The Pros and Cons of SEZs

Prepared by Rakhine Thahaya Association (Yangon)

ABSTRACT A large number of people simply do not understand what an SEZ is and whether it will be good or bad for their regions. This paper is based on well-known international papers for examining whether it will be suitable or not for the regions. No facts, opinion and analysis are included from Rakhine Thahaya Association. KEYWORDS Economy. Liberalization. Globalization. Special Economic Zones. Foreign And Domestic Investment

single window clearance, (v) simplified procedures, and (vi) exemptions from various restrictions that characterise the investment climate in the domestic economy. These benefits foster a conductive business environment to attract local and foreign investment, which would not otherwise have been forthcoming. As a result of these benefits, many developing countries have been promoting zones with the expectation that they will provide the engine of growth to propel industrialisation. Emerging of SEZs Worldwide, the first known instance of an SEZ seems to have been an industrial park set up in Puerto Rico in 1947 to attract investment from the US mainland. In the 1960s, Ireland and Taiwan followed suit, but in the end of the 1970s, China designed its own model of Special Economic Zones (SEZs) gain global currency with its largest SEZ being the metropolis of Shenzhen. Special Economic Zones have been established in several countries, including the Peoples Republic of China, Iran, Jordan, Poland, Kazakhstan, the Philippines and Russia. North Korea has also attempted this to a degree, but failed. In the United States, SEZs are referred to as Urban Enterprise Zones. According to the International Labour Organisation (ILO, Boyenge 2007), the number of countries operating SEZs has grown from 25 in 1975 to more than 130. The number of SEZs has exploded, from 79 in 1975 to more than 3,500 (including zones in developed economies), an increase of over 4,000 percent in 30 years. Most of that expansion occurred in the past 20 years.

Introduction An SEZ is a geographically demarcated region that has economic laws that are more liberal than the countrys typical economic laws and where all the units therein have specific privileges. SEZs are specifically delineated dutyfree enclaves and are deemed to be foreign territory for the purposes of trade operations, duties and tariffs. The principal goal is to increase foreign investment. SEZs may be set up for manufacturing of goods or rendering services or both and may be multi-product, sector specific, or Free Trade and Warehousing Zone, including tourism and retail sales, permit people to reside on site. These are inspired by the Becattini (1990) concept of industrial district. It is defined as a socio-territorial entity which is characterised by the active presence of both a community of people and a cluster of firms in one bounded area. Unlike Export Processing Zones (EPZs) which are enclosed industrial estates, SEZs are mega industrial towns spread over several square km. Zones are usually provided with a physical infrastructure supporting the activities of the firms and economic agents operating within them. This infrastructure usually includes real estate, roads, electricity, water, and telecommunications. Zones are defined by a specific regulatory regime. This regime may be contained in one or several dedicated laws or through a set of measures contained in a number of texts. The administration of the regime usually requires a dedicated governance structure, centralized or decentralized. The main objectives of the SEZs are: a) Generation of additional economic activity; b) Promotion of exports of goods and services; c) Promotion of investment from domestic and foreign sources; d) Creation of employment opportunities; e) Development of infrastructure facilities. The promotion of SEZs is an attempt to deal with infrastructural deficiencies, procedural complexities, bureaucratic hassles and barriers raised by monetary, trade, fiscal, taxation, tariff and labour policies. These structural bottlenecks affect the investment climate adversely by increasing production and transaction costs. Since countrywide development of infrastructure is expensive and implementation of structural reforms would require time, due to given socio-economic and political institutions, the establishment of industrial enclaves (SEZs/EPZs) is seen as an important strategic tool for expediting the process of industrialisation in these countries. The zones offer numerous benefits such as, (i) tax incentives, (ii) provision of standard factories/plots at low rents with extended lease period, (iii) provision of infrastructure and utilities, (iv)

Table 1. Key Demographic Figures

Focusing on the approximately 2,500 zones in developing and emerging economies identified by FIAS (2008), Figure 1 shows the mix of zones across regions. More than 1,000 zones have been identified in East and South Asia, with a large number in India, China, Vietnam, and the Philippines. Thirty percent of all zones worldwide are in Latin America; most of these in Central America, Mexico, and the Caribbean. Sub-Saharan Africa accounts for only 4 percent of zones.

