…from textile hubs to pharmaceutical giants
Africa’s Special Economic Zones are the latest and most high-profile attempt to draw investment and unlock economic growth. They have been hailed as ‘a new engine of global trade’, but their benefits remain unclear. Do they deliver? What drives the incentives that motivate foreign investors to participate in these areas? What are their spillovers to the rest of the economy? And are the conditions for success or failure similar?
In the global race to win-over foreign direct investment, developing countries – including sub-Saharan African economies, have turned to special economic zones (SEZs) as a way to create a competitive advantage. SEZs are spaces in which rules are relaxed or unique in order to encourage investment and trade. The most common elements of an SEZ include tax exemptions or deferrals, elimination of import duties, less restricted movement of labour and capital, simplified Customs procedures, and duty-free reserves for raw materials.
African countries use investment incentives to entice foreign firms to expand production in a sector lacking sufficient domestic capacity. These efforts have successfully transformed the economies of some African countries. However, they have also created new distortions which may undermine growth, even when the original objectives are achieved. In particular, the ubiquitous presence of special economic zones has fostered rent-seeking behaviour and rent extraction that undermines the development strategies they were intended to support.
Africa’s SEZs have avoided some of the warts which plagued other sub-Saharan African initiatives, including corruption and infrastructure challenges – and they hold considerable promise. But in order for them to truly rise above their competition, the business and legal conditions underpinning the zones must be tailored in a way that matches the specifics of particular sectors.
In the case of many prime end-use industries, such as pharmaceuticals and textiles, the economic benefits of SEZs have been slow to materialize; and these industries have been largely unaffected by other growth drivers. In turn, this has led many to conclude that there is little or no evidence for the touted role of SEZs in Africa’s growth and development. New research shows that this conclusion is mistaken. There does exist considerable evidence for specific types of African industries benefitting from protection regarding taxation and regulation, but what’s missing from the debate is a more nuanced understanding of how the different types of benefits emanating from the presence of SEZs interact with one another.
The conditions under which growth takes place are considerably more complex than just taxes and regulation, and they require a broader discourse regarding the role SEZs play as policy instruments to support growth. As such, development strategies based on SEZs must address a range of factors – including effective coordination between domestic and foreign firms under an enabling legal environment to shield them from rent-seeking behaviour; credible competition policies; regulatory capacity; investor protection, and dispute resolution mechanisms – in order to achieve their intended impact.
Theories of economic development posit that countries benefit most when they focus on developing their comparative advantage. This requires a particular focus on private sector institutions to support spillovers and overcome coordination failures. The reality of the African experience is that the prevailing institutional environments in many countries are not conducive to private sector-led growth. The private sector’s participation in African SEZs is therefore by no means guaranteed; and even if it does take place, its potential impact on aggregate productivity is not assured because firms may face conflicting incentives as a result of rent-seeking behaviour by public officials and the need for coordinated action across many sectors.
These firms are subject to tax holidays and delayed Customs procedures aimed at attracting entrepreneurs, but they also tend to display limited interaction with their local communities. This means that their impact on overall productivity in host countries is far lower than that of dynamic foreign firms – those that have a competitive advantage caused by economies of scale and scope – which embed themselves in local communities and act as anchors for future growth initiatives.
While SEZs can bring new employment opportunities and foreign investment to an area, they often prioritise the needs and interests of foreign firms over local workers and businesses. This can lead to a concentration of wealth and power in the hands of a few, while the rest of the population is left behind. Additionally, there is a risk that SEZs may become enclaves of prosperity, disconnected from the rest of the economy and society. This can create social and political tensions as those outside the SEZs feel excluded from the benefits of economic growth.
Another challenge facing African SEZs is the need for adequate infrastructure. While some SEZs may have been successful in attracting foreign investment, the lack of reliable electricity, transportation and communication networks can hinder the growth and productivity of businesses operating within the zones. This can lead to increased costs, delayed shipments and reduced competitiveness, which can ultimately undermine the potential benefits of SEZs.
Furthermore, there is a risk that SEZs may become overly-reliant on foreign investment and exports, leading to vulnerability to external shocks and economic crises. If global demand for the products produced in SEZs were to decline or if there are disruptions to the global supply chain, the SEZs could suffer significant economic losses. To mitigate this risk, it is important for host countries to diversify their economies and encourage the development of domestic industries that can serve as a backup to the SEZs.
What’s more, the success of SEZs in Africa is also contingent on the availability and quality of infrastructure. Without adequate roads, ports and energy supplies, firms will struggle to access raw materials and transport finished goods to market. In addition, SEZs can exacerbate existing regional disparities if they are only located in certain areas – leading to uneven economic development across the country. For this reason, it is important for host governments to create a more equitable geographic distribution of SEZs and ensure the zones are located equidistant from major cities.
The criticisms of SEZs outlined above do not mean that they are completely ineffective. On the contrary, when properly designed and implemented, SEZs can be beneficial to a host country’s economy. By providing tax holidays, imposing regulations that simplify Customs procedures and exempting firms in these zones from complying with domestic law for certain periods of time, the host governments hope to attract foreign investment and generate employment by making the zones more attractive to entrepreneurs than other regions in the country. These policies can also promote exports from these zones by reducing transaction costs for domestic firms that want to export their products and services from there.
Lastly, transparency and accountability are key to ensuring that SEZs deliver on their promises. Governments must be transparent about the incentives offered to investors and ensure they are in line with the country’s development objectives. Additionally, there must be mechanisms in place to monitor and evaluate the impact of SEZs, both in terms of economic growth and social/environmental sustainability.
The main challenges facing African SEZs can be minimised by following certain design principles. First, host governments should tailor their incentives and competitiveness policies specifically to the needs of their industries and sectors, in order to achieve maximum efficiency and achieve the desired impact on economic growth. For instance, if an industrial sector has no existing infrastructure or market demand for its products or services, there is little benefit for foreign investment. Similarly, if a firm is already operating at full capacity, there is little reason for it to relocate into an SEZ. These and other factors need to be taken into account as governments determine the design of their SEZs.
The inclusion of small- and medium-sized firms in the process early on can also help ensure they benefit from the same incentives and competitiveness policies. This can help promote inclusive growth in the country and avoid social exclusion. Additionally, host governments should consider whether noncompliance with national laws should be an acceptable condition for foreign investors operating in their SEZs.
The Dawa Industrial Zone in Ghana, for example, demonstrates the importance of transparency, accountability and tailoring incentives and support services to the needs of investors in promoting the growth and development of SEZs. The Ghanaian government has tailored incentives and support services to meet the needs of investors in the zone, including streamlined administrative procedures and infrastructure. By promoting collaboration among investors and sharing best practices, the Dawa Industrial zone helps to build a supportive business ecosystem that encourages innovation and learning.
The success of African SEZs therefore depends on effective coordination between foreign and domestic firms, as well as the legal and regulatory environment under which they operate. Without these complementary elements, the advantages SEZs can provide will be limited – while their potential harms may outweigh any benefits they may bring to an economy or industry. As such, SEZs must be viewed as part of a broader development strategy rather than a standalone provider of economic growth.
The writer is an award-winning financial advisory, trade and transformation consulting pro with almost two decades of enterprise leadership experience across EMEA.
