Special Economic Zones in Africa
Special Economic Zones in Africa
Political Economy Challenges and Solutions
Abstract and Keywords
African countries have sought to replicate the success of East Asia by implementing special economic zones (SEZs). Despite decades of international experience, there is still no blueprint for successful SEZ policies, and the majority of SEZs fall well below expectations. This chapter argues that this is largely due to flaws in the political economy of SEZ schemes, which prevent replication of ‘best practice’ in SEZ development and management. It applies a ‘robust political economy’ framework, which divides political economy problems into those of inadequate knowledge and distorted incentives, to explain the problems with African SEZs and to suggest possible solutions.
Much has been made of the role of special economic zones (SEZs) in contributing to East Asia’s economic success. This has led to a rush of countries seeking to replicate this model of export-led growth and structural transformation by launching SEZ programmes of their own. The wave of SEZ projects in sub-Saharan Africa (SSA) is a case in point. The scale of their expansion in recent years has been remarkable, and more zones may be developed over the next decade than during the three preceding decades combined. This recent crop of SEZs should be expected to benefit from the experience of SEZ policy-making and implementation over recent decades. Yet the majority of SEZ projects continue to fall well below expectations, with the experience in SSA being particularly disappointing.
This chapter argues that often-cited problems with SEZs can largely be attributed to the political economy surrounding them. Because political economy issues are context-specific, the avenues to replicate ‘best practice’ for SEZ development and management are limited. We apply a ‘robust political economy’ framework, which divides political economy problems into those of inadequate knowledge and distorted incentives. The framework helps us examine the nature of the political economy problems that different countries seem to encounter, as well as to suggest some possible solutions to these problems. As we argue, governments should consider political economy concerns when setting the initial strategic objectives and carrying out strategic planning of zones.
(p.235) Section 12.2 provides a brief introduction to SEZs, their objectives, and international experience in their use. Section 12.3 discusses the experience of SSA countries with SEZs and traces some of the usual explanations for their failure back to their root causes of political economy. In Section 12.4, we introduce the political economy framework, which we apply to SEZs in Section 12.5, and illustrate with examples from the African experience. Section 12.6 concludes by outlining how political economy considerations can be understood and mitigated in the planning and implementation stages of SEZ programmes.
12.2 Special Economic Zones: Theory and Experience
SEZs are demarcated geographical areas within a country’s national boundaries. In these zones, rules of business are different, and often more liberal, from those that prevail in the national territory. Typically, these zones offer advantages to investors in terms of infrastructure, special customs regimes such as duty free import and export, special regulatory regimes, and a range of fiscal incentives. Export-processing zones (EPZs), free-trade zones (FTZ), and free ports are all different forms of SEZs. We will use ‘SEZ’ as a generic term, encompassing a broad range of such regime types.
SEZs have a long-established role in international trade. However, it was only in the 1970s and 1980s, starting with East Asia and Latin America, that zones became a cornerstone of trade and investment policy. In 1986, the International Labour Organization (ILO) reported 176 zones in 47 countries. By 2006, this had risen to 3,500 zones in 130 countries (Boyenge 2007).
SEZs have played a catalytic role in supporting structural transformation. This includes East Asia’s ‘tiger economies’ such as China, which used SEZs as platforms to support the development of export-oriented manufacturing. In Latin America, countries such as the Dominican Republic, El Salvador, and Honduras used EPZs to take advantage of preferential access to the US market. These zones generated large-scale manufacturing sectors in economies previously dependent on agricultural commodities. In the Middle East and North Africa, SEZs played an important role in promoting diversification in the Arab Republic of Egypt, Morocco, and the United Arab Emirates, among others.
SEZs are designed as instruments of trade, investment, and spatial industrial policy. They are generally established with a few specific, but by no means exclusive, policy goals, with export promotion and foreign direct investment (FDI) attraction central to almost all zones (FIAS 2008). They also unlock agglomeration economies by concentrating economic infrastructure and public (p.236) goods in one geographic area, allowing industries to overcome minimum size thresholds and begin to leverage scale economies (Collier and Page 2009).
In addition, zones have played an important role within the political economy of reform. In many countries, they have supported partial exposure to global markets while maintaining protective barriers in a ‘stepwise’ approach to reform. SEZs have helped piloting experimental new policies before rolling them out to the broader economy; and in the absence of political will to undertake reforms, acted as ‘second best environments’ and ‘pressure valves’ to absorb excess labour.
