Free Trade or Penalty-Free Crime? - By Roger Bate

Economists love free trade, but it draws a decidedly mixed reception elsewhere. Since the Uruguay Round paved the way for the WTO in 1995, there's been no significant multilateral movement towards removing the remaining barriers to global commerce. And while new regional trade pacts have been inked all over the place, much of the political focus has been on more limited unilateral fixes -- notably the creation of free trade zones to smooth the multi-stage, multi-country supply chains that have come to dominate commerce in industrial goods.

There are roughly 3,500 free trade zones worldwide in which most national regulation is suspended -- more than 2,000 of them in developing and transition economies. And while policymakers typically promote FTZs as a means of job creation, more often than not the real purpose is to liberalize markets hindered by interest group conflict, local government corruption, or ideological rigidity.

Usually, these zones are established in the poorest parts of countries that would otherwise languish for lack of infrastructure or business-friendly governance. They often become home to multinational manufacturers of middle- and low-tech goods, such as clothing and consumer electronics, or to firms repackaging products like cigarettes and pharmaceuticals for re-export. Thus FTZs may speed local development, as well as signaling the advantages of free markets to other localities within the country. Think of the "special economic zones" in which Deng Xiaoping introduced capitalism to post-Maoist China.

All is not roses, though. FTZs sometimes make it possible for autocratic regimes to perpetuate illiberal societies -- for example, North Korea -- using them to generate desperately needed foreign exchange. More commonly, FTZs become havens for smugglers, money launderers, and terrorists in search of hard currency. And these problems can discredit both open trade and regulatory reform by equating the free-for-all of cowboy capitalism with free markets.

A few FTZs in rich countries, such as the St Regis-Mohawk Reservation in New York State that serves as a major transit point for smuggled cigarettes, illustrate the downside. But for the most part, highly industrialized countries manage to maintain civil institutions and the rule of law in FTZs without undermining their attraction to investors. The same can't be said for developing countries, particularly those with weak political and economic institutions.

Panama's Colón Free Trade Zone, with its proximity to the Canal, is one of the busiest FTZs in the world -- and a beehive of illicit activity. The Panamanian military has been known to collude with importers seeking to evade regulation, getting a cut of the savings on goods otherwise subject to stiff tariffs. More ominously, it has cooperated with smugglers to transport weapons and illicit goods to private militias across South America that mix radical politics with crime.

Perhaps not surprisingly, organized crime often fills the power vacuum left by the absence of regulation: The environment of "no rules" becomes one of rule by the most brutal. For example, laissez-faire and corruption allowed Aruba to become a haven for the Sicilian-based Caruana-Cuntrera family, which controlled 60 percent of all property on the island in the early 1990s.