Economics for Everyone: Special Economic Zones (SEZ)

Special Economic Zone (SEZ) is a special geographical region which has different laws when compared to other regions. SEZs are projected as duty free area for the purpose of trade, operations, duty and tariffs. SEZ units are self-contained and integrated having their own infrastructure and support services.

Jul 13, 2015 08:07 IST IIFL Prof. M. Guruprasad |

Special Economic Zone (SEZ) is a specifically delineated duty-free enclave and shall be deemed to be foreign territory for the purposes of trade operations and duties and tariffs. In order words, SEZ is a geographical region that has economic laws different from a country's typical economic laws. Usually the goal is to increase foreign investments. SEZs have been established in several countries, including China, India, Jordan, Poland, Kazakhstan, Philippines and Russia.
 
Any private/public/joint sector or state government or its agencies can set up an SEZ, a foreign agency can set up SEZs in India. Special Economic Zones (SEZ) are growth engines that can boost manufacturing, augment exports and generate employment. Business units that set up establishments in an SEZ would be entitled for a package of incentives and a simplified operating environment.
 
Special Economic Zone (SEZ) is a special geographical region which has different laws when compared to other regions. SEZs are projected as duty free area for the purpose of trade, operations, duty and tariffs. SEZ units are self-contained and integrated having their own infrastructure and support services. 
 
SEZ’s enjoys tax breaks, simplified procedures, less regulations and restrictions, exemption from customs and duties, all of which is done to
  • Generate additional Economic activity
  • Promote exports of goods and services
  • Promote Investment from domestic and foreign sources
  • Create employment opportunities
  • Develop Infrastructure facilities
The world first known instance of SEZ have been found in an industrial park set up in Puerto Rico in 1947. In the 1960s, Ireland and Taiwan followed suit, but in the 1980s China made the SEZs gain global acceptance with its largest SEZ being the metropolis of Shenzhen.
 
India Background
For long time, India experimented with the concept of such units in the form of Export Processing Zones (EPZ). In 2000, the policy makers incorporated the SEZs into the EXIM Policy of India. Five year later, SEZ Act (2005) was also introduced and in 2006 SEZ Rules were formulated. Thus the Special Economic Zone (SEZ) policy in India first came into inception on April 1, 2000. The prime objective was to enhance foreign investment and provide an internationally competitive and hassle free environment for exports. SEZs play a key role in rapid economic development of a country. In the early 1990s, it helped China and the policy makers in India thought of similar export-processing zones could offer similar benefits – with appropriate incentives.
 
It is expected that this will trigger a large flow of foreign and domestic investment in SEZs, in infrastructure and productive capacity, leading to generation of additional economic activity and creation of employment opportunities.
 
Economic effects of SEZ
According to economists
SEZs can be broadly defined as—
 
“Demarcated geographic areas contained within a country’s national boundaries where the rules of business are different from those that prevail in the national territory. These differential rules principally deal with investment conditions, international trade and customs, taxation, and the regulatory environment; whereby the zone is given a business environment that is intended to be more liberal from a policy perspective and more effective from an administrative perspective than that of the national territory.”
 
Now, let us see the kind of economic impact which operates under the SEZ and makes it as a powerful force for driving growth.
 
Various studies focus on the economic effects and roles of SEZ (and similarly on Export Processing Zone (EPZ)) across countries. Several studies attempt to provide a theoretical framework to analyze these economic effects, i.e., its benefits and costs, based on the standard “2 x 2 x 2” Heck-Ohlin trade model for small countries. Others present a general theory of Economic Zones or they discuss their structural and spatial evolution. In general, Economic Zones can be defined as export enclaves, where a national (or local) government provides foreign industries an international accessibility (e.g. harbor, airport, etc.), gives up  repressive national regulations (e.g. ban of trade unions) and offers economic incentives (financial and tax). The main advantage for the enterprises in these zones is the low wages for the unskilled labor force. However, unless a country succeeds in establishing some sort of higher, i.e. more qualified forms of industrial production; its economy is threatened by other low wage countries.
 
SEZ do attract the firms in sectors whose basis of competition is highly dependent on the available supply of low-wage, flexible, and unskilled or semiskilled workers, a set of requirements. Special Economic  Zones create the following advantages such as  (1) minimize costs (through fiscal incentives and administrative efficiencies); (2) provide access to serviced land and more reliable infrastructure; and (3) reduce the investment requirement, lowering risk and providing operational and strategic flexibility.

