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Caveat on Special Economic Zones

The newest topic in economic development theory is the establishment of special economic zones (SEZs). This refers to geographically designated areas of a country set aside for specifically targeted economic activities to promote national economic growth by using support measures to attract both foreign and domestic investments.

By Jealous Chishamba

Business activity in the designated areas is subject to different rules from those prevailing in the rest of the economy. Those rules can pertain to investment conditions, trade, customs and taxes, among others.

SEZs can have different forms of ownership. In publicly owned and operated zones, the government takes on the role of developer, operator and regulator of the zones, whereas in privately-owned zones, companies develop, manage and operate the zones under the government’s regulatory oversight.

According to past experiences in other countries, it is too simplistic to say that private sector development of zones is better than public sector development bearing in mind the success of many East Asian countries and of Mauritius with public sector–led models. However, on the balance, the private sector can be much more dynamic in implementing zones in many countries hence reducing implementation failure. In light of the growing importance of SEZs as a policy instrument, SEZs warrant a closer and more critical inspection.

If implemented properly, SEZs play an important role in attracting investors who can benefit from a wide array of fiscal and regulatory exemptions within the SEZs’ borders. The call for special zones is justified as a solution to asymmetry in economic development; helps alleviate large-scale unemployment; and decongest capital cities.

China is at the top of any list of success stories in attracting investment and promoting exports through SEZs. At the bottom of the list probably sits Africa, where, outside of Mauritius and partial success in Kenya, Lesotho, and Madagascar, most zones initiatives have been failures. Anecdotal evidence turns up many examples of investments in zone infrastructure resulted in “white elephants,” or zones that largely resulted in an industry taking advantage of tax breaks without producing substantial employment or export earnings.

Notably, zones have to be truly “special” and provide services that are not available outside of zones, with particular focus on infrastructure and the business environment. Zones should be developed to overcome nationwide binding constraints, such as rigid and constraining regulatory regimes, poor infrastructure and inadequate trade logistics in a limited area. They must be accessible to basic infrastructure, such as power, water and roads.

The determination of zone locations varies from economy to economy. Some adopt a top-down approach to the establishment of zone networks, with the government deciding on the location and the size of the territory that will gain zone status. Others take a bottom-up approach whereby local municipalities or even companies can request the granting of zone status. Last but not least, some economies use a mixture of the two approaches.

Most African countries are interested in continuing to learn from the Chinese experience on industrial zones. Ironically, developing countries are often attracted by success results of SEZs, but they do not want to go through the basics required before the special zones can be implemented or created.

For example, Zimbabwe has ten provinces which have specific development needs and competitive advantages. As a starting point, the government reportedly earmarked Norton and Mazowe areas for agriculture. Although there is no single and universally accepted classification of SEZs, the commonest approaches is to group them according to key factors such as their development objectives, their location and the types of activities they house instead of impromptu classification.

For Zimbabwe, the current influx of many economic agents into the capital city demonstrates that there are deficiencies which still need to be addressed to enable various provinces and cities attract the redundant labour.

In countries suffering from high levels of unemployment, zones have been used to boost job creation by attracting investment in highly labour-intensive industries. Currently, the government has promulgated the SEZs Bill and Act in a bid to copy and paste the success results from other countries.

Putting in place a clear and transparent legal and regulatory framework is the first step to zone programme development. It helps to establish the rules of the game for all stakeholders involved in the process.

The only way to empower the provinces and cities in Zimbabwe is to implement SEZs in “good faith”.

Although strong commitment from the government is needed, projects must be designed carefully on the basis of clear strategic plans. The commercial case must be present. Moreover, that commercial case must be based on sustainable sources of competitiveness and creation of value chains, not based on fiscal incentives only.

In practice, the success of zones is almost fully intertwined with the competitiveness of the national economy, alignment with national development strategy and the national investment environment.

Whereas the establishment of SEZs is a noble idea, Zimbabwe needs to overcome the past stigma and make the zone programmes truly successful. Sometimes zones fail because they miss the basics such as power, water, one-stop services and lack of institutional authority to implement developmental programmes. In addition, there are several conditions to be met before zones can yield the intended benefits. This should include a rigorous assessment of local market conditions, connectivity, the industrial base, the supply chain, the business environment, and land and labour supplies. To ensure its smooth and efficient operation, private-sector participation can be encouraged through a public-private partnership (PPP) approach. In such cases, experienced private-sector partners will be responsible for zone development and operation and for the provision of certain on-site infrastructure and services.

For Zimbabwe, there should be a clear strategy for SEZs which is fully integrated in the country’s industrial policy and economic development strategy. The strategy must be based on comparative advantage for each province which is critical to ensure their viability and long-term sustainability based on real market demand.

Analysts and high-level panel discussions on the economic zones programme argue that a predictable and transparent legal and regulatory framework is needed to ensure the clarity of roles and responsibilities of various parties and to provide protection and certainty to the developers and investors. Such a framework helps to ensure that the zones attract the right investments and are implemented with high standards. That will also avoid unpredictable risks, such as bureaucratic setbacks or interference and land speculation, among other factors.

Achieving success with SEZs programmes in the future will require adopting a more flexible approach to using the instruments of economic zones in the most effective way to leverage a country’s sources of comparative advantage, and to ensure flexibility to allow for evolution of the zone programme over time.

Fundamentally, this will require a change in mind-set away from the traditional reliance on fiscal incentives and instead focusing on facilitating a more effective business environment to foster firm-level competitiveness, local economic integration, innovation and sustainability. It will also require proactive, flexible, and innovative policy approaches to address today’s significant macroeconomic constraints and the many unanticipated challenges that no doubt will shape the environment in the years to come.

A haphazard approach in the decision of zones breeds nepotism hence a recipe for failure of the special zones programme. An important caveat is that establishment of SEZs is not a switch and go, and in some countries, there are zones which have failed to attract investors. These were not truly “special” in terms of business environment and infrastructure provisions, and many constraints were not significantly improved inside the zones.

Given the great complexity and potential risks of zone programmes, strong and long-term government commitment is needed to ensure policy continuity and the adequate provision of various public goods. Regulatory uncertainty stemming from frequent and non-transparent changes of legislation and ambiguous fees and charges imposed at the municipal level also plague the success of a noble idea.

Chishamba is a Zimbabwean banker with experience in treasury and corporate banking. He writes in his personal capacity.

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