Doing ecozones right

by BEN KRITZ, Manila Times, Aug 22, 2019

THE Philippine Economic Zone Authority (PEZA) and the Department of Finance (DoF) have been at odds for months over the latter’s proposal, contained in the second package of the comprehensive tax reform program (CTRP) currently stalled in Congress, to rationalize fiscal incentives. Because somebody at PEZA does not know how to do basic math, the conversation has now shifted from the specifics of adjusting tax perks to business locators to a more general assessment of the real value of economic zones.

PEZA, which relies on its authority to offer tax incentives to lure businesses to the Philippines, is of course against the proposed rationalization, saying that it would drive away investors. Under the reform measure, the process of granting incentives would be streamlined and centralized, and incentives would generally be reduced. The DoF says that this is necessary because the government is losing too much potential tax revenue — P1.12 trillion in the three years between 2015 and 2017, about three-fourths of that given away by PEZA.

The investment promotion agency countered that this was worthwhile, because ecozones added P10 trillion to the economy in the same time period. Finance Undersecretary Gil Beltran, who does know how to do math, explained that is not the case — the real figure is closer to P3.5 trillion. That of course raises the question of whether or not fiscal incentives as they are currently managed are too costly; although PEZA would likely still argue that they are not, but most reasonable people would conclude otherwise, and perhaps wonder if ecozones are actually as valuable as advertised.

The basic objective of special economic zones is to accelerate development and growth of the host economy by attracting foreign capital and facilitating technology transfer. The concept was first tested in the 1950s (in Ireland), and became popular in developing economies over the next couple of decades; China has perhaps been the most successful in implementing them according to the original model.

Ideally, an ecozone should increase employment, increase exports, and encourage the growth of local value chains, suppliers and complementary businesses. It is considered best practice to locate ecozones in otherwise economically disadvantaged areas; this sometimes works, but is dependent on the availability of labor and infrastructure. Here in the Philippines, the ecozones in Cagayan and Cavite are close to the original concept. Ecozones consisting of single buildings or parts of buildings housing BPO companies in Metro Manila are stretching it, perhaps beyond usefulness, as the dubious economic statistics noted above suggest.

Studies of the long-term outcomes of ecozones indicate that their supposed benefits to the broader economy have been a bit oversold. Yes, they do increase exports, but in some cases the gain is negligible; as the DoF’s Beltran pointed out, about 80 percent of the inputs for exports originating in ecozones here are imported, reducing the net value to the economy. Ecozones do increase local employment, but that gain is tempered as well by the trade balance; directly, by the importation of foreign workers, and indirectly by the preference for imported rather than locally sourced material inputs.

Because these outcomes suggest that a more effective approach might be just what PEZA has been doing, considering “ecozones” in terms of individual companies and their potential contributions to the economy rather than in terms of physical areas. That being the case, there has gradually been a shift in thinking from promoting the development of ecozones to simply liberalizing foreign investment laws. That, however, is not as politically palatable an idea as it might have been a few years ago before the rise of nationalism, so the original ecozone idea, flawed though it may be, is still an option. To get the most out of it, the best framework to use would be something in between the rigid, location-bound original ecozone concept and PEZA’s loose, wink-and-a-nod interpretation of it.

Rationalizing fiscal incentives is a good first step. Under the tax reform proposal being considered, many incentives would be reduced, but the administration of them would be simplified, so that they could be processed and approved more quickly. In some cases, available incentives will actually be increased, although with the trade-off of much more stringent qualifications regarding the use of local labor and suppliers, among other things.

In line with the present government’s overarching policy priority to reduce poverty, the moratorium on new ecozones in Metro Manila should be made permanent, and probably extended to other well-developed metropolitan areas such as Cebu, Davao, and the Clark-Subic corridor.

Ecozones should be placed in poorer provinces that have heretofore been ignored by national-level investment promotion agencies. That would make locating in the Philippines a tougher sell, of course, and would attract far fewer potential investors; on the other hand, the ones that do set up shop in places like Masbate or the Mindanao hinterlands would have a much bigger positive impact on both the local and the national economy.