Ten years ago, Ras Al Khaimah (RAK) was just a blueprint to attract new businesses to one of the farthest corners of the United Arab Emirates (UAE). Today, the free trade zone (FTZ) is said to be home to 4,000 businesses from 120 countries and has four marketing offices outside the emirate. "We are specifically targeting the small to medium [-sized] businesses," says Oussama El Omari, chief executive of RAK, which recently hosted the 10th World Free Zone Convention, an annual gathering of FTZ directors from around the world. "This is where we can provide the most support."

The strategy seems to be serving RAK well. Though located about 70 miles from the UAE's urban heart of Dubai and 140 miles from Abu Dhabi, it has formed an enclave dedicated to small, up-and-coming companies. According to a report in The Khaleej Times, offshore firms in the FTZ increased from 900 in 2009 to 1,250 in 2010.

RAK's ability to establish a destination for foreign direct investment (FDI) is just one example of the increasingly important role FTZs play in the local economy. In the UAE and the Gulf at large, semi-autonomous trade zones have proliferated in recent years. Businesses find them especially attractive because, unlike in the sovereign jurisdiction where a local partner must own at least 51% of a company, foreigners can own their operations outright.

Most of the UAE's 36 FTZs are located in Dubai, but other emirates have been setting up their own, including Masdar, a green energy FTZ in Abu Dhabi. The oldest zone in the UAE, Jebel Ali Free Zone, is also one of the largest in the Middle East and ships 11 million containers each month.

"Free zones have proximity and a physical connection to the host economy, but enjoy a total separation from the rules and regulations related to the licensing and sponsoring of employees and the creation of businesses," notes Khaled Ahmed, senior vice president of corporate strategy at Economic Zones World (EZW), a developer and operator of economic, logistics and industrial parks under Dubai World that runs the Jebel Ali zone.

Wooing Foreign Investment

EZW started with the Jebel Ali 25 years ago "in the middle of nowhere, literally," Ahmed says. The emirates' leaders had a vision to both encourage FDI into Dubai and help boost economic development, he adds. As of June, Jafza — as the zone is known — had more than 6,500 registered companies and contributed 26% and 7.6% to the Dubai and UAE economies, respectively.

Last year, total FDI through the UAE's FTZs reached US$73 billion. That helped make the UAE the second-largest recipient of FDI in the Arab world, after Saudi Arabia which attracted US$114 billion of FDI, according to the United Nations Conference on Trade and Development. The UAE was home to 230 new FDI projects last year, which put the country at 14th in the world (or a 1.7% global share) for such investment, according to Sheikha Lubna Al Qasimi, its minister of foreign trade.

"The free zones have assisted the rapid growth of Dubai," says Jimmy Haoula, a managing partner at law firm Bin Shabib & Associates in Dubai. "They opened up Dubai to the world."

There are about 3,000 FTZs scattered across the globe in about 135 countries, through which billions of goods move each year. The volume has subsided slightly in the last two years as the global economy faced the most crippling recession in 80 years. "Everyone is affected," says Ahmed of EZW. But he maintains that Jebel Ali's sheer size and history in the region's supply chain give it an advantage in recovering from the downturn. One reason: As companies seek to reduce costs, they are consolidating offices throughout the region "and they are bringing [their business] to the free zone," Ahmed states. "Rather than having an office in Emirates Towers in Dubai or in Cairo, I can be close to my trade. Training, marketing and administration are all coming back to the zone."

The success of Jebel Ali has prompted additional free zones to be established in the emirate; from Dubai Healthcare City to Dubai International Financial Centre. Abu Dhabi is now getting global attention for its efforts to invest its petrodollars into Masdar, an effort to build a carbon-neutral city along with a free zone dedicated to green energy. Green is a smart move, noted Gokhan Akinci, the lead investment policy officer for the World Bank's Investment Climate Department International Finance Corporation. "Zones will have to be green within and without," he said at the Ras Al Khaimah conference. "Businesses are a lot more conscious about their carbon footprint."

But newer, less-established FTZs are struggling to fill office space. Recently, Sheikh Maktoum Al Maktoum, CEO of Al Fajer Properties, called for Dubai to create a regulatory body to coordinate the emirate's 16 FTZs and help boost license applications, according to The National newspaper in Abu Dhabi. Al Fajer's projects are located in Jumeirah Lakes Towers, which is run by Dubai Multi Commodities Centre. Property consultants say the project's 50 office towers have the highest number of vacancies, the newspaper reported.

Smaller FTZs off the beaten track, like RAK, are choosing to "target the businesses that can't afford Dubai in general," El Omari notes, specifically "the ones who have concerns about mushrooming costs." To entice cost-conscious executives, RAK recently announced special offers on various licensing programs to mark its 10th anniversary.

Less Savory Customers

But free zones are also attracting customers they could do without. Counterfeiting and money laundering can flourish in FTZs, given the very nature of their creation has streamlined bureaucracy to allow the rapid movement of goods.

Even illicit trade is now globalized, said Pat Heneghan, the global chief executive officer on anti-illicit trade at British American Tobacco in London, at the world free zone conference in November. The issue for business and governments, he added, is how to balance the need to supervise with the need to move trade efficiently.

As part of the panel discussion on illicit activities, Omar Schteiwi, chairman of the Brand Owners Protection Group, an anti-counterfeiting group based in the region, said the UAE was the second largest source of counterfeit goods after China in 2008 and 2009, according to data from European Union Customs.

The U.S. government has also recognized free trade zones as susceptible for illicit financial activity, and is concerned that those activities could result in financing for terrorist initiatives, for example.

The UAE has felt pressure to tighten oversight on trade with Iran. The emirate of Ras Al Khaimah is just 60 miles from the Islamic Republic by way of the Strait of Hormuz and its free zone stopped issuing new licenses to companies in Iran in the summer.

RAK's El Omari says his trade zone, like others in the UAE, are complying with sanctions against Iran and that stepped up requirements for Iranian companies seeking a license has essentially prevented applications from being submitted.

In September, the Dubai Financial Services Authority, which regulates activity in the Dubai International Financial Centre free zone, announced it had frozen the accounts of the Dubai branch of the Persian International Bank. And the UAE's central bank recently signed an agreement with the Dubai Multi Commodities Centre requiring the free zone to share information on financial transactions suspected of having links to money laundering and terrorist financing. Part of the agreement also requires the FTZ to appoint a compliance officer to monitor financial transactions.

Such challenges aside, free zones will continue to play a role in the development of the UAE's economy. "There's no doubt there is an appetite for the niche market in free zones," says Bin Shabib's Haoula.