Despite the theoretical advantages of SEZs and high-profile success stories like China, SEZs have a decidedly mixed record. Investments in zone infrastructure have in many cases resulted in ‘white elephants’, which cost more to maintain than the benefits that they bring. SEZs can become zones where investors take advantage of tax breaks without delivering substantial employment or export earnings. Many traditional EPZs have been successful in attracting investment and creating employment in the short term, yet failed to sustain competitiveness in the face of rising wages or eroding trade preferences. Empirical research shows that many SEZs have been successful in generating exports and employment, and come out marginally positive in cost-benefit assessments (Warr 1989; Chen 1993; Jayanthakumaran 2003; Arce-Alpazer, Monge-González, and J. Rosales-Tijerino 2005; Wang 2013). However, as they give preferences to specific firms and distort markets, economists view zones as a second-best solution to policies promoting competitiveness more generally (Hamada 1974; World Bank 1992; Madani 1999). Another concern is that zones, by and large, have failed to extend benefits outside their enclaves or to contribute to upgrading of the domestic skills and the production base (Kaplinsky 1993). The SEZs in Africa are by no means shielded from these problems.
12.3 SEZs in Africa
Several African countries, including Liberia, Mauritius, and Senegal, launched SEZ programmes in the early 1970s. However, most African countries did not operationalize their programmes until the 1990s or 2000s. As of 2014, the majority of countries in SSA have active SEZ programmes, most of these being traditional EPZs and industrial parks.
The African experience with SEZs over the past two decades has been less than spectacular. With the exception of Mauritius and the partial initial success of Kenya, Madagascar, and Lesotho,1 most African zones have failed (p.237) to attract significant investment, promote exports, and create sustainable employment (Farole 2011). No country except Mauritius has managed to use SEZs to support a successful process of structural transformation. Even where SEZs have had some initial success, the quality of investment and employment has often been poor, undermining their sustainability. For example, Madagascar lost tens of thousands of jobs in SEZs following recent political turmoil and the country’s subsequent suspension from African Growth and Opportunity Act (AGOA) (Staritz and Morris 2013).
One reason for the failure of African SEZs may simply be poor timing. East Asia’s success was driven in part by an unprecedented era of globalization, underpinned by the emergence of global manufacturing production networks. Because most African countries launched their zones later, they faced a more established global competition. However, this is only a small part of the explanation. Most blame for the failed African SEZ schemes lies with zone planning and implementation, rather than with the global environment. While African zones in most cases established physical and regulatory environments that were more attractive than their national markets, these improvements were far from sufficient to attract footloose international investors. Other African zones have failed due to a lack of physical or social infrastructure, regulatory uncertainty, policy instability, weak implementation capacity, or lack of institutional coordination (Farole 2011).
These observations suggest that the real problems with African SEZs may lie in a lack of sustained political will or strategic planning, if not simply poor choice of location. However, it is still unclear why such problems emerged and persisted. There is no lack of research on the planning and implementation on SEZs in other countries. Legions of international consultants and development agencies have spent time and money on the matter. Asian countries with successful SEZs also provide technical expertise and financial support for African SEZ development as part of their bilateral development assistance (Bräutigam and Xiaoyang 2011).
Despite all this global experience and expertise, failures persist. We suggest that while most issues with SEZs, such as location, planning, regulatory frameworks, customs, administrative capacity, and management are technical in nature, their application and coordination rely on a solid political economy. A country’s politics and public institutions shape both the strategic thinking as well as the planning and implementation of SEZs, and are therefore crucial for SEZ success.
In Section 12.4 we outline the robust political economy framework, which we use to analyse the challenge of SEZs. We then apply the framework to the African experience, to show how political economy factors explain the difference between success and failure.
Economics usually treats governments as a ‘black box’, where the policies that set the rules by which economic agents act are exogenous (Basu 2000: 5). Such a framework assumes that policymakers have access to all relevant data and information to forecast the outcomes of different policies, and that the interest of policy makers and other government officials are the same as the stated objectives of the government. In standard macroeconomic models, there is no room for transaction costs of policy execution, and governments function by automation and based on perfect information.
Political economy models, by contrast, treat governments and the people within them as having their own goals and information asymmetries, and focus on the interaction between market and government actors. The School of Public Choice is a strand of political economy that applies the principles of incentives of economic agents to non-market actors, and explores the actions of people in politics or political institutions. Public choice extends the fundamental logic of standard microeconomic models, of rational actors who maximize personal utility, to the individuals within public institutions. It helps explain collective decision-making, such as policy adoption and implementation, by allowing for policies to emerge from the interplay among actors in political institutions (DiLorenzo 1988; Buchanan 2003; Wagner 2007).
