Special economic zone

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A special economic zone (SEZ) is an area in which the business and trade laws are different from the rest of the country. SEZs are located within a country's national borders, and their aims include increasing trade balance, employment, increased investment, job creation and effective administration. To encourage businesses to set up in the zone, financial policies are introduced. These policies typically encompass investing, taxation, trading, quotas, customs and labour regulations. Additionally, companies may be offered tax holidays, where upon establishing themselves in a zone, they are granted a period of lower taxation.

Contents

The creation of special economic zones by the host country may be motivated by the desire to attract foreign direct investment (FDI). [1] [2] The benefits a company gains by being in a special economic zone may mean that it can produce and trade goods at a lower price, aimed at being globally competitive. [1] [3] In some countries, the zones have been criticized for being little more than labor camps, with workers denied fundamental labor rights. [4]

Definition

The definition of an SEZ is determined individually by each country. According to the World Bank in 2008, the modern-day special economic zone typically includes a "geographically limited area, usually physically secured (fenced-in); single management or administration; eligibility for benefits based upon physical location within the zone; separate customs area (duty-free benefits) and streamlined procedures." [5]

History

The United States has long applied special economic rules to its outlying territories for the purpose of economic development. Section 936 corporate tax exemptions for Puerto Rico began with Operation Bootstrap in the 1940s and ended in 2006. [6] The federal minimum wage for U.S. territories has in the past been lower than in the states, and as of 2024, American Samoa is still adjusting upward to the nation-wide minimum. [7]

Modern SEZs appeared from the late-1950s in industrial countries. The first was in Shannon Airport in County Clare, Ireland. [8] Some tax-free jurisdictions such as the Cayman Islands offer technology companies a way to keep their IP offshore in a Special Economic Zone (see Cayman Enterprise City).

From the 1970s onward, zones providing labour-intensive manufacturing have been established, starting in Latin America and East Asia. The first in China following the opening of China in 1979 by Deng Xiaoping was the Shenzhen Special Economic Zone, which encouraged foreign investment and simultaneously accelerated industrialization in this region. [9] : 50–51  These zones attracted investment from multinational corporations [1] and allowed export-oriented Chinese businesses to respond quickly to demand in foreign markets. [9] : 50  China continues to maintain Special Economic Zones and certain open coastal areas. Most of China's SEZs are located in former treaty ports and therefore have symbolic significance in demonstrating a "reversal of fortunes" in China's dealings with foreigners since the century of humiliation. [9] : 51  Researcher Zongyuan Zoe Liu writes that "[t]he success of these cities as 'red' treaty ports represented another step in China's overall reform and opening-up plan while legitimizing the leadership of the CPC over the Chinese state and people." [9] : 51 

Numerous African countries have set up SEZs in connection with China, [2] including over the period 1990 to 2018 establishing SEZs in Nigeria (two), Zambia, Djibouti, Kenya, Mauritius, Mauritania, Egypt, and Algeria. [10] Generally, the Chinese government takes a hands-off approach, leaving it to Chinese enterprises to work to establish such zones (although it does provide support in the form of grants, loans, and subsidies, including support via the China Africa Development Fund). [10] The Forum on China-Africa Cooperation promotes these SEZs heavily. [10]

As of at least 2024, there is a trend of southeast Asian countries to develop and increase their SEZs. [11] : 55  Since 2015, Thailand developed ten SEZs. [11] : 55  As of 2024, Indonesia has 13 SEZs, the Philippines has 12 SEZs, and Cambodia has 31 SEZs. [11] : 55 

Economic impacts

Special Economic Zones (SEZs) have a significant impact on the economies where they are established, offering several key benefits that contribute to economic growth and development. One of the most important effects is the attraction of Foreign Direct Investment (FDI). By offering tax breaks, streamlined regulations, and enhanced infrastructure, SEZs provide a favorable environment for foreign companies looking to invest. This influx of capital can generate substantial economic activity, including job creation within the zones and in related sectors such as logistics, transportation, and services.

