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PORTS & FREE TRADE ZONES
From Site Selection magazine, November 2013
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Have Special Economic Zones Entered the 21st Century?

Separating from the pack may require breaking free from the past.

PORTS & FREE TRADE ZONES
In January 2013 Hoganas of Sweden broke ground at Mieum district in Busan-Jinhae Free Economic Zone in southeastern Korea with officials from the FEZ and the City of Busan. Korea’s system of free economic zones, free trade zones and foreign investment zones is in the vanguard of zone programs worldwide. Early this year the Korean government announced it would launch a system of “mini-FEZs” across the country. The nation’s foreign direct investment rose 44.7 percent to $3.39 billion in the first quarter of 2013 from the same period in 2012.
by Martin Norman
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lthough many disagree on exactly where to trace the origins of the modern special economic zone, just about everyone would agree that zones have seen tremendous changes since the 1980s. The evolution of zones has been steady and increasingly rapid. Transitions from government to private sector management, from export-exclusive to mixed-used zones and from isolated enclaves to linked-in growth poles have all been a part of this change. Zones also face increasing challenges in the areas of governance and providing pilots for change in post-conflict environments such as El Salvador and Nepal.

What do we know about zones in 2013? What are the current trends and challenges? Do zones still offer advantages to investors or are they a thing of the past?

What aspects of zones have entered the 21st Century, plugging into global value chains, and practicing corporate social responsibility?

Which aspects are stuck back in the mid-20th century, ring-fencing good practices in isolated enclaves and relying on government patronage?

Here is my list of zone trends and what they mean for the investor of today.

There are more kinds of zones and a multitude of new names for zones.

In 1990, the variety on offer was mostly restricted to export processing zones (EPZs), free zones, industrial estates and large China-like SEZs. Now, the investor is faced with what appears to be a smorgasbord of zone dishes: Cayman “Enterprise City,” Qualified Industrial Zones (QIZ) of Egypt, Free Industrial Zones (FIZ) of Georgia, and Industrial Development Zones (IDZs) of South Africa (renamed SEZs in 2012), just to name a few.

“The investor is faced with what appears to be a smorgasbord of zone dishes.

Add these to the more traditional varieties of free trade zones, free ports, IT Parks, and foreign trade zones, and companies are faced with an increasingly confusing investment/location decision. The question is: Do either the new or traditional varieties really offer added value to the investor? Sometimes they are simply warmed-over, repackaged EPZs. The investors of today face a confusing scenario as they make site location decisions.

Governments continue to get site selection wrong — on a massive scale.

Site selection really boils down to two simple questions:

  1. ) Which market failure would a zone on that site be tackling? Poor access to land? A substandard infrastructure? Excessive red tape?
  2. ) Is there a business case and demand for a zone in that location? This should be based on an identified market opportunity and the surrounding conditions for zone development (adequate infrastructure, the ability to comply with socially and environmentally responsible development, ease of construction, abundant labor, etc.).

There are many reasons why countries continue to select the wrong sites for zones, but two of the most prevalent are:

Political considerations: A prime minister or members of parliament want to bring “development” to their region (without a clear idea of exactly what they are trying to accomplish) and win votes at the same time.

To increase growth and bring jobs to a depressed area.

In both cases they fail to see that if the zone is not fixing a market failure and there is no business case for locating a zone on that site, they will have a high-profile multi-million-dollar failure on their hands with little impact on growth and jobs. At the same time, scarce resources will have been diverted from potentially transformative activities. It’s not that nothing should be done in a depressed area, but usually a zone is not the right tool to use.

Bangladesh, for example, is a country that is beginning to get this right. In 2008, the government proposed a large SEZ model in the economically depressed area of Noakhali. None of the previous siting decisions for their EPZs had been based on proper site assessment, resulting in a spotty record of EPZ results.

“Bangladesh is a country that is beginning to get it right.

For the first time a site assessment was conducted for Noakhali, and the study concluded that the cost of development would be nearly half a billion US dollars with little economic benefit. The government correctly decided not to construct a zone on that site, and all of their siting decisions since that time have been based on proper site assessment.

BioconSyngene

Indian biotech giant Biocon got its 90-acre (36-hectare) Biocon Park in the Bommasandra area of Bangalore approved as an SEZ in 2005, and has populated it since with facilities worth more than $121 million. Last year it inaugurated a new 300-scientist R&D center.

Other countries are still making this mistake. We commonly see this, especially in Africa, where sites selected for zones often have no demand, and the very companies who were assumed would locate there have never been asked about their potential interest. These are the kinds of situations in which a government has to have the flexibility to step back from a planned project, ask some tough questions, and be willing to scrap the project if necessary.

Zones are increasingly becoming a focus of social and environmental initiatives.

