FEATURED | The Future of Special Economic Zones

FEATURED | The Future of Special Economic Zones

By Jong Woo Kang and Shahid Yusuf,
Asian Development Bank

 Image Attribute: epa01795959 A construction worker walks across a main street in the Futian district, the central business district of Shenzhen, China, 16 July 2009. EPA/YM YIK  .

Image Attribute: epa01795959 A construction worker walks across a main street in the Futian district, the central business district of Shenzhen, China, 16 July 2009. EPA/YM YIK .

The popularity of Special Economic Zones (SEZs) remains strong in the second decade of the 21st century in spite of the progress over the past decade in trade liberalization and deregulation, in building institutions and in improving the business environment. Export Processing Zones (EPZs) and SEZs were instruments of choice in the latter third of the 20th century for economies with closed and tightly regulated markets and weak institutions. Creating these islands was viewed as a means of exploring the viability of a more open regime and of the institutions needed to make it work. Although many economies are now cognizant of the advantages accruing from deregulation and liberalized trade, they still face opposition from entrenched domestic interests who stand to lose. Hence, policy makers continue to rely on SEZs to bolster development and to test the edge of new initiatives as with the greening of cities and creation of logistics hubs.

Well-designed and managed EPZ-type SEZs are a viable option for low and lower middle-income economies—as in South Asia—which need time to further dismantle trade barriers, other restrictions that cloud the investment climate, and build the institutional scaffolding for industrialization. But many outright SEZ failures and the modest returns of others argue for close attention to the location, design, and management of zones, yoking the establishment of new zones and retaining existing ones to longer term economy-wide policy action. Economies pinning hopes on more advanced zone stages must also consider the global shift toward services. With potential growth forecast to be lower in both advanced and emerging economies, and trade distortions taking a toll, an upturn in merchandise trade appears unlikely in the medium term and an increased focus on services a better bet.[1] Research by Neumark and Kolko (2009) on the US zones suggest those that do better stress marketing and trade facilitation services.

Until perhaps 2 decades ago, the way forward for a late starting economy was to pursue an export-oriented industrial strategy, starting with the assembly and processing of light manufactures, becoming a part of global production networks with the help of FDI, and gradually diversifying and moving up value chains. For Asia’s low and lower middle-income economies, manufacturing might remain the SEZ staple. However, even these economies need to take account of the higher profits to be earned from enlarging the services content of manufactures. This becomes more important as they diversify into more complex and less ubiquitous products and move up the value chain. It is worth noting that FDI in services now accounts for between two-thirds and 70% of investment.[2]

The leading edge of zone development may be in the kinds of entities that are being sponsored by upper middle and advanced economies. They use a mix of public and private initiatives to carve out zones for logistics, financial, knowledge-based, and entertainment services. Zones for services appear to be the wave of the future, mirroring the preponderance of services in GDP and their rising share in trade (Elmsand Low 2015). Currently, among Asia’s developing economies, only India is a major services exporter (23%)—mainly ICT-based services—and value added by services in exports is also among the highest (51%). The Republic of Korea; the PRC; and Taipei, China all lag behind. Only 14% of the Republic of Korea’s exports and 14% of PRC exports are in services; and value added by services in exports is 35% for both economies (Chung 2015). Thus, there is much catching up to do and opportunities to enlarge services exports.

The Republic of Korea’s Incheon Free Economic Zone is furnished with multi-modal transport and a suite of amenities, including a golf course. The Songdo ubiquitous city lying within the zone offers an IT-rich environment catering to providers of commercial, medical, educational, and hospitality services. Depending on how well Songdo fares, the Republic of Korea intends to build many more smart and ubiquitous cities. Dalian in the PRC has set up a thriving Software Park and Shanghai is promoting an SEZ that will host an international financial center. Dubai, meanwhile, is a new style SEZ with a port and free zone, an international financial center, an “internet city” and large newly reclaimed areas reserved for housing—mainly for sale to foreigners. The United Kingdom and Japan among others are also on the bandwagon with several zones in the pipeline, and services the primary activity.

The concept of urban development and creation of smart cities will increasingly be an integral part of high-technology and knowledge based SEZs by combining R&D centers, e-governance, skilled labor and other commercial and recreational centers. Given this changing trend, governments should perceive SEZs not only as a self-contained entity, but also as part of longer-term urban development.