SEZ’s can lead to growth in Gross Regional Product (GRP) per capita, reflecting an increase in the economic output of the region. Similarly, they can contribute to higher personal income levels and attract more FDI projects, which bring in both capital and expertise. These economic improvements can contribute to higher living standards for the local population.

In addition to attracting investment, SEZs are crucial for generating employment. The businesses that establish themselves in these zones require workers, leading to an increase in jobs for the local population. This can, in turn, result in higher income levels and better living standards for people in the surrounding areas. However, it is important to note that the positive economic effects of SEZs do not always translate into positive social impacts. For instance, despite the economic growth they bring, SEZs may not always lead to a significant reduction in unemployment rates, as some regions may experience a mismatch between job creation and local labor market needs.

SEZs also play a vital role in boosting exports. Many companies operating in these zones focus on manufacturing goods for international markets, helping to increase a country’s exports, which can improve the trade balance and generate foreign exchange earnings. [12]

Furthermore, SEZs contribute to local economic development by stimulating demand for local goods and services. As businesses in the zones require input from local suppliers, this creates additional economic activity and encourages further investments in the region. Infrastructure development is another major benefit. The establishment of SEZs often leads to improvements in transportation networks, utilities, and communication systems, which can have positive effects beyond the zone itself, benefiting the wider economy. Additionally, SEZs can serve as hubs for technology transfer and innovation. Foreign companies often bring advanced technologies and expertise, which can help local firms improve their own operations and boost their competitiveness. This knowledge transfer is essential for skill development within the local workforce, enhancing their capabilities and preparing them for future economic challenges. [13]

However, SEZs also have some drawbacks, such as a possible increase in inequalities between regions or the potential for inefficient resource diversification. Indeed, the economic benefits of SEZs are unevenly distributed. Critics argue that these zones often benefit large multinational corporations disproportionately while providing limited gains for local businesses and communities. In Poland, for example, SEZs have concentrated economic activity in select regions, creating significant disparities in development. Moreover, the focus on foreign investors can result in dependency on external capital, which may not always align with the host country’s long-term economic priorities. [14] This is directly linked to the theory of a balanced economy, which claims that an economy can only grow if all sectors are financed simultaneously. In contrast, the unbalanced development theory argues that investing in certain sectors—or, in this context, specific regions—can lead to the development of other sectors. [15]

Another drawback is the fact that tax incentives can disrupt the equilibrium between the state and companies. When companies make sufficient profits, they pay higher taxes, which allows the government to invest without raising taxes. However, if this is not the case, the government may need to increase taxes. In a tax incentive system, to maintain equilibrium, the revenue generated by the system must be high enough to prevent the state from having to raise taxes. [15]

Another issue is the so-called "race to the bottom" among EU member states. The lack of harmonized tax policies enables countries to compete aggressively by offering increasingly generous incentives to attract investors. While this may benefit individual SEZs in the short term, it undermines collective EU goals of equitable economic development and cohesion. Furthermore, these tax breaks often fail to deliver proportional benefits, as many foreign firms bring their own labor force, limiting local job creation and exacerbating inequalities. [16]

Finally, while SEZs are heralded for their ability to attract Foreign Direct Investment (FDI), their broader economic implications often reveal significant shortcomings. One major concern is their role in facilitating tax evasion. By offering highly competitive tax rates and other financial incentives, SEZs sometimes create conditions where corporations exploit loopholes to minimize their tax liabilities. This practice undermines state revenues, limiting the ability of governments to invest in public services and infrastructure. For instance, Ireland's Shannon SEZ, while successful in drawing foreign investment, has been criticized for perpetuating "tax haven" dynamics that weaken EU fiscal cohesion. [14]

SEZ location

The location of an SEZ and the presence of good infrastructure can determine whether an SEZ will be productive or not. The incentive is to establish SEZs in decentralized areas to promote employment and economic activities. However, SEZs located near large cities tend to be more productive. [17] This is especially true if the SEZs have access to efficient communication and transportation systems, such as proximity to a port or an airport. [18]