Figure 1. Regional Breakdown of Zones in Developing and Emerging Economies, 2008

The Pros of SEZs: Human Development and Poverty Reduction SEZs may affect human capabilities Employment effects Human capital formation effects Technology upgrading effects Employment Effects Ownership Arrangements Ownership patterns between the public and the private sector also show strong regional patterns: Latin American zones are dominated by the private sector, African and Asian zones are split between public and private sectors, and zones in the Middle East and North Africa as well as Eastern Europe and Central Asia are mainly controlled by the public sector. According to FIAS, 62 percent of the 2,301 zones in developing and transition countries are private sector developed and operated. This contrasts greatly with the 1980s, when less than 25 percent of zones worldwide were in private hands. The key factor behind the rise of private zones is the perception that private zones are more successful than most public zones, as well as a general lack of funding for new government zone development.
Region Americas Asia and the Pacific Sub-Saharan Africa Middle East and North Africa Central and Eastern Europe and Central Asia Total Public Zones 146 435 49 173 69 872 Private Zones 394 556 65 40 374 1,429 Total 540 991 114 213 443 2,301

Table 2. Relative Importance of SEZs in East Asian Economies (as share of National economy)

Many developing and transforming countries typically have a major unemployment problem and one of the aims of the host governments in establishing SEZs is the increase in employment. The employment effect of SEZs operates through three channels: 1) SEZs generate direct employment for skilled and unskilled labour; 2) SEZs also generate indirect employment; and 3) SEZs generate employment for women workers. It is believed that employment creation generates incomes, creates non-pecuniary benefits, improves the quality of life of labour and enhances their productivity. These, in turn, have poverty reduction effect. SEZs directly employ between 63 million (FIAS) and 68 million (ILO) persons worldwide (see Table 1).

Note: Excludes single factory programs. Sources: BearingPoint; ILO database; WEPZA (2007); FIAS research.

Table 3 Private and Public Sector Zones in Developing and Transition Economies Table 4. Employment Contribution of SEZs

Figure 2. Ownership Structure of SEZ Investments, 2009

Figure 3. SEZ Labour Market Integration

Attracting Foreign Direct Investments (FDIs) The first proximate measure of success of an SEZ program is the investment it attracts. Without investment, there will be no employment or exports and no possibility of realizing structural economic benefits. Forerunning ASEAN countries such as Malaysia, Thailand, and Indonesia have received massive FDIs from Japan and Asian Newly Industrializing Economies (NIEs) such as South Korea, Taiwan, Hong Kong and Singapore since the middle of the 1980s.

Figure 4. Average Monthly Wages plus Benefits (Converted at Purchasing Power Parity [PPP])

Land prices skyrocketing Zone fever along with other real estate speculation led to a severe threat to arable land in the country. Meanwhile, the threat of requisition in areas near SEZs led farmers to reduce their investment in the land. The skyrocketing of land prices expelled the local people from their native lands. Loss of agricultural land The building of SEZs on prime agricultural lands would lead to a serious implication for food security. Misuse of land for real estate
Figure 5. Share of females in the SEZ Workforce Compared with the Overall Nonagricultural Workforce

