Jun 14, 2014

The political economy of special economic zones

From a paper by Lotta Moberg
This paper is a first attempt to apply a robust political economy framework to explain when Special Economic Zones (SEZs) can contribute to economic development. A robust political economy is one that channels the actions of self-interested individuals with limited information to promote economic progress. In the right institutional context, SEZs tend to promote economic growth. In the wrong institutional context, they can cause resource misallocation and rent-seeking. Policy makers introducing SEZs must overcome the knowledge problem to avoid misdirected economic planning. Yet, the scheme can only fulfill its purpose if it also prevents destructive rent-seeking behavior, both from businesses and from government authorities. The political economy framework of SEZs can be applied to judge their potential efficacy, something that orthodox studies of country features such as natural resources, infrastructure, and zone location fail to do. The Indian and Chinese experiences with SEZs illustrate these points.
A draft of the paper is here.  

When setting up a SEZ many decisions have to be made. The SEZs should be self-sustained; one does not want to run out of electricity, like it happened in Nigeria. Location is also important as well as the main type of economic activity to be performed in the zone. The zone should be close to the port; but, at the same time, it should be close to areas that can provide skilled labor. So, many things have to be "right". How to do that? 

Generally speaking, participation of the private sector should be maximised as a way to decentralise decision-making in the Hayek sense. The author argues:
If private investors do make bad investments, then they, not the country’s taxpayers, pay for the mistake. p. 10. 
The Indian experience has not been very positive precisely because the process has been managerially centralised:
As of 2005, most companies had to go through 15 authorities to enter an Indian zone. p. 19.
On the other hand, the tax system must be absolutely certain.

The Chinese case has been a success, and that is largely due to the decentralised nature of the administration, which goes back in time. China rulers realised that a country that big could not be effectively managed from the center. Indeed, local governments have substantial influence in the decision making process. 

Some literature on SEZs:
A critical assessment of the SEZ in Panama is here. Positive effects of the SEZs in China are reported here (see also here for a study on SEZs in China and India). Some describe the SEZs in China as the most important step towards liberalisation. But the implementation of the idea in Africa, by Chinese, has not been easy, and the Nigerian experience has not been positive. 

The Russian experience was not positive at least until the end of the 1990s. 


  1. SEZs are mysterious beasts ... providing privileges to foreign investors that are not available to domestic investors does not seem sensible ... allowing goods to be produced that can only be exported (and perhaps re-imported) so that they are not available to domestic consumers goes against logic ... the concept is also based on a false or misleading premise that foreign investment is necessary for economic growth ... capital-friendly policies should be made available to domestic investors, then foreign investors will come in ... as it is, SEZs are an admission that policies are too burdensome for rational economic choices ... but it beggars the imagination that poor countries would give advantages to (rich) foreigners that are not available to their own citizens

    1. This is a valid criticism to a certain extent, but it ignores the pragmatic aspect. An SEZ is never the best option in an ideal world, but reforming the entire country's economy is unlikely to be politically feasible. A SEZ is a step that may be actually achievable, even in countries with relatively poor governance, and it is likely to be an improvement on the status quo.

  2. Clearly the framework for analysis should be the theory of the second best. The question should be does the SEZ permit erosion of (one of) the most damaging departures from first best? In a circumstance in which no foreign investment is permitted, a SEZ where some investment is permitted is likely to be positive. The same can be said for a regime of generally very high import restrictions, A "free trade" zone that permits some imports even if only for re-export is an efficiency - promoting policy.

  3. In my opinion special economic zone is good place for business.