June 29, 2022

How Special Economic Zones Are Quietly Advancing State Capitalism

If advancing economic freedom comes at the cost of property rights, has economic freedom really been advanced?

In April 2017, professor Tom W. Bell from Chapman University wrote an article for FEE called How Special Economic Zones are Quietly Advancing Freedom where he describes how economic zones are being used by states to improve economic freedom.

Special Economic Zones (SEZs) are geographically limited areas, usually business parks, that are exempted from various taxes and regulations. Governments create SEZs to attract foreign investment, in theory by increasing ease of doing business.

My day-to-day work as an SEZ consultant for the Adrianople Group has forced me to adopt a far less optimistic view of SEZs. I have personally known professor Tom W. Bell for the better part of the last decade, and I believe that he is one of the world’s most astute and brilliant observers of the global SEZ industry. His perspective is informed by decades of intensive research during which time he has published dozens of articles making the free market case for SEZs.

There are a number of high profile success stories, such as the Kigali Free Zone in Rwanda or Shenzhen in China, where SEZs have been used to promote economic freedom and have achieved incredible results.

But these do not represent the full picture. Recently, our research team has created the world’s first map of every single SEZ in the world. There are more than 7,500 SEZs in 70 countries, and the overwhelming majority are not bastions of economic freedom—many are, in fact, the opposite.

SEZs are not quietly advancing freedom—they are actually advancing state capitalism.

Government Expenditures

Our research has found that 36 percent of SEZs are entirely financed by the government, and another 32 percent are partially financed by the government. Only 31 percent of SEZs are entirely financed by the private sector.

Many SEZs have become white elephants. White elephants are economic development projects that have received massive amounts of government spending, but amount to nothing.

For example, the Port of Colombo in Sri Lanka received $1.5 billion in financing from Chinese state run corporations. The port was to feature a large smart city, complete with a business center, residential district, shopping malls, and office towers. However, in 2015 the zone was scrapped due to the lack of private sector tenants. Prior to the pandemic, the attached airport was already nearly empty.

Nigeria’s Abuja Technology Village was announced in 2006. The government owned Abuja Investments Company planned on financing its construction with a $900 million investment. More than a decade later, the village still has not attracted any major tenants. The Nigerian Export Processing Zones Authority is now threatening to revoke the zone’s regulatory privileges.

The Mochovce Nuclear Power Plant in Slovakia, which also included an adjacent SEZ, cost the government upwards of $1.7 billion. This makes it the 4th most expensive building in the world, costing more than the Burj Khalifa in Dubai. Despite this, construction took 15 years and the plant produces significantly less power than was initially expected.

All of the above white elephant SEZs could be construed to be libertarian projects. The Port of Colombo, Abuja Technology Village, and the Mochovce Nuclear Power Plant all enjoyed generous tax and regulatory advantages. Alone, these incentives would be great. However, lack of demand, incompetant state-run management, and government financing all resulted in the failure of these zones. The question that needs to be asked is whether the incentives offered by these zones outweigh the fact that they are costing taxpayers large amounts of money.

Land Grabs and Expropriation

The creation of some SEZs challenges the very foundation of economic liberty: property rights. Many SEZs are built on land that was expropriated by the state, then used for private economic development. In some cases, the land is formally seized through eminent domain. In other cases, land that was de jure state owned but de facto privately managed is seized for the project.

Land expropriation is a particularly severe problem in countries with weak state recognition of property rights. Informal communities will appear on land that is government owned. These communities will develop their own rules governing property rights. In many cases, these communities of so-called “squatters” have existed for decades, even centuries. When these governments “privatize” government owned land, they will often relocate the pre-existing communities by force. In countries with poor state recognition of property rights, land “privatization” sometimes amounts to the expropriation of land that may have been continuously privately owned for centuries.

This pattern of confiscatory privatization is widespread in India. Professor Michael Levien, from Johns Hopkins University, has written numerous papers where he discusses land acquisition issues for Indian SEZs. He argues that almost all of the largest SEZs in India acquired their land through expropriation. Worst of all, these zones often became white elephant projects and failed.

In 2015, the Indian government conducted a survey to see whether government owned farmland which had been allotted to private SEZ developers was being used. The survey found that in some regions, as much as 96 percent of the land was undeveloped. As a result, Indian farmers found themselves without land or economic development. Levien writes that “such developments [have] only minimally and precariously absorbed the labour of dispossessed farmers. […] [It has instead] drastically amplified existing class and caste inequalities, undermined food security and, surprisingly, fuelled non‐productive economic activity.”

