Market Analysis

In the Zone

Special Economic Zones are all the rage in the Emerging Markets. But do they help or hinder global economic development?

What does it mean to be "in the zone"? If you're a baseball player, you might be on a hitting streak. If you're Britney Spears, it might be the name of the last album you released before an ill-advised relationship with one of your backup dancers threw your tabloid-riddled life into a tailspin. But if you're doing business in a developing country, it might mean you're setting up shop in a Special Economic Zone (SEZ).

SEZs are designated areas where companies receive more favorable economic treatment than they would in other parts of a country. Over 120 countries have established SEZs, including China, India, Pakistan, Saudi Arabia, Iran, Poland, and the Philippines. They frequently offer low tax rates, lower tariffs and duties, and relaxed regulations in an effort to entice foreign companies to do business there. Typically, SEZs are established in developing countries to attract foreign investment, increase employment, or transfer new technologies. These privileged areas often enable companies to gain a foothold that supports expansion throughout a country, affording special treatment to manufacturing, pharmaceuticals, information technology, chemicals, or other industries.

Infrastructure plays a large role in the success of SEZs. Poor infrastructure is a deterrent to foreign companies considering doing business in a developing country. Inadequate basic infrastructure makes some emerging markets unsuitable for large manufacturing centers, call centers, or technology parks. But many SEZs have their own infrastructure that is more advanced than outside areas. For example, electricity is available for only hours a day in some countries, but many SEZs have their own power generation plants to deliver uninterrupted electricity day or night.

China has arguably had the most success with the SEZ model. In fact, many countries model their own projects after China's to emulate the many successes there. The city of Shenzhen was once a sleepy fishing village. But in 1980, the Chinese government designated Shenzhen an SEZ and the city's growth has been nothing less than phenomenal. Shenzhen is now home to over 10 million people. It boasts the fourth largest economy among cities in China and has the highest GDP per capita of any Chinese city. Exports from Shenzhen alone exceed those of many large countries, including India! Shenzhen is also home to one of mainland China's two stock exchanges (the other is in Shanghai), making it an important financial center as well. In total, SEZs account for almost 90% of China's exports and 70% of China's rapidly growing economy.

India is also ramping up its use of SEZs. The Subcontinent was home to Asia's first Economic Processing Zone (a predecessor to the SEZ), established in Kandla in 1965. More recently, the government enacted the Special Economic Zones Act in 2005, and interest in SEZs has since exploded. Hundreds of these areas have been approved, and many are already up-and-running.

SEZs aren't without critics. Some blame the lax regulation in SEZs for humanitarian abuses against workers. Environmental enforcement in some SEZs has also been called into question. Some of the economic advantages have also been debated. Opponents of India's push to establish new SEZs argue existing companies in India will simply move their operations into these areas to receive the tax benefit without generating any additional employment or economic activity.

But overall, the economic benefits of SEZs are well established. Lower taxes and tariffs, less regulation, and favorable trade laws have made them islands of economic freedom. As such, the rapid growth therein should come as no surprise. Nor should many legislators' aversion to applying their attributes on a much broader scale. It's conceivable an entire country could be run like an SEZ with great success. Unfortunately, SEZs don't lend themselves to legislators' penchant for meddling with economic issues, so it's unlikely we'll see the nation of SEZania on a map any time soon.

To be fair, SEZs are incubators, not optimizers. But with a few tweaks, the policies incorporated in SEZs would have far-reaching benefits if applied country-wide. And some policymakers are doing just that. Developed and developing countries alike are lowering taxes and reducing other burdens on business to capitalize on the growing wave of globalization. An unfortunate notable exception to these trends is the US, where protectionist rhetoric has become increasingly prevalent, and politicians seem inclined to raise, rather than lower, taxes. We could learn a thing or two from these economically vibrant areas.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.