Free Trade Zones – Definition and Meaning

In simple words, free trade means free international trade. The classical economists like Adam Smith, Ricardo and others strongly favored free trade and this doctrine held the field for nearly one hundred years. How ever later, the countries all over the world began to adhere to the policy of imposing restrictions in one form or other.

History and Development of Free Trade Zones

During the last 20 years, the labor charges in developed countries have increased substantially. According to a recent estimate, the labor cost is nearly 1 USD per hour for semi-skilled workers in most European Countries, U.S and Japan. This high labor cost was due to the acute shortage of both skilled and unskilled labor in most of these countries. Countries like Germany, France, Switzerland, Sweden, Austria, Belgium and England even imported laborers from other countries. Therefore, the cost of production involving a considerable labor content has become noncompetitive in these countries. Therefore, these countries prefer to send the raw materials and components to developing countries where trained man power and skill are available at a comparatively lower cost. So that they may have finished products which they can market at competitive prices.

In order to take advantage of this situation, various developing countries which have strong labour force began to organize Free Trade Zones (FTZs) in their countries. These FTZs not only provide employment to millions of people in these under developed countries and improve their economy, but also provide an opportunity to earn foreign exchanges to the extent of the conversion costs.

The foreign business men establishing their units in these zones are generally not willing to buy the parts or products made by the local producers since these local products could not meet their needs for the supply, reliability and quality control. This is especially true for original equipment’s i.e., parts going into the production. Since these components, raw materials and equipment’s can only be obtained in the world markets, the countries organizing Free Trade Zones have liberalized their import and currency regulations considerably.

Today, there is a keen competition amongst the developing countries to attract more and more foreign investors to establish their units in the Free Trade Zones organized in their countries. Particularly, countries which have no natural or other resources and have only labour force are very keen in attracting the foreign investors to their countries. Countries like Singapore, South Korea, Hong Kong, and Greenland developed strong competition for investments in FTZs. Hong Kong for example, has no restrictions on the use of dollar accounts on the import of materials or equipment’s. Ireland has been very successful in obtaining foreign investment by granting, a 15 year tax holiday on all profits from exports. South Korea, Singapore and Taiwan offer similar benefits and have created an attractive investment climate.

Today, there are more than 100 FTZs, Trade Free Zones or Custom Free Areas in one form or the other operating free in different parts of the world. Their number is also increasing and wherever they have established they have benefited the foreign trade of the country and proved as an effective device in the reduction of investment costs mainly due to the exemptions from Customers and Central Excise duties and simplification of procedures.

Meaning of Free Trade Zones

The expression Free Trade Zone (FTZ) consists of two terms Free Trade and Zones. In simple words, it refers to an area where free trade is allowed. But this is not a sufficient definition to explain the broad features of a FTZ.

According to E.Miracle and S.Albaum, “a free trade zone is basically an enclosed, policed area without resident population, in adjacent to or near a port of entry into which foreign goods, not otherwise prohibited, may be brought without formal customs entry or payment of duties. While the area is technically outside the customs territory of the country in which it is located, it is subjected, equally with adjacent regions, to all laws, pertaining to public health, carrier inspection, postal service, labor conditions and immigration”.

This definition is exhaustive enough to highlight the various special features of a FTZ. They are as follows.

  1. The FTZ is located in a country or a territory where free trade is legally prohibited.
  2. Resident population is disallowed in that zone.
  3. The boundaries of the zone must be adequately guarded. Policemen are generally in charge of the security force.
  4. The zone should be located nearer or adjacent to a port of entry. This stipulation is prescribed to solve administrative difficulties. If the zone is situated far away from a port of entry, the goods imported should be transported once again to the zone causing considerable hardship to the customs authorities. Since the whole territory other than the FTZ is actually subject to import control, the customs authorities should ensure that the goods are really transported to the FTZ or elsewhere on each occasion. This will not only upset the production schedule of the industrial unit but also cause undue administrative problems.
  5. The goods imported for the productive use of the industrial units of the zone should not be subjected to any import duty or customs formalities.
  6. All other laws except import laws and regulations are equally applicable to the FTZ also.

Thus FTZ is a boon to under developed countries particularly to countries where there is a large mass of unemployed semi skilled and skilled labor force. Since we are also facing acute problems of unemployment and under employment, the FTZs can offer immense opportunities to our labor force. Besides, they will also help us sufficiently in building up our foreign exchange reserve.

The FTZs can also help our country to solve a number of problems. In our country, exports of non traditional goods are gaining more importance. The Government is also providing substantial facilities for export of non traditional goods. India is already exporting a large number of new products such as light engineering goods, textile and ready made garments, plastic products, machinery and plants and electric equipment’s.

With the facilities available in the FTZ, there is no doubt that it will become easier for our products exported from this zone, to sell at competitive rates in foreign countries. For progressing units, more ever these Export processing Zones can provide the added advantages of new technology and technical know how which are of considerable use and benefit to our domestic economy.

The industries operating in the FTZ do not compete with the domestic enterprises. This is because, they use only labor intensive components or assemblies which are again shipped back to the home country for completion or if they produce finished products, the producer sells them through his established sales and service organization. Host country manufacturers could not also compete in other markets since they could neither afford to maintain the expensive sales nor service net work needed abroad.

Credit: International Business-CU

About Abey Francis

Abey Francis is the founder of MBAKnol - A Blog about Management Theories and Practices - and he's always happy to share his passion for innovative management practices. You can found him on Google+ and Facebook. If you’d like to reach him, send him an email to: [email protected]

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