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IFS - Freeports: What are they? What do we know? And what will we know?

This report analyses the rationale for Freeports and what we can learn about their potential impact from past policies and a planned evaluation.

Contents

In January 2020, the UK government formally announced its intention to create a number of Freeports across the UK, with the aim of promoting job creation and regeneration, boosting trade, investment and innovation, and supporting the ‘levelling up’ agenda. The Freeports offer various tax and customs reliefs, simplified import and export procedures, enhanced trade promotion, and additional support for innovation, increasing their attractiveness to both domestic and international businesses. They also benefit from an injection of seed capital from central government and the full local retention of business rates revenue from qualifying new development, in order to enable investment in complementary infrastructure and skills.

This report aims to provide an accessible overview of the Freeports programme, looking at existing evidence on the potential impacts of the policy, and what we may learn about its actual impacts from future evaluation.

What are Freeports?

Freeports are not a new idea – indeed, there are examples from thousands of years ago. The UK has also previously had Freeports as recently as 2012, although these were rather limited affairs focusing on customs measures that were little different from what was available elsewhere in the country via other schemes.

The new Freeports – of which it is planned there will eventually be eight in England, two in Scotland, at least one in Wales and potentially one in Northern Ireland – benefit from not only customs measures, but a range of tax reliefs, enhanced support for trade promotion and innovation, seed capital to help pay for infrastructure and other enabling activities, and full local retention of business rates revenue from new and expanded developments located in the Freeports. This makes them more substantive special economic zones (SEZs) than previous UK Freeports.

In addition, councils covering Freeports are being encouraged to make use of existing powers to relax the usual planning regime, such as via local development orders, which involves pre-approving certain types of developments, although they not be mandated to do so. Alongside other partners in their Freeports, they also have to put in place a skills and employment strategy to help local residents, particularly from deprived or otherwise traditionally disadvantaged backgrounds, to obtain the new jobs created, and strategies for innovation and decarbonisation. Seed capital and any additional retained business rates revenues generated can be used to fund these strategies.

Each Freeport is a maximum of 45 km in diameter. Within its outer boundary, it will include a number of ‘customs sites’ where the customs measures are in place, and between one and three ‘tax sites’ where the tax reliefs and increased local retention of growth in business rates revenues will apply. The tax sites are required to be ‘under-developed’ land and limited to 6 km2 per Freeport.

With the exception of some simplified declaration and authorisation processes, the customs measures can already be applied for by businesses elsewhere in the UK. The tax measures are more significant, albeit temporary, and include enhanced allowances for investment and generous reliefs from employer National Insurance contributions (NICs), business rates and stamp duty land tax. 

The benefits available to Freeports in Scotland and Wales will be almost identical to those in England: although some elements of the scheme are devolved, the Scottish and Welsh Governments have agreed to largely mirror the situation in England. The situation for Northern Ireland is more complex as the Northern Ireland Protocol to the Brexit agreement and the recent Windsor Framework may mean it is not possible to offer the full set of tax reliefs and other measures available elsewhere in the UK, although it may be possible to offer alternative benefits instead.  

Progress to date

The UK government opened the bidding process for Freeports in England in November 2020. Each prospective Freeport had to bring together a consortium of local councils, port operators and potentially other public and private sector organisations (such as Local Enterprise Partnerships, universities and businesses in the property, logistics or industrial sectors) who would put together the bid and, if selected, set up a governing body to manage and promote the Freeport. As part of their bids, they had to identify target sectors and demonstrate how the tax and other incentives available would overcome issues (such as polluted land and coordination failures) that would otherwise stymie the development of these sectors at their ports and elsewhere in the UK – with further information on this sought following selection.

