The Porto Franco Regime in Canadian and Russian Sea Ports as an Instrument of Socio-Economic Development in the Arctic
Zolotoy Rog Bay in Vladivostok, Russia. Photo: Alexxx Malev
What direction is the Arctic developing in today? Most likely it is a direction of substantial change. First of all, the region is experiencing significant changes in climate conditions. Arctic sea ice has been decreasing steadily since the 1980s and will continue to do so, creating longer windows for navigation in the region.1) These changes will significantly affect the volume and character of maritime activities in the region, particularly shipping.2) An assessment of Arctic shipping between 2011-2014 shows that the extent of Arctic shipping on the global scale was already significant.3) Another study of shipping in the Arctic between 2015-2017 shows that the overall number of voyages steadily increased by an average of 5506 unique vessels per year.4) Notwithstanding the fact that the growth rate might be not very high, this increasing trend is stable and may spike in future. This implies an increase in volume of transportation along such routes as the Northwest Passage and Russia’s Northern Sea Route, which may further serve as an alternative to other currently wide-used routes (e.g. through the Suez Canal). Subsequently, positive changes may occur in spheres such as tourism, connectivity and infrastructure, inward migration, and others.5) Therefore, it is expected that the Arctic will be developing as an area of increasing economic interest and investment attractiveness.
While there is no panacea to resolve all the region’s problems at once, and there no universal instrument for ensuring comprehensive socio-economic development in the Arctic, the establishment of free ports –ports under a “porto franco” regime –may boost social and economic growth of the Arctic region by facilitating investment, international trade, transportation infrastructure, and essential research and development activities. Establishing free ports may increase the amount of foreign direct investments, and subsequently enhance social-economic development of the regions. Moreover, a “porto franco” regime may be a significant contribution towards the “blue economy” and sustainability of the regional development in the Arctic.
However, there are a number of obstacles for accelerated socio-economic development in the Arctic, including the development of maritime shipping and seaport infrastructure. The first and most apparent obstacle is severe climate conditions, due to which shipping in this region is slower and riskier.6)) The second obstacle is a lack of developed infrastructure in the northern territories of Canada, Russia, and Alaska. The third problem, as a number of scholars have previously mentioned, is a lack of human capital in the Arctic.7) There is a demand for highly qualified specialists, particularly in such spheres as construction, business management, meteorology, environmental protection and marine industries. These issues will be discussed in the paragraphs below. Nonetheless, if there was more political will to establish free port regime on a grand scale, this would be an effective stimulant for socio-economic development across the Arctic.
The Concept of “Porto Franco” and its Main Advantages
The term “porto franco” derives from Italian and means a sea harbor providing for duty-free import of foreign goods. A “porto franco” was established for the first time in Livorno, Italy in 1547.8) “Porto franco” or a free port is a formally defined area with preferential tax and customs regulations, and it creates a favorable regime for foreign investment and businesses. Free ports are a part of the broader concept of “special economic zone”, which implies a limited territory with a special legal regime for doing business. Although free ports have existed for centuries, in recent decades they have seen a growing importance as transportation, logistics and trade platforms, with their number and locations expanding.9) It should be mentioned that a free port could be not only a seaport, but also include a territory of an airport or other logistic hub. For instance, the territory of Vladivostok Free Port includes several seaports and an international airport.10)
Typically, as a type of special economic zone, free ports envisage lower tax rates and tariffs, lenient state control requirements and other incentives, which differ from the rest territory of the country. Free ports are created with the explicit aim of attracting investment, promoting trade and boosting domestic manufacturing activity and local employment. Despite the variation of how free ports are structured and administered in different countries, the key tangible benefits they can offer are broadly consistent and fall into four main categories: duty exemption, duty deferral, tariff inversion and tax incentives, which will be briefly described below.
Duty Exemption. Products enter a free port without incurring import tariffs or duties. This allows the products to be processed and perhaps combined with other products or engineered into finished goods, for eventual re-export to a third country. For example, this advantage has been proven successful at the Jebel Ali free port in the United Arab Emirates. It was created in 1985, it is now one of the world’s largest ports, home to thousands of businesses from 100 countries and 135,000 employees. Although the domestic UAE market is relatively modest, global companies use Dubai as a processing and manufacturing hub in order to take advantage of its infrastructure, duty savings and strategic location. This port now accounts for 20% of UAE’s foreign direct investment. 11) Indeed, it appears to be a successful example of regional development.
