14 May 2018

India and its SEZs: an incompatible relationship?

Erzie writes:*

Over the past decades, the establishment of Special Economic Zones (SEZs) - geographical regions concentrated with production or export and import activities governed by special economic laws - has become an increasingly popular policy option for governments of developing countries. SEZs promise to stimulate economic growth and development by attracting investments, increasing exports and providing employment. SEZs have been successful in Asian tiger economies as well as in China.

These success stories have incentivised many countries to introduce SEZs in the hope of achieving similar success, but most SEZs tend to perform poorly.

This blogpost will discuss India’s attempt to develop SEZs. In 2005, the Indian government accepted the SEZ Act, which has shaped the existence of India’s present day SEZs. Prior to the enactment of this Act, India had experience with the establishment of numerous Export Processing Zones. However, due to lack of good governance of economic policy and inefficient management, these zones ultimately failed in meeting the expectations. The SEZ Act aimed to revive India’s export zones by loosening regulations and strongly promoting private SEZ development. As a result, the SEZs sector has grown tremendously. Around 500 SEZs are formally approved, of which roughly 350 are "notified," i.e., have land in possession. According to Jenkins et al., 180 of these 350 SEZs  are actually exporting. Although 180 SEZs may seem impressive, the performance of these SEZs remains contested. The underlying reason can be identified through two main characteristics of Indian SEZs.

Firstly, the majority of the SEZs are less than 1 sq. km in surface area. To put this in perspective, The Economic Times claims that ideally a SEZ should be over 1,000 sq. km to be productive. The small size of SEZs is primarily the result of India’s land acquisition problems that have hindered the development of large SEZs cities. India’s land market is distorted as a result of two main land laws that inhibit land assembly. The Urban Land Ceiling Act of 1976 limits private ownership of urban land and only allows the government to transact in urban areas, creating an artificial shortage in the supply of land and pushing up prices. Moreover, the land use conversion and clause hinders SEZ entrepreneurs. If they decide to move away from expensive urban land, new challenges emerge. The absence of established commercial networks and infrastructure in India’s rural areas impede SEZ entrepreneurs from moving to these areas as it hinders productivity. In addition, India’s land laws have made it difficult for entrepreneurs to obtain a permit to convert agricultural land to commercial land, which disincentives entrepreneurs from developing SEZs in rural areas. Consequently, the land laws impede the development of large SEZs and thus, contribute little to economic growth.

Secondly, the vast majority of India’s SEZs focus on IT services. IT SEZs merely require 0.098 sq. km and therefore also hardly require new infrastructure or industrialisation in general. Moreover, IT SEZs perform poorly in generating employment for the local population as this sector requires a highly-skilled workforce. The lack of generating employment is especially typical for SEZs in rural areas as most of the population is illiterate and unskilled. Only during the initial set up of the SEZs can the rural population become employed but in the longer run they will find themselves unemployed in the SEZ sector. As a result, current SEZs have failed to enhance employment rates.

The combination of these two main characteristics has hindered India’s SEZs story from turning into a success story. Perhaps if India resolves its aforementioned internal issues and considers policy reforms, may there still be hope for SEZs in India.

Bottomline: Despite the potency of SEZs, India’s experiences with developing SEZs has been difficult. Indian SEZs have failed to contribute to significant economic growth and development due to land use laws hindering private SEZ investors to expand their area. Indian SEZs do not increase employment in rural areas due to its primary specialisation in IT services.

* Please help my growth and development economics students by commenting on unclear analysis, other perspectives, data sources, etc. (Or you can just say something nice :)

1 comment:

Darian Finckenstein said...

Great post Erzie! There is a lot of discussion around SEZ in India. With reference to governments ‘creating an artificial shortage in the supply of land and pushing up prices’, this encourages rent seeking behaviour. Firms buy the land and sit on it without industrialising or cultivating it, before selling it at a profit. This goes against the idea of SEZ.

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