alternative form of currency.

The government has promised that the UK’s free ports will not allow the storage of art, but they have said little about other high-value items. “I don’t see any reason why precious metals trading, for instance, for money-laundering purposes, couldn’t be done through a free port,” says Murphy. “It would be very easy.”

The UK government’s failure to provide details about how it plans to tackle money laundering in free ports is concerning, especially since free ports have almost always failed to adequately deal with the issue.

The European Parliament’s 2018 report found that “with the exception of Luxembourg, there is not one country that obliges free port operators to carry out the type of customer due diligence that binds financial institutions under anti-money laundering laws”.

Examining more than 600 free zones, the OECD found that the establishment of one additional free zone was associated with a 5.9% increase in the value of exports of counterfeit products.

The UK’s lax regulation will attract the wrong people

For those looking to launder ill-gotten gains or trade in illegal goods, the UK’s free ports would be particularly desirable. Such activities typically depend on the creation and use of anonymous shell companies as a means of obscuring the true owners of dodgy assets. This is an area the UK has long excelled in.

It takes less than a day and under £100 to register a company in the UK, and there is no need to provide proof of identity. If the company is small enough, it will never need to have its accounts audited.

“We have an appallingly lax company regulation regime,” says Murphy. “Some 400,000 companies are struck off in the UK each year without a question being asked. What is the chance that many of those might have tax liabilities, undisclosed trade or whatever else? An enormous number, in my opinion, but the government says: ‘No, they don’t trade so they can’t – they must be dormant.’ How could it know that?”

Given the obvious risks and dubious benefits of rolling out free ports across the UK, one might expect the government to have conducted detailed economic modelling of the plan. No modelling has been done, the International Trade Committee was told. The chief secretary to the treasury, Steve Barclay, told the committee: “It is very difficult to model exactly what the impact on jobs, inward investment and innovation will be.”

Instead, modelling is to be done once contracts are agreed and the nature of the business to be conducted in free ports is known. 

By then, however, it will be too late. The UK government will be bound to honour its commitments to free ports investors on pain of investor-state dispute settlementThey might be advertised as a boon to trade and investment in deprived areas, but the UK’s free ports seem more likely to benefit less savoury business practices.

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