  • Some economists provide the following conceptual framework. According to them some of the key success factors of SEZ are
  • By combining private property rights protection, tax break and preferential long-term land use fee, attract foreign direct investment;
  • In the absence of any significant crowding out effect, do not reduce domestically owned capital formation;
  • If bringing more advanced FDI, will boost technology progress, i.e. total factor productivity growth.
  • This is because the law of SEZs explicitly provides the following policy packages for foreign investors:
Private Property Rights Protection
 
Tax incentives:
  • Land use policy
 
Liberal economic and labor laws:



Concept of Clusters
According to some experts, Shenzhen (China), SEZ is a combination of a SEZ and a collection of Clusters. It was one of the earliest and the most successful Chinese SEZ during last 30 years. During this period, many clusters appeared and disappeared within the zone, from traditional service clusters to modern service clusters, from manufacturing clusters to high-tech clusters, etc. Today, Shenzhen’s four foundation clusters—logistical cluster, financial cluster, real estate cluster and high-tech cluster—have contributed more than half Shenzhen’s GDP. Also, if we take the point of view of an individual foreign investor angle, we find the SEZ satisfies the basic requirements for building clusters. That are: SEZ has good location where has potential market demand, low logistic costs, low labour cost and etc; and a SEZ easily gets local skilled labour; and a SEZ usually has its own city plan—which clusters are set where. By such plan, foreign investors have quick access to information spillover.
 
It is important at this point of time to understand the concept of Clusters and how they are similar and or different from Special Economic Zones.
 
Special Economic Zones (SEZ) are limited geographic regions where the authorities offer some preferential policies for pushing local economy development. A cluster, on the other hand, is market economy phenomenon, in which several firms locate themselves in some certain geographical areas for the purpose of reducing costs and, raising profits on the basis of external economies between the firms ( for example Silicon Valley(U.S), IT industry in Bangalore (India), SME  cluster, Footwear and Garment clusters in India and many more.
 
Theory of SEZ tells us that a SEZ is a special place where is set for developing local economy and where enjoys some certain preferential economy policy. The theory of Clusters says that a cluster is also a special economy agglomeration. Porter (1998) describes clusters as geographic concentrations of interconnected companies and institutions in a particular field, encompassing linked industries and other entities important for competition. The term business cluster, also known as an industry cluster, competitive cluster, or Porterian cluster, was introduced and popularized by Michael Porter in The Competitive Advantage of Nations (1990).


India – Policy outlook towards of SEZ
As per law, SEZ units are deemed to be outside the customs territory of India. Goods and services coming into SEZs from the Domestic Tariff Area (DTA) are treated as exports from India and goods and services rendered from the SEZ to the DTA are treated as imports into India. In all SEZs the statutory functions are controlled by the government. Government also controls the operation and maintenance function in the seven central government controlled SEZs. The rest of the operations and maintenance are privatised. State governments have a very important role to play in the establishment of SEZs. Representative of the state government, who is a member of the inter-ministerial committee on private SEZ, is consulted while considering the proposal. Before recommending any proposals to the ministry of commerce and industry (department of commerce), the states must satisfy themselves that they are in a position to supply basic inputs like water, electricity, etc. The state governments have been requested to simplify the procedures/returns and for introduction of a single window clearance mechanism by delegating appropriate powers to development commissioners of SEZs. 
 
India-pixel Process and Administrative set up of SEZ
The developer submits the proposal for establishment of SEZ to the concerned State Government. The State Government has to forward the proposal with its recommendation within 45 days from the date of receipt of such proposal to the Board of Approval. The applicant also has the option to submit the proposal directly to the Board of Approval. The Board of Approval has been constituted by the Central Government in exercise of the powers conferred under the SEZ Act. All the decisions are taken in the Board of Approval by consensus.


The functioning of the SEZs is governed by a three tier administrative set up. The Board of Approval is the apex body and is headed by the Secretary, Department of Commerce. The Approval Committee at the Zone level deals with approval of units in the SEZs and other related issues. Each Zone is headed by a Development Commissioner, who is ex-officio chairperson of the Approval Committee. 
 
The performance of the SEZ units are monitored by a unit approval committee consisting of development commissioner, custom and representative of state government on an annual basis. It is compulsory for every SEZ units in India to achieve positive net foreign exchange earnings as per the formula given in the    Handbook of Procedures. For this particular purpose, a legal undertaking is required which has to be executed by a separate unit of the Development Commissioner.

