A New Look at Special Economic Zones in Asia | Asian Development Bank

A New Look at Special Economic Zones in Asia

Article | 8 December 2015

As countries in developing Asia adjust to shifting global economic realities, new tools to drive development can appear hard to come by.

As countries in developing Asia adjust to shifting global economic realities – including lower trade volumes, volatile commodity prices, and ongoing slow growth in industrial economies – new tools to drive development can appear hard to come by.

Economists have spoken about a “new normal,” in which economic development, like the industrialization that made countries like Japan and the U.S. – and more recently the People Republic of China (PRC) wealthy, will be more elusive and harder to maintain.

While mainstream economic development across Asia remains focused on building and maintaining infrastructure, providing better public services, and creating a positive business environment, many countries, including regional heavyweights like India, have returned to the concept of special economic zones (SEZs) as a core element in their development strategies.

A new report from the Asian Development Bank on SEZs, part of the Asian Economic Integration Report 2015, looks at the factors that can drive successful SEZs and what can make them a tool for growth and development.

SEZs have a mixed reputation. There have been stunning success stories – such as Shenzhen, which turned a fishing village in southeastern PRC into an industrial powerhouse in under three decades.

Shenzhen’s success has been largely attributed to its ability to create what economists call “backward and forward linkages” with its domestic economy. This meant that for every foreign investor that took advantage of Shenzhen’s tax incentives and built-to-export infrastructure, there were Chinese firms providing intermediate goods and services, ensuring that the SEZ was not a stand-alone freeport, but an integral part of the region’s industrialization. In turn, this fostered technology transfer and skills development.

Shenzhen’s example inspired copycat SEZs not only in PRC, but around the world. The latest estimate is that there are over 4,300 SEZs in operation globally, up from 500 two decades ago.

But for every success story, there are also failures. Oversold and poorly planned, many SEZs have promised industrial development and good jobs, only to incur heavy costs through expensive tax breaks and poor governance. A common problem has been the failure to calibrate incentives. Rather than promoting industrial clusters, like Shenzhen, many zones have become enclaves with few links to the domestic economy.

Other issues include poor location and limited transport connectivity with major trading destinations. Some have simply been too small to allow for economies of scale and scope.

Some economists have recommended that countries steer clear of SEZs altogether. Their rationale is that given the costs and mixed records, the risks outweigh the returns. Better to concentrate on domestic reforms that have fewer distortions, the thinking goes.

Counting on domestic reforms to materialize, however, also poses risks. SEZs can be a politically low cost way to experiment with economic reforms that may otherwise be unable to be passed through national legislation. Where SEZs have seen the greatest success, they have shown a politically viable path for development friendly economic and regulatory reforms at a national level.

ADB’s new analysis argues that if designed correctly, SEZs can continue to help countries attract foreign investment, develop domestic industries, and encourage better economic policymaking and reforms.

The special chapter notes that the number of SEZs in an economy is positively related to overall export performance. Countries in Asia with SEZs attract significantly more foreign direct investment (FDI), with the existence of SEZs corresponding to 82% greater FDI levels.

Putting in place independent governing authorities and enabling legal frameworks are key ingredients that can help SEZs increase the chances of success. Among the countries in Asia with SEZs, those with independent SEZ authorities increase exports by 27% compared to those without.

Most importantly, the report argues that a clear link to an economy’s development strategy increases the likelihood SEZs will have broad nationwide impact.