The lure of creating Special Economic Zones (SEZ)

Special Economic Zones (SEZs), in a nutshell, are pockets of investors' paradise in a region or a country. Governments try to provide as much facilities - such as tax breaks, subsidies in buying land or constructing factories, or a commitment to train the required manpower - to attract investors to a particular area. With increased investment, politicians, policymakers and economists believe that it will create enough economic spillovers to spur economic development in the region. Eventually, the whole region can get industrialized, creating much wealth for the citizens of the region.

Because of this belief, many countries are rushing into creating SEZs. For example, just India is creating around 200 SEZs. Politicians promise large influx of future employment opportunities to locals, which makes the locals happy. There is large-scale investment in infrastructure that shows economic activity in the region. However, the long-run impact is mixed at best. This Economist article shows that most SEZs fail, and there are only a few successful SEZs. Politically, they may sound great, but economically, they may not be the right way to go.

This is mainly because SEZs do not exist in a bubble. Yes, they get special privileges from the government, but these privileges can create distortions within the economy. If I am a local investor, and region A has an SEZ and region B in the same country does not, then I would be more willing to invest in region A. Subsequently, there is more movement of migrant workers to region A. So, the rest of the country can become economically stagnant, while the SEZ region grows.

However, the above scenario can only happen if the SEZ is successful. If the SEZ fails to attract investment from locals and abroad, then all the capital used to set up the SEZ will go to waste. Besides, with the ease at which factories nowadays can locate from one country to another, if an SEZ loses its competitive advantage, it will makes investors flee, creating a lot of unemployment as a consequence.

So what is the best direction for industrialization? Instead of creating pockets of special zones, governments can take a more holistic approach and try to improve the investment climate of the whole country. If governments work to reduce bureaucracy, simplify registration, and invest in creating a resourceful workforce, investors will be willing to invest in the country. If the government wants to give a 'carrot' to foreign investors, it can do so by promoting that workers in the country are educated and efficient, the government is efficient and property rights are strictly enforced. These factors can encourage more investment that actually adds value to the local economy, rather than attract investment that is quick to leave the minute any facilities diminish.