Special Economic Zones: A Primer
Special Economic Zones: A Primer
Is this a special ingredient for development? Or do only naïve numbskulls say that?
A Special Economic Zone (SEZ) is designed to transform the business environment in a specific area. The government typically offers tax breaks, tariff reductions, and other incentives to encourage investment. Each SEZ operates differently—some focus on tax exemptions, while others offer relaxed labor, environmental, and bureaucratic regulations. The ultimate goal is to attract both foreign and domestic investors to boost production, create jobs, and stimulate economic growth.
The Benefits of SEZs
A key advantage of SEZs is tariff exemptions, which allow firms to import raw materials, machinery, and equipment "duty-free" as long as they meet conditions like exporting the finished product or hiring local labor. This is crucial because foreign firms may not find the high-quality materials or equipment they need locally. Even when the materials are available in the host country, they might be of inferior quality compared to imports.
Governments need a “goldilocks” attitude with tax breaks: generous enough to attract investors but not so much that they deprive themselves of crucial tax revenue. Sometimes, SEZ firms pay little or no corporate tax, but their workers still contribute income tax. This trade-off shifts the focus from corporate tax revenue to income tax revenue as local employment increases.
Lax regulations in SEZs streamline administrative processes—faster business registration or customs clearance. In countries like the Democratic Republic of Congo, where registering a business can take six months, simplifying these services makes SEZs attractive to investors frustrated with red tape.
Governments also invest heavily in SEZ infrastructure, ensuring reliable utilities like electricity and water. This creates a two-tiered system where SEZs enjoy uninterrupted power while the rest of the country may face inconsistent supply. SEZs might impose conditions like minimum investment requirements, hiring local workers, or mandating exports, especially in Export Processing Zones (EPZs).
What are the different types of SEZs?
Freeports: These are large port cities that host business activity aimed at production in both the domestic and foreign market. They are usually huge and encompass entire cities. Examples include the Shenzhen SEZ and Jebel Ali Free Zone in Dubai.
Export Processing Zone (EPZ): EPZs are smaller than Freeports. They are usually industrial parks and don’t have significant amounts of residential property. These are popular SEZs which are common across Asia, Latin America, and Africa. They are used to support manufacturing. They helped Mexico, Honduras and others transform from agricultural exporters to textile manufacturers. Now EPZs have evolved to have warehousing services and call centers. Ghana has an EPZ at its port in Tema. EPZs are set up to prevent SEZ firms from competing with local businesses and to generate foreign currency. However, due to new agreements from the WTO, EPZs are falling out of favor.
Free trade Zones: They are even smaller than EPZs. Typically located in ports, free trade zones are fenced-in and do not host residents. They focus on trading promoting activities such as warehousing, storage, and transshipment. America has 250 free trade zones called “foreign trade zones”. The firms operating in American zones are taxed as if they are on foreign soil, equipped with facilities for handling and shipping, they are meant to attract US trading activity, employment and value add. Others include Panama’s Colon Free Zone near the Panama Canal.
Single Factory Zones: These are the smallest SEZs. They include one company that has a simply tax break arrangement. There are so many of these and no one can count them all.
Enterprise Zones: They are urban residential areas in need of revitalization. Their specific aim is to lessen unemployment and boost the economy in particular areas that lag behind the country. This idea started under Margaret Thatcher in the UK, then spread to U.S. and France which have introduced zones in poor suburbs outside the main city. When Obama launched this in 2014 they were called “Promise Zones” and when Trump launched his in 2019 they were called “Opportunity Zones”. Results on these are very mixed.
How Many SEZ’s are there?
As of 2019, UNCTAD puts the number at 5400.
By region, Europe, Africa, the Middle East, and North America have the least amount of Special Economic zones, while East Asia, Southeast Asia, Latin America, and South Asia have the most. India itself has more special economic zones than the entire African continent, and China has over 10x the amount Africa does.
How do Economists view SEZs?
