Published 22 February 2011
The idea of a Special Economic Zone is to create a ‘hot house’ environment – a fenced-in enclave separate from the norms of the rest of the economy – that is conducive to rapid economic growth. The goal is to increase foreign direct investment typically by multinationals, using tax holidays, duty-free import of inputs and other incentives to create a cluster of similar manufacturing businesses so that synergies are achieved.
This is how it is meant to work.
Here in Cambodia, the government has approved 21 SEZs throughout the country. However, only six are operational to date, meaning some two-thirds are still idle, more than eight years after getting approval. Out of total exports of $US3.4 billion in 2010, SEZ’s only exported $US100 million.
The modern SEZ was first refined by in the early 1980s by the Chinese government under Deng Xiaoping when it became clear to him that China’s command economy was no longer able to produce the growth the country needed. China’s idea of its SEZ was modelled on the example of Hong Kong’s free market economy with its low tax rates and docile workers driving prosperity.
These zones essentially allowed the Chinese authorities – spurred on by fear that the Chinese economy was falling irreparably behind – to experiment with different forms of economic organisation to find out what would work. One of the most successful of these SEZs was in Shenzhen, which developed from a small village into a city with a population over 10 million within 20 years while attracting $30 billion.
Since then the Chinese-style SEZ has become a key part of the Beijing Consensus whereby rapid economic growth is more important than democratic freedoms.
Part of the formula for successful SEZs is to harness the country’s comparative advantages, especially access to cheap land (to build factories) and labour, to help earn foreign exchange, provide employment opportunities and, hopefully, the chance for the labour force to acquire new skills that can then flow through to the rest of the economy.
It is important that the zones product tangible benefits for the host country because, eventually the tax advantage on offer inevitably get fazed out as the economy reaches a point that the incentives used to attract investment are no longer needed. This is because the forgone taxes are generally expensive, especially in an emerging economy that usually has a very small tax base (such as here in Cambodia). In fact, an over-reliance on incentives can easily backfire.
However, whereas China developed key infrastructure around SEZs to give them the best chance of success, here in Cambodia, the authorities required the developers themselves to foot the bill for even basic services, such as electricity supply. Moreover, the corporate tax rate at 20% is less attractive than the 15% offered in China at the start of its own SEZ experiment.
Then there is the serious problem of low productivity relative to wages here in Cambodia, also making the country a less attractive investment destination. Only by increasing skill levels has this got a chance to change. This is because productivity is not necessarily about how hard employees work but is all about return on investment. Higher skills usually means higher levels of output per worker and, therefore, higher wages.
Instead of focusing on a small number of large sustainable SEZs, and building infrastructure around them to increase their attractiveness, the government has handed out licences mostly to well-placed business people, such as Kith Meng, Mong Reththy and Lao Meng Khin, possibly out of fear that foreigners might garner too many advantages from the zones. Instead, the zones have become a licence for these well-connected tycoons to print money.
There is no doubt that Cambodian SEZs can attract large foreign companies. Japanese food seasoning multinational Ajinomoto opened its first packing factory at the Phnom Penh SEZ in October last year and Hyundai is scheduled to begin assembling vehicles at the Neang Koh Kong SEZ soon.
On Feb 17 at the fourth Cambodia Economic Forum, managing director of Japanese-Cambodia joint venture PPSEZ, Hiroshi Uematsu, as reported by The Phnom Penh Post, said his company had already spent $US20 million on its SEZ and had 26 companies working there, including Yamaha Motors.
However, according to an assessment of the Manhattan SEZ by SY Batith, investors claimed that the absence of a commercial court, the high cost of electricity cost compared to neighbouring countries, plus the fact that almost all raw material must be imported, combined with the general lack of skilled labour (requiring onsite training) are all factors that inhibit investment.
At the Economic Forum, World Bank’s country manager, Qimiao Fan, warned that “industrial policy, investment in human capital, special economic zones are not the silver bullets for growth and poverty reduction, while UNDP regional director, Ajay Chhibber, warned against over-reliance of garment exports to the United States and the European Union.
The traditional benefits of SEZs are that they boost employment, increase and diversify exports, and attract FDI/ retain domestic investment. There are also dynamic benefits such as the transfer of technology and skills, stimulate local economy through linkages, streamline administrative and regulatory interfaces and, with luck, pilot new economic policies.
A newly emerging approach to SEZs is now being considered in the light of past experience that could have valuable lessons for Cambodia. In this brave new world, the zone authority regulates activities only within zone, while private developer builds/owns/operates zones on cost-recovery basis. Moreover, one-stop shop makes procedures as simple as possible. Zone enterprise designation extended to service intermediaries.
The new strategy also involves large-scale ‘mega zones’ that are integrated using IT systems & networks. These are usually predicated on public-private partnerships and aim to serve a range of markets, not just export. There is a move beyond just manufacturing, reducing regulation to encourage mixed use of the zone and to create a competitive environment, with streamlined procedures that become as automated as possible.
There is also a shift towards universal tax incentives and adherence to universal best practice in labour rights to protect the reputations of participants.
There are a couple of trail-blazers in this field: Dubai’s Jebel Ali Free Zone (JAFZ), and the Philippines Economic Zones Authority (PEZA).
JAFZ has employed an integrated development approach based on a strong private-public partnership, with clear roles for each player. Initial Government support greatly assisted JAFZA achieve commercial credibility, while its commitment enabled JAFZA to avoid speculators.
PEZA, meanwhile, is attached to the Philippine Department of Trade and Industry. Its first policy decision was to focus all efforts in encouraging private sector investments in SEZs, rather than establish more public SEZs. Under the PEZA, Philippines has shown dramatic improvements in investment climate, with the result that PEZA is a shining example of successful regulatory reform improving overall investment climate in the country.
There is much to learn from these examples. Now is the time to review the progress of SEZs in Cambodia so that the country as a whole can benefit from their presence here.