Following an assessment process and final decisions by ministers, eight winning bids were announced alongside the March 2021 Budget. Seven were based around seaports (Felixstowe and Harwich, Humber, Liverpool, Plymouth, Solent, Teesside and Thames) and one around an airport (East Midlands Airport). The tax sites for the Freeports in England were activated during late 2021 and early 2022. The time taken to develop and agree full business cases mean that five Freeports were fully approved by the end of February 2023, making them eligible for seed capital and for greater local retention of business rates (which is backdated to the activation of the tax sites in question). A number of business and infrastructure investment projects and collaborations with local universities and training providers have already started, as activities in the Freeports begin to ramp up. The remaining three Freeports in England are expected to receive final government approval in the coming months.

Bidding for the Scottish Freeports opened in March 2022, and the Welsh Freeport in September 2022, with decisions being taken jointly by the UK and devolved governments. It was initially hoped to announce the two Scottish Green Freeports by the end of summer 2022 but the two winning bidders (Firth of Forth and Inverness and Cromarty Firth) were only announced in January 2023, which means that the timeframe for them to begin operating has been pushed back from spring to late 2023. The UK and Welsh governments aim to announce the chosen Welsh Freeport in early spring 2023, so that it can begin operating by the first quarter of 2024.

What are the government's aims?

The government has three stated aims for the Freeports programme:

  • to promote regeneration and job creation – this is the ‘lead policy objective’;
  • to establish Freeports as national hubs for global trade and investment;
  • to create hotbeds for innovation.

Freeports are part of the government’s levelling up agenda, with several Freeports in areas (such as Teesside, Liverpool and the Humber) with high levels of deprivation and low levels of income and employment, and a particular focus on increasing the skills and employment of those from disadvantaged backgrounds.

The UK government also expects that the Freeports will contribute to decarbonisation of the economy and progress towards its target of reaching net zero greenhouse gas emissions by 2050, with most Freeports targeting sectors consistent with these goals. The two Scottish Freeports are set to be branded as ‘Green Freeports’ and the Scottish Government has made contribution to decarbonisation a fourth formal objective of the programme.  

Key findings on the Freeports programme and the scope for evaluating it

The economics of the Freeports programme

1. The core of the Freeports programme is the location-specific and time-limited tax incentives and other benefits that it provides. All else equal, such policy variation across locations and times would be undesirable: not only does it distort the timing and location of economic activity, but the efficiency cost of taxation rises more than proportionally with the tax rate, such that the costs are increased if some places/times have higher tax rates and others lower ones (rather than them all having the same tax rate). However, the economic case for the Freeports programme, and large parts of the government’s broader levelling up agenda, is that all else may often not be equal. For example, one may have concerns about the inequalities between places that can arise even in an efficiently functioning market: efficiency is no guarantee of fairness. Tax incentives and other support could therefore be used to help with levelling up, which is a central aim of the programme. It is worth noting though that if one’s primary concern is people’s material living standards, using the tax and benefit system to redistribute income to poorer households can sometimes be a better approach than trying to influence where economic activity takes place. 

2. Perhaps more important to the economic case for Freeports therefore is that markets, on their own, may not be efficient. For example, businesses may under-invest in research and workforce skills from society’s perspective, because they cannot capture the full benefit of that spending, as other businesses benefit from what they discover and hire the workers they have trained. Businesses may struggle to raise finance, especially for new and potentially risky ventures with large upfront costs, as banks and other lenders may find it difficult to assess the prospects of the project succeeding with sufficient confidence. Such market failures – which are termed externalities, and information asymmetries, respectively – can provide a rationale for government intervention to help overcome them. 

3. In the context of Freeports and some other place-based policies, a key example relates to agglomeration effects. This is the idea that there can be benefits to certain kinds of businesses from being near other related businesses (or research centres), allowing more interchange of specialised people and ideas and making shared resources and infrastructure more cost-effective. While such clusters can form spontaneously, it can be hard for businesses to co-ordinate on achieving this outcome, and each may not take into account the benefit they bring to others. In that case there can be a role for government in catalysing such clusters by, for example, providing tax and other incentives for businesses to locate in a particular location. Agglomeration effects could make the clusters generated self-sustaining after the ending of the incentives, and make such geographically targeted incentives more effective and better value than smaller incentives available nationwide. 