Urban development can also occur through charter cities and Special Governance Zones (SGZs) as proposed by Fuller and Romer (2012) and Wei (1999), respectively. A charter city is a new type of special zone, one that can serve as an incubator for reform. It extends the concept of an SEZ by increasing its size to city scale and expanding the scope of reforms. During this century of rapid urbanization, charter cities can offer the developing world a choice between several well-run cities, each of which competing to attract residents. This combination of choice and competition is the best strategy for improving the quality of life. A strong argument for charter cities is that urbanization is trending upward in the developing world at a time when the capacity to govern remains in short supply (Fuller and Romer 2014). The potential gains from this strategy are much larger than those from further reducing trade barriers to private goods and services (Clemens 2011, cited by Fuller and Romer 2014).

A related concept is that of the SGZ, as proposed by Wei (1999). An SGZ is a geographically limited area within an economy, in which a comprehensive package of civil service reform, redefined role of government in the economy, enhanced rule of law, and enhanced citizens’ voice will take place.[3] At the initial stage, political and fiscal support from the central government and an international organization is crucial. In the long run, the local government in the SGZ will accrue revenues to more than offset the initial cost of the reform.

To a certain extent, an SGZ is similar to an SEZ, but SGZs focus primarily on governance reform, while SEZs are motivated by economic objectives. Another key similarity is that an administrative body using simplified rules and regulations often governs SEZs.

Image Attribute: The upcoming SEZ in Western India - Gujarat International Finance-Tech City is modelled as per SGZ principles. Photo Courtesy: Darshan Belani

Image Attribute: The upcoming SEZ in Western India - Gujarat International Finance-Tech City is modelled as per SGZ principles. Photo Courtesy: Darshan Belani

These concepts are perhaps best approximated by the experience of the People's Republic of China (PRC). At the start of SEZ development in the early 1980s, several top leaders perceived the advantages of reforms despite high uncertainty. Besides fiscal and non-fiscal incentives, the SEZs (especially the comprehensive SEZs and ETDZs) were given greater political and economic autonomy. They had the legislative authority to develop municipal laws and regulations along the basic lines of national laws and regulations, including local tax rates and structures, and to govern and administer zones. At that time, in addition to the PRC’s National People’s Congress and its Standing Committee, only the provincial-level People’s Congress and its Standing Committee had such legislative power. The discretion allowed more freedom in pursuing new policies and development measures deemed necessary to vitalize the economy. At the same time, local governments made great efforts to build a sound business environment. They not only put in place an efficient regulatory and administrative system, but also good infrastructure such as roads, water, electricity, gas, sewers, telecommunications, and ports—in most cases involving heavy government direct investments, especially in the initial stage. These successful SEZs were testing grounds for reforms, preselected by virtue of location in coastal regions close to ports with good manpower availability and access to pre-existing infrastructure.

Global production networks are becoming increasingly complex with MNCs cutting across industries, dividing their activities more precisely, and searching the globe to find optimum locations for relocating production. SEZs that address structural, institutional, and infrastructural bottlenecks—and potentially harness agglomeration economies— not only offer a platform for attracting FDI, but can incentivize firms to take advantage of opportunities and compete on the basis of innovation and learning. When weaved into RCI, SEZs can serve as an effective instrument in further spurring competitiveness and structural transformation by expanding the scope for scale economies and coverage of comparative advantage across regions and borders.

Regional growth initiatives can use SEZs to seed or integrate with domestic industrial clusters, and benefit from local or regional labor markets. This may begin to unlock the potential of zones as catalysts rather than enclaves. By providing strong links to networks that foster horizontal partnerships between SEZs and governments—identifying areas of comparative advantage, economic complementarities and economies of scale—it will be possible to exploit opportunities emerging from international production sharing of MNCs in terms of fragmentation of production value chains and linking to GVCs, cluster development, multimodal transport and logistics, and ICT.