Both the public and private sectors are finally waking up to the realization that zones are excellent locations for increasing social and environmental compliance among companies. Zones were once (and from many corners are still) criticized widely for exempting the companies located in zones from important labor and environmental controls.

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Shown above are the entrance to a free economic zone in Bangladesh (left) and the high-tech TV screen manufacturing process at LG’s facilities in Paju, South Korea.
Photos courtesy of Martin Norman and LG

However, because of the co-location of zone companies, increased scrutiny of on-site zone management, and unique compliance enforcement mechanisms that often exist inside SEZs, zones are actually ideal formats for piloting increased compliance mechanisms. Some zones in Latin America, for example, are closing their doors to the containers of their clients who continue to pollute the environment after repeated warnings. Also, Bangladesh has been implementing aggressive social, environmental and gender programs since 2007. Results have been concrete: compliance with labor laws of more than 90 percent, proper treatment of 60,000 cubic meters of water per day, and increased representation of women among the supervisory ranks.

Zones are increasingly providing central effluent treatment plants and energy-saving infrastructure, and many are on the cutting edge of eco-efficiency and low-carbon projects. This is all very good news for investors, for governments, for those who are fighting for better conditions in zones, and of course for the workers themselves.

Zones are increasingly being established to take advantage of cross-border opportunities.
GFEZEverTech

In October the Gwangyang Bay FEZ Authority concluded an investment agreement with Korean ship and heavy equipment manufacturer EverTech, which had previously relocated to China. EverTech will invest 4 billion won (US$3.7 million) through 2014 to build a production plant in the Yulchon I Industrial Complex.
Photo courtesy of GFEZ

This is a very good development. Two countries can strategically play off their comparative advantages by placing zones near their borders. It only makes sense that in an increasingly integrated world economy, countries would identify cross-border opportunities and seek to use zones as a tool for concentrating business around this opportunity.

There are several interesting examples of this. The 100-percent private zone CODEVI on the border of the Dominican Republic and Haiti focuses on the apparel industry. It relies on the electric power grid of the Dominican Republic and the lower cost structure in Haiti. The just-reopened Kaesong Industrial Zone between the two Koreas is an example of economic collaboration between the two countries and often serves as a gauge of their relationship on any given day. Myanmar, currently the target of massive foreign investment, especially from Japan, has great plans for taking advantage of border opportunities with Thailand’s northern regions of Mae Sot and Mae Sai through its Dawei Special Economic Zone and other zones planned along the border.

However, governments are still doing “bottom up” zone planning.

Governments often proceed with expensive zone projects without ever asking if a zone is the appropriate tool for achieving its economic and growth goals, whether those goals include job creation, increasing exports, diversifying exports, or increasing foreign direct investment. A site is chosen because the government is keen to establish special economic zones, a few key industries are targeted, construction is begun either by the government or a private developer and attempts are made to attract investors.

A much more effective approach is a “top down” approach which starts with two or three key economic goals, looks at the entire palette of economic tools available (zones, value chain initiatives, growth pole development, industrial policies and sector-wide promotion), and comes up with a mix of these tools that will reach the key goals.

Zones may or may not be included in this mix. If there is a strategic reason for a zone, the next decision is which of the many varieties of special economic zones (e.g., free trade zones, free ports, IT Parks, large Chinese-type SEZs) will best address the market failure that has been identified.

‘Follow the Developers’

Have special economic zones already entered the 21st Century? In many ways they have not. The old EPZ model is still used widely, even if they are rarely called “EPZs” anymore. Bad habits persist in site selection, and governments are still using a bottom-up planning approach.

However, zones are a bit more enlightened in taking advantage of multiple new opportunities for cross-border trade in an increasingly integrated world, and in seeing themselves as test pilots for creating great labor and environmental practices.

In the meantime, how are investors to make sense of all this and make good decisions on where and when to expand? I’d say follow the private zone developers. They have become increasingly savvy in the last decade in scoping out opportunities for growth, understanding which countries present the best value proposition, and even joining forces.

“With one foot in and one foot out of the 21st Century, special economic zones will continue to both entice and confuse investors.”

My money is also on the zones that are using innovative social and environmental techniques and proactively using this as a major investment promotion tool. These zones are investing now to either design eco-efficient features from the design stage or retrofit existing zone infrastructure. They understand and are on the cutting edge of where an increasingly aware and socially responsible market is headed. Chances are, if they understand this now, they will also pick up on future trends, and that will be good for everyone connected to their zone.

MartinNorman

With one foot in and one foot out of the 21st Century, special economic zones will continue to both entice and confuse investors. The more enlightened zones will take advantage of the confusion and pull ahead of the pack.


Martin Norman, Senior Private Sector Development Specialist with the Competitive Industries Practice Group of the World Bank, has worked in economic development around the world, including long-term projects in Nigeria, Botswana and El Salvador and, most recently, as program manager with the World Bank Group in Bangladesh.

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