4. There is good evidence that agglomeration effects are important in practice. Freeports have been asked to identify the sectors they will target, and to demonstrate how the incentives provided by the programme could help to overcome coordination problems and other market failures. They have had also had to agree broad plans for the use of the tax sites, and put in place plans for complementary investments in infrastructure, skills and innovation, with the aim of maximising the likelihood of developing successful self-sustaining clusters. However, governments and active industrial policy, as well as markets, can fail. A key risk is that the wrong locations and sectors may be chosen, and Freeports may not be successful in creating the clusters that they hope for. In this context, too-tight a focus on particular sectors could prevent other, potentially more viable, sectors from locating in the Freeports. This means there could be a tension between ensuring plans are sufficiently adaptable to respond to market signals, and maintaining a focus on sectors associated with positive externalities and agglomeration effects. 

5. Another important risk is that, even if there is significant activity in the Freeports, a large part of that would have happened there even in the absence of the policy (‘deadweight’) or would have happened elsewhere in the UK (‘displacement’). Similarly, the people and capital employed in Freeports might otherwise have been employed elsewhere. If activity would have taken place elsewhere in the UK, for example in an alternative cluster with even better agglomeration benefits but without the Freeport incentives, it is possible that the Freeports could reduce UK-wide productivity. Given the Freeports programme’s focus on regeneration and levelling up deprived places, this does not necessarily mean the policy would be a failure: the reductions in geographical inequality could still make it worthwhile. However, the higher the deadweight and displacement associated with the policy, the less likely it will represent good value for money.

6. As well as displacing activity from the rest of the country, the Freeports could also generate additional activity elsewhere, and particularly in neighbouring areas, through increased demand via supply chains and workers’ incomes. These positive spill-over effects are likely to be smaller when the deadweight and displacement effects of the policy are larger. 

7. The government is trying to minimise deadweight and displacement in several ways. The tax sites chosen were undeveloped or under-developed locations, and the tax breaks are only available for new employment and investment, not things already happening. Freeports are largely seeking to specialise in sectors that are not already operating at scale elsewhere in the UK, and, as discussed above, were required to show that there were viability gaps and market failures that meant worthwhile investment in those sectors would not go ahead without government support (although not all of the ‘market failures’ identified are necessarily true market failures). In addition, the councils covering the Freeports can, if they want, apply a ‘displacement test’ to deny business rates relief to businesses relocating from elsewhere. However, while such measures should reduce deadweight and displacement to some degree, they cannot fully mitigate this important risk (especially for harder-to-measure types of displacement), and how successful they will be is an important open question.

8. There are no specific financial incentives related to skills, innovation and decarbonation, despite these being core objectives of the programme: for example, while tax allowances for investment in buildings, plant and machinery are more generous in Freeports than elsewhere, tax allowances for investment in research and development are not. However, these activities are being supported via seed capital and potentially the additional retained business rates that Freeports areas will receive as development takes place.

Evidence on the potential impacts of the customs and tax incentives

Bearing in mind these economic considerations, what can we learn from empirical analysis of other, related tax and place-based policies? 

9. The customs benefits enjoyed by Freeports are unlikely to have a big effect, in large part because similar benefits are available elsewhere if businesses apply for them. Moreover, most of the businesses taking advantage of similar policies in the United States do so to be able to pay import duties on the goods they produce rather than on the inputs they import. The structure of UK duty rates mean that this is likely to be far less lucrative than in the US.  

10. The tax incentives are likely to have a more significant effect on businesses’ investment and location decisions, in turn affecting employment, earnings and productivity in Freeports and, to a lesser extent, the rest of the country. Evidence both from past reforms to the specific taxes in question and from comparable place-based policies is consistent with this.

