Tuesday, January 3, 2012

The Use of Free Zones for the Promotion of the Offshore Industry in MERCOSUR Countries: A Reasonable Choice?

This paper discusses the suitability of using free zones as a mechanism for the promotion of the offshore industry in MERCOSUR countries, both from a legal and a broader policy perspective. From a legal perspective, the paper examines the consistency of the incentives offered by free zones with WTO disciplines and discusses the implications that stem from this for offshore suppliers that operate within free zones. 

The paper also discusses the merits of using free zones in light of the attributes sought by multinational corporations when choosing an offshore destination and suggests that, instead of offering goods-biased fiscal incentives, governments should focus on improving IT and communications infrastructure, training the local workforce, encouraging research and development, upgrading the legal framework, and securing a business-friendly environment.

The information technology (IT) revolution opened a window of opportunities for companies to contract out segments of their business process to outsiders in search of efficiencies and economies of scale, unleashing what is usually referred to as “outsourcing,” i.e., “the act of transferring some bof a company’s recurring internal activities and decisions rights to outside providers, as set in a contract.” The same practice is known as ”offshore outsourcing” or simply “offshoring” when the outside provider is located outside the territory where the outsourcing company is located. Depending on the business model chosen, offshoring can be “captive” when the outside supplier is an affiliated firm and “non-captive” when the offshore work is allocated to an independent thirdparty supplier. 

What began with the offshoring of information technology services now includes a wide array of IT-enabled services, including business process offshoring and higher-value services associated with knowledge-process offshoring. The global market for the offshoring of IT and ITenabled services was estimated at around $90 billion in 2008 (up from $30 billion to $35 billion  five years earlier), of which IT services accounted for 60 percent. It is expected that the offshoring market will continue to expand geographically, through different sectors as well as across business  functions. Originally concentrated in a reduced number of countries the geographical diversification of the offshoring market is growing steadily. The Latin America and Caribbean region appears to be an increasingly important offshoring destination. The bulk of business processes  offshored to this region used to be in relatively low-skilled contact centres, but now the offshoring of higher value-added services is growing steadily.

Offshoring can bring a number of benefits for the offshore country, including the creation  of attractive employment opportunities,industrial diversification, export revenues, knowledge transfer, and economic upgrading. Not surprisingly, a stiff contest is underway among developing countries to attract the largest possible volume of offshore businesses into their territory. To  succeed in this highly competitive environment, governments must, on the one hand, understand what type of local attributes multinational corporations are looking for when choosing an offshore destination, and, on the other hand, implement policies that are suitable for boosting those soughtafter attributes in such a way that maximizes the returns for the host country

The offshore industry is relatively new in MERCOSUR countries, and so are the policies designed for supporting its development. In this vein, it is not uncommon to use trade policy instruments such as free zones, originally designed for encouraging trade in goods, such as free zones as a mechanism for supporting the offshore industry. In its most basic form, a free zone simply consists of a special customs regime applicable to part of the territory of a country where any goods introduced are generally regarded, insofar as import duties and taxes are concerned, as being outside the customs territory.

But the type of incentives offered by a free zone may go  well beyond a special customs regime, depending on the specific purpose the zone regime aims 
to achieve. During the second half of the twentieth century, some countries began to use free zones to promote export-oriented manufacturing activities, which offered not just customs duty exemptions, but also exemptions on indirect taxes levied on inputs used for the manufacturing of exported products, direct tax incentives for free zone users, a more liberal regulatory environment, and a modern infrastructure

Inter-American Development Bank.Gabriel Gari,Centre for Commercial Law Studies, Queen Mary University of London. Integration and Trade Sector POLICY BRIEF No.IDB-PB-13.Dcember, 2011