What lessons can India learn from China on SEZs?

As a signature policy initiative of Indian Prime Minister Narendra Modi, the Make in India campaign has been billed as an effort to boost export-led manufacturing growth which currently accounts for around only 16 percent of the economy. The campaign makes direct  reference to Special Economic Zones (SEZs), but it remains unclear as to how exactly SEZs will contribute to transforming India into an international manufacturing hub.

Proponents of a more East Asian model of development have traditionally looked to China’s policies on SEZs in attracting foreign investment and lifting industrial growth. Seeking to emulate China’s success, Murasoli Maran – former Indian Commerce Minister and a key architect behind the SEZ Policy in 2000s – once called upon a new generation of SEZs to do for India what Shenzhen had done for China: attract foreign investment to export-orientated industries, promote trade and economic growth, and create large-scale employment opportunities.

The results have been less than encouraging. Since the SEZ Act in 2005, only one third of the almost 200 SEZs that are now functioning have been formally approved. Many SEZs currently in operation are underperforming with total exports from the zones making up $ 82.4 billion out of India’s total merchandise exports of $314.4 billion in 2013-2014. Fewer  than 10 million Indians are currently employed in the formal manufacturing sector compared to China which has upwards of 150 million in manufacturing employment.

India’s SEZs have underperformed for various reasons. Slowing international trade and economic downturns in the traditional export markets of Europe and the United States meant that SEZ facilities have been underutilized by Indian exporters due to low global demand.

On the domestic front, the greatest challenge currently facing SEZs is land acquisition by private developers needed to expand national industrialization efforts. Serving as a broker between developers and landowners, state governments find themselves in the uncomfortable position of mediating these disputes and acquiring land on the behalf of private developers. As governments withdraw from their role in land acquisitions, private developers have been faced with growing debts and compensation packages for landowners. Although 60 percent of India’s SEZs are in the IT sector – which requires less land and develops quicker than larger multi-product manufacturing zones –  nearly  85 percent of land acquired for SEZs has been used for manufacturing.

Another problem has to do with the use of fiscal incentives. The subsidizing of exports has resulted in excessive tax concessions being offered by SEZs in situations where investments would already be made outside the zones and subject to normal taxation rules. This has not only posed fiscal burdens upon central and state governments, but also deprived them of tax revenue that it can ill afford to lose. Rather than creating new business, this has given rise to a series of ‘white elephants’ where tax concessions or holidays have been offered by SEZs even when industries are underperforming or have little incentive to perform.

The opposite has been true in China. Under Deng Xiaoping’s ‘Open Door Policy’ in 1978, China’s early-stage SEZs were pivotal in accelerating its transition towards becoming a market economy as it tested the efficacy of its economic and institutional reforms under a controlled environment. While the rest of the Chinese economy grew at 10 percent GDP growth rate from 1980 to 1984, Shenzhen grew by a 58 percent annual growth rate and accounted for 50.6 percent of China’s total FDI. At present, SEZs account for 22 percent of China’s national GDP, 46 percent of FDI, 60 percent of exports, and have created more than 30 million jobs since its inception.

So what can India learn from China’s SEZ policies? First, the size and distance of SEZs matters. Shenzhen’s SEZ was by far more comprehensive and covers 126 square miles compared to Indian SEZs near Mumbai and Delhi that are considerably smaller with multi-product SEZs covering 3.9 square miles. Although Indian SEZs have tended to be smaller and sector-specific with few multi-product zones due to problems with land acquisition, Chinese SEZs have benefitted from greater access to large-scale areas and closer proximity to core processing facilities and institutional infrastructure provided by municipalities.

Second, China adopted an effective mixture of fiscal and non-fiscal incentives. Beyond simple tax concessions, SEZs benefited from streamlined administrative procedures, proper investments in high-quality infrastructure, and targeted policies for attracting skilled labour. This included greater flexibility in hiring and firing workers and favourable policies that were put in place to attract skilled labour such as housing, research funding, or educational subsidies.

Third, China’s early-stage SEZs benefited from decentralization and preferential policies which gave them the freedom to pursue new political and economic reforms that were deemed necessary at the time. For instance, Shenzhen was granted the same political status as Guangzhou in 1981, same provincial status as Guangdong in 1988, and eventually legislative power in 1992. This enabled Shenzhen to experiment with policy innovations – such as wage reform and social insurance packages – when it had not been practiced anywhere else in China.

A ‘Make in India’ campaign that fails to successfully integrate SEZs may represent another missed opportunity. If India’s SEZs are to succeed, Delhi can draw lessons from Beijing’s playbook but will need to develop more sophisticated policies to meet its own contemporary needs: a stronger commitment to high-quality business environments and export infrastructure, decentralization and preferential policies, and an effective mixture of fiscal and non-fiscal incentives.

This article was first published in Centre on Asia and Globalisation’s China-India Brief #75. The article is written by Timothy Yu. Timothy is an MPP Candidate at the Lee Kuan Yew School of Public Policy. He was previously with the Canada China Business Council in Shanghai, China.