Skill Formation (Human Capital Formation) Effects Skill formation for the poor unskilled workers also occurs through assimilation of industrial discipline. This might increase the welfare of poor unskilled workers by increasing the range of job opportunities available to them. Improved skills and productivity increase workers income earning capacity. Given the high labour turnover rate in the SEZs, domestic firms can benefit from this training by hiring workers previously employed in the zone firms. In the long-term, the creation of a macro environment in which returns to education and skill development are high, is an important component of the skill formation effect of SEZs. Zone units raise the demand for and wages of skilled workers through technology transfer and capital investment, which in turn provides positive incentives for educational attainment and skill formation. Technology Upgrading Effects Foreign collaborations are a direct source of new technology, managerial, and marketing networks in the zones. But they also narrow the technology gap between the foreign and domestic firms indirectly by promoting spillovers within the zone and then outside the zone. The Cons of SEZs: Emerging Issues The policy of promoting zones is expected to give a big push to exports, employment and investment in SEZs. But the policy has come under heavy criticism. Dissenters contend that the policy would be misused for real estate development rather than for generating exports. Concerns have also been expressed on the displacement of farmers by land acquisition, loss of fertile agricultural land, a huge revenue loss to the exchequer and adverse consequences of uneven growth. Land acquisition By offering a political solution (involving state force) to an economic problem, the land broker function of states has increasingly come under attack by peasants unwilling to relinquish their land. Perhaps the biggest concern about the SEZ is the potential for real estate speculation and loss of agricultural land. The SEZ will lead to a large-scale land acquisition by developers, displacement of farmers, meagre compensation and no alternative livelihood for them.

Promoters will get land cheaply and will make their fortune out of real estate development and speculation in discriminately. The minimum requirement for processing area, the rest will be for residential, recreational facilities. By subtracting the land and development costs from the sale prices for industrial and residential plots, the developer of Mahindra World City, MWC, in India is making over US$135,000 per acre on industrial leases. Labour Abuse In addition to real estate speculation, zones also produced other problems. When large companies enter a rural village, a considerable hope of residents is that they or their kids will receive employment. Indeed, this is often the promise given by companies and governments to convince farmers that they will benefit from having their land acquired. However, seven million people out of Shenzhens total population of 12 million are migrant workers, with almost no legal or social protection [French 2006]. 1992 data for the Guangdong province, home of Shenzhen, shows very high death rates among industrial workers and more than 500,000 child labourers [Weil 1996]. In 2003, at least half the firms in Shenzhen owed their employees wage arrears [ICFTU 2003], and at least one-third of Chinese zone workers received less than minimum wage [Jayanthakumaran 2003]. This labour abuse is accompanied, unsurprisingly, by crime. Shenzhen now has a crime rate that is nine times higher than that of Shanghai, and is notorious for the trafficking of women and sex trade [Goswami 1997]. Relaxed customs have also led to large-scale smuggling; two of the original zones, Shantou and Xiamen, were hit by massive tax and smuggling frauds in 2000 and 1999 respectively [Business China 2006]. Social Structure Damage While the villages were still largely agrarian before the arrival of SEZs, they had begun to experience urbanizing pressures. After SEZs, farmers started small shops and businesses. These include general provision stores, photo shops, car and construction parts shops, juice and small vegetable stands. The SEZs has most dramatically accelerated urbanization of the villages, by unleashing a process of land dispossession, real estate speculation and attendant changes in land use. The farmers on MWC claimed that they were promised jobs and first class infrastructural improvements to the village, such as 24-hour electricity, roads, schools and medical clinics. But 75 per cent of households that had land acquired say that they received more loss than benefit from the SEZ, over 70 per cent of the landless in the survey reported that they had neither lost nor benefited (the 30 per

