How do you solve a problem like protectionism? With a U.S. president threatening a trade war, populism dominating political headlines in Europe, and decreasing popularity of trade deals, think-tankers and political pundits are scrambling for ways to escape a vicious circle towards ever-higher barriers to trade. Turning this development around may take a long time. In the mean time, though, countries may still create spaces where the barriers do not apply.
Enter the special economic zone, or “SEZ.” An SEZ is a geographical area where investors enjoy tariff exemptions and other kinds of tax breaks. By making particular areas of a country more attractive for investors, the zones can spur production and exports and create numerous employment opportunities. As I write in my book on the topic, “The Political Economy of Special Economic Zones,” SEZs can serve as the economic lifeline for otherwise closed countries.
SEZs come about in many different circumstances, but often in the context of adverse economic conditions. The first modern version emerged in Ireland in 1959 at the Shannon Airport. Thanks to new aircraft technology, planes flying between the U.S. and Europe no longer had to stop in Ireland to refuel. With its declining role in air traffic, the airport introduced an SEZ to attract investments and hence save the local economy.
Japan’s Prime Minister Shinzō Abe is using SEZs as a way to get around the country’s infamously rigid labor laws and restrictions on foreign workers. As part of his package of economic policies to revive Japan’s economy, Abe is introducing reforms in SEZs that meet too much popular resistance to be feasible when proposed on a national scale.
Or take the United States. It is a prime example of more-liberalized zones working as a counterweight to protectionism. It introduced SEZs in 1934, in response to the Smoot-Hawley Tariff Act. Under this law, tariffs rose to historic levels, which seriously damaged the country’s import-exporting businesses. These responded to their new predicament by convincing lawmakers to create Foreign Trade Zones, an American variation on the SEZ concept.
Since China ushered in economic success with their SEZs, starting in the 1980s, the SEZ scene has been dominated by developing economies. All around the world, countries with an abundance of poor and poorly educated people are attracting multinational manufacturers to invest in their SEZs. So widely spread are the zones that countries without them easily fall behind in the competition for foreign direct investments. As such, zones seem like a must for developing countries, rather than nice-to-have.
Many poor countries are highly protectionist, with no political support for change. As a result, SEZs have established themselves as the policy of choice for numerous governments. Unable to pull back their support for interest groups appealing for trade protection, policy-makers use zones to attract investors and create jobs while keeping trade barriers high for the rest of the country.
Might renewed protectionism in the U.S. usher in the rise of SEZs on a large-scale here? It would be an easy way for the Trump administration to preserve manufacturing jobs while pursuing protectionism.
SEZs are a tool policy-makers can use to point to the jobs their policies created, without accounting for the possible costs. These costs stem from the risk of SEZs wasting resources, as companies move into zones in search of tax breaks. Some zones also allow politicians to deceive the people with what looks like a liberalization policy but is actually a tool to preserve a system of protectionism.
Before the US embarks on the SEZ track, we should ponder the political economy fallacies with SEZs. So for anyone interested in learning about the history, future, and political economy of SEZs, my book is self-recommended. It will also give you an insight into the role of SEZs in international production, with value chains spanning rich and poor countries alike.
The world is enjoying previously unseen levels of prosperity combined with rising protectionism. With international trade under attack, people are rightly worried about inward-looking policies stifling growth and prosperity. SEZs may be our way to prevent protectionism from causing such damage.
Lotta Moberg is the Director of Economics at Refugee Cities.