The making of free zones

Nigerian Consultant on Free Zones, Mr Chris Ndibe, wrote a book on “Understanding Free Zones Scheme: Nigeria Perspective’’, which we started running last week.
The second part of the scintillating work is published on Saturday.
Regulatory Framework
A crucial aspect of a successful Free Zone programme is the simplification and streamlining of investment approvals, expatriate work permits, removal of required import and export licences etc. as well as accelerated on-site Customs inspection procedures and automatic foreign exchange access.  Free Zone legislation is increasingly incorporating features to increase the ‘transparency’ and ‘automaticity’ of the programmes.  A key global trend is the movement toward the establishment of ‘one-stop-shops’ to consolidate and expedite government approval.
The key guidelines for the development of a best practice Zone regulatory framework are:
(i)        Install streamlined procedures for business registration embodying a simple declarative investment registration system, rather than any sort of investment approval regime.  Key elements would include: application to a single government office to provide the licence; promulgation of a list of ineligible activities and other explicit criteria for approval or denial.
(ii)        Facilitate provision of secondary permits and authorisations.  Additional permits – lands, buildings labour, health and safety, etc. – can be facilitated by vesting all such authorisations within the Free Zone Authority rather than other ministries and agencies.  The Zone Authority should have offices in each Zone to perform these services.
(iii)        Develop special Customs rules and regulations drawing upon WCO and WTO provisions, and fast-track implementation of automated Customs systems, with proper inventory controls and audit systems, within the Free Zones.
 Institutional Framework
One of the major factors behind the success and failure of Zone programmes is the autonomy and effectiveness of the body charged with regulating operations. One element is particularly important especially in the context of the rising number of private Zones. It is critical that Zone Authorities remain engaged in purely regulatory functions, and do not own, develop or operate Zones since opportunities for perceived and actual conflict of interest are multiplied when the entity charged with guiding and monitoring Zone performance is simultaneously one of the Zone operators being monitored.
Below are best practice guidelines for the development of an effective institutional framework:  

1. Ensure adequate autonomy of the Zone Authority particularly over staffing, budgets, spending and policy-making.
2. Ensure adequate authority by constituting an independent Board comprising key government officials and private sector representatives reporting to the highest level of government. Ideally, allow private sector representatives to constitute the majority of Board membership to ensure flexibility and customer focus.
3. Ensure that the Zone Authority serves as a one-stop-shop by promulgating legislation that provides the body with single-point authority over other government bodies in core areas.

(iv)        Ensure that the body delegates, outsources and privatises as many non-core functions and services as possible to focus on core activities.
(v)        Annual reports of zones Authority should X-ray the yearly activities; achievement and problem area. Submission of annual is very important to overall assessment of the regulatory agency.
Critical issues that need to be addressed in the configuration of a Free Zone development programme is the type to be promoted.  The following approach is recommended: 

1. Permit industrial estates to host Free Zone enterprises as well as those licensed under other regimes.
2. Ensure that the Free Zone regime is flexible, allowing a range of commercial as well as manufacturing activities.
3. Promote private rather than public development of zones.  International experience suggests that this increases the chances of success.Reasons Why Private Free Zones Are Better
   Although Mexico’s approach has been unique due to circumstances that may not apply throughout the world, I would like share with you some good reasons why I believe zones should be private:

