Many countries have set up free trade zones (FTZs) to boost business activity and reap the benefits from free trade. These zones have been instrumental in the evolution of trade routes for the integrated supply chains of the global economy. However, FTZs may also facilitate illegal and criminal activities such as trade in counterfeit and pirated products, by providing a relatively safe environment, good infrastructure and light oversight.

Many countries around the world have set up free trade zones (FTZs) as a way to spur economic development. FTZs provide tax advantages and other regulatory exemptions that have been a boost to trade facilitation, business formation and foreign investment. Research indicates that the number of FTZ is growing and that flows moving through them are expanding.

Free trade zones (FTZs) have a long and cherished role in world trade, dating back to at least the early 1700s. They can provide numerous, unequivocal benefits to business and host countries. However, lightly regulated FTZs are also attractive to parties engaged in illegal and criminal activities, such as trade in counterfeit and pirated products or smuggling and money laundering, as these zones offer a relatively safe environment with both good infrastructure and limited oversight.

The 2017 OECD and EU Intellectual Property Office (EUIPO) report, Mapping the Real Routes of Trade in Fake Goods notes that parties that engage in the trade of counterfeit and pirated products tend to ship infringing products via complex routes, with many intermediate stops along the way (OECD/EUIPO, 2017). The transit points are used to i) facilitate falsification of documents in ways that camouflage the original point of departure, ii) establish distribution centres for counterfeit and pirated goods, and iii) repackage or re-label goods. In addition, while imports of counterfeit goods are, in most cases, targeted by local enforcement authorities, goods in transit are often not within their scope, which means they are less likely to be intercepted. The analysis in this report refers to goods that are placed in free trade zones, and does not refer to “goods in transit”, as referred to Article 5 of GATT.

Zones provide numerous benefits to business. The advantages can include savings in taxes and customs duties, more flexible labour rules than those applicable in the customs territories of host countries, laxer regulation and oversight of corporate activities, fewer restrictions on corporate activities and opportunities to improve distribution of goods to diverse markets. Meanwhile, the costs for choosing to locate in a zone, which might include a variety of special zone fees, are often quite low, perhaps even lower than would otherwise be the case if the business were established in the customs territory of the host country.

Free Trade Zones can provide a range of advantages to countries that host them and to businesses that operate in these zones. However, light regulation applied to zones’ operations can attract parties engaged in illegal and criminal activities. Existing governance gaps can provide rogue operators with a relatively safe environment in which to carry out their illicit activities. Consequently, FTZs can facilitate trade in counterfeit and pirated products, as well as smuggling and money laundering.

While FTZs have existed for some time, in more recent decades their operation has been subject to international agreements, notably those of the World Trade Organization (WTO) and the World Customs Organization (WCO). The possibility of the misuse of FTZs for the purposes of illicit trade, for which the previous chapter provides some solid evidence, has also prompted a number of actors to foster multilateral actions to strengthen the regulation of zone activities. Most have focused on developing recommendations to more effectively combat corruption and money laundering.

This report has quantitatively and qualitatively examined the economic role played by Free Trade Zones, especially in the context of trade in counterfeit and pirated goods. It has done so by analysing the economic rationales for Free Trade Zones from the perspectives of both host countries and industry, and it has conducted an econometric analysis of the role that the FTZs play in spurring trade in counterfeit and pirated goods.