Free Trade Zone

What It Means

A free trade zone (called a foreign trade zone in the United States) is a part of a country where goods from foreign nations are not subject to normal export and import laws. All nations impose some restrictions on imported products. The most common types of restrictions are tariffs (taxes on imports) and quotas (limits on the number of imports). Historically, nations have imposed these restrictions in order to protect their domestic industries. When, for example, cars made in Germany are shipped to the United States, they are subject to taxes that have the end result of making them more expensive to U.S. consumers than domestic cars. Given the choice between domestic and German cars, Americans will be more likely to buy domestic cars if they cost substantially less.

Products may, however, be shipped to free trade zones within a country without being subject to tariffs, quotas, or other restrictions. Free trade zones are usually near seaports, airports, or at national borders. While in a free trade zone, products may be assembled, repackaged, refinished, and in many cases even manufactured. Products cannot, however, be sold to consumers in a free trade zone. When products leave the free trade zone and make their way to consumers, normal tariffs and quotas are enforced.

When Did It Begin

Predecessors to what we now call free trade zones existed at the time of the ancient Roman Empire, if not earlier. When traders from foreign lands entered the Empire’s borders, the government offered them a space where they could be free from mistreatment. When the shipping trade between European countries grew in the late Middle Ages, many port cities in Europe became the equivalent of today’s free trade zones, allowing foreign ships to dock so that they could assemble, repack, and manufacture their goods before bringing them to consumers. The number of such ports grew in sixteenth–eighteenth century Europe with the rise of mercantilism, an economic ideology according to which individual countries sought to gain financial advantages over their trading partners.

The American version of free trade zones, which the government refers to as foreign trade zones, came into being in 1934 with the passage of the Foreign Trade Zones Act. This act set up the country’s first free trade zone in New York City. By the early twenty-first century there were more than 200 free trade zones in the United States.

More Detailed Information

The basic function of a free trade zone is to facilitate international trade. When goods are shipped to a free trade zone, the seller of those goods has more flexibility to conduct business and the potential to cut costs. For example, an importer of fabrics in Los Angeles might want to store a shipment of her wares and display them to prospective customers before going through the formalities of and incurring the costs associated with the import process. She might therefore choose to leave the goods at a free trade zone near Los Angeles for several months. Once the importer has lined up customers and prepared to distribute the fabrics, she can move the goods out of the free trade zone and into the hands of those customers, paying any relevant taxes at that time.

Another advantage of free trade zones is that they facilitate the quicker movement of goods across borders. A ship stopping in Copenhagen, Denmark, for example, can unload its cargo and take on a new load without sorting through the bureaucratic tangle of laws that apply to all the various goods it is transporting.

The ability to manufacture and manipulate goods inside a free trade zone also offers advantages for businesses as well as for the regional economy surrounding the zone. For example, an imported watch might be subject to tariffs in many countries, but the assorted metals out of which that watch is built may not be taxed in their raw form. A U.S. watch company could, then, theoretically set up a manufacturing facility within a U.S. free trade zone in order to get access to cheap foreign metals instead of paying for high-priced metals originating in the United States. The company could hire local employees to build the watches, and then when the watches are sent to retail outlets in the United States, the watches would be treated as an import subject to tariffs. Paying these tariffs might be cheaper than using U.S. materials, with the end result that the company can produce lower-priced watches that sell in greater numbers. At the same time, the local economy around the free trade zone benefits from the jobs provided by the watch maker.

Free trade zones are also intended to allow developing countries to join the global economy. Global corporations often find it fruitful to set up factories in free trade zones located in poor countries. The corporations benefit from the low cost of labor in those areas, and the local economy grows as a result of new jobs. Free trade zones frequently entice global corporations to set up shop by providing them with generous tax breaks. The resulting lower costs of manufacturing more than compensate for the tariffs that will ultimately have to be paid when the goods reach their final destination.

Recent Trends

Since the middle of the twentieth century, the tendency in international trade has been toward globalization, the increasing economic unity of all countries in the world. Proponents of globalization believe that it will bring about peace, unity, and higher standards of living. A large hurdle to globalization is the existence of tariffs, quotas, and other trade restrictions, and powerful groups such as the World Trade Organization (WTO) are committed to the ongoing reduction of barriers to international trade.

The number of free trade zones grew immensely at the end of the twentieth century and the beginning of the twenty-first century. This trend was particularly marked in developing countries, who competed with one another to attract foreign businesses to their free trade zones. But free trade zones, like globalism in general, were subject to intense criticism. Some people argued that free trade zones empowered corporations and corrupt governments at the expense of the poor individuals in developing countries.