In the race to attract foreign direct investment, countries are opening SEZs at a furious rate. Winnowing down the choices requires some serious due diligence.

Author: Valentina Pasquali

LEADERS AND LAGGARDS

Perhaps the best-known special economic zone is Shenzhen in southern China. The SEZ was carved out of a market town called Sham Chun Hui in 1979—all part of Deng Xiao Ping’s campaign to bring free markets to the Peoples’ Republic. Since then, officials in the country have steadily expanded the number and scope of SEZs. Beijing pushed the envelope farther in 2013 with the establishment of the Shanghai Pilot Free-Trade Zone. That zone permits foreign direct investment in a number of sectors, including finance, and allows for the full convertibility of the renminbi under certain conditions. “Instead of remaining ‘the World’s Factory,’ China now wants to become an innovator,” says Connie Carter, a professor of business law at Royal Roads University in Canada. “Not just ‘Made in China’ but also ‘Designed in China’ and ‘Invented in China.’” In its push to develop a service-based economy, Carter says, “an experiment in the financial services industry is a logical next step.”

China’s SEZ program, which now boasts thousands of zones across the nation, is widely considered the most successful ever. “In China, SEZs were seen as an experiment of capitalism in a communist country that had no economic freedom,” says Martin Ibarra, the vice chairman of the World Free Zones Organization.

Other Asian countries have embraced the concept as well. Vietnam, South Korea, the Philippines, Thailand, Indonesia and, to some extent, Cambodia have all rolled out economic zones. Elsewhere, the Jebel Ali port in Dubai, the Colón Free-Trade Zone and the Panama Pacifico Special Economic Area in Panama, and the SEZs in Mauritius, Costa Rica and the Dominican Republic get high marks from corporate executives.

But there are also mediocre products—and outright failures. An excessive emphasis on fiscal incentives can undermine a zone’s success by making it too costly for government officials to finance. At the same time, unwarranted involvement by local leaders can scare away foreign companies.

SEZs that don’t keep ambition in check can also unravel. “Sometimes governments want them to be a panacea that will solve ten different problems at once, improving the balance of payment, increasing FDI and exports and technology transfers, creating jobs, improving female employment, and so on and so forth,” says Jean-Paul Gauthier, the London-based managing director of consulting firm Locus Economica. “One individual SEZ won’t do that for them, but there are various SEZs around the world that have done one or the other.”

If Latin America and the Caribbean, the Persian Gulf and East and Southeast Asia have achieved dramatic results with SEZs, others haven’t done so well. SEZ programs in South Asia and Africa are, with some exceptions, generally considered the biggest laggards.


TWILIGHT FOR SOME SPECIAL ECONOMIC ZONES?

GAUTHIER, Locus Economica: SEZs can do well for a time, then lose steam.

Nestled in the hilly outskirts of Medellín, Colombia’s second-largest city, lies the Rionegro Free-Trade Zone. Set up in 1993, Rionegro now houses more than 80 companies. Observers call it a prime example of a what makes SEZs so alluring to corporates. But it’s also a primer on the difficulties of maintaining their appeal.

Global IT company Unisys has set up shop in a two-story industrial building in Rionegro. More than 350 young Colombians work the computers and phones of its highly specialized call center, serving its Spanish-language clients across the world, particularly financial institutions. “We are here because we have tax benefits, which means we can provide services to our clients in Colombia and abroad at very competitive prices,” says Carlos Ferrer, general manager and vice president for Unisys Lacsa (Central, Southern and Andean Latin America). “When I evaluate one site over another with Treasury, we look at things like the cost of land and utilities, which are both cheaper in Rionegro than [in] Medellín or Bogotá.”

Rionegro management says electricity in the free-trade zone is purchased in bulk, making it substantially cheaper than elsewhere in Colombia. Warehouses come equipped with access to water, gas and telecommunication networks, banking and logistics services and an offshoot of national tax and customs office DIAN. 

Every country I go to is setting up or revamping their SEZ program.

~ Thomas Farole, World Bank

But the biggest attraction for global corporations like Unisys is the tax setup. Corporate occupants of Rionegro do not pay customs tax on imported goods. The corporate tax rate is 15% versus 25% elsewhere in the country. “The FTZ regime has been a key tool for Colombia to compete, as we always had higher corporate taxes than other countries in the region,” says Martin Ibarra, the honorary president and founder of the Free Zones Association of the Americas.

The tax relief, however, underscores some of the difficulties of keeping an SEZ competitive. In 2013, Bogotá lowered the country’s corporate tax rate from 33% to 25%, bringing it in line with the regional average. The nation has also embraced a single-factory licensing scheme that grants all qualifying companies the same fiscal treatment as Rionegro

Indeed, SEZs tend to have a limited competitive advantage period. “These things have a life cycle,” says Jean-Paul Gauthier, the London-based managing director of consulting firm Locus Economica. “They can do very well for a country for 20 years and then flag.”

World Bank economist Thomas Farole agress. “What ends up happening is a mix of tax and customs incentives.... But just call it a tax incentive rather than an SEZ.”              

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