Vivid Thoughts: Economic Zones as a tool for industrialisation
This piece is one of a series prepared by Vivid Economics, in partnership with WEPZA (World Economic Processing Zones Association), the world’s first association of Special Economic Zones.
Special Economic Zones are a key policy tool used in investment promotion and industrial development around the world. This blog provides an overview of how SEZs have been used to promote various development objectives in countries around the world.
Economic Zones as a tool for industrialisation
Economic Zones (EZs) include a range of geographically delineated zones which deploy specific policies and incentives aimed at promoting activities leading to economic growth. These zones go by many names, reflecting their range of goals and include freeports, free zones, industrial parks, and innovation centres to name a few. Governments design and implement EZs to achieve various economic development goals such as a) increased exports, b) increased employment and skills development, c) attracting foreign investment and d) developing capabilities in selected industries.
As Economic Zones have evolved over time the benefits they provide host countries and the incentives they need to attract investors has shifted. The first EZ was created in Shannon, Ireland, 1959. Since that time, there has been significant expansion in the function of EZs and the benefits which they provide. Broadly, EZs have evolved across three archetypes, as illustrated in Figure 1:
- Zones 1.0, Export Processing Zones (EPZs);
- Zones 2.0, Special Economic Zones (SEZs); and,
- Zones 3.0, Innovation centres.
Figure 1 EZs have developed to fulfil different roles in economic development of host countries
Source: Vivid Economics
The ability of EZs to achieve a wide array of policy objectives is strengthened by their export-orientation, integration in global supply chains, and business and investment density (IFC, 2017). The attractiveness of promoting policy goals through EZs stems from their:
- exposure to global supply chains, and the international transfer of technology and skills,
- geographic density, and clustering of specialised economic activity,
- (in some cases) a separate legal structure, which allows for regulatory experimentation.
However, EZs remain most effective when they target a small number of objectives and are aligned with wider national government goals. Zones that are most successful have identified a core economic or social policy objective they want to pursue. In contrast, those that are unsuccessful have lacked focus (DNA Economics, n.d.). The South African Industrial Development Zones (IDZs) programme is one such example. These zones were initially developed with no over-arching policy objective, resulting in a variety of incentives focused on quite different investor outcomes. This lack of focus resulted in zones that were unattractive to all groups of investors.
With the guidance of Vivid Economics, Indonesia is currently developing its SEZs, which will be aligned with a ‘Zones 2.0’ approach, for the combined objectives of industrialisation and green growth. Indonesia’ medium-term development plan (RPJMN) targets the development of a comparative advantage in Indonesia’s primary sectors (BAPPENAS, 2015). The development of Zones 2.0 is an established tool to attract investment towards higher value manufacturing and therefore can help Indonesia to transition away from primary resource extraction towards manufacturing. Additional benefits from the development of SEZs include the transfer of skills and technology, the diversification of exports and the economy-wide application of SEZ piloted policies.
Vivid’s leverages global expertise in green growth to develop Green EZs that unlock high-value industrialisation in Indonesia. Vivid expertise in green growth policies is used to ensure Indonesia’s SEZ strategy maximises synergies between manufacturing and environmental sustainability. This has involved recommendations to improve the footprint of EZs focused on heavy emitting sectors and help plan SEZs focused on low-carbon production. The development of Indonesia four planned tourism SEZs towards eco-tourism is central to Vivid’s recommendations.
To encourage investment, EZs must rely on incentives aligned with the needs of potential investors. Incentives address constraints which otherwise deter investors from investing in a zone. They are more likely to achieve beneficial outcomes given clear zone objectives. The set of investors a zone aims to attract will depend on its objectives. Focused zone objectives simplify the range of potential investor characteristics and investment criteria incentives must fulfil. For instance, key investor characteristics that determine investment requirements and incentives are 1) geography of potential investors (national, regional or international), and 2) sectors in which they operate.
As zones develop towards higher-value industrial activity, investors increasingly rank soft and hard infrastructure incentives as determinants for investment. Growing competition amongst EZs worldwide has led to a convergence in fiscal and financial incentives offered to investors (Farole & Akinci, 2011). Infrastructure provision and effective customs environments (i.e. hard and soft infrastructure) however are strongly correlated with long-term investment and employment in EZs. Investor surveys identify transport infrastructure, cost of utilities and land access issues as top site-specific requirements. SEZ regimes which provide access to markets through preferential trading agreements, and a ‘one-stop shop’ for business, are also identified as top investor priorities.