It’s a mixed bag. Some economists think they are essential for growth as long as they are well managed. Some economists are skeptical of them or believe that they cause growth spurts to the economy in the short term. But over the long term, performance tapers off and the state is ultimately forgoing crucial tax revenue.
The metrics of success of SEZs come from looking to see if that zone has led to more foreign direct investment (as an input) and more production, exports, and employment (as an output). But it’s also really important to look at the political economy of an SEZ.
How did SEZs start?
The world's first-documented free-trade zone was established on the Greek Island of Delos in 166 BC. So the idea has been around for millennia. It’s tough to say when the “first” SEZ was.
The Kingdom of Spain wanted cars in the country, so Spain made a proto- special economic zone to attract Ford’s factories in Cadiz, Spain in the 1920s.
In the 1930s, President FDR tried to spur international trade through foreign trade zones(FTZs). America has currently 193 active FTZs. One of the first American zones was the Navy Yard in 1937.
In Latin America, the first zone was Colombia’s Barranquilla Zone in 1958. In Europe, you have Ireland’s Shannon Airport in 1959. In South Asia, India made one in Kandla in 1965, and in East Asia, Taiwan made one in Kaohsiung(Gao-shyong) in 1966. In Southeast Asia, Singapore made their first one in 1969, and in Africa, Mauritius made theirs in the 1970s.
Why do they Exist?
The core idea behind Special Economic Zones (SEZs) is to overcome the challenges that developing countries face due to inefficient governments and dysfunctional markets. A prime example of this inefficiency is the power sector. When I visited my family’s home country, Ghana, and later Ivory Coast, I witnessed firsthand the frequent power outages that plague both nations. In Ghana, these blackouts have a name: "Dumsor." To manage the constant disruptions, homeowners and businesses have turned to importing generators just to keep the lights on. SEZs are designed to bypass these kinds of inefficiencies by offering reliable infrastructure, such as uninterrupted electricity, to create environments that are more attractive to investors and more conducive to growth.
Example of Inefficient Governments & Markets in Developing Countries:
Many African nations have state-owned monopolies responsible for providing cheap electricity. The government subsidizes these utilities to keep prices low for consumers. For instance, in Zambia, ZESCO (the Zambia Electricity Supply Corporation) is the state-owned utility that generates most of its power from hydroelectric sources, like the World Bank-funded Kariba Dam, accounting for 90% of the country's electricity, with some additional thermal coal plants.
To keep electricity affordable, the government sets tariffs below the cost of production. The average cost to produce electricity in Zambia is about $90 per MWh (90 US cents per kWh). But most Zambians are poor, they only makes $1300 a year, and even that number is skewed. Consumers pay a “residential tariff” of only $50 per MWh. This creates a $40 per MWh subsidy from the government to ZESCO, which adds up to $720 million per year for the roughly 18 GWh (18 million MWh) of electricity generated annually. ($40 per MWh×18 million MWh=$720 million per year. Note: This is a simplification to get my point across. But this is generally how this works)
With only $3.5 billion in foreign reserves and government revenue of K141B $5.4B USD as of September 2024 exchange rates), this subsidy significantly strains Zambia’s finances. As a result, ZESCO remains underfunded, unable to invest in necessary infrastructure upgrades, leading to frequent power outages and insufficient electricity supply. Rural areas still lack electricity, and the lack of competition also discourages efficiency improvements.
This scenario is common in other African countries, like Zimbabwe with ZESA, its state-owned monopoly.
When monopolies consistently run at a loss, they deplete the country’s financial reserves. This hinders investment in maintenance or expansion and forces governments to borrow, often from international investors. Without competition, monopolies face little pressure to improve. In poorly managed state-owned firms, much of the budget goes to salaries and pensions, leaving little for infrastructure upgrades. Bailouts become necessary just to maintain operations..
Electricity subsidies are just one example of government inefficiency. Similar practices include fuel subsidies or draining foreign reserves to artificially strengthen the currency, which lowers the cost of food imports. These actions reflect a government using borrowed funds or depleting reserves to subsidize consumption rather than investing in long-term growth.