Buchanan and Tullock (1962) suggest treating government officials as rational and utility maximizing, just as economists treat businesses and households, albeit with very different pursuits. Politicians seek to be re-elected, civil servants may seek larger offices and more staff, and bureaucrats seek more leisure time (Niskanen 1971; Tullock 1987). As a result, the self-interest of policy makers and policy executives often conflict with their assumed goal of maximizing social welfare. While assumptions of rational self-interest may produce optimal policies in the market place, in politics, they can lead to corruption and other forms of rent-seeking. Officials may, for instance, use trade policy for personal gains by selling import or export quotas (Krueger 1974) or by adjusting tariff rates to please interest groups (Grossman and Helpman 1994). Political elites may use foreign aid that they receive for their personal advantage, rather than distributing it effectively (Friedman 1958; Bauer 1971). They can even gain by depressing economic development (Easterly 2007). Officials may thus use policies to enrich themselves both financially and politically at the expense of the economy as a whole.
Another line of political economy studies starts with the assumption that the government is not perfectly informed. Even if a government has the right incentives and tries honestly to improve economic conditions, it lacks the knowledge and understanding of market fluctuations and possibilities that it (p.239) would need in order to improve on an economy’s resource allocation (Lavoie 1985; Horwitz 1996; Boettke 1998).
Much insight about the limited knowledge emerges from the ‘calculation debate’ over the feasibility of government planning in the Soviet Union (Horwitz 1998). As Hayek (1935: 157) explains, even if a central authority could calculate all prevailing prices, it would be unable to perform the multiple small adjustments in prices that constantly take place in a market regime. Not only are market participants more familiar with the details about local market conditions. They also constantly obtain and digest feedback on their performance through their profits, which allows for regular improvement and updates. This logic applies well to industrial policy, which relies on the premise that government can mitigate consequences of market failures (see, e.g., Harrison and Rodriguez-Clare 2009: 4). Industrial policy often fails because government is at an inherent disadvantage to market participants when it comes to knowing what development projects are actually worthwhile (Keck 1988).
A robust political economy analysis accounts for the absence of both government benevolence and of government omniscience. It considers problems caused by distorted incentives in the absence of benevolence as well as the limited knowledge of policy makers. This forms a reality-based, positive theory of policy-making, where policies are not exogenous and not automatically in the interest of the public.
Arguing that people in government are fallible is not to say that policymakers always get things wrong. Policy makers may well act for the benefit of social welfare and governments are sometimes successful in improving welfare through productive public investments. The goal with a robust political economy analysis is to identify policies and institutions that safeguard against policy makers exploiting their positions of power or wasting public resources. In the absence of alignment between incentives and beneficial policies and between knowledge and power, policy-making will often work against the common good. The right institutional environment can align the self-interest of public officials while still benefiting the citizenry and allowing market actors to allocate resources when they possess the superior knowledge to do so. This institutional environment constitutes a robust political economy (Leeson and Subrick 2006; Pennington 2011) (see Figure 12.1).
In the SEZ context, a robust political economy enhances the chances of zones improving market conditions and spurring economic development. Obstacles to getting SEZs right, such as providing a sufficient quantity and quality of infrastructure, can thus be overcome by introducing the right institutions. SEZs can only be successful when they benefit an economy despite the limitations of distorted incentives and inadequate knowledge. The more prominent the (p.240) political economy problems, the more careful a government must be when setting up the policies and institutions regulating SEZs.
In Section 12.5 we discuss the main political economy problems with SEZs, with a focus on the African context. The analysis deals with the two main political economy problems, namely distorted incentives and inadequate knowledge. If the incentives are not aligned with a successful outcome, the knowledge of proper SEZ policies and location will be irrelevant, as policy makers will not choose to act on them. In the presence of problems stemming from inadequate knowledge, any amount of political will and coherent motivation of an administration will be insufficient to get an SEZ scheme right.
12.5 The Political Economy of African SEZs
Many African SEZ programmes have suffered from both distorted incentives and imperfect information. In this section, we discuss how such political economy factors have manifested themselves and contributed to underperformance of African SEZs.
12.5.1 Problems of Distorted Incentives
African SEZ investments are often hampered by weak SEZ governance, inefficient bureaucracies, and poorly designed legal frameworks. Such problems may appear to stem from inadequate funding or weak capacity. However, at their root, they result from a lack of incentives of policy makers and other officials to improve on SEZ governance, policies, and laws.
The most blatant example of rent-seeking is when politicians use the privileges that SEZs confer, including access to cheap land and fiscal incentives, for (p.241) self-enrichment. SEZs around the world are rife with examples of corrupt land deals involving government officials. There have also been many instances where board members of an SEZ regulator pursue their own political and business interests in the SEZs by influencing SEZ regulations in ways that do not benefit the programme as a whole (Farole 2011: 182; Levien 2011).