Thus the stages of a SEZ are
  • Anybody who wishes to develop a SEZ submits a proposal to the Board of Approval (BoA). A Single Window approval mechanism has been provided through a members inter ministerial Board of Approval (BoA), headed by the Secretary, Department of Commerce.
  • The BoA then grants an ‘in-principle’ or a ‘formal’ approval.
  • The Central Government issues a notification when the developer proves the possession, contiguity and irrevocable rights on Land. These are called ‘Notified SEZs’
  • BoA allows the Developer for authorised operation. The SEZs that start operations are called ‘Operational SEZs’
  • Developer/Units are allowed various Tax Concessions/exemptions for effecting Exports
India’s SEZ Act 2005 further amended the country’s foreign investment policy and converted its EPZs to SEZs, with notable zones including Noida, Chennai, Cochin, and Falta. Since the act’s promulgation, the Indian government has also been accepting proposals for additional, far smaller SEZs, which must be proposed by developers to the Indian Board of Approval.

Incentives for SEZ  
  • The advantages of setting up a sourcing or manufacturing platform within a SEZ are numerous and include:
  • Duty free domestic procurement of goods for the development and maintenance of your company;
  • 100% income tax exemption on export income for first five years, 50% for five years following;
  • Exemption from Minimum Alternate Tax, Central Sales Tax, Service Tax, State Sales Tax, and a number of other taxes usually levied by local governments;
  • External commercial borrowing allowed up to US $500 million a year without restriction;
  • Permission to manufacture products directly, as long as the goods you are producing fall within a sector which allows 100% FDI
Present Scenario: Trends and Progress:

The Top 10 states in terms of SEZ approvals are

Total employment in SEZs in terms of number of people (As on 30th September, 2014)


Challenges:
Special Economic Zones (SEZs) are likely to be central to realising Prime Minister Mr. Narendra Modi’s ambitious Make in India agenda. But according to some experts the withdrawal of tax incentives in the recent past has made SEZs an unattractive proposition, say industry experts. Under the original scheme, businesses in SEZs were exempted from the minimum alternate tax (MAT) on book profits and developers were exempted from payment of the dividend distribution tax (DDT). But with indications that companies were misusing the policy for real estate arbitrage and other tax benefits, these exemptions were withdrawn.

From 2011-12, MAT exemptions for SEZ units and developers were withdrawn and DDT exemptions for developers were terminated. MAT was levied on book profits at the rate of 20 per cent, while DDT was levied at 20 per cent on dividends distributed to shareholders.

According to a study on analysing the cost benefit analysis of the SEZ policy, says the imposition of MAT has made SEZs unattractive and adversely impacted investor sentiment. Thus the withdrawal of direct tax benefits has been a setback for the SEZ program and has affected its future prospects”. India has signed a number of free trade agreements (FTAs), with countries such as Sri Lanka, Japan and the Association of Southeast Asian Nations (Asean), under which import duties have been slashed to zero for several product lines. This impacts local sales of SEZ units, which are taxed at higher rates. Experts propose that “manufacturers in India should have the ‘most favoured nation’ status that implies lowest tariff under the FTAs”. According to them, “such reductions should be extended to all manufacturers, not simply the ones in SEZs”.

But according to some experts, taxation issues are not the only ones impeding SEZs. According to them, “Despite offering many incentives and schemes for promotion of manufacturing at the Centre and state levels, manufacturing growth has not risen substantially. Therefore, incentives need to be carefully evaluated and studied. Incentives should not be the only reason for units to be located in SEZs. Success depends on the business facilitation measures adopted. Location, infrastructure, logistics and professional zone management are four key factors determining success of SEZs.”A major reason for the success of SEZs in China was the creation of complementary infrastructure, power, roads and ports; these are lacking in India. According to experts, in order to get SEZs and manufacturing going in India, the focus should be on creating the necessary infrastructure which will require a more holistic approach.
Deficiencies in the availability and quality of power are an equally important constraint.”
 
SOURCES:
Thomas Farole, Gokhan Akinci, (2011) Special Economic Zones, Progress, Emerging Challenges, and Future Directions. The International Bank for Reconstruction and Development/The World Bank
 
Jin Wang (2009), The Economic Impact of Special Economic Zones: Evidence from Chinese Municipalities, London School of Economics, Job Market Paper
 
Ren Lu( 2008),  Chinese Special Economic Zones as Clusters, A Case Study of Shenzhen’s Modern Service Clusters
 
Meng Guangwen,Tianjin (2003) The Theory and Practice of Free Economic Zones: A Case Study of Tianjin, People’s Republic of China, University of Heidelberg, Germany
www.sezindia.nic.in
Economist.com
INDIATIMES NEWS NETWORK
Business Standard
www.factly.in
Wikipedia
Prof.M.Guruprasad, AICAR BUSINESS SCHOOL

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