1. In today’s world we are heading towards a global economy; you must be competitive and efficient in order to survive. This is something that the private sector always has in mind; and the reason is that they are profit oriented.
2. Private zones are developed according to long term plans; you don’t have to worry if there’s a change in the administration, or in the political party in power.
3. Private free zone budgets and expenses are strictly monitored and controlled, you have to be competitive.
4. Private zones are innovative and flexible because of pressure exerted by ownership to obtain maximum benefit from the available resources. In other word, we have to repay the loans to the banks.
5. In case of a dispute, a multinational company established in a private zone has a better chance to come with a fair settlement instead of having to sue the government of its host country  
6. A client company does not have to deal with any corruption or bureaucracy.
7. There is no political conflict of interest while negotiation with any labor unions.
8. There is no conflict of interest with a private free zone if the government wishes to negotiate a free trade agreement with other countries.
9. Under a system based on private EPZs you do not have the government in direct competition with the private sector; on the contrary, they will be working together.
10. The privatization of existing public free zones around the world would generate extra cash the government could use to invest in public infrastructure and social development without losing jobs or foreign exchange income.
11. The public, if not well managed can be a drain instead of revenue generation
    
    Outlook for Free Zone Development
    
    What is the outlook for free zones in the context of global integration and trade liberalisation?  Some analysts argue that the rationale for Zones is diminishing as average tariff rates fall around the world especially in Africa with the single market agreement that is being signed. Our analysis suggests that this is not the case.  The case for Free Zones may actually be stronger in the context of trade liberalisation.  Even with the full implementation of the Uruguay Round and the single market agreement, some tariff and non-tariff barriers will remain in most countries.  Developing country exporters will need to compete with exporters in other countries who are operating in a duty and tax-free environment.  Second, even with lowered tariffs, anti-export biases will not be removed.  Various policy distortions, procedural inefficiencies and infrastructural inadequacies will deter exporters, many of which can be avoided by continued development of focused investment and export promotion mechanisms as occurs in Free Zones.The prevalence of Free Zones in industrialised countries with open economies also underscores the importance of the concept of competitiveness.    Many companies choose an FTZ location because of the important advantages of operating in a flexible, duty-free environment. Operating costs are lower as a result of reduced insurance, security and overhead costs.  Cash flow is enhanced by the ability to postpone duty payments only upon entry into the domestic customs territory.  FTZs in the U.S. have been critical in enabling manufacturers to operate ‘just-in-time’ systems.  In fact, most vehicles manufacturers in the U.S. are located in FTZs or have factories provided with FTZ status.  Mechanisms such as Free Zones that provide efficiency advantages are even more important despite the advent of modern production and distribution concepts and approaches, and they could be the key to the reduction of transaction cost.
    There is little doubt that Free Zones must reinvent themselves in response to global integration, international trading rules and the rise of regional FTAs. Zones cannot and should not compete on the basis of fiscal incentives, but rather differentiate themselves in terms of facilities, services and most importantly, streamlined procedures.  Many zones, especially privately operated ones, are rapidly reconfiguring themselves into efficient distribution, production and trade facilitation hubs to reduce logistics costs.  International manufactures have realised that here is much greater scope to reduce logistics cost than production costs.  This can be accelerated within a Free Zone setting, by reducing transaction processing times and paperwork requirements. 
    There is a continuing role for Zones in many countries to incubate and accelerate policy reform.  In most developing country settings, the greatest scope may lie in introducing new Customs control concepts.  In others, Zones might be used to side-step public or private monopolies in telecommunications.  In still others, Zones may provide a better environment to attract foreign investments.
    The greatest emphasis is that, Free Zones now increasingly compete on the basis of business- enabling policy environments, rather than on the basis of fiscal and customs incentives.  They are increasingly integrated into national markets from a physical, policy and economic standpoint.  They are increasingly utilised as platforms to move goods between countries in today’s global marketplace.  They have increased their compliance with WTO and ILO norms, as well as decreased their dependence on scarce state resources, becoming more socially responsible development tools as a result.  They have, in short, evolved and adapted to a new situation, and are, in our view, unlikely to disappear.  
    As Robert Koopman once narrated that incomes in developing countries have been converging with those of rich countries since 1990s because growth has accelerated in developing economies, while in developed economies it has slowed down. The performances of developing country G-20 members have been particularly strong.
    Successive round of tariff reductions continued liberalization through accessions, well designed and clearer international rules and their transparent application has facilitated reinforced and augmented the many domestic policy reforms that helped bring the world closer together – through increased globalization and faster economic convergence.
    There is still more that can be done and must and must be down. Continued reductions in trade barriers and trade costs can help the global recovery and broad based economic growth. Free Zones, by design, aimed to reduce costs and encourage economic synergies, card make substantive contributions to economic growth and development.
     