However, corruption is not likely to be the main part of the African story. Distorted incentives primarily cause more subtle and legitimate forms of rent-seeking. In particular, politicians motivated by electoral gains have the incentive to use SEZs as an instrument to show visible progress and results. Given the short-term nature of the election cycles, the emphasis tends to be on immediate gains, which is usually at odds with the long-term nature of SEZs. Politicians also have the incentive to use SEZs as an instrument to confer privileges on various domestic constituencies, and therefore to quell potential internal political dissent. We will discuss these problems in turn.
188.8.131.52 The Appeal of Visible and Short-Term Results
The visible and marketable nature of SEZs gives politicians an incentive to adopt them even though simpler, quicker, and less expensive ways to promote job creation and growth may exist. SEZs can actually delay the process of getting the right policies in place, since it takes both time and money to develop and implement laws, regulations, and infrastructure projects.
It also becomes politically attractive to concentrate government efforts on the ‘hardware’ of SEZs, such as infrastructure, which is easy to measure and to display to the public as signs of progress. The ‘software’ of an SEZ, such as a good business climate, a proper legal framework, and the professional and effective execution of it, generates much less political capital. These SEZ features cannot be measured as easily or showcased visibly with ground-breaking ceremonies and modern entry gates. The emphasis on outward appearance of SEZs has often resulted in zones that fail to address the fundamental investment constraints that should have been their raison d’être. Senegal, for example, long faced problems of policy distortions and an unfriendly and unpredictable investment environment. Yet, its legal framework for SEZs has changed many times since its inception in the 1970s, often reinforcing rather than overturning the country’s investment climate weaknesses (Baissac 2011). South Africa has by far the best industrial infrastructure in Africa, yet its industrial development zones programme included significant provision of infrastructure. Meanwhile its regulatory regime, which was most in need of change, saw virtually no improvements (CDE 2012).
Because capital-intensive investments in industrial parks are attractive showcases for progress, policy makers also have the incentive to dismiss the value of other forms of production and usage of land. Agriculture in particular (p.242) has frequently been held in low esteem in comparison to manufacturing-oriented SEZs, despite most African countries having a comparative advantage in agriculture. Moreover, the very designation of a piece of land as an SEZ can raise its value substantially, which has often resulted in questionable deals to convert agricultural land into SEZs, without appropriate compensation to those previously using or occupying it. Widespread land grabbing was observed following India’s 2005 SEZ Act, resulting in the ‘conversion of the fertile land into cement structures’ (Khan 2008: 14; Mitra 2008: 13; Levien 2012). Viet Nam has seen around 100,000 rural villagers displaced to make way for industrial zones and complexes—a 2005 report asserted that more than a third of them were inadequately compensated (Action Aid Vietnam 2005). Nigeria has also faced protests from local communities over land compensation and resettlement around the SEZ of Lekki. These clashes inevitably cause delays in SEZ projects. They may also contribute to suboptimal use of land.
The political appeal of SEZ growth is also an incentive to attract more businesses to SEZs, regardless of whether they have the potential to be competitive or to fulfil their targets for investments and exports. The government may lower its standards for SEZ licences to attract a larger quantity of firms, many of which are not competitive enough to bring a positive contribution to the zone. If SEZ authorities have quantitative goals, they have the incentive to offer zone licences cheaply. One of the visible manifestations of this in African SEZs is the failure of many allegedly committed investors to actually set up operations on the ground.
In trying to expand their SEZ schemes, policy makers tend to cause inefficient fragmentation of resources. They often allocate investment to peripheral regions that are poorly positioned to attract investment with or without a zone. Several countries have SEZ programmes designed to establish one zone in each region, province, or state. In 2009, for instance, Tanzania announced plans to establish twenty-five to thirty zones, spread out around the country, before its first SEZ was even operational. Such expansion has serious fiscal implications in most countries. In the case of Tanzania’s zones, government committed itself to securing the land and carrying out feasibility studies for all twenty-five to thirty zones. South Africa is launching a new SEZ programme with thirteen identified zones, including at least one zone per province, with government commitment to finance feasibility studies and finance infrastructure in each zone location. Lesotho faced serious financial constraints preventing investments to expand successful industrial estates in and around the capital. The government nevertheless invested scarce resources in developing zones in remote regions. Not surprisingly, these zones went unoccupied while supply constraints in core areas worsened.
Many African SEZs have seen poor performance because of conflicting interests across official institutions. This complicates the work of building the authority, capacity, and communications between people that an SEZ scheme needs, thus hindering coordination across government bureaucracies.
Coordination failure among institutions can sometimes result in the creation of multiple, overlapping SEZ regimes. Tanzania, for example, launched an EPZ programme in 2002, led by its National Development Corporation. Four years later, when the EPZ programme was still not operational, the government passed a law setting up an SEZ regime under the purview of the Ministry of Planning, Economy, and Empowerment. The multiple regimes not only created internal policy confusion and competing interests, but also diluted already limited financial resources and sent conflicting signals to the investment community.