cent who reported a loss did so on account of the loss of livestock). Uneven growth The setting up of SEZs in a region where there is already a strong tradition of manufacturing and exports aggravated regional disparities. Inequities The incentives dished out to SEZs created a tilted playing field between SEZ and non-SEZ investors. Relocation Companies simply relocated to SEZs to take advantage of the tax concessions being offered and little net activity would be generated. Revenue loss The policy would cause a revenue loss of millions of dollars. Conclusion As SEZ programs continue to proliferate, particularly in developing countries, it is critical for policy makers to learn from past experiences and anticipate the implications of the emerging and potential issues discussed in this paper. Future SEZ program success will require adopting a more flexible approach to use SEZ instruments effectively to leverage a countrys comparative advantage and ensure flexibility so that the zone program can evolve over time. There is, however, no conclusive evidence regarding the role of the zones in the development process of a country. The literature review indicates that while some countries have been able to capture the dynamic and static gains from zone operations, many others have not [Aggarwal 2006a]. Moreover, SEZ impacts on host societies go well beyond economic efficiency. Zone programs that fail to offer opportunities for quality employment and upward mobility for trained staff, derive their competitive advantage from exploiting low-wage workers, and neglect to ensure environmental sustainability are unlikely to be successful in achieving the possible dynamic benefits, and are likely to be forced into a race to the bottom. By contrast, zone programs that recognize the value of skilled workers and seek to provide the social infrastructure and working environment in which such workers thrive will be in a position to facilitate upgrading. Firms located in economic zones are known to have much more female-intensive employment than firms in the rest of the economy (Milberg and Amengual 2008). In this regard, zones have created an important avenue for young women to enter the formal economy. On the other hand, zones have long been criticized for failing to meet labor standards, particularly for not appropriately considering the specific needs of female workers. Thus, zone programs will need to strengthen their approach to social and environmental compliance issues, establish clear standards, and put in place effective Monitoring and Evaluation (M&E) programs. At the national policy level, economic zones should be seen as an opportunity to experiment with policy innovations.

Available data suggest that SEZs are an important destination of FDI in some countries. In the Philippines, for example, the share of FDI flows going to the countrys ecozones increased from 30 percent in 1997 to over 81 percent in 2000 (UNCTAD, 2003). However in many other countries, . . . zones have played a marginal role in FDI attraction and most investment is of domestic origin (FIAS, 2008, p. 35). ILO counts the SEZs of advanced economies in its statistics, but FIAS does not. Types of Zones
The first modern zone was established in Ireland in 1959. Since then, a variety of different zone setups have evolved that are subsumed under the SEZ concept in this paper, namely: Free Trade Zones (FTZs) also known as commercial free zones) are fenced-in, duty-free areas, offering warehousing, storage, and distribution facilities for trade, transshipment, and re-export operations. Export Processing Zones (EPZs) are industrial estates aimed primarily at foreign markets. Hybrid EPZs are typically sub-divided into a general zone open to all industries and a separate EPZ area reserved for exportoriented, EPZ-registered enterprises. Enterprise Zones (EZs) are intended to revitalize distressed urban or rural areas through the provision of tax incentives and financial grants. Freeports typically encompass much larger areas. They accommodate all types of activities, including tourism and retail sales, permit on-site residence, and provide a broader set of incentives and benefits. Single factory EPZ schemes provide incentives to individual enterprises regardless of location; factories do not have to locate within a designated zone to receive incentives and privileges.* Specialized zones include science/technology parks, petrochemical zones, logistics parks, airport-based zones, and so on.
*Single factory EPZ programs are similar to bonded manufacturing warehouse schemes, although they typically offer a broader set of benefits and more flexible controls.

Annex Acronyms and Abbreviations

CIS Commonwealth of Independent States EPZ Export Processing Zone FDI foreign direct investment FIAS Foreign Investment Advisory Service FTA free trade agreement FTZ free trade zone IBRD International Bank for Reconstruction and Development ICFTU International Confederation of Free Trade Unions ICT information communications technology IFC International Finance Corporation ILO International Labour Organization IT information technology MIGA Multilateral Investment Guarantee Agency NTBs non-tariff barriers OECD Organisation for Economic Co-operation and Development QIZ qualified industrial zone SCM subsidies and countervailing measures SEZ special economic zone UNCTAD United Nations Conference on Trade and Development WCO World Customs Organization WEPZA World Economic Processing Zones Association WTO World Trade Organization

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