Duty Deferral. For goods that ultimately enter a free port, duty is deferred and payable only when the goods leave the port, not when they first arrive. This allows companies to warehouse and process goods before incurring duties, improving cash flow cycles and making just-in-time inventory management easier. To some extent, this advantage of a free port can help to effectively support small and medium fishery producers. For example, more than 60 companies which catch and/or process sea products currently enjoy tax incentives as residents of Free Port of Vladivostok.12) The regime of a free port can serve as instrument to maintain fishing production in a particular port, as outsourcing of fish production to countries with more favorable business conditions is a regular practice.13)
Tariff Inversion. Modern tariff regimes usually prescribe that finished goods (products) are often subjected to a lower tariff rate than their component parts. This encourages importing finished goods rather than importing their components. The regime of free port allows a company to import components duty free, then to manufacture a product on the territory of the port, and then import a finished product to the host economy while paying less import duties.
Tax Incentives. This advantage generally envisages a temporary (usually from 5 to 10 years) financial support to incentivize beneficial and genuinely new economic activity. Typical examples include lower value added tax (VAT) rates on goods brought in through the port, and reduced rates of corporation tax for companies located within the port.
It should be mentioned that, according to statistics of the World Shipping Council, all leading seaports in twenty-foot equivalent units of cargo capacity (TEU) are free ports.14) This creates a positive record for the concept of “porto franco,” but not enough to prove its potential for sea ports in the Arctic. Nevertheless, ideas of establishing free ports and similar initiatives have been increasing their presence in the minds of Russian and Canadian officials and experts.
The Case of Canada
If one were to look at the map of Canada, it can be seen that the High North territories occupy more than one third of the country. Even more importantly, this area is pierced with many sea channels and straits. The future of Canada can hardly be imagined without the comprehensive development of its Arctic territories. They are rich in natural resources and, of course, have a strategic geographical position as a bridge between Asia and Europe.
However, the Arctic territories of Canada, and the maritime shipping infrastructure there, can be characterized as undeveloped. Indeed, Canada’s Arctic is one of the least settled among all Northern states. Some experts say that Canada is desperately falling behind the world’s greatest powers in the question of the socio-economic development of Arctic territories.15) While there has been limited effort on Canada’s part to encourage investment and population growth in its northern regions, Russia is actively composing a new development strategy of the Arctic and introducing special policies (see section below), while China, a country far from the Arctic, has also introduced an Arctic strategy and has been developing many infrastructure projects with a plan to expand the area of such projects to the Arctic. In the light of these developments, the restricted approach taken by Canada to cultivate its Arctic territory seems irrational.
According to Canada’s Northern Strategy, domestically the focus is on promoting the human security of northerners and the sustainable development of the Arctic regions.16) Canada does not have a lot of experience in using special legal regimes such as free ports or special economic zones for its regional development. There are some state programs, which aim to stimulate the development of specific regions. For instance, in 2019 Canada’s Arctic and Northern Policy Framework was launched, and detailed a long-term, strategic vision that will guide the Government of Canada’s activities and investments in the Arctic to 2030 and beyond. The Framework will better align Canada’s national and international policy objectives with the priorities of Indigenous peoples and Arctic and Northern residents. 17) However, there are no concrete and tangible policies which are explicitly devoted to boosting economic development in the Arctic territories.
Nowadays, the key issue for Canada is development of the Northwest Passage. The creation of a free port or special economic zone regime can be beneficial in this regard. Former Northwest Territories premier Bob McLeod has vocally suggested deliberate, planned investments to position the Arctic territories of Canada as an international trade and transportation hub, including designating them as a special economic zone, which could help extend and secure Canadian interests in the region.18)
While the benefits of a free port regime have not gained much attention in the Canadian Government, indeed, it may be an appropriate instrument of socio-economic development. Firstly, free ports in the Canadian Arctic can benefit from a convenient geographical location, as they will be closer to Europe and Russia by sea and to Asia by air. The establishment and further development of free ports in the Canadian North can turn the region to a multimodal transportation hub, with logistic chains between Asia, North America and Europe. Additionally, the development of free ports and marine infrastructure in Canadian Arctic would be a good and timely response to increasing volume of trade and traffic in the High North, which would bring with it jobs, opportunities, and economic stimulus.