Many zones are deliberately positioned near borders to facilitate cross-border trade by allowing businesses to leverage tariff advantages and access multiple markets efficiently. For instance, companies operating in border zones can easily source raw materials from neighboring countries or export finished goods to nearby markets. [19]

Another important consideration is why firms choose SEZs inside or outside the EU. SEZs in the EU offer unparalleled access to the European market, political stability, and high production standards, which enhance the reputation of products. Additionally, the advanced infrastructure and strong emphasis on sustainability in EU SEZs attract firms focused on long-term investments. Conversely, SEZs in non-EU countries may appeal to businesses seeking lower labor costs, less stringent regulations, or tax incentives that might not comply with EU competition rules. For example, firms targeting high-growth emerging markets or wishing to bypass stricter EU regulations might opt for SEZs outside the EU. [20]

SEZ regulation in Europe

It is worth noting that SEZs in Europe are often seen as “unlikely cases” because they operate under stricter regulations compared to other regions. Unlike zones in Asia or Africa, European SEZs must align with EU state aid rules and fair competition principles. This makes their model unique, as they prioritize high-value-added industries, green energy, and technology sectors over labor-intensive manufacturing. These characteristics underscore Europe’s commitment to sustainable and knowledge-driven economic growth. [21]

The regulatory framework governing SEZs in Europe operates at multiple levels, encompassing EU, national, and local jurisdictions.

At the EU level, the regulations emphasize compliance with overarching principles of state aid, competition, and customs policies. However, SEZs often challenge these principles through deviations justified by their economic benefits. For instance, Articles 107-109 of the Treaty on the Functioning of the European Union (TFEU) explicitly prohibit state aid that distorts competition, unless such aid is deemed necessary for fostering regional development or addressing specific market failures. SEZs navigate these constraints by demonstrating their contributions to broader economic goals, such as reducing regional disparities or promoting innovation, thus aligning with permissible exemptions under EU law Customs regulations are similarly governed by the EU. Policies like Regulation 524/2008 enable the establishment of tariff-free zones, aimed at facilitating trade and attracting investment. These zones must operate transparently and ensure non-discriminatory treatment to avoid unfair competition Economic and social cohesion is central to the EU’s regulatory framework, requiring SEZs to align with the Union’s objective of equitable regional development. For example, the SEZ established in Italy’s Campania region explicitly targets underdeveloped areas, offering fiscal incentives and streamlined administrative processes to stimulate growth. Such initiatives are designed to comply with EU policies on regional cohesion while addressing localized economic challenges. [22]

Taxation within SEZs, however, falls under the purview of national governments. The EU lacks the authority to harmonize tax systems across member states, resulting in significant variations in SEZ tax policies. For instance, some countries offer aggressive tax incentives to attract Foreign Direct Investment (FDI), leading to a "race to the bottom" that exacerbates economic disparities between regions. National authorities independently design these fiscal policies, often prioritizing immediate investment inflows over long-term equitable development [14]

SEZs justify their breaches of EU principles by emphasizing their potential to generate significant economic and social benefits. For instance, they argue that tax incentives and regulatory flexibility are critical for attracting Foreign Direct Investment (FDI) and creating jobs in economically lagging regions. These justifications often rely on data demonstrating positive spillover effects, such as increased regional productivity and enhanced infrastructure. Nevertheless, these arguments remain contentious, as critics highlight risks like tax evasion, resource misallocation, and exacerbation of regional inequalities [16]

SEZ practical cases

Poland – East-Europe develop country

In Poland, Special Economic Zones (SEZs) were established to attract foreign investment and promote economic development. The primary goal of creating SEZs in Poland was to reduce structural unemployment and boost the economy in the poorest regions of the country. The main fiscal instruments used to attract FDI include tax breaks on corporate, personal income, and real estate taxes. These tax incentives can be applied for a period of 10 to 15 years. The Polish government created 14 SEZs, with the first becoming operational in 1995. Its creation resulted in the establishment of 55,000 new jobs and a significant increase in FDI, particularly in the automotive sector, as it attracted major industry players like General Motors. These zones are characterized by several attractive features, including high-quality infrastructure, a skilled workforce, and various tax incentives such as tax exemptions on profits and property within specified limits. [23]