Ethically, this approach might be seen as “good” because the government is prioritizing the immediate needs of the poor by trying to provide access to affordable energy and food. However, economically, it's “bad” because a poor country should ideally prioritize its borrowing and spending on investments that drive sustainable development, rather than short-term consumption concentrated in urban areas. Typically this policy doesn’t even help the majority of people since a slight majority of African countries aren’t predominately urbanized. Only 23 out of 54 African countries have a majority population that lives in cities.
State-owned monopolies can work in more emerging developing countries like China or Vietnam, which have sufficient reserves and government revenue to sustain subsidies (China Foreign Reserves: $3.23T & $1.6T Government Revenue & Vietnam’s Foreign Reserves: $80B & ~$70B in government revenue) . But in capital-poor countries like Ethiopia, Pakistan, or Zambia, these models lead to underperformance and reliance on bailouts from institutions like the IMF.
Leaders aware of these inefficiencies may attempt reforms—privatization of inefficient state owned firms, allow competition, raising tariffs, or cutting subsidies—but these efforts get push back from the elite and urban poor/middle class.
The incumbent elite pushes back against reforms since these reforms might unravel the patronage network (unless the state owned firms are sold to them. See my article on Burkina Faso). Even if inefficient government firms are privatized, we have examples where some of these firms being driven to the ground in private hands (see my article on Mali).
Also the urban populations protest as they are accustomed to low electricity rates. With elections looming, leaders frequently abandon reforms to avoid unrest or political fallout, creating a tension between necessary market reforms and political realities that makes meaningful change difficult. Nigeria is going through this right now. Nigerian President Bola Tinubu, abruptly cut fuel subsidies and is harmonizing exchange rates between the black market and government rate. But for the average Nigerian, its extremely painful and causes protests.
We saw this in Angola too:
The goal of Special Economic Zones (SEZs) is to create functional markets in areas that typically struggle with weak property rights, poor infrastructure, or mismanagement. By offering a favorable business environment, SEZs aim to attract investors, boost production, increase exports, and generate local employment. However, their success is far from guaranteed—while some SEZs have thrived, many have failed.
The potential for economic development is clear, but the outcomes are mixed. Why do I emphasize "potential"? Because SEZs have about a 50% success rate when it comes to driving rapid economic growth.
To illustrate this contrast, let’s look at two examples: Shenzhen, China, and Fordlandia, Brazil.
Shenzhen, China
Shenzhen was once a modest farming and fishing village with a population of about 30,000. In 1980, Deng Xiaoping designated it as one of China’s first Special Economic Zones (SEZs) as part of his ambitious reform agenda. Its proximity to Hong Kong made it an ideal location for attracting foreign investment and testing market-oriented policies.
Shenzhen, along with Zhuhai (Joo-hai), Shantou(Shahn-toe), and Xiamen(Sha-men), became China’s pioneering SEZs. These four zones accounted for 60% of the country’s foreign direct investment (FDI), with Shenzhen alone drawing 51% in the early 1980s. By 1984, the experiment expanded to 14 other cities, known as “Open Coastal Cities”, further accelerating China’s integration into the global economy. In 1990, the establishment of the Shenzhen Stock Exchange cemented the city’s role in China's economic rise.
Despite internal resistance to more reforms after the Tiananmen Square protests of 1989, Deng Xiaoping doubled down on reforms during his 1992 Southern Tour, leading to the creation of 35 more SEZs along the coast. These zones attracted a significant share of China’s FDI and exports, playing a key role in the country’s rapid industrialization.
Today, Shenzhen is known as China’s Silicon Valley and hosts the fourth-busiest container port in the world. Its stock exchange ranks among the top ten globally, with a market capitalization of $3.5 trillion USD as of September 2024.
Other SEZ success stories include Mauritius, which evolved from a sugar plantation colony into a hub for textiles and tourism, boasting the second-highest living standards in Africa after Seychelles. Similarly, Honduras and the Dominican Republic have leveraged SEZs to become significant textile exporters to the United States.