Currently, there are no concrete initiatives under discussion in Canada which would reflect or invoke the principle of “porto franco”. However, due to the recent pro-active position of Arctic economic development demonstrated by Russia and China, the Canadian Government may pay more attention to special programs of socio-economic development of its northern regions going forward.
The Case of Russia
Russia has more extensive practice of using special legal regimes for development of far-distant regions, including its High North territories. One of the most prominent examples is the Free Port of Vladivostok. The status of a free port was granted to the city earlier (from 1861 to 1909), and a new era of free trade started there from October 12, 2015. According to the economic growth assessment made by the experts, the creation of the free port of Vladivostok should lead to an increase of the GRDP of the region, reaching 2.2 times its initial rate in 2025 and 3.4 times in 2034. Newly created jobs are also forecasted, up to 84 000 in 2021, and 108 000 in 2025. This port introduces low tax incentives for investors (instead of company income tax (CIT) at the usual 20 percent rate, the Vladivostok Free Port CIT rate is 5 percent for the first 5 years, then 12 percent during the next 5 years). The port is an increasing center for auto production and has increased its TEU capacity by 200,000 per annum. The example of Vladivostok shows how a special legal regime of “porto franco” can positively shape maritime shipping. Relative success of the free port in Vladivostok motivated the Russian Government to implement such initiative in other seaports.
As it was decided during negotiations of Russian Federal Government and regional authorities of Murmansk region, in 2020 an advanced development zone “Capital of the Arctic” will be established in Murmansk, and the local seaport will become a free port. This was announced by Russian Deputy Prime Minister Yury Trutnev as part of an offsite meeting of the Presidium of the Russian State Commission for Arctic Development in Murmansk.19) The liberalized trade and investment regulations in the area of the port are expected to contribute to general socio-economic development of the region.
But an even more grand-scale initiative is coming to Russian Arctic. There have recently been calls to expand the status of free port to the entire Arctic territories of Russia and create a preferential legal regime there. A bill devoted to a special economic regime in the Arctic area has already been introduced to the Russian Parliament. It is expected that the companies will enjoy a free trade regime, easier administrative procedures, and a tax reduction (e.g. 7% income tax).20) This regime will be similar to the Free Port of Vladivostok. The initiative to implement a “porto franco” regime was chosen as an instrument to accelerate the development of the Arctic region. In April 2020, the bill passed the first reading and is likely to be adopted by the end of summer 2020.
Having free ports in Vladivostok and Murmansk is a step towards creating a belt of free ports along the Northern Sea Route. As stated in Business Index North 2019, cargo transport along the Northern Sea Route is increasing rapidly.21) The initiative to establish free ports along the Northern Sea Route may gain more and more rational grounds for its implementation. However, the question of real effectiveness of the Northern Sea Route is still under discussion. The main argument for the Route is considered to be shorter distance. For example, the way through the Arctic from Rotterdam to Asian markets in Japan, Korea, and China is one third shorter than through Egypt, so ships can clear it ten days faster. The arguments against it are the complexity of the Route in the winter, the lack of infrastructure, the lack of icebreakers for vessels, and other concerns. Due to these negative factors, the CMA CGM, France’s largest container transport company, refused to use the Northern Sea Route and other transport corridors in the Arctic in 2019, mainly because of environmental concerns.22) In August 2019 Norwegian Foreign Minister Ine Marie Erickson Søreide expressed doubts about the economic viability of the Northern Sea Route and spoke of the necessity to check its compliance with environmental standards.23) In this complicated situation, a “porto franco” regime can serve as an additional argument in favor of the Northern Sea Route’s effectiveness.
“Porto Franco” in the Arctic: to be or not to be?
