Why SEZs may not be a solution?

The successes of economic growth clusters like Silicon Valley, Route 128 (in Boston) and the Shenzen-Guangdong Special Economic Zone (SEZ) in China have spawned a huge interest in creating SEZs and other concentrated growth areas, across the world. SEZs are industrial enclaves, where industrial and manufacturing units can be established and run on a fast track, and where investment is incentivized by the presence of good quality infrastructure, tax and duty breaks/moratoriums, flexible labor laws, and subsidized land.

It is widely believed that Governments can replicate similar geographic clusters by identifying appropriate strategic locations, based on either the presence of a big university or closeness to a major port or some other similar location. Then with massive investments in both physical infrastructure and by bureaucratic management, entrepreneurship can be kickstarted.

But globally such experiments at kickstarting entrepreneurship have yielded more failures than successes. In a recent special report on Innovation, The Economist flays the obsession of Governments to create geographic clusters like the Silicon Valley. It argues that the French have poured billions into 'poles de competitivite' with abysmal results, and Singapore, Dubai and others are doing much the same to artificially create clusters of economic growth. A study by INSEAD, looking at German Government's efforts to create biotechnology clusters on a par with those found in California concluded that Germany had essentially wasted $20 bn. A similar experiment by the Singapore Government to form a "biopolis" has been assessed by the World Bank to have a success probability of only 50-50.

It is estimated that there are over 3000 SEZs operating worldwide today. Most of them are in the developing countries and are located in the vicinity of ports. Apart from those in China, and a few in the Persian Gulf, like Jebel Ali (Dubai) and Aqaba (Jordan), and Eastern Europe, SEZs have had limited success in achieving the desired objectives. But each of the successful examples have had inherent advantages that were leveraged to build up the success.

Starting with Shenzen in 1980, the Chinese SEZs have developed over a long period of focussed and targetted policies, whose requirement grew out of the limitations imposed on capitalist economic growth and inflow of foreign capital in a communist country. These SEZs were already organic economic growth centers, whose potential was sought to be channelized by notifying them. All the 6 SEZs in Shanghai (Pudong), Guangdong (Shantou, Shenzhen, and Zhuhai), Fujian (Xiamen) and Hainan (entire province) provinces have the natural advantage of straddling the Asia Pacific rim, bordering the high growth East Asian economies and Japan. These SEZs were geographically and strategically ideal locations for situating export based manufacturing industries.

But even in China, the story is not as simple as widely perceived. The SEZ policy has created severe distortions in the socio-economic fabric of the country. The coastal regions, around the SEZs have grown extraordinarily rich, while the hinterland has remained in Mao's age. This in turn has triggered off a massive labor migration to these areas, estimated to have crossed 110 million. All the FDI was more or less confined to the SEZs and their ancillary areas. The World Bank estimates that 90% of FDI went to the coastal provinces, and less than 2% to the Western provinces. There is a school of thought that subscribes to the view that while the SEZs have undoubtedly contributed to the growth of the Chinese economy, it has also resulted in a more than disproportionate share of transfer of wealth from China and besides creating very profound internal distortions.

Interestingly, while China has just 6 SEZs, the Indian government have already sanctioned 154 and more are on the pipeline. As can be seen from the details of the 154 SEZs sanctioned in India, the smaller ones form the major proportion of SEZs. A mere 7 SEZ are situated in more than 1000 hectares. Only 11 have area between 200 and 1000 hectares, of which just 4 SEZs have more than 250 hectares. Of these, 71 SEZs or 46% have extents less than 25 hectares, and another 35 have extents between 25-100 hectares. In other words, 106 out of the 154 SEZs sanctioned, or nearly 70%, are situated in lesss than 100 hectares. In fact, of these small SEZs there are also 24 SEZs with 10 or less hectares! The 3.34 hct, Selecto Systems promoted IT/ITES SEZ at Faridabad, must be in competition for being the smallest SEZ in the world! Do small geographic entities provide any susbtantial economies of scale to justify the concessions given to SEZs? Is there not a critical mass of area which is a pre-requisite for an SEZ?

The India experiment with SEZs is one of the more generous of its kind. The scale of fiscal transfers estimated by way of tax concessions are staggering. The Finance Ministry has estimated the revenue loss to be more than Rs 1,74,000 Cr. The generous tax concessions will surely open up the possibility of investments from other areas shifting base to SEZs. As has happened in China, with its huge costs, this would have long lasting adverse implications for balanced regional development of the country. Equally generous and more incentive distortionary, is the provision of the SEZ Act, 2005, which requires only 25% of the land to be used for industrial purposes. This presents the real estate developers and other land hoarders a perfect opportunity for backdoor entry into the SEZ bandwagon, especially in an age of sky-rocketting land values.

Gujarat, with 5 functioning SEZs and 12 more to start next year, is a good example of the development of SEZs. Rather than being artificial constructs with little basis in inherent locational and other strengths, Gujarat SEZs have developed in response to market forces and are anchored on critical locational advantages like ports. Instead of the land being forcibly or otherwise acquired by the Government and then handed over, its SEZ lands have been acquired through mutually beneficial market transactions between the buyer and the seller.

As experience from across the globle shows, SEZs cannot be artificial constructs. Any economic entity - individual, firm, institution, region, or country - cannot be exogenously tailored into developing overnight into prosperity. Development of such SEZs require numerous forward and backward linkages, whose presence is critical for its success. Many of these ingredients cannot be developed merely by active Government facilitation, however robust and teasing, and emerges only through the natural process of economic growth of the area. Governments can and should only facilitate the creation and unleashing of pent up market forces.

At this stage of its economic growth India surely does not need SEZs to attract foreign investors nor be the predominant instrument for catalysing private entrepreneurship. Nor is the Government using SEZs as a policy tool in ensuring balanced regional development. The biggest justification for SEZs therefore arises from a need to provide a less regulated and more simplified environment for setting up and running an industrial unit, and adeqate infrastructure for the same. These desirables are inevitable accompaniments for economic development in any part of the world, and will be increasingly so in the days ahead. While it may be alright to temporarily provide this environment selectively through a few SEZs, the larger requirement of providing the same environment across the entire economy should not be lost sight of.