Fordlandia, Brazil
Henry Ford, the American industrialist who revolutionized car manufacturing, was courted by the Brazilian government in the late 1920s to invest in rubber production. In 1928, Brazil granted Ford tax breaks to establish Fordlandia, a settlement deep in the Amazon, centered around the Hevea brasiliensis “HEE-vee-uh Brazil-ee-en-sis” (a really good rubber tree). The goal was to create an American-style town with modern amenities—electricity, running water, American housing, and restaurants serving American food—all in an effort to industrialize Brazil's rubber industry.
At first, the idea seemed promising. Fordlandia exposed Brazilians to American work culture, and thanks to the weak Brazilian real, Ford could pay locals a fraction of American wages, yet still above their average income. It was a bubble of modernity in the jungle, complete with golf and ballroom dancing.
But the project was a massive failure.
Ford ignored local agricultural experts and attempted to implement American farming techniques unsuited to the Amazon. Rubber trees were planted too close together, leaving them vulnerable to pests and diseases. Extracting the rubber became unprofitable. The seringueiros “Seh-reen-Guei-rohs” (Brazilian rubber workers) were not accustomed to the rigid Midwestern work schedules and resented bans on alcohol, leading to a riot in 1930.
The logistics were another nightmare—transporting goods and machinery to such a remote area was costly and difficult, and the infrastructure, including housing and water systems, was poorly planned for the Amazonian environment.
To make matters worse, the invention of synthetic rubber rendered the production of natural rubber relatively unnecessary. With unprofitably high costs and low productivity, Fordlandia collapsed, becoming a symbol of a failed SEZ experiment.
To grasp the magnitude of Fordlandia’s failure, imagine if Elon Musk attempted to create a futuristic city in Africa called “MuskXland”. Suppose he struck a deal with Felix Tshisekedi(Chee-seh-KEH-dee), the President of the Democratic Republic of Congo, to build a manufacturing hub for Tesla in Lubumbashi(Loo-boom-BAH-shee), the mining capital known for its copper & cobalt. If Musk’s intense work culture clashed with local traditions, infrastructure planning was flawed, and cobalt became irrelevant due to a materials science technological breakthrough in Japan, the project would be a disaster—just like Fordlandia.
When SEZs fail, the signs are clear: abandoned infrastructure, lack of investor interest, poor location, and fiscal incentives inferior to neighboring SEZs. This has happened numerous times. Often, failure stems from governments’ inability to coordinate infrastructure, create links to the broader economy, and offer competitive incentives.
In Nigeria, for example, the success of SEZs has been mixed. Nigeria has several SEZs. Calabar (1992), Onne(2000), Kano (2001), Lagos (2002), Lekki (2006), Ogun-Guangdong (2007), and more. Calabar has oil & gas investment. Zones like Lekki have seen success with the Dangote refinery and Chinese investment. While others, like Kano (2001), focused on textiles and agriculture, have struggled due to poor infrastructure and weak investment flows. Nigeria’s non-fossil fuel exports remain underwhelming, with no single good exceeding $1 billion in exports—nor even $100 million in textiles.
Concluding Thoughts
This article only begins to explore the complexities of SEZs.
But even now, one thing should be clear: development isn’t as simple as saying, "Let a visionary American entrepreneur run your city!" or "Just copy what East Asia did!" Economic growth is far more nuanced, requiring a deep understanding of local contexts, strong governance, and the right balance of incentives and infrastructure.
I understand the political tradeoffs in letting market forces run the energy industry. Plus, there’s no guarantee that they will work
To me, I wonder how African countries can expand power capacity?
How well does Build Operate transfer work?
I wish you had chosen another example for failure.
Forlandia mixes bad luck (synthetic rubber), stupidity (geography and American ignorance), was centered around a then existing ressource based activity.
There are zones that failed even when they set up to do what Shenzen, Singapore or Mauritius did (export based manufacturing close to a port). And I think not enough attention is paid to the causes (like indequate labor supply for instance).