Another example is the EPZ Authority in Nigeria. Four years after its launch in 1992, before the first zone was established, the government created the Oil & Gas Free Zone Authority. The two organizations were in conflict for many years over which had the authority over a number of important activities. The Attorney General was ultimately forced to mediate.
The most common bureaucratic coordination problems occur not in the planning but in the implementation of SEZs. Several zone projects have failed because of misaligned incentives between groups promoting exports and investment and those responsible for fiscal matters, such as ministries of finance or customs. In Nigeria, the government has disputed with the customs officials for some twenty years, as they refuse to implement certain key SEZ incentives. The Tinapa SEZ, in the south-east of Nigeria, represents an extreme case of the consequences of conflicting interest. Announced in the mid-2000s, the zone was to become a ‘duty-free shopping’ destination. However, while the plan on which the investment was made called for a duty exemption of $5,000 per person, in the end, customs allowed only an exemption of $330 per person. This fatally undermined the business case for the zone after hundreds of millions of dollars were already invested, leaving it struggling for survival (CNN 2010; Daily Champion 2012).
So-called ‘one-stop shops’ are intended to showcase the potential of SEZs to deliver streamlined, efficient services. Ironically, when they fail to align the incentives and practices across agencies with highly disparate institutional objectives, one-stop shops vividly exemplify the challenge of coordination. Civil servants administering the work permits at a one-stop shop may for instance adopt the same protectionist and security-focused approach that dominates the immigration agencies in the rest of the country. There are in fact few African countries where central SEZ authorities have had decision-making power over the regulatory activities in the one-stop shop.
(p.244) When Lesotho introduced a one-stop shop for investors in 2007, the physical co-location of agencies did little to resolve the problems of facilitation because officers still reported to individual ministries (Farole 2011: 216). The head of the one-stop shop thus had no authority to ensure that the officers worked efficiently and provided quality service. The Dakar EPZ in Senegal was similarly plagued by an excessive bureaucracy and long delays in customs and agencies granting permits. Such defects are by no means limited to African SEZs. A 2005 study of Indian SEZs found that companies often needed to pass through fifteen different authorities before they could invest in the zones (Aggarwal 2005: 26).
Investment promotion activities supporting SEZs pose another common coordination challenge of agencies’ incentives. Relatively small countries such as Ireland, Sri Lanka, and Uganda often manage SEZs through their Investment Promotion Agency. However, most countries establish a separate SEZ Authority for promotion and regulatory oversight of the SEZs. This separation is sensible considering the different nature of the roles of the agencies. But separation also causes operational disconnect between the agencies, with little coordination between marketing, planning, and execution, and no formal process for handoff or cross-support of investor aftercare between the agencies. In many cases in SSA, including Tanzania, Nigeria, and Kenya, the lack of formal institutional link between the agencies, such as sitting on each other’s boards or even forming joint committees, contributes to operational disconnect.
Misaligned incentives between SEZs and local governments also lead to coordination problems in SEZ policy execution. In Ghana, the development plans for the Tema zone assumed that provision of water would be provided by the local municipality responsible for water provision in the area. Municipal officials, however, had no incentive to invest in delivering water to the zone. Because they did not receive any share of revenues from, or even political recognition for, the success of the zone, they prioritized delivering water to their municipal residents and businesses. Zone investors, with highly water-intensive activities like cocoa processing, were therefore forced to bring in water by tanker truck, at great cost.
In Nigeria, institutional competition and bureaucratic coordination failures led to a situation where the country’s flagship zone in Calabar was ultimately unconnected to the Calabar port, which established its own free zone. For many years, national institutions also failed to agree to dredge the port, and goods shipped to and from Calabar therefore had to go by road via Lagos instead.
Finally, misaligned incentives between public and private sector actors can in many cases cause coordination failure. Design and construction of SEZs requires coordination between off-site, typically public, infrastructure and on-site, often private, development, to ensure that they are seamlessly connected. (p.245) Time lags or discrepancies in the infrastructure delivered can result in destructive disagreements and mistrust between public and private parties. Governments often have the incentive to link their offsite investments to other political programmes, which may affect timing and alter approaches from initial plans. They may also want to secure private commitment before implementing public investments. Private zone investors, on the other hand, are reluctant to invest before the government commits to delivering infrastructure. In Ghana’s initial development of the Tema zone, misalignments in the expectations of the private developers and government led to a stalemate that stalled zone development for almost seven years (Farole 2010). Similar problems contributed to delays in the development in the Eastern zone in Ethiopia.
