A growing number of governments around the world are embracing special economic zones (SEZs) as an economic policy tool. Their motivations range from promoting industrialisation and attracting foreign direct investment (FDI) to levelling up the country’s development. Douglas Zeng, a senior economist at the World Bank, draws on his research of SEZs around the world to explain what these governments must learn from the successes and failures of established free zones, and why the concept is not well-suited to every country.
Q: What are governments’ most common pitfalls when launching an SEZ programme?
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A: As a highly complex policy tool, there are many things that could go wrong. Among the most common are lack of strategic planning. Using the ‘we build it and they will come’ approach without fully understanding the private sector demand is a recipe for failure. Another pitfall is failure to address market and government failures. Some governments focus too much on fiscal incentives but don’t address the infrastructure and business environment issues for the zones, which defeats the purpose of SEZs. Another relates to the policy and legal environment. A robust legal and regulatory framework is the prerequisite for a successful SEZ, and it must be coupled with strong implementation and operational capacity. The fourth pitfall is an inability to mitigate environmental and social risks. Zones must fully comply with rising international environmental, social and governance standards.
Q: So SEZs are not recommended for every country?
A: The results of my research show that the success of SEZs in developing countries is mixed. It’s not a policy tool for every government, and a prudent approach is vitally important. An SEZ is supposed to complement market forces by helping overcome market failures. Those failures need to be properly identified ex ante and typically include a malfunctioning land market, deficient industrial infrastructure needed for industrial agglomeration, and a poor regulatory and business environment caused by the government’s co-ordination failures internally or with the private sector. If such failures can be addressed through nationwide and sector-wide reforms, then the SEZ approach might not be necessary. Even if a zone approach is fully justified, without sufficiently strong investor demand, the programme shouldn’t proceed. And if there is sufficient demand, it’s better to implement it through the private sector or a public-private partnership to maximise market forces.
Q: Can new programmes draw any lessons from China, the concept’s pioneer?
A: The first modern free zone was actually the Shannon Free Zone in Ireland, which started in 1959. However, three key lessons can be learned from China, which might be the country where this concept has had the biggest impact. The reason that Shenzhen, China’s first SEZ which opened in 1980, is very successful is mainly due to its role as the testbed of many market-oriented policy reforms. This covered land, taxation, the labour market, state-owned enterprises and investment, especially FDI. Another lesson is to take a gradual approach. China started its programme at a small scale, with only four SEZs at the beginning. And once they were successful, China scaled it up nationwide. Finally, strong commitment is needed. Even when reforms associated with SEZs faced strong opposition within the government, the top leadership was able to push the reforms through with strong conviction.
Q: What does the incoming 15% global minimum corporate tax signal for SEZs’ future?
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A: The generous fiscal benefits offered by many governments to attract potential investors to free zones can lead to big revenue losses. And the results aren’t proportional. Studies and surveys show that what investors want the most from a zone is a conducive business environment, efficient services and aftercare, and high-quality infrastructure, not fiscal incentives. The incoming 15% global minimum corporate tax can help prevent governments from offering generous fiscal incentives, especially tax holidays, and shift their focus towards improving the business environment. In the long run, this would help zones be more competitive and sustainable. Therefore, it’s long overdue.
Free Zones Awards 2023
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