The scale of India’s land grab issues are only rivaled by China’s. More than 50 million Chinese farmers suffered land dispossession between 1980 and 2003, with nearly 43 percent of villages in the country being affected. It is important to note that it is unclear how many of these affected farmers were dispossessed to make way for SEZ developments, although the sheer scale of China’s SEZ development policies suggests that the number is massive.

Land confiscation issues are not unique to China and India. They can be found wherever large, state-funded SEZs exist. Informal agricultural communities in Myanmar, the Philippines, and Cambodia have all faced similar dispossessions.

In a truly free market, where land acquisition was done fairly, farmers would view SEZ development projects the way Americans view winning the lottery. The value of their land would increase exponentially overnight, and they would become instantly wealthy by selling their land. Instead, they become the targets of expropriation and eminent domain. Developers do not want to pay the fair market price for land, preferring to use the government as a tool of expropriation.

If advancing economic freedom comes at the cost of property rights, has economic freedom really been advanced?

Rampant Corruption

Corruption is also rampant in the SEZ industry. Anyone who has been to any SEZ conferences can attest to this—at SEZ conferences, corrupt practices are blatantly advertised and yet the “c word” is only ever mentioned in whispers. Because SEZs are legally exempted from the rules that apply elsewhere in their home countries, they are prone to becoming havens of corruption.

Corruption in SEZs is difficult to write about because it often does not leave a paper trail. Anecdotally, I have heard many stories. For example, my sources in the Democratic Republic of Congo tell me that there are more than 700 “briefcase zones” in the country. Briefcase zones exist on paper, but in practice do not own any land or produce anything. In the DRC, these zones are often used by small time mining companies in order to secure tax benefits for their projects.

Perhaps the most famously corrupt SEZ is the Golden Triangle Special Economic Zone in Laos. The zone is famous for its involuntary prostitution, drug production, and wildlife trafficking. An OECD report on the illegal wildlife trade argues that the independent legal system of certain Southeast Asian SEZs makes it difficult for authorities to prosecute criminals.

In most countries, the problems with corruption are less obvious. A Ukrainian study found that areas with a high density of lobbyists are more likely to receive SEZ status. Indian SEZs suffer from the very same issues – businessmen are routinely caught bribing officials to designate their land as an SEZ in order to benefit from the incentives the zones offer. Even successful zones, such as Shenzhen in China, reportedly suffer from serious corruption issues.

Mitigating corruption in SEZs is fairly simple: all countries need to do is fully privatize the zones, remove the government money, and let market forces make or break their zone programs. Adopting a solution like this is not often politically palatable, however, as the zones often exist to funnel government funds into the hands of politically connected crony capitalists.

Instead, countries around the world frequently announce mass crackdowns, where they arrest corrupt officials. In the last year alone there have been SEZ corruption crackdowns in dozens of countries ranging from Saudi Arabia to Jordan to the Philippines. Mass arrests are ineffective, because if the incentives for corruption do not change, then a new crop of corrupt officials simply emerges to replace the previous cohort.

How SEZs Can Be Better

When I first began studying SEZs, I saw them as a means of advancing liberty. Sadly, the weight of my experiences working with SEZs has dashed my naive enthusiasm.

Professor Tom W. Bell would, I suspect, agree with many of the above criticisms that I have made in this article. The main point of contention is whether or not SEZs are, on the net, good or bad for freedom.

At best, SEZs reinforce the status quo. They neither advance nor diminish economic freedom. At worst, SEZs are another tool used by governments to advance state capitalism. By branding themselves as free market projects, then failing, they might actually hurt liberty.

But SEZs can be reformed to be better.

The third of SEZs that are not state funded are already doing great. According to an International Labor Organization and World Bank study from 2008, more than half of the world’s manufactured goods are produced in SEZs. That same study found that SEZs that are privately managed have lower vacancy rates, are less corrupt, and more efficient

In order to both improve the economies of their home countries and advance freedom, SEZs only need to do three things:

1. Be entirely privately funded and managed

2. Be located on land that is purchased on the market rather than seized through eminent domain or privatization of informally owned land

3. Be allowed to fail if market conditions do not favor the development of certain zones

Zones that follow these three rules will either succeed or fail, depending on whether or not market demand exists for what they have to offer. They will not become bloated state-sponsored leviathans that continue to survive year after year despite high vacancy rates. Only then, when zones are truly subject to market forces, will they begin to do what they are supposed to do, and quietly advance freedom.

This article, How Special Economic Zones Are Quietly Advancing State Capitalism, was originally published by the Foundation for Economic Education and appears here with permission.  Please support their mission.