11. The employer NICs relief will incentivise businesses to hire additional employees, and particularly low and middle earners. Evidence from the academic literature suggests that this will result in increases in employment. Evidence for short-term impacts on wages is more limited; if they do increase, the increases may potentially spill over to areas outside the Freeports as employers outside Freeports seek to remain competitive with those inside them. 

12. There is strong evidence that enhanced tax allowances for investment do increase investment, although some evidence suggests the effect may be smaller during economic downturns or periods of economic uncertainty. The temporary nature of the incentives is likely to magnify the short-term boost to investment, due to investment being brought forward from future years.

13. The exemption from business rates will also incentivise investment in the buildings and integral plant and machinery this tax is charged on. It is also likely to lead to increases in land and property values and rents, benefitting existing landowners. Exemption from stamp duty land tax will also likely increase land and property values. But it will have the welcome effect of substantially reducing the cost of property transactions, making it easier for those best placed to develop and do business in Freeports to buy or lease land and property.

14. Evidence from enterprise zones in France and the US, which share several key features with the UK’s Freeports, suggests that the package of tax incentives on offer will likely increase investment and employment in the Freeport sites, benefiting the residents of surrounding areas (although evidence of improvements in residents’ incomes and poverty rates is weaker). However, it also suggests that a significant part of the increase in activity in enterprise zones is displaced from neighbouring areas. In the case of Freeports, the risk may be of displacement from other ports rather than displacement from neighbouring areas.

15. Studies of the UK’s previous place-based tax and spending policies also find evidence of displacement. This is particularly true for businesses serving largely local or regional markets, including wholesalers and retailers and many parts of the services sector. Displacement is less likely to be as big an issue if the Freeports can successfully target businesses serving national or global markets, able to export or compete with imports. The sectoral focuses of the Freeports, and institutional arrangements aimed at ring-fencing tax site land for such ‘tradeable’ sectors, will hopefully help in this regard.  

16. A range of evidence also suggests that place-based policies may have different impacts in different types of places. In particular, there is some evidence that enterprise zones in France which were in areas that were less economically depressed to begin with, or which had stronger transport links, were more effective. Studies of EU regional development policy finds bigger positive impacts in areas with higher skills and better governance. This suggests that choosing Freeport sites with an eye to levelling up may come with a trade-off in terms of maximising overall economic benefits. But it also suggests that funding for infrastructure improvements and efforts to improve skills, which the Freeports programme provides, are useful complements to the tax incentives.

17. All of this suggests that the tax incentives and other benefits enjoyed by Freeports are likely to boost investment and employment, potentially benefiting residents of the surrounding area, but that this boost to Freeports will come partly at the expense of other areas. The Office for Budget Responsibility expects the Freeports to generate little additional activity, with most of it being displaced from other areas. The government and the Freeports appear to be much more optimistic: for example, the English Freeports themselves expect to create more than 200,000 additional jobs between them. The government has, to date, not published a full assessment of the effects it expects Freeports to have, which makes it difficult to scrutinise and evaluate these competing claims.    

What will future evaluation tell us about Freeports’ actual impacts?

18. The application of the Freeports policies to a small number of specifically chosen areas with certain characteristics (i.e. large ports), and the potential displacement and spillover effects (both negative and positive) on other parts of the country, make it a fundamentally difficult policy to evaluate. This is true of the impacts on both the local economies in the areas surrounding Freeports and the wider UK economy, which in turn make it extremely challenging to assess the programme’s value for money. Of course, the same is true of many government policies, and it is still worth evaluating the programme as thoroughly as possible.

19. The main quantitative evaluation approach proposed by the consortium tasked with evaluating it (which we advise) is to compare the change in trends in outcomes of interest (such as investment, employment and wages) in Freeport areas following their designation with what happens in other similar areas of the country not selected as Freeports, called control areas. For this approach to reliably estimate the causal impact of the Freeports programme, we have to assume that the trends in the control areas are a good indicator of what would have happened in the Freeport areas in the absence of the programme. 

