Special Economic Zones (SEZs) are geographical spaces in which firms are provided with regulatory or financial incentives. Typically, in a SEZ, “the rules of business are different from those that prevail in the national territory. These rules principally deal with investment conditions, international trade and customs, taxation, and the regulatory environment; whereby the zone is given a business environment that is intended to be more liberal from a policy perspective and more effective from an administrative perspective than that of the national territory” (Farole, 2011, p. 23). SEZs aim to encourage particular types of economic activity by improving the investment climate (Conway 2015).
SEZs can be broadly classified into four categories:
- export processing zones facilitate manufacture of goods for export, are small in size, and offer supporting infrastructure and services;
- free trade zones facilitate international trade in both goods and services, are small in size and are physically separated from the rest of the economy;
- freeports are large scale and cover a range of both domestic and international activities;
- enterprise zones cover a range of economic activities within deprived areas, often in remote regions.
SEZs are normally established with the aim of achieving one or more of the following policy objectives:
- attracting foreign direct investment (FDI) –almost all SEZs aim, in part, to attract foreign direct investment.
- supporting export development – For countries which have adopted protectionist import substitution policies, SEZs permit a country to develop and diversify exports while keeping protective barriers intact.
- acting as experimental laboratories for the application of new policies and approaches – in some countries, such as China, foreign direct investment, legal, land, labour, and pricing policies were introduced and tested first within SEZs before being extended to the rest of the economy.
There has been a large increase in the number of SEZs, with over 3,500 export processing zones employing 66 million people across 130 countries (UNIDO 2009). The majority of SEZs are in Asia and Latin America, where they were first introduced in the 1970s. They are less widespread in Africa, but increasing (UNIDO 2009).
Assessment of SEZ performance is difficult because of a lack of sufficiently accurate longitudinal performance-related data. In addition, there is a strong interaction between SEZs and the wider investment climate, making it difficult to isolate the effects of SEZs. Evidence for the success of SEZs is reliant on country case studies which are highly context specific.
Quantitative empirical research shows that many SEZs have been successful in generating exports and employment, and come out marginally positive in cost-benefit assessments (Jayanthakumaran 2003, Monge-González et al. 2005). Most examples of successful SEZs are from East Asia, where SEZs have facilitated industrial development and technological upgrading. SEZs in China provided a platform for attracting foreign direct investment and not only supported the development of China’s export-oriented manufacturing sector, but also served as a catalyst for sweeping economic reforms that later were extended throughout the country (Farole and Akinci 2011). In Latin America, countries such as the Dominican Republic, El Salvador, and Honduras used free trade zones to take advantage of preferential access to U.S. markets and have generated large-scale manufacturing sectors in economies that previously were reliant on agricultural commodities. In the Middle East and North Africa, SEZs have played an important role in catalysing export-oriented diversification in countries such as Egypt, Morocco, and the United Arab Emirates.
However, using case studies from Africa, Asia and Latin America, Farole and Akinci (2011) show that many SEZs have resulted in industries taking advantage of tax breaks without producing substantial employment or export earnings. Moreover, although many export-processing zones have been successful in attracting investment and creating employment in the short-term, many have failed to remain sustainable when labour costs have risen or when preferential trade access is lost. There is limited evidence that SEZs have been successful in sub-Saharan Africa, with the exception of Mauritius, where the SEZ was a central policy tool supporting a highly successful process of economic diversification and industrialisation (Farole and Akinci 2011). SEZs have also had limited success in South Asia, with the exception of Bangladesh in ready -made garments exports (Khan 2010, Jenkins at al. 2014).
Moberg (2015) argues that the success of SEZs depends on the nature of state-business relations in the country. Where state-business relations are collusive or rent-seeking, SEZs may be set up or function as a mechanism of rent-extraction of political elites from foreign and domestic private firms. On the other hand, where state-business relations are collaborative, political elites have an incentive to provide high quality infrastructure and well enforced and streamlined regulatory procedures to firms located in SEZs to enable them to be successful exporters. Moberg suggests that SEZs in India have not been successful as local elites considered these SEZs as a way of extracting bribes and were not interested in their long-term development. However, SEZs in China have been largely successful as the political decentralisation that occurred in the reform process led to local governments having an interest in the success of SEZs as they gained a share of the tax revenues from the firms’ profits.
How did the state of Penang in Malaysia become a major export hub?
Penang, a state in northwest Malaysia, is a pioneer in the establishment of free trade zones in East Asia and has become a major export hub for electronics. After consolidating its position in manufacturing trade by engaging in low-end activities and final assembly within production networks in the 1980s and 1990s, it has now moved into several electronics-related product lines with high-growth prospects.
Committed political leadership contributed to the emergence of a synergistic relationship between the state and multinational corporations that was critical for the state’s success in exports and technological upgrading. The most important initiative of the Penang government in fostering collaborative state-business relations was the creation of the Penang Development Corporation (PDC). This was the principal development agency of the government, but it was able to maintain independence from the bureaucracy, which allowed it to be the key coordinating agency for the formulation and implementation of an export-oriented industrialisation strategy, with a clear focus on electronics as the leading sector.
Key components of industrial policy were a strong emphasis on cluster development, the encouragement of close links between multinationals and local firms, and the effective use of industrial estates for infrastructure development. An innovative land bank policy allowed market acquisition of private land, and a skill development policy through the Penang Skill Development Centre helped ensure that skill shortages did not hamper the progress of industries up the value-added ladder.
Crucial to the role of the PDC in creating an export hub in Penang were the proactive attempts to develop links between local firms and multinational affiliates, and to address emerging bottlenecks in skills development and infrastructure
Source: Athukorala (2014).
- Athukorala, P. (2014). Growing with global production sharing: The tale of Penang Export Hub, Malaysia. Competition and Change, 18(3), 221-245. See document online
- Conway, K. (2015). Evidence and approaches note – Special economic zones. London: DFID.
- Farole, T. (2011). Special economic zones in Africa: Comparing performance and learning from global experiences. Washington, DC: World Bank. See document online
- Farole, T., & Akinci, G. (Eds.). (2011). Special economic zones: Progress, emerging challenges and future directions. Washington, D.C. The World Bank. See document online
- Jayanthakumaran, K. (2003). Benefit-cost appraisals of export processing zones: A survey of the literature. Development Policy Review, 21(1), 51–65. See document online
- Jenkins, R., Kenedy, L., & Mukhopadhyay, P. (2014). Power, policy and protest: The politics of India’s special economic zones. Delhi: Oxford University Press.
- Khan, M. (2010). Political settlements and the governance of growth-enhancing institutions (SOAS Working Paper). London: School of African and Oriental Studies. See document online
- Moberg, L. (2015). The political economy of special economic zones. Journal of Institutional Economics, 11(1), 167-90. See document online
- Monge-González, R., Rosales-Tijerino, J., & Arce-Alpizar, G. (2005). Cost-benefit analysis of the free trade zone system: The impact of foreign direct investment in Costa Rica (OAS Trade, Growth and Competitiveness Studies). See document online
- UNIDO. (2009). Industrial development report 2009: Breaking in and moving up: New industrial challenges for the bottom billion and the middle-income countries. Geneva: UNIDO. See document online