Democracy Lab

Free Trade or Penalty-Free Crime?

Free Trade Zones are meant to promote trade and improve economies. But they often end up being a cover for crime.

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. 

Aruba's nearness to Colombia and anything-goes ethos within its FTA made the country an ideal waypoint in the American-European narcotics trade. By the mid-1990s, Aruba's reputation had also made it a no-go zone for legitimate foreign investors wishing to avoid guilt by association. And under pressure from multinational corporations (and foreign governments), the Aruban government finally grew the backbone to overhaul its laws.

Evidence of counterfeit goods passing through FTZs has led business trade groups to call for greater regulation of free trade zones elsewhere. The Jebel Ali FTZ in Dubai is one of Europe's largest sources of counterfeit goods. In 2008, the year I visited the zone to investigate the fake-pharmaceutical supply chain, 15 percent of incidents of seized counterfeits at EU borders were in transit from United Arab Emirates.

FTZs also facilitate the packaging/rebranding of pharmaceuticals not licensed by the patent holder, leading to uncertain provenance and hence concerns about quality. A public health inspector found label-modification activities in the FTZs of the Netherlands Antilles; zones in China, Panama, and the UAE are also regularly implicated. When my research group bought pharmaceuticals from bogus Canadian websites, the drugs would often come from China via Dubai, with payment going to accounts held in Panama.

The FTZ-terrorism connection is especially disturbing. There's evidence that a Colombian cartel used FTZs to funnel cocaine revenues to Hezbollah in exchange for protected access to Mideast drug consumers. Lax banking laws in one Asian country allowed the traffickers to launder the funds through what's called a "black market peso exchange." Colombian traffickers would deposit money in an Asian bank account and then buy the currency back with pesos, using the currency to move the drug shipments in and out of Panama (including the Colon FTZ). The network utilized a peso exchange system in Miami as well.

An FTZ in the Ciudad del Este, located at the juncture of Brazil, Paraguay, and Argentina, has also been a source of concern for security experts. The "Tri-Border Area" (TBA) became infamous for the trafficking of illicit goods due to lax border security, thanks to a mix of corruption and a desire to attract tourists with hassle-free entry. After 9/11, Paraguayan police responded to U.S. pressure by arresting a Lebanese immigrant whose electronics store fronted for a massive money-laundering and DVD piracy scheme that funded Hezbollah.

Some economists have argued that the kinds of corruption we see in FTZs do more good than harm by giving investors a way to duck costly, inefficient government bureaucracies. But, more typically, the cowboy-capitalist FTZs offer nothing positive. While the better-managed FTZs provide millions worldwide with employment and trade benefits, the worst encourage cronyism, corruption, and illegal trafficking, discrediting a concept that can be immensely beneficial.

Moreover, the problem is not beyond solution: As noted above, Aruba eventually stood up to entrenched interests, implementing comprehensive background checks, tightening oversight of incoming and outgoing shipments, and maintaining better inventory controls. In fact, as Aruba's FTZ went legitimate, it became more prosperous; it is now the preferred venue for Venezuelan investors seeking relief from their country's corrupt, regulation-bound government.

Aruba still has problems with inventory management, and it does not have the oversight of American FTZs. But the turnaround shows that developing country FTZs are not beyond the influence of western interests, both authorities and multinational corporations -- and can actually make a bigger buck by treading the straight and narrow.    

Photo by Jesus Alcazar/AFP/Getty Images

National Security

Not Much Better Than 'Nothing'

Esquire's article about "The Shooter" got it wrong, but our veterans' care is still shot.

Phil Bronstein's riveting Esquire feature on "The Shooter" -- the unnamed Navy SEAL who reportedly killed Osama Bin Laden during the May 2011 raid on the terrorist's compound in Pakistan -- is making waves, not least for claiming that that the former sailor has been deserted by his country. "[H]ere is what he gets from his employer and a grateful nation: Nothing. No pension, no healthcare, and no protection for himself or his family," Bronstein wrote.

A number of veterans have criticized the piece for its failure to accurately report on the benefits available to those who have left the service. But the article raises important issues with our nation's care for veterans. Although all veterans are eligible for government benefits, many struggle to obtain them. Perhaps more important, many (like the Shooter) perceive the system as being so broken that it may as well be closed to them. Similarly, the piece raises questions about the antiquated military retirement system, which gives nothing to sailors like the Shooter, who left the Navy after 16 years, but much to those who serve for 20 years, regardless of what they do in the service. More broadly, these questions lead to a much bigger one: What should the nation provide its veterans, and can the nation afford the current social contract with the military?