184.108.40.206 Avoiding REFORMS
Finally, SEZs are sometimes used for political, rather than an economic, purposes. This may not be a problem if the zones allow for better policies than would have been feasible in their absence. In the case of Mauritius, for example, the SEZ programme was the result of a process of political compromise that opened the door for a substantial political experimentation and reform. However, too often, officials use SEZs as a tool to appease regional interests, often with the aim of alleviating unemployment and spurring growth in lagging parts of the country. As such, SEZs can be a way for policy makers to avoid broader reforms that may mitigate these problems in the long term.
12.5.2 The Problem of Inadequate Knowledge
Even with the best of intentions and aligned incentives, the success of government policies is limited by the inadequate knowledge of policy makers. When it comes to SEZs, government officials face knowledge gaps on several crucial features, including their optimal location, appropriate industry focus, and the best combination of features that will attract investors. SEZs are often meant to open up new frontiers for a country, such as giving new life to an underutilized port or establishing new lines of production. However, the novelty that SEZs bring to an economy also makes it inherently difficult for the government to know the right combination of factors that will make a zone work.
220.127.116.11 Misguided Infrastructure Spending and Industry Concentration
Government miscalculations can lead to costly mistakes, not least in the form of misguided infrastructure projects. One example of this is the Bataan EPZ in the Philippines. In the 1970s and 1980s, the central government invested (p.246) almost $200 million in upgrading the port and built road, bridges, and other zone facilities, but this was still not enough to attract investors to its remote location. As a result, the performance of the zone was dismal. Even sixteen years after its founding, the failure of the Bataan zone was so discouraging that it had the international community questioning the zone model of development entirely (Warr 1987; Moran 2011: 16). Bataan shows that while poor infrastructure is a commonly cited reason for SEZ failure, more infrastructure investment is not a solution if the SEZ is poorly located. In Africa, the unused infrastructure in the Calabar zone in Nigeria provides a parallel story, as does the case of the Coega Industrial Development Zone in South Africa, where more than $300 million of infrastructure investment generated less than 3,000 operational jobs in its first decade (CDE 2012).
Some governments set specific goals for the type of production that an SEZ should host. SEZs are often meant to develop a country by opening up new lines of manufacturing and linking them with global supply chains. Therefore, one cannot simply mimic the production that is already taken place in a country. Governments must instead make qualified guesses about the country’s potential comparative advantages.
Due to the knowledge problem, however, SEZ policies often end up targeting the wrong industries. They may thus exclude crucial investors in industries that have growth potential in the country (Farole 2011: 161). India’s new SEZ act exempts information technology (IT) zones from minimum size requirements, which has spurred their proliferation compared to zones with other industries. The Indian SEZ scheme has underperformed, and the heavy reliance on IT-only zones is seen as a burden rather than a benefit (Govardan and Srivastav 2012; Mishra 2013).
18.104.22.168 Picking the Right Investors and Incentives
Regardless of the efforts made to vet potential investors, the logic of the knowledge problem implies that policy makers can never fully predict the success of SEZ developers. Indeed, many SEZs in SSA suffered from poor quality private investment. An early example of this was the investment in Ghana’s Tema zone by the Malaysian investor Business Focus in the early 1990s. The company did not live up to its promised investments, and later abandoned the project (Farole 2010). Several investors that have come as part of China’s high-level ‘Trade and Co-operation zones’, have turned out to be inexperienced in zone development and lacking in financial capabilities.
The problem of inadequate knowledge is also expressed in the design and implementation of fiscal incentive regimes for SEZs. SEZ designers cannot know the real value of the projects’ costs and benefits. Unable to assess whether these investments would have come about without the incentives, they seem to overlook the full cost of tax expenditures. In African zones, (p.247) this neglect frequently leads to sunset clauses on tax breaks being renewed, or firms shutting down and reopening under a new name, so that governments never succeed in realizing the tax revenues originally expected.
22.214.171.124 The Mistake of SEZ Replication
A common mistake is to believe that a model that worked in one country will do so in another. Governments often refer to previous SEZ successes elsewhere, and assume that those models are replicable.
China’s SEZ success is most often cited to motivate the development of new SEZ programmes. The whole country developed at a time when its SEZs could serve both as centres for growth and as showcases for economic reform. However, China in the 1980s enjoyed some particular circumstances that have not been and are not likely to be replicated elsewhere. One of many important differences between China and contemporary SEZ schemes is that most countries introducing SEZs today have already taken steps to open up to FDI, liberalize trade, and in other ways promote a free market economy. SEZs in African economies can therefore not be expected to have similar transformational effects. This significantly narrows the margin for error for African SEZ programmes.