As of the end of 2014, the SEZs employed approximately 250,000 workers, demonstrating a significant increase from previous years. The cumulative investment in these zones was estimated at $23.3 billion by 2012. The Polish SEZs are regarded as some of the most competitive in Central Europe, with consistent interest from investors, averaging around 100 new permits issued per year. This ongoing demand led the Polish government to extend the favorable regime associated with these zones for an additional six years. Each SEZ is managed by specific entities or agencies dedicated to their development (Structure and Management). Originally, the zones were set up for a period of twenty years, but this has since been extended to 2026. The Polish government has recognized the importance of these zones in maintaining a competitive edge in attracting investment.

The success of the Polish SEZs can be attributed to their strategic design and the incentives offered, which facilitate the establishment and operation of businesses, thereby contributing to regional economic growth and enhancing the overall investment climate in Poland. [24]

SEZs in Poland are attractive to investors due to several factors:

Ireland – North-Europe developed country

Ireland is often cited as a success story in the use of Special Economic Zones (SEZs) to attract foreign investment and stimulate economic growth, with the Shannon Free Zone as a notable example. Established in 1959, this zone is recognized as the first modern industrial free zone, designed to attract international capital into manufacturing and services, addressing the structural changes in air transport at the time. The Shannon Free Zone offered attractive tax conditions, including an exemption from taxes on export profits for 25 years and a highly competitive corporate tax rate. This strategy aimed to reduce bureaucracy and create a business-friendly environment, thus facilitating the establishment of foreign businesses in Europe.

The development of the zone was accompanied by modern infrastructure and integrated services, which allowed for improved operational efficiency for businesses. Industrial relations, characterized by an informal and cooperative approach, further strengthened this favorable environment. By 1968, the Shannon Free Zone employed nearly 4,000 people and played a key role in Ireland's exports, becoming a driver of economic growth. The Shannon Development agency continuously adjusted its strategy to ensure the competitiveness and sustainability of the zone, demonstrating its commitment to adapting to the needs of investors.

The Irish government also played a crucial role in the success of these zones, particularly through the Industrial Development Authority (IDA), which worked to position Ireland as an attractive destination for foreign investment. The Irish experience shows how targeted tax incentives, robust infrastructure, and a business-friendly environment can transform a country into a leading player in attracting foreign direct investment. [24]

Italy – South-Europe with developed country

The case of Special Economic Zones (SEZs) in Italy is illustrated by the establishment of the SEZ in the Campania region, which marked the country's first such initiative. This SEZ was introduced through Legislative Decree No 91 on June 20, 2017, and became operational in 2018. Its main objective is to foster economic growth in the region by offering fiscal and administrative advantages to businesses operating within its defined areas. The Campania SEZ spans 37 municipalities out of the 550 in the region, covering a total area of 5,154 hectares. These zones were selected based on their strategic location near ports and transport hubs, aiming to enhance accessibility to logistical and industrial networks. The design of the SEZ focuses on improving infrastructure, especially to facilitate the movement of goods through road, rail, sea, and air transport.

One of the main features of the Campania SEZ is the array of benefits it offers to companies. Businesses within these zones enjoy various incentives, including exemptions from specific regulations and streamlined procedures for obtaining permits related to environmental, construction, and port operations. Tax credits are available, with higher benefits for larger enterprises and those in areas affected by natural disasters.

The key advantages for companies investing in the SEZs in Southern Italy include:

The SEZ's effectiveness is linked to the region's transport accessibility, which has been carefully analyzed. Campania boasts a well-developed multimodal transport network, offering good connections both nationally and locally. However, challenges such as congestion at key transport nodes and access to intermodal facilities have been identified, which could impact the operational efficiency of businesses in the zone.