Alongside specifically labeled SEZs, regional economic corridors (REC) have been used as a tool for development. Enhanced trade and transport links centered on SEZ development around economic corridors can facilitate integrated regional trade and development, generating a wider range of economic benefits—including a substantial increase in trade among economies in the region. SEZ development without regional cooperation and the establishment of economic corridors amounts to enclave planning with limited returns that may not always justify the underlying economic and social costs. In the context of GMS, for instance, the development of transport corridors is an integral part of success stories of SEZs (particularly in Viet Nam). However, all potential benefits would accrue to participating economies only through a coordinated strategy that integrates regional trade expansion and growth with SEZ development.

SEZs may also be established to promote industrial clusters as a way to achieve agglomeration. In the PRC, while market forces are usually responsible for initially producing industrial clusters, the government supports or facilitates them in various ways, including setting up an industrial park on the basis of an existing cluster (Zeng 2010). After decades of development, some clusters have begun to grow out of certain SEZs, such as ICT clusters in Zhongguancun (Beijing) and Shenzhen, the electronics and biotech clusters in Pudong (Shanghai), the software cluster in Dalian, and the optoelectronics cluster in Wuhan. The emergence of these clusters actually hinges on SEZ success, which serves as their “greenhouse” and “incubator”.

Given how many zones are in play or planned in Asia and across the world, it is vital for economies to ensure they deliver adequate returns. Greater reliance on private developers might be one way of achieving this—because to earn a profit they would try harder to provide a better business climate as well as physical facilities and social milieu (Moberg 2015). In taking the private sector route, governments should support appropriate policy arrangements and basic infrastructure investments.

A second desirable step would be to rigorously evaluate the benefits from zones and determine whether they generate additional activity or merely displace activities that would have occurred in their absence. By designing experiments to effectively conduct this evaluation, instituting a transparent decision-making process, and collecting and making available all relevant data on bids would permit the kind of much-needed assessment but remains lacking even in zones in advanced economies (Overman 2011).[4]

SEZs have enjoyed a long history and by all accounts retain the backing of policy makers the world over. Instead of fading from the scene as economies developed and the initial justification for zones eroded, additional reasons were discovered first for next generation zones that accommodated changing institutional and structural realities. Clearly there are zones for all seasons and economy-wide economic liberalization and institutional strengthening seemingly create new niches. Under these circumstances, a desirable course for governments is to select approaches carefully and spend resources wisely, to evaluate performance with reference to clear criteria, and to be ready to withdraw support from zones that do not make the cut.

About The Authors:

This article is an extract from Special Chapter, “How Can Special Economic Zones Catalyze Economic Development?” written by Jong Woo Kang and Shahid Yusuf. Background papers were provided by Aradhna Aggarwal, Mohiuddin Alamgir, Zhenshan Yang, Peter Warr, Jayant Menon, Benjamin Endriga, and Grendell Vie Magoncia. Econometric analysis was provided by Ana Kristel Molina, Marthe Hinojales, Renz Calub, and Suzette Dagli. Pilar Dayag provided data and research support

EndNotes:

[1] World Trade Organization. 2015. Modest trade recovery to continue in 2015 and 2016 following three years of weak expansion. WTO 2015 Press Releases. 14 April. https://www.wto. org/english/news_e/pres15_e/pr739_e.htm; S. J. Evenett and J. Fritz. 2015. Crisis-era trade distortions cut LDC export growth 5.5% per year. Centre for Economic Policy Research’s Policy Portal. 16 June. http://www.voxeu.org/article/crisis-era-trade-distortions-cut-ldc-exportgrowth- 55-year; B. Hoekman, ed. 2015. The Global Trade Slowdown: A New Normal? London: CEPR Press.

[2] UNCTAD. 2014. Investing in the SDGs: An Action Plan. World Investment Report 2014.Geneva.

[3] The actual name could also be “special administrative zone,” “clean administration area,”and so on, depending on the circumstances of the economy.

[4] H. Overman. 2011. Open evaluation of new enterprise zones stands to increase understanding of the impact of urban policy at little cost. Spatial Economics Research Centre Blog. 5 July. http://spatial-economics.blogspot.com/2011/07/open-evaluation-and-future-ofevidence.html

Publication Details:

The views expressed in this publication are those of the authors and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent.

ADB, 2015. ASIAN ECONOMIC INTEGRATION REPORT 2015 How Can Special Economic Zones Catalyze Economic Development? © Asian Development Bank. https://openaccess.adb.org. Available under a CC BY 3.0 IGO license.
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