Not so special

Published by rudy Date posted on April 4, 2015

The world is awash with free-trade zones and their offshoots. Many are not worth the effort

WHEN the first modern free-trade zone was established at Shannon airport in 1959, few outside Ireland paid much attention. Now everyone seems to be an admirer of “special economic zones” (SEZs) that offer a combination of tax-and-tariff incentives, streamlined customs procedures and less regulation. Three out of every four countries have at least one. The world now counts about 4,300 SEZs, and more are being added all the time. Myanmar and Qatar have recently unveiled new ones; Indian officials call their SEZ ambitions “revolutionary”; Shinzo Abe, Japan’s prime minister, announced special strategic zones as part of his reform agenda.

Fans of SEZs can point to several success stories, none bigger than China’s zone near Hong Kong, set up in 1980 and since dubbed “the Miracle of Shenzhen”. This was a way to experiment with economic reforms that Chinese leaders were fearful of rolling out nationwide in one go. Shenzhen attracted thousands of foreign investors, and the policies tested there have spread to other cities. But the craze for SEZs suggests that governments too often see them as an easy win: make an announcement, set aside some land, offer tax breaks, and—hey presto!—deprived regions or struggling industries are healed. If only it were that easy. Popular as they are, SEZs are often flops (see article). Africa is littered with white elephants. India has hundreds that failed to get going, including more than 60 in Maharashtra state alone in just the past few years.

Nor are these efforts cost-free. The incentives offered to attract investors mean forgone tax revenues (at least in the short term). They create distortions inside economies, one reason why nationwide liberalisation is always better than patchwork efforts. Zones are increasingly a haven for money-laundering through, for instance, the mis-invoicing of exports. To ensure that these costs are more than offset by jobs and investment, governments must learn from the failures.

First, offering nothing but fiscal incentives may help get a zone off the ground, but it does not make for a lasting project. The most successful zones are entwined with the domestic economy: South Korea, for example, has been good at fostering links with local suppliers. Zones need to be connected to global markets. Improving infrastructure for this purpose has a bigger impact on the success of zones than tax breaks do. This often requires public spending to upgrade roads, railways and ports to handle the extra freight. Lack of such investment has been the downfall of many an SEZ in Africa. Lots of the continent’s new zones will fail for lack of a reliable power supply or because they are too far from a port.

Second, the right balance has to be struck between adequate political oversight and freedom from government bureaucracy. Too much interference from the centre negates the opportunity to experiment. There are legitimate worries that Japan’s new zones will fail because central-government officials reject ideas for deregulation for fear of offending vested interests. Bringing in private developers to run zones may help: that was done to good effect in the Philippines. Yet ambitious ideas for “charter cities”—zones built around new urban areas with the power to set their own laws—may be too close to setting up states within states.

Zoning out
The concept also has its limits. Export-focused zones work best in relatively low-end manufacturing, and have the biggest impact when trade barriers are high (think Bangladesh and clothing). China’s new zone in Shanghai, centred on financial services, has roused limited enthusiasm—the piecemeal deregulation of activities like foreign-exchange trading is hard to pull off and potentially destabilising.

If they encourage experimentation in otherwise sclerotic economies, SEZs can be useful. The failure of some may seem a price worth paying, if you end up with a Shenzhen-style blockbuster. But they require patience and planning, and they are always inferior to nationwide reforms that cut trade barriers and boost competitiveness. The countries that don’t need zones at all are the really special ones. –

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