Free zones of discomfort

Posted On Friday, 13 May 2005 02:00 Published by eProp Commercial Property News
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Free zones, or export-processing zones, have become common among countries with aspirations to become forces in the global economy.

Infrastructure IndustryFor their defenders, they are the leading edge of dynamic entrepreneurial development. To their critics, they are expensive, faddish exercises in beggar-thy-neighbour economics. Free zones, or export-processing zones, have become common among countries with aspirations to become forces in the global economy.

They have swelled in number over the past 30 years to a global total of more than 5000 zones employing about 40-million people. But their future is unclear. Along with growing restrictions from global and regional trade rules, free zones also face complaints that the sacrifices and efforts they entail are simply not worth it.

There are many permutations of the free zone, from simple "free ports" where goods can be unloaded and loaded without going through customs, to Chinese-style "special economic zones" that encompass an entire municipality. But a more typical pattern is the exportprocessing zone — an enclave, often physically fenced off and close to a port.

Export-processing zones generally use low taxes and tariffs and streamlined regulation to attract foreign direct investment and boost exports. The attraction of such zones is enhanced by prominent examples of apparent success.

The modern trend was started by Ireland, which set up export zones around Shannon airport in 1960. The symbol of Mexico’s haul towards prosperity was the explosion of maquiladoras on the US border, making cheap clothes and toys for the US market. China’s abrupt turn towards market liberalisation in 1979, sparking extraordinary economic growth, coincided with the designation of Shenzhen as the first of its special economic zones.

The model has been copied by countries around the world — and more such constructions are on the way. The Indian government this week submitted a bill to parliament reviving plans for special economic zones, to enable companies to bypass restrictive national labour laws and compete with Chinese producers.

At a meeting of the World Free Zone Convention, held last month in the Aegean free zone in Izmir, Turkey, speakers from eastern Europe, Africa and Latin America extolled the virtues of the free zone as a trailblazer for liberalisation and growth — importing capital, creating technological spillovers for the domestic economy and providing jobs.

Turkish Trade Minister Kursad Tuzmen, a strong supporter of free zones, told the meeting that export zones should provide a workable model for wider liberalisation.

There are indeed examples of economic zones having been in the vanguard of nationwide liberalisation — in essence, turning the entire economy into a free zone. In the Irish case, export zones developed into a successful strategy for attracting foreign direct investment, giving rise to one of the rich world’s lowest rates of corporate tax.

But on top of traditional complaints that free zones undercut wages and labour conditions are concerns that their benefits have been oversold and their differential treatment of exporters and domestic producers is not sustainable.

Free zones have long had to contend with criticism that, by competing on low tax and low labour regulation, they exemplify the global Dutch auction of wages and labour standards feared by trade unions and antiglobalisation activists. The International Confederation of Free Trade Unions argues that export processing zones "spearhead the race to the bottom".

These concerns have not been enough to stop the spread of zones. Even an International Labour Organisation commission co-chaired by President Benjamin Mkapa of Tanzania, which reported last year on the social dimension of globalisation, acknowledged the concerns but noted: "Wages and working conditions and opportunities for employment for women are often seen to be better (in the zones) than the national average."

More recent challenges to free zones, however, may present bigger problems. One is that international rules have tightened considerably. In an attempt to stop the distortion of trade, World Trade Organisation (WTO) agreements prevent governments from subsidising production for export, or at least authorise retaliation against them if they do.

True, there are exemptions in the WTO agreements for poor countries and for arrangements that existed before the rules were introduced. John Mutti, an expert on investment incentives at Grinnell College, Iowa, says no one has brought a WTO case against another nation’s export zones. But he says: "There might well be strong objections from, say, domestic US manufacturers to Chinese exporters continuing to receive incentives."

Governments may have to be more circumspect than before about handing out blatantly export-oriented subsidies. For countries aspiring to join trading blocs such as the European Union (EU), there are even stricter rules: export zones violate EU laws on targeted state aid to companies.

Even more fundamental, there is perennial scepticism about the intrinsic worth of free zones. International institutions such as the World Bank and the Organisation for Economic Co-operation and Development have long warned that they are far from a panacea.

Some simply do not work: the World Bank singled out the Dakar economic zone in Senegal, where restrictive rules on investment, low productivity and high transport costs meant that it had only 10 companies employing 600 people after 14 years of existence.

Some doubt whether, even for those that do attract investment, free zones actually do anything more than hand tax advantages to companies that would have invested in any case. Rather than acting as a battering ram for economy-wide liberalisation, free zones may also reduce pressure for it by bringing in enough foreign exchange to keep an economy stable while diminishing the need for fundamental reform.

If the exports produced use a lot of imports, the value actually added by the host economy can be minimal. Moreover, by separating export-oriented companies in an enclave, the potential to transfer technology and production skills to the rest of the economy is diminished.

The World Bank advises against giving overly generous concessions, such as a permanent tax holiday or subsidised utilities. In practice, the costs and benefits are hard to judge, as the Aegean free zone shows. It has 361 companies with 3000 workers and last year turned more than $3bn in gross exports. Its authorities reckon it attracted 10% of the foreign direct investment that Turkey has attracted in the past 10 years.

Free zones, it seems, will have to adapt to survive. Given the impetus behind them, it appears unlikely that their exponential growth will suddenly grind to a halt. But between restrictive trade rules and suspicious finance ministries, they will have to fight hard to prove their worth in a global economy where the competition for investment becomes ever more intense.

 

Last modified on Monday, 04 November 2013 11:09
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