So, why may “porto franco” work in the Arctic? Unlike many other regions, which often have just a single super port, the Arctic region contains dozens of potentially successful, large-sized ports (Kirkenes, Vardø, Arkhangelsk, Belomorsk, Murmansk, Tiksi, Churchill, and others). The Arctic network of free ports will make it easier and more cost-effective for businesses to set up operations away from major seaports which already exist. Opening new shipping routes through the network of free ports will surely optimize business processes of shipment companies.
Free ports are likely to have a spillover effect and, consequently, manufacturing clusters may emerge. Increasing the share of manufacturing activity in the economies of the Russian and Canadian Arctic regions would have positive effects on productivity, wage levels, and employment. Supply chain flexibility offered by free ports can be used by auto manufacturers, pharmaceutical companies, and food processors who are dealing with perishable products.
The fishing industry may considerably benefit from the establishment of such free ports or special economic zones. Statistics show that the fishing industry might remain a dominant sector of economy in the Arctic, as it shows steady growth. Vessels engaged in fishing operations in aggregate logged a total of 51,093, 75,892, and 80,958 trips in 2015, 2016, and 2017, respectively, which constituted more trips than all other vessel types in each year.24) The further development of fisheries requires not only more efficient transportation routes between Asia, North America, Russia, and Europe, but also developed infrastructure to support, build and repair fishing vessels. Innovations and new production technologies are also greatly in demand. Free ports may significantly contribute to meeting these demands. Moreover, a free port follows the perception of “blue growth” and would definitely contribute to the innovative, integrated and multisectoral approach to the management of aquatic resources, which is aimed at maximizing the ecosystem of goods and services obtained from the use of oceans, inland waters and wetlands, while also providing social and economic benefits.25)
Concluding Remarks
If “porto franco” may work in the Arctic, why then is such a regime not booming as a development instrument in the Arctic already? The reasons are connected with a lack of political will, prevailing protectionist policies, and environmental concerns. It should be mentioned that, besides the fact that free ports are under discussion and even implementation in particular countries, the “porto franco” regime has been previously considered as an instrument of development of the entire Arctic. Tero Vauraste, the head of the Arctic Economic Council, has mentioned that one of the Council’s objectives is to establish an Arctic free trade zone. Such a zone would aim at fostering strong market connections and ensuring market access within the region, as well as globally.26) However, this initiative cannot be executed in the near future, as the Arctic is burdened by a number of different and incompatible trade regimes.27) The conservative and protective approach of Arctic countries to trade and investments in the region (e.g. restrictions on free exchange of the best-available technologies and services) complicates socio-economic development in the Arctic. Nevertheless, the idea of a free trade zone is highly supported by the private sector, which motivates the Council not to abandon the free trade area initiative.
As for environmental concerns, they are one of the main reasons which preclude Arctic countries from intensive economic development of the region. However, the idea of sustainable development implies maintaining a balance between economic growth and environmental safety. The establishment of free ports and the subsequent increase in industrial and transportation activity can still be a feasible option if special commitments and policies on environmental protection are implemented. For example, the Polar Code of the International Maritime Organization has been adopted to protect environment and ecosystems of the Arctic by, among other regulations, setting new requirements for vessel navigational safety and pollution prevention.28) Such legal and policy instruments can specifically cover activities in free ports, thus ensuring eco-safety and sustainability of businesses in Arctic free ports.
The Arctic states used to play a key role in supporting successful cooperation in the region and meeting the challenges that now confront the region. The Arctic is currently one of the most lucrative regions for economic development. Taking into account some positive findings presented in the Business Index North 2019 report, we can be more optimistic about the idea of free ports along the Northern Sea Route. Under a “porto-franco” regime, some Arctic seaports may theoretically enter the world’s top 50 ports in terms of overall capacity by 2028. But the question is not about the numbers, but about how these numbers are achieved. “Porto franco” may be a significant contribution towards the “blue economy” and sustainability of the regional development in the Arctic. But a sufficient political will of all the Arctic states is required in order to effectively implement the free trade policies.
Anton Tugushev, Candidate of Science in Laws, Researcher at City University of Hong Kong.
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