The Campania SEZ plays a significant role in Italy’s broader economic strategy, as highlighted by its inclusion in the National Recovery and Resilience Plan. This plan aims to provide substantial financial resources to strengthen SEZs and improve regional economies. The goal is to revitalize areas that face economic challenges by boosting industrial development and attracting foreign investment. Despite its advantages, the SEZ faces challenges related to transport bottlenecks, particularly during peak periods. Measures to address these issues, such as improving transport infrastructure and enhancing the efficiency of logistics networks, are being considered by policymakers. [26]

Albania – Developing country in the Balkans

The development of SEZs in Albania is particularly interesting for several reasons. For Albania, SEZs represent a key instrument to stimulate industrialization, reduce unemployment, and modernize infrastructure. Strategically located along important trade routes connecting Europe to the Balkans, Albania’s SEZs position the country as a gateway for businesses looking to access markets in both Western Europe and the Mediterranean. These zones are also a way to attract advanced technologies, diversify the economy, and strengthen regional partnerships.

From the EU’s perspective, Albania’s SEZs are significant for fostering economic stability and growth in the Western Balkans, a region with strategic importance for European integration. Supporting the success of SEZs in Albania can help reduce regional disparities, promote political stability, and align Albania’s economic policies with EU standards key steps as the country pursues EU membership sins years now. Additionally, the SEZs offer European firms an opportunity to establish operations in a cost-competitive environment while maintaining proximity to the EU market. [27]

In Albania, the concept of Special Economic Zones (SEZs) is embodied by the "Technological and Economic Development Areas" (ZTSE), established under Law No. 54/2015. These zones aim to attract investments by creating favorable conditions for both local and foreign businesses. The ZTSE encompasses various economic activities, while excluding those that could harm the environment or national resources. They offer a distinct framework with specific fiscal and customs arrangements to promote industrial development and trade.

Companies operating in these zones benefit from several incentives, such as a 50% deduction on profits for the first five years of activity and the ability to deduct 20% of annual capital expenditures over a three-year period from the start of operations. Goods of Albanian origin delivered to the area are treated as exports with a 0% VAT rate, and constructions within the area are exempt from property tax for five years. Additionally, employers can deduct 150% of wages and social security contributions paid to employees during their first year of activity, providing a significant incentive to reduce labor cost.

The ZTSE are designed to offer flexibility in employment, allowing for atypical arrangements such as part-time or temporary contracts. This flexibility can enhance employment rates and boost the local economy. Among its development goals, the Albanian government is focusing on specific zones like Koplik and Spitale to stimulate regional economic activity and generate jobs.

This economic incentive model seeks to create a favorable business environment, inspired by successful models elsewhere, such as the Shannon Free Zone in Ireland or the Special Economic Zones in Poland, which have demonstrated their effectiveness in attracting foreign investments and fostering local economic development. Ultimately, the ZTSE aim to leverage a combination of fiscal incentives, regulatory flexibility, and targeted development strategies to boost productivity and drive economic growth in Albania. [28]

Types

The term special economic zone [29] [30] can include: [1] [31]

World Bank special economic zone types [5]
TypeObjectiveSizeTypical LocationTypical ActivitiesMarkets
FTZSupport trade<50 hectares (120 acres)Port of entryEntrepôts and trade related Domestic, re-export
EPZ (traditional)Export manufacturing<100 hectares (250 acres)NoneManufacturing, processingMostly export
EPZ (single Unit/free enterprise)Export manufacturingNo minimumCountrywideManufacturing, processingMostly export
EPZ (hybrid)Export manufacturing<100 hectares (250 acres)NoneManufacturing, processingExport, domestic
Free port/SEZIntegrated development>1,000 hectares (2,500 acres)NoneMulti-useInternal, domestic, export
Urban enterprise zoneUrban revitalization<50 hectares (120 acres)Urban/ruralMulti-useDomestic

Challenges

SEZs do not differ from other facilities in industrializing economies. As with any technique administered used by a globalized economy there are oversights by actors that are not domestic. Transnational criminal organizations and terrorist groups have taken advantage of Special Economic Zones and their lack of regulations. [32]