12.5.3 Political Economy Implications for SEZ policy
To understand how SEZs become successful, governments often look at the symptoms of SEZ success rather than its causes. The political economy insights imply that what is commonly described as the reasons for SEZ success, such as infrastructure, beneficial location, and a good business environment, are in fact symptoms of institutions that align incentives and enhance decision making. The political economy analysis also implies that it is futile to try to replicate successful SEZs by matching their level of infrastructure investments, strategic positioning, or regulatory regimes. Here, we will discuss the political economy factors that determine the final outcomes of SEZ schemes, by shaping the gap between the de jure and de facto SEZ environment.
In approaching the design and implementation of SEZs, governments must aim at creating a robust political economy, in which SEZs are successful despite the inevitable and natural flaws of both government and civil servants. Policy makers need to acknowledge these flaws, and understand the obstacles to SEZ success that they cause. Only then can remedies be found that target the root causes of SEZ failure. We conclude this chapter by discussing some potential solutions to the specific political economy problems with SEZ that we have discussed.
Acknowledging the political economy challenges with SEZs opens up the possibility to mitigate their deleterious effects. The incentive problem implies that institutions and policies need to align the incentives of policy makers and bureaucrats with promoting long-run social welfare. The very nature of the incentive problem may make many existing stakeholders reluctant to establish such institutions and policies, but this in no way makes the task of proposing political economy improvements futile. People with an interest in beneficial long-run societal outcomes can still try to influence policy makers by any means that their political system allows. The knowledge problem implies that policy makers need to realize that while information gathering may help, they can never fully predict the outcomes of different SEZ policies. Therefore, a careful and conservative approach should be taken when embarking on large, costly, and long-term projects like SEZs.
Our suggested solutions are by no means an exhaustive list of plausible measures to take. Solutions to political economy problems are context specific, and will inevitably vary with the political and economic circumstances of different countries at different times. We therefore focus on the types of approaches that have been effective so far at managing or at least alleviating the political economy problems that SEZs face.
A starting point is to ensure transparency in the deliberation process where the decision to adopt SEZs and the nature of the SEZ regime to be implemented is made. Such deliberation should involve all stakeholders, including domestic business, local communities, and the media. Governments that engage in open and public debate over an SEZ programme are less prone both to the incentive problem and the knowledge problem. Public debates can reveal adverse incentives that may ultimately undermine SEZ programmes, whether related to land, the industries and activities that are being promoted, or the nature of decision-making.
Public debates also alleviate knowledge problems. Through detailed debates regarding all aspects of planned SEZs, issues emerge that might not otherwise have been considered. In South Africa, following the relative failure of their industrial development zones, a long and intense public debate ran parallel to the process of restructuring the regime into a more inclusive SEZ programme. This public discourse was instrumental in ensuring greater flexibility to meet local needs and limiting the extent to which an SEZ regime targeting FDI may bias against local investors.
Feasibility studies are commonly seen as a procedural activity that must be ‘ticked off’ before a government can introduce an SEZ. However, by making these studies open to public review, they are an important part in a transparent SEZ process. Feasibility studies can help detect occasions of distorted (p.249) incentives. Due diligence analyses are also important for determining which private developers and key anchor tenants should receive special government benefits. It is not only important to avoid developers that lack sufficient technical or financial capacity, but also developers that are selected on the basis of their personal and/or political connections. Due diligence should at a minimum apply to legal, business operations, and financial matters.
A high level of transparency in the institutional design of an SEZ programme is also important, but is rarely pursued by the board of the SEZ authority. This is likely because such boards have traditionally been composed mainly of government ministries and agencies. Broader representation, including from the private sector, community groups, and labour, provides a better check against distorted incentives through conflicts of interests. This can also help mitigate the knowledge problem on an ongoing basis, as these groups have more insights into businesses on the ground and the condition of workers and communities affected by the SEZs. An increasingly common approach is to ensure that half or more of board members come from outside the government, and that these members are elected or appointed by their community, rather than being appointed by the government.
The private sector plays a fundamental role in addressing both the knowledge problem and the incentive problem. While some of the biggest SEZ success stories are run by governments or state-owned enterprises, including in China, Singapore, the United Arab Emirates, and Malaysia, SEZs that rely on public resources often fail to benefit the economy at large, as they are channelled into SEZs that could be used more productively elsewhere. Private SEZ developers can be an effective antidote. Private businesses have better knowledge about commercial realities, and can bring technical and managerial expertise. Their willingness to commit funding to an SEZ project is also an important market signal of its feasibility. As such, it serves as a check against projects with little chance of commercial success. Private companies also have the incentive to carefully avoid risky or unpromising investments, and are not constrained by short-term political considerations (Moberg 2015). International experience from countries such as the Dominican Republic, Colombia, and the Philippines shows that the private sector brings credibility and a network of potential investors to locate in an industrial park. Privately developed parks therefore tend to command higher prices from end users and attract higher value-added activities.