By law, all veterans are eligible for healthcare and other benefits from the Department of Veterans Affairs (VA). However, because the VA lacks the resources to treat every veteran, it prioritizes those who get access to its care, based on disability status, medical needs, and income. In practice, this closes doors to veterans without a "service-connected disability" rating. Last week's VA data shows there were 819,008 veterans waiting for such a rating, with 585,876 waiting for more than 125 days (what the VA calls its "claims backlog"). This backlog has been steadily growing over the past decade, as young and old veterans file claims at record-breaking rates. The VA currently projects the backlog will continue to grow until 2015, at which point it will see the effects of additional personnel, new computer systems, and process changes. Until then, veterans must wait to have their claims decided, a process that can take months or years.

Iraq and Afghanistan veterans can get into the VA healthcare system for up to five years after their discharge, and their initial claims are now being fast-tracked by the VA as well. But this approach still falls short for some veterans, because it covers only potentially service-connected ailments and does not provide any health coverage for families. And veterans must still contend with delays in seeking other benefits, such as their disability compensation, GI Bill benefits, and other programs.

So it's not exactly true, as the Esquire piece originally reported, that the Shooter will get "nothing" from his country after he leaves the Navy. But there is a perception that exists, for better or worse, that the VA is closed to new veterans. Cumulatively, the various barriers to entry (and the delays associated with each one) contribute to this perception. And the limits on VA benefits, and their ability to provide for military families, also contribute to the perception that the VA isn't doing enough for today's veterans. (A majority of servicemembers have families today, something that was not true during the mid-20th century, when the current VA benefits structure was built.) The nation could choose to do more for veterans, but doing so will cost a lot of money, at a time when budgets are being squeezed, even at the Defense Department and VA.

The second big issue raised by the Esquire piece relates to the basic fairness and effectiveness of the military retirement system. This system gives a generous retirement package to those who serve for 20 years or longer -- including at least 50 percent of base pay, health insurance (including family coverage), and other benefits like commissary access. However, the military retirement system gives nothing to those who serve fewer than 20 years, no matter how difficult or dangerous their service. The system does not distinguish between SEALs like the Shooter, who had a record of 12 combat deployments and the military's toughest training assignments, and those who serve 20 years in a relatively safe and comfortable job within the military. And by setting an arbitrary retirement mark of 20 years, the system creates many unintended effects and skewed incentives within the force, as chronicled well by Air Force vet and entrepreneur Tim Kane in his new book about the failures of the military personnel system.

A better retirement system would do away with the arbitrary 20-year retirement timeline, and also reflect the relative dangers and hardships of service. Veterans who serve for 5, 10, or 15 years should earn some retirement benefits for their service -- more than the Thrift Savings Plan and VA benefits they do today. And those who serve in the most difficult or dangerous jobs -- such as Navy SEALs, explosive ordnance disposal technicians, aircraft carrier flight deck crewmen, and infantrymen -- deserve to have their retirement timelines and benefits reflect their service. These personnel often face the most danger, inflict the most punishment on their bodies on the job, and frequently have the most difficulty translating their service into the civilian workforce. The retirement system should reflect these realities of service.

For most of the nation's history, the national social contract with veterans was quite stingy. From the Revolution through the Civil War, the government limited its support to care and pensions for those injured in the line of duty, and sometimes for their families, and that was it. The contract expanded after the First and Second World War to include a comprehensive package of disability compensation, educational benefits, housing benefits, and other programs. At the end of the Vietnam War, the military changed from a conscription-based force to a recruitment-based force -- and adjusted its pay and benefits systems accordingly. However, the VA's system of care and benefits remains largely unchanged from the post-World War II era.

For all its failings, the Esquire article asks an important, fundamental question: What does the nation owe its veterans in the 21st century? Telling the story through the lens of the SEAL who killed bin Laden puts a fine point on the issue, but the issue is much larger than one sailor. The social contract must evolve to fit today's force, and today's generation of veterans. The old VA models of disability compensation and healthcare do not fit the needs of today's veterans well, nor do they fit the realities of today's workforce and health insurance market well either, particularly after the passage of the Affordable Care Act. The antiquated military retirement model does not fit today's force either, and should evolve to reflect the demands being placed on today's military personnel. The time to fix these issues is now, while we still have the nation's attention focused on issues affecting veterans and military personnel, and still feel grateful for what the Shooter and his teammates did on a dark night in Abbottabad.

John Moore/Getty Images