    LINKAGES BETWEEN FREE TRADE ZONE AND LOCAL ECONOMY
    
    Statistics between countries are very difficult to use properly – particularly statistics on a vague concept such as linkages which has different meanings between different countries which have been misused. 
    Free Trade Zones around the world seem to have had a number of different priorities either consciously or unconsciously. 
    The purpose of creating or establishing in 1992 was for employment purposes generating foreign and developing Kano and the idle city of Calabar. It was to create a large number of jobs and earned foreign exchange. Those goals were achieved; linkage would have been an important criterion. It may well be now that the nation can undertake to encourage linkages. But to have incorporated it in 1992 would have been costly in terms of the goals of relieving unemployment or attracting investment. 
    It is very difficult to use a single policy instrument like a Free Trade Zone to achieve all the goals that a nation can potentially achieve simultaneously. Similarly, it is very unlikely that a private company will achieve a maximum cash flow, a minimum growth rate, the highest profits and a good reputation and a clean environment all at the same time. We don’t expect them to. We look for growth companies with stable companies. We look for companies with high cash flows, and we are not upset when some companies have high cash flows and other companies have high growth rates. That is part of the mix, it is what management chooses to use the companies for – what management aims to achieve – that is important.
    In export processing zones we should also not be concerned when we see one zone attracting a great level of unemployment and another zone being used for regional development and another zone attracting a great deal of foreign exchange, but they generally do not accomplish all of these at the same time.
     
    The Meaning of Linkages
    When we talk about linkages we assume that all Free Zones have been created with purpose of having linkages to the local economy. Each of us may have a different meaning for the term “linkages”. We can use it in a way narrow sense to mean those products that we purchase from local industry to use in our Free Trade Zone for export. But in a broader sense it has a much wider meaning. 
    When a manufacturer comes into a country with a Free Trade Zone he immediately establishes linkages to the local economy. He buys electric power from the local economy and water and many of the infrastructure services including construction crews hired from the local economy. As the factory begins to operate, it may also purchase repair Services on computers and other types of utility products, light bulbs, wiring as well as the services to get these things done from the local economy. It may also purchase educational services from the local economy.
    The biggest item that many of the factories in free trade zones purchase is labour from the local economy and in doing so they provide wages to all of the employees in the zones; and this is the largest linkage in many of the FTZs, not the purchase of materials, but the purchase of labour which spends its income in the local economy. It is here that you get multiplier ratios.
    When the export manufacturers in the FTZ pays a worker five hundred dollars, he or she goes out and buys food which supports a food worker and the food worker uses his income to buy food and housing and electricity and household goods, and it multiplies throughout the economy. It is not unusual to discover that creation of two indirect jobs is the impact on the local economy of every job created in a Free Trade Zone.
    Sometimes when we focus entirely on linkages to domestic industrial products, it undervalues the impact that we have had on the economies of the countries with FTZs. If there are thirty or forty thousand people working in an FTZ, and recognizing that family size is five or six individuals, we may be talking about the FTZ supporting 150,000 or 200,000 individuals in that country out of the creation of direct export jobs in these zones and perhaps another 600,000 people through the creation of indirect jobs. So a single zone of 30,000-40,000 workers may be supporting a population of a million people and that is an impressive statistic when we are not even talking about industrial linkages.
    We should be aware of the fact that FTZs connect to local economies at many different levels and not just at the industrial raw materials level.
    When we talk about linkages there were times when it was felt unattractive to have foreign firms getting involved in the domestic economy but now we want these foreign buyers to get more and more involved in the local economy.