A flexible legal regime for SEZs allows for continuous adaptation, which addresses both types of political economy problems. The knowledge problem stems from the impossibility of predicting what circumstances that the SEZ regime will need to cope with in the future. When the mistake in a legal regime become clear, it is therefore important that policy makers can adjust them. As we have seen in this chapter, countries with rigid initial legal regimes have later been (p.250) forced to introduce new ones that are better adapted to current economic conditions. Establishing a flexible legal framework from the start avoids the problems that such parallel regimes may cause. It also avoids the incentive of different ministries to introduce their own regimes as a form of ‘empire-building’. In the Panamá Pacífico SEZ, a former air force base with a focus on logistics, the legal regime granted special fiscal incentives for civil aviation sector ‘maintenance and repair operations’. As it later became clear that the SEZ could attract investment in call centres, the SEZ law was sufficiently flexible to incorporate working hour flexibility. This attracted a large investment by Dell. Similarly, Jordan’s Aqaba SEZ legislative framework was flexible enough to enable subsequent regulations addressing the needs of the area’s tourism sector. This ultimately became Aqaba SEZ’s key investment sector.2
The right power structure can mitigate an SEZ programme’s internal coordination challenges. International experience of failed and successful SEZs suggests that an SEZ regime should be regulated by an autonomous, powerful government authority, possibly linked to the head of state or of the government. An autonomous agency helps relieve the SEZ programme of day-to-day political considerations that may distort its incentives. Linking such an agency to a central authority facilitates coordination across various government ministries and agencies. By contrast, if the SEZ authority is the responsibility of a particular ministry such as the ministry of trade and industry, other ministries often have little incentive to coordinate their activities to support its aims.
The successful zones regimes of Jordan and Dubai both rely on a strong, centralized authority. In Jordan, once King Abdullah had decided to proceed with the 375 km2 Aqaba SEZ project, a series of feasibility studies were commissioned, including organizational audits of existing government bodies. The clear objective was to merge the various bodies into a single, overarching authority, the Aqaba SEZ Authority, which is run by six commissioners who wield ministerial powers and report directly to the prime minister (Farole, Baissac, and Gauthier 2013).
Other countries have succeeded with very different structures of power, which suggests that the best set-up is context specific. For example, in the Panamá Pacífico zone, Aqaba-style ‘true one-stop shop’ was not feasible for political reasons. The regime designers therefore granted the overall administrative and financial coordination to a new, permanent agency. An effective ‘hybrid model’ SEZ one-stop shop was developed, with physical coordination and service delivery done centrally, but with decisions about SEZ licences taken by separate authorities.
(p.251) There are other proven mechanisms to overcome institutional coordination challenges of SEZs. Too often, inter-agency memoranda of understanding and service-level agreements break down when the political incentive for coordination is weak. A way to avoid gridlock is the use of a ‘silence is consent’ provision in the SEZ law. This provision, used in Senegal among other places, grants authorization by default if an applicant does not receive a response to its application for a licence or a work permit within a specific period of time.
Finally, the fiscal proceeds sharing arrangements for SEZ institutions are critical. The revenue from SEZs must be correctly assigned between local and national authorities to avoid coordination challenges and institutional conflicts. In its early years, the China–Singapore Suzhou SEZ, a joint venture between the governments of China and Singapore, suffered from misaligned incentives between the authorities running the zone and the local government of Suzhou. The SEZ authorities pursued returns on its investment while the local government was concerned about wider socioeconomic outcomes and tax revenues. Local governments in China are responsible for the provision of most public goods and services, and their main source of revenue is the value-added tax paid by industrial firms. As the SEZ was allowed to keep all tax revenues collected, the local government had no incentive to support the project. Instead, it invested in competing industrial zone projects. The conflict was finally resolved by re-aligning the incentives of all stakeholders. National authorities rearranged the tax-sharing formula for SEZs, striking a balance between national and local government as well as the SEZ authorities. This gave the local municipality the incentive to invest in key social and economic infrastructure linked to the zone and to support its development more generally.
These are just some of the legal, institutional, and procedural approaches that can address the political economy challenges of SEZs. By no means do they guarantee success, as they alleviate, rather than eliminate, political economy problems. The complexity and context specificity of SEZs means that there is no ‘best practice’ that guarantees success. Recognizing this reality is, however, a starting point for a successful SEZ regime. We hope that the principles outlined in this section, of transparency, broad participation, technical expertise, and leveraging the incentives for coordination, may help policy makers trying to steer through the muddy waters of the political economy challenges of SEZs.
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