20. To help ensure this, the control areas should be as similar as possible to the Freeport areas. But the more similar the control areas are, the more likely it is that they will be affected by displacement or spillover effects. In that sense, they are not really unaffected ‘control’ areas illustrating what happens in the absence of the policy: they too are affected by it. If the control areas were to be affected by displacement or spillover effects, then this would bias estimates of the effects of the programme on Freeport areas, and on the UK as a whole.

21. The suggested approach for overcoming these challenges is to use economic modelling of various displacement and spillover effects via the labour, product and capital markets. So far, crucial details of precisely how this would be done have not yet been worked out, and the challenges in doing this in a way that avoids effectively assuming (rather than estimating) the scale of displacement and spillover effects will be daunting. However, the broad approach proposed is significantly better than a simple before-and-after comparison of outcomes in Freeport areas, and is a reasonable response to a fundamentally difficult evaluation problem. 

22. Other government policies over the coming years – most obviously those also designed to promote regeneration or levelling up – might affect Freeports more or less than the areas with which they are being compared, making it hard to separate out the effects of Freeports from the effects of these other policies. But outcomes might also diverge for reasons unrelated to policy. The facts that there are only eight Freeports in England, and that we are interested in outcomes more than five years after the policy was announced, will make it harder to be confident that any divergence in outcomes between the Freeport areas and comparator areas is caused by the Freeports policy rather than by other developments that happen to affect those areas differently.

23. Even if the overall impacts of the Freeports programme could be estimated well, it would still be challenging to assess its value for money. A thorough assessment would require not only estimates of specific impacts, such as how much tax revenue is generated (or lost) by additional (or displaced) activity as a result of the policy, but also assessments of how much value is placed on outcomes ranging from additional employment (and the resulting loss of time to spend with family or in other ways they might value) to decarbonisation to levelling up. Again, these difficulties are not unique to the Freeports programme, and a growing body of academic research provides guidance as to how to go about it. But it is not straightforward.

24. The monitoring and evaluation framework emphasises the role of ongoing monitoring, process and theory-based evaluation, using a range of quantitative metrics and qualitative feedback. The aim of these will be to check whether implementation is going as planned and whether milestones are being reached, to assess whether the anticipated mechanisms leading to positive economic impacts are operating, to identify which parts of the programme are working best, and to assess which factors are associated with successful implementation. This sensibly recognises that successfully implementing the Freeports programme – and learning from it – requires much more than just estimating its impact; information on the ‘how’, ‘where’, ‘why’ and ‘why not’ is also vital. It may also facilitate learning between the Freeports themselves, allowing honing of programme design and implementation. These elements may turn out to be the most valuable part of the evaluation exercise. And while the theory-based approach will not provide definitive estimates of the programme’s impacts or benefit-to-cost ratio, it will generate a range of indicative evidence on the success or failure of the policy.

Conclusion

25. Our reading of the evidence is that the Freeports programme will likely attract additional investment and jobs to Freeport areas, potentially boosting incomes and reducing poverty for local residents. However, part of this activity will be displaced from elsewhere in the country, and while measures are in place to mitigate this, it is unclear at this stage both how successful they will be, and how large a proportion of activity will be displaced or deadweight as opposed to genuinely additional. This, as well as the overall amount of activity in the Freeports, will be a crucial determinant of the overall value-for-money of the Freeports programme. But value for money will also depend on a wide range of other factors, including the weight placed on levelling up poorer areas (one of the key objectives of the Freeports and wider government policy). 

26. The nature of the Freeports programme means it is unlikely we will ever have definitive figures for its overall economic impacts and benefit-to-cost ratio. But the proposed quantitative economic impact assessment will provide useful indicative evidence on the programme’s overall impact on various economic outcomes. And a focus on monitoring and process evaluation can help the sharing of best practice between Freeports and learning about how the benefits of similar policies could be maximised in future.

Report – Freeports: what are they, what do we know, and what will we know?

Original article link: https://ifs.org.uk/publications/freeports-what-are-they-what-do-we-know-and-what-will-we-know

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