RATIONALE/BENEFITS FOR FREE ZONE DEVELOPMENT By Chris Okwy Ndibe

Why Develop Free Zones?

Zone development is one of the
many trade policy tools at the disposal of a developing country
government.  Typically, they are created
as open market cases within an economy that is dominated by distortion trade,
macroeconomic and exchange rate regulations, and other government controls.

The rationale for the development
of Free Zones differs between developing and developed countries.  For developing countries, free zones have
traditionally had both a policy and infrastructure rationale.  The typical free zone policy package of
import and export duty exemptions; streamlined customs and administrative
controls and procedures, liberal foreign exchange policies, income tax
incentive – meant to boost an investor’s competitiveness and reduce business
entry and operating cost.  Export
oriented Free Zones (EPZs) are intended to convey ‘free trade status’ to export
manufacturers to enable them to compete in global markets, and counter- balance
the anti-export bias of trade policies.

Madani (1999), Cling &
Letilly (2002) and Gauthier (2004) outlined four broader policy reasons for the
development of Zones, especially Export Processing Zones, in developing
countries as follows;

(i)         To support a
wider economic reform strategy.  In
this view EPZs are a simple tool permitting a country to develop and to
diversify exports.  Zones are ways of
reducing anti-export bias while keeping protective barriers intact.  The EPZs of Taiwan and South Korea followed
this pattern.

(ii)        
To serve as
‘pressure values’ to alleviate growing unemployment.  A lot of the Free Zone are associated with
this and are examples of robust, job creating programme that have remained
enclaves with little linkages to the host economies.

(iii)      
To serve as
experimental laboratories for the application of new polices and approaches.  China’s Special Economic Zones are classical
examples of this category.  Financial,
legal, labour and other policies were introduced and tested first within the
Special Economic Zones before being extended to the rest of the economy. 

(iv)      
To attract Foreign
Direct Investment into the countries: Foreign Direct Investment (FDI) is
one of the corner stones of the modern-day economy and is central to the process
of long-term economic development and sustainability for both transition and
developing markets world-wide. In recent years, policy makers, especially in
the developing nations, have come to the conclusion that Foreign Direct
Investment is needed to boost the growth in their economy.

The ‘hardware’ of the Free Zones
are fully serviced sites with purpose built facilities for sale or lease –  aimed at enhancing the competitiveness of
manufacturers and service providers, and realising agglomeration benefits from
concentrating industries in one geographical area.  These include efficiencies in government
supervision of enterprises and provision of off-site infrastructure facilities,
improved environmental controls, and increased supply and subcontracting relationships
among industries, amongst others.  This
infrastructure rationale is one of the most important driving forces behind
Zone development in countries that are poor in infrastructure like Nigeria.

The rationale for Free Zone
development in industrialised countries is more varied.  The new Special Economic Zones programme in
South Korea and above two dozen Foreign Access Zones in Japan, for example, are
explicitly intended to promote foreign investment.  In contrast the main rationale for Shannon
Free Zone in Ireland was to establish a ‘growth pole’ in economically
distressed southern part of the country. 

Revitalisation in the
economically distressed urban and rural areas is the motivation behind the many
enterprise Zone-style programmes in UK, France and the USA.  But enhancing trade efficiency and
manufacturing competitiveness is the principal rationale behind Free Zone
programmes in most industrialised countries. 
Many Companies choose a Free Zone location because of the important
advantage of operating in a flexible, duty-free environment.

Operating costs are lower as a
result of reduced overhead, insurance and security cost, cash flow is enhanced
by the ability to postpone duty payments only upon entry into the domestic
Customs Territory.  The Foreign Trade
Zones in the US have been critical in enabling manufacturers to operate
‘just-in-time’ systems.  The efficiency
advantages provided by Free Zones are even more important for industrialised
countries and approaches and the reduction of tariff barriers.

Many studies have evaluated the
economic performance of Free Zone programmes in developing countries.  Most of the studies focused on government
developed and operated Zones and neglected private zone development.  Critics of Zone development, on the other
hand, have focused on the social and environmental impacts of Zones, and have
largely been dismissive of economic contributions.  Almost all the studies failed to evaluate
zone contributions relative to the counterfactual – if zones did not exist.  How do Free Zones and Zone-based enterprises
compare with local firms or those operating under other incentive regimes?

From the above attempt to
evaluate some of the socio-economic benefits of Free Zones we can conclude that
the economic benefits are both static and dynamic.  The static benefits which are straightforward
include:

·        
Employment creation and income generation;

·        
Export growth and diversification;

·        
Foreign Exchange earnings;

·        
Foreign direct investment’

·        
Increase in government revenue.

The dynamic benefits are more
difficult to measure and are far more important to long-term contributions from
Zone development.  The most common
include:

·        
Indirect employment creation/backward linkages;

·        
Skills upgrading and female employment’

·        
Technological transfer;

·        
‘Demonstration effect’ arising from application
of ‘best practices’;

·        
Regional development.

Although some critics argue that
Zone development has a negative socio-economic impact, particularly in relation
to the role of women, labour and working conditions in Zones. The positive
impacts outweigh its costs and the benefits are obviously amplified in poorer
countries where jobs and foreign exchange earnings and government resources are
scarce.

Below is a short note on the overall
consensus on the goals and objectives of Free Zone:

This process
integrates the zone into the regional and national economy and promotes
regional development beyond the immediate and limited servicing of the enclave
structure. Eventually, it was hoped, these domestic supplier firms would mature
to compete in the international market.

In developing
countries in the early stages of development, a linkage has occurred when the
firms in the zones used basic production processes, where domestic raw
materials and intermediate inputs could be used. A great success story in this
regard is the experience of the Indonesian zones, where the dominant garment
industry uses domestic cloth and other raw intermediate inputs for its
production.

Linkages also
occur in advanced developing countries like South Korea and Taiwan, where a
large industrial base already existed and could provide electronics firms in
their zones with high quality, internationally components.

The second
assumption equates creating jobs with alleviating unemployment. Free zones have
created jobs which wouldn’t have been there without the existence of the
scheme. For some of the employed workers in the zone, the alternative to the
Free Zone employment would have been unemployment, underemployment or return to
village subsistence life. If the workers are unemployed, their opportunity cost
is zero and any new activity – including the free zone firms – which expands
employment will have a high economic rate of return.