SEZs also pose significant governance challenges. The preferential treatment granted to businesses within these zones can lead to regulatory arbitrage, where companies exploit differences in laws to their advantage, often at the expense of environmental and labor standards. This has sparked concerns about externalities, such as increased pollution and strained public resources, that extend beyond the boundaries of the SEZs. [14]

See also

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  20. ↑ Frick, Susanne A.; Rodríguez-Pose, Andrés (2 November 2023). "What draws investment to special economic zones? Lessons from developing countries". Regional Studies. 57 (11): 2136–2147. Bibcode:2023RegSt..57.2136F. doi:10.1080/00343404.2023.2185218.
  21. ↑ Frick, Susanne A.; Rodríguez-Pose, Andrés (2 November 2023). "What draws investment to special economic zones? Lessons from developing countries". Regional Studies. 57 (11): 2136–2147. Bibcode:2023RegSt..57.2136F. doi:10.1080/00343404.2023.2185218.
  22. ↑ Győrffy, Dóra (October 2024). "Liberal and illiberal industrial policy in the EU: the political economy of building the EV battery value chain in Sweden and Hungary". Comparative European Politics. 22 (5): 574–593. doi:10.1057/s41295-023-00374-0.
  23. ↑ "Policy brief: European special economic zones" (PDF). ESPON. 2020.{{cite journal}}: Cite journal requires |journal= (help)
  24. 1 2 Berlinguer, Aldo; Laera, Roberto; Vito Boccia, Antonio. "Special economic areas, best practices for attracting investment and flexible forms of employment. Economic impact in Albania". Economic Impact in Albania: 1.
  25. ↑ Lille, Lydia Coudroy de (2007). "Les zones économiques spéciales en Pologne : un tremplin pour l'emploi régional ou des miettes de la mondialisation ?". Annales de géographie (in French). 658 (6): 645–666. doi:10.3917/ag.658.0645. ISSN   0003-4010.
  26. ↑ Buonocore, Ciro; Carlucci, Fabio; Ciciarelli, Lucia; Papola, Andrea; Tinessa, Fiore; Tocchi, Daniela; Trincone, Barbara (2023). "Accessibility analysis in spatial planning: A case of special economic zones (SEZs) in Campania, Southern Italy". Land Use Policy. 132. Bibcode:2023LUPol.13206763B. doi:10.1016/j.landusepol.2023.106763.
  27. ↑ Bartlett, William; Krasniqi, Besnik A; Ahmetbasic, Jasmina (2017). "Study on Special Economic Zones (SEZs) in the Western Balkans". doi:10.13140/RG.2.2.17283.20003/1.{{cite journal}}: Cite journal requires |journal= (help)
  28. ↑ Berlinguer, Aldo; Laera, Roberto; Vito Boccia, Antonio. "Special economic areas, best practices for attracting investment and flexible forms of employment. Economic impact in Albania". Economic Impact in Albania: 1.
  29. ↑ УПРАВЛЕНИЕ ОСОБЫМИ ЭКОНОМИЧЕСКИМИ ЗОНАМИ СУБЪЕКТА Archived 8 April 2022 at the Wayback Machine РФ Масаев С.Н. В сборнике: XIII Всероссийское совещание по проблемам управления ВСПУ-2019 Труды. Под общей редакцией Д.А. Новикова. 2019. С. 1773–1778.
  30. ↑ Masaev S. Destruction of the Resident Enterprise in the Special Economic Zone with Sanctions Archived 26 June 2020 at the Wayback Machine . Publisher: IEEE. 2019
  31. ↑ Economic Zones in the ASEAN (PDF), United Nations Industrial Development Organization, 2015, p. 26, archived from the original (PDF) on 30 September 2020, retrieved 16 September 2016
  32. ↑ Latin American Special Economic Zones and Their Impacts on Regional Security (Report). Archived from the original on 10 December 